[Federal Register Volume 69, Number 148 (Tuesday, August 3, 2004)]
[Notices]
[Pages 46612-46623]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-17650]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50100; File No. SR-Phlx-2003-59]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Amendments No. 1, 2, 3, 4, and 5 and Notice of Filing and 
Order Granting Accelerated Approval to Amendments No. 6 and 7 to the 
Proposed Rule Change by the Philadelphia Stock Exchange, Inc. Relating 
to the Exchange's New Electronic Trading Platform, ``Phlx XL''

July 27, 2004.

I. Introduction

    On October 3, 2003, the Philadelphia Stock Exchange, Inc. (``Phlx'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to section 19(b)(1) of the Securities 
Exchange Act of 1934 (the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to adopt new rules for the implementation of its 
new electronic trading platform, ``Phlx XL.'' 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 proposed rule change and Amendments No. 1, 
2, 3, 4, and 5 were published for comment in the Federal Register on 
June 15, 2004.\5\ The Commission received no comments with respect to 
the proposal, as amended. On July 6, 2004 and July 15, 2004, the Phlx 
filed Amendments No. 6 and 7, respectively, to the proposed rule

[[Page 46613]]

change.\6\ This order approves the proposed rule change and Amendments 
No. 1, 2, 3, 4, and 5; grants accelerated approval to Amendments No. 6 
and 7 to the proposed rule change; and solicits comments from 
interested persons on Amendments No. 6 and 7.
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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, 2003 
(``Amendment No. 1''); December 11, 2003 (``Amendment No. 2''); 
January 28, 2004 (``Amendment No. 3''); and May 10, 2004 
(``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'').
    \5\ See Securities Exchange Act Release No. 49832 (June 8, 
2004); 69 FR 33442 (``Notice'').
    \6\ See letters from Richard S. Rudolph, Director and Counsel, 
Phlx, to Deborah Lassman Flynn, Assistant Director, Division, 
Commission, dated July 2, 2004 (``Amendment No. 6'') and July 14, 
2004 (``Amendment No. 7''). In Amendment No. 6, the Exchange (i) 
corrected technical drafting and typographical errors and omissions 
contained in the proposed rule text, and (ii) provided a more 
detailed description of the procedures by which the opening price on 
Phlx XL would be established. In Amendment No. 7, the Exchange 
further clarified the procedures by which the opening price on Phlx 
XL would be established for a six month pilot period, and reiterated 
its Section 11(a) representations.
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II. Description of the Proposal

    The Exchange proposes to adopt rules regarding the Exchange's new 
electronic trading platform, Phlx XL. The proposal would permit on-
floor Exchange Registered Options Traders (``ROTs''), to be called 
Streaming Quote Traders (``SQTs''), to submit streaming electronic 
option quotations via an electronic interface with the Exchange's 
Automated Options Market (``AUTOM'') System.\7\
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    \7\ 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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A. Implementation and Deployment

    The Exchange proposes to begin the initial rollout of Phlx XL on an 
issue-by-issue basis, beginning with the first of approximately 10 
issues not later than 10 days following the Commission's approval of 
the proposed rules applicable to Phlx XL.\8\ The Exchange also proposes 
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.\9\
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    \8\ See Notice, supra note 5.
    \9\ See id. In January 2004, the Exchange submitted a proposal 
to modify the timing of the deployment of the ROT Access feature of 
its 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 Registered Options 
Traders 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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B. Streaming Quote Traders and Streaming Quote Options

    An SQT would be defined in proposed Phlx Rule 1014(b)(ii) as a 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. The Exchange's Options 
Committee may, on an issue-by-issue basis, determine the specific 
issues, to be known as ``Streaming Quote Options,'' in which SQTs may 
generate and submit option quotations.\10\ Phlx XL would allow an 
individual SQT to submit its own firm disseminated quotes representing 
its trading interest.
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    \10\ See proposed Phlx Rule 1080(k).
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C. Market Maker Obligations

1. Specialist and SQT Quoting Requirements
    Under the proposal, an SQT would be required to quote continuous, 
two-sided markets in not less than 60% of the series in each Streaming 
Quote Option in which such SQT is assigned.\11\ The specialist assigned 
in a Streaming Quote Option would be required, however, to quote 
continuous, two-sided markets in 100% of the series in each assigned 
option. ROTs, including SQTs and 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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    \11\ 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 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, after a six-month implementation 
period, the specialist and any SQT assigned in a Streaming Quote Option 
on Phlx XL would be required to submit electronic quotations with a 
size of not less than 10 contracts \12\ beginning on the date on which 
such Streaming Quote Option begins trading on Phlx XL.\13\
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    \12\ The ten-contract minimum quotation size obligation would 
apply only to an SQT or specialist's undecremented quote.
    \13\ During a six-month implementation 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.
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    An SQT would be permitted to submit electronic quotations only 
while physically present on the floor of the Exchange. 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.
2. Non-SQT ROT Quoting Requirements
    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.\14\ A non-SQT ROT would not, however, have the same continuous, 
electronic quoting requirements as an SQT trading the same Streaming 
Quote Option, unless it traded 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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    \14\ See Phlx Rule 1080, Commentary .04.
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    The proposed rule would require that, after a six-month 
implementation period, non-SQT ROTs would be required to provide 
quotations with a size of not less than 10 contracts

[[Page 46614]]

beginning on the date on which the Streaming Quote Option begins 
trading on Phlx XL.\15\ The same size requirements set forth for non-
SQT ROTs in open outcry would apply to non-SQT ROTs that 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.\16\
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    \15\ During the initial six-month implementation 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.
    \16\ See proposed Phlx Rule 1014(b)(ii)(C)(2).
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    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.\17\
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    \17\ Phlx Rule 1014, Commentary .01 provides that, 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 and 
75% of his total contracts that quarter in assigned options.
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D. ROT Limit Orders

    The proposed rule change would amend the Exchange's rules regarding 
ROT electronic access to the limit order book.\18\ 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. 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, after the phased-in implementation discussed above,\19\ 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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    \18\ See proposed Phlx Rule 1080(b)(i)(B) and Commentary .04.
    \19\ See note 15 and accompanying text.
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    The proposed rule would provide that, with respect to 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.\20\
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    \20\ With respect to 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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E. Assignment in Streaming Quote Options

    Under the proposal, the Options Allocation, Evaluation and 
Securities Committee (``OAESC'')\21\ would assign SQTs in one or more 
eligible options in a fashion similar to the current practice of 
allocating trading privileges to specialists. Proposed Phlx Rule 507 
would 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.
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    \21\ 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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    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 
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.
    To clarify that proposed Phlx Rule 507 is not intended to function 
as a barrier to entry to the Exchange's marketplace and to account for 
the possibility that quote capacity could become an issue for SQT 
applicants, the Exchange proposes to add Phlx Rule 507(b)(iii) to 
provide that (i) there is 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. Proposed Phlx Rule 507 also states that, based on 
system constraints, capacity restrictions or other factors relevant to 
the maintenance of a fair and orderly market, the Board would be 
permitted to 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 would not be permitted to 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 has been objectively determined by the Board 
and submitted to the Commission for approval or effectiveness pursuant 
to a proposed rule change filed under section 19(b) of the Act. The 
Committee would be required to 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, been a member of the Exchange and 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

[[Page 46615]]

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.

F. Trade Allocation in Streaming Quote Options

    The proposed rules would codify the allocation algorithm that would 
apply to orders or electronic quotes in Streaming Quote Options that 
result in automatic executions \22\ via the AUTOM System.\23\ 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.\24\
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    \22\ Trades in Streaming Quote Options involving inbound orders 
and specialist and SQT quotes delivered via AUTOM would be 
automatically executed by the Book Match function (described below 
in Section II.I). 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).
    \23\ 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 
described below in Section II.J pursuant to Phlx Rule 1080(c)(iii). 
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.
    \24\ 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).
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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.\25\
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    \25\ 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 
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 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.\26\
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    \26\ 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)(4) 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).
    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 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 of orders for five contracts 
or fewer.\27\
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    \27\ Proposed Phlx Rule 1014 (g)(vii)(B)(1)(a) provides 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%.
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    With respect to 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 a specified percentage of the 
contracts to be allocated, depending on how many ROTs are on 
parity.\28\
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    \28\ Specifically, the specialist would receive: (i) 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; (ii) 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; or (iii) 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. 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.
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    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 via the electronic interface representing the 
Exchange's disseminated price would be entitled to receive a number of 
contracts that is the proportion of the remaining aggregate size 
associated with SQT quotes and non-SQT ROT limit orders on the book 
entered via the electronic interface 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 via the electronic interface. 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 \29\ 
limit orders

[[Page 46616]]

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 the 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 order.
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    \29\ 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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    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 \30\ 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.
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    \30\ See supra note 23.
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    Specialist not on parity. If the specialist is not quoting at the 
Exchange's disseminated quote, SQTs quoting at the disseminated price 
and non-SQT ROTs that have placed limit orders on the limit order book 
via the electronic interface which represent the Exchange's 
disseminated price would be entitled to receive the 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 via the electronic interface. 
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) 
provides 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.
    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. 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 also permit the specialist 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 its 
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 its electronically submitted quotation would not apply 
if the bid or offer is in response 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.\31\ The Exchange also proposes to 
amend Phlx Rule 1033(a)(ii) and OFPA F-32 to provide that orders 
executed under the Rule and OFPA are subject to the provisions of the 
Plan for the Purpose of Creating an Options Intermarket Linkage 
(``Linkage Plan'') and Phlx Rules 1083 `` 1087.
---------------------------------------------------------------------------

    \31\ Phlx Rule 1033(a)(ii) and OFPA 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).
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G. Crowd Area

    For purposes of Phlx Rule 1014, Commentary .05(c), 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. 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

[[Page 46617]]

particular Crowd Area at any specific time.

H. SQT Zones

    Proposed Phlx Rule 1014, Commentary .05(b) would provide that an 
SQT may be assigned to, and thus submit quotes electronically in, 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.\32\ Thus, each member organization must have 
at least one SQT physically present in each SQT Zone in which it 
submits electronic quotations. An SQT Zone could consist of multiple 
Crowd Areas.
---------------------------------------------------------------------------

    \32\ 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(b) 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.
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I. Book Match

    Book Match is a feature of AUTOM that currently provides automatic 
executions for inbound AUTOM-delivered customer and off-floor broker-
dealer orders against customer limit orders on the book.\33\ The 
proposed rules would amend Book 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.
---------------------------------------------------------------------------

    \33\ 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.
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J. Book Sweep

    Similar to Book Match, the Book Sweep function currently matches 
specialist quotations generated automatically 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 amended in Phlx XL for Streaming Quote Options 
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 to the SQT that submitted the 
quotation. 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 (e.g., 2.10 bid, 2 offer). The current functionality of Book 
Sweep would remain effective for non-Streaming Quote Options, however, 
proposed Phlx Rule 1080(c)(iii) would apply the enhanced Book Sweep 
functionality for Streaming Quote Options.

K. Firm Quotations

    Definition of disseminated size. The Exchange proposes to amend 
Phlx Rule 1082 by establishing by rule the Exchange's firm quotation 
size with respect to non-Streaming Quote Options and with respect to 
Streaming Quote Options.\34\
---------------------------------------------------------------------------

    \34\ 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 at least the sum of the size 
associated with: (i) Limit orders; and (ii) specialists' quotations 
generated automatically 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 proposes 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 at least the sum of the size 
associated with limit orders, specialists' quotations,\35\ and SQTs' 
quotations. The Exchange would disseminate the aggregate size of these 
three components.
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    \35\ 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) provides 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 to which such SQT is assigned, in accordance with proposed Phlx 
Rule 1014(b)(ii)(B).
    Proposed Phlx Rule 1082(a)(ii)(C)(2) provides 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.\36\ If no specialist or SQT has revised its 
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

[[Page 46618]]

such exhaustion with a size of one contract.
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    \36\ 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.
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    Responsible broker or dealer. Currently, the Exchange's 
disseminated market is deemed to represent the quotations of all ROTs 
in that option unless an ROT has expressly indicated otherwise.\37\ 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.
---------------------------------------------------------------------------

    \37\ See Phlx Rule 1080, Commentary .01(c).
---------------------------------------------------------------------------

    Because SQTs and specialists would be quoting independently in 
Streaming Quote Options, each individual SQT and specialist would be 
deemed to be a ``responsible broker or dealer'' in Streaming Quote 
Options under proposed new Phlx Rule 1082(b)(ii). There thus would be 
individual ``responsible brokers or dealers,'' and no ``collective'' 
firm quotation requirement in Streaming Quote Options.
    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 (e.g., 1.00 bid, 1.00 offer) or crosses (e.g., 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'' would begin 
during which SQTs and/or specialists whose quotations are locked may 
eliminate the locked market.\38\ 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 would 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 would automatically 
execute against each other in accordance with the allocation algorithm 
set forth in Phlx Rule 1014(g)(vii).
---------------------------------------------------------------------------

    \38\ The Options Committee may shorten the duration of 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 would automatically be restored to its 
original terms.

L. Other Rules and OFPAs

    The Wheel. The Exchange proposes to amend OFPA F-24 to reflect that 
the Wheel will apply only to non-Streaming Quote Options.
    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.
    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) 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.\39\ 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.
---------------------------------------------------------------------------

    \39\ For a complete description of these order types, see Phlx 
Rule 1066.
---------------------------------------------------------------------------

    Eligible order delivery size. 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.
    Opening Rotations. In Amendment No. 7, the Exchange proposed 
additional amendments to Phlx Rule 1017, Priority and Parity at 
Openings in Options, and OFPAs A-12 and A-14, to adopt more specific 
rules relating to the manner in which the Exchange conducts openings, 
including openings in Streaming Quote Options. The Exchange proposes to 
adopt the proposed opening rules on a pilot basis, beginning on the 
first day of the deployment of Phlx XL, and scheduled to expire after 
180 days.
    The proposed rules address the opening process in three main parts: 
the pre-opening, the opening rotation, and the specialist's calculation 
of the price of the opening trade of the session in a given series. 
First, prior to the opening, the specialist would determine from

[[Page 46619]]

Floor Brokers, and from orders resting on the limit order book, the 
size and prices of those orders which are near the previous closing 
prices of those options in which the specialist is assigned. In 
addition, the specialist would consider markets from ROTs in the crowd 
and, respecting Streaming Quote Options traded on Phlx XL, would 
consider electronic quotations submitted by SQTs in addition to 
establishing the specialist's own quote in the series. This would 
enable the specialist to ascertain orders and quotes on both sides of 
the market in a series to determine eventually the opening price in the 
series.
    Because the proposed opening will not initially be automated, there 
would be no ``broadcast'' of opening limit orders and quotes on the 
Phlx XL system. The participants would, however, have access to market 
information necessary to ascertain bids and offers in the pre-opening 
phase. Specialists would be able to view the entire limit order book, 
including orders resting on the book from the previous trading session 
and any orders submitted before the opening, on their on-floor screens 
(known as the X-Station), and would be able to view all electronically 
submitted quotes in Phlx XL options, while SQTs would have the same 
view of the limit order book and their own quotes, but not those of 
other SQTs. Non-SQT ROTs would be able to view the current on-floor 
displayed market, whether generated by a pre-opening quote or by limit 
orders at the then-best bid or offer. All in-crowd SQTs and the 
specialist, together with non-SQT ROTs in the crowd, would be able to 
ascertain all in-crowd verbal bids and offers.
    Currently, OFPA A-12 requires the specialist to accept and include 
in the opening for options all market orders which are placed on the 
book five minutes or more prior to the opening of the underlying 
security, unless exempted by a Floor Official. The proposed rule change 
would modify this provision to require the specialist to accept and 
include in the opening for options all market orders that are placed on 
the book prior to the opening in the underlying security. Market orders 
that are received following the opening in the underlying security but 
prior to the opening in the overlying option will be accepted, but will 
not be included in the opening trade. If, however, such a market order 
could be executed against a contra-side order to fill an imbalance on 
the opening, the specialist would be required to match the market order 
and the contra-side order before the specialist could execute an order 
(or quotation with respect to Streaming Quote Options) for his own 
account.\40\ The purpose of this provision is to allow the specialist 
to conduct an orderly opening in the particular series by establishing 
a ``cut-off'' time (the opening in the underlying security) after which 
the specialist would consider market orders already received in 
determining the opening price, without including potentially chaotic, 
last-minute market orders received after the opening in the underlying 
security but before the specialist has opened the series. Market orders 
would have precedence over limit orders at an opening regardless of 
account type (i.e., customer, Firm, broker-dealer, ROT, 
specialist).\41\ Following the pre-opening phase, the specialist would 
conduct an opening rotation.\42\
---------------------------------------------------------------------------

    \40\ Phlx Rule 1019 requires the specialist to give precedence 
to orders entrusted to him as an agent in any option in which he is 
registered before executing at the same price any purchase or sale 
in the same option for an account in which he has an interest. The 
Exchange represents that its Market Surveillance Department conducts 
surveillance for violations of this requirement. Therefore, 
according to the Exchange, if a specialist intends to trade for his 
own account on the opening, the specialist must first be sure that 
he does not trade ahead of any orders (as agent) even if received 
after the cut-off. Otherwise, he would be subject to possible 
disciplinary action for violation of Rule 1019, regardless of when 
such a market order is received (i.e., in this circumstance, after 
the underlying security opens but prior to the opening in the 
underlying security). See Amendment No. 7, supra note 6.
    \41\ The Exchange recently made technological changes that 
removed the member firm identifier from orders received via AUTOM. 
Therefore, the specialist can identify the account type in which an 
order is placed (i.e., whether the order is for a customer, firm, 
broker-dealer or ROT account), but cannot identify the specific 
member organization that submitted the order.
    \42\ 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. See Exchange Rule 1047, 
Commentary .01.
---------------------------------------------------------------------------

    The proposed rule change would provide that the opening price is 
the price at which the specialist determines that the greatest number 
of contracts will trade, provided that such opening price falls within 
an acceptable range to be determined by the Options Committee. An 
acceptable range would be determined as a percentage of the highest bid 
as the lower boundary of the acceptable range, and as a percentage of 
the highest offer as the upper boundary of the acceptable range. For 
example, such an acceptable range may be established as 75% of the 
lowest bid and 125% of the highest offer. Once determined by the 
Options Committee, such an acceptable range would be announced to the 
membership via regulatory circular.\43\ In the interest of a fair and 
orderly market, a Floor Official could provide a specific exemption 
from the established acceptable range in a particular series.
---------------------------------------------------------------------------

    \43\ This provision in the proposed rule is based on Chicago 
Board Options Exchange, Inc. Rule 6.2B(e)(ii).
---------------------------------------------------------------------------

    Proposed Commentary .03(b) to the rule includes further limitations 
on the opening price to be determined by the specialist. First, if two 
or more prices would satisfy the criteria for determining the opening 
price, the price which would leave the fewest number of contracts 
resting on the limit order book would be selected as the opening price. 
If there are still two or more prices that would each satisfy such 
criteria, the price which is closest to the previous session's closing 
price would be selected as the opening price. Complex orders and 
contingency orders would not participate in opening rotations or in the 
determination of an opening price.
    Once the specialist determines the opening price, the Exchange 
would disseminate the opening trade price to the Option Price Reporting 
Authority (``OPRA''). At this point, the series would be open for 
trading. Once the opening trade price in a series has been disseminated 
to OPRA, the specialist, ROTs and SQTs trading such series would be 
required to fulfill their respective quoting obligations under Rule 
1014.
    The proposed rule also includes circumstances in which a specialist 
would not open a series. Specifically, the specialist would not open a 
series if: it is not within an acceptable range, as described above, 
unless a specific exemption is given by a Floor Official in the 
interest of a fair and orderly market; the opening trade would leave a 
market order imbalance (i.e., there are more market orders to buy or to 
sell for the particular series than can be satisfied by the market 
orders, limit orders and specialist or SQT quotations on the opposite 
side). For purposes of this provision, ``market orders'' would include 
those orders that are treated as limit orders in accordance with Rule 
1017(b) (i.e., orders at a limited price order to buy which is at a 
higher price than the price at which the option is to be opened and a 
limited price order to sell which is at a lower price than the price at 
which the option is to be opened) and market-on-opening orders.
    In such a circumstance, the specialist would request bids and 
offers from ROTs in the crowd and, in the case of Streaming Quote 
Options, SQTs that are assigned in the option. Such ROTs and/

[[Page 46620]]

or SQTs would be required to respond to such a request immediately. The 
series could not open until responses to the specialist's request have 
been received and the consequent opening price is deemed by a Floor 
Official to be compatible with a fair and orderly market.
    Finally, the proposed rule concerning openings would address the 
situation in which there are no orders in a particular series when the 
underlying security opens. In such a situation the Exchange would 
disseminate quotations in such series generated automatically upon the 
opening in the underlying security.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendments No. 6 and 7, including whether 
Amendments No. 6 and 7 are 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-hlx-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 Amendments No. 6 
and 7 of File Number SR-Phlx-2003-59 and should be submitted on or 
before August 24, 2004.

IV. Discussion

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the Act and the rules and 
regulations promulgated thereunder applicable to a national securities 
exchange and, in particular, with the requirements of section 6(b) of 
the Act.\44\ Specifically, the Commission finds that approval of the 
proposed rule change, as amended, is consistent with section 6(b)(5) of 
the Act \45\ in that it is designed to facilitate transactions in 
securities; to prevent fraudulent and manipulative acts and practices; 
to promote just and equitable principles of trade; to foster 
cooperation and coordination with persons engaged in regulating, 
clearing, settling, processing information with respect to, and 
facilitating transactions in securities; to remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system; and, in general, to protect investors and the public interest.
---------------------------------------------------------------------------

    \44\ 15 U.S.C. 78f(b). In approving this proposal, the 
Commission has considered the proposed rule's impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
    \45\ 15 U.S.C. 78f(b)(5).
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A. Market Maker Obligations

    Phlx Rule 1014, as amended, would continue to govern market maker 
obligations. Under the proposed rule change, specialists would be 
required to maintain a continuous, two-sided quote in 100% of the 
series of Streaming Quote Options to which it is assigned, while each 
SQT would be required to maintain a continuous, two-sided quote in at 
least 60% of the Streaming Quote Options to which it is assigned. Non-
SQT ROTs would be required to quote verbally in response to a request 
for a market, and maintain a two-sided quoting obligations in a 
designated percentage of series of Streaming Quote Options in the 
calendar quarter that followed a calendar quarter that it transacted 
more than 20% of its contract volume electronically in a Streaming 
Quote Option. However, if a non-SQT ROT transacts less than 20% of its 
contract volume electronically, it would not be bound by the quote 
spread parameters and the electronic quoting obligations set forth in 
Rule 1014, and electronic quotes would not count towards its in-person 
trading requirement.
    The Commission believes that the obligations for specialists and 
ROTs (SQTs and non-SQTs) are consistent with the Act. As market makers, 
SQTs and non-SQT ROTs receive certain benefits for carrying out their 
duties. For example, a lender may extend credit to a broker-dealer 
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 the broker-dealer's activities as a specialist or market maker 
on a national securities exchange.\46\ The Commission believes that a 
market maker should have an affirmative obligation to hold itself out 
as willing to buy and sell options for their own account on a regular 
or continuous basis to justify this favorable treatment. In this 
regard, by excluding electronic transactions from being applied towards 
satisfying a non-SQT ROTs in-person requirements where the non-SQT ROT 
transacts 20% or less of its contract volume electronically and is not 
required to continuously quote or comply with quote-width requirements, 
the Commission believes that the Exchange's proposal would impose such 
affirmative obligations on SQTs and non-SQT ROTs.
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    \46\ See 12 CFR 221.5(c)(6).
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    The Commission also believes that allowing an SQT and the 
specialist in a Streaming Quote Option to quote with a size of less 
than ten contracts during the initial stages of deployment of Phlx XL 
is not unreasonable, so that such SQTs and specialists may determine 
during this period of time that their quotation systems and models 
function properly and reliably, and may make any changes necessary to 
manage their risk while providing fair and orderly markets in the 
Streaming Quote Option.

B. Assignment in Streaming Quote Options

    The Commission believes that the Exchange's SQT qualification and 
allocation requirements, which set forth objective criteria for the 
assignment of SQTs to Streaming Quote Options, are consistent with the 
Act. The Commission notes that the proposed requirements are similar to 
those adopted by other options exchanges.\47\ In particular, the 
Commission notes that the proposed rule change, as amended, (i) places 
no limit on the number of

[[Page 46621]]

qualifying ROTs that may become SQTs, and (ii) requires the OAESC to 
approve any applicant that is qualified as an ROT in good standing and 
that satisfies the technological readiness and testing requirements. 
The Commission also notes that the Exchange has no discretion to defer 
or limit the approval of qualifying applications for SQT status. In the 
event that the Board defers or limits the approval of qualifying 
applicants, such deferral or limitation must be based on system 
constraints and any basis for such deferral or limitation must be 
objectively determined by the Board and approved by the Commission 
pursuant to a proposed rule change filed under section 19(b) of the 
Act. Moreover, 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.
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    \47\ See, e.g., CBOE Rule 8.3(a); ISE Rule 802(a); and BOX 
Chapter VI, Section 4.
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C. Allocation Algorithm

    The Commission believes that the Phlx's proposed trade allocation 
algorithm that would apply to orders and electronic quotes in Streaming 
Quote Options that result in automatic executions via the AUTOM System 
is consistent with the Act. The Commission also believes that Phlx XL, 
including the proposed trade allocation algorithm, should substantially 
enhance incentives to quote competitively by providing market 
participants with the ability to independently submit their quotes and 
rewarding market participants that quote at the best price with an 
allocation of the resulting trade.
    The proposed rules codify the automatic allocation algorithm that 
applies 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. The proposed rules also codify how manual trades would be 
initiated and executed in Phlx XL. The Commission believes that the 
various types of Phlx XL executions, including automated and manual 
executions, should allow specialists, SQT ROTs, and non-SQT ROTs to 
provide more efficient and immediate executions for inbound orders and 
market maker quotations subject to priority and allocation principles.
    The Commission notes that the proposal does not provide for split 
price executions. Consequently, if the size associated with 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 automatically at the Exchange's disseminated size would be 
allocated automatically in accordance with Phlx Rule 1014(g)(vii), and 
the contracts remaining in such an order would be represented by the 
specialist and handled in accordance with Exchange rules. The 
Commission emphasizes that the contracts remaining for such orders 
should be handled in a manner that does not effectuate a trade-through 
\48\ of better prices on other markets in violation of Exchange rules 
and the Linkage Plan.
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    \48\ 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 e.g., Phlx 
Rule 1085.
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    The Commission also notes 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, subject to 
the provisions of the Linkage Plan and Exchange rules.

D. Specialist Fiduciary Duties

    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 Commission believes that this provision should help ensure that 
the specialist complies with its fiduciary obligation when acting as 
agent for a limit order. In the situation where the off-floor broker-
dealer limit order resting on the limit order book is executed and 
allocated automatically, the Commission 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 not unreasonable since the specialist is not 
acting as ``agent'' in that circumstance.

E. ROT Limit Orders

    The Commission 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. In addition, the Commission 
notes that 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 would reward non-SQT ROTs who provide 
liquidity at the best price. Moreover, non-SQT ROTs that place price-
improving limit orders would continue to receive a special allocation 
under the Exchange's proposal. Therefore, the Commission believes that 
the proposal should provide incentives for market participants to quote 
competitively.

F. Book Match

    The Commission believes that the proposed enhancements to Book 
Match should provide for a greater number of automatic executions by 
matching inbound orders against booked limit orders and SQT and 
specialist quotations that are included in the Exchange's disseminated 
quotation, which should result in customers receiving quicker, more 
efficient executions for a larger number of trades.

G. Locked Markets

    The Commission believes that the proposed rules relating to a one-
second ``counting period,'' during which SQTs and/or specialists whose 
quotations are locked may eliminate a locked market, are consistent 
with the Commission's Quote Rule. The Commission notes that, during the 
one-second ``counting period,'' market makers would continue to be 
required to honor their quotes and, thus, would be obligated to execute 
incoming orders pursuant to proposed Phlx Rule 1082. The Commission 
also notes that the market makers whose quotes are locked would 
continue to be obligated under the Quote Rule for at least one contract 
to each other during the counting period. At the end of the counting 
period, assuming neither market maker has changed its quotes, the 
market makers' quotes would execute against each other in all series. 
Accordingly, the Commission believes that the proposed ``counting 
period'' provides a reasonable method for SQTs or specialists that lock 
or cross a market

[[Page 46622]]

to unlock or uncross the market. Importantly, during the ``counting 
period,'' the SQTs or specialists whose quotes are locked would remain 
obligated to execute customer and broker-dealer orders eligible for 
automatic execution at the locked price.

H. Firm Quotations

    The Commission believes that the proposed amendments to the 
Exchange's ``Firm Quote'' requirements are consistent with the Act. The 
Commission notes that the requirement that specialists' quotations 
automatically generated be included in the disseminated size should 
result in a more accurate and transparent reflection of the size for 
which the Exchange is firm.

I. Opening the Market on Phlx XL

    In Amendment No. 7, the Exchange proposes additional amendments to 
its rules relating to the manner in which the Exchange conducts 
openings to provide a more detailed description of the procedures by 
which the opening price on Phlx XL would be established. The proposed 
opening rules set forth which orders and quotes the specialist in a 
particular option is required to accept prior to the opening in a given 
series. The proposed opening rules also provide that the opening price 
is the price at which the specialist determines that the greatest 
number of contracts would trade, subject to the opening price falling 
within an acceptable range, to be determined by the Options Committee. 
In addition, the proposed opening rules sets forth the circumstances in 
which a specialist would not open a series. The Exchange proposes to 
adopt the proposed opening rules on a pilot basis, beginning on the 
first day of the deployment of Phlx XL, and scheduled to expire after 
180 days.
    The Commission believes that the proposed rules governing the 
opening procedures on Phlx XL provide a reasonable process by which 
Phlx participants, including SQTs, would access and participate in the 
rotations. The Commission also believes that the proposed rules 
governing the opening procedures on Phlx XL should provide greater 
transparency with respect to the manner an opening price is determined 
on the Exchange. In addition, the Commission believes that approving 
the opening rules on a pilot basis should provide the Phlx and the 
Commission an opportunity to review the operation of the proposal and 
address any potential concerns that may arise.

J. Application of ``Effect v. Execute'' Exemption From Section 11(a) of 
the Act

    Section 11(a) of the Exchange Act \49\ prohibits a member of a 
national securities exchange from effecting transactions on that 
exchange for its own account, the account of an associated person, or 
an account over which it or its associated person exercises discretion 
(collectively, ``covered accounts'') unless an exception applies. In 
addition to the exceptions set forth in the statute, Rule 11a2-2(T) 
\50\ provides exchange members with an exemption from this prohibition. 
Known as the ``effect versus execute'' rule, Rule 11a2-2(T) permits an 
exchange member, subject to certain conditions, to effect transactions 
for covered accounts by arranging for an unaffiliated member to execute 
the transactions on the exchange. To comply with the Rule's conditions, 
a member (i) must transmit the order from off the exchange floor; (ii) 
may not participate in the execution of the transaction once it has 
been transmitted to the member performing the execution; \51\ (iii) may 
not be affiliated with the executing member; and (iv) with respect to 
an account over which the member has investment discretion, neither the 
member nor its associated person may retain any compensation in 
connection with effecting the transaction, except as provided in the 
Rule.
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    \49\ 15 U.S.C. 78k(a).
    \50\ 17 CFR 240.11a2-2(T).
    \51\ The member, however, may participate in clearing and 
settling the transactions.
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    In a letter to the Commission,\52\ the Notice, and in Amendment No. 
7, the Phlx represents that the transactions effected pursuant to the 
Phlx XL rules, both automatic and manual, satisfy the conditions of 
Rule 11a2-2(T).\53\ The Commission notes that the staff of the Division 
previously provided interpretive guidance to the Phlx regarding its 
AUTO-X system.\54\ Based on Phlx's instant representations, the 
Commisson believes that its previous guidance is still applicable to 
Phlx XL. Accordingly, the Commission finds that Phlx XL's electronic 
order submission and execution process satisfies the four conditions of 
Rule 11a2-2(T).\55\
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    \52\ See letter from Richard S. Rudolph, Counsel, Phlx, to 
Catherine McGuire, Chief Counsel, Division, Commission, dated April 
15, 2002 (``April 2002 Letter'').
    \53\ Based on the Phlx's representations in Amendment No. 7, the 
staff believes that the Exchange's rules relating to the manual 
execution by specialists of off-floor broker-dealer orders that were 
received by the AUTO-X system comply with the requirements of 
Section 11(a) of the Act and Rule 11a2-2(T) thereunder. As discussed 
above, off-floor broker-dealers would enter these orders through 
AUTOM. According to the Phlx, the member firm identifier is removed 
from orders received through AUTOM. This, according to the Phlx, 
should prevent members from using affiliated persons on the exchange 
floor to influence or guide their orders' execution.
    \54\ See letter from Paula R. Jenson, Deputy Chief Counsel, 
Division, Commission, to Richard S. Rudolph, Counsel, Phlx, dated 
April 15, 2002.
    \55\ The Commission and its staff, on numerous occasions, have 
considered the application of Rule 11a2-2(T) to electronic trading 
and order routing systems. See, e.g., Securities Exchange Act 
Release Nos. 49068 (January 13, 2004) (Order approving the Boston 
Options Exchange as an options trading facility of the Boston Stock 
Exchange); 44983 (October 25, 2001) (Order approving the Archipelago 
Exchange as the equities trading facility of PCX Equities Inc.); 
29237 (May 31, 1991) (regarding NYSE's Off-Hours Trading Facility); 
15533 (January 29, 1979) (regarding the Amex Post Execution 
Reporting System, the Amex Switching System, the Intermarket Trading 
System, the Multiple Dealer Trading Facility of the Cincinnati Stock 
Exchange, the PCX's Communications and Execution System, and the 
Phlx's Automated Communications and Execution System); and 14563 
(March 14, 1978) (regarding the NYSE's Designated Order Turnaround 
System). See also letter from Larry E. Bergmann, Senior Associate 
Director, Division, Commission, to Edith Hallahan, Associate General 
Counsel, Phlx (March 24, 1999) (regarding Phlx's VWAP Trading 
System); letter from Catherine McGuire, Chief Counsel, Division, 
Commission, to David E. Rosedahl, PCX (November 30, 1998) (regarding 
Optimark); and Letter from Brandon Becker, Director, Division, 
Commission, to George T. Simon, Foley & Lardner (November 30, 1994) 
(regarding Chicago Match).
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V. Accelerated Approval of Amendments No. 6 and 7

    Pursuant to section 19(b)(2) of the Act,\56\ the Commission may not 
approve any proposed rule change, or amendment thereto, prior to the 
thirtieth day after the date of publication of the notice of filing 
thereof, unless the Commission finds good cause for so finding. The 
Commission hereby finds good cause for approving Amendments No. 6 and 7 
to the proposed rule change prior to the thirtieth day after publishing 
notice of Amendments No. 6 and 7 in the Federal Register pursuant to 
section 19(b)(2) of the Act.\57\ Amendment No. 6 corrects technical 
drafting and typographical errors and omissions contained in the 
proposed rule text and, in response to concerns raised by Commission 
staff, provides a more detailed description of the procedures by which 
the opening price on Phlx XL would be established. Amendment No. 7 
provides additional description of the procedures by which the opening 
price on Phlx XL would be established. The Commission notes that the 
rules relating to the opening procedures on the Phlx are modeled on

[[Page 46623]]

and substantially similar to the existing rules of the other options 
exchanges. The Commission previously approved these rules and, 
therefore, believes that accelerating such rules for Phlx XL on a six 
month pilot basis is appropriate, because the revisions do not raise 
new issues of regulatory concern. Therefore, the Commission finds that 
accelerated approval of Amendments No. 6 and 7 is consistent with 
section 19(b)(2) of the Act.\58\
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    \56\ 15 U.S.C. 78s(b)(2).
    \57\ Id.
    \58\ Id.
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VI. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change, as amended, is consistent with the Act and the rules and 
regulations thereunder applicable to a national securities exchange, 
and, in particular, with section 6(b)(5) of the Act.\59\
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    \59\ 15 U.S.C. 78f(b)(5).
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    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\60\ that the proposed rule change and Amendments No. 1, 2, 3, 4, 
and 5 (SR-Phlx-2003-59) are approved, that Amendments No. 6 and 7 
thereto are approved on an accelerated basis, and that the opening 
procedures are approved on a pilot basis until January 31, 2005. 
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    \60\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\61\
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    \61\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 04-17650 Filed 8-2-04; 8:45 am]
BILLING CODE 8010-01-P