[Federal Register Volume 70, Number 9 (Thursday, January 13, 2005)]
[Notices]
[Pages 2444-2447]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-123]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50997; File No. SR-Phlx-2003-40]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the Philadelphia Stock Exchange, Inc. and Notice of Filing 
and Order Granting Accelerated Approval to Amendments No. 2, 3, 4 and 5 
Relating to the Options Floor Broker Management System

January 7, 2005.

I. Introduction

    On June 2, 2003, the Philadelphia Stock Exchange, Inc. (``Phlx'' or 
``Exchange''), filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC'') a proposed rule change pursuant to Section 
19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 
19b-4 thereunder,\2\ to adopt new rules relating to the implementation 
of its Floor Broker Management System (``FBMS'' or ``System''). On July 
28, 2003, the Exchange filed Amendment No. 1 to the proposed rule 
change. On August 7, 2003, the proposed rule change, as amended, was 
published for comment in the Federal Register to solicit comment from 
interested persons.\3\ No comments were received.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 48265 (July 31, 
2003), 68 FR 47137.

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[[Page 2445]]

    On August 1, 2003, the Exchange submitted Amendment No. 2 to the 
proposed rule change.\4\ On August 15, 2003, the Exchange submitted 
Amendment No. 3 to the proposed rule change.\5\ On October 9, 2003, the 
Exchange submitted Amendment No. 4 to the proposed rule change.\6\ On 
December 14, 2004, the Exchange submitted Amendment No. 5 to the 
proposed rule change.\7\ This order approves the proposed rule change, 
as amended, and notices and grants accelerated approval to Amendments 
No. 2, 3, 4, and 5.
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    \4\ See letter from Richard S. Rudolph, Director and Counsel, 
Phlx, to Nancy J. Sanow, Assistant Director, Division of Market 
Regulation (``Division''), Commission, dated July 31, 2003. In 
Amendment No. 2, the Exchange represents that it intends to 
implement supplementary surveillance and examination programs 
designed to address, among other things, trading ahead and front-
running.
    \5\ See letter from Richard S. Rudolph, Director and Counsel, 
Phlx, to Jennifer Colihan, Special Counsel, Division, Commission, 
dated August 14, 2003. In Amendment No. 3, the Exchange proposes to 
clarify that in the event that floor brokers or their employees are 
required to record order information on trade tickets pursuant to 
proposed Phlx Rule 1063(e) due to a systems malfunction, they must 
enter the information recorded on trade tickets into AUTOM for 
inclusion in the electronic audit trail. In Amendment No. 3, the 
Exchange further proposes to exempt non-multiply listed index 
options, foreign currency, and other options traded exclusively on 
the Exchange other than equity options from the requirements of 
proposed Phlx Rule 1063.
    \6\ See letter from Richard S. Rudolph, Director and Counsel, 
Phlx, to Jennifer Colihan, Special Counsel, Division, Commission, 
dated October 9, 2003. In Amendment No. 4, the Exchange proposes to 
delete ``options traded on the Exchange other than equity options'' 
from the list of products it proposed to exempt from the 
requirements of proposed Phlx Rule 1063(e)(ii). The Exchange also 
commits to store information regarding products exempt from the 
requirements of proposed Phlx Rule 1063 in the same format used for 
non-exempt products. Further, the Exchange proposes to amend 
proposed Phlx Rule 1063 to provide that, until February 1, 2004, the 
requirement that floor brokers record order information into the 
FBMS prior to representing such orders in the trading crowd shall 
not apply to complex orders or other orders if a Floor Official 
makes a determination that there was an influx of orders at the time 
the floor broker received the order such that entry of the 
information required by the rule is not reasonably feasible. The 
Exchange also included provisions for documenting such a decision by 
a Floor Official.
    \7\ In Amendment No. 5, the Exchange proposes to delete the 
provisions in proposed Phlx Rule 1063 that provided that until 
February 1, 2004, the requirement that floor brokers record order 
information into the FBMS prior to representing such orders in the 
trading crowd shall not apply to complex orders or other orders if a 
Floor Official makes a determination that there was an influx of 
orders at the time the floor broker received the order such that 
entry of the information required by the rule is not reasonably 
feasible. Amendment No. 5 also clarifies how the Exchange would 
handle order data regarding Foreign Currency Options, Customized 
Foreign Currency Options and FLEX Options, and how the FBMS would 
identify the broker-dealer submitting an order. Finally, Amendment 
No. 5 provides that the requirements of proposed Phlx Rule 1063(e) 
would take effect on January 10, 2005.
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II. Background

    The proposed rule change is intended to fulfill certain of the 
undertakings contained in an order issued by the Commission relating to 
the settlement of an enforcement action against the American Stock 
Exchange LLC, Chicago Board Options Exchange, Inc., Pacific Exchange, 
Inc. and Phlx (collectively ``Options Exchanges'') for failure to 
comply with their own rules and to enforce compliance with their own 
rules by their members and persons associated with their members \8\ as 
is required by Section 19(g) of the Act.\9\ The Order found that the 
Options Exchanges impaired the operations of the options market by: (1) 
Following a course of conduct under which they refrained from multiply 
listing a large number of options; and (2) inadequately discharging 
their obligations as self-regulatory organizations by failing 
adequately to enforce compliance with (a) certain of their rules, 
including order handling rules, that promote competition as well as 
investor protection, and (b) certain of the rules prohibiting 
anticompetitive conduct, such as harassment, intimidation, refusals to 
deal and retaliation directed at market participants who sought to act 
competitively. In addition, the Commission found that the Options 
Exchanges failed to enforce compliance with their trade reporting 
rules, which promote transparency of the market and facilitate 
surveillance and enforcement of other exchange rules and the federal 
securities laws.
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    \8\ See 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'').
    \9\ 15 U.S.C. 78s(g).
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    As part of the Order, the Options Exchanges agreed to, and were 
ordered to comply with, a variety of undertakings. Among other things, 
they agreed to, and were ordered to, design and implement an accurate, 
time-sequenced, consolidated options audit trail system (``COATS'') 
that will enable the Options Exchanges to reconstruct markets promptly, 
effectively surveil them and enforce order handling, firm quote, 
trading reporting and other rules. The Options Exchanges were required 
to complete this undertaking in five phases. The Options Exchanges have 
completed the first four phases. The final phase of the undertaking to 
implement COATS requires that each exchange incorporate into its audit 
trail all non-electronic orders. This proposed rule change addresses 
that aspect of the undertaking.

III. Description

    The Exchange proposes to effect rule changes on a permanent basis 
to support the implementation of its new system, known as FBMS. FBMS 
would create an accurate, time-sequenced electronic options order audit 
trail for manual orders received by the Exchange's floor brokers

A. Operation of FBMS

    FBMS is a component of AUTOM \10\ designed to enable floor brokers 
and/or their employees to enter, route and report transactions stemming 
from option orders received on the Exchange. Floor brokers or their 
employees would access the System through an electronic Exchange-
provided handheld device on which they would have the ability to enter 
the required information as set forth in proposed Phlx Rule 1063(e), 
either from their respective posts on the options trading floor or in 
the trading crowd.
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    \10\ 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 feature, AUTO-X. 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.
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    Specifically, proposed Phlx Rule 1063(e) sets forth the requirement 
that a floor broker or such floor broker's employees must, 
contemporaneously upon receipt of an order and prior to the 
representation of such an order in the crowd, record the required 
information regarding all option orders represented by such floor 
broker onto the System. Additionally, the proposed rule change provides 
that upon the execution of such an order, the floor broker would be 
required to enter the time of execution of the trade.\11\
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    \11\ Once the floor broker executes an order using the System, 
the time of execution would be automatically recorded into the 
electronic audit trail.
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    Proposed Phlx Rule 1063(e) would require floor brokers or their 
employees to record the following specific information onto the System 
upon receipt of an order: (i) The order type (i.e., customer, firm, 
broker-dealer); (ii) the option symbol; (iii) buy, sell, or cancel; 
(iv) call, put, complex (i.e., spread, straddle), or contingency order

[[Page 2446]]

as described in Phlx Rule 1066; (v) number of contracts; (vi) limit 
price or market order or, in the case of a complex order, net debit or 
credit, if applicable; (vii) whether the transaction is to open or 
close a position; and (viii) The Options Clearing Corporation (``OCC'') 
clearing number of the broker-dealer that submitted the order. These 
enumerated elements of an order are currently written on trade tickets; 
the proposed new rule would simply require them to be entered onto the 
System. Upon entry of the order into the System, the System would 
automatically record the time of entry, and will assign an 
identification code that is particular to that order for purposes of 
the electronic audit trail.
    With regard to FLEX, Foreign Currency, and Customized Foreign 
Currency Options, under proposed Phlx Rule 1063(f), floor brokers or 
their employees would be required to enter the above-described data 
elements into the Exchange's electronic audit trail in the same 
electronic format as the required information for equity and index 
options. Floor brokers or their employees must enter the required 
information for FLEX, Foreign Currency and Customized Foreign Currency 
Options into the electronic audit trail on the same business day that a 
specific event surrounding the lifecycle of an order in FLEX, Foreign 
Currency, or Customized Foreign Currency Options (including, without 
limitation, orders, price or size changes, execution or cancellation) 
occurs.

B. Ticket Marking Requirements and the System

    Currently, various Exchange rules require floor brokers to mark 
trade tickets with certain notations, depending on the type of trade 
and the crowd participants involved. The Exchange is proposing to amend 
its rules concerning the ticket marking requirements so that floor 
brokers would be required to enter similar notations onto the System. 
For example, the Exchange is proposing to amend Phlx Rule 1015 and 
corresponding OFPA A-11 to require that a floor broker or his employees 
make the appropriate notice in the FBMS when an order is for the 
account of a broker/dealer. Also, by way of example, the Exchange is 
proposing to amend Phlx OFPA C-3 to require in the situation in which a 
floor broker represents an order for a market maker on another national 
securities exchange, such floor broker or his employees must so 
indicate on the FBMS and must ensure that the order is represented in 
the trading crowd as a ``BD'' order for the purposes of the Exchange's 
yielding requirements.

C. System Malfunctions

    Proposed Phlx Rule 1063 would require that, in the event of a 
malfunction in the FBMS, floor brokers would be required to record the 
required information on trade tickets, and would not be permitted to 
represent an order for execution which has not been time stamped with 
the time of entry on the trading floor. Such trade tickets would be 
required to be time stamped upon the execution of such an order. This 
reflects the current practice of recording information concerning 
orders represented and executed by options floor brokers onto trade 
tickets, and using time stamps to record the time of receipt of an 
order, and the time of execution. Once it is determined that such 
malfunction no longer exists, floor brokers or their employees would be 
required to enter the required information that is recorded on such 
trade tickets into AUTOM, using the FBMS, for inclusion in the 
electronic audit trail.

D. Clearing Information

    Proposed Phlx Rule 1063(e) would require floor brokers or their 
employees to enter clearing information onto the FBMS no later than 
five minutes after the execution of a trade. Such clearing information 
would be required to include the account number(s) of each contra-side 
participant to the floor broker's trade in the crowd and the number of 
contracts bought or sold, which would be immediately reported via AUTOM 
to the clearing firm of each crowd participant involved in the trade. 
Once the clearing information is reported, crowd participants involved 
in the trade would receive a position update, enabling them to know 
their respective positions on a real-time basis and to make 
appropriate, informed and timely hedging and transactional decisions.

E. Trade Reporting

    Currently, Exchange members or member organizations that initiate 
an options transaction are required to report the execution of such 
trades within 90 seconds of the execution.\12\ The FBMS includes a 
feature that would report transactions executed in the trading crowd by 
the floor broker automatically upon execution. Once a trade involving a 
floor broker is executed in the trading crowd, such a floor broker 
would simply indicate on the system that the order was executed, which 
would automatically generate an electronic report.
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    \12\ Phlx Rule 1051 and OFPA F-2 currently provide that a member 
or member organization initiating an options transaction, whether 
acting as principal or agent, must report or ensure that the 
transaction is reported within 90 seconds of the execution to the 
tape. Transactions not reported within 90 seconds after execution 
shall be designated as late.
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    The Exchange is also proposing amendments to Phlx Rule 1051 and 
OFPA F-2 in order to address the situation in which a floor broker who 
initiates a transaction executes all or a portion of the transaction 
against a contra-side limit order on the specialist's limit order 
book.\13\ Currently, in such a situation, the specialist manually 
executes the booked limit order on the AUTOM System against the order 
represented by the floor broker. Upon such manual execution, the 
transaction is reported automatically by AUTOM.
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    \13\ The electronic ``limit order book'' is the Exchange's 
automated specialist limit order book, which automatically routes 
all unexecuted AUTOM orders to the book and displays orders real-
time in order of price-time priority. Orders not delivered through 
AUTOM may also be entered onto the limit order book. See Phlx Rule 
1080, Commentary .02.
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    The proposed amendment would require that when an order represented 
by a floor broker is executed against a limit order on the book, the 
specialist must report or ensure that the portion of the transaction 
represented by such specialist is reported to the tape. The purpose of 
this provision is to address the situation in which an order 
represented by a floor broker executes a booked limit order is executed 
by the specialist, in which case AUTOM automatically reports the 
execution of the booked limit order. Thus, the floor broker in this 
situation would not be required to report that portion of the 
transaction on the System, despite the fact that the floor broker 
involved may have in fact ``initiated'' the transaction. If the booked 
limit order represents the entire contra-side to the order represented 
by the floor broker, the specialist would be required to report the 
entire transaction. If the booked limit order represents a portion of 
the transaction, the specialist would be required to report that 
portion of the transaction, while the floor broker initiating the 
transaction would be responsible for reporting the remaining portion of 
the transaction he or she initiated.

IV. Discussion

    After careful consideration, the Commission finds that the proposed 
rule change is consistent with Act and the rules and regulations 
thereunder applicable to a national securities

[[Page 2447]]

exchange.\14\ In particular the Commission finds that the proposed rule 
change is consistent with Section 6(b)(5) of the Act,\15\ which 
requires among other things, that the Exchange's rules be designed to 
promote just and equitable principles of trade, to remove impediments 
and to perfect the mechanism of a free and open market and a national 
market system, and in general, to protect investors and the public 
interest.
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    \14\ 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).
    \15\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the rules as proposed should allow the 
Exchange to comply with its obligations under the Order in that they 
will result in the creation of an audit trail that incorporates manual 
orders sent to Phlx. Specifically, the proposed rules would require 
that Phlx floor brokers enter certain order details contemporaneously 
upon receipt and prior to representation into the FBMS. Once an order 
is entered into the FBMS, the System would automatically timestamp the 
order as received by the Exchange and assign it a unique order 
identification number, which allows the system to track the order 
through its life on the floor up to the point of execution. Upon 
execution, the floor broker would enter the time the execution took 
place. Floor brokers or their employees would then be required to enter 
clearing information onto the FBMS no later than five minutes after the 
execution of a trade.
    The Commission also believes that the Exchange's plan for recording 
order details in the event of a systems outage or malfunction is 
reasonable. In the event of a systems outage or malfunction, floor 
brokers would revert to use of trade tickets and would record on those 
tickets the times that various events occur in the life of the order. 
Further, the Exchange would ensure that the information recorded on 
trade tickets is entered into AUTOM so that it can be incorporated into 
the electronic audit trail.
    Finally, the Commission notes that the Exchange acknowledges the 
need for effective and proactive surveillance for activities such as 
trading ahead and front-running. The Exchange represents that it 
currently conducts automated surveillance for such activities and will 
incorporate a review of order entry into the System as part of such 
surveillance. Further, the Exchange states that it also intends to 
implement supplementary surveillance and examination programs related 
to the requirement to enter order information into the FBMS, which will 
be designed to address, among other things, trading ahead and front-
running. The Commission views effective surveillance relating to the 
use of the FBMS as critical to the integrity of COATS and expects that 
the Exchange will inform the Commission of any problems it encounters 
in conducting effective surveillance.
    The Commission finds good cause for approving Amendments No. 2, 3, 
4, and 5 to the proposed rule change, prior to the thirtieth day after 
the date of the publication of notice thereof in the Federal Register. 
The Commission notes that the amendments would more closely conform the 
Phlx's rules to those of the other options exchanges, the rules for 
which were subject to notice and comment. The Commission believes that 
because the proposed amendments raise no new issues of regulatory 
concern, it is appropriate to accelerate approval of these amendments 
so that the rules may be implemented on a timely basis.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change 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 
SR-Phlx-2003-40 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 SR-Phlx-
2003-40. 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 
Exchange. 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 SR-Phlx-2003-40 and 
should be submitted on or before February 3, 2005.

VI. Conclusion

    For all of the aforementioned reasons, the Commission finds that 
the proposed rule change is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to a national 
securities exchange.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\16\ that the proposed rule change (SR-Phlx-2003-40), as amended, 
is approved, and Amendments No. 2, 3, 4, and 5 are approved on an 
accelerated basis.
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    \16\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
 [FR Doc. E5-123 Filed 1-12-05; 8:45 am]
BILLING CODE 8010-01-P