[Federal Register Volume 70, Number 146 (Monday, August 1, 2005)]
[Notices]
[Pages 44138-44144]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-4076]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52114; File No. SR-Phlx-2005-44]


Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; 
Notice of Filing and Immediate Effectiveness of a Proposed Rule Change 
and Amendment Nos. 1 and 2 Thereto Relating to Payment for Order Flow 
Program

July 22, 2005.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on July 1, 2005, the Philadelphia Stock Exchange, Inc. (``Phlx'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the Exchange. On July 
20, 2005, the Phlx submitted Amendment No. 1 to the proposed rule 
change.\3\ On July 21, 2005, the Phlx submitted Amendment No. 2 to the 
proposed rule change.\4\ The Phlx has designated this proposal as one 
changing a fee imposed by the Phlx under Section 19(b)(3)(A)(ii) of the 
Act \5\ and Rule 19b-4(f)(2) thereunder,\6\ which renders the proposal, 
as amended, effective upon filing with the Commission. The Commission 
is publishing this notice to solicit comments on the proposed rule 
change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Exchange: (1) Revised the proposed 
rule text to clarify the provision on the return of any excess 
payment for order flow funds that are billed but not reimbursed to 
specialists; (2) revised the purpose section to clarify that 
Directed Registered Options Traders (``Directed ROTs'') may elect to 
be assessed or not to be assessed a payment for order flow fee and 
to clarify the example of how payment for order flow reimbursement 
is calculated; and (3) made several technical corrections to the 
proposed rule change.
    \4\ In Amendment No. 2, the Exchange made a technical correction 
to the proposed rule text.
    \5\ 15 U.S.C. 78s(b)(3)(A)(ii).
    \6\ 17 CFR 240.19b-4(f)(2).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Phlx proposes to amend its equity options payment for order 
flow program as follows: (1) A payment for order flow fee will be 
assessed only on electronically delivered orders, thus payment for 
order flow fees will not be assessed on non-electronically delivered 
orders, i.e., floor brokered orders; (2) payment for order flow fees 
will increase from $0.40 to $0.60 per contract for all options other 
than Nasdaq-100 Index Tracking StockSM traded under the 
symbol QQQQ (``QQQQ''),\7\ and iShares FTSE/Xinhua China Index Fund 
(``FXI Options''), an exchange-traded fund; (3) the payment for order 
flow fee will decrease from $1.00 to $0.75 for options on QQQQ; (4) 
Directed ROTs may elect to be assessed or not to be assessed a payment 
for order flow fee for orders directed to them; and (5) Directed ROTs 
will no longer be able to request reimbursement for payment for order 
flow paid to order flow providers.
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    \7\ The Nasdaq-100[supreg], Nasdaq-100 Index[supreg], 
Nasdaq[supreg], The Nasdaq Stock Market[supreg], Nasdaq-100 
SharesSM, Nasdaq-100 TrustSM, Nasdaq-100 Index 
Tracking StockSM, and QQQSM are trademarks or 
service marks of The Nasdaq Stock Market, Inc. (``Nasdaq'') and have 
been licensed for use for certain purposes by the Philadelphia Stock 
Exchange pursuant to a License Agreement with Nasdaq. The Nasdaq-100 
Index[supreg] (``Index'') is determined, composed, and calculated by 
Nasdaq without regard to the Licensee, the Nasdaq-100 
TrustSM, or the beneficial owners of Nasdaq-100 
SharesSM. The Exchange states that Nasdaq has complete 
control and sole discretion in determining, comprising, or 
calculating the Index or in modifying in any way its method for 
determining, comprising, or calculating the Index in the future.
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Equity Options Payment for Order Flow Program in Effect Beginning June 
2, 2005 \8\

    Beginning June 2, 2005, the Exchange established a payment for 
order flow program to take into account Directed Orders \9\ pursuant to 
new Exchange Rule 1080(l).\10\ Pursuant to Exchange Rule 1080(l), 
Exchange specialists,\11\ SQTs \12\ and RSQTs \13\ trading on the 
Exchange's electronic options trading platform, Phlx XL,\14\ may 
receive Directed Orders from Order Flow Providers.\15\
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    \8\ On June 2, 2005, the Exchange filed to amend its payment for 
order flow program effective as a pilot program for trades involving 
payment for order flow and Directed ROTs settling on or after June 
2, 2005 through May 27, 2006. See Securities Exchange Act Release 
No. 51909 (June 22, 2005), 70 FR 37484 (June 29, 2005) (SR-Phlx-
2005-37). Although the Commission subsequently abrogated SR-Phlx-
2005-37 on July 7, 2005, it was in effect until the filing of the 
current proposal, SR-Phlx-2005-44, on July 1, 2005. See Securities 
Exchange Act Release No. 51984 (July 7, 2005), 70 FR 40413 (July 13, 
2005).
    \9\ The term ``Directed Order'' means any customer order to buy 
or sell which has been directed to a particular specialist, Remote 
Streaming Quote Trader (``RSQT'') (as defined below), or Streaming 
Quote Trader (``SQT'') (defined below) by an Order Flow Provider (as 
defined below). The provisions of Exchange Rule 1080(l) are in 
effect for a one-year pilot period to expire on May 27, 2006. See 
Securities Exchange Act Release No. 51759 (May 27, 2005), 70 FR 
32860 (June 6, 2005) (SR-Phlx-2004-91).
    \10\ See Securities Exchange Act Release No. 51909 (June 22, 
2005), 70 FR 37484 (June 29, 2005) (SR-Phlx-2005-37).
    \11\ The Exchange uses the terms ``specialist'' and ``specialist 
unit'' interchangeably herein.
    \12\ An SQT is an Exchange Registered Options Trader (``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. 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. See Exchange Rules 1014(b)(ii) and 1080.
    \13\ An RSQT is an Exchange ROT that is a member or member 
organization of the Exchange with no physical trading floor presence 
who has received permission from the Exchange to generate and submit 
option quotations electronically through AUTOM in eligible options 
to which such RSQT has been assigned. An RSQT may only submit such 
quotations electronically from off the floor of the Exchange. An 
RSQT may only trade in a market making capacity in classes of 
options in which he is assigned. See Exchange Rule 1014(b)(ii)(B). 
See Securities Exchange Act Release Nos. 51126 (February 2, 2005), 
70 FR 6915 (February 9, 2005) (SR-Phlx-2004-90) and 51428 (March 24, 
2005), 70 FR 16325 (March 30, 2005) (SR-Phlx-2005-12).
    \14\ In July 2004, the Exchange began trading equity options on 
Phlx XL, followed by index options in December 2004. See Securities 
Exchange Act Release No. 50100 (July 27, 2004), 69 FR 46612 (August 
3, 2004) (SR-Phlx-2003-59).
    \15\ The term ``Order Flow Provider'' means any member or member 
organization that submits, as agent, customer orders to the 
Exchange. See Exchange Rule 1080(l).

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[[Page 44139]]

    The Exchange charges a payment for order flow fee of $0.40 on 
equity options traded on the Phlx, other than options on the QQQQ, 
which are assessed a payment for order flow fee of $1.00, and FXI 
Options, which are not assessed a payment for order flow fee.
    Pursuant to Exchange Rule 1080, specialists, SQTs and RSQTs may 
receive Directed Orders in accordance with the provisions of Exchange 
Rule 1080(l). When a Directed Order is received, the specialist, SQT or 
RSQT to whom the order is directed (the ``Directed Participant'') is 
not assessed a payment for order flow fee.\16\ For trades involving 
Directed Orders, the payment for order flow fee is assessed, however, 
on a specialist and ROT \17\ when they are not Directed Participants 
for that transaction, as long as they are allocated any remaining 
contracts after the Directed Participant receives its trade allocation 
if the specialist or Directed ROT makes arrangements to pay for order 
flow and has elected to participate in the Exchange's payment for order 
flow program.\18\ The Exchange states that thus, the payment for order 
flow fee is applied, in effect, to equity option transactions between a 
ROT and a customer, and also to trades between a specialist and a 
customer when an order is directed to a Directed ROT.
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    \16\ The Exchange states that this is similar to previous 
Exchange payment for order flow programs where the payment for order 
flow fee was not assessed on the specialist because the specialist 
would be asking, in effect, for reimbursement of its own funds.
    \17\ References to ROTs include all ROTs, i.e., on-floor ROTs, 
SQTs, and RSQTs, other than an SQT or RSQT to whom an order is 
directed (``Directed ROT'').
    \18\ For example, if an order is directed to an RSQT and the 
RSQT receives its trade allocation, after all public customers 
bidding or offering at the same price have received allocations, any 
contracts remaining from the Directed Order may be allocated to the 
specialist, SQTs, or RSQTs, as well as other ROTs in accordance with 
Exchange Rule 1014(g)(viii).
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    For orders that are delivered electronically,\19\ but are not 
directed to a Directed Participant, the specialist is not assessed a 
payment for order flow fee.\20\ ROTs are assessed the applicable 
payment for order flow fee if the specialist participates in the 
Exchange's payment for order flow program.
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    \19\ The Exchange states that electronically-delivered orders do 
not include orders delivered through the Floor Broker Management 
System pursuant to Exchange Rule 1063.
    \20\ The Exchange states that this is similar to its equity 
options payment for order flow program in effect prior to June 2, 
2005 where the payment for order flow fee was not assessed on the 
specialist because the specialist would be asking, in effect, for 
reimbursement of its own funds.
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    For orders that are executed and not delivered electronically and 
thus not directed to a Directed Participant, such as orders represented 
by a floor broker, (``Non-Directed Orders''), a payment for order flow 
fee is assessed if the specialist or at least one Directed ROT 
participates in the Exchange's payment for order flow program for that 
option. If there are no Directed ROTs participating in the exchange's 
payment for order flow program, the specialist will not be billed a 
payment for order flow fee for that option if the specialist 
participates in the payment for order flow program. Also, if the 
specialist does not participate in the payment for order flow program 
and there is one Directed ROT who participates in the payment for order 
flow program for that option, the Directed ROT will not be charged a 
payment for order flow fee.\21\
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    \21\ The Exchange proposes to clarify the assessment of the 
payment for order flow fee for Non-Directed Orders as it appeared in 
the Exchange's previous filing. See supra note 10. The Exchange 
believes that specific examples should help to clarify when a 
payment for order flow fee is assessed in connection with Non-
Directed Orders. Thus, for Non-Directed Orders: (1) A payment for 
order flow fee will be assessed on the specialist for equity option 
transactions between the specialist and customer if a Directed ROT 
participates in the Exchange's payment for order flow program in 
that option; (2) if the specialist does not participate in the 
payment for order flow program and there is one Directed ROT who 
participates in the payment for order flow program for that option, 
the Directed ROT will not be charged a payment for order flow fee; 
(3) a payment for order flow fee will be assessed on all ROTs, 
including Directed ROTs for equity option transactions between a 
ROT, including a Directed ROT, and a customer, if the specialist 
participates in the Exchange's payment for order flow program for 
that option, i.e., if there are no Directed ROTs participating in 
the Exchange's payment for order flow program, the specialist who is 
participating in the payment for order flow program will not be 
billed a payment for order flow fee for that option; and (4) a 
payment for order flow fee will be assessed on all ROTs, except the 
Directed ROT, for equity option transactions between a ROT and a 
customer if only one Directed ROT participates in the Exchange's 
payment for order flow program for that option. If the specialist 
and at least one Directed ROT participate in the program, then the 
specialist, Directed ROT(s), and ROT(s) will be assessed a payment 
for order flow fee. Also, if a specialist does not participate in 
the payment for order flow program, but more than one Directed ROT 
participates in the payment for order flow program, then the 
specialist, Directed ROT(s) and ROT(s) will be assessed a payment 
for order flow fee. No payment for order flow fee will be assessed 
if the specialist and all Directed ROTs elect not to participate in 
the Exchange's payment for order flow program for that option.
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    The Exchange must be notified of the election to participate or not 
to participate in the payment for order flow program in writing no 
later than five business days prior to the start of the month for which 
reimbursement for monies expended on payment for order flow will be 
requested.\22\ The result of electing not to participate in the program 
is a waiver of the right to any reimbursement of payment for order flow 
funds for such month(s). If a specialist or Directed ROT opts into the 
program for all options and does not request any payment for order flow 
reimbursement more than two times in a six-month period, it will be 
precluded from entering in its entirety in the payment for order flow 
program for the next three months.
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    \22\ Specialists and Directed ROTs are required to notify the 
Exchange in writing to either elect to participate or not to 
participate in the program. Once an election to participate or not 
to participate in the Exchange's payment for order flow program in a 
particular month has been made, no notice to the Exchange is 
required in a subsequent month, as described above, unless there is 
a change in participation status. For example, if a Directed ROT 
elected to participate in the program and provided the Exchange with 
the appropriate notice, that Directed ROT would not be required to 
notify the Exchange in the subsequent month(s) if it intends to 
continue to participate in the program. However, if it elects not to 
participate (a change from its current status), it would need to 
notify the Exchange in accordance with the requirements stated 
above. Specialists and Directed ROTs who have notified the Exchange 
in writing as to whether they elected to participate or not to 
participate in the program that was in effect prior to June 2, 2005 
did not need to notify the Exchange again, unless there was a change 
from their current status.
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    Beginning with transactions settling on or after June 2, 2005, the 
Exchange modified the time periods during which specialists and 
Directed ROTs elect to participate in the program. Specialists and 
Directed ROTs may elect to participate or not to participate in the 
payment for order flow program on an option-by-option basis if they 
notify the Exchange in writing no later than three business days prior 
to entering into or opting out of the payment for order flow program. 
Specialists or Directed ROTs may only opt into or out of the Exchange's 
payment for order flow program by option one time in any given month.
    Thus, if at any time during a month, a specialist or Directed ROT 
opts into the payment for order flow program for a particular option, a 
payment for order flow fee will be assessed that month. For example, a 
payment for order flow fee will be assessed, even beginning mid-month, 
if an option is allocated, or reallocated from a non-participating 
specialist unit, to a specialist unit that participates in the 
Exchange's payment for order flow program. In addition, payment for 
order flow fees will be assessed, even beginning mid-month, if order 
flow is directed to a Directed ROT who has elected to participate in 
the Exchange's payment for order flow program, even if the specialist 
to whom the option is allocated has opted out of

[[Page 44140]]

the program, as long as the required notice is given.
    The payment for order flow fee is billed and collected on a monthly 
basis. Because the specialists and Directed ROTs in the payment for 
order flow program are not charged the payment for order flow fee for 
orders directed to them, they may not request reimbursement for order 
flow funds in connection with any transactions directed to them to 
which they were a party.
    Payment for order flow reimbursements are requested on an option-
by-option basis, consistent with the payment for order flow program in 
effect prior to June 2, 2005. The Exchange states that the collected 
funds are to be used as a reimbursement for monies expended to attract 
options orders to the Exchange by making payments to Order Flow 
Providers who provide order flow to the Exchange. The Exchange states 
that the funds will be received only after submitting an Exchange 
certification form identifying the amount of the requested funds.\23\
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    \23\ The Exchange states that specialists and Directed ROTs are 
given instructions as to when the certification forms are required 
to be submitted. While all determinations concerning the amount that 
will be paid for orders and which Order Flow Providers shall receive 
these payments are made by the specialists and Directed ROTs in the 
payment for order flow program, they must provide to the Exchange on 
an Exchange form certain information as required by the Exchange.
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    The Exchange further states that the amount received in 
reimbursement will be limited. For a specialist who elects to 
participate in the Exchange's payment for order flow program 
(``participating specialist''), the amount of reimbursement is limited 
to the percentage of ROT monthly volume to total participating 
specialist and ROT monthly volume in the equity option payment for 
order flow program. For a Directed ROT, the amount of reimbursement is 
limited to the percentage of ROT and specialist monthly volume to total 
ROT, specialist and that Directed ROT's monthly volume in the payment 
for order flow program. Payment for order flow charges are assessed and 
reimbursed as described in detail below:
Participating Specialist Method
    If a participating specialist unit has a payment for order flow 
arrangement with an Order Flow Provider to pay that Order Flow Provider 
$0.50 per contract for order flow routed to the Exchange and that Order 
Flow Provider sends 90,000 customer contracts to the Exchange in one 
month for one option, then the participating specialist would be 
required, pursuant to its agreement with the Order Flow Provider, to 
pay the Order Flow Provider $45,000 for that month. Assuming that the 
90,000 represents 30,000 participating specialist contracts, 30,000 ROT 
contracts (which includes 10,000 from Directed ROTs who, in effect, are 
ROTs for that order) and 30,000 contracts from firms, broker-dealers 
and other customers, the participating specialist may request 
reimbursement of up to 50% (30,000 ROTs contracts/60,000, which is 
comprised of 30,000 ROT contracts + 30,000 specialist contracts)) of 
the amount paid ($45,000 x 50% = $22,500). Although the ROTs will have 
paid a total of $30,000 (30,000 contracts x $.40 per contract, which 
equals $12,000, + $18,000 Non-Directed Orders (as calculated below)) 
into the payment for order flow fund for that month, the participating 
specialist may collect up to $22,500 of its $22,500 reimbursement 
request. The excess funds (funds remaining after reimbursement requests 
are processed, which in this instance totals $7,500 ($30,000-$22,500) 
for that particular month are rebated on a pro rata basis by option to 
all those who were billed payment for order flow charges in that option 
for that same month.
Directed ROT Method
    If a Directed ROT unit has a payment for order flow arrangement 
with an Order Flow Provider to pay that Order Flow Provider $0.60 per 
contract for order flow routed to the Exchange and that Order Flow 
Provider sends 90,000 customer contracts to the Exchange in one month 
for one option, then the Directed ROT would be required, pursuant to 
its agreement with the Order Flow Provider, to pay the Order Flow 
Provider $54,000 for that month. Assuming that the 90,000 represents 
30,000 specialist contracts, 20,000 ROT contracts, 10,000 Directed ROT 
contracts and 30,000 contracts from firms, broker-dealers and other 
customers, the Directed ROT may request reimbursement of up to 83.33% 
(50,000 which is comprised of 30,000 + 20,000/60,000, which is 
comprised of 30,000 + 20,000 + 10,000) of the amount paid ($54,000 x 
83.33% = $44,998.20). However, because the specialist and ROTs will 
have paid $26,000 (50,000 contracts x $0.40 per contract, which equals 
$20,000, + $6,000 from the Non-Directed transactions (as calculated 
below)) into the payment for order flow fund for that month, the 
Directed ROT may collect only $26,000 of its $44,998.20 reimbursement 
request. If there were any excess funds for that particular month, they 
would be rebated on a pro rata basis by option to all those who were 
billed payment for order flow charges in that option for that same 
month.
Non-Directed Order Method
    The Exchange states that funds billed and collected for Non-
Directed Orders are apportioned on a pro rata basis among those seeking 
reimbursement.\24\ For example, if Order Flow Providers send 90,000 
Non-Directed customer contracts to the Exchange's trading floor via a 
floor broker in one month for one option in which both the specialist 
and Directed ROT participate in the payment for order flow program, 
then the specialist and ROTs (including the Directed ROT) will be 
billed the applicable per contract payment for order flow fee on orders 
matching with a customer. Thus, assuming that the 90,000 represents 
30,000 specialist contracts, 30,000 ROT contracts, and 30,000 contracts 
from firms, broker-dealers and other customers, the Exchange will bill 
payment for order flow charges of $24,000 (30,000 specialist contracts 
x $0.40 per contract = $12,000 plus 30,000 ROT contracts x $0.40 per 
contract = $12,000) on these transactions.
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    \24\ See supra note 21 for further details regarding the Non-
Directed Order method.
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Distribution of Available Funds
    Funds collected from the payment for order flow program will be 
available as described below. The payment for order flow funds will be 
collected and distributed on a pro rata basis. Each specialist and 
Directed ROT in the payment for order flow program has an amount from 
which it can request payment for order flow funds. The participating 
specialist fund will contain payment for order flow funds as calculated 
by the participating specialist reimbursement method plus payment for 
order flow funds allocated to it from the Non-Directed allocation 
method. The Directed ROT fund will contain payment for order flow funds 
as calculated by the Directed ROT reimbursement method plus payment for 
order flow funds allocated to it from the Non-Directed method.
    For example, the payment for order flow funds distributed from Non-
Directed Orders to specialists and Directed ROTs in the payment for 
order flow program would be calculated as follows: Assuming the 
activity in the month is 300,000 contracts for which the specialist 
traded 150,000 contracts and the Directed ROT traded 50,000 contracts 
and 100,000 contracts from firms, broker-dealers, ROTs and other 
customers, the participating specialist

[[Page 44141]]

fund, which includes Directed Orders and Non-Directed Orders represents 
75% (150,000/150,000 + 50,000) of the total Non-Directed payment for 
order flow charges for that option $24,000, which totals $18,000 (75% x 
$24,000) and the Directed ROT fund represents 25% (50,000/150,000 + 
50,000) x $24,000) of the total Non-Directed payment for order flow 
charges for that option ($6,000). Thus, the Participating specialist 
fund will include $18,000 (75% (150,000/150,000 + 50,000) x $24,000) 
from the Non-Directed calculation plus $12,000 from the participating 
specialist calculation above and the Directed ROT fund will include 
$6,000 (25% (50,000/150,000 + 50,000) x $24,000) from the Non-Directed 
calculation plus $20,000 from the Directed ROT calculation above. As 
stated above, any excess funds for that particular month will be 
rebated on a pro rata basis by option to all those who were billed 
payment for order flow charges in that option for that same month.
    The Exchange states that excess funds are reflected as a credit on 
the monthly invoices and rebated on a pro rata, option-by-option, basis 
to the specialists and ROTs who were billed payment for order flow 
charges for that same month.
    The Exchange states that reimbursements may not exceed the payment 
for order flow amount billed and collected in a given month.\25\
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    \25\ The Exchange states that no other changes to the Exchange's 
payment for order flow program were made. For example, the 500 
contract cap per individual cleared side of a transaction continued 
to be imposed. Thus, the applicable payment for order flow fee is 
imposed only on the first 500 contracts, per individual cleared side 
of a transaction. For example, if a transaction consists of 750 
contracts by one ROT, the applicable payment for order flow fee 
would be applied to, and capped at, 500 contracts for that 
transaction. Also, if a transaction consists of 600 contracts, but 
is equally divided among three ROTs, the 500 contract cap would not 
apply to any such ROT and each ROT would be assessed the applicable 
payment for order flow fee on 200 contracts, as the payment for 
order flow fee is assessed on a per ROT, per transaction basis. See 
Securities Exchange Act Release Nos. 47958 (May 30, 2003), 68 FR 
34026 (June 6, 2003) (proposing SR-Phlx-2002-87); 48166 (July 11, 
2003), 68 FR 42450 (July 17, 2003) (approving SR-Phlx-2002-87); and 
50471 (September 29, 2004), 69 FR 59636 (October 5, 2004) (SR-Phlx-
2004-60). In addition, the Exchange states that it also continued to 
implement a quality of execution program.
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Proposed Equity Options Payment for Order Flow Program To Be in Effect 
for Transactions Settling on or After July 1, 2005

    The Exchanges proposes that only orders that are delivered 
electronically, over AUTOM, would be assessed a payment for order flow 
fee if the specialist has elected to opt into the payment for order 
flow program for that option. For those orders that are not delivered 
electronically, i.e., represented by a floor broker, a payment for 
order flow fee would no longer be assessed on those equity option 
transactions.\26\
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    \26\ Electronically-delivered orders do not include orders 
delivered through the Floor Broker Management System pursuant to 
Exchange Rule 1063.
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    If the specialist unit opts into the program, the Exchange would 
charge a payment for order flow fee of $0.60 on all equity options 
traded on the Exchange that are delivered electronically over AUTOM, 
other than options on the QQQQ, which would be assessed a payment for 
order flow fee of $0.75. FXI Options would continue to not be assessed 
a payment for order flow fee.
Directed ROTs and ROTs
    The Exchange states that, for Directed Orders received over AUTOM, 
the Directed ROT would elect to be assessed or not to be assessed a 
payment for order flow fee for orders directed to them when the 
specialist has elected to participate in the payment for order flow 
program for that option. Directed ROTs would not be able to request 
reimbursement for payment for order flow paid to order flow providers.
    Directed ROTs would be required to notify the Exchange of the 
election to pay or not to pay the payment for order flow fee in writing 
no later than five business days prior to the start of the month for 
which the payment for order flow fee is to be assessed.\27\
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    \27\ For the month of July 2005, Directed ROTs must notify the 
Exchange by close of business on July 1, 2005. Directed ROTs would 
be required to notify the Exchange in writing to either elect to pay 
the payment for order flow fee or not to pay the fee when the 
specialist has elected to opt into the payment for order flow 
program for that option. The Directed ROT would not need to notify 
the Exchange in writing to either elect to pay the payment for order 
flow fee or not to pay the fee if the specialist for that option 
does not participate in the Exchange's payment for order flow 
program. Once an election to pay the payment for order flow fee or 
not to pay the payment for order flow fee in a particular month has 
been made, no notice to the Exchange would be required in a 
subsequent month unless there is a change in participation status.
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    However, the payment for order flow fee would be assessed on any 
ROT (but not the Directed ROT for that transaction when the Directed 
ROT has opted out of the payment for order flow program) if the ROT 
participates in the allocation of any remaining contracts after the 
Directed ROT receives its trade allocation. The Exchange states that 
thus, consistent with current practice, the payment for order flow fee 
would be applied, in effect, to equity option transactions between a 
ROT (and Directed ROT who has elected to be assessed a payment for 
order flow fee) and a customer.\28\ Equity option transactions between 
a customer and ROT would continue to be assessed a payment for order 
flow fee.
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    \28\ Thus, the payment for order flow fee would not be assessed 
on transactions between: (1) A specialist and a ROT; (2) a ROT and a 
ROT; (3) a ROT and a firm; and (4) a ROT and a broker-dealer. The 
ROT payment for order flow fee would not apply to index options or 
foreign currency options. For purposes of the payment for order flow 
program, a firm is defined as a proprietary account of a member 
firm, and not the account of an individual member and a broker-
dealer orders are orders entered from other than the floor of the 
Exchange, for any account (i) in which the holder of beneficial 
interest is a member or non-member broker-dealer or (ii) in which 
the holder of beneficial interest is a person associated with or 
employed by a member or non-member broker-dealer. This includes 
orders for the account of an ROT entered from off-the-floor.
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Specialists
    Specialists would not be assessed a payment for order fee.\29\
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    \29\ For purposes of this filing and assessing payment for order 
flow fees, the Exchange does not differentiate between specialists 
and specialists who receive Directed Orders.
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    The Exchange states that, consistent with current practice, the 
Exchange would have to be notified of the election to participate or 
not to participate in the payment for order flow program in writing no 
later than five business days prior to the start of the month for which 
reimbursement for monies expended on payment for order flow would be 
requested.\30\ The Exchange states that the result of electing not to 
participate in the program would be a waiver of the right to any 
reimbursement of payment for order flow funds for such month(s). If a 
specialist opts in its entirety into the program and does not request 
any payment for order flow reimbursement more than two times in a six-
month period, it would be precluded from entering in its entirety in 
the payment

[[Page 44142]]

for order flow program for the next three months.
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    \30\ The Exchange states that, consistent with the current 
practice, specialists would be required to notify the Exchange in 
writing to either elect to participate or not to participate in the 
program. Once an election to participate or not to participate in 
the Exchange's payment for order flow program in a particular month 
has been made, no notice to the Exchange is required in a subsequent 
month, as described above, unless there is a change in participation 
status. For example, if a specialist elected to participate in the 
program and provided the Exchange with the appropriate notice, that 
specialist would not be required to notify the Exchange in the 
subsequent month(s) if it intends to continue to participate in the 
program. However, if it elects not to participate (a change from its 
current status), it would need to notify the Exchange in accordance 
with the requirements stated above. Specialists who have already 
notified the Exchange in writing as to whether they have elected to 
participate or not to participate in the program that was in effect 
prior to July 1, 2005 do not need to notify the Exchange again, 
unless there is a change from their current status.
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    Specialists would also be able to elect to participate or not to 
participate in the payment for order flow program on an option-by-
option basis if they notify the Exchange in writing no later than three 
business days prior to entering into or opting out of the payment for 
order flow program. Specialists may only opt into or out of the 
Exchange's payment for order flow program by option one time in any 
given month.
    Thus, if at any time during a month, a specialist opts into the 
payment for order flow program for a particular option, a payment for 
order flow fee would be assessed for that portion of the month. For 
example, a payment for order flow fee would be assessed, even beginning 
mid-month, if an option is allocated, or reallocated from a non-
participating specialist unit, to a specialist unit that participates 
in the Exchange's payment for order flow program.
    Payment for order flow charges apply to ROTs or Directed ROTs that 
have elected to be assessed the payment for order flow fee as long as 
the specialist unit for that option has elected to participate in the 
Exchange's payment for order flow program.
    The payment for order flow fee would continue to be billed and 
collected on a monthly basis. Because the specialists would not be 
charged the payment for order flow fee, they may not request 
reimbursement for order flow funds in connection with any transactions 
to which they were a party.
    The Exchange states that specialists would request payment for 
order flow reimbursements on an option-by-option basis, consistent with 
the current practice. The Exchange further states that the collected 
funds are to be used by each specialist as a reimbursement for monies 
expended to attract options orders to the Exchange by making payments 
to Order Flow Providers who provide order flow to the Exchange. 
Specialists would receive their respective funds only after submitting 
an Exchange certification form identifying the amount of the requested 
funds.\31\
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    \31\ The Exchange states that, consistent with the current 
practice regarding specialist units, specialists would be given 
instructions as to when the certification forms are required to be 
submitted. While all determinations concerning the amount that would 
be paid for orders and which order flow providers shall receive 
these payments are made by the specialists, the specialists would 
provide to the Exchange on an Exchange form certain information as 
required by the Exchange, which may include what firms they paid for 
order flow, the amount of the payment and the price paid per 
contract.
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    The amount a specialist may receive in reimbursement would be 
limited. For a specialist who has elected to participate in the 
Exchange's payment for order flow program for electronically delivered 
orders, the amount of reimbursement would be limited to the percentage 
of ROT and Directed ROT monthly volume to total participating 
specialist, Directed ROT, and ROT monthly volume in the equity option 
payment for order flow program.
Specialist Calculation
    Funds collected from the payment for order flow program would be 
available to the specialist participating in the payment for order flow 
program as described below:
    If a specialist unit in the payment for order flow program has a 
payment for order flow arrangement with various Order Flow Providers to 
pay the Order Flow Providers $0.50 per contract for order flow routed 
to the Exchange, including for order flow sent to Directed ROTs, and 
those Order Flow Providers send 90,000 customer contracts to the 
Exchange in one month for one option, then the specialist would be 
required, pursuant to its agreement with the Order Flow Providers, to 
pay the Order Flow Providers $45,000 for that month. Assuming that the 
90,000 represents 30,000 specialist contracts, 30,000 total ROT and 
Directed ROT \32\ contracts (comprised of 10,000 ROT contracts, 10,000 
Directed ROT ``A'' contracts, 7,000 Directed ROT ``B'' contracts, and 
3,000 Directed ROT ``C'' contracts), and 30,000 contracts from firms, 
broker-dealers and other customers, the specialist would be able to 
request reimbursement of up to 50% (30,000 ROT and Directed ROT 
contracts/60,000, which is comprised of 30,000 ROT and Directed ROT 
contracts + 30,000 specialist contracts) of the amount paid ($45,000 x 
50% = $22,500). Because the ROTs and Directed ROTs would have paid a 
total of $18,000 (30,000 contracts x $.60 per contract into the payment 
for order flow fund for that month, the specialist may collect up to 
$18,000 of its $22,500 reimbursement request.
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    \32\ For purposes of this example, the Directed ROTs have 
elected to be assessed the payment for order flow fee by notifying 
the Exchange in writing, consistent with the notification 
requirements previously discussed.
---------------------------------------------------------------------------

    Assuming, however, that Directed ROT ``B'' elects not to be 
assessed a payment for order flow fee and has notified the Exchange 
pursuant to the requirements set forth above, then the specialist would 
be obligated to pay for 83,000 contracts (or $41,500 (83,000 x $.50 per 
contract)). The ROTs and Directed ROTs ``A'' and ``C'' would have paid 
$13,800 (23,000 contracts x $.60 per contract) into the payment for 
order flow fund for that option for that month. Thus, the amount the 
specialist would be able to collect is up to $13,800 of its $20,750 
($41,500 x 50%) reimbursement request.
    If all Directed ROTs have notified the Exchange that they elect not 
to be assessed a payment for order flow fee in the above-referenced 
example, then the specialist would be obligated to pay for 70,000 
contracts (or $35,000 (70,000 x $.50 per contract)). The ROTs would 
have paid $6,000 (10,000 contracts x $.60 per contract) into the 
payment for order flow fund for that option for that month. Thus, the 
amount the specialist may collect is up to $6,000 of its $17,500 
($35,000 x 50%) reimbursement request.
    The Exchange states that, consistent with current practice, any 
excess funds (funds remaining after reimbursement requests are 
processed) for a particular month that are not requested by the 
participating specialist would be returned to the ROTs and Directed 
ROTs (who have opted to pay the payment for order flow fee) by option 
who have been charged payment for order flow fees. The excess funds 
would be reflected as a credit on the monthly invoices and rebated on a 
pro rata, option-by-option, basis to the ROTs and Directed ROTs who 
were billed payment for order flow charges for that same month.
    The Exchange states that participating specialists would not be 
able to receive more than the payment for order flow amount billed and 
collected in a given month.
    In addition, a 500-contract cap per individual cleared side of a 
transaction would continue to be imposed. The Exchange states that it 
would also continue to implement a quality of execution program. 
Further, the Exchange may audit a specialist's payments to Order Flow 
Providers to verify the use and accuracy of the payment for order flow 
funds remitted to the specialists based on their certification 
form.\33\
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    \33\ See Exchange Rule 760.
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    This proposal would be in effect for trades settling on or after 
July 1, 2005 and would remain in effect as a pilot program that is 
scheduled to expire on May 27, 2006, the same date as the one-year 
pilot program in effect in connection with Directed Orders.\34\
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    \34\ See supra note 8.
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    Below is the text of the proposed rule change, as amended. Proposed 
new

[[Page 44143]]

language is in italics; proposed deletions are in [brackets].
* * * * *

Summary of Equity Option Charges (P. 3/6)

    For any top 120 option listed after February 1, 2004 and for any 
top 120 option acquired by a new specialist unit ** within the first 
60-days of operations, the following thresholds will apply, with a cap 
of $10,000 for the first 4 full months of trading per month per option 
provided that the total monthly market share effected on the Phlx in 
that top 120 Option is equal to or greater than 50% of the volume 
threshold in effect:

------------------------------------------------------------------------
                                                               National
                                                                market
                                                                share
                                                              (percent)
------------------------------------------------------------------------
First full month of trading................................            0
Second full month of trading...............................            3
Third full month of trading................................            6
Fourth full month of trading...............................            9
Fifth full month of trading (and thereafter)...............           12
------------------------------------------------------------------------

    ** A new specialist unit is one that is approved to operate as a 
specialist unit by the Options Allocation, Evaluation, and Securities 
Committee on or after February 1, 2004 and is a specialist unit that is 
not currently affiliated with an existing options specialist unit as 
reported on the member organization's Form BD, which refers to direct 
and indirect owners, or as reported in connection with any other 
financial arrangement, such as is required by Exchange Rule 783.
Real-Time Risk Management Fee
    $.0025 per contract for firms/members receiving information on a 
real-time basis.

            Equity Option Payment for Order Flow Fees*(1)(2)
------------------------------------------------------------------------
              Registered option trader **+                 Per contract
------------------------------------------------------------------------
QQQ (NASDAQ-100 Index Tracking Stock SM)................   [$1.00] $0.75
Remaining Equity Options, except FXI Options............  [$0.40] $0.60
------------------------------------------------------------------------
See Appendix A for additional fees.
* Assessed on transactions resulting from customer orders, subject to a
  500-contract cap, per individual cleared side of transaction
** Any excess payment for order flow funds billed but not reimbursed to
  specialists will be returned to the applicable ROTs and Directed ROTs
  who have elected to be assessed a payment for order flow fee
  (reflected as a credit on the monthly invoices) and distributed on a
  pro rata basis.
+ Only incurred when the specialist [or Directed ROT] elects to
  participate in the payment for order flow program.
(1) For orders delivered electronically: [(a)] Assessed on ROTs [and
  Directed ROTs] when the specialist unit opts into the program. ROTs
  who receive Directed Orders may elect to be assessed the payment for
  order flow fee on customer orders directed to and executed by them [;
  (b) assessed on specialists and ROTs when a Directed ROT opts into the
  program]
(2) No payment for order flow fees will be assessed on orders that are
  not delivered electronically [For orders not delivered electronically,
  the above-referenced fees are assessed on all ROTs, including Directed
  ROTs, and specialists if two or more specialist/ROTs have elected to
  participate in the Exchange's payment for order flow program.]

* * * * *

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

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

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

1. Purpose
    The Exchange represents that the purpose of the proposal, as 
amended, is to adopt a competitive Exchange payment for order flow 
program. Payment for order flow programs are in place at each of the 
other options exchanges in varying amounts and covering various 
options. The Exchange states that the funds generated by the Exchange's 
payment for order flow fee are intended to be used to reimburse 
specialists for order flow payments made to order flow providers for 
equity options delivered to the Exchange or when Directed ROTs elect to 
be charged a payment for order flow fee, the specialists, based on the 
Exchange's understanding, may make the payment for order flow payment 
to the Order Flow Provider on behalf of the Directed ROT. The Exchange 
believes that this proposal should also allow Directed ROTs to make 
arrangements with Order Flow Providers who do not accept payment for 
order flow. The Exchange believes that, in today's competitive 
environment, changing its payment for order flow program to compete 
more directly with other options exchanges is important and 
appropriate.
    In making these proposed modifications to the Exchange's payment 
for order flow program, the Exchange believes that the modified program 
would better facilitate both specialists' and Directed ROTs' existing 
business relationships with Order Flow Providers, while minimizing the 
existing administrative burdens on both the specialists and Directed 
ROTs and the Exchange. Additionally, the Exchange believes that the 
proposed program would simplify the reimbursement process by having 
only one reimbursement request processed for each equity option, rather 
than the multiple requests under the previous program and, when 
Directed ROTs elect to be charged a payment for order flow fee, by 
having consolidated payments to Order Flow Providers.
2. Statutory Basis
    The Exchange believes that its proposal, as amended, is consistent 
with Section 6(b) of the Act \35\ in general, and furthers the 
objectives of Sections 6(b)(4) and 6(b)(5) of the Act \36\ in 
particular, in that it is designed to provide for the equitable 
allocation of reasonable dues, fees, and other charges among the Phlx's 
members and is designed to enable the Exchange to compete with other 
markets in attracting customer order flow. Because the Exchange payment 
for order flow fees are collected only from member organizations 
respecting customer transactions delivered electronically, the Phlx 
believes that there is a direct and fair correlation between those 
members who fund the payment for order flow fee program and those who 
receive the benefits of the Exchange program. The Exchange believes 
that participating specialists, Directed ROTs, and ROTs potentially 
benefit from additional customer order flow. In addition, the Phlx 
believes that the proposed Exchange payment for order flow fees would 
serve to enhance the competitiveness of the Phlx and its members and 
that this proposal therefore is consistent with and furthers the 
objectives of the Act, including Section 6(b)(5) thereof,\37\ which 
requires the rules of exchanges to be designed to promote just and 
equitable principles of trade, and to remove impediments to and perfect 
the mechanism of a free and open market and a national market system. 
The Exchange believes that attracting more order flow to the Exchange, 
should, in turn, result in increased liquidity, tighter markets, and

[[Page 44144]]

more competition among Exchange members.
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    \35\ 15 U.S.C. 78f(b).
    \36\ 15 U.S.C. 78f(b)(4)-(5).
    \37\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

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

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

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

    No written comments were either solicited or received.

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

    The foregoing proposed rule change, as amended, has been designated 
as a fee change pursuant to Section 19(b)(3)(A)(ii) of the Act \38\ and 
Rule 19b-4(f)(2) \39\ thereunder, because it establishes or changes a 
due, fee, or other charge imposed by the Exchange. Accordingly, the 
proposal will take effect upon filing with the Commission. At any time 
within 60 days of the filing of such proposed rule change, the 
Commission may summarily abrogate such rule change if it appears to the 
Commission that such action is necessary or appropriate in the public 
interest, for the protection of investors, or otherwise in furtherance 
of the purposes of the Act.\40\
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    \38\ 15 U.S.C. 78s(b)(3)(A)(ii).
    \39\ 17 CFR 240.19b-4(f)(2).
    \40\ The effective date of the original proposed rule change is 
July 1, 2005, the effective date of Amendment No. 1 is July 20, 
2005, and the effective date of Amendment No. 2 is July 21, 2005. 
For purposes of calculating the 60-day period within which the 
Commission may summarily abrogate the proposal, the Commission 
considers the period to commence on July 21, 2005, the date on which 
the Exchange submitted Amendment No. 2.
---------------------------------------------------------------------------

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-Phlx-2005-44 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-9303.
    All submissions should refer to File Number SR-Phlx-2005-44. 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, as amended, between the Commission and any 
person, other than those that may be withheld from the public in 
accordance with the provisions of 5 U.S.C. 552, will be available for 
inspection and copying in the Commission's Public Reference Room. 
Copies of such filing also will be available for inspection and copying 
at the principal office of the Phlx. All comments received will be 
posted without change; the Commission does not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-Phlx-2005-44 and should be submitted on 
or before August 22, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\41\
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    \41\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-4076 Filed 7-29-05; 8:45 am]
BILLING CODE 8010-01-P