[Federal Register Volume 70, Number 198 (Friday, October 14, 2005)]
[Notices]
[Pages 60120-60125]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-5645]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52568; File No. SR-Phlx-2005-58]


Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; 
Notice of Filing and Immediate Effectiveness of a Proposed Rule Change 
and Amendment No. 1 Thereto Relating to Its October 2005 Equity Options 
Payment for Order Flow Program

October 6, 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 September 29, 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 
October 3, 2005, the Phlx submitted Amendment No. 1 to the proposed 
rule change.\3\ 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 \4\ 
and Rule 19b-4(f)(2) thereunder,\5\ 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.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Exchange revised the proposed text 
to correct typographical errors contained in the proposed Schedule 
of Fees and to reflect that options on the Nasdaq-100 Index Tracking 
StockSM are now traded under the symbol ``QQQQ.''
    \4\ 15 U.S.C. 78s(b)(3)(A)(ii).
    \5\ 17 CFR 240.19b-4(f)(2).
---------------------------------------------------------------------------

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 in a number of ways, as described in detail below.

A. Equity Option Payment for Order Flow Program Prior to October 1, 
2005

    Pursuant to the Exchange's payment for order flow program in effect 
for transactions settling on or after July 1, 2005,\6\ only orders that 
are delivered electronically, over AUTOM, are assessed a payment for 
order flow fee to a Registered Options Trader (``ROT'') or

[[Page 60121]]

a Directed ROT,\7\ but not a specialist,\8\ if the specialist elects 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 is not assessed on those 
equity option transactions.\9\
---------------------------------------------------------------------------

    \6\ The program that took effect on July 1, 2005 is a pilot 
program that is scheduled to expire on May 27, 2006, the same date 
the one-year pilot program in connection with Directed Orders is due 
to expire. See Securities Exchange Act Release Nos. 51759 (May 27, 
2005), 70 FR 32860 (June 6, 2005) (SR-Phlx-2004-91) and 52114 (July 
22, 2005), 70 FR 44138 (August 1, 2005) (SR-Phlx-2004-44).
    \7\ Directed ROTs are either Streaming Quote Traders (``SQTs'') 
or Remote Streaming Quote Traders (``RSQTs'') that receive Directed 
Orders. An SQT is an Exchange 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 1080l. 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). The term ``Directed Order'' means any customer order to 
buy or sell, which has been directed to a particular specialist, 
RSQT, or SQT by an Order Flow Provider (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).
    \8\ The Exchange uses the terms ``specialist'' and ``specialist 
unit'' interchangeably herein.
    \9\ Electronically-delivered orders do not include orders 
delivered through the Floor Broker Management System pursuant to 
Exchange Rule 1063.
---------------------------------------------------------------------------

    If the specialist unit opts into the program, the Exchange charges 
a payment for order flow fee to ROTs of $0.60 on all equity options 
traded against a customer order on the Exchange that are delivered 
electronically over AUTOM, other than options on the Nasdaq-100 Index 
Tracking StockSM traded under the symbol QQQQ (``QQQQ''),\10\ which are 
assessed a payment for order flow fee of $0.75. FXI Options are not 
assessed a payment for order flow fee.
---------------------------------------------------------------------------

    \10\ The Nasdaq-100(r), 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] (the ``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. 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.
    The Exchange proposes to modify the symbol ``QQQ'' in its Fee 
Schedule to ``QQQQ'' to reflect that the options on the Nasdaq-100 
Index Tracking Stock are currently traded under the symbol ``QQQQ.'' 
See Amendment No. 1.
---------------------------------------------------------------------------

1. Directed ROTs and ROTs
    For Directed Orders received over AUTOM, Directed ROTs may 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 
may not request reimbursement for payment for order flow paid to Order 
Flow Providers.\11\
---------------------------------------------------------------------------

    \11\ 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).
---------------------------------------------------------------------------

    Directed ROTs must notify the Exchange of the election to pay or 
not to pay the payment for order flow fee for Directed Orders 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.\12\
---------------------------------------------------------------------------

    \12\ Directed ROTs are 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 
does 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 is 
required in a subsequent month unless there is a change in 
participation status.
---------------------------------------------------------------------------

    However, the payment for order flow fee is 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 
the payment for order flow fee applies, 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.\13\
---------------------------------------------------------------------------

    \13\ Thus, the payment for order flow fee is not 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 does 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.
---------------------------------------------------------------------------

2. Specialists
    Specialists are not assessed a payment for order fee.\14\ 
Consistent with current practice, 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.\15\ The Exchange states that 
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 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 will be precluded from entering in its 
entirety in the payment for order flow program for the next three 
months.
---------------------------------------------------------------------------

    \14\ For purposes of assessing payment for order flow fees, the 
Exchange does not differentiate between specialists and specialists 
who receive Directed Orders.
    \15\ Specialists must 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 may also 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 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 is assessed for that portion of the month. For example, 
a payment for order flow fee is 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

[[Page 60122]]

order flow fee) as long as the specialist unit for that option elects 
to participate in the Exchange's payment for order flow program.
    The payment for order flow fee is billed and collected on a monthly 
basis. Because the specialists are not 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 may request payment for order 
flow reimbursements on an option-by-option basis. 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 receive their respective funds only after submitting an 
Exchange certification form identifying the amount of the requested 
funds.\16\
---------------------------------------------------------------------------

    \16\ The Exchange states that Specialists 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, the specialists will 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.
---------------------------------------------------------------------------

    The Exchange states that the amount a specialist may receive in 
reimbursement is limited. For a specialist who elects to participate in 
the Exchange's payment for order flow program for electronically 
delivered orders, the amount of reimbursement is 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.
3. Specialist Calculation
    Funds collected from the payment for order flow program are 
available to the specialist participating in the payment for order flow 
program. The amount of funds that are available are determined by a 
specific specialist calculation.\17\
---------------------------------------------------------------------------

    \17\ For example, 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 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 may 
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 will 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.
    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 is 
obligated to pay for 83,000 contracts (or $41,500 (83,000 x $.50 per 
contract)). The ROTs and Directed ROTs ``A'' and ``C'' will 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 may collect is up to $13,800 of its $20,750 ($41,500 
x 50%) reimbursement request. (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).
    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 is obligated to pay for 
70,000 contracts (or $35,000 (70,000 x $.50 per contract)). The ROTs 
will 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 any excess funds (funds remaining after 
reimbursement requests are processed) for a particular month that are 
not requested by the participating specialist are returned, by option, 
to the ROTs and Directed ROTs (who have opted to pay the payment for 
order flow fee) who have been charged payment for order flow fees. The 
excess funds are reflected as a credit on the monthly invoices and 
rebated on a pro rata basis by option to the ROTs and Directed ROTs who 
were billed payment for order flow charges for that same month.
    Participating specialists may not 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 is imposed. The Exchange also implements 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.\18\
---------------------------------------------------------------------------

    \18\ See Exchange Rule 760.
---------------------------------------------------------------------------

B. This Proposal: Equity Options Payment for Order Flow Program To Be 
in Effect for Transactions Settling on or After October 1, 2005

    The proposal, as discussed below, would be in effect for trades 
settling on or after October 1, 2005 and would remain in effect as a 
pilot program that is scheduled to expire on May 27, 2006, the same 
date that the one-year pilot program relating to Directed Orders is due 
to expire.\19\
---------------------------------------------------------------------------

    \19\ See Securities Exchange Act Release No. 51759 (May 27, 
2005), 70 FR 32860 (June 6, 2005) (SR-Phlx-2004-91).
---------------------------------------------------------------------------

    The payment for order flow rate would remain unchanged under the 
program to be in effect for transactions settling on or after October 
1, 2005 (``October program''). Specifically, the following rates would 
continue to apply: (1) Equity options other than QQQQ and FXI Options 
will be assessed $0.60 per contract; (2) options on QQQQ will be 
assessed $0.75 per contract; and (3) no payment for order flow fee will 
be assessed on FXI Options. Consistent with the current program, trades 
resulting from either Directed or non-Directed Orders that are 
delivered electronically over AUTOM and executed on the Exchange would 
be assessed a payment for order flow fee, while non-electronically-
delivered orders (i.e., represented by a floor broker) would not be 
assessed a fee.\20\
---------------------------------------------------------------------------

    \20\ For purposes of this proposal, electronically-delivered 
orders do not include orders delivered through the Floor Broker 
Management System pursuant to Exchange Rule 1063.
---------------------------------------------------------------------------

    However, the following aspects of the October program would be new 
or different: (1) Assessing the payment for order flow fee; (2) 
allowing Directed ROTs to elect to participate or not to participate in 
the payment for order flow program; (3) establishing separate pools of 
funds for each Directed ROT and each specialist unit that participates 
in the Exchange's payment for order flow program, with the funds no 
longer being pooled on an option-by-option basis; (4) eliminating the 
reimbursement process whereby specialists requested funds to reimburse 
them for payments made to Order Flow Providers; (5) allowing the 
Exchange to make payments directly to Order Flow Providers at the 
direction of the Directed ROT or specialist unit; (6) carrying forward 
each month excess funds (funds not requested by specialist units or 
Directed ROTs to be paid to Order Flow Providers), up to a certain 
amount or, at the direction of the specialist unit or Directed ROT 
rebating the excess funds on a pro-rata basis; and (7) establishing a 
payment for order flow advisory group, which would conduct periodic 
reviews to assist in determining the effectiveness of the Exchange's 
payment for order flow program.

[[Page 60123]]

Assessment of the Payment for Order Flow Fee and Participation in the 
Payment for Order Flow Program
    Specialist and Directed ROTs who participate in the Exchange's 
payment for order flow program would be assessed a payment for order 
flow fee, in addition to ROTs. Therefore, the payment for order flow 
fee would be assessed, in effect, on equity option transactions between 
a customer and an ROT, a customer and a Directed ROT, or a customer and 
a specialist. The payment for order flow fees would be assessed when 
the specialist, or Directed ROT to whom the order is directed, 
participates in the Exchange's payment for order flow program.
    Specialist units would continue to be permitted to opt into or out 
of the Exchange's payment for order flow program. The Exchange also 
proposes to allow Directed ROTs to be permitted to opt into or out of 
the Exchange's payment for order flow program for orders directed to 
them.
    For both specialist units and Directed ROTs, 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 date on which the payment for order flow fee will be 
assessed.\21\ Specialist units and Directed ROTs may only opt into or 
out of the Exchange's payment for order flow program one time in any 
given month. The Exchange represents that the result of electing not to 
participate in the program would be a waiver of the right to direct the 
Exchange to make payments to Order Flow Providers. If a specialist unit 
or Directed ROT opts into the program and does not direct the Exchange 
to make any payment for order flow payments to Order Flow Providers 
more than two times in a six-month period, it would be precluded from 
entering into the payment for order flow program for the next three 
months.
---------------------------------------------------------------------------

    \21\ Specialist units and Directed ROTs 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 would 
be required in a subsequent month, as described above, unless there 
is a change in participation status. For example, if a specialist 
unit elected to participate in the program and provided the Exchange 
with the appropriate notice, that specialist unit 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. Specialist units and Directed ROTs who 
currently participate in the Exchange's payment for order flow 
program in effect beginning July 1, 2005, would not need to notify 
the Exchange again regarding their participation status, unless 
there is a change from their current status.
---------------------------------------------------------------------------

    If at any time during a month, a specialist unit or Directed ROT 
opts into the payment for order flow program, 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 or if a ROT is designated as 
a Directed ROT mid-month.
    The amount a specialist unit or Directed ROT may request that the 
Exchange pay to Order Flow Providers would be limited to the amount 
billed and collected for that month,\22\ plus any excess funds that 
were carried over from previous months (funds collected but not 
requested by a specialist unit or Directed ROT). However, specialist 
units or Directed ROTs, would be able to request that any excess funds 
be rebated on a pro-rata basis to the applicable members (i.e., the 
applicable ROT, Directed ROT or specialist)\23\ who paid into that pool 
of funds. If excess funds are rebated, they would be reflected as a 
credit on the invoices.\24\
---------------------------------------------------------------------------

    \22\ The Exchange intends to have the National Securities 
Clearing Corporation collect the payment for order flow fees, along 
with other Exchange fees, on behalf of the Exchange on a monthly 
basis.
    \23\ See Amendment No. 1, note 3, supra.
    \24\ If a specialist unit or a Directed ROT leaves the Exchange 
mid-month, any excess funds in that specialist unit or Directed ROT 
pool would be rebated to the applicable Exchange members on a pro 
rata basis. This process would occur automatically without any 
request having to be made by any party. Per Telephone call between 
Michou H.M. Nguyen, Commission and Cynthia K. Hoekstra, Exchange on 
October 4, 2005.
---------------------------------------------------------------------------

    The available payment for order flow funds would be disbursed by 
the Exchange according to the instructions of the specialist units and 
Directed ROTs.\25\ Specialist units and Directed ROTs would be given 
instructions as to how to submit their payment directions. The Exchange 
would not be involved in the determination of the terms governing the 
orders that qualify for payment or the amount of any payment. The 
Exchange would provide administrative support for the program in such 
matters as maintaining the funds, keeping track of the number of 
qualified orders each specialist unit and Directed ROT directs to the 
Exchange, and making payments to the Order Flow Providers on behalf of, 
and at the direction of, the specialist units or Directed ROT.
---------------------------------------------------------------------------

    \25\ A specialist unit or a Directed ROT would certify to the 
Exchange that payment for order flow funds directed by either of 
them to be paid to Order Flow Providers reflect payment arrangements 
entered into by the specialist unit or Directed ROT and the Order 
Flow Provider.
---------------------------------------------------------------------------

    Separate pools of funds would be available to each specialist unit 
and Directed ROT solely for those trades where the payment for order 
flow fee was assessed and would be aggregated for use by each 
specialist unit and each Directed ROT to attract customer orders to the 
Exchange from Order Flow Providers that accept payment as a factor in 
making their order routing decisions. For Directed Orders, payment for 
order flow fees would be assessed on a per contract basis (when the 
specialist or Directed ROT opts into the program) and would be 
aggregated into separate pools of funds for use by each specialist unit 
or Directed ROT. For non-directed electronically-delivered orders, 
payment for order flow fees would continue to be assessed on a per 
contract basis and would be allocated for use by the participating 
specialist.
    The Exchange is also proposing to establish a payment for order 
flow advisory group, which would conduct periodic reviews to assist in 
determining the effectiveness of the Exchange's payment for order flow 
program.\26\
---------------------------------------------------------------------------

    \26\ In connection with determining the effectiveness of the 
Exchange's payment for order flow program, the advisory group would 
review whether excess funds should continue to be carried over from 
previous months (in instances where specialist units and Directed 
ROTs do not request that excess funds be rebated to the applicable 
members who paid into the payment for order flow pools).
---------------------------------------------------------------------------

    The 500-contract cap per individual cleared side of a transaction 
would continue to be imposed. The Exchange would also continue to 
implement a quality of execution program.\27\
---------------------------------------------------------------------------

    \27\ See Exchange Rule 760.
---------------------------------------------------------------------------

    Below is the text of the proposed rule change, as amended. Proposed 
new 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:

First full month of trading: 0% national market share

[[Page 60124]]

Second full month of trading: 3% national market share
Third full month of trading: 6% national market share
Fourth full month of trading: 9% national market share
Fifth full month of trading (and thereafter): 12% national market share

    ** 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**+]
    (1) For trades resulting from either Directed or non-Directed 
Orders that are delivered electronically and executed on the Exchange: 
Assessed on ROTs, specialists and Directed ROTs on those trades when 
the specialist unit or Directed ROT elects to participate in the 
payment for order flow program.***
    (2) No payment for order flow fees will be assessed on trades that 
are not delivered electronically.

QQQQ (NASDAQ-100 Index Tracking Stock\SM\) $0.75 per contract
Remaining Equity Options, except FXI Options $0.60 per contract

    *Assessed on transactions resulting from customer orders, subject 
to a 500-contract cap, per individual cleared side of transaction. This 
proposal will be in effect for trades settling on or after October 1, 
2005 and will remain in effect as a pilot program that is scheduled to 
expire on May 27, 2006.
    ***Any excess payment for order flow funds billed but not utilized 
by the specialist or Directed ROT [reimbursed to specialists] will be 
carried forward unless the Directed ROT or specialist elects to have 
those funds rebated to the applicable ROT, Directed ROT or specialist 
on a pro rata basis, reflected as a credit on the monthly invoices. 
[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 elects to participate in the 
payment for order flow program.]
    [(1) For orders delivered electronically: Assessed on 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.
    [(2) No payment for order flow fees will be assessed on orders that 
are not delivered electronically]
    See Appendix A for additional fees.

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 more competitive and administratively efficient 
payment for order flow program. This proposal would give both 
specialist units and Directed ROTs the ability to compete for order 
flow by allowing them to elect to participate or not to participate in 
the Exchange's payment for order flow program. The proposal would also 
establish separate pools of payment for order flow funds for each 
specialist and each Directed ROT. The proposal would permit the 
specialist units and Directed ROTs to instruct the Exchange as to how 
to distribute the available payment for order flow funds directly to 
order flow providers.
    According to the Phlx, the Exchange's trading environment has 
changed. Now, ROTs must submit their orders electronically through 
streaming quote devices. Therefore, particular trading crowds are not 
relevant in that ROTs may stream from anywhere on the trading floor or 
off the trading floor.\28\ ROTs have unlimited access to stream any and 
all equity option issues without limitations, with participation spread 
among various issues and specialists.\29\
---------------------------------------------------------------------------

    \28\ A ROT is either a SQT or a RSQTs, as defined in footnote 7, 
supra. A SQT may only stream from the floor. A RSQT may only stream 
from off the floor. Per Telephone call among Michou H.M. Nguyen, 
Commission, Cynthia K. Hoekstra, Exchange and William N. Briggs, 
Exchange on October 4, 2005.
    \29\ Exchange Rule 507 places no limit on the number of 
qualifying ROTs that may become SQTs or RSQTs; any applicant that is 
qualified as an ROT in good standing and that satisfies the 
technological readiness and testing requirements shall be approved 
as an SQT. RSQTs must also demonstrate additional qualifications. 
See Exchange Rule 507, Application for Assignment in Streaming Quote 
Options.
---------------------------------------------------------------------------

    The Exchange believes that the ``pooling'' of payment for order 
flow fees collected by the Exchange is similar to the practices 
currently in effect at the Chicago Board Options Exchange, Inc. 
(``CBOE''), the International Securities Exchange (``ISE''), Inc and 
the Pacific Exchange, Inc (``PCX'').\30\ Payment for order flow funds 
generated from this proposal originate from electronic orders--
generally the same type of orders for which Order Flow Providers expect 
payment. Only specialists, Directed ROTs and ROTs that stream quotes 
will be assessed the payment for order flow fee, as floor-brokered 
orders are not part of the program.
---------------------------------------------------------------------------

    \30\ See Securities Exchange Act Release Nos. 52474 (September 
20, 2005), 70 FR 56520 (September 27, 2005) (SR-CBOE-2005-72) (all 
funds generated by CBOE's ``marketing fee'' are collected by CBOE 
and recorded according to the Designated Primary Market-Maker 
(``DPM'') station and class where the options subject to the fee are 
traded); 48568 (September 30, 2003), 68 FR 57720 (October 6, 2003) 
(SR-ISE-2003-23) (ISE has divided the options it trades into ten 
groups, with one Primary Market Maker assigned to each group. The 
ISE maintains a payment for order flow fund for each group, 
consisting of the fees collected from market makers trading options 
in that group); and 48175 (July 14, 2003), 68 FR 43245 (July 21, 
2003) (SR-PCX-2003-30) (PCX collects and segregates the ``marketing 
fee'' proceeds by trading post).
---------------------------------------------------------------------------

    According to the Exchange, it has further added supplementary 
administrative practices that are necessary to remain competitive with 
other options exchanges and should help to ease the accounting burden 
on membership. This is achieved by eliminating the reimbursement 
process and by having the Exchange act as the program administrator 
remitting payments directly to Order Flow Providers per the 
instructions of the specialist unit or Directed ROT in a manner, which 
the Exchange believes is substantially similar to that of other options 
exchanges.\31\
---------------------------------------------------------------------------

    \31\ See Securities Exchange Act Release Nos. 51650 (May 3, 
2005), 70 FR 24663 (May 10, 2005) (SR-CBOE-2005-34) (the ``marketing 
fee'' collected by CBOE is disbursed by CBOE according to the 
instructions of the DPM); and 48175 (July 14, 2003), 68 FR 43245 
(July 21, 2003) (SR-PCX-2003-30) (PCX collects and segregates the 
fee proceeds by trading post and makes the funds available to Lead 
Market Makers (``LMM''). The LMMs determine the specific terms 
governing the orders that qualify for payment and the amounts to be 
paid).

---------------------------------------------------------------------------

[[Page 60125]]

2. Statutory Basis
    The Exchange believes that its proposal, as amended, is consistent 
with Section 6(b) of the Act \32\ in general, and furthers the 
objectives of Sections 6(b)(4) and 6(b)(5) of the Act \33\ in 
particular, in that it is an equitable allocation of reasonable dues, 
fees, and other charges among the Phlx's members.
---------------------------------------------------------------------------

    \32\ 15 U.S.C. 78f(b).
    \33\ 15 U.S.C. 78f(b)(4)-(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 not 
necessary or appropriate in furtherance of the purposes of the Act.

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 \34\ and 
Rule 19b-4(f)(2) \35\ 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, as amended, 
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.\36\
---------------------------------------------------------------------------

    \34\ 15 U.S.C. 78s(b)(3)(A)(ii).
    \35\ 17 CFR 240.19b-4(f)(2).
    \36\ The effective date of the original proposed rule change is 
September 29, 2005, the effective date of Amendment No. 1 is October 
3, 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 October 3, 2005, the date on 
which the Exchange submitted Amendment No. 1.
---------------------------------------------------------------------------

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-2005-58 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-2005-58. 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-2005-58 and should be submitted on 
or before November 4, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\37\
---------------------------------------------------------------------------

    \37\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

J. Lynn Taylor,
Assistant Secretary.
[FR Doc. E5-5645 Filed 10-13-05; 8:45 am]
BILLING CODE 8010-01-P