[Federal Register Volume 71, Number 239 (Wednesday, December 13, 2006)]
[Notices]
[Pages 74979-74982]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-21171]


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SECURITIES AND EXCHANGE COMMISSION

Release No. 34-54886; File No. SR-Phlx-2006-74]


Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; 
Notice of Filing of Proposed Rule Change, and Amendment Nos. 1 and 2 
Thereto, Relating To a Pilot Program to Quote and Trade Options in 
Penny Increments

December 6, 2006.
    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 November 13, 2006, 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 substantially prepared by the 
Phlx. On November 22, 2006, the Exchange filed Amendment No. 1 to the 
proposed rule change.\3\ The Exchange filed Amendment No. 2 to the 
proposed rule change on December 5, 2006.\4\ The Commission is 
publishing this notice to solicit comments on the proposed rule change, 
as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 replaced the original filing in its 
entirety.
    \4\ Amendment No. 2 replaced the previous filing in its 
entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Phlx, pursuant to Section 19(b)(1) of the Act \5\ and Rule 19b-
4 thereunder,\6\ proposes to amend various Exchange rules in order to 
establish a six-month pilot period, beginning on January 26, 2007 (the 
``pilot''), during which certain options would be quoted and traded on 
the Exchange in minimum increments of $0.01 for all series in such 
options with a price of less than $3.00, and in minimum increments of 
$0.05 for all series in such options with a price of $3.00 or higher, 
except that options overlying the Nasdaq-100 Index Tracking Stock 
(``QQQQ'') \7\ would be quoted and traded in minimum increments of 
$0.01 for all series regardless of the price. A list of all such 
options would be communicated to Phlx's membership via Exchange 
circular.
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    \5\ 15 U.S.C. 78s(b)(1).
    \6\ 17 CFR 240.19b-4.
    \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] (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.
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    The text of the proposed rule change, including Exhibit 2 (a draft 
Exchange circular which includes a list of all options to be included 
in the pilot), is available on the Phlx's Web site at http://www.phlx.com, at the Phlx's Office of the Secretary, and at the 
Commission's Public Reference Room.

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 and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
Sections A, B, and C below, of the most significant aspects of such 
statements.

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

1. Purpose
    The purpose of the proposed rule change is to establish a six-month 
pilot program during which certain options would be quoted and traded 
in increments of $0.01.

Scope of the Pilot

    Proposed Phlx Rule 1034(a)(i)(B) states that the pilot would begin 
on January 26, 2007, and would extend for a six-month period. There 
will be 13 options included in the pilot as determined by the 
Commission, subject to a rollout schedule to be determined. The rollout 
would begin on January 26, 2007. The options included in the pilot are:

------------------------------------------------------------------------
                 Symbol                        Underlying security
------------------------------------------------------------------------
IWM....................................  Ishares Russell 2000
QQQQ...................................  QQQQ
SMH....................................  SemiConductor Holders
GE.....................................  General Electric
AMD....................................  Advanced Micro Devices
MSFT...................................  Microsoft
INTC...................................  Intel
CAT....................................  Caterpillar
WFMI...................................  Whole Foods
TXN....................................  Texas Instruments
A......................................  Agilent Tech Inc.
FLEX...................................  Flextronics International
SUNW...................................  Sun Micro
------------------------------------------------------------------------

Changes to Minimum Increments

    The Exchange proposes to adopt Phlx Rule 1034(a)(i)(B), which would 
provide that the options included in the pilot would be quoted in 
minimum increments of $0.01 for all series in such options with a price 
of less than $3.00, and in minimum increments of $0.05 for all series 
in such options with a price of $3.00 or higher, except that options 
overlying the QQQQ would be quoted and traded in minimum increments of 
$0.01 for all series regardless of the price. A list of all such 
options would be communicated to Phlx's membership via Exchange 
circular.

Automatic Executions During Crossed Markets

    The Exchange anticipates that the instance of crossed markets 
(where the bid price is greater than the offer price) will increase in 
options traded in penny increments. Accordingly, the Exchange proposes 
to amend its rules concerning automatic executions during crossed 
markets, and its exemption from Trade-Through \8\ liability when a 
Trade-Through occurs due to an automatic execution when the Exchange's 
disseminated market is crossed, or crosses the disseminated market of 
another options exchange, and the Exchange's disseminated price on the 
opposite side of the market for the

[[Page 74980]]

incoming order establishes, or is equal to, the NBBO.
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    \8\ ``Trade-Through'' means a transaction in an options series 
at a price that is inferior to the National Best Bid or Offer 
(``NBBO''), but shall not include a transaction that occurs at a 
price that is one minimum quoting increment inferior to the NBBO 
provided a Linkage Order is contemporaneously sent to each 
Participant Exchange disseminating the NBBO for the full size of the 
Participant Exchange's bid (offer) that represents the NBBO. See 
Phlx Rule 1083(t).
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    Currently, orders on the Exchange that are otherwise eligible for 
automatic execution are handled manually by the specialist when the 
Exchange's disseminated market is crossed by more than one minimum 
trading increment (as defined in Phlx Rule 1034) (i.e., 2.10 bid, 2 
offer), or crosses the disseminated market of another options exchange 
by more than one minimum trading increment.\9\ The effect of this is 
that the Exchange currently provides automatic executions during 
crossed markets when the Exchange's disseminated market is crossed by 
not more than one minimum trading increment, or crosses the 
disseminated market of another options exchange by not more than one 
minimum trading increment, and the Exchange's disseminated price on the 
opposite side of the market for the incoming order establishes, or is 
equal to, the NBBO.\10\ The Exchange proposes to delete Phlx Rule 
1080(c)(iv)(A), which would thereby mean that the Exchange will provide 
automatic executions in options where the Exchange's disseminated 
market is the NBBO \11\ and is crossed, or crosses the disseminated 
market of another options exchange, regardless of the amount by which 
such market is crossed.\12\
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    \9\ See Phlx Rule 1080(c)(iv)(A).
    \10\ See Phlx Rule 1085(b)(10). See also Securities Exchange Act 
Release No. 53449 (March 8, 2006), 71 FR 13441 (March 15, 2006) (SR-
Phlx-2005-45).
    \11\ The Exchange provides automatic executions only when its 
disseminated market is the NBBO. See Phlx Rule 1080(c)(iv)(E).
    \12\ The Exchange notes that another options exchange currently 
provides automatic executions during crossed markets regardless of 
the amount by which the market is crossed. See Securities Exchange 
Act Release No. 54229 (July 27, 2006), 71 FR 44058 (August 3, 2006) 
(SR-CBOE-2005-90).
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Trade-Throughs

    Currently, Phlx Rule 1085(b) affords Exchange members several 
exemptions from Trade-Through liability and the requirements under 
Phlx's rules and the Plan for the Purpose of Creating and Operating an 
Intermarket Option Linkage concerning satisfaction of Trade-Throughs. 
Among the exemptions from such liability and satisfaction 
responsibility is current Phlx Rule 1085(b)(10), which provides an 
exemption when the Trade-Through was the result of an automatic 
execution when the Exchange's disseminated market is the NBBO and is 
crossed by not more than one minimum trading increment (as defined in 
Phlx Rule 1034), or crosses the disseminated market of another options 
exchange by not more than one minimum trading increment.
    In order to be consistent with the proposed rule change (described 
above) to provide automatic executions when the Exchange's disseminated 
market is the NBBO regardless of the amount by which the market is 
crossed, the Exchange proposes to amend the rule to state that there 
would be an exemption from such liability and satisfaction 
responsibility when the Trade-Through was the result of an automatic 
execution when the Exchange's disseminated market is the NBBO and is 
crossed, or crosses the disseminated market of another options 
exchange. The proposed rule change would delete the current language 
contained in Phlx Rule 1085(b)(10) that limits the exemption from 
Trade-Through and satisfaction liability to automatic executions at the 
NBBO during markets that are crossed by one minimum trading increment. 
The Exchange believes that the proposed rule change would facilitate 
the prompt resolution of crossed markets by permitting automatic 
executions when the Exchange's disseminated market is crossed, or 
crosses the disseminated market of another options exchange, regardless 
of the amount by which the market is crossed.

Report to the Commission

    Proposed Phlx Rule 1034(a)(i)(C) would require the Exchange to 
prepare and submit an analytical report to the Commission that 
addresses the impact of the first three months of the pilot on the 
quality of the Exchange's markets and options quote traffic and 
capacity on or before the last day of the fourth month of the pilot. 
The purpose of this provision is to comply with the Commission's 
mandate that the Exchange submit such a report within the time frame 
specified in the rule.

Zero-Bid Option Series

    Currently, Phlx Rule 1080(i) states that the Exchange's AUTOM 
System will convert market orders to sell a particular option series to 
limit orders to sell with a limit price of $0.05 that are received when 
the bid price for such series is zero. The proposal would amend Phlx 
Rule 1080(i) to state that the system will convert such orders to limit 
orders to sell with a limit price of the minimum trading increment 
applicable to such series. The effect of this with respect to options 
quoted and traded in minimum increments of $0.01 would be that such 
conversion would be to a limit order to sell at $0.01, rather than 
$0.05.

Quote Mitigation

    The Exchange recognizes that quoting and trading in $0.01 
increments will most assuredly result in a greater number of quotations 
submitted in options that are included in the pilot. Therefore, in 
order to mitigate quote traffic, the Exchange proposes to amend Phlx 
Rule 1082, Firm Quotations, by adopting new Phlx Rule 1082(a)(ii)(C), 
which would modify the Exchange's definition of ``disseminated size'' 
such that the Exchange will disseminate fewer updated quotations.
    Specifically, proposed Phlx Rule 1082(a)(ii)(C) would set forth the 
conditions under which the Exchange would disseminate updated 
quotations based on changes in the Exchange's disseminated price and/or 
size. The proposed rule would require the Exchange to disseminate an 
updated bid and offer price, together with the size associated with 
such bid and offer, when: (1) The Exchange's disseminated bid or offer 
price increases or decreases; (2) the size associated with the 
Exchange's disseminated bid or offer decreases; or (3) the size 
associated with the Exchange's bid (offer) increases by an amount 
greater than or equal to a percentage (never to exceed 20%) of the size 
associated with previously disseminated bid (offer). Such percentage, 
which would never exceed 20%, would be determined on an issue-by-issue 
basis by the Exchange and announced to membership via Exchange 
circular. The percentage size increase necessary to give rise to a 
refreshed quote may vary from issue to issue, depending, without 
limitation, on the liquidity, average volume, and average number of 
quotations submitted in the issue. Proposed Phlx Rule 1082(b)(ii)(C) 
would not be limited to options included in the pilot, and would thus 
apply to all options traded on the Exchange.
    The Exchange represents that participants on its system would not 
be notified of any incremental increase in the size of the Exchange's 
quote under proposed Phlx Rule 1082(a)(ii)(C)(3) until such quote is 
disseminated to OPRA. Therefore, no participant on the Exchange's 
system would have information that is unavailable to another 
participant.
    The Exchange believes that the limitation on dissemination of 
quotations that increase in size by a nominal amount should 
significantly mitigate the amount of options quote traffic on the 
Exchange, and addresses issues of options quote capacity on the 
Exchange and in the National Market System.

[[Page 74981]]

    In addition to the measures proposed above concerning mitigation of 
quote traffic on the Exchange, the Exchange has filed other proposed 
rule changes that the Exchange believes should reduce the number of 
quotations generated on the Exchange.
    Specifically, the Commission recently approved a proposed rule 
change stating that, on a six-month pilot basis, Streaming Quote 
Traders (``SQTs''),\13\ Remote Streaming Quote Traders (``RSQTs''),\14\ 
and SQTs and RSQTs that receive Directed Orders \15\ (``DSQTs'' and 
``DRSQTs'' respectively) are deemed not to be assigned in any option 
series until the time to expiration for such series is less than nine 
months.\16\ Accordingly, the market making obligations described in 
Phlx Rule 1014(b)(ii)(D) do not apply to SQTs, RSQTs, DSQTs and DRSQTs 
respecting series with an expiration of nine months or greater, and 
thus they will be required to submit fewer quotes.
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    \13\ An SQT is an Exchange Registered Options Trader (``ROT'') 
who has received permission from the Exchange to generate and submit 
option quotations electronically through AUTOM in eligible options 
to which such SQT is assigned. An SQT may only submit such 
quotations while such SQT is physically present on the floor of the 
Exchange. See Phlx Rule 1014(b)(ii)(A).
    \14\ An RSQT is an ROT that is a member or member organization 
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. See Phlx Rule 
1014(b)(ii)(B).
    \15\ The term ``Directed Order'' means any customer order (other 
than a stop or stop-limit order as defined in Phlx Rule 1066) to buy 
or sell which has been directed to a particular specialist, RSQT, or 
SQT by an Order Flow Provider. See Phlx Rule 1080(l)(i)(A).
    \16\ See Securities Exchange Act Release No. 54648 (October 24, 
2006), 71 FR 63375 (October 30, 2006) (SR-Phlx-2006-52).
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    Additionally, the Exchange filed a proposed rule change authorizing 
the Exchange's Options Allocation, Evaluation and Securities Committee 
(``OAESC'') \17\ to assign trading privileges in options to SQTs and 
RSQTs by ``root symbol,'' as applied by the Options Clearing 
Corporation, such that an SQT or RSQT, on request, may be assigned in 
only certain series of an option.\18\ The market making obligations 
applicable to SQTs and RSQTs thus would not apply to series in which an 
SQT or RSQT is not assigned, which should reduce the number of 
quotations required to be submitted.
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    \17\ The OAESC is a standing committee of the Exchange that has 
jurisdiction over the allocation, retention and transfer of the 
privileges to deal in all options to, by and among members on the 
options and foreign currency options trading floors. It is 
responsible for appointing specialists, alternate or assistant 
specialists or odd-lot dealers on the options and foreign currency 
options trading floors. It also establishes standards for the 
periodic review and evaluation of their performance and is empowered 
to suspend or revoke their appointments upon showing of reasonable 
cause therefore. See Phlx By-Law Article X, Section 10-7(a); see 
also Phlx Rule 500.
    \18\ See Securities Exchange Act Release No. 54807 (November 21, 
2006), 71 FR 69173 (November 29, 2006) (SR-Phlx-2006-53).
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    The Exchange has also submitted a separate proposal to establish a 
maximum number of quoting participants that may be assigned to a 
particular equity option at any one time.\19\ This would limit the 
number of participants quoting in a particular equity option and thus 
should limit the number of quotations submitted in such equity options.
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    \19\ See SR-Phlx-2006-81.
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    In another separate submission, the Exchange has proposed to 
establish monthly Performance Evaluations by the Exchange of its member 
organizations that have SQTs and RSQTs, to determine whether they have 
fulfilled performance standards relating to, among other things, 
quality of markets, efficient quote submission to the Exchange 
(including quotes submitted through a third party vendor), competition, 
observance of ethical standards, and administrative factors.\20\ Under 
that proposal, failure to meet established minimum performance 
requirements could result in restriction by the OAESC of additional 
options assignments; suspension, termination, or restriction of an 
existing assignment on one or more options; or suspension, termination, 
or restriction of an SQT's or RSQT's status as such. The Exchange 
believes that such evaluations and possible consequences for failure to 
meet specific minimum standards should encourage efficient quoting and 
use of the Exchange's capacity and bandwidth by providing a 
disincentive for SQTs and RSQTs to submit quotations that do not 
improve the Exchange's disseminated price or materially increase the 
Exchange's disseminated size.
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    \20\ See Securities Exchange Act Release No. 54859 (December 1, 
2006) (SR-Phlx-2006-51).
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2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) of the Act,\21\ in general, and furthers the 
objectives of Section 6(b)(5) of the Act,\22\ in particular, in that 
the proposed rule change is designed to promote just and equitable 
principles of trade, to remove impediments to and perfect the mechanism 
of a free and open market and a national market system, and, in 
general, to protect investors and the public interest, by establishing 
rules concerning the pilot, while simultaneously mitigating quote 
traffic.
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    \21\ 15 U.S.C. 78f(b).
    \22\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

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

    Written comments on the proposed rule change were neither solicited 
nor received.

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

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

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change 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 No. SR-Phlx-2006-74 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE, 
Washington, DC 20549-1090.

All submissions should refer to File No. SR-Phlx-2006-74. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your

[[Page 74982]]

comments more efficiently, please use only one method. The Commission 
will post all comments on the Commission's Internet Web site at http://www.sec.gov/rules/sro.shtml. Copies of the submission, all subsequent 
amendments, all written statements with respect to the proposed rule 
change that are filed with the Commission, and all written 
communications relating to the proposed rule change between the 
Commission and any person, other than those that may be withheld from 
the public in accordance with the provisions of 5 U.S.C. 552, will be 
available for inspection and copying in the Commission's Public 
Reference Room. Copies of such filing also will be available for 
inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File No. SR-Phlx-2006-74 and should be 
submitted on or before January 3, 2007.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\23\
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    \23\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E6-21171 Filed 12-12-06; 8:45 am]
BILLING CODE 8011-01-P