[Federal Register: November 13, 2002 (Volume 67, Number 219)]
[Notices]
[Page 68898-68901]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr13no02-123]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-46763; File No. SR-Phlx-2002-04]
Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.;
Order Granting Approval to Proposed Rule Change and Amendments No. 1
Through 7 Thereto and Notice of Filing and Order Granting Accelerated
Approval to Amendment No. 8 Relating to Electronic Interface With AUTOM
for Specialists and Registered Options Traders
November 1, 2002.
I. Introduction
On January 15, 2002, the Philadelphia Stock Exchange, Inc.
(``Phlx'' or ``Exchange'') filed with the Securities and Exchange
Commission (``SEC'' or ``Commission''), pursuant to section 19(b)(1) of
the Securities Exchange Act of 1934 (``Act'') \1\ and rule 19b-4
thereunder \2\ a proposed rule change relating to an electronic
interface with the Exchange's Automated Options Market (``AUTOM'') \3\
for specialists and Registered Options Traders (``ROTs'').\4\ On March
6, 2002, the Exchange filed Amendment No. 1 to the proposed rule
change.\5\ On March 14, 2002, the Exchange filed Amendment No. 2 to the
proposed rule change.\6\ On March 26, 2002, the Exchange filed
Amendment No. 3 to the proposed rule change.\7\ On April 2, 2002, the
Exchange filed Amendment No. 4 to the proposed rule
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change.\8\ On May 16, 2002, the Exchange filed Amendment No. 5 to the
proposed rule change.\9\ On June 12, 2002, the Exchange filed Amendment
No. 6 to the proposed rule change.\10\ On June 19, 2002, the Exchange
filed Amendment No. 7 to the proposed rule change.\11\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ AUTOM is the Exchange's electronic order delivery and
reporting system, which provides for the automatic entry and routing
of equity option and index option orders to the Exchange trading
floor. Orders delivered through AUTOM may be executed manually, or
certain orders are eligible for AUTOM's automatic execution feature
(``AUTO-X''). Equity option and index option specialists are
required by the Exchange to participate in AUTOM and its features
and enhancements. Option orders entered by Exchange members into
AUTOM are routed to the appropriate specialist unit on the Exchange
trading floor.
\4\ A ROT is a regular member or a foreign currency options
participant of the Exchange located on the trading floor who has
received permission from the Exchange to trade in options for his
own account. See Phlx rule 1014(b).
\5\ See letter from Richard S. Rudolph, Director and Counsel,
Phlx, to Nancy J. Sanow, Assistant Director, Division of Market
Regulation (``Division''), Commission, dated March 5, 2002
(``Amendment No. 1'').
\6\ See letter from Richard S. Rudolph, Director and Counsel,
Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission,
dated March 13, 2002 (``Amendment No. 2'').
\7\ See letter from Richard S. Rudolph, Director and Counsel,
Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission,
dated March 25, 2002 (``Amendment No. 3'').
\8\ See letter from Richard S. Rudolph, Director and Counsel,
Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission,
dated April 1, 2002 (``Amendment No. 4'').
\9\ See letter from Richard S. Rudolph, Director and Counsel,
Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission,
dated May 15, 2002 (``Amendment No. 5'').
\10\ See letter from Richard S. Rudolph, Director and Counsel,
Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission,
dated June 11, 2002 (``Amendment No. 6'').
\11\ See letter from Richard S. Rudolph, Director and Counsel,
Phlx, to Nancy J. Sanow, Assistant Director, Division, Commission,
dated June 18, 2002 (``Amendment No. 7'').
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The proposed rule change and Amendments No. 1-7 were published for
comment in the Federal Register on June 27, 2002.\12\ No comments were
received on the proposed rule change or Amendments No. 1-7. The
Exchange filed Amendment No. 8 to the proposed rule change on November
1, 2002.\13\
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\12\ See Securities Exchange Act release No. 46095 (June 20,
2002), 67 FR 43372.
\13\ See letter from Richard S. Rudolph, Director and Counsel,
Phlx, to Deborah Lassman Flynn, Assistant Director, Division,
Commission, dated October 31, 2002 (``Amendment No. 8''). In
Amendment No. 8, the Phlx proposes to eliminate the language
contained in proposed Phlx rule 1014(g)(i)(B)(5) regarding the use
of ``best efforts'' in the allocation of orders. The Phlx has
determined that the proposed language is unnecessary because the
price-improving ROT's identification information will be input into
the system at the time the ROT's order is placed on the limit order
book and, therefore, will be available to the person responsible for
the allocation of orders at the time that an execution occurs at
that price.
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II. Description of the Proposal
The Exchange proposes to amend Phlx rule 1080 to enable a ROT or
specialist to improve the Phlx bid or offer by enabling ROTs and
specialists to place limit orders on the electronic limit order book
\14\ through an electronic interface with AUTOM (``Price Improving ROT/
Specialist'').
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\14\ The electronic ``limit order book'' is the Exchange's
automated specialist limit order book, to which all unexecuted limit
orders routed to the Exchange through AUTOM are displayed on the
basis of price-time priority. Orders not delivered through AUTOM
also may be entered onto the limit order book. See Phlx rule 1080,
commentary.02.
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Currently, Phlx rule 1080 provides that, generally, only agency
orders \15\ may be entered into AUTOM and only Exchange options
specialists may access the limit order book electronically. A Phlx ROT
(or a floor broker on the ROT's behalf) may only place an order for an
ROT's account on the limit order book maintained by the specialist by
requesting the specialist to do so. In addition, Phlx ROTs cannot
improve the Phlx's displayed bid or offer, except by asking the
specialist to do so. Specifically, under existing Phlx rules, Phlx ROTs
are able to improve the Phlx market with respect to a given option
series only by verbally announcing their trading interest in a loud and
audible fashion. The specialist is then required by Phlx rules to
reflect this trading interest in the displayed quote.
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\15\ The Exchange has defined an agency order as any order
entered on behalf of a public customer, and does not include any
order entered for the account of a broker-dealer, or any account in
which a broker-dealer or an associated person of a broker-dealer has
any direct or indirect interest. See, e.g., Phlx rule 229.02. See
also, Securities Exchange Act release No. 40970 (January 25, 1999),
64 FR 4922 (February 1, 1999) (File No. SR-Phlx-98-44).
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The proposal would limit the need for specialist involvement by
providing that on-floor orders for the proprietary account(s) of ROTs,
up to 1,000 contracts, are eligible for delivery via AUTOM, through the
use of Exchange approved proprietary systems. To be displayed, on-floor
orders for the proprietary accounts of ROTs delivered via AUTOM would
be required to be for a minimum size of, at least, the lesser of: (i)
The AUTO-X guarantee for the option that is the subject of such an
order, or (ii) 20 contracts.\16\
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\16\ This requirement applies only to Phlx ROT and specialist
orders entered via electronic interface.
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Proposed paragraph (g) of Phlx rule 1014 provides that a Price-
Improving ROT/Specialist that enters an order through an electronic
interface with AUTOM that results in an improvement in the then-
prevailing market disseminated by the Exchange (i.e., raises the bid or
lowers the offer) must announce, loudly and audibly in the crowd, that
he has improved the displayed market. The proposal also requires that
an ROT or specialist that posts a bid or offer through electronic
interface with AUTOM, and subsequently elects to cancel such a bid or
offer, cancel such bid or offer through the electronic interface.
In addition, the proposal would allow specialists to improve the
prevailing market by placing price-improving orders via a similar
electronic interface with AUTOM as that used by ROTs. The use of a
specific electronic interface is intended to distinguish the
specialists' price improving orders under the instant proposed rule
from their general two-sided quoting obligations, including quotes
generated by Auto-Quote or specialized quote feed.\17\
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\17\ A specialist may establish a specialized connection with
AUTOM, known as a specialized quote feed, which enables the
specialist to provide quotations based on a proprietary pricing
model, by-passing the Exchange's Auto-Quote System. See Phlx rule
1080, Commentary. 01(c).
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Inbound orders eligible for execution against ROT or specialist
orders entered into AUTOM via electronic interface would be executed by
the specialist and allocated, initially, by the individual responsible
for allocating trades under existing Exchange rules.\18\ No later than
January 2004, the Exchange will modify the AUTO-X system \19\ and will
automatically execute incoming orders against ROT and specialist orders
that improve the disseminated price, as well as orders that match such
price-improving orders.
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\18\ Currently, under the Exchange's Option Floor Procedure
Advice (``OFPA'') F-2, the largest participant in a trade is
responsible for allocating contracts to crowd participants. In a
separate rule proposal, the Exchange has proposed amendments to OFPA
F-2 and rule 1014(g) regarding who is responsible for allocating a
trade. Under that proposal, if a trade involved a floor broker, the
floor broker would be responsible for allocating contracts among
crowd participants but could delegate the responsibility to the
specialist or an assistant to the specialist under the specialist's
direct supervision (``Assistant''), provided that the specialist (or
Assistant) agrees to be responsible for allocating the trades. In
all other cases where the specialist is a participant, the
specialist or Assistant would allocate the trade. If neither the
specialist nor floor broker is involved, but there is more than one
buyer or seller, the largest participant would be responsible for
allocating trades. If neither the specialist nor floor broker is
involved, and there is only one buyer and seller, the seller would
be responsible for allocating trades. See File no. SR-Phlx-2001-28.
\19\ The Exchange will deploy the modified system over a 15-
month period. Proposed commentary .04 to Phlx rule 1080.
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Price-Improving, ``Matching,'' and Special Parity Rule
The other crowd participants (including the specialist) may match a
price-improving order through an electronic interface with AUTOM, but
must loudly and audibly announce their intention to do so, as well as
their size. If Auto-Quote or Specialized Quote Feed matches a price-
improving order, the specialist and crowd participants on that quote
would be deemed to be matching the price-improving order. In such a
situation, the ``Special Allocation'' would entitle the Price Improving
ROT/Specialist to receive the largest number of contracts among all
crowd participants that have matched a price-improving order, subject
to size.\20\
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Any partial contracts would be rounded up in favor of the Price
Improving ROT/Specialist. In no event would a Price Improving ROT/
Specialist or crowd participant that matches a price-improving order be
required to participate in a trade above that Price Improving ROT/
Specialist's size.
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\20\ Proposed Phlx rule 1014(g)(i)(B)(1) would entitle a Price
Improving ROT/Specialist to participate in at least 60% of the
contracts in the transaction if matched by one single crowd
participant. If the Price Improving ROT/Specialist's order is
matched by two or more crowd participants (including the
specialist), the Price Improving ROT/Specialist would be entitled to
participate in at least 40% of the contracts in the transaction; a
matching specialist would be entitled to participate in 30%, and
other crowd participants on parity with the Price Improving ROT/
Specialist would be entitled to participate in 30% of the contracts
in the transaction, in the aggregate. If matched by two or more
crowd participants (but not the specialist), the Price Improving
ROT/Specialist would be entitled to participate in 40% of the
contracts in the transaction, and the other crowd participants would
be entitled to participate in 60% of the transaction, in the
aggregate.
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The Special Allocation would remain in effect until: (1) The lesser
of 20 contracts or the AUTO-X guarantee for the option that is the
subject of the price-improving quote have been executed against the
price-improving quotes eligible to receive an allocation; (2) the ROT
or specialist who improved the price cancels the price-improving order;
or (3) the original price-improving order is superseded by a new price-
improving order, unless the new price-improving order is cancelled
before at least one contract executes at the price of the new price-
improving order.\21\ If any of those conditions are satisfied, the
Special Allocation would no longer be in effect, and crowd members with
orders that have not been filled would be considered to be on parity.
If the specialist were one of the crowd members, the specialist would,
consistent with applicable exchange rules, be entitled to receive the
specialist guarantee.\22\
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\21\ See proposed Phlx rule 1014(g)(i)(B)(2). The Exchange
represents that the purpose of this third condition is to eliminate
the possibility that a crowd participant could, by placing and then
immediately canceling a price-improving order, cause a Price
Improving ROT/Specialist to lose its entitlement under the Special
Allocation.
\22\ Pursuant to Phlx rule 1014(g)(ii), the specialist is
entitled to receive an allocation of up to 40% of an incoming order,
when the specialist is on parity with the best quote.
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Finally, the Exchange represents that it has determined to develop
a proposal for an alternative model for ROT access, which would involve
giving ROTs the ability to electronically post their own quotations in
competition with the specialist and to have their own quotation
generation models, as opposed to having their electronic access be
limited to sending limit orders on a strike-by-strike basis.\23\
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\23\ Under this approach, the Exchange would adopt a new trade
allocation rule similar to that of the International Securities
Exchange rule 713. Subject to approval under the governance
requirements set forth in the Exchange's rules and in the Act, the
Exchange would submit the proposal for Commission approval as the
permanent solution to compliance with section IV.B.h.(i)(aa) of the
Settlement Order.
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III. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning Amendment No. 8, including whether Amendment No. 8
to the proposed rule change is consistent with the Act. Persons making
written submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, NW., Washington,
DC 20549-0609. 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 will also be available for inspection and copying at the
principal office of the Phlx. All submissions should refer to File No.
SR-Phlx-2002-04 and should be submitted by December 4, 2002.
IV. Discussion
After careful review, the Commission finds that the proposed rule
change, as amended by Amendments No. 1 through 8, is consistent with
the requirements of the Act and the rules and regulations thereunder
applicable to a national securities exchange.\24\ The Commission finds
that the proposed rule change, which provides a mechanism for members
of the trading crowd who improve the disseminated market, or match a
price-improved market, to be directly allocated Auto-X order flow, is
designed to remove impediments to and perfect the mechanism of a free
and open market, promote just and equitable principles of trade, and in
general, to protect investors and the public interest, is consistent
with section 6(b)(5) of the Act.\25\
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\24\ In approving the proposed rule change, the Commission notes
that it has considered its impact on efficiency, competition, and
capital formation. 15 U.S.C. 78c(f).
\25\ 15 U.S.C. 78f(b)(5).
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The Commission believes that the proposed rule change, once fully
implemented,\26\ should substantially enhance incentives to quote
competitively by automating the process by which trading crowd
participants can improve the disseminated quote and by ensuring that
the price-improving ROT is rewarded with incoming order flow.\27\
Specifically, the Phlx's proposal will allow ROTs to improve the
disseminated quote by placing limit orders directly on the limit order
book through an electronic interface with Exchange systems. Moreover,
the Phlx has represented that it has determined to develop the
capability to allow ROTs to electronically post their own quotations in
competition with the specialist.
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\26\ The Phlx plans to file for Commission approval a plan to
fully implement the proposed rule change. See letter from Lanny A.
Schwartz, Executive Vice President and General Counsel, Phlx, to
Elizabeth King, Associate Director, Commission, dated October 31,
2002.
\27\ The Exchange filed this proposed rule change pursuant to
the requirements of section IV.B.h.(i)(aa) of the Commission's
September 11, 2000, Order Instituting Administrative Proceedings
Pursuant to section 19(h)(1) of the Act, which required the Phlx (as
well as other floor-based options exchanges) to adopt new, or amend
existing rules to substantially enhance incentives to quote
competitively and substantially reduce disincentives to act
competitively (``Settlement Order''). See Securities Exchange Act
release no. 43268 (September 11, 2000), Administrative Proceeding
file no. 3-10282.
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In addition, the Phlx proposal will ensure that price-improving
ROTs are rewarded with incoming order flow. The Phlx proposal provides
an incentive to improving the disseminated quote by providing the
price-improving ROT with an execution of at least 40%, up to 20
contracts, of an incoming order, regardless of whether other market
participants, including the specialist, match the price-improving
order. For these reasons, the Commission believes that the Phlx's
proposal, once fully implemented, will satisfy section IV.B.h.(i)(aa)
of the Settlement Order.
Finally, the Commission finds good cause for approving Amendment
No. 8 to the proposed rule change prior to the thirtieth day after the
date of publication in the Federal Register. Amendment No. 8 eliminates
language requiring a person responsible for the allocation of efforts
to use best efforts to allocate orders to price-improving ROTs. The
Exchange represents that this language is unnecessary because Phlx's
system would identify the source of a price-improving order placed on
the limit order book. If, for some reason, a specialist experienced any
difficulty allocating an order to a price-improving ROT, the identity
of the price-improving ROT could readily be determined by the system.
Accordingly, there are no novel issues of regulatory concern and the
Commission finds good cause for approving Amendment No. 8 to the
proposed rule change on an accelerated basis.
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V. Conclusion
It is therefore ordered, pursuant to section 19(b)(2) of the Act
\28\ that the proposed rule (SR-Phlx-2002-04), as amended by Amendments
No. 1 through 7, is approved and Amendment No. 8 is approved on an
accelerated basis.
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\28\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\29\
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\29\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-28747 Filed 11-12-02; 8:45 am]