[Federal Register: October 23, 2003 (Volume 68, Number 205)]
[Notices]
[Page 60762-60764]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr23oc03-84]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-48648; File No. SR-Phlx-2003-37]
Self-Regulatory Organizations; Order Granting Approval of
Proposed Rule Change by the Philadelphia Stock Exchange, Inc. to Delete
the Prohibition Against the Delivery of Electronically Generated Orders
Via AUTOM
October 16, 2003.
I. Introduction
On May 19, 2003, 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 to delete Phlx Rule 1080(i)
(``Rule''), which prohibits the delivery of electronically generated
orders via Phlx's AUTOM system. Notice of the proposed rule change was
published for comment in the Federal Register on June 11, 2003.\3\ The
Commission received two comments regarding the proposal--one from
Interactive Brokers Group LLC (``IB'') supporting the proposal (``IB
Letter''), and the other from Susquehanna International Group LLP
(``SIG'') opposing the proposal (``SIG Letter'') \4\. The Phlx
submitted a response to the SIG Letter (``Phlx Response'').\5\
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Securities Exchange Act Release No. 47977 (June 4, 2003), 68
FR 35049.
\4\ See letters to Jonathan G. Katz, Secretary, SEC, from David
M. Battan, Vice President and General Counsel, IB, dated July 22,
2003; and Gerald D. O'Connell, Director of Compliance, SIG, dated
July 9, 2003.
\5\ See letter from Richard S. Rudolph, Director and Counsel,
Phlx, to Jonathan G. Katz, Secretary, SEC, dated October 6, 2003.
---------------------------------------------------------------------------
This order approves the proposed rule change.
II. Description of the Proposal
The Exchange is proposing to delete the Rule, which prohibits the
delivery of electronically generated orders, i.e., orders that were
created and communicated electronically without manual input,\6\ via
AUTOM.\7\ According to the Exchange, it has enhanced its AUTOM and
AUTO-X systems so that the concerns the Rule was intended to address
have been minimized. For example, the Exchange modified its Auto-Quote
\8\ system to enable the Exchange to disseminate a firm quotation size
of at least the sum of limit orders at the Exchange's disseminated
price.\9\ The Exchange has also expanded the order types \10\ and
delivery sizes \11\ eligible for AUTOM delivery and automatic execution
via AUTO-X.
---------------------------------------------------------------------------
\6\ Specifically, the Rule required order entry to involve
manual input such as entering the terms of the order into an order-
entry screen or manually selecting a displayed order against which
the off-setting order should be sent.
\7\ AUTOM is the Exchange's electronic order delivery, routing,
execution and reporting system, which provides for the automatic
entry and routing of equity option and index option orders to the
Exchange trading floor. Orders delivered through AUTOM may be
executed manually, and 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.
Option orders entered by Exchange members into AUTOM are routed to
the appropriate specialist unit on the Exchange trading floor.
\8\ Auto-Quote is the Exchange's electronic options pricing
system, which enables specialists to automatically monitor and
instantly update quotations.
\9\ See Securities Exchange Act Release No. 46325 (August 8,
2002), 67 FR 53376 (August 15, 2002) (SR-Phlx-2002-15).
\10\ In October 2002, the Commission permanently approved an
Exchange pilot that allowed orders for the account(s) of broker-
dealers to be delivered via AUTOM, and to be eligible for automatic
execution via AUTO-X. See Securities Exchange Act Release No. 46660
(October 15, 2002), 67 FR 64951 (October 22, 2002) (SR-Phlx-2002-
50). The Exchange then adopted rules providing for automatic
executions for eligible orders at the Exchange's disseminated size,
subject to a minimum and maximum eligible size range to be
determined by the specialist, on an issue-by-issue basis. See
Securities Exchange Act Release No. 46886 (November 22, 2002), 67 FR
72015 (December 3, 2002) (SR-Phlx-2002-39). Most recently, the
Exchange adopted rules providing an equal firm quotation size and
equal AUTO-X guaranteed size for both customer and broker-dealer
orders. See Securities Exchange Act Release No. 47646 (April 8,
2003), 68 FR 17976 (April 14, 2003) (SR-Phlx-2003-18).
\11\ In March 2003, the Exchange adopted rules to increase the
eligible AUTOM order delivery size for off-floor broker-dealer
orders from 200 contracts to 1,000 contracts for all options. At the
same time, the Exchange determined to allow delivery of Immediate or
Cancel orders via AUTOM. See Securities Exchange Act Release No.
47543 (March 20, 2003), 68 FR 14737 (March 26, 2003) (SR-Phlx-2003-
11).
---------------------------------------------------------------------------
III. Summary of Comments and Phlx's Response
1. IB Letter
In its letter supporting the proposal, IB urged the Commission to
approve the proposal because IB believes the Rule
[[Page 60763]]
``hinders the public's access to the Exchange and serves only to
protect those market participants who have not invested the proper time
and capital to ensure that their trading systems are sufficiently
robust and advanced.'' IB also expressed the view that the Rule is
difficult and expensive to enforce, and encourages traders to insert
manual steps in their trading processes that increase the chance of
error. IB concluded that removal of the Rule will enable customers to
post competitive limit orders more quickly; force specialists to
upgrade their operations and update prices faster; and thus improve the
quality of the options National Best Bid and Offer (``NBBO'') and
enhance the linkage system.
2. SIG Letter
In its letter opposing the proposal, SIG stated that the concerns
and conditions that prompted adoption of the Rule have not changed. SIG
contended that removal of the Rule will ``unfairly place specialists at
a competitive disadvantage [vis-a-vis] professional customers and
broker-dealers who generate and send orders electronically.'' Further,
SIG expressed the view that adoption of the proposal will discourage
liquidity providers from quoting deep markets, ``as occasional errors
or delays in quote updates will be instantaneously met with economic
loss from electronic pick-off orders of professionals.''
SIG stated that the likelihood that Phlx will adopt a hybrid
trading system will further compound the problems arising from
electronically generated orders. Specifically, SIG believes that
increased quoting by market makers in a hybrid system will create more
instances of quote errors and anomalies, which will increase the
opportunities for professional traders to pick off liquidity providers.
Accordingly, SIG believes that any withdrawal of the Rule should be
accompanied by adoption of an effective decrementation feature or other
means to address quote clogging once a hybrid system is introduced.
In addition, SIG believes that recent enhancements to Phlx's AUTOM
and AUTO-X systems--such as a change to Auto-Quote that enables Phlx to
disseminate a firm quote size of at least the sum of limit orders at
Phlx's disseminated price--do not warrant removal of the Rule. Rather,
SIG stated that the enhancements exacerbate the disadvantages to
specialists and market makers from electronically generated orders.
Finally, SIG argued that the Rule should be bolstered rather than
eliminated. Specifically, SIG believes that regulators should enforce
the human intervention requirement of the Rule by categorizing ``queue-
trading'' (which occurs when an off-floor system is programmed to
identify a quoting error or quote delay and then queues an order on the
screen to be sent to the exchange with the stroke of a key) as
electronically generated.
3. Phlx Response to SIG Letter
In its response to the SIG Letter, the Phlx reiterated its belief
that the systems changes it has made to AUTOM and AUTO-X have
``narrowed the gap with respect to any actual or perceived advantage an
off-floor customer or broker-dealer could have over a specialist * *
*.'' The Exchange also noted that it has developed and deployed new
electronic technology that provides for the automatic execution of
eligible inbound customer and off-floor broker-dealer limit orders
against booked customer limit orders at the Exchange's disseminated
price (called ``Book Match''), and a new component of AUTOM, ``Book
Sweep,'' designed to automatically execute limit orders on the book
when the Exchange's electronic options pricing system, Auto-Quote, or a
specialist's quote sent to the Exchange via specialized quote feed
locks or crosses a limit order on the book. Phlx stated that as a
result of its technology changes and as a competitive initiative, it
proposed to delete the Rule. However, the Exchange also stated that it
will continue to surveil for, and enforce, compliance with Exchange
rules that help specialists and ROTs in managing their risk while
making markets on the Exchange. In addition, the Exchange represented
that it expects to monitor the effects of the deletion of this
prohibition in order to readily ascertain its effects on the risk
management activities of on-floor members and member organizations. If
the Exchange determines that such effects are detrimental to the risk
management activities of on-floor members and member organizations, the
Exchange expects to take appropriate action, including the filing of
appropriate rules and/or systems changes, to address such a situation.
IV. Discussion
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange.\12\
Specifically, the Commission believes that the proposal is consistent
with Section 6(b)(5) of the Act,\13\ which requires, among other
things, that the rules of an exchange be designed to promote just and
equitable principles of trade, to foster cooperation and coordination
with persons engaged in facilitating transactions in securities, to
remove impediments to and perfect the mechanism of a free and open
market, and to protect investors and the public interest. Specifically,
the Commission believes that the proposal should permit faster entry
and execution of orders on the Exchange, thereby providing investors
with improved services. The Commission also believes the proposal
should facilitate the entry by traders of competitive limit orders on
the Exchange, which should narrow spreads and improve the quality of
the NBBO. Finally, the Commission notes that the Exchange has addressed
the possible risk exposure issue of specialists and ROTs by
representing that it will surveil for and enforce Exchange rules
designed to help specialists and ROTs manage risk.\14\ The Commission
expects the Exchange to monitor the effects of the proposal on the risk
management activities of on-floor members and member organizations, and
take appropriate action if necessary.
---------------------------------------------------------------------------
\12\ In approving this proposal, the Commission has considered
the proposed rule's impact on efficiency, competition, and capital
formation. 15 U.S.C. 78(c)(f).
\13\ 15 U.S.C. 78f(b)(5).
\14\ For example, the Exchange committed to continue to surveil
for, and enforce, compliance with Phlx Rule 1080(c)(ii), which sets
forth the obligations of an Exchange Order Entry Firm, defined as a
member organization of the Exchange that is able to route orders to
AUTOM, and a User, defined as any person or firm that obtains access
to AUTO-X through an Order Entry Firm. Specifically, the rule
requires Order Entry Firms to comply with all applicable Exchange
options trading rules and procedures; provide written notice to all
Users regarding the proper use of AUTO-X; and neither enter nor
permit the entry of multiple orders in call options and/or put
options in the same option issue within any 15-second period for an
account or accounts of the same beneficial owner.
---------------------------------------------------------------------------
V. Conclusion
For the reasons discussed above, the Commission finds that the
proposal is consistent with the Act and the rules and regulations
thereunder.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act
\15\, that the proposed rule change (SR-Phlx-2003-37), be, and hereby
is, approved.
---------------------------------------------------------------------------
\15\ Id.
[[Page 60764]]
---------------------------------------------------------------------------
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\16\
---------------------------------------------------------------------------
\16\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-26747 Filed 10-22-03; 8:45 am]
BILLING CODE 8010-01-P