FR Doc E6-21171

[Federal Register: December 13, 2006 (Volume 71, Number 239)]
[Notices]
[Page 74979-74982]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr13de06-86]

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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
Shares^SM, Nasdaq-100 Trust^SM, Nasdaq-100 Index
Tracking Stock^SM, and QQQ^SM 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
Trust^SM, or the beneficial owners of Nasdaq-100
Shares^SM. 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 rule-comments@sec.gov. 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