[Federal Register: January 27, 2004 (Volume 69, Number 17)]
[Notices]
[Page 3974-3987]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr27ja04-146]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-49098; File No. SR-PHLX-2003-73]
Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.;
Order Approving Proposed Rule Change and Notice of Filing and Order
Granting Accelerated Approval of Amendment No. 3 Thereto Relating to
the Demutualization of the Philadelphia Stock Exchange, Inc.
January 16, 2004.
I. Introduction
On November 17, 2003, the Philadelphia Stock Exchange, Inc.
(``Phlx'' or ``Exchange'') filed with the Securities and Exchange
Commission (``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: (1) Amend its Certificate of
Incorporation to eliminate a reference to ``not for profit'' and a
restriction on the payment of dividends (``Plan of Conversion'' and
such amendments to the Certificate of Incorporation, the ``Conversion
Amendment''); and (2) merge a newly-created, wholly-owned shell
subsidiary of the Phlx with and into the Phlx, with the Phlx surviving
as a demutualized Delaware stock corporation (``Merger'' and together
with the Plan of Conversion, the ``Plan of Demutualization'') pursuant
to an Agreement and Plan of Merger (``Merger Agreement''). On November
24, 2003, the Phlx submitted Amendment No. 1 to the proposed rule
change.\3\ On November 26, 2003, the Phlx submitted Amendment No. 2 to
the proposed rule change.\4\ On December 3, 2003, the proposed rule
change was published for comment in the Federal Register.\5\ On
December 29, 2003, the Phlx submitted Amendment No. 3 to the proposed
rule change.\6\ The Commission received one comment letter in response
to the proposed rule change.\7\ This order approves the proposed rule
change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Letter from Edith Halihan, Deputy General Counsel, Phlx,
to Nancy Sanow, Assistant Director, Division of Market Regulation
(``Division''), Commission, dated November 21, 2003. (``Amendment
No. 1''). In Amendment No. 1, the Phlx made technical conforming
changes to the exhibits to the proposed rule change.
\4\ See Letter from Edith Halihan, Deputy General Counsel, Phlx,
to Nancy Sanow, Assistant Director, Division, Commission, dated
November 26, 2003 (``Amendment No. 2''). In Amendment No. 2, the
Phlx amended the proposed rule change to reflect that on November
25, 2003, the members of the Phlx (as that term is defined in
Section I-1(b) of the current By-laws of the Phlx, the ``Members'')
approved the Plan of Conversion, the Merger, and all transactions to
be effected in connection therewith. Also, on November 18, 2003,
holders of equitable title (``Owners'') to memberships in the Phlx
(each such membership a ``Seat'') voted to approve the Plan of
Demutualization as a whole.
\5\ See Securities Exchange Act Release No. 48847 (November 26,
2003), 68 FR 67720 (``Notice'').
\6\ See Letter from Edith Halihan, Deputy General Counsel, Phlx,
to Nancy Sanow, Assistant Director, Division, Commission, dated
December 23, 2003 (``Amendment No. 3''). In Amendment No. 3 the Phlx
formally submitted the Conversion Amendment as part of the proposed
rule change.
\7\ See Letter from Joseph Carapico, General Partner, Andrew W.
Snyder, General Partner and Richard B. Feinberg, Limited Partner,
Penn Mont Securities, to Jonathan G. Katz, Secretary, Commission,
dated December 19, 2003 (``Penn Mont Letter'').
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II. Description of Proposed Rule Change
The purpose of the proposed rule change is to implement the Plan of
Demutualization. In connection with the Plan of Demutualization,
trading privileges will be separated from corporate ownership of the
Phlx and will be made available exclusively through trading permits.
\8\
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\8\ The Exchange, however, plans to retain its existing Foreign
Currency Option (``FCO'') participations (as defined in section 1-
1(i) of the amended By-laws). After the demutualization, the ability
to trade FCOs on the Phlx will also be available through a Series A-
1 Permit, as set forth in proposed Rule 908(b).
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As a result of the demutualization, a total of 50,500 shares of
Class A Common Stock (100 shares per Seat) will be issued to existing
equitable Seat holders and will represent 100% of the common equity
ownership in the Phlx outstanding immediately after the
demutualization. In addition, all Members and holders of equity trading
permits (``ETPs'') who are affiliated with Member Organizations and are
not suspended will be entitled to receive
[[Page 3975]]
new Series A-1 Permits (``Permits'') to enable them to continue their
trading activities on the Exchange without interruption.\9\ Similarly,
Member Organizations will maintain their status as members of the Phlx
upon their compliance with certain deposit and registration
requirements.
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\9\ Pursuant to Rule 23 of the current Phlx Rules, the Exchange
has issued ETPs, four of which are currently outstanding. In the
demutualization, these ETPs will be eliminated in accordance with
current Rule 23 and pursuant to proposed Rule 971, and the rights
and privileges of ETPs will be conferred on existing ETP holders by
Permits.
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The Exchange proposes to effect the Plan of Demutualization for a
number of reasons, including to expand its sources of capital and
revenue; to facilitate its ability to enter into relationships with
strategic or financial partners who may be crucial for the Exchange's
future development, capital formation and viability; to facilitate the
introduction of new products and thus potentially increase transaction
volume and Exchange revenues; and to better position itself to react to
new opportunities and challenges.
The Exchange represents that, after the effective date of the
demutualization, it will continue to be a national securities exchange
registered under section 6 of the Act.\10\ The Exchange also represents
that, except as is necessary to implement the new permit structure to
replace the existing structure of owning and leasing seats as a basis
for trading rights and Exchange memberships, it is not proposing any
significant changes to its existing operational and trading structure
in connection with the demutualization. The Exchange further states
that the demutualization will not affect its functions as a self-
regulatory organization (``SRO'') and will not affect the designation
of the Exchange as ``designated examining authority'' (``DEA'') for
those Member Organizations for which the Exchange currently is the DEA.
Moreover, the Exchange notes that it is not proposing any changes to
its existing disciplinary system, fines or the related appellate
process in connection with the Plan of Demutualization.\11\
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\10\ 15 U.S.C. 78f.
\11\ On January 7, 2004 the Exchange filed a proposed rule
change pursuant to section 19(b) of the Act, SR-Phlx-2004-02, to
adopt fees applicable to Series A-1 Permits and to make conforming
changes to its fee schedule as a result of the demutualization. The
Merger Agreement provides that the effectiveness of the Merger (and
thus the Plan of Demutualization in general), among other things, is
conditioned upon such filing becoming effective or being approved by
the Commission, as the case may be. This proposed rule change was
filed as a fee change pursuant to Section 19(b)(3)(A)(ii) of the
Act, 15 U.S.C. 78(s)(b)(3)(A)(ii).
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A. Capital Structure of the Demutualized Phlx
Changes to the capital structure of the Phlx, as set forth in
Article FOURTH of the proposed Certificate of Incorporation, generally
reflect the proposed conversion of the Phlx from a non-stock Delaware
corporation to a demutualized Delaware stock corporation.
Pursuant to Article FOURTH of the proposed Certificate of
Incorporation, after the Merger, the authorized capital stock of the
Phlx will consist of:
50,500 shares of Class A Common Stock;
949,500 shares of Class B Common Stock, par
value $0.01 per share (``Class B Common Stock,'' and together with the
Class A Common Stock, the ``Common Stock''); and
100,000 shares of preferred stock, par value
$0.01 per share, one of which will be designated as ``Series A
Preferred Stock.''
Upon consummation of the demutualization, the only capital stock
outstanding will be the 50,500 shares of Class A Common Stock and the
single share of Series A Preferred Stock. The Exchange proposes to
authorize more shares of common stock (in the form of the Class B
Common Stock) and preferred stock to allow for a more flexible approach
to third-party investments and strategic relationships, which the
Exchange believes will be critically important to its survival. The
proposed Certificate of Incorporation will allow the Board of Governors
to create and issue in the future additional classes or series of
preferred stock without stockholder approval. In a separate
undertaking, however, the Exchange has agreed to submit any such
creation and issuance of additional classes or series of preferred
stock to the Commission pursuant to section 19(b) of the Act.\12\ The
issuance and the sale, transfer or other disposition of the Exchange's
capital stock will be subject to certain voting and ownership
limitations, described below.
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\12\ 15 U.S.C. 78s(b).
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1. Common Stock
a. Class A Common Stock and Class B Common Stock
Pursuant to Article FOURTH (b)(i) of the proposed Certificate of
Incorporation, the Class A Common Stock and the Class B Common Stock
will be identical in all respects and will have equal rights and
privileges, except for the right to receive the Contingent Dividend (as
defined below). Pursuant to Article FOURTH (b)(vi) of the proposed
Certificate of Incorporation, each share of Class A Common Stock will
automatically convert into one share of Class B Common Stock on the
third anniversary of the closing of the Plan of Demutualization (the
``Dividend Termination Date''). \13\ The proposed Certificate of
Incorporation will provide that, before the automatic conversion, the
Exchange will have to notify the holders of the Class A Common Stock in
accordance with certain specific requirements set forth in the
Certificate of Incorporation.
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\13\ The automatic conversion will be effected as a matter of
administrative convenience to consolidate the Common Stock into a
single class after the Contingent Dividend will no longer be
potentially payable (i.e., on the Dividend Termination Date). At the
time of conversion, because the Contingent Dividend will no longer
be potentially payable, the Class A Common Stock and the Class B
Common Stock will have identical rights and privileges.
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b. Dividends (Including the Contingent Dividend)
Currently, the existing Certificate of Incorporation provides that
the Phlx is ``not for profit'' and ``no capital stock shall ever be
issued and no dividend shall ever be paid'' by the Phlx. After the
demutualization, this restriction on paying dividends will be removed,
and the Phlx's stockholders will have all dividend and other
distribution rights of a stockholder in a Delaware stock corporation
(except as may be limited by the rights any preferred stock may have,
once issued).
Section 30-4 of the proposed By-laws, however, will prohibit the
payment of dividends from any revenues the Phlx derives from regulatory
fines, fees or penalties. The Exchange will apply this limitation to
its net income, prospectively only, commencing with the fiscal year in
which the Merger occurs.\14\ To determine the amount of the limitation,
the Phlx will first calculate: (i) the amount of regulatory fines, fees
and penalties that it has accrued for the fiscal year in which the
Merger occurs and later time periods (collectively, ``Regulatory Fee
Amount'');\15\ and (ii) the amount of
[[Page 3976]]
regulatory costs and expenses \16\ accrued for the same time period
(collectively, ``Regulatory Cost Amount''). The Exchange will determine
the applicable restriction by determining the excess, if any, of the
Regulatory Fee Amount over the Regulatory Cost Amount, and applying
that to the amount of its net income for the fiscal year in which the
Merger occurs and later periods. The Exchange advises that this
restriction concerning the payment of dividends shall not prevent it
from paying dividends from: (i) Capital, surplus or retained earnings
of the Exchange which were (without regard to this restriction)
available for the payment of dividends at the time of the Merger; or
(ii) capital contributions or other capital items, in each case, no
portion of which is attributable to Regulatory Fees.
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\14\ The Exchange indicates that its rationales for applying
this restriction prospectively are: (i) Prior to the effectiveness
of the Conversion Amendment, the Exchange's Certificate of
Incorporation has provided that the Exchange is ``not for profit''
and has prohibited the payment of dividends altogether; and (ii) the
Exchange has not compiled, and could not reasonably reconstruct, the
information necessary for determining Regulatory Costs and
Regulatory Fee Amounts (as defined herein) for prior periods.
\15\ According to the Exchange, regulatory fines and penalties
will include such amounts imposed by the Business Conduct Committee
and/or the Phlx's Board of Governors (``Board''), but not late
charges or interest charged. Regulatory fees shall include the
Exchange's fees relating to registered representative registration
(currently, initial, renewal and transfer fees), as well as its off-
floor trader (currently, initial and annual) and examinations fees.
\16\ In the Phlx's view, these amounts include costs reasonably
related to the Exchange's regulatory function. Specifically, the
Exchange intends to include the direct and allocated costs and
expenses of the regulatory and enforcement groups as well as an
allocation of the direct and allocated costs of technology, legal,
compliance and other departments that support the regulatory and
enforcement groups and work on regulatory projects. The Exchange's
cost allocation methodology includes an employee's compensation and
benefits-related costs and the overhead attributable to that
employee, such as, for example, occupancy costs, office supplies,
and administrative support and an allocation of management costs
(again, adding, for example, the secretary's and managers' direct
and allocated costs).
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Pursuant to Article FOURTH (b)(ii) of the proposed Certificate of
Incorporation, the Class A Common Stock will carry with it the right to
a contingent dividend (the ``Contingent Dividend'') payable in cash if
a Liquidity Event occurs on or before the Dividend Termination Date. A
``Liquidity Event'' will be any investment of net cash proceeds in the
Phlx's capital or that of one of its subsidiaries, either by means of a
public offering or private placement of the common or preferred stock
of the Phlx or the common stock or other securities of the subsidiary.
The amount payable as the Contingent Dividend will depend, as follows,
on the aggregate amount of net cash proceeds received by the Phlx and/
or the subsidiary from all Liquidity Events occurring on or before the
Dividend Termination Date:
If the aggregate net cash proceeds will be at
least $50 million but less than $100 million, the amount payable as a
Contingent Dividend will be $7,500 for each 100 shares of Class A
Common Stock ($3,787,500 in the aggregate).
If the aggregate net cash proceeds will be at
least $100 million but less than $150 million, the amount payable as a
Contingent Dividend will be $17,500 for each 100 shares of Class A
Common Stock then outstanding ($8,837,500 in the aggregate).
If the aggregate net cash proceeds will be at
least $150 million, the amount payable as a Contingent Dividend will be
$29,700 for each 100 shares of Class A Common Stock then outstanding
($14,998,500 million in the aggregate).
If no Liquidity Event occurs on or before the Dividend Termination
Date, the right to receive the Contingent Dividend will terminate
without further action on behalf of the Exchange and the Class A Common
Stock will be automatically converted into Class B Common Stock, as
indicated above.
c. Liquidation Rights and Preferences
Currently, Owners have the right to receive all distributions upon
a liquidation of the Exchange, on the basis of their pro-rata interest
in the Phlx, except as such right may be limited by certain rights of
the holders of FCO participations. After the demutualization, the Phlx
Common Stock will have the right to receive all distributions upon a
liquidation of the Phlx, subject to the rights of any preferred stock
that may be issued in the future and the rights of the holder of the
Series A Preferred Stock.
d. Voting Rights/Election of Directors
Currently, non-Member Owners do not have voting rights under the
Exchange's existing Certificate of Incorporation, By-laws and Rules
with respect to any matters relating to the Exchange, with certain very
limited exceptions.\17\ After the demutualization, pursuant to Article
FOURTH (b)(iii) of the proposed Certificate of Incorporation, the
holders of Phlx Common Stock will vote on all matters on which
stockholders are entitled to vote except for the election and removal
of the On-Floor Governors, and, in the case of a contest for the
position, the selection of the On-Floor Vice Chairman of the Exchange.
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\17\ In addition, existing contractual arrangements between
Owners of Seats or Member Organizations, on the one hand, and non-
Owner Members, on the other hand, such as leases or A-B-C
agreements, in all but one case contain a provision that entitles
the Seat Owner or the Member Organization, respectively, to direct
the Member's vote with respect to the Plan of Demutualization.
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The holders of the Class A Common Stock and Class B Common Stock
will vote together as a single class on all matters, except that: (i)
any amendment, alteration or repeal of any of the provisions of the
proposed Certificate of Incorporation that adversely affects the
rights, powers or privileges of the Class A Common Stock (but not of
the Class B Common Stock) will require the affirmative vote of a
majority of the shares of the Class A Common Stock then outstanding,
voting separately as a class; and (ii) any amendment, alteration or
repeal of any of the provisions of the proposed Certificate of
Incorporation that adversely affects the rights, powers or privileges
of the Class B Common Stock (but not of the Class A Common Stock) will
require the affirmative vote of a majority of the shares of Class B
Common Stock then outstanding, voting separately as a class.
In addition, pursuant to Section 22-1 of the proposed By-laws, the
By-Laws may be amended by the affirmative vote of a majority of the
entire Board of Governors, or by the affirmative vote of the holders of
a majority of the shares of common stock then issued and outstanding,
at any regular or special meeting of the Board of Governors or the
stockholders (as the case may be). Unlike pursuant to Section 22-1 of
the existing By-laws, after the demutualization, Members (or Member
Organizations) will have no right to vote in relation to By-law
amendments or to propose By-law amendments. The Phlx states that such
change is consistent with the Exchange's proposed post-demutualization
structure as a Delaware stock corporation in accordance with applicable
Delaware law.
With respect to management equity awards, Section 6-1 of the
proposed By-laws provides that, the Exchange will not at any time adopt
any stock incentive or option plan or arrangement, or any other equity
based compensation plan or arrangement, for the benefit of its
governors or officers that authorizes the issuance of stock, stock
options or any other securities exercisable or exchangeable for or
convertible into any equity interest in the Exchange representing more
than 10% of the Common Stock outstanding at such time.
e. Voting Limitations Regarding the Common Stock
Article FOURTH (b)(iii)(A) of the proposed Certificate of
Incorporation provides that each stockholder will be entitled to one
vote for each share of Common Stock held of record on the books of the
Phlx, subject to the applicable voting restrictions as described below.
In connection with the demutualization, the Exchange proposes to
include certain voting limitations as set forth in Article FOURTH
(b)(iii)(B) of the proposed Certificate of Incorporation. The
limitations will provide that, if any Person (as defined
[[Page 3977]]
below) either alone or together with its Related Persons (as defined
below), at any time owns of record or beneficially, whether directly or
indirectly, more than 20% of the then outstanding shares of Common
Stock (such shares of Common Stock in excess of such 20% limit being
hereinafter referred to as ``Excess Shares''), that Person and its
Related Persons will not have any right to vote, or to give any consent
or proxy with respect to, the Excess Shares, and the Excess Shares will
be deemed not to be present for the purposes of determining whether a
quorum is present at any meeting or vote of the stockholders of the
Exchange. For purposes of the proposed Certificate of Incorporation,
``Related Persons'' means: (i) with respect to any Person, all
``affiliates'' and ``associates'' of such Person (as such terms are
defined in Rule 12b-2 under the Act);\18\ (ii) with respect to any
natural person constituting a ``member'' (as such term is defined in
the Act) of the Exchange, any broker or dealer with which such member
is associated; and (iii) any two or more Persons that have any
agreement, arrangement or understanding (whether or not in writing) to
act together for the purpose of acquiring, holding, voting or disposing
of shares of common stock. The term ``Person'' will be defined in the
proposed Certificate of Incorporation to mean an individual,
partnership (general or limited), joint-stock company, corporation,
limited liability company, trust or unincorporated organization, and a
government or agency or political subdivision thereof.
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\18\ 17 CFR 240.12b-2.
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Notwithstanding the foregoing, a Person, either alone or together
with its Related Persons, owning of record or beneficially, whether
directly or indirectly, more than 20% of the then outstanding shares of
Common Stock will be allowed to exercise voting rights, and give
proxies and consents, with respect to those shares exceeding 20%,
provided that:
such Person (and its Related Persons owning any
Common Stock) has delivered to the Board of Governors a notice in
writing, not less than 45 days (or any shorter period to which the
Board of Governors shall expressly consent) before the proposed
exercise of its voting rights, of its intention to do so; and
before the intended exercise, the Board of
Governors has adopted an amendment to the By-Laws adding a provision to
expressly permit such Person's exercise of voting rights in excess of
20%; and the amendment has been filed with the Commission as a proposed
rule change under Section 19(b) of the Act \19\ and has become
effective.
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\19\ 15 U.S.C. 78s(b).
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The Board of Governors will not be permitted to adopt any amendment
to the proposed By-laws described in the foregoing paragraph unless the
Board of Governors has determined that: (i) the exercise of those
voting rights by the Person in question and/or its Related Persons will
not impair the Exchange's ability to discharge its responsibilities
under the Act and the rules and regulations thereunder and is otherwise
in the best interests of the Exchange and its stockholders; (ii) the
exercise of those voting rights by that Person and its Related Persons
will not impair the Commission's ability to enforce the Act; and (iii)
that Person and its relevant Related Persons are not subject to any
applicable statutory disqualification. In making those determinations,
the Board of Governors may impose on the Person in question and its
Related Persons such conditions and restrictions as it may in its sole
discretion deem necessary, appropriate or desirable in furtherance of
the objectives of the Act and the governance of the Exchange. Under the
proposed Certificate of Incorporation, however, in no event will a
Person who is a Member of the Exchange, either alone or together with
its Related Persons, be permitted to vote shares in excess of 20% of
the outstanding Common Stock.\20\
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\20\ See Section II.A.1.f. for a discussion regarding the
ownership limitations placed on Members under the proposed
Certificate of Incorporation.
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f. Ownership Limitations, Notification Requirements and Transfer
Requirements Regarding the Common Stock
Pursuant to Article FOURTH (b)(v) of the proposed Certificate of
Incorporation, no Person, either alone or together with its Related
Persons, will be allowed to own, of record or beneficially, directly or
indirectly, more than 40% of the then outstanding shares of Common
Stock of the Phlx and to the extent any Person (or its Related Persons)
purports to own more than 40% of the then outstanding shares of common
stock, that Person (and its Related Persons) will not be allowed to
exercise any of the rights or privileges incident to the ownership of
shares of common stock with respect to the shares exceeding the 40%
limit, unless:
such Person (as well as its Related Persons) has
delivered to the Board of Governors a notice in writing, not less than
45 days (or such shorter period to which the Board of Governors
expressly consents) before the acquisition of that ownership, of its
intention to acquire the ownership; and
before the intended exercise, the Board of
Governors has adopted an amendment to the By-Laws, adding a provision
to expressly permit that Person's ownership in excess of 40%, and the
amendment has been filed with the Commission as a proposed rule change
under Section 19(b) of the Act, which has become effective.
The Board of Governors will not be permitted to adopt any amendment
to the proposed By-laws described in the foregoing paragraph unless the
Board of Governors has determined that: (i) Such acquisition of such
ownership by such Person in question and/or its Related Persons will
not impair the Exchange's ability to discharge its responsibilities
under the Act and the rules and regulations thereunder and is otherwise
in the best interests of the Exchange and its stockholders; (ii) such
acquisition of such ownership by such Person and its Related Persons
will not impair the Commission's ability to enforce the Act; and (iii)
that Person and its relevant Related Persons are not subject to any
applicable statutory disqualification. In making those determinations,
the Board of Governors may impose on the Person in question and its
Related Persons such conditions and restrictions as it may in its sole
discretion deem necessary, appropriate or desirable in furtherance of
the objectives of the Act and the governance of the Exchange.
Unless the conditions specified above are met, if any Person
exceeds the 40% threshold, either alone or together with its Related
Persons, the Phlx will have the right, but not the obligation, to
purchase from that Person and its Related Persons the shares of Common
Stock that exceed the 40% threshold for a price equal to the par value
of the shares of Common Stock.
In addition, pursuant to Article FOURTH (b)(v)(B) of the proposed
Certificate of Incorporation, no Member, either alone or together with
its Related Persons, will be allowed to own, of record or beneficially,
directly or indirectly, more than 20% of the then outstanding shares of
Common Stock of the Exchange. To the extent that any Member (or its
Related Persons) purports to so own more than 20% of the then
outstanding shares of Common Stock, that Member (and its Related
Persons) will not be allowed to exercise any of the rights or
privileges incident to the ownership of shares of Common Stock with
respect to the shares exceeding the 20% limit.
[[Page 3978]]
If any Member exceeds the 20% threshold, either alone or together
with its Related Persons, the Phlx will have the right, but not the
obligation, to purchase from that Member and its Related Persons the
shares of Common Stock that exceed the 20% threshold for a price equal
to the par value of the shares of Common Stock. Also, unlike ownership
by non-Members in excess of 40%, the proposed Certificate of
Incorporation does not contain a proviso allowing for Members to own
shares in excess of 20% with appropriate notification and a By-law
amendment sanctioned by the Commission.
In addition, pursuant to Article FOURTH (b)(iv) and (v) of the
proposed Certificate of Incorporation, any Person, either alone or
together with its Related Persons, that at any time owns (whether by
acquisition or by a change in the number of shares outstanding) of
record or beneficially, directly or indirectly, 5% or more of the then
outstanding shares of Common Stock will be required, immediately upon
so owning 5% or more of the then outstanding shares of Common Stock, to
give the Board of Governors written notice of that ownership and will
be required to update the notice promptly after any ownership change.
However, an updated notice will not have to be provided to the Board of
Governors in the event of an increase or decrease of less than 1% (of
the then outstanding shares of Common Stock) in the ownership
percentage so reported (for that purpose, the increase or decrease will
be measured cumulatively from the amount shown on the immediately
preceding report) unless such increase or decrease of less than 1%
results in such Person's owning more than 20% or more than 40% of the
shares of Common Stock then outstanding (at a time when such Person so
owned less than those percentages) or results in such Person's owning
less than 20% or less than 40% of the shares of Common Stock then
outstanding (at a time when such Person so owned more than those
percentages). These voting and ownership limitations, together with the
notification requirements, are intended to establish a system of
supervision and control to effectively prevent acquisition of voting
power of or assertion of control over the Exchange without the approval
of both the Board of Governors and the Commission. In addition, the
proposed 20% threshold on member ownership is designed to prevent any
Member Organization from dominating the Exchange. These notification
requirements will also allow the Exchange to fulfill its reporting
obligations to the Commission \21\ and to better monitor the voting and
ownership limitations in the proposed Certificate of Incorporation
described above.
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\21\ 17 CFR 249.1a.
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g. Transfer Restrictions
Pursuant to Section 29-1 of the proposed By-laws, no stockholder of
the Exchange may sell, transfer (by operation of law or otherwise) or
otherwise dispose of any shares of Class A Common Stock except in
blocks of 100 shares per sale, transfer or disposition. This transfer
restriction is intended to ensure that the number of holders of common
stock of the Exchange will not exceed the threshold for having to
register the Exchange with the Commission under Section 12 of the
Act.\22\ The Exchange believes that, at least for some period of time
after the demutualization, the obligation of being a public reporting
company would be overly burdensome on the Exchange as compared to the
advantages conferred by that status.
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\22\ 15 U.S.C. 78l.
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In addition, the Phlx states that Article 29 of the proposed By-
laws contains other restrictions typical for a Delaware stock
corporation to ensure compliance with the Securities Act of 1933
(``Securities Act''),\23\ and to allow for efficient future marketing
of the capital stock by an underwriter in connection with and after a
potential initial public offering of shares of capital stock of the
Exchange.\24\ Accordingly, Section 29-2 of the proposed By-laws
provides that after the demutualization, no sale, transfer or other
disposition of the capital stock of the Exchange may be effected
except: (i) Pursuant to an effective registration statement under the
Securities Act and in accordance with all applicable state securities
laws; (ii) upon delivery to the Exchange of an opinion of counsel
satisfactory to the Board that such sale, transfer or other disposition
may be effected pursuant to a valid exemption from the registration
requirements of the Securities Act and all applicable state securities
laws; (iii) upon delivery to the Exchange of such certificates or other
documentation as counsel to the Exchange shall deem necessary or
appropriate in order to ensure that such sale, transfer or other
disposition complies with the Securities Act and all applicable state
securities laws; or (iv) pursuant to such procedures as the Chairman of
the Board (or his designee) may adopt from time to time with respect to
such transactions. In addition, no sale, transfer or other disposition
of the capital stock of the Exchange may be effected by any holder of
such stock until all amounts due and owing by such holder to the
Exchange (whether any such amounts relate to such holder's status as a
stockholder, Member, participant or Member (or participant)
Organization of the Exchange or otherwise) shall have been paid in
full.
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\23\ 15 U.S.C. 77.
\24\ The Phlx notes that no such transaction is currently
contemplated at this time.
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In addition, Section 29-3 of the proposed By-laws provides that no
stockholders, if requested by the Exchange or any underwriter of equity
securities of the Exchange, may sell or otherwise transfer or dispose
of any shares of capital stock of the Exchange held by such stockholder
during the 180-day period following the effective date of a
registration statement of the Exchange filed under the Securities Act
in respect of that class of capital stock. If requested by the Exchange
or any such underwriters, each stockholder will be required to execute
an agreement to the foregoing effect. The Exchange may impose stop-
transfer instructions with respect to the shares (or securities)
subject to the foregoing restriction until the end of said 180-day
period.
2. Series A Preferred Stock/Phlx Member Voting Trust
a. Designation and Issuance of Series A Preferred Stock to Phlx Member
Voting Trust/Trust Agreement
Article FOURTH of the proposed Certificate of Incorporation will
designate one share of preferred stock as the ``Series A Preferred
Stock.'' The Series A Preferred Stock will have the sole power to: (i)
Select the On-Floor Governors, and (ii) remove the On-Floor Governors
in accordance with specified procedures in connection with the removal
of Governors.
As set forth in the Trust Agreement, at the effective time of the
Merger, the Exchange will issue the share of Series A Preferred Stock
to the Trust. Pursuant to Section 4.1 of the Trust Agreement, the
Trustee of the Trust will have to vote the share of Series A Preferred
Stock with respect to the designated nominees for election as On-Floor
Governors, or the removal of On-Floor Governors, as the case may be, as
directed by the vote of the Member Organization Representatives of
Member Organizations entitled to vote.
The single share of the Series A Preferred Stock, issued to the
Trust governed by the Trust Agreement, is designed to facilitate the
exercise by Members and Member Organizations of their rights to fair
representation in the
[[Page 3979]]
selection and removal of On-Floor Governors of the Exchange and to
facilitate the administration of the affairs of the Exchange in
accordance with the Act. The voting arrangements implemented through
the Trust Agreement and the Series A Preferred Stock are designed to
give ``members'' (as defined in Section 3(a)(3)(A) of the Act) \25\ a
voice in the management of the Exchange after the demutualization.
These arrangements are necessary for two reasons: (i) Under Delaware
law, only stockholders can elect the directors of a Delaware
corporation; and (ii) after the demutualization, Members and Member
Organizations that were not Owners at the time of the demutualization
will not be stockholders of the Exchange.
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\25\ 15 U.S.C. 78c(a)(3)(A).
---------------------------------------------------------------------------
b. Dividend Rights
Because the Series A Preferred Stock will be issued only to enable
the non-stockholder Member Organizations to vote indirectly for the On-
Floor Governors, Article FOURTH (a)(i) of the proposed Certificate of
Incorporation will provide that the Series A Preferred Stock will not
have the right to receive any dividends.
c. Liquidation Preferences
Pursuant to Article FOURTH (a)(ii) of the proposed Certificate of
Incorporation, upon liquidation of the Phlx the holder of the share of
Series A Preferred Stock will be entitled to receive an amount equal to
the par value of the share of Series A Preferred Stock (or $0.01) held
by the holder after the payment of, or provision for, obligations of
the Phlx and any preferential amounts payable to holders of any other
class or series of outstanding shares of preferred stock.
d. Transferability
Article FOURTH (a)(iv) of the proposed Certificate of Incorporation
will provide that the Series A Preferred Stock will not be transferable
(whether by sale, pledge, operation of law or any other disposition)
without the prior written consent of the Board. If the Board determines
that it is in the best interests of the Exchange or its stockholders
for any holder of the share of Series A Preferred Stock to sell the
share to the Exchange or any other person, the holder will be required
under Article FOURTH (a)(iii) of the proposed Certificate of
Incorporation to effect the sale as directed by the Board.\26\
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\26\ Any proposal to sell the Series A Preferred Stock would
have to be filed with the Commission pursuant to Section 19(b) of
the Act.
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B. Corporate Governance of the Demutualized Phlx
According to Article SIXTH of the proposed Certificate of
Incorporation and Sections 4-1 and 4-4 of the proposed By-laws, the
principal management of the Phlx after demutualization will continue to
rest with the Board and the Standing Committees of the Exchange. To
ensure compliance with the Act in the context of a demutualized
Exchange, Article SIXTH of the proposed Certificate of Incorporation
will provide that, in managing the business and affairs of the Phlx,
the Governors will have to consider applicable requirements for
registration as a national securities exchange under Section 6(b) of
the Act,\27\ including the requirements that: (i) the rules of the Phlx
be designed to protect investors and the public interest, and (ii) the
Phlx be so organized and have the capacity to carry out the purposes of
the Act and (except as otherwise provided in the Act or the rules and
regulations thereunder) to enforce compliance by its Members and
persons associated with its Members with the Act, the rules and
regulations thereunder, and the rules of the Phlx.
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\27\ 15 U.S.C. 78s(b).
---------------------------------------------------------------------------
1. Board of Governors--Composition; Eligibility
Article SIXTH of the proposed Certificate of Incorporation,
together with Section 4 of the proposed By-laws, will set forth the
required number and composition of the Board. Pursuant to Section 4-1
of the proposed By-laws, the composition of the Board will be the same
as before the demutualization and, as set forth in Section 4-3(b) of
the proposed By-laws, will consist initially of the same individuals in
office at the time of the demutualization. According to Article SIXTH
(a) of the proposed Certificate of Incorporation, the Board will
continue to have a total of 22 Governors and be composed as follows:
the Chairman of the Board, who will be the
individual then holding the office of Chief Executive Officer
(``CEO'');
11 Non-Industry Governors (of whom at least five
will have to be public Governors); and
10 Industry Governors (of whom five will have to
be On-Floor Governors and five will have to be Off-Floor Governors).
The criteria set forth in the Exchange's current By-laws for
eligibility of persons to serve as a Governor within each category of
Governor will remain the same after demutualization.
2. Board of Governors--Classification and Term Limits
According to Section 4-3(a) of the proposed By-laws, the Board will
remain classified, with Governors serving staggered three-year terms.
Governors (other than the Chairman) may serve for up to two consecutive
three-year terms starting from the effective time of the Merger. In
order to preserve continuity post-demutualization, Section 4-3(b) of
the proposed By-laws will provide that Governors who hold their
positions at the effective time of the Merger will continue to hold
those positions, in their respective classes, until their original
terms expire and that the term limits will not take into consideration
any service as Governor before the demutualization but will only apply
from and after the effective time of the Merger. The Exchange believes
that this provision serves to ensure continuity in the governing body
of the Exchange through such a significant corporate event as the
demutualization.
3. Nomination and Election of Governors
According to the Phlx, the Exchange's nomination and election
procedures are revised to ensure continuing fair representation for
Members and Member Organizations in the context of the demutualized
Exchange, while at the same time adapting the Exchange to its proposed
status as a demutualized business corporation with stockholders.
Generally, the new nomination and election structure of the Exchange
will be as follows:
The Non-Industry Governors, Off-Floor Governors
and the Chairman of the Board will continue to be nominated by the
Nominating and Elections Committee and will be elected by the holders
of the Common Stock at meetings of stockholders.
Stockholders will be permitted to make
independent nominations of Non-Industry and Off-Floor Governors upon
written notice of the nominations not less than 90 nor more than 120
days before the first Monday in February of each year (or such other
date as the Board may establish). These nominations will be subject to
review by the Nominating and Elections Committee.
Member Organizations, as described below, will designate the On-
Floor Governors in accordance with the following procedures:
On-Floor Governors will be nominated by the
Nominating and Elections Committee from recommendations made: (i) By
members
[[Page 3980]]
of the Nominating and Elections Committee; or (ii) by any Member,
participant or Member Organization Representative.
Independent nominations by Member Organization
Representatives will be valid only if signed by Member Organization
Representatives representing no less than 50 votes.
Member Organizations, through their authorized
Member Organization Representative, will vote for designated On-Floor
Governors among nominees so selected at the annual meeting of Members
and Member Organizations.
Nominees for Governors receiving the highest
numbers of votes for the category of Governor for which they were
respectively nominated as candidates will be declared the ``Designated
Nominees'' for those offices. In case of a tie, the Nominating and
Elections Committee will make the selection as to who among the tying
nominees shall be designated.
On-Floor Governors will then be elected by the
Trust owning the share of Series A Preferred Stock based on the
``Designated Nominees'' elected by the Member Organization
Representatives as described above.
4. Governors--Vacancies and Removal
In accordance with Section 3-8 of the proposed By-laws, vacancies
(including vacancies created by increases in the size of the Board of
Governors) will continue to be filled by the Nominating and Elections
Committee, upon approval by a majority of the Governors. With respect
to the removal of Governors, Article SIXTH (b) of the proposed
Certificate of Incorporation and Sections 3-3 and 4-4 of the proposed
By-laws will provide that Governors may be removed only for cause or,
under certain circumstances, upon recommendation by a majority of the
Board of Governors. In addition, Governors may be removed only by a
66\2/3\% vote of the group that elected them (i.e., the holders of
common stock, in the case of the Non-Industry or Off-Floor Governors,
or the share of Series A Preferred Stock as instructed by a vote of the
Member Organization Representatives, in the case of the On-Floor
Governors).
An On-Floor Governor may be removed at any annual or special
meeting. A special meeting for the removal of an On-Floor Governor may
be called by the Chairman of the Board of Governors or the Board of
Governors or, only in the case of a special meeting of Member
Organization Representatives for the purpose of voting on the removal
of an On-Floor Governor, by the Member Organization Representatives
representing a majority of the then issued and outstanding permits. If
such a meeting is proposed to be called by Member Organization
Representatives, such Member Organization Representatives must provide
the Chairman written notice prior to calling any such meeting stating
in reasonable detail the basis for, and the facts and circumstances
purported to warrant, such removal of the relevant On-Floor Governor.
5. Committees
No changes will be made in Board committee structure or composition
as part of the demutualization process, except as follows:
pursuant to Sections 10-6 and 10-17 of the
proposed By-laws, respectively, at least half of the Admissions
Committee and the Foreign Currency Options Committee, respectively,
will have to be Members, participants or persons affiliated with Member
Organizations or participant organizations;
pursuant to Sections 10-20 and 10-16 of the
proposed By-laws, respectively, at least half of the Options Committee
and the Floor Procedure Committee, respectively, will have to be
Members or persons affiliated with Member Organizations;
pursuant to Section 10-6 of the proposed By-
laws, the Business Conduct Committee will share with the Admissions
Committee jurisdiction over the revocation of permits and foreign
currency options participations in connection with disciplinary
matters; and
pursuant to Section 10-7(a) and (b) of the
proposed By-laws, certain term limits applicable to members of the
Allocations Committees will be eliminated.
The existing Certificate of Incorporation and By-laws do not
include any specification as to the composition of the Admissions
Committee, Foreign Currency Options Committee, the Options Committee or
the Floor Procedure Committee and, therefore, do not require the
committees to include any Industry Governors. Accordingly, the Phlx
states that the proposed rule change will ensure participation of
Industry Governors on each of these committees, thereby allowing
Industry Governors to take part in decisions made in vital areas of
day-to-day trading operations and membership matters. The elimination
of term limits respecting the Allocations Committees is intended to
achieve consistency with most other committees, which do not have such
limits.
6. Management and Executive Officers
The management structure of the Exchange, including its executive
officers, will remain unchanged in the demutualization in accordance
with Article V of the proposed By-laws. The CEO position will continue
to be a full-time position to be appointed by the Board, and the holder
of this position will act as the Board's Chairman. The person acting as
CEO at the time of the demutualization will be the only nominee for the
position of Chairman of the Board, and will be elected by the votes of
the holders of the Common Stock. The existing requirement that the CEO
may not be a partner of a Member (or participant) Organization, nor an
employee, agent, consultant, officer, director or stockholder of a
Member (or participant) Organization will be retained. The CEO will
appoint the other officers of the Exchange.
7. Limitation of Liability and Indemnification
Articles FIFTEENTH and SIXTEENTH of the proposed Certificate of
Incorporation and Section 4-18 of the proposed By-laws will include
provisions substantially similar to the Article EIGHTEENTH of the
existing Certificate of Incorporation, in accordance with Section 145
of the Delaware General Corporation Law. Such provisions eliminate the
personal liability of Governors (and other persons mentioned below) for
monetary damages for breach of fiduciary duty as a Governor, except for
liability:
for any breach of the Governor's duty of loyalty
to the Phlx or its stockholders;
for acts or omissions not in good faith or that
involve intentional misconduct or a knowing violation of law;
under Section 174 of the Delaware General
Corporation Law regarding unlawful dividends and stock purchases; or
for any transaction from which the Governor
obtained an improper personal benefit.
The proposed Certificate of Incorporation and By-laws will further
permit the Phlx to indemnify to the fullest extent permitted under and
in accordance with the laws of the State of Delaware any Governor (or
director) or officer of the Phlx, and any person that is or was serving
at the request of the Phlx as a Governor, committee member or in-house
legal counsel, officer, director (or person in similar position),
employee or agent of another corporation or of a partnership (general
or limited), limited liability company,
[[Page 3981]]
joint venture, trust or other enterprise or business entity, against
expenses (including attorneys' fees), judgments, fines and amounts paid
in settlement actually and reasonably incurred by the person in
connection with any action, suit or proceeding if the person acted in
good faith and in a manner the person reasonably believed to be in or
not opposed to the best interests of the Phlx, and, with respect to any
criminal action or proceeding, had no reasonable cause to believe the
person's conduct was unlawful. The Phlx may also pay the expenses of
indemnified persons incurred in defending a suit or proceeding in
advance of the final disposition of the suit or proceeding. The
proposed Certificate of Incorporation will also permit the Phlx to
secure insurance on behalf of any officer, director, employee or other
agent for any liability arising out of his or her actions in that
capacity. The Exchange believes that these indemnification provisions
are substantially similar to those generally employed by other Delaware
stock corporations and the scope of the persons covered is intended to
continue to attract and retain qualified personnel.
C. Members and Member Organizations
1. Member Organizations and Member Organization Representatives
As under the current structure, a Member will continue to be
permitted to be associated with more than one Member Organization.\28\
In accordance with proposed Rule 908(c)(ii), each holder of a permit
will be obliged, however, to designate only a single eligible
organization with which the Member is associated as the Member's
``primary affiliation'' for the purposes of voting, as will be provided
in Article III of the proposed By-laws. A Member will be allowed to
qualify as a Member Organization only the entity the Member has
designated as his or her primary affiliation. Accordingly, every Member
shall have one primarily-affiliated Member Organization and may have
more than one associated Member Organization.
---------------------------------------------------------------------------
\28\ See Phlx Rule 793.
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Unlike the current Phlx regime, after demutualization, individual
Members will not directly be accorded voting rights. Rather, in regard
to the election and removal of On-Floor Governors, Member Organizations
will be entitled to exercise voting rights in respect of the permits
held by those Members who have designated the Member Organization as
their primary affiliation. Specifically, pursuant to proposed Rule 921
and Section 12-8 of the proposed By-laws, each Member Organization will
have to register with the Exchange and designate a single individual as
its ``Member Organization Representative.'' The concept of a Member
Organization Representative is designed to facilitate the post-
demutualization voting process. Permit holders, or Members, themselves
will not exercise any voting rights. Instead, voting rights associated
with a permit will be exercised by the Member Organization with which
the Member is primarily associated and, as noted above, will be
exercised by the Member Organization's Member Organization
Representative. The Member Organization Representative will be the only
person who may exercise the voting rights in respect of the Member
Organization in respect of matters on which Member Organizations may
vote. Proposed Rule 921 also will provide that a Member Organization
Representative will have to accept the designation by filling out a
registration documentation required by the Exchange.
Pursuant to proposed Rules 921 and 972, with the exception of
certain provisions in proposed Rule 921(c) retaining the existing
concept of ``inactive nominees'' in order to alleviate hardships,
failure to qualify a Member Organization Representative at any time
will prevent a Member Organization from exercising any rights in
connection with the Exchange, including the right to vote for
designated On-Floor Governors as described below.
According to proposed Rule 924, Members \29\ will be liable with
respect to any fees, fines, dues, penalties or other amounts imposed by
the Exchange in connection with such Member's permit or any activities
conducted in connection with such permit, whether or not any such
obligation was incurred on behalf of his account or on behalf of his
Member Organization. In addition, proposed Rule 924 will provide that
Member Organizations will be liable with respect to any fees, fines,
dues, penalties or other amounts imposed by the Exchange in connection
with such Member Organization and any Member associated with such
Member Organization in connection with a permit or any activities
conducted in connection with such permit by such Member on behalf or
for the account of such Member Organization. Under proposed Rule
924(b), similar to the rule in effect today, Member Organizations will
have the ability to allocate responsibilities among themselves
regarding Members associated with more than one Member Organization,
provided that any such arrangements have been provided to the Exchange
in the form required by it at least 30 days prior to their desired
effectiveness.
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\29\ This rule also applies to FCO participants and participant
organizations with respect to FCO participations.
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2. Voting Rights
After the demutualization, holders of permits will not have any
voting rights. Member Organizations will have the right to:
designate the five On-Floor Governors for
election to the Board in accordance with Section 3-12 of the proposed
By-laws;
remove the On-Floor Governors in accordance with
Sections 3-2(c) and 3-3 of the proposed By-laws (together with the
right to designate the On-Floor Governors, the ``Designation Rights'');
and
designate the On-Floor Vice-Chair in a contested
election as described below.
Each permit will carry one vote. As discussed above, the vote may
be exercised only by the qualified Member Organization Representative
of a Member Organization designated by a holder of a permit as its
primary affiliation.
The Designation Rights will be exercised in accordance with the
following procedure:
based on input from the membership or others,
the Nominating and Elections Committee will propose a slate of
qualified On-Floor Governors;
in addition, the Member Organization
Representatives, representing at least 50 permits, will be permitted to
propose qualified alternative candidates;
the Member Organization Representatives, at an
annual meeting of Members and Member Organizations, will then elect the
designated On-Floor Governors from among the Nominating and Elections
Committee's slate and any qualified individuals nominated by Member
Organization Representatives in accordance with the nomination
procedures.
The winners of this election will then be eligible for designation
as On-Floor Governors. In compliance with Delaware corporate law, the
designated On-Floor Governors will be formally elected by the Trust
that holds the single outstanding share of Series A Preferred Stock in
accordance with Article FOURTH (a)(iii) of the proposed Certificate of
Incorporation.
[[Page 3982]]
3. Contested Election of the On-Floor Vice Chairman
With respect to the election of the On-Floor Vice Chairman, Section
4-2 of proposed By-laws will provide that, if there is a contest for
the position of On-Floor Vice Chairman of the Board, the On-Floor Vice
Chairman of the Board may be selected from the On-Floor Governors by a
vote of the Member Organization Representatives, as promptly as
possible after the annual meeting of stockholders at a special meeting
of Members and Member Organizations called for that purpose.
4. Voting Concentration Limits
In order to prevent any group of Members of Member Organizations
from dominating elections of the Member Organization Representatives,
the proposed By-laws will provide in Section 3-12(c) that if any Member
Organization, directly or indirectly, possesses the right to vote more
than 20% of the then outstanding permits, that Member Organization will
not have any right to vote, or to give any consent or proxy with
respect to, any permits exceeding the 20% (``Excess Permits''), and the
Excess Permits will not be considered present for the purposes of
determining whether a quorum is present at any meeting or vote of the
Members or Member Organizations, and will not be entitled to vote in
determining the number of permits required for a quorum or to be voted
for approval of or to give consent with respect to any matter presented
to the Members or the Member Organizations.
5. Member and Member Organization Meetings and Actions
Pursuant to Section 3-2 of the proposed By-laws, annual meetings of
Members and Member Organizations will be held on the second Monday in
March of each year to designate nominees for On-Floor Governors. Except
with respect to a special meeting called for the purpose of removing an
On-Floor Governor, special meetings of Members or the Member
Organization Representatives may be called at any time only by the
Chairman of the Board or by a majority of the Board.
At all meetings of Members and Member Organizations, each Member
Organization Representative may cast his or her vote in person or by
proxy, provided that no action will become effective unless there shall
have been voted a majority of the number of permits outstanding at such
time, not including any Excess Permits. Each Member Organization
Representative may cast the number of votes equal to the number of
permits held by Members having designated the Member Organization
Representative's Member Organization as its primary affiliation
(subject to the voting restrictions described above).
Section 3-11 of the proposed By-laws will provide that notice of
any meeting of Members and Member Organizations must be given to each
Member Organization Representative entitled to vote at such meeting not
less than 10 days nor more than 50 days before the date of the meeting.
6. Disciplinary Actions and Appeal Process
The Exchange states that enforcement of any disciplinary action and
appeals of any disciplinary action will be conducted in the same manner
as before the demutualization.
D. Permits and Trading Rights
1. Issuance of Permits and Application Process
Under the proposed Plan of Demutualization, access to the Exchange
facilities and the right to trade will be conferred by the newly-issued
permits rather than by ownership or leasing of Seats of the Exchange.
As discussed above, trading of foreign currency options will continue
to be allowed through the existing FCO participations, but, following
the demutualization, will also be permitted through permits, as will be
provided in proposed Rule 908(c)(i).
Proposed Rule 971 will provide that all ETPs and ETP use agreements
will terminate with immediate effect as of the close of trading on the
day the Merger becomes effective without any further action on the part
of any party thereto. Similarly, proposed Rule 971 will also provide
that all leases of Seats and all leases and A-B-C agreements with
respect to such Seats, will terminate with immediate effect as of the
close of trading on the day the Merger becomes effective without any
further action on the part of any party thereto. All provisions in the
Certificate of Incorporation, By-laws and Rules relating to the
transfer or lease of a Seat or A-B-C agreement, and all defined terms
related thereto (such as ``Lessor'' and ``Lessee'') will be amended as
necessary to reflect that, after the demutualization, these provisions
and defined terms will only apply to FCO participations. These
provisions will no longer be applicable to permits, because permits
(including the Series A-1 Permits) will not constitute property that
can be transferred by its holder (except within the same member
Organization). Similarly, the provisions relating to ETPs, such as Rule
23, will be deleted.
To provide an orderly transition from Seats to permits, proposed
Rule 972 will allow each Member (including, without limitation, each
holder of an ETP), inactive nominee and Member Organization holding
that status immediately before the effective time of the Merger that,
at that time, is not subject to any suspension of that status, to
maintain that status. All Members and ETP holders who fulfill the
requirements described in the previous sentence will receive Series A-1
Permits immediately upon the demutualization.
Proposed Rule 972 will also provide that existing Member
Organizations will maintain their status for a period of 15 days
following the Merger. Each Member Organization, however, will have to
provide to the Admissions Committee and the Exchange, as applicable,
before the end of the 15-day period, the following:
the security deposit or alternative compliance
with proposed Rule 909 (the ``security requirement'') (as described
below);
the form to be filed by the Member
Organization's qualifying permit holder; and
the designation of the Member Organization's
Member Organization Representative in the form prescribed by the
Exchange.
If a Member Organization fails within that period to comply with
the security requirement and/or to furnish the form to be filed by the
Member Organization's qualifying Member, the Member Organization's
status as such will immediately be suspended. If a Member Organization
fails to designate a Member Organization Representative, the Member
Organization may not exercise any voting rights with respect to any
permits held by persons who are associated with the Member
Organization.
2. Classes or Series of Trading Permits
Immediately after the demutualization, pursuant to Section 12-1 of
the proposed By-laws and proposed Rule 908, there will be only one
series of permit, called the ``Series A-1 Permit,'' which will confer
upon its holder all the rights and privileges of a Member of the
Exchange. An individual will be allowed to hold a Series A-1 Permit if
he or she meets the qualification criteria that will be set forth in
Article XII of the proposed By-laws and Rules 901 and 908 and/or may be
imposed by the Admissions Committee (which criteria the Exchange
intends will remain largely the same as
[[Page 3983]]
they were before the demutualization), including the requirements that
a Member be an individual at least 21 years of age and be associated
with a Member Organization.\30\ Pursuant to Sections 12-1 and 12-4 of
the proposed By-laws and proposed Rule 908(b), Series A-1 Permits will
be limited or unlimited in number and may be issued from time to time
by the Exchange, as determined by the Board in its sole discretion.
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\30\ Under Sections 12-2 and 12-4 of the proposed By-laws, Stock
Clearing Corporation of Philadelphia (``SCCP''), as an eligible
corporation, may hold a permit but will continue not to be subject
to the qualification criteria applicable to persons seeking a
permit. SCCP, a subsidiary of the Phlx, is a registered clearing
agency.
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After demutualization, Section 12-1 of the proposed By-laws will
empower the Board to:
authorize the issuance of an unlimited or
restricted number of additional permits;
terminate or eliminate any class or series of
permits; and
create additional classes or series of permits.
The Exchange represents that any of these actions will continue to
be subject to Commission review and/or approval. In accordance with
Section 12-3 of the proposed By-laws, no person will be allowed to hold
more than one permit.
3. Qualifications
Initially, except to the extent provided in applicable product and/
or activity criteria set forth in the proposed Rules, qualifications
and other requirements for Members to conduct certain activities (e.g.,
to act as a specialist or a floor broker), to trade certain products
(e.g., special capital requirements for specialists for certain equity
securities, allocation of books and Registered Options Trader
assignments) or to use specific facilities of the Exchange (e.g.,
testing requirements for use of certain Exchange technology) will
remain largely the same as they were before the demutualization.
4. Security Requirement
According to proposed Rule 909, each Member Organization will have
to provide to, and maintain security with, the Exchange (or alternative
compliance) for the payment of any claims owed to the Exchange, to
SCCP, and to Members and/or other Member Organizations. Currently,
Section 14-5 of the By-laws provides that the Exchange (through the
Admissions Committee) may dispose of any Seat upon written notice if
amounts owed to the Exchange exceed a certain threshold amount and have
been outstanding for at least one year. This possibility will be
eliminated in connection with the elimination of Seats in the
demutualization. Accordingly, the Exchange proposes the security
requirement to protect itself in the case of non-payment of certain
amounts owed. The proposed security requirement will consist of:
(i) excess net capital of at least the amount required by the
Exchange, as will be published by the Exchange from time to time; \31\
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\31\ In accordance with the By-laws and Rules, the Member
Organization will be subject to monthly reporting obligations to
evidence the maintenance of that excess net capital requirement.
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(ii) an acceptable guaranty by a clearing Member Organization that
is acceptable to the Exchange; or
(iii) a deposit with the Exchange in an amount not to exceed
$50,000.
The amount of the security for a Member Organization will remain
the same regardless of the number of permits issued to affiliates of
the Member Organization. If a Member Organization's registration is
terminated and no Members remain associated with the Member
Organization, the Exchange will be permitted to apply the proceeds of
any remaining security to the payment of any amounts owed by or on
behalf of the Member Organization to, or claimed by, the Exchange, to
SCCP, and to other Member Organizations, and any balance of the
security thereafter remaining will be returned to the Member
Organization or, in the case of a guaranty, the guaranty will be
returned to the guarantor Member Organization.
The proposed By-laws will also provide in Section 12-9(b) that
following the demutualization, Members, Member Organizations and
holders of FCO participations will have to pledge in writing to abide
by the proposed Certificate of Incorporation, the proposed By-laws, the
proposed Rules and any other rules and regulations of the Exchange.
5. Term and Termination of Permits
Pursuant to proposed Rule 908(e), the holder of a permit will be
allowed to terminate the permit at any time upon written notice to the
Exchange. The Exchange will be allowed to terminate any individual
permit in accordance with the By-laws and Rules of the Exchange only
upon:
the non-payment of any dues, foreign currency
options users' fees, fees, fines, penalties, other charges, and/or
other monies due and owed the Exchange;
the insolvency of a Member or Member
Organization (or if the Business Conduct Committee has determined the
Member or Member Organization to be financially unsafe to continue
trading); or
the Exchange's imposition of a disciplinary
sanction.
The terminating permit holder and each Member Organization with
which the holder is associated will remain responsible for all
obligations of the terminating Member, including, without limitation,
all applicable dues, fees, charges, fines, penalties and other
obligations arising from the holding or use of a permit before its
termination.
Pursuant to proposed Rule 908(f), the Exchange will be able to
terminate the entire series of Series A-1 Permits on no less than 60
days' notice to the permit holders.\32\ If, however, within six months
after any such termination of the entire series of Series A-1 Permits,
the Exchange issues any other class or series of permit with respect to
any securities product previously covered by the Series A-1 Permit, any
permit holder of a terminated Series A-1 Permit, who meets the
applicable eligibility requirements with respect to such new class or
series of permit, will be entitled to receive on terms no less
favorable than those applicable to other persons such new class or
series of permit so long as such permit holder will trade with such new
class or series of permit such product in the same capacity as he had
done with a Series A-1 Permit before such termination (but only if he
had continuously traded such product in such capacity for at least one
year prior to such termination). In addition, such holder of the
terminated Series A-1 Permit will be required to apply for such new
permit within 30 days of the later to occur of: (i) The termination of
the series of Series A-1 Permits; or (ii) the initial issuance of the
new class or series of permit.
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\32\ As noted above, the Exchange represents that certain
actions with respect to the permits, including termination of any
class or series of permits will be subject to Commission review and
approval.
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6. Transfer of Permits
Section 12-1(b) of the proposed By-laws, as well as proposed Rule
908(h), will provide that, unless the Board resolves otherwise, no
permit may be sold, transferred (by operation of law or otherwise),
leased or otherwise encumbered by any person to whom such permit is
issued by the Exchange. However, proposed Rule 908(h) provides that the
existing concept of ``inactive nominees'' will be retained to alleviate
certain administrative hardships for Member Organizations,
[[Page 3984]]
such that a permit can be transferred to and from an inactive nominee.
E. Fees, Dues and Charges
Currently, the Board of Phlx has the authority to set fees, dues
and other charges \33\ in its sole discretion, subject to the
requirements under the Act, including filing requirements. Pursuant to
lease agreements, Members who lease Seats from Owners are ordinarily
required to make lease payments in respect of the lease.
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\33\ According to the Exchange, the existing and proposed By-
laws and Rules may refer to ``dues, fees and other charges'' to
cover various types of monies owed to the Exchange; however, no
substantive difference is intended.
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After the demutualization, the Board of the Phlx will continue to
have the authority to set Member fees, dues and other charges in its
sole discretion in accordance with Section 14-1 of the proposed By-
laws. However, seat leases and lease payments (other than with respect
to FCO participations) will no longer exist. All other Exchange charges
in effect at the time of the demutualization will continue to apply
until changed.\34\ The Exchange notes that all fees are subject to
change, both before and after demutualization, subject to approval by
the Board and filing with the Commission.
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\34\ Separately, with the elimination of Seats and leases
thereof, the Exchange filed a proposed rule change pursuant to
Section 19(b) of the Act to adopt fees applicable to Series A-1
Permits and to make conforming changes to its fee schedule as a
result of the demutualization. See supra note 11.
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In connection with the demutualization, the Exchange proposes to
make certain corresponding changes to the defined terms applicable to
its By-laws and Rules. These changes, reflected in Section 1-1 of the
existing and the proposed By-laws, as well as in Rules 1 through 21 of
the existing Rules and 1 through 22 of the proposed Rules, are
generally designed to adapt such defined terms to the proposed post-
demutualization structure of the Exchange, as described herein.
F. Summary of Non-Demutualization-Related Changes
Certain aspects of the proposed rule change are not directly
related to the Plan of Demutualization. According to the Exchange,
these changes are principally of a clean-up nature and are intended to
delete obsolete provisions that relate mainly to membership, to provide
clarity and to avoid confusion following the demutualization.
1. Definition of Member Firm, Member Corporation and Member
Organization
The Exchange proposes to harmonize the use of the defined terms
Member Firm, Member Corporation and Member Organization throughout its
By-laws and Rules by eliminating the separate defined terms ``Member
Firm'' (Rule 3 of the existing Rules) and ``Member Corporation'' (Rule
4 of the existing Rules) and amending the defined term ``Member
Organization'' (Rule 6 of the existing Rules and Rule 3 of the proposed
Rules) to include any Member Firm and Member Corporation, as they were
previously defined. Wherever such defined terms appear in either the
By-laws or the Rules, the Exchange proposes to make the corresponding
change to Member Organization. The Exchange believes that these changes
eliminate certain definitional inconsistencies.
2. Convertible Memberships
The Exchange proposes to delete the parts of Article XII of the
existing By-laws that relate to ``convertible memberships'' on the
Exchange, together with any references to any classes of memberships
that existed in connection with the Exchange's pre-1975 status as an
unincorporated entity. No such convertible membership has been
outstanding at any time and any transitional rules relating to the
Exchange's previous unincorporated status are obviously no longer
required.
3. Commissions
The Exchange proposes to delete Article XIX of the existing By-laws
in its entirety, which relates to certain requirements for fixed rates
of commissions for transactions effected on or by the use of the
facilities of the Exchange. The Exchange believes these provisions do
not comport with Section 6(e) of the Act.\35\ To avoid confusion, the
Phlx proposes that these provisions be deleted without replacement. The
Exchange also proposes to delete related Rule 248.
---------------------------------------------------------------------------
\35\ 15 U.S.C. 78f(e).
---------------------------------------------------------------------------
4. Market-Maker Membership
The Exchange proposes to delete Article XXIII of the existing By-
laws, relating to Market-Maker Memberships, in its entirety. The Phlx
advises that no such Market-Maker Membership has been issued since the
1970s and none is currently outstanding. Following the demutualization,
the Exchange is not initially proposing to create a specific permit for
market-makers; any rights and privileges required to engage in market
making on the Exchange initially will be granted through the proposed
Series A-1 Permit. The Exchange also proposes to delete related Rules
456-459. The Phlx advises that these deletions are intended to avoid
confusion with respect to these unused membership-related provisions.
5. Exchange Options Trading
The Exchange proposes to delete Article XXVI of the existing By-
laws, relating to Exchange options trading through a classification of
membership named ``Options Membership'' in its entirety. The Phlx
states that no such Options Membership has at any time been issued and
outstanding. Following the demutualization, the Exchange will not
initially create a specific permit to trade options on the Exchange;
any rights and privileges required to engage in trading options on the
Exchange initially will be granted through the proposed Series A-1
Permit. Accordingly, this deletion is also intended to avoid confusion.
6. References to the Exchange's Constitution
The Exchange proposes to delete references to the ``Constitution of
the Exchange'' from the Rules 111, 201A and 960.2, as well as from the
Commentary to Rule 803. Where applicable, the references will be either
deleted in their entirety or will be replaced by references to the
Certificate of Incorporation. The Exchange advises that it has not had
a Constitution since its incorporation in 1972 and, since that time,
has been governed exclusively by its Certificate of Incorporation and
By-laws.
7. References to the Exchange's President
The Exchange proposes to delete references to the Exchange's
``President'' from the Rules and replace such references with
``Chairman of the Board of Governors.'' The Exchange indicates that it
has not established the position of a President and has no immediate
plans to establish such a position after the demutualization.
8. Participation in Mandatory Decimalization Testing
The Exchange proposes to delete Rule 650 in its entirety, which
relates to the mandatory participation of Members in certain programs
concerning the testing of the Exchange's system in connection with
decimalization. According to the Phlx, such tests have been performed,
and, therefore, Rule 650 has become obsolete.
III. Summary of Comments
The Commission received one comment letter in response to the
[[Page 3985]]
proposed rule change.\36\ The Penn Mont Letter stated that the Plan of
Demutualization was flawed for two reasons. First, the letter noted
that, after the demutualization, members no longer would have the
ability to propose and vote on rulemaking initiatives. Second, the Penn
Mont Letter stated that, in light of the Commission's recent approval
of the two-board structure for the New York Stock Exchange, Inc.
(``NYSE''), the Phlx should adopt the same structure for its Board of
Governors.
---------------------------------------------------------------------------
\36\ See Penn Mont Letter, infra note 7.
---------------------------------------------------------------------------
In responding to the Penn Mont Letter, the Exchange noted that the
reason for eliminating Members' right to petition with respect to
changes to the By-laws is that Delaware law requires that stockholders
amend the By-laws.\37\ The Phlx pointed out that Members will continue
to have the same voice in rulemaking at the Exchange through the
various committees of the Board of Governors. Specifically, the Phlx
noted that Members, either by serving on such committees or by
contacting committee members, can raise issues for discussion or rules
for adoption. The Exchange noted that, in connection with the
demutualization, it proposed to increase member involvement on several
committees and that, in its view, the current and proposed committee
structure and the Exchange's governance structure are consistent with
the fair representation requirements of Section 6(b)(3) of the Act.\38\
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\37\ Letter from Edith Hallahan, Deputy General Counsel, Phlx,
to Nancy Sanow, Assistant Director, Division, Commission, dated
January 11, 2004.
\38\ 15 U.S.C. 78f(b)(3).
---------------------------------------------------------------------------
Regarding the Penn Mont Letter's recommendation that the Phlx adopt
the same dual-board structure that was recently approved for the NYSE,
the Exchange noted its belief that at this time the governance
structure proposed in its filing is consistent with the Act and the
structures of other SROs and is appropriate on a going forward basis.
The Exchange stated that both the NYSE's governance specifically and
the governance structure of SROs in general are important policy
issues, separate from the Exchange's immediate plan to demutualize. The
Phlx noted that it would be unfair to delay its efforts to demutualize
for this reason alone because the Exchange can and should continue to
evaluate its governance structure in the future.
IV. Discussion
After careful review, 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.\39\ In particular, the Commission finds that the proposed
rule change is consistent with Section 6(b)(1) of the Act,\40\ which
requires a national securities exchange to be so organized and have the
capacity to carry out the purposes of the Act and to enforce compliance
by its members and persons associated with its members with the
provisions of the Act. The Commission also finds that the proposed rule
change is consistent with Section 6(b)(3) of the Act, which requires
that the rules of a national securities exchange assure the fair
representation of its members in the selection of its directors and
administration of its affairs, and provide that one or more directors
shall be representative of issuers and investors and not be associated
with a member of the exchange, broker, or dealer. Further, the
Commission finds that the proposed rule change is consistent with
Section 6(b)(5) of the Act,\41\ in that it is designed, among other
things, to prevent fraudulent and manipulative acts and practices; 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.
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\39\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
\40\ 15 U.S.C. 78f(b).
\41\ 15 U.S.C. 78f(b)(5).
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A. Changes in Control of the Phlx
The proposed Certificate of Incorporation imposes limitations on
direct and indirect changes in control of the Phlx through voting and
ownership limitations placed on the Common Stock, and monitors
potential changes in control through a notification requirement, once a
threshold percentage of ownership of the Common Stock is reached. The
Commission believes that the limitations on direct and indirect changes
in control of the Phlx are sufficient to enable the Phlx to carry out
its self-regulatory responsibilities, and to enable the Commission to
fulfill its responsibilities under the Act.\42\
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\42\ The Commission has not formally established the standards
for control persons of shareholder-owned national securities
exchanges. It expects, however, to consider providing guidance on
this issue in the future.
---------------------------------------------------------------------------
The proposed Certificate of Incorporation provides that, unless
approved by the Board and effective under Section 19(b) of the Act, no
Person, either alone or together with its Related Persons, has any
right to vote, or to give any consent or proxy with respect to, more
than 20% of the then outstanding shares of Common Stock (any shares of
Common Stock owned in excess of 20% are referred to as ``Excess
Shares''). In addition, such Excess Shares will be deemed not to be
present for the purposes of determining whether a quorum is present at
any meeting or vote of the stockholders of the Exchange.\43\
---------------------------------------------------------------------------
\43\ Phlx Certificate of Incorporate, Article FOURTH, paragraph
(b)(iii)(B).
---------------------------------------------------------------------------
Moreover, no Person (either alone or together with its Related
Persons, unless approved by the Board and effective under Section 19(b)
of the Act) may own, of record or beneficially, whether directly or
indirectly, more than 40% of the then outstanding shares of Common
Stock of the Phlx. To the extent that such Person (or its Related
Persons) purports to own more than 40% of the then outstanding shares
of Common Stock, the Person (and its Related Persons) will not be
entitled to exercise any rights and privileges incident to ownership of
shares in excess of the 40% limit.\44\ Finally, the Exchange has the
right, but not the obligation, to purchase the shares in excess of the
40% threshold for a price equal to the par value of the Common Stock.
---------------------------------------------------------------------------
\44\ Phlx Certificate of Incorporation, Article FOURTH,
paragraph (b)(v)(A).
---------------------------------------------------------------------------
Article FOURTH of the Phlx Certificate of Incorporation will
require the Board to approve a By-law amendment to permit any Person,
together with its Related Persons, to exercise voting rights with
respect to their excess shares or to own more than 40% of the
outstanding shares. This amendment to the By-laws would have to be
filed with the Commission pursuant to Section 19(b) of the Act. The
proposed rule change would present the Commission with an opportunity
to determine what additional measures, if any, might be necessary to
provide sufficient regulatory jurisdiction over the proposed
controlling persons.
The proposed Certificate of Incorporation provides that no Member
(either alone or together with its Related Persons) will be allowed to
own, of record or beneficially, whether directly or indirectly, more
than 20% of the then outstanding shares of Common Stock of the
Phlx.\45\ To the extent any Member (or its Related Persons) purports to
own more than 20% of the then outstanding shares of Common Stock, that
Member (and its Related Persons) will not be allowed to exercise any of
the rights or
[[Page 3986]]
privileges incident to the ownership of shares of Common Stock with
respect to the shares exceeding the 20% limit. If any Member exceeds
the 20% threshold, the Phlx will have the right, but not the
obligation, to purchase from that Person and its Related Persons either
the shares of Common Stock that exceed the 20% threshold for a price
equal to the par value of the shares of such Common Stock.
---------------------------------------------------------------------------
\45\ Phlx Certificate of Incorporation, Article FOURTH,
paragraph (b)(v)(B).
---------------------------------------------------------------------------
The Commission finds that the limitation on member ownership is
consistent with the Act. Today, a member who trades on an exchange can
have an ownership interest in the exchange. However, a member's
interest could become so large as to cast doubt on whether the exchange
can fairly and objectively exercise its self-regulatory
responsibilities with respect to that member. A member that also is a
controlling shareholder of an exchange might be tempted to exercise
that controlling influence by directing the exchange to refrain from
diligently surveiling the member's conduct or from punishing any
conduct that violates the rules of the exchange or the federal
securities laws. An exchange also might be reluctant to surveil and
enforce its rules zealously against a member that the exchange relies
on as its largest source of capital.
The proposed Certificate of Incorporation requires any Person
(either alone or together with its Related Persons) that at any time
owns (whether by acquisition or by a change in the number of shares
outstanding) of record or beneficially, directly or indirectly, 5% or
more of the then outstanding shares of the Common Stock to immediately
give the Board of Governors written notice of that ownership and update
the notice promptly after an ownership change of a specified
percentage.\46\ The Commission believes that this approach is
consistent with the Act in that it allows the Phlx to comply with the
reporting requirements of Form 1, the application for (and amendments
to application for) registration as a national securities exchange.
Exhibit K of Form 1 requires any exchange that is a corporation or
partnership to list any persons that have an ownership interest of 5%
or more in the exchange; and Rule 6a-2(a)(2) under the Act requires an
exchange to update its Form 1 within ten days after any action that
renders inaccurate the information previously filed in Exhibit K.\47\
Exhibit K imposes no obligation on an exchange to report parties whose
ownership interests in the exchange is less than 5%. Similarly, the
proposed Certificate of Incorporation requires the Phlx to monitor
changes in its ownership structure only when a Person acquires an
interest that equals or exceeds 5%.\48\
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\46\ Phlx Certificate of Incorporation, Article FOURTH,
paragraph (b)(iv) and (v).
\47\ 17 CFR 240.6a-2(a)(2).
\48\ The Commission notes, however, that the Exchange should
disclose periodically, or otherwise make available upon request,
information regarding the number of outstanding shares of Common
Stock, so that persons with a stake in the Common Stock can
determine whether they are reaching or have reached any of the
thresholds that restrict that person's ability to vote or own the
shares.
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B. Fair Representation
Section 6(b)(3) of the Act requires that the rules of an exchange
assure fair representation of its members in the selection of its
directors and administration of its affairs and provide that one or
more directors be representative of issuers and investors and not be
associated with a member of the exchange, or with a broker or dealer.
Under the proposed Certificate of Incorporation, the Exchange will
continue to have a total of 22 Governors and will be composed of 11
Non-Industry Governors (of whom at least five must be Public
Governors); 10 Industry Governors (of whom five must be On-Floor
Governors and five must be Off-Floor Governors); and the Chairman of
the Board, who will be the individual then holding the office of CEO.
The Non-Industry Governors, Off-Floor Governors, and the Chairman of
the Board will continue to be nominated by the Nominating and Elections
Committee and will be elected by the holders of the Common Stock. On-
Floor Governors will be nominated by the Nominating and Elections
Committee from recommendations made by members of that committee or by
any Member, participant, or Member Organization Representative. Also,
independent nominations by Member Organization Representatives will be
valid if signed by Member Organization Representatives representing no
less than 50 votes. Member Organizations, through their authorized
Member Organization Representative, will vote for designated On-Floor
Governors among nominees selected at the annual meeting of Member and
Member Organizations. The nominees for On-Floor Governors who received
the highest number of votes will be the Designated Nominees, who will
then be elected by the Trust owning the share of Series A Preferred
Stock
In addition, pursuant to the proposed By-laws, at least half of the
Admissions Committee and the Foreign Currency Options Committee will
have to be Members, participants or persons affiliated with Member
Organizations and at least half of the Options Committee and the Floor
Procedure Committee will have to be Members or persons affiliated with
Member Organizations. Further, the proposed By-laws require that the
Business Conduct Committee share jurisdiction over the revocation of
permits and foreign currency options participations in connection with
disciplinary matters with the Admissions Committee. The Commission
finds that the selection of the five On-Floor Governors out of a total
of 22 Governors of the Phlx Board and the manner in which such
Governors will be nominated and elected, together with the
representation of members on key committees, satisfies the fair
representation requirements in Section 6(b)(3) of the Act.\49\
---------------------------------------------------------------------------
\49\ 15 U.S.C. 78f(b)(3).
---------------------------------------------------------------------------
The Commission notes that the proposal does not require that
holders of foreign currency options (``FCO'') participations expressly
be represented on the committees or on the Board of Governors, although
representation on various committees and on the Board as On-Floor
Governors is open to them. According to the Phlx, members holding
solely FCO participations represent a de minimis amount of the
membership and most Members that trade foreign currency options also
hold regular memberships. In addition, the Phlx will retain its Foreign
Currency Options Committee, of which at least 50% of its members must
be permit holders or participants or be associated with a member or
participant organization. In light of these provisions and the small
number of FCO participants currently at the Exchange, the Commission
believes that the provisions relating to FCO participations are
consistent with the fair representation requirements of the Act. The
Commission also finds that the requirement that the Board be composed
of 11 Non-Industry Governors, of whom at least five must be Public
Governors, is consistent with Section 6(b)(3) of the Act, which
requires that one or more directors be representative of issuers and
investors.
The Commission also notes that the proposed Certificate of
Incorporation expressly requires the Governors, in managing the
business and affairs of the Phlx, to consider applicable requirements
for registration as a national securities exchange under Section 6(b)
of the Act, including the requirements that the rules of the Phlx be
designed to protect investors and the public interest and the Phlx
shall be so organized and have the capacity to carry
[[Page 3987]]
out the purposes of the Act and (subject to exceptions set forth in the
Act and rules and regulations thereunder) to enforce compliance with
its members and persons associated with its members, with the
provisions of the Act and rules and regulations thereunder and with the
Phlx's rules. In the Commission's view, this provision will serve to
remind the Governors that they must consider the requirements of the
Act when taking actions on behalf of the Phlx.
The Penn Mont Letter, the sole comment letter received by the
Commission on the proposal, pointed to the Commission's recent approval
of a dual-board governance structure for the NYSE \50\ and urged that
the Exchange amend its filing to take into account this new structure.
The Commission notes that SROs, such as the Phlx, just recently have
had the opportunity to review and assess the governance changes made by
the NYSE in light of their own governance structures. Although the
Exchange should be assessing its own governance structure in light of
the recently-approved changes for the NYSE and in light of governance
reforms recently approved for listed issuers,\51\ the Commission
believes that these issues can be addressed separately from the
demutualization.\52\
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\50\ Securities Exchange Act Release No. 48946 (December 18,
2003), 68 FR 75012 (December 29, 2003).
\51\ Securities Exchange Act Release No. 48745 (November 4,
2003), 68 FR 64154 (November 12, 2003).
\52\ In March 2003, the Commission's Chairman sent a letter to
the SROs, including the Phlx, asking that they review their own
corporate governance practices in light of new listing standards for
publicly traded companies. See Letter from William H. Donaldson,
Chairman, Commission, to Meyer S. Frucher, Chairman and Chief
Executive Officer, Phlx, dated March 26, 2003. In September 2003,
the Commission's Chairman sent another letter to the SROs, including
the Phlx, asking that they review the extent of public
representation on their boards and key committees, decision-making
processes relating to the nomination of directors and compensation
of executives, and public disclosure of these processes and
compensation arrangements. See Letter from William H. Donaldson,
Chairman, Commission, to Meyer S. Frucher, Chairman and Chief
Executive Officer, Phlx, dated September 23, 2003.
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Finally, the Penn Mont Letter stated that the Plan of
Demutualization is flawed because members no longer will have the
ability to propose independent rulemaking based on a vote of the
membership. The Commission believes that the Phlx's response to this
comment is persuasive, namely, that Delaware law requires that
stockholders amend the By-laws. Moreover, as the Exchange points out,
Members will retain a voice in Exchange rulemaking through
participation on various Board Committees, some of which now will
require at least half of the Committees' composition be Members or
persons affiliated with Member Organizations.
C. Dividends
With the demutualization, the holders of Common Stock will have the
dividend and other distribution rights of a stockholder in a Delaware
stock corporation (except as may be limited by the rights any preferred
stock may have, if any such stock is issued). The proposed By-laws,
however, will prohibit the payment of dividends from any revenues
received by the Exchange from regulatory fines, fees or penalties.\53\
In the proposed rule change, the Phlx describes the methodology it will
use to determine the amount of regulatory fines, fees and penalties
that are subject to the dividend limitation, taking into account the
amount of regulatory costs and expenses. The Commission finds that the
prohibition on the use of regulatory fines, fees or penalties to fund
dividends is consistent with Section 6(b)(3) of the Act because it will
ensure that the regulatory authority of the Exchange is not used
improperly to benefit the shareholders.
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\53\ Phlx By-Laws, Section 30-4.
---------------------------------------------------------------------------
V. Accelerated Approval of Amendment No. 3
The Commission finds good cause exists for approving Amendment No.
3 to the proposed rule change prior to the thirtieth day after the
amendment is published for comment in the Federal Register, pursuant to
Section 19(b)(2) of the Act.\54\ In Amendment No. 3, the Phlx formally
submitted the Conversion Amendment as part of the proposed rule change
in order to clarify that it is, in fact, a part of the proposed rule
change. Also, the Phlx noted that the Conversion Amendment was briefly
described in the proposed rule change and that it will be in effect
just a very brief period of time prior to consummation of the Merger.
---------------------------------------------------------------------------
\54\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------
In the amendment, the Phlx also submitted copies of written
comments received from market participants regarding the Plan of
Demutualization after the Phlx had filed the proposed rule change with
the Commission on November 17, 2003, and copies of the Exchange's
responses to those comments.\55\
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\55\ Instruction D to Form 19b-4 states that if, after the
proposed rule change is filed but before the Commission takes final
action, the SRO receives or prepares any correspondence or other
communications reduced to writing (including any comment letters) to
and from the SRO concerning the proposed rule change, copies of the
communications must be filed in accordance with Instruction F to the
form.
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The Commission believes that acceleration of the amendment is
appropriate. The Conversion Amendment was described in the Notice and
the filing of its actual rule text presents no new issues.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 3, including whether the amendment
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. Comments
may also be submitted electronically at the following e-mail address:
rule-comments@sec.gov. All comment letters should refer to File No. SR-
Phlx-2003-73. This file number should be included on the subject line
if e-mail is used. To help the Commission process and review comments
more efficiently, comments should be sent in hardcopy or by e-mail but
not by both methods. 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 refer to File No. SR-Phlx-2003-73, and
should be submitted by February 17, 2004.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\56\ that the proposed rule change (SR-PHLX-03-73), as amended, be
and hereby is, approved, and Amendment No. 3 is approved on an
accelerated basis.
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\56\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\57\
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\57\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-1668 Filed 1-26-04; 8:45 am]
BILLING CODE 8010-01-P