[Federal Register Volume 65, Number 80 (Tuesday, April 25, 2000)]
[Notices]
[Pages 24246-24248]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-10258]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42700; File No. SR-Phlx-99-39]


Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; 
Order Approving Proposed Rule Change Regarding Specialist Enhanced 
Participation

April 18, 2000.

I. Introduction

    On October 4, 1999, the Philadelphia Stock Exchange, Inc. 
(``Exchange'' or ``Phlx'') submitted to 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 seeking to amend Exchange Rule 
1014, ``Obligations and Restrictions Applicable to Specialists and 
Registered Options Traders,'' and its corollary Option Floor Procedure 
Advice B-6 to revise the enhanced participation available to Exchange 
specialists. The proposal was amended on November 4, 1999.\3\ Notice of 
the proposed rule change and Amendment No. 1 appeared in the Federal 
Register on November 30, 1999.\4\ The Commission received no comments 
on the proposal. This order approves the proposed rule change, as 
amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Exchange made technical changes to 
the proposal. See Letter from Nandita Yagnik, Phlx, to Richard 
Strasser, Assistant Director, Division of Market Regulation, 
Commission, dated November 3, 1999 (``Amendment No. 1'').
    \4\ See Securities Exchange Act Release No. 42161 (November 19, 
1999), 64 FR 66958.
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II. Description of the Proposal

    On August 26, 1994, the Commission approved the Exchange's proposal 
to adopt an enhanced participation for Exchange specialists in equity 
options.\5\ The enhancement, or ``enhanced parity split,'' provides 
Exchange specialists with a greater participation in parity trades than 
the specialists would otherwise be entitled to receive.
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    \5\ See Securities Exchange Act Release No. 34606 (August 26, 
1994), 59 FR 45741 (September 2, 1994). Initially , the enhanced 
parity split was approved as a one year pilot expiring August 26, 
1995.
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    On November 30, 1994, the Commission approved the Exchange's 
proposal to make the enhanced parity split available to index option 
specialists.\6\ The enhanced parity split was later revised with 
respect to

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situations where less than three controlled accounts are on parity with 
a specialist.\7\ The enhanced parity split was renewed unaltered and on 
a continuing pilot basis on three subsequent occasions.\8\ Thereafter, 
the enhanced parity split was extended until December 31, 1998, and 
revised so that it would apply to: (1) All index options; (2) 50% of 
each specialist's equity options; and (3) all new options allocated to 
a specialist during the year. In addition, specialists were permitted 
to revise the list of eligible equity options on a quarterly basis, 
instead of annually.\9\ Finally, in July 1999, the enhanced parity 
split was permanently approved.\10\
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    \6\ See Securities Exchange Act Release No. 35028 (November 30, 
1994), 59 FR 63151 (December 7, 1994).
    \7\ See Securities Exchange Act Release No. 35429 (March 1, 
1995), 60 FR 12802 (March 8, 1995).
    \8\ See Securities Exchange Act Release No. 36122 (August 18, 
1995), 60 FR 44530 (August 28, 1995); 37254 (August 5, 1996), 61 FR 
42080 (August 13, 1996); and 38924 (August 11, 1997), 62 FR 44160 
(August 19, 1997).
    \9\ See Securities Exchange Act Release No. 39401 (December 4, 
1997), 62 FR 65300 (December 11, 1997).
    \10\ See Securities Exchange Act Release No. 41588 (July 1, 
1999), 64 FR 37185 (July 9, 1999. The Exchange also received 
approval to give specialists an enhanced parity split when they 
develop and trade a new product (``New Products Split''). Under the 
New Products Split, when the specialist is on parity with three or 
more controlled accounts, the specialist receives 40% of the 
contracts and the controlled accounts receive the remaining 60%. 
When the specialist is on parity with less than three controlled 
accounts in the crowd, the specialist receives 60% of the contracts 
and the controlled accounts receive 40%. In either of these 
situations, if a customer is on parity, the customer may not receive 
a lesser allotment than any other crowd participant including the 
specialist. Id.
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    The enhanced parity split works as follows: when an equity or index 
option specialist is on parity with one controlled account \11\ and an 
order for more than five contracts comes into the crowd, the specialist 
will receive 60% of the contracts and the controlled account will 
receive 40%. When the specialist is on parity with two controlled 
accounts and the order is for more than five contracts, the specialist 
will receive 40% of the contracts and each controlled account will 
receive 30%. When the specialist is on parity with three or more 
controlled accounts and the order is for more than five contracts, the 
specialist will be counted as two crowd participants when allocating 
the contracts. In any of these situations, if a customer order is on 
parity, the customer will not be disadvantaged by receiving a lesser 
allotment than any other crowd participant, including the specialist. 
Thus, a customer on parity is assured a minimum participation that is 
equal to the participation of the specialist.\12\
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    \11\ A controlled account is defined as ``any account controlled 
by or under common control with a member broker-dealer.'' Customer 
accounts, which include discretionary accounts, are defined as all 
accounts other than controlled accounts. See Exchange Rule 
1014(g)(i).
    \12\ The application of this enhanced parity split is mandatory. 
Therefore, with respect to any equity or index option transaction 
that implicates the enhanced parity split, the specialist is 
required to accept the preferential allocation and may not decline 
the enhancement. If an equity or index option trade is on parity, 
but not subject to the enhanced parity split (i.e., the order is for 
five or less contracts), the Exchange specialist is required to 
allocate the contracts according to the Exchange's priority and 
parity rules. See Exchange Rule 119, ``Precedence of Highest Bid,'' 
and Exchange Rule 120, ``Precedence of Offers at Same Price.''
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    The Exchange now proposes to revise the manner in which the 
enhanced parity split operates only in those cases where the specialist 
is on parity with three or more controlled accounts and the order is 
for more than five contracts. Under the proposal, the specialist will 
receive 30% of the contracts instead of being counted as two crowd 
participants in determining the number of contracts the specialist is 
entitled to receive.

III. Discussion

    For the reasons discussed below, the Commission finds that the 
proposed rule change is consistent with the Act and the rules and 
regulations under the Act applicable to a national securities exchange. 
In particular, the Commission believes the proposed rule change is 
consistent with the section 6(b)(5) \13\ requirements that the rules of 
an exchange be designed to promote just and equitable principles of 
trade, prevent fraudulent and manipulative acts and practices, and 
protect investors and the public interest.\14\ The Commission also 
finds that the proposal may serve to remove impediments to and perfect 
the mechanism of a free and open market by helping the Exchange to 
attract and retain specialist units.
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    \13\ 15 U.S.C. 78f(b)(5).
    \14\ In approving this proposed rule change, the Commission has 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
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    When an equity or index option specialist is on parity with three 
or more controlled accounts and the order is for more than five 
contracts, the proposal gives the specialist 30% of the contracts, 
rather than counting the specialist as two crowd participants. The 
proposal will significantly increase the specialist's enhanced 
participation when the specialist is on parity with five or more 
controlled accounts. Under the proposal, however, when the specialist 
is on parity with three or four controlled accounts, the specialist's 
enhanced participation will be reduced.\15\ The Exchange recognizes 
that the proposal will reduce the number of contracts that a specialist 
will receive when the specialist is on parity with three or four 
controlled accounts.\16\ The Exchange, however, believes that the 
proposal will provide a more equitable treatment to all specialists 
such that specialists of both small and large crowds will receive a 
significant enhanced participation when there are five of more 
controlled accounts on parity.\17\
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    \15\ For example, under the current enhanced participation if 
there is an initiating order of fifty contracts, and three 
controlled accounts are on parity, the Specialist will receive 
twenty contracts and the controlled accounts will each receive ten 
contracts. In contrast, under the proposal the specialist will only 
receive fifteen contracts.
    \16\ See Amendment No. 1, supra note 3.
    \17\ Id.
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    The Commission recognizes that the purpose of the enhanced parity 
split is to encourage specialists to make deep and liquid markets to 
attract order flow to the Exchange. The Commission has previously noted 
that specialists have responsibilities and costs that crowd 
participants do not share, such as the staff costs associated with the 
requirement to continually update and disseminate quotes.\18\ As a 
result, the Commission believes it is reasonable for the Exchange to 
grant certain advantages to specialists, such as the enhanced parity 
split, to attract and retain well capitalized specialists at the 
Exchange. As long as these advantages do not unreasonably restrain 
competition and do not harm investors, the Commission believes that the 
granting of such benefits to specialists, in general, is within the 
business judgment of the Exchange. In this regard, the Commission 
believes that it is reasonable for the Exchange to revise the enhanced 
parity split as proposed.
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    \18\ See, e.g., Security Exchange Act Release No. 35177 
(December 29, 1994), 60 FR 2419 (January 9, 1995).
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    The Commission believes that the proposal should provide reasonable 
benefits to specialists, given their heightened responsibilities and 
costs. The Commission believes that the approval of the proposal is 
consistent with the Act because the newly revised enhanced parity split 
should not unreasonably restrain competition and should not result in 
harm to investors. The Commission notes that customer orders on parity 
will continue to be assured a minimum participation equal to any other 
crowd participant, including the specialist.

IV. Conclusion

    It Is Therefore Ordered, pursuant to section 19(b)(2) of the 
Act,\19\ that the

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proposed rule change (SR-Phlx-99-39), as amended, is approved.
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    \19\ 15 U.S.C. 78S(B)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
Margaret H. McFarland,
Deputy Secretary.
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    \20\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 00-10258 Filed 4-24-00; 8:45 am]
BILLING CODE 8010-01-M