[Federal Register Volume 65, Number 101 (Wednesday, May 24, 2000)]
[Notices]
[Pages 33606-33611]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-13069]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42791; File No. SR-Phlx-00-44]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by the Philadelphia Stock 
Exchange, Inc. Adopting a Pilot Program To Assess a Monthly Credit of 
Up to $1,000 to Qualified Members

May 16, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder, \2\ notice is hereby given 
that on May 15, 2000, the Philadelphia Stock Exchange, Inc. (``Phlx'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II, and III, below, which Items have been prepared by the 
Exchange. Today the Phlx filed an amendment to the proposed rule change 
(``Amendment No. 1'').\3\ The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Edith Hallahan, Deputy General Counsel, 
Phlx, to Nancy Sanow, Assistant Director, Division of Market 
Regulation, Commission, dated May 15, 2000. Amendment No. 1 
summarizes the two comment letters the Exchange received in response 
to this proposal and clarifies who is eligible for this credit. Due 
to the substantive nature of Amendment No. 1, this proposed rule 
change is deemed filed and immediately effective as of today.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Phlx proposes to amend its schedule of fees, dues, and charges 
to allow for a monthly credit of up to $1,000 to be applied against all 
fees, dues, charges, and other amounts as may from time to time be owed 
to the Exchange that month, except fines, late fees, out-of-pocket 
expenses,\4\ pass-through costs,\5\ capital funding fees,\6\ and any 
fees paid by equity trading permit holders in respect of any trading 
permits the Exchange may issue (``credit-eligible fees'') \7\ by 
members who own the membership by which they are a member (``member-
owners'') and certain other categories of members described below.\8\ 
This credit is proposed as a six month pilot program.
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    \4\ Out-of-pocket expenses include charges for wireless 
telephone services, postage, ILX machines and Dow Jones News 
Service.
    \5\ Pass-through costs include charges for member health 
insurance and parcel delivery services.
    \6\ Capital funding fees are fees assessed on owners to provide 
funding for technological improvements and other capital needs. The 
Commission approved the capital funding fee for a pilot period 
extending to July 6, 2000. See Securities Exchange Act Release No. 
42405 (February 8, 2000) 65 FR 8226 (February 17, 2000) (SR-Phlx-99-
51); and Securities Exchange Act Release No. 42714 (April 24, 2000), 
65 FR 25782 (May 3, 2000) (SR-Phlx-00-29). The proposal to adopt the 
capital funding fee on a permanent basis is pending with the 
Commission. See Securities Exchange Act Release No. 42318 (January 
5, 2000), 65 FR 2216 (January 13, 2000) (SR-Phlx-99-49).
    \7\ The credit-eligible fees are fees assessed on members and 
include transaction as well as trading floor fees. Transaction fees 
include equity transaction value charges, equity floor brokerage 
transaction fees, option comparison charges, and option transaction 
charges. Trading floor fees include charges for trading post/booth, 
controller space, shelf space, transmission, execution/communication 
charge, and floor facility fees. Fees assessed on foreign currency 
options participants are not considered credit-eligible fees.
    \8\ This proposed rule change is intended to replace SR-Phlx-99-
54, which was filed with the Commission on December 22, 1999 and 
withdrawn by letter dated May 13, 2000.
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    In addition to member-owners, a monthly credit of up to $1,000 may 
be applied against credit-eligible fees incurred by the following 
persons, who are so closely connected to the owners that the Exchange 
believes they should be treated as member-owners: (1) All members who 
are a party to an A-B-C Agreement \9\ with a member organization who 
owns that membership; or (2) all members who are lessees if: (a) the 
member is also an owner of a different membership; (b) the member is an 
immediate family member of the owner of that membership; \10\ (c) the 
member is associated with a member organization in which the owner has 
an interest of at least ten percent; (d) the member leases from an 
owner or a

[[Page 33607]]

related entity of the owner who provides order flow to the Exchange 
through the member consisting of at least 5,000 equity trades over the 
preceding twelve months or 50,000 option contracts over the preceding 
twelve months; or (e) the member leases from a clearing firm or a 
related entity of the clearing firm that provides clearing services to 
the leasing member. The aforementioned categories (including member-
owners) are hereinafter to as ``qualified members.''
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    \9\ Pursuant to Phlx Rule 940, the parties to an A-B-C Agreement 
are an employee, general partner, or officer, and the member 
organization with which such person is associated. The member 
organization provides all or part of the funds for the purchase of a 
membership of which the legal title is placed in the member and the 
equitable title is placed in the member organization.
    \10\ Immediate family member is defined as a member's spouse, 
parents, stepmother, stepfather, mother-in-law, father-in-law, 
brothers, brothers-in-laws, stepbrothers, sisters, sisters-in-law, 
stepsisters, children, stepchildren, and any other person living 
with the member for whom the member provides at least 50 percent of 
his/her financial support per year.
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    Specifically, the amount of credit-eligible fees owed to the 
Exchange shall be reduced on a monthly basis by an amount equal to: (1) 
$1,000 per month if such fees, dues, charges, and other amounts equal 
to or greater than $1,000, or (2) the amount of such fees, dues, 
charges and other amounts if such fees, dues, charges and other amounts 
are less that $1,000.\11\ Credits may not be carried over from one 
month to the next and only one credit of up to $1,000 is available per 
membership per month.
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    \11\ For example, if a member has $1,500 in credit-eligible fees 
for the month, such member is entitled to the full $1,000 credit. 
However, if the member has $600 in credit-eligible fees for the 
month, such member is entitled to a $600 credit.
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    Credits cannot be shared among members, except qualified member(s) 
in the same member organization may aggregate their credit(s). The 
monthly credit of up to $1,000 will be applied against the invoice of 
the member or member organization with which is associated. However, in 
no event shall the aggregate credit(s) exceed $1,000 per membership per 
month.
    The Exchange initially intends that the request to receive the 
credit will be application driven, which applicant submitting an 
Exchange form delineating the credit-eligible fees for that calendar 
month. The credit is proposed for a six month pilot period.\12\ The 
Exchange reserves the right to suspend the credit at any time.
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    \12\ This credit is part of the Exchange's long-term financing 
plan, which separately includes the $1,500 capital funding fee.
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
sections A, B, and C below, of the most significant aspects of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    a. Introduction. The purpose of the proposed rule change is to 
amend the Exchange's schedule of fees, dues and charges to allow for a 
monthly credit of up to $1,000 to be applied against certain fees, 
dues, charges and other amounts, as defined above, owed to the Exchange 
by a qualified member of the Exchange.
    As more fully explained below, the Exchange believes that the 
proposed credit should provide qualified members with additional 
liquidity and an incentive for seat owners to trade on the Exchange. In 
turn, the Exchange believes that this will introduce additional 
liquidity into the marketplace to the benefit of the investing public.
    The Exchange believes that leasing of memberships by passive 
holders of equitable title to lessees who trade on the Exchange (e.g., 
members) does not necessarily promote the long-term interests of the 
Exchange. Although the practice of leasing by financial investors to 
members is permitted by the rules of the Exchange, and may provide an 
important means by which members can access trading rights on the 
Exchange, the Exchange believes that lessors who are passive financial 
investors have a limited stake and interest in the liquidity, 
technology or operations of the Exchange.
    Moreover, such lessors have limited practical ability to influence 
the affairs of the Exchange because practically all voting rights are 
vested in the ``members'' under Phlx's Certificate of Incorporation and 
By-Laws.\13\
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    \13\ A lessor entitled to vote in any decision relating to a 
compromise or arrangement between the Phlx and its creditors or its 
members, or relating to a reorganization of the Phlx. See e.g. 
Article Thirteenth of the Exchange's Certificate of Incorporation 
and Phlx By-Law Article XII, Section 12-6.
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    The Exchange also believes that members who acquire membership and 
access trading on the Exchange by means of a lease may in many cases 
have a very limited stake in the well-being and survival of the 
Exchange. Although such members may have voting rights, they have no 
capital investment in their membership, and, because leases typically 
may be terminated on 30 days notice,\14\ they do not necessarily have 
the incentive to act in the long-term best interests of the Exchange.
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    \14\ See Phlx Rule 930(b).
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    Specifically, by terminating a lease with 30 days notice, lessees 
who do not have ``other'' business interests or relationships with the 
Exchange beyond the mere existence of a lease (such as those 
relationships enumerated in part b. below) may, and often do, leave the 
Exchange to trade on another exchange, perhaps seeking to trade a 
certain ``hot'' option or other product. Thus, their potential 
commitment to the Exchange's long-term well-being and survival is 
undercut by their easy ability to pursue business endeavors that 
further their own well-being. Further, although member-lessees may be 
appointed to certain Exchange committees and sub-committees, their 
motivation to devote the time to such service may be less, as is their 
incentive to make decisions focused on the long-term. Both daily and 
longer terms, strategic decision-making could thus be affected.
    This short-term commitment may also bear on the quality and 
quantity of liquidity provided on the Exchange. Building order flow 
commitments with order flow providers is a long-term endeavor, often 
requiring regular performance, evaluation, and most importantly, a 
relationship with the trading crowd providing liquidity. Thus, 
familiarity and consistency of crowd participation are an important 
marketing mechanism to order flow providers. Providing liquidity also 
involves a longer-term view of sacrificing profit today for continued 
order flow, as well as acknowledging that not every order is a 
profitable one, but continuous order flow, spawned by ample liquidity, 
should, over time, provide more opportunity for additional order flow.
    Lessees that do not have other business interests or relationships 
such as those referred to in part b. below may also have a limited 
stake in the technology of the Exchange, including participation in and 
good use of technology, nor would they necessarily have an incentive to 
invest in the longer-term development of that technology. Such 
investment is not only financial, but also strategic. Such lessees may 
also have a limited stake in the operations of the Exchange, including 
the continued long-term refinement and upgrading of facilities, other 
equipment and the pricing of such operations. In sum, lessees, absent 
other factors tying them to the Exchange, may be less vested in the 
long-term success of the Exchange, in terms of a lesser incentive to 
create liquidity, invest in technology and be active in strategic and 
daily decision-making.

[[Page 33608]]

    In contrast, the Exchange is of the view that members who own their 
own memberships (and their functional equivalents, such as members who 
lease their members from close family members), and members who have 
certain other business or financial relationships which owners who are 
active on the Exchange (e.g., members who are associated with member 
organizations and hold their memberships pursuant to ``A-B-C 
Agreements'') have a combination of financial incentives and voting 
rights (in some cases, indirectly via the owners with whom they are 
closely related or associated) to create liquidity on the Exchange, to 
invest in systems and compliance infrastructure, to be active in and 
informed about the decision-making processes of the Exchange, and 
otherwise to act in the Exchange's long-term best interests. By 
providing the credit described in this filing to these groups of 
members, the Exchange expects to create economic incentives for owners 
to trade on the Exchange by actively using their memberships (or 
selling them to persons who would do so) and for members to organize 
their affairs in ways that, the Exchange's view, properly align the 
interests of the members with the long-term interest of the Exchange. 
The Exchange also believes that the credit should help retain or create 
liquidity on the Exchange by freeing up funds that member-owners of 
their functional equivalents may otherwise be expending on credit-
eligible fees.\15\
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    \15\ The Exchange notes that, as part of its overall strategic 
financing plan, contemporaneously with the implementation of the 
credit described in this filing, it is separately instituting a 
$1,500 monthly capital funding fee upon all ``owners,'' regardless 
of their level of activity (if any) of the Exchange. See supra notes 
6 and 12. Although the credit is not available to offset all or any 
portion of the capital funding fee, the credit will enable member-
owners and others eligible for the credit to defray a portion of the 
transaction and other fees charged by the Exchange (and that, in 
general, result from member activity on the Exchange), thereby 
effectively reducing, for member-owners and other eligible members 
the cost of trading on the Exchange. Therefore, the credit may also 
have the indirect effect of blunting the incremental economic burden 
of the capital funding fee for owners who are active and, directly 
or indirectly, trading on (or otherwise providing certain economic 
benefits to) the Exchange. In addition, the credit frees up funds 
for trading activity on the Exchange that would otherwise be used 
for the payment of credit-eligible Exchange fees.
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    Although the credit described in this filing is available to some 
Exchange members and not others, it meets the criteria set forth in 
Sections 6(b)(4) \16\ and 6(b)(5) \17\ of the Act because it: (i) 
provides for ``* * * the equitable allocations of dues, fees and other 
charges among its members * * * and other persons using its 
facilities;'' and (ii) is not designed ``* * * to permit unfair 
discrimination between customers, issuers, brokers or dealers.'' 
Although the Exchange is not aware of precedents in which other 
exchanges have established fee or credit programs based upon ownership 
of seats or the connection between lessees and their lessors, as the 
Phlx proposes to adopt in this filing, the Commission has approved many 
exchange fee and credit arrangements that do not threat all members (or 
other persons covered by Sections 6(b)(4) \18\ and (5)) \19\ equally, 
such as credits and discounts based on transaction volume, fees based 
upon the usage by certain members of equipment or other services or 
resources of an exchange, and fee structures that distinguish among the 
various activities of persons and firms (e.g., specialists versus floor 
brokers, or specialists versus market makers). As with the proposed 
credit, such measures are designed to promote and encourage certain 
behaviors and/or discourage others. The Exchange believes that this is 
an appropriate, nondiscriminatory business strategy.
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    \16\ 15 U.S.C. 78f(b)(4).
    \17\ 15 U.S.C. 78f(b)(5).
    \18\ 15 U.S.C. 78f(b)(4).
    \19\ 15 U.S.C. 78f(b)(5).
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    As more fully articulated below, the Exchange believes that the 
credit is equitably distributed and not unfairly discriminatory, 
because it is based on legitimate, reasonable business interests of the 
Exchange, and is reasonably designed to further those interests. 
Moreover, it does not unfairly single out individuals or groups for 
personal or political reasons. To the contrary, and member may become 
eligible for the credit by changing the way in which such member 
finances his or her access to the Exchange by purchasing the membership 
or by changing the member's lease arrangement.
    b. More Detailed Rationale Specifically Applied to the Various 
Eligibility Criteria--i. Member-Owners. In many areas of economic life, 
businesses and governments establish incentives to encourage behavior 
that is deemed desirable. In the case of exchanges, volume discounts 
and credits encourage members to direct transaction volume and trading 
activity to the exchange; other fee structures are designed to deter 
excessive usage of exchange resources or to cause scarce resources to 
be allocated more efficiently (e.g., equipment service fees or fees 
relating to use of post/booth space on the floor).\20\ The Exchange, as 
a matter of policy, believes that owner-membership or its functional 
equivalents as described above, should be encouraged because:
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    \20\ See e.g. Securities Exchange Act Release Nos. 41748 (August 
16, 1999), 64 FR 46218 (August 24, 1999) (SR-CBOE-99-34); 40496 
(September 29, 1998), 63 FR 54175 (October 8, 1998) (SR-PCX-98-42); 
and 41108 (February 25, 1999), (64 FR 10516 (March 4, 1999) (SR-BSE-
99-2).
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    (A) Unlike passive, financial investors, owner-members risk their 
capital by their trading and other activities on the floor, thereby (in 
many cases) creating liquidity in our market and generating revenues 
for the Exchange, both directly though transaction-based revenues, and 
indirectly, by generating activity that results in tape revenues under 
the Consolidated Tape Association (``CTA'') and Options Price Reporting 
Authority (``OPRA'') plans.\21\
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    \21\ The CTA Plan and the OPRA Plan are approved by the 
Commission as national market system plans under Rule 11Aa3-2, 17 
CFR 240.11Aa3-2, governing the dissemination of market information 
for certain equity securities and options, respectively; these plans 
govern both the fees that can be charged for such information as 
well as the distribution of revenues derived from those fees among 
participants in these plans, including the Exchange.
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    Seat ownership is one aspect of Exchange ``investment'' and the 
actual use of that membership by the qualified member is a different 
form. Member-owners on their functional equivalents, have additional 
operational and market risks. For example, a qualified member who is 
also a specialist or market maker may have additional risks related to 
fluctuations in the securities market and order-processing errors in 
addition to market risks associated with seat ownership. Similarly, a 
qualified member who is also a specialist may have risks (in addition 
to seat risk) associated with the specialists' obligation to promote a 
fair and orderly market and, particularly, maintain the limit order 
book. Furthermore, in addition to any fees assessed on owners, 
qualified members also contribute to the Exchange by paying transaction 
fees, such as equity transaction value charges, equity floor brokerage 
transaction fees, option comparison charges and option transaction 
charges, and trading floor fees, such as trading post/both, controller 
space, shelf space, transmission, execution/communication charges, and 
floor facility fees.
    (B) Unlike members who lease their seats under typical lease 
arrangements that may be cancelled on 30 days' notice, member-owners 
have a significant capital investment at risk; and
    (C) Unlike owners that are not members, member-owners may have 
voting rights under the Exchange's by-

[[Page 33609]]

laws, and may participate on certain Exchange committees.\22\
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    \22\ See supra note 13.
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    Because of their dual interest in preserving and increasing the 
value of their memberships, and in the technological, operational, and 
regulatory infrastructure that affects the present and future 
conditions of transacting business on or at the Exchange, the Exchange 
believes that member-owners have powerful incentives to create 
liquidity on the Exchange, and to participate responsibly in the 
business life of the Exchange through the exercise of voting rights, 
and through service on the Board and certain Exchange committees. The 
concept (and the underlying policy) of making the credit available to 
member-owners is not unlike that of the federal government in providing 
tax incentives to homeowners that are not available to renters. The 
long-term capital stake of the homeowner in his or her property 
promotes various behaviors that have social utility in that it fosters 
community-oriented behavior, and increases the prospect that the 
homeowner will make further socially useful investments in the property 
and in the neighborhood.
    The Exchange believes that similar principles are involved in the 
instant case. The ability to lease memberships has been available for 
many years. Over time, the equitable ownership of memberships by 
passive financial investors has become a very pervasive phenomenon at 
the Exchange, with 324 of the Exchange's 505 memberships being owned by 
such financial investors.\23\ Of those memberships owned by passive 
financial investors, approximately 48 memberships are currently dormant 
(neither used for active trading nor leased).\24\ Although the Exchange 
believes that leasing of memberships has a legitimate role in providing 
members a means of accessing trading rights on the Exchange, it also 
believes that the extent to which long-term capital investment is 
currently divorced from voting rights and trading interest in not 
healthy insofar as it relates to the long-term viability of the 
institution and its membership as a whole. The credit should create an 
incentive for owners to actively use their trading rights though 
membership and for members to reconsider the manner in which they 
finance their access to the Exchange. Furthermore, the Exchange 
believes that the credit will free up funds for those owners who are 
most likely to put their capital to work by trading and creating 
liquidity on the floor. The credit may also effectively (but 
indirectly) lessen the overall impact of the capital funding fee on 
those owners who are trading at the Exchange and (because the credit 
may be applied against transactional fees) create further incentives to 
trade.
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    \23\ As of March 31, 2000, 324 memberships were subject to lease 
agreements. This number may change on a monthly basis.
    \24\ As of March 31, 2000, 48 seats were dormant (neither used 
for active trading nor leased).
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    The Exchange notes that no member may claim that his or her lack of 
eligibility for the credit is unfair or discriminatory. Any member may 
obtain eligibility for the credit by changing his or her method of 
financing their access to the Exchange--e.g., by purchasing their 
membership and (if they choose) borrowing from third-party lenders to 
effect that purchase. Any owner may obtain eligibility for the credit 
by, for instance, becoming an Exchange member (if they qualify for this 
and subject to the procedures set forth in the Exchange's rules).
    ii. Members/Member Organizations with A-B-C Agreements. By 
definition, with respect to A-B-C Agreements, there is a very close 
nexus between a member and the member organization with whom the member 
is associated; in general, the member is an employee of the member 
organization. This close connection is reflected in the fact that the 
member organization provides all or part of the funds for the purchase 
of the membership of which the legal title is placed in the member, 
while the equitable title remains with the member organization.\25\ In 
addition, the Exchange's By-Laws state, in part, that ``[a]n A-B-C 
Agreement is a contract between the member and member organization with 
which the member is associated in which a portion of the risk of 
fluctuations in the value of the membership shall rest with the member 
organization rather than with the member.'' \26\
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    \25\ See Phlx Rules 940 and 941.
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    Pursuant to the A-B-C Agreement, the member contributes to use of 
the membership to the member organization and subjects the membership 
to the claims of the creditors of the member organization. Moreover, 
the member organization pays the dues, fees, and other charges on 
behalf of the member. Thus, given this unique business relationship, 
owners who are member organizations have significant capital investment 
at risk and have a long-term interest in preserving and increasing the 
value of their membership, much like member-owners. For this reason, 
the Exchange is providing the credit to members who are a party to an 
A-B-C Agreement with a member organization who owns that membership. 
\27\
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    \27\ See supra note 3.
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    iii. Lessees. As stated previously, although leasing arrangements 
are permitted, lessees, other than the five types of qualifying members 
discussed in detail below (``non-qualifying lessees''), may have a 
limited stake in the long-term well-being of the Exchange. In fact, 
non-qualifying lessees may lack the incentive to engage in certain 
types of behavior that promote the long-term best interests of the 
Exchange, including providing liquidity and investing in technology 
enhancements. Specifically, non-qualifying lessees who do not put their 
own (or a member with whom they have a close nexus) capital at risk 
with respect to membership may provide liquidity or order flow with 
less of a long-term view and more of a focus on their current market 
risk only. This view may be at odds with behavior needed to address 
long-term Exchange needs. These non-qualifying lessees who do not have 
the types of additional connections to owners on the Exchange described 
below, may only have the incentive to participate in a self-focused way 
for their short-term benefit. If the credit were made available to all 
lessees, it would not serve its purpose as an inducement to promote 
owner-membership or other relationships to the Exchange that the 
Exchange believes are the most conductive to its continued health and 
success. Therefore, the Exchange is not making the credit available to 
all lessees. However, the Exchange is seeking to provide the credit to 
those qualified members whose relationship with the owners from whom 
they lease their seats is such that the Exchange believes they (either 
individually or indirectly when viewed in conjunction with their 
owners) have incentives properly aligned with the long-term interests 
of the Exchange.
    (A) Members who are Lessees but who also are Owners of Different 
Memberships. Members who are lessees but who also are owners of a 
different membership should be accorded the same treatment as the 
traditional member-owners who were previously discussed. These members, 
who are also owners, have an interest in preserving and increasing the 
value of their membership as well as an interest in preserving and 
increasing the standard of technology and the operational and 
regulatory infrastructure that affects the present and future 
conditions of transacting business at the Exchange. As with traditional 
member-owners, the Exchange believes that the credit will

[[Page 33610]]

free up funds for those members who are also owners thereby encouraging 
them to put their capital to work by trading and creating liquidity on 
the floor. As previously discussed, the credit may also effectively 
(but indirectly) lessen the overall impact of the capital funding fee 
on those owners who are trading at the Exchange.
    (B) Members who Lease from Close Family Members. At the Phlx, many 
members firms are family businesses, which choose to structure their 
operations with the owner being a relative (rather than that member) 
for tax or estate planning purposes. The Exchange believes that there 
is commonality of interest in property of close family members, thus 
affording the credit to members who lease from close family members. 
This concept is one that is widely accepted, especially in connection 
with rules relating to the securities industry and tax law. For 
example, Rule 16a-1(a)(2) under the Act \28\ defines the term 
``beneficial owner'' to mean any person who, directly or indirectly, 
through any contract, arrangement, understanding, relationship or 
otherwise, has or shares a direct or indirect pecuniary interest in the 
equity securities. Indirect pecuniary interest is then defined to 
include securities held by members of a person's immediate family 
sharing the same household.\29\ In addition, Rule 701 under the 
Securities Act of 1933 \30\ exempts from Section 5 of the Securities 
Act \31\ certain offers and sales of securities under a written 
compensatory benefit plan established by the issuer for the 
participation of their employees and their family members who acquire 
such securities from such persons though gifts or domestic relations 
orders. Family members are defined in Rule 701(c)(3) \32\ the same as 
``immediate family'' is defined in Rule 16a-1(e).\33\
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    \28\ 17 CFR 240.16a-1.
    \29\ Immediate family is defined to mean any child, stepchild, 
grandchild, parent, stepparent, grandparent, spouse, sibling, 
mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-
in-law, or sister-on-law, and shall include adoptive relationships. 
17 CFR 240.16a-1(e).
    \30\ 17 CFR 230.71.
    \31\ 15 U.S.C. 77e.
    \32\ 17 CFR 230.701(c)(3).
    \33\ 17 CFR 240.16a-1.
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    Tax laws also recognize the commonality of interest in property of 
close family members. For example, the Internal Revenue Code (``IRC'') 
recognizes the shared interests of family members by way of attributing 
the ownership of stock held by close family members to the 
taxpayer.\34\ The IRC treats stock owned by these close family members 
as owned by the taxpayer in determining the tax liability of the 
taxpayer in various situations.\35\
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    \34\ See 26 U.S.C. Section 318.
    \35\ See 26 U.S.C. Section 301 et. seq.
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    A further example is the National Association of Securities 
Dealers, Inc. (``NASD'') Freeriding and Withholding Interpretation,\36\ 
which restricts sales by NASD members to accounts in which so-called 
``restricted persons'' have a beneficial interest. Such restrictions 
are also applicable, with some exceptions, to immediate family members 
of those restricted persons.
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    \36\ NASD Conduct Rule IM-2110-1. The Freeriding and Withholding 
Interpretation is based on the premise that NASD members have an 
obligation to make a bona fide distribution of securities of a 
public offering that trade at a premium in the secondary market.
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    The Exchange believes that it should not penalize members who 
choose to lease memberships from close family members, as it believes 
that these persons are the functional equivalents of member-owners, and 
the same rationale applies to giving the credit to these members as to 
member-owners.
    (C) Members who are Associated with a Member Organization in which 
the Owner has an Interest of at Least Ten Percent. Members who are 
lessees and are associated with a member organization in which the 
owner has at least a ten percent interest also should be eligible for 
the credit based on their closely aligned interests with the owner. The 
federal securities laws and rules of the securities industry have long 
recognized that a ten percent ownership interest is a significant 
capital investment. For example, Section 16 of the Act \37\ requires 
any person who is the beneficial owner of more than ten percent of an 
equity security registered under Section 12 of the Act \38\ to file a 
statement with the Commission indicating his ownership interest. 
Section 16 \39\ also treats such beneficial owners as a company 
insiders and limits their ability to realize ``short swing'' profits. 
In enacting Section 16,\40\ the Congress found that a ten percent owner 
was sufficiently involved in the affairs of the issuer to be treated as 
an insider.
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    \37\ 15 U.S.C. 78p.
    \38\ 15 U.S.C. 78L.
    \39\ 15 U.S.C. 78p.
    \40\ Id.
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    Moreover, for purposes of NASD Conduct Rule 2720, which restricts 
the ability of an NASD member to participate in the distribution of a 
public offering of its own securities or the securities of the member's 
parent or affiliate, a company is presumed to control a member (and 
thus is an affiliate) if the company beneficially owns ten percent or 
more of the member firm. Finally, under the NASD's Freeriding and 
Withholding Interpretation,\41\ an individual with a ten percent or 
more equity interest in an NASD member firm is deemed restricted by 
virtue of his ownership interest, and, thus, NASD member firms may not 
sell so-called ``hot issues'' to that individual.
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    \41\ See supra note 33.
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    In each of these examples, Congress or the NASD found that a ten 
percent owner is sufficiently involved in the affairs of the subject 
entity to be subject to the applicable restriction. A similar analysis 
is applicable with respect to owners of Phlx memberships who hold a ten 
percent or greater interest in the very member organization with which 
the lessee is associated. The interests of the owner, the member lessee 
and the member organization are sufficiently aligned to allow the 
lessee member the benefit of the credit.
    (D) Members who Lease From Owners or Their Affiliates who Provide 
Order Flow to the Exchange Member. Similar to member-owners and other 
eligible members discussed above, members who lease from owners or 
their affiliates who provide order flow to the Exchange through the 
member have a direct contractual relationship with that owner. For 
example, a floor broker who executes orders entered by the owner from 
whom the member leases his or her seat has a fiduciary relationship 
with that owner. The member derives income, by way of commissions, from 
the order floor provider and the order flow provider, in turn, provides 
revenue to the Exchange mainly by way of transaction fees (and 
indirectly via tape revenues). Giving a credit to members in this 
situation should encourage the member to fully maximize the business 
relationship between the floor broker and order flow provider by 
encouraging the member to get more order flow, which in turn equates to 
an increase in fees paid by the floor broker to the Exchange. The 
Exchange believes that by extending the credit to this category of 
members who are closely associated with the owner, it is encouraging 
behavior that is beneficial to the long-term interests of the Exchange, 
e.g., providing more order flow.
    (E) Members who Lease From a Clearing Firm or a Related Entity of 
the Clearing Firm That Provides Clearing Services to the Leasing 
Member. Members who lease from a clearing firm or related entity of the 
clearing firm that provides clearing services to the leasing member 
should also be eligible to receive the credit. Members have a close 
connection to their clearing firms, or

[[Page 33611]]

related entity of the clearing firms, in that the clearing firms 
provide important and essential services by contractual agreement with 
such members; for instance, they guarantee members' trades. In 
addition, clearing firms lend money and extend credit; they also manage 
risk by way of tracking positions and other monitoring functions. 
Moreover, the clearing firm offers various ancillary services to the 
members, including stock executions services, office space and other 
business amenities. Therefore, given this close connection between the 
members and clearing firms or their affiliates, the Exchange believes 
that the credit is appropriate and should further their joint interest 
in the well-being of the Exchange.
2. Statutory Basis
    For these reasons, the Exchange believes that the proposed rule 
change is consistent with Section 6(b) of the Act, \42\ in general, and 
with Section 6(b)(4) \43\ in that it provides for the equitable 
allocation of reasonable dues, fees and other charges.
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    \42\ 15 U.S.C. 78f(b).
    \43\ 15 U.S.C. 78(b)(4)
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange believes that the proposed rule imposes no 
inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    Although written comments were not solicited, the Exchange issued a 
circular dated September 27, 1999 which announced certain actions taken 
at the September 1999 Phlx Board of Governors meeting. These actions 
included the approval of a monthly credit of up to $1,000 and invited 
telephone comments to be made to the Chairman. The Exchange has 
received two written comments; although these comments do not 
specifically address the proposed $1,000 credit, they do make reference 
to a ``rebate'' and a ``credit.'' Both letters raised the issue, among 
other things, of fairness in that some members would receive the credit 
and not others; this issue is addressed in detail in section A.1. 
above.\44\
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    \44\ See supra note 3.
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III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    The foregoing proposed rule change has become immediately effective 
upon filing pursuant to Section 19(b)(3)(A)(ii) of the Act \45\ and 
Rule 19b-4(f)(2) \46\ thereunder because it establishes a due, fee, or 
other charge. At any time within 60 days of the filing of such proposed 
rule change, the Commission may summarily abrogate such rule change if 
it appears to the Commission that such action is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act.
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    \45\ 15 U.S.C. 78s(b)(3)(A)(ii).
    \46\ 17 CFR 240.19b-4(f)(2).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room, 450 Fifth Street NW., Washington, 
DC 20549. Copies of such filing will also be available for inspection 
and copying at the principal office of the Phlx. All submissions should 
refer to File No. SR-Phlx-00-44 and should be submitted by June 14, 
2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\47\
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    \47\ 17 CFR 240.19b-4(f)(6)(iii).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-13069 Filed 5-23-00; 8:45 am]
BILLING CODE 8010-01-M