[Federal Register Volume 62, Number 152 (Thursday, August 7, 1997)]
[Notices]
[Pages 42618-42622]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-20838]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38898; File No. SR-Phlx-97-11]


Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 3: Thereto by the Philadelphia Stock Exchange, Inc., 
Relating to PACE Execution Guarantees

August 1, 1997.
    On March 3, 1997, the Philadelphia Stock Exchange, Inc. (``Phlx'' 
or ``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b) of the 
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend Phlx Rule 229 
(``Rule''), Philadelphia Stock Exchange Automated Communication and 
Execution System (``PACE''). On April 4, 1997, the Phlx filed Amendment 
No. 1 to the proposal.\3\ On April 22, 1997, the Exchange filed 
Amendment No. 2 to the proposed rule change.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 makes several clarifying revisions to the 
proposal and corrects a typographical error. See Letter from Philip 
H. Becker, Senior Vice President, Chief Regulatory Officer, Phlx, to 
James T. McHale, Special Counsel, Office of Market Supervision 
(``OMS''), Division of Market Regulation (``Division''), Commission, 
dated April 3, 1997 (``Amendment No. 1'').
    \4\ Amendment No. 2 clarifies the operation of the proposed rule 
change by revising the fourth example in Section I, B ``Proposed 
Changes,'' infra. See letter from Philip H. Becker, Senior Vice 
President, Chief Regulatory Officer, Phlx, to James T. McHale, 
Special Counsel, OMS, Division, Commission, dated April 17, 1997 
(``Amendment No. 2'').
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    Notice of the proposal and Amendment Nos. 1 and 2 was published for 
comment and appeared in the Federal Register on May 5, 1997.\5\ No 
Comment letters were received on the proposal. On June 16, 1997, the 
Phlx filed Amendment No. 3 to the proposed rule change.\6\ This order 
approves the Phlx's proposal, as amended.
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    \5\ See Securities Exchange Act Release No. 38544 (April 24, 
1997), 62 FR 24525 (May 5, 1997).
    \6\ Amendment No. 3 provides that specialists may change their 
applicable execution guarantee from the First Guarantee to the 
Second Guarantee (defined herein) and vice versa, upon one day's 
notice. In addition Amendment No. 3 revises Supplementary Materials 
.05 and .10(a)(i) to Rule 229 to clarify that where the customer 
order is greater than the size of the PACE Quote (defined herein), 
such order will receive an execution under the First Guarantee, 
unless the specialist agrees to the Second Guarantee. See Letter 
from Philip H. Becker, Senior Vice President, Chief Regulatory 
Officer, Phlx, to Michael Walinskas, Senior Special Counsel, OMS, 
Division, Commission, dated May 23, 1997 (``Amendment No. 3'').
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I. Description of the Proposal

A. History of PACE

    The PACE System has served as the Exchange's automatic order 
routing and execution system for securities on the equity trading 
floor, providing certain execution guarantees. Initially, the PACE 
System was created to provide an efficient mechanism for the delivery 
of small customer orders (up to 599 shares) to the specialist for 
manual execution. Thereafter, PACE order size eligibility increased, 
automatic execution became a feature of PACE, and the professional 
execution standard for PACE orders greater than 600 shares was 
codified.\7\ Pursuant to Supplementary Material .02 of the Rule, only 
agency orders are currently executed through PACE.\8\ PACE orders are 
only eligible for execution after the primary market has opened.\9\
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    \7\ See Securities Exchange Act Release Nos. 23630 (September 
16, 1986) (SR-Phlx-86-30); and 25716 (May 19, 1988) (SR-Phlx-87-30).
    \8\See Securities Exchange Act Release Nos. 26968 (June 23, 
1989) (SR-Phlx-89-13 defining agency orders); and 36442 (October 31, 
1995) (SR-Phlx-95-32 permitting broker-dealer orders on PACE). 
Although approval for the delivery of broker-dealer orders through 
PACE was received, this feature is not currently utilized by broker-
dealers. See Amendment No. 1, supra note 3.
    \9\ See Securities Exchange Act Release No. 27596 (January 8, 
1990) (SR-Phlx-89-15 at n.6). See also Chicago Stock Exchange, 
Incorporated (``CHX'') Rules, Article XX, Rule 37(a)(4).
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B. Proposed Changes

    The Phlx proposes to amend Rule 229 to revise the: (1) Execution 
guarantee applicable to PACE market and marketable limit orders \10\ 
over 599 shares; (2) out-of-range protection provisions; (3) execution 
price for partial round lots; and (4) organizational and miscellaneous 
provisions.
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    \10\ Market orders are defined as orders to buy or sell a stated 
amount of a security at the best price obtainable after the order is 
represented on the Exchange. Marketable limit orders are defined by 
the Exchange as orders to buy or sell a stated amount of a security 
at a specified price, which is received at a time when the market is 
trading at or better than the specified price. See letter from 
Philip H. Becker, Senior Vice President and Chief Regulatory 
Officer, Phlx, to Michael Walinskas, Senior Special Counsel, OMS, 
Division, Commission, dated July 25, 1997 (``Second Phlx Letter'').
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(i) Execution Guarantees
    The Exchange proposes to amend the execution guarantee applicable 
to market and marketable limit orders greater than 599 shares.\11\ 
Currently, pursuant to the first paragraph of Rule 229.05, market 
orders up to 599 shares are stopped at the PACE Quote at the time of 
entry of such orders into the system (``Stop Price''), regardless of 
the size of the PACE Quote, and are subject to a delay of up to 15 
seconds in order to receive an opportunity for price improvement. This 
feature is known as the ``Public Order Exposure System'' or ``POES.'' 
If such market order is not executed at an improved price within the 15 
second window, the order will be automatically executed at the Stop 
Price.\12\ Moreover, the second paragraph of Rule 229.05 provides that, 
subject to these procedures (i.e., the procedures outlined in the first 
paragraph of Rule 229.05), the specialist may voluntarily

[[Page 42619]]

agree to execute market orders greater than 599 shares. Thus, market 
orders over 599 shares that a specialist voluntarily agrees to accept 
for automatic execution are currently entitled to the same execution at 
the PACE Quote, regardless of the size of the PACE Quote. These orders 
are also subject to POES.
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    \11\ The Exchange is not amending the automatic execution 
guarantee applicable to orders fro 599 shares or less. Therefore, as 
currently provided in Supplementary Materials .05 and .10(a) of Rule 
229, if an order is for 599 shares or less, it will continue to be 
automatically executable at the PACE Quote, regardless of the size 
of the PACE Quote. The PACE Quote is defined as the best bid/ask 
quote among the American, Boston, Cincinnati, Chicago, New York, 
Pacific, or Philadelphia Stock Exchanges, or the Intermarket Trading 
System/Computer Assisted Execution System (``ITS/CAES'') quote, as 
appropriate.
    \12\ If the PACE Quote at the time of order entry into the 
system reflects a \1/8\ point spread between the best bid and offer, 
that order will be executed immediately without the 15 second delay. 
In a separate rule filing, the Exchange has proposed to modify POES, 
increasing the execution delay from 15 to 30 seconds.See Securities 
Exchange Act Release No. 38864 (July 23, 1997) (SR-Phlx-97-32).
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    Limit orders are governed by separate provisions in Rule 229, 
namely Supplementary Materials .09 and .10. Currently, round-lot limit 
orders up to 599 shares and the round-lot portion of partial round-lot 
(``PRL'') orders up to 599 shares which are entered at the PACE Quote 
are executed at the PACE Quote. This automatic execution guarantee for 
marketable limit orders up to 599 shares is unaffected by this 
proposal, apart from being reorganized into new sub-paragraph (i) of 
Rule 229.10(a). In addition, like market orders, currently specialists 
may voluntarily agree to automatically execute marketable limit orders 
greater than 599 shares, and such orders are entitled to the same 
execution at the PACE Quote, regardless of the size of the PACE 
Quote.\13\
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    \13\ See Second Phlx Letter, supra note 10.
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    The Exchange is now proposing to adopt new standards (reflected in 
Rules 229.05 and 229.10(a)(i)) governing the automatic execution of 
market and marketable limit orders over 599 shares by specialists. 
Specifically, where a specialist voluntarily agrees to automatically 
execute market or marketable limit orders greater than 599 shares, an 
order will be automatically executable at the PACE Quote, if it is: (a) 
Greater than 599 shares; (b) less than or equal to the size of the 
specialist's maximum automatic execution guarantee; and (c) less than 
or equal to the size of the PACE Quote. Orders greater than the size of 
the PACE Quote will be guaranteed a manual execution at the PACE Quote 
price up to the size of the PACE Quote, with the balance of the order 
receiving a professional execution,\14\ in accordance with Rule 
229.10(b) (``the First Guarantee''). In addition, for orders greater 
than the size of the PACE Quote, the specialist may guarantee an 
automatic execution at the PACE Quote, up to the size of the order 
(provided that it is less than or equal to the specialist's maximum 
automatic execution guarantee size), regardless of the size of the PACE 
Quote (``the Second Guarantee''). The First and Second execution 
guarantees are proposed to be added to Rule 229.05 for market orders 
and Rule 229.10(a)(i) for marketable limit orders. Both guarantees can 
voluntarily be elected by the Phlx specialist.
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    \14\ Currently, a professional execution is described in Rule 
229.10(b), listing specific circumstances and standards that apply. 
The Exchange is proposing to add the general standards that all 
orders subject to Supplementary Material .10(b) be executed 
consistent with prevailing market conditions, fair and orderly 
markets and other applicable rules of the Exchange. For instance, 
the rules of priority, parity and precedence apply to PACE orders, 
as do many other important trading rules.
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    Rule 229.07(b) will continue to apply to market orders greater than 
599 shares where the specialist has not agreed to provide automatic 
executions. The proposal would amend Rule 229.07(b), however, to 
provide that where the specialist has not agreed to automatically 
execute market orders greater than 599 shares, an order greater than 
599 shares is manually executed, and entitled to a professional 
execution pursuant to Rule 229.10(b) and other applicable rules of the 
Exchange.\15\ While these PACE-delivered orders are not subject to the 
execution parameters set forth in Supplementary Material .05 to the 
Rule, the rule change would make clear that they are subject to the 
professional execution standard set forth in Rule 229.10(b).\16\
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    \15\ Limit orders greater than 599 shares, where the specialist 
has not agreed to automatically execute orders over 599 shares, also 
will receive a professional execution pursuant to Rule 229.10(b). 
Telephone Conversation on July 16, 1997, between Edith Hallahan, 
Director and Special Counsel, Regulatory Services, Phlx, and James 
T. McHale, Special Counsel, OMS, Division, Commission.
    \16\ See also Section I, B, iv, infra.
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    The following is an example of how the proposal would operate, 
assuming the specialist has voluntarily agreed to provide an automatic 
execution guarantee for orders greater than 599 shares and thus would 
be required to provide at least the minimum guarantee (the First 
Guarantee). In this example, the PACE Quote bid is composed of 1,000 
shares (Pacific Exchange ``PCX''), 500 shares (New York Stock Exchange 
``NYSE''), and 500 shares (CHX), for an aggregate total size \17\ of 
2,000 shares and the specialist's maximum automatic execution guarantee 
is 2,500 shares.
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    \17\ The aggregate total size is provided for purposes of 
providing a complete example and does not affect the outcome, 
because only the size of the PACE Quote is relevant to the proposed 
execution guarantee. See Amendment No. 1, supra note.
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    (1) The specialist receives a market order to sell 1,000 shares. 
This order is equal to the size of the PACE Quote (single market PCX) 
bid (1,000 shares) and less than the specialist's maximum automatic 
execution guarantee size of 2,500 shares, thus, is automatically 
executable.
    (2) The specialist receives a market order to sell 1,100 shares. 
The order is greater than the PACE Quote bid size (PCX for 1,000 
shares), and thus would revert to manual status, with the specialist 
obligated to fill 1,000 shares at the PACE Quote, and the remaining 100 
shares entitled to a professional execution.
    (3) The specialist receives a market order to sell 2,200 shares. 
Same result: the entire order would revert to manual status with the 
specialist obligated to fill 1,000 shares at the PACE Quote, and the 
balance of 1,200 shares receiving a professional execution.
    (4) The specialist receives a market order to sell 3,000 shares. 
The order reverts to manual, because it exceeds the specialist's 
maximum automatic execution guarantee, and the entire 3,000 share order 
receives a professional execution.\18\ The fact that the aggregate size 
of the best bid is for 2,000 shares does not determine or affect the 
execution.
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    \18\ There is no guarantee up to the PACE Quote size, because 
the customer order size is greater than the specialist's maximum 
automatic execution guarantee. See Amendment No. 2, supra note 4.
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    Assuming the specialist has voluntarily agreed to provide an 
automatic execution guarantee for orders greater than 599 shares, the 
specialist may also determine to provide more than the minimum 
guarantee by guaranteeing an automatic execution at the PACE Quote to 
all orders within the specialist's maximum guarantee size, regardless 
of the size of the PACE Quote (i.e. the Second Guarantee). For 
instance, where the specialist's maximum automatic execution guarantee 
is 2,500 shares and the PACE Quote bid is composed of 1,000 shares 
(PCX), 500 shares (NYSE), and 500 shares (CHX), for an aggregate total 
size of 2,000 shares, a market order to sell 2,200 shares is received. 
This order is automatically executed at the PACE Quote, because it is 
less than the specialist's maximum size guarantee for automatic 
execution, despite the PACE Quote size being 1,000 shares.
    The Exchange believes that in light of significant changes to the 
marketplace as well as the competitive environment, one purpose of this 
proposal is to update the PACE automatic execution guarantees. For 
instance, new SEC Rule 11Ac1-4 (``Display Rule'') \19\ requires 
specialists and market makers to, under normal market conditions, 
display within 30 seconds the price and full size of customer limit 
orders better than or, where the specialist's quote is the PACE Quote, 
that enhance the size of the specialist's quote.\20\ Other changes in

[[Page 42620]]

the marketplace include the increase in third market trading, 
internalization, payment for order flow practices and the use of 
technology, as cited by the Commission both in the Rule 11Ac1-4 
Adopting Release, as well as in the Market 2000 Study.\21\
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    \19\ 17 CFR 240.11Ac1-4
    \20\ See Securities Exchange Act Release No. 37619A (September 
6, 1996), 61 FR 48290 (September 12, 1996) (``Rule 11Ac1-4 Adopting 
Release''). See also Securities Exchange Act Release Nos. 38110 
(January 2, 1997), 62 FR 1279 (January 9, 1997) (revising effective 
date until January 13, 1997); and 38139 (January 8, 1997), 62 FR 
1385 (January 10, 1997) (revising effective date to January 20, 
1997).
    \21\ See Rule 11Ac1-4 Adopting Release at 8 and note 12, supra 
note 20.
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    With respect to the current competitive environment, the Exchange 
notes that other regional exchange automated order delivery and 
execution systems provide various types of execution guarantees. For 
market orders, other regional exchange rules permit conditioning 
automatic execution at the PACE Quote on the displayed size of the PACE 
Quote. For instance, the Chicago Stock Exchange MAX System limits 
automatic execution to orders less than or equal to the size of the 
displayed ITS/BBO or NBBO, as the case may be.\22\ Thus, the effect of 
the Exchange's proposal is to similarly consider the PACE quote size 
for certain order sizes, consistent with other systems.
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    \22\ See CHX, Article XX, Rule 37(b)(11), which states that 
notwithstanding anything contrary in Rule 37, no market or 
marketable limit order is automatically executed if it is greater 
than he size of the ITS/BBO (equivalent to the PACE Quote) or NBBO 
(the national best bid or offer disseminated pursuant to Rule 11Ac1-
1 under the Exchange Act), as the case may be. In addition, much 
like the First Guarantee, if a customer order routed through the MAX 
system exceeds the size of the ITS/BBO or NBBO, the specialist will 
execute the order manually at the price of the ITS/BBO or NBBO up to 
the size of the ITS/BBO or NBBO, with the balance of the order 
remaining as an ``open order'' for execution. Telephone conversation 
on July 9, 1997, between J. Craig Long, Esq., Foley & Larder, and 
James T. McHale, Special Counsel, OMS, Division, Commission.
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(ii) Out-of-Range Protection
    The Exchange also is proposing to amend the Rule's provisions 
respecting out-of-range executions. Currently, pursuant to 
Supplementary Material .07(a) of the Rule, member organizations which 
enter market orders (up to 599 shares) after the opening may elect to 
have such orders executed (i) in accordance with the procedures set 
forth in Rule 229.05, or (ii) if such execution price would be outside 
the NYSE high-low range for the day, manually at or within the NYSE 
high-low range of the day. Thus, market orders that would result in an 
out-of-range execution may be handled manually by the specialist, 
instead of receiving an automatic execution, if so elected by the PACE 
order entry firm. This is referred to as out-of-range protection, a 
long-standing feature of the PACE System.\23\
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    \23\ See e.g., Securities Exchange Act Release No. 28629 
(November 20, 1990) (SR-Phlx-90-19).
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    Under the proposal, the limitation to orders less than 599 shares 
in Supplementary Material .07(a) respecting market orders will be 
deleted. In addition, the Exchange is proposing to adopt an out-of-
range protection provision for limit orders not currently covered by 
such a provision, namely orders less than 600 shares.\24\ As discussed 
above, the Exchange believes that out-of-range protection is an 
important PACE System feature and should be properly codified into the 
Rule as applicable to all order types. The Exchange notes that out-of-
range protection is common to regional exchange systems.\25\
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    \24\ Limit orders for 600 shares or more are covered by the out-
of-range protection provision in Rule 229.10(b)(4).
    \25\ See e.g., CHX, Article XX, Rule 37(a)(6), (b)(11) and 
(e)(6), which provide for stopping such orders.
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(iii) Execution of Partial Round-Lot Orders
    The Exchange also proposes to amend the Rule's provisions 
respecting the execution guarantee applicable to PRL orders. Currently, 
Supplementary Material .07(b) of the Rule states that the odd-lot 
portion of PRLs of 601 or more shares shall be executed at the same 
price as the round-lot portion. In addition, Rule 229.07(b) provides 
that, in the case of a PRL order, the round-lot portion(s) of which is 
executed at more than one price, the odd-lot portion shall be executed 
at the same price as the last round-lot portion is executed. A similar 
provision appears in Supplementary Materials .09 and .10(c) to Rule 
229. These provisions are proposed to be amended, such that, in the 
case of a PRL order, the round-lot portion(s) of which is executed at 
more than one price, the odd-lot portion shall be executed at the same 
price as the first 100 shares (round-lot), not the last round-lot 
portion, as the provisions currently state. The Exchange believes that 
the proposed execution procedure should, in most situations, result in 
a better execution price for the customer, because later round-lots are 
generally executed at inferior prices, as the market responds to the 
prior execution.\26\
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    \26\ See Letter from Edith Hallahan, Director and Special 
Counsel, Regulatory Services, Phlx, to Michael Walinskas, Senior 
Special Counsel, OMS, Division, Commission, dated June 25, 1997 
(``First Phlx Letter'').
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(iv) Organizational and Miscellaneous Provisions
    Lastly, the Exchange is also proposing to reorganize Rule 229 by 
separating marketable limit orders \27\ and otherwise clarifying 
Supplementary Material .10(a). Further, Supplementary Material .07(b) 
is proposed to be amended to reflect that orders exceeding a 
specialist's automatic execution guarantee may nevertheless be 
delivered through the PACE System. Currently, this provision states 
that market orders (round-lots of 600 to 1000 shares or such greater 
size which the specialist agrees to accept and partial round-lots of 
601 to 1099 shares or such greater size which the specialist agrees to 
accept) which are entered after the opening shall not be subject to the 
execution parameters set forth in Rule 229 and shall be executed in 
accordance with other applicable rules of the Exchange. The proposal 
would clarify that this provision applies to orders which the 
specialist has not agreed to accept for automatic execution and are, 
instead, only delivered through the PACE System. The proposal would 
also codify that such orders are executable in accordance with 
Supplementary Material .10(b).
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    \27\ The provisions respecting non-marketable limit orders would 
be reorganized as sub-paragraph (ii) but otherwise remain unchanged.
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II. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and, in 
particular, the requirements of Section 6(b)(5) of the Act.\28\ 
Specifically, the Commission believes that the proposed rule change is 
designed to promote just and equitable principles of trade and 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, and is not designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers.\29\
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    \28\ 15 U.S.C. 78f(b)(5).
    \29\ In approving the proposed rule change, the Commission notes 
that it has considered the proposed rule's impact on efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f).
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    The proposed rule change would amend Rule 229.05 and Rule 
229.10(b)(i), respectively, to provide that where a specialist 
voluntarily agrees to automatically execute market or marketable limit 
orders greater than 599 shares, an order is automatically executable at 
the PACE Quote, if it is: (a) Greater than 599 shares; (b) within the 
specialist's maximum automatic execution guarantee; and (c) less than 
or

[[Page 42621]]

equal to the size of the PACE Quote.\30\ Under this First Guarantee, 
orders greater than the size of the PACE Quote would be guaranteed a 
manual execution at the PACE Quote price up to the size of the PACE 
Quote, with the balance of the order receiving a professional execution 
in accordance with Rule 229.10(b). In addition, for orders greater than 
the size of the PACE Quote, the specialist may guarantee an automatic 
execution at the PACE Quote price, up to the size of the order 
(provided it is less than or equal to the specialist's maximum 
automatic execution guarantee), regardless of the size of the PACE 
Quote (the Second Guarantee).
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    \30\ Consistent with the existing provisions of Rules 229.05 and 
229.10(a), if an order is for 599 shares or less, it will continue 
to be automatically executable at the PACE Quote, regardless of the 
size of the PACE Quote, as the Exchange is not amending the 
automatic execution guarantee applicable to orders for 599 shares or 
less.
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    The Commission believes that limiting the automatic execution 
guarantee applicable to PACE market and marketable limit orders over 
599 shares to the size of the PACE Quote (unless the specialist agrees 
to the second Guarantee) is reasonable and consistent with the Act. The 
Commission recognizes that to the extent a customer order exceeds the 
size of the PACE Quote, Phlx specialists must execute the order as 
principal, thus taking on additional risk. A specialist may reasonably 
determine that orders that are greater in size than reflected in the 
PACE Quote justify separate pricing. The First Guarantee will provide 
the specialist with the flexibility of electing such a limited 
guarantee. This increased flexibility should help to encourage 
specialist participation in providing at least a limited guarantee for 
orders over 599 shares. The First Guarantee also serves to ensure that 
customers receive the best price that is available in the intermarket 
system in the stock, up to the size of the PACE Quote. The Second 
Guarantee serves to provide the specialist with the discretion to 
accept the increased risk associated with guaranteeing execution of 
orders at the PACE Quote when such orders exceed the size that the PACE 
Quote is based upon. The Commission also notes that conditioning 
automatic execution at the PACE Quote price on the displayed size of 
the PACE Quote is consistent with the rules of other regional 
markets.\31\ Finally, the Commission finds that permitting specialists 
to change from the First Guarantee to the Second Guarantee and vice 
versa with one day's notice to PACE users is reasonable.\32\
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    \31\ For example, the Chicago Stock Exchange MAX system limits 
automatic execution to orders less than the size of the ITS/BBO. See 
supra note 22.
    \32\ See Amendment No. 3, supra note 6.
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    The Commission believes that the amendment to the out-of-range 
guarantee for market and marketable limit orders also is consistent 
with the Act.\33\ Specifically, providing that all market orders are 
subject to out-of-range protection, as opposed to only those market 
orders up to 599 shares as is currently the case, provides member 
organizations with more flexibility by allowing them to elect out-of-
range protection for all market orders within the parameters of the 
specialists guarantee. This, in turn, should benefit investors by 
providing out-of-range protection to larger orders and should help the 
Exchange compete for order flow. Moreover, the Commission believes that 
adopting an out-of-range protection provision for limit orders not 
currently covered by such a provision (i.e., orders less than 600 
shares) is reasonable and consistent with the Act. Finally, the 
Commission notes that while neither specialists nor member 
organizations are required under the federal securities laws to provide 
out-of-range protection, allowing out-of-range protection to all orders 
is consistent with the Act.
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    \33\ Out-of-range protection allows members organizations 
entering orders after the opening to elect to have such orders 
executed automatically at the PACE Quote, or if such execution price 
would be outside the NYSE high-low range for the day, manually at or 
within the NYSE high-low range of the day.
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    The Commission finds the change in execution of partial round-lot 
orders to be consistent with the Act. Specifically, the proposal amends 
Rules 229.07(b), 229.09, and 229.10(c) to provide that in the case of a 
PRL order, the round-lot portion of which is executed at more than one 
price, the odd-lot portion shall be executed at the same price as the 
first 100 shares, not the last 100 shares, as the rules currently 
provide. The Commission believes that this approach should generally 
provide superior PRL order executions. For example, if the market for 
XYZ stock is initially 20 x 20\1/8\, and a PACE market order to buy 650 
shares is received, the specialist intending to execute the first 300 
shares at 20\1/8\, would generally execute 350 shares at that price, 
including the 50 share odd-lot in the first execution.\34\ Thereafter, 
if the market were to become 20\1/8\ x 2\1/4\, the specialist would 
execute the remaining 300 shares at 20\1/4\. The Rule does not require 
that the odd-lot portion be executed with the first round-lot, but 
encourages it by requiring that the odd-lot portion receive the same 
price as the first round-lot. Accordingly, these odd-lots should 
receive a more prompt execution, and in most situations a better price, 
because later round lots are generally executed at inferior prices, as 
the market responds to the prior execution.\35\
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    \34\ This example assumes that the specialist has not agreed to 
automatically execute market or marketable limit orders greater than 
599 shares. If the incoming order is for 599 shares or less, it is 
executable in full at the PACE quote, such that generally it would 
not be executed at more than one price and thus would not trigger 
this provision. See First Phlx Letter, supra note 26.
    \35\ Id. The Commission notes that intervening market events 
could cause the market to move in the opposite direction (i.e. in 
the customer's favor). In the above example, after the first 
execution at 20\1/8\, the market could become 19\7/8\ x 20, such 
that the remainder of the order would be executed at 20, a better 
price. Under the new procedure, executing the odd-lot portion at the 
first price is less favorable to the customer. The Commission 
believes, however, that basing the odd-lot execution price on the 
execution price for the first 100 shares generally will provide a 
more favorable execution for customer orders.
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    Finally, the Commission believes that the organizational changes 
made to Rule 229, separating marketable limit orders and clarifying 
Supplementary Material .10(a), should help clarify operation of the 
Rule. Moreover, the amendment to Rule 229.07(b), providing that market 
orders which the specialist has not agreed to accept for automatic 
execution may nevertheless be delivered through the PACE system, 
clarifies that such orders are to be executed in accordance with Rule 
229.10(b),\36\ as well as other applicable rules of the Exchange. The 
Commission believes that this should further encourage the delivery of 
customer orders through the PACE system, and, as such, is consistent 
with Section 11A of the Act,\37\ and paragraph (a)(1) thereunder, which 
encourages the use of new data processing and communications techniques 
that create the opportunity for more efficient and effective market 
operations. Accordingly, the Commission finds that this change is 
appropriate and consistent with the Act.
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    \36\ The Commission also finds that the addition of general 
standards (i.e. that all orders subject to Rule 229.10(b) be 
executed ``consistent with prevailing market conditions, fair and 
orderly markets and other applicable Exchange rules'') strengthens 
the language of the Rule. The additional language clarifies, for 
example, that the rules of priority, parity and precedence apply to 
PACE orders.
    \37\ 15 U.S.C. 78k-1
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    The Commission finds good cause for approving Amendment No. 3 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice thereof in the Federal Register. Amendment No. 3 
states that specialists, after their initial determination to provide a 
manual or automatic guarantee (i.e. the First or Second Guarantee), may 
change from

[[Page 42622]]

one guarantee to the other, effective the next day. The Commission 
finds that this is a reasonable approach and strikes an appropriate 
balance between the needs of specialists to change their guarantee in a 
moving market, and the needs of member organizations to know which 
guarantee applies. Amendment No. 3 also amends the text of Rules 229.05 
and 229.10(a)(i), respectively, to clarify that where the specialist 
has voluntarily agreed to automatically execute market and marketable 
limit orders greater than 599 shares and the order size is greater than 
the size of the PACE Quote, the order shall manually receive an 
execution at the PACE Quote up to the size of the PACE Quote, with the 
balance of the order receiving a professional execution (the First 
Guarantee), provided that the specialist may guarantee an automatic 
execution at the PACE Quote up to the entire size of the specialist's 
automatic execution guarantee (the Second Guarantee). The Commission 
finds this language strengthens the proposals by clarifying that unless 
the specialist specifically elects to provide the Second Guarantee, the 
First Guarantee will be in effect. The Commission also notes that no 
comments were received on the original Phlx proposal, which was subject 
to the full 21-day comment period. Therefore, the Commission believes 
that it is consistent with Section 6(b)(5) of the Act to approve 
Amendment No. 3 to the proposed rule change on an accelerated basis.
    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 3 to the proposed rule change. 
Persons making written submissions should file six copies thereof with 
the Secretary, Securities and Exchange Commission, 450 Fifth Street, 
N.W., Washington, D.C. 20549. 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 Section, 450 Fifth Street, N.W., Washington, D.C. 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-97-11 and should be submitted by August 28, 1997.
    For the foregoing reasons, the Commission finds that the Phlx's 
proposal, as amended, is consistent with the requirements of the Act 
and the rules and regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\38\ that the amended proposed rule change (SR-Phlx-97-11) is 
approved.

    \38\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\39\
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    \39\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-20838 Filed 8-6-97; 8:45 am]
BILLING CODE 8010-01-M