Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices 23291

12 In approving this proposal, the Commission has

considered the proposed rule’s impact on

efficiency, competition, and capital formation. 15

U.S.C. 78c(f).

13 15 U.S.C. 78o–3(b)(6).

14 15 U.S.C. 78k–1(a)(1)(C).

15See supra note 6.

16The initial compliance date for the reporting of

listed securities under Rule 11Acl–5 was May 1,

2001. The Commission has temporarily exempted

(until July 31, 2001) all orders in Nasdaq securities.

Letter from Annette L. Nazareth, Director, Division

of Market Regulation, SEC, to Stuart J. Kaswell,

Senior Vice President and General Counsel,

Securities Industry Association, dated April 12,

2001.

17See supra note 6.

18 15 U.S.C. 78s(b)(2).

19 15 U.S.C. 78s(b)(2).

20 17 CFR 200.30–3(a)(12).

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

C. Self-Regulatory Organization’s

Statement on Comments on the

Proposed Rule Change Received From

Members, Participants, or Others

Nasdaq did not solicit or receive

written comments on the proposed rule

change.

III. 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 at

the Commission’s Public Reference

Room. Copies of such filing will also be

available for inspection and copying at

the principal office of the NASD. All

submissions should refer to File No.

SR–NASD–2001–29 and should be

submitted by May 29, 2001.

IV. Commission’s Findings and Order

Granting Accelerated Approval of

Proposed Rule Change

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

association.12 In particular, the

proposed rule change is consistent with

the requirements of Section 15A(b)(6) 13

of the Act in that it is designed to foster

cooperation and coordination with

persons engaged in processing

information with respect to securities, 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.

In addition, the proposed rule change

is consistent with Section 11A(a)(1)(C)

of the Act,14 which provides that it is in

the public interest and appropriate for

the protection of investors and the

maintenance of fair and orderly markets

to assure the availability to brokers,

dealers, and investors of information

with respect to quotations and

transactions in securities. In adopting

Rule 11Ac1–5, the Commission stated

that the Rules would help further this

and other national market system

objectives.15 Many market centers may

not have the necessary systems in place

to collect and disseminate the statistical

information required by the Rule.

Moreover, developing such systems and

allocating firm personnel necessary to

produce internally the reports required

by the rule may be a significant burden

on some firms and may not be

completed by the applicable compliance

dates.16 The Commission anticipated

that self-regulatory organizations might

choose to provide services to assist their

members in complying with the Rule.17

The ReSourceSM Service could enable

many NASD member market centers to

comply with Rule 11Acl–5 in a more

cost-effect and timely manner.

Pursuant to Seciton 19(b)(2),18 the

Commission finds good cause for

approving the proposed rule change

prior to the thirtieth day after the date

of publication of notice thereof in the

Federal Register. Accelerated approval

of the ReSourceSM Service will give

subscribing firms an alternative means

to comply with Rule 11Ac1–5 and allow

sufficient time for market centers to

develop and test their systems. Members

must begin this process as soon as

possible to ensure that they are prepared

to comply with the Rule on August 1,

2001. Nasdaq states that many NASD

members have inquired as to whether

Nasdaq will offer such a service. Nasdaq

believes that members may be hesitant

to subscribe to the Service due to

concern the ReSourceSM Service may

not be approved or approved too late to

enable members to comply with Rule

11Ac1–5. Moreover, a prospective

subscriber of Nasdaq’s ReSourceSM

Service may be hesitant to commit

resources to programming and testing

systems for ReSourceSM if there is a

possibility that approval will be

delayed. Accelerated approval will

eliminate uncertainty regarding the

ReSourceSM Service.

Accelerated approval of the

ReSourceSM Service also will facilitate

Nasdaq’s ability to develop and test

systems. Nasdaq represents that based

on conversations with members, it has

developed an estimate of the number of

firms that are likely to subscribe and the

resources required to provide the

ReSourceSM Service. However, Nasdaq

cannot confirm its estimates until it

confirms the number of subscribers,

which practically can be accomplished

only when a subscriber pays for the

ReSourceSM service. In addition, the

cost of the ReSourceSM Service will be

an important factor that potential

subscribers will consider in determining

whether to subscribe. Accelerated

approval of the ReSourceSM service will

enable Nasdaq to finalize their fee

schedule sooner.

It is therefore ordered, pursuant to

Section 19(b)(2) of the Act,19 that the

proposed rule change, SR–NASD–2001–

29 is approved on an accelerated basis.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.20

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 01–11518 Filed 5–7–01; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

(Release No. 34–44233; File No. SR–PCX–

00–25)

Self-Regulatory Organizations; Notice

of Filing of Amendment No. 3 to

Proposed Rule Change by the Pacific

Exchange, Inc. Relating to the

Archipelago Exchange

April 30, 2001.

Pursuant to Section 19(b)(1) under the

Securities Exchange Act of 1934

(‘‘Exchange Act’’) 1 and Rule 19b–4

thereunder,2 notice is hereby given that

on April 19, 2001, the Pacific Exchange,

Inc. (‘‘PCX’’ or ‘‘Exchange’’), through its

subsidiary PCX Equities, Inc. (‘‘PCXE’’

or ‘‘Corporation’’), filed with the

Securities and Exchange Commission

(‘‘Commission’’ or ‘‘SEC’’) Amendment

No. 3 to the proposed rule change as

described in Items I, II and III below,

which Items have been prepared by the

PCXE. On December 15, 2000, the

proposed rule change and Amendment

No. 1 was published for comment in the

23292 Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices

3See Securities Exchange Act Release No. 43608

(Nov. 21, 2000), 65 FR 78822 (Dec. 15, 2000) (‘‘Arca

Proposing Release’’).

4See letter from Cherie Macauley, Wilmer, Cutler

& Pickering, Counsel for the Exchange to John

Polise, Senior Special Counsel, Division of Market

Regulation, Commission, dated February 26, 2001

(‘‘Amendment No. 2’’). The Commission does not

believe that notice of Amendment No. 2 is

necessary. Amendment No. 2 is similar to

Amendment No. 3, but there are some substantive

differences in Amendment No. 3 that supersede

Amendment No. 2. Amendment No. 2 is publicly

available in the Commission’s Public Reference

Room and the PCX’s principal place of business.

Federal Register.3 On February 27,

2001, the PCXE filed Amendment No. 2

to the proposal.4 The Commission is

publishing this notice to solicit

comments on Amendment No. 3 to the

proposed rule change from interested

persons. The Commission is also

publishing the PCX’s Supplemental

Response to Comment Letters as

Appendix A, B, and C.

I. Self-Regulatory Organization’s

Statement of the Terms of Substance of

the Proposed Rule Change

The PCX, through its wholly owned

subsidiary PCXE, is proposing to create

a new electronic trading facility of the

PCXE, called the Archipelago Exchange

(‘‘ArcaEx’’ or ‘‘Arca’’). The proposed

changes to the proposed rules, as

published in the Arca Proposing

Release, are below.

Additions are in italics; Deletions are

in [brackets].

Rules of PCX Equities, Inc.

* * * * *

Rule 1

Definitions

Rule 1.1—No change.

(a)–(p)—No change.

Imbalance

(q) For the purposes of the Opening

Auction, [and] the Market Order

Auction and the Trading Halt Auction,

as the case may be, the term

‘‘Imbalance’’ shall mean the number of

buy or sell shares [orders] that can not

be matched with other shares [orders] at

the Indicative Match Price at any given

time.

Indicative Match Price

(r) For the purposes of the Opening

Auction, [or] the Market Order Auction

and the Trading Halt Auction, as the

case may be, the term ‘‘Indicative Match

Price’’ shall mean for each security (1)

the price at which the maximum

volume of shares [orders] are

executable; or (2) if there are two or

more prices at which the maximum

volume of shares [orders] are

executable, the price that is closest to

the closing price of the previous trading

day’s normal market hours, as

determined by the Consolidated Tape.

(s)–(w)—No change.

NASD

(x) The term ‘‘NASD’’ shall mean the

National Association of Securities

Dealers, Inc.

Nasdaq

(y) The term ‘‘Nasdaq’’ shall mean

The Nasdaq Stock Market, Inc.

Nasdaq Market Maker

(z) The term ‘‘Nasdaq Market Maker’’

shall mean (1) a Nasdaq market maker

as defined in NASD Rule 4200(a)(22), as

amended from time to time, or (2) an

electronic communications network

(‘‘ECN’’).

Nasdaq/NM Security

(aa) The term ‘‘Nasdaq/NM Security’’

shall mean any security (i) designated

as a national market system security

pursuant to the NASD’s ‘‘National

Market System Securities Designation

Plan with respect to Nasdaq Securities,’’

filed with and approved by the

Commission pursuant to SEC Rule

11Aa2–1 under the Exchange Act and

(ii) that is either listed on the

Corporation pursuant to Rule 5 or as to

which unlisted trading privileges have

been granted pursuant to Section 12(f)

of the Exchange Act.

Nasdaq System

(bb) The term ‘‘Nasdaq System’’ shall

mean the system operated by Nasdaq.

Nasdaq System BBO

(cc) The term ‘‘Nasdaq System BBO’’

shall mean the best bid or offer that is

disseminated pursuant to SEC Rule

11Ac1–1 among the Nasdaq System

participants in those issues that are

traded on the Nasdaq System.

(dd)–(gg) [(x)–(aa)]—No change.

OTC/UTP Participant

(hh) The term ‘‘OTC/UTP Participant’’

shall mean any registered national

securities exchange or national

securities association that is a signatory

to the OTC/UTP Plan.

OTC/UTP Plan

(ii) The term ‘‘OTC/UTP Plan’’ shall

mean the Nasdaq National Market/

Unlisted Trading System/ Unlisted

Trading Privileges Plan, as from time to

time amended according to its

provisions.

OTC/UTP Primary Market

(jj) The term ‘‘OTC/UTP Primary

Market’’ for a Nasdaq/NM Security

means Nasdaq; provided, however, that

if for any 12-month period the number

of reported transactions and the

reported share volume in a Nasdaq/NM

Security in any other OTC/UTP

Participant’s market exceeds 50% of the

aggregate reported transactions and

reported share volume of all OTC/UTP

Participants in such security, then that

OTC/UTP Participant’s market shall be

the OTC/UTP Primary Market.

OTC/UTP Regulatory Halt

(kk) The term ‘‘OTC/UTP Regulatory

Halt’’ means a trade suspension or halt

called by the OTC/UTP Primary Market

for the purpose of dissemination of

material news.

(ll)–(uu) [(bb)–(kk)]—No change.

Sponsorship Provisions

(vv) [(ll)] The term ‘‘Sponsorship

Provisions’’ shall mean the provisions

set [sent] forth in Rule 7.29(b)(2). For a

Sponsored Participant to obtain

authorized access to the Archipelago

Exchange, the Sponsored Participant

and its Sponsoring ETP Holder must

enter into an agreement which

incorporates the Sponsorship

Provisions.

(ww)–(aaa) [(mm)–(qq)]—No change.

* * * * *

Rule 2

Equity Trading Permits

Rules 2.1–2.4—No change.

[Publication of Approved ETP

Applications]

Rule 2.5. Reserved. [With respect to

each ETP that is issued, the Corporation

shall promptly distribute a notice

thereof to all ETP Holders by publishing

the name of each new ETP Holder in the

Corporation’s Weekly Bulletin.]

Rules 2.6–2.100—No change.

* * * * *

Rule 7

Equities Trading

Rules 7.1–7.5—No change.

Trading Differentials

Rule 7.6(a)—No change.

Commentary:

.01–.04—No change.

.05 The minimum price variation

(‘‘MPV’’) for equity securities traded on

the Archipelago Exchange shall be [1/64

of $1.00 for those securities that are

quoted in fractions and] $0.01 [for those

equity securities that are quoted in

decimals]; provided, however, at all

times the MPV shall be consistent with

the Decimalization Implementation

Plan.

.06 The minimum price improvement

increment (‘‘MPII’’) on the Archipelago

Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices 23293

Exchange shall be equal to $0.01 or 10%

of the NBBO spread, whichever is more.

(b)—No change.

Rules 7.7 –7.17—No change.

Trading in Nasdaq/NM Securities

Rule 7.18[. Reserved.] (a) Access.

(1) The Corporation shall permit each

Nasdaq Market Maker, acting in its

capacity as a market maker, telephone

access, or such other access as may be

established between the Corporation

and the Nasdaq System (collectively,

‘‘approved access’’), to the Corporation

for each Nasdaq/NM Security in which

such market maker is registered as a

market maker. Such approved access

shall include appropriate procedures to

assure the timely response to

communications received through

telephone or other approved access.

(2) Nasdaq Market Makers may use

such approved access to transmit orders

for execution on the Corporation.

Market Makers, via the facilities of the

Corporation, may send orders via

approved access to any Nasdaq Market

Maker in each Nasdaq/NM security in

which it displays quotations.

(3) Any order received via approved

access from a Nasdaq Market Maker

shall be effected in accordance with the

Rules of the Corporation applicable to

transactions on the Archipelago

Exchange.

(4) No Market Maker shall permit the

imposition of any access or execution

fee, or any other fee or charge, with

respect to transactions in Nasdaq/NM

Securities effected with Nasdaq Market

Makers that are communicated to the

Corporation through telephone access.

(b) Display. The Corporation will

display on the Archipelago Exchange, at

a minimum, the Nasdaq System BBO.

(c) OTC/UTP Regulatory Halts.

Whenever, in the exercise of its

regulatory function, the OTC/UTP

Primary Market for a Nasdaq/NM

Security determines that an OTC/UTP

Regulatory Halt is appropriate, the

Corporation shall halt or suspend

trading in that security until the

notification by the OTC/UTP Primary

Market that the halt or suspension is no

longer in effect. The Corporation will

assume that adequate publication or

dissemination has occurred upon the

expiration of one hour after initial

publication in a national news

dissemination service of the information

that gave rise to an OTC/UTP

Regulatory Halt and may, at its

discretion, re-open trading at that time,

notwithstanding notification from the

OTC/UTP Primary Market that the halt

or suspension is no longer in effect.

(d) Applicability. The following Rules

of the Corporation will not be applicable

to transactions on the Corporation in

Nasdaq/NM Securities: Rules 7.16, 7.55–

7.57.

Rules 7.19–7.22—No change.

Obligations of Market Makers

Rule 7.23(a). General. ETP Holders

who are registered as Market Makers in

one or more securities traded on the

Corporation must engage in a course of

dealings for their own account to assist

in the maintenance, insofar as

reasonably practicable, of fair and

orderly markets on the Corporation in

accordance with this Rule. The

responsibilities and duties of a Market

Maker specifically include, but are not

limited to, the following:

(1)–(5)—No change.

(6) [Enter and maintain a] Maintain

one Cleanup Order in each security in

which the Market Maker is registered as

such for each Market Order Auction.

(b)–(d)—No change.

Rules 7.24–7.30—No change.

Orders and Modifiers

Rule 7.31.

(a)–(e)—No change.

(f) Tracking Order.

(1)–(6)—No change.

(7) The Corporation shall suspend the

Tracking Order Process for a security

when a locked or crossed market exists

in that security. The Tracking Order

Process for that security shall resume

when the locked or crossed market in

that security no longer exists.

(8)[(7)]—No change.

(g)–(h)—No change.

(i) Directed Order.

(1) Any market or limit order to buy

or sell which has been directed to a

particular Market Maker by the User.

(2) The Corporation shall suspend the

Directed Order Process for a security

when a locked or crossed market exists

in that security. The Directed Order

Process for that security shall resume

when the locked or crossed market in

that security no longer exists.

(j)–(r)—No change.

(s) Cross Order. A two-sided order

with instructions to match the identified

buy-side with the identified sell-side at

a specified price (the ‘‘cross price’’). For

the purposes of this Rule 7.31(s), an

order of block size shall have the same

meaning as set forth in Rule 7.57. A

Cross Order will be executed as follows;

provided, however, no Cross Orders

shall be matched at the cross price

without interacting with any orders in

the Arca Book unless the cross price

improves the BBO by the MPII:

(1)—No change.

(2) If the cross price is outside the

NBBO,

(A) and the cross price is between the

BBO,

(i) first, the portion of the Cross Order

that may be executed in another market

shall be routed away for execution

[pursuant to Section 5 of Rule 7]; and

(ii) then, the remainder of the Cross

Order shall be matched at the cross

price without interacting with any

orders in the Arca Book.

(B) and the cross price is at the BBO,

(i) first, the portion of the Cross Order

that may be executed in another market

shall be routed away for execution

[pursuant to Section 5 of Rule 7];

(ii)–(iii)—No change.

(C) and the cross price is outside the

BBO,

(i) and the NBBO is better than the

BBO,

(1) first, the portion of the Cross Order

that may be executed in another market

shall be routed away for execution

[pursuant to Section 5 of Rule 7];

(2)–(3)—No change.

(ii) and the NBBO equals the BBO,

(1)—No change.

(2) then, the portion of the Cross

Order that may be executed in another

market shall be routed away for

execution [pursuant to Section 5 of Rule

7];

(3)—No change.

(t) Auction-Only Limit Order. A limit

order that is to be executed only during

the Market Order Auction or the

Trading Halt Auction, as the case may

be.

(u) Cleanup Order.

(1)(A) [Only Market Makers may

submit] Cleanup Orders may be

submitted on behalf of Market Makers

only [to the Archipelago Exchange].

Cleanup Orders may not be submitted

on behalf of any Users other than

Market Makers.

(B) Archipelago Exchange, on behalf

of each Market Maker, will submit each

Cleanup Order.

(C) Only one Cleanup Order per

security may be submitted on behalf of

each Market Maker.

(2) Cleanup Orders must be submitted

[to the Archipelago Exchange] before

6:15 am (Pacific Time) and remain in

effect until the conclusion of the Market

Order Auction.

(3)–(5)—No change.

(6) Cleanup Orders will only be

executed if:

(A) There is an Imbalance [of Market

Orders] at the conclusion of the Market

Order Auction, as provided in Rule

7.35; and

(B) The Imbalance is less than or

equal to the aggregate size of all Cleanup

Orders in the relevant security.

(7)–(8)—No change.

(v)–(w)—No change.

(x) Primary Only Order (PO Order).

For exchange-listed securities only, a

23294 Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices

market order that is to be routed as a

market-on-open order to the primary

market for participation in the primary

market opening or re-opening process.

(1) A PO Order entered for

participation in the primary market

opening must be entered before 6:28 am

(Pacific Time) and it will not be

included in the Market Order Auction.

(2) A PO Order entered for

participation in the primary market reopening after a trading halt must be

entered after trading was halted on the

Corporation and before the Re-Opening

Time. The PO Order will not be

included in the Trading Halt Auction.

Rules 7.32–7.33—No change.

Trading Sessions

Rule 7.34(a)—No change.

(b) Market Maker Obligations.

(1) [During the Core Trading Session,]

Market Makers will be obligated to enter

Q Orders in securities in which they are

registered in accordance with Rule 7.23,

beginning at the start of the Core

Trading Session or at such earlier time

during the Opening Session as

determined from time to time by the

Corporation, and continuing until the

end of the Core Trading Session. [by the

time Core Trading Hours begin. During

the Opening Session and the Late

Trading Session,] Market Makers are not

obligated to enter Q Orders in securities

in which they are registered at any

times other than those established

pursuant to the previous sentence.

(2) Market Makers [are required to

enter at least] must maintain one

Cleanup Order for all securities in

which they are registered for each

Market Order Auction.

(c)—No change.

(d) Orders Permitted in Each Session.

(1) During the Opening Session:

(A) Orders eligible for the Display

Order Process [(other than Q Orders)]

and for the Working Order Process that

have been designated as available for

the Opening Session are eligible for

entry into and execution on the

Archipelago Exchange.

(B)–(F)—No change.

(G) Notwithstanding that the Market

Order Auction occurs during the

Opening Session, as set forth in Rule

7.34(a)(1), the following orders not

designated for the Opening Session

shall participate in the Market Order

Auction:

(i) Market orders designated for the

Core Trading Session and entered prior

to the conclusion of the Market Order

Auction; and

(ii) Limited Price Orders designated

for the Core Trading Session and

entered prior to 6:28 am (Pacific Time).

(2)–(3)—No change.

(e)–(f)—No change.

Opening Session Auctions

Rule 7.35. (a) Order Entry and

Cancellation Before Opening Auction

(1)—No change.

(2) Only Limited Priced Orders

designated for the Opening Session will

be eligible for the Opening Auction.

Market orders entered before the

Opening Auction or during the Opening

Session will participate in the Market

Order Auction. Limited Price Orders

designated for the Core Trading Session

and not designated for the Opening

Session will become eligible for

execution at the commencement of the

Market Order Auction pursuant to Rule

7.35(c) [7.37 at the commencement of

the Core Trading Session].

(3)–(4)—No change.

(b)—No change.

(c) Market Order Auction.

(1)—No change.

(2) Reduction of Imbalances

(A) Any Imbalance in the Market

Order Auction may be reduced by new

orders, entered on the side of the market

opposite the Imbalance, pursuant to the

following priority:

(i) Market orders;

(ii) Limited Price Orders eligible for

the Opening Session;

(iii) Limited Price Orders designated

for the Core Trading Session and

entered before 6:28 am (Pacific Time);

(iv) Auction-Only Limit Orders; and

(v) Cleanup Orders.

(B) Between 6:28 am (Pacific Time)

and the conclusion of the Market Order

Auction, Limited Price Orders eligible

for the Opening Session or the Core

Trading Session may be cancelled, but

Limited Price Orders not eligible for the

Opening Session, market orders,

Auction-Only Limit Orders and Cleanup

Orders may not be cancelled.

(C)—No change.

(3) Determination of Market Order

Auction Price

(A) If there is no Imbalance, orders

will be executed in the Market Order

Auction at the Indicative Match Price as

of 6:30 am (Pacific Time).

(B) If an Imbalance exists, or if an

equilibrium exists between buy market

orders and sell market orders, as many

buy market orders and sell market

orders as possible shall be matched, on

a time priority basis, once an NBBO is

available,

(i) at the midpoint of the NBBO at

6:30 am (Pacific Time), in the case of

exchange-listed securities for which the

Corporation is not the primary market;

or

(ii) at the midpoint of the NBBO at

6:30 am (Pacific Time), in the case of

Nasdaq-listed securities, provided that

the NBBO is not crossed; or

(iii) at the midpoint of the first

uncrossed NBBO after 6:30 am (Pacific

Time), in the case of Nasdaq securities

in which the NBBO is crossed but one

side of the BBO is not crossed by the

NBBO; or

(iv) at the midpoint of the first

uncrossed NBBO after 6:30 a.m. (Pacific

Time), in the case of Nasdaq securities

in which the NBBO is crossed and where

both sides of the BBO are crossed by the

NBBO; or

([i]v) at the bid (offer) of the BBO that

was crossed prior to 6:30 am (Pacific

Time), in the case of Nasdaq securities

in which the BBO is crossed by a market

participant; or

(vi) at the Indicative Match Price as of

6:30 am (Pacific Time) in the case of

those issues for which the Corporation

is the primary market. If equilibrium

exists between buy and sell market

orders, the match price shall be at the

last Corporation sale price in the

security regardless of the trading

session[,provided, that,]; however, if the

last Corporation sale price is lower than

[inferior to] the BBO, the match price

shall be the displayed bid in the

security, or if the last Corporation sale

price is higher than the BBO, the match

price will be the displayed offer in the

security [Corporation bid (offer)].

Such executions shall be designated

with a modifier to identify them as

Market Order Auction trades. The

market orders that are eligible for, but

not executed in the Market Order

Auction, shall become eligible for

execution in the Core Trading Session

immediately upon conclusion of the

Market Order Auction.

(d) [Reserved.] Re-Opening After

Trading Halts. To re-open trading in a

security following a trading halt in that

security, the Archipelago Exchange

shall conduct a Trading Halt Auction,

as described below:

(1) Re-Opening Time. After trading in

a security has been halted, the

Corporation shall disseminate the

estimated time at which trading in that

security will re-open (the ‘‘Re-Opening

Time’’).

(2) Publication of Indicative Match

Price and Imbalances

(A) Immediately after trading is halted

in a security, and various times

thereafter as determined from time to

time by the Corporation, the Indicative

Match Price of the Trading Halt Auction

and the volume available to trade at

such price, shall be published via

electronic means as determined from

time to time by the Corporation. If such

a price does not exist (i.e., there is an

Imbalance of market orders), the

Archipelago Exchange shall indicate via

Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices 23295

electronic means that an Indicative

Match Price does not exist.

(B) Immediately after trading is halted

in a security, and various times

thereafter as determined from time to

time by the Corporation, the market

order Imbalance associated with the

Trading Halt Auction, if any, shall be

published via electronic means as

determined from time to time by the

Corporation.

(C) If the difference between the

Indicative Match Price and the last price

prior to the trading halt, as determined

by the Consolidated Tape, is equal to or

greater than a pre-determined amount,

as determined from time to time by the

Corporation, the Archipelago Exchange

will assign a ‘‘SIG’’ designator to such

Indicative Match Price and publish such

designator via electronic means as

determined from time to time by the

Corporation.

(3) Reduction of Imbalances

(A) Any Imbalance in the Trading

Halt Auction may be reduced by new

orders, entered on the side of the market

opposite the Imbalance, pursuant to the

following priority:

(i) Market orders;

(ii) Limited Price Orders; and

(iii) Auction-Only Limit Orders.

(B) Primary Only Orders may be

submitted to the Archipelago Exchange

during a trading halt. Cleanup Orders

are not eligible for execution in the

Trading Halt Auction.

(C) The Corporation, if it deems such

action necessary, will disseminate the

time, prior to the time that orders are

matched pursuant to the Trading Halt

Auction, at which orders may no longer

be cancelled.

(D) Interaction with ITS

(i) If a pre-opening indication is

required pursuant to the ITS Plan, the

Corporation will disseminate three

minutes prior to the Re-Opening Time

the applicable price range, consisting of

the Indicative Match Price as one end of

the price range and the Indicative Match

Price plus an amount determined by the

Corporation for the higher end of the

price range.

(ii) The Archipelago Exchange will

treat any responses to a pre-opening

indication as an Auction-Only Limit

Order.

(E) Other market centers may use

private communication connections to

enter Auction-Only Limit Orders for a

Trading Halt Auction.

(4) Determination of Trading Halt

Auction Price

(A) For exchange-listed stocks:

(i) If there is no Imbalance and no

other market center has re-opened

trading in the security, orders will be

executed in the Trading Halt Auction at

the Indicative Match Price as of the ReOpening Time.

(ii) If an Imbalance exists, or if an

equilibrium exists between buy market

orders and sell market order, or if

another market center has re-opened

trading in the security, as many buy

market orders and sell market orders as

possible shall be matched, on a time

priority basis, at the midpoint of the first

uncrossed, unlocked NBBO, once an

NBBO is available.

(B) For Nasdaq stocks:

(i) If there is no Imbalance, orders will

be executed in the Trading Halt Auction

at the Indicative Match Price as of the

Re-Opening Time.

(ii) If an Imbalance exists, or if an

equilibrium exists between buy market

orders and sell market orders, as many

buy market orders and sell market

orders as possible shall be matched, on

a time priority basis, once an NBBO is

available,

(a) at the midpoint of the NBBO at the

Re-Opening Time, provided that the

NBBO is not crossed; or

(b) at the midpoint of the first

uncrossed NBBO after the Re-Opening

Time, in the case in which the NBBO is

crossed, but one side of the BBO is not

crossed by the NBBO; or

(c) at the midpoint of the first

uncrossed NBBO after the Re-Opening

Time, in the case in which the NBBO is

crossed and where both sides of the BBO

are crossed by the NBBO; or

(d) at the bid (offer) of the BBO that

was crossed prior to the Re-Opening

Time, in the case in which the BBO is

crossed by a market participant; or

(C) For those issues for which the

Corporation is the primary market:

Orders will be executed at the Indicative

Match Price at the Re-Opening Time. If

equilibrium exists between buy and sell

market orders, the match price shall be

at the last Corporation sale price in the

security regardless of the trading

session; however, if the last Corporation

sale price is lower than the BBO, the

match price shall be the displayed bid

in the security, or if the last Corporation

sale price is higher than the BBO, the

match price will be the displayed offer

in the security.

(5) If any orders are not executed in

their entirety during the Trading Halt

Auction, then such orders shall be

executed in accordance with Rule 7.37

after the completion of the Trading Halt

Auction.

(6) After the completion of the

Trading Halt Auction, the Archipelago

Exchange will re-open for trading the

previously halted security in accordance

with Rule 7.

(e)—No change.

(f) Whenever in the judgment of the

Corporation the interests of a fair and

orderly market so require, the

Corporation may adjust the timing of

the auctions set forth in this Rule.

Order Ranking and Display

Rule 7.36. The Archipelago Exchange

shall display to Users and other market

participants all non-marketable limit

orders in the Display Order Process. The

Archipelago Exchange will also

disseminate current consolidated

quotations/last sale information, and

such other market information as may

be made available from time to time

pursuant to agreement between the

Corporation and other market centers.

(a) Ranking. Orders of Users shall be

ranked and maintained in the Display

Order Process and/or Working Order

Process of the Arca Book according to

price-time priority, such that within

each price level, all orders shall be

organized by the time of entry in the

following manner.

(1) Display Order Process. Within the

Display Order Process:

(A)—No change.

(B) The displayed portion of Reserve

Orders (not the reserve size) shall be

ranked at the specified limit price and

the time of order entry. If the displayed

portion of the Reserve Order is

decremented such that 99 shares or

fewer are displayed [in its entirety], the

displayed portion of the Reserve Order

shall be refreshed for

(i) the displayed amount; or

(ii) the entire reserve amount, if the

remaining reserve amount is smaller

than the displayed amount,

from the reserve portion and shall be

submitted and ranked at the specified

limit price and the new time that the

displayed portion of the order was

refreshed.

(C)—No change.

(2)—No change.

(b)–(c)—No change.

Order Execution

Rule 7.37. Subject to the restrictions

on short sales under Rule 10a–1 under

the Exchange Act, like-priced orders,

bids and offers shall be matched for

execution by following Steps 1 through

5 in this Rule; provided, however, for an

execution to occur in any Order Process,

the price must be equal to or better than

the NBBO, unless the Archipelago

Exchange has routed orders to all away

markets at the NBBO.

(a)–No change.

(b) If an incoming marketable order

has not been executed in its entirety

pursuant to paragraph (a) of this Rule,

any remaining part of the order shall be

routed to the Display Order Process.

23296 Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices

5 15 U.S.C. 78c(a).

6 In addition to the proposed rule changes, the

PCX proposes several corrections to the text of the

Arca Proposing Release:

(1) Section 2(c)(iv) (Order Execution), footnote

82—Footnote 82 should read ‘‘ ‘Marketable’ means,

for a Limited Price Order, the price crosses or

matches the NBBO on the other side of the market.

Market orders are always considered marketable.’’

See Arca Proposing Release at 78827.

(2) Section 2(c)(vii) (Opening Session Auctions)—

In the second paragraph under ‘‘Opening

Auctions,’’ the references to ‘‘the last .T sale’’

should be replaced with the phrase ‘‘the prior day’s

closing price.’’ See Arca Proposing Release at

78832.

(3) Section 2(c)(vii) (Opening Session Auctions)—

Example 3 of the Market Order Auction should be

deleted. See Arca Proposing Release at 78833.

7See Arca Proposing Release, note 3, supra.

(1) Step 2: Display Order Process.

(A) An incoming marketable order

shall first attempt to be matched for

execution against orders in the Display

Order Process at the display price of the

resident order for the total amount of

stock available at that price or for the

size of the incoming order, whichever is

smaller. For the purposes of this

subsection, the size of an incoming

Reserve Order includes the displayed

and reserve size and the size of the

portion of the Reserve Order resident in

the Display Order Process is equal to its

displayed size. If the incoming

marketable order has not been executed

in its entirety, the remaining part of the

order shall be routed to the Working

Order Process.

(B)—No change.

(2) Step 3: Working Order Process.

(A)–(B)—No change.

(C) If any change in the NBBO or

other available away trading interest

would cause a potential match between

the away order and an order in the

Working Order Process, a commitment

to trade shall be sent to that market

center or market participant pursuant to

Step 5 below after having proceeded

through Step 4.

(c)—No change.

(d) Step 5: Routing Away.

(1)—No change.

(2) If an order has not been executed

in its entirety pursuant to paragraphs (a)

through (c) of this Rule and it has not

been designated as a Fill-or-Return, Fillor-Return Plus Order or PNP Order, the

order shall be routed for execution as

follows:

(A)(i) The order shall be routed, either

in its entirety or as component orders,

to another market center or market

participant as a limit order priced at the

quote published by the market center or

market participant.

(ii) Based upon a User’s instruction, a

marketable reserve order may be routed

(1) serially as component orders, such

that each component corresponds to the

displayed size, or (2) only once in its

entirety, including both the displayed

and reserve portions.

(B)–(E)—No change.

(e)—No change.

Rules 7.38–7.42—No change.

Use of Directed Order Process

Rule 7.43[.Reserved.] It shall be

considered conduct inconsistent with

just and equitable principles of trade for

a User to use the Directed Order Process

for the purpose of bypassing otherwise

applicable fees.

Rules 7.44–7.64—No change.

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

PCXE included statements concerning

the purpose of, and basis for, the

proposed rule change and discusses 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 PCXE 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

As discussed in detail in the Arca

Proposing Release, the PCX proposes to

establish rules for Arca, a new exchange

facility, as that term is defined in

Section 3(a) of the Exchange Act.5 Arca,

which is operated by Archipelago

Exchange, L.L.C., is an electronic

securities communications and trading

facility intended for the use of ETP

Holders and their customers. Arca

would provide automatic order

execution capabilities in the equity

securities listed or traded on the PCXE.

Arca would operate in place of PCXE’s

traditional floor trading facilities. In

addition to certain minor changes, like

renumbering rules,6 the PCXE proposes

the following substantive changes to the

proposed rule changes set forth in the

Arca Proposing Release.7

a. Implementation of OTC/UTP Plan

To implement the OTC/UTP Plan, the

PCX proposes the addition of Proposed

Rule 7.18—‘‘Trading in Nasdaq/NM

Securities’’—as well as a number of new

definitions in Proposed Rule 1. These

rule revisions are described below.

i. Definitions

The PCX introduces the following

new terms in Proposed Rule 1:

(1) Proposed Rule 1.1(x)—PCXE has

inserted as Proposed Rule 1.1(x) the

following definition of the term

‘‘NASD’’ shall mean ‘‘the National

Association of Securities Dealers, Inc.’’

(2) Proposed Rule 1.1(y)—PCXE has

added the definition of the term

‘‘Nasdaq’’ as Proposed Rule 1.1(y).

‘‘Nasdaq’’ means ‘‘The Nasdaq Stock

Market, Inc.’’

(3) Proposed Rule 1.1(z)—PCXE has

added the definition of the term

‘‘Nasdaq Market Maker’’ as Proposed

Rule 1.1(z). A ‘‘Nasdaq Market Maker’’

shall mean (1) a Nasdaq market maker

as defined in NASD Rule 4200(a)(22), as

amended from time to time, or (2) an

electronic communications network

(‘‘ECN’’).

(4) Proposed Rule 1.1(aa)—PCXE has

added as Proposed Rule 1.1(aa) the

definition of the term ‘‘Nasdaq/NM

Security,’’ which means ‘‘any security

(i) designated as a national market

system security pursuant to the NASD’s

‘National Market System Securities

Designation Plan with respect to Nasdaq

Securities,’ filed with and approved by

the Commission pursuant to SEC Rule

11Aa2–1 under the Exchange Act and

(ii) that is either listed on the

Corporation pursuant to Rule 5 or as to

which unlisted trading privileges have

been granted pursuant to Section 12(f)

of the Exchange Act.’’

(5) Proposed Rule 1.1(bb)—PCXE has

inserted the definition of the term

‘‘Nasdaq System’’ as Proposed Rule

1.1(bb). ‘‘Nasdaq System’’ means ‘‘the

system operated by Nasdaq.’’

(6) Proposed Rule 1.1(cc)—PCXE has

added the definition of the term

‘‘Nasdaq System BBO’’ as Proposed Rule

1.1(cc). ‘‘Nasdaq System BBO’’ means

‘‘the best bid or offer that is

disseminated pursuant to SEC Rule

11Ac1–1 among the Nasdaq System

participants in those issues that are

traded on the Nasdaq System.’’

(7) Proposed Rule 1.1(hh)—PCXE has

added the definition of the term ‘‘OTC/

UTP Participant’’ as Rule 1.1(hh).

‘‘OTC/UTP Participant’’ is defined as

‘‘any registered national securities

exchange or national securities

association that is a signatory to the

OTC/UTP Plan.’’

(8) Proposed Rule 1.1(ii)—PCXE has

inserted the definition of the term

‘‘OTC/UTP Plan as Proposed Rule

1.1(ii). ‘‘OTC/UTP Plan’’ shall mean

‘‘the Nasdaq National Market/Unlisted

Trading System/Unlisted Trading

Privileges Plan, as from time to time

amended according to its provisions.’’

Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices 23297

(9) Proposed Rule 1.1(jj)—PCXE has

inserted the definition of the term

‘‘OTC/UTP Primary Market’’ as

Proposed Rule 1.1(jj). ‘‘OTC/UTP

Primary Market’’ for a Nasdaq/NM

Security ‘‘means Nasdaq; provided,

however, that if for any 12-month

period the number of reported

transactions and the reported share

volume in a Nasdaq/NM Security in any

other OTC/UTP Participant’s market

exceeds 50% of the aggregate reported

transactions and reported share volume

of all OTC/UTP Participants in such

security, then that OTC/UTP

Participant’s market shall be the OTC/

UTP Primary Market.’’

(10) Proposed Rule 1.1(kk)—PCXE has

inserted the definition of ‘‘OTC/UTP

Regulatory Halt’’ as Proposed Rule

1.1(kk). An ‘‘OTC/UTP Regulatory Halt’’

is ‘‘a trade suspension or halt called by

the OTC/UTP Primary Market for the

purpose of dissemination of material

news.’’

ii. Trading in Nasdaq/NM Securities

To implement the OTC/UTP Plan for

the PCXE, PCXE has added Proposed

Rule 7.18, ‘‘Trading in Nasdaq/NM

Securities,’’ which is described in more

detail below.

Paragraph (a) of Proposed Rule 7.18

describes access for trading Nasdaq/NM

Securities. Paragraph (a)(1) reads: ‘‘The

Corporation shall permit each Nasdaq

Market Maker, acting in its capacity as

a market maker, telephone access, or

such other access as may be established

between the Corporation and the

Nasdaq System (collectively, ‘‘approved

access’’), to the Corporation for each

Nasdaq/NM Security in which such

market maker is registered as a market

maker. Such approved access shall

include appropriate procedures to

assure the timely response to

communications received through

telephone or other approved access.’’

Paragraph (a)(2) states that ‘‘Nasdaq

Market Makers may use such approved

access to transmit orders for execution

on the Corporation. Market Makers, via

the facilities of the Corporation, may

send orders via approved access to any

Nasdaq Market Maker in each Nasdaq/

NM security in which it displays

quotations.’’ Paragraph (a)(3) provides

that ‘‘[a]ny order received via approved

access from a Nasdaq Market Maker

shall be effected in accordance with the

Rules of the Corporation applicable to

transactions on the Archipelago

Exchange.’’ Paragraph (a)(4) reads: ‘‘No

Market Maker shall permit the

imposition of any access or execution

fee, or any other fee or charge, with

respect to transactions in Nasdaq/NM

Securities effected with Nasdaq Market

Makers that are communicated to the

Corporation through telephone access.’’

Paragraph (b) of Proposed Rule 7.18

states that ‘‘[t]he Corporation will

display on the Archipelago Exchange, at

a minimum, the Nasdaq System BBO.’’

Paragraph (c), which describes OTC/

UTP Regulatory Halts states:

‘‘Whenever, in the exercise of its

regulatory function, the OTC/UTP

Primary Market for a Nasdaq/NM

Security determines that an OTC/UTP

Regulatory Halt is appropriate, the

Corporation shall halt or suspend

trading in that security until the

notification by the OTC/UTP Primary

Market that the halt or suspension is no

longer in effect. The Corporation will

assume that adequate publication or

dissemination has occurred upon the

expiration of one hour after initial

publication in a national news

dissemination service of the information

that gave rise to an OTC/UTP Regulatory

Halt and may, at its discretion, re-open

trading at that time, notwithstanding

notification from the OTC/UTP Primary

Market that the halt or suspension is no

longer in effect.’’

Finally, paragraph (d) states that

‘‘[t]he following Rules of the

Corporation will not be applicable to

transactions on the Corporation in

Nasdaq/NM Securities: Rules 7.16,

7.55–7.57.’’

b. Re-Opening After Trading Halts

The PCX has introduced a procedure,

called the Trading Halt Auction, for reopening a security after a trading halt.

The Trading Halt Auction is described

in detail in Proposed Rule 7.35(d).

Moreover, the definitions of certain

auction-related terms have been revised

to reflect this new procedure.

i. Definitions

The following definitions have been

revised to accommodate the Trading

Halt Auction:

(1) Proposed Rules 1.1(q) and (r)—The

definitions of ‘‘Imbalance’’ and

‘‘Indicative Match Price’’ have been

revised to indicate that these terms are

applicable to the Trading Halt Auction

as well as the Opening and Market

Order Auctions.

(2) Proposed Rule 7.31(t)—The

definition of an Auction-Only Limit

Order has been revised to state that it is

a limit order that is to be executed

during the Trading Halt Auction or the

Market Order Auction.

(3) Proposed Rule 7.31(x)—The

definition of a Primary Only Order (‘‘PO

Order’’) has been revised to clarify that

a User may submit a PO Order for

participation in the primary market reopening process as well as the primary

market opening process. Proposed Rule

7.31(x)(2) states that ‘‘[a] PO Order

entered for participation in the primary

market re-opening after a trading halt

must be entered after trading was halted

on the Corporation and before the ReOpening Time. The PO Order will not

be included in the Trading Halt

Auction.’’

ii. Trading Halt Auction

Subject to certain minor variations,

the Trading Halt Auction, as described

in Proposed Rule 7.35, operates in much

the same fashion as the Market Order

Auction. Specifically, to re-open trading

in a security following a trading halt in

that security, Arca will conduct a

Trading Halt Auction, as described

below.

After trading in a security has been

halted, the PCXE will disseminate the

estimated time at which trading in that

security will re-open. This estimated

time will be designated the ‘‘ReOpening Time.’’ Similarly, immediately

after trading is halted in a security, and

various times thereafter as determined

from time to time by the PCXE, the

Indicative Match Price of the Trading

Halt Auction and the volume available

to trade at such price, shall be published

via electronic means as determined from

time to time by the PCXE. If such a price

does not exist (i.e., there is an Imbalance

of market orders), Arca shall indicate

via electronic means that an Indicative

Match Price does not exist. In addition,

immediately after trading is halted in a

security, and various times thereafter as

determined from time to time by the

PCXE, the market order Imbalance

associated with the Trading Halt

Auction, if any, will be published via

electronic means as determined from

time to time by the PCXE. If the

difference between the Indicative Match

Price and the last price prior to the

trading halt, as determined by the

Consolidated Tape, is equal to or greater

than a pre-determined amount, as

determined from time to time by the

PCXE, Arca will assign a ‘‘SIG’’

designator to such Indicative Match

Price and publish such designator via

electronic means as determined from

time to time by the PCXE.

Any Imbalance in the Trading Halt

Auction may be reduced by new orders

entered on the side of the market

opposite the Imbalance, pursuant to the

following priority: (1) market orders; (2)

Limited Price Orders; and (3) AuctionOnly Limit Orders. Cleanup Orders are

not eligible for execution in the Trading

Halt Auction. Primary Only Orders may

be submitted to Arca during a trading

halt for execution in the primary

market. The PCXE, if it deems such

23298 Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices

action necessary, will disseminate the

time, prior to the time that orders are

matched pursuant to the Trading Halt

Auction, at which orders may no longer

be cancelled.

During the Trading Halt Auction,

Arca will interact with ITS as follows:

If a pre-opening indication is required

pursuant to the ITS Plan, the PCXE will

disseminate three minutes prior to the

Re-Opening Time the applicable price

range, consisting of the Indicative Match

Price as one end of the price range and

the Indicative Match Price plus an

amount determined by the PCXE for the

higher end of the price range. Arca will

treat any responses to a pre-opening

indication as an Auction-Only Limit

Order. In addition to ITS, other market

centers may use private communication

connections to enter Auction-Only

Limit Orders for a Trading Halt Auction.

Arca will determine the price of the

Trading Halt Auction as follows: For

exchange-listed stocks, if there is no

Imbalance and no other market center

has re-opened trading in the security,

orders will be executed in the Trading

Halt Auction at the Indicative Match

Price as of the Re-Opening Time.

However, if an Imbalance exists, or if an

equilibrium exists between buy market

orders and sell market order, or if

another market center has re-opened

trading in the security, as many buy

market orders and sell market orders as

possible shall be matched, on a time

priority basis, at the midpoint of the

first uncrossed, unlocked NBBO, once

an NBBO is available.

For Nasdaq stocks, if there is no

Imbalance, orders will be executed in

the Trading Halt Auction at the

Indicative Match Price as of the ReOpening Time. However, if an

Imbalance exists, or if an equilibrium

exists between buy market orders and

sell market orders, as many buy market

orders and sell market orders as possible

shall be matched, on a time priority

basis, once an NBBO is available: (1) at

the midpoint of the NBBO at the ReOpening Time, provided that the NBBO

is not crossed; (2) at the midpoint of the

first uncrossed NBBO after the ReOpening Time, in the case in which the

NBBO is crossed, but one side of the

BBO is not crossed by the NBBO; (3) at

the midpoint of the first uncrossed

NBBO after the Re-Opening Time, in the

case in which the NBBO is crossed and

where both sides of the BBO are crossed

by the NBBO; or (4) at the bid (offer) of

the BBO that was crossed prior to the

Re-Opening Time, in the case in which

the BBO is crossed by a market

participant.

For those issues for which the

Corporation is the primary market,

orders will be executed at the Indicative

Match Price at the Re-Opening Time. If

equilibrium exists between buy and sell

market orders, the match price shall be

at the last Corporation sale price in the

security regardless of the trading

session. However, if the last Corporation

sale price is lower than the BBO, the

match price shall be the displayed bid

in the security, or if the last Corporation

sale price is higher than the BBO, the

match price will be the displayed offer

in the security.

Finally, if any orders are not executed

in their entirety during the Trading Halt

Auction, then such orders shall be

executed in accordance with Rule 7.37

after the completion of the Trading Halt

Auction. In addition, after the

completion of the Trading Halt Auction,

Arca will re-open for trading the

previously halted security in accordance

with Rule 7.

c. Miscellaneous

In addition to rule revisions related to

trading in Nasdaq securities and the

Trading Halt Auctions, the PCX

proposes the following miscellaneous

changes:

i. Rule 1—Definitions

(1) Proposed Rules 1.1(q) and (r)—

PCXE has changed the term ‘‘orders’’ to

‘‘shares’’ in the definitions of

‘‘Imbalance’’ and ‘‘Indicative Match

Price.’’

ii. Rule 2—Equity Trading Permits

(1) Proposed Rule 2.5—PCXE has

deleted Rule 2.5, ‘‘Publication of

Approved ETP Applications.’’

iii. Rule 7—Equities Trading

(1) Proposed Rule 7.6(a), Comm. 05—

In Commentary .05 of Proposed Rule

7.6(a), PCXE has deleted the reference to

a minimum price variation (‘‘MPV’’) of

1/64th of $1.00 for those securities

quoted in fractions, thereby limiting the

MPV for equity securities traded on

Arca to $0.01.

(2) Proposed Rule 7.6(a), Comm. 06—

PCXE has revised Commentary .06 to

Proposed Rule 7.6(a). To clarify the

applicable spread, PCXE has inserted

‘‘NBBO’’ into the statement that the

‘‘minimum price improvement

increment (‘‘MPII’’) on the Archipelago

Exchange shall be equal to $0.01 or 10%

of the NBBO spread, whichever is

more.’’

(3) Proposed Rules 7.23(a)(6),

7.31(u)(1)–(2) and 7.34(b)(2)—These

proposed rules have been revised to

clarify that (1) each Market Maker must

maintain only one Cleanup Order and

(2) Arca will submit each Cleanup Order

on behalf of each Market Maker.

(4) Proposed Rules 7.31(f)(7) and

7.31(i)(2)—Pursuant to these two

proposed rules, the Corporation shall

suspend the Directed and Tracking

Order Processes for a security when a

locked or crossed market exists in that

security. The Directed and Tracking

Order Processes for that security will

resume when the locked or crossed

market in that security no longer exists.

(5) Proposed Rule 7.31(s)—PCXE has

deleted the references to ‘‘Section 5 of

Rule 7’’ from the definition of a Cross

Order.

(6) Proposed Rule 7.31(u)(6)(A)—

PCXE has deleted the phrase ‘‘of Market

Orders’’ from paragraph (u)(6)(A) of the

definition of a Cleanup Order.

(7) Proposed Rule 7.34(b)(1)—

Proposed Rule 7.34(b)(1) has been

revised to clarify that Market Makers are

obligated to enter Q Orders in securities

in which they are registered beginning

at the start of the Core Trading Session

or at such earlier time during the

Opening Session as determined from

time to time by the PCXE, and

continuing until the end of the Core

Trading Session. Market Makers are not

obligated to enter Q Orders at any other

times that the PCXE is open for

business.

(8) Proposed Rules 7.34(d)(1)(G),

7.35(a)(2) and 7.35(c)(2)(A)(iii)—These

proposed rules have been revised to

clarify that, although the Market Order

Auction occurs during the Opening

Session, the following orders, which

have not been designated for the

Opening Session will participate in the

Market Order Auction: (1) Market orders

designated for the Core Trading Session

and entered prior to the conclusion of

the Market Order Auction and (2)

Limited Price Orders designated for the

Core Trading Session and entered prior

to 6:28 am (Pacific Time).

(9) Proposed Rule 7.35(c)(2)(B)—PCXE

has added ‘‘Limited Price Orders not

eligible for the Opening Session’’ to the

list of order types that may not be

cancelled between 6:28 am (Pacific

Time) and the conclusion of the Market

Order Auction.

(10) Proposed Rule 7.35(c)(3)(B)—This

section has been modified to indicate

that, if the Market Order Auction price

is based upon the NBBO under

Proposed Rule 7.35(c), then the price

will not be determined until an NBBO

is available.

(11) Proposed Rule 7.35(c)(3)(B)(iii)—

This subparagraph has been revised to

state ‘‘at the midpoint of the first

uncrossed NBBO after 6:30 am (Pacific

Time), in the case of Nasdaq securities

in which the NBBO is crossed but one

side of the BBO is not crossed by the

NBBO.’’

Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices 23299

8 15 U.S.C. 78f(b).

9 15 U.S.C. 78f(b)(5).

10 17 CFR 200.30–3(a)(12).

11See Arca Proposing Release, note 3, supra.

12Letter from Michael T. Dorsey, Senior Vice

President, General Counsel and Secretary, Knight

Trading Group, Inc., to Jonathan G. Katz, Secretary,

SEC, dated Feb. 9, 2001 (‘‘Knight Letter’’); Letter

from Steve Wunsch, President, Arizona Stock

Exchange (‘‘AZX’’), to Jonathan G. Katz, Secretary,

SEC, dated Feb. 1, 2001 (‘‘AZX Letter’’); Letter from

Robert R. Glauber, Chief Executive Officer and

President, NASD Regulation, Inc. (‘‘NASDR’’), to

Jonathan G. Katz, Secretary, SEC, dated Jan. 26,

2001 (‘‘NASDR Letter’’); Letter from Richard G.

Ketchum, President, Nasdaq, to Jonathan G. Katz,

Secretary, SEC, dated Jan. 22, 2001 (‘‘Nasdaq II

Letter’’); Letter from Jeffrey T. Brown, Cincinnati

Stock Exchange (‘‘CSE’’), to Jonathan G. Katz,

Secretary, SEC, dated Jan. 8, 2000 (‘‘CSE Letter’’);

Letter from David Hultman, D.A. Davidson & Co.,

to Jonathan G. Katz, Secretary, SEC, dated Jan. 5,

2000 (‘‘D.A. Davidson Letter’’); Letter from Los

Angeles Specialists Association (‘‘LASA’’), to

Continued

(12) Proposed Rule 7.35(c)(3)(B)(iv)—

Another pricing scenario has been

added to the Market Order Auction. In

this scenario, if an Imbalance exists, or

if an equilibrium exists between buy

market orders and sell market orders, as

many buy market orders and sell market

orders as possible shall be matched, on

a time priority basis, once an NBBO is

available, ‘‘at the midpoint of the first

uncrossed NBBO after 6:30 a.m. (Pacific

Time), in the case of Nasdaq securities

in which the NBBO is crossed and

where both sides of the BBO are crossed

by the NBBO.’’

(13) Proposed Rule 7.35(c)(3)(B)(vi)—

PCXE has clarified the wording of

Proposed Rule 7.35(c)(3)(B)(vi) to state

the following: ‘‘[I]f equilibrium exists

between buy and sell market orders, the

match price shall be at the last

Corporation sale price in the security

regardless of the trading session;

however, if the last Corporation sale

price is lower than the BBO, the match

price shall be the displayed bid in the

security, or if the last Corporation sale

price is higher than the BBO, the match

price will be the displayed offer in the

security.’’

(14) Proposed Rule 7.35(f)—PCXE has

added paragraph (f) to Proposed Rule

7.35, which reads ‘‘[w]henever in the

judgment of the Corporation the

interests of a fair and orderly market so

require, the Corporation may adjust the

timing of the auctions set forth in this

Rule.’’

(15) Proposed Rule 7.36(a)(1)(B)—

PCXE has revised this paragraph to read:

‘‘The displayed portion of Reserve

Orders (not the reserve size) shall be

ranked at the specified limit price and

the time of order entry. If the displayed

portion of the Reserve Order is

decremented such that 99 shares or

fewer are displayed, the displayed

portion of the Reserve Order shall be

refreshed for (1) the displayed amount;

or (2) the entire reserve amount, if the

remaining reserve amount is smaller

than the displayed amount, from the

reserve portion and shall be submitted

and ranked at the specified limit price

and the new time that the displayed

portion of the order was refreshed.’’

(16) Proposed Rule 7.37(b)(2)(C)—

PCXE has added the phrase ‘‘after

having proceeded through Step 4’’ to the

end of Proposed Rule 7.37(b)(2)(C).

(17) Proposed Rule 7.37(d)(2)(A)(ii)—

In this Proposed Rule, PCXE has

clarified that a marketable reserve order

may be routed either (1) serially as

component orders, such that each

component corresponds to the

displayed size or (2) only once in its

entirety, including both the displayed

and reserve portions.

(18) Proposed Rule 7.43—PCXE has

added Proposed Rule 7.43, ‘‘Use of the

Directed Order Process.’’ Proposed Rule

7.43 states that ‘‘[i]t shall be considered

conduct inconsistent with just and

equitable principles of trade for a User

to use the Directed Order Process for the

purpose of bypassing otherwise

applicable fees.’’

2. Statutory Basis

The Exchange believes the proposed

rule change is consistent with Section

6(b) of the Act,8 in general, and furthers

the objectives of Section 6(b)(5),9 in

particular, in that it is designed to

promote just and equitable principles of

trade, to foster cooperation and

coordination with persons engaged in

facilitating transactions in securities,

and to remove impediments and perfect

the mechanisms of a free and open

market and to protect investors and the

public interest.

B. Self-Regulatory Organization’s

Statement on Burden on Competition

The Exchange does not believe that

the proposed rule change will impose

any burden on competition that is not

necessary or appropriate in furtherance

of the purposes of the Act.

C. Self-Regulatory Organization’s

Statement on Comments on the

Proposed Rule Change Received from

Members, Participants, or Others

Written comments on the proposed

rule change were neither solicited nor

received.

III. Date of Effectiveness of the

Proposed Rule Change and Timing for

Commission Action

Within 35 days of the date of

publication of this notice in the Federal

Register or within such longer period (i)

as the Commission may designate up to

90 days of such date if it finds such

longer period to be appropriate and

publishes its reasons for so finding or

(ii) as to which the self-regulatory

organization consents, the Commission

will—

(A) by order approve such proposed

rule change, or

(B) institute proceedings to determine

whether the proposed rule change

should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views and

arguments concerning Amendment No.

3, including whether Amendment No. 3

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. Copies of such filing will also be

available for inspection and copying at

the principal office of the PCX. All

submissions should refer to Amendment

No. 3 of File No. SR–PCX–00–25 and

should be submitted by May 29, 2001.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.10

Margaret McFarland,

Deputy Secretary.

Appendix A

April 19, 2001.

VIA MESSENGER

John Polise, Division of Market Regulation,

Securities and Exchange Commission,

Mail Stop 1001, 450 Fifth Street, N.W.,

Washington, DC 20549.

Re: Archipelago Exchange: Supplemental

Response to Comment Letters SR–PCX–00–

25, Amendment No. 3

Dear Mr. Polise: On behalf of the Pacific

Exchange, Inc., via its wholly owned

subsidiary PCX Equities, Inc., (collectively,

‘‘PCX’’), we appreciate the opportunity to

respond to the comment letters submitted to

the Securities and Exchange Commission

(‘‘SEC’’ or ‘‘Commission’’) regarding the

Archipelago Exchange (‘‘ArcaEx’’) rule

filing.11

To date, nine commenters have submitted

ten comment letters concerning ArcaEx.12

23300 Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices

Jonathan G. Katz, Secretary, SEC, dated Jan. 4, 2000

(‘‘LASA Letter’’); Letter from San Francisco

Specialists Association (‘‘SFSA’’), to Jonathan G.

Katz, Secretary, SEC, dated Jan. 3, 2000 (‘‘SFSA

Letter’’); Letter from John F. Malitzis, Associate

General Counsel, Nasdaq, to Jonathan G. Katz,

Secretary, SEC, dated Dec. 28, 2000 (‘‘Nasdaq I

Letter’’); and Letter from Lanny A. Schwartz,

Executive Vice President and General Counsel,

Philadelphia Stock Exchange (‘‘Phlx’’), to Jonathan

G. Katz, Secretary, SEC, dated Dec. 21, 2000 (‘‘Phlx

Letter’’).

13See AZX Letter; CSE Letter; D.A. Davidson

Letter; SFSA Letter; and LASA Letter.

14SFSA Letter at 1 and LASA Letter at 1.

15 15 D.A. Davidson Letter at 1.

16CSE Letter at 1.

17AZX Letter at 1.

18See Knight Letter; Nasdaq II Letter; Phlx Letter;

and Nasdaq I Letter.

19See NASDR Letter.

20Nasdaq II Letter at 1–3.

21As the Commission noted previously in other

contexts, the PCX’s use of Archipelago Exchange,

L.L.C., personnel and equipment does not alter the

determination that ArcaEx should be regulated as

a facility. See Securities Exchange Act Release No.

41210 (Mar. 24, 1999), 64 FR 15857 (Apr. 1, 1999)

(approval order of Phlx’s VWAP Trading System)

(‘‘VWAP Release’’) (‘‘The Commission notes that

the Exchange’s use of [Universal Trading

Technologies Corporation’s] personnel and

equipment in operating the [VWAP] System does

not alter the Commission’s determination that the

System is properly regulated as a facility of the

Exchange.’’).

22See Securities Exchange Act Release No. 39086

(Sept. 17, 1997), 62 FR 50036 (Sept. 24, 1997)

(‘‘PCX OptiMark Release’’). See also Securities

Exchange Act Release No. 41967 (Sept. 30, 1999),

64 FR 54704 (Oct. 7, 1999) (approval order for

Nasdaq Application of OptiMark System) (‘‘Nasdaq

OptiMark Release’’); Securities Exchange Act

Release No. 35030 (Nov. 30, 1994), 59 FR 63141

(Dec. 7, 1999) (approval order for Chicago Match

System) (‘‘Chicago Match Release’’).

23 23 VWAP Release.

24Similarly, pursuant to the requirements of

Section 19 of the Exchange Act, the PCX intends

to set forth in a separate rule filing the fees that will

be charged for the use of ArcaEx services. See

Knight Letter at 2–3.

25Nasdaq II Letter at 1–3.

26See, e.g., PCX OptiMark Release and VWAP

Release. See also Nasdaq OptiMark Release and

Chicago Match Release.

27 Knight’s argument that PCX’s reliance on

unlisted trading privileges is in some way

inappropriate is incorrect. Knight Letter at 4. Under

the Exchange Act, the PCX, as a registered national

securities exchange, may trade securities listed on

the PCX and/or securities admitted to unlisted

trading privileges. See generally Section 12 of the

Exchange Act.

28Nasdaq II Letter at 3–6.

29 In response to Nasdaq’s conflict of interest

concerns regarding ArcaEx (see Nasdaq II Letter at

5), we note that the PCX will rely solely on its own

regulatory staff to perform any regulatory functions

concerning ArcaEx. In that vein, no employees of

Archipelago Exchange, L.L.C., or Archipelago

Holdings, L.L.C., nor any dual employees of PCX

and the ArcaEx companies will be involved in

regulatory oversight. Furthermore, all PCX

regulatory staff must act in accordance with strict

standards of confidentiality with regard to ArcaEx,

just as they must in all their oversight dealings.

30See Section 6(b)(1) of the Exchange Act (the

PCX will ‘‘comply * * * with the provisions of this

title, the rules and regulations thereunder, and the

rules of the exchange’’).

31Proposed PCXE Rule 14.3 is based on the

NASD’s Plan of Allocation and Delegation of

Functions by NASD to Subsidiaries.

Five commenters fully supported the

proposal.13 Of these five favorable letters,

three represented PCX members. For

example, the Los Angeles and San Francisco

Specialists Associations stated that they

‘‘strongly support the PCX’s proposal and

urge the [Commission] to approve this

proposal as soon as possible.’’ 14 Similarly,

D.A. Davidson wrote that it ‘‘applauds the

effort to create a New Marketplace which will

level the playing field for all participants.’’ 15

In addition to member support, the ArcaEx

proposal was received favorably by two

established electronic marketplaces—the

Cincinnati Stock Exchange (‘‘CSE’’) and the

Arizona Stock Exchange (‘‘AZX’’). The CSE

‘‘believes that the PCX proposal is an

innovative approach that seeks to challenge

the floor-based exchange models for the

benefit of public investors.’’ 16 The AZX

urged the Commission ‘‘to expedite the PCX

proposed rule change’’ because it believes

that it will help to resolve pressing market

structure issues.17

In contrast, three commenters, including

two traditional markets—Nasdaq and the

Philadelphia Stock Exchange (‘‘Phlx’’)—and

a wholesale market maker, Knight Trading

Group, Inc. (‘‘Knight’’) opposed the ArcaEx

rule change.18 In addition, NASD Regulation,

Inc., (‘‘NASDR’’) submitted a comment letter,

but did not express a view in favor of or in

opposition to the filing.19 In this letter, the

PCX addresses the various concerns

expressed by the commenters, particularly

Nasdaq, Phlx and Knight, about the ArcaEx

proposal. As discussed in detail below, the

PCX does not believe any of the concerns

raised in the comment letters should serve as

an impediment to approval of the rule filing.

I. ArcaEx is Properly Regulated as a Facility

of an Exchange

The PCX believes that, contrary to

Nasdaq’s assertions,20 ArcaEx is properly

regulated as a facility of an exchange and not

as an exchange itself. Section 3(a)(2) of the

Securities Exchange Act of 1934 (‘‘Exchange

Act’’) provides that:

the term ‘‘facility’’ when used with respect to

an exchange includes its premises, tangible

or intangible property whether on the

premises or not, any right to the use of such

premises or property or any service thereof

for the purpose of effecting or reporting a

transaction on an exchange (including,

among other things, any system of

communication to or from the exchange, by

ticket or otherwise maintained by or with the

consent of the exchange), and any right of the

exchange to the use of any property or

service.

ArcaEx will use PCX equipment and

personnel 21 and involve the participation of

PCX market makers. Furthermore, executions

performed on ArcaEx will be regulated and

reported as PCX trades. In addition, by

supplying an electronic trading system for

the use of the PCX members and their

customers, ArcaEx will provide a ‘‘service

* * * for the purpose of effecting * * * a

transaction on an exchange,’’ thus providing

the PCX the ‘‘right of the exchange to the use

of * * * [such] service.’’ Because effecting

and reporting ArcaEx matches involves the

PCX’s premises, property and services,

ArcaEx will meet the definition of a

‘‘facility’’ of an exchange as defined in

Section 3(a)(2) of the Exchange Act.

Regulating ArcaEx as a ‘‘facility’’ of the

PCX is consistent with the approach the

Commission has followed in other cases

similar to the PCX and ArcaEx situation. For

example, the Commission approved the

PCX’s proposal to establish an exchange

facility called the PCX Application of the

OptiMark System, which was a trading

system owned and operated by an entity

other than an exchange.22 Likewise, the Phlx,

itself, has contracted with third parties to

establish the VWAP Trading System as a

facility of the Phlx.23 In neither of these

circumstances did the Commission require

the entities which contracted with the

exchanges to create a facility to register as

national securities exchanges themselves.

Because ArcaEx is a facility of the PCX, a

rule filing conforming to the requirements of

Section 19 of the Exchange Act and Rule

19b–4 thereunder is the appropriate

regulatory format for soliciting comments

and seeking Commission approval of the

arrangement.24 Despite Nasdaq’s statements

to the contrary,25 there is no need to file a

Form 1 for ArcaEx because the PCX is

already registered as a national securities

exchange. Again, the use of a Rule 19b–4

filing for the creation of a new exchange

facility follows the procedure used, and

accepted by the Commission, with regard to

other exchange facilities.26 Correspondingly,

PCX, as the registered national securities

exchange for the facility, will amend its Form

1 to the extent revision is required by Rule

6a–2 under the Exchange Act for the creation

of the ArcaEx facility.27

II. The Relationship Between PCX and the

ArcaEx Facility Satisfies the Regulatory

Requirements of the Exchange Act

The PCX believes that ArcaEx, as a facility

of the PCX, is designed to operate in a

manner that is consistent with the regulatory

purposes of the Exchange Act. Nasdaq’s

concerns about ArcaEx’s compliance with the

securities laws as well as the SEC’s ability to

oversee the ArcaEx facility are unfounded.28

The relationship between PCX and the

ArcaEx facility—in both a rules-related

context and a contractual context—ensures

ArcaEx’s compliance with the securities

laws.

First and foremost, the PCX will be fully

responsible for all activity that takes place

through ArcaEx, including its regulation and

oversight, because ArcaEx is a part of the

exchange.29 The PCX will comply with its

obligations under the Exchange Act with

regard to ArcaEx, just as it does with its

current trading facilities.30

Second, ArcaEx, as a party that has agreed

to operate a facility of a self-regulatory

organization, is required to cooperate with

the PCX in meeting its regulatory

responsibilities and to submit to Commission

oversight and examination. Such cooperation

and oversight will be assured through the

application of proposed PCXE Rule 14.3 of

the PCX Plan of Delegation.31 Proposed PCXE

Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices 23301

32See, e.g., PCX OptiMark Release.

33See, e.g., Section 6(b)(5) of the Exchange Act

(the exchange must have rules designed to prevent,

among other things, ‘‘fraudulent and manipulative

acts and practices [and] to promote just and

equitable principles of trade’’).

34 Knight Letter at 4 and Nasdaq II Letter at 7–

9. See also NASDR Letter.

35 In addition, PCX will cooperate with the

Commission’s Automation Review Policy with

regard to ArcaEx. See Securities Exchange Act

Release No. 27445, 54 FR 48703 (Nov. 24, 1989)

(‘‘ARP I Release’’) and Securities Exchange Act

Release No. 29185, 56 FR 22490 (May 15, 1991)

(‘‘ARP II Release’’). Specifically, in accordance with

the details of ARP I and ARP II, PCX will ensure

that ArcaEx has ‘‘the capacity to accommodate

current and reasonably anticipated future trading

volume levels adequately and to respond to

localized emergency conditions.’’ ARP I Release at

48705–06.

36Nasdaq II Letter at 10.

37Similarly, we note that, in the ArcaEx

Proposing Release, the Commission requested

comment on the minimum price improvement

provided by ArcaEx in cross and directed orders.

ArcaEx Proposing Release at 78836–37. We believe

that the proposed crossing and directed order

procedures were well designed in that they provide

the customer with the best displayed quote within

ArcaEx plus a minimum increment. We believe this

is consistent with the Exchange Act and encourage

the Commission to approve the proposal.

38For example, PCXE Rule 7.20 states that

[t]he Corporation may designate to be traded in

the CABINET System those securities which in the

judgment of the Corporation do not trade with

sufficient frequency to warrant their retention in the

specialist system * * *. Bids and offers in

securities dealt in by use of cabinets shall be

written on floor tickets which shall be filed in the

cabinets in the following sequence: 1. According to

price, and 2. According to the time received at the

CABINET. Orders, including all bids and offers, in

such securities shall be filled in the sequence

indicated above.

PCX Rule 7.20. For other examples of cabinet

trading rules, see, e.g., CHX Art. XX, Rule 11 and

CSE Rule 11.7.

39Nasdaq II Letter at 10.

40See generally Securities Exchange Act Release

No. 40760 (Dec. 8, 1998), 63 FR 70844 (Dec. 22,

1998) (‘‘ATS Release’’). In redefining the term

‘‘exchange’’ in the ATS Release, the Commission

concluded that the fundamental characteristics of

an exchange are: (1) bringing together the orders for

securities of multiple buyers and sellers; and (2)

using established, non-discretionary methods

(whether by providing a trading facility or by

setting rules) under which such orders interact with

each other, and the buyers and sellers entering such

orders agree to the terms of a trade. See Rule 3b–

16 under the Exchange Act. Indeed, despite critical

comments by several commenters, the Commission

rejected the ‘‘liquidity’’ standard Nasdaq now seeks

to resurrect.

41Securities Exchange Act Release No. 27611

(Jan. 12, 1990), 55 FR 1980, 1900 (Jan. 19, 1990)

(‘‘Delta Release’’). See also Board of Trade of the

City of Chicago v. SEC, 923 F.2d 1270 (7th Cir.

1991).

Rule 14.3(a), which applies to Archipelago

Exchange, L.L.C., (‘‘Archipelago Exchange’’),

the operator and owner of the ArcaEx trading

system, states:

The books, records, premises, officers,

directors, agents and employees of

Archipelago Exchange, L.L.C., shall be

deemed to be the books, records, premises,

officers, directors, agents and employees of

PCX and PCX Equities for purposes of and

subject to oversight pursuant to the Securities

Exchange Act. The books and records of

Archipelago Exchange, L.L.C., shall be

subject at all times to inspection and copying

by the PCX, PCX Equities and the SEC.

By legally equating the premises, personnel

and records of Archipelago Exchange with

those of the PCX, both the PCX and the SEC

have jurisdiction over Archipelago

Exchange’s premises, personnel and records

to the same extent that the PCX and the SEC

have jurisdiction over the PCX’s premises,

personnel and records.

In addition, proposed PCXE Rule 14.3(b)

further enhances the SEC and PCX’s ability

to oversee all relevant aspects of the ArcaEx

facility. Under this rule, the SEC and the PCX

are granted access, not only to the operator

of ArcaEx, but also to the parent company of

the operator, Archipelago Holdings, L.L.C.

(‘‘Holdings’’). Specifically, proposed PCXE

Rule 14.3(b) states that ‘‘[a]ll officers and

directors of Archipelago Holdings, L.L.C.,

shall be deemed to be officers and directors

of PCX and PCX Equities for purposes of and

subject to oversight pursuant to the Securities

Exchange Act.’’

Finally, the SEC and PCX’s access to and

oversight of ArcaEx’s operating company and

its parent is further solidified in the private

contracts related to ArcaEx. Each of the

clauses in Rule 14.3 is included in the

agreements between PCX and Archipelago

Exchange and Holdings. Therefore,

Archipelago Exchange and Holdings have a

private contractual obligation as well as a

regulatory obligation to abide by Rule 14.3.

The relationship between the PCX and

ArcaEx is structured in the same fashion as

other facility arrangements between an

exchange and third parties.32 Such facility

arrangements have proven effective in the

past and there is no reason to believe that the

oversight quality will be hampered in any

way in the present case.

III. PCX Will Conduct All Necessary

Surveillance of ArcaEx

As part of its obligations under the

Exchange Act and pursuant to its own

rules,33 the PCX will conduct all necessary

surveillance of the operation of and trading

through ArcaEx, including a full audit trail

capability. In doing so, ArcaEx, like all

facilities of an exchange, will be subject to

full oversight of the SEC. Pursuant to this

oversight, the SEC will ensure that the PCX’s

surveillance program is adequate based on all

relevant circumstances. Nevertheless, such

an evaluation of a surveillance program is not

accomplished via the public comment

process of a Rule 19b–4 filing.

Notwithstanding this fact, PCX emphasizes

that it has, not only the technological

capability to establish and maintain an audit

trail, but also the staff expertise and capital

resources to satisfactorily oversee a new

electronic market trading an increased

number of securities. Therefore, the

commenters’ expressed fears that PCX is

unprepared to regulate ArcaEx are

unfounded.34

PCX, as a well-established exchange, has

the requisite staff experience to support and

to supplement the technological surveillance

necessary for the all-electronic ArcaEx.

Throughout its long trading history, PCX has

succeeded in attracting qualified

management and regulatory staff, who have

repeatedly demonstrated their familiarity

with the federal securities laws and the selfregulatory role of a registered exchange.

Furthermore, the PCX personnel have had

the opportunity to hone their regulatory

skills in both floor and electronic trading

environments, like the PCX Application of

OptiMark, making them particularly wellsuited to the task at hand.

Furthermore, consistent with the

requirements of the Exchange Act, PCX will

demonstrate to the SEC, as necessary, that it

has adequate financial resources to fund a

surveillance program for a fully electronic

trading facility. Finally, PCX intends to

implement a state-of-the-art electronic system

for producing detailed audit trails of all

orders submitted to ArcaEx. In accordance

with its regulatory responsibilities, PCX will

demonstrate to the Commission that the

technology of the system will be more than

adequate for the surveillance of, and trading

on, ArcaEx.35

IV. The Exchange Act Does Not Require a

Market Maker in Every Security

Contrary to Nasdaq’s assertion that a

failure to require a market maker in every

security is a ‘‘clear statutory deficiency,’’ 36

the Exchange Act neither explicitly nor

implicitly makes such a demand on an

exchange.37 First, no specific provision of the

Exchange Act, including Sections 6 or 11A,

or any rules and regulations promulgated

thereunder, compel an exchange to employ

market makers as a source of liquidity.

Second, current established trading

practices also support the notion that a

market maker need not be registered in every

security traded on an exchange. The

Commission permits exchanges to trade

securities via cabinet trading programs.38

With cabinet trading, buy and sell limit

orders are booked for execution on the

exchange and executed outside the regular

specialist or market maker system. ArcaEx

should not be held to a different standard

than that applied to traditional exchanges.

Third, no market maker requirement can be

implied from the basic definition of what

constitutes an exchange. Nasdaq claims that

because ‘‘provid[ing] a ready source of

liquidity’’ is ‘‘the most fundamental

requirement of a securities exchange,’’ every

exchange must require a market maker or

specialist to be assigned to each security

listed on that market.39 The Commission,

however, specifically has rejected this

argument in its discussion of the basic

characteristics of an ‘‘exchange’’ in the ATS

Release.40

Nasdaq’s argument is merely a reiteration

of the now-discarded definition of an

‘‘exchange’’ promulgated in the Delta

Release.41 In 1990, the Commission

interpreted the statutory definition of an

exchange narrowly to include only those

organizations that were ‘‘designed * * * to

centralize trading and provide buy and sell

quotations on a regular and continuous basis

so that purchasers and sellers have a

reasonable expectation that they can

regularly execute their orders at those price

23302 Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices

42 Delta Release at 1900.

43ATS Release at 70899.

44ATS Release at 70899 (emphasis added).

45ATS Release at 70845.

46See, e.g., Letter from Robert L. D. Colby,

Division of Market Regulation, SEC, to Gerald

Putnam, Archipelago, L.L.C., dated Jan. 12, 2001.

47 Knight Letter at 5, n. 13, and Nasdaq II Letter

at 9.

48See, e.g., Securities Exchange Act Release No.

43545 (Nov. 9, 2000), 65 FR 69581 (Nov. 17, 2000).

49 Id. (the PCX request to expand the number of

eligible Nasdaq/NM securities).

50See, e.g., Proposed PCXE Rules 1.1(gg), 7.32

and 7.37(d).

51See Proposed PCXE Rule 7.31(x).

52See generally Proposed PCXE Rule 7.37.

53See Proposed PCXE Rule 7.37(d) (describing

‘‘Routing Away,’’ Step 5 of the trading algorithm,

after the Directed Order, Display Order, Working

Order and Tracking Order Processes).

54 Knight Letter at 4–5 and Nasdaq II Letter at 6–

7.

55An ‘‘ETP’’ is an Equity Trading Permit issued

by the PCXE for effecting approved securities

transactions on the PCXE’s Trading Facilities.

Proposed PCXE Rule 1.1(m). An ‘‘ETP Holder’’ is

‘‘a sole proprietorship, partnership, corporation,

limited liability company or other organization in

good standing that has been issued an ETP. An ETP

Holder must be a registered broker or dealer

pursuant to Section 15 of the Exchange Act.’’ See

Proposed PCXE Rule 1.1(n).

56A ‘‘Sponsored Participant’’ means ‘‘a person

which has entered into a sponsorship arrangement

with a Sponsoring ETP Holder pursuant to

[Proposed PCXE] Rule 7.29.’’ Proposed PCXE Rule

1.1(jj).

57Proposed PCXE Rule 1.1(gg).

quotations.’’42 In 1998, in light of the rapid

technological changes taking place in the

securities industry, the Commission

rescinded the Delta definition and expressly

rejected liquidity provided by markets

makers as a defining characteristic of a

securities exchange. In reaching this

conclusion, the Commission explained that

‘‘while the Delta interpretation was

appropriate at the time, its emphasis on the

‘expectation’ of regular execution of orders at

quoted prices no longer reflects today’s

markets where alternative trading systems

compete directly with registered exchanges

and Nasdaq.’’43 The Commission further

clarified that:

More fundamentally, although traditional

exchanges still provide liquidity through

two-sided quotations and, hence, raise an

expectation of execution at the quoted price,

this is no longer the essential characteristic

of a securities market where stock and other

securities exchange hands. Today’s

technology enables market participants and

investors to tap simultaneous and multiple

sources of liquidity from remote locations.

Market makers and specialists may be

important liquidity providers on a particular

exchange, but liquidity now comes from

many sources.44

Furthermore, when the Commission

broadened the definition of an exchange to

include a greater variety of business models,

it did so with the intent of ‘‘encouraging

innovative new markets’’45 and fostering the

development of new technology-driven

trading designs. ArcaEx is such an

‘‘innovative’’ market and, therefore, there is

no basis for commanding ArcaEx to alter its

computer-based architecture to require

market makers in every security.

V. The Alternative Order Routing Methods

of ArcaEx Expand Investor Choice in a

Manner Consistent with the Exchange Act

Nasdaq and Knight questioned the status

and function of the Archipelago electronic

communications network 46 (‘‘ECN’’) after the

creation of ArcaEx.47 The broker-dealer

commonly referred to as the Archipelago

ECN will continue to exist as a registered

broker-dealer renamed WAVE. The functions

and activities of WAVE, however, will differ

from the current activities of the Archipelago

ECN. In particular, WAVE will perform three

primary functions, including acting as (1) for

a limited period of time, a residual ECN, (2)

an introducing broker and (3) a routing

broker. In order to perform these limited

functions, WAVE will exist as an entity

separate and distinct from ArcaEx. In

addition, NASDR, rather than PCX, will be

the Designated Examining Authority (‘‘DEA’’)

for WAVE, just as it has been for the

Archipelago ECN. We discuss the proposed

business and regulation of WAVE in more

detail below.

A. WAVE Will Perform Three Primary

Functions

1. WAVE Will Continue to Perform as an

ECN for a Limited Period of Time

First, as a temporary matter, WAVE will

continue to act as an ECN, to the extent

necessary, for a limited period of time.

Specifically, PCX and Archipelago have

agreed that all securities eligible to be traded

on ArcaEx (i.e., listed securities or securities

with unlisted trading privileges (‘‘UTP’’))

will be traded only on ArcaEx; they will not

be traded on PCX and the ECN. Therefore, no

security will be traded concurrently on both

ArcaEx and the ECN. As of this date,

however, the plan for trading over-thecounter (‘‘OTC’’) pursuant to UTP (the socalled ‘‘OTC/UTP Plan’’) only permits PCX,

as an exchange participating in the Plan, to

trade 1000 of the Nasdaq/NM securities.48

Until the OTC/UTP Plan has been expanded

to incorporate all Nasdaq securities,49 WAVE

will continue to act as an ECN for those

securities excluded from the Plan. Once the

OTC/UTP Plan has been expanded—which is

expected to occur later this year—the

remaining Nasdaq securities will be

transferred for trading from the Archipelago

ECN to ArcaEx pursuant to a roll-out plan.

The ECN will cease to operate as such once

all the Nasdaq securities have been

transferred to ArcaEx.

2. WAVE Will Act as an Introducing Broker

Second, WAVE plans to register as an ETP

Holder and act as an introducing broker for

institutions or other entities who are not ETP

Holders themselves. WAVE’s position as the

routing broker will not bestow any special

status on WAVE in its capacity as an ETP

Holder. WAVE, acting as an ETP Holder, and

its customers will have the exact same access

to ArcaEx as any other ETP Holder and its

customers. In this regard, PCX and

Archipelago will establish appropriate

information barriers to address any concerns

regarding WAVE’s status relative to other

ETP Holders.

3. WAVE Will Supply ArcaEx With a Routing

Service

Finally, the ongoing WAVE function most

relevant for ArcaEx is a routing service.

WAVE will route orders, as necessary, from

ArcaEx to other market centers.50 Given

various technical issues associated with

market center-to-market center routing

within the strictures of today’s intermarket

structure, PCX and Archipelago have opted

to employ the services of a routing broker,

rather than rely on routing orders to other

markets directly from PCX itself.

Despite the decision to employ WAVE in

this intermarket capacity, no User is required

to utilize the WAVE routing services.

Furthermore, those Users who opt out of the

WAVE routing services are not precluded

from entering any order types, except a very

limited subset of orders that specifically

incorporates a WAVE routing requirement

within the definition of the order. This

limited subset includes Primary Only Orders

as well as NOW Orders, if routing of the

NOW Order is required.51 The only trading

condition for those Users who do not use the

WAVE routing services is that each order, if

it has not been fully executed after it has

progressed through each step of the ArcaEx

trading algorithm,52 must be returned to the

User or the User’s designated agent prior to

reaching the routing step of the algorithm.53

After the order is returned to the User, the

User may then route the order to another

market center as the User sees fit. In other

words, the trading mechanism is the same for

orders that do not rely on WAVE and orders

that do rely on WAVE, except orders that do

not rely on WAVE, of course, must, by

definition, be routed outside of ArcaEx

through another mechanism. The specifics of

the routing function and its impact on

ArcaEx Users are discussed in more detail

below.

i. ArcaEx Provides Its Users With a Choice

as to How Their Orders Will Be Routed to

Away Markets

ArcaEx has been designed to provide its

Users with a choice as to how they wish to

route orders to away markets. In this regard,

Nasdaq and Knight misinterpret the various

options available to Users in ArcaEx’s routing

structure.54 These two commenters correctly

identify one ArcaEx routing option: a User

may choose to utilize the routing services

provided by WAVE, the broker-dealer

affiliate of Archipelago Exchange, L.L.C. To

do so, the User must enter into a routing

agreement with WAVE under which WAVE

‘‘agrees to act as agent for routing orders of

the ETP Holder 55 and the ETP Holder’s

Sponsored Participants 56 entered into the

Archipelago Exchange to other market

centers or broker-dealers for execution,

whenever such routing is required.’’57

Nasdaq and Knight, however, fail to

recognize that a User is not required to use

WAVE’s routing services. Instead of signing

a routing agreement with WAVE, a User may

bypass WAVE entirely and opt to rely on its

Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices 23303

58For a definition of the Fill-or-Return, Fill-orReturn Plus or PNP order types, see, respectively,

Proposed PCXE Rules 7.31(p), 7.31(r) and 7.31(w).

59See Proposed PCXE Rule 7.32. ArcaEx’s

provision of alternative routing services other than

WAVE is akin to Nasdaq’s efforts regarding

SuperMontage to allow Nasdaq members to

establish order routing arrangements with other

market participants, such as telephone access or

direct links, in addition to, or in place of,

SuperMontage’s routing arrangements. See

Securities Exchange Act Release No. 43863 (Jan. 19,

2001), 66 FR 8020, 8049 (Jan. 26, 2001)

(‘‘SuperMontage Release’’).

60Proposed PCXE Rule 7.31(p).

61Proposed PCXE Rule 7.31(r).

62See Proposed PCXE Rule 7.31(w).

63 Knight Letter at 4–5 and Nasdaq II Letter at 11–

12.

64See Proposed PCXE Rule 7.31(x) (‘‘For

exchange listed securities, [a Primary Only Order]

is a market order that is to be routed as a marketon-open order to the primary market for

participation in the primary market opening

process’’).

65See Nasdaq II Letter at 11–12.

66E.g., Section 6(b)(5) of the Exchange Act (the

rules of an exchange may not be designed to permit

‘‘unfair discrimination’’); ATS Release at 70874

(standards for access ‘‘should act to prohibit

unreasonably discriminatory denials of access. A

denial of access is reasonable if it is based on

objective standards.’’). See Section 19(f) of the

Exchange Act.

67See Knight Letter at 5 and Nasdaq II Letter at

9.

68Nasdaq II Letter at 6–7.

69See Phlx Letter.

70 Id. The Phlx also asserts that customer priority

is a Congressional directive. The PCX has found no

securities law requirement that would force ArcaEx

to incorporate customer priority into its trading

algorithm.

71See Securities Exchange Act Release No. 14563

(Mar. 14, 1978), 43 FR 11542, 11543 (Mar. 17, 1978)

(‘‘1978 Release I’’); Securities Exchange Act Release

No. 14713 (Apr. 27, 1978), 43 FR 18557, 18588

(May 1, 1978) (‘‘1978 Release II’’); Securities

Exchange Act Release No. 15533 (Jan. 29, 1979), 44

FR 6084, 6092 (Jan. 31, 1979) (‘‘1979 Release’’). The

1978 and 1979 Releases cite the House Report at

54–57.

own routing abilities or those of another

broker-dealer by utilizing the Fill-or-Return,

Fill-or-Return Plus or Post No Preference

(‘‘PNP’’) order types 58 supplied by ArcaEx.59

A Fill-or-Return order is ‘‘[a]n order to buy

or sell that is to be executed in whole or in

part on the Corporation, and the portion not

so executed is to be cancelled, without

routing the order to another market

center.’’ 60 A Fill-or-Return order, therefore,

allows the order originator to re-route the

order to another market in a manner of its

own choosing, once it is informed that the

order has not been executed in its entirety on

the ArcaEx. This alternative allows the User

to implement its own customized means for

accomplishing the order routing.

Similarly, a User may wish to rely upon

the routing capabilities of another entity,

rather than its own routing resources or

WAVE. ArcaEx facilitates such relationships

by providing a User with the opportunity to

enter Fill-or-Return Plus orders into ArcaEx.

A Fill-or-Return Plus order is:

[a]n order to buy or sell that is to be

executed in whole or in part on the

Corporation, and the portion not so executed

is to be cancelled, without routing the order

to another market center or market

participant. In the event any portion of the

order is not executed on the Corporation and

must be cancelled, the Archipelago

Exchange, after canceling the unexecuted

portion of the order, shall send an

administrative message to an ETP Holder

designated by the order entry ETP Holder

informing the designated ETP Holder that a

portion of the order was cancelled.61

The administrative message informs the

designated ETP Holder that an order has not

been executed. The designated ETP Holder

may then use this information to send an

order via its own routing mechanisms to

another market in accordance with the

original User’s instructions.

Finally, a User may prefer to send PNP

Orders to ArcaEx. A PNP Order is ‘‘a limit

order to buy or sell that is to be executed in

whole or in part on the Corporation, and the

portion not so executed is to be ranked in the

Arca Book, without routing any portion of

the order to another market center; provided,

however, the Corporation shall cancel a PNP

that would lock or cross the NBBO.’’ 62 This

order type provides the User with the ability

to use ArcaEx as a final order destination

when it suits the User’s investment needs.

As Nasdaq and Knight note in their

comment letters,63 certain order types which

involve a routing element unique to ArcaEx,

like the Primary Only Order,64 require the

User to utilize WAVE’s routing services. As

discussed above, however, the rules for

trading on ArcaEx in no way preclude a User

from pursuing trading opportunities similar

to those provided by ArcaEx orders through

the routing services supplied by brokerdealers other than WAVE. Users easily may

do so by entering Fill-or-Return or Fill-orReturn Plus orders. Furthermore, no denial of

access issues arise with any order type,

regardless of their routing mechanism.65

Every User must satisfy identical, objective

requirements for submitting each order type;

the requirements do not vary based on the

identity of the User or otherwise unfairly

discriminate against any particular class of

Users.66

ii. WAVE Will Not Enjoy a Competitive

Advantage as a Result of its Routing Services

Contrary to the concerns expressed by

Nasdaq and Knight,67 WAVE will not enjoy

a competitive advantage over other brokerdealers as a result of the routing services it

provides to ArcaEx. In addition to providing

only one of the methods by which Users may

route orders to away markets, as discussed

above, WAVE will be limited in what trading

activities it may perform. WAVE will not, for

example, conduct proprietary transactions on

ArcaEx or in securities traded on ArcaEx.

Furthermore, information barriers will be

maintained, as necessary, to ensure that

WAVE may not unfairly take advantage of

knowledge gained as the ArcaEx routing

broker.

B. WAVE Will Be Separate and Distinct From

ArcaEx

WAVE and ArcaEx will be separate and

distinct corporate entities (WAVE, L.L.C.,

and Archipelago Exchange, L.L.C.,

respectively). As mentioned above, both are

wholly-owned subsidiaries of the same

holding company, Archipelago Holdings,

L.L.C., whose officers and directors are

deemed to be officers and directors of PCX

and PCXE for purposes of the Exchange Act.

As such WAVE and ArcaEx each have their

own trading systems as well as their own

compliance, finance and sales functions.

C. WAVE Will Be Assigned to a Designated

Examining Authority Other Than the PCX

Nasdaq expressed concerns about the

heightened potential for conflicts of interest

if the PCX were to regulate WAVE.68 To

avoid even the perception of a conflict of

interest, PCX agrees that an SRO other than

PCX should be WAVE’s DEA. In particular,

PCX and Archipelago believe that NASDR is

the most appropriate SRO to act as WAVE’s

DEA. Based on discussions with NASDR,

PCX understands that NASDR has agreed to

undertake the DEA responsibilities with

respect to WAVE.

VI. ArcaEx Operates in Compliance With

Section 11(a) of the Securities Exchange Act

The Phlx believes that PCX should not

abandon priority for public customer agency

orders over proprietary orders of brokerdealers in implementing ArcaEx.69 The Phlx

argues that the requirement that brokerdealer orders yield priority, parity and

precedence to customer orders is a statutory

requirement under Section 11(a) of the

Exchange Act.70 The PCX disagrees. As

discussed in detail in Appendix A, the order

execution algorithm of ArcaEx complies with

the requirements of, and satisfies the policy

concerns underlying, Section 11(a) without

requiring public customer priority.

Section 11(a) of the Exchange Act prohibits

a member of a national securities exchange

from effecting transactions on the exchange

for its own account, the account of an

associated person, or an account in which it

or an associated person exercises investment

discretion (collectively, ‘‘covered accounts’’),

unless an exception applies. In enacting this

provision, Congress was concerned about

members benefiting in their principal

transactions from special ‘‘time and place’’

advantages associated with floor trading—

such as the ability to ‘‘execute decisions

faster than public investors.’’ 71 The

Commission, however, has adopted a number

of exceptions to the general statutory

prohibition for situations in which the

principal transactions contribute to the

fairness and orderliness of exchange markets

or do not reflect any time and place trading

advantages.

The Phlx apparently assumes that the PCX

is relying upon the Section 11(a) exception

set forth in Rule 11a1–1(T) (‘‘the proprietary

trading rule’’), which has, as one of its

requirements, public customer priority. PCX,

however, believes that ArcaEx satisfies the

requirements of another exception to Section

11(a), which does not require public

23304 Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices

72Rule 11a2–2(T) permits an exchange member,

subject to certain conditions, to effect transactions

for covered accounts by arranging for an

unaffiliated member to execute the transactions

directly on the exchange floor. To comply with the

rule’s conditions, a member (1) must transmit the

order from off the exchange floor; (2) may not

participate in the execution of the transaction once

it has been transmitted to the member performing

the execution; (3) may not be affiliated with the

executing member; and (4) with respect to an

account over which the member or an associated

person has investment discretion, neither the

member nor the associated person may retain any

compensation in connection with effecting the

transaction without express written consent from

the person authorized to transact business for the

account in accordance with the rule. 73See 1978 Release II at 18560. 74For a detailed analysis of how ArcaEx satisfies

the requirements of the effect versus execute rule,

see Appendix B.

75See, e.g., Letter from Larry E. Bergmann, Senior

Associate Director, Division of Market Regulation,

SEC, to Edith Hallahan, Associate General Counsel,

Phlx, dated Mar. 24, 1999 (‘‘VWAP Letter’’)

(approving Phlx’s VWAP Trading System); Letter

from Catherine McGuire, Chief Counsel, Division of

Market Regulation, SEC, to David E. Rosedahl, PCX,

dated Nov. 30, 1998 (‘‘OptiMark Letter’’) (approving

the PCX Application of OptiMark); Letter regarding

Chicago Match, from Brandon Becker, Director,

Division of Market Regulation, SEC, to George T.

Simon, Partner, Foley & Lardner, dated Nov. 30,

1994 (‘‘Chicago Match Letter’’); and Securities

Exchange Act Release No. 29237 (May 31, 1991), 56

FR 24853 (May 31, 1991) (approving the New York

Stock Exchange’s Off-Hours Trading Facility).

76See 1979 Release at 6087, n. 35.

77Nasdaq II Letter at 11.

78Proposed PCXE Rule 7.31(h)(2).

79Proposed PCXE Rule 7.36.

80For a detailed analysis of the benefits of

discretionary orders in addition to how they

comply with the Quote Rule, see Appendix B.

81See Rule 11Ac1–1 under the Securities

Exchange Act.

82See Rule 11Ac1–1(a)(4) under the Securities

Exchange Act.

83PCX OptiMark Release at 50046.

84As the Commission has stated repeatedly, the

Quote Rule is premised on the notion of a bid or

offer at one specified price and one specified size.

See, e.g., Exchange Act Release No. 35030 (Nov. 30,

1994), 59 FR 63141, 63145 (1994).

85Rule 11Ac1–1(a)(4) under the Exchange Act.

86For a description of CAP orders, see, e.g., NYSE

Rules 13 and 123A.

87See, e.g., OptiMark Release, 62 FR at 50046.

88This may be especially true for indications of

interest expressed by those who do not constitute

‘‘members’’ or ‘‘responsible broker-dealers’’ within

the meaning of the Quote Rule. See Order Handling

Release, 61 FR at 48311, n. 248.

89As described in the proposed PCXE Rules (see

Proposed PCXE Rule 7.35), ArcaEx has developed

an automated opening for its order-driven market,

which is designed to provide efficient price

discovery, while ensuring investor protection. PCX,

based on its business judgment, believes the ArcaEx

opening mechanism will prove effective for its

Users. In addition, PCX believes that the opening

is consistent with, and fosters the goals of, the

Exchange Act. In that vein, PCX also believes that

ArcaEx complies with the pre-opening application

of the ITS Plan.

90Nasdaq II Letter at 12.

customer priority. This alternative exception

is Rule 11a2–2(T), commonly referred to as

the ‘‘effect versus execute’’ rule.72

The effect versus execute rule imposes four

requirements ‘‘designed to put members and

non-members on the same footing, to the

extent practicable, in light of the purposes of

Section 11(a).’’ 73 ArcaEx will place all of its

Users—both ETP Holders and non-ETP

Holders—on the ‘‘same footing,’’ as intended

by Rule 11a2–2(T). Given ArcaEx’s

automated matching and execution services,

no User will enjoy any special control over

the timing of execution or special order

handling advantages, as all orders will be

centrally processed for execution by

computer, rather than being handled by a

member through bids or offers made on the

trading floor. Because ArcaEx’s open,

electronic structure is designed to prevent

any ETP Holders from gaining any time and

place advantages, the PCX believes that

ArcaEx satisfies the four requirements of the

‘‘effect versus execute’’ rule as well as the

general policy objectives of Section 11(a).74

This result is consistent with the

Commission’s application of the effect versus

execute rule in similar situations. In the past,

the Commission and its staff have allowed

exchanges to sponsor innovative trading

systems in reliance on Rule 11a2–2(T),

finding that such facilities, by design, do not

provide any special time and place advantage

to members.75 In particular, where the

execution is performed by the facility itself

through an automated service, it has been

determined that ‘‘the member would not

retain any ability to control the timing of the

execution or otherwise enjoy the kind of

special order-handling advantages inherent

in being on an exchange floor.’’ 76 Like these

trading systems, ArcaEx ensures that ETP

Holders do not have any special or unique

trading advantages and, therefore, complies

with Section 11(a).

VII. The Treatment of Discretionary Orders

in ArcaEx Complies With the Firm Quote

Rule

In its comment letter, Nasdaq questioned

whether ArcaEx’s discretionary orders

comply with Rule 11Ac1–1 under the

Securities Exchange Act, the so-called Quote

Rule.77 Under the proposed PCXE Rules, a

discretionary order is defined as ‘‘an order to

buy or sell a stated amount of a security at

a specified, undisplayed price (the

‘discretionary price’), in addition to, at a

specified, displayed (‘displayed price’).’’ 78

For all non-marketable discretionary orders,

the discretionary order will be displayed to

all Users at the displayed price. No Users

will see the discretionary price of the orders.

An undisplayed, discretionary price order

will be afforded price priority in the Arca

Book, but not time priority relative to

displayed orders.79 As discussed in more

detail in Appendix B,80 the PCX believes that

its discretionary orders, not only comply

with the requirements of the Quote Rule, but

also provide significant benefits to the

markets.

The Quote Rule mandates national

securities exchanges, subject to certain

exceptions, to collect and disseminate ‘‘best

bids’’ and ‘‘best offers’’ from a ‘‘responsible

broker or dealer.’’ 81 ArcaEx’s treatment of

discretionary orders complies with the

requirements of this Rule for a number of

reasons. First, an important attribute of a bid

or offer subject to the Quote Rule is that it

represents the ‘‘bid price and the offer price

communicated by an exchange member or

OTC market maker to any broker or dealer,

or to any customer.’’ 82 Accordingly, ‘‘[i]n

order to constitute a bid or offer, the

underlying trading interest must have been

communicated to at least one potential

counterparty.’’ 83 On ArcaEx, the

discretionary price of a discretionary order is

not communicated to any Users of the

system; only ArcaEx is aware of the full

potential trading interest of these orders until

trades occur. Accordingly, because ArcaEx

does not publish the discretionary aspect of

these discretionary orders, they should not be

deemed to be a ‘‘bid or offer’’ within the

meaning of the Quote Rule.

Second, discretionary orders allow the

investor to express a more complex—and

more accurate—trading interest than the

single price and size of a conventional

order.84 Unlike ‘‘bids’’ and ‘‘offers,’’

discretionary orders reflect the fact that there

is usually more than one price at which an

investor is willing to buy or sell. Because

these discretionary orders represent a

qualitatively different set of information from

the traditional price and size information,

they are more analogous to indications of

interest, than bids and offers. Therefore, like

indications of interest, discretionary orders

should be excluded from the requirements of

the Quote Rule.85 The Commission reached

a similar conclusion in its analysis of

OptiMark Profiles, finding that ‘‘Profiles are

analogous to indications of interest or CAP

orders,86 neither of which are displayed in

exchanges or on Nasdaq.’’ 87 Therefore, the

inchoate trading interest of discretionary

orders should not be treated as a bid or offer

under the Quote Rule.88

VIII. PCX Will Continue To Participate in

the National Market System

Nasdaq also voiced concern over ArcaEx’s

integration into the Intermarket Trading

System (‘‘ITS’’) because aspects of the ArcaEx

trading algorithm appeared to conflict with

two basic components of the ITS Plan—the

pre-opening application 89 and continuous,

two-sided quotations.90 The PCX remains

supportive of the national market system and

intends to continue to comply with the

national market system plans once ArcaEx

becomes operational. Discussions are

ongoing with the relevant operating

committees, among others, regarding the

integration of ArcaEx into the national

market system.

IX. PCX Will Maintain All Required Books

and Records in the United States

The PCX represents that it will keep all

books and records that it is required to

maintain under the Exchange Act, including

those related to ArcaEx, in the United States.

* * * * *

The PCX believes that the proposed rule

change is consistent with the requirements of

the Exchange Act, including Sections 6 and

11A, and the rule and regulations thereunder

applicable to a national securities exchange.

In particular, the PCX believes that the

ArcaEx rules are designed to promote just

and equitable principles of trade, remove

Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices 23305

91See Pub. L. No. 94–29, 89 Stat. 110 (June 4,

1975).

92See Securities Reform Act of 1975, Report of

the House Comm. on Interstate and Foreign

Commerce, H.R. Rep. No. 94–123, 94th Cong., 1st

Sess. (1975) (‘‘House Report’’); Securities Acts

Amendments of 1975, Report of the Senate Comm.

on Banking, Housing and Urban Affairs, S. Rep. No.

94–75, 94th Cong., 1st Sess. (1975).

93See Securities Exchange Act Release No. 14563

(Mar. 14, 1978), 43 FR 11542, 11543 (Mar. 17, 1978)

(‘‘1978 Release I’’); Securities Exchange Act Release

No. 14713 (Apr. 27, 1978), 43 FR 18557, 18588

(May 1, 1978) (‘‘1978 Release II’’); Securities

Exchange Act Release No. 15533 (Jan. 29, 1979), 44

FR 6084, 6092 (Jan. 31, 1979) (‘‘1979 Release’’). The

1978 and 1979 Releases cite the House Report at

54–57.

94See Section 11(a)(1)(A), 15 U.S.C.

§ 78k(a)(1)(A). In addition to the application of Rule

11a2–2(T), as discussed below, ETP Holders who

are registered as market makers on the Archipelago

Exchange (‘‘ArcaEx’’) may also take advantage of

this market maker exemption from Section 11(a), at

least for securities in which they make a market.

95See Section 11(a)(1)(D) of the Securities

Exchange Act.

96See Section 11(a)(1)(F) of the Securities

Exchange Act.

97The member may participate, however, in

clearing and settling the transaction.

98See 1978 Release II at 18560.

99See Rule 11a2–2(T)(e) under the Securities

Exchange Act.

100See, e.g., Letter from Larry E. Bergmann,

Senior Associate Director, Division of Market

Regulation, SEC, to Edith Hallahan, Associate

General Counsel, Phlx, dated Mar. 24, 1999

(‘‘VWAP Letter’’) (approving Phlx’s VWAP Trading

System); Letter from Catherine McGuire, Chief

Counsel, Division of Market Regulation, SEC, to

David E. Rosedahl, PCX, dated Nov. 30, 1998

(‘‘OptiMark Letter’’) (approving the PCX

Application of OptiMark); Letter regarding Chicago

Match, from Brandon Becker, Director, Division of

Market Regulation, SEC, to George T. Simon,

Partner, Foley & Lardner, dated Nov. 30, 1994

(‘‘Chicago Match Letter’’); and Securities Exchange

Act Release No. 29237 (May 31, 1991), 56 FR 24853

(May 31, 1991) (approving the New York Stock

Exchange’s Off-Hours Trading Facility).

101See 1979 Release at 6087, n. 35.

102See id. at 6987.

103For a detailed description of how ArcaEx will

operate, see Securities Exchange Act Release No.

43608 (Nov. 21, 2000). Capitalized terms not

defined herein will have the meanings given them

in that release.

104Among the systems considered by the

Commission are (1) the Phlx’s VWAP Trading

System (see VWAP Letter); (2) the PCX Application

of OptiMark (see OptiMark Letter); (3) Chicago

Match (see Chicago Match Letter); (4) the Amex’s

Post Execution Reporting System and the Amex

Switching System (see 1979 Release at n. 25); (5)

ITS; (6) the Multiple Dealer Trading Facility of the

Continued

impediments to and perfect the mechanism

of a free and open market and a national

market system, and, in general protect

investors and the public interest, as required

by Section 6(b)(5) of the Securities Exchange

Act. For the foregoing reasons, the PCX

requests that the Commission approve the

proposed rule changes regarding ArcaEx.

If you have any questions or concerns,

please feel free to call Kathryn Beck of the

PCX at 415.393.7936, Brandon Becker at

202.663.6979 or the undersigned at

202.663.6855.

Sincerely,

Cherie Macauley

cc: Annette Nazareth,

Robert L.D. Colby,

Belinda Blaine,

Larry Bergman,

Caite McGuire,

Steve Williams,

Patrick Joyce,

John Roeser,

Marc McKayle,

Kathryn Beck,

Dave Rosedahl.

Appendix B—ArcaEx Operates in

Compliance With Section 11(a) of the

Securities Exchange Act

A. Background

Section 11(a) of the Securities Exchange

Act (‘‘Exchange Act’’) prohibits a member of

a national securities exchange from effecting

transactions on the exchange for its own

account, the account of an associated person,

or an account in which it or an associated

person exercises investment discretion

(collectively, ‘‘covered accounts’’), unless an

exception applies. First enacted as part of the

Securities Acts Amendments of 1975,91

Section 11(a) was intended by Congress to

address trading advantages enjoyed by

exchange members and conflicts of interest

in money management.92 In particular, as

noted by the Securities and Exchange

Commission (‘‘SEC’’ or ‘‘Commission’’),

Congress was concerned about members

benefiting in their principal transactions

from special ‘‘time and place’’ advantages

associated with floor trading—such as the

ability to ‘‘execute decisions faster than

public investors.’’ 93

Where principal transactions contribute to

the fairness and orderliness of exchange

markets or do not reflect any time and place

trading advantages, they are excepted from

the prohibition. Among the transactions

excepted under Section 11(a)(1) are those by

a dealer acting in the capacity of a market

maker,94 bona fide arbitrage or hedge

transactions,95 and transactions made to

offset errors.96 Rule 11a2–2(T) under the

Exchange Act provides an exception in

addition to those delineated in the statute.

Commonly referred to as the ‘‘effect versus

execute’’ rule, Rule 11a2–2(T) permits an

exchange member, subject to certain

conditions, to effect transactions for covered

accounts by arranging for an unaffiliated

member to execute the transactions directly

on the exchange floor. To comply with the

rule’s conditions, a member (1) must transmit

the order from off the exchange floor; (2) may

not participate in the execution of the

transaction once it has been transmitted to

the member performing the execution;97 (3)

may not be affiliated with the executing

member; and (4) with respect to an account

over which the member or an associated

person has investment discretion, neither the

member nor the associated person may retain

any compensation in connection with

effecting the transaction without express

written consent from the person authorized

to transact business for the account in

accordance with the rule.

As described by the Commission, these

four requirements—off-floor transmission,

non-participation in order execution,

execution through an unaffiliated member

and non-retention of compensation for

discretionary accounts—were ‘‘designed to

put members and non-members on the same

footing, to the extent practicable, in light of

the purposes of Section 11(a).’’ 98 If a

transaction meets the requirements of the

‘‘effect versus execute’’ rule, it will be

deemed to be ‘‘consistent with the purpose

of Section 11(a)(1) of the Act, the protection

of investors, and the maintenance of fair and

orderly markets.’’ 99

In the past, the Commission and its staff

have allowed exchanges to sponsor

innovative trading systems in reliance on

Rule 11a2–2(T), finding that such facilities,

by design, do not provide any special time

and place advantage to members.100 In

particular, where the execution is performed

by the facility itself through an automated

service, it has been determined that ‘‘the

member would not retain any ability to

control the timing of the execution or

otherwise enjoy the kind of special orderhandling advantages inherent in being on an

exchange floor.’’ 101 Rule 11a2–2(T) thus has

been applied in a functional manner, taking

into account the structural characteristics

that distinguish the operation of an

automated trading system from traditional

floor activities. This approach represents the

sensible conclusion by the Commission and

its staff that implementation of Section 11(a)

should reflect the ‘‘continuing rapid pace of

economic, technological and regulatory

changes in the markets.’’ 102

B. Discussion

ArcaEx represents a new electronic trading

facility of the PCXE that may be utilized by

ETP Holders and their customers to effect the

purchase and sale of securities.103 As

discussed in more detail below, ArcaEx will

place all of its Users—both ETP Holders and

non-ETP Holders—on the ‘‘same footing,’’ as

intended by Rule 11a2–2(T). Given the

automated matching and execution services,

no ETP Holder will enjoy any special control

over the timing of execution or special order

handling advantages, as all orders will be

centrally processed for execution by

computer, rather than being handled by a

member through bids or offers made on the

trading floor. Because ArcaEx’s open,

electronic structure is designed to prevent

any ETP Holders from gaining any time and

place advantages, ArcaEx satisfies the four

requirements of the ‘‘effect versus execute’’

rule as well as the general policy objectives

of Section 11(a).

1. Off-Floor Transmission

Rule 11a2–2(T) requires the orders for a

covered account transaction to be transmitted

from off the exchange floor. In considering

the application of this requirement to a

number of automated trading and electronic

order-handling facilities operated by national

securities exchanges, the Commission has

deemed the off-floor requirement to be met

if the order is transmitted from off the floor

directly to the exchange floor by electronic

means.104 Like these other automated

23306 Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices

CSE; (7) the PCX’s Communications and Execution

System (‘‘COMEX’’); and (8) the Phlx’s Automated

Communications and Execution System (‘‘PACE’’)

(see 1979 Release at nn. 19–35 and accompanying

text).

105The Commission has not considered the lack

of a traditional physical floor to be an impediment

to the satisfaction of the off-floor requirement. See,

e.g., 1979 Release (discussing the CSE’s NSTS

satisfaction of this requirement).

106See generally 1978 Release I.

107See id.

108See 1979 Release at n. 25.

109See VWAP Letter; OptiMark Letter and

Chicago Match Letter.

110See 1979 Release. See also VWAP Letter,

OptiMark Letter and Chicago Match Letter.

111 Id.

112Proposed PCXE Rule 7.31(h)(2)

113Proposed PCXE Rule 7.36.

114See Rule 11Ac1–1 under the Securities

Exchange Act.

115See Rule 11Ac1–1(a)(4) under the Securities

Exchange Act.

116Securities Exchange Act Release No. 39086

(Sept. 17, 1997), 62 FR 50036, 50046 (1997) (‘‘PCX

OptiMark Release’’).

117See Securities Exchange Act Release No.

37619A (Sept. 12, 1996), 61 FR 48290, 48313 (1996)

(‘‘Order Handling Release’’). See also PCX

OptiMark Release at 50046.

118Order Handling Release at 48313.

systems, orders sent to ArcaEx will be

transmitted from remote terminals directly to

the system by electronic means. Therefore,

Users’ orders electronically received by

ArcaEx satisfy the off-floor transmission

requirement for the purposes of the ‘‘effect

versus execute’’ rule.105

2. Non-Participation in Order Execution

The ‘‘effect versus execute’’ rule further

provides that the exchange member and its

associated person may not participate in the

execution of the transaction once the order

has been transmitted. This requirement

originally was intended to prevent members

with their own brokers on the exchange floor

from using those persons to influence or

guide their orders’ execution.106 It does not

preclude members from canceling or

modifying orders, or from modifying

instructions for executing orders, after they

have been transmitted; provided, however,

that such cancellations or modifications are

also transmitted from off the exchange

floor.107

In analyzing the application of the nonparticipation requirement to automated

exchange facilities, the Commission

specifically noted in regard to the COMEX

and PACE systems that (1) the ‘‘initiating

member relinquishes any ability to influence

or guide the execution of its order at the time

that order is transmitted into the system’’ and

(2) ‘‘[while] the execution of the order is

thereafter automatic and does not involve

any independent executing member, the

design of those systems insures that members

do not possess any special or unique trading

advantages in handling their orders after

transmitting them to the floors of the Phlx or

the PSE.’’ 108 As a result, orders transmitted

to the COMEX and PACE systems were

deemed to comply with this requirement.

More recently, the Commission reached the

same conclusion concerning the VWAP

Trading System, OptiMark and the Chicago

Match, stating that a member does not retain

the ability to influence or guide the execution

of an order after the member submits the

order to each of these systems.109

As with these other trading systems, the

orders submitted to ArcaEx similarly meet

the non-participation requirement. Upon

submission to ArcaEx, an order will enter the

queue and be executed against another order

in the Arca Book based on an established

matching algorithm. The execution depends,

not on the ETP Holder, but rather, upon what

other orders are entered into ArcaEx at or

around the same time as the subject order,

what orders are resident in the Arca Book

and where the order is ranked based on the

price-time priority ranking algorithm.

Therefore, at no time following the

submission of an order is an ETP Holder able

to acquire control or influence over the result

or timing of orders generated. That is, unlike

a floor broker who currently enjoys a trading

advantage inherent to being present on an

exchange floor for transactions being

executed on that floor, no ETP Holder may

take advantage of any non-member User

through use of ArcaEx. As a result, the nonparticipation requirement is met where ETP

Holder orders are matched and executed

automatically in the ArcaEx.

3. Execution Through Unaffiliated Member

Although Rule 11a2–2(T) contemplates

having an order executed by an exchange

member who is unaffiliated with the member

initiating the order, the Commission has

recognized in the past that this requirement

is not applicable where automated exchange

facilities are used. For example, in

considering the operation of COMEX and

PACE, among other systems, the Commission

noted that, while there is no independent

executing exchange member, the execution of

an order is automatic once it has been

transmitted into the systems.110 Because the

design of these systems ensures that members

do not possess any special or unique trading

advantages in handling their orders after

transmitting them to the exchange floors, the

Commission has stated that executions

obtained through these systems satisfy the

independent execution requirement of Rule

11a2–2(T).111 This principle is directly

applicable to ArcaEx; the design of ArcaEx

ensures that ETP Holders do not have any

special or unique trading advantages in

handling their orders after transmission.

Accordingly, an ETP Holder effecting a

transaction by utilizing ArcaEx satisfies the

requirement for execution through an

unaffiliated member.

4. Non-Retention of Compensation for

Discretionary Accounts

Finally, the exemption in Rule 11a2–2(T)

states that, in the case of a transaction

effected for an account for which the

initiating member exercises investment

discretion, in general, the member may not

retain compensation for effecting the

transaction. As a prerequisite to use of

ArcaEx, if an ETP Holder is to rely on Rule

11a2–2(T) for a managed account transaction,

the ETP Holder must comply with the

limitations on compensation as set forth in

paragraph (a)(2)(iv) of the ‘‘effect versus

execute’’ rule.

C. Conclusion

In sum, ArcaEx is designed to, and does,

comply with the letter and spirit of Section

11(a) of the Exchange Act.

Appendix C—ArcaEx Discretionary

Orders Comply With Rule 11Ac1–1 and

Foster the Goals of the Exchange Act

A. Background

In its rule filing, the PCX has proposed the

use of discretionary orders on ArcaEx. A

discretionary order is defined as ‘‘an order to

buy or sell a stated amount of a security at

a specified, undisplayed price (the

‘discretionary price’), in addition to, at a

specified, displayed price (‘displayed

price’).’’ 112 For all non-marketable

discretionary orders, the discretionary order

will be displayed to all Users at the displayed

price. No Users will see the discretionary

price of the orders. An undisplayed,

discretionary price order will be afforded

price priority in the Arca Book, but not time

priority relative to displayed orders.113

B. Discussion

1. Discretionary Orders Comply With the

Firm Quote Rule

Rule 11Ac1–1 under the Securities

Exchange Act (‘‘Exchange Act’’), the so-called

‘‘Quote Rule,’’ mandates national securities

exchanges, subject to certain exceptions, to

collect and disseminate ‘‘best bids’’ and ‘‘best

offers’’ from a ‘‘responsible broker or

dealer.’’114 ArcaEx’s treatment of

discretionary orders complies with the

requirements of the Rule.

a. The Discretionary Price of a Discretionary

Order is Not Communicated to Other Market

Participants

An important attribute of a bid or offer

subject to the Quote Rule is that it represents

the ‘‘bid price and the offer price

communicated by an exchange member or

OTC market maker to any broker or dealer,

or to any customer.’’115 Accordingly, ‘‘[i]n

order to constitute a bid or offer, the

underlying trading interest must have been

communicated to at least one potential

counterparty. Bids and offers are intended to

attract other parties to deal with the person

publishing the bid or offer.’’116 For example,

in the Order Handling Release, the

Commission deemed the entry of priced

orders into an electronic communications

network (‘‘ECN’’) to be bids and offers where

these orders were widely disseminated.117

Such priced orders are subject to the Quote

Rule because, just like market maker or

specialist quotations, they are ‘‘entered to

elicit other buying and selling interest.’’118

Applying this logic, the Commission

concluded that OptiMark Profiles were not

bids or offers because only OptiMark was

Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices 23307

119PCX OpitMark Release at 50046. 120As the Commission has stated repeatedly, the

Quote Rule is premised on the notion of a bid or

offer at one specified price and one specified size.

See, e.g., Securities Exchange Act Release No.

35030 (Nov. 30, 1994), 59 FR 63141, 63145 (1994). 121Rule 11Ac1–1(a)(4) under the Securities

Exchange Act. 122For a description of CAP orders, see, e.g.,

NYSE Rules 13 and 123A.

123See, e.g., OptiMark Release at 50046.

124This may be especially true for indications of

interest expressed by those who do not constitute

‘‘members’’ or ‘‘responsible broker-dealers’’ within

the meaning of the Quote Rule. See Order Handling

Release at 48311, n. 248.

125See Order Handling Release at 48290.

126See Announcement of Written Requests Sent

to Registered National Securities Exchanges

concerning Availability of Quotation Information,

Securities Exchange Act Release No. 11288, 40 FR

15015 (1975).

127See OpitMark Release at 50046.

128 Id.

129See Securities Exchange Act Release No.

40760 (Dec. 8, 1998), 63 FR 70844, 70866 (Dec. 22,

1998) (‘‘ATS Release’’).

130See Rule 301(b)(3) under the Exchange Act

(‘‘An [ATS] shall comply with the requirements set

forth in paragraph (b)(3)(ii) of this section, with

respect to any covered security in which the [ATS]:

(A) displays subscriber orders to any person (other

than [ATS] employees’’).

131S. Rep. No. 75, 94th Cong., 1st Sess. 8 (1975)

at 101.

132See ATS Release at 70844.

133See NNMS Release at 3995 (reserve orders

‘‘allow market makers quoting in Nasdaq to

compete more effectively with alternative trading

systems that provide a reserve size feature’’).

134 In fact, ATS meets the definition of an

exchange, but need not register as such, provided

it complies with Regulation ATS. See Rule 3a1–

1(a)(2) under the Exchange Act.

135See generally ATS Release.

136The use of discretionary orders will help to

further the national market system goal of fostering

‘‘an opportunity for investors’ orders to be executed

without the participation of a dealer.’’ See Section

11A(a)(1)(C)(v) of the Securities Exchange Act. See

also PCX OptiMark Release at 50046 (approving

OptiMark, in part, because it ‘‘would increase the

ability of investors’ orders to interact directly with

other investor orders on the PCX’’).

137Securities Exchange Act Release No. 43084

(July 28, 2000), 65 FR 48406, 48407 (Aug. 8, 2000)

(‘‘Disclosure of Order Routing and Execution

Practices Release’’).

138See, e.g., Securities Exchange Act Release No.

42344 (Jan 14, 2000), 65 FR 3987, 3995 (Jan. 25,

2000) (‘‘Increased participation in NNMSS [as a

result of the attractiveness of reserve orders for large

investors] should enhance the depth and liquidity

of the market for NNM securities, to the benefit of

all market participants’’).

139See, e.g., ATS Release at 70867; PCXx

OptiMark Release at 50046 (‘‘contrary to the NYSE’s

assertion, the [PCX] is not operating a hidden

market in violation of the Firm Quote Rule’’).

‘‘aware of the potential trading interest until

the trade occurs.’’119

With discretionary orders on ArcaEx, the

discretionary price of a discretionary order is

not communicated to any Users of the

system. Only ArcaEx is aware of the full

potential trading interest of these

discretionary orders until trades occur.

Accordingly, because ArcaEx does not

publish the discretionary aspect of these

discretionary orders, they should not be

deemed to be a ‘‘bid or offer’’ within the

meaning of the Quote Rule.

b. Discretionary Orders Represent a More

Complex Trading Interest Than Traditional

‘‘Bids’’ or ‘‘Offers’’

Discretionary orders allow the investor to

express a more complex—and more

accurate—trading interest than the single

price and size of a conventional order.120

Unlike ‘‘bids’’ and ‘‘offers,’’ discretionary

orders reflect the fact that there is usually

more than one price at which an investor is

willing to buy or sell. Because these

discretionary orders represent a qualitatively

different set of information from the

traditional price and size information, they

are more analogous to indications of interest,

than bids and offers. Therefore, like

indications of interest, discretionary orders

should be excluded from the requirements of

the Quote Rule.121 The Commission reached

a similar conclusion in its analysis of

OptiMark Profiles, finding that ‘‘Profiles are

analogous to indications of interest or CAP

orders,122 neither of which are displayed in

exchanges or on Nasdaq.’’123 Therefore, the

inchoate trading interest of discretionary

orders should not be treated as a bid or offer

under the Quote Rule.124

c. Inclusion of Discretionary Orders Would

Impair the Existing Quote Information

Because the discretionary orders represent

a more complex expression of trading

preferences than traditional orders, any

attempt to include them in the public

quotation stream would undermine the

Commission’s efforts to improve the ‘‘quality

of published quotations, competition and

price efficiency.’’125 The Commission has

long recognized that ‘‘quotation information

is of significant value to the marketplace as

a whole insofar as a quotation reflects the

considered judgment of a market professional

as to various factors affecting the market,

including the current price levels and size of

buying and selling interest.’’126 Because the

discretionary orders do not represent any

‘‘current’’ market judgment as to a particular

transaction price or size, the investing public

at large would be misled and confused by its

inclusion in public quotations.127

Furthermore, the Commission has previously

stated that the dissemination of contingent

trading interest, like discretionary orders,

‘‘would likely be very difficult’’ and ‘‘could

create confusion for investors.’’128

2. The Commission Has Approved the Use of

Similar Orders in Other Contexts

a. Exchanges Must Be Allowed To Compete

on Equal Footing With Alternative Trading

Systems

In adopting Regulation ATS, the

Commission expressly recognized the value

of conditional orders and specifically

allowed ATSs to continue using reserve size

orders, negotiation features and other similar

conditional orders.129 Specifically, under

Rule 301(b)(3), if a portion of a subscriber’s

order is not displayed to others, that

undisplayed portion is not subject to the

public display requirements in Rule

301(b)(3).130

Because a fundamental goal of the national

market system is to ‘‘achieve a market

characterized by*** fair competition,’’131

the Commission previously has recognized

the importance of facilitating

‘‘opportunit[ies] for registered exchanges to

better compete with alternative trading

systems.’’132 Therefore, the Commission

should not prohibit a registered exchange’s

use of these order types when it allows an

ATS to use them.133 Such an unnecessary

prohibition creates an unlevel playing field

between exchanges and ATSs—two trading

venues which are considered true

competitors in today’s markets134—in

opposition to the national market system

goals.135

b. ArcaEx’s Discretionary Orders

Electronically Perform the Same Function as

Provided Manually in Today’s Trading

Environment

In a traditional floor trading environment,

broker-dealers enjoy the discretion to ‘‘work’’

an order to ensure that the customer receives

the best price for the trade. This special

handling permits the broker-dealer to

respond to the ever-changing state of the

market. For example, a broker may represent

a customer’s trading interest at one price,

given the state of the current market, but be

prepared to offer the trade at a different price

if the market moves. To provide an effective

trading platform, ArcaEx must be permitted

to provide an electronic mechanism which

replicates some of these value-added

activities of market intermediaries. Therefore,

ArcaEx has designed the discretionary

orders. This order type allows an aspect of

the order to respond to the dynamic trading

environment without the need for manual

order handling.136

3. Discretionary Orders Benefit Investors in

an Electronic Environment

a. Discretionary Orders Enhance Liquidity

The Commission has emphasized that one

of its goals as a regulator is to provide ‘‘the

deepest, most liquid markets possible’’ and to

‘‘minimize short-term price volatility.’’137

Discretionary orders can help the

Commission reach this goal. By providing

investors with greater flexibility in the

handling of their orders, the discretionary

orders will encourage greater investor

participation on the PCX, which, in turn, will

increase the depth and liquidity of the

securities markets.138 For example, the

discretionary orders allow a certain amount

of anonymity for a trade—something which

may be very attractive to various segments of

the market which would otherwise be

disinclined to trade on ArcaEx. Therefore,

the introduction of the discretionary order is

likely to attract new market participants, both

retail and institutional, thereby enhancing

liquidity through increased order flow to

ArcaEx.

b. Discretionary Orders Facilitate Investor

Protection

In the past, the Commission has rejected

claims that the use of conditional order types

in electronic trading environments create a

hidden market to the detriment of

investors.139 The Commission has concluded

that ‘‘when orders are not displayed to

23308 Federal Register / Vol. 66, No. 89 / Tuesday, May 8, 2001 / Notices

140See ATS Release at 70867.

141See, e.g., PCX OptiMark Release at 50046

(‘‘The failure to disseminate Profile does not

provide any other market participant with an unfair

market advantage as a result of seeing the trading

interest that is not shown to others. Any User only

knows its own Profile; it has no special access to

other Users’ Profiles. Moreover, Users have no

control or influence in determining the outcome of

a match, other than through the construction of

their own Profiles.’’)

142See Proposed PCXE Rule 7.36.

143See Proposed PCXE Rule 7.37.

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3The Phlx defines a Top 120 Option as one of the

120 most actively traded equity options nationwide

during a six-month measuring period. The Phlx

revises its list of the Top 120 Options every six

months using data that the Options Clearing

Corporations provides.

4The transactions in Top 120 Options that are

currently excepted from the $1.00 fee are

transactions between: (1) A specialist and an ROT;

(2) an ROT and an ROT; (3) a specialist and a firm;

(4) an ROT and a firm; (5) a specialist and a brokerdealer; and (6) and ROT and and a broker-dealer.

See Securities Exchange Act Release Nos. 43177

(Aug. 18, 2000), 65 FR 51889 (Aug. 25, 2000) (SR–

Phlx–00–77); 43480 (Oct. 25, 2000), 65 FR 66275

(Nov. 3, 2000) (SR–Phlx–00–86 and SR–Phlx–00–

87); and 43481 (Oct. 25, 2000), 65 FR 66277 (Nov.

3, 2000) (SR–Phlx–00–88 and SR–Phlx–00–89),

5See Securities Exchange Act Release Nos. 43921

(February 2, 20001), 66 FR 9739 (Feb. 9, 2001) (SR–

Phlx–00–107) (amending Phlx rules to create listing

criteria and trading rules to allow the Phlx to list

QQQ options); 44054 (Mar. 8, 2001), 66 FR 15314

(Mar. 16, 2001) (SR–Phlx–01–31) (increasing the

automatic execution guarantee for QQQ options to

100 contracts); and 44055 (March 8, 2001), 66 FR

15310 (Mar. 16, 2001) (SR–Phlx–01–32) (amending

Phlx rules to create a one-point strike price interval

for QQQ options and establishing the hours of

trading for QQQ options).

6 15 U.S.C. 78f(b).

7 15 U.S.C. 78f(b)(4) and (5).

anyone, the Commission’s concerns about a

two-tiered market—where some market

participants have information others do not—

are absent.’’140

ArcaEx’s discretionary orders will not

provide any market participant with an

unfair trading advantage.141 All Users will

see the same orders ranked in the Arca Book,

i.e., ArcaEx will display to all User those

orders which are displayed in the Limit

Order Process of the Arca Book, but not the

working orders in the Working Order

Process.142 No Users will have special access

to trading interest that is not available to

others on ArcaEx. All Users have the

equivalent opportunity to receive fills based

on both displayed and undisplayed orders.

Furthermore, no Users will be able to control

or influence the trades resulting from

conditional trading interest; the trades will

only be executed pursuant to an established

algorithm.143 Therefore, discretionary orders

fail to hurt investors in any way; they only

provide benefits to the marketplace, as

discussed in detail above.

C. Conclusion

Discretionary orders comply with Rule

11Ac1–1. Moreover, not only do such orders

not present any potential for investor harm,

they affirmatively will benefit both investor

and market liquidity.

[FR Doc. 01–11472 Filed 5–7–01; 8:45 am]

BILLING CODE 8010–01–U

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–44237; File No. SR–PHLX–

2001–43]

Self-Regulatory Organizations; Notice

of Filing and Immediate Effectiveness

of Proposed Rule Change by the

Philadelphia Stock Exchange, Inc.

Adding QQQ Options to the

Exchange’s List of the Top 120 Equity

Options

April 30, 2001.

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 March 30,

2001, the Philadelphia Stock Exchange,

Inc. (‘‘Phlx’’) filed with the Securities

and Exchange Commission the proposed

rule change as described in Items I, II,

and III below, which Items the Phlx has

prepared. The Commission is

publishing this notice to solicit

comments on the proposed rule change

from interested persons.

I. Self-Regulatory Organization’s

Statement of the Terms of Substance of

the Proposed Rule Change

The Phlx proposes to revise its list of

the Top 120 Options 3 by adding options

on Units of Beneficial Interest in the

Nasdaq-100 Trust, Series 1, which are

widely known as and traded under the

symbol ‘‘QQQ’’. Options on the QQQ

index will be added to the Phlx’s list of

the Top 120 Options effective April 2,

2001, and will include trades that settle

on that date.

All of the options on the Phlx’s list of

Top 120 Options are included in the

Phlx’s payment for order flow program,

in which a marketing fee (currently

$1.00) is imposed on the transactions of

specialists and ROTs, which the

specialists may use to attract order flow

to Phlx. QQQ options will be included

in the marketing fee program once they

are added to the list of Top 120 Options.

The inclusion of QQQ options on the

list means that there will be 121 Options

on the Phlx’s list of the Top 120 options

through June 30, 2001, when the current

measuring period ends.

II. Self-Regulatory Organization’s

Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule

Change

In its filing with the Commission, the

Phlx included statements concerning

the purpose of and basis for the

proposed rule change and discussed any

comments it received on the proposed

rule change. The text of these statements

may be examined at the places specified

in Item IV below. The Phlx has prepared

summaries, set forth in Sections A, B,

and C below, or the most significant

aspects of such statements.

A. Self-Regulatory Organization’s

Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule

Change

1. Purpose

The purpose of the proposed rule

change is add QQQ options to the Phlx’s

list of the Top 120 Options. The list of

the Top 120 Options identifies the 120

most actively traded equity options as

measured by their trading volume on all

U.S. options markets. The list of Top

120 Options is recalculated every six

months, with the measuring periods

running from January 1 through June 30

and from June 1 through November 30.

The Phlx assembled its current list of

Top 120 Options using data that the

Options Clearing Corporation gathered

during the period from June 1, 2000

through November 30, 2000.

The Phlx currently imposes a $1.00

per contract fee on transactions of Phlx

specialists and Registered Options

Traders (‘‘ROTs’’) in the Top 120

Options, with some exceptions.4 Under

the program, Phlx specialists may use

the proceeds raised from the marketing

fee to attract order flow to the Phlx.

Because options on the QQQ index are

now traded on the Phlx,5 the Phlx is

proposing to add QQQ options to its list

of the Top 120 Options during the

current measuring period. Accordingly,

from April 2, 2001, the effective date of

this proposal, through June 30, 2001, the

end of the current measuring period,

there will be a total of 121 options on

the Phlx’s list of the Top 120 Options.

2. Statutory Basis

The inclusion of QQQ options on the

Phlx’s list of the Top 120 Options would

bring QQQ options into the Phlx’s

payment for order flow program. The

Phlx believes that the QQQ specialist

unit and the ROTs who pay the $1.00

marketing fee should receive the

benefits of increase order flow, and that

the proposed rule change would

equitably allocate reasonable fees among

the Phlx’s members. Accordingly, the

Phlx—believes that the proposal is

consistent with Section 6(b) of the Act,6

and in particular furthers the objectives

of Sections 6(b)(4) and 6(b)(5) of the

Act.7 Moreover, the Phlx believes that

the inclusion of QQQ options in its list

of Top 120 Options, and the