[Federal Register Volume 66, Number 97 (Friday, May 18, 2001)]
[Notices]
[Pages 27715-27720]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-12543]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44292; File No. SR-Phlx-2001-49]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by the Philadelphia Stock 
Exchange, Inc. Adopting a Monthly Credit of up to $1,000 to Qualified 
Members for an Aggregate Period of 36 Months

May 11, 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 April 24, 2001, the Philadelphia Stock Exchange, Inc. (``Phlx'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II, and III, below, which Items have been prepared by the 
Exchange. The Commission is publishing this notice to solicit comments 
on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Phlx, pursuant to Rule 19b-4 under the Act, proposes to adopt 
for an aggregate period of 36 months (``permanently adopt'') \3\ its 
current pilot program that allows a monthly credit of up to $1,000 to 
be applied against fees, dues, charges and other amounts as may from 
time to time be owed to the Exchange that month (collectively referred 
to as ``credit-eligible fees'') \4\, except fines, late fees, out-of-
pocket expenses,\5\ pass-through costs,\6\ capital funding fees,\7\ 
payment for order flow fees,\8\ any fees paid by equity trading permit 
holders respecting any trading permits the Exchange may issue, the fee 
for electronic communications networks,\9\ and the fee for the print 
subscription of the Phlx Guide \10\ by members who own the membership 
by which they are a member (``member-owners'') and certain other 
categories of members described below. The Exchange's current pilot 
program \11\ is in effect through May 16, 2001.
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    \3\ This total period of 36 months includes the time period that 
the previous pilot programs were in effect. The first pilot program 
became effective upon filing on May 16, 2000 and lasted six months, 
expiring on November 16, 2000. See Securities Exchange Act Release 
No. 42791 (May 16, 2000), 65 FR 33606 (May 24, 2000) (SR-Phix-00-
44). The pilot program was then extended for an additional six-month 
period through May 16, 2001. See Securities Exchange Act Release No. 
43567 (November 15, 2000), 65 FR 71187 (November 29, 2000) (SR-Phlx-
00-100). Therefore, the credit program will be in effect from May 
16, 2000 until May 16, 2003.
    \4\ The credit-eligible fees are fees assessed on members and 
include transaction as well as trading floor fees. Transaction fees 
include equity transaction value charges, equity floor brokerage 
transaction fees, option comparison charges and option transaction 
charges. Trading floor fees include charges for trading post/booth, 
controller space, shelf space, transmission, execution/communication 
charge and floor facility fees. Fees assessed on foreign currency 
options participants are not considered credit-eligible fees.
    \5\ Out-of-pocket expenses include charges for wireless 
telephone services, postage, ILX machines and Dow Jones News 
Service.
    \6\ Pass-through costs include charges for member health 
insurance and parcel delivery services.
    \7\ Capital funding fees are those fees assessed on owners to 
provide for funding for technological improvements and other capital 
needs. On June 29, 2000, the Commission permanently approved the 
capital funding fee. See Securities Exchange Act Release No. 4 2993 
(June 29, 2000) 65 FR 42415 (July 10, 2000) (SR-Phlx-99-510.
    \8\ Payment for order flow fees are those fees imposed on 
transactions by Phlx specialists and Registered Options Traders in 
the Top 120 Options on the Phlx. See Securities Exchange Act Release 
Nos. 43177 (August 18, 2000), 65 FR 51889 (August 25, 2000) (SR-
Phlx-00-77); 43480 (October 25, 2000), 65 FR 66275 (November 3, 
2000) (SR-Phlx-00-86 and SR-Phlx-00-87); 43481 (October 25, 2000), 
65 FR 66277 (November 3, 2000) (SR-Phlx-00-88 and SR-Phlx-00-89); 
and 44237 (April 30, 2001) (SR-Phlx-01-43).
    \9\ An ECN fee is currently a $2,500 monthly fee, imposed on a 
one-year pilot basis, for ECNs that are member organizations and 
send order flow to the Exchange's equity trading floor. See 
Securities Exchange Act Release No. 44155 (April 5, 2001), 66 FR 
19274 (April 13, 2001) (SR-Phlx-01-09).
    \10\ See Securities Exchange Act Release No. 44198 (April 18, 
2001), 66 FR 21035 (April 26, 2001) SR-Phlx-2001-47).
    \11\ See Securities Exchange Act Release No. 43567 (November 15, 
2000), 65 FR 71187 (November 29, 2000) (SR-Phlx-00-100). This credit 
is part of the Exchange's long-term financing plan, which separately 
includes a $1,500 capital funding fee. See supra note 7. The 
Exchange reserves the right to suspend the credit at any time.
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    In addition to member-owners, a monthly credit of up to $1,000 may 
be applied against credit-eligible fees incurred by the following 
persons, who are so closely connected to the owners that the Exchange 
believes they should be treated as member-owners: (1) all members who 
are parties to an A-B-C Agreement \12\ with a member organization who 
owns that membership; or (2) all members who are lessees if: (a) the 
member is also an owner of a different membership; (b) the member is an 
immediate family member of the owner of that membership; \13\ (c) the 
member is associated with a member organization in which the owner of 
that membership has an interest of at least ten percent; (d) the member 
leases from an owner or a related entity of the owner who provides 
order flow to the Exchange through the member or member organization 
consisting of at least 5,000 equity trades over the preceding twelve 
months or 50,000 option contracts over the preceding twelve months; or 
(e) the member leases from a clearing firm or a related entity of the 
clearing firm that provides clearing services to the leasing member. 
The aforementioned categories

[[Page 27716]]

(including member-owners) are hereinafter referred to as ``qualified 
members.''
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    \12\ Pursuant to Phlx Rule 940, the parties to an A-B-C 
Agreement are an employee, general partner, or officer and the 
member organization with which such person is associated. The member 
organization provides all or part of the funds for the purchase of a 
membership of which the legal title is placed in the member and the 
equitable title is placed in the member organization.
    \13\ Immediate family member is defined as a member's spouse, 
parents, stepmother, stepfather, mother-in-law, father-in-law, 
brothers, sons-in-law, brothers-in-law, stepbrothers, sisters, 
daughters-in law, sisters-in-law, stepsisters, children, 
stepchildren or any other person living with the member for whom the 
member provides at least 50 percent of his/her financial support per 
year.
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    Specifically, the amount of credit-eligible fees owed to the 
Exchange shall be reduced on a monthly basis by an amount equal to: (1) 
$1,000 per month if such fees, dues, charges and other amounts are 
equal to or greater than $1,000, or (2) the amount of such fees, dues 
charges and other amounts if such fees, dues, charges and other amounts 
are less than $1,000.\14\ Credits may not be carried over from one 
month to the next and only one credit of up to $1,000 is available per 
membership per month.
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    \14\ For example, if a member has $1,500 in credit-eligible fees 
for the month, such member is entitled to the full $1,000 credit. 
However, if the member has $600 in credit-eligible fees for the 
month, such member is entitled to a $600 credit.
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    Credits cannot be shared among members, except qualified member(s) 
in the same member organization may aggregate their credit(s). The 
monthly credit of up to $1,000 will be applied against the invoice of 
the member or member organization with which the member is associated. 
However, in no event shall the aggregated credit(s) exceed $1,000 per 
membership per month.
    Initially, any request to receive the credit was application 
driven, with each applicant submitting an Exchange form delineating the 
credit-eligible fees for that calendar month. To reduce the burden on 
members, the Exchange may now include the amount of the credit directly 
on a member's invoice, once it has been established that the member is 
eligible for the credit, in lieu of the member completing a credit form 
each month.\15\ A member's eligibility shall be determined by the 
opening of trading on the first business day of each month. The 
Exchange reserves the rights to suspend the credit at any time.
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    \15\ The Exchange believes, at this time placing the amount of 
credit on a member's invoice should reduce the burdens associated 
with completing the credit form each month. However, the Exchange 
may revert to the credit form application process at a later date if 
it is determined that credits are more efficiently processed that 
way. If any changes are made to the credit form process, members wil 
be given updated instructions as to how to apply for the credit.
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II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

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

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

1. Purpose
a. Introduction. The purpose of the proposed rule change is to amend 
the Exchange's schedule of fees, dues, and charges to allow for a 
monthly credit of up to $1,000 to be applied against certain fees, 
dues, charges and other amounts, as defined above, owed to the Exchange 
by a qualified member of the Exchange.
    As more fully explained below, the Exchange believes that the 
proposed credit should provide qualified members with additional 
liquidity and an incentive for seat owners to trade on the Exchange. In 
turn, the Exchange believes that this will introduce additional 
liquidity into the marketplace to the benefit of the investing public.
    The Exchange believes that leasing of memberships by passive 
holders of equitable title to leasees who trade on the Exchange (e.g., 
members) does not necessarily promote the long-term interests of the 
Exchange. Although the practice of leasing by financial investors to 
members is permitted by the rules of the Exchange, and may provide an 
important means by which members can access trading rights on the 
Exchange, the Exchange believes that lessors who are passsive finanical 
investors have a limited stake and interest in the liquidity, 
technology or operations of the Exchange.
    Moreover, such lessors have limited practical ability to influence 
the affairs of the Exchange, because practically all voting rights are 
vested in ``members'' under Phlx's Certificate of Incorporation and By-
Laws.\16\
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    \16\ A lessor is entitled to vote in any decision relating to a 
compromise or arrangement between the Phlx and its creditors or its 
members, or relating to a reorganization of the Phlx. See e.g. 
Article Thirteenth of the Exchange's Certificate of Incorporation 
and Phlx By-Law Art. XII, Section 12-6.
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    The Exchange also believes that members who acquire membership and 
access trading on the Exchange by means of a lease may in many cases 
have a very limited stake in the well-being and survival of the 
Exchange. Although such members may have voting rights, they have no 
capital investment in their membership, and, because leases typically 
may be terminated on 30 days notice,\17\ they do not necessarily have 
the incentive to act in the long-term best interests of the Exchange.
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    \17\ See Phlx Rule 930(b).
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    Specifically, by terminating a lease with 30 days notice, lessees 
who do not have ``other'' business interests or relationships with the 
Exchange beyond the mere existence of a lease (such as those 
relationships enumerated in part b. below) may, and often do, leave the 
Exchange to trade on another exchange, perhaps seeking to trade a 
certain ``hot'' option or other product. Thus, their potential 
commitment to the Exchange's long-term well-being and survival is 
undercut by their easy ability to pursue business endeavors that 
further their own well-being. Further, although member-lessees may be 
appointed to certain Exchange committees and sub-committees, their 
motivation to devote the time to such service may be less, as is their 
incentive to make decisions focused on the long-term. Both daily and 
longer term, strategic decision-making could thus be affected.
    This short-term commitment may also bear on the quality and 
quantity of liquidity provide don the Exchange. Building order flow 
commitments with order flow providers is a long-term endeavor, often 
requiring regular performance, evaluation, and most importantly, a 
relationship with the trading crowd providing liquidity. Thus, 
familiarity and consistency of crowd participation are an important 
marketing mechanism to order flow providers. Providing liquidity also 
involves a longer-term view of sacrificing profit today for continued 
order flow, as well as acknowledging that not every order is a 
profitable one, but continuous order flow, spawned by ample liquidity, 
should, over time, provide more opportunity for additional order flow.
    Lessees that do not have other business interests or relationships 
(such as those referred to in part b. below) may also have a limited 
stake in the technology of the Exchange, including participation in and 
good use of technology, nor would they necessarily have an incentive to 
invest in the longer-term development of that technology. Such 
investment is not only financial, but also strategic. Such lessees may 
also have a limited stake in the operations of the Exchange, including 
the continued long-term refinement and upgrading of facilities, other 
equipment and the pricing of such operations. In sum, lessees, absent 
other factors tying them to the Exchange, may be less vested in the 
long-term success of the

[[Page 27717]]

Exchange, in terms of a lesser inventive to create liquidity,invest in 
technology and be active in strategic and daily decision-making.
    In contrast, the Exchange is of the view that members who own their 
own memberships (and their functional equivalents, such as members who 
lease their memberships from close family members), and members who 
have certain other business or financial relationships with owners who 
are active on the Exchange (e.g., members who are associated with 
member organizations and hold their memberships pursuant to ``A-B-C 
Agreements'') have a combination of financial incentives and voting 
rights (in some cases, indirectly via the owners with whom they are 
closely related or associated) to create liquidity on the Exchange, to 
invest in systems and compliance infrastructure, to be active in and 
informed about the decision-making processes of the Exchange, and 
otherwise to act in the Exchange's long-term best interests. By 
providing the credit described in this filing to these groups of 
members, the Exchange expects to create economic incentives for owners 
to trade on the Exchange by actively using their memberships (or 
selling them to persons who would do so) and for members to organize 
their affairs in ways that, in the Exchange's view, properly align the 
interests of the members with the long-term interests of the Exchange. 
The Exchange also believes that the credit should help retain or create 
liquidity on the Exchange by freeing up funds that member-owners or 
their functional equivalents may otherwise be expending on credit-
eligible fees.\18\
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    \18\ The Exchange notes that, as part of its overall strategic 
financing plan, contemporaneously with the implementation of the 
credit described in this filing, it separately instituted a $1,500 
monthly capital funding fee upon all ``owners,'' regardless of their 
level of activity (if any) on the Exchange. See supra note 7. 
Although the credit is not available to offset all or any portion of 
the capital funding fee, the credit will enable member-owners and 
others eligible for the credit to defray a portion of the 
transaction and other fees charged by the Exchange (that, in 
general, result from member activity on the Exchange), thereby 
effectively reducing, for member-owners and other eligible members 
the cost of trading on the Exchange. Therefore, the credit may also 
have the indirect effect of blunting the incremental economic burden 
of the capital funding fee for owners who are active and, directly 
or indirectly, trading on (or otherwise providing certain economic 
benefits to) the Exchange. In addition, the credit frees up funds 
for trading activity on the Exchange that would otherwise be used 
for the payment of credit-eligible Exchange fees.
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    Although the credit described in this filing is available to some 
Exchange members and not others, it meets the criteria set forth in 
Sections 6(b)(4) \19\ and 6(b)(5) \20\ of the Act because it: (i) 
provides for ``* * * the equitable allocation of dues, fees and other 
charges among its members * * *  and other persons using its 
facilities;'' and (ii) is not designed ``* * * to permit unfair 
discrimination between customers, issuers, brokers or dealers.'' 
Although the Exchange is not aware of precedent sin which other 
exchanges have established fee or credit programs based upon ownership 
of seats or the connection between lessees and their lessors, as the 
Phlx proposes to adopt in this filing, the Commission has approved many 
exchange fee and credit arrangements that do not treat all members (or 
other persons covered by Sections 6(b)(4) \21\ and (5)) \22\ equally, 
such as credits and discounts based on transaction volume, fees based 
upon the usage by certain members of equipment or other services or 
resources of an exchange, and fee structures that distinguish among the 
various activities of persons and firms (e.g., specialists versus floor 
brokers, or specialists versus market makers). As with the credit, such 
measures are designed to promote and encourage certain behaviors and/or 
discourage others. The Exchange believes that this is an appropriate, 
nondiscriminatory business strategy.
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    \19\ 15 U.S.C. 78f(b)(4).
    \20\ 15 U.S.C. 78f(b)(5).
    \21\ 15 U.S.C. 78f(b)(4).
    \22\ 15 U.S.C. 78f(b)(5).
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    As more fully articulated below, the Exchange believes that the 
credit is equitably distributed and not unfairly discriminatory, 
because it is based on legitimate, reasonable business interests of the 
Exchange, and is reasonably designed to further those interests. 
Moreover, it does not unfairly single out individuals or groups for 
personal or political reasons. To the contrary, any member may become 
eligible for the credit by changing the way in which such member 
finances his or her access to the Exchange by purchasing the membership 
or by changing the member's lease arrangement.
    b. More Detailed Rationale Specifically Applied to the Various 
Eligibility Criteria. i. Member-Owners. In many areas of economic life, 
businesses and governments establish incentives to encourage behavior 
that is deemed desirable. In the case of exchanges, volume discounts 
and credits encourage members to direct transaction volume and trading 
activity to the exchange; other fee structures are designed to deter 
excessive usage of exchange resources or to cause scarce resources to 
be allocated more efficiently (e.g., equipment service fees or fees 
relating to use of post/booth space on the floor).\23\ The Exchange, as 
a matter of policy, believes that owner-membership or its functional 
equivalents as described above, should be encouraged because:
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    \23\ See e.g., Securities Exchange Act Release Nos. 41748 
(August 16, 1999), 64 FR 46218 (August 24, 1999) (SR-CBOE-99-34); 
40496 (September 29, 1998), 63 FR 54175 (October 8, 1998) (SR-PCX-
98-42); and 41108 (February 25, 1999), 64 FR 10516 (March 4, 1999) 
(SR-BSE-99-2).
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    (A) Unlike passive, financial investors, owner-members risk their 
capital by their trading and other activities on the floor, thereby (in 
many cases) creating liquidity in our market and generating revenues 
for the Exchange, both directly through transaction-based revenues, and 
indirectly, by generating activity that results in tape revenues, such 
as under the Consolidated Tape Association (``CTA'') and Options Price 
Reporting Authority (``OPRA'') plans.\24\
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    \24\ The CTA Plan and the OPRA Plan are approved by the 
Commission as national market system plans under Exchange Act Rule 
11Aa3-2, 17 CFR 240.11Aa3-2, governing the dissemination of market 
information for certain equity securities and options, respectively; 
these plans govern both the fees that can be charged for such 
information as well as the distribution of revenues derived from 
those fees among participants in these plans, including the 
Exchange.
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    Seat ownership is one aspect of Exchange ``investment'' and the 
actual use of that membership by the qualified member is a different 
form. Member-owners or their functional equivalents, have additional 
operational and market risks. for example, a qualified member who is 
also a specialist or market maker may have additional risks related to 
fluctuations in the securities market and order-processing errors in 
addition to market risks associated with seat ownership. Similarly, a 
qualified member who is also a specialist may have risks (in addition 
to seat risk) associated with the specialists' obligation to promote a 
fair and orderly market and, particularly, maintain the limit order 
book. Furthermore, in addition to any fees assessed on owners, 
qualified members also contribute to the Exchange by paying transaction 
fees, such as equity transaction value charges, equity floor brokerage 
transaction fees, option comparison charges and option transaction 
charges, and trading floor fees, such as trading post/booth, controller 
space, shelf space, transmission, execution/communication charges and 
floor facility fees.
    (B) Unlike members who lease their seats under typical lease 
arrangements that may be cancelled on 30 days' notice, member-owners 
have a

[[Page 27718]]

significant capital investment at risk; and
    (C) Unlike owners that are not members, member-owners may have 
voting rights under the Exchange's by-laws, and may participate on 
certain Exchange committees.\25\
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    \25\ See supra note 16.
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    Because of their dual interest in preserving and increasing the 
value of their memberships, and in the technological, operational, and 
regulatory infrastructure that affects the present and future 
conditions of transacting business on or at the Exchange, the Exchange 
believes that member-owners have powerful incentives to create 
liquidity on the Exchange, and to participate responsibility in the 
business life of the Exchange through the exercise of voting rights, 
and through service on the Board and certain Exchange committees. The 
concept (and the underlying policy) of making the credit available to 
member-owners is not unlike that of the federal government in providing 
tax incentives to homeowners that are not available to renters. The 
long-term capital stake of the homeowner in his or her property 
promotes various behaviors that have social utility in that it fosters 
community-oriented behavior, and increases the prospect that the 
homeowner will make further socially useful investments in the property 
and in the neighborhood.
    The Exchange believes that similar principles are involved in this 
proposed rule change. The ability to lease memberships has been 
available for many years. Over time, the equitable ownership of 
memberships by passive financial investors has become a very pervasive 
phenomenon at the Exchange, with 326 of the Exchange's 505 memberships 
being owned by such financial investors.\26\ Of those memberships owned 
by passive financial investors, approximately 13 memberships are 
currently dormant (neither used for active trading nor leased).\27\ 
Although the Exchange believes that leasing of memberships has a 
legitimate role in providing members a means of accessing trading 
rights on the Exchange, it also believes that the extent to which long-
term capital investment is currently divorced from voting rights and 
trading interest is not healthy insofar as it relates to the long-term 
viability of the institution and its membership as a whole. The credit 
should create an incentive for owners to actively use their trading 
rights through membership and for members to reconsider the manner in 
which they finance their access to the Exchange. Furthermore, the 
Exchange believes that the credit will free up funds for those owners 
who are most likely to put their capital to work by trading and 
creating liquidity on the floor. The credit may also effectively (but 
indirectly) lessen the overall impact of the capital funding fee on 
those owners who are trading at the Exchange and (because the credit 
may be applied against transactional fees) create further incentives to 
trade.
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    \26\ As of March 31, 2001, 326 memberships were subject to lease 
agreements. This number may change on a monthly basis.
    \27\ As of March 31, 2001, 13 seats were dormant (neither used 
for active trading nor leased).
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    The Exchange notes that no member may claim that his or her lack of 
eligibility for the credit is unfair or discriminatory. Any member may 
obtain eligibility for the credit by changing his or her method of 
financing their access to the Exchange--e.g., by purchasing their 
membership and (if they choose) borrowing from third-party lenders to 
effect that purchase. Any owner may obtain eligibility for the credit 
by, for instance, becoming an Exchange member (if they qualify for this 
and subject to the procedures set forth in the Exchange's rules).
    ii. Members/Member Organizations with A-B-C Agreements. By 
definition, with respect to A-B-C Agreements, there is a very close 
nexus between a member and the member organization with whom the member 
is associated; in general, the member is an employee of the member 
organization. This close connection is reflected in the fact that the 
member organization provides all or part of the funds for the purchase 
of the membership of which the legal title is placed in the member, 
while the equitable title remains with the member organization.\28\ In 
addition, the Exchange's By-Laws state, in part, that ``[a]n A-B-C 
Agreement is a contract between the member and member organization with 
which the member is associated in which a portion of the risk of 
fluctuations in the value of the membership shall rest with the member 
organization rather than with the member.''
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    \28\ See Phlx Rules 940 and 941.
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    Pursuant to the A-B-C Agreement, the member contributes the use of 
the membership to the member organization and subjects the membership 
to the claims of the creditors of the member organization. Moreover, 
the member organization pays the dues, fees and other charges on behalf 
of the member. Thus, given this unique business relationship, owners 
who are member organizations have significant capital investment at 
risk and have a long-term interest in preserving and increasing the 
value of their membership, much like member-owners. For this reason, 
the Exchange is providing the credit to members who are parties to an 
A-B-C Agreement with a member organization who owns that 
membership.\29\
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    \29\ See supra note 12.
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    iii. Lessees. As stated previously, although leasing arrangements 
are permitted, lessees, other than five types of qualifying members 
discussed in detail below (``non-qualifying lessees''), may have a 
limited stake in the long-term well-being of the Exchange. In fact, 
non-qualifying lessees may lack the incentive to engage in certain 
types of behavior that promote the long-term best interests of the 
Exchange, including providing liquidity and investing in technology 
enhancements. Specifically, non-qualifying lessees who do not put their 
own (or a member with whom they have a close nexus) capital at risk 
with respect to a membership may provide liquidity or order flow with 
less of a long-term view and more of a focus on their current market 
risk only. This view may be at odds with behavior needed to address 
long-term Exchange needs. These non-qualifying lessees who do not have 
the types of additional connections to owners on the Exchange described 
below, may only have the incentive to participate in a self-focused way 
for their short-term benefit. If the credit were made available to all 
lessees, it would not serve its purpose as an inducement to promote 
owner-membership or other relationships to the Exchange that the 
Exchange believes are the most conducive to its continued health and 
success. Therefore, the Exchange is not making the credit available to 
all lessees. However, the Exchange is seeking to provide the credit to 
those qualified members whose relationship with the owners from whom 
they lease their seats is such that the Exchange believes they (either 
individually or indirectly when viewed in conjunction with their 
owners) have incentives properly aligned with the long-term interests 
of the Exchange.
    (A) Members Who Are Lessees But Who Are Owners of Different 
Memberships. Members who are lessees but who also are owners of a 
different membership should be accorded the same treatment as the 
traditional member-owners who were previously discussed. These members, 
who are also owners, have an interest in preserving and increasing the 
value of their membership as well as an interest in preserving and 
increasing the standard of technology and the operational and 
regulatory infrastructure that affects the present and future 
conditions of

[[Page 27719]]

transacting business at the Exchange. As with traditional member-
owners, the Exchange believes that the credit will free up funds for 
those members who are also owners thereby encouraging them to put their 
capital to work by trading and creating liquidity on the floor. As 
previously discussed, the credit may also effectively (but indirectly) 
lessen the overall impact of the capital funding fee on those owners 
who are trading at the Exchange.
    (B) Members Who Lease From Close Family Members. At the Phlx, many 
member firms are family businesses, which choose to structure their 
operations with the owner being a relative (rather than that member) 
for tax or estate planning purposes. The Exchange believes that there 
is commonality of interest in property of close family members, thus 
affording the credit to members who lease from close family members. 
This concept is one that is widely accepted, especially in connection 
with rules relating to the securities industry and tax law. For 
example, Commission Rule 16a-1(a)(2) \30\ under the Act defines the 
term ``beneficial owner'' to mean any person who, directly or 
indirectly, through any contract, arrangement, understanding, 
relationship or otherwise, has or shares a direct or indirect pecuniary 
interest in the equity security. Indirect pecuniary interest is then 
defined to include securities held by members of a person's immediate 
family sharing the same household.\31\ In addition, Rule 701 under the 
Securities Act of 1933 (``Securities Act'') \32\ exempts from Section 5 
of the Securities Act \33\ certain offers and sales of securities under 
a written compensatory benefit plan established by the issuer for the 
participation of their employees and their family members who acquire 
such securities from such persons though gifts or domestic relations 
orders. Family members are defined in Rule 701(c)(3) \34\ the same as 
``immediate family'' is defined in Rule 16a-1(e).\35\
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    \30\ 17 CFR 240.16a-1(a)(2).
    \31\ Immediate family is defined to mean any child, stepchild, 
grandchild, parent, stepparent, grandparent, spouse, sibling, 
mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-
in-law, or sister-in-law, and shall include adoptive relationships. 
17 CFR 240.16a-1(e).
    \32\ 17 CFR 230.701.
    \33\ 15 U.S.C. 77e.
    \34\ 17 CFR 230.701(c)(3).
    \35\ 17 CFR 240.16a-1.
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    Tax laws also recognize the commonality of interest in property of 
close family members. For example, the Internal Revenue Code (``IRC'') 
recognizes the shared interests of family members by way of attributing 
the ownership of stock held by close family members to the 
taxpayer.\36\ The IRC treats stock owned by these close family members 
as owned by the taxpayer in determining the tax liability of the 
taxpayer in various situations.\37\
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    \36\ See 26 U.S.C. Section 318.
    \37\ See 26 U.S.C. Section 301 et seq.
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    A further example is the National Association of Securities 
Dealers, Inc. (``NASD'') Freeriding and Withholding Interpretation,\38\ 
which restricts sales by NASD members to accounts in which so-called 
``restricted persons'' have a beneficial interest. Such restrictions 
are also applicable, with some exceptions, to immediate family members 
of those restricted persons.
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    \38\ NASD Conduct Rule IM-2110-1. The Freeriding and Withholding 
Interpretation is based on the premise that NASD members have an 
obligation to make a bona fide distribution of securities of a 
public offering that trade at a premium in the secondary market.
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    The Exchange believes that it should not penalize members who 
choose to lease memberships from close family members, as it believes 
that these persons are the functional equivalents of member-owners, and 
the same rationale applies to giving the credit to these members as to 
member-owners.
    (C) Members who are Associated with a member Organization in which 
the Owner of That Membership has an Interest of at Least Ten Percent. 
Members who are lessees and are associated with a member organization 
in which the owner has at least a ten percent interest also should be 
eligible for the credit based on their closely aligned interests with 
the owner. The federal securities laws and rules of the securities 
industry have long recognized that a ten percent ownership interest is 
a significant capital investment. For example, Section 16 of the Act 
\39\ requires any person who is the beneficial owner of more than ten 
percent of an equity security registered under Section 12 of the Act 
\40\ to file a statement with the Commission indicating his ownership 
interest. Section 16 \41\ also treats such beneficial owners as company 
insiders and limits their ability to realize ``short swing'' profits. 
In enacting Section 16,\42\ the Congress found that a ten percent owner 
was sufficiently involved in the affairs of the issuer to be treated as 
an insider.
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    \39\ 15 U.S.C. 78p.
    \40\ 15 U.S.C. 78l.
    \41\ 15 U.S.C. 78p.
    \42\ Id.
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    Moreover, for purposes of NASD Conduct Rule 2720, which restricts 
the ability of an NASD member to participate in the distribution of a 
public offering of its own securities or the securities of the member's 
parent or affiliate, a company is presumed to control a member (and 
thus is an affiliate) if the company beneficially owns ten percent or 
more of the member firm. Finally, under the NASD's Freeriding and 
Withholding Interpretation,\43\ an individual with a ten percent or 
more equity interest in an NASD member firm is deemed restricted by 
virtue of his ownership interest, and, thus, NASD member firms may not 
sell so-called ``hot issues'' to that individual.
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    \43\ See supra note 38.
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    In each of these examples, Congress or the NASD found that a ten 
percent owner is sufficiently involved in the affairs of the subject 
entity to be subject to the applicable restriction. A similar analysis 
is applicable with respect to owners of Phlx memberships who hold a ten 
percent or greater interest in the very member organization with which 
the lessee is associated. The interests of the owner, the member lessee 
and the member organization are sufficiently aligned to allow the 
lessee member the benefit of the credit.
    (D) members who Lease from Owners or Their Affiliates who Provide 
Order Flow to the Exchange. Similar to member-owners and other eligible 
members discussed above, members who lease from owners or their 
affiliates who provide order flow to the Exchange through the member or 
member organization have a direct contractual relationship with that 
owner. For example, a floor broker who executes orders entered by the 
owner from whom the member leases his or her seat has a fiduciary 
relationship with that owner. The member derives income, by way of 
commissions, from the order floor provider and the order flow provider, 
in turn, provides revenue to the Exchange mainly by way of transaction 
fees (and indirectly via tape revenues). Giving a credit to members in 
this situation should encourage the member to fully maximize the 
business relationship between the floor broker and order flow provider 
by encouraging the member to get more order flow, which in turn equates 
to an increase in fees paid by the floor broker to the Exchange. The 
Exchange believes that by extending the credit to this category of 
members who are closely associated with the owner, it is encouraging 
behavior that is beneficial to the long-term interests of the Exchange, 
e.g., providing more order flow.
    (E) Members who Lease from a Clearing Firm or a Related Entity of 
the Clearing Firm That Provides Clearing Services to the Leasing 
Member. Members who lease from a clearing firm

[[Page 27720]]

or related entity of the clearing firm that provides clearing services 
to the leasing member should also be eligible to receive the credit. 
Members have a close connection to their clearing firms, or related 
entity of the clearing firms, in that the clearing firms provide 
important and essential services by contractual agreement with such 
members; for instance, they guarantee members' trades. In addition, 
clearing firms lend money and extend credit; they also manage risk by 
way of tracing positions and other monitoring functions. Moreover, the 
clearing firm offers various ancillary services to the members, 
including stock executions services, office space and other business 
amenities. Therefore, given this close connection between the members 
and clearing firms or their affiliates, the Exchange believes that the 
credit is appropriate and should further their joint interest in the 
well-being of the Exchange.
2. Statutory Basis
    For these reasons, the Exchange believes that the proposed rule 
change is consistent with Section 6(b) of the Act,\44\ in general, and 
with Section 6(b)(4).\45\
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    \44\ 15 U.S.C. 78f(b).
    \45\ 15 U.S.C. 78(b)(4).
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B. Self-Regulatory Organization's Statement on Burden on Competition

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

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

    No written comments were either solicited or received respecting 
the permanent adoption of the credit for 36 months.\46\
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    \46\ Written comments were received in connection with the first 
proposed rule change relating to the credit, which implemented the 
initial pilot program for the credit (in effect May 16, 2000 through 
November 16, 2000). Those comments are discussed in the Commission's 
Notice of Filing and Immediate Effectiveness of that initial pilot 
program. See Securities Exchange Act Release Act Release No. 42791 
(May 16, 2000), 65 FR 33606 (May 24, 2000)(SR-Phlx-00-44).
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III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    The Exchange has designated the proposed rule change as a fee 
change pursuant to Section 19(b)(3)(A)(ii) of the Act \47\ and Rule 
19b-4(f)(2) thereunder \48\ because it establishes a due, fee or other 
charge. Accordingly, the proposal will take effect upon filing with the 
Commission. At any time within 60 days of the filing of the proposed 
rule change, the Commission may summarily abrogate such rule change if 
it appears to the Commission that such action is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act.
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    \47\ 15 U.S.C. 78s(b)(3)(A)(ii).
    \48\ 17 CFR 240.19b-4(f)(2).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room, 450 Fifth Street NW., Washington DC 
20549. Copies of such filing will also be available for inspection and 
copying at the principal office of the Phlx. All submissions should 
refer to File No. SR-Phlx-2001-49, and should be submitted by June 8, 
2001.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\49\
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    \49\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 01-12543 Filed 5-17-01; 8:45 am]
BILLING CODE 8010-01-M