Document ID: SEC-2007-1175-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: American Stock Exchange LLC
Posted Date: 2007-08-22T04:00Z

[Federal Register: August 22, 2007 (Volume 72, Number 162)]
[Notices]               
[Page 47086-47089]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr22au07-155]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56269; File No. SR-Amex-2007-75]

 
Self-Regulatory Organizations; American Stock Exchange LLC; 
Notice of Filing and Order Granting Accelerated Approval to a Proposed 
Rule Change, as Modified by Amendments No. 1 and 2, To Establish a 
Directed Order Program

August 15, 2007.
    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 July 24, 2007, the American Stock Exchange LLC (``Amex'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I and 
II below, which Items have been substantially prepared by the Exchange. 
On July 30, 2007, the Exchange filed Amendment No. 1 to the proposed 
rule change. On August 15, 2007, the Exchange filed Amendment No. 2 to 
the proposed rule change. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons 
and is approving the proposed rule change, as amended, on an 
accelerated basis.
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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 Exchange proposes to adopt Amex Rule 996-ANTE and amend Amex 
rule 935-ANTE establishing the Exchange's Directed Order Program (the 
``Program''). The text of the proposed rule change is available on 
Exchange's Web site (http://www.amex.com), at Amex's principal office, 

and at the Commission's Public Reference Room.

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

    In its filing with the Commission, Amex 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 III below. Amex has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

[[Page 47087]]

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

1. Purpose
    The Exchange proposes to adopt rules establishing the Exchange's 
Directed Order Program (the ``Program''). Proposed Rule 996-ANTE 
provides that specialists, Registered Options Traders (``ROTs''), 
Supplemental Registered Options Traders (``SROTs''), and Remote 
Registered Options Traders (``RROTs'') (collectively, the ``Directed 
Order Participants'') \3\ may choose to enter into arrangements with an 
Order Flow Provider,\4\ whereby a Directed Order Participant would be 
directed orders upon meeting certain eligibility requirements.
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    \3\ The Exchange's SROT and RROT programs were recently approved 
by the Commission on April 12, 2006 and April 13, 2006, 
respectively. See Securities Exchange Act Release Nos. 53635 (April 
12, 2006), 71 FR 20144 (April 12, 2006) (order approving the SROT 
program) and 53652 (April 13, 2006), 71 FR 20422 (April 20, 2006) 
(order approving the RROT program).
    \4\ Order Flow Providers are defined in proposed Rule 996-ANTE 
as any member or member organization that submits, as agent, 
customer orders to the Exchange.
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Eligibility
    The Exchange will allow for the receipt of marketable orders, 
through the Exchange's order routing system when the Exchange's 
disseminated quote is the NBBO, where the order flow providing firm 
(``Order Flow Provider'') \5\ transmitting that order has specified a 
specialist, ROT, SROT or RROT in that class as the Directed Order 
Participant for its orders that class. To be eligible for the Program 
the Directed Order Participant: (i) Must submit quotes electronically 
through the Exchange's ANTE system, in options classes in which it is 
assigned; (ii) must comply with its quoting obligations under Exchange 
rules and provide continuous two-sided quotations in not less than 100% 
of the series of each class for which it receives directed orders; and 
(iii) must also be quoting at the best bid or offer on the Exchange 
(the ``ABBO'').\6\
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    \5\ An ``Order Flow Provider'' is any member or member 
organization that submits, as agent, customer orders to the 
Exchange. See proposed Rule 996-ANTE(d).
    \6\ Pursuant to Exchange Rule 958-ANTE(h)(iii)(A), ROTs are 
responsible for quoting continuous two-sided markets in a certain 
percentage of series based on the volume of contracts executed 
electronically on the Exchange during the previous quarter. Pursuant 
to Exchange Rules 993-ANTE (c)(ii) and 994-ANTE (c)(iv), SROTs and 
RROTs are responsible for quoting continuous two-sided markets in 
60% of the series of their assigned classes.
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Enhanced Participation and Allocation
    An eligible Directed Order Participant who is directed orders will 
receive an enhanced participation equal to the greater of 40% of the 
remaining directed orders, when more than one market participant is 
quoting at the ABBO, or the amount the Directed Order Participant would 
be entitled to receive pursuant to the allocation algorithm set forth 
in Rule 935-ANTE(a)(4).
    The enhanced participation rate is based on the number of contracts 
remaining after all non-broker-dealer customer orders in the book at 
the best price have been satisfied. If an eligible Directed Order 
Participant receives enhanced participation under the rule, then no 
other participation entitlement set forth in Amex Rules shall apply to 
such order. The eligible Directed Order Participant must also be 
quoting at the ABBO to receive the guaranteed percentage, and can never 
be allocated more contracts than his quote size.\7\ Any contracts 
remaining after the eligible Directed Order Participant has received 
his allocation shall be allocated among the remaining participants 
according to the allocation algorithm set forth in Rule 935-ANTE(a)(4). 
No participant will be allocated contracts in excess of the size of his 
disseminated quote.
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    \7\ The allocation algorithm in Rule 935-ANTE (a)(4) is 
comprised of a Component A and a Component B. Component A is the 
parity component of the algorithm. In this component all market 
participants (except for non-broker-dealer customers) who were 
either quoting or had orders at the ABBO will be treated equally. 
Accordingly, the percentage used for Component A is an equal 
percentage derived by dividing 100 by the number of market 
participants at the ABBO. Component B is the size pro rata component 
and is designed to reward market participants who quote in size. The 
percentage used for Component B is the percentage that the size of 
each market participant's quote or order at the ABBO represents 
relative to the total number of contracts in the disseminated bid 
(for sell orders) and offer (for buy orders). The weight each 
component will have in the final percentage used to allocate 
executed contracts will initially be equal.
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    Finally, the Exchange notes that an eligible Directed Order 
Participant may not step up and match the ABBO after it receives an 
order, but must be publicly quoting at the ABBO when the order is 
received.\8\ An Order Flow Provider is prohibited from notifying a 
Directed Order Participant of its intention to submit a directed order, 
so that the Directed Order Participant may not change its quotation to 
match the ABBO immediately prior to the submission of the directed 
order, and then fade his quote. Specifically, the Exchange currently 
has rules in place to prevent such conduct as being inconsistent with 
just and equitable principles of trade and to prevent the misuse of 
material non-public information.\9\
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    \8\ The Exchange's disseminated quote must be at the NBBO at the 
time of receipt of the Directed Order. See proposed Rule 996-
ANTE(a).
    \9\ See Amex Rules 3(j) and 16.
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    The Exchange proposes that the effective date of the Program shall 
be August 20, 2007.\10\
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    \10\ See Amendment No. 2.
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2. Statutory Basis
    The proposed rule change is consistent with section 6(b) of the Act 
\11\ in general and furthers the objectives of Section 6(b)(5) of the 
Act \12\ in particular in that it is designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of change, to foster cooperation and coordination with 
persons engaged in facilitating transactions in securities, and to 
remove impediments to and perfect the mechanism of a free and open 
market and a national market system.
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    \11\ 15 U.S.C. 78f.
    \12\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The proposed rule change does not 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

    No written comments were solicited or received with respect to 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. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or     Send an e-mail to rule-comments@sec.gov. Please include 

File Number SR-Amex-2007-75 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-Amex-2007-75. This file

[[Page 47088]]

number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). 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, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of Amex. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number SR-Amex-2007-75 and should be 
submitted on or before September 12, 2007.

IV. Commission's Findings and Order Granting Accelerated Approval of 
the Proposed Rule Change

    After careful consideration, the Commission finds that the proposed 
rule change is consistent with the requirements of section 6 of the Act 
\13\ and the rules and regulations thereunder applicable to a national 
securities exchange \14\, and, in particular, the requirements of 
section 6(b)(5) of the Act.\15\ Section 6(b)(5) requires, among other 
things, that the rules of a national securities exchange be designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, 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.
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    \13\ 15 U.S.C. 78f.
    \14\ 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).
    \15\ 15 U.S.C. 78f(b)(5).
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    Pursuant to section 19(b)(2) of the Act,\16\ the Commission may not 
approve any proposed rule change, or amendment thereto, prior to the 
30th day after the date of publication of notice of the filing thereof, 
unless the Commission finds good cause for so doing and publishes its 
reasons for so finding. The Commission notes that the proposed rule 
change is substantially similar to rule changes by CBOE and ISE that 
were recently approved by the Commission on a permanent basis.\17\ The 
Commission believes that the proposed rule changes to establish a 
Directed Order Program on the Amex do not raise additional significant 
regulatory issues that have not been previously considered by the 
Commission. Accordingly, the Commission hereby finds good cause for 
approving the proposed rule change, as amended, prior to the 30th day 
after publishing notice thereof in the Federal Register.
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    \16\ 15 U.S.C. 78s(b)(2).
    \17\ See, e.g., Securities Exchange Act Release Nos. 51799 (June 
2, 2005), 70 FR 33564 (June 8, 2005) (order approving SR-CBOE-2004-
71), 55826 (May 29, 2007), 72 FR 31357 (SR-CBOE-2007-47) (permanent 
approval of CBOE's Preferred Market-Maker Program), 51759 (May 27, 
2005), 70 FR 32860 (June, 6, 2005) (order approving SR-Phlx-2004-
91), 51818 (June 10, 2005), 70 FR 35146 (June 16, 2005) (order 
approving SR-ISE-2005-18), and 55864 (June 5, 2007), 72 FR 32378 (SR 
ISE 2007-35) (permanent approval of the ISE's pilot program for 
preferenced orders).
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    The Commission has previously approved a rule that guarantees a 
specialist a portion of each order when the specialists quote is equal 
to the ABBO.\18\ The Commission has closely scrutinized exchange rule 
proposals to adopt or amend a participation guarantee where the 
percentage of participation would rise to a level that could have a 
material adverse impact on quote competition within a particular 
exchange.\19\ Because the proposal would not increase the overall 
percentage of an order that is guaranteed beyond the currently 
acceptable threshold, but instead would allow any specialist, ROT, SROT 
or RROT appointed to an options class to be designated as a Directed 
Order Participant and be eligible to receive an enhanced participation 
guarantee instead of the specialist, the Commission does not believe 
that the proposal will negatively impact quote competition on the 
Exchange. Under the proposal, the remaining portion of each order will 
still be allocated based on the competitive bidding of market 
participants.
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    \18\ See, e.g., Securities Exchange Act Release No. 49747 (May 
20, 2004), 69 FR 30344 (May 27, 2004) (SR-Amex-2003-89).
    \19\ See, e.g., Securities Exchange Act Release No. 43100 (July 
31, 2000), 65 FR 48788 (August 9, 2000).
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    Under the proposal, in order to be eligible to receive an 
participation guarantee in any options series, the Exchange proposes to 
require that a specialist, ROT, SROT, or RROT maintain continuous 
quotes in not less than 100% of the series of any options class it for 
which it receives Directed Orders.\20\ In addition, a Directed Order 
Participant will have to be quoting at the NBBO at the time the 
Directed Order is received to capitalize on the enhanced participation 
guarantee.\21\ The Commission believes it is critical that the Directed 
Order Participate cannot step up and match the NBBO after it receives 
an order, but must be publicly quoting at that price when the order is 
received. In this regard, the Exchange's proposal prohibits an Order 
Flow Provider from notifying a Directed Order Participant of its 
intention to submit a Directed Order, so that the Directed Order 
Participant may not change its quotation to match the ABBO prior to the 
submission of the Directed Order, and then fade his quote. The Exchange 
represented that it has rules in place to prevent such conduct as being 
inconsistent with just and equitable principles of trade and to prevent 
the misuse of material non-public information.\22\ Furthermore, the 
Exchange represented that it will proactively conduct surveillance for 
compliance with the applicable rules in conjunction with the Exchange's 
Directed Order Flow Program and enforce these rules.
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    \20\ See Amex Rule 996-ANTE. The specialist, ROT, SROT, or RROT 
also must have an appointment/allocation in such options class. Id.
    \21\ Specifically, Rule 996-ANTE requires a Directed Order 
Participant to be quoting at the ABBO while the Exchange's 
disseminated quote is the NBBO in order to be eligible to receive an 
enhanced participation for the order.
    \22\ See Amex Rules 3(j) and 16.
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    The Commission emphasizes that approval of this proposal does not 
affect a broker-dealer's duty of best execution. A broker-dealer has a 
legal duty to seek to obtain best execution of customer orders, and any 
decision to preference a particular specialist, ROT, SROT, or RROT must 
be consistent with this duty.\23\ A broker-dealer's duty of best 
execution derives from common law agency principles and fiduciary

[[Page 47089]]

obligations, and is incorporated in rules of self-regulatory 
organization and, through judicial and Commission decisions, the 
antifraud provisions of the federal securities laws.\24\
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    \23\ See, e.g., Newton v. Merrill, Lynch, Pierce, Fenner & 
Smith, Inc., 135 F.3d 266, 269-70, 274 (3d Cir.), cert. denied, 525 
U.S. 811 (1998); Certain Market Making Activities on Nasdaq, 
Securities Exchange Act Release No. 40900 (January 11, 1999) 
(settled case) (citing Sinclair v. SEC, 444 F.2d 399 (2d Cir. 1971); 
Arleen Hughes, 27 SEC 629, 636 (1948), aff'd sub nom. Hughes v. SEC, 
174 F.2d 969 (D.C. Cir. 1949)). See also Order Execution 
Obligations, Securities Exchange Act Release No. 37619A (September 
6, 1996), 61 FR 48290 (September 12, 1996) (``Order Handling Rules 
Release'').
    \24\ Order Handling Rules Release, 61 FR at 48322. See also 
Newton, 135 F.3d at 270. Failure to satisfy the duty of best 
execution can constitute fraud because a broker-dealer, in agreeing 
to execute a customer's order, makes an implied representation that 
it will execute it in a manner that maximizes the customer's 
economic gain in the transaction. See Newton, 135 F.3d at 273 
(``[T]he basis for the duty of best execution is the mutual 
understanding that the client is engaging in the trade--and 
retaining the services of the broker as his agent--solely for the 
purpose of maximizing his own economic benefit, and that the broker 
receives her compensation because she assists the client in reaching 
that goal.''); Marc N. Geman, Securities Exchange Act Release No. 
43963 (February 14, 2001) (citing Newton, but concluding that 
respondent fulfilled his duty of best execution). See also Payment 
for Order Flow, Securities Exchange Act Release No. 34902 (October 
27, 1994), 59 FR 55006, 55009 (November 2, 1994) (``Payment for 
Order Flow Final Rules''). If the broker-dealer intends not to act 
in a manner that maximizes the customer's benefit when he accepts 
the order and does not disclose this to the customer, the broker-
dealer's implied representation is false. See Newton, 135 F.3d at 
273-274.
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    The duty of best execution requires broker-dealers to execute 
customers' trades at the most favorable terms reasonably available 
under the circumstances, i.e., at the best reasonably available 
price.\25\ The duty of best execution requires broker-dealers to 
periodically assess the quality of competing markets to assure that 
order flow is directed to the markets providing the most beneficial 
terms for their customer orders.\26\ Broker-dealers must examine their 
procedures for seeking to obtain best execution in light of market and 
technology changes and modify those practices if necessary to enable 
their customers to obtain the best reasonably available prices.\27\ In 
doing so, broker-dealers must take into account price improvement 
opportunities, and whether different markets may be more suitable for 
different types of orders or particular securities.\28\
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    \25\ Newton, 135 F.3d at 270. Newton also noted certain factors 
relevant to best execution--order size, trading characteristics of 
the security, speed of execution, clearing costs, and the cost and 
difficulty of executing an order in a particular market. Id. at 270 
n. 2 (citing Payment for Order Flow, Securities Exchange Act Release 
No. 33026 (October 6, 1993), 58 FR 52934, 52937-38 (October 13, 
1993) (Proposed Rules)). See In re E.F. Hutton & Co. (``Manning''), 
Securities Exchange Act Release No. 25887 (July 6, 1988). See also 
Payment for Order Flow Final Rules, 59 FR at 55008-55009.
    \26\ Order Handling Rules Release, 61 FR at 48322-48333 (``In 
conducting the requisite evaluation of its internal order handling 
procedures, a broker-dealer must regularly and rigorously examine 
execution quality likely to be obtained from different markets or 
market makers trading a security.''). See also Newton, 135 F.3d at 
271; Market 2000: An Examination of Current Equity Market 
Developments V-4 (SEC Division of Market Regulation January 1994) 
(``Without specific instructions from a customer, however, a broker-
dealer should periodically assess the quality of competing markets 
to ensure that its order flow is directed to markets providing the 
most advantageous terms for the customer's order.''); Payment for 
Order Flow Final Rules, 59 FR at 55009.
    \27\ Order Handling Rules, 61 FR at 48323.
    \28\ Order Handling Rules, 61 FR at 48323. For example, in 
connection with orders that are to be executed at a market opening 
price, ``[b]roker-dealers are subject to a best execution duty in 
executing customer orders at the opening, and should take into 
account the alternative methods in determining how to obtain best 
execution for their customer orders.'' Disclosure of Order Execution 
and Routing Practices, Securities Exchange Act Release No. 43590 
(November 17, 2000), 65 FR 75414, 75422 (December 1, 2000) (adopting 
new Rules 11Ac1-5 and 11Ac1-6 under the Act and noting that 
alternative methods offered by some Nasdaq market centers for pre-
open orders included the mid-point of the spread or at the bid or 
offer).
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    For these reasons, the Commission believes that the proposal is 
consistent with the requirements of Section 6(b)(5) of the Act,\29\ and 
will not jeopardize market integrity or the incentive for market 
participants to post competitive quotes.\30\
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    \29\ 15 U.S.C. 78f(b)(5).
    \30\ Approval of this proposal is in no way an endorsement of 
payment for order flow by the Commission.
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\31\ that the proposed rule change (SR-Amex-2007-75), as modified 
by Amendments No. 1 and 2, be, and hereby is, approved on an 
accelerated basis.
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    \31\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\32\
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    \32\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E7-16468 Filed 8-21-07; 8:45 am]

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