01-2955. Self-Regulatory Organizations; Notice of Filing and Immediate Effectiveness of Proposed Rule Change by the Philadelphia Stock Exchange, Inc., Relating to Automatic Price Improvement for Equities Trading in Decimals

January 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 January 26, 2001, the Philadelphia Stock Exchange, Inc. (“Phlx” or “Exchange”), filed with the Securities and Exchange Commission (“Commission”) the proposed rule change as described in Items I, II and III below, which Items have been prepared by the Exchange. On January 29, 2001, the Phlx amended the proposal.^[3] The Exchange filed the proposal pursuant to Section 19(b)(3)(A) of the Act,^[4] and Rule 19b-4(f)(6) thereunder,^[5] which renders the proposal effective upon filing with the Commission.^[6] The Commission is publishing this notice to solicit comments on the proposed rule change, as amended, from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change

The Phlx proposes to codify a new automated price improvement feature for equities traded in decimals into Phlx Rule 229.07. The text of the proposed rule change is below. Proposed new language is in italics. Proposed deletions are in brackets.

Rule 229. Philadelphia Stock Exchange Automated Communication and Execution System (PACE)

PACE provides a system for the automatic execution of orders on the Exchange equity floor under predetermined conditions. Orders accepted under the system may be executed on a fully automated or manual basis in accordance with the provisions of this Rule. Securities admitted to dealings on the equity floor are eligible for trading on the PACE System in which equity specialists and member organizations may choose to participate. The conditions under which orders will be accepted and executed are set forth below. When used in the Rule, PRL means a combined round-lot and odd-lot order, and PACE Quote means the best bid/ask quote among the American, Boston, Cincinnati, Chicago, New York, Pacific or Philadelphia Stock Exchange, or the Intermarket Trading System/Computer Assisted Execution System (“ITS/CAES”) quote, as appropriate. The PACE rules, conditions and guidelines do not apply to orders not on the system, and existing rules governing orders not on the system are not affected hereby.

Supplementary Material:

General

The following PACE execution parameters are minimum standards applicable to agency orders received through PACE. Orders transmitted to the floor through the PACE system can be executed on a basis better than the applicable minimum standard:

.01-.06 No change.

.07 (a) Member organizations which enter market orders after the opening may elect to have such orders executed

(i) in accordance with the procedures set forth in Supplementary Material Section .05 or,

(ii) if such execution price would be outside the New York market high-low range for the day manually at or within the New York market high-low range of the day.

(b) Market orders (round-lots of 600 to 2000 shares or such greater size which the specialist agrees to accept and PRL's of 601 to 2099 shares or such greater size which the specialist agrees to accept) which are entered after the opening and which the specialist has not agreed to accept for automatic execution shall not be subject to the execution parameters set forth in Supplementary Material .05 and shall be executed in accordance with Supplementary Material .10(b) and other applicable rules of the Philadelphia Stock Exchange; provided, however, that the odd-lot portion of PRL's of 601 or more shares shall be executed at the same price as the round-lot portion. In the case of a PRL order, the round-lot portion(s) of which is executed at more than one price, the odd-lot portion shall be executed at the same price as the first round-lot portion is executed.

(c) Price Improvement for PACE Orders.

(i) Automatic Price Improvement—Where the specialist voluntarily agrees to provide automatic price improvement to all customers and all eligible market orders in a security, automatically executable market and marketable limit orders in New York Stock Exchange and American Stock Exchange listed securities received through PACE for 599 shares or less shall be provided with automatic price improvement from the PACE Quote when received of 1/16 for equities trading in fractions or, either $.01 or a percentage of the PACE Quote when the order is received for equities trading in decimals [from the PACE Quote when received] beginning at 9:30 A.M., except where:

(A) a buy order would be improved to a price less than the last sale or a sell order would be improved to a price higher than the last sale (except as provided in (E) below); or

(B) a buy order would be improved to the last sale price which is a downtick or a sell order would be improved to the last sale price which is an uptick (except as provided in (E) below). The PACE System will determine whether the last sale price is a downtick or an uptick. The PACE System does not recognize changes from the previous day's close.

In these situations, the order is not eligible for automatic price improvement, and is, instead, automatically executed at the PACE Quote. A specialist may voluntarily agree to provide automatic price improvement to larger orders in a particular security to all customers under this provision.

A specialist may choose to provide automatic price improvement where the PACE Quote is 3/16 or greater or 1/8 or greater for equities trading in fractions; [, or .03 or greater or .05 or greater] for equities trading in decimals , a specialist may choose to provide automatic price improvement of: (i) $.01 where the PACE Quote is either $.05 or greater, or $.03 or greater, or (ii) where the PACE Quote is $.02 or greater, a percentage of the PACE Quote when the order is received, up to 50%, rounded to the nearest penny, and at least $.01, in a particular security to all customers.

(C) Automatic price improvement will not occur for odd-lot orders, nor where the execution price before or after the application of automatic price improvement would be outside the primary market high/low range for the day, if so elected by the entering member organization.

(D) The POES window of Supplementary Material .05 above does not apply where an order is subject to automatic price improvement or manual price protection.

(E) Sell Order Enhancement I—A specialist may choose to give automatic price improvement to all sell orders of 100 shares or more, as determined by the specialist, in a particular security which would be improved to the last sale on an uptick; or,

Sell Order Enhancement II—A specialist may choose to give automatic price improvement to all sell orders of 100 shares or more, as determined by the specialist, in a particular security which would be improved to a price higher than the last sale.

(ii) Mandatory Manual Double-up/Double-down Price Protection—Where the specialist does not agree to provide automatic price improvement in a security, the specialist must provide manual double-up/double-down price protection in any instance where the bid/ask of the PACE Quote is 1/8 or greater for equities trading in fractions, or .05 or greater for equities trading in decimals, beginning at 9:30 A.M., to all customers and all eligible orders in a security, where the PACE System shall stop eligible automatically executable market and marketable limit orders of 599 shares or less in New York Stock Exchange or American Stock Exchange listed securities received through PACE in double-up/down situations in order to receive an opportunity for price improvement over the PACE Quote when received. Orders are “stopped” by the specialist at the PACE Quote when received, meaning that the order is guaranteed to receive at least that price by the end of the trading day. A specialist may voluntarily agree to provide manual double-up/double-down price protection to larger orders in a particular security to all customers under this provision. Where the execution (stop) price would be outside the primary market high/low range for the day, if so elected by the entering member organization, the order will be handled manually pursuant to paragraph (a) above. Odd-lot orders are not eligible for double-up/double-down manual price protection.

A double-up/double down situation is defined as a trade that would be at least:

(i) 1/4 (up or down) for equities trading in fractions, or .10 (up or down) for equities trading in decimals from the last regular way sale on the primary market; or

(ii) 1/4 for equities trading in fractions, or .10 for equities trading in decimals from the regular way sale that was the previous intraday change on the primary market.

(iii) Member organizations entering orders may elect to participate in manual double-up/double-down price protection. Failure to elect will result in the activation of the double-up/double-down feature for that User, but specialists determine whether to provide automatic price improvement in a particular security.

(iv) Extraordinary Circumstances—Both automatic price improvement and manual double-up/double-down price protection may be disengaged in a security or floor-wide in extraordinary circumstances with the approval of two Floor Officials. In addition to fast market conditions, for purposes of this paragraph, extraordinary circumstances also include systems malfunctions and other circumstances that limit the Exchange's ability to receive, disseminate or update market quotations in a timely and accurate manner.

* * * * *

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 its proposal and discussed any comments it received regarding the proposal. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in Sections A, B and C below, of the most significant aspects of such statements.

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

1. Purpose

The Exchange proposes to incorporate a new form of automatic price improvement for equities trading in decimals, based on a percentage of the spread between the bid and offer.

According to the Phlx, price improvement statistics are often used by order flow providers as a measure of both a specialist's and an exchange's execution quality. Broker-dealers are subject to the fiduciary duty of best execution respecting their order routing decisions. The Phlx has long sought to encourage the development of features, and specialist participation in such features, that contribute to higher price improvement figures and thus encourage better execution quality for the Exchange. The proposal is intended to codify a new automatic price improvement choice for equities trading in decimals that enables price improvement greater than one penny.

Currently, specialists may choose to provide automatic price improvement of $.01 for equities trading in decimals (where the PACE ^[7] Quote ^[8] is either $.05 or greater, or $.03 or greater).^[9] Automatic price improvement is a feature of the Exchange's PACE System that automatically executes eligible orders at a price better than the PACE Quote. Although participation in automatic price improvement (as well as participation in PACE as a whole) is voluntary, specialists are required to manually provide price improvement in certain situations described in Phlx Rule 229.07(c)(ii) (double downtick protection).

The proposal amends Phlx Rule 229, Supplementary Material .07(c), such that, for equities trading in decimals, a specialist may choose to provide automatic price improvement in the form of a percentage of the PACE Quote when an order is received, up to 50%, rounded to the nearest penny. This “percentage price improvement” feature would be available to all customers where the PACE Quote is $.02 or greater in a particular security. For example, where the PACE Quote is $10.00-$10.50 (a spread of $.50), a specialist electing this feature and choosing a percentage of 30 would provide automatic price improvement of $.15 to an eligible PACE order; thus, an incoming eligible sell order would receive an execution price of $10.15, whereas, absent automatic price improvement, it would be automatically executed at $10.00. If the specialist in this example chooses a percentage of 25, the resulting $.125 (12-1/2 cents) would be rounded down to 12 cents. Thus, the new feature provides automatic price improvement greater than one penny.^[10]

2. Statutory Basis

The Phlx believes that the proposal is consistent with section 6(b) of the Act,^[11] in general, and furthers the objectives of section 6(b)(5) ^[12] in particular, in that it is designed to promote just and equitable principles of trade, remove impediments to and perfect the mechanism of a free and open market and protect investors and the public interest by extending automated price improvement more widely to equities traded in decimals.

B. Self-Regulatory Organization's Statement on Burden on Competition

The Phlx does not believe that the proposed rule change will result in any 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.

III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action

Because the foregoing proposed rule change does not:

(i) Significantly affect the protection of investors or the public interest;

(ii) Impose any significant burden on competition; and

(iii) Become operative for 30 days from the date on which it was filed, or such shorter time as the Commission may designated, it has become effective pursuant to section 19(b)(3)(A) of the Act ^[13] and Rule 19b-4(f)(6) ^[14] thereunder. 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.

The Phlx has requested that the Commission waive the 5-day pre-filing notice requirement, and the 30-day operative waiting period, to allow the Phlx to implement the feature for decimal trading beginning January 29, 2001. The Commission finds good cause for waiving both the 5-day pre-filing notice requirement and the 30-day operative waiting period. Waiving these requirements will allow investors to reap the benefits of the Phlx's new price improvement program without delay. For these reasons, the Commission finds good cause for waiving the 5-day pre-filing notice requirement and the 30-day operative waiting period.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views and arguments concerning the foregoing, including whether the proposal 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 Phlx. All submissions should refer to file number SR-Phlx-01-12 and should be submitted by February 27, 2001.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.^[14]

Jonathan G. Katz,

Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  See January 29, 2001 letter from Edith Hallahan, Deputy General Counsel, Phlx to Joseph P. Morra, Special Counsel, Division of Market Regulation, Commission (“Amendment No. 1”). At the Commission's request, the Phlx filed Amendment No. 1, which asks that the proposal be implemented on a six-month pilot basis.

4.  15 U.S.C. 78s(b)(3)(A).

5.  17 CFR 240.19b-4(f)(6).

6.  The Phlx has asked the Commission to waive the 5-day pre-filing notice requirement. See Rule 19b-4(f)(6)(iii). 17 CFR 240.19b-4(f)(6)(iii).

7.  PACE is the Exchange's automated order delivery, routing, execution and reporting system for equities.

8.  The PACE Quote is the NBBO, or National Best Bid/Offer.

9.  See Securities Exchange Act Release No. 43206 (August 25, 2000), 65 FR 53250 (September 1, 2000) (SR-Phlx-00-08).

10.  The new price improvement feature will be implemented on a six-month pilot basis, beginning January 29, 2001.

11.  15 U.S.C. 78f(b).

12.  15 U.S.C. 78f(b)(5).

13.  15 U.S.C. 78s(b)(3)(A).

14.  17 CFR 240.19b-4(f)(6).

14.  17 CFR 200.30-3(a)(12).