04-2362. Joint Industry Plan; Order Approving Joint Amendment No. 8 to the Options Intermarket Linkage Plan Relating to Satisfaction Orders and Trade-Throughs

January 29, 2004.

I. Introduction

On December 18, 2003, December 22, 2003, December 29, 2003, and December 30, 2003, the International Securities Exchange, Inc. (“ISE”), the Pacific Exchange, Inc. (“PCX”), the American Stock Exchange LLC (“Amex”), the Philadelphia Stock Exchange, Inc. (“Phlx”), and the Chicago Board Options Exchange, Inc. (“CBOE”) (collectively, the “Participants”), respectively submitted to the Securities and Exchange Commission (“SEC” or “Commission”) in accordance with section 11A of the Securities Exchange Act of 1934 (“Act”)^[1] and Rule 11Aa3-2 thereunder,^[2] a proposed amendment to the Options Intermarket Linkage Plan (the “Plan”).^[3] The amendment proposes to extend the pilot provision limiting trade-through liability to 10 contracts per satisfaction order at the end of the day for an additional five months, until June 30, 2004.

The proposed amendment to the Plan was published in the Federal Register on January 6, 2004.^[4] No comments were received on the proposed amendment. This order approves the proposed amendment to the Plan.

II. Description of the Proposed Amendment

In Joint Amendment No. 8, the Participants propose to extend the pilot provision contained in section 8(c)(ii)(B)(2)(c) of the Plan that limits trade-through liability to 10 contracts per satisfaction order at the end of the day for an additional five months, until June 30, 2004, in order to gain more experience with the limitation on trade-through liability. Pursuant to the pilot, an exchange member's trade-through liability is limited to 10 contracts per Satisfaction Order for the period between five minutes prior to the close of trading in the underlying security and the close of trading in the options class.

III. Discussion

When this pilot was originally proposed in Joint Amendment No. 4 to the Plan,^[5] the Participants represented to the Commission that their members had expressed concerns regarding their obligations to fill Satisfaction Orders (which arise after a trade-through ^[6] ) at the close of trading in the underlying security. Specifically, the Participants represented that their members were concerned that they may not have sufficient time to hedge the positions they acquire.^[7] The Participants stated that they believed that their proposal to limit liability for trade-throughs for the last five minutes of trading in the underlying security to the filling of 10 contracts per exchange, per transaction would protect small customer orders, but still establish a reasonable limit for their members' liability. The Participants further represented that the proposal should not affect a member's potential liability under an exchange disciplinary rule for engaging in a pattern or practice of trading through other markets under section 8(c)(i)(C) of the Plan.

The Commission approved the proposal for a one-year pilot ^[8] to give the Participants and the Commission an opportunity to evaluate: (1) The need for the limitation on liability for trade-throughs near the end of the trading day; (2) whether 10 contracts per Satisfaction Order is the appropriate limitation; and (3) whether the opportunity to limit liability for trade-throughs near the end of the trading day leads to an increase in trade-throughs. In its approval order, the Commission requested that the Participants provide a report to the Commission at least sixty days prior to seeking permanent approval of the pilot program. The Commission specified that the report should include information about the number and size of trade-throughs that occur during the last seven minutes of the trading day, the number and size of Satisfaction Orders that Participants might be required to fill without the limitation on liability and how those amounts are affected by the limitation on liability, and the extent to which the Participants use the underlying market to hedge their options positions.^[9]

In connection with the request in Joint Amendment No. 8 to extend the pilot for an additional five months until June 30, 2004, the Commission notes that the Participants represent that if they seek to make the limitations on trade-throughs permanent, they will submit the above-referenced report to the Commission no later than March 31, 2004. The Participants further represent in Joint Amendment No. 8 that each exchange plans to submit individual reports regarding the requested data and that these reports will detail the number of trade-throughs in the last seven minutes of options trading and the rest of the day, as well as the number and size of Satisfaction Orders that would have been filled absent the current exemption. In addition, the Participants represent that the reports will provide information on the extent to which the exchange's members hedge their options trading during the day as part of their overall risk management. Finally, the Participants represent that they will make every effort to provide specific information regarding their members' hedging at the end of the trading day.

After careful consideration, the Commission finds that the proposed amendment to the Plan seeking to extend the current pilot is consistent with the requirements of the Act and the rules and regulations thereunder. Specifically, the Commission finds that the proposed amendment to the Plan is consistent with section 11A of the Act ^[10] and Rule 11Aa3-2 thereunder,^[11] in that extending the pilot, while the Participants gather and evaluate data relating to the effect of the operation of the pilot, is appropriate in the public interest, for the protection of investors and the maintenance of fair and orderly markets. Therefore, the Commission is extending the effectiveness of section 8(c)(ii)(B)(2)(c) of the Plan for an additional five months, until June 30, 2004.

IV. Conclusion

It is therefore ordered, pursuant to section 11A of the Act ^[12] and Rule 11Aa3-2 thereunder,^[13] that the proposed Plan Amendment No. 8 is approved on a pilot basis until June 30, 2004.

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

Jill M. Peterson,

Assistant Secretary.

Footnotes

1.  15 U.S.C. 78k-1.

2.  17 CFR 240.11Aa3-2.

3.  On July 28, 2000, the Commission approved a national market system plan for the purpose of creating and operating an intermarket options market linkage proposed by the Amex, CBOE, and ISE. See Securities Exchange Act Release No. 43086 (July 28, 2000), 65 FR 48023 (August 4, 2000). Subsequently, upon request by the Phlx and PCX, the Commission issued orders to permit these exchanges to participate in the Plan. See Securities Exchange Act Release Nos. 43573 (November 16, 2000), 65 FR 70850 (November 28, 2000) and 43574 (November 16, 2000), 65 FR 70851 (November 28, 2000).

4.  See Securities Exchange Act Release No. 49010 (December 30, 2003), 69 FR 706.

5.  See Securities Exchange Act Release No. 47028 (December 18, 2002), 67 FR 79171 (December 27, 2002) (Notice of Proposed Joint Amendment No. 4).

6.  Trade-throughs occur when a broker-dealer executes its customer's order on one exchange at a price inferior to another exchange's disseminated quote.

7.  See letter from Michael Simon, Senior Vice President and General Counsel, ISE, to Annette Nazareth, Director, Division of Market Regulation, Commission, dated November 19, 2002.

8.  See Securities Exchange Act Release No. 47298 (January 31, 2003), 68 FR 6524 (February 7, 2003) (approval of pilot program on a 120-day basis); see also Securities Exchange Act Release No. 48055 (June 18, 2003), 68 FR 37869 (June 25, 2003) (approval of pilot program).

9.  Id.

10.  15 U.S.C. 78k-1.

11.  17 CFR 240.11Aa3-2.

12.  15 U.S.C. 78k-1.

13.  17 CFR 240.11Aa3-2.

14.  17 CFR 200.30-3(a)(29).