01-32031. Self-Regulatory Organizations; Philadelphia Stock Exchange, Inc.; Order Approving Proposed Rule Change and Amendment Nos. 1 and 2 Thereto Relating to the Trading of Nasdaq Securities on the Floor of the Exchange

December 20, 2001.

I. Introduction

On November 16, 2000, the Philadelphia Stock Exchange, Inc. (“Phlx” or “Exchange”) submitted to the Securities and Exchange Commission (“SEC” or “Commission”), pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”),^[1] and rule 19b-4 thereunder,^[2] a proposed rule change regarding the trading of Nasdaq securities on the floor of the Exchange, pursuant to unlisted trading privileges (“UTP”). Notice of the proposed rule change was published in the Federal Register on December 14, 2000.^[3] On May 14, 2001, the Exchange submitted Amendment No. 1 to the proposed rule change.^[4] Amendment No. 1 was published in the Federal Register on July 16, 2001.^[5] On June 22, 2001, the Exchange submitted Amendment No. 2 to the proposed rule change.^[6] The Commission received two comment letters on the proposed rule change and a response from Phlx.^[7] This order approves the proposed rule change, as amended.

II. Description of the Proposal

The Phlx proposes to reinstate trading in certain over-the-counter (“OTC”) securities, i.e., Nasdaq National Market Securities (“Nasdaq/NM Securities”), on the floor of the Exchange, pursuant to UTP under section 12(f) of the Act.^[8] Therefore, Phlx seeks reinstatement of the pilot program and accompanying rules to permit the trading of Nasdaq/NM Securities on the Exchange pursuant to UTP (“Phlx OTC/UTP Pilot Program” or “Pilot”).^[9] Generally, the Exchange proposes to make only minor changes to the Phlx rules that specifically govern trading of Nasdaq/NM Securities, such as to revise the term “Nasdaq/NM Securities.” The Phlx has, however, proposed a new allocation procedure for Nasdaq/NM Securities. The Phlx has proposed to reinstate its Pilot to trade Nasdaq/NM Securities on a six-month pilot basis.

III. Summary of Comments

The Commission received two comments on the proposed rule change and a response from Phlx.^[10] One commenter, Knight, opposed the proposal. In its letter, Knight argued that the proposal should not be approved because: (1) Phlx has failed to demonstrate how permitting Phlx specialists to trade certain Nasdaq/NM Securities pursuant to the Pilot will maintain fair and orderly markets (as required by section 12(f)(1)(E)(i) of the Act ^[11] ) (of particular concern to Knight is the fact that members of regional UTP exchanges will be held to the less stringent rules of regional exchanges than NASD market maker members); (2) members of regional UTP exchanges trading Nasdaq/NM Securities currently act in a manner inconsistent with the SEC Rule 11Ac1-1 ^[12] (the “Firm Quote Rule”), by failing to execute transactions at prices that were displayed in the Nasdaq Montage; and (3) members of regional UTP exchanges trading Nasdaq/NM Securities currently act in a manner inconsistent with NASD's Locked/Crossed Market Rule ^[13] and Trade-or-Move Rule.^[14]

The Phlx responded to the Knight Letter. In its response letter, the Phlx countered each of Knight's arguments by contending that: (1) The SEC has already determined that permitting regional exchanges and their specialists and dealers to trade Nasdaq/NM Securities pursuant to the OTC/UTP Plan ^[15] is consistent with fair and orderly markets; (2) the Knight Letter offers no evidence that members of regional UTP exchanges routinely violate the Firm Quote Rule; and (3) even through regional exchange specialists are not bound by the NASD's Locked/Crossed Market and Trade-or-Move Rules, regional specialists on a voluntary basis routinely comply with Trade-or-Move messages received by them pre-opening. Moreover, the Phlx noted that it does not intend to trade or quote during the pre-opening session.

The other commenter, Ashton, supported the proposal. Ashton operates the eVWAP trading system (“eVWAP”) as a facility of the Phlx through its Universal Trading Technologies Corporation subsidiary. eVWAP is a pre-opening order matching session for the electronic execution of large-sized stock orders at a standardized volume weighted average price. Ashton noted that the Phlx soon will be filing amendments to Phlx Rule 237 (The eVWAP Morning Session) to expand eligibility of certain Nasdaq/NM Securities to eVWAP. Ashton stated that many eVWAP participants have requested the addition of Nasdaq issues for eVWAP matching.

Ashton also responded to the Knight Letter. In the Ashton Letter, Ashton counters two of Knight's arguments by contending that: (1) The SEC has already determined that UTP trading of Nasdaq/NM securities is in furtherance of fair and orderly markets; and (2) the federal statutory and regulatory scheme dictates that self-regulatory organizations' rules govern their own members (Ashton questions whether Knight is requesting a complete overhaul of the Act to impose a single self-regulatory, NASDR, over all market participants trading Nasdaq/NM Securities).

IV. Discussion

The Commission finds that the proposed rule change, as needed, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange, and in particular, with the requirements of section 6(b)(5) of the Act.^[16] The Commission believes that Phlx has proposed rules that should ensure that trading in Nasdaq/NM Securities on its floor occurs in an orderly fashion,^[17] consistent with the requirements of the Act. The Commission, therefore, believes that the proposal should remove impediments to and perfect the mechanism of a free and open market in a manner that is consistent with the protection of investors and the public interest.^[18] The Commission also notes that Phlx's response to the comments raised in the Knight Letter were sufficient.^[19]

Furthermore, the proposed rule change is consistent with section 12(f)(2) of the Act,^[20] which grants the Commission explicit authority to approve UTP in OTC securities. Section 12(f)(2) of the Act requires the Commission, before approving UTP, to determine that the granting of UTP is consistent with the maintenance of fair and orderly markets and the protection of investors. The Commission believes that the proposed rule change is consistent with these goals and thus, the Commission is approving the proposed rule change, subject to the Phlx complying with the requirements of the OTC/UTP Plan.

V. Conclusion

It is therefore ordered, pursuant to section 19(b)(2) of the Act,^[21] that the proposed rule change (SR-Phlx-2000-20), as amended, is approved on a pilot basis effective for a six month period beginning on the date trading begins.^[22]

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.^[23]

 

Margaret H. McFarland,

Deputy Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  Securities Exchange Act Release No. 43692 (Dec. 8, 2000), 65 FR 78240.

4.  See Form 19b-4 dated May 14, 2001 (“Amendment No. 1”).

5.  Securities Exchange Act Release No. 44533 (July 10, 2001), 66 FR 37083.

6.  See letter from Diana Tenenbaum, Phlx, to Nancy J. Sanow, Senior Special Counsel [sic], Division of Market Regulation, SEC, dated June 21, 2001 (“Amendment No. 2”). In Amendment No. 2, the Exchange corrected a citation to SEC “Rule 11Ac1-1” on page 22 of the amended Form 19b-4, deleted a reference to subsection “(ii)” on page 25 of the amended Form 19b-4, and changed all references to “issue” and “issues” in the proposed Rule 516 to read “security” and “securities,” respectively.

7.  See letters to Jonathan G. Katz, Secretary, SEC, from Michael T. Dorsey, Senior Vice President and General Counsel, Knight Trading Group, Inc., dated December 19, 2000 (“Knight Letter”); William W. Uchimoto, Executive Vice President and General Counsel, Ashton Technology Group, Inc., dated February 23, 2001 (“Ashton Letter”); and Edith Hallahan, Deputy General Counsel, Phlx, dated April 2, 2001 (“Phlx Letter”).

8.  15 U.S.C. 781(f).

9.  The Commission notes that the Phlx began trading Nasdaq/NM Securities pursuant to the Pilot in February 1993. See Securities Exchange Act Release No. 31672 (Dec. 30, 1992), 58 FR 3054 (Jan. 7, 1993). The effectiveness of the Pilot was extended four times before the Phlx decided to cease trading such securities pending reorganization of its OTC/UTP Pilot Program as a whole. See Securities Exchange Act Release No. 36087 (Aug. 10, 1995), 60 FR 42637, 42638 (Aug. 16, 1995). The Phlx OTC/UTP Pilot Program expired on February 12, 1996. Id.

10.  See note 7 supra.

11.  15 U.S.C. 781(f)(1)(E)(i).

12.  17 CFR 240.11Ac1-1.

13.  NASD Rule 4613(e).

14.  NASD Rule 4613(b)(2).

15.  The OTC/UTP Plan refers to the Joint Self-Regulatory Organization Plan Governing the Collection, Consolidation, and Dissemination of Quotation and Transaction Information for Nasdaq-Listed Securities Traded on Exchanges on an Unlisted Trading Privileges Basis. The participants of the OTC/UTP Plan are the American Stock Exchange LLC, the Chicago Stock Exchange, Inc., the Cincinnati Stock Exchange, Inc., the National Association of Securities Dealers, Inc., the Pacific Exchange, Inc., and the Philadelphia Stock Exchange, Inc.

16.  15 U.S.C. 78f(b)(5).

17.  The Commission notes that trading in Nasdaq/NM Securities will occur on the Phlx's equity floor, which is separate from the Phlx's options floor. Therefore, Phlx's proposal does not raise any side-by-side trading concerns. In addition, Phlx Rule 1014, which prohibits Registered Options Traders (“ROTs”) from executing proprietary options transactions in Phlx-listed options on OTC securities, if, during the preceding hour, the ROT was physically at the trading post where such OTC security trades, will apply during the Pilot.

18.  In approving this proposal, the Commission has considered its impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).

19.  The Commission notes that the Phlx's rules regarding short sales do not require an exemption from the Commission's short sale rule, Rule 10a-1, since Nasdaq securities currently are excluded from the Rule. See CFR 240.10a-1(a)(ii), However, Nasdaq has applied to become a national securities exchange. See Securities Exchange Act Release No. 44396 (June 7, 2001), 66 FR 31952 (June 13, 2001). If Nasdaq becomes a registered exchange, Nasdaq securities will be exchange-listed and the exemption in subparagraph (ii) of Rule 10a-1 will no longer be available. Accordingly, trading in Nasdaq securities would be subject to Rule 10a-1 unless Phlx obtains an exemption from the Rule. The Commission notes that Nasdaq has requested an exemption from Rule 10a-1.

20.  15 U.S.C. 781(f)(2).

21.  15 U.S.C. 78s(b)(2).

22.  Phlx has advised the Commission that it expects to begin trading in January 2002.

23.  17 CFR 200.30-3(a)(12).