

[Federal Register: February 1, 2007 (Volume 72, Number 21)]
[Notices]               
[Page 4738-4740]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr01fe07-94]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55162; File No. SR-Amex-2006-106]

 
Self-Regulatory Organizations; American Stock Exchange LLC; Order 
Granting Approval to Proposed Rule Change as Modified by Amendment No. 
1 Thereto, Relating to the Adoption of a Penny Pilot Program

January 24, 2007.

I. Introduction

    On November 9, 2006, the American Stock Exchange LLC (``Amex'' or 
``Exchange'') filed with the Securities and Exchange Commission

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(``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 to permit certain option classes to be quoted in 
pennies on a pilot basis and to adopt a quote mitigation strategy. The 
proposed rule change was published for comment in the Federal Register 
on November 20, 2006.\3\ The Commission received four comment letters 
on the proposed rule change.\4\ On January 18, 2007, the Exchange filed 
Amendment No. 1 to the proposed rule change.\5\ The Exchange responded 
to the comment letters on January 19, 2007.\6\ This order approves the 
proposed rule change as modified by Amendment No. 1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 54741 (November 9, 
2006), 71 FR 67176.
    \4\ See letters to Nancy M. Morris, Secretary, Commission, from 
Wayne Jervis, Managing Member of the General Partner, Jervis 
Alternative Asset Management Co. (``JAAMCO''), dated December 1, 
2006 (``JAAMCO Letter''); from Christopher Nagy, Chair, Securities 
Industry and Financial Markets Association (``SIFMA'') Options 
Committee, dated December 20, 2006 (``SIFMA Letter''); from Peter J. 
Bottini, Executive Vice-President, optionsXpress, Inc. 
(``optionsXpress''), dated November 17, 2006 (``optionsXpress 
Letter''); and from Patrick Sexton, Associate General Counsel, 
Chicago Board Options Exchange, Inc. (``CBOE''), dated December 12, 
2006 (``CBOE Letter'').
    \5\ Amendment No. 1 proposed to replace Glamis Gold, which was 
delisted, with Agilent Tech, Inc. in the list of options classes 
permitted to be quoted in pennies. Amendment No. 1 is technical in 
nature, and the Commission is not publishing Amendment No. 1 for 
public comment.
    \6\ See letter to Nancy Morris, Secretary, Commission, from 
Jeffrey P. Burns, Vice President and General Counsel, Amex, dated 
January 19, 2007. On January 23, 2007, Amex supplemented its initial 
response by providing additional information about its Holdback 
Timer. See letter to Nancy Morris, Secretary, Commission, from 
Jeffrey P. Burns, Vice President and General Counsel, Amex, dated 
January 23, 2007 (collectively ``Exchange Response'').
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II. Description of the Proposal

A. Scope of the Penny Pilot Program

    Amex proposes to amend its rules to permit certain option classes 
to be quoted in pennies during a six-month pilot (``Penny Pilot 
Program''), which would commence on January 26, 2007. Specifically, 
proposed Commentary .01 to Amex Rule 952 would set forth the parameters 
of the Penny Pilot Program and note that information concerning the 
Penny Pilot Program will be communicated to members via Regulatory 
Circular.
    Currently, all six options exchanges, including Amex, quote options 
in nickel and dime increments. The minimum price variation for 
quotations in options series that are quoted at less than $3 per 
contract is $0.05 and the minimum price variation for quotations in 
options series that are quoted at $3 per contract or greater is $0.10. 
Under the Penny Pilot Program, beginning on January 26, 2007, market 
participants would be able to begin quoting in penny increments in 
certain series of option classes.
    The Penny Pilot Program would include the following thirteen 
options: Ishares Russell 2000 (IWM); NASDAQ-100 Index Tracking Stock 
(QQQQ); SemiConductor Holders Trust (SMH); General Electric Company 
(GE); Advanced Micro Devices, Inc. (AMD), Microsoft Corporation (MSFT); 
Intel Corporation (INTC); Caterpillar, Inc. (CAT); Whole Foods Market, 
Inc. (WFMI); Texas Instruments, Inc. (TXN); Flextronics International 
Ltd. (FLEX); Sun Microsystems, Inc. (SUNW); and Agilent Technologies, 
Inc. (A). The Exchange will communicate the list of options to be 
included in the Penny Pilot Program to its membership via Regulatory 
Circular.
    The minimum price variation for all classes included in the Penny 
Pilot Program, except for the QQQQs, would be $0.01 for all quotations 
in option series that are quoted at less than $3 per contract and $0.05 
for all quotations in option series that are quoted at $3 per contract 
or greater. The QQQQs would be quoted in $0.01 increments for all 
options series.
    Amex commits to deliver a report to the Commission during the 
fourth month of the pilot, which would be composed of data from the 
first three months of trading. The report would analyze the impact of 
penny pricing on market quality and options system capacity.

B. Quote Mitigation Proposal

    To mitigate quote message traffic, Amex has represented to the 
Commission that it has already implemented or intends to implement the 
following quote mitigation strategies.
     Join Quote. The Amex, through the ANTE system,\7\ provides 
that registered options traders (``ROTs'') may either stream their own 
quotes or join the specialist's disseminated quotation in some or all 
of his assigned classes or series (``join quote''). In order to 
participate in ``join quote,'' a ROT must be physically present in the 
trading crowd. The purpose of allowing ROTs to piggyback on 
specialists' quotes is partly to reduce market data traffic by allowing 
ROTs to join the specialist's quote in the less actively traded series 
(far out months, etc.) while auto-quoting the more actively traded 
series.
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    \7\ See Securities Exchange Act Release No. 49747 (May 20, 
2004), 69 FR 30344 (May 27, 2004) (SR-Amex-2003-89).
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     Monitoring. The Amex actively monitors the quotation 
activity of its market participants. When the Exchange detects that a 
market participant is disseminating significantly more quotes than the 
average market participant, the Exchange contacts the market 
participant and alerts them to potentially excessive quotation 
activity. Often such monitoring reveals that the market participant may 
have internal system issues or has incorrectly set system parameters. 
Alerting the market participant usually leads to the market participant 
to take steps to reduce the number of quotes for dissemination.
     Holdback Timers. The Amex has the systematic ability to 
limit the dissemination of quotations and other changes to the Amex 
Best Bid or Offer (``ABBO'') according to prescribed time criteria 
(``Holdback Timer''). For instance, if there is a change in the price 
of a security underlying an option, multiple market participants may 
adjust the price or size of their quotes. Rather than disseminating 
each individual change, the Holdback Timer permits the Exchange to wait 
until multiple market participants have adjusted their quotes and then 
to disseminate a new quotation. This helps to prevent the 
``flickering'' of quotations. The Amex proposes to codify the Holdback 
Timer in this rule filing. As proposed in Amex Rule 958A-ANTE, the 
Exchange will utilize a Holdback Timer that delays quotation updates 
for no longer than one (1) second.
     Delisting. The Amex commits to the Commission that it will 
delist options with an average daily volume (``ADV'') of less than 25 
contracts. However, the Amex represented to the Commission that it has 
been its policy to be much more aggressive in delisting relatively 
inactive options, thereby eliminating the quotation traffic attendant 
to such listings.

III. Discussion

    After careful review of the proposal, the comment letters, and the 
Exchange's response thereto, the Commission finds that the proposed 
rule change, as modified by Amendment No. 1, is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange.\8\ In particular, the 
Commission finds that the proposal is consistent with Section 6(b)(5) 
of the

[[Page 4740]]

Act,\9\ which requires, among other things, that the rules of an 
exchange be designed 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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    \8\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \9\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the implementation of a limited six-
month Penny Pilot Program by Amex and the five other options exchanges 
will provide valuable information to the exchanges, the Commission and 
others about the impact of penny quoting in the options market. In 
particular, the Penny Pilot Program will allow analysis of the impact 
of penny quoting on: (1) Spreads; (2) transaction costs; (3) payment 
for order flow; and (4) quote message traffic.
    The Commission believes that the thirteen options classes to be 
included in the penny pilot program represent a diverse group of 
options classes with varied trading characteristics. This diversity 
should facilitate analyses by the Commission, the options exchanges and 
others. The Commission also believes that the Penny Pilot Program is 
sufficiently limited that it is unlikely to increase quote message 
traffic beyond the capacity of market participants' systems and disrupt 
the timely receipt of quote information. Nevertheless, because the 
Commission expects that the Penny Pilot Program will increase quote 
message traffic, the Commission is also approving the Exchange's 
proposal to reduce the number of quotations it disseminates.
    In this regard, the commenters expressed concern about Amex's 
proposed quote mitigation strategy.\10\ In particular, although 
optionsXpress generally supported Amex's Holdback Timer, it expressed 
concern that a longer holdback timer period could negatively impact 
market quality and undermine transparency in the options market.\11\
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    \10\ JAAMCO did not comment directly on Amex's proposal, but 
rather stated its strong support for quoting in penny increments in 
the options market, which it believes will improve inequities in the 
marketplace. See JAAMCO Letter, supra note 4.
    \11\ See optionsXpress Letter, supra note 4. OptionsXpress also 
stated its view that current problems with the intermarket linkage 
will be exacerbated in the option classes participating in the Penny 
Pilot Program. Id.
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    In addition, SIFMA recommends that all six of the option exchanges 
adopt a comprehensive and uniform quote mitigation strategy.\12\ In 
particular, SIFMA strongly supports the adoption of the Holdback Timer 
mitigation proposal as the most efficient means of reducing quotation 
traffic. SIFMA, however, expressed concern that the lack of uniformity 
among the quote mitigation proposals adopted by the exchanges will 
impose a burden on member firms and cause confusion for market 
participants, especially retail investors.
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    \12\ See SIFMA Letter, supra note 4.
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    Although SIFMA urges the adoption of a uniform and comprehensive 
approach to quote mitigation, it does not oppose Amex's quote 
mitigation proposals. In fact, SIFMA acknowledges that certain of 
Amex's proposals, such as notifying members whose quote activity 
suggests systems malfunctions or wrong settings and delisting inactive 
series can contribute to quote mitigation. SIFMA, however, expressed 
its belief that these proposals do not go far enough to resolve the 
industry's concerns regarding systems capacity.
    The Commission supports efforts to implement a uniform, industry-
wide quote mitigation plan. It does not, however, believe such efforts 
preclude individual exchanges from initiating their own quote 
mitigation strategies. The Commission does not believe that Amex's 
proposed quote mitigation strategies will lead to confusion among 
market participants.
    Finally, CBOE commented that it did not have a fundamental 
objection to Amex's use of the Holdback Timer, but sought additional 
information concerning how the Holdback Timer functions and how orders 
sent to Amex by CBOE members or by CBOE though linkage might be 
impacted by the Holdback Timer.\13\ Specifically, CBOE requested 
additional information about the extent to which the Holdback Timer is 
utilized throughout the day and whether it is used uniformly in all 
option classes traded on Amex. In response, Amex indicated that it 
intends to use the Holdback Timer uniformly in all option classes.\14\ 
In addition, the Amex committed to apply the Holdback Timer mechanism 
throughout the trading day for a period of up to, but no more than, one 
second.\15\ In further response to inquiry from CBOE, the Amex 
represented that it does not intend to disclose the precise length of 
the timer to its members, to non-members or to the other exchanges.\16\
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    \13\ See CBOE Letter, supra note 4.
    \14\ Telephone conversation between Michael T. Bickford, Senior 
Vice President, Amex, and Jennifer L. Colihan, Special Counsel, 
Cyndi N. Rodriguez, Special Counsel, and Johnna B. Dumler, Special 
Counsel, Division of Market Regulation, Commission, on January 23, 
2007. See also Exchange Response, supra note 6.
    \15\ Telephone conversation between Michael T. Bickford, Senior 
Vice President, Amex, and Jennifer L. Colihan, Special Counsel, 
Cyndi N. Rodriguez, Special Counsel, and Johnna B. Dumler, Special 
Counsel, Division of Market Regulation, Commission, on January 23, 
2007.
    \16\ Id.
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    In addition, CBOE inquired whether the Holdback Timer will apply 
only to market maker quotations and asked the Exchange to clarify what 
information will be delayed by the Holdback Timer. Amex clarified that 
the Holdback Timer will be applied when there is a change in the price 
and/or size of the security underlying an option. The Exchange will 
wait (for a period up to one second) until multiple market participants 
have adjusted their quotes and then will disseminate a new quotation. 
The Exchange will apply the Holdback Timer to all data that it sends to 
OPRA.\17\ Finally, in response to CBOE's inquiry regarding the 
treatment of incoming marketable orders, Amex indicated that Holdback 
Timer only ``addresses the dissemination of quote changes on the 
Exchange not the execution of orders.''\18\ Therefore, incoming 
marketable orders sent to the Exchange will automatically trade against 
Amex's current internal quotation that may be delayed during the one 
second holdback period.
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    \17\ See Exchange Response, supra note 6.
    \18\ Telephone conversation between Michael T. Bickford, Senior 
Vice President, Amex, and Jennifer L. Colihan, Special Counsel, 
Cyndi N. Rodriguez, Special Counsel, and Johnna B. Dumler, Special 
Counsel, Division of Market Regulation, Commission, on January 23, 
2007.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\19\ that the proposed rule change (SR-Amex-2006-106), as modified 
by Amendment No. 1, be, and hereby is, approved on a six-month pilot 
basis, which will commence on January 26, 2007.
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    \19\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-1591 Filed 1-31-07; 8:45 am]

BILLING CODE 8011-01-P
