

[Federal Register: February 9, 2007 (Volume 72, Number 27)]
[Notices]               
[Page 6302-6305]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr09fe07-93]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55230; File No. SR-BSE-2006-16]

 
Self-Regulatory Organizations; Boston Stock Exchange, Inc.; 
Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto To 
Adopt a Universal Price Improvement Period for Public Customer Orders

February 2, 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 December 11, 2006, the Boston Stock Exchange, Inc. (``BSE'' 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 substantially prepared by the BSE. 
On February 1, 2007, BSE filed Amendment No. 1 to the proposed rule 
change.\3\ The Commission is publishing this notice to solicit comments 
on the proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, BSE granted the Commission an extension 
of the time period specified in Section 19(b)(2) of the Act for 
Commission action.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend the rules of the Boston Options 
Exchange (``BOX'') to adopt a Universal Price Improvement Period 
(``UPIP'') to offer the opportunity for price improvement for eligible 
Public Customer \4\ orders. The text of the proposed rule change is 
available at BSE, the Commission's Public Reference Room, and http://www.bostonstock.com/legal/pending_rule_filings.html
.

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    \4\ Capitalized terms not otherwise defined herein shall have 
the meanings prescribed under the BOX rules.
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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 BSE 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 IV below. The BSE 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
    Currently, the BOX offers Options Participants, who wish to price 
improve their Customer Orders, access to a price improvement auction 
referred to as the ``PIP'' (Price Improvement Period). In order for a 
Customer Order to be entered into a PIP auction, Options Participants 
must be willing to improve the execution price themselves or seek price 
improvement through the PIP via a Directed Order. In either instance, 
initial access to the PIP is dependent upon the ability of at least one 
party to guarantee price improvement for the full size of the Customer 
Order. UPIP, however, is a universal price improvement mechanism such 
that all Public Customer Orders submitted to the BOX Trading Host will 
be eligible for potential price improvement in the UPIP auction, 
subject to the eligibility requirements discussed below. UPIP is 
similar to the PIP and other price improvement mechanisms, such as the 
Price Improvement Mechanism (``PIM'') of the International Stock 
Exchange, Inc. (``ISE'') and the Simple Auction Liaison system 
(``SAL'') of the Chicago Board Options Exchange, Incorporated 
(``CBOE''), that initiate auctions in penny increments through which 
exchange participants compete to potentially price improve a customer 
order above the National Best Bid or Offer (``NBBO''). Unlike the PIP 
and other similar price improvement mechanisms, however, UPIP permits a 
broader universe of orders to obtain price improvement.
    In the discussion to follow, BSE provides an overview of the UPIP 
auction and discusses some of the more salient features and benefits of 
the UPIP. In addition, BSE addresses the underlying purpose of the UPIP 
by, in part, comparing the UPIP to the industry practice of ``paying 
for order flow,'' and by discussing the overall effectiveness of UPIP 
in the context of the Commission's Penny Pilot.\5\
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    \5\ See Securities Exchange Act Release No. 54789 (November 20, 
2006), 71 FR 68654 (November 27, 2006) (SR-BSE-2006-49).
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    a. UPIP Eligibility. Under the proposed rule, a Public Customer 
Order will be eligible for the UPIP auction (``Eligible Order'') 
provided certain conditions have been satisfied.\6\ For example, the 
Eligible Order must be a Limit, Market or BOX-Top Order that is 
marketable against the NBBO.\7\ In addition, the Trading Host will not 
permit the commencement of a UPIP auction in the following scenarios: 
(1) If a PIP or UPIP in the same series is already underway, or (2) if 
the NBBO is locked or crossed and the BOX Best Bid or Offer (``BBO'') 
on the same side of the market as the Eligible Order equals the NBBO.
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    \6\ See proposed rule Section 29(e) of Chapter V of the BOX 
Rules.
    \7\ The Exchange also notes that an Eligible Order must be for a 
series of options that is open for trading and can not indicate a 
minimum quantity condition or be an Inbound Inter-Market Linkage P/A 
order.
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    b. The UPIP Order \8\ and the Auction. Upon satisfaction of the 
foregoing conditions, the BOX Trading Host will proceed to 
automatically commence a UPIP auction. Prior to the commencement, 
however, the BOX Trading Host will transmit a broadcast message 
(``Broadcast Message'') to Options Participants informing them of the 
auction's initiation, the relevant details of the UPIP Order (i.e., the 
UPIP Order's series, size and side of the market), the end time of the 
auction, and the applicable Start Price.\9\ The Start Price for each 
auction is driven primarily by the price of the BBO on the opposite 
side of the market from the UPIP Order vis-[agrave]-vis the NBBO such 
that if the BBO is equal to the NBBO, the Start Price will be one 
improvement increment (e.g., a penny) better than the NBBO. Conversely, 
if the BBO does not equal the NBBO, the Start Price will be the NBBO. 
The same conditions apply with respect to the Start Price whether or 
not the NBBO is locked or crossed.
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    \8\ Under the proposal, upon commencement of the UPIP auction 
the ``Eligible Order'' shall be referred to as the ``UPIP Order.''
    \9\ The Start Price is defined as the minimum/maximum (buy/sell) 
price at which an Improvement Order must be submitted.
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    The rule proposal allows UPIP Orders to be modified and cancelled 
at any time prior to the conclusion of the UPIP auction. The 
cancellation of a UPIP Order will result in the subsequent

[[Page 6303]]

cancellation of all related Improvement Orders. Certain modifications 
of a UPIP Order will not result in the termination of the UPIP auction. 
Such modifications include the reduction of a UPIP Order quantity, the 
recharacterization of the UPIP Order type from a Limit Order to a BOX 
Top or Market Order, and an improvement of the UPIP Order's original 
limit price. Otherwise, any other modification will result in the 
termination of the UPIP auction.
    c. Improvement Orders and the Auction. Any Options Participant may 
submit an Improvement Order \10\ in response to a Broadcast Message for 
an impending UPIP auction. Such Improvement Orders shall be visible to 
all Options Participants and are required to be submitted in increments 
of one-penny or more and must equal or improve the Start Price. 
Improvement Orders may also be cancelled or modified by the Options 
Participant prior to the conclusion of the UPIP auction. An increase in 
the quantity of the Improvement Order or modifications of the 
Improvement Order's limit price will result in the creation of a new 
Improvement Order reflecting the revised terms (i.e., increased 
quantity amount or modified price) and the cancellation of the original 
Improvement Order. At the conclusion of a UPIP auction, the unexecuted 
portion of an Improvement Order will be cancelled by the Trading Host.
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    \10\ Improvement Orders are those orders submitted to a UPIP 
auction in response to a Broadcast Message by Options Participants 
that are on the opposite side of the market as the UPIP Order.
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    d. Improvement Orders and Priority. Like the PIP, Improvement 
Orders may be submitted by any BOX market participant such as Customers 
(including CPOs), Order Flow Providers (``OFP''), or Market Makers 
(including Executing Participants \11\). Improvement Orders will 
generally be ranked in order of price and time. The rule proposal, 
however, provides alternative ranking and/or allocation status for 
certain Improvement Orders depending on certain criteria, as discussed 
more fully below.
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    \11\ An ``Executing Participant'' is defined in the BOX Rules as 
a Market Maker that systemically indicates its willingness to accept 
and receive Directed Orders. See Section 5(c)(i) of Chapter VI of 
the BOX Rules.
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    i. Proprietary Improvement Orders. Under the rule proposal, the 
Options Participant who submitted the Eligible Order to BOX and 
subsequently submitted a Proprietary Improvement Order will be last in 
time priority at all price levels in the relevant UPIP auction. 
Notwithstanding, if the Proprietary Improvement Order is generated by 
an automated quotation system that operates independently from the 
existence or non-existence of the pending Eligible Order prior to its 
submission to BOX, the Options Participant's Proprietary Improvement 
Order will be treated like an ordinary Improvement Order and qualify 
for execution at each price level without prejudice.
    ii. Executing Participant Improvement Orders. The rule proposal 
also seeks to deter Executing Participants who receive Directed Orders 
from simply releasing the Directed Order to the BOX Book in order to 
compete in the ensuing UPIP auction by placing the Executing 
Participant last in priority at all price levels in any subsequent UPIP 
auction related to that Directed Order.
    iii. Customer Price Improvement Orders. Similar to the CPO in the 
PIP, Public Customers that submit a CPO to an OFP must indicate the 
price at which the order shall be placed in the BOX Book (``BOX Book 
Reference Price'') \12\ as well as the price at which the Public 
Customer would like to participate in any UPIP that may occur while the 
order is on the BOX Book. In order for the CPO to be eligible for 
participation in a UPIP auction, the BOX Book Reference Price must 
equal the BBO at the commencement of a UPIP auction.\13\ The CPO will 
also benefit from enhanced time priority pursuant to NBBO Prime as 
described in section iv below.
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    \12\ The BOX Book reference price must be stated in standard 
five-cent or ten-cent increments.
    \13\ The Exchange also notes that a CPO must be in the same 
series and on opposite side of the UPIP Order.
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    iv. NBBO Prime. The current rule proposal allows certain 
Improvement Orders to be designated as NBBO Prime (``NBBO Prime 
Order''). The NBBO Prime designation is only applicable for a UPIP 
auction, not the PIP, and generally confers time priority to a 
particular Improvement Order over other Improvement Orders and 
Unrelated Orders with the same price upon satisfaction of certain 
conditions, as discussed more fully below. Any Improvement Order may be 
eligible for the NBBO Prime designation in a UPIP auction.
    In order to receive the benefits of the NBBO Prime designation, the 
same beneficial account,\14\ such as a customer account, for whom the 
Options Participant is acting as principal or agent (whether Market 
Maker, OFP, or Customer) and is seeking the NBBO Prime designation must 
itself have quotes or orders on the BOX Book that are on the opposite 
side of the UPIP Order (``NBBO Prime Participant Quote''). The NBBO 
Prime Participant Quote must be equal to the NBBO and must have been on 
the BOX Book prior to receipt of the Eligible Order by the Trading 
Host. In addition, NBBO Prime Orders shall only have enhanced time 
priority for the quantity that does not exceed the size of its NBBO 
Prime Participant Quote; any residual quantity will be handled in 
accordance with the normal time priority rules. As between NBBO Prime 
Orders, the priority shall be governed by the relevant Trading Host 
order receipt time stamp of each NBBO Prime Participant Quote.
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    \14\ For purposes of the proposed rule, a ``beneficial account'' 
means the underlying type of account (e.g., customer, broker-dealer, 
market maker, etc.) on whose behalf the Participant is trading.
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    An Options Participant seeking priority through the NBBO Prime 
designation must indicate to the Trading Host the order number of the 
NBBO Prime Participant Quote when the Options Participant submits the 
Improvement Order for the same beneficial account. In addition, under 
the proposed rule the Options Participant is permitted the flexibility 
to indicate whether the NBBO Prime Participant Quote size should be 
decremented to reflect any execution of the NBBO Prime Order. In the 
absence of such an indication, the Trading Host will not decrement the 
NBBO Prime Participant Quote. Market Makers will not be required to 
identify their relevant order number but will need to indicate to the 
Trading Host that their applicable NBBO Prime Participation Quote size 
should be decremented; otherwise their NBBO Prime Participation Quote 
size will remain unchanged on the BOX Book.
    e. Price Protection in the UPIP. As previously discussed, the 
potential execution price of any UPIP auction will be, except in 
limited circumstances,\15\ at least equal to the NBBO at the time UPIP 
auction commences. At the conclusion of the UPIP auction, including in 
the event of a premature termination (as discussed more fully below), 
the UPIP Order shall be matched against the best prevailing orders. 
These orders include Improvement Order(s), CPOs, Unrelated Orders, and 
quotes submitted during the UPIP auction that are equal to or better

[[Page 6304]]

than the Start Price. In addition, the rule proposal provides for the 
initial quantity of the UPIP Order to be ``stopped'' against any order 
on the BOX Book that is marketable against the UPIP Order at the time 
the UPIP Order is received by the Trading Host (``Initial BOX Book 
Quote'') \16\ up to the size of the Initial BOX Book Quote (``Initial 
Aggregate Quote Size''). When the UPIP auction terminates, the UPIP 
Order may be matched against the Initial Aggregate Quote Size of the 
Initial BOX Book Quote and will not be executed at a price worse than 
the Initial BOX Book Quote.
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    \15\ At the conclusion of a UPIP auction, the quantity of the 
UPIP Order that exceeds the Initial Aggregate Quote Size, if any, 
will not execute against Improvement Orders at prices inferior to 
the NBBO except in the following circumstances: (1) In accordance 
with Chapter XII, Section 3(e) of BOX Rules; or (2) the away options 
exchange posting the NBBO is conducting a trading rotation in that 
options class.
    \16\ The Initial BOX Book Quote is defined as the quote(s) and/
or order(s) on the BOX Book at the best price, on the opposite side, 
and in the same series as the Eligible Order at the time the Trading 
Host receives it. The Initial Aggregate Quote Size is defined as the 
aggregate size of the Initial BOX Book Quote.
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    A modification or cancellation of the Initial BOX Book Quote during 
the UPIP auction that decreases the Initial Aggregate Quote size below 
the size of the UPIP Order, at the commencement of the UPIP auction, 
will cause the UPIP auction to immediately terminate. Such modification 
or cancellation will only be processed after the UPIP Order has been 
executed. An Options Participant who is part of the Initial BOX Book 
Quote, and whose cancellation or modification of its order/quote causes 
the UPIP auction to terminate, will have its order/quote placed at the 
end of the quote and order queue at the applicable price level on the 
BOX Book. At which point, the UPIP Order will be matched according to 
the UPIP trade allocation rules. Any modification or cancellation of 
the Initial BOX Book Quote that does not cause the Initial Aggregate 
Quote Size to decrease below the size of the UPIP Order, however, will 
be processed immediately by the Trading Host without penalty and the 
UPIP auction will continue.\17\
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    \17\ The Exchange also notes that any orders or quotes on the 
opposite side of the UPIP Order that are received by the BOX Book 
after the UPIP auction has commenced (i.e., orders that are not 
otherwise part of the Initial BOX Book Quote), may be cancelled or 
modified without causing the UPIP auction to terminate as described 
in this paragraph (n).
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    f. Treatment of Unrelated Orders in the UPIP. Unrelated Orders that 
are submitted to the Trading Host during a UPIP auction that are on the 
opposite side of the market from a UPIP Order and are executable 
against the NBBO will be executed immediately against the UPIP Order at 
the mid-point of the National Best Bid (or Offer) and the best of 
either the best UPIP Improvement Order, the UPIP Start Price or the 
National Best Offer (or Bid).\18\ If the Unrelated Order on the 
opposite of the market as the UPIP Order has a quantity equal to or 
greater than the UPIP Order, the UPIP auction will terminate; 
otherwise, the immediate execution of the Unrelated Order will not 
cause the termination of the UPIP auction and the auction will 
continue. Conversely, an Unrelated Order that is on the same side of 
the market as the UPIP Order that is executable against the NBBO will 
cause the UPIP to immediately terminate.
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    \18\ Any rounding required will be to the benefit of the 
Unrelated Order.
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    g. UPIP versus Payment for Order Flow. As the Commission has 
previously indicated, payment for order flow (``PFOF'') programs are 
made possible by the fixed bid/ask spreads that are presently imposed 
on the marketplace. The UPIP, however, infiltrates those spreads by 
allowing Options Participants to bid or offer a UPIP Order in penny 
increments. The UPIP is, in many ways, the antithesis of PFOF programs 
because it transfers any ``payment'' that is paid by an Options 
Participant for an order to the customer, rather than the customer's 
broker. The pennies that were once accrued to the broker are now paid 
directly to customers in the form of price improvement.
    h. UPIP and the Penny Pilot. The impending ``Penny Pilot Program'' 
planned for 2007 endeavors, in part, to determine whether price 
improvement is possible in a ``penny-quoting'' environment and the cost 
of such an environment in the face of possible increased quote traffic 
and the related burdens placed on capacity. BOX believes UPIP is the 
Penny Pilot but on a much grander scale. UPIP will allow penny pricing 
for all option classes without any traffic consequences.
2. Statutory Basis
    The proposal is consistent with the requirements of Section 6(b) of 
the Act,\19\ in general, and Section 6(b)(5) of the Act,\20\ in 
particular, in that it provides potential price improvement in excess 
of the NBBO to certain qualifying orders, it is generally designed to 
promote just and equitable principles of trade, to prevent fraudulent 
and manipulative acts and, in general, to protect investors and the 
public interest.
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    \19\ 15 U.S.C. 78f(b).
    \20\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
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

    The Exchange has neither solicited nor received comments on the 
proposed rule change.

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which BSE consents, the Commission shall: (a) By order approve such 
proposed rule change, or (b) institute proceedings to determine whether 
the proposed rule change should be disapproved.

IV. 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 No. SR-BSE-2006-16 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-BSE-2006-16. This file 
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

[[Page 6305]]

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 also will be available for 
inspection and copying at the principal office of the BSE. 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-BSE-2006-16 and should be 
submitted on or before March 2, 2007.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\21\
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    \21\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E7-2171 Filed 2-8-07; 8:45 am]

BILLING CODE 8010-01-P
