

[Federal Register: August 8, 2007 (Volume 72, Number 152)]
[Notices]               
[Page 44593-44596]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr08au07-114]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56186; File No. SR-BSE-2006-56]

 
Self-Regulatory Organizations; Boston Stock Exchange, Inc.; 
Notice of Filing of Amendment No. 2 to the Proposed Rule Change and 
Order Granting Accelerated Approval of Proposed Rule Change as Modified 
by Amendments No. 1 and 2 Thereto To Add to the Boston Options Exchange 
a New Functionality Called an Auto Auction Order

August 2, 2007.

I. Introduction

    On December 15, 2006, the Boston Stock Exchange, Inc. (``BSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposal to amend the Boston Options Exchange (``BOX'') Rules to add a 
new functionality referred to as an Auto Auction Order (``AAO'') to 
make it easier for customers to participate in a price improvement 
auction (``Improvement Auction''). On February 1, 2007, BSE filed 
Amendment No. 1 to the proposed rule change. The proposed rule change 
was published for comment in the Federal Register on February 12, 
2007.\3\ The Commission received one comment letter regarding the 
proposal.\4\ BSE filed a response to the comment letter on June 8, 
2007.\5\ On June 8, 2007, BSE filed Amendment No. 2 to the proposed 
rule change.\6\ This order approves the proposed rule

[[Page 44594]]

change, as modified by Amendments No. 1 and 2, on an accelerated basis.
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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. 55233 (February 2, 
2007), 72 FR 6626 (``Notice'').
    \4\ See letter to Nancy M. Morris, Secretary, Commission, from 
Michael J. Simon, Secretary, International Securities Exchange, LLC 
(``ISE''), dated March 5, 2007 (``ISE Letter'').
    \5\ See letter to Nancy M. Morris, Secretary, Commission, from 
William Meehan, General Counsel, BSE, dated June 8, 2007 (``BSE 
Letter'').
    \6\ In Amendment No. 2, BSE amended the proposal to reflect that 
AAOs may be entered only for Public Customer accounts and only in a 
series for which the standard trading increment is greater than one 
cent. BSE also made corresponding technical changes to the rule 
text.
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II. Description of the Proposal

    BSE proposes to amend the BOX Rules to add a new order 
functionality called an AAO that would automatically participate in any 
Improvement Auction (e.g., Price Improvement Period (``PIP'') auction) 
\7\ if it meets certain criteria. An AAO is a Limit Order that is 
submitted by an Order Flow Provider (``OFP'') \8\ on behalf of a Public 
Customer \9\ to the BOX Trading Host in one-cent increments in a series 
whose minimum trading increment is greater than one cent. The penny 
incremented limit price that is entered by the Public Customer is 
referred to as the ``AAO Maximum Improvement Price.'' The AAO Maximum 
Improvement Price is the maximum (if the order is to buy) or minimum 
(if the order is to sell) price at which the Public Customer is willing 
to trade in any Improvement Auction.
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    \7\ See Chapter V, Section 18 of the BOX Rules.
    \8\ ``Order Flow Provider'' is defined as an Options Participant 
representing as agent Customer Orders on BOX and those non-Market 
Maker Participants conducting proprietary trading. See Chapter I, 
Section 1(a)(46) of the BOX Rules.
    \9\ ``Public Customer'' is defined a person that is not a broker 
or dealer in securities. See Chapter I, Section 1(a)(50) of the BOX 
Rules.
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    The BOX Trading Host will round AAOs to the nearest minimum trading 
increment (up if the order is to sell and down if the order is to buy) 
and place it on the BOX Book (``AAO Limit Order''). The AAO Limit Order 
will be processed as a standard Limit Order as described in Chapter 5, 
Section 14(c)(i) of the BOX Rules and will be traded in accordance with 
Chapter 5, Section 16 of the BOX Rules.

A. Eligibility

    An AAO will be eligible to participate in any Improvement Auction 
that may occur when the AAO is on the opposite side of the market from 
the order seeking improvement and the AAO Limit Price is equal to the 
National Best Bid or Offer (``NBBO''). If the AAO is eligible, the BOX 
trading engine will automatically create a new order (the ``AAO 
Improvement Order'') at the end of the auction phase, but prior to any 
trade allocations, with the following terms:
    (1) The quantity of the AAO Improvement Order will be the lesser of 
the remaining quantity on the BOX Book at the AAO Limit Price or the 
quantity of the order seeking improvement in the auction; and
    (2) the price of the AAO Improvement Order will be equal to the 
price of the best Improvement Order, Primary Improvement Order, or 
unrelated order (on the same side of the market as the AAO) submitted 
to the Improvement Auction.

B. Trade Processing of AAO

    During an Improvement Auction, if the number of contracts executed 
in the Improvement Auction against the AAO Improvement Order is less 
than the quantity of the AAO Limit Order, then, prior to the processing 
of any other orders in the same series on the opposite side of the 
market as the AAO Limit Order, the quantity of the AAO Limit Order will 
be decremented on the BOX Book by the size of the executed quantity of 
the AAO Improvement Order. Any residual quantity that remains after 
part of an AAO has traded (either on the BOX Book or in the Improvement 
Auction) will continue to be eligible to trade in any subsequent 
Improvement Auctions. In addition, the residual quantity will maintain 
its priority on the BOX Book in accordance with Chapter V, Section 16 
of the BOX Rules.
    Any AAO Improvement Order created by the BOX Trading Host will be 
assigned the time priority of the related AAO Limit Order. As such, the 
AAO Improvement Order is granted time priority at its relevant price 
level in an Improvement Auction. Any modification to the AAO Maximum 
Improvement Price that causes the rounded AAO Limit Price to change or 
any increase in the quantity of the AAO will cause a new time priority 
to be assigned to the AAO Limit Order on the BOX Book. Any changes to 
the AAO Maximum Improvement Price that do not effect the AAO Limit 
Price will not cause a change to the time priority of the original 
order.
    Additionally, a new AAO received in a particular series that is on 
the opposite side of the market from another AAO, which is already on 
the BOX Book, and is marketable at the AAO Maximum Improvement Price of 
the other booked AAO (e.g., a buy AAO is on the BOX Book with a Limit 
Price bid of $2.00 with an AAO Maximum Improvement Price of $2.03 and a 
new sell AAO is received by the BOX Trading Host with an AAO Maximum 
Improvement Price of $2.02), will be matched at the mid-point of the 
two AAO Maximum Improvement Prices, rounded to the nearest penny 
increment in the favor of the AAO that is already on the BOX Book.\10\ 
The quantity of the resulting trade will be for the lesser quantity of 
the two AAOs.
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    \10\ The Commission notes that a non-AAO incoming order that is 
marketable at the AAO Limit Price will execute against the AAO at 
the displayed Limit Price.
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III. 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 Number SR-BSE-2006-56 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-BSE-2006-56. 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 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, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of 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-2006-56 and should be 
submitted on or before August 29, 2007.

[[Page 44595]]

IV. Discussion

    After careful review of the amended proposal, the ISE Letter, and 
the BSE Letter, the Commission finds that the proposed rule change is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities exchange\11\ 
and, in particular, the requirements of section 6 of the Act.\12\ 
Specifically, the Commission finds that the proposed rule change is 
consistent with section 6(b)(5) of the Act,\13\ which requires, among 
other things, that the rules of a national securities exchange be 
designed to prevent fraudulent and manipulative acts and practices, 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. Significant aspects of the proposal are discussed below.
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    \11\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \12\ 15 U.S.C. 78f.
    \13\ 15 U.S.C. 78f(b)(5).
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A. Order Exposure

    The proposal provides that the undisplayed penny price of an AAO 
resting on the BOX Book can execute against the undisplayed penny price 
of another AAO.\14\ The commenter notes that other orders in the BOX 
marketplace, such as market orders and limit orders that are marketable 
against the displayed price of an AAO, would not receive the benefit of 
the hidden penny price. The commenter believes that the proposal thus 
provides a mechanism by which participants can cross orders on BOX with 
no exposure to the marketplace.\15\ In response, BSE has amended its 
proposal to limit the use of the AAO to only Public Customers.\16\ The 
Commission believes that the amended proposal is consistent with 
Section 6(b)(5) of the Act.\17\
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    \14\ See proposed Chapter V, Section 14(c)(v)(F) of the BOX 
Rules.
    \15\ See ISE Letter, supra note 4, at 1-2.
    \16\ See Amendment No. 2, supra note 6.
    \17\ 15 U.S.C. 78f(b)(5).
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B. Priority and Price Competition

    The commenter also argues that the AAO would not provide for 
additional price improvement opportunities, would discourage aggressive 
competition in the PIP, and would unfairly advantage the AAO in the PIP 
auction. First, the commenter contends that the AAO would not provide 
for any increased opportunities for price improvement in the PIP 
because the AAO Improvement Order would be generated at the conclusion 
of the three second exposure period (and thus not be broadcast to other 
BOX Participants) and would only match the best price provided by other 
BOX participants, even if the AAO contained an AAO Maximum Improvement 
Price that would provide additional price improvement to the PIP 
order.\18\ Second, the commenter believes that the proposal will 
discourage other BOX Participants from competing aggressively for PIP 
orders because it provides time priority for the AAO Improvement Order 
in the PIP based upon the entry time of the original AAO. Third, the 
commenter argues that the AAO is unfairly advantaged in the PIP auction 
because only through use of an AAO can a participant adjust the price 
at which they are willing to participate in the PIP auction without 
other participants knowing about its interest and still maintain its 
initial time priority.\19\
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    \18\ See ISE Letter, supra note 4, at 2.
    \19\ See ISE Letter, supra note 4, at 3. As noted above, an AAO 
would not lose its initial time priority if there are changes to the 
initial penny order price, so long as the change does not affect the 
displayed limit order price. See proposed Chapter V, Section 
14(c)(v)(E) of the BOX Rules.
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    In response, BSE argues that the AAO will provide increased price 
improvement opportunities because it would increase the size available 
at the best Improvement Order price.\20\ Further, BSE argues that the 
AAO will encourage aggressive quoting in the PIP by incenting 
competitors to put forth their best price to potentially better the AAO 
Maximum Improvement Price and thus increase their likelihood of 
allocation. In addition, BSE analogizes the AAO to BOX's Customer PIP 
Order,\21\ which also is displayed on the BOX Book at a standard 
increment but contains a penny price that is not broadcast to PIP 
participants.\22\ BSE represents that the AAO functionality is being 
proposed to make it easier for customers to participate in an 
Improvement Auction, especially non-professional customers who lack the 
ability to monitor and adjust prices fast enough to be competitive, and 
who may not have access to a broker that utilizes the CPO function. BSE 
therefore believes that the AAO functionality will increase competition 
in the PIP because it will allow more new entrants. Additionally, BSE 
notes that since Public Customer orders already have priority status in 
Improvement Auctions pursuant to customer priority rules, the AAO will 
only incrementally increase the priority available to them.\23\
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    \20\ See BSE Letter, supra note 5, at 2.
    \21\ See Securities Exchange Release No. 49068 (January 13, 
2004), 69 FR 2775 (January 20, 2004).
    \22\ See BSE Letter, supra note 5, at 2.
    \23\ See BSE Letter, supra note 5, at 3.
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    The Commission agrees that the availability of the AAO should 
increase the ability of Public Customers to participate in Improvement 
Auctions.\24\ The Commission also does not believe that the possibility 
of undisclosed AAO penny interest will give Improvement Auction 
participants a disincentive to enter their best prices and may provide 
a further incentive to enter their best prices to increase the 
likelihood of participating in the execution of the order. Further, the 
AAO functionality provides the potential for increased size available 
at the best Improvement Price. The Commission therefore believes that 
the AAO functionality is consistent with the Act.
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    \24\ BSE represents that only a few OFPs have made CPOs 
available to non-professional customers due, in large part, to the 
constraints that are generally associated with the software 
development an OFP is required to undertake to handle the processing 
of the CPO. See Notice, supra note 3.
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    The Commission further notes that an AAO Limit Order would only be 
eligible to participate in an Improvement Auction, and thus receive 
time priority, when the AAO Limit Order equals the NBBO on the opposite 
side of the Improvement Auction order at the start of the auction. The 
AAO is similar to the Market Maker Prime (``MMP'') designation in the 
PIP, in which a market maker that has a quote at the moment the PIP 
commences that is equal to the NBBO on the same side as the PIP Primary 
Improvement Order is eligible to be designated MMP for that particular 
PIP auction and receive priority over other Improvement Orders in the 
auction.\25\ The Commission believes that the proposal to give time 
priority to an AAO that quotes aggressively before an Improvement Order 
is initiated is consistent with the Act and may provide a further 
incentive for Public Customers to publicly display their best prices, 
which would benefit all options market participants.
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    \25\ The MMP who participates in a PIP will have partial 
priority over all other competing orders, including the AAO, entered 
into the PIP at the same limit price. See Chapter V, Section 19(b) 
of the BOX Rules.
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C. Penny Pilot

    The commenter argues that the Penny Pilot Program \26\ is the 
appropriate

[[Page 44596]]

method to approach penny pricing in the options markets, rather than a 
mechanism that bypasses auction market principles.\27\ As discussed 
above, with respect to the commenter's substantive arguments, the 
Commission believes the AAO functionality is consistent with the Act. 
Further, the Commission notes that the proposal, as amended, is 
intended to make it easier for Public Customers to participate in the 
PIP (or other future Improvement Auctions), which already allows 
trading in penny increments. In addition, pursuant to the amended 
proposal, AAOs may only be entered in series that are limited to 
quoting in standard increments greater than one cent. The Commission 
believes it is consistent with the Act to allow BSE to implement 
another initiative designed to allow limited trading in penny 
increments at the same time it participates in the Penny Pilot Program.
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    \26\ The Penny Pilot was approved by the Commission to allow BOX 
to permit certain option classes to be quoted in pennies on a pilot 
basis. See Securities Exchange Act Release No. 55155 (January 23, 
2007), 72 FR 4741 (February 1, 2007) (SR-BSE-2006-49).
    \27\ See ISE Letter, supra note 4, at 3.
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D. Accelerated Approval

    The Commission finds good cause to approve the proposal prior to 
the thirtieth day after the proposal was published for comment in the 
Federal Register. The proposed rule change, as modified by Amendment 
No. 1, was published for full notice and comment.\28\ Amendment No. 2, 
which limits the AAO functionality to Public Customer accounts, and in 
a series for which the standard trading increment is greater than one 
cent, modifies the proposal in response to issues raised by a 
commenter. For these reasons, the Commission finds good cause, 
consistent with section 19(b)(2) of the Act, to grant accelerated 
approval to the proposed rule change.
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    \28\ See Notice, supra note 3.
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V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\29\ that the proposed rule change (SR-BSE-2006-56), as modified by 
Amendments No. 1 and 2, be, and it hereby is, approved on an 
accelerated basis.
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    \29\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\30\
Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E7-15431 Filed 8-7-07; 8:45 am]

BILLING CODE 8010-01-P
