Self-Regulatory Organizations; Order Granting Approval to Proposed Rule Changes by the Philadelphia Stock Exchange, Inc. Relating to Equity Trading Permits and Notice and Order Granting Accelerated Approval to Amendments No. 3 Thereto

I. Introduction

On January 12, 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”) and Rule 19b-4 thereunder, a proposed rule change to amend its Certificate of Incorporation to add a new article authorizing the Board of Governors to issue Equity Trading Permits (“ETPs”). The Exchange filed amendments to the proposed rule change on May 30, 2000 and July 12, 2000. The proposed rule change was published for comment in the Federal Register on September 1, 2000. On December 17, 2001, the Exchange filed Amendment No. 3 to the proposal.

Also on January 12, 2000, the Exchange submitted to the Commission, pursuant to Section 19(b)(1) of the Act and Rule 19b-4 thereunder, a proposed rule change to adopt a rule setting forth the terms and conditions of ownership of ETPs. The Exchange filed amendments to the proposed rule change on May 30, 2000 and July 12, 2000. The proposed rule change was published for comment in the Federal Register on September 1, 2000. On December 17, 2001, the Exchange filed Amendment No. 3 to the proposal.

The Commission received two comment letters regarding the proposals. This notice and order approves both proposed rule changes, as amended, and solicits comments from interested persons on Amendment No. 3 to each proposed rule change.

II. Description of the Proposal

A. SR-Phlx-00-02

The Exchange proposes to amend its Certificate of Incorporation by adding a new Article Twenty-First (“Article Twenty-First”) that authorizes the Exchange's Board of Governors (“Board”) to issue trading permits that would allow the holders of such permits to conduct business on the Exchange. Article Twenty-First also authorizes the Board to adopt rules governing, among other things, the terms, conditions, number, and transferability of permits, the qualifications that members and non-members must meet to be issued a permit, and the dues and other charges to be paid to the Exchange in connection with the permits.

Article Twenty-First permits the Board to authorize the Chairman of the Board or any Board committee to exercise any powers of the Board with respect to the permits. Article Twenty-First also provides that permit holders shall be eligible to serve on, or nominate candidates for election to, the Board or Committees thereof or other Exchange Committees referred to in the By-Law or Rules of the Exchange.

Article Twenty-First is intended to give the Board the flexibility to create a means, other than the purchase or lease of an Exchange membership, for qualified persons to acquire trading rights on the Exchange. The Exchange's Certificate of Incorporation provides that the purpose of the Exchange is to “act as and to provide a securities exchange where the [Exchange's] members and other persons authorized by it can [do business].” In Article Twenty-First, the Exchange makes clear that such “other persons” authorized to do business at the Exchange includes holders of trading permits authorized by the Board.

B. Phlx-00-03

Phlx Rule 23 will govern the terms and conditions of ETPs, which are intended to confer access privileges to the Exchange's equity trading floor. Phlx Rule 23 establishes two classes of ETPs. Regular Equity Trading Permits (“Regular ETPs”) authorize their holders to trade equity securities on any facility of the Exchange, in any capacity permitted to members, including as a specialist. Off-Floor Equity Trading Permits (“Off-Floor ETPs”) allow holders electronic and telephonic access, but not physical access, to the Exchange floor.

Phlx Rule 23(a) provides that the two classes of ETPs may be issued by the Exchange to applicants pursuant to resolution of the Board of Governors (“Board”) for such fee as may be established from time to time by the Board. The Exchange may issue a maximum of 75 ETPs.

Phlx Rule 23(b) requires ETP applications to be approved by the Exchange. The application process for applicants who are not members of the Exchange would also include an admissions determination by the Exchange's Admissions Committee. ETP applicants who are members of the Exchange when they apply for an ETP would have already received a favorable admissions determination by the Exchange's Admissions Committee. With respect to ETP applicants who are not Exchange members, the admissions process would be the same as that currently required in connection with membership applicants, and the decision to grant or deny an application for admission as an ETP holder would be made by the Admissions Committee under its established procedures. Phlx Rule 23(b) also requires the applicant to sign a pledge to abide by the By-Laws and rules of the Exchange and to submit to the Exchange's disciplinary jurisdiction.

Phlx Rule 23(c) provides that, except as may be otherwise set forth in the Rule or in other rules of the Exchange or effective Commission filings, an ETP holder will have the right to transact business on the floor of the Exchange to the same extent and in the same manner, and would be deemed to have the same rights and obligations, as a member of the Exchange without options privileges. It also establishes that an ETP holder will not be entitled by virtue of the ETP to vote in any election or on any amendment to the By-Laws or on any other matter, or to petition or to be counted as part of a quorum at meetings of members. ETP holders will, however, be eligible to serve on, and nominate candidates for, the Board of Governors and Exchange committees if elected or appointed and subject to existing qualification requirements for service, to the same extent as members. Because an ETP confers no equity interest in Exchange assets or property, Phlx Rule 23(c) establishes clearly that an ETP will not entitle its holder to share in any distribution of the assets or funds of the Exchange in the event of any voluntary or involuntary liquidation, dissolution, or winding up of the affairs of the Exchange, or to purchase options privileges. Finally, Phlx Rule 23(c) provides that specialist members who elect to sell or lease their memberships in favor of Regular ETPs would continue to be specialists in their allocated securities.

Phlx Rule 23(d) establishes the rights of holders of Off-Floor ETPs. An Off-Floor ETP holder will be able, if accompanied by a regular member, to visit the floor of the Exchange, but will not have the privilege of transacting business on it. Consequently, an Off-Floor ETP holder will not be eligible to apply for specialist privileges. With this exception, an Off-Floor ETP holder will have the same rights as a Regular ETP holder. In particular, an Off-Floor ETP holder will be authorized, for the purpose of trading equity securities, to maintain electronic or telephonic access to (i) the floor facilities on the equities floor of the Exchange of a member or member organization or a Regular ETP holder, (ii) the Philadelphia Stock Exchange Automated Communication and Execution System (“PACE”), and (iii) such other automated trading systems of the Exchange as may be made available to members of the Exchange without options privileges.

Phlx Rule 23(e) establishes the ability of the Exchange to impose fees and charges on ETP holders. An ETP holder will be subject to the same obligations and duties (including the payment of Exchange fees and charges) imposed on Exchange members, except that ETP holders will not be charged annual membership dues, technology fees, or any capital assessments that could be imposed in the future. Phlx Rule 23(e) establishes that all provisions of the Exchange's Certificate of Incorporation and By-Laws, and the rules, regulations, requirements, orders, directions and decisions adopted pursuant to them which by their terms are applicable to Exchange members will also apply to ETP holders unless their application is inconsistent with the provisions of Rule 23. Likewise, all references in such documents to “non-members” will not be construed to apply to ETP holders. Consistent with Phlx Rule 23(e), the Exchange intends to charge a $200 application fee for every ETP application made by members and non-members. Non-member applicants for ETPs will also be required to complete the same admissions process required by the Exchange for membership applicants, and will be charged the $1,500 initiation fee upon issuance of the ETP just as members are charged this fee upon election to membership. After an ETP is issued, its holder will be subject to the same fees as Phlx members (except as otherwise noted in Phlx Rule 23(e)) in addition to a monthly ETP fee.

Phlx Rule 23(f) makes clear that, unlike a membership, an ETP may not be transferred by lease, sale, gift, involuntary transfer, or any other means or as collateral to secure any obligation, except that an ETP may be transferred within the holder's ETP organization to (i) an individual who has applied for and been approved by the Admissions Committee as an ETP holder, or (ii) an “inactive nominee” registered as such with the Exchange.

Phlx Rule 23(g) provides that an individual ETP holder associated with a broker-dealer will be required to qualify such broker-dealer as an ETP firm or an ETP corporation just as a member would register it as a member firm or member corporation under current Exchange rules. Except to the extent otherwise set forth in Phlx rule 23 or in other Exchange rules or effective Commission filings, an ETP organization will have the same rights and obligations as a member organization of the Exchange. The organization would cease to be an ETP organization of the Exchange upon termination of the ETP pursuant to which the ETP organization is qualified.

Phlx Rule 23(g) also requires every ETP applicant whose fees are to be paid by such ETP organization to file, along with his or her ETP application, an agreement between the ETP applicant and the ETP organization (an “ETP Use Agreement”) providing that the ETP organization may direct the transfer of the ETP to another qualified individual within the ETP organization and that the ETP holder may not object to such transfer. The ETP Use Agreement is in some respects analogous to the A-B-C Agreement provided for in Exchange Rule 930 pursuant to which a member contributes the use of a membership to the membership organization. Like the A-B-C Agreement provided for in Rule 940, the ETP Use Agreement would restrict the use of the ETP by its holder in the event of the holder's termination of his association with the ETP organization.

Phlx Rule 23(h) permits the Exchange to suspend or expel an individual ETP holder on the same basis as a member. It also permits the Exchange to amend the terms of, to discontinue offering or to terminate existing ETPs of one or more classes at any time upon thirty days written notice. Similarly, Phlx Rule 23(h) requires an ETP holder to provide the Exchange thirty days written notice prior to termination of the ETP. The Exchange is required to provide notice of an ETP's termination to the membership in the same manner it provides notice of a proposed transfer of a membership. The ETP holder will remain liable for all obligations incurred as an ETP holder until these obligations are discharged, and the Exchange is authorized to draw upon any security provided pursuant to Rule 23(i), discussed below, for the payment of such obligations at any time if they remain unpaid as of the date of termination.

Phlx Rule 23(i) requires ETP organizations to provide acceptable security for payment of any claims pursuant to By-Law 15-3 upon termination of an ETP. The proceeds of the posted security may be applied by the Exchange upon termination of any ETP in the same manner as proceeds of membership transfers under By-law 15-3. The security requirement may be met, at the option of the ATP organization, by providing a letter of credit or other guaranty acceptable to the Exchange, or by depositing $50,000 with the Exchange to be held in a segregated account with all other such deposits and held by the Exchange as security. The security required is the same for each ETP organization, regardless of the number of ETPs issued to its associated persons, and is unrelated to any security requirement established by SCCP. The requirement does not apply to member organizations or ETP organizations that have been in good standing at the Exchange for the previous year. Consequently, ETP organizations in good standing for one year after providing such security will be entitled to its return, subject to any prior or appending claims. Finally, Phlx Rule 23(i) makes clear that at such time as no ETP holders remain associated with the ETP organization, the Exchange shall release any remaining security following payment of claims pursuant by By-Law 15-3 and upon execution by the ETP holder and ETP organization of releases satisfactory to the Board of Governors.

The Exchange expects to first undertake the ETP offering by distributing an informational circular and an ETP Application Form to be completed and returned to the Exchange together with payment of the Exchange's application fee. In addition to the ETP Application Form, applicants who are not Exchange members will be required to supply to the Admissions Committee all information required for that Committee to make an admissions determination under its established procedures, as discussed above.

III. Summary of Comments

The Commission received two comment letters in response to the proposed rule changes. One commenter expressed general support for the proposal, stating that it would place the Phlx “in a pro-competitive position with other exchanges that have reduced the cost of access to electronic trading facilities.” The other commenter, however, challenged the Phlx's authority to authorize the Board to issue trading permits without a membership vote, and stated that the purpose of the proposal was to harm persons who lease seats to members wishing to trade on the Phlx Floor (“Lessors”).

The commenter argued that the Phlx Certificate of Incorporation contemplates a fixed number of membership seats, possession of which gives a person or entity access and trading rights to the Phlx trading floor. Issues relating to membership seats, including different classes of members, are governed by the Exchange's By-Laws, according to the commenter. The commenter goes on to argue that the proposed ETPs are “de facto membership seats,” and thus should be governed by the By-Laws, a change to which requires a membership vote, not the Certificate of Incorporation. The commenter describes the addition of a new article to the Certificate of Incorporation to create the ETPs as an attempt by the Exchange to do an end-run around its By-Laws, and avoid a full membership vote on the proposal.

The Exchange, however, believes that the Certificate of Incorporation already permits ETPs, and that an amendment of the Exchange's By-Laws is not required. Further, the Exchange believes that the proposed amendment to the Certificate of Incorporation authorizes ETPs in any event and supersedes any inconsistent provision in the By-Laws as a matter of basic corporate law.

The Wayne Letter also contends that the Exchange's proposal to create ETPs is part of “a methodical plan to destroy both Lessors and the value of PHLX membership seats.” The commenter states that “[t]hrough the proposed trading permits, the PHLX is attempting to divert seat rental income from Lessors directly to the Exchange,” and that it is the intention of the Board that if the proposal is approved, persons wishing to trade on the Exchange will purchase a permit rather than lease a seat. The commenter states that the Board owes a fiduciary duty to Lessors, which prohibits it from competing directly against Lessors in this manner.

The Exchange has considered this comment and stated that its business judgment the potential benefits to the Exchange of the trading permits, including the potential for increased access and enhance competition on the trading floor and the opportunity to attract additional order flow and new business, justify any possible dilution of memberships and may, in the longer term, result in higher prices for regular memberships. The Exchange believes that ETPs are in the best interests of the Exchange and its membership as a whole (including both lessee members and lessor owners), and notes that the Exchange's stated purpose in Article Third of its Certificate of Incorporation is “[t]o act as and to provide a securities exchange where [its] members and other persons authorized by it” can deal in securities.

IV. Discussion

After careful review, the Commission finds that the proposed rule changes are consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange. In particular, the Commission finds that the proposed rule changes further the objectives of Sections 6(b)(2), 6(b)(3), and 6(b)(5).

The Commission believes that the proposed rule changes are consistent with Section 6(b)(5) of the Act and are not designed to permit unfair discrimination between customers, issuers, brokers or dealers. The Commission finds that ETPs may help facilitate transactions by allowing more broker-dealers direct access to the Phlx market and attracting greater order flow consistent with Section 6(b)(2) of the Act.

In addition, the Commission finds that the proposed rule change is consistent with Section 6(b)(3) of the Act. The Commission notes that the Exchange's Board can issue no more than 75 ETPs, which is not significant in relation to the number of regular members on the Exchange. The Commission also notes that the Phlx is a member-controlled exchange, which includes 52 members using a membership on the equity floor, whose interests are represented on the Nominating and Election Commission and Business Conduct Commission, and that the Phlx has committed to appointing a qualified ETP holder, or associated person thereof, to the Exchange's Business Conduct Committee at the next annual appointment of Business Conduct Committee members. Finally, the Commission notes that any disciplinary or trading rules affecting these members are subject to the rule filing process, which requires that proposed rules be submitted to the Commission for consideration and approval.

V. Amendment No. 3

A. SR-Phlx-00-02

The Commission finds good cause for approving Amendment No. 3 to SR-Phlx-00-02 prior to the thirtieth day after the date of publication of notice thereof in the Federal Register. In Amendment No. 3, the Exchange amended the Certificate of Incorporation to provide that the permit holders may serve on, or nominate candidates for the Board or Committees. The Amendment also added language to the Certificate of Incorporation which clarified that permit holders are not members of the Exchange for purposes of DGCL and shall have no rights or privileges conferred upon members of a nonstock corporation solely by DGCL. In addition to making changes to the language of the Certificate of Incorporation, the Exchange represented that the Board of Governors will appoint a qualified ETP holder, or associated person thereof, to the Exchange's Business Conduct Committee at the next annual appointment of Business Conduct Committee members, presently scheduled for March 2002, and that it has authorized the Board to issue only 75 permits.

The Commission finds that the Exchange's proposed changes and representations made in Amendment No. 3 further strengthen and clarify the proposed rule change and raise no new regulatory issues. The Commission believes that permitting ETP holders to serve on the Board or Committees, and nominate candidates for the Board, is appropriate and furthers the objectives of Section 6(b)(3) of the Act, which states that the rules of the exchange must assure a fair representation of its members in the selection of its directors and administration of its affairs. These goals are also furthered by the Exchange's commitment to place an ETP holder on the Business Conduct Committee.

Therefore, the Commission finds that granting accelerated approval to Amendment No. 3 is appropriate and consistent with Section 19(b)(2) of the Act.

B. SR-Phlx-00-03

The Commission finds good cause for approving Amendment No. 3 to SR-Phlx-00-03 prior to the thirtieth day after the date of publication of notice thereof in the Federal Register. In Amendment No. 3, the Exchange amended Rule 23(a) to provide that the Exchange may issue a maximum of 75 ETPs.

Amendment No. 3 also clarified in proposed Rule 23(c) that ETPs holders are deemed to be members for purposes of eligibility requirements to serve on the Board or Exchange Committees and for the purpose of nominating candidates for the Board. The Commission believes that permitting ETP holders to serve on, and nominate candidates for, the Board or Committees is appropriate and furthers the objectives of Section 6(b)(3) of the Act, which states that the rules of the exchange must assure a fair representation of its members in the selection of its directors and administration of its affairs.

In addition, Amendment No. 3 added language to proposed Rule 23(c) to clarify that ETPs issued by the Exchange are not “Regular Memberships” or “Convertible Memberships” of the Exchange, and that ETP holders are not members of the Exchange for purposes of DGCL, and shall have no rights or privileges conferred upon members of a nonstock corporation solely by the DGCL. The amendment clarifies the status of ETPs and ETP holders.

Amendment No. 3 also added language to proposed Rule 23(i) to make clear that ETP organizations will be required to post security with the Exchange, the proceeds of which may be applied by the Exchange upon termination of any ETP in the same manner as proceeds of membership transfers under Exchange By-Law 15-3. Exchange By-Law 15-3 provides that the proceeds from the transfer of a membership shall be applied by the Exchange to satisfy existing claims against such member. Again, the Commission believes that this change is merely to clarify the procedure that will be followed in the event an ETP is terminated.

Finally, Amendment No. 3 makes technical non-substantive changes to the proposal to ensure internal consistency exists in the Exchange rules.

The Commission finds that the Exchange's proposed changes in Amendment No. 3 further strengthen and clarify the proposed rule change. Therefore, the Commission finds that granting accelerated approval to Amendment No. 3 is appropriate and consistent with Section 19(b)(2) of the Act.

VI. Solicitation of Comments

Interested persons are invited to submit written data, views, and arguments concerning Amendment Nos. 3, including whether the proposed amendments are consistent with the Act. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. Copies of the submission, all subsequent amendments, all written statements with respect to the proposed amendment that are filed with the Commission, and all written communications relating to the amendment 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 at the Commission's Public Reference Room. Copies of such filing also will be available for inspection and copying at the principal office of the Phlx.

All submissions should refer to File Nos. SR-Phlx-00-02 and SR-Phlx-00-03 and should be submitted by February 8, 2002.

VII. Conclusion

For all of the aforementioned reasons, the Commission finds that the proposed rule changes are consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange.

It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that he proposed rule changes (SR-Phlx-00-02 and SR-Phlx-00-03), as amended, are approved.