Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change, and Amendment Nos. 1, 2, and 3 Thereto, by the Boston Stock Exchange, Inc. Relating to the Trading of Market Orders on the Boston Options Exchange, 22156-22162 [E5-2044]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 70, Number 81 (Thursday, April 28, 2005)]
[Notices]
[Pages 22156-22162]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E5-2044]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51597; File No. SR-BSE-2004-51]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change, and Amendment Nos. 1, 2, and 3 Thereto, by the Boston Stock 
Exchange, Inc. Relating to the Trading of Market Orders on the Boston 
Options Exchange

April 21, 2005.
    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 15, 2004, 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 prepared by the Exchange. On 
January 5, 2005, the Exchange filed Amendment No. 1 to the proposed 
rule change. On April 19, 2005, the Exchange filed Amendment No. 2 to 
the proposed rule change.\3\ On April 21, 2005, the Exchange filed 
Amendment No. 3 to the proposed rule change.\4\ 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    \3\ Amendment No. 2 superseded and replaced the original filing 
and Amendment No. 1 in their entirety.
    \4\ In Amendment No. 3, BSE made several conforming and 
technical changes to the proposed rule text.
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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 allow market orders to trade on BOX. The text of 
the proposed rule change is set forth below. Italics indicate 
additions; brackets indicate deletions.\5\
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    \5\ At the request of the BSE, the Commission staff has made 
several corrections to the rule text. Telephone conversation between 
Annah Kim, Chief Regulatory Officer, BOX, et al., and Ira Brandriss, 
Assistant Director, Division of Market Regulation (``Division''), et 
al., on April 21, 2004.
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Rules of the Boston Stock Exchange

Rules of the Boston Options Exchange Facility

Trading of Options Contracts on BOX
Chapter V. Doing Business on BOX
    Sec. 1 through Sec. 8 No change.
    Sec. 9 Opening the Market.
    The following rules are in effect until August 6, 2005:
    (a) Pre-Opening Phase. For some period of time before the opening 
in the underlying security (as determined by BOXR but not less than one 
hour and distributed to all BOX Participants via regulatory circular 
from BOXR), the BOX Trading Host will accept orders and quotes. During 
this period, known as the Pre-Opening Phase, orders and quotes are 
placed on the BOX Book but do not generate trade executions. Complex 
Orders and contingency orders (except ``Market-on-Opening'', Minimum 
Volume, and Fill and Kill orders) do not participate in the opening and 
are not accepted by the BOX Trading Host during this Pre-Opening Phase. 
BOX-Top Orders and Price Improvement Period orders are not accepted 
during the Pre-Opening Phase.
    (b) Calculation of Theoretical Opening Price. From the time that 
the BOX Trading Host commences accepting orders and quotes at the start 
of the Pre-Opening Phase, the BOX Trading Host will calculate and 
provide the Theoretical Opening Price (``TOP'') for

[[Page 22157]]

the current resting orders and quotes on the BOX Book during the Pre-
Opening Phase. The TOP is that price at which the Opening Match would 
occur at the current time, if that time were the opening, according to 
the Opening Match procedures described in paragraph (e) below. The 
quantity that would trade at this price is also calculated. The TOP is 
re-calculated and disseminated every time a new order or quote is 
received, modified or cancelled and where such event causes the TOP 
price or quantity to change.
    A TOP can only be calculated if an opening trade is possible. An 
opening trade is possible if: (i) The BOX Book is crossed (highest bid 
is higher than the lowest offer) or locked (highest bid equals lowest 
offer), or ii) there are Market or Market-on-Opening Orders in the BOX 
Book and at least one order or quote on the opposite side of the 
market.
    (c) Broadcast Information During Pre-Opening Phase. The BOX Trading 
Host will disseminate information to all BOX Participants about resting 
orders in the BOX Book that remain from the prior business day and any 
orders or quotes sent in before the Opening Match. This information 
will be disseminated in the usual BOX format of five best limits and 
associated quantity, aggregating all orders and quotes at each price 
level. This broadcast will also include the TOP and the quantity 
associated with the TOP. Any orders or quotes which are at a price 
better i.e. bid higher or offer lower) than the TOP, as well as all 
Market and Market-on-Opening orders will be shown only as a total 
quantity on the BOX Book at a price equal to the TOP.
    (d) Market Maker Obligations During Pre-Opening Phase. BOX Market 
Makers holding an assignment on a given options class are obliged, as 
part of their obligations to ensure a fair and orderly market, to 
provide continuous two-sided quotes according to the BOX minimum 
standards commencing with the minute preceding the scheduled opening of 
the market for the underlying security.
    (e) Opening Match.
    (i) Complex Orders and contingency orders do not participate in the 
Opening Match or in the determination of the opening price. The BOX 
Trading Host will establish the opening price at the time of the 
Opening Match. The opening price is the TOP at the moment of the 
Opening Match. The BOX Trading Host will process the series of a class 
in a random order, starting at the first round minute after the opening 
for trading of the underlying security in the primary market, and at 
each round minute thereafter. If the opening of a particular class is 
to occur within 15 seconds of the next round minute, the opening of 
that class will take place at the next subsequent round minute after 
the round minute that is 15 or less seconds away (i.e. within 75 
seconds). The TOP/opening price of a series is the ``market-clearing'' 
price which will leave bids and offers which cannot trade with each 
other. In determining the priority of orders to be filled, the BOX 
Trading Host will give priority to Market Orders first, then to Market-
on-Opening orders [first], then to Limit Orders whose price is better 
than the opening price, and then to resting orders on the BOX Book at 
the opening price. One or more series of a class may not open because 
of conditions cited in paragraph (f) of this Section 9.
    (ii) The BOX Trading Host will determine a single price at which a 
particular option series will be opened. BOX will calculate the optimum 
number of options contracts that could be matched at a price, taking 
into consideration all the orders on the BOX Book.
    (1) The opening match price is the price which will result in the 
matching of the highest number of options contracts.
    (2) Should two or more prices satisfy the maximum quantity 
criteria, the price which will leave the fewest resting contracts in 
the BOX Book will be selected as the opening match price.
    (3) Should there still be two or more prices which meet both 
criteria in subparagraphs (1) and (2), the price which is closest to 
the previous day's closing price will be selected as the opening match 
price. For new classes in which there is no previous day's closing 
price, BOX will utilize the price assigned to the class by BOX at the 
time the class was created (``reference price'').
    (f) As the Opening Match price is determined by series, the BOX 
Trading Host will proceed to move the series from the Pre-Opening Phase 
to the continuous or regular trading phase and disseminate to OPRA and 
to all Options Participants the opening trade price, if any. At this 
point, the BOX trading system is open for trading and all orders and 
quotes are accepted and processed according to the BOX trading rules. 
When the BOX Trading Host cannot determine an opening price, but none 
of the reasons exist for delaying an opening as outlined in paragraph 
(g) of this Section 9, below, the series will nevertheless move from 
Pre-Opening Phase to the continuous trading phase.
    (g) The BOX Trading Host will not open a series if one of the 
following conditions is met:
    i. The opening price is not within an acceptable range as 
determined by the MRC, and will be announced to all BOX Participants 
via the Trading Host. (In making this determination the MRC will 
consider, among other factors, all prices that exceed a variance 
greater than [of] either $.50 or 20% to the previous day's closing 
price.)
    ii. There is a Market Order, Market-on-Opening order or quote with 
no corresponding order or quote on the opposite side.
    (h) If one of the conditions in paragraph (g) of this Section 9 is 
met, the MRC will not open the series but will send a RFQ. MRC will 
delay the opening of the series until such time as responses to the RFQ 
from the BOX Market Makers assigned to the class, or other interested 
trading parties, have been received and booked by the BOX Trading Host 
and the consequent opening price is deemed compatible with an orderly 
market.
    (i) MRC may order a deviation from the standard manner of the 
opening procedure, including delaying the opening in any option class, 
when it believes it is necessary in the interests of a fair and orderly 
market.
    (j) The procedure described in this Section 9 may be used to reopen 
a class after a trading halt.
* * * * *
Sec. 14 Order Entry
    (a) through (b) No change.
    (c) The following types of orders may be submitted to the Trading 
Host:
    i. through iii. No change.
    iv. Market Order. Market Orders submitted to BOX are executed at 
the best price obtainable for the total quantity available when the 
order reaches the BOX market. Any remaining quantity is executed at the 
next best price available for the total quantity available. This 
process continues until the Market Order is fully executed. Prior to 
execution at each price level, Market Orders are filtered pursuant to 
the procedures set forth in Chapter V, Section 16(b) of these Rules to 
avoid trading through the NBBO.
    At the opening, Market Orders have priority over Market-on-Opening 
Orders and Limit Orders. In the case where the lowest offer for any 
options contract is $.05, and an Options Participant enters a Market 
Order to sell that series, any such Market Order shall be considered a 
Limit Order to sell at a price of $.05.
    (d) Where no order type is specified, the Trading Host will reject 
the order.

[[Page 22158]]

    i. The following designations can be added to one or both of the 
order types referred to in paragraph (c) above:
    (1) through (3) No change.
    (4) Minimum Volume (MV). An MV designation can be added to [both] 
Limit Orders, [and] BOX Top Orders, and Market Orders. MV orders will 
only be executed if the specified minimum volume is immediately 
available to trade (at the specified price or better in the case of 
Limit Orders). If this is not the case the order will be automatically 
cancelled by the Trading Host. In the case of Limit Orders, where a 
volume equal to or greater than the specified minimum volume of an MV 
order trades, the residual volume will be filtered against trading 
through the NBBO according to the procedures set forth in Section 16(b) 
of this Chapter V and, if applicable, placed on the BOX Book. In the 
case of BOX-Top Orders, where a volume equal to or greater than the 
specified minimum volume of an MV order trades, the residual volume 
will be converted to a Limit Order at the price at which the BOX-Top 
Order was executed pursuant to Section 14(c)(ii) of this Chapter V and 
will be filtered against trading through the NBBO according to the 
procedures set forth in Section 16(b) of this Chapter V and, if 
applicable, placed on the BOX Book. In the case of Market Orders, where 
a volume equal to or greater than the specified minimum volume of an MV 
order trades, the residual volume will be filtered against trading 
through the NBBO according to the procedures set forth in Section 16(b) 
of this Chapter V and, if applicable, executed with any orders on the 
BOX Book.
    (e) through (i) No change.
* * * * *
Sec. 16 Execution and Price/Time Priority
    (a) No change.
    (b) Filtering of BOX In-Bound Orders to Prevent Trade-Throughs.
    i. No change.
    ii. If the order is a BOX-Top Order, the Trading Host will handle 
the order in the following manner:
    (1) In the case where the best price on the BOX Book on the 
opposite side of the market from the BOX-Top order is equal to the 
NBBO, the BOX-Top Order will be executed for all the quantity available 
at this price. Any remaining quantity will be converted to a Limit 
Order at this execution price pursuant to Section 14(c)(ii) of this 
Chapter V and filtered as described in subparagraph b(iii) below.
    (2) In the case where the best price on the BOX Book on the 
opposite side of the market from the BOX-Top Order is not equal to the 
NBBO, the BOX-Top Order will be converted to a Limit Order for its 
total quantity at the then current NBBO pursuant to Section 14(c)(ii) 
of this Chapter V and filtered as described in subparagraph b(iii) 
below.
    If the Order is a Market Order, the Trading Host will handle the 
order in the following manner:
    (1) In the case where the best price on the BOX Book on the 
opposite side of the market is equal to the NBBO, the Market Order will 
be executed for all the quantity available at this price. Any remaining 
quantity will be filtered as described in subparagraph b(iii) below.
    (2) In the case where the best price on the BOX Book on the 
opposite side of the market from the Market Order is not equal to the 
NBBO, the Market Order will be filtered as described in subparagraph 
b(iii) below.
    iii. The Trading Host will filter the relevant orders as follows:
    The filter will determine if the order is executable against the 
NBBO (an order is deemed ``executable against the NBBO'' when, in the 
case of an order to sell(buy), its limit price is equal to or 
lower(higher) than the best bid(offer) across all options exchanges. By 
definition, a BOX-Top Order or a Market Order is executable against the 
NBBO).
    (1) If the order is not executable against the NBBO, the order will 
be placed on the BOX Book. However, if the order is a P or P/A Order, 
and not executable against the NBBO, it will be immediately cancelled 
pursuant to Chapter XII of these Rules.
    (2) If the order is executable against the NBBO, the filter will 
determine whether there is a quote on BOX that is equal to the NBBO.
    a. If there is a quote on BOX that is equal to the NBBO, then the 
order will be executed against the relevant quote. Any remaining 
quantity of the order is exposed on the BOX Book at the NBBO for a 
period of three seconds. If the order is not executed during the three 
second exposure period, then the order will be handled by the Trading 
Host pursuant to subparagraph b(iii)(2)(c) below. Pursuant to Chapter 
XII, Section 2(c)-(d) of these Rules, in the case of a P/A Order, if 
the size of the P/A Order is larger than the Firm Customer Quote Size, 
or, in the case of a P Order, if the size of the P Order is larger than 
the Firm Principal Quote Size, and any quantity remains after execution 
against the relevant quote, then such remaining quantity is exposed on 
the BOX Book at the NBBO for a period of three seconds. Any quantity 
remaining on the BOX Book after the three second exposure period will 
be cancelled. BOX will inform the sending Participant Exchange of the 
amount of the order that was executed and the amount, if any, that was 
cancelled; or
    b. If there is not a quote on BOX that is equal to the NBBO, then 
the order is exposed on the BOX Book at the NBBO for a period of three 
seconds, unless such order is a P or P/A Order. If the order is a P or 
P/A order it will be immediately cancelled pursuant to the Chapter XII 
of these Rules. If the order is not executed during the three second 
exposure period, then the order will be handled by the Trading Host 
pursuant to subparagraph b(iii)(2)(c) below.
    c. At the end of the three second exposure period, any unexecuted 
quantity will be handled by the Trading Host in the following manner:
    1. If the best BOX price is now equal to the NBBO, the remaining 
unexecuted quantity will be placed on the BOX Book and immediately 
executed against that quote. Any remaining quantity will be i) in the 
case of Public Customer orders, sent as P/A order(s) to the exchange 
displaying the NBBO, or ii) in the case of market maker or proprietary 
broker-dealer orders, returned to the submitting Options Participant; 
or
    2. If the best BOX price is not equal to the NBBO, then any 
remaining unexecuted quantity will be (i) in the case of Public 
Customer orders, sent as P/A Order(s) to the exchange displaying the 
NBBO, or (ii) in the case of market maker or proprietary broker-dealer 
orders, returned to the submitting Options Participant.
    iv. Notwithstanding the foregoing, if an Order is submitted while a 
PIP is in progress, and the Order is in the same series and on the 
opposite side of the Customer Order submitted to the PIP (the ``PIP 
Order''), under the circumstances set forth in Section 18(i) of this 
Chapter V, the Order will be immediately executed against the PIP Order 
up to the lesser of (a) the size of the PIP Order, or (b) the size of 
the Order, at a price equal to either (i) one penny better than the 
NBBO or (ii) the NBBO. The remainder of the Order, if any, continues to 
be filtered as set forth in this Section 16(b).
* * * * *
Sec. 18 The Price Improvement Period (``PIP'')
    (a) through (d) No change.
    (e) Options Participants, both OFPs and Market Makers, executing 
agency orders may designate BOX-Top Orders, Market Orders, and 
marketable limit Customer Orders for price improvement and submission 
to the PIP. Customer Orders designated for the PIP (PIP Orders) shall 
be submitted to BOX with

[[Page 22159]]

a matching contra order, the ``Primary Improvement Order'', equal to 
the full size of the [Customer] PIP Order. The Primary Improvement 
Order shall be on the opposite side of the market than that of the 
[Customer] PIP Order and represent a higher bid (lower offer) than that 
of the National Best Bid Offer (NBBO) at the time of the commencement 
of the PIP. BOX will not permit a PIP to commence unless at least three 
(3) Market Makers were quoting in the relevant series at the time an 
Options Participant submits a Primary Improvement Order to initiate a 
PIP. BOX will commence a PIP by broadcasting a message to Participants 
that (1) states that a Primary Improvement Order has been processed; 
(2) contains information concerning series, size, price and side of 
market, and; (3) states when the PIP will conclude (``PIP Broadcast'').
    i. No change.
    ii. The Options Participant who submitted the Primary Improvement 
Order is not permitted to cancel or to modify the size of its Primary 
Improvement Order or the [Customer] PIP Order at any time during the 
PIP, and may modify only the price of its Primary Improvement Order by 
improving it. The subsequent price modifications to a Primary 
Improvement Order are treated as new Improvement Orders for the sake of 
establishing priority in the PIP process. Market Makers, except for a 
Market Maker that submits the relevant Primary Improvement Order, may: 
(1) Submit competing Improvement Order(s) for any size up to the size 
of the [Customer] PIP Order; (2) submit competing Improvement Order(s) 
for any price equal to or better than the Primary Improvement Order; 
(3) improve the price of their Improvement Order(s) at any point during 
the PIP; and (4) decrease the size of their Improvement Order(s) only 
by improving the price of that order.
    iii. At the conclusion of the PIP, the [Customer] PIP Order shall 
be matched against the best prevailing order(s) on BOX, in accordance 
with price/time priority as set forth in Section 16 of this Chapter V, 
whether Improvement Order(s), including CPO(s) and PPO(s), or unrelated 
order(s) received by BOX during the PIP (excluding unrelated orders 
that were immediately executed during the interval of the PIP). Such 
unrelated orders may include agency orders on behalf of Public 
Customers, market makers at away exchanges and non-BOX[Box] Participant 
broker-dealers, as well as non-PIP proprietary orders submitted by 
Options Participants.
    iv. No change.
    (f) through (h) No change.
    (i) In cases where an [executable] unrelated order is submitted to 
BOX on the same side as the [Customer] PIP Order, such that it would 
cause an execution to occur prior to the end of the PIP, the PIP shall 
be deemed concluded and the [Customer] PIP Order shall be matched 
pursuant to paragraph (e)(iii) of this Section 18, above.
    Specifically, the submission to BOX of a BOX-Top Order or Market 
Order on the same side as a PIP Order will prematurely terminate the 
PIP when, at the time of the submission of the BOX-Top Order or Market 
Order, the best Improvement Order is equal to or better than the NBBO. 
(If a BOX-Top Order or Market Order is a buy order, the best 
Improvement Order is better than the NBBO when the price of the best 
Improvement Order is lower than the National Best Offer. If a BOX-Top 
Order or a Market Order is a sell order, the best Improvement Order is 
better than the NBBO when the price of the best Improvement Order is 
higher than the National Best Bid.) Following the execution of the PIP 
Order, any remaining Improvement Orders are cancelled and the BOX-Top 
Order or Market Order is filtered pursuant to Section 16(b) of this 
Chapter V.
    In cases where an unrelated order is submitted to BOX on the 
opposite side of the PIP Order, such that it would cause an execution 
to occur prior to the end of the PIP as set forth below, the unrelated 
order shall be immediately executed against the PIP Order up to the 
lesser of (a) the size of the PIP Order, or (b) the size of the 
unrelated order, at a price equal to either (i) one penny better than 
the NBBO, if the best BOX price on the opposite side of the market from 
the unrelated order is equal to the NBBO at the time of execution, or 
(ii) the NBBO. The remainder of the unrelated order, if any, shall be 
filtered pursuant to Section 16(b) of this Chapter V. The remainder of 
the PIP Order, if any, shall be executed at the conclusion of the PIP 
auction pursuant to Paragraph (e)(iii) of this Section 18, above.
    Specifically, a BOX-Top Order or a Market Order on the opposite 
side of a PIP Order will immediately execute against the PIP Order 
when, at the time of the submission of the BOX-Top Order or Market 
Order, the best Improvement Order is equal to or better than the NBBO. 
(If a BOX-Top Order or Market Order is a buy order, the best 
Improvement Order is better than the NBBO when the price of the best 
Improvement Order is lower than the National Best Offer. If a BOX-Top 
Order or a Market Order is a sell order, the best Improvement Order is 
better than the NBBO when the price of the best Improvement Order is 
higher than the National Best Bid.)
    It shall be considered conduct inconsistent with just and equitable 
principles of trade for any Participant to enter unrelated orders into 
BOX for the purpose of disrupting or manipulating the Improvement 
Period process.
    (j) through (k) No change.
* * * * *

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 Exchange 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 Exchange 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
    The purpose of the proposed rule change is to allow Market Orders 
to trade on BOX. BSE notes that all of the other options exchanges 
trade market orders.\6\ Currently, BOX has two order types which are 
similar to the proposed Market Order: Market-on-Opening Orders, which 
are valid only during the pre-opening and opening match phases, and 
BOX-Top Orders, which may be submitted only during the continuous 
trading phase. The majority of BOX's current (and prospective) order 
flow providers (``OFPs'') have requested the ability to trade market 
orders on BOX because their technology is designed for the use of 
market orders and their customers prefer market orders over BOX-Top 
Orders. BOX wishes to accommodate and attract order flow from these 
OFPs. Indeed, many OFPs are reluctant to send their Customer Orders to 
BOX without this order type, thereby depriving many investors of the 
possibility of price improvement through BOX's price improvement

[[Page 22160]]

mechanism, formally referred to as the Price Improvement Period 
(``PIP'').
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    \6\ See American Stock Exchange Rule 950(b), Chicago Board 
Options Exchange Rule 6.53(a), International Securities Exchange 
Rule 715(a), Pacific Exchange Rule 6.62, and Philadelphia Stock 
Exchange Rule 1066(a).
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    BOX's Market-on-Opening Orders are executed on the market opening 
at the best price available in the market until all volume (required to 
fill the order) on the opposite side of the market has been traded or 
the order quantity has been exhausted. Any residual volume left after 
part of a Market-on-Opening Order has been executed is automatically 
converted to a limit order at the price at which the original Market-
on-Opening Order was executed.
    BOX-Top Orders are executed at the best price available in the 
market for the total quantity available from any contra bid (offer). In 
general, any residual volume left after part of a BOX-Top Order has 
been executed is automatically converted to a limit order at the price 
at which the original BOX-Top Order was executed.
    Similar to these order types, Market Orders would be executed at 
the best price available in the market for the total quantity available 
from any contra bid (offer). If the full quantity of a Market Order 
could not be executed at the initial execution price, the remaining 
quantity of the Market Order would then execute at the next best price 
available from any contra bid (offer), and so on, until the Market 
Order was fully executed. To avoid trading through the national best 
bid or offer (``NBBO''), Market Orders would be filtered prior to 
execution at each price level pursuant to the procedures set forth in 
Chapter V, Section 16(b) of the BOX Rules.
    During the opening, Market Orders will have priority over Market-
on-Opening and Limit Orders.
    BSE wishes to clarify how Market Orders would be treated in the 
following situations:

Market Order Entered When the Lowest Offer Is $.05

    In the case where the lowest offer for any options contract is 
$.05, and a BOX participant enters a Market Order to sell that series, 
any such Market Order shall be considered a Limit Order to sell at a 
price of $.05.

Market Order Designated as a Minimum Volume Order

    A Market Order could be designated as a minimum volume (MV) order 
and would only be executed if the specified minimum volume is 
immediately available to trade. If a volume equal to or greater than 
the specified minimum volume of an MV order trades, the residual volume 
would be filtered against trading through the NBBO according to the 
procedures set forth in Section 16(b) of Chapter V of the BOX Rules 
and, if applicable, executed with any orders on the BOX Book.

Market Order Entered During a PIP

    In general, the BOX PIP is a three-second auction starting at a 
price better than the current NBBO during which BOX Participants 
compete to participate in the execution of the Customer Order submitted 
to the PIP (``PIP Order'') by submitting specially designated orders 
called Improvement Orders in one penny increments that are valid only 
in the PIP process. If a Market Order is submitted to BOX during a PIP 
that is in the same series as the PIP Order, under certain 
circumstances the submission of the Market Order may prematurely 
terminate the PIP, or the Market Order may immediately execute against 
the PIP Order at the NBBO or better. In this regard, Market Orders are 
treated like BOX-Top Orders, and BSE is taking this opportunity to 
clarify in the BOX Rules the treatment of BOX-Top Orders in the same 
circumstances.

Premature Termination

    The submission to BOX of a Market Order on the same side as a PIP 
Order will prematurely terminate the PIP when, at the time of the 
submission of the Market Order, the best Improvement Order is equal to 
or better than the NBBO. If a Market Order is a buy order, the best 
Improvement Order is better than the NBBO when the price of the best 
Improvement Order is lower than the National Best Offer. If a Market 
Order is a sell order, the best Improvement Order is better than the 
NBBO when the price of the best Improvement Order is higher than the 
National Best Bid. When the PIP is terminated, the PIP Order is matched 
against the best prevailing orders on BOX (whether Improvement Orders 
or unrelated orders received by BOX during the PIP \7\), pursuant to 
Paragraph (e)(iii) of Section 18 of Chapter V of the BOX Rules. Then 
the Market Order is filtered pursuant to Paragraph (b) of Section 16 of 
the BOX Rules.
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    \7\ Excluding unrelated orders that were immediately executed 
during the interval of the PIP, as described below.
---------------------------------------------------------------------------

    Under these circumstances, allowing the PIP to continue would 
violate BOX's priority rules. For example, assume the NBBO and the best 
BOX price in the relevant series is $2.00 bid--$2.10 offer and the PIP 
Order is a buy order for 20 contracts. The PIP starts at $2.09 (one 
penny better than the National Best Offer). During the PIP interval, 
Improvement Orders are submitted to the PIP until the price of the best 
Improvement Order is $2.07. Then a Market Order to buy 20 contracts is 
submitted to BOX. If the PIP continued, the Market Order would have 
been executed at $2.10, a price that would have violated BOX's priority 
rules because the best Improvement Order at $2.07 is at a better price 
than $2.10. On BOX, even though Improvement Orders may only execute 
against PIP Orders, the priority rules still apply, and no order can be 
executed at a price worse than the best price available to another 
order. Therefore, the PIP must terminate, the PIP Order must be 
executed in full, and any left over Improvement Orders must be 
cancelled immediately before the Market Order is executed. The result 
would be the same regardless if the Market Order was to buy 10 
contracts or to buy 30 contracts.
    To demonstrate a different scenario, assume the NBBO and the best 
BOX price in the relevant series is $2.00 bid--$2.10 offer and the PIP 
Order is a buy order for 20 contracts. The PIP starts at $2.09 (one 
penny better than the National Best Offer). During the PIP interval, 
Improvement Orders are submitted to the PIP until the price of the best 
Improvement Order is $2.07. Then the NBBO changes to $2.00 bid--$2.05 
offer, but the BBO stays the same. Then a Market Order to buy 20 
contracts is submitted to BOX. Pursuant to BOX's NBBO filter, the 
Market Order would be exposed internally on BOX for three seconds at 
$2.05, and become the best BOX bid. Currently, there is no order on BOX 
that the Market Order could execute against, including the PIP Order, 
since they are on the same side. Therefore, the PIP may continue. 
However, if the price of the best Improvement Order had been $2.05 (or 
lower) when the NBBO changed, the submission of a Market Order would 
cause the PIP to prematurely terminate because the submission of any 
additional Improvement Orders at better prices would result in a trade-
through of the best BOX bid (the exposed Market Order) when the PIP 
Order was executed at the end of the PIP.

Immediate Execution

    A Market Order on the opposite side of a PIP Order will immediately 
execute against the PIP Order when, at the time of the submission of 
the Market Order, the best Improvement Order is equal to or better than 
the NBBO. If a Market Order is a buy order, the best Improvement Order 
is better than the NBBO when the price of the best Improvement Order is 
lower than the National Best Offer. If a Market Order is a sell order, 
the best Improvement Order is better than the NBBO when the price

[[Page 22161]]

of the best Improvement Order is higher than the National Best Bid. The 
Market Order immediately executes against the PIP Order up to the 
lesser of (a) the size of the PIP Order, or (b) the size of the Market 
Order, at a price equal to either (i) one penny better than the NBBO, 
if the best BOX price on the opposite side of the market from the 
Market Order is equal to the NBBO at the time of the execution, or (ii) 
the NBBO. The remainder of the Market Order, if any, is filtered 
pursuant to Section 16(b) of Chapter V of the BOX Rules. The remainder 
of the PIP Order, if any, continues in the PIP process.\8\
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    \8\ BSE believes these execution prices are consistent with 
BOX's priority rules. When the best BOX price on the opposite side 
of the market from the Market Order is equal to the NBBO at the time 
of execution, executing the Market Order at the NBBO would violate 
the time priority of the order on the BOX book with the best BOX 
price.
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    Under these circumstances, allowing the PIP to continue without 
immediately executing the Market Order against the PIP Order would 
violate BOX's priority rules. For example, assume the NBBO and the best 
BOX price in the relevant series is $2.00 bid--$2.10 offer and the PIP 
Order is a buy order for 20 contracts. The PIP starts at $2.09 (one 
penny better than the National Best Offer). During the PIP interval, 
Improvement Orders are submitted to the PIP until the price of the best 
Improvement Order is $2.07. Then, assume a Market Order to sell 20 
contracts is submitted to BOX. If the Market Order did not immediately 
execute against the PIP Order, it would have been executed at $2.00 
with the best BOX bid which would violate BOX's priority rules because 
the PIP Order, not the best BOX bid, has priority for the best price. 
Furthermore, the Market Order would not be available to execute against 
the PIP Order at the end of the PIP. The PIP Order could have missed 
the opportunity to receive an execution at $2.01.
    Assume the same situation as described above, except that a Market 
Order to sell 30 contracts is submitted to BOX. The Market Order would 
be partially executed against the PIP Order at $2.01 and the remainder 
of the Market Order (10 contracts) would be filtered pursuant to 
Section 16(b) of Chapter V of the BOX Rules. If the Market Order was a 
Market Order to sell 10 contracts, the Market Order would be executed 
in full against the PIP Order at $2.01, and the remainder of the PIP 
Order would continue in the PIP process.
    To demonstrate a different scenario, assume the NBBO in the 
relevant series is $2.05 bid--$2.10 offer, the best BOX price is $2.00 
bid--$2.10 offer and the PIP Order is a buy order for 20 contracts. The 
PIP starts at $2.09 (one penny better than the National Best Offer). 
During the PIP interval, Improvement Orders are submitted to the PIP 
until the price of the best Improvement Order is $2.07. Then, assume a 
Market Order to sell 20 contracts is submitted to BOX. If the Market 
Order did not immediately execute against the PIP Order, it would have 
been exposed internally on BOX for three seconds at $2.05. If the 
Market Order was executed at $2.05 during this three second exposure 
period against any order other than the PIP Order, this would violate 
BOX's priority rules because the PIP Order has priority and is entitled 
to the better price. Therefore, the Market Order immediately executes 
against the PIP Order at $2.05. However, if the price of the best 
Improvement Order is $2.04, the option of immediately executing the 
Market Order against the PIP Order at $2.05 is not available because 
the PIP Order is already guaranteed a better execution at $2.04, 
pursuant to the best Improvement Order, and therefore the PIP 
continues.

Related Amendments

    Currently, the BOX Rules address the treatment of unrelated orders 
on the same side as a PIP Order, but do not address the treatment of 
unrelated orders on the opposite side of a PIP Order. BSE proposes to 
add subparagraph (b)(iv) to Section 16 of Chapter V of the BOX Rules 
and to amend Paragraph (i) of Section 18 of Chapter V of the BOX rules 
to address the treatment of unrelated orders on the opposite side of a 
PIP Order, as described above. BSE also proposes to eliminate the term 
``executable'' from Paragraph (i) of Section 18 of Chapter V of the BOX 
rules because this term is not clearly defined. BSE proposes to specify 
when a Market Order (or BOX-Top Order) would immediately execute 
against a PIP Order, or cause the PIP to prematurely terminate.\9\
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    \9\ BSE intends to file a proposal to clarify when Limit Orders 
would immediately execute against a PIP Order, or cause the PIP to 
prematurely terminate.
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    Paragraph (b) of Section 16 of Chapter V of the BOX Rules describes 
how inbound orders to BOX are filtered to avoid trading-through the 
NBBO. BOX proposes to add subparagraph (iv) to clarify that at each 
step in the filtering process, under certain circumstances if an order 
(including a Market Order) is an unrelated order on the opposite side 
of a PIP Order, the order will be immediately executed against the PIP 
Order as described above, and that any remaining quantity will continue 
in the filtering process as set forth in Paragraph (b) of Section 16 of 
Chapter V of the BOX Rules.
    BSE also proposes to amend Paragraph (e)(iii) of Section 18 of 
Chapter V of the BOX Rules to specifically exclude unrelated orders 
that were immediately executed during the interval of a PIP from the 
list of orders that PIP Orders are matched against at the conclusion of 
the PIP.
2. Statutory Basis
    The Exchange believes that the proposal, as amended, is consistent 
with the requirements of Section 6(b) of the Act,\10\ in general, and 
Section 6(b)(5) of the Act,\11\ in particular, in that the proposal is 
designed to promote just and equitable principles of trade, to prevent 
fraudulent and manipulative acts, 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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    \10\ 15 U.S.C. 78f(b).
    \11\ 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 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 the Exchange consents, the Commission will:
    (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

[[Page 22162]]

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 (https://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-BSE-2004-51 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number SR-BSE-2004-51. 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 (https://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. Copies of such 
filing also will be available for inspection and copying at the 
principal office of the Exchange. 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-2004-51 and should be submitted on or before May 19, 
2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-2044 Filed 4-27-05; 8:45 am]
BILLING CODE 8010-01-P