Self-Regulatory Organizations; Boston Stock Exchange, Inc.; Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto, Relating to the Treatment of Limit Orders That Are Submitted to the Boston Options Exchange During a Price Improvement Period, 1786-1793 [E7-406]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 72, Number 9 (Tuesday, January 16, 2007)]
[Notices]
[Pages 1786-1793]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-406]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55050; File No. SR-BSE-2006-03]


Self-Regulatory Organizations; Boston Stock Exchange, Inc.; 
Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto, 
Relating to the Treatment of Limit Orders That Are Submitted to the 
Boston Options Exchange During a Price Improvement Period

January 5, 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 8, 2006, the Boston Stock Exchange, Inc. (``BSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change. On January 4, 2007, the BSE 
filed Amendment No. 1 to the proposed rule change. The proposed rule 
change is described in Items I, II, and III below, which Items have 
been prepared substantially by the Exchange. The Commission is 
publishing this notice to solicit comments on the proposed rule change, 
as amended, from interested persons.
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    \1\ 5 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    As described in more detail herein, the Exchange proposes to modify 
the Boston Options Exchange (``BOX'') Rules to clarify the treatment of 
Limit Orders that are submitted to the BOX during a Price Improvement 
Period (``PIP'').\3\ In addition, this proposal clarifies that certain 
Improvement Orders (as explained below) are not accepted by the BOX 
Trading Host. The text of the proposed rule change is available at the 
Exchange, the Commission's Public Reference Room, and https://
www.bostonstock.com/legal/pending_rule_filings.html.
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    \3\ Capitalized terms not otherwise defined herein shall have 
the meanings prescribed under the BOX Rules.
---------------------------------------------------------------------------

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 self-regulatory organization 
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 self-regulatory organization 
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 clarify the treatment 
of Limit Orders that are submitted to the BOX during a PIP. In 
addition, this proposal clarifies that certain Improvement Orders (as 
explained below) are not accepted by the BOX Trading Host.

I. Background and Introduction

    In general, the BOX PIP is a three-second auction starting at a 
price better than the current National Best Bid and Offer (``NBBO''), 
during which BOX Participants compete to participate in the execution 
of the Customer Order submitted to the PIP (the ``PIP Order'') by 
submitting specially designated orders called Improvement Orders in one 
penny increments that are only accepted in a PIP auction. A Limit 
Order, in the same series as the PIP Order, that is submitted to BOX 
during a PIP auction is considered an ``unrelated order'' pursuant to 
the BOX PIP Rules,\4\ and under certain circumstances, may prematurely 
terminate the PIP or may immediately execute against the PIP Order. 
When the PIP is prematurely 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).\5\ Then the Limit 
Order is filtered from trading through the NBBO and executed 
accordingly.\6\
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    \4\ See paragraph (a) of Section 18 of Chapter V of the BOX 
Rules.
    \5\ Pursuant to Paragraph (e)(iii) of Section 18 of Chapter V of 
the BOX Rules.
    \6\ Pursuant to Paragraph (b) of Section 16 of Chapter V of the 
BOX Rules (``Filter Rule''). Pursuant to the Filter Rule, a Limit 
Order that has a Buy (Sell) limit price equal to or better than the 
National Best Offer (Bid), and the Best BOX Offer (Bid) is not equal 
to the National Best Offer (Bid), the Limit Order is ``exposed'' for 
three seconds to seek potential BOX orders that can match the 
National Best Offer (Bid) before the order is routed to an away 
market that is equal to the National Best Offer (Bid).
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Competing Principles Underlying the Treatment of Unrelated Orders in a 
PIP
    The BOX trading system operates under four main principles when 
handling the interaction of an unrelated Limit Order with the PIP 
process. Specifically, the BOX system:
    1. Allows the PIP to continue for as long as possible. The BSE 
believes that in most cases this will maximize the price improvement 
potential to the PIP Order.
    2. Maintains the relative price/time priority of all orders on the 
system, including Improvement Orders.
    3. Will not allow Improvement Orders to lock or cross the BOX Book.
    4. Never ``holds-up'' the processing of any order and seeks to 
execute an order as quickly as practicable in order to mitigate the 
risk of adverse market movements.
    On the few occasions when these four principles intersect or are in 
conflict, BSE has sought to maintain a reasonable balance between the 
interests of all orders while offering each order the best available 
price, without violating any BOX Rules or the securities laws. 
Therefore, the first principle, allowing the PIP to continue for as 
long as possible, will apply until it conflicts with any of the other 
three (3) principles.
    Consideration of the size of orders or the potential execution 
volume at any PIP price level is not one of these main principles of 
the BOX system. The BOX system does not consider the number of 
contracts that may be executed at the best PIP improvement price when 
determining priority or when the PIP should terminate. Having at least 
one contract available at the best improvement price is all that is 
required.

II. Same Side Limit Orders--Premature Termination Events

    The submission to BOX of a Limit Order that is on the same side of 
the market as the PIP Order will prematurely terminate the PIP, 
allowing the PIP Order to be immediately executed against the best 
prevailing orders on BOX (whether Improvement Orders or unrelated 
orders received by BOX during the PIP), if at the time the Limit Order 
is submitted to BOX:
    i. The Buy (Sell) Limit Order price is equal to or higher (lower) 
than the National Best Offer (Bid) and either:

[[Page 1787]]

    (a) The BOX Best Offer (Bid) is equal to the National Best Offer 
(Bid); or
    (b) The BOX Best Offer (Bid) is higher (lower) than the National 
Best Offer (Bid) and the price of the best Improvement Order is equal 
to or lower (higher) than the National Best Offer (Bid); or
    ii. The Buy (Sell) Limit Order price is lower (higher) than the 
National Best Offer (Bid) and its limit price equals or crosses the 
price of the best Improvement Order.\7\
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    \7\ See proposed paragraph (i) of Section 18 of Chapter V of the 
BOX Rules.
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    In short, a same side Limit Order will terminate the PIP if the 
Limit Order matches the best BOX price (i.e., the BOX BBO or the best 
Improvement Order) provided the best BOX price is better than or equal 
to the NBBO (i.e., the Limit Order is marketable)\8\ or if the Limit 
Order is non-marketable and its limit price is superior to the best 
Improvement Order. Therefore, the first factor to consider when 
determining whether the PIP will prematurely terminate is whether the 
Limit Order is marketable upon receipt by BOX.
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    \8\ A Limit Order is marketable when the Buy (Sell) Limit Order 
price is equal to or higher (lower) than the National Best Offer 
(Bid).
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A. If the Limit Order Is Marketable

    The rule contemplates two different marketable Limit Order 
scenarios.
1. Scenario One
    At the time of the submission of the Limit Order, the Buy (Sell) 
Limit Order price is equal to or higher (lower) than the National Best 
Offer (Bid) and the BOX Best Offer (Bid) is equal to the National Best 
Offer (Bid).\9\ The following example illustrates this scenario.
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    \9\ See proposed paragraph (i)(i)(a) of Section 18 of Chapter V 
of the BOX Rules.
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    Example A--

                                                                         Table A
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                          Early            PIP order
       NBBO               BOX BBO           PIP order        Best IO price    Limit order price   Limit order size     termination         execution
--------------------------------------------------------------------------------------------------------------------------------------------------------
       2.00-2.10           2.00-2.10            Buy 20k               2.07        Buy at 2.10                 20                YES               2.07
--------------------------------------------------------------------------------------------------------------------------------------------------------

    As shown in Table A, assume the NBBO and the BOX BBO in the 
relevant series are $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 auction, Improvement Orders 
are submitted to the PIP until the price of the best Improvement Order 
is $2.07 for 20 contracts. Then a Limit Order to buy 20 contracts at a 
limit price of $2.10 is submitted to BOX. In this example, since the 
Buy Limit Order price of $2.10 is equal to the National Best Offer also 
at $2.10 and the BOX Best Offer of $2.10 is equal to the National Best 
Offer at $2.10, then the PIP will immediately terminate. Upon 
termination, the PIP Order will execute in full against the best 
Improvement Order at $2.07 and any remaining Improvement Orders will be 
immediately cancelled. The Buy Limit Order will then execute against 
the BOX Offer at $2.10. The result would be the same regardless of the 
Limit Order size or if the best Improvement Order was anywhere between 
$2.09 through $2.01.\10\
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    \10\ The Trading Host will not accept Improvement Orders equal 
to or lower than $2.00 because the BOX system will not allow 
Improvement Orders to lock or cross the Best Bid or Offer on the BOX 
Book. See proposed Supplementary Material .03 to Section 18 of 
Chapter V of the BOX Rules and discussion below.
---------------------------------------------------------------------------

    BSE wants to maximize the price to the PIP Order while also 
minimizing any potential market risk to the Limit Order by having BOX 
execute the Limit Order as soon as a matching order is available at the 
National Best Offer (Bid). In order to avoid a delay of the Limit Order 
execution against the matching BOX Offer, which Offer might otherwise 
be cancelled, BSE has chosen to strike a balance among the competing 
principles and give the PIP Order the price improvement that is 
immediately available to the PIP Order by prematurely terminating the 
PIP auction. In this Example A, if a PIP is not underway the Limit 
Order could execute against the BOX Offer at $2.10. However, in this 
situation in which a PIP is underway, allowing the PIP to continue and 
immediately executing the Limit Order at $2.10 against the BOX Offer 
would violate BOX price priority rules. This is because the best 
Improvement Order at $2.07 is at a lower (i.e., better) price than the 
limit price of $2.10. On BOX, even though Improvement Orders may only 
execute against PIP Orders, price priority rules still apply, and no 
order can be executed at a price inferior to the best price available 
to another order.
2. Scenario Two
    At the time of the submission of the Limit Order, the Buy (Sell) 
Limit Order price is equal to or higher (lower) than the National Best 
Offer (Bid), the BOX Best Offer (Bid) is higher (lower) than the 
National Best Offer (Bid), and the price of the best Improvement Order 
is equal to or lower (higher) than the National Best Offer (Bid).\11\ 
The following is an example of this market scenario.
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    \11\ See proposed paragraph (i)(i)(b) of Section 18 of Chapter V 
of the BOX Rules.
---------------------------------------------------------------------------

    Example B--

                                                                         Table B
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                                                                                                                          Early            PIP order
       NBBO               BOX BBO           PIP order        Best IO price    Limit order price   Limit order size     termination         execution
--------------------------------------------------------------------------------------------------------------------------------------------------------
       2.00-2.05           2.00-2.10            Buy 20k               2.05        Buy at 2.05                 20                YES               2.05
--------------------------------------------------------------------------------------------------------------------------------------------------------

    If we take Example A above and make the following changes in the 
market scenario: the NBBO improves to $2.00 bid--$2.05 offer after the 
PIP begins, the best Improvement Order is for 20 contracts at $2.05, 
and a Limit Order with a limit price to buy at $2.05 is submitted to 
BOX, the PIP would also terminate prematurely. In this Example B, since 
the Buy Limit Order price of $2.05 is still equal to the National Best 
Offer also at $2.05 (i.e., marketable), the BOX Best Offer ($2.10) is 
higher than the National Best Offer ($2.05) and the price of the best 
Improvement Order ($2.05) is equal to the National Best Offer at $2.05, 
the market conditions meet the requirements of the rule and

[[Page 1788]]

the PIP will immediately terminate. The PIP Order will execute in full 
against the best Improvement Order at $2.05 and any remaining 
Improvement Orders will be immediately cancelled. Because the Limit 
Order matches the National Best Offer at $2.05 the Limit Order would be 
exposed internally on BOX at $2.05 pursuant to the Filter Rule.\12\
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    \12\ Section 16(b) of Chapter V of the BOX Rules.
---------------------------------------------------------------------------

    As in Scenario One, BSE wants to maximize the price to the PIP 
Order while also limiting the market risk to the Limit Order, by having 
BOX give the Limit Order the opportunity to execute as soon as 
practicable at the National Best Offer (Bid). In this case, because the 
BOX Offer at $2.10 is inferior to the National Best Offer at $2.05, the 
Limit Order would ordinarily (i.e., absent a PIP auction underway) be 
exposed at $2.05 pursuant to the Filter Rule. However, if the BOX 
trading system were to continue the PIP, no further price improvement 
would be possible when the best Improvement Order is $2.05. The Trading 
Host could not accept Improvement Orders equal to or lower than the 
$2.05 Limit Order price as long as the Limit Order is being exposed 
because the Limit Order would have priority and the BOX system will not 
allow Improvement Orders to lock or cross the opposite side BOX Best 
Bid of $2.05.\13\
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    \13\ See proposed Supplementary Material .03 to Section 18 of 
Chapter V of the BOX Rules and discussion below.
---------------------------------------------------------------------------

    Alternatively, if BOX were to hold the unrelated Limit Order until 
the end of the PIP auction this could cause the Limit Order to lose an 
opportunity to trade. Rather, BSE has chosen to strike a balance among 
the competing principles by giving the PIP Order the then-available 
price improvement and prematurely terminating the PIP.
    If the best Improvement Order was only at $2.07 in Example B, the 
best Improvement Order price would be higher than the National Best 
Offer price of $2.05, and the PIP would continue because it does not 
create a situation that violates BOX price/time priority rules. The 
Limit Order would be exposed internally on BOX at $2.05. Although the 
PIP continues, the Trading Host would not accept Improvement Orders 
equal to or lower than the $2.05 Limit Order price because it will not 
allow Improvement Orders to lock or cross the opposite side order 
exposed on the BOX Book.\14\
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    \14\ See proposed Supplementary Material .03 to Section 18 of 
Chapter V of the BOX Rules and discussion below.
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B. If the Limit Order Is Non-Marketable

    The PIP auction will also prematurely terminate early when at the 
time of the submission, the Buy (Sell) Limit Order price is lower 
(higher) than the National Best Offer (Bid) (i.e., non-marketable) and 
the price of the Limit Order equals or crosses the price of the best 
Improvement Order.\15\ The following is an example of this market 
scenario.
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    \15\ See proposed paragraph (i)(ii) of Section 18 of Chapter V 
of the BOX Rules.
---------------------------------------------------------------------------

    Example C--

                                                                         Table C
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                                                                                                                          Early            PIP order
       NBBO               BOX BBO           PIP order        Best IO price    Limit order price   Limit order size     termination         execution
--------------------------------------------------------------------------------------------------------------------------------------------------------
       2.00-2.10           2.00-2.10            Buy 20k               2.05    Buy/Sell at 2.05                20                YES               2.05
--------------------------------------------------------------------------------------------------------------------------------------------------------

    As shown in Table C, assume the NBBO and the BOX BBO are $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 auction, Improvement Orders are submitted to the PIP 
until the price of the best Improvement Order is $2.05 for 20 
contracts. Then a Limit Order to buy 20 contracts at a limit price of 
$2.05 is submitted to BOX. In this Example C, since the Buy Limit Order 
price of $2.05 is lower than the National Best Offer at $2.10 and the 
limit price equals or crosses the price of the best Improvement Order 
(i.e., $2.05), then the PIP will immediately terminate. The PIP Order 
will execute in full against the best Improvement Order at $2.05 and 
any remaining Improvement Orders will be immediately cancelled. The Buy 
Limit Order will then be placed on the BOX Book at $2.05.
    As in the other scenarios, BSE wants to maximize the price to the 
PIP Order and also limit the market risk to the Limit Order, by having 
BOX display the Limit Order and giving the Limit Order the opportunity 
to execute as soon as practicable. In this case, because the Buy Limit 
Order at $2.05 is better than the current BOX Best Bid at $2.00, the 
Limit Order must be displayed at $2.05 pursuant to the Display 
Rule.\16\ However, if the BOX trading system were to continue the PIP, 
it could create a situation very similar to the one explained in 
Scenario 2 and Example B above. Specifically, no further price 
improvement would be possible when the best Improvement Order is $2.05. 
The Trading Host could not accept Improvement Orders equal to or lower 
than the $2.05 Limit Order price as long as the Limit Order is being 
displayed because the Limit Order would have priority and the BOX 
system will not allow Improvement Orders to lock or cross the opposite 
side BOX Best Bid of $2.05.\17\
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    \16\ Section 16(a) of Chapter V of the BOX Rules.
    \17\ See proposed Supplementary Material .03 to Section 18 of 
Chapter V of the BOX Rules and discussion below.
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    For clarification purposes only, the following is a similar 
scenario in which the PIP would not prematurely terminate.
    Example D--

                                                                         Table D
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                                                                                                                          Early            PIP order
       NBBO               BOX BBO           PIP order        Best IO price    Limit order price   Limit order size     termination         execution
--------------------------------------------------------------------------------------------------------------------------------------------------------
       2.00-2.10           2.00-2.10            Buy 20k               2.07        Buy at 2.05                 20                 NO       2.07 or 2.06
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Assume we take Example C above and make the following changes in 
the market scenario: Improvement Orders are submitted to the PIP until 
the price of the best Improvement Order is $2.07 for 20 contracts. Upon 
receipt of the Buy Limit Order, there wouldn't be an order on BOX that 
the Limit Order could execute against and the Limit Order

[[Page 1789]]

would then be placed on the BOX Book at $2.05 and displayed as the BOX 
Best Bid. Because the Improvement Order at $2.07 is higher than the 
$2.05 Limit Order price, the PIP will continue. BOX will not accept 
Improvement Orders lower than $2.06 \18\ because this would lock or 
cross the BOX Best Bid (the Limit Order at $2.05).
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    \18\ The BOX Trading Host is programmed to continue to accept 
Improvement Orders at $2.06 or higher and will not accept 
Improvement Orders at $2.05 or lower unless the Limit Order is 
cancelled, in which case the Trading Host will begin to accept them 
again.
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III. Opposite Side Limit Order-Immediate Execution

    The submission to BOX of a Limit Order on the opposite side of a 
PIP Order will immediately execute against a PIP Order when the Sell 
(Buy) Limit Order price is equal to or crosses the National Best Bid 
(Offer) and;
    i. The BOX Best Bid (Offer) is equal to the National Best Bid 
(Offer); or
    ii. The BOX Best Bid (Offer) is lower (higher) than the National 
Best Bid (Offer) and neither the best Improvement Order nor BOX Best 
Offer (Bid) is equal to or crosses the National Best Bid (Offer).
    In short, the opposite side Limit Order will immediately execute 
against a PIP Order when the Limit Order could match the BOX Best Bid 
(Offer) and/or the National Best Bid (Offer) and the Limit Order is 
superior to the best Improvement Order. Whether the opposite side Limit 
Order is marketable \19\ or not upon receipt by BOX is the first factor 
to consider when determining whether the Limit Order will immediately 
execute against the PIP Order. If the Limit Order is marketable and the 
best Improvement Order is not equal to or lower (higher) than the 
National Best Bid (Offer), then the Limit 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 Limit Order.\20\ The execution price of 
the PIP Order against the Limit Order in this case will be determined 
by whether the BOX Best Bid (Offer) is equal to the National Best Bid 
(Offer) or it is lower (higher) than the National Best Bid (Offer) at 
the time of execution. Where the Limit Order is for at least the full 
size of the PIP Order, the PIP is prematurely terminated with the 
cancellation of all the Improvement Orders.
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    \19\ For an opposite side Limit Order, it is marketable when the 
Sell (Buy) Limit Order price is equal to or lower than the National 
Best Bid (Offer).
    \20\ The remainder of the Limit Order, if any, is filtered from 
trading through the NBBO pursuant to the Filter Rule and executed 
accordingly. The remainder of the PIP Order, if any, continues in 
the PIP process.
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A. If the BOX BBO Equals the NBBO

    If the BOX Best Bid (Offer) is equal to the National Best Bid 
(Offer) at the time of the execution, then the execution price will be 
one penny better than the National Best Bid (Offer).
    Example E--

                                                                         Table E
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                                                                                                                     Execute  against      PIP order
       NBBO               BOX BBO           PIP order        Best IO price    Limit order price   Limit order size      PIP  order         execution
--------------------------------------------------------------------------------------------------------------------------------------------------------
       2.00-2.10           2.00-2.10            Buy 20k               2.07       Sell at 2.00                 20                YES               2.01
--------------------------------------------------------------------------------------------------------------------------------------------------------

    As shown in Table E, assume the NBBO and the BOX BBO 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 Limit Order to sell 20 contracts with a limit 
price of $2.00 is submitted to BOX. Because the Sell Limit Order price 
is equal to the National Best Bid at $2.00 (i.e., marketable) and the 
BOX Best Bid of $2.00 is equal to the National Best Bid, the Limit 
Order will be immediately executed in full against the PIP Order at 
$2.01, one penny better than the National Best Bid. Since the Limit 
Order is the same size as the PIP Order, the PIP terminates as well in 
this example. Any Improvement Orders will be immediately cancelled.
    BSE wants to maximize the price to the PIP Order and also limit the 
market risk to the Limit Order, by having BOX give the Limit Order the 
opportunity to execute as soon as a matching order is available. In 
this case the PIP Order is immediately available to execute against the 
Limit Order at $2.01, which provides price improvement to both the PIP 
Order and the Limit Order. ``Holding'' the Limit Order until the PIP 
has run its full course might cause the Limit Order to miss the $2.00 
BOX Best Bid which could be cancelled or modified during the lapse. 
Also, the PIP Order could have missed the opportunity to receive an 
execution at $2.01. In contrast, allowing the PIP to continue without 
immediately executing the Limit Order against the PIP Order would cause 
a violation of BOX priority rules. First, in this example, executing 
the Limit Order against the PIP Order at the National Best Bid of $2.00 
would violate the time priority of the $2.00 order on the BOX Book that 
is the BOX Best Bid price. Additionally, if the Limit Order did not 
immediately execute against the PIP Order, the Limit Order would have 
been executed at $2.00 with the BOX Best Bid, which would be a priority 
violation of the PIP Order, which can trade at $2.01. In order to not 
violate priority rules and also to not hold up the Limit Order from 
executing against a matching order, BSE has chosen to strike a balance 
among the competing principles and give the PIP Order as well as the 
Limit Order the price improvement that is immediately available.
    In contrast, the PIP would continue if the Limit Order in Example E 
had a limit price of $2.05 instead of $2.00, making it non-marketable, 
in which case the Limit Order would be placed on the BOX Book and 
displayed. Meanwhile, BOX gives the PIP Order the opportunity for 
further improvement. Since the Limit Order price of $2.05 is better 
than the best Improvement Order at $2.07, the Limit Order might be 
available to execute against the PIP Order at the end of the PIP 
process.\21\
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    \21\ The Limit Order could be cancelled before the end of the 
PIP, in which case the Limit Order would not be available to execute 
with the PIP Order.
---------------------------------------------------------------------------

    Example F--

[[Page 1790]]



                                                                         Table F
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                         Execute  against     PIP order
       NBBO               BOX BBO            PIP order         Best IO price     Limit order price   Limit order size       PIP  order        execution
--------------------------------------------------------------------------------------------------------------------------------------------------------
       2.00-2.10           2.00-2.10             Buy 20k                2.07        Sell at 2.00                  30                 YES      2.01
--------------------------------------------------------------------------------------------------------------------------------------------------------

    If we take Example E above and make the following changes in the 
market scenario: A Limit Order to sell 30 contracts with a limit price 
of $2.00 is submitted to BOX, the Limit Order would be partially 
executed against the PIP Order at $2.01 and the remainder of the Limit 
Order (10 contracts) would be filtered from trading through the NBBO 
pursuant to the Filter Rule and execute with the size of BOX Bid at 
$2.00. However, if in this Example F the Limit Order was a Limit Order 
to sell 10 contracts, the Limit 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.

B. The BOX BBO Does Not Equal the NBBO

    When the BOX Best Bid (Offer) is lower (higher) than the National 
Best Bid (Offer) and neither the best Improvement Order nor BOX Best 
Offer (Bid) is equal to or crosses the National Best Bid (Offer), the 
PIP Order will execute against the Limit Order and the execution price 
will be the National Best Bid (Offer).
    Example G --

                                                                         Table G
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                     Execute  against      PIP order
       NBBO               BOX BBO           PIP order        Best IO price    Limit order price   Limit order size      PIP  order         execution
--------------------------------------------------------------------------------------------------------------------------------------------------------
       2.05-2.10           2.00-2.10            Buy 20k               2.07       Sell at 2.00                 15                YES               2.05
--------------------------------------------------------------------------------------------------------------------------------------------------------

    As shown in Table G, assume the NBBO in the relevant series is 
$2.05 bid and $2.10 offer and the BBO is at $2.00 bid -$2.10 offer, the 
PIP Order is a buy order for 20 contracts, and the best Improvement 
Order is $2.07. Then an opposite side unrelated Limit Order to sell 15 
contracts at $2.00 is received. Because the Sell Limit Order price is 
lower than or equal to the National Best Bid at $2.05 (i.e., 
marketable), the BOX Best Bid of $2.00 is lower than the National Best 
Bid at $2.05, and the best Improvement Order at $2.07 does not equal or 
cross the National Best Bid at $2.05, the Sell Limit Order will be 
immediately executed in full against the PIP Order at the National Best 
Bid of $2.05. The PIP will proceed to duration for 5 contracts, which 
may or may not receive additional Improvement Orders lower than the 
$2.07 price (perhaps to the best possible price for the PIP Order of 
$2.01).
    BSE wants to maximize the price to the PIP Order while limiting the 
market risk to the Limit Order, by having BOX give the Limit Order the 
opportunity to execute as soon as a matching order is available. In 
this case it is the PIP Order that is immediately available at the 
price of $2.05, which provides price improvement to both the PIP Order 
and the Limit Order. This situation occurs because the BOX Best Bid of 
$2.00 is lower than the National Best Bid of $2.05, so pursuant to the 
Filter Rule, the BOX system will seek to have the Limit Order executed 
at the National Best Bid price of $2.05. Since this price is lower than 
the BOX Best Offer ($2.10), and also lower than the best Improvement 
Order ($2.07), the Limit Order is also the best price available for the 
PIP Order. Therefore, in order to maximize the price improvement to the 
PIP Order the unrelated opposite side Limit Order will immediately 
execute against the PIP Order ensuring the PIP Order a $2.05 price for 
15 contracts.
    The benefit of this policy can also be shown by contrasting it with 
the possible outcomes if BOX allowed the PIP to continue without 
immediately executing the Limit Order against the PIP Order. In this 
situation, if the Limit Order does not execute against the PIP Order, 
then the Limit Order would be exposed on the BOX Book at $2.05 to seek 
a buy order at $2.05. However, the Limit Order could be cancelled prior 
to the receipt of a response, in which case the PIP Order would end up 
trading with the Improvement Order at an inferior price ($2.07) to the 
Limit Order price ($2.05). Alternatively, allowing the Limit Order to 
be exposed on the BOX Book at $2.05 could result in the submission of a 
responsive buy order, which would stop the PIP at that point because 
the buy order is a same side unrelated order. Therefore, it is more 
reasonable to avoid this unnecessary, and potentially detrimental, 
delay and instead follow Example G by immediately executing the PIP 
Order and the Limit Order at $2.05 upon receipt of the Limit Order.

C. Addition Example--Opposite Side Limit Order

    In order to further clarify the operation of the rule for opposite 
side Limit Orders, consider the following example where the Limit Order 
does not immediately execute against the PIP Order.
    Example H--

[[Page 1791]]



                                                                         Table H
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                     Execute  against      PIP order
       NBBO               BOX BBO           PIP  order       Best IO price    Limit order price   Limit order size      PIP  order         execution
--------------------------------------------------------------------------------------------------------------------------------------------------------
       2.05-2.10           2.00-2.10            Buy 20k               2.05       Sell at 2.00                 15                 NO               2.05
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Take Example G above and make the following changes in the market 
scenario: The price of the best Improvement Order is $2.05. The Limit 
Order will not immediately execute against the PIP Order at $2.05 
because the PIP Order is already likely to receive at least a partial 
execution at $2.05 with the best Improvement Order.\22\ Therefore, the 
PIP continues in order to seek further price improvement with the 
unrelated Limit Order being exposed as a sell at $2.05 in accordance 
with the Filter Rule.
---------------------------------------------------------------------------

    \22\ This occurs even if the aggregate quantity of the best 
Improvement Orders at $2.05 or lower do not equal the full size of 
the PIP Order (i.e., the system does not check to determine that the 
combined quantity of all the Improvement Orders at $2.05 or lower is 
for the full size quantity of the PIP Order). See Example I.
---------------------------------------------------------------------------

IV. Matching Unrelated Orders

    In order to further clarify the operation of the rule for unrelated 
Limit Orders as discussed above, consider the following example where 
the first unrelated Limit Order does not terminate the PIP and a second 
unrelated order that could match the first is received by BOX.
    Example I--

                                                                         Table I
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                 1     1     2     2
     NBBO           BOX BBO        PIP order     Best IO price     IO size      Limit  order   Limit  order   Limit  order   Limit  order    PIP order
                                                                                   price           size          price           size        execution
--------------------------------------------------------------------------------------------------------------------------------------------------------
  2.05-2.10       2.00-2.10         Buy 20k            2.05               5    Sell at 2.00            20    Buy at 2.05             20           2.05
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Take Example H above and make the following changes in the market 
scenario: The size of the best Improvement Order at $2.05 is only 5 
contracts; a ``same side'' unrelated order is also received (Limit 
Order 2). As in Example H, the ``opposite side'' Limit Order 
1 will not immediately execute against the PIP Order at $2.05 
because the PIP Order is already likely to receive at least a partial 
execution at $2.05 with the best Improvement Order (in this case 5 
contracts). Therefore, the PIP continues in order to seek further price 
improvement with the unrelated Limit Order 1 being exposed as 
a sell at $2.05 in accordance with the Filter Rule.
    However, if a buy order for $2.05 is received in response to the 
exposure of the sell Limit Order 1, this Limit Order 
2 would also be considered an unrelated same side Limit Order. 
As in Example C, since the buy Limit Order price of $2.05 is lower than 
the National Best Offer at $2.10 and the limit price equals the price 
of the best Improvement Order ($2.05), then the PIP will immediately 
terminate. As stated above, when the PIP is prematurely 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).\23\ Therefore, in this Example I the PIP Order will execute in 
full--5 contracts against the best Improvement Order at $2.05 and the 
remaining 15 contracts against the exposed opposite side unrelated 
Limit Order 1 at $2.05 because the Limit Order was next in 
time priority. Since the two unrelated orders match, the remaining size 
of Limit Order 1 will then execute 5 contracts against Limit 
Order 2 at $2.05. The remaining 15 contracts of Limit Order 
2 will then be placed on the BOX Book and displayed at $2.05.
---------------------------------------------------------------------------

    \23\ Pursuant to Paragraph (e)(iii) of Section 18 of Chapter V 
of the BOX Rules.
---------------------------------------------------------------------------

Additional Matching Unrelated Order Examples

    Example J--

                                                                         Table J
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                     Execute against
       NBBO               BOX BBO           PIP order        Best IO price    Limit order price   Limit order size     second limit        PIP order
                                                                                                                          order            execution
--------------------------------------------------------------------------------------------------------------------------------------------------------
       2.00-2.10           2.00-2.10            Buy 20k               2.07       Sell at 2.05                 20                 NO               2.05
--------------------------------------------------------------------------------------------------------------------------------------------------------

    As shown in Table J, assume the NBBO and the BOX BBO 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 Limit Order to sell 20 contracts (i.e., 
opposite side of the market from the PIP Order) with a limit price of 
$2.05 is submitted to BOX. The PIP would continue because the Sell 
Limit Order price is higher than the National Best Bid, making it non-
marketable, in which case the Limit Order would be placed on the BOX 
Book and displayed as the new BOX Best Offer (and new National Best 
Offer) at $2.05. Meanwhile, BOX gives the PIP Order the opportunity for 
further improvement. Since the Limit Order price of $2.05 is better 
than the best Improvement Order at $2.07, the Limit Order might be 
available to execute against the PIP Order at the end of the PIP 
process. Then a Limit Order to buy 20 contracts (i.e. on the same side 
of the

[[Page 1792]]

market as the PIP Order), with a limit price of $2.05 is submitted to 
BOX. Since the buy Limit Order price of $2.05 is equal to the new 
National Best Offer, then the PIP immediately terminates. The Sell 
Limit Order would be executed with the PIP Order in full at $2.05. The 
Buy Limit Order would be placed on the BOX Book and displayed as the 
BOX Best Bid at $2.05.
    Example K--

                                                                         Table K
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                     Execute against
       NBBO               BOX BBO           PIP order        Best IO price    Limit order price   Limit order size     second limit        PIP order
                                                                                                                          order            execution
--------------------------------------------------------------------------------------------------------------------------------------------------------
       2.00-2.10           2.00-2.10            Buy 20k               2.04       Sell at 2.05                 20                YES               2.05
--------------------------------------------------------------------------------------------------------------------------------------------------------

    As shown in Table K, assume the NBBO and the BOX BBO 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). The only difference from Example J is that 
during the PIP interval Improvement Orders are submitted to the PIP 
until the price of the best Improvement Order is $2.04. Then, assume a 
Limit Order to sell 20 contracts (i.e., opposite side of the market 
from the PIP Order) with a limit price of $2.05 is submitted to BOX. 
The PIP would continue because the Sell Limit Order price is higher 
than the National Best Bid, making it non-marketable, in which case the 
Limit Order would be placed on the BOX Book and displayed as the new 
BOX Best Offer (and new National Best Offer) at $2.05. Meanwhile, BOX 
gives the PIP Order the opportunity for further improvement. Since the 
Limit Order price of $2.05 is worse than the best Improvement Order at 
$2.04, the Limit Order would not execute against the PIP Order at the 
end of the PIP process. Then a Limit Order to buy 20 contracts (i.e. on 
the same side of the market as the PIP Order), with a limit price of 
$2.05 is submitted to BOX. Since the buy Limit Order price of $2.05 is 
equal to the new National Best Offer, then the PIP immediately 
terminates. The best Improvement Order would be executed with the PIP 
Order in full at $2.04. The Sell Limit Order would then execute with 
the Buy Limit Order in full at $2.05.

V. Improvement Order Clarification

    The BOX Trading Host does not accept Improvement Orders that lock 
or cross the BOX Book on the same side of the market as the PIP Order. 
To accept such Improvement Orders would violate the price priority of 
the resting orders on the BOX Book.

VI. Reports

    BSE is currently obligated to provide certain reports to the 
Commission that provide data about BOX-Top and Market Orders that 
terminate the PIP prematurely, as well as BOX-Top and Market Orders 
that immediately execute against a PIP Order. BSE represents that it 
will provide the same information for Limit Orders that terminate the 
PIP prematurely or immediately execute against a PIP Order.
2. Statutory Basis
    The Exchange believes that the proposal is consistent with the 
requirements of Section 6(b) of the Act,\24\ in general, and Section 
6(b)(5) of the Act,\25\ in particular, in that it 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 by clarifying 
the treatment of Limit Orders that are submitted to the BOX during a 
PIP and that certain Improvement Orders are not accepted by the BOX 
Trading Host.
---------------------------------------------------------------------------

    \24\ 15 U.S.C. 78f(b).
    \25\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

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 
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-2006-03 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-2006-03. 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

[[Page 1793]]

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-
2006-03 and should be submitted on or before February 6, 2007.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
---------------------------------------------------------------------------

    \26\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E7-406 Filed 1-12-07; 8:45 am]
BILLING CODE 8011-01-P