The PHLX plan is in response to the announcement last week by the Chicago Board Options Exchange (CBOE) of a similar plan, under which CBOE will assess a $.40 per contract fee on CBOE market makers (including Designated Primary Market Makers). The funds collected under the plan would be used by the Designated Primary Market Makers to purchase order flow.
The CBOE plan was filed with the SEC last week and became effective at the time of filing under SEC procedures permitting certain types of proposals, including those involving dues, fees and other charges, to become immediately effective without providing the usual process for exchange rule proposals which involves publication in the Federal Register and a public comment period before the proposal can be effective.
The PHLX immediately protested the SEC's approach of permitting the CBOE plan to be effective upon filing in a letter to Robert L.D. Colby, the Deputy Director of the SEC's Division of Market Regulation dated July 7, 2000 and at a July 10, 2000 meeting between the Exchange's Chairman and CEO, Meyer ("Sandy") Frucher and Annette Nazareth, Director of Market Regulation and other members of the SEC staff.
The PHLX letter notes that payment for order flow is a very controversial practice and one that is relatively new in the listed options world. It also notes that the involvement of an exchange directly in the practice in the manner described in the CBOE plan is unprecedented in the listed options arena and raises serious legal and policy concerns. In light of those concerns, and because of various deficiencies in the CBOE filing (particularly the fact that the aspects of the plan pertaining to the distribution of the funds collected were not detailed in the filing and, in any event, did not constitute a "due, fee or other charge"), the PHLX requested that the CBOE filing not be permitted to become effective until after the usual publication and comment period. The PHLX also requested that, if the CBOE plan were to be effective on filing, it be immediately abrogated by the SEC.
The SEC declined to immediately abrogate the CBOE plan on the technical grounds cited in the PHLX letter, but invited the PHLX and others to submit further comments in support of abrogating the plan. The PHLX strongly believes that the CBOE plan will have extremely serious implications for the market in listed options, and represents a danger to the investing public. Therefore, the PHLX intends to file a further request that the Commission abrogate the CBOE plan on the grounds that abrogation is necessary or appropriate in the public interest, for the protection of investors and otherwise in furtherance of the purposes of the Securities Exchange Act.
Mr. Frucher stated: "The CBOE plan will involve the CBOE -- a self-regulatory organization -- directly in the business of payment for order flow, which we believe is inappropriate for a regulator. Moreover, this plan will create a competitive environment in which other exchanges will be compelled to adopt plans which call for even higher levels of market maker assessment and payment levels to order flow providers. Although the PHLX does not believe that payment for order flow is, or should be, illegal generally, or that it represents a threat to best execution and the discharge of brokers' fiduciary obligations in all circumstances, we believe that the CBOE has opened the dam to a flood of order flow payments, which will achieve an order of magnitude which will be unhealthy for price competition and investors. It will also create an enormous burden on small market makers, who will be compelled by the CBOE and other plans which will inevitably be filed by other exchanges to contribute to the war chest. These are among the reasons that we intend to request that the SEC abrogate the CBOE plan and to decline to approve other similar plans involving options exchanges taxing members to pay for order flow."
Mr. Frucher continued: "Although the PHLX believes that exchange-sponsored payment for order flow plans where the Exchange effects a compulsory assessment from its trading crowds represents bad public policy, we felt that we needed to establish the PHLX plan to maintain and enhance our competitive position in light of the CBOE plan.
Mr. Frucher concluded his remarks by noting: " We hope that the SEC abrogates the CBOE plan and does not approve other similar plans. However, if the SEC sees fit to permit these arrangements, the PHLX intends to do whatever is necessary to be a potent competitor."
The PHLX is the first securities exchange in the U.S. and the nation's fastest growing sectors index options exchange. Founded in 1790, PHLX is a market leader in the trading of over 2,300 stocks, 770 equity options, eleven sectors index options, and 100 currency pairs.
