PCX Rulemaking:
Notice of Filing of a Proposed Rule Change and Amendment No. 1 Thereto Relating to the Archipelago Exchange

SECURITIES AND EXCHANGE COMMISSION

(Release No. 34-43608; File No. SR-PCX-00-25)

November 21, 2000

Self-Regulatory Organizations; Notice of Filing of a Proposed Rule Change by the Pacific Exchange, Inc. and Amendment No. 1 thereto Relating to the Archipelago Exchange

Pursuant to Section 19(b)(1) under the Securities Exchange Act of 1934 ("Act")¹ and Rule 19b-4 thereunder,² notice is hereby given that on July 31, 2000, the Pacific Exchange, Inc. ("PCX" or "Exchange"), through its subsidiary PCX Equities, Inc. ("PCXE" or "Corporation") pursuant to delegated authority, filed with the Securities and Exchange Commission ("Commission" or "SEC") the proposed rule change as described in Items I, II and III below, which Items have been prepared by the PCXE. On November 9, 2000, the Exchange filed Amendment No. 1 to the proposal.³ The Commission is publishing this notice to solicit comments on the proposed rule change, as amended, from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

The PCX, through its wholly-owned subsidiary PCXE, proposes to create a new electronic trading facility of the PCXE, called the Archipelago Exchange ("Arca"). The text of the proposed rule change has been posted to the Commission's web site, www.sec.gov, and is attached here (in blacklined version) as Appendix A.

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 PCXE 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 PCXE 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

The PCXE proposes to establish rules for Arca, a new exchange facility, as that term is defined in Section 3(a)(2) of the Act.⁴ Arca, which is to be operated by Archipelago Exchange, L.L.C., would be an electronic securities communications and trading facility intended for the use of Equity Trading Permit ("ETP") Holders and their customers.⁵ Arca would provide automatic order execution capabilities in the equity securities listed or traded on the PCXE. It is the PCXE's intent to operate the Arca facility in the place of the PCXE's traditional floor trading environment and thus PCXE also proposes to eliminate the existing PCXE Rules related to floor trading.

1. Relationship of Archipelago Exchange, L.L.C., to PCX Equities, Inc.

The PCX and PCXE have entered into various agreements with Archipelago Holdings, L.L.C., under which Archipelago Exchange, L.L.C., a subsidiary of Archipelago Holdings, L.L.C., would operate Arca as a facility of the PCXE. Pursuant to these agreements, PCX and PCXE would maintain responsibility for all regulatory functions related to the facility and Archipelago Exchange, L.L.C., would be responsible for the business of the facility to the extent those activities are not inconsistent with the regulatory and oversight functions of PCX and PCXE.

The relationship between the PCX, PCXE, and the Archipelago entities is explained further in proposed PCXE Rule 14.3.⁶ Under proposed PCXE Rule 14.3(a), the books, records, premises, officers, directors, agents and employees of Archipelago Exchange, L.L.C., would be deemed to be the books, records, premises, officers, directors, agents and employees of PCX and PCXE for purposes of, and subject to, oversight pursuant to the Act. The books and records of Archipelago Exchange, L.L.C., would be subject at all times to inspection and copying by the PCX, PCX Equities, and the SEC. In addition, proposed PCXE Rule 14.3(b) states that "[a]ll officers and directors of Archipelago Holdings, L.L.C., shall be deemed to be officers and directors of PCX and PCXE for purposes of and subject to oversight pursuant to the Securities Exchange Act." As set forth in proposed PCXE Rule 14.3(c), however, paragraphs (a) and (b) of proposed PCXE Rule 14.3 would not be deemed to create any rights or benefits for any person or entity other than the SEC.

2. Archipelago Exchange

The PCXE describes Arca, the proposed electronic trading venue, as a limit order book, characterized by price-time priority that would provide execution enhancements such as additional order types. Under the proposal, market makers would participate electronically in Arca to enhance liquidity in the book and could interact with order flow subject to automatic price improvement requirements. In addition, orders could be crossed on Arca subject to price improvement where the price and time priority of the limit order book is protected.

Arca is described in more detail in the following subsections. Specifically, subsection (a) describes who may access Arca. Subsection (b) discusses the registration requirements as well as the trading obligations of market makers and Odd Lot Dealers. Subsection (c) describes trading on Arca in detail, including a description of how orders are executed during Arca's three trading sessions. Finally, subsections (d) through (g) discuss the proposed rules regarding trade execution and reporting, clearance and settlement, Arca's interaction with OptiMark, and the limitation of liability with regard to Arca, respectively.

a. Access to the Archipelago Exchange

The PCXE would authorize any ETP Holder or Sponsored Participant (collectively, "Users")⁷ who meet certain enumerated requirements to obtain access to Arca. A "Sponsored Participant" is a person, such as an institutional investor, who has entered into a sponsorship arrangement with an ETP Holder.⁸ The requirements for access are as follows: First, all Users -- both ETP Holders and Sponsored Participants - would have to enter into a User Agreement⁹ with Archipelago Exchange, L.L.C., the operator of the Arca facility.¹⁰ Second, Sponsored Participants would have to enter into a sponsorship arrangement with a "Sponsoring ETP Holder," which is defined as an ETP Holder that has been designated by a Sponsored Participant to execute, clear and settle transactions on Arca.¹¹ The sponsorship arrangement consists of three separate components. First, the Sponsored Participant would have to enter into and maintain a customer agreement with its Sponsoring ETP Holder, establishing a proper relationship and account through which the Participant may trade on Arca.¹²

Second, the Sponsored Participant and its Sponsoring ETP Holder would have to enter into a written agreement which incorporates the Sponsorship Provisions,¹³ which include the following:

(1)The Sponsoring ETP Holder acknowledges and agrees that: (i) all orders entered by its Sponsored Participant and any person acting on behalf of or in the name of such Sponsored Participant and any executions occurring as a result of such orders are binding in all respects on the Sponsoring ETP Holder and (ii) the Sponsoring ETP Holder is responsible for any and all actions taken by such Sponsored Participant and any person acting on behalf of or in the name of such Sponsored Participant.

(2)The Sponsored Participant agrees that it will comply with the PCXE Certificate of Incorporation, Bylaws, Rules and procedures with regard to its activity on Arca as if the Sponsored Participant were an ETP Holder.

(3)The Sponsored Participant agrees that it will maintain, keep current and provide to the Sponsoring ETP Holder a list of its Authorized Traders who may obtain access to Arca on behalf of the Sponsored Participant(s).

(4)The Sponsored Participant agrees that it will familiarize its Authorized Traders with all of the Sponsored Participant's obligations under its Arca-related agreements and the PCXE Rules and will assure that they receive appropriate training prior to any use or access to Arca.

(5)The Sponsored Participant agrees that it will not permit anyone other than Authorized Traders to use or obtain access to Arca.

(6)The Sponsored Participant agrees that it will take reasonable security precautions to prevent unauthorized use or access to Arca, including unauthorized entry of information into Arca, or the information and data made available therein. The Sponsored Participant understands and agrees that it is responsible for any and all orders, trades and other messages and instructions entered, transmitted or received under identifiers, passwords and security codes of Authorized Traders, and for the trading and other consequences thereof.

(7)The Sponsored Participant acknowledges its responsibility for establishing adequate procedures and controls that permit it to effectively monitor its employees, agents and customers' use of and access to Arca for compliance with the terms of the Sponsorship Provisions.

(8)The Sponsored Participant agrees that it will pay when due all amounts, if any, payable to the Sponsoring ETP Holder, Archipelago Exchange, L.L.C., PCXE, or any other third parties that arise from the Sponsored Participant's access to and use of Arca. Such amounts include, but are not limited to, applicable exchange and regulatory fees.¹⁴

Finally, the Sponsoring ETP Holder would have to provide PCXE with a "Notice of Consent,"¹⁵ which acknowledges the Sponsoring ETP Holder's responsibility for the orders, executions and actions of its Sponsored Participant.¹⁶

As a further condition to access to Arca, each ETP Holder would have to maintain an up-to-date list of persons who could obtain access to Arca on behalf of the ETP Holder or the ETP Holder's Sponsored Participants, i.e., Authorized Traders,¹⁷ and provide the list to the PCXE upon request. In addition, each ETP Holder would have to have reasonable procedures to ensure that all of its Authorized Traders maintain the physical security of Arca and otherwise comply with the PCXE Rules. If the PCXE determines that an Authorized Trader has caused an ETP Holder to violate the PCXE Rules, the PCXE could direct the ETP Holder to suspend or withdraw the person's status as an Authorized Trader.¹⁸

b. Market Makers

The PCXE intends to replace its traditional floor specialists with market makers¹⁹ trading on Arca. Based on this change, the PCXE proposes to delete all existing PCXE Rules related to specialists and substitute rules related to market makers, as discussed in more detail below.²⁰ The registered market makers would be designated as dealer-specialists on the PCXE for all purposes under the Act.²¹

i. Registration of Market Makers

To act as a market maker on Arca, an ETP Holder would have to register as a market maker by filing a written application with the PCXE.²² In determining whether to approve a market maker application, the PCXE would consider, among other things, the ETP Holder's capital operations, personnel, technical resources, and disciplinary history.²³ The applicant's registration would become effective upon receipt by the ETP Holder of notice of the PCXE's approval of the registration. If the application is disapproved, the applicant would have the opportunity to be heard upon the specific grounds of the denial under the provisions of Rule 10.13.²⁴

A market maker's registration could be suspended or terminated by the PCXE upon a determination of any substantial or continued failure by the market maker to engage in dealings in accordance with the market maker's obligations under proposed PCXE Rule 7.23, as discussed below.²⁵ In addition, a registered market maker could withdraw its registration by giving written notice to the PCXE. The withdrawal would become effective on the tenth business day following the PCXE's receipt of the notice. A market maker who fails to give a ten-day notice of withdrawal could be subject to formal disciplinary action pursuant to PCXE Rule 10. After a withdrawal, the ETP Holder would not be permitted to re-register as a market maker for a period of six months.²⁶

In addition to registering as a market maker generally, a market maker also would have to register in each security in which it wishes to make a market on Arca. To become registered in a security, a market maker would have to file a security registration application form with the PCXE. In determining whether to approve or disapprove the market maker's registration in a security, the PCXE could consider: (1) the financial resources available to the market maker; (2) the market maker's experience, expertise and past performances in making markets, including the market maker's performance in other securities; (3) the market maker's operational capability; (4) the maintenance and enhancement of competition among market makers in each security in which it is registered; (5) the existence of satisfactory arrangements for clearing the market maker's transactions; and (6) the character of the market for the security (e.g., price, volatility, and relative liquidity). Registration in a security would become effective on the first business day following the PCXE's approval of the registration.²⁷

Under the proposal, PCXE could terminate a market maker's registration in a security if the market maker fails to enter quotations in the security within five business days after the market maker's registration in the security becomes effective.²⁸ Furthermore, PCXE could suspend or terminate the market maker's registration in a security or securities whenever, in the PCXE's judgment, the interests of a fair and orderly market are best served by such action.²⁹

In addition, a market maker could voluntarily terminate its registration in a security by providing PCXE with a one-day written notice. A market maker that failed to give advance written notice of such termination could be subject to formal disciplinary action pursuant to PCXE Rule 10.³⁰ Finally, an ETP Holder could seek review of any action taken by the PCXE pursuant to proposed PCXE Rule 7.22 governing a market maker's registration in a security, including the denial of the application for, or the termination or suspension of, a market maker's registration in a security or securities, in accordance with PCXE Rule 10.³¹

ii. Market Maker Authorized Traders

Each market maker would have to apply in writing to the PCXE to register a "Market Maker Authorized Trader" or "MMAT,"³² which is an Authorized Trader that performs market making activities on behalf of his or her market maker. An MMAT would have to be an officer, partner, employee or another associated person of a market maker, who is properly qualified to perform market making activities and has been trained and certified in the use of Arca.³³ Once registered, an MMAT could only submit orders for the account of its own market maker.³⁴

The PCXE may suspend or withdraw an MMAT's registration if the PCXE determines that: (1) the person has caused the market maker to fail to comply with the securities laws, rules and regulations or the Bylaws, Rules or procedures of the PCXE; (2) the person is not properly performing the responsibilities of an MMAT; (3) the person has failed to pass the Series 7 or to acquire the requisite certification and/or training, as necessary; or (4) PCXE believes it is in the interest of maintaining fair and orderly markets. If the PCXE suspended the registration of a person as an MMAT, the market maker could not allow the person to submit orders to Arca. In addition, PCXE would withdraw the registration of an MMAT upon the written request of the MMAT's market maker.³⁵

iii. Obligations of Market Makers

Market makers electronically engage in a course of dealings for their own account to enhance liquidity available to Arca and to assist in the maintenance, insofar as reasonably practicable, of fair and orderly markets. In addition, market makers may interact with directed order flow, subject to price improvement requirements and certain obligations and duties.

Specifically, market makers would have to satisfy the following responsibilities and duties during Core Trading Hours:³⁶ (1) maintain continuous, two-sided Q Orders, which are limit orders submitted to Arca by a market maker, in those securities in which the market maker is registered to trade;³⁷ (2) maintain adequate minimum capital in accordance with PCXE Rule 4.1; (3) remain in Good Standing³⁸ with the PCXE; (4) inform PCXE of any material change in financial or operational condition or in personnel; (5) clear and settle transactions through the facilities of a registered clearing agency; and (6) enter and maintain a Cleanup Order in each security in which the market maker is registered as such for each Market Order Auction.³⁹ If the PCXE found any substantial or continued failure by a market maker to meet the above responsibilities and duties, the PCXE could subject the market maker to disciplinary action or suspension or revoke the market maker's registration in one or more securities. In accordance with PCXE Rule 10, an ETP Holder could seek review of actions taken by the PCXE pursuant to this Rule 7.23.⁴⁰

The market maker could apply to the PCXE to withdraw temporarily from its market maker status. This request would have to be based on a demonstrated legal or regulatory requirement that necessitates its temporary withdrawal. The PCXE would act promptly on the request and, if the request is granted, the PCXE could temporarily reassign the securities to another market maker.⁴¹

iv. Odd Lot Dealers

In addition to the market maker obligations discussed above, a market maker would have to become an Odd Lot Dealer⁴² for each security in which it is registered as a market maker.⁴³ Furthermore, a market maker could apply to register as an Odd Lot Dealer in any other security.

Any market maker could become registered as an Odd Lot Dealer in any security by filing an odd lot registration form with the PCXE. Registration as an Odd Lot Dealer becomes effective on the first business day following the PCXE's approval of the registration. In considering the approval of the registration of the market maker as an Odd Lot Dealer in a security, the PCXE would consider such factors as financial resources, capital operations, personnel, technical resources and disciplinary history. If the PCXE denies an application to become an Odd Lot Dealer in a security or securities, the applicant could seek review of the decision in accordance with PCXE Rule 10.13.⁴⁴

Once registered, an Odd Lot Dealer is obligated to: (1) maintain an Odd Lot Tracking Order, as described in proposed PCXE Rule 7.31(g), during each day in which the PCXE is open for business for each security in which the Odd Lot Dealer is registered as such;⁴⁵ and (2) register and maintain registration as an Odd Lot Dealer in a minimum of 100 securities if the Odd Lot Dealer registers as such in any security for which it is not registered as a market maker.⁴⁶

Under proposed PCXE Rule 7.25(d) an Odd Lot Dealer's registration in a security or securities could be suspended or terminated if: (1) the PCXE determines that the Odd Lot Dealer has substantially or continually failed to engage in dealings as required of an Odd Lot Dealer; or (2) in the PCXE's judgment, the interests of a fair and orderly market are best served by such action. An ETP Holder could seek review of any such termination or suspension in accordance with proposed PCXE Rule 10.⁴⁷

Finally, an Odd Lot Dealer could voluntarily terminate its registration as such in a security or securities by providing the PCXE with a one-day written notice of such termination. An Odd Lot Dealer that fails to give advance notice of termination to the PCXE could be subject to formal disciplinary action pursuant to proposed PCXE Rule 10.⁴⁸

v. Limitations on Dealings

Under the proposed rules, a market maker could: (1) conduct an investment banking or public securities business; (2) function as a General Authorized Trader ("GAT"), i.e., an Authorized Trader who performs only non-market making activities on behalf of an ETP Holder;⁴⁹ or (3) make markets in the options overlying the security in which it makes markets; (collectively, "Other Business Activities") or it could be affiliated with a broker-dealer that engages in Other Business Activities only if there is an Information Barrier (also commonly referred to as a Chinese Wall) between the market making activities and the Other Business Activities.⁵⁰

An Information Barrier is an organizational structure in which the market making functions are conducted in a physical location separate from the locations in which the Other Business Activities are conducted in a manner that impedes the free flow of communications between MMATs and persons conducting the Other Business Activities. However, upon request and not on his or her own initiative, an MMAT performing the function of a market maker could furnish to persons at the same firm or an affiliated firm ("affiliated persons") the same sort of market information that the MMAT would make available to any other person in the normal course of its market making activity. The MMAT would have to provide such information to affiliated persons in the same manner that he or she would make such information available to a non-affiliated person.⁵¹

Procedures would have to be implemented to prevent the use of material non-public corporate or market information in the possession of persons on one side of the barrier from influencing the conduct of persons on the other side of the barrier. The procedures, at a minimum, would have to provide that (1) the MMAT performing the function of a market maker does not take advantage of knowledge of pending transactions, order flow information, corporate information, or recommendations arising from Other Business Activities; and (2) all information pertaining to the market maker's positions and trading activities is kept confidential and not made available to persons on the other side of the Information Barrier.⁵²

Although persons on one side of the barrier could not exercise influence or control over persons on the other side of the barrier, the following could occur: (1) the market making function and the Other Business Activities could be under common management as long as any general management oversight does not conflict with or compromise the market maker's responsibilities; (2) the same person or persons (the "Supervisor") could be responsible for the supervision of the market making and the GAT functions of the same firm or affiliated firms in order to monitor the overall risk exposure of the firm or affiliate firms. While the Supervisor could establish general trading parameters with respect to both market making and other proprietary trading other than on an order-specific basis, the Supervisor could not (1) act as either an MMAT or GAT; (2) provide to any GAT any information relating to market making activity beyond the information that an MMAT would normally provide to any other person in the course of its market making activity; or (3) provide an MMAT with specific information regarding the firm's pending transactions or order flow arising out of its GAT activities.⁵³

An ETP Holder that intends to implement an Information Barrier would have to submit to the PCXE a written statement setting forth the following:

(1)the manner in which it intends to comply with the requirements of an Information Barrier (as discussed above) and the compliance and audit procedures it will implement to maintain the Barrier;

(2)the names and titles of the person(s) responsible for the maintenance and surveillance of the procedures;

(3)a commitment to provide the PCXE with such information and reports as the PCXE could request relating to its transactions;

(4)a commitment to take appropriate remedial action against any person violating this Rule or the ETP Holder's internal compliance and audit procedures and that it recognizes that the PCXE could take appropriate remedial action in the event of such a violation;

(5)whether the ETP Holder or an affiliate intends to clear its proprietary trades, and, if so, the procedures established to ensure that information with respect to such clearing activities will not be used to compromise the Information Barrier (which procedures, at a minimum, would have to be the same as those used by the ETP Holder or the affiliate to clear for unaffiliated third parties). These procedures would have to provide that any information pertaining to market maker securities positions and trading activities, and information derived from any clearing and margin financing arrangements, could be made available only to those employees specifically authorized to have access to such information or to other employees in senior management positions who are involved in exercising general managerial oversight with respect to market making activity. Furthermore, any margin financing arrangements would have to be sufficiently flexible so as not to limit the ability of any market maker to meet market making or other obligations under the PCXE Rules; and

(6)that it recognizes that any trading by a person while in possession of material, non-public information received as a result of the breach of the internal controls could be a violation of the Act, the rules thereunder, or PCXE Rules.⁵⁴

After the submission of the written statement detailing the internal controls and compliance and audit procedures to PCXE, if the PCXE determines that the structure and procedures are acceptable, PCXE will inform the ETP Holder in writing of their acceptability. Absent a finding that an ETP Holder's Information Barrier procedures are acceptable, a market maker could not conduct Other Business Activities.⁵⁵

Finally, an ETP Holder or an affiliate of the ETP Holder could clear the ETP Holder's market maker transactions if it establishes procedures to ensure that information with respect to clearing activities would not be used to compromise the Information Barrier. In this regard, the procedures would have to provide that any information pertaining to market maker securities positions and trading activities, and information derived from any clearing and margin financing arrangements, could be made available only to those employees (other than employees actually performing clearing and margin functions) specifically authorized to have access to such information or to other employees in senior management positions who are involved in exercising general managerial oversight with respect to the market making activity. Furthermore, any margin financing arrangements would have to be sufficiently flexible so as not to limit the ability of any market maker to meet market making or other obligations under the PCXE Rules.⁵⁶

c. Trading on the Archipelago Exchange

i. Order Entry

Users would enter into Arca the following standard types of orders: market orders, limit orders, Day Orders, Good-Til-Canceled (GTC) Orders, Immediate-or-Cancel Orders, Stop Orders, Stop Limit Orders, Do Not Reduce, Do Not Increase, and Timed Orders.⁵⁷

In addition, Users could utilize Working Orders, which are defined to include "any order with a conditional or undisplayed price and/or size designated as a Working Order,'" including All-or-None, Discretionary, and Reserve Orders.⁵⁸ An All-or-None Order is a limit order which is to be executed in its entirety or not at all.⁵⁹ A Discretionary Order is an order to buy or sell a stated amount of a security at a specified, undisplayed price (the "discretionary price"), in addition to at a specified, displayed price ("displayed price").⁶⁰ For example, a User could submit a Discretionary Order to buy 5000 shares of XYZ at 20, with discretion to 20.25. In that case, the User represents a displayed price of 20, but the User is willing to buy the 5000 shares at a price up to the discretionary price of 20.25. A Reserve Order is a limit order with a portion of the size displayed and with a reserve portion of the size ("reserve size") that is not displayed on the Arca book.⁶¹ For example, a User could submit a Reserve Order to buy 5000 shares of XYZ at 20 with a request that 1000 shares be displayed. Therefore, the 1000 shares are displayed and 4000 shares, as the reserve size, are not displayed.

Arca would also accept NOW Orders.⁶² A NOW Order is a Limited Price Order⁶³ that is to be executed in whole or in part on Arca, and the portion not so executed would be routed pursuant to Rule 7.37(d) only to one or more NOW Recipients for immediate execution as soon as the order is received by the NOW Recipient. Any portion not immediately executed by the NOW Recipient would be cancelled. If a NOW Order is not marketable when it is submitted to the PCXE, it would be cancelled. NOW Orders cannot be Directed Orders.⁶⁴ For the purposes of a NOW Order, a NOW Recipient means any exchange, ECN, or other broker-dealer (1) with which Arca maintains an electronic linkage, which includes ITS, and (2) which provides instantaneous responses to NOW Orders routed from Arca. The PCXE would designate from time to time those exchanges, ECNs, or other broker-dealers that qualify as NOW Recipients.⁶⁵ An Auction-Only Limit Order, which is a limit order that could be executed only during the Market Order Auction, would also be submitted to Arca.⁶⁶ In addition, Users could submit Primary Only Orders ("PO Orders") which are market orders, for exchange-listed securities only, that are to be routed as a market-on-open order to the primary market for participation in the primary market opening process. A PO Order would have to be entered before 6:28 a.m. (Pacific Time) and it would not be included in the Market Order Auction.

Furthermore, as discussed in more detail in other sections, Users could submit Tracking Orders, Odd Lot Tracking Orders, Directed Orders, Directed Fills, Q Orders, Fill-or-Return Orders, Fill-or-Return Plus Orders, PNP Orders, Cross Orders and Cleanup Orders as well.⁶⁷

Finally, as a general matter, consistent with proposed PCXE Rules, ETP Holder Users of Arca could enter both proprietary orders and agency orders for the account of a customer. Proprietary orders entered into Arca are subject to the same display and execution processes as agency orders. An ETP Holder User that enters a proprietary order into Arca would mark the order with the appropriate designator to identify the order as proprietary.⁶⁸

ii. Order Ranking and Display

Arca would maintain an electronic file of orders, called the Arca Book, which contains all the User's orders in the four components, called Processes, of the Arca Book.⁶⁹ Specifically, the Arca Book contains the Directed Order, Display Order, Working Order, and Tracking Order Processes. Limited Price Orders of Users submitted to Arca (other than such orders as Directed Fills and Tracking Orders) would be ranked and maintained in the Display Order Process and/or Working Order Process of the Arca Book according to price-time priority, such that within each price level, all orders would be organized by the time of entry, as discussed in more detail below.

The displayed portion of orders are ranked in the Display Order Process. One category of orders -- limit orders, with no other conditions -- would be ranked in the Display Order Process based on the specified limit price and the time of original order entry. With regard to Reserve Orders, the displayed portion of Reserve Orders (not the reserve size) would be ranked in the Display Order Process at the specified limit price and the time of order entry. If the displayed portion of the Reserve Order is decremented in its entirety, the displayed portion of the Reserve Order would be refreshed for the displayed amount from the reserve portion and would be submitted and ranked at the specified limit price and the new time that the displayed portion of the order was refreshed. Finally, Discretionary Orders would be ranked in the Display Order Process based on the displayed price (not the discretionary price) and the time of order entry. If a Discretionary Order is decremented, it remains ranked based on the displayed price and the time of original order entry.

Only All-or-None Orders and the undisplayed portion of Reserve Orders and Discretionary Orders are ranked in the Working Order Process. The reserve portion of Reserve Orders would be ranked in the Working Order Process based on the specified limit price and the time of original order entry. After the displayed portion of a Reserve Order is refreshed from the reserve portion, the reserve portion remains ranked based on the original time of order entry, while the displayed portion is sent to the Display Order Process with a new time-stamp. Discretionary Orders would be ranked in the Working Order Process based on the displayed price and the time of original order entry. After a Discretionary Order is decremented, it remains ranked as described above. All-or-None Orders would be ranked in the Working Order Process based on the specified limit price and the time of order entry.

PCXE offers the following example to clarify how orders are ranked in the Display and Working Order Processes. Suppose that the following orders are submitted to Arca by Users:

10:00 a.m. - Order A - Limit order to buy 1000 XYZ at 20

10:01 a.m. - Order B - Reserve Order to buy 5000 XYZ at 20 (show 1000)

10:02 a.m. - Order C - Limit order to buy 500 XYZ at 20

10:03 a.m. - Order D - Discretionary Order to buy 5000 XYZ at 20 (discretion to 20.25)

10:04 a.m. - Order E - All-or-None to buy 1500 XYZ at 20

10:05 a.m. - Order F - Q Order to buy 1000 XYZ at 20

10:06 a.m. - Order G - Limit order to buy 700 XYZ at 20

10:07 a.m. - Order H - Q Order to buy 500 XYZ at 20

10:08 a.m. - Order I - Discretionary Order to buy 10,000 XYZ at 20 (discretion to 20.25)

iii. Order Display and Dissemination

Arca would operate the Arca Book on an open basis. All orders at all price levels in the Display Order Process of the Arca Book would be displayed to all Users on an anonymous basis. In addition, the same information would be made available to other interested parties.⁷⁰ Furthermore, the best-ranked displayed order(s) to buy and sell in the Arca Book and the corresponding aggregate size of such orders associated with such prices would be collected and made available to quotation vendors for dissemination pursuant to the requirements of Rule 11Ac1-1⁷¹ under the Act.⁷²

iv. Order Execution

Subject to the restrictions on short sales under Rule 10a-1 under the Act,⁷³ like-priced orders, bids and offers would be matched for execution by following Steps 1 through 5, as described below; provided, however, that for an execution to occur in any Order Process the price would have to be equal to or better than the NBBO,⁷⁴ unless Arca has routed orders to all away markets at the NBBO:

Step 1: Directed Order Process. The first step of the Arca execution algorithm is the Directed Order Process. Through this process, Users could direct an order to a market maker with whom they have a relationship and the market maker would execute the order. To access this process, the User would have to submit a Directed Order, which is a market or limit order to buy or sell which has been directed to a particular market maker by the User.⁷⁵ Any type of order other than a Directed Order would skip the Directed Order Process and immediately enter Step 2, the Display Order Process. The Directed Order Process is available only during Core Trading Hours.⁷⁶

In the Directed Order Process, the User's Directed Order would be executed against a Directed Fill, which is the order of the User's designated market maker. Specifically, any market maker could submit a standing instruction to Arca for the parameters of a Directed Fill, including, but not limited to, the size of the order, the Users that could send such market maker a Directed Order, the price improvement algorithm, and the period of time the instruction is effective. The market maker's Directed Fill described in the instruction would be generated only in response to a Directed Order directed to such market maker. The Directed Fill is a limit order with a size that is equal to or less than the size of the Directed Order and a price that improves the BBO⁷⁷ by an automatically preset amount, which would have to be equal to or greater than the Minimum Price Improvement Increment,⁷⁸ pursuant to a price improvement algorithm; provided, however, that the Directed Fill would not be generated if the price is not equal to or better than the NBBO. In other words, a market maker may not execute against a Directed Order without improving the best price on the Arca Book. A market maker may modify the parameters of the instruction for a Directed Fill from time to time, as the PCXE permits.⁷⁹

If a User submits a marketable⁸⁰ Directed Order to Arca and the User's designated market maker has a standing instruction for a Directed Fill, the Directed Order would be executed against the Directed Fill of the designated market maker. If a User submits a marketable Directed Order and the User's designated market maker has not submitted an instruction for a Directed Fill, or if a User submits any order other than a marketable Directed Order, the Directed Order would enter the Display Order Process without interacting with any Directed Fills.⁸¹

Step 2: Display Order Process. If an incoming marketable order has not been executed in its entirety in the Directed Order Process, any remaining part of the order would be routed to the Display Order Process, Step 2 of the execution algorithm.⁸² In the Display Order Process, Arca would match an incoming marketable order against orders in the Display Order Process at the display price of the resident order for the total size available at that price or for the size of the incoming order, whichever is smaller. For the purposes of the Display Order Process, the size of an incoming Reserve Order includes the displayed and reserve size and the size of the portion of the Reserve Order resident in the Display Order Process is equal to its displayed size. If the incoming marketable order has not been executed in its entirety, the remaining part of the order would be routed to the Working Order Process.⁸³

An incoming order that is not marketable would skip the Display Order Process and enter the Working Order Process to be executed against any Discretionary Orders at or better than the NBBO.⁸⁴

Step 3: Working Order Process. An incoming marketable order would be matched for execution against orders in the Working Order Process in the following manner: An incoming marketable order would be matched against orders within the Working Order Process in the order of their ranking, at the price of the displayed portion (or in the case of an All-or-None Order, at the limit price), for the total amount of stock available at that price or for the size of the incoming order, whichever is smaller. If the BBO is outside the NBBO and any Discretionary Orders within the Working Order Process have a discretionary price equal to or better than the NBBO, the incoming order would execute against such Discretionary Order(s) at the NBBO up to the size of the smaller of the two orders. If an incoming marketable order is a Discretionary Order or a Reserve Order and its prices overlap with the prices of a Discretionary Order(s) in the Working Order Process, then the orders would be executed at the display price of the order that was entered first up to the size of the smaller of the two orders. For the purposes of this subsection, the size of the incoming Reserve Order includes the displayed and reserve size. If the incoming marketable order has not been executed in its entirety, the remaining part of the order would be routed to the Tracking Order Process.⁸⁵

An incoming order that is not marketable would be matched for execution against orders in the Working Order Process in the following manner: The incoming order would be matched against any Discretionary Orders in the Working Order Process that have discretionary prices that would satisfy an otherwise displayable incoming Limited Price Order. The execution would occur at the limited price of the incoming order. If the incoming order is a Discretionary Order and its prices overlap with the prices of a Discretionary Order in the Working Order Process, then the orders would be executed at the discretionary price of the incoming order that would be the best price available for the order entered first. If any change in the NBBO or other available away trading interest would cause a potential match between the away order and an order in the Working Order Process, a commitment to trade would be sent to that market center or market participant⁸⁶ pursuant to Step 5 below.⁸⁷

Step 4: Tracking Order Process. During Core Trading Hours only, the fourth step of the execution algorithm is the Tracking Order Process. If an order has not been executed in its entirety in the Directed, Display, or Working Order Processes, Arca then would match and execute any remaining part of the order in the Tracking Order Process, unless the order or portion thereof was received from another market center or market participant, in which case it would be cancelled immediately.⁸⁸

If the unfilled order or portion of an order that enters the Tracking Order Process is a mixed lot or round lot order, Arca would match the order against any Tracking Orders.⁸⁹ Any User could submit an instruction to Arca for the parameters of a Tracking Order at any time during the day, where such parameters include: (1) the maximum aggregate size, which is the aggregate size of all partial orders generated in the Tracking Order Process for a particular security that the User is willing to trade on that day; (2) the maximum tradeable size, which is the maximum size of any partial order generated in response to an order entering the Tracking Order Process that the User is willing to trade on that day; (3) the price in relation to the NBBO; and (4) the relevant security. Once a User has submitted an instruction for the parameters of the Tracking Order, the instruction would remain in effect until closing or until the User has traded its maximum aggregate size for that day, whichever comes first.⁹⁰

Users who have submitted an instruction for the parameters of a Tracking Order would be assigned trades on a price/time rotating basis, such that within each price level, trades would be assigned by the time the Users' instructions are received by Arca. Within each price level, the first User to send an instruction for a Tracking Order would be the first User to be assigned a trade in the rotation process. For each order that enters the Tracking Order Process, the Tracking Order Process would rotate once through the Users in the rotation pattern. In each rotation, the User would be responsible for one trade up to the User's maximum tradeable size.

The order described in the User's Tracking Order instruction would be generated only if an unfilled round or mixed lot order enters the Tracking Order Process and it is such User's turn as determined by the Tracking Order Process rotation pattern.

Each partial order generated in a rotation is a limit order in which (1) the price is set at or better than the NBBO at the time the unfilled order enters the Tracking Order Process, based on the User's parameters; and (2) the size is (i) equal to the User's maximum tradeable size if the unfilled order is equal to or larger than the maximum tradeable size; or (ii) equal to the size of the unfilled order if the unfilled order is smaller than the maximum tradeable size. A User could modify the parameters of the instruction for the Tracking Order from time to time, as the PCXE permits.

After the order has been matched against any Tracking Orders, if the order has not been executed in its entirety and the remaining part of the order is an odd lot, the odd lot order would be executed in the Odd Lot Tracking Order Process, as described below. Otherwise the order would be routed pursuant to the final step of the execution algorithm.

If the unfilled order or portion of an order that enters the Tracking Order Process is an odd lot, Arca would match the order against any Odd Lot Tracking Orders⁹¹ ("OLTOs"), using the same rotation process described above with regard to Tracking Orders.⁹² An OLTO, which could only be submitted to Arca by a registered Odd Lot Dealer, is a Tracking Order in which: (1) the maximum aggregate size is unlimited; (2) the maximum tradeable size is 99 shares; (3) the price is set at the NBBO; (4) the security is one in which the Odd Lot Dealer is registered as such; and (5) the instruction would have to be in effect for the duration of Core Trading Hours. The order described in the instruction would be generated only if an unfilled odd lot market order enters the Odd Lot Tracking Order Process or an odd lot limit order causes a locked market as described in proposed PCXE Rule 7.56.

Whenever in the judgment of the PCXE, because of an influx of orders, a system malfunction, or other unusual conditions or circumstances, the interests of a fair and orderly market so require, the PCXE could suspend the Tracking Order Process. If the PCXE suspends the Tracking Order Process, the Process wouldbecome operational again when the PCXE determines that the conditions supporting the suspension no longer exist.⁹³

Step 5: Routing. The fifth step of the Arca execution algorithm, which involves routing orders away to other market centers or market participants, is available only to those ETP Holders who have entered into a Routing Agreement. A Routing Agreement is an agreement between an ETP Holder and a broker-dealer affiliate of Archipelago Exchange, L.L.C., under which the broker-dealer affiliate agrees to act as agent for routing orders of the ETP Holder and the ETP Holder's Sponsored Participants to other market centers or broker-dealers for execution, whenever routing is required.⁹⁴

For those ETP Holders that are parties to a Routing Agreement and indicate that they wish the order to be routed away, if necessary, if the order has not been executed in its entirety pursuant to the other Order Processes, the order would routed to another market center or market participant as follows:⁹⁵ Arca would route the order to another market center or market participant as a limit order priced at the quote published by the market center or market participant. Arca would attempt to match the part of the order that has not been routed away against then available trading interest in the Arca Book for an internal fill by following Steps 1 through 4 again.

Orders routed to other market centers or market participants would remain outside Arca for a prescribed time period during which such orders could be executed (in whole or in part) or declined. While an order remains outside Arca, it would have no time standing relative to other orders received from Users at the same price which could be executed against the Arca Book. Requests from Users to cancel their orders while the order is routed away to another market center or market participant and remains outside Arca would be processed, subject to applicable trading rules of the relevant market center or market participant.

In the event that a marketable order routed from Arca to another market center or market participant is not executed in its entirety at the other market center or market participant's quote (i.e., all attempts to fill the order are declined or timed-out), Arca would attempt to match the residual or declined market order against then available trading interest in the Arca Book for an internal fill by following Steps 1 through 4 above. Any remaining unmatched trading interest would be re-routed to another market center or market participant at the next available displayed price level.

When routing an order away to another market center, the PCXE would utilize such electronic intermarket linkages and order delivery facilities as could be approved by the Board of Directors from time to time, subject to such applicable requirements as could be agreed to with the relevant market center.

Under the proposal, if an ETP Holder has not entered into a Routing Agreement, the ETP Holder and its Sponsored Participants could submit to Arca only Fill-or-Return, Fill-or-Return Plus, or PNP Orders, which are orders that could not be routed outside of Arca.⁹⁶ Specifically, a Fill-or-Return Order is an order to buy or sell that is to be executed in whole or in part on the PCXE, and any portion not executed on the PCXE is to be cancelled, without routing the order to another market center or market participant.⁹⁷ Similarly, a Fill-or-Return Plus Order is a Fill-or-Return Order, except, in the event any portion of the order is not executed on the PCXE and would have to be cancelled, Arca, after canceling the unexecuted portion of the order, would send an administrative message to an ETP Holder designated by the order entry ETP Holder informing the designated ETP Holder that a portion of the order was cancelled.⁹⁸ A Post No Preference ("PNP") Order is a limit order to buy or sell that is to be executed in whole or in part on the PCXE, and the portion not so executed is to be ranked in the Arca Book, without routing any portion of the order to another market center. However, the PCXE would cancel a PNP Order that would lock or cross the NBBO.⁹⁹ Therefore, if an order has not been executed in its entirety pursuant to the other Order Processes and it has been designated as a Fill-or-Return, Fill-or-Return Plus Order, or a PNP Order, the order would be cancelled at the routing step, without routing the order away from Arca.¹⁰⁰

Finally, if an order has not been executed in its entirety after following Steps 1 - 5, the order would be ranked in the Arca Book pursuant to Rule 7.36.¹⁰¹

Examples. The following examples clarify the order execution process for the Arca Book. Assuming PCXE has the orders in the Arca Book as specified in the ranking example above (see Section 2(c)(ii)), suppose an incoming order, which is not a Directed Order and therefore bypasses the Directed Order Process, enters Arca:

Example 1. Suppose the incoming order is a market order to sell 1000 shares of XYZ. The market order would execute against Order A, filling both Order A and the incoming order for 1000 shares at the price of 20.

Example 2. Suppose the incoming order is a market order to sell 5000 shares of XYZ.

(1)The incoming order would execute against Order A, filling Order A and executing 1000 shares of the incoming order at 20.

(2)Next, 1000 shares of the incoming order would execute against the 1000 displayed shares of Order B1 at 20, without affecting the 4000 undisplayed shares of Order B2 in the Working Order Process.

(3)Third, the incoming order would execute against Order C, filling both Order C and executing 500 shares of the incoming order at 20.

(4)Finally, the remaining 2500 shares of the incoming order would execute against 2500 shares of D1 at 20, completing the incoming order.

Example 3. Suppose the incoming order is a market order to sell 25,200 shares of XYZ.

(1)The incoming order would execute against Orders A, B1, and C in the same manner as in Example 3.

(2)Then, the incoming order would execute against Order D1 for 5000 shares at 20, filling Order D.

(3)Next, the incoming order would execute against Order F for 1000 shares at 20, thereby filling Order F.

(4)The incoming order then would execute against Order G for 700 shares at 20, thereby filling Order G.

(5)Then, the incoming order would execute against Order H for 5000 shares at 20, thereby filling Order H.

(6)Then, the incoming order would execute against Order I1 for 10,000 shares at 20, thereby filling Order I.

(7)Then, because the incoming order has exhausted orders in the Display Order Process and has not been filled in its entirety, it enters the Working Order Process. First, the incoming order is executed against the 4000 shares of reserve size for Order B2. This fills the balance of Order B.

(8)The incoming order does not interact with Order D2 in the Working Order Process because Order D was filled in the Display Order Process.

(9)The incoming order then executes against the 1500 shares of Order E at 20, thereby filling both Order E and the incoming order.

Example 4. Suppose the incoming order is a market order to sell 25,300 shares of XYZ. The order would be executed as described in Example 3, paragraphs (1) - (9). The remaining 100 shares would be routed to the Tracking Order Process, where they would be executed against Tracking Order(s), if any.

Example 5. Suppose the incoming order is a market order to sell 25,250 shares of XYZ. The order would be executed as described in Example 3, paragraphs (1) - (9). The remaining 50 shares would be routed to the Tracking Order Process, where they would be executed against Odd Lot Tracking Order(s), if any.

v. Crosses

Arca permits the execution of a Cross Order, which is defined as a two-sided order with instructions to match the identified buy-side with the identified sell-side at a specified price (the "cross price"), subject to price improvement requirements described below.¹⁰² A Cross Order would be executed as follows; provided, however, no Cross Orders would be matched at the cross price without interacting with any orders in the Arca Book unless the cross price improves the BBO by the Minimum Price Improvement Increment.¹⁰³

(1)If the cross price is equal to or better than the NBBO and is between the BBO, the orders could be crossed without interacting with any other orders.

(2)If the cross price is equal to or better than the NBBO and is at the BBO, the remainder of the Cross Order could be crossed, after any relevant portion is matched against any displayed orders with priority in the Arca Book.

(3)If the cross price is outside the NBBO and is between the BBO, the remainder of the Cross Order could be crossed, after the relevant portion is routed away to other markets for execution.

(4)If the cross price is outside the NBBO and is at the BBO, the remainder of the Cross Order could be crossed, after any relevant portion is first routed away to other markets for execution and then any relevant portion is matched against any displayed orders with priority in the Arca Book.

(5)If the cross price is outside the NBBO and the BBO and the NBBO is better than the BBO, the relevant portion of the order first would be routed away to other markets for execution. Then, the Cross Order would be matched at the displayed price (if the Cross Order is smaller than block size¹⁰⁴ ) or at the cross price (if the Cross Order is of block size) against displayed orders with priority in the Arca Book. Then, the Cross Order would be matched at the price at which the Working Order is represented in the Book against all Working Orders with priority. Finally, any remainder of the Cross Order would be matched at the cross price.

(6)If the cross price is outside the NBBO and the BBO and the NBBO equals the BBO, then the Cross Order first would be matched at the displayed price (if the Cross Order is smaller than block size) or at the cross price (if the Cross Order is of block size) against displayed orders with priority in the Arca Book. Then, the Cross Order would be matched at the price at which the Working Order is represented in the Book against all Working Orders with priority. Then, the relevant portion of the order would be routed away to other markets for execution. Finally, any remainder of the Cross Order would be matched at the cross price.

vi. Trading Sessions

Arca would have three trading sessions each day the PCXE is open for business: the Opening Session, the Core Trading Session and the Late Trading Session. The Opening Session begins at 5:00:00 a.m. (Pacific Time) and concludes at the commencement of the Core Trading Session. The Opening Auction and the Market Order Auction¹⁰⁵ would occur during the Opening Session. The Core Trading Session begins for each security at 6:30:00 a.m. (Pacific Time) or at the conclusion of the Market Order Auction, whichever comes later, and concludes at 1:00:00 p.m. (Pacific Time). Finally, the Late Trading Session begins after the conclusion of the Core Trading Session and concludes at 5:00:00 p.m. (Pacific Time).¹⁰⁶

During the Core Trading Session, market makers would be obligated to enter Q Orders in securities in which they are registered by the time Core Trading Hours begin. During the Opening Session and the Late Trading Session, market makers are not obligated to enter Q Orders in securities in which they are registered. Market makers are required to enter at least one Cleanup Order for all securities in which they are registered for each Market Order Auction.¹⁰⁷

Any Day Order entered into Arca could remain in effect for one or more consecutive trading sessions on a particular day. For each Day Order entered into Arca, the User would have to designate for which trading session(s) the order would remain in effect. Any GTC Order entered into Arca would remain in effect only during Core Trading Sessions, unless the User indicates that the GTC Order would remain in effect for the Opening and/or Late Trading Sessions.¹⁰⁸

For each trading session, some order types are eligible to be executed and others are not eligible to be executed. During the Opening Session, orders eligible for the Display Order Process (other than Q Orders) and for the Working Order Process that have been designated as available for the Opening Session are eligible for entry into and execution on Arca. Stop Orders are not eligible for execution during the Opening Session. Users could enter market and Auction Only Limit Orders for inclusion in the Market Order Auction. Market orders and Auction Only Limit Orders are not eligible for execution during the Opening Session, except during the Market Order Auction. Neither the Directed Order Process nor the Tracking Order Process is available during the Opening Session. For the purposes of the Opening Session, market Directed Orders are eligible for execution in the Market Order Auction. NOW Orders are eligible for execution during the Opening Session; however, NOW Orders are not eligible for the Opening Auction or the Market Order Auction. PNP Orders are eligible for execution during the Opening Session.¹⁰⁹

During the Core Trading Session, market orders, Stop Orders, NOW Orders, PNP Orders and orders eligible for the Directed Order, Display Order, Working Order, and Tracking Order Processes are eligible for entry into and execution on Arca.¹¹⁰

During the Late Trading Session, orders eligible for the Display Order Process (other than Q Orders) and for the Working Order Process, including NOW Orders and PNP Orders, that have been designated as available for the Late Trading Session are eligible for entry into and execution on Arca. Market orders and Stop Orders are not eligible for execution during the Late Trading Session. The Directed Order Process and Tracking Order Process are not available during the Late Trading Session.¹¹¹

Because Arca would operate the Opening and Late Trading Sessions outside of traditional trading hours, the PCXE requires certain customer disclosures.¹¹² In particular, no ETP Holder could accept an order from a non-ETP Holder for execution in the Opening or Late Trading Session without disclosing to such non-ETP Holder that:

(1) Except for market orders eligible for execution during the Market Order Auction, Limited Price Orders are the only orders that are eligible for execution during the Opening and Late Trading Sessions;

(2) An order would have to be designated specifically for trading in the Opening and/or Late Trading Session to be eligible for trading in the Opening and/or Late Trading Session; and

(3)Extended hours trading involves material trading risks, including the possibility of lower liquidity, high volatility, changing prices, unlinked markets, an exaggerated effect from news announcements, wider spreads and any other relevant risk. The disclosures required pursuant to this paragraph could take the following form or such other form as provides substantially similar information:

1. Risk of Lower Liquidity. Liquidity refers to the ability of market participants to buy and sell securities. Generally, the more orders that are available in a market, the greater the liquidity. Liquidity is important because with greater liquidity it is easier for investors to buy or sell securities, and as a result, investors are more likely to pay or receive a competitive price for securities purchased or sold. There may be lower liquidity in extended hours trading as compared to regular market hours. As a result, your order may only be partially executed, or not at all.

2. Risk of Higher Volatility. Volatility refers to the changes in price that securities undergo when trading. Generally, the higher the volatility of a security, the greater its price swings. There may be greater volatility in extended hours trading than in regular market hours. As a result, your order may only be partially executed, or not at all, or you may receive an inferior price in extended hours trading than you would during regular markets hours.

3. Risk of Changing Prices. The prices of securities traded in extended hours trading may not reflect the prices either at the end of regular market hours, or upon the opening of the next morning. As a result, you may receive an inferior price in extended hours trading than you would during regular market hours.

4. Risk of Unlinked Markets. Depending on the extended hours trading system or the time of day, the prices displayed on a particular extended hours system may not reflect the prices in other concurrently operating extended hours trading systems dealing in the same securities. Accordingly, you may receive an inferior price in one extended hours trading system than you would in another extended hours trading system.

5. Risk of News Announcements. Normally, issuers make news announcements that may affect the price of their securities after regular market hours. Similarly, important financial information is frequently announced outside of regular market hours. In extended hours trading, these announcements may occur during trading, and if combined with lower liquidity and higher volatility, may cause an exaggerated and unsustainable effect on the price of a security.

6. Risk of Wider Spreads. The spread refers to the difference in price between what you can buy a security for and what you can sell it for. Lower liquidity and higher volatility in extended hours trading may result in wider than normal spreads for a particular security.

Finally, trades on Arca executed and reported outside of the Core Trading Session would have to be designated as .T trades.¹¹³

vii. Opening Session Auctions

Definitions. Arca would operate two auctions during its Opening Session - the Opening Auction and the Market Order Auction. In preparation for a description of these two auctions, PCXE would define several new terms applicable to the auctions.

First, for the purposes of the Opening Auction and the Market Order Auction, PCXE proposes to define the term "Indicative Match Price" to mean "for each security (1) the price at which the maximum volume of orders are executable; or (2) if there are two or more prices at which the maximum volume of orders are executable, the price that is closest to the closing price of the previous trading day's normal market hours, as determined by the Consolidated Tape."¹¹⁴ In addition, the PCXE defines the term "Imbalance" as the number of buy or sell shares that can not be matched with other orders at the Indicative Match Price at any given time.¹¹⁵

Finally, the PCXE introduces the Cleanup Order for the Market Order Auction.¹¹⁶ Cleanup Orders (1) could be submitted only by market makers; (2) would have to be submitted to Arca before 6:15 a.m. (Pacific Time) and remain in effect until the conclusion of the Market Order Auction; (3) would have to be 2500 shares in size; (4) would have to be entered as both buy or sell orders, provided, however, the Cleanup Order could be executed only on the side of the market opposite the Imbalance; (5) would be executed at the Indicative Match Price as of the time of the Market Order Auction; and (6) would be executed only if: (i) there was an Imbalance of eligible orders at the conclusion of the Market Order Auction, as provided in proposed PCXE Rule 7.35; and (ii) the Imbalance is less than or equal to aggregate size of all Cleanup Orders in the relevant security. If there is an Imbalance and Cleanup Orders would be executed, the market orders which make up the Imbalance would be divided equally among, and allocated to, all market makers registered in the relevant security and executed against such market makers' Cleanup Orders. If no Imbalance exists at the time of the Market Order Auction, all Cleanup Orders would be cancelled at that time.

Order Entry and Cancellation Before the Opening Auction.¹¹⁷ Users could submit any orders to Arca beginning at 4:30 a.m. (Pacific Time). Any such Limited Price Orders designated for the Opening Session would be queued until 5:00 a.m. (Pacific Time) at which time they would be eligible to be executed pursuant to the Opening Auction. Any such market orders would be queued until the Market Order Auction at which time they would be executed pursuant to the Market Order Auction.

Only Limited Priced Orders designated for the Opening Session would be eligible for the Opening Auction. Market orders entered before the Opening Auction would participate in the Market Order Auction. Limited Price Orders not designated for the Opening Session would become eligible for execution pursuant to Rule 7.37 at the commencement of the Core Trading Session.

Beginning at 4:30 a.m. (Pacific Time), and various times thereafter as determined from time to time by the PCXE, the Indicative Match Price of the Opening Auction, and any Imbalance associated therewith, would be published via electronic means as determined from time to time by the PCXE. Orders that are eligible for the Opening Auction could not be cancelled between 4:58 a.m. (Pacific Time) and the conclusion of the Opening Auction.

Opening Auction. At 5:00 a.m. (Pacific Time), Limited Price Orders designated for the Opening Session are matched and executed in the Opening Auction. The orders in the Opening Auction would be executed at the Indicative Match Price as of the time of the Opening Auction. Orders that are eligible for, but not executed in, the Opening Auction would become eligible for the Opening Session immediately upon conclusion of the Opening Auction.¹¹⁸

For example, if the last .T sale is 50, Arca has an a limit order to buy 1000 shares at 50.5 and a limit order to sell 1000 shares at 50.2, the opening execution would occur at 50.2 for 1000 shares. As another example, suppose the last .T sale is at 50 and Arca has (1) a limit order to buy 1500 shares at 50.5; (2) a limit order to sell 1000 shares at 50.25; and (3) a limit order to sell 300 at 50.5. The opening execution would occur at 50.5 for 1300 shares. The remaining 200 shares would be bid at 50.5 in the Opening Session.

Market Order Auction.¹¹⁹ Beginning at 5:00 a.m. (Pacific Time), and various times thereafter as determined from time to time by the PCXE, the Indicative Match Price of the Market Order Auction and the volume available to trade at such price, would be published via electronic means as determined from time to time by the PCXE. If such a price does not exist (i.e., there is an Imbalance of market orders), Arca would indicate via electronic means that an Indicative Match Price does not exist. In addition, beginning at 5:00 a.m. (Pacific Time), and various times thereafter as determined from time to time by the PCXE, the market order Imbalance associated with the Market Order Auction, if any, would be published via electronic means as determined from time to time by the PCXE. If the difference between the Indicative Match Price and the closing price of the previous trading day's normal market hours, as determined by the Consolidated Tape, is equal to or greater than a pre-determined amount, as determined from time to time by the PCXE, Arca would assign a "SIG" designator to such Indicative Match Price and publish such designator via electronic means as determined from time to time by the PCXE.

For example, suppose Arca has the following orders: (1) market order to buy 5000 shares; (2) Auction-Only Limit Order to sell 1000 at 50; (3) limit order to sell 1000 at 50.50; and (4) limit order to sell 500 at 50.75. Arca would publish an Indicative Match Price of 50.75, a volume of 2500 shares and a buy Imbalance of 2500 shares.

As another example, suppose Arca has the following orders: (1) market order to buy 3000 shares; (2) market order to sell 1000; (3) limit order to sell 1000 at 41.00; and (4) limit order to sell 1000 at 41.25. Arca would publish an Indicative Match Price of 41.25 and a volume of 3000 shares and would not publish an Imbalance.¹²⁰

Any Imbalance in the Market Order Auction could be reduced by new orders, entered on the side of the market opposite the Imbalance, pursuant to the following priority: (1) market orders; (2) Limited Price Orders eligible for the Opening Session; (3) Limited Price Orders entered before 6:28 a.m. (Pacific Time); (4) Auction-Only Limit Orders; and (5) Cleanup Orders. Between 6:28 a.m. (Pacific Time) and the conclusion of the Market Order Auction, Limited Price Orders eligible for the Opening Session or the Core Trading Session could be cancelled, but market orders, Auction-Only Limit Orders and Cleanup Orders could not be cancelled. In addition, between 6:28 a.m. (Pacific Time) and the conclusion of the Market Order Auction, market orders and Auction-Only Limit Orders could not be entered on the same side as the Imbalance. Market orders and Auction-Only Limit Orders could be entered on the opposite side of the Imbalance, however, any time before the Market Order Auction.¹²¹

Arca would determine the price of the Market Order Auction as follows: If there is no Imbalance, orders would be executed in the Market Order Auction at the Indicative Match Price as of 6:30 a.m. (Pacific Time). If an Imbalance exists, or if an equilibrium exists between buy market orders and sell market orders, as many buy market orders and sell market orders as possible would be matched, on a time priority basis, (1) at the midpoint of the NBBO at 6:30 a.m. (Pacific Time), in the case of exchange-listed securities for which the PCXE is not the primary market; (2) at the midpoint of the NBBO at 6:30 a.m. (Pacific Time), in the case of Nasdaq securities, provided that the NBBO is not crossed; (3) at the midpoint of the first uncrossed NBBO after 6:30 a.m. (Pacific Time), in the case of Nasdaq securities in which the NBBO is crossed but the BBO is not crossed by the NBBO; (4) at the bid (offer) of the BBO that was crossed prior to 6:30 a.m. (Pacific Time), in the case of Nasdaq securities in which the BBO is crossed by a market participant; or (5) at the Indicative Match Price as of 6:30 a.m. (Pacific Time) in the case of those issues for which the PCXE is the primary market; if an equilibrium exists between buy and sell market orders, the match price would be the last Corporation sale price in the security regardless of the trading session, provided that, if the last Corporation sale price is inferior to the BBO, the match price would be the Corporation bid (offer). Such executions would be designated with a modifier to identify them as Market Order Auction trades. The market orders that are eligible for, but not executed in the Market Order Auction, would become eligible for execution in the Core Trading Session immediately upon conclusion of the Market Order Auction.¹²²

The following examples clarify how the Market Order Auction works:

Example 1. Suppose Arca has the following orders: (1) Market order to buy 5000; (2) Opening Session active limit order to buy 1000 at 50; (3) Opening Session active limit order to sell 1000 at 50.5; (4) Core Session limit order to sell 500 at 50.25; (5) Auction Only Limit order to sell 3000 at 50.5 and; (6) One market maker Cleanup Order for 2500 shares. The Market Order Auction would occur at 50.5 with the market order being executed against orders in the following manner: (1) 1000 executed against the Opening Session Limit sell order; (2) 500 executed against the Core Session limit order; (3) 3000 executed against the Auction Only Limit Order; and (4) 500 executed against the Cleanup Order.

Example 2. Suppose Arca has the following orders: (1) Market order to buy 5000; (2) Market order to sell 5000; and (3) NBBO at 6:30 is 50 to 50.5. The Market Order Auction would occur at 50.25 with the market buy order being executed against the market sell order at the mid-point of the spread.

Example 3. Suppose Arca has the following orders: (1) Market order to buy 5000; (2) Market order to sell 5000; and (3) NBBO at 6:30: 50.6 bid quoted at 6:29 and 50.5 offer quoted at 6:15. The Market Order Auction would occur at 50.55 with the market buy order being executed against the market sell order at the price of the most recent quote.

Example 4. Suppose Arca has the following orders for Nasdaq securities: (1) Market order to buy 5000; (2) Market order to sell 5000; (3) Opening Session active limit order to sell 1000 at 50.5; and (4) NBBO at 6:30: 50.6 bid quoted at 6:29 and 50.5 offer quoted at 6:15 (Arca). The Market Order Auction would occur at 50.5 with the market buy order being executed against the market sell order at the price of the Arca quote that has been locked crossed.

Transition to Core Trading Session. Limited Price Orders entered before 6:28 a.m. (Pacific Time) would participate in the Market Order Auction. Limited Price Orders designated for the Core Trading Session entered after 6:28 a.m. (Pacific Time) would become eligible for execution at 6:30 a.m. (Pacific Time) or at the conclusion of the Market Order Auction, whichever is later. Market orders entered after 6:28 a.m. (Pacific Time) and before 6:30 a.m. (Pacific Time), which are eligible for either the Market Order Auction or the Core Trading Session, would become eligible for execution at 6:30 a.m. (Pacific Time) or at the conclusion of the Market Order Auction, whichever is later, unless otherwise provided in proposed Rule 7.35(c)(2)(C). Stop Orders entered before or during the Opening Session become eligible for execution at 6:30 a.m. (Pacific Time) or at the conclusion of the Market Order Auction, whichever is later.¹²³

viii. Odd and Mixed Lots

In addition to round lots, Users could also submit odd and mixed lots to Arca and, therefore, proposed PCXE Rule 7.38 describes the treatment of odd and mixed lots on Arca. All odd lot orders submitted by Users to Arca would have to be market orders or limit orders, where such orders are subject to no additional conditions. In other words, odd lot orders could not be Working Orders, Directed Orders, Directed Fills, Tracking Orders, or other similar orders. As an exception to this prohibition on conditional odd lot orders, Odd Lot Dealers could submit Odd Lot Tracking Orders. Mixed lot orders could be any order type supported by Arca.¹²⁴

Round lot, mixed lot, and odd lot orders are treated in the same manner in Arca, except in the Tracking Order Process. The Tracking Order Process treats odd lot orders in a different manner from mixed lot and round lot orders, as discussed above.¹²⁵

Finally, proposed PCXE Rule 7.38(c) states that the following actions related to odd lot orders would be considered conduct inconsistent with just and equitable principles: (1) combining odd lot orders given by different customers into a round lot order or orders unless specifically requested to do so by the customers giving the orders; (2) unbundling round lots for the purpose of entering odd lot limit orders in comparable amounts; (3) failing to aggregate odd lot orders into round lots when such orders are for the same account or for various accounts in which there is a common monetary interest; and (4) entering both buy and sell odd lot limit orders in the same stock before one of the orders is executed for the purpose of capturing the spread in the stock.¹²⁶

ix. Miscellaneous Trading Rules

A. Trading Units and Differentials

The PCXE proposes to reduce the unit of trading in stocks from the current 100 shares to 1 share.¹²⁷ The PCXE also proposes to establish the minimum price variation for equity securities traded on Arca as 1/64 of $1.00 for those securities that are quoted in fractions and $0.01 for those equity securities that are quoted in decimals. However, at all times, the minimum price variation would have to be consistent with the Decimalization Implementation Plan.¹²⁸ In addition, the PCXE proposes to make the Minimum Price Improvement Increment on Arca equal to $0.01 or 10% of the spread, whichever is more.¹²⁹

B. Firm Orders and Quotes

The proposed rules require that ETP Holders submit firm quotes and orders to Arca. Proposed PCXE Rule 7.17(a) states no ETP Holder could submit to the PCXE an order (including Q Orders) to buy from or sell to any person any security at a stated price and/or size unless such ETP Holder is prepared to, and, upon submission of an appropriate contra-side order, does, purchase or sell, as the case may be, at such price and/or size and under such conditions as are stated at the time of submission of such order to buy or sell. Additionally, proposed PCXE Rule 7.17(b) requires that all bids and all offers be made in accordance with the provisions of Rule 11Ac1-1 under the Act,¹³⁰ governing the dissemination of quotations for reported securities.

C. Trading Halts and Suspensions

The PCXE guidelines for trading halts and suspensions are set forth in proposed PCXE Rules 7.12 and 7.13. PCXE proposes to keep current PCXE Rule 7.47, entitled "Trading Halts Due to Extraordinary Market Volatility," renumbered as proposed PCXE Rule 7.12. In addition, proposed PCXE Rule 7.13 regarding trading suspensions states that, except as otherwise stated in the proposed rules, the Chair of the Board or the President, or the officer designee of the Chair or the President, would have the power to suspend trading in any and all securities traded on the PCXE whenever in his or her opinion such suspension would be in the public interest. No such action would continue longer than a period of two days, or as soon thereafter as a quorum of Directors can be assembled, unless the Board approves the continuation of such suspension.¹³¹

D. Clearly Erroneous Policy

Given the change from a manual to an electronic trading environment, the PCXE proposes to adopt a rule regarding clearly erroneous submissions to Arca.¹³² Proposed PCXE Rule 7.11 would allow an ETP Holder that receives an execution on an order that was submitted erroneously to the PCXE for its own or customer account to request that the PCXE review the transaction. Such a request for review could be made via telephone and in writing via facsimile or e-mail. The telephonic request should be submitted immediately and the written request should be submitted within fifteen (15) minutes of the time the trade in question was executed. Once the request has been received, an officer of the PCXE designated by the President would review the transaction under dispute and determine whether it is clearly erroneous, with a view toward maintaining a fair and orderly market and the protection of investors and the public interest. For the purposes of proposed PCXE Rule 7.11, the terms of a transaction executed on the PCXE are "clearly erroneous" when there is an obvious error in any term, such as price, number of shares or other unit of trading, or identification of the security. Each party to the transaction would provide, on a timely basis, any supporting written information as could be reasonably requested by the designated officer to aid resolution of the matter.

Unless both parties (or party, in the case of a cross) to the disputed transaction agree to withdraw the initial written request for review, the transaction under dispute would be reviewed, and a determination would be rendered by the designated PCXE officer. If the officer determines that the transaction is not clearly erroneous, the officer would decline to take any action in connection with the completed trade. In the event that the officer determines that the transaction in dispute is clearly erroneous, the officer would declare the transaction null and void or modify one or more of the terms of the transaction to achieve an equitable rectification of the error that would place the parties in the same position, or as close as possible to the same position that they would have been in, had the error not occurred. The officer would promptly notify the parties of the determination reached and would issue a written resolution of the matter. The ETP Holder aggrieved by the officer's determination could appeal such determination in accordance with the provisions of proposed PCXE Rule 10.13.

In the event of any disruption or a malfunction in the use or operation of any electronic communications and trading facilities of the PCXE, the Chief Executive Officer or the President could declare a transaction arising out of the use or operation of such facilities during the period of such disruption or malfunction null and void or modify the terms of these transactions. Absent extraordinary circumstances, any such action of the Chief Executive Officer or President would be taken within thirty (30) minutes of detection of the erroneous transaction. Each ETP Holder involved in the transaction would be notified as soon as practicable, and the ETP Holder aggrieved by the action could appeal such action in accordance with the provisions of proposed PCXE Rule 10.13.

E. Trading Ahead of Customer Limit Orders

PCXE proposes to adopt a rule prohibiting ETP Holders from trading ahead of customer limit orders.¹³³ Proposed PCXE Rule 6.16 states that:

No ETP Holder may accept and hold an unexecuted limit order from its customer (whether its own customer or a customer of another ETP Holder) and continue to trade on the Corporation the subject security for its own account at prices that would satisfy the customer's limit order, without executing that limit order; provided, however, that an ETP Holder may negotiate specific terms and conditions applicable to the acceptance of limit orders only with respect to limit orders that are:

(1) for institutional customer accounts, where such account is defined as the account of:

(A) a bank, savings and loan association, insurance company, or registered investment company;

(B) an investment adviser registered either with the Securities and Exchange Commission under Section 203 of the Investment Advisers Act of 1940¹³⁴ or with a state securities commission (or agency or office performing like functions); or

(C) any other entity (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million; or

(2) 10,000 shares or more, unless such orders are less than $100,000 in value.

d. Trade Execution and Reporting

Under the proposal, executions occurring as a result of orders matched against the Arca Book would be reported by the PCXE to an appropriate consolidated transaction reporting system. Executions occurring as a result of orders routed away from Arca would be reported to an appropriate consolidated transaction reporting system by the relevant reporting market center. Arca would promptly notify Users of all executions of their orders as soon as the executions take place.¹³⁵

e. Clearance and Settlement

Under the proposed rule for clearance and settlement, each ETP Holder would have to be a clearing firm, clear transactions on the PCXE through a clearing firm, or clear transactions through an entity duly authorized by the PCXE.¹³⁶ Pursuant to proposed PCXE Rule 7.14, an ETP Holder would have to give up the name of the clearing firm through whom each transaction on the PCXE would be cleared. If the identity of the clearing firm subsequently changed, the ETP Holder would have to report such change to the PCXE at least five (5) business days in advance.¹³⁷

Pursuant to proposed PCXE Rule 7.14, each clearing firm would have to be admitted to the PCXE as an ETP Holder, by meeting the qualification requirements for becoming an ETP Holder. However, if a clearing firm becomes an ETP Holder for the sole purpose of acting as a clearing firm on the PCXE, the clearing firm would not have to pay the regular ETP Holder fee. As a general matter, the clearing firm would be responsible for the clearance of the transactions effected by each ETP Holder which gives up such clearing firm's name pursuant to a letter of authorization, letter of guarantee or other authorization given by such clearing firm to such ETP Holder, which authorization would be submitted to the PCXE.¹³⁸

Notwithstanding any other provisions contained in proposed PCXE Rule 7.14 to the contrary, the Board could extend or postpone the time of the delivery of a transaction on the PCXE whenever, in its opinion, such action is called for by the public interest, by just and equitable principles of trade or by the need to meet unusual conditions. In such case, delivery would be effected at such time, place and manner as directed by the Board of Directors.¹³⁹

The details of each transaction executed within Arca would be automatically processed for clearance and settlement on a locked-in basis. ETP Holders would not have to separately report their transactions to the PCXE for trade comparison purposes. All transactions effected by a Sponsored Participant would be cleared and settled, using the relevant Sponsoring ETP Holder's mnemonic or its clearing firm's mnemonic, as applicable.¹⁴⁰

f. Interaction with PCXE Application of the OptiMark System

The PCXE Application of the OptiMark System would continue to operate as it does now. In addition, however, the information from the Arca Book, but not the orders themselves, would be submitted to OptiMark at relevant times during Core Trading Hours in the form of Arca Profiles.¹⁴¹ Arca Profiles are defined as "the satisfaction profile generated by the OptiMark System from processing the Arca Book."¹⁴² Any Order generated from a Cycle representing matches involving Arca Profiles would be routed as an Immediate-or-Cancel Order to Arca for execution against the relevant Arca limit order. If the relevant limit order is no longer available on Arca, the Order generated from the Cycle would be automatically cancelled.¹⁴³

g. Limitation of Liability

The PCXE proposes to limit the liability of the PCXE, Archipelago Exchange, L.L.C., and their respective affiliates with regard to Arca.¹⁴⁴ Specifically, proposed PCXE Rule 7.42 states that:

Neither the PCXE, any affiliate of the PCXE, Archipelago Exchange, L.L.C., nor any affiliate of the Archipelago Exchange, L.L.C., would be liable to Users for any loss, damages, claim or expense:

(1) growing out of the use or enjoyment of Arca; or

(2) arising from or occasioned by any inaccuracy, error or delay in, or omission of or from the collection, calculation, compilation, maintenance, reporting or dissemination of any information derived from Arca, resulting either from any act or omission by the PCXE, any affiliate of the PCXE, Archipelago Exchange, L.L.C., or any affiliate of Archipelago Exchange, L.L.C., or from any act, condition or cause beyond the reasonable control of the PCXE, any affiliate of the PCXE, Archipelago Exchange, L.L.C., or any affiliate of Archipelago Exchange, L.L.C., including, but not limited to, flood, extraordinary weather conditions, earthquake or other acts of God, fire, war, insurrection, riot, labor dispute, accident, action of government, communications or power failure, or equipment or software malfunction.

Furthermore, proposed PCXE Rule 7.42(c) states that "[n]either the Corporation, any affiliate of the Corporation, Archipelago Exchange, L.L.C., nor any affiliate of the Archipelago Exchange, L.L.C., makes any express or implied warranties or conditions to Users as to results that any person or party may obtain from Archipelago Exchange for trading or for any other purpose, and all warranties of merchantability or fitness for a particular purpose or use, title, and non-infringement with respect to Arca are hereby disclaimed."

3. PCXE Membership Structure: Equity Trading Permits

With the introduction of Arca, the PCXE intends to simplify its membership rules to reflect more accurately the change from a traditional floor trading environment. The PCXE would only have one category of members, as that term is defined in the Section 3 of the Act:¹⁴⁵ ETP Holders.¹⁴⁶ Any registered broker-dealer who wishes to be a member once Arca begins operation would have to become an ETP Holder by purchasing an Equity Trading Permit ("ETP")¹⁴⁷ from the PCXE.¹⁴⁸ By becoming an ETP Holder, the registered broker-dealer may effect approved securities transactions on the PCXE's two trading facilities, Arca and the PCXE Application of OptiMark. As is the case under the current PCXE Rules, an ETP Holder: (1) must agree to be bound by the Certificate of Incorporation, Bylaws and Rules of the PCXE, and by all applicable rules and regulations of the SEC; (2) have no ownership or distribution rights in the PCXE; and (3) have limited voting rights to nominate two Directors to the PCXE's Board of Directors and one Governor to the Board of Governors of the PCX Parent.

With the elimination of the trading floor and the introduction of remote electronic trading on the PCXE, two aspects of the current PCXE Rules relating to memberships become obsolete. First, under the existing PCXE Rules, an ETP Firm must have a natural person, a Nominee, to act as its representative on the PCXE. Because an ETP Firm no longer needs a natural person to act on its behalf on the floor, the concept of a Nominee of the ETP Firm has been eliminated.¹⁴⁹ Therefore, an ETP Firm would be re-designated as an ETP Holder.¹⁵⁰ In addition, the definition of an ETP Holder would no longer be defined as a "natural person" or "Nominee," but rather a "sole proprietorship, partnership, corporation, limited liability company or other organization" that has been issued an ETP.¹⁵¹

Second, an important difference between an Equity Automated Systems Access Permits ("ASAP") and an ETP today is that an ETP allows its holder to transact business on the floor of the PCXE, whereas the Equity ASAP does not.¹⁵² Because the PCXE proposes to eliminate the floor, there will no longer be a need for two separate membership categories. Therefore, Equity ASAP Holders would be re-designated as ETP Holders and the rules related to Equity ASAP Holders would be deleted.¹⁵³

4. Applicability of Existing PCXE Rules

In addition to the new proposed rules set forth above, the PCXE proposes to delete the following existing PCXE Rules, which relate primarily to floor trading and specialists or are otherwise inapplicable to the new trading environment: PCXE Rule 1.1(g) (Floor Trader); PCXE Rule 1.1(o) (Non-Resident Organization); PCXE Rule 2.12(a); PCXE Rule 2.24 (Trading Floor Employees of ETP Firms); PCXE Rule 4.1(b-c) (Minimum Net Capital for Specialist Firms); PCXE Rule 4.2 (Specialist Post Capital); PCXE Rule 6.8 (Discretionary Transactions); PCXE Rule 6.16(b) (Miscellaneous Prohibitions); PCXE Rule 7.1(a)(6) (Freely Transferable Security); PCXE Rule 7.1(a)(8) (Local Security); PCXE Rule 7.1(a)(9) (Dually Traded Security); PCXE Rule 7.2, Comm. 01; PCXE Rule 7.4 (Types of Orders); PCXE Rule 7.5 (Authority of Trading Officials); PCXE Rule 7.8 (Trading Floor Standards); PCXE Rule 7.12 (Recognized Quotations); PCXE Rule 7.14 (Trading in "When Issued/Distributed" Securities); PCXE Rule 7.17 (Manner of Bidding and Offering); PCXE Rule 7.18 (Types of Bids or Offers); PCXE Rule 7.19 (Priority and Precedence of Bids and Offers); PCXE Rule 7.20 (Cabinet Dealings); PCXE Rule 7.21 (Error Accounts); PCXE Rule 7, Section 5 (ETP Holders Acting as Specialists); PCXE Rule 7, Section 6 (Specialists Acting as Odd-lot Dealers); PCXE Rule 7, Section 7 (Trading Practices and Procedures) (except for Rule 7.40 - Short Sales, Rule 7.45 - Stock Option Transactions and Rule 7.47 - Trading Halts Due to Extraordinary Market Volatility); PCXE Rule 7, Section 8 (Contracts in Securities) (except for Rules 7.50 & 7.51 - Definitions and General Provisions and Rule 7.53 - Delivery of Securities); PCXE Rule 7.69 (Liability of Corporation Relating to Operation of ITS); PCXE Rule 7.70 (Pacific Computerized Order Access System ("P/COAST")); PCXE Rule 10.12(g) (Floor Citations); PCXE Rule 10.13 (Summary Sanction Procedures); and PCXE Rule 12.1(a); PCXE Equity Floor Procedure Advices.

Furthermore, minor conforming changes have been made throughout the existing PCXE Rules to conform the proposed rules to the new terminology associated with Arca. For example, PCXE has deleted references to, among other things, Equity ASAP Holders, ETP Firms and the trading floor throughout the PCXE Rules. Finally, any other existing PCXE rules which have not been deleted or amended as specified remain in effect as they are currently.

The Exchange believes the proposed rule change is consistent with Section 6(b) of the Act,¹⁵⁴ in general, and furthers the objectives of Section 6(b)(5),¹⁵⁵ in particular, in that it is designed to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in facilitating transactions in securities, and to remove impediments and perfect the mechanisms of a free and open market and to protect investors and the public interest.

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 that is not necessary or appropriate in furtherance of the purposes of the Act. In fact, PCX and PCXE believe that the introduction of a fully electronic trading venue will serve to enhance competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received from Members, Participants, or Others

Written comments on the proposed rule change were neither solicited nor received.

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 self-regulatory organization 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. SEC's Solicitation of Comments

The PCX proposes that Arca become a facility of PCXE that would replace the PCX's traditional floor-based auction market for equity securities. The PCX's proposal presents several novel issues with respect to the operation of a national securities exchange. In addition to requesting comments concerning the overall proposal, the Commission requests comments addressed to the following specific items: (1) Discretionary Orders, (2) the minimum price improvement level, (3) customer order priority, and (4) the opening and late trading sessions.

First, the PCX's proposal would enable users to submit "Discretionary Orders" for execution on Arca. Proposed PCXE Rule 7.31(h)(2) defines a Discretionary Order as "an order to buy or sell a stated amount of a security at a specified, undisplayed price (the 'discretionary price'), in addition to at a specified, displayed price." For example, an incoming marketable limit order may be matched for execution against the displayed price of a Discretionary Order. An otherwise non-marketable incoming limit order, however, may trigger an execution against a Discretionary Order at a price within the undisplayed, discretionary price range of the Discretionary Order. The PCX believes that Discretionary Orders will help replicate the dynamic of a traditional floor-based auction market, in particular the trading discretion of a floor broker.¹⁵⁶

The Commission notes that, pursuant to Rule 11Ac1-1 under the Act¹⁵⁷ (the "Quote Rule"), each responsible broker or dealer is required promptly to communicate to its exchange or association, pursuant to the procedures established by that exchange or association, its best bids, offers, and quotation sizes for any subject security. The Commission seeks general comments on the proposed availability of Discretionary Orders on Arca in the light of the Quote Rule. In addition, the Commission seeks specific comments on the following:

• What are the potential advantages or disadvantages of Discretionary Orders with regard to:
  a) price discovery;
  b) market transparency; and
  c) transaction costs for investors?

• Should a distinction be made between Discretionary Orders placed on behalf of public customers and Discretionary Orders placed by PCXE market makers trading for their own accounts?

Second, proposed PCXE Rule 7.6(a), Commentary .06, would establish a minimum price improvement increment of $.01 or 10% of the spread, whichever is greater, with regard to the execution of Directed Orders¹⁵⁸ and Cross Orders.¹⁵⁹ Accordingly, under the PCX's proposal, the minimum price improvement increment for Directed Orders and Cross Orders would not be less than $.01. The Commission notes that, under the PCX's proposal, the minimum price variation for equity securities traded on Arca would be 1/64 of $1.00 for securities that are quoted in fractions, and $.01 for equity securities that are quoted in decimals.¹⁶⁰ The Commission seeks comment on whether the PCX's proposed minimum price improvement interval that may be greater than the minimum price variation for internalized or otherwise preferenced orders is appropriate.¹⁶¹

Third, historically, securities exchanges have adopted rules that give priority to the agency orders of public customers over the proprietary trades of member firms, in recognition that traders on the floor of an exchange generally possess an informational advantage over public customers. Because the PCX seeks to establish Arca as a purely electronic facility that would not employ a trading floor, the PCX does not believe that its users would possess any informational advantage over public customers who submit agency orders for execution on the Arca Book. Accordingly, the Arca Book would not give precedence to agency orders over principal orders, but rather would rank orders based upon price/time priority.¹⁶² The Commission seeks comment on the order execution priority of the Arca Book, including whether market makers' orders should have priority equal to orders of the same type placed by public customers.

Fourth, and finally, the PCX proposes to operate three distinct trading sessions: an opening session, a core trading session, and a late trading session. The opening session, which would begin at 5:00 a.m. (Pacific Time) and run until the start of the core trading session, would include an Opening Auction at the start of the opening session and a Market Order Auction that would begin at 6:30 a.m. (Pacific Time). The core trading session for each security would begin immediately after conclusion of the Market Order Auction for such security. The Commission seeks comments about the opening session, particularly the opening procedures and the transition from the opening session to the core trading session.

The PCX also proposes to operate a late trading session that would begin when the core trading session ends and conclude at 5:00 p.m. (Pacific Time), contingent upon arrangements with the Consolidated Tape Association. Currently, after-hours trading sessions for listed securities end at 3:30 p.m. (Pacific Time). The Commission invites comments about the PCX's proposed late trading session, including the possible extension of the late trading session to 5:00 p.m. (Pacific Time).

The Commission invites interested persons to submit written data, views, and arguments concerning the proposed rule change, including whether it is consistent with the Act. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-0609. 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 will also be available for inspection and copying at the principal office of the PCX.

All submissions should refer to File No. SR-PCX-00-25 and should be submitted by [insert date 21 days from the date of publication in the Federal Register].

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.¹⁶³

Jonathan G. Katz

Secretary

Appendix A: Text of the Proposed Rule Change

At this time, this material is provided in PDF format.

• Part 1: Rules 1 through 6

• Part 2: Rule 7

• Part 3: Rules 8 through 14

Footnotes

¹15 U.S.C. 78s(b)(1).

²17 CFR 240.19b-4.

³This notice represents Amendment No. 1 and replaces the proposed rule change, as originally filed, in its entirety. See letter from Cherie Macauley, Counsel for the Exchange, Wilmer, Cutler, & Pickering, to John Polise, Senior Special Counsel, Division of Market Regulation, dated November 9, 2000 ("Amendment No. 1").

⁴ Under the Act the "term facility' when used with respect to an exchange includes its premises, tangible or intangible property whether on the premises or not, any right to the use of such premises or property or any service thereof for the purpose of effecting or reporting a transaction on an exchange (including, among other things, any system of communication to or from the exchange, by ticker or otherwise, maintained by or with the consent of the exchange), and any right of the exchange to the use of any property or service." See 15 U.S.C. 78c(a)(2).

⁵See proposed PCXE Rule 1.1(e) (definition of "Archipelago Exchange").

⁶In addition to proposed PCXE Rule 14.3, the PCXE proposes to clarify the Delegation Plan by adding the following language to proposed PCXE Rule 14.1(b): "and all officers, directors, employees, and agents of PCX Equities are officers, directors, employees, and agents of the PCX for purposes of the Act. The books and records of PCX Equities would be subject at all times to inspection and copying by the PCX."

⁷See proposed PCXE Rule 1.1(oo) (definition of "User").⁸See proposed PCXE Rule 1.1(jj) (definition of "Sponsored Participant").

⁹See proposed PCXE Rule 1.1(pp) (definition of "User Agreement").

¹⁰See proposed PCXE Rule 7.29(a).

¹¹See proposed PCXE Rule 1.1(kk) (definition of "Sponsoring ETP Holder"). A Sponsoring ETP Holder must be either (i) a clearing firm with membership in a clearing agency registered with the Commission that maintains facilities through which transactions may be cleared or (ii) a correspondent firm with a clearing arrangement with any such clearing firm. Id.