PCX Rulemaking:

(x) Primary Only Order (PO Order). For exchange-listed securities only, a market order that is to be routed as a market-on-open order to the primary market for participation in the primary market opening or re-opening process.

(1) A PO Order entered for participation in the primary market opening must be entered before 6:28 am (Pacific Time) and it will not be included in the Market Order Auction.

(2) A PO Order entered for participation in the primary market re-opening after a trading halt must be entered after trading was halted on the Corporation and before the Re-Opening Time. The PO Order will not be included in the Trading Halt Auction.

Rules 7.32 - 7.33 -- No change.

Rule 7.34(a) -- No change.

(b) Market Maker Obligations.

(1) [During the Core Trading Session,] Market Makers will be obligated to enter Q Orders in securities in which they are registered in accordance with Rule 7.23, beginning at the start of the Core Trading Session or at such earlier time during the Opening Session as determined from time to time by the Corporation, and continuing until the end of the Core Trading Session. [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 at any times other than those established pursuant to the previous sentence.

(2) Market Makers [are required to enter at least] must maintain one Cleanup Order for all securities in which they are registered for each Market Order Auction.

(d) Orders Permitted in Each Session.

(1) During the Opening Session:

(A) 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 the Archipelago Exchange.

(B) - (F) -- No change.

(G) Notwithstanding that the Market Order Auction occurs during the Opening Session, as set forth in Rule 7.34(a)(1), the following orders not designated for the Opening Session shall participate in the Market Order Auction:

(i) Market orders designated for the Core Trading Session and entered prior to the conclusion of the Market Order Auction; and

(ii) Limited Price Orders designated for the Core Trading Session and entered prior to 6:28 am (Pacific Time).

(2) - (3) -- No change.

(e) - (f) -- No change.

Rule 7.35. (a) Order Entry and Cancellation Before Opening Auction

(1) -- No change.

(2) Only Limited Priced Orders designated for the Opening Session will be eligible for the Opening Auction. Market orders entered before the Opening Auction or during the Opening Session will participate in the Market Order Auction. Limited Price Orders designated for the Core Trading Session and not designated for the Opening Session will become eligible for execution at the commencement of the Market Order Auction pursuant to Rule 7.35(c) [7.37 at the commencement of the Core Trading Session].

(b) -- No change.

(c) Market Order Auction.

(1) -- No change.

(2) Reduction of Imbalances

(A) Any Imbalance in the Market Order Auction may be reduced by new orders, entered on the side of the market opposite the Imbalance, pursuant to the following priority:

(i) Market orders;

(ii) Limited Price Orders eligible for the Opening Session;

(iii) Limited Price Orders designated for the Core Trading Session and entered before 6:28 am (Pacific Time);

(iv) Auction-Only Limit Orders; and

(v) Cleanup Orders.

(B) Between 6:28 am (Pacific Time) and the conclusion of the Market Order Auction, Limited Price Orders eligible for the Opening Session or the Core Trading Session may be cancelled, but Limited Price Orders not eligible for the Opening Session, market orders, Auction-Only Limit Orders and Cleanup Orders may not be cancelled.

(C) -- No change.

(3) Determination of Market Order Auction Price

(A) If there is no Imbalance, orders will be executed in the Market Order Auction at the Indicative Match Price as of 6:30 am (Pacific Time).

(B) 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 shall be matched, on a time priority basis, once an NBBO is available,

(i) at the midpoint of the NBBO at 6:30 am (Pacific Time), in the case of exchange-listed securities for which the Corporation is not the primary market; or

(ii) at the midpoint of the NBBO at 6:30 am (Pacific Time), in the case of Nasdaq-listed securities, provided that the NBBO is not crossed; or

(iii) at the midpoint of the first uncrossed NBBO after 6:30 am (Pacific Time), in the case of Nasdaq securities in which the NBBO is crossed but one side of the BBO is not crossed by the NBBO; or

(iv) 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 and where both sides of the BBO are crossed by the NBBO; or

([i]v) at the bid (offer) of the BBO that was crossed prior to 6:30 am (Pacific Time), in the case of Nasdaq securities in which the BBO is crossed by a market participant; or

(vi) at the Indicative Match Price as of 6:30 am (Pacific Time) in the case of those issues for which the Corporation is the primary market. If equilibrium exists between buy and sell market orders, the match price shall be at the last Corporation sale price in the security regardless of the trading session[,provided, that,]; however, if the last Corporation sale price is lower than [inferior to] the BBO, the match price shall be the displayed bid in the security, or if the last Corporation sale price is higher than the BBO, the match price will be the displayed offer in the security [Corporation bid (offer)].

Such executions shall 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, shall become eligible for execution in the Core Trading Session immediately upon conclusion of the Market Order Auction.

(1) Re-Opening Time. After trading in a security has been halted, the Corporation shall disseminate the estimated time at which trading in that security will re-open (the "Re-Opening Time").

(2) Publication of Indicative Match Price and Imbalances

(A) Immediately after trading is halted in a security, and various times thereafter as determined from time to time by the Corporation, the Indicative Match Price of the Trading Halt Auction and the volume available to trade at such price, shall be published via electronic means as determined from time to time by the Corporation. If such a price does not exist (i.e., there is an Imbalance of market orders), the Archipelago Exchange shall indicate via electronic means that an Indicative Match Price does not exist.

(B) Immediately after trading is halted in a security, and various times thereafter as determined from time to time by the Corporation, the market order Imbalance associated with the Trading Halt Auction, if any, shall be published via electronic means as determined from time to time by the Corporation.

(C) If the difference between the Indicative Match Price and the last price prior to the trading halt, as determined by the Consolidated Tape, is equal to or greater than a pre-determined amount, as determined from time to time by the Corporation, the Archipelago Exchange will assign a "SIG" designator to such Indicative Match Price and publish such designator via electronic means as determined from time to time by the Corporation.

(3) Reduction of Imbalances

(A) Any Imbalance in the Trading Halt Auction may be reduced by new orders, entered on the side of the market opposite the Imbalance, pursuant to the following priority:

(i) Market orders;

(ii) Limited Price Orders; and

(iii) Auction-Only Limit Orders.

(B) Primary Only Orders may be submitted to the Archipelago Exchange during a trading halt. Cleanup Orders are not eligible for execution in the Trading Halt Auction.

(C) The Corporation, if it deems such action necessary, will disseminate the time, prior to the time that orders are matched pursuant to the Trading Halt Auction, at which orders may no longer be cancelled.

(D) Interaction with ITS

(i) If a pre-opening indication is required pursuant to the ITS Plan, the Corporation will disseminate three minutes prior to the Re-Opening Time the applicable price range, consisting of the Indicative Match Price as one end of the price range and the Indicative Match Price plus an amount determined by the Corporation for the higher end of the price range.

(ii) The Archipelago Exchange will treat any responses to a pre-opening indication as an Auction-Only Limit Order.

(E) Other market centers may use private communication connections to enter Auction-Only Limit Orders for a Trading Halt Auction.

(4) Determination of Trading Halt Auction Price

(A) For exchange-listed stocks:

(i) If there is no Imbalance and no other market center has re-opened trading in the security, orders will be executed in the Trading Halt Auction at the Indicative Match Price as of the Re-Opening Time.

(ii) If an Imbalance exists, or if an equilibrium exists between buy market orders and sell market order, or if another market center has re-opened trading in the security, as many buy market orders and sell market orders as possible shall be matched, on a time priority basis, at the midpoint of the first uncrossed, unlocked NBBO, once an NBBO is available.

(B) For Nasdaq stocks:

(i) If there is no Imbalance, orders will be executed in the Trading Halt Auction at the Indicative Match Price as of the Re-Opening Time.

(ii) 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 shall be matched, on a time priority basis, once an NBBO is available,

(a) at the midpoint of the NBBO at the Re-Opening Time, provided that the NBBO is not crossed; or

(b) at the midpoint of the first uncrossed NBBO after the Re-Opening Time, in the case in which the NBBO is crossed, but one side of the BBO is not crossed by the NBBO; or

(c) at the midpoint of the first uncrossed NBBO after the Re-Opening Time, in the case in which the NBBO is crossed and where both sides of the BBO are crossed by the NBBO; or

(d) at the bid (offer) of the BBO that was crossed prior to the Re-Opening Time, in the case in which the BBO is crossed by a market participant; or

(C) For those issues for which the Corporation is the primary market: Orders will be executed at the Indicative Match Price at the Re-Opening Time. If equilibrium exists between buy and sell market orders, the match price shall be at the last Corporation sale price in the security regardless of the trading session; however, if the last Corporation sale price is lower than the BBO, the match price shall be the displayed bid in the security, or if the last Corporation sale price is higher than the BBO, the match price will be the displayed offer in the security.

(5) If any orders are not executed in their entirety during the Trading Halt Auction, then such orders shall be executed in accordance with Rule 7.37 after the completion of the Trading Halt Auction.

(6) After the completion of the Trading Halt Auction, the Archipelago Exchange will re-open for trading the previously halted security in accordance with Rule 7.

(f) Whenever in the judgment of the Corporation the interests of a fair and orderly market so require, the Corporation may adjust the timing of the auctions set forth in this Rule.

Rule 7.36. The Archipelago Exchange shall display to Users and other market participants all non-marketable limit orders in the Display Order Process. The Archipelago Exchange will also disseminate current consolidated quotations/last sale information, and such other market information as may be made available from time to time pursuant to agreement between the Corporation and other market centers.

(a) Ranking. Orders of Users shall 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 shall be organized by the time of entry in the following manner.

(1) Display Order Process. Within the Display Order Process:

(A) -- No change.

(B) The displayed portion of Reserve Orders (not the reserve size) shall be ranked at the specified limit price and the time of order entry. If the displayed portion of the Reserve Order is decremented such that 99 shares or fewer are displayed [in its entirety], the displayed portion of the Reserve Order shall be refreshed for

(i) the displayed amount; or

(ii) the entire reserve amount, if the remaining reserve amount is smaller than the displayed amount,

from the reserve portion and shall be submitted and ranked at the specified limit price and the new time that the displayed portion of the order was refreshed.

(C) -- No change.

(2) -- No change.

Rule 7.37. Subject to the restrictions on short sales under Rule 10a-1 under the Exchange Act, like-priced orders, bids and offers shall be matched for execution by following Steps 1 through 5 in this Rule; provided, however, for an execution to occur in any Order Process, the price must be equal to or better than the NBBO, unless the Archipelago Exchange has routed orders to all away markets at the NBBO.

(a) -- No change.

(b) If an incoming marketable order has not been executed in its entirety pursuant to paragraph (a) of this Rule, any remaining part of the order shall be routed to the Display Order Process.

(1) Step 2: Display Order Process.

(A) An incoming marketable order shall first attempt to be matched for execution against orders in the Display Order Process at the display price of the resident order for the total amount of stock available at that price or for the size of the incoming order, whichever is smaller. For the purposes of this subsection, 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 shall be routed to the Working Order Process.

(B) -- No change.

(2) Step 3: Working Order Process.

(A) - (B) - No change.

(C) 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 shall be sent to that market center or market participant pursuant to Step 5 below after having proceeded through Step 4.

(d) Step 5: Routing Away.

(1) -- No change.

(2) If an order has not been executed in its entirety pursuant to paragraphs (a) through (c) of this Rule and it has not been designated as a Fill-or-Return, Fill-or-Return Plus Order or PNP Order, the order shall be routed for execution as follows:

(A) (i) The order shall be routed, either in its entirety or as component orders, to another market center or market participant as a limit order priced at the quote published by the market center or market participant.

(ii) Based upon a User's instruction, a marketable reserve order may be routed (1) serially as component orders, such that each component corresponds to the displayed size, or (2) only once in its entirety, including both the displayed and reserve portions.

(B) - (E) -- No change.

(e) -- No change.

Rules 7.38 - 7.42 -- No change.

Rule 7.43[.Reserved.] It shall be considered conduct inconsistent with just and equitable principles of trade for a User to use the Directed Order Process for the purpose of bypassing otherwise applicable fees.

Rules 7.44 - 7.64 -- No change.

II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, the PCXE included statements concerning the purpose of, and basis for, the proposed rule change and discusses 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

1. Purpose

As discussed in detail in the Arca Proposing Release, the PCX proposes to establish rules for Arca, a new exchange facility, as that term is defined in Section 3(a) of the Exchange Act.⁵ Arca, which is operated by Archipelago Exchange, L.L.C., is an electronic securities communications and trading facility intended for the use of ETP Holders and their customers. Arca would provide automatic order execution capabilities in the equity securities listed or traded on the PCXE. Arca would operate in place of PCXE's traditional floor trading facilities. In addition to certain minor changes, like renumbering rules,⁶ the PCXE proposes the following substantive changes to the proposed rule changes set forth in the Arca Proposing Release.⁷

a. Implementation of OTC/UTP Plan

To implement the OTC/UTP Plan, the PCX proposes the addition of Proposed Rule 7.18 -- "Trading in Nasdaq/NM Securities" -- as well as a number of new definitions in Proposed Rule 1. These rule revisions are described below.

i. Definitions

The PCX introduces the following new terms in Proposed Rule 1:

(1) Proposed Rule 1.1(x) - PCXE has inserted as Proposed Rule 1.1(x) the following definition of the term "NASD" shall mean "the National Association of Securities Dealers, Inc."

(2) Proposed Rule 1.1(y) - PCXE has added the definition of the term "Nasdaq" as Proposed Rule 1.1(y). "Nasdaq" means "The Nasdaq Stock Market, Inc."

(3) Proposed Rule 1.1(z) - PCXE has added the definition of the term "Nasdaq Market Maker" as Proposed Rule 1.1(z). A "Nasdaq Market Maker" shall mean (1) a Nasdaq market maker as defined in NASD Rule 4200(a)(22), as amended from time to time, or (2) an electronic communications network ("ECN").

(4) Proposed Rule 1.1(aa) - PCXE has added as Proposed Rule 1.1(aa) the definition of the term "Nasdaq/NM Security," which means "any security (i) designated as a national market system security pursuant to the NASD's National Market System Securities Designation Plan with respect to Nasdaq Securities,' filed with and approved by the Commission pursuant to SEC Rule 11Aa2-1 under the Exchange Act and (ii) that is either listed on the Corporation pursuant to Rule 5 or as to which unlisted trading privileges have been granted pursuant to Section 12(f) of the Exchange Act."

(5) Proposed Rule 1.1(bb) - PCXE has inserted the definition of the term "Nasdaq System" as Proposed Rule 1.1(bb). "Nasdaq System" means "the system operated by Nasdaq."

(6) Proposed Rule 1.1(cc) - PCXE has added the definition of the term "Nasdaq System BBO" as Proposed Rule 1.1(cc). "Nasdaq System BBO" means "the best bid or offer that is disseminated pursuant to SEC Rule 11Ac1-1 among the Nasdaq System participants in those issues that are traded on the Nasdaq System."

(7) Proposed Rule 1.1(hh) - PCXE has added the definition of the term "OTC/UTP Participant" as Rule 1.1(hh). "OTC/UTP Participant" is defined as "any registered national securities exchange or national securities association that is a signatory to the OTC/UTP Plan."

(8) Proposed Rule 1.1(ii) - PCXE has inserted the definition of the term "OTC/UTP Plan as Proposed Rule 1.1(ii). "OTC/UTP Plan" shall mean "the Nasdaq National Market/Unlisted Trading System/ Unlisted Trading Privileges Plan, as from time to time amended according to its provisions."

(9) Proposed Rule 1.1(jj) - PCXE has inserted the definition of the term "OTC/UTP Primary Market" as Proposed Rule 1.1(jj). "OTC/UTP Primary Market" for a Nasdaq/NM Security "means Nasdaq; provided, however, that if for any 12-month period the number of reported transactions and the reported share volume in a Nasdaq/NM Security in any other OTC/UTP Participant's market exceeds 50% of the aggregate reported transactions and reported share volume of all OTC/UTP Participants in such security, then that OTC/UTP Participant's market shall be the OTC/UTP Primary Market."

(10) Proposed Rule 1.1(kk) - PCXE has inserted the definition of "OTC/UTP Regulatory Halt" as Proposed Rule 1.1(kk). An "OTC/UTP Regulatory Halt" is "a trade suspension or halt called by the OTC/UTP Primary Market for the purpose of dissemination of material news."

ii. Trading in Nasdaq/NM Securities

To implement the OTC/UTP Plan for the PCXE, PCXE has added Proposed Rule 7.18, "Trading in Nasdaq/NM Securities," which is described in more detail below.

Paragraph (a) of Proposed Rule 7.18 describes access for trading Nasdaq/NM Securities. Paragraph (a)(1) reads: "The Corporation shall permit each Nasdaq Market Maker, acting in its capacity as a market maker, telephone access, or such other access as may be established between the Corporation and the Nasdaq System (collectively, "approved access"), to the Corporation for each Nasdaq/NM Security in which such market maker is registered as a market maker. Such approved access shall include appropriate procedures to assure the timely response to communications received through telephone or other approved access." Paragraph (a)(2) states that "Nasdaq Market Makers may use such approved access to transmit orders for execution on the Corporation. Market Makers, via the facilities of the Corporation, may send orders via approved access to any Nasdaq Market Maker in each Nasdaq/NM security in which it displays quotations." Paragraph (a)(3) provides that "[a]ny order received via approved access from a Nasdaq Market Maker shall be effected in accordance with the Rules of the Corporation applicable to transactions on the Archipelago Exchange." Paragraph (a)(4) reads: "No Market Maker shall permit the imposition of any access or execution fee, or any other fee or charge, with respect to transactions in Nasdaq/NM Securities effected with Nasdaq Market Makers that are communicated to the Corporation through telephone access."

Paragraph (b) of Proposed Rule 7.18 states that "[t]he Corporation will display on the Archipelago Exchange, at a minimum, the Nasdaq System BBO."

Paragraph (c), which describes OTC/UTP Regulatory Halts states: "Whenever, in the exercise of its regulatory function, the OTC/UTP Primary Market for a Nasdaq/NM Security determines that an OTC/UTP Regulatory Halt is appropriate, the Corporation shall halt or suspend trading in that security until the notification by the OTC/UTP Primary Market that the halt or suspension is no longer in effect. The Corporation will assume that adequate publication or dissemination has occurred upon the expiration of one hour after initial publication in a national news dissemination service of the information that gave rise to an OTC/UTP Regulatory Halt and may, at its discretion, re-open trading at that time, notwithstanding notification from the OTC/UTP Primary Market that the halt or suspension is no longer in effect."

Finally, paragraph (d) states that "[t]he following Rules of the Corporation will not be applicable to transactions on the Corporation in Nasdaq/NM Securities: Rules 7.16, 7.55 - 7.57."

b. Re-Opening after Trading Halts

The PCX has introduced a procedure, called the Trading Halt Auction, for re-opening a security after a trading halt. The Trading Halt Auction is described in detail in Proposed Rule 7.35(d). Moreover, the definitions of certain auction-related terms have been revised to reflect this new procedure.

i. Definitions

The following definitions have been revised to accommodate the Trading Halt Auction:

(1) Proposed Rules 1.1(q) and (r) - The definitions of "Imbalance" and "Indicative Match Price" have been revised to indicate that these terms are applicable to the Trading Halt Auction as well as the Opening and Market Order Auctions.

(2) Proposed Rule 7.31(t) - The definition of an Auction-Only Limit Order has been revised to state that it is a limit order that is to be executed during the Trading Halt Auction or the Market Order Auction.

(3) Proposed Rule 7.31(x) - The definition of a Primary Only Order ("PO Order") has been revised to clarify that a User may submit a PO Order for participation in the primary market re-opening process as well as the primary market opening process. Proposed Rule 7.31(x)(2) states that "[a] PO Order entered for participation in the primary market re-opening after a trading halt must be entered after trading was halted on the Corporation and before the Re-Opening Time. The PO Order will not be included in the Trading Halt Auction."

ii. Trading Halt Auction

Subject to certain minor variations, the Trading Halt Auction, as described in Proposed Rule 7.35, operates in much the same fashion as the Market Order Auction. Specifically, to re-open trading in a security following a trading halt in that security, Arca will conduct a Trading Halt Auction, as described below.

After trading in a security has been halted, the PCXE will disseminate the estimated time at which trading in that security will re-open. This estimated time will be designated the "Re-Opening Time." Similarly, immediately after trading is halted in a security, and various times thereafter as determined from time to time by the PCXE, the Indicative Match Price of the Trading Halt Auction and the volume available to trade at such price, shall 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 shall indicate via electronic means that an Indicative Match Price does not exist. In addition, immediately after trading is halted in a security, and various times thereafter as determined from time to time by the PCXE, the market order Imbalance associated with the Trading Halt Auction, if any, will be published via electronic means as determined from time to time by the PCXE. If the difference between the Indicative Match Price and the last price prior to the trading halt, 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 will 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.

Any Imbalance in the Trading Halt Auction may 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; and (3) Auction-Only Limit Orders. Cleanup Orders are not eligible for execution in the Trading Halt Auction. Primary Only Orders may be submitted to Arca during a trading halt for execution in the primary market. The PCXE, if it deems such action necessary, will disseminate the time, prior to the time that orders are matched pursuant to the Trading Halt Auction, at which orders may no longer be cancelled.

During the Trading Halt Auction, Arca will interact with ITS as follows: If a pre-opening indication is required pursuant to the ITS Plan, the PCXE will disseminate three minutes prior to the Re-Opening Time the applicable price range, consisting of the Indicative Match Price as one end of the price range and the Indicative Match Price plus an amount determined by the PCXE for the higher end of the price range. Arca will treat any responses to a pre-opening indication as an Auction-Only Limit Order. In addition to ITS, other market centers may use private communication connections to enter Auction-Only Limit Orders for a Trading Halt Auction.

Arca will determine the price of the Trading Halt Auction as follows: For exchange-listed stocks, if there is no Imbalance and no other market center has re-opened trading in the security, orders will be executed in the Trading Halt Auction at the Indicative Match Price as of the Re-Opening Time. However, if an Imbalance exists, or if an equilibrium exists between buy market orders and sell market order, or if another market center has re-opened trading in the security, as many buy market orders and sell market orders as possible shall be matched, on a time priority basis, at the midpoint of the first uncrossed, unlocked NBBO, once an NBBO is available.

For Nasdaq stocks, if there is no Imbalance, orders will be executed in the Trading Halt Auction at the Indicative Match Price as of the Re-Opening Time. However, 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 shall be matched, on a time priority basis, once an NBBO is available: (1) at the midpoint of the NBBO at the Re-Opening Time, provided that the NBBO is not crossed; (2) at the midpoint of the first uncrossed NBBO after the Re-Opening Time, in the case in which the NBBO is crossed, but one side of the BBO is not crossed by the NBBO; (3) at the midpoint of the first uncrossed NBBO after the Re-Opening Time, in the case in which the NBBO is crossed and where both sides of the BBO are crossed by the NBBO; or (4) at the bid (offer) of the BBO that was crossed prior to the Re-Opening Time, in the case in which the BBO is crossed by a market participant.

For those issues for which the Corporation is the primary market, orders will be executed at the Indicative Match Price at the Re-Opening Time. If equilibrium exists between buy and sell market orders, the match price shall be at the last Corporation sale price in the security regardless of the trading session. However, if the last Corporation sale price is lower than the BBO, the match price shall be the displayed bid in the security, or if the last Corporation sale price is higher than the BBO, the match price will be the displayed offer in the security.

Finally, if any orders are not executed in their entirety during the Trading Halt Auction, then such orders shall be executed in accordance with Rule 7.37 after the completion of the Trading Halt Auction. In addition, after the completion of the Trading Halt Auction, Arca will re-open for trading the previously halted security in accordance with Rule 7.

c. Miscellaneous

In addition to rule revisions related to trading in Nasdaq securities and the Trading Halt Auctions, the PCX proposes the following miscellaneous changes:

i. Rule 1 - Definitions

(1) Proposed Rules 1.1(q) and (r) - PCXE has changed the term "orders" to "shares" in the definitions of "Imbalance" and "Indicative Match Price."

ii. Rule 2 - Equity Trading Permits

(1) Proposed Rule 2.5 - PCXE has deleted Rule 2.5, "Publication of Approved ETP Applications."

iii. Rule 7 - Equities Trading

(1) Proposed Rule 7.6(a), Comm. 05 - In Commentary .05 of Proposed Rule 7.6(a), PCXE has deleted the reference to a minimum price variation ("MPV") of 1/64th of $1.00 for those securities quoted in fractions, thereby limiting the MPV for equity securities traded on Arca to $0.01.

(2) Proposed Rule 7.6(a), Comm. 06 - PCXE has revised Commentary .06 to Proposed Rule 7.6(a). To clarify the applicable spread, PCXE has inserted "NBBO" into the statement that the "minimum price improvement increment ("MPII") on the Archipelago Exchange shall be equal to $0.01 or 10% of the NBBO spread, whichever is more."

(3) Proposed Rules 7.23(a)(6), 7.31(u)(1)-(2) and 7.34(b)(2) - These proposed rules have been revised to clarify that (1) each Market Maker must maintain only one Cleanup Order and (2) Arca will submit each Cleanup Order on behalf of each Market Maker.

(4) Proposed Rules 7.31(f)(7) and 7.31(i)(2) - Pursuant to these two proposed rules, the Corporation shall suspend the Directed and Tracking Order Processes for a security when a locked or crossed market exists in that security. The Directed and Tracking Order Processes for that security will resume when the locked or crossed market in that security no longer exists.

(5) Proposed Rule 7.31(s) - PCXE has deleted the references to "Section 5 of Rule 7" from the definition of a Cross Order.

(6) Proposed Rule 7.31(u)(6)(A) - PCXE has deleted the phrase "of Market Orders" from paragraph (u)(6)(A) of the definition of a Cleanup Order.

(7) Proposed Rule 7.34(b)(1) - Proposed Rule 7.34(b)(1) has been revised to clarify that Market Makers are obligated to enter Q Orders in securities in which they are registered beginning at the start of the Core Trading Session or at such earlier time during the Opening Session as determined from time to time by the PCXE, and continuing until the end of the Core Trading Session. Market Makers are not obligated to enter Q Orders at any other times that the PCXE is open for business.

(8) Proposed Rules 7.34(d)(1)(G), 7.35(a)(2) and 7.35(c)(2)(A)(iii) - These proposed rules have been revised to clarify that, although the Market Order Auction occurs during the Opening Session, the following orders, which have not been designated for the Opening Session will participate in the Market Order Auction: (1) market orders designated for the Core Trading Session and entered prior to the conclusion of the Market Order Auction and (2) Limited Price Orders designated for the Core Trading Session and entered prior to 6:28 am (Pacific Time).

(9) Proposed Rule 7.35(c)(2)(B) - PCXE has added "Limited Price Orders not eligible for the Opening Session" to the list of order types that may not be cancelled between 6:28 am (Pacific Time) and the conclusion of the Market Order Auction.

(10) Proposed Rule 7.35(c)(3)(B) - This section has been modified to indicate that, if the Market Order Auction price is based upon the NBBO under Proposed Rule 7.35(c), then the price will not be determined until an NBBO is available.

(11) Proposed Rule 7.35(c)(3)(B)(iii) - This subparagraph has been revised to state "at the midpoint of the first uncrossed NBBO after 6:30 am (Pacific Time), in the case of Nasdaq securities in which the NBBO is crossed but one side of the BBO is not crossed by the NBBO."

(12) Proposed Rule 7.35(c)(3)(B)(iv) - Another pricing scenario has been added to the Market Order Auction. In this scenario, 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 shall be matched, on a time priority basis, once an NBBO is available, "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 and where both sides of the BBO are crossed by the NBBO."

(13) Proposed Rule 7.35(c)(3)(B)(vi) - PCXE has clarified the wording of Proposed Rule 7.35(c)(3)(B)(vi) to state the following: "[I]f equilibrium exists between buy and sell market orders, the match price shall be at the last Corporation sale price in the security regardless of the trading session; however, if the last Corporation sale price is lower than the BBO, the match price shall be the displayed bid in the security, or if the last Corporation sale price is higher than the BBO, the match price will be the displayed offer in the security."

(14) Proposed Rule 7.35(f) - PCXE has added paragraph (f) to Proposed Rule 7.35, which reads "[w]henever in the judgment of the Corporation the interests of a fair and orderly market so require, the Corporation may adjust the timing of the auctions set forth in this Rule."

(15) Proposed Rule 7.36(a)(1)(B) - PCXE has revised this paragraph to read: "The displayed portion of Reserve Orders (not the reserve size) shall be ranked at the specified limit price and the time of order entry. If the displayed portion of the Reserve Order is decremented such that 99 shares or fewer are displayed, the displayed portion of the Reserve Order shall be refreshed for (1) the displayed amount; or (2) the entire reserve amount, if the remaining reserve amount is smaller than the displayed amount, from the reserve portion and shall be submitted and ranked at the specified limit price and the new time that the displayed portion of the order was refreshed."

(16) Proposed Rule 7.37(b)(2)(C) - PCXE has added the phrase "after having proceeded through Step 4" to the end of Proposed Rule 7.37(b)(2)(C).

(17) Proposed Rule 7.37(d)(2)(A)(ii) - In this Proposed Rule, PCXE has clarified that a marketable reserve order may be routed either (1) serially as component orders, such that each component corresponds to the displayed size or (2) only once in its entirety, including both the displayed and reserve portions.

(18) Proposed Rule 7.43 - PCXE has added Proposed Rule 7.43, "Use of the Directed Order Process." Proposed Rule 7.43 states that "[i]t shall be considered conduct inconsistent with just and equitable principles of trade for a User to use the Directed Order Process for the purpose of bypassing otherwise applicable fees."

2. Statutory Basis

The Exchange believes the proposed rule change is consistent with Section 6(b) of the Act,⁸ in general, and furthers the objectives of Section 6(b)(5),⁹ 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.

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. Solicitation of Comments

Interested persons are invited to submit written data, views and arguments concerning Amendment No. 3, including whether Amendment No. 3 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 Amendment No. 3 of File No. SR-PCX-00-25 and should be submitted by [date within 21 days of publication].

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.¹⁰

Jonathan G. Katz, Secretary

Appendix A

April 19, 2001

John Polise
Division of Market Regulation
Securities and Exchange Commission
Mail Stop 1001
450 Fifth Street, N.W.
Washington, DC 20549

Re:Archipelago Exchange: Supplemental Response to Comment Letters

SR-PCX-00-25, Amendment No. 3

Dear Mr. Polise:

On behalf of the Pacific Exchange, Inc., via its wholly owned subsidiary PCX Equities, Inc., (collectively, "PCX"), we appreciate the opportunity to respond to the comment letters submitted to the Securities and Exchange Commission ("SEC" or "Commission") regarding the Archipelago Exchange ("ArcaEx") rule filing.¹¹

To date, nine commenters have submitted ten comment letters concerning ArcaEx.¹² Five commenters fully supported the proposal.¹³ Of these five favorable letters, three represented PCX members. For example, the Los Angeles and San Francisco Specialists Associations stated that they "strongly support the PCX's proposal and urge the [Commission] to approve this proposal as soon as possible."¹⁴ Similarly, D.A. Davidson wrote that it "applauds the effort to create a New Marketplace which will level the playing field for all participants."¹⁵ In addition to member support, the ArcaEx proposal was received favorably by two established electronic marketplaces -- the Cincinnati Stock Exchange ("CSE") and the Arizona Stock Exchange ("AZX"). The CSE "believes that the PCX proposal is an innovative approach that seeks to challenge the floor-based exchange models for the benefit of public investors."¹⁶ The AZX urged the Commission "to expedite the PCX proposed rule change" because it believes that it will help to resolve pressing market structure issues.¹⁷

In contrast, three commenters, including two traditional markets -- Nasdaq and the Philadelphia Stock Exchange ("Phlx") -- and a wholesale market maker, Knight Trading Group, Inc. ("Knight") opposed the ArcaEx rule change.¹⁸ In addition, NASD Regulation, Inc., ("NASDR") submitted a comment letter, but did not express a view in favor of or in opposition to the filing.¹⁹ In this letter, the PCX addresses the various concerns expressed by the commenters, particularly Nasdaq, Phlx and Knight, about the ArcaEx proposal. As discussed in detail below, the PCX does not believe any of the concerns raised in the comment letters should serve as an impediment to approval of the rule filing.

I. ArcaEx is Properly Regulated as a Facility of an Exchange

The PCX believes that, contrary to Nasdaq's assertions,²⁰ ArcaEx is properly regulated as a facility of an exchange and not as an exchange itself. Section 3(a)(2) of the Securities Exchange Act of 1934 ("Exchange Act") provides that:

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 ticket 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.

ArcaEx will use PCX equipment and personnel²¹ and involve the participation of PCX market makers. Furthermore, executions performed on ArcaEx will be regulated and reported as PCX trades. In addition, by supplying an electronic trading system for the use of the PCX members and their customers, ArcaEx will provide a "service . . . for the purpose of effecting . . . a transaction on an exchange," thus providing the PCX the "right of the exchange to the use of . . . [such] service." Because effecting and reporting ArcaEx matches involves the PCX's premises, property and services, ArcaEx will meet the definition of a "facility" of an exchange as defined in Section 3(a)(2) of the Exchange Act.

Regulating ArcaEx as a "facility" of the PCX is consistent with the approach the Commission has followed in other cases similar to the PCX and ArcaEx situation. For example, the Commission approved the PCX's proposal to establish an exchange facility called the PCX Application of the OptiMark System, which was a trading system owned and operated by an entity other than an exchange.²² Likewise, the Phlx, itself, has contracted with third parties to establish the VWAP Trading System as a facility of the Phlx.²³ In neither of these circumstances did the Commission require the entities which contracted with the exchanges to create a facility to register as national securities exchanges themselves.

Because ArcaEx is a facility of the PCX, a rule filing conforming to the requirements of Section 19 of the Exchange Act and Rule 19b-4 thereunder is the appropriate regulatory format for soliciting comments and seeking Commission approval of the arrangement.²⁴ Despite Nasdaq's statements to the contrary,²⁵ there is no need to file a Form 1 for ArcaEx because the PCX is already registered as a national securities exchange. Again, the use of a Rule 19b-4 filing for the creation of a new exchange facility follows the procedure used, and accepted by the Commission, with regard to other exchange facilities.²⁶ Correspondingly, PCX, as the registered national securities exchange for the facility, will amend its Form 1 to the extent revision is required by Rule 6a-2 under the Exchange Act for the creation of the ArcaEx facility.²⁷

II. The Relationship between PCX and the ArcaEx Facility Satisfies the Regulatory Requirements of the Exchange Act

The PCX believes that ArcaEx, as a facility of the PCX, is designed to operate in a manner that is consistent with the regulatory purposes of the Exchange Act. Nasdaq's concerns about ArcaEx's compliance with the securities laws as well as the SEC's ability to oversee the ArcaEx facility are unfounded.²⁸ The relationship between PCX and the ArcaEx facility -- in both a rules-related context and a contractual context -- ensures ArcaEx's compliance with the securities laws.

First and foremost, the PCX will be fully responsible for all activity that takes place through ArcaEx, including its regulation and oversight, because ArcaEx is a part of the exchange.²⁹ The PCX will comply with its obligations under the Exchange Act with regard to ArcaEx, just as it does with its current trading facilities.³⁰

Second, ArcaEx, as a party that has agreed to operate a facility of a self-regulatory organization, is required to cooperate with the PCX in meeting its regulatory responsibilities and to submit to Commission oversight and examination. Such cooperation and oversight will be assured through the application of proposed PCXE Rule 14.3 of the PCX Plan of Delegation.³¹ Proposed PCXE Rule 14.3(a), which applies to Archipelago Exchange, L.L.C., ("Archipelago Exchange"), the operator and owner of the ArcaEx trading system, states:

The books, records, premises, officers, directors, agents and employees of Archipelago Exchange, L.L.C., shall be deemed to be the books, records, premises, officers, directors, agents and employees of PCX and PCX Equities for purposes of and subject to oversight pursuant to the Securities Exchange Act. The books and records of Archipelago Exchange, L.L.C., shall be subject at all times to inspection and copying by the PCX, PCX Equities and the SEC.

By legally equating the premises, personnel and records of Archipelago Exchange with those of the PCX, both the PCX and the SEC have jurisdiction over Archipelago Exchange's premises, personnel and records to the same extent that the PCX and the SEC have jurisdiction over the PCX's premises, personnel and records.

In addition, proposed PCXE Rule 14.3(b) further enhances the SEC and PCX's ability to oversee all relevant aspects of the ArcaEx facility. Under this rule, the SEC and the PCX are granted access, not only to the operator of ArcaEx, but also to the parent company of the operator, Archipelago Holdings, L.L.C. ("Holdings"). Specifically, 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 PCX Equities for purposes of and subject to oversight pursuant to the Securities Exchange Act."

Finally, the SEC and PCX's access to and oversight of ArcaEx's operating company and its parent is further solidified in the private contracts related to ArcaEx. Each of the clauses in Rule 14.3 is included in the agreements between PCX and Archipelago Exchange and Holdings. Therefore, Archipelago Exchange and Holdings have a private contractual obligation as well as a regulatory obligation to abide by Rule 14.3.

The relationship between the PCX and ArcaEx is structured in the same fashion as other facility arrangements between an exchange and third parties.³² Such facility arrangements have proven effective in the past and there is no reason to believe that the oversight quality will be hampered in any way in the present case.

III. PCX Will Conduct All Necessary Surveillance of ArcaEx

As part of its obligations under the Exchange Act and pursuant to its own rules,³³ the PCX will conduct all necessary surveillance of the operation of and trading through ArcaEx, including a full audit trail capability. In doing so, ArcaEx, like all facilities of an exchange, will be subject to full oversight of the SEC. Pursuant to this oversight, the SEC will ensure that the PCX's surveillance program is adequate based on all relevant circumstances. Nevertheless, such an evaluation of a surveillance program is not accomplished via the public comment process of a Rule 19b-4 filing. Notwithstanding this fact, PCX emphasizes that it has, not only the technological capability to establish and maintain an audit trail, but also the staff expertise and capital resources to satisfactorily oversee a new electronic market trading an increased number of securities. Therefore, the commenters' expressed fears that PCX is unprepared to regulate ArcaEx are unfounded.³⁴

PCX, as a well-established exchange, has the requisite staff experience to support and to supplement the technological surveillance necessary for the all-electronic ArcaEx. Throughout its long trading history, PCX has succeeded in attracting qualified management and regulatory staff, who have repeatedly demonstrated their familiarity with the federal securities laws and the self-regulatory role of a registered exchange. Furthermore, the PCX personnel have had the opportunity to hone their regulatory skills in both floor and electronic trading environments, like the PCX Application of OptiMark, making them particularly well-suited to the task at hand.

Furthermore, consistent with the requirements of the Exchange Act, PCX will demonstrate to the SEC, as necessary, that it has adequate financial resources to fund a surveillance program for a fully electronic trading facility. Finally, PCX intends to implement a state-of-the-art electronic system for producing detailed audit trails of all orders submitted to ArcaEx. In accordance with its regulatory responsibilities, PCX will demonstrate to the Commission that the technology of the system will be more than adequate for the surveillance of, and trading on, ArcaEx.³⁵

IV. The Exchange Act Does Not Require a Market Maker in Every Security

Contrary to Nasdaq's assertion that a failure to require a market maker in every security is a "clear statutory deficiency,"³⁶ the Exchange Act neither explicitly nor implicitly makes such a demand on an exchange.³⁷ First, no specific provision of the Exchange Act, including Sections 6 or 11A, or any rules and regulations promulgated thereunder, compel an exchange to employ market makers as a source of liquidity.

Second, current established trading practices also support the notion that a market maker need not be registered in every security traded on an exchange. The Commission permits exchanges to trade securities via cabinet trading programs.³⁸ With cabinet trading, buy and sell limit orders are booked for execution on the exchange and executed outside the regular specialist or market maker system. ArcaEx should not be held to a different standard than that applied to traditional exchanges.

Third, no market maker requirement can be implied from the basic definition of what constitutes an exchange. Nasdaq claims that because "provid[ing] a ready source of liquidity" is "the most fundamental requirement of a securities exchange," every exchange must require a market maker or specialist to be assigned to each security listed on that market.³⁹ The Commission, however, specifically has rejected this argument in its discussion of the basic characteristics of an "exchange" in the ATS Release.⁴⁰

Nasdaq's argument is merely a reiteration of the now-discarded definition of an "exchange" promulgated in the Delta Release.⁴¹ In 1990, the Commission interpreted the statutory definition of an exchange narrowly to include only those organizations that were "designed . . . to centralize trading and provide buy and sell quotations on a regular and continuous basis so that purchasers and sellers have a reasonable expectation that they can regularly execute their orders at those price quotations."⁴² In 1998, in light of the rapid technological changes taking place in the securities industry, the Commission rescinded the Delta definition and expressly rejected liquidity provided by markets makers as a defining characteristic of a securities exchange. In reaching this conclusion, the Commission explained that "while the Delta interpretation was appropriate at the time, its emphasis on the expectation' of regular execution of orders at quoted prices no longer reflects today's markets where alternative trading systems compete directly with registered exchanges and Nasdaq."⁴³ The Commission further clarified that:

More fundamentally, although traditional exchanges still provide liquidity through two-sided quotations and, hence, raise an expectation of execution at the quoted price, this is no longer the essential characteristic of a securities market where stock and other securities exchange hands. Today's technology enables market participants and investors to tap simultaneous and multiple sources of liquidity from remote locations. Market makers and specialists may be important liquidity providers on a particular exchange, but liquidity now comes from many sources.⁴⁴

Furthermore, when the Commission broadened the definition of an exchange to include a greater variety of business models, it did so with the intent of "encouraging innovative new markets"⁴⁵ and fostering the development of new technology-driven trading designs. ArcaEx is such an "innovative" market and, therefore, there is no basis for commanding ArcaEx to alter its computer-based architecture to require market makers in every security.

V. The Alternative Order Routing Methods of ArcaEx Expand Investor Choice in a Manner Consistent with the Exchange Act

Nasdaq and Knight questioned the status and function of the Archipelago electronic communications network⁴⁶ ("ECN") after the creation of ArcaEx.⁴⁷ The broker-dealer commonly referred to as the Archipelago ECN will continue to exist as a registered broker-dealer renamed WAVE. The functions and activities of WAVE, however, will differ from the current activities of the Archipelago ECN. In particular, WAVE will perform three primary functions, including acting as (1) for a limited period of time, a residual ECN, (2) an introducing broker and (3) a routing broker. In order to perform these limited functions, WAVE will exist as an entity separate and distinct from ArcaEx. In addition, NASDR, rather than PCX, will be the Designated Examining Authority ("DEA") for WAVE, just as it has been for the Archipelago ECN. We discuss the proposed business and regulation of WAVE in more detail below.

A. WAVE Will Perform Three Primary Functions

1. WAVE Will Continue to Perform as an ECN for a Limited Period of Time

First, as a temporary matter, WAVE will continue to act as an ECN, to the extent necessary, for a limited period of time. Specifically, PCX and Archipelago have agreed that all securities eligible to be traded on ArcaEx (i.e., listed securities or securities with unlisted trading privileges ("UTP")) will be traded only on ArcaEx; they will not be traded on PCX and the ECN. Therefore, no security will be traded concurrently on both ArcaEx and the ECN. As of this date, however, the plan for trading over-the-counter ("OTC") pursuant to UTP (the so-called "OTC/UTP Plan") only permits PCX, as an exchange participating in the Plan, to trade 1000 of the Nasdaq/NM securities.⁴⁸ Until the OTC/UTP Plan has been expanded to incorporate all Nasdaq securities,⁴⁹ WAVE will continue to act as an ECN for those securities excluded from the Plan. Once the OTC/UTP Plan has been expanded -- which is expected to occur later this year -- the remaining Nasdaq securities will be transferred for trading from the Archipelago ECN to ArcaEx pursuant to a roll-out plan. The ECN will cease to operate as such once all the Nasdaq securities have been transferred to ArcaEx.

2. WAVE Will Act as an Introducing Broker

Second, WAVE plans to register as an ETP Holder and act as an introducing broker for institutions or other entities who are not ETP Holders themselves. WAVE's position as the routing broker will not bestow any special status on WAVE in its capacity as an ETP Holder. WAVE, acting as an ETP Holder, and its customers will have the exact same access to ArcaEx as any other ETP Holder and its customers. In this regard, PCX and Archipelago will establish appropriate information barriers to address any concerns regarding WAVE's status relative to other ETP Holders.

3. WAVE Will Supply ArcaEx With a Routing Service

Finally, the ongoing WAVE function most relevant for ArcaEx is a routing service. WAVE will route orders, as necessary, from ArcaEx to other market centers.⁵⁰ Given various technical issues associated with market center-to-market center routing within the strictures of today's intermarket structure, PCX and Archipelago have opted to employ the services of a routing broker, rather than rely on routing orders to other markets directly from PCX itself.

Despite the decision to employ WAVE in this intermarket capacity, no User is required to utilize the WAVE routing services. Furthermore, those Users who opt out of the WAVE routing services are not precluded from entering any order types, except a very limited subset of orders that specifically incorporates a WAVE routing requirement within the definition of the order. This limited subset includes Primary Only Orders as well as NOW Orders, if routing of the NOW Order is required.⁵¹ The only trading condition for those Users who do not use the WAVE routing services is that each order, if it has not been fully executed after it has progressed through each step of the ArcaEx trading algorithm,⁵² must be returned to the User or the User's designated agent prior to reaching the routing step of the algorithm.⁵³ After the order is returned to the User, the User may then route the order to another market center as the User sees fit. In other words, the trading mechanism is the same for orders that do not rely on WAVE and orders that do rely on WAVE, except orders that do not rely on WAVE, of course, must, by definition, be routed outside of ArcaEx through another mechanism. The specifics of the routing function and its impact on ArcaEx Users are discussed in more detail below.

i. ArcaEx Provides Its Users With a Choice as to How Their Orders Will Be Routed to Away Markets

ArcaEx has been designed to provide its Users with a choice as to how they wish to route orders to away markets. In this regard, Nasdaq and Knight misinterpret the various options available to Users in ArcaEx's routing structure.⁵⁴ These two commenters correctly identify one ArcaEx routing option: a User may choose to utilize the routing services provided by WAVE, the broker-dealer affiliate of Archipelago Exchange, L.L.C. To do so, the User must enter into a routing agreement with WAVE under which WAVE "agrees to act as agent for routing orders of the ETP Holder⁵⁵ and the ETP Holder's Sponsored Participants⁵⁶ entered into the Archipelago Exchange to other market centers or broker-dealers for execution, whenever such routing is required."⁵⁷

Nasdaq and Knight, however, fail to recognize that a User is not required to use WAVE's routing services. Instead of signing a routing agreement with WAVE, a User may bypass WAVE entirely and opt to rely on its own routing abilities or those of another broker-dealer by utilizing the Fill-or-Return, Fill-or-Return Plus or Post No Preference ("PNP") order types⁵⁸ supplied by ArcaEx.⁵⁹ A Fill-or-Return order is "[a]n order to buy or sell that is to be executed in whole or in part on the Corporation, and the portion not so executed is to be cancelled, without routing the order to another market center."⁶⁰ A Fill-or-Return order, therefore, allows the order originator to re-route the order to another market in a manner of its own choosing, once it is informed that the order has not been executed in its entirety on the ArcaEx. This alternative allows the User to implement its own customized means for accomplishing the order routing.

Similarly, a User may wish to rely upon the routing capabilities of another entity, rather than its own routing resources or WAVE. ArcaEx facilitates such relationships by providing a User with the opportunity to enter Fill-or-Return Plus orders into ArcaEx. A Fill-or-Return Plus order is:

[a]n order to buy or sell that is to be executed in whole or in part on the Corporation, and the portion not so executed is to be cancelled, without routing the order to another market center or market participant. In the event any portion of the order is not executed on the Corporation and must be cancelled, the Archipelago Exchange, after canceling the unexecuted portion of the order, shall 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.⁶¹

The administrative message informs the designated ETP Holder that an order has not been executed. The designated ETP Holder may then use this information to send an order via its own routing mechanisms to another market in accordance with the original User's instructions.

Finally, a User may prefer to send PNP Orders to ArcaEx. A PNP Order is "a limit order to buy or sell that is to be executed in whole or in part on the Corporation, 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; provided, however, the Corporation shall cancel a PNP that would lock or cross the NBBO."⁶² This order type provides the User with the ability to use ArcaEx as a final order destination when it suits the User's investment needs.

As Nasdaq and Knight note in their comment letters,⁶³ certain order types which involve a routing element unique to ArcaEx, like the Primary Only Order,⁶⁴ require the User to utilize WAVE's routing services. As discussed above, however, the rules for trading on ArcaEx in no way preclude a User from pursuing trading opportunities similar to those provided by ArcaEx orders through the routing services supplied by broker-dealers other than WAVE. Users easily may do so by entering Fill-or-Return or Fill-or-Return Plus orders. Furthermore, no denial of access issues arise with any order type, regardless of their routing mechanism.⁶⁵ Every User must satisfy identical, objective requirements for submitting each order type; the requirements do not vary based on the identity of the User or otherwise unfairly discriminate against any particular class of Users.⁶⁶

ii. WAVE Will Not Enjoy a Competitive Advantage as a Result of its Routing Services

Contrary to the concerns expressed by Nasdaq and Knight,⁶⁷ WAVE will not enjoy a competitive advantage over other broker-dealers as a result of the routing services it provides to ArcaEx. In addition to providing only one of the methods by which Users may route orders to away markets, as discussed above, WAVE will be limited in what trading activities it may perform. WAVE will not, for example, conduct proprietary transactions on ArcaEx or in securities traded on ArcaEx. Furthermore, information barriers will be maintained, as necessary, to ensure that WAVE may not unfairly take advantage of knowledge gained as the ArcaEx routing broker.

B. WAVE Will Be Separate and Distinct from ArcaEx

WAVE and ArcaEx will be separate and distinct corporate entities (WAVE, L.L.C., and Archipelago Exchange, L.L.C., respectively). As mentioned above, both are wholly-owned subsidiaries of the same holding company, Archipelago Holdings, L.L.C., whose officers and directors are deemed to be officers and directors of PCX and PCXE for purposes of the Exchange Act. As such WAVE and ArcaEx each have their own trading systems as well as their own compliance, finance and sales functions.

C. WAVE Will Be Assigned to a Designated Examining Authority Other Than the PCX

Nasdaq expressed concerns about the heightened potential for conflicts of interest if the PCX were to regulate WAVE.⁶⁸ To avoid even the perception of a conflict of interest, PCX agrees that an SRO other than PCX should be WAVE's DEA. In particular, PCX and Archipelago believe that NASDR is the most appropriate SRO to act as WAVE's DEA. Based on discussions with NASDR, PCX understands that NASDR has agreed to undertake the DEA responsibilities with respect to WAVE.

VI. ArcaEx Operates in Compliance with Section 11(a) of the Securities Exchange Act

The Phlx believes that PCX should not abandon priority for public customer agency orders over proprietary orders of broker-dealers in implementing ArcaEx.⁶⁹ The Phlx argues that the requirement that broker-dealer orders yield priority, parity and precedence to customer orders is a statutory requirement under Section 11(a) of the Exchange Act.⁷⁰ The PCX disagrees. As discussed in detail in Appendix A , the order execution algorithm of ArcaEx complies with the requirements of, and satisfies the policy concerns underlying, Section 11(a) without requiring public customer priority.

Section 11(a) of the Exchange Act prohibits a member of a national securities exchange from effecting transactions on the exchange for its own account, the account of an associated person, or an account in which it or an associated person exercises investment discretion (collectively, "covered accounts"), unless an exception applies. In enacting this provision, Congress was concerned about members benefiting in their principal transactions from special "time and place" advantages associated with floor trading -- such as the ability to "execute decisions faster than public investors."⁷¹ The Commission, however, has adopted a number of exceptions to the general statutory prohibition for situations in which the principal transactions contribute to the fairness and orderliness of exchange markets or do not reflect any time and place trading advantages.

The Phlx apparently assumes that the PCX is relying upon the Section 11(a) exception set forth in Rule 11a1-1(T) ("the proprietary trading rule"), which has, as one of its requirements, public customer priority. PCX, however, believes that ArcaEx satisfies the requirements of another exception to Section 11(a), which does not require public customer priority. This alternative exception is Rule 11a2-2(T), commonly referred to as the "effect versus execute" rule.⁷²

The effect versus execute rule imposes four requirements "designed to put members and non-members on the same footing, to the extent practicable, in light of the purposes of Section 11(a)."⁷³ ArcaEx will place all of its Users -- both ETP Holders and non-ETP Holders -- on the "same footing," as intended by Rule 11a2-2(T). Given ArcaEx's automated matching and execution services, no User will enjoy any special control over the timing of execution or special order handling advantages, as all orders will be centrally processed for execution by computer, rather than being handled by a member through bids or offers made on the trading floor. Because ArcaEx's open, electronic structure is designed to prevent any ETP Holders from gaining any time and place advantages, the PCX believes that ArcaEx satisfies the four requirements of the "effect versus execute" rule as well as the general policy objectives of Section 11(a).⁷⁴

This result is consistent with the Commission's application of the effect versus execute rule in similar situations. In the past, the Commission and its staff have allowed exchanges to sponsor innovative trading systems in reliance on Rule 11a2-2(T), finding that such facilities, by design, do not provide any special time and place advantage to members.⁷⁵ In particular, where the execution is performed by the facility itself through an automated service, it has been determined that "the member would not retain any ability to control the timing of the execution or otherwise enjoy the kind of special order-handling advantages inherent in being on an exchange floor."⁷⁶ Like these trading systems, ArcaEx ensures that ETP Holders do not have any special or unique trading advantages and, therefore, complies with Section 11(a).

VII. The Treatment of Discretionary Orders in ArcaEx Complies with the Firm Quote Rule

In its comment letter, Nasdaq questioned whether ArcaEx's discretionary orders comply with Rule 11Ac1-1 under the Securities Exchange Act, the so-called Quote Rule.⁷⁷ Under the proposed PCXE Rules, a discretionary order is defined 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 (displayed price')."⁷⁸ For all non-marketable discretionary orders, the discretionary order will be displayed to all Users at the displayed price. No Users will see the discretionary price of the orders. An undisplayed, discretionary price order will be afforded price priority in the Arca Book, but not time priority relative to displayed orders.⁷⁹ As discussed in more detail in Appendix B ,⁸⁰ the PCX believes that its discretionary orders, not only comply with the requirements of the Quote Rule, but also provide significant benefits to the markets.

The Quote Rule mandates national securities exchanges, subject to certain exceptions, to collect and disseminate "best bids" and "best offers" from a "responsible broker or dealer."⁸¹ ArcaEx's treatment of discretionary orders complies with the requirements of this Rule for a number of reasons. First, an important attribute of a bid or offer subject to the Quote Rule is that it represents the "bid price and the offer price communicated by an exchange member or OTC market maker to any broker or dealer, or to any customer."⁸² Accordingly, "[i]n order to constitute a bid or offer, the underlying trading interest must have been communicated to at least one potential counterparty."⁸³ On ArcaEx, the discretionary price of a discretionary order is not communicated to any Users of the system; only ArcaEx is aware of the full potential trading interest of these orders until trades occur. Accordingly, because ArcaEx does not publish the discretionary aspect of these discretionary orders, they should not be deemed to be a "bid or offer" within the meaning of the Quote Rule.

Second, discretionary orders allow the investor to express a more complex -- and more accurate -- trading interest than the single price and size of a conventional order.⁸⁴ Unlike "bids" and "offers," discretionary orders reflect the fact that there is usually more than one price at which an investor is willing to buy or sell. Because these discretionary orders represent a qualitatively different set of information from the traditional price and size information, they are more analogous to indications of interest, than bids and offers. Therefore, like indications of interest, discretionary orders should be excluded from the requirements of the Quote Rule.⁸⁵ The Commission reached a similar conclusion in its analysis of OptiMark Profiles, finding that "Profiles are analogous to indications of interest or CAP orders,⁸⁶ neither of which are displayed in exchanges or on Nasdaq."⁸⁷ Therefore, the inchoate trading interest of discretionary orders should not be treated as a bid or offer under the Quote Rule.⁸⁸

VIII. PCX Will Continue to Participate in the National Market System

Nasdaq also voiced concern over ArcaEx's integration into the Intermarket Trading System ("ITS") because aspects of the ArcaEx trading algorithm appeared to conflict with two basic components of the ITS Plan -- the pre-opening application⁸⁹ and continuous, two-sided quotations.⁹⁰ The PCX remains supportive of the national market system and intends to continue to comply with the national market system plans once ArcaEx becomes operational. Discussions are ongoing with the relevant operating committees, among others, regarding the integration of ArcaEx into the national market system.

IX. PCX Will Maintain All Required Books and Records in the United States

The PCX represents that it will keep all books and records that it is required to maintain under the Exchange Act, including those related to ArcaEx, in the United States.

The PCX believes that the proposed rule change is consistent with the requirements of the Exchange Act, including Sections 6 and 11A, and the rule and regulations thereunder applicable to a national securities exchange. In particular, the PCX believes that the ArcaEx rules are designed to promote just and equitable principles of trade, remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general protect investors and the public interest, as required by Section 6(b)(5) of the Securities Exchange Act. For the foregoing reasons, the PCX requests that the Commission approve the proposed rule changes regarding ArcaEx.

If you have any questions or concerns, please feel free to call Kathryn Beck of the PCX at 415.393.7936, Brandon Becker at 202.663.6979 or the undersigned at 202.663.6855.

Sincerely, Cherie Macauley

cc: Annette Nazareth

Robert L. D. Colby

Belinda Blaine

Larry Bergman

Caite McGuire

Steve Williams

Patrick Joyce

John Roeser

Marc McKayle

Kathryn Beck

Dave Rosedahl

Appendix B

A. Background

Section 11(a) of the Securities Exchange Act ("Exchange Act") prohibits a member of a national securities exchange from effecting transactions on the exchange for its own account, the account of an associated person, or an account in which it or an associated person exercises investment discretion (collectively, "covered accounts"), unless an exception applies. First enacted as part of the Securities Acts Amendments of 1975,⁹¹ Section 11(a) was intended by Congress to address trading advantages enjoyed by exchange members and conflicts of interest in money management.⁹² In particular, as noted by the Securities and Exchange Commission ("SEC" or "Commission"), Congress was concerned about members benefiting in their principal transactions from special "time and place" advantages associated with floor trading -- such as the ability to "execute decisions faster than public investors."⁹³

Where principal transactions contribute to the fairness and orderliness of exchange markets or do not reflect any time and place trading advantages, they are excepted from the prohibition. Among the transactions excepted under Section 11(a)(1) are those by a dealer acting in the capacity of a market maker,⁹⁴ bona fide arbitrage or hedge transactions,⁹⁵ and transactions made to offset errors.⁹⁶ Rule 11a2-2(T) under the Exchange Act provides an exception in addition to those delineated in the statute.

Commonly referred to as the "effect versus execute" rule, Rule 11a2-2(T) permits an exchange member, subject to certain conditions, to effect transactions for covered accounts by arranging for an unaffiliated member to execute the transactions directly on the exchange floor. To comply with the rule's conditions, a member (1) must transmit the order from off the exchange floor; (2) may not participate in the execution of the transaction once it has been transmitted to the member performing the execution;⁹⁷ (3) may not be affiliated with the executing member; and (4) with respect to an account over which the member or an associated person has investment discretion, neither the member nor the associated person may retain any compensation in connection with effecting the transaction without express written consent from the person authorized to transact business for the account in accordance with the rule.

As described by the Commission, these four requirements -- off-floor transmission, non-participation in order execution, execution through an unaffiliated member and non-retention of compensation for discretionary accounts -- were "designed to put members and non-members on the same footing, to the extent practicable, in light of the purposes of Section 11(a)."⁹⁸ If a transaction meets the requirements of the "effect versus execute" rule, it will be deemed to be "consistent with the purpose of Section 11(a)(1) of the Act, the protection of investors, and the maintenance of fair and orderly markets."⁹⁹

In the past, the Commission and its staff have allowed exchanges to sponsor innovative trading systems in reliance on Rule 11a2-2(T), finding that such facilities, by design, do not provide any special time and place advantage to members.¹⁰⁰ In particular, where the execution is performed by the facility itself through an automated service, it has been determined that "the member would not retain any ability to control the timing of the execution or otherwise enjoy the kind of special order-handling advantages inherent in being on an exchange floor."¹⁰¹ Rule 11a2-2(T) thus has been applied in a functional manner, taking into account the structural characteristics that distinguish the operation of an automated trading system from traditional floor activities. This approach represents the sensible conclusion by the Commission and its staff that implementation of Section 11(a) should reflect the "continuing rapid pace of economic, technological and regulatory changes in the markets."¹⁰²

B. Discussion

ArcaEx represents a new electronic trading facility of the PCXE that may be utilized by ETP Holders and their customers to effect the purchase and sale of securities.¹⁰³ As discussed in more detail below, ArcaEx will place all of its Users -- both ETP Holders and non-ETP Holders -- on the "same footing," as intended by Rule 11a2-2(T). Given the automated matching and execution services, no ETP Holder will enjoy any special control over the timing of execution or special order handling advantages, as all orders will be centrally processed for execution by computer, rather than being handled by a member through bids or offers made on the trading floor. Because ArcaEx's open, electronic structure is designed to prevent any ETP Holders from gaining any time and place advantages, ArcaEx satisfies the four requirements of the "effect versus execute" rule as well as the general policy objectives of Section 11(a).

1. Off-Floor Transmission

Rule 11a2-2(T) requires the orders for a covered account transaction to be transmitted from off the exchange floor. In considering the application of this requirement to a number of automated trading and electronic order-handling facilities operated by national securities exchanges, the Commission has deemed the off-floor requirement to be met if the order is transmitted from off the floor directly to the exchange floor by electronic means.¹⁰⁴ Like these other automated systems, orders sent to ArcaEx will be transmitted from remote terminals directly to the system by electronic means. Therefore, Users' orders electronically received by ArcaEx satisfy the off-floor transmission requirement for the purposes of the "effect versus execute" rule.¹⁰⁵

The "effect versus execute" rule further provides that the exchange member and its associated person may not participate in the execution of the transaction once the order has been transmitted. This requirement originally was intended to prevent members with their own brokers on the exchange floor from using those persons to influence or guide their orders' execution.¹⁰⁶ It does not preclude members from canceling or modifying orders, or from modifying instructions for executing orders, after they have been transmitted; provided, however, that such cancellations or modifications are also transmitted from off the exchange floor.¹⁰⁷

In analyzing the application of the non-participation requirement to automated exchange facilities, the Commission specifically noted in regard to the COMEX and PACE systems that (1) the "initiating member relinquishes any ability to influence or guide the execution of its order at the time that order is transmitted into the system" and (2) "[while] the execution of the order is thereafter automatic and does not involve any independent executing member, the design of those systems insures that members do not possess any special or unique trading advantages in handling their orders after transmitting them to the floors of the Phlx or the PSE."¹⁰⁸ As a result, orders transmitted to the COMEX and PACE systems were deemed to comply with this requirement. More recently, the Commission reached the same conclusion concerning the VWAP Trading System, OptiMark and the Chicago Match, stating that a member does not retain the ability to influence or guide the execution of an order after the member submits the order to each of these systems.¹⁰⁹

As with these other trading systems, the orders submitted to ArcaEx similarly meet the non-participation requirement. Upon submission to ArcaEx, an order will enter the queue and be executed against another order in the Arca Book based on an established matching algorithm. The execution depends, not on the ETP Holder, but rather, upon what other orders are entered into ArcaEx at or around the same time as the subject order, what orders are resident in the Arca Book and where the order is ranked based on the price-time priority ranking algorithm. Therefore, at no time following the submission of an order is an ETP Holder able to acquire control or influence over the result or timing of orders generated. That is, unlike a floor broker who currently enjoys a trading advantage inherent to being present on an exchange floor for transactions being executed on that floor, no ETP Holder may take advantage of any non-member User through use of ArcaEx. As a result, the non-participation requirement is met where ETP Holder orders are matched and executed automatically in the ArcaEx.

3. Execution through Unaffiliated Member

Although Rule 11a2-2(T) contemplates having an order executed by an exchange member who is unaffiliated with the member initiating the order, the Commission has recognized in the past that this requirement is not applicable where automated exchange facilities are used. For example, in considering the operation of COMEX and PACE, among other systems, the Commission noted that, while there is no independent executing exchange member, the execution of an order is automatic once it has been transmitted into the systems.¹¹⁰ Because the design of these systems ensures that members do not possess any special or unique trading advantages in handling their orders after transmitting them to the exchange floors, the Commission has stated that executions obtained through these systems satisfy the independent execution requirement of Rule 11a2-2(T).¹¹¹ This principle is directly applicable to ArcaEx; the design of ArcaEx ensures that ETP Holders do not have any special or unique trading advantages in handling their orders after transmission. Accordingly, an ETP Holder effecting a transaction by utilizing ArcaEx satisfies the requirement for execution through an unaffiliated member.

4. Non-Retention of Compensation for Discretionary Accounts

Finally, the exemption in Rule 11a2-2(T) states that, in the case of a transaction effected for an account for which the initiating member exercises investment discretion, in general, the member may not retain compensation for effecting the transaction. As a prerequisite to use of ArcaEx, if an ETP Holder is to rely on Rule 11a2-2(T) for a managed account transaction, the ETP Holder must comply with the limitations on compensation as set forth in paragraph (a)(2)(iv) of the "effect versus execute" rule.

C. Conclusion

In sum, ArcaEx is designed to, and does, comply with the letter and spirit of Section 11(a) of the Exchange Act.

Appendix C

A. Background

In its rule filing, the PCX has proposed the use of discretionary orders on ArcaEx. A discretionary order is defined 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 (displayed price')."¹¹² For all non-marketable discretionary orders, the discretionary order will be displayed to all Users at the displayed price. No Users will see the discretionary price of the orders. An undisplayed, discretionary price order will be afforded price priority in the Arca Book, but not time priority relative to displayed orders.¹¹³

B. Discussion

1. Discretionary Orders Comply with the Firm Quote Rule

Rule 11Ac1-1 under the Securities Exchange Act ("Exchange Act"), the so-called "Quote Rule," mandates national securities exchanges, subject to certain exceptions, to collect and disseminate "best bids" and "best offers" from a "responsible broker or dealer."¹¹⁴ ArcaEx's treatment of discretionary orders complies with the requirements of the Rule.

a. The Discretionary Price of a Discretionary Order is Not Communicated to Other Market Participants

An important attribute of a bid or offer subject to the Quote Rule is that it represents

the "bid price and the offer price communicated by an exchange member or OTC market maker to any broker or dealer, or to any customer."¹¹⁵ Accordingly, "[i]n order to constitute a bid or offer, the underlying trading interest must have been communicated to at least one potential counterparty. Bids and offers are intended to attract other parties to deal with the person publishing the bid or offer."¹¹⁶ For example, in the Order Handling Release, the Commission deemed the entry of priced orders into an electronic communications network ("ECN") to be bids and offers where these orders were widely disseminated.¹¹⁷ Such priced orders are subject to the Quote Rule because, just like market maker or specialist quotations, they are "entered to elicit other buying and selling interest."¹¹⁸ Applying this logic, the Commission concluded that OptiMark Profiles were not bids or offers because only OptiMark was "aware of the potential trading interest until the trade occurs."¹¹⁹

With discretionary orders on ArcaEx, the discretionary price of a discretionary order is not communicated to any Users of the system. Only ArcaEx is aware of the full potential trading interest of these discretionary orders until trades occur. Accordingly, because ArcaEx does not publish the discretionary aspect of these discretionary orders, they should not be deemed to be a "bid or offer" within the meaning of the Quote Rule.

b. Discretionary Orders Represent a More Complex Trading Interest than Traditional "Bids" or "Offers"

Discretionary orders allow the investor to express a more complex -- and more accurate -- trading interest than the single price and size of a conventional order.¹²⁰ Unlike "bids" and "offers," discretionary orders reflect the fact that there is usually more than one price at which an investor is willing to buy or sell. Because these discretionary orders represent a qualitatively different set of information from the traditional price and size information, they are more analogous to indications of interest, than bids and offers. Therefore, like indications of interest, discretionary orders should be excluded from the requirements of the Quote Rule.¹²¹ The Commission reached a similar conclusion in its analysis of OptiMark Profiles, finding that "Profiles are analogous to indications of interest or CAP orders,¹²² neither of which are displayed in exchanges or on Nasdaq."¹²³ Therefore, the inchoate trading interest of discretionary orders should not be treated as a bid or offer under the Quote Rule.¹²⁴

c. Inclusion of Discretionary Orders Would Impair the Existing Quote Information

Because the discretionary orders represent a more complex expression of trading preferences than traditional orders, any attempt to include them in the public quotation stream would undermine the Commission's efforts to improve the "quality of published quotations, competition and price efficiency."¹²⁵ The Commission has long recognized that "quotation information is of significant value to the marketplace as a whole insofar as a quotation reflects the considered judgment of a market professional as to various factors affecting the market, including the current price levels and size of buying and selling interest."¹²⁶ Because the discretionary orders do not represent any "current" market judgment as to a particular transaction price or size, the investing public at large would be misled and confused by its inclusion in public quotations.¹²⁷ Furthermore, the Commission has previously stated that the dissemination of contingent trading interest, like discretionary orders, "would likely be very difficult" and "could create confusion for investors."¹²⁸

2. The Commission Has Approved the Use of Similar Orders in Other Contexts

a. Exchanges Must Be Allowed to Compete on Equal Footing with Alternative Trading Systems

In adopting Regulation ATS, the Commission expressly recognized the value of conditional orders and specifically allowed ATSs to continue using reserve size orders, negotiation features and other similar conditional orders.¹²⁹ Specifically, under Rule 301(b)(3), if a portion of a subscriber's order is not displayed to others, that undisplayed portion is not subject to the public display requirements in Rule 301(b)(3).¹³⁰

Because a fundamental goal of the national market system is to "achieve a market characterized by . . . fair competition,"¹³¹ the Commission previously has recognized the importance of facilitating "opportunit[ies] for registered exchanges to better compete with alternative trading systems."¹³² Therefore, the Commission should not prohibit a registered exchange's use of these order types when it allows an ATS to use them.¹³³ Such an unnecessary prohibition creates an unlevel playing field between exchanges and ATSs -- two trading venues which are considered true competitors in today's markets¹³⁴ -- in opposition to the national market system goals.¹³⁵

b. ArcaEx's Discretionary Orders Electronically Perform the Same Function as Provided Manually in Today's Trading Environment

In a traditional floor trading environment, broker-dealers enjoy the discretion to "work" an order to ensure that the customer receives the best price for the trade. This special handling permits the broker-dealer to respond to the ever-changing state of the market. For example, a broker may represent a customer's trading interest at one price, given the state of the current market, but be prepared to offer the trade at a different price if the market moves. To provide an effective trading platform, ArcaEx must be permitted to provide an electronic mechanism which replicates some of these value-added activities of market intermediaries. Therefore, ArcaEx has designed the discretionary orders. This order type allows an aspect of the order to respond to the dynamic trading environment without the need for manual order handling.¹³⁶