Self-Regulatory Organizations; NASDAQ OMX PHLX, Inc.; Order Approving a Proposed Rule Change, as Modified by Amendment No. 1, Relating to the Establishment of NASDAQ OMX PSX as a Platform for Trading NMS Stocks, 56633-56641 [2010-23104]
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Federal Register / Vol. 75, No. 179 / Thursday, September 16, 2010 / Notices
necessary or appropriate in the public
interest, for the protection of investors,
or otherwise in furtherance of the
purposes of the Act.
IV. Solicitation of Comments
Interested persons are invited to
submit written data, views, and
arguments concerning the foregoing,
including whether the proposed rule
change is consistent with the Act.
Comments may be submitted by any of
the following methods:
Electronic Comments
• Use the Commission’s Internet
comment form (https://www.sec.gov/
rules/sro.shtml) or
• Send an e-mail to rulecomments@sec.gov. Please include File
Number SR–OCC–2010–15 on the
subject line.
Paper Comments
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• Send paper comments in triplicate
to Elizabeth M. Murphy, Secretary,
Securities and Exchange Commission,
100 F Street, NE., Washington, DC
20549–1090.
2010–15 and should be submitted on or
before October 7, 2010.
For the Commission by the Division of
Trading and Markets, pursuant to delegated
authority.16
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010–23106 Filed 9–15–10; 8:45 am]
BILLING CODE 8010–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–62877; File No. SR–PHLX–
2010–79]
Self-Regulatory Organizations;
NASDAQ OMX PHLX, Inc.; Order
Approving a Proposed Rule Change,
as Modified by Amendment No. 1,
Relating to the Establishment of
NASDAQ OMX PSX as a Platform for
Trading NMS Stocks
September 9, 2010.
I. Introduction
On June 8, 2010, NASDAQ OMX
PHLX, Inc. (‘‘PHLX’’ or ‘‘Exchange’’),
filed with the Securities and Exchange
Commission (‘‘Commission’’), pursuant
All submissions should refer to File
to Section 19(b)(1) of the Securities
Number SR–OCC–2010–15. This file
Exchange Act of 1934 (‘‘Act’’),1 and Rule
number should be included on the
2
subject line if e-mail is used. To help the 19b–4 thereunder, a proposed rule
change to establish NASDAQ OMX PSX
Commission process and review your
as a new electronic platform for trading
comments more efficiently, please use
only one method. The Commission will NMS stocks. The proposed rule change
post all comments on the Commission’s was published for comment in the3
Federal Register on July 26, 2010. On
Internet Web site (https://www.sec.gov/
August 5, 2010, the Exchange filed
rules/sro.shtml). Copies of the
Amendment No. 1 to the proposed rule
submission, all subsequent
change.4 The Commission received no
amendments, all written statements
comment letters regarding the proposed
with respect to the proposed rule
rule change. This order approves the
changes that are filed with the
proposed rule change, as modified by
Commission, and all written
Amendment No. 1.
communications relating to the
proposed rule change between the
II. Background
Commission and any person, other than
The Exchange proposes to establish a
those that may be withheld from the
new cash equities trading platform, to
public in accordance with the
be called NASDAQ OMX PSX (‘‘PSX or
provisions of 5 U.S.C. 552, will be
‘‘System’’).5 The System will be an openavailable for inspection and copying in
the Commission’s Public Reference
16 17 CFR 200.30–3(a)(12).
Section, 100 F Street, NE., Washington,
1 15 U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
DC 20549, on official business days
3 See Securities Exchange Act Release No. 62519
between the hours of 10 a.m. and 3 p.m.
(July 16, 2010), 75 FR 43597 (‘‘Notice’’).
Copies of such filings also will be
4 Amendment No. 1 clarifies that the proposal to
available for inspection and copying at
accept orders routed by Nasdaq Execution Services,
the principal office of OCC and on
LLC to the Exchange on a one-year pilot basis is
OCC’s Web site at https://
made by the Exchange, rather than by The
NASDAQ Stock Market, LLC (‘‘Nasdaq’’). This is a
www.theocc.com. All comments
received will be posted without change; technical amendment and is not subject to notice
and comment.
the Commission does not edit personal
5 The Exchange previously operated an electronic
identifying information from
trading facility, XLE, for the trading of cash equity
securities. XLE ceased its operations in October
submissions. You should submit only
2008 following the acquisition of the Exchange by
information that you wish to make
The NASDAQ OMX Group, Inc. (‘‘NASDAQ OMX’’),
available publicly. All submissions
the parent corporation of Nasdaq. See Securities
should refer to File Number SR–OCC–
Exchange Act Release No. 58613 (September 22,
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access fully electronic integrated order
display and execution system for NMS
stocks. PSX will not list securities, but
rather will trade NMS stocks listed on
other exchanges on an unlisted trading
privileges basis.
The System will allow PSX
participants to enter orders at multiple
price levels. Orders will be integrated
and displayed via data feeds to
participants and other data subscribers.
PSX participants will be able to access
the aggregated trading interest of all
other PSX participants in accordance
with non-discretionary order execution
algorithms. The System will not route
orders to other market centers.
In contrast with most markets, which
employ a price/time execution priority
system (where the displayed order on
the book that is first in time at the best
price is satisfied fully, then the next in
time at that price, and so on), PSX will
use a price/pro rata execution priority
system,with displayed orders receiving
priority over non-displayed orders.
Specifically, multiple orders displayed
on the PSX book at the best price would
be allocated shares of an incoming order
pro rata based on the proportion of the
size of the displayed order to the total
size of all displayed orders at that price.
Once all displayed size at any price
level is exhausted, the same pro rata
logic would apply to non-displayed
orders at that price level.
The Exchange proposes to adopt new
rules governing trading on the System.
The proposed new rules are based to a
substantial extent on the rules of
Nasdaq 6 and NASDAQ OMX BX, Inc.
(‘‘BX’’). In addition, the Exchanges
proposes to apply the PHLX rules listed
in proposed PHLX Rule 3202, including
certain rules that governed XLE when it
was operational, to PHLX members with
respect to their activities on the
System.7 The Exchange also proposes to
amend PHLX Rule 803 (Criteria For
Listing—Tier I) to support unlisted
trading privileges for NMS stocks on
PSX and PHLX Rule 985 (Affiliate and
Ownership Restrictions) to address
potential competitive advantage and
conflict of interest concerns regarding
2008), 73 FR 57181 (October 1, 2008) (SR–Phlx2008–65). Since ceasing operations of XLE, the
Exchange has solely operated an options market.
6 Unlike Nasdaq, PSX will not route orders to
other exchanges and will not have market makers.
As a result, the PSX rules do not contain provisions
related to outbound routing or market makers that
are found in Nasdaq’s rules.
7 The Exchange also proposes to delete two
existing PHLX Rules relating to XLE, PHLX Rule
160 (NMS Stock Execution on the Exchange) and
PHLX Rule 188 (Trade Execution and Reporting),
and to move their content to the proposed rules
governing PSX. See proposed PHLX Rules 3301(a),
3305(a)(1) and 3309).
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inbound routing from Nasdaq to PSX.
Finally, the Exchange proposes to adopt
rules governing Recommendations to
Customers (Suitability) and Best
Execution and Interpositioning,8 and
commentaries relating thereto, which
rules shall be applicable to all members
of the Exchange, including those trading
on PSX.
Pursuant to the terms of a regulatory
services agreement (the ‘‘FINRA RSA’’)
between PHLX and Financial Industry
Regulatory Authority, Inc. (‘‘FINRA’’),
administration and enforcement of
many of the new rules applicable to the
System will be supported by FINRA. In
addition, certain regulatory
responsibilities of PHLX relating to PSX
may be administered by personnel
employed by Nasdaq or ‘‘BX’’ 9 pursuant
to a regulatory services agreement (the
‘‘Intercompany RSA’’).
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III. Discussion and Commission
Findings
After careful review of the proposed
rule change, the Commission finds that
the proposed rule change is consistent
with the requirements of the Act and the
rules and regulations thereunder
applicable to a national securities
exchange.10 Specifically, the
Commission finds that the proposed
rule change is consistent with Section
6(b)(5) of the Act,11 which requires,
among other things, that the rules of a
national securities exchange be
designed to prevent fraudulent and
manipulative acts and practices; to
promote just and equitable principles of
trade; to foster cooperation and
coordination with persons engaged in
regulating, clearing, settling, and
processing information with respect to,
and facilitating transactions in
securities; to remove impediments to
and perfect the mechanism of a free and
open market and a national market
system; and, in general, to protect
investors and the public interest.
Section 6(b)(5) of the Act also requires
that the rules of an exchange not be
designed to permit unfair
discrimination among customers,
issuers, brokers, or dealers.
Overall, the Commission believes that
approving the Exchange’s proposed rule
change could benefit the public and
market participants. Approval of the
proposal would establish rules for the
8 See
proposed PHLX Rules 763 and 764.
of Nasdaq and BX is a self-regulatory
organization (‘‘SRO’’) owned by NASDAQ OMX
and, therefore, an affiliate of the Exchange.
10 In approving this proposed rule change, the
Commission has considered the proposed rule’s
impact on efficiency, competition and capital
formation. 15 U.S.C. 78c(f).
11 15 U.S.C. 78f(b)(5).
9 Each
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operation of a new electronic facility for
the trading of cash equity securities that
is designed to encourage displayed
orders of larger size, which could foster
best execution, price discovery,
competition and innovation. The
discussion below does not review every
detail of the proposed rule change, but
rather focuses on the most significant
rules and policy issues considered in
review of the proposals.
A. Proposed New Rules for PSX
1. Access and Participation
The System will only have one class
of membership and, unlike Nasdaq, will
not have a separate class of market
makers.12 In addition, PSX will make its
facilities available to electronic
communications networks (‘‘ECN’’) and
alternative trading systems (‘‘ATS’’) that
meet certain requirements, to allow
such ECNs and/or ATSs to display best
prices and size of orders on PSX and
members to access such orders.13 PSX
will provide authorized access for
Sponsored Participants on terms
identical to those set forth in Nasdaq
Rule 4211(d) (Sponsored Participants).14
The System will be accessible to all
PHLX members that meet the
registration, qualification and other
membership requirements set forth in
the PHLX rules.15 In addition, in order
to trade on PSX, a member must comply
with certain additional requirements set
forth in proposed PHLX Rule 3211 (PSX
Participant Registration). Such
12 See
Notice, supra note 3, 75 FR at 43598.
proposed Rule 3223. The ATS or ECN must
be a PHLX member organization, enter into and
comply with applicable agreements, agree that
PHLX may disseminate the ECN’s or ATS’s best
priced orders, demonstrate that it is in compliance
with applicable regulatory requirements, and accept
automated executions against orders that it enters
into the System.
14 See proposed Rule 3211(d). The Exchange has
represented that upon implementation by Nasdaq of
recently approved changes to its rule governing
Sponsored Participants, the Exchange will adopt
and implement identical rules to govern sponsored
access on PSX. See Securities Exchange Act Release
No. 61345 (January 13, 2010), 75 FR 32631 (January
20, 2010) (SR–NASDAQ–2008–104). If NASDAQ’s
rules are superseded by rules adopted by the
Commission, the Exchange has represented that
PSX will operate sponsored participant access in
accordance with such rules. See Notice, supra note
3, 75 FR at 43598.
15 As discussed above, proposed PHLX Rule 3202
sets forth the current PHLX Rules applicable to
market participants trading on PSX, and includes,
among others, PHLX Rule 600 (Registration) and
PHLX Rule 604 (Registration and Termination of
Registered Persons). In a separate order, the
Commission approved the amendment of PHLX
Rule 604 to require all members trading on PSX to
register representatives and principals in
accordance with rules similar to those governing
registration of associated persons of members of
Nasdaq. See Securities Exchange Act Release No.
62776 (August 26, 2010), 75 FR 53727 (September
1, 2010) (SR–Phlx–2010–91).
13 See
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requirements are substantially similar to
the requirements set forth in Nasdaq
Rule 4611 (Nasdaq Market Center
Participant Registration), and include,
among others, the execution of
applicable agreements with the
Exchange, membership in or access to a
registered clearing agency through
which PSX-compared trades may be
settled, compliance with all applicable
rules and operating procedures of
PHLX 16 and the Commission in the use
of PSX, and maintenance of equipment
to prevent the improper use of and
access to PHLX systems.17
Each PSX participant will be under a
continuing obligation to inform PHLX of
any noncompliance with any of the
registration requirements.18 Failure by a
PSX participant to comply with any
registration requirements, including
failure to comply with any PHLX rules
applicable to PSX, shall subject such
participant to censure, fine, suspension
or revocation of its registration as a PSX
participant, or any other appropriate
penalty under the rules of the
Exchange.19 The Exchange may
terminate access to the System if a
participant fails to meet the participant
eligibility qualifications.20
The Commission finds that the
Exchange’s access and participation
requirements for the System are
consistent with Section 6(b)(5) of the
Act, which requires, among other
things, that the rules of a national
securities exchange be designed to
prevent fraudulent and manipulative
acts and practices; to promote just and
equitable principles of trade; to foster
cooperation and coordination with
persons engaged in regulating, clearing,
settling, and processing information
with respect to, and facilitating
transactions in securities; to remove
impediments to and perfect the
mechanism of a free and open market
and a national market system; and, in
general, to protect investors and the
public interest.21 Section 6(b)(5) also
requires that the rules of an exchange
not be designed to permit unfair
discrimination among customers,
issuers, brokers, or dealers. The
Commission notes that the access and
participation requirements applicable to
PSX are substantially similar to rules of
16 In addition to proposed rules specific to the
operation of PSX, members must comply with
existing PHLX rules governing member conduct, to
the extent that they are relevant to trading on PSX.
The PHLX Rules applicable to activities of members
on PSX are listed in proposed PHLX Rule 3202.
17 See proposed PHLX Rule 3211(a).
18 See proposed PHLX Rule 3211(b).
19 See proposed PHLX Rule 3228(a).
20 See proposed PHLX Rule 3222.
21 15 U.S.C. 78f(b)(5).
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Nasdaq previously approved by the
Commission.22 The Commission also
notes that all PSX participants will
participate on consistent terms when
entering orders into PSX for posting and
accessing liquidity. In addition, the
Commission notes that the membership
and registration requirements applicable
to PSX are set forth in the current rules
of the Exchange, which have been
previously approved by the
Commission.
2. Trading System and Regulation NMS
Compliance
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a. PSX Order Entry, Display and
Execution
The System will operate, and orders
can be entered into the System, from 9
a.m. to 5 p.m., Eastern Time, on each
business day.23 PSX will not have any
specialized opening or closing
processes, and will begin to process all
eligible orders at 9 a.m.24
Participants may submit multiple
orders at multiple price levels, which
PSX will manage and display,
consistent with the parameters of each
order.25 PSX will time-stamp each order
upon receipt, although, as discussed
below, the time stamp will not
determine the order’s ranking for
execution purposes.26 The System will
not display orders on an attributable
basis.27 Orders may be entered either as
Displayed Orders or Non-Displayed
Orders.28
Displayed Orders will be displayed
anonymously to participants through
the System book feed and the aggregate
size of all best-priced Displayed Orders
to buy and sell on the System will be
transmitted for display to the
appropriate network processor (unless
the aggregate size is less than one round
lot).29 Non-Displayed Orders and
Reserve Size will not be displayed, but
will nevertheless remain available for
potential execution against incoming
orders.30
Incoming marketable orders
automatically execute against resting
orders on the PSX book, and the posted
orders are decremented accordingly.31
Incoming orders that are not marketable
22 See Securities Exchange Act Release No. 53128
(January 13, 2006), 71 FR 3550 (January 23, 2006)
(order approving Nasdaq’s application to register as
a national securities exchange) (‘‘Nasdaq
Registration Approval Order’’).
23 See proposed PHLX Rules 3217 and 3306(a)(3).
24 See proposed PHLX Rule 3302.
25 See proposed PHLX Rule 3306.
26 Id.
27 See proposed PHLX Rule 3301(a).
28 See proposed PHLX Rule 3301(e).
29 See proposed PHLX Rule 3306(c)(1) and (2).
30 See proposed PHLX Rule 3306(c)(3).
31 See proposed PHLX Rule 3307(a)(2).
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against posted interest in the System
book will be cancelled or posted to the
book, depending on the time-in-force for
the order.32 An incoming order with a
price that crosses the price of an order
posted on the book will execute at the
price of the posted order. Thus, any
potential price improvement resulting
from an execution in the System will
accrue to the taker of liquidity.33
As provided by PHLX Rule 3309,
executions occurring as a result of
orders matched on PSX shall be
reported by PHLX to an appropriate
consolidated transaction reporting
system. As transactions executed in the
System will be cleared and settled
anonymously, the transaction reports
produced by the System will indicate
the price and size of the transaction, but
will not reveal contra party identities.34
To determine the allocation of
incoming marketable orders against
orders on the book, the System uses a
price/pro-rata algorithm, with Displayed
Orders receiving priority over Nondisplayed Orders and round lot orders
receiving priority over odd lot orders.35
The algorithm executes trading interest
in the System as follows:
• Better priced trading interest will be
executed ahead of inferior-priced
trading interest;
• Displayed Orders at a particular
price with a size of at least one round
lot will be executed ahead of NonDisplayed Orders and the reserve
portion of Reserve Orders (collectively,
‘‘non-displayed interest’’) at the same
price;
• Displayed Orders at a particular
price with a size of at least one round
lot will be executed ahead of odd lot at
the same price; however, odd-lot
Displayed Orders will execute ahead of
non-displayed interest of one round lot
at the same price, as Displayed Orders
will always execute ahead of NonDisplayed Orders at the same price; 36
• As among equally priced Displayed
Orders with a size of at least one round
lot, the System will allocate round lot
portions of incoming executable orders
to displayed trading interest within the
System pro rata based on the size of the
Displayed Orders. Portions of an order
that would be executed in a size other
than a round lot if they were allocated
on a pro rata basis will be allocated for
execution against available displayed
trading interest on the basis of a random
function that assigns probability of
execution based on the size of displayed
32 See
proposed PHLX Rule 3301(h).
proposed PHLX Rule 3307(a)(3).
34 See proposed PHLX Rule 3310.
35 See proposed PHLX Rule 3307(a)(1).
36 See id.
33 See
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56635
interest.37 As among equally priced
Displayed Orders with a size of less
than one round lot, the System will
allocate incoming orders based on the
size of the Displayed Orders, but not in
pro rata fashion.38 If there are two or
more odd lot orders of equal size, the
System will determine the order of
execution on the basis of a random
function that assigns each order an
equal probability of execution. This
same allocation methodology applies to
equally-priced non-displayed interest
with a size of at least one round lot or
with a size of less than one round lot,
as the case may be.
The Commission finds that the
Exchange’s trading rules for the System,
including PSX’s execution priority
rules, are consistent with the Act. The
Commission notes that, other than with
respect to the price/pro rata execution
priority system, the Exchange’ market
model for the trading of cash equity
securities is substantially similar to each
of Nasdaq’s and BX’s equity market
models and does not raise novel issues.
The Commission believes that PSX’s
price/pro rata execution priority system
may encourage participants, particularly
those who wish to execute orders of
large size, to display liquidity on the
System. This in turn could facilitate the
efficient execution of large orders, and
foster best execution and price
discovery. A novel exchange priority
system that is designed to achieve these
goals also may foster competition and
innovation. Accordingly, the
Commission finds that the price/pro rata
execution priority system proposed by
PHLX is consistent with the Act.
b. Regulation NMS
The Exchange will implement such
systems, procedures, and rules in
connection with the operation of PSX as
are necessary to render it capable of
meeting the requirements for automated
quotations.39
37 For example, if Displayed Orders to buy at 10
reside on the PSX book with sizes of 6,000
(Participant A) and 4,000 (Participant B), and an
incoming order to sell 1,100 at 10 comes into the
System, the System will allocate 600 shares of the
incoming order to Participant A and 400 shares of
the incoming order to Participant B. The remaining
100 shares of the incoming order will be allocated
on the basis of a random function that assigns a
60% probability of executing the 100 shares to
Participant A and a 40% probability to Participant
B.
38 Thus, a resting displayed order with a size of
90 shares would get filled in full before a displayed
order with size of 50 shares.
39 See proposed PHLX Rule 3306(c)(4). As defined
in PHLX Rule 600(b) of Regulation NMS under the
Act, 17 CFR 242.600(b), the term ‘‘quotation’’
includes the ‘‘bid price or the offer price
communicated by a member of a national securities
exchange * * * to any broker or dealer, or to any
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mstockstill on DSKH9S0YB1PROD with NOTICES
The Exchange has designed PSX’s
rules relating to orders, modifiers, and
order execution to comply with the
requirements of Regulation NMS. The
proposed Rules are consistent with
Regulation NMS 40 by requiring that all
orders be processed in a manner that
avoids trading through protected
quotations 41 and avoids locked and
crossed markets.42 PSX will not route
orders to other market centers. Proposed
PHLX Rule 3305(b) provides that in
addition to such other designations as
may be chosen by a market
participant,43 all orders that are not
entered with a time in force of ‘‘System
Hours Immediate or Cancel’’ 44 must be
designated as an Intermarket Sweep
Order, a Pegged Order, a Price to
Comply Order, or a Post-Only Order.45
Any orders that are entered into the
System that would lock or cross another
order in the System will be execute d to
avoid a lock or cross.46
As described in the Notice, a System
Hours Immediate or Cancel Order is
compliant with Regulation NMS
because by its terms it would not
execute or post at a price that would
result in a trade-through of a protected
quotation or lock or cross another
market.47 A Pegged Order similarly is
compliant with Regulation NMS
customer, at which it is willing to buy or sell one
or more round lots of an NMS security, either as
principal or agent.’’ Thus, the term ‘‘quotation’’
includes orders entered into the System by PSX
participants, notwithstanding the fact that PSX will
not have market makers with obligations to
maintain continuous two-sided quotations. Under
Rule 602 of Regulation NMS, brokers and dealers
are required to communicate to a national securities
exchange or national securities association their
best bids, best offers, and quotation sizes. By
displaying orders communicated to it by its
members and complying with the requirements for
automation described in Rule 600(b)(3), PSX will
display ‘‘automated quotations’’ within the meaning
of that rule, and therefore its best bid and best offer
will constitute ‘‘protected quotations’’ entitled to
trade-through protection under Regulation NMS.
40 17 CFR 242.611.
41 See discussion of protected quotations supra
note 39.
42 See proposed PHLX Rules 3305(b) and 3213(c).
43 As is the case with Nasdaq, different order
designations can be combined. Thus, for example,
a Price to Comply Order could be entered with
reserve size or as a Non-displayed Order.
44 A ‘‘System Hours Immediate or Cancel’’ order
is an immediate or cancel order that may be entered
between 9 a.m. and 5 p.m. Eastern Time, PSX’s
hours of operation. If a System Hours Immediate or
Cancel order (or a portion thereof) is not
marketable, the order (or unexecuted portion
thereof) is canceled and returned to the entering
participant. See proposed PHLX Rule 3301(h)(1).
45 See proposed PHLX Rule 3305(b).
46 See proposed PHLX Rule 3213(c). In addition,
members may enter orders that are re-priced if they
would lock or cross so as to avoid executing.
47 See Notice, supra note 3, 75 FR at 43603;
proposed PHLX Rule 3301(h).
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because it continually re-prices to avoid
locking or crossing.48
The proposed rules also permit PSX
participants to submit Intermarket
Sweep Orders to comply with
Regulation NMS. Orders so designated
will be automatically matched and
executed within the System.49 As
described in the Notice, when a
participant enters an Intermarket Sweep
Order it is representing that it is also
simultaneously routing one or more
additional limit orders (also marked as
Intermarket Sweep Orders), as
necessary, to execute against the full
displayed size of any protected bid or
offer (as defined in Rule 600(b) of
Regulation NMS) in the case of a limit
order to sell or buy with a price that is
superior to the limit price of the order
identified as an Intermarket Sweep
Order.50
Both a Price to Comply and a PostOnly Order are also designed to comply
with the Regulation NMS.51
Specifically, if at the time of entry, a
Price to Comply Order will lock or cross
the quotation of an external market, the
order will be priced to the current best
offer (for bids) or to the current best bid
(for offers) but displayed at a price one
minimum price increment lower than
the offer (for bids) or higher than the bid
(for offers).52 Thus, an incoming order
priced to execute against the displayed
price will receive the superior
undisplayed price.53 If, at the time of
entry, a Post-Only Order will lock an
order on the System, the order will be
re-priced and displayed on the System
to one minimum price increment (i.e.,
$0.01 or $0.0001) below the current best
offer (for bids) or above the current best
bid (for offers).54
The Commission believes that by
requiring all orders to be entered with
48 See Notice, supra note 3, 75 FR at 43603;
proposed PHLX Rule 3301(f)(4).
49 See proposed PHLX Rule 3301(f)(6).
50 See Notice, supra note 3, 75 FR at 43603. The
Exchange has represented that members will be
responsible for ensuring that their use of
Intermarket Sweep Orders complies with
Regulation NMS, and the Exchange’s T+1
surveillance program will monitor members’ use of
Intermarket Sweep Orders.
51 See Notice, supra note 3, 75 FR at 43603.
52 See proposed PHLX Rule 3301(f)(8).
53 For example, if the national best bid and best
offer is $9.97×$10.00, and a participant enters a
price to comply order to buy 10,000 shares at
$10.01, the order will display at $9.99, but will
reside on the System book at $10.00. If a seller then
enters an order at $9.99, it will execute at $10.00,
up to the full 10,000 shares of the order.
54 See proposed PHLX Rule 3301(f)(10). For
example, if the System best bid and best offer is
$9.97×$10.00, and a participant enters a Post-Only
Order to buy at $10.01, the order will be repriced
and displayed at $9.99. If a seller enters an order
at $9.96, the order will be repriced and displayed
at $9.98.
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one of the designations described above,
all PSX orders should either be priced
or cancelled in a manner consistent
with the avoidance of trade-throughs
and locked and crossed markets. The
Commission also notes that, because
PSX will not route orders to other
market centers, the Exchange’s
Regulation NMS policies and
procedures under Rule 611(a) will rely
on information provided by Nasdaq for
purposes of determining whether
another trading center is experiencing a
failure, material delay, or malfunction of
its systems or equipment within the
meaning of Rule 611(b)(1).55
The Commission finds that the rules
relating to orders, modifiers, and order
execution that are designed to comply
with Regulation NMS are consistent
with the Act.
2. Section 11 of the Act
Section 11(a)(1) of the Act 56 prohibits
a member of a national securities
exchange from effecting transactions on
that exchange for its own account, the
account of an associated person, or an
account over which it or its associated
person exercises discretion (collectively,
‘‘covered accounts’’) unless an exception
applies. Rule 11a2–2(T) under the Act,57
known as the ‘‘effect versus execute’’
rule, provides exchange members with
an exemption from the Section 11(a)(1)
prohibition. 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
transactions on the exchange. To
comply with Rule 11a2–2(T)’s
conditions, a member: (i) Must transmit
the order from off the exchange floor;
(ii) may not participate in the execution
of the transaction once it has been
transmitted to the member performing
the execution; 58 (iii) may not be
affiliated with the executing member;
and (iv) with respect to an account over
which the member has investment
discretion, may not, nor may its
associated person, retain any
compensation in connection with
effecting the transaction except as
provided in the Rule.
In a letter to the Commission, the
Exchange requests that the Commission
concur with PHLX’s conclusion that
members who enter orders into the
System satisfy the requirements of Rule
11a2–2(T).59 For the reasons set forth
55 See
Notice, supra note 3, 75 FR at 43603–42604
U.S.C. 78k(a)(1).
57 17 CFR 240.11a2–2(T).
58 The member may, however, participate in
clearing and settling the transaction.
59 See Letter from Charles Rogers, Chief
Regulatory Officer, PHLX, to Elizabeth M. Murphy,
56 15
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below, the Commission believes that
Exchange members entering orders into
the System would satisfy the conditions
of the Rule.
The Rule’s first condition is that
orders for covered accounts be
transmitted from off the exchange floor.
The System receives orders
electronically through remote terminals
or computer-to-computer interfaces. In
the context of other automated trading
systems, the Commission has found that
the off-floor transmission requirement is
met if a covered account order is
transmitted from a remote location
directly to an exchange’s floor by
electronic means.60 Because PSX
receives orders electronically through
remote terminals or computer-tocomputer interfaces, the Commission
believes that the System satisfies the offfloor transmission requirement.
Second, the Rule requires that the
member not participate in the execution
of its order. PHLX has represented that
at no time following the submission of
an order is a member organization able
to acquire control or influence over the
result or timing of an order’s
execution.61 According to the Exchange,
the execution of a member’s order is
determined by what other orders are
present in the System and the priority
of those orders.62 Accordingly, the
Commission believes that a member
Secretary, Commission, dated August 18, 2010
(‘‘PHLX 11(a) Letter’’).
60 See, e.g., Securities Exchange Act Release Nos.
61419 (January 26, 2010), 75 FR 5157 (February 1,
2010) (SR–BATS–2009–031) (approving BATS
options trading); 59154 (December 23, 2008), 73 FR
80468 (December 31, 2008) (SR–BSE–2008–48)
(approving equity securities listing and trading on
BSE); 57478 (March 12, 2008), 73 FR 14521 (March
18, 2008) (SR–NASDAQ–2007–004 and SR–
NASDAQ–2007–080) (approving NOM options
trading) ; 53128 (January 13, 2006), 71 FR 3550
(January 23, 2006) (File No. 10–131) (approving The
Nasdaq Stock Market LLC); 44983 (October 25,
2001), 66 FR 55225 (November 1, 2001) (SR–PCX–
00–25) (approving Archipelago Exchange); 29237
(May 24, 1991), 56 FR 24853 (May 31, 1991) (SR–
NYSE–90–52 and SR–NYSE–90–53) (approving
NYSE’s Off-Hours Trading Facility); and 15533
(January 29, 1979), 44 FR 6084 (January 31, 1979)
(‘‘1979 Release’’).
61 See PHLX 11(a) Letter, supra note 59.
62 See id. A member may cancel or modify the
order, or modify the instruction for executing the
order, but only from off the floor. The Commission
has stated that the non-participation requirement is
satisfied under such circumstances, so long as such
modifications or cancellations are also transmitted
from off the floor. See Securities Exchange Act
Release No. 14713 (April 27, 1978), 43 FR 18557
(May 1, 1978) (‘‘1978 Release’’) (stating that the
‘‘non-participation requirement does not prevent
initiating members from canceling or modifying
orders (or the instructions pursuant to which the
initiating member wishes orders to be executed)
after the orders have been transmitted to the
executing member, provided that any such
instructions are also transmitted from off the floor’’).
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does not participate in the execution of
an order submitted to the System.
Third, Rule 11a2–2(T) requires that
the order be executed by an exchange
member who is unaffiliated with the
member initiating the order. The
Commission has stated that this
requirement is satisfied when
automated exchange facilities, such as
PSX, are used, as long as 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.63 PHLX has represented that
the design of the System ensures that no
member organization has any special or
unique trading advantage in the
handling of its orders after transmitting
its orders to the System.64 Based on the
Exchange’s representation, the
Commission believes that PSX satisfies
this requirement.
Fourth, in the case of a transaction
effected for an account with respect to
which the initiating member or an
associated person thereof exercises
investment discretion, neither the
initiating member nor any associated
person thereof may retain any
compensation in connection with
effecting the transaction, unless the
person authorized to transact business
for the account has expressly provided
otherwise by written contract referring
to Section 11(a) of the Act and Rule
11a2–2(T).65 PHLX represents that
member organizations relying on Rule
11a2–2(T) for transactions effected
through the System must comply with
this condition of the Rule.66
63 In considering the operation of automated
execution systems operated by an exchange, the
Commission noted that, while there is not an
independent executing exchange member, the
execution of an order is automatic once it has been
transmitted into the system. 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, the Commission has stated that
executions obtained through these systems satisfy
the independent execution requirement of Rule
11a2–2(T). See 1979 Release, supra note 60.
64 See PHLX 11(a) Letter, supra note 59.
65 See 17 CFR 240.11a2–2(T)(a)(2)(iv). In addition,
Rule 11a2–2(T)(d) requires a member or associated
person authorized by written contract to retain
compensation, in connection with effecting
transactions for covered accounts over which such
member or associated persons thereof exercises
investment discretion, to furnish at least annually
to the person authorized to transact business for the
account a statement setting forth the total amount
of compensation retained by the member in
connection with effecting transactions for the
account during the period covered by the statement.
See 17 CFR 240.11a2–2(T)(d). See also 1978
Release, supra note 62 (stating ‘‘[t]he contractual
and disclosure requirements are designed to assure
that accounts electing to permit transaction-related
compensation do so only after deciding that such
arrangements are suitable to their interests’’).
66 See PHLX 11(a) Letter, supra note 59.
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56637
B. Exception to Limitation on Affiliation
Between PSX and Its Members
Although the Exchange will not route
orders to other market centers, it
proposes to receive orders routed to it
by other market centers, including
orders routed from Nasdaq.67 Nasdaq
Execution Services, LLC (‘‘NES’’) is the
approved outbound routing facility of
Nasdaq for cash equities. NES is owned
by NASDAQ OMX, which also owns the
Exchange.68 Thus, NES is an affiliate of
the Exchange.
Nasdaq is permitted to operate NES as
a facility providing outbound routing
services from Nasdaq to other market
centers, subject to the conditions that:
(1) NES is operated and regulated as a
facility of Nasdaq; (2) NES only
provides outbound routing services
unless otherwise approved by the
Commission; (3) the designated
examining authority of NES is a SRO
unaffiliated with Nasdaq; and (4) the
use of NES for outbound routing is
available only to Nasdaq members and
the use of NES remains optional.69
Currently, NES may not route Directed
Orders 70 to a facility of an exchange
that is an affiliate of Nasdaq, other than
BX.71 In connection with PHLX’s
resumption of equity trading on PSX
pursuant to this filing, Nasdaq has
proposed a rule change to permit NES
to route all forms of orders, including
Directed Orders, to PSX.72
Recognizing that the Commission has
expressed concern regarding the
potential for conflicts of interest in
instances where a member firm is
affiliated with an exchange to which it
is routing orders, the Exchange proposes
the following limitations and conditions
to NES’s affiliation with the Exchange to
permit the Exchange to accept inbound
orders that NES routes in its capacity as
a facility of Nasdaq:
• First, the Exchange states that
pursuant to the FINRA RSA, FINRA will
review NES’s compliance with the
Exchange’s rules through FINRA’s
examination program.73 Pursuant to the
67 See
Notice, supra note 3, 75 FR at 43604.
Securities Exchange Act Release No. 58179
(July 17, 2008), 73 FR 42874 (July 23, 2008) (order
approving NASDAQ OMX’s acquisition of PHLX).
69 Nasdaq Rule 4758.
70 Nasdaq Rule 4751(f)(9) defines Directed Orders
as immediate-or-cancel orders that are directed to
an exchange other than Nasdaq without checking
the Nasdaq book.
71 Nasdaq Rule 4751(f)(9).
72 See Securities Exchange Act Release No. 62736
(August 17, 2010) (SR–Nasdaq–2010–100).
73 The Exchange also states that NES is subject to
independent oversight by FINRA, its Designated
Examining Authority, for compliance with financial
responsibility requirements. See Notice, supra note
3, 75 FR at 43605.
68 See
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FINRA RSA, however, PHLX retains
ultimate responsibility for enforcing its
rules with respect to NES.
• Second, FINRA and the Exchange 74
will monitor NES for compliance with
the Exchange’s trading rules, and will
collect and maintain certain related
information.75
• Third, the Exchange states that
FINRA will provide a report to the
Exchange’s CRO, on at least a quarterly
basis, that: (i) Quantifies all alerts (of
which the Exchange and FINRA are
aware) that identify NES as a participant
that has potentially violated
Commission or Exchange rules, and (ii)
quantifies the number of all
investigations that identify NES as a
participant that has potentially violated
Commission or Exchange rules.76
• Fourth, the Exchange proposes Rule
985(c)(2), which will require NASDAQ
OMX, as the holding company owning
both the Exchange and NES, to establish
and maintain procedures and internal
controls reasonably designed to ensure
that NES does not develop or implement
changes to its system, based on nonpublic information regarding planned
changes to the Exchange’s systems
obtained as a result of its affiliation with
the Exchange, until such information is
available generally to similarly situated
Exchange members, in connection with
the provision of inbound order routing
to the Exchange.77
• Fifth, the Exchange proposes that
routing of orders from NES to the
Exchange, in NES’s capacity as a facility
of Nasdaq, be authorized for a pilot
period of one year.78
The operation of NES as a facility of
Nasdaq providing outbound routing
services from that exchange will be
subject to Nasdaq oversight, as well as
74 The Exchange represents that personnel
performing real-time oversight of equity trading on
Nasdaq will also perform similar functions with
respect to PSX pursuant to the Intercompany RSA,
under the direction, authority, and oversight of
PHLX’s Chief Regulatory Officer (‘‘CRO’’) and the
Regulatory Oversight Committee (‘‘ROC’’) of its
Board of Governors.
75 The Exchange represents that both FINRA and
the Exchange will collect and maintain all alerts,
complaints, investigations and enforcement actions
in which NES (in its capacity as a facility of Nasdaq
routing orders to the PSX) is identified as a
participant that has potentially violated applicable
Commission or Exchange rules. The Exchange and
FINRA will retain these records in an easily
accessible manner in order to facilitate any
potential review conducted by the Commission’s
Office of Compliance Inspections and
Examinations. See Notice, supra note 3, 75 FR at
43605.
76 See id.
77 See proposed PHLX Rule 985(c)(2); Notice,
supra note 3, 75 FR at 43605.
78 See Amendment No. 1, supra note 4. In
Amendment No. 1, the Exchange clarified that its
proposal, as opposed to Nasdaq’s corresponding
proposal, be approved on a one year pilot basis.
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Commission oversight. Nasdaq will be
responsible for ensuring that NES’s
outbound routing function is operated
consistent with Section 6 of the Act and
Nasdaq rules. In addition, Nasdaq must
file with the Commission rule changes
and fees relating to NES’s outbound
routing function.
In the past, the Commission has
expressed concern that the affiliation of
an exchange with one of its members
raises potential conflicts of interest, and
the potential for unfair competitive
advantage.79 Although the Commission
continues to be concerned about
potential unfair competition and
conflicts of interest between an
exchange’s self-regulatory obligations
and its commercial interest when the
exchange is affiliated with one of its
members, for the reasons discussed
below, the Commission believes that it
is consistent with the Act to permit NES
to provide inbound routing to the
Exchange on a pilot basis, subject to the
conditions described above.
The Exchange has proposed five
conditions applicable to NES’s routing
activities, which are enumerated above.
The Commission believes that these
conditions mitigate its concerns about
potential conflicts of interest and unfair
competitive advantage. In particular, the
Commission believes that FINRA’s
oversight of NES,80 combined with
FINRA’s monitoring of NES’s
compliance with the equity trading
rules and quarterly reporting to the
Exchange’s CRO, will help to protect the
independence of the Exchange’s
regulatory responsibilities with respect
to NES. The Commission also believes
that the proposed addition of Rule
985(c) is designed to ensure that NES
cannot use any information advantage it
may have because of its affiliation with
the Exchange. Furthermore, the
Commission believes that the
Exchange’s proposal to allow NES to
route orders inbound to the Exchange
from Nasdaq, on a pilot basis, will
provide the Exchange and the
Commission an opportunity to assess
the impact of any conflicts of interest of
allowing an affiliated member of the
79 See, e.g., Securities Exchange Act Release Nos.
54170 (July 18, 2006), 71 FR 42149 (July 25, 2006)
(SR–NASDAQ–2006–006) (order approving
Nasdaq’s proposal to adopt Nasdaq Rule 2140,
restricting affiliations between Nasdaq and its
members); 53382 (February 27, 2006), 71 FR 11251
(March 6, 2006) (SR–NYSE–2005–77) (order
approving the combination of the New York Stock
Exchange, Inc. and Archipelago Holdings, Inc.); and
58673 (September 29, 2008), 73 FR 57707 (October
8, 2008) (SR–Amex–2008–62) (order approving the
combination of NYSE Euronext and the American
Stock Exchange LLC).
80 This oversight will be accomplished through
the 17d–2 Agreement between FINRA and the
FINRA RSA.
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Exchange to route orders inbound to the
Exchange and whether such affiliation
provides an unfair competitive
advantage. The Commission notes that it
previously approved inbound routing by
NES to an affiliate under substantially
similar conditions.81
C. Listing Standards/Unlisted Trading
Privileges
The Exchange has represented that it
will not resume its listings business,
and instead will trade all NMS stocks on
the System pursuant to unlisted trading
privileges (‘‘UTP’’), consistent with
Section 12(f) of the Act 82 and Rule 12f–
5 thereunder.83 Rule 12f–5 requires an
exchange that extends unlisted trading
privileges to securities to have in effect
a rule or rules providing for transactions
in the class or type of security to which
the exchange extends unlisted trading
privileges.84
In connection with its proposal to
trade NMS stocks 85 on PSX on an
unlisted trading privileges basis, the
Exchange proposes several amendments
to PHLX Rule 803, including amending
PHLX Rule 803(o) (Unlisted Trading
Privileges) to, among other things, (1)
clearly state that the Exchange will not
list any securities, and that any
provisions of PHLX Rules 800 through
868 that permit listing of securities will
not be effective until the Exchange
amends its rules to make any changes
needed to comply with Rule 10A–3
under the Act 86 and to incorporate
additional qualitative listing standards,
and (2) enhance the listing requirements
for new derivative securities products
(as defined in Rule 19b–4(e) under the
Act 87) trading on the Exchange. In
addition, the Exchange proposes to
adopt new listing standards for
securities linked to the performance of
81 See Securities Exchange Act Release No. 59154
(December 23, 2008), 73 FR 80468, (December 31,
2008) (SR–BSE–2008–48) (‘‘BX Equities Market
Approval Order’’).
82 15 U.S.C. 78l(f).
83 17 CFR 240.12f–5. See Notice, supra note 3, 75
FR at 43599.
84 17 CFR 240.12f–5. See also Securities Exchange
Act Release No. 35737 (April 21, 1995), 60 FR
20891 (April 28, 1995) (adopting Rule 12f–5).
85 Proposed PHLX Rule 803(o) defines ‘‘NMS
Stocks’’ for purposes of the rule as having the
meaning given such term by Rule 600 under
Regulation NMS, including, but not limited to,
common stock, preferred stock and similar issues,
shares or certificates of beneficial interest of trusts,
notes, limited partnership interests, warrants,
certificates of deposit for common stock,
convertible debt securities, American Depositary
Receipts, contingent value rights, Trust Shares,
Trust Issued Receipts, Index Fund Shares, Equity
Index-Linked Securities, Commodity-Linked
Securities, Equity-Linked Notes, and Managed Fund
Shares.
86 17 CFR 240.10A–3.
87 17 CFR 240.19b–4(e)
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indexes and commodities (including
currencies) and managed fund shares, to
allow such securities to trade on PSX
pursuant to unlisted trading
privileges.88 The Exchange also
proposes PHLX Rule 3230 to establish
additional rules to govern trading of
Commodity-Related Securities on PSX
pursuant to unlisted trading privileges,
including a requirement that members
provide all purchasers of a newly issued
Commodity-Related Securities with a
prospectus.
The Commission finds that these rules
are consistent with the Act. The
Commission notes that the Exchange
will not list any securities for trading on
PSX until it amends its rules to make
any changes needed to comply with
Rule 10A–3 under the Act 89 and to
incorporate additional qualitative listing
standards. The Commission also notes
that these rules are similar to the rules
of other Exchanges.90
D. Regulation of the Exchange and its
Members
As a facility of the Exchange, PSX will
be subject to the Exchange’s SRO
functions and the Exchange will have
regulatory responsibility for the
activities of the System.
Notwithstanding the delegation of such
responsibilities via contract, the
Exchange retains ultimate legal
responsibility for the regulation of its
members and its market activities,
including activities on PSX.
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1. Disciplinary Rules
Trading on PSX is subject to the
Exchange’s disciplinary rules set forth
in PHLX Rules 960.1 through 960.12.91
Such rules provide the Exchange with
disciplinary jurisdiction over its
members so that it can enforce
88 See proposed PHLX Rules 803(m) and (n). As
with other standards, PHLX represented that it will
not list these securities until the filing and approval
of a proposed rule change to authorize such listing.
In connection with adopting these new standards,
the Exchange also proposed to (1) delete current
PHLX Rules 803(m) and (n), which contain listing
standards for products that are covered by the new
listing standards and (2) amend PHLX Rule 803(f)
(Other Securities) to adopt continued listing
requirement provisions that are complementary to
the new standards for securities linked to
commodities.
89 17 CFR 240.10A–3.
90 As proposed to be amended, the requirements
of PHLX Rule 803(o) are substantially similar to the
requirements set forth in Rule 14.1 (Unlisted
Trading Privileges) of EDGX Exchange, Inc. (‘‘Direct
Edge’’). Proposed PHLX Rule 3230 substantially
mirrors the requirements of Nasdaq Rule 4630
(Trading in Commodity-Related Securities).
Proposed Rules 803(m) and (n) are substantially
similar to those set forth in Nasdaq Rules 5710
(Securities Linked to Performance of Indexes and
Commodities (Including Currencies)) and 5735
(Managed Fund Shares).
91 See proposed PHLX Rule 3202.
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members’ compliance with its rules and
the Act and the rules and regulations
thereunder. The Exchange’s rules also
permit it to sanction members for
violations of its rules and violations of
the Act by, among other things,
expelling or suspending members,
limiting or terminating members’
activities, functions, or operations,
fining or censuring members, or
suspending or barring a person from
being associated with a member.92
2. Order Audit Trail System
PHLX proposes rules requiring FINRA
members trading on PSX to comply with
FINRA’s Order Audit Trail System
(‘‘OATS’’) requirements,93 which rules
are substantially similar to Nasdaq
Rules Series 6950 (‘‘Order Audit Trail
System).94 Like Nasdaq, OATS data will
be used by PHLX for regulatory
purposes only.95
3. Trading Halts; Clearly Erroneous
Transactions
PSX’s proposed rule relating to
trading halts is substantially similar to
Nasdaq Rule 4120 (Trading Halts),
except that the PSX rule includes only
those provisions relevant to securities
traded on an unlisted trading privileges
basis.96 Proposed PHLX Rule 3100
provides that PSX will participate in the
circuit breaker pilot program for stocks
included in the S&P 500® Index, which
ends on December 10, 2010.97 Current
92 See PHLX Rule 960.10 and proposed PHLX
Rule 3221.
93 See proposed PHLX Rule 3400 Series.
94 As is the case for Nasdaq members under the
Nasdaq rules, PHLX members that are not FINRA
members must compile and maintain audit trail
information for securities listed on Nasdaq, but are
required to transmit this information to FINRA only
if requested. See proposed PHLX Rule 3405. If
PHLX resumes operations as a listing market in the
future, all members will be required to maintain
audit trail information for securities listed on
PHLX, and to transmit the information to FINRA
upon request, but daily OATS reporting for such
securities would not be required. Id.
95 See Securities Exchange Act Release No. 53128
(January 13, 2006); 71 FR 3350 (January 23, 2006)
(File No. 10–131).
96 See proposed PHLX Rule 3100.
97 See proposed PHLX Rule 3100(a)(4). See also
Securities Exchange Act Release No. 62252 (June
10, 2010), 75 FR 34186 (June 16, 2010) (order
approving rules relating to the circuit breaker pilot
program adopted by other national securities
exchanges). Nasdaq and the other equities
exchanges have proposed to expand the circuit
breaker pilot program to include securities in the
Russell 1000 Index and certain exchange traded
products. See, e.g., Securities Exchange Act Release
Nos. 62414 (June 30, 2010), 75 FR 39081 (July 7,
2010) and 62415 (June 30, 2010), 75 FR 39086 (July
7, 2010). The Exchange has represented that it will
promptly submit a proposed rule change in
accordance with Section 19(b) of the Act and Rule
19b–4(f)(6) thereunder to adopt corresponding
changes to the rules governing PSX if and when the
Commission approves the corresponding Nasdaq
rule. See Letter from John Yetter, Vice President
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PHLX Rule 133 (Trading Halts Due to
Extraordinary Market Volatility) will
also apply to trading on PSX.98
PHLX has proposed a rule which is
substantially similar to Nasdaq Rule
11890 (Clearly Erroneous Transactions)
to govern the breaking of clearly
erroneous transactions.99 Appeals from
determinations regarding trades made
by PHLX staff will be made to a
committee of industry and non-industry
experts established under the PHLX ByLaws, which committee is subject to
identical compositional
requirements 100 as NASDAQ’s Market
Operations Review Committee, which
performs a comparable function under
NASDAQ rules.101
The Commission finds that the
Exchange’s proposed rules relating to
the regulation of PSX and its members
are consistent with the requirements of
the Act. The Commission notes that the
proposed rules relating to the regulation
of PSX are substantially similar to rules
of Nasdaq previously approved by the
Commission.102 In addition, the
disciplinary rules applicable to PSX are
set forth in the current rules of the
Exchange, which have been previously
approved by the Commission.
4. Regulatory Contracts
The Exchange represents that it is a
party to two regulatory services
agreements (the ‘‘Regulatory
Contracts’’).103 Pursuant to the FINRA
and Deputy General Counsel, The NASDAQ OMX
Group, to David Shillman, Associate Director,
Division of Trading and Markets, Commission,
dated September 8, 2010 (‘‘Yetter Letter’’).
98 See proposed PHLX Rule 3202.
99 See proposed PHLX Rule 3312. As a result of
precipitous declines in the prices of certain
securities on May 6, 2010, however, the
Commission and the national securities exchanges
are currently evaluating the advisability of further
changes to clearly erroneous rules. As a result of
this evaluation, Nasdaq and the other equities
exchanges have proposed to amend their clearly
erroneous execution rules to set forth clearer
standards and curtail their discretion with respect
to breaking erroneous trades. See, e.g., Securities
Exchange Act Release Nos. 62334 (June 21, 2010),
75 FR 36732 (June 28, 2010) and 62342 (June 21,
2010), 75 FR 36752 (June 28, 2010). The Exchange
has represented that it will promptly file a proposed
rule change to amend its clearly erroneous rule in
a manner consistent with Nasdaq’s clearly
erroneous rule, in accordance with Section 19(b) of
the Act and Rule 19b–4(f)(6) thereunder, if and
when the Commission approves the corresponding
Nasdaq rule. See Yetter Letter, supra note 97.
100 See Section 10–10 of the PHLX By-Laws,
which requires that 20% of the members of the
committee represent PHLX members, and prohibits
more than 50% of the committee’s members from
being employed by firms that are market makers or
that derive more than 10% of their revenues from
market making.
101 By-Laws of Nasdaq, Article III, Section 6.
102 See Nasdaq Registration Approval Order,
supra note 22.
103 See Notice, supra note 3, 75 FR at 43604.
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RSA, FINRA will provide a range of
regulatory services to the Exchange and
its facilities, including PSX, including
T+1 surveillance, investigation, and
enforcement with respect to the
Exchange’s rules, arbitration services,
and membership services.104 Under the
FINRA RSA, FINRA will conduct T+1
market surveillance and examine
members to monitor compliance with
applicable PHLX rules and securities
laws and regulations.105 The
Intercompany RSA provides that
employees and contractors of each party
may perform regulatory services for the
Exchange.106 All regulatory services
performed for the Exchange under the
Intercompany RSA, including those
performed with respect to the System,
are subject to the direction, authority,
and oversight of the Exchange’s CRO
and the ROC, and all personnel
performing services for the Exchange
under the Intercompany RSA are subject
to the jurisdiction, authority and
oversight of the Exchange’s CRO and
ROC.107 The Exchange represents that
any personnel performing real-time
oversight of equity trading on Nasdaq
will also perform similar functions with
respect to PSX, under the direction,
authority, and oversight of the
Exchange’s CRO and the ROC.108 The
Exchange represents that the Exchange
retains ultimate legal responsibility for,
and control of, functions performed for
PHLX under the Regulatory
Contracts.109
The Exchange has represented that
many aspects of compliance with PSX
rules, such as avoidance of locked and
crossed markets and trade throughs, will
be enforced by the System itself, and the
Exchange will periodically test
operations of PSX to determine that the
System is operating in accordance with
applicable rules.110
The Commission notes that the
Exchange will continue to bear ultimate
regulatory responsibility for functions
performed on its behalf under the
Regulatory Contracts. Further, the
Exchange retains ultimate legal
responsibility for the regulation of its
members and its markets (including
PSX).
The Commission believes that it is
consistent with the Act and the public
interest to allow the Exchange to
contract with FINRA to perform
surveillance, disciplinary, and
104 Id.
105 Id.
106 Id.
107 Id.
108 Id.
109 Id.
110 Id.
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enforcement functions.111 Surveillance,
discipline, and enforcement are
fundamental elements to a regulatory
program, and constitute core selfregulatory functions. It is essential to
the public interest and the protection of
investors that these functions are carried
out in an exemplary manner. With
respect to certain regulatory functions
contracted to FINRA by the Exchange,
including surveillance, disciplinary and
enforcement functions, the Commission
previously noted its belief that FINRA
has the expertise and experience to
perform such functions on behalf of an
exchange, and that the contracting of
such functions to FINRA is consistent
with the Act and the public interest.112
The Commission continues to believe
that this is true with respect to FINRA’s
regulation of the Exchange and the
conduct of its members pursuant to the
FINRA RSA.
The Commission believes that it is
consistent with the Act and the public
interest to allow the Exchange to enter
into the Intercompany RSA. Nasdaq and
BX have self-regulatory obligations
similar to those of the Exchange, and it
is beneficial to the public interest and
the protection of investors that these
functions are carried out in an
exemplary manner. The Commission
notes that the Exchange has represented
that all regulatory services performed
for the Exchange under the
Intercompany RSA are subject to the
direction, authority, and oversight of the
Exchange’s CRO and ROC, and any
personnel performing such services for
the Exchange are subject to the
jurisdiction, authority and oversight of
the Exchange’s CRO and ROC. In this
way, the Exchange will maintain control
over the performance of regulatory
services with respect to the Exchange.
The Exchange, unless relieved by the
Commission of its responsibility,113
shall bear the responsibility for selfregulatory conduct and primary liability
111 See, e.g., Securities Exchange Act Release No.
40760 (December 8, 1998), 63 FR 70844 (December
22, 1998). See also Securities Exchange Act Release
Nos. 57478 (March 12, 2008) 73 FR 14521, (March
18, 2008) (order approving rules governing the
trading of options on the NASDAQ Options Market)
(‘‘NOM Approval Order’’); 50122 (July 29, 2004), 69
FR 47962 (August 6, 2004) (order approving File
No. SR–Amex–2004–32) (‘‘Amex Approval Order’’);
42455 (February 24, 2000), 65 FR 11388 (March 2,
2000) (File No. 10–127) (order approving ISE’s
registration as a national securities exchange) (‘‘ISE
Registration Approval Order’’); Nasdaq Registration
Approval Order, supra note 22.
112 See Nasdaq Registration Approval Order,
supra note 22; BX Equities Market Approval Order,
supra note 81.
113 See Section 17(d)(1) of the Act and Rule 17d2 thereunder. 15 U.S.C. 78q(d)(1); and 17 CFR
240.17d–2. The Commission notes that it is not
approving or declaring effective the FINRA RSA or
the Intercompany RSA.
PO 00000
Frm 00140
Fmt 4703
Sfmt 4703
for self-regulatory failures, not the SRO
retained to perform regulatory functions
on the Exchange’s behalf.114 In
performing these functions, however, an
SRO may nonetheless bear liability for
causing or aiding and abetting the
failure of the Exchange to perform its
regulatory functions.115 Accordingly,
although FINRA, Nasdaq and BX will
not act on their own behalf under their
respective SRO responsibilities in
carrying out regulatory services for the
Exchange pursuant to the FINRA RSA or
Intercompany RSA, as applicable, such
SROs may have secondary liability if,
for example, the Commission finds that
the contracted functions are being
performed so inadequately as to cause a
violation of the federal securities laws
by the Exchange.116
E. Additional Proposed Rules for the
Exchange
PHLX proposes to adopt rules
addressing recommendations to
customers (or suitability) and best
execution and interpositioning,117
which mirror the requirements of NASD
Rules 2310 and 2320. Although
members would become subject to these
rules by virtue of being members of
FINRA, PHLX believes that the
requirements set forth in these rules are
sufficiently important that they should
be explicitly set forth in the PHLX
rulebook.118
The Commission finds that the
proposed rules regarding suitability and
best execution and interpositioning are
consistent with the Act. The
Commission notes that rules are
substantially similar to the requirements
of NASD Rules 2310 and 2320.
V. Conclusion
It is therefore ordered, pursuant to
Section 19(b)(2) of the Act,119 that the
proposed rule change (SR–PHLX–2010–
79), as modified by Amendment No. 1,
be, and it hereby is, approved, except
for (1) the circuit breaker pilot program,
which is approved on a pilot basis
through December 10, 2010, and (2) the
inbound routing of orders from NES to
PSX, which is approved on a pilot basis
through September 9, 2011.
Although the Commission’s approval
of the rule proposal, as amended, is
final and the proposed rules are
therefore effective, it is further ordered
114 See NOM Approval Order, supra note 111;
Nasdaq Registration Approval Order, supra note 22;
Amex Approval Order, supra note 111; and ISE
Registration Approval Order, supra note 111.
115 Id.
116 Id.
117 See proposed PHLX Rules 763 and 764.
118 See Notice, supra note 3, 75 FR at 43604.
119 15 U.S.C. 78s(b)(2).
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that the operation of PSX is conditioned
on the satisfaction of the following
requirements:
A. Examination by the Commission.
The Exchange must have, and must
represent in a letter to the staff in the
Commission’s Office of Compliance
Inspections and Examinations that it has
adequate surveillance procedures and
programs in place to effectively regulate
PSX.
B. Trade Processing and Exchange
Systems. The Exchange must have, and
must represent in a letter to the staff in
the Commission’s Division of Trading
and Markets that it has adequate
procedures and programs in place, as
noted in Commission Automation
Review Policy guidelines,120 to
effectively process trades and maintain
the confidentiality, integrity, and
availability of the Exchange’s systems.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.121
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010–23104 Filed 9–15–10; 8:45 am]
BILLING CODE 8010–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–62885; File No. SR–FINRA–
2010–032]
Self-Regulatory Organizations;
Financial Industry Regulatory
Authority, Inc.; Order Granting
Approval of Proposed Rule Change
Relating to Clearly Erroneous
Transactions
I. Introduction
September 10, 2010.
On June 17, 2010, the Financial
Industry Regulatory Authority, Inc.
(‘‘FINRA’’) filed with the Securities and
Exchange Commission (‘‘Commission’’),
pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (‘‘Act’’),
and Rule 19b–4 thereunder, a proposed
rule change to amend its rules to set
forth clearer standards and curtail its
discretion with respect to breaking
mstockstill on DSKH9S0YB1PROD with NOTICES
120 On
November 16, 1989, the Commission
published its first Automation Review Policy (‘‘ARP
I’’), in which it created a voluntary framework for
self-regulatory organizations to establish
comprehensive planning and assessment programs
to determine systems capacity and vulnerability. On
May 9, 1991, the Commission published its second
Automation Review Policy (‘‘ARP II’’) to clarify the
types of review and reports that were expected from
self-regulatory organizations. See Securities
Exchange Act Release Nos. 27445 (November 16,
1989), 54 FR 48703 (November 24, 1989); and 29185
(May 9, 1991), 56 FR 22490 (May 15, 1991).
121 17 CFR 200.30–3(a)(12).
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19:19 Sep 15, 2010
Jkt 220001
erroneous trades.1 The proposed rule
change was published for comment in
the Federal Register on June 28, 2010.2
The Commission received nine
comment letters on the proposal.3 BATS
responded to the comments in a letter
dated August 16, 2010.4 This order
approves the proposed rule change.
II. Background and Description of the
Proposal
On May 6, 2010, the U.S. equity
markets experienced a severe
disruption.5 Among other things, the
1 Also, on June 17, 2010, each of BATS Exchange,
Inc. (‘‘BATS’’), NASDAQ OMX BX, Inc. (‘‘BX’’),
Chicago Board Options Exchange, Incorporated
(‘‘CBOE’’), Chicago Stock Exchange, Inc. (‘‘CHX’’),
EDGA Exchange, Inc. (‘‘EDGA’’), EDGX Exchange,
Inc. (‘‘EDGX’’), International Securities Exchange
LLC (‘‘ISE’’), The NASDAQ Stock Market LLC
(‘‘Nasdaq’’), National Stock Exchange, Inc. (‘‘NSX’’),
New York Stock Exchange LLC (‘‘NYSE’’), NYSE
Amex LLC (‘‘NYSE Amex’’), NYSE Arca, Inc.
(‘‘NYSE Arca’’) (collectively, the ‘‘Exchanges’’) filed
similar proposed rule changes with respect to
breaking erroneous trades. See Securities Exchange
Act Release Nos. 62330 (June 21, 2010), 75 FR
36725; 62331 (June 21, 2010), 75 FR 36746; 62332
(June 21, 2010), 75 FR 36749; 62333 (June 21, 2010),
75 FR 36759; 62334 (June 21, 2010), 75 FR 36732;
62335 (June 21, 2010), 75 FR 37494; 62336 (June 21,
2010), 75 FR 36743; 62337 (June 21, 2010), 75 FR
36739; 62338 (June 21, 2010), 75 FR 36762; 62339
(June 21, 2010), 75 FR 36765; 62340 (June 21, 2010),
75 FR 36768; and 62342 (June 21, 2010), 75 FR
36752. These proposals also were approved today.
See Securities Exchange Act Release No. 62886
(Sept. 10, 2010).
2 See Securities Exchange Act Release No. 62341
(June 21, 2010), 75 FR 36756.
3 See letter from Peter Ianello, Partner, CSS, LLC,
to Elizabeth Murphy, Secretary, Commission, dated
July 15, 2010 (‘‘CSS Letter’’); letter from Gary
DeWaal, Senior Managing Director and Group
General Counsel, Newedge USA, LLC, to Elizabeth
M. Murphy, Secretary, Commission, dated July 19,
2010 (‘‘Newedge Letter’’); letter from Karrie
McMillan, General Counsel, Investment Company
Institute, to Elizabeth M. Murphy, Secretary,
Commission, dated July 19, 2010 (‘‘ICI Letter’’);
David C. Cushing, Director of Global Equity
Trading, Wellington Management Company, LLP, to
Elizabeth M. Murphy, Secretary, Commission, dated
July 19, 2010 (‘‘Wellington Letter’’); letter from John
A. McCarthy, General Counsel, GETCO, to Elizabeth
Murphy, Secretary, Commission, dated July 20,
2010 (‘‘GETCO Letter’’); letter from Ira P. Shapiro,
Managing Director, BlackRock, Inc., to Elizabeth M.
Murphy, Secretary, Commission, dated July 20,
2010 (‘‘BlackRock Letter’’); and letter from Manisha
Kimmel, Executive Director, Financial Information
Forum, On behalf of the FIF Front Office
Committee, to Elizabeth M. Murphy, Secretary,
Commission, dated July 21, 2010 (‘‘FIF Letter’’);
letter from Ann Vlcek, Managing Director and
Associate General Counsel, Securities Industry and
Financial Markets Association, to Elizabeth M.
Murphy, Secretary, Commission, dated July 26,
2010 (‘‘SIFMA Letter’’); and letter from Leonard J.
Amoruso, General Counsel, Knight Capital Group,
Inc., to Elizabeth M. Murphy, Secretary,
Commission, dated July 27, 2010 (‘‘Knight Letter’’).
4 See letter from Eric J. Swanson, SVP and
General Counsel, BATS, to Elizabeth M. Murphy,
Secretary, Commission, dated August 16, 2010
(‘‘BATS Letter’’).
5 The events of May 6 are described more fully
in the report of the staffs of the Commodity Futures
Trading Commission (‘‘CFTC’’) and the Commission,
PO 00000
Frm 00141
Fmt 4703
Sfmt 4703
56641
prices of a large number of individual
securities suddenly declined by
significant amounts in a very short time
period, before suddenly reversing to
prices consistent with their pre-decline
levels. This severe price volatility led to
a large number of trades being executed
at temporarily depressed prices,
including many that occurred at prices
dramatically away from pre-decline
levels. In response, the Exchanges and
FINRA exercised their authority under
their clearly erroneous execution rules
to break trades that were effected at
prices 60% or more away from predecline prices, using a process that was
not sufficiently clear or transparent to
market participants. There are reports
that the lack of clear guidelines for
dealing with clearly erroneous
transactions under circumstances such
as occurred on May 6, and the lack of
transparency surrounding the
Exchanges’ and FINRA’s decision to
break only trades at least 60% away
from the market, added to the confusion
and uncertainty faced by investors on
May 6.6
The Commission is concerned that
events such as those that occurred on
May 6 can undermine the integrity of
the U.S. securities markets.
Accordingly, it is working on a variety
of fronts to assess the causes and
contributing factors of the May 6 market
disruption and to fashion policy
responses that will help prevent a
recurrence. The Commission also
recognizes the importance of moving
quickly to implement steps that could
help limit potential harm from extreme
price volatility. On June 10, 2010, the
Commission approved rules, on a pilot
basis, that require the Exchanges to
pause trading in securities included in
the S&P 500 Index if the price moves
10% or more in a five-minute period.7
By establishing circuit breakers that
uniformly pause trading in these
securities across all markets, the new
rules are designed to facilitate
coordinated price discovery and provide
time for investors to trade at rational
prices. In addition to the individual
stock trading pause rules, FINRA
titled Report of the CFTC and SEC to the Joint
Advisory Committee on Emerging Regulatory Issues,
‘‘Preliminary Findings Regarding the Market Events
of May 6, 2010,’’ dated May 18, 2010.
6 See, e.g., Written Statement of Leonard J.
Amoruso, Senior Managing Director and General
Counsel, Knight Capital Group, Inc., Submitted
before the CFTC–SEC Advisory Committee on
Emerging Regulatory Issues, Panel Discussion, ‘‘The
events of May 6—views and observations regarding
liquidity, trading and the apparent breakdown of an
orderly market,’’ dated June 22, 2010.
7 See Securities Exchange Act Release Nos. 62251;
75 FR 34183 (June 10, 2010); and 62252, 75 FR
34186 (June 16, 2010).
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]]>Agencies
[Federal Register Volume 75, Number 179 (Thursday, September 16, 2010)]
[Notices]
[Pages 56633-56641]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-23104]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-62877; File No. SR-PHLX-2010-79]
Self-Regulatory Organizations; NASDAQ OMX PHLX, Inc.; Order
Approving a Proposed Rule Change, as Modified by Amendment No. 1,
Relating to the Establishment of NASDAQ OMX PSX as a Platform for
Trading NMS Stocks
September 9, 2010.
I. Introduction
On June 8, 2010, NASDAQ OMX PHLX, Inc. (``PHLX'' or ``Exchange''),
filed with the Securities and Exchange Commission (``Commission''),
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to
establish NASDAQ OMX PSX as a new electronic platform for trading NMS
stocks. The proposed rule change was published for comment in the
Federal Register on July 26, 2010.\3\ On August 5, 2010, the Exchange
filed Amendment No. 1 to the proposed rule change.\4\ The Commission
received no comment letters regarding the proposed rule change. This
order approves the proposed rule change, as modified by Amendment No.
1.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 62519 (July 16,
2010), 75 FR 43597 (``Notice'').
\4\ Amendment No. 1 clarifies that the proposal to accept orders
routed by Nasdaq Execution Services, LLC to the Exchange on a one-
year pilot basis is made by the Exchange, rather than by The NASDAQ
Stock Market, LLC (``Nasdaq''). This is a technical amendment and is
not subject to notice and comment.
---------------------------------------------------------------------------
II. Background
The Exchange proposes to establish a new cash equities trading
platform, to be called NASDAQ OMX PSX (``PSX or ``System'').\5\ The
System will be an open-access fully electronic integrated order display
and execution system for NMS stocks. PSX will not list securities, but
rather will trade NMS stocks listed on other exchanges on an unlisted
trading privileges basis.
---------------------------------------------------------------------------
\5\ The Exchange previously operated an electronic trading
facility, XLE, for the trading of cash equity securities. XLE ceased
its operations in October 2008 following the acquisition of the
Exchange by The NASDAQ OMX Group, Inc. (``NASDAQ OMX''), the parent
corporation of Nasdaq. See Securities Exchange Act Release No. 58613
(September 22, 2008), 73 FR 57181 (October 1, 2008) (SR-Phlx-2008-
65). Since ceasing operations of XLE, the Exchange has solely
operated an options market.
---------------------------------------------------------------------------
The System will allow PSX participants to enter orders at multiple
price levels. Orders will be integrated and displayed via data feeds to
participants and other data subscribers. PSX participants will be able
to access the aggregated trading interest of all other PSX participants
in accordance with non-discretionary order execution algorithms. The
System will not route orders to other market centers.
In contrast with most markets, which employ a price/time execution
priority system (where the displayed order on the book that is first in
time at the best price is satisfied fully, then the next in time at
that price, and so on), PSX will use a price/pro rata execution
priority system,with displayed orders receiving priority over non-
displayed orders. Specifically, multiple orders displayed on the PSX
book at the best price would be allocated shares of an incoming order
pro rata based on the proportion of the size of the displayed order to
the total size of all displayed orders at that price. Once all
displayed size at any price level is exhausted, the same pro rata logic
would apply to non-displayed orders at that price level.
The Exchange proposes to adopt new rules governing trading on the
System. The proposed new rules are based to a substantial extent on the
rules of Nasdaq \6\ and NASDAQ OMX BX, Inc. (``BX''). In addition, the
Exchanges proposes to apply the PHLX rules listed in proposed PHLX Rule
3202, including certain rules that governed XLE when it was
operational, to PHLX members with respect to their activities on the
System.\7\ The Exchange also proposes to amend PHLX Rule 803 (Criteria
For Listing--Tier I) to support unlisted trading privileges for NMS
stocks on PSX and PHLX Rule 985 (Affiliate and Ownership Restrictions)
to address potential competitive advantage and conflict of interest
concerns regarding
[[Page 56634]]
inbound routing from Nasdaq to PSX. Finally, the Exchange proposes to
adopt rules governing Recommendations to Customers (Suitability) and
Best Execution and Interpositioning,\8\ and commentaries relating
thereto, which rules shall be applicable to all members of the
Exchange, including those trading on PSX.
---------------------------------------------------------------------------
\6\ Unlike Nasdaq, PSX will not route orders to other exchanges
and will not have market makers. As a result, the PSX rules do not
contain provisions related to outbound routing or market makers that
are found in Nasdaq's rules.
\7\ The Exchange also proposes to delete two existing PHLX Rules
relating to XLE, PHLX Rule 160 (NMS Stock Execution on the Exchange)
and PHLX Rule 188 (Trade Execution and Reporting), and to move their
content to the proposed rules governing PSX. See proposed PHLX Rules
3301(a), 3305(a)(1) and 3309).
\8\ See proposed PHLX Rules 763 and 764.
---------------------------------------------------------------------------
Pursuant to the terms of a regulatory services agreement (the
``FINRA RSA'') between PHLX and Financial Industry Regulatory
Authority, Inc. (``FINRA''), administration and enforcement of many of
the new rules applicable to the System will be supported by FINRA. In
addition, certain regulatory responsibilities of PHLX relating to PSX
may be administered by personnel employed by Nasdaq or ``BX'' \9\
pursuant to a regulatory services agreement (the ``Intercompany RSA'').
---------------------------------------------------------------------------
\9\ Each of Nasdaq and BX is a self-regulatory organization
(``SRO'') owned by NASDAQ OMX and, therefore, an affiliate of the
Exchange.
---------------------------------------------------------------------------
III. Discussion and Commission Findings
After careful review of the proposed rule change, the Commission
finds that the proposed rule change is consistent with the requirements
of the Act and the rules and regulations thereunder applicable to a
national securities exchange.\10\ Specifically, the Commission finds
that the proposed rule change is consistent with Section 6(b)(5) of the
Act,\11\ which requires, among other things, that the rules of a
national securities exchange be designed to prevent fraudulent and
manipulative acts and practices; to promote just and equitable
principles of trade; to foster cooperation and coordination with
persons engaged in regulating, clearing, settling, and processing
information with respect to, and facilitating transactions in
securities; to remove impediments to and perfect the mechanism of a
free and open market and a national market system; and, in general, to
protect investors and the public interest. Section 6(b)(5) of the Act
also requires that the rules of an exchange not be designed to permit
unfair discrimination among customers, issuers, brokers, or dealers.
---------------------------------------------------------------------------
\10\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition and
capital formation. 15 U.S.C. 78c(f).
\11\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
Overall, the Commission believes that approving the Exchange's
proposed rule change could benefit the public and market participants.
Approval of the proposal would establish rules for the operation of a
new electronic facility for the trading of cash equity securities that
is designed to encourage displayed orders of larger size, which could
foster best execution, price discovery, competition and innovation. The
discussion below does not review every detail of the proposed rule
change, but rather focuses on the most significant rules and policy
issues considered in review of the proposals.
A. Proposed New Rules for PSX
1. Access and Participation
The System will only have one class of membership and, unlike
Nasdaq, will not have a separate class of market makers.\12\ In
addition, PSX will make its facilities available to electronic
communications networks (``ECN'') and alternative trading systems
(``ATS'') that meet certain requirements, to allow such ECNs and/or
ATSs to display best prices and size of orders on PSX and members to
access such orders.\13\ PSX will provide authorized access for
Sponsored Participants on terms identical to those set forth in Nasdaq
Rule 4211(d) (Sponsored Participants).\14\
---------------------------------------------------------------------------
\12\ See Notice, supra note 3, 75 FR at 43598.
\13\ See proposed Rule 3223. The ATS or ECN must be a PHLX
member organization, enter into and comply with applicable
agreements, agree that PHLX may disseminate the ECN's or ATS's best
priced orders, demonstrate that it is in compliance with applicable
regulatory requirements, and accept automated executions against
orders that it enters into the System.
\14\ See proposed Rule 3211(d). The Exchange has represented
that upon implementation by Nasdaq of recently approved changes to
its rule governing Sponsored Participants, the Exchange will adopt
and implement identical rules to govern sponsored access on PSX. See
Securities Exchange Act Release No. 61345 (January 13, 2010), 75 FR
32631 (January 20, 2010) (SR-NASDAQ-2008-104). If NASDAQ's rules are
superseded by rules adopted by the Commission, the Exchange has
represented that PSX will operate sponsored participant access in
accordance with such rules. See Notice, supra note 3, 75 FR at
43598.
---------------------------------------------------------------------------
The System will be accessible to all PHLX members that meet the
registration, qualification and other membership requirements set forth
in the PHLX rules.\15\ In addition, in order to trade on PSX, a member
must comply with certain additional requirements set forth in proposed
PHLX Rule 3211 (PSX Participant Registration). Such requirements are
substantially similar to the requirements set forth in Nasdaq Rule 4611
(Nasdaq Market Center Participant Registration), and include, among
others, the execution of applicable agreements with the Exchange,
membership in or access to a registered clearing agency through which
PSX-compared trades may be settled, compliance with all applicable
rules and operating procedures of PHLX \16\ and the Commission in the
use of PSX, and maintenance of equipment to prevent the improper use of
and access to PHLX systems.\17\
---------------------------------------------------------------------------
\15\ As discussed above, proposed PHLX Rule 3202 sets forth the
current PHLX Rules applicable to market participants trading on PSX,
and includes, among others, PHLX Rule 600 (Registration) and PHLX
Rule 604 (Registration and Termination of Registered Persons). In a
separate order, the Commission approved the amendment of PHLX Rule
604 to require all members trading on PSX to register
representatives and principals in accordance with rules similar to
those governing registration of associated persons of members of
Nasdaq. See Securities Exchange Act Release No. 62776 (August 26,
2010), 75 FR 53727 (September 1, 2010) (SR-Phlx-2010-91).
\16\ In addition to proposed rules specific to the operation of
PSX, members must comply with existing PHLX rules governing member
conduct, to the extent that they are relevant to trading on PSX. The
PHLX Rules applicable to activities of members on PSX are listed in
proposed PHLX Rule 3202.
\17\ See proposed PHLX Rule 3211(a).
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Each PSX participant will be under a continuing obligation to
inform PHLX of any noncompliance with any of the registration
requirements.\18\ Failure by a PSX participant to comply with any
registration requirements, including failure to comply with any PHLX
rules applicable to PSX, shall subject such participant to censure,
fine, suspension or revocation of its registration as a PSX
participant, or any other appropriate penalty under the rules of the
Exchange.\19\ The Exchange may terminate access to the System if a
participant fails to meet the participant eligibility
qualifications.\20\
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\18\ See proposed PHLX Rule 3211(b).
\19\ See proposed PHLX Rule 3228(a).
\20\ See proposed PHLX Rule 3222.
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The Commission finds that the Exchange's access and participation
requirements for the System are consistent with Section 6(b)(5) of the
Act, which requires, among other things, that the rules of a national
securities exchange be designed to prevent fraudulent and manipulative
acts and practices; to promote just and equitable principles of trade;
to foster cooperation and coordination with persons engaged in
regulating, clearing, settling, and processing information with respect
to, and facilitating transactions in securities; to remove impediments
to and perfect the mechanism of a free and open market and a national
market system; and, in general, to protect investors and the public
interest.\21\ Section 6(b)(5) also requires that the rules of an
exchange not be designed to permit unfair discrimination among
customers, issuers, brokers, or dealers. The Commission notes that the
access and participation requirements applicable to PSX are
substantially similar to rules of
[[Page 56635]]
Nasdaq previously approved by the Commission.\22\ The Commission also
notes that all PSX participants will participate on consistent terms
when entering orders into PSX for posting and accessing liquidity. In
addition, the Commission notes that the membership and registration
requirements applicable to PSX are set forth in the current rules of
the Exchange, which have been previously approved by the Commission.
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\21\ 15 U.S.C. 78f(b)(5).
\22\ See Securities Exchange Act Release No. 53128 (January 13,
2006), 71 FR 3550 (January 23, 2006) (order approving Nasdaq's
application to register as a national securities exchange) (``Nasdaq
Registration Approval Order'').
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2. Trading System and Regulation NMS Compliance
a. PSX Order Entry, Display and Execution
The System will operate, and orders can be entered into the System,
from 9 a.m. to 5 p.m., Eastern Time, on each business day.\23\ PSX will
not have any specialized opening or closing processes, and will begin
to process all eligible orders at 9 a.m.\24\
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\23\ See proposed PHLX Rules 3217 and 3306(a)(3).
\24\ See proposed PHLX Rule 3302.
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Participants may submit multiple orders at multiple price levels,
which PSX will manage and display, consistent with the parameters of
each order.\25\ PSX will time-stamp each order upon receipt, although,
as discussed below, the time stamp will not determine the order's
ranking for execution purposes.\26\ The System will not display orders
on an attributable basis.\27\ Orders may be entered either as Displayed
Orders or Non-Displayed Orders.\28\
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\25\ See proposed PHLX Rule 3306.
\26\ Id.
\27\ See proposed PHLX Rule 3301(a).
\28\ See proposed PHLX Rule 3301(e).
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Displayed Orders will be displayed anonymously to participants
through the System book feed and the aggregate size of all best-priced
Displayed Orders to buy and sell on the System will be transmitted for
display to the appropriate network processor (unless the aggregate size
is less than one round lot).\29\ Non-Displayed Orders and Reserve Size
will not be displayed, but will nevertheless remain available for
potential execution against incoming orders.\30\
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\29\ See proposed PHLX Rule 3306(c)(1) and (2).
\30\ See proposed PHLX Rule 3306(c)(3).
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Incoming marketable orders automatically execute against resting
orders on the PSX book, and the posted orders are decremented
accordingly.\31\ Incoming orders that are not marketable against posted
interest in the System book will be cancelled or posted to the book,
depending on the time-in-force for the order.\32\ An incoming order
with a price that crosses the price of an order posted on the book will
execute at the price of the posted order. Thus, any potential price
improvement resulting from an execution in the System will accrue to
the taker of liquidity.\33\
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\31\ See proposed PHLX Rule 3307(a)(2).
\32\ See proposed PHLX Rule 3301(h).
\33\ See proposed PHLX Rule 3307(a)(3).
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As provided by PHLX Rule 3309, executions occurring as a result of
orders matched on PSX shall be reported by PHLX to an appropriate
consolidated transaction reporting system. As transactions executed in
the System will be cleared and settled anonymously, the transaction
reports produced by the System will indicate the price and size of the
transaction, but will not reveal contra party identities.\34\
---------------------------------------------------------------------------
\34\ See proposed PHLX Rule 3310.
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To determine the allocation of incoming marketable orders against
orders on the book, the System uses a price/pro-rata algorithm, with
Displayed Orders receiving priority over Non-displayed Orders and round
lot orders receiving priority over odd lot orders.\35\ The algorithm
executes trading interest in the System as follows:
---------------------------------------------------------------------------
\35\ See proposed PHLX Rule 3307(a)(1).
---------------------------------------------------------------------------
Better priced trading interest will be executed ahead of
inferior-priced trading interest;
Displayed Orders at a particular price with a size of at
least one round lot will be executed ahead of Non-Displayed Orders and
the reserve portion of Reserve Orders (collectively, ``non-displayed
interest'') at the same price;
Displayed Orders at a particular price with a size of at
least one round lot will be executed ahead of odd lot at the same
price; however, odd-lot Displayed Orders will execute ahead of non-
displayed interest of one round lot at the same price, as Displayed
Orders will always execute ahead of Non-Displayed Orders at the same
price; \36\
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\36\ See id.
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As among equally priced Displayed Orders with a size of at
least one round lot, the System will allocate round lot portions of
incoming executable orders to displayed trading interest within the
System pro rata based on the size of the Displayed Orders. Portions of
an order that would be executed in a size other than a round lot if
they were allocated on a pro rata basis will be allocated for execution
against available displayed trading interest on the basis of a random
function that assigns probability of execution based on the size of
displayed interest.\37\ As among equally priced Displayed Orders with a
size of less than one round lot, the System will allocate incoming
orders based on the size of the Displayed Orders, but not in pro rata
fashion.\38\ If there are two or more odd lot orders of equal size, the
System will determine the order of execution on the basis of a random
function that assigns each order an equal probability of execution.
This same allocation methodology applies to equally-priced non-
displayed interest with a size of at least one round lot or with a size
of less than one round lot, as the case may be.
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\37\ For example, if Displayed Orders to buy at 10 reside on the
PSX book with sizes of 6,000 (Participant A) and 4,000 (Participant
B), and an incoming order to sell 1,100 at 10 comes into the System,
the System will allocate 600 shares of the incoming order to
Participant A and 400 shares of the incoming order to Participant B.
The remaining 100 shares of the incoming order will be allocated on
the basis of a random function that assigns a 60% probability of
executing the 100 shares to Participant A and a 40% probability to
Participant B.
\38\ Thus, a resting displayed order with a size of 90 shares
would get filled in full before a displayed order with size of 50
shares.
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The Commission finds that the Exchange's trading rules for the
System, including PSX's execution priority rules, are consistent with
the Act. The Commission notes that, other than with respect to the
price/pro rata execution priority system, the Exchange' market model
for the trading of cash equity securities is substantially similar to
each of Nasdaq's and BX's equity market models and does not raise novel
issues. The Commission believes that PSX's price/pro rata execution
priority system may encourage participants, particularly those who wish
to execute orders of large size, to display liquidity on the System.
This in turn could facilitate the efficient execution of large orders,
and foster best execution and price discovery. A novel exchange
priority system that is designed to achieve these goals also may foster
competition and innovation. Accordingly, the Commission finds that the
price/pro rata execution priority system proposed by PHLX is consistent
with the Act.
b. Regulation NMS
The Exchange will implement such systems, procedures, and rules in
connection with the operation of PSX as are necessary to render it
capable of meeting the requirements for automated quotations.\39\
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\39\ See proposed PHLX Rule 3306(c)(4). As defined in PHLX Rule
600(b) of Regulation NMS under the Act, 17 CFR 242.600(b), the term
``quotation'' includes the ``bid price or the offer price
communicated by a member of a national securities exchange * * * to
any broker or dealer, or to any customer, at which it is willing to
buy or sell one or more round lots of an NMS security, either as
principal or agent.'' Thus, the term ``quotation'' includes orders
entered into the System by PSX participants, notwithstanding the
fact that PSX will not have market makers with obligations to
maintain continuous two-sided quotations. Under Rule 602 of
Regulation NMS, brokers and dealers are required to communicate to a
national securities exchange or national securities association
their best bids, best offers, and quotation sizes. By displaying
orders communicated to it by its members and complying with the
requirements for automation described in Rule 600(b)(3), PSX will
display ``automated quotations'' within the meaning of that rule,
and therefore its best bid and best offer will constitute
``protected quotations'' entitled to trade-through protection under
Regulation NMS.
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[[Page 56636]]
The Exchange has designed PSX's rules relating to orders,
modifiers, and order execution to comply with the requirements of
Regulation NMS. The proposed Rules are consistent with Regulation NMS
\40\ by requiring that all orders be processed in a manner that avoids
trading through protected quotations \41\ and avoids locked and crossed
markets.\42\ PSX will not route orders to other market centers.
Proposed PHLX Rule 3305(b) provides that in addition to such other
designations as may be chosen by a market participant,\43\ all orders
that are not entered with a time in force of ``System Hours Immediate
or Cancel'' \44\ must be designated as an Intermarket Sweep Order, a
Pegged Order, a Price to Comply Order, or a Post-Only Order.\45\ Any
orders that are entered into the System that would lock or cross
another order in the System will be execute d to avoid a lock or
cross.\46\
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\40\ 17 CFR 242.611.
\41\ See discussion of protected quotations supra note 39.
\42\ See proposed PHLX Rules 3305(b) and 3213(c).
\43\ As is the case with Nasdaq, different order designations
can be combined. Thus, for example, a Price to Comply Order could be
entered with reserve size or as a Non-displayed Order.
\44\ A ``System Hours Immediate or Cancel'' order is an
immediate or cancel order that may be entered between 9 a.m. and 5
p.m. Eastern Time, PSX's hours of operation. If a System Hours
Immediate or Cancel order (or a portion thereof) is not marketable,
the order (or unexecuted portion thereof) is canceled and returned
to the entering participant. See proposed PHLX Rule 3301(h)(1).
\45\ See proposed PHLX Rule 3305(b).
\46\ See proposed PHLX Rule 3213(c). In addition, members may
enter orders that are re-priced if they would lock or cross so as to
avoid executing.
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As described in the Notice, a System Hours Immediate or Cancel
Order is compliant with Regulation NMS because by its terms it would
not execute or post at a price that would result in a trade-through of
a protected quotation or lock or cross another market.\47\ A Pegged
Order similarly is compliant with Regulation NMS because it continually
re-prices to avoid locking or crossing.\48\
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\47\ See Notice, supra note 3, 75 FR at 43603; proposed PHLX
Rule 3301(h).
\48\ See Notice, supra note 3, 75 FR at 43603; proposed PHLX
Rule 3301(f)(4).
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The proposed rules also permit PSX participants to submit
Intermarket Sweep Orders to comply with Regulation NMS. Orders so
designated will be automatically matched and executed within the
System.\49\ As described in the Notice, when a participant enters an
Intermarket Sweep Order it is representing that it is also
simultaneously routing one or more additional limit orders (also marked
as Intermarket Sweep Orders), as necessary, to execute against the full
displayed size of any protected bid or offer (as defined in Rule 600(b)
of Regulation NMS) in the case of a limit order to sell or buy with a
price that is superior to the limit price of the order identified as an
Intermarket Sweep Order.\50\
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\49\ See proposed PHLX Rule 3301(f)(6).
\50\ See Notice, supra note 3, 75 FR at 43603. The Exchange has
represented that members will be responsible for ensuring that their
use of Intermarket Sweep Orders complies with Regulation NMS, and
the Exchange's T+1 surveillance program will monitor members' use of
Intermarket Sweep Orders.
---------------------------------------------------------------------------
Both a Price to Comply and a Post-Only Order are also designed to
comply with the Regulation NMS.\51\ Specifically, if at the time of
entry, a Price to Comply Order will lock or cross the quotation of an
external market, the order will be priced to the current best offer
(for bids) or to the current best bid (for offers) but displayed at a
price one minimum price increment lower than the offer (for bids) or
higher than the bid (for offers).\52\ Thus, an incoming order priced to
execute against the displayed price will receive the superior
undisplayed price.\53\ If, at the time of entry, a Post-Only Order will
lock an order on the System, the order will be re-priced and displayed
on the System to one minimum price increment (i.e., $0.01 or $0.0001)
below the current best offer (for bids) or above the current best bid
(for offers).\54\
---------------------------------------------------------------------------
\51\ See Notice, supra note 3, 75 FR at 43603.
\52\ See proposed PHLX Rule 3301(f)(8).
\53\ For example, if the national best bid and best offer is
$9.97x$10.00, and a participant enters a price to comply order to
buy 10,000 shares at $10.01, the order will display at $9.99, but
will reside on the System book at $10.00. If a seller then enters an
order at $9.99, it will execute at $10.00, up to the full 10,000
shares of the order.
\54\ See proposed PHLX Rule 3301(f)(10). For example, if the
System best bid and best offer is $9.97x$10.00, and a participant
enters a Post-Only Order to buy at $10.01, the order will be
repriced and displayed at $9.99. If a seller enters an order at
$9.96, the order will be repriced and displayed at $9.98.
---------------------------------------------------------------------------
The Commission believes that by requiring all orders to be entered
with one of the designations described above, all PSX orders should
either be priced or cancelled in a manner consistent with the avoidance
of trade-throughs and locked and crossed markets. The Commission also
notes that, because PSX will not route orders to other market centers,
the Exchange's Regulation NMS policies and procedures under Rule 611(a)
will rely on information provided by Nasdaq for purposes of determining
whether another trading center is experiencing a failure, material
delay, or malfunction of its systems or equipment within the meaning of
Rule 611(b)(1).\55\
---------------------------------------------------------------------------
\55\ See Notice, supra note 3, 75 FR at 43603-42604
---------------------------------------------------------------------------
The Commission finds that the rules relating to orders, modifiers,
and order execution that are designed to comply with Regulation NMS are
consistent with the Act.
2. Section 11 of the Act
Section 11(a)(1) of the Act \56\ prohibits a member of a national
securities exchange from effecting transactions on that exchange for
its own account, the account of an associated person, or an account
over which it or its associated person exercises discretion
(collectively, ``covered accounts'') unless an exception applies. Rule
11a2-2(T) under the Act,\57\ known as the ``effect versus execute''
rule, provides exchange members with an exemption from the Section
11(a)(1) prohibition. 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
transactions on the exchange. To comply with Rule 11a2-2(T)'s
conditions, a member: (i) Must transmit the order from off the exchange
floor; (ii) may not participate in the execution of the transaction
once it has been transmitted to the member performing the execution;
\58\ (iii) may not be affiliated with the executing member; and (iv)
with respect to an account over which the member has investment
discretion, may not, nor may its associated person, retain any
compensation in connection with effecting the transaction except as
provided in the Rule.
---------------------------------------------------------------------------
\56\ 15 U.S.C. 78k(a)(1).
\57\ 17 CFR 240.11a2-2(T).
\58\ The member may, however, participate in clearing and
settling the transaction.
---------------------------------------------------------------------------
In a letter to the Commission, the Exchange requests that the
Commission concur with PHLX's conclusion that members who enter orders
into the System satisfy the requirements of Rule 11a2-2(T).\59\ For the
reasons set forth
[[Page 56637]]
below, the Commission believes that Exchange members entering orders
into the System would satisfy the conditions of the Rule.
---------------------------------------------------------------------------
\59\ See Letter from Charles Rogers, Chief Regulatory Officer,
PHLX, to Elizabeth M. Murphy, Secretary, Commission, dated August
18, 2010 (``PHLX 11(a) Letter'').
---------------------------------------------------------------------------
The Rule's first condition is that orders for covered accounts be
transmitted from off the exchange floor. The System receives orders
electronically through remote terminals or computer-to-computer
interfaces. In the context of other automated trading systems, the
Commission has found that the off-floor transmission requirement is met
if a covered account order is transmitted from a remote location
directly to an exchange's floor by electronic means.\60\ Because PSX
receives orders electronically through remote terminals or computer-to-
computer interfaces, the Commission believes that the System satisfies
the off-floor transmission requirement.
---------------------------------------------------------------------------
\60\ See, e.g., Securities Exchange Act Release Nos. 61419
(January 26, 2010), 75 FR 5157 (February 1, 2010) (SR-BATS-2009-031)
(approving BATS options trading); 59154 (December 23, 2008), 73 FR
80468 (December 31, 2008) (SR-BSE-2008-48) (approving equity
securities listing and trading on BSE); 57478 (March 12, 2008), 73
FR 14521 (March 18, 2008) (SR-NASDAQ-2007-004 and SR-NASDAQ-2007-
080) (approving NOM options trading) ; 53128 (January 13, 2006), 71
FR 3550 (January 23, 2006) (File No. 10-131) (approving The Nasdaq
Stock Market LLC); 44983 (October 25, 2001), 66 FR 55225 (November
1, 2001) (SR-PCX-00-25) (approving Archipelago Exchange); 29237 (May
24, 1991), 56 FR 24853 (May 31, 1991) (SR-NYSE-90-52 and SR-NYSE-90-
53) (approving NYSE's Off-Hours Trading Facility); and 15533
(January 29, 1979), 44 FR 6084 (January 31, 1979) (``1979
Release'').
---------------------------------------------------------------------------
Second, the Rule requires that the member not participate in the
execution of its order. PHLX has represented that at no time following
the submission of an order is a member organization able to acquire
control or influence over the result or timing of an order's
execution.\61\ According to the Exchange, the execution of a member's
order is determined by what other orders are present in the System and
the priority of those orders.\62\ Accordingly, the Commission believes
that a member does not participate in the execution of an order
submitted to the System.
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\61\ See PHLX 11(a) Letter, supra note 59.
\62\ See id. A member may cancel or modify the order, or modify
the instruction for executing the order, but only from off the
floor. The Commission has stated that the non-participation
requirement is satisfied under such circumstances, so long as such
modifications or cancellations are also transmitted from off the
floor. See Securities Exchange Act Release No. 14713 (April 27,
1978), 43 FR 18557 (May 1, 1978) (``1978 Release'') (stating that
the ``non-participation requirement does not prevent initiating
members from canceling or modifying orders (or the instructions
pursuant to which the initiating member wishes orders to be
executed) after the orders have been transmitted to the executing
member, provided that any such instructions are also transmitted
from off the floor'').
---------------------------------------------------------------------------
Third, Rule 11a2-2(T) requires that the order be executed by an
exchange member who is unaffiliated with the member initiating the
order. The Commission has stated that this requirement is satisfied
when automated exchange facilities, such as PSX, are used, as long as
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.\63\ PHLX has represented that the
design of the System ensures that no member organization has any
special or unique trading advantage in the handling of its orders after
transmitting its orders to the System.\64\ Based on the Exchange's
representation, the Commission believes that PSX satisfies this
requirement.
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\63\ In considering the operation of automated execution systems
operated by an exchange, the Commission noted that, while there is
not an independent executing exchange member, the execution of an
order is automatic once it has been transmitted into the system.
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, the Commission has
stated that executions obtained through these systems satisfy the
independent execution requirement of Rule 11a2-2(T). See 1979
Release, supra note 60.
\64\ See PHLX 11(a) Letter, supra note 59.
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Fourth, in the case of a transaction effected for an account with
respect to which the initiating member or an associated person thereof
exercises investment discretion, neither the initiating member nor any
associated person thereof may retain any compensation in connection
with effecting the transaction, unless the person authorized to
transact business for the account has expressly provided otherwise by
written contract referring to Section 11(a) of the Act and Rule 11a2-
2(T).\65\ PHLX represents that member organizations relying on Rule
11a2-2(T) for transactions effected through the System must comply with
this condition of the Rule.\66\
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\65\ See 17 CFR 240.11a2-2(T)(a)(2)(iv). In addition, Rule 11a2-
2(T)(d) requires a member or associated person authorized by written
contract to retain compensation, in connection with effecting
transactions for covered accounts over which such member or
associated persons thereof exercises investment discretion, to
furnish at least annually to the person authorized to transact
business for the account a statement setting forth the total amount
of compensation retained by the member in connection with effecting
transactions for the account during the period covered by the
statement. See 17 CFR 240.11a2-2(T)(d). See also 1978 Release, supra
note 62 (stating ``[t]he contractual and disclosure requirements are
designed to assure that accounts electing to permit transaction-
related compensation do so only after deciding that such
arrangements are suitable to their interests'').
\66\ See PHLX 11(a) Letter, supra note 59.
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B. Exception to Limitation on Affiliation Between PSX and Its Members
Although the Exchange will not route orders to other market
centers, it proposes to receive orders routed to it by other market
centers, including orders routed from Nasdaq.\67\ Nasdaq Execution
Services, LLC (``NES'') is the approved outbound routing facility of
Nasdaq for cash equities. NES is owned by NASDAQ OMX, which also owns
the Exchange.\68\ Thus, NES is an affiliate of the Exchange.
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\67\ See Notice, supra note 3, 75 FR at 43604.
\68\ See Securities Exchange Act Release No. 58179 (July 17,
2008), 73 FR 42874 (July 23, 2008) (order approving NASDAQ OMX's
acquisition of PHLX).
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Nasdaq is permitted to operate NES as a facility providing outbound
routing services from Nasdaq to other market centers, subject to the
conditions that: (1) NES is operated and regulated as a facility of
Nasdaq; (2) NES only provides outbound routing services unless
otherwise approved by the Commission; (3) the designated examining
authority of NES is a SRO unaffiliated with Nasdaq; and (4) the use of
NES for outbound routing is available only to Nasdaq members and the
use of NES remains optional.\69\ Currently, NES may not route Directed
Orders \70\ to a facility of an exchange that is an affiliate of
Nasdaq, other than BX.\71\ In connection with PHLX's resumption of
equity trading on PSX pursuant to this filing, Nasdaq has proposed a
rule change to permit NES to route all forms of orders, including
Directed Orders, to PSX.\72\
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\69\ Nasdaq Rule 4758.
\70\ Nasdaq Rule 4751(f)(9) defines Directed Orders as
immediate-or-cancel orders that are directed to an exchange other
than Nasdaq without checking the Nasdaq book.
\71\ Nasdaq Rule 4751(f)(9).
\72\ See Securities Exchange Act Release No. 62736 (August 17,
2010) (SR-Nasdaq-2010-100).
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Recognizing that the Commission has expressed concern regarding the
potential for conflicts of interest in instances where a member firm is
affiliated with an exchange to which it is routing orders, the Exchange
proposes the following limitations and conditions to NES's affiliation
with the Exchange to permit the Exchange to accept inbound orders that
NES routes in its capacity as a facility of Nasdaq:
First, the Exchange states that pursuant to the FINRA RSA,
FINRA will review NES's compliance with the Exchange's rules through
FINRA's examination program.\73\ Pursuant to the
[[Page 56638]]
FINRA RSA, however, PHLX retains ultimate responsibility for enforcing
its rules with respect to NES.
---------------------------------------------------------------------------
\73\ The Exchange also states that NES is subject to independent
oversight by FINRA, its Designated Examining Authority, for
compliance with financial responsibility requirements. See Notice,
supra note 3, 75 FR at 43605.
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Second, FINRA and the Exchange \74\ will monitor NES for
compliance with the Exchange's trading rules, and will collect and
maintain certain related information.\75\
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\74\ The Exchange represents that personnel performing real-time
oversight of equity trading on Nasdaq will also perform similar
functions with respect to PSX pursuant to the Intercompany RSA,
under the direction, authority, and oversight of PHLX's Chief
Regulatory Officer (``CRO'') and the Regulatory Oversight Committee
(``ROC'') of its Board of Governors.
\75\ The Exchange represents that both FINRA and the Exchange
will collect and maintain all alerts, complaints, investigations and
enforcement actions in which NES (in its capacity as a facility of
Nasdaq routing orders to the PSX) is identified as a participant
that has potentially violated applicable Commission or Exchange
rules. The Exchange and FINRA will retain these records in an easily
accessible manner in order to facilitate any potential review
conducted by the Commission's Office of Compliance Inspections and
Examinations. See Notice, supra note 3, 75 FR at 43605.
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Third, the Exchange states that FINRA will provide a
report to the Exchange's CRO, on at least a quarterly basis, that: (i)
Quantifies all alerts (of which the Exchange and FINRA are aware) that
identify NES as a participant that has potentially violated Commission
or Exchange rules, and (ii) quantifies the number of all investigations
that identify NES as a participant that has potentially violated
Commission or Exchange rules.\76\
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\76\ See id.
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Fourth, the Exchange proposes Rule 985(c)(2), which will
require NASDAQ OMX, as the holding company owning both the Exchange and
NES, to establish and maintain procedures and internal controls
reasonably designed to ensure that NES does not develop or implement
changes to its system, based on non-public information regarding
planned changes to the Exchange's systems obtained as a result of its
affiliation with the Exchange, until such information is available
generally to similarly situated Exchange members, in connection with
the provision of inbound order routing to the Exchange.\77\
---------------------------------------------------------------------------
\77\ See proposed PHLX Rule 985(c)(2); Notice, supra note 3, 75
FR at 43605.
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Fifth, the Exchange proposes that routing of orders from
NES to the Exchange, in NES's capacity as a facility of Nasdaq, be
authorized for a pilot period of one year.\78\
---------------------------------------------------------------------------
\78\ See Amendment No. 1, supra note 4. In Amendment No. 1, the
Exchange clarified that its proposal, as opposed to Nasdaq's
corresponding proposal, be approved on a one year pilot basis.
---------------------------------------------------------------------------
The operation of NES as a facility of Nasdaq providing outbound
routing services from that exchange will be subject to Nasdaq
oversight, as well as Commission oversight. Nasdaq will be responsible
for ensuring that NES's outbound routing function is operated
consistent with Section 6 of the Act and Nasdaq rules. In addition,
Nasdaq must file with the Commission rule changes and fees relating to
NES's outbound routing function.
In the past, the Commission has expressed concern that the
affiliation of an exchange with one of its members raises potential
conflicts of interest, and the potential for unfair competitive
advantage.\79\ Although the Commission continues to be concerned about
potential unfair competition and conflicts of interest between an
exchange's self-regulatory obligations and its commercial interest when
the exchange is affiliated with one of its members, for the reasons
discussed below, the Commission believes that it is consistent with the
Act to permit NES to provide inbound routing to the Exchange on a pilot
basis, subject to the conditions described above.
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\79\ See, e.g., Securities Exchange Act Release Nos. 54170 (July
18, 2006), 71 FR 42149 (July 25, 2006) (SR-NASDAQ-2006-006) (order
approving Nasdaq's proposal to adopt Nasdaq Rule 2140, restricting
affiliations between Nasdaq and its members); 53382 (February 27,
2006), 71 FR 11251 (March 6, 2006) (SR-NYSE-2005-77) (order
approving the combination of the New York Stock Exchange, Inc. and
Archipelago Holdings, Inc.); and 58673 (September 29, 2008), 73 FR
57707 (October 8, 2008) (SR-Amex-2008-62) (order approving the
combination of NYSE Euronext and the American Stock Exchange LLC).
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The Exchange has proposed five conditions applicable to NES's
routing activities, which are enumerated above. The Commission believes
that these conditions mitigate its concerns about potential conflicts
of interest and unfair competitive advantage. In particular, the
Commission believes that FINRA's oversight of NES,\80\ combined with
FINRA's monitoring of NES's compliance with the equity trading rules
and quarterly reporting to the Exchange's CRO, will help to protect the
independence of the Exchange's regulatory responsibilities with respect
to NES. The Commission also believes that the proposed addition of Rule
985(c) is designed to ensure that NES cannot use any information
advantage it may have because of its affiliation with the Exchange.
Furthermore, the Commission believes that the Exchange's proposal to
allow NES to route orders inbound to the Exchange from Nasdaq, on a
pilot basis, will provide the Exchange and the Commission an
opportunity to assess the impact of any conflicts of interest of
allowing an affiliated member of the Exchange to route orders inbound
to the Exchange and whether such affiliation provides an unfair
competitive advantage. The Commission notes that it previously approved
inbound routing by NES to an affiliate under substantially similar
conditions.\81\
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\80\ This oversight will be accomplished through the 17d-2
Agreement between FINRA and the FINRA RSA.
\81\ See Securities Exchange Act Release No. 59154 (December 23,
2008), 73 FR 80468, (December 31, 2008) (SR-BSE-2008-48) (``BX
Equities Market Approval Order'').
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C. Listing Standards/Unlisted Trading Privileges
The Exchange has represented that it will not resume its listings
business, and instead will trade all NMS stocks on the System pursuant
to unlisted trading privileges (``UTP''), consistent with Section 12(f)
of the Act \82\ and Rule 12f-5 thereunder.\83\ Rule 12f-5 requires an
exchange that extends unlisted trading privileges to securities to have
in effect a rule or rules providing for transactions in the class or
type of security to which the exchange extends unlisted trading
privileges.\84\
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\82\ 15 U.S.C. 78l(f).
\83\ 17 CFR 240.12f-5. See Notice, supra note 3, 75 FR at 43599.
\84\ 17 CFR 240.12f-5. See also Securities Exchange Act Release
No. 35737 (April 21, 1995), 60 FR 20891 (April 28, 1995) (adopting
Rule 12f-5).
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In connection with its proposal to trade NMS stocks \85\ on PSX on
an unlisted trading privileges basis, the Exchange proposes several
amendments to PHLX Rule 803, including amending PHLX Rule 803(o)
(Unlisted Trading Privileges) to, among other things, (1) clearly state
that the Exchange will not list any securities, and that any provisions
of PHLX Rules 800 through 868 that permit listing of securities will
not be effective until the Exchange amends its rules to make any
changes needed to comply with Rule 10A-3 under the Act \86\ and to
incorporate additional qualitative listing standards, and (2) enhance
the listing requirements for new derivative securities products (as
defined in Rule 19b-4(e) under the Act \87\) trading on the Exchange.
In addition, the Exchange proposes to adopt new listing standards for
securities linked to the performance of
[[Page 56639]]
indexes and commodities (including currencies) and managed fund shares,
to allow such securities to trade on PSX pursuant to unlisted trading
privileges.\88\ The Exchange also proposes PHLX Rule 3230 to establish
additional rules to govern trading of Commodity-Related Securities on
PSX pursuant to unlisted trading privileges, including a requirement
that members provide all purchasers of a newly issued Commodity-Related
Securities with a prospectus.
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\85\ Proposed PHLX Rule 803(o) defines ``NMS Stocks'' for
purposes of the rule as having the meaning given such term by Rule
600 under Regulation NMS, including, but not limited to, common
stock, preferred stock and similar issues, shares or certificates of
beneficial interest of trusts, notes, limited partnership interests,
warrants, certificates of deposit for common stock, convertible debt
securities, American Depositary Receipts, contingent value rights,
Trust Shares, Trust Issued Receipts, Index Fund Shares, Equity
Index-Linked Securities, Commodity-Linked Securities, Equity-Linked
Notes, and Managed Fund Shares.
\86\ 17 CFR 240.10A-3.
\87\ 17 CFR 240.19b-4(e)
\88\ See proposed PHLX Rules 803(m) and (n). As with other
standards, PHLX represented that it will not list these securities
until the filing and approval of a proposed rule change to authorize
such listing. In connection with adopting these new standards, the
Exchange also proposed to (1) delete current PHLX Rules 803(m) and
(n), which contain listing standards for products that are covered
by the new listing standards and (2) amend PHLX Rule 803(f) (Other
Securities) to adopt continued listing requirement provisions that
are complementary to the new standards for securities linked to
commodities.
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The Commission finds that these rules are consistent with the Act.
The Commission notes that the Exchange will not list any securities for
trading on PSX until it amends its rules to make any changes needed to
comply with Rule 10A-3 under the Act \89\ and to incorporate additional
qualitative listing standards. The Commission also notes that these
rules are similar to the rules of other Exchanges.\90\
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\89\ 17 CFR 240.10A-3.
\90\ As proposed to be amended, the requirements of PHLX Rule
803(o) are substantially similar to the requirements set forth in
Rule 14.1 (Unlisted Trading Privileges) of EDGX Exchange, Inc.
(``Direct Edge''). Proposed PHLX Rule 3230 substantially mirrors the
requirements of Nasdaq Rule 4630 (Trading in Commodity-Related
Securities). Proposed Rules 803(m) and (n) are substantially similar
to those set forth in Nasdaq Rules 5710 (Securities Linked to
Performance of Indexes and Commodities (Including Currencies)) and
5735 (Managed Fund Shares).
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D. Regulation of the Exchange and its Members
As a facility of the Exchange, PSX will be subject to the
Exchange's SRO functions and the Exchange will have regulatory
responsibility for the activities of the System. Notwithstanding the
delegation of such responsibilities via contract, the Exchange retains
ultimate legal responsibility for the regulation of its members and its
market activities, including activities on PSX.
1. Disciplinary Rules
Trading on PSX is subject to the Exchange's disciplinary rules set
forth in PHLX Rules 960.1 through 960.12.\91\ Such rules provide the
Exchange with disciplinary jurisdiction over its members so that it can
enforce members' compliance with its rules and the Act and the rules
and regulations thereunder. The Exchange's rules also permit it to
sanction members for violations of its rules and violations of the Act
by, among other things, expelling or suspending members, limiting or
terminating members' activities, functions, or operations, fining or
censuring members, or suspending or barring a person from being
associated with a member.\92\
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\91\ See proposed PHLX Rule 3202.
\92\ See PHLX Rule 960.10 and proposed PHLX Rule 3221.
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2. Order Audit Trail System
PHLX proposes rules requiring FINRA members trading on PSX to
comply with FINRA's Order Audit Trail System (``OATS'')
requirements,\93\ which rules are substantially similar to Nasdaq Rules
Series 6950 (``Order Audit Trail System).\94\ Like Nasdaq, OATS data
will be used by PHLX for regulatory purposes only.\95\
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\93\ See proposed PHLX Rule 3400 Series.
\94\ As is the case for Nasdaq members under the Nasdaq rules,
PHLX members that are not FINRA members must compile and maintain
audit trail information for securities listed on Nasdaq, but are
required to transmit this information to FINRA only if requested.
See proposed PHLX Rule 3405. If PHLX resumes operations as a listing
market in the future, all members will be required to maintain audit
trail information for securities listed on PHLX, and to transmit the
information to FINRA upon request, but daily OATS reporting for such
securities would not be required. Id.
\95\ See Securities Exchange Act Release No. 53128 (January 13,
2006); 71 FR 3350 (January 23, 2006) (File No. 10-131).
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3. Trading Halts; Clearly Erroneous Transactions
PSX's proposed rule relating to trading halts is substantially
similar to Nasdaq Rule 4120 (Trading Halts), except that the PSX rule
includes only those provisions relevant to securities traded on an
unlisted trading privileges basis.\96\ Proposed PHLX Rule 3100 provides
that PSX will participate in the circuit breaker pilot program for
stocks included in the S&P 500[supreg] Index, which ends on December
10, 2010.\97\ Current PHLX Rule 133 (Trading Halts Due to Extraordinary
Market Volatility) will also apply to trading on PSX.\98\
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\96\ See proposed PHLX Rule 3100.
\97\ See proposed PHLX Rule 3100(a)(4). See also Securities
Exchange Act Release No. 62252 (June 10, 2010), 75 FR 34186 (June
16, 2010) (order approving rules relating to the circuit breaker
pilot program adopted by other national securities exchanges).
Nasdaq and the other equities exchanges have proposed to expand the
circuit breaker pilot program to include securities in the Russell
1000 Index and certain exchange traded products. See, e.g.,
Securities Exchange Act Release Nos. 62414 (June 30, 2010), 75 FR
39081 (July 7, 2010) and 62415 (June 30, 2010), 75 FR 39086 (July 7,
2010). The Exchange has represented that it will promptly submit a
proposed rule change in accordance with Section 19(b) of the Act and
Rule 19b-4(f)(6) thereunder to adopt corresponding changes to the
rules governing PSX if and when the Commission approves the
corresponding Nasdaq rule. See Letter from John Yetter, Vice
President and Deputy General Counsel, The NASDAQ OMX Group, to David
Shillman, Associate Director, Division of Trading and Markets,
Commission, dated September 8, 2010 (``Yetter Letter'').
\98\ See proposed PHLX Rule 3202.
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PHLX has proposed a rule which is substantially similar to Nasdaq
Rule 11890 (Clearly Erroneous Transactions) to govern the breaking of
clearly erroneous transactions.\99\ Appeals from determinations
regarding trades made by PHLX staff will be made to a committee of
industry and non-industry experts established under the PHLX By-Laws,
which committee is subject to identical compositional requirements
\100\ as NASDAQ's Market Operations Review Committee, which performs a
comparable function under NASDAQ rules.\101\
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\99\ See proposed PHLX Rule 3312. As a result of precipitous
declines in the prices of certain securities on May 6, 2010,
however, the Commission and the national securities exchanges are
currently evaluating the advisability of further changes to clearly
erroneous rules. As a result of this evaluation, Nasdaq and the
other equities exchanges have proposed to amend their clearly
erroneous execution rules to set forth clearer standards and curtail
their discretion with respect to breaking erroneous trades. See,
e.g., Securities Exchange Act Release Nos. 62334 (June 21, 2010), 75
FR 36732 (June 28, 2010) and 62342 (June 21, 2010), 75 FR 36752
(June 28, 2010). The Exchange has represented that it will promptly
file a proposed rule change to amend its clearly erroneous rule in a
manner consistent with Nasdaq's clearly erroneous rule, in
accordance with Section 19(b) of the Act and Rule 19b-4(f)(6)
thereunder, if and when the Commission approves the corresponding
Nasdaq rule. See Yetter Letter, supra note 97.
\100\ See Section 10-10 of the PHLX By-Laws, which requires that
20% of the members of the committee represent PHLX members, and
prohibits more than 50% of the committee's members from being
employed by firms that are market makers or that derive more than
10% of their revenues from market making.
\101\ By-Laws of Nasdaq, Article III, Section 6.
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The Commission finds that the Exchange's proposed rules relating to
the regulation of PSX and its members are consistent with the
requirements of the Act. The Commission notes that the proposed rules
relating to the regulation of PSX are substantially similar to rules of
Nasdaq previously approved by the Commission.\102\ In addition, the
disciplinary rules applicable to PSX are set forth in the current rules
of the Exchange, which have been previously approved by the Commission.
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\102\ See Nasdaq Registration Approval Order, supra note 22.
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4. Regulatory Contracts
The Exchange represents that it is a party to two regulatory
services agreements (the ``Regulatory Contracts'').\103\ Pursuant to
the FINRA
[[Page 56640]]
RSA, FINRA will provide a range of regulatory services to the Exchange
and its facilities, including PSX, including T+1 surveillance,
investigation, and enforcement with respect to the Exchange's rules,
arbitration services, and membership services.\104\ Under the FINRA
RSA, FINRA will conduct T+1 market surveillance and examine members to
monitor compliance with applicable PHLX rules and securities laws and
regulations.\105\ The Intercompany RSA provides that employees and
contractors of each party may perform regulatory services for the
Exchange.\106\ All regulatory services performed for the Exchange under
the Intercompany RSA, including those performed with respect to the
System, are subject to the direction, authority, and oversight of the
Exchange's CRO and the ROC, and all personnel performing services for
the Exchange under the Intercompany RSA are subject to the
jurisdiction, authority and oversight of the Exchange's CRO and
ROC.\107\ The Exchange represents that any personnel performing real-
time oversight of equity trading on Nasdaq will also perform similar
functions with respect to PSX, under the direction, authority, and
oversight of the Exchange's CRO and the ROC.\108\ The Exchange
represents that the Exchange retains ultimate legal responsibility for,
and control of, functions performed for PHLX under the Regulatory
Contracts.\109\
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\103\ See Notice, supra note 3, 75 FR at 43604.
\104\ Id.
\105\ Id.
\106\ Id.
\107\ Id.
\108\ Id.
\109\ Id.
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The Exchange has represented that many aspects of compliance with
PSX rules, such as avoidance of locked and crossed markets and trade
throughs, will be enforced by the System itself, and the Exchange will
periodically test operations of PSX to determine that the System is
operating
