[Federal Register Volume 76, Number 4 (Thursday, January 6, 2011)]
[Notices]
[Pages 814-817]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-33365]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-63627; File No. SR-Phlx-2010-153]


Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Order 
Approving a Proposed Rule Change To Update and Streamline the Process 
for Specialist Evaluations and Clarify the Time Within Which SQTs and 
RSQTs Must Begin To Electronically Quote After Assignment

December 30, 2010.

I. Introduction

    On November 5, 2010, the NASDAQ OMX PHLX LLC (``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 update and streamline the process for 
specialist evaluations and clarify the time within which Streaming 
Quote Traders (``SQTs'') and Remote Streaming Quote Traders (``RSQTs'') 
must begin to electronically quote after assignment. The proposed rule 
change was published for comment in the Federal Register on November 
17, 2010.\3\ The Commission received no comment letters regarding the 
proposal. This order approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 63305 (November 10, 
2010), 75 FR 70331 (``Notice'').
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II. Description of the Proposal

    The purpose of the proposed rule change is to amend Phlx By-Law 
Article XI Section 11-1; Rules 507, 508, 510, 511, and 515; and OFPA C-
8 to revise the process the Exchange will use to assess specialist 
performance, as well as to ensure timely electronic quotations by SQTs 
and RSQTs and the ability of the Exchange to control allocation 
transfers.
    Rules 500 through 599 (the ``Allocation and Assignment Rules'') 
generally describe the process for: application for becoming and 
appointment of specialists; allocation of classes of options to 
specialist units and individual specialists; \4\ application for 
becoming and approval of SQTs \5\ and RSQT \6\ (collectively, the 
``Streaming Quote Traders'') \7\ and assignment of options to them; and 
performance evaluations for specialist units and SQTs. The Allocation 
and Assignment Rules also indicate, among other things, under what 
circumstances new specialist allocations and Streaming Quote Trader 
assignments may not be made.
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    \4\ A specialist unit may have one or more individual 
specialists. See proposed Supplementary Material .05 to Rule 511.
    \5\ An SQT is a Registered Options Trader (``ROT'') who has 
received permission from the Exchange to generate and submit option 
quotations electronically in options to which such SQT is assigned. 
An SQT may only submit such quotations while such SQT is physically 
present on the floor of the Exchange. See Rule 1014(b)(ii)(A).
    \6\ An RSQT is an ROT that is a member or member organization 
with no physical trading floor presence who has received permission 
from the Exchange to generate and submit option quotations 
electronically in options to which such RSQT has been assigned. An 
RSQT may only submit such quotations electronically from off the 
floor of the Exchange. See Rule 1014(b)(ii)(B).
    \7\ SQTs also include Directed SQTs (``DSQTs'') and Directed 
RSQTs (``DRSQTs''), which are SQTs and RSQTs that receive a Directed 
Order. Exchange Rule 1080(l)(i)(A) defines Directed Order.
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    Rules 511 and 515 deal with specialist evaluations and certain 
allocation procedures. Currently, Rule 511

[[Page 815]]

indicates, among other things, that specialist performance evaluations 
may be used to inform Exchange decisions regarding allocating new 
options classes, reallocating options classes for substandard 
performance, determining whether a specialist that has been transferred 
an options class is performing adequately, and determining whether a 
staff reorganization or material change with respect to a specialist 
unit has affected the ability of the unit to continue to perform 
adequately in order to retain allocated securities. Rule 511 also 
discusses the process and timing for doing routine and special (cause) 
evaluations and reviews.
    Currently, Rule 515 discusses specialist performance evaluations 
for options specialists and indicates, among other things, the timing 
and frequency of evaluations. The criterion to evaluate specialists may 
include, but is not limited to, quality of markets, observance of 
ethical standards, administrative responsibilities, and trade 
correction and exemptive relief data. Rule 515, as well as OFPA C-8, 
also discusses the use of floor broker questionnaires in the specialist 
evaluation process, which asks floor brokers their opinions of 
specialist performance.\8\
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    \8\ The Exchange currently presumes that a specialist unit 
performed below minimum standards if the specialist unit was rated 
in the bottom 10% of all units in the aggregate results for all 
questionnaires.
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    The Exchange now proposes to consolidate Rules 511 and 515 into a 
combined Rule 511 and to adopt for specialist units \9\ an objective 
review process that is similar to the process currently in use for 
Streaming Quote Traders per current Rule 510. The Exchange also 
proposes to relocate portions of the existing evaluation process from 
Rule 515 into Rule 511. As such, there would be two types of specialist 
evaluations or reviews per revised Rule 511: (i) Routine Specialist 
Performance Evaluations, which would be conducted on at least an annual 
basis, and would take into account any Minimum Performance Reviews 
conducted by the Exchange; and (ii) Special Circumstance Evaluations, 
which may be conducted on an ad hoc basis.
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    \9\ Proposed Supplementary Material .05 to Rule 511 states that 
reference to specialist unit within Rule 511 means the unit as a 
whole or any subpart of its operation that is acting in a specialist 
capacity on the Exchange and is subject to evaluation; and that a 
specialist unit may have one or more individual specialists. As 
such, individual specialist actions may be attributable to relevant 
specialist units in respect of matters discussed in this proposal 
such as evaluations. The proposed language in Rule 511 was moved 
from Rule 515 and updated to reflect current usage.
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    Further, the Exchange proposes changes to Rule 511 so that 
specialist suspension, termination, or restriction of allocations in 
one or more options may occur after two or more consecutive sub-
standard Minimum Performance Reviews or after Special Circumstance 
Evaluations and after written notice. As discussed below, following 
substandard minimum performance, a specialist unit may have an 
opportunity for an informal meeting with Exchange staff. Moreover, the 
proposed rules provide the circumstances under which a specialist or 
specialist unit \10\ may appeal, after filing a written notice of 
appeal with the Exchange, from a decision of the Exchange following a 
Minimum Performance Review or a Special Circumstance Evaluation in 
accordance with Exchange By-Law Article XI, Section 11-1.\11\
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    \10\ In proposed Rule 511(d) and Rule 511(e), a specialist has 
the right to request an appeal on behalf of his specialist unit.
    \11\ By-Law Article XI Section 11-1(c) states that an appeal 
shall be heard by a special committee of the Board of Governors 
composed of three (3) Governors, of whom at least one (1) shall be 
an Independent Governor. The person requesting review may appeal by 
filing a written notice thereof with the Secretary of the Exchange 
within ten (10) days after a decision. The person requesting review 
shall be permitted to submit a written statement to and/or appear 
before this special committee. The Secretary of the Exchange shall 
certify the record of the proceeding, if any and the written 
decision and shall submit these documents to the special committee. 
The special committee's review of the action shall be based solely 
on the record, the written decision and any statement submitted by 
the person requesting the review. The special committee shall 
prepare and deliver to such person a written decision and reasons 
therefor. If the special committee affirms the action, the action 
shall become effective ten (10) days from the date of the special 
committee's decision. There shall be no appeal to the Board of 
Governors from any decision of the special committee.
    The Exchange is correcting a reference in By-Law Article XI 
Section 11-1(c) from Rule 511(e) to Rule 511(d) or (e), in light of 
the internal numbering changes proposed in Rule 511; and cross-
referencing Rule 507, which notes the availability of the appeal 
process.
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Routine Specialist Performance Evaluations

    Routine Specialist Performance Evaluations pursuant to proposed 
Rule 511(c) would be conducted at annual (or more frequent) intervals 
to determine whether specialists have fulfilled performance standards 
that may include, but are not limited to, trade correction data, 
exemptive relief data, quality of markets data, proper execution of 
duties as a specialist unit, competition among market makers and in 
representing the Exchange as specialist unit, observance of ethical 
standards, and administrative factors. The Exchange also may consider, 
when doing routine evaluations, any other relevant information 
including, but not limited to, trading data, regulatory history, the 
number of requests for quote spread parameter relief, how a specialist 
unit optimizes the submission of quotes through the Specialized Quote 
Feed as defined in Rule 1080 by evaluating the number of individual 
quotes per quote block received by the Exchange, and such other factors 
and data as may be pertinent in the circumstances.
    The Exchange also proposes to establish new minimum performance 
standards for specialist units.\12\ Specifically, new Rule 511(d) 
proposes minimum acceptable performance standards for specialist units 
using the following criteria: (i) The percentage of time that the 
specialist unit represents or exceeds the Phlx Best Bid or Offer 
(``PBBO'') in the options allocated to the unit \13\ and (ii) quoting 
requirements of specialist units pursuant to Rule 1014.\14\ If the 
percentage of the total time that the options allocated to a specialist 
unit represent or exceed the PBBO is in the lowest quartile of all 
specialist units for two or more consecutive months, this may be 
considered sub-standard performance, that is, performance that does not 
attain minimum performance standards. If a specialist unit fails to 
meet the quoting requirements as prescribed by Rule 1014, this may be 
considered sub-standard performance.
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    \12\ For consistency, the Exchange proposes appeal language in 
Rules 510 and 511 that is similar, in relevant part, to that of Rule 
507: An appeal to the Board of Governors from a decision of the 
Exchange * * * may be requested * * * by filing with the Secretary 
of the Exchange written notice of appeal within ten (10) days after 
the decision has been rendered, in accordance with Exchange By-Law 
Article XI, Section 11-1.
    \13\ In that the Exchange would specifically establish a measure 
of specialist performance on Phlx, the Exchange would change the 
requirement to PBBO from NBBO (National Best Bid or Offer). A 
reference in Commentary .01 of Rule 510 would similarly be changed 
to PBBO for the sake of conformity.
    \14\ This rule change proposal would make no changes to current 
quoting requirements for specialists delineated in Rule 1014.
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    The Exchange proposes a process that would allow a specialist to 
meet with Exchange staff regarding alleged sub-standard performance. 
Specifically, the Exchange proposes in new Rule 511(d)(ii) that if the 
Exchange finds that a specialist unit failed to meet Minimum 
Performance Standards, it would provide written notice to the unit. 
Pursuant to new Rule 511(d)(iii), the specialist unit may request and 
the Exchange may hold an informal meeting with the head specialist and 
any other appropriate specialist of the specialist unit to discuss the 
failure to meet

[[Page 816]]

minimum standards and to explore possible remedies. The Exchange would 
give notice of the meeting and no verbatim record would be kept. If, 
after receiving such notice from the Exchange, the specialist unit 
refuses or otherwise fails without reasonable justification to meet 
with the Exchange, the Exchange may refer the matter to the Exchange's 
Business Conduct Committee for the commencement of formal disciplinary 
proceedings. If the Exchange believes there are no mitigating 
circumstances that would demonstrate substantial improvement of or 
reasonable justification for the failure to meet minimum standards, the 
Exchange could take remedial action pursuant to Rule 511(d)(ii).
    The Exchange proposes in Rule 511(d)(ii) that if it finds sub-
standard minimum performance by a specialist unit, the Exchange may 
take the following remedial actions: (i) Restriction of allocations in 
additional options (subsection (d)(ii)(A)); (ii) suspension, 
termination, or restriction of allocations in one or more options 
(subsection (d)(ii)(B)); or (iii) suspension, termination, or 
restriction of the specialist or specialist unit's registration in 
general (subsection (d)(ii)(C)). Specialist units or specialists 
therein may appeal to the Board of Governors from a decision of the 
Exchange pursuant to subsection (d)(ii)(B) or subsection (d)(ii)(C) by 
filing the requisite notice of appeal. Under the proposal, Minimum 
Performance Reviews would be conducted at least annually but may be 
conducted more frequently, including at monthly intervals.
    The Exchange also proposes to eliminate the floor broker 
questionnaire. The Exchange believes that the questionnaire, which is 
subjective in nature and not based on data, provides limited value in 
the Exchange's current specialist review process. Instead, the Exchange 
believes that the proposed revised specialist performance evaluations 
it now proposes will better inform the evaluation process and make it 
increasingly data-based, thereby rendering the floor broker 
questionnaires unnecessary.

Special Circumstance Evaluations

    Under the proposal, the Exchange may also, but is not required to, 
conduct Special Circumstance Evaluations pursuant to proposed Rule 
511(e) whenever the Exchange believes that circumstances warrant such 
reviews. For example, a Special Circumstance Evaluation may be 
conducted if a specialist unit's performance appeared to be so 
deficient as to call into question the Exchange's integrity or impair 
the Exchange's reputation for maintaining efficient, fair and orderly 
markets. Special Circumstance Evaluations also may be conducted within 
six months of new allocations \15\ and within four months of transfers 
of allocations to specialist units.\16\ Special Circumstance 
Evaluations may incorporate the same review methodology and procedures 
as established for routine Specialist Performance Evaluations or 
Minimum Performance Reviews. However, Special Circumstance Evaluations 
may instead (or in addition) examine such other matters related to a 
specialist unit's performance as the Exchange deems necessary and 
appropriate.
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    \15\ For purposes of conformity with the proposed six month 
period, 90 days would be changed to 180 days (six months) in Rule 
511(b).
    \16\ While Special Circumstance Evaluations are optional during 
the noted four month and six month periods, the Exchange also may 
conduct separate Minimum Performance Reviews during that period.
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    The Exchange may determine, pursuant to a Rule 511 Special 
Circumstance Evaluation, that a specialist unit that received a new 
allocation has not complied with the commitments that it made when 
applying for the options class, including, but not limited to, 
commitments regarding capital, personnel and order flow (subsection 
(e)(i)(A)) or that the performance of a specialist unit was inadequate 
after the transfer of one or more options classes or when there has 
been a material change in the specialist unit (subsection (e)(i)(B)). 
After the Exchange indicates to the applicable specialist unit why its 
performance is inadequate, the specialist unit would be afforded thirty 
days in which to improve its performance. If the specialist unit does 
not improve its performance, the Exchange may, after written notice, 
remove and reallocate one or more securities that were allocated to 
such unit. Specialist units and specialists therein may appeal to the 
Board of Governors from a decision of the Exchange pursuant to proposed 
subsection (e)(ii) by filing the requisite notice of appeal.\17\
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    \17\ See supra note 11.
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    Additionally, the proposed rules establish limits on the allocation 
of new options to specialist units that fail to perform adequately. 
Under proposed Rule 511(e)(iii), if a specialist allocation in an 
option is terminated as a result of a Special Circumstance Evaluation, 
the specialist unit may not receive an allocation (or re-allocation) in 
the terminated option or options for a period not to exceed six months. 
Similarly, under proposed Rule 511(d)(v), if an allocation is 
terminated because a specialist exhibits sub-standard performance in 
terms of best bid and offer or in terms of quoting requirements, such 
specialist may not receive an allocation (or re-allocation) in the 
terminated option or options for a period not to exceed six months; and 
if an allocation is terminated because a specialist unit exhibits sub-
standard performance in terms of minimum quoting requirements per Rule 
1014, such specialist unit may not receive an allocation (or re-
allocation) in the terminated option or options for a period not to 
exceed twelve months.
    As discussed, all specialists and specialist units would have the 
right to appeal from an Exchange decision that was taken pursuant to a 
Specialist Evaluation or a Special Circumstance Evaluation. Moreover, 
the Exchange would provide written notice regarding the lack of 
adequate performance and give specialist units an opportunity to 
discuss performance before the Exchange would take remedial action.
    In Rule 510 (regarding SQTs and RSQTs) and Rule 511 (regarding 
specialists), the Exchange proposes to eliminate the right to appeal 
from an Exchange's determination to restrict additional options 
allocations based on failure to meet minimum performance requirements. 
The Exchange believes that a formal appeal process for restriction of 
allocations or assignments in additional (not currently allocated or 
assigned) options, which would require a 10 day notice period followed 
by a potentially lengthy appeals proceeding, is not necessary and may 
be counterproductive in light of the Exchange's desire to efficiently 
allocate or assign additional options on a timely basis.

Assignment in Options

    Rule 507 deals with the process of applying for approval as an SQT 
or RSQT on the Exchange and assignment of options to SQTs and 
RSQTs.\18\ The Exchange proposes to add new Commentary .01 to Rule 507 
to state that within not more than thirty business days after 
assignment of an option pursuant to this rule, an assigned SQTs

[[Page 817]]

or RSQTs shall begin to generate and submit electronic quotations for 
such option through the Exchange's electronic quotation, execution, and 
trading system. Should an assigned SQT or RSQT not generate electronic 
quotes within the requisite time frame, the Exchange would have the 
ability to terminate the assignment in question after providing written 
notice to the assigned SQT or RSQT, and make a re-assignment, unless 
there are exigent circumstances that the Exchange believes may not have 
allowed timely generation and submission of electronic quotes.
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    \18\ Rule 507 also defines the Maximum Number of Quoters 
(``MNQ'') in equity options, which establishes the greatest number 
of SQT and RSQT assignments that the Exchange may make in a 
particular class of option. MNQ in equity options is currently set 
in Commentary .02 to Rule 507 at no more than: (i) Twenty-four 
market participants (SQTs and RSQTs) for equity options in the top 
5% most actively traded options; (ii) nineteen market participants 
for the next 10% most actively traded options; (iii) and seventeen 
market participants for all other options.
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Transfer of Allocated Option Classes

    Rule 508 deals with agreements between specialist units to transfer 
one or more options classes that are already allocated by the Exchange 
to one of such units. Currently, Rule 508 states that failure to 
provide the Exchange with prior notice of an arranged (agreed-upon) 
transfer of one or more already allocated options classes in accordance 
with this rule permits the Exchange to reallocate such options classes. 
Pursuant to the proposed change, Rule 508 would state that failure to 
provide the Exchange prior notice of a transfer in accordance with this 
Rule, or failure to obtain Exchange approval of a transfer, would 
permit the Exchange to recover the allocated securities and reallocate 
them. The Exchange believes that this is appropriate given that the 
Exchange initially makes the allocation of the option class after 
evaluating the relevant factors, and should continue to have a similar 
ability to evaluate the propriety of subsequent transfer of the same 
option class.
    The Exchange proposes to delete Commentary .01 to Rule 508 that 
currently indicates that no member may effect a change in the floor 
trading location of any equity option or index option class until 
forty-five calendar days after final approval of the change by the 
Exchange has been disseminated to the option floor. The Exchange 
believes that the 45-day period is unnecessarily long in light of the 
current fast-paced trading environment. In addition, the Exchange 
proposes technical rule changes to ensure conformity of rule language 
and delete references that are obsolete or no longer in use. The 
reference to Registrant would be changed to specialist or specialist 
unit in Rules 508 and 511, and the reference to ``grant'' would be 
changed to ``allocate'' in Rule 511 for purposes of conformity.\19\ The 
Exchange further proposes to remove the reference to initial 
implementation of the existing rule in Commentary .02 of Rule 510. The 
Exchange also proposes to make conforming changes in Rule 511 in light 
of the changes to Rule 515.
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    \19\ The Exchange notes that this change in terminology conforms 
it to current usage.
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III. Discussion

    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 \20\ and, in 
particular, the requirements of Section 6(b) of the Act \21\ and the 
rules and regulations thereunder. Specifically, the Commission finds 
that the proposal is consistent with Section 6(b)(5) of the Act,\22\ 
which requires, among other things, that the rules of a national 
securities exchange be designed to promote just and equitable 
principles of trade, 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.
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    \20\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \21\ 15 U.S.C. 78f(b).
    \22\ 15 U.S.C. 78f(b)(5).
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    The Commission believes that the Exchange's proposal updates its 
specialist evaluation process to make it more objective and more 
consistent with the process used for other Streaming Quote Traders. 
While the Exchange is changing its process for evaluating specialists, 
it is not proposing any changes to existing specialist obligations, 
including the quoting requirements for specialists delineated in Rule 
1014. Further, though the Exchange would replace the current formal 
appeal and hearing process with a more informal hearing process in the 
context of alleged failure of performance, it would retain an 
opportunity for the specialist or specialist unit to be heard on the 
matter before the Exchange takes remedial action. In addition, the 
Exchange would preserve the requirement to provide advance written 
notice to a specialist or a specialist unit to inform it of its right 
to appeal an Exchange's decision regarding a specialist's failure to 
meet the minimum performance standards. Accordingly, the Commission 
believes the streamlined specialist evaluation procedures are 
reasonable and will allow the Exchange to monitor and review specialist 
performance in the interests of ensuring compliance with all applicable 
requirements.
    Further, the Commission believes that the proposed time requirement 
for a SQT or a RSQT to electronically quote, i.e., within thirty 
business days after assignment, is reasonable. This provision will 
allow the Exchange to ensure that new appointments are utilized 
promptly and would enable the Exchange to, in the absence of exigent 
circumstances, reassign those options after a written notice is 
provided to the previously assigned SQT or RSQT.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\23\ that the proposed rule change (SR-Phlx-2010-153) be, and 
hereby is, approved.
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    \23\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\24\
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    \24\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-33365 Filed 1-5-11; 8:45 am]
BILLING CODE 8011-01-P