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[Federal Register Volume 80, Number 28 (Wednesday, February 11, 2015)]
[Notices]
[Pages 7663-7665]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-02748]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-74210; File No. SR-BOX-2014-28]

 Self-Regulatory Organizations; BOX Options Exchange LLC; Order 
Approving Proposed Rule Change Adopt BOX Rule 7300 To Allow the 
Exchange To Trade Preferenced Orders

February 5, 2015.

I. Introduction

    On December 8, 2014, BOX Options Exchange LLC (``BOX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') a proposed rule change pursuant to Section 
19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 
19b-4 thereunder,\2\ to permit BOX Options Participants 
(``Participants'') to submit orders for which a Market Maker is 
designated to receive an Preferred allocation on the Exchange 
(``Preferenced Orders''). The proposed rule change was published in the 
Federal Register on December 24, 2014.\3\ 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. 73878 (December 18, 
2014), 79 FR 77579 (``Notice'').
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II. Description of the Proposed Rule Change

    As described in more detail below, the Exchange proposes to adopt 
new BOX Rule 7300 to establish a program that will permit Participants 
to submit Preferenced Orders to Market Makers and for Maker Makers to 
receive Preferred allocations on such orders.\4\ As proposed, a 
Preferenced Order is any order, whether on a single options instrument 
or on a Complex Order Strategy, for which a Preferred Market Maker is 
designated with respect to such order, upon submission of such order to 
BOX.\5\ A Preferred Market Maker is a Market Maker designated as such 
by a Participant with respect to an order submitted by such Participant 
to BOX.\6\
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    \4\ See Notice, supra note 3 at 77579.
    \5\ Proposed BOX Rule 7300(a)(1).
    \6\ Proposed BOX Rule 7300(a)(2).
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    All order types and designations available on BOX will be eligible 
to be entered as Preferenced Orders, except for Customer Cross Orders 
(which do not involve market makers) and Directed Orders (which relate 
to BOX's PIP and COPIP matching algorithms).\7\

[[Page 7664]]

Preferenced Orders will be treated the same as other orders submitted 
to the Exchange, including being executed in price/time priority in 
accordance with the existing matching algorithm on the Exchange,\8\ 
with some exceptions as described below and in proposed Rule 7300.\9\ 
Although Complex Orders may be submitted as Preferenced Orders, such 
orders will be given the same treatment as Complex Orders submitted 
without designation.\10\
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    \7\ Proposed BOX Rule 7300(d).
    \8\ See Notice, supra note 3 at 77579.
    \9\ Proposed BOX Rule 7300(b).
    \10\ See Notice, supra note 3 at 77581.
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    Proposed BOX Rule 7300(c)(2) requires that a Preferred Market Maker 
maintain a continuous two-sided market, pursuant to BOX Rule 
8050(c)(1), throughout the trading day, in options classes for which it 
accepts Preferenced Orders, for 99% of the time the Exchange is open 
for trading in each such option class.\11\ However, a Preferred Market 
Maker will not be required to quote in intra-day add-on series or 
series that have an expiration of nine months or greater in the classes 
for which it receives Preferenced Orders.\12\
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    \11\ Proposed BOX Rule 7300(a)(2).
    \12\ Id. Compliance with this requirement will be determined on 
a monthly basis, however, this does not relieve a Preferred Market 
Maker from meeting the quoting requirement on a daily basis, nor 
does it prohibit the Exchange from taking disciplinary action 
against a Preferred Market Maker for failing to meet this 
requirement each trading day. The Exchange will determine compliance 
with these obligations on a monthly basis. Id.
    If a technical failure or limitation of a system of the Exchange 
prevents a Market Maker from maintaining, or prevents a Market Maker 
from communicating to the Exchange, timely and accurate electronic 
quotes in an issue, the duration of such failure shall not be 
considered in determining whether the Market Maker has satisfied its 
quoting obligation. The Exchange may consider other exceptions to 
this obligation based on a demonstrated legal or regulatory 
requirement or other mitigating circumstances. Id.
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Preferred Allocation

    Pursuant to proposed BOX Rule 7300(c), when the total quantity of 
all orders available for execution on the Exchange against a 
Preferenced Order on a single options series is less than or equal to 
the executable quantity of the Preferenced Order at a given price 
level, all such orders at that price will be filled and the balance of 
the Preferenced Order, if any, will be executed, if possible, against 
orders at the next best price level.\13\ At the final price level, 
where the remaining quantity of the Preferenced Order is less than the 
total quantity of orders on the Exchange available for execution, and 
after all Public Customer orders have been filled, the Preferred Market 
Maker will receive a Preferred allocation set forth below, provided 
that: (1) The price level is at the NBBO, (2) the Preferred Market 
Maker has an existing quote on the opposite side of the Preferenced 
Order that is at the NBBO at the time the Preferenced Order is 
received, and (3) the Preferred Market Maker would not receive an 
allocation greater than 40% if allocated according to the Exchange's 
normal price/time priority.\14\
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    \13\ Proposed BOX Rule 7300(c).
    \14\ Proposed BOX Rule 7300(c)(2).
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    The Preferred allocation will be limited by the total quantity of 
the Preferred Market Maker's quote and will be 40% of the remaining 
quantity of the Preferenced Order after all Public Customer orders are 
filled, or 50% of the remaining quantity if only one other executable, 
non-Public Customer order matches the Preferenced Order at the final 
price level.\15\ Under the Exchange's proposal, Legging Orders will not 
be considered when determining whether the Preferred Market Maker 
receives its 40% or 50% allocation.\16\
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    \15\ Proposed BOX Rule 7300(c)(2); See Notice, supra note 3 at 
77580.
    \16\ Proposed BOX Rule 7300(c)(2).
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    Once the Preferenced Order is allocated to the Preferred Market 
Maker, or if no Preferred Allocation is made, BOX will distribute any 
remaining unallocated quantity of the Preferenced Order to all 
remaining orders and quotes, not including any Legging Order, that have 
not already received an allocation.\17\ This includes any quote by a 
Preferred Market Maker if no Preferred allocation was previously made. 
Allocations will be made in order of time priority. Following the 
allocation of all remaining order and quotes described above, any 
remaining unallocated quantity of the Preferenced Order will be 
allocated to any Legging Order at the same price.\18\
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    \17\ Proposed BOX Rule 7300(c)(3).
    \18\ Proposed BOX Rule 7300(c)(4).
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III. Discussion and Commission Findings

    The Commission has carefully reviewed the proposed rule change and 
finds that the proposed rule change is consistent with the Act and the 
rules and regulations thereunder applicable to a national securities 
exchange.\19\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 6(b) of the Act,\20\ in general, 
and furthers the objectives of Section 6(b)(5) of the Act.\21\ Section 
6(b)(5) requires, among other things, that the rules of the 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 
facilitating transactions in securities, and to remove impediments to 
and perfect the mechanism of a free and open market and a national 
market system.
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    \19\ 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).
    \20\ 15 U.S.C. 78f(b).
    \21\ 15 U.S.C. 78f(b)(5).
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    The Commission has previously approved rules of other national 
securities exchanges that provide for enhanced participation 
guarantees.\22\ The Commission has closely scrutinized such exchange 
rule proposals where the percentage of enhanced participation would 
rise to a level that could have a material adverse impact on quote 
competition within a particular exchange.\23\
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    \22\ See Securities Exchange Act Release No. 51759 (May 27, 
2005), 70 FR 32860 (June 6, 2005) (SR-Phlx-2004-91) (``Phlx 
Order''); see also e.g., Securities Exchange Act Release Nos. 47628 
(April 3, 2003), 68 FR 17697 (April 10, 2003) (SR-CBOE-00-55) 
(``CBOE Order''); 52331 (August 24, 2005), 70 FR 51856 (August 31, 
2005) (SR-ISE-2004-16) (``ISE Order''); 52506 (September 23, 2005), 
70 FR 57340 (September 30, 2005) (SR-CBOE-2005-58); 59472 (February 
27, 2009) 74 FR 9843 (March 6, 2009) (SRNYSEALTR-2008-14)(``NYSEALTR 
Order''); 60469 (August 10, 2009), 74 FR 41478 (August 17, 2009)(SR-
NYSEArca-2009-73) (``NYSE Arca Notice''); 68070 (October 18, 2012), 
77 FR 65037 (October 18, 2012) (SR-C2-2012-24) (``C2 Order''); and 
74129 (January 23, 2015), 80 FR 4954 (January 29, 2015) (``BX 
Order'').
    \23\ See Phlx Order, supra note 22 at 32861.
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    BOX's proposal to permit Preferred Market Makers to receive a 40% 
allocation (or 50% where there is only one other non-public customer 
order at the same price as the Preferenced Order) will not increase the 
overall percentage of an order that is guaranteed to the Preferred 
Market Maker beyond the currently acceptable threshold.\24\ Under the 
proposal, the remaining portion of each order will be available for 
allocation based on the competitive bidding of market participants. 
Therefore, the Commission does not believe that the proposal will 
negatively impact quote competition or order flow on BOX.
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    \24\ Id. See also CBOE Order, supra note 22 at 17708 (citing 
Securities Exchange Act Release No. 45936 (May 15, 2002), 67 FR 
36279, 26280 (May 23, 2002); Securities Exchange Act Release No. 
42835 (May 26, 2000), 65 FR 35683, 35685-66 (June 5, 2000); 
Securities Exchange Act Release No. 42455 (February 24, 2000), 65 FR 
11388, 11398 (March 2, 2000); Securities Exchange Act Release No. 
43100 (July 31, 2000), 65 FR 48778, 48787-88 (August 9, 2000)).
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    A Preferred Market Maker will have to be quoting at, or better 
than, the NBBO at the time a Preferenced Order is received in order to 
obtain the 40% or 50% guarantee. The Commission

[[Page 7665]]

believes that it is critical that a Preferred Market Maker must not be 
permitted to step up and match the NBBO after it receives a directed 
order in order to receive the Preferred Allocation. In this regard, 
BOX's proposal prohibits notifying a DMM of an intention to submit a 
Directed Order so that such DMM could change its quotation to match the 
NBBO immediately prior to submission of the Directed Order, and then 
fade its quote. BOX submitted a letter to the Commission representing 
that it will provide the necessary protections against that type of 
conduct, and will proactively conduct surveillance for, and enforce 
against, such violations.\25\
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    \25\ See Letter from Bruce Goodhue, Chief Regulatory Officer, 
BOX, to David Hsu, Assistant Director, Commission, dated February 4, 
2015.
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    BOX's proposed rules will require Preferred Market Makers to quote 
at a higher level than other marker makers who are not Preferred Market 
Makers. Currently, market makers on BOX are required to quote 60% of 
the trading day.\26\ In order to receive the participation entitlement, 
Preferred Market Makers will be required to quote 99% of the trading 
day. The Commission believes that requiring heightened quoting by a 
market maker in order to be eligible to receive a Preferred Allocation 
is consistent with what other exchanges have required as part of their 
directed order programs.\27\
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    \26\ BOX Rule 8050(e).
    \27\ See supra note 22.
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    The Commission emphasizes that approval of this proposal does not 
affect a broker-dealer's duty of best execution. A broker-dealer has a 
legal duty to seek to obtain best execution of customer orders, and any 
decision to preference a particular Preferred Market Maker must be 
consistent with this duty.\28\ A broker-dealer's duty of best execution 
derives from common law agency principles and fiduciary obligations, 
and is incorporated in SRO rules and, through judicial and Commission 
decisions, the antifraud provisions of the federal securities laws.\29\ 
The duty of best execution requires broker-dealers to execute 
customers' trades at the most favorable terms reasonably available 
under the circumstances, i.e., at the best reasonably available 
price.\30\ The duty of best execution requires broker-dealers to 
periodically assess the quality of competing markets to assure that 
order flow is directed to the markets providing the most beneficial 
terms for their customer orders.\31\ Broker-dealers must examine their 
procedures for seeking to obtain best execution in light of market and 
technology changes and modify those practices if necessary to enable 
their customers to obtain the best reasonably available prices.\32\ In 
doing so, broker-dealers must take into account price improvement 
opportunities, and whether different markets may be more suitable for 
different types of orders or particular securities.\33\
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    \28\ See, e.g., Newton v. Merrill, Lynch, Pierce, Fenner & 
Smith, Inc., 135 F.3d 266, 269-70, 274 (3d Cir.), cert. denied, 525 
U.S. 811 (1998); Certain Market Making Activities on Nasdaq, 
Securities Exchange Act Release No. 40900 (Jan. 11, 1999) (settled 
case) (citing Sinclair v. SEC, 444 F.2d 399 (2d Cir. 1971); Arleen 
Hughes, 27 SEC 629, 636 (1948), aff'd sub nom. Hughes v. SEC, 174 
F.2d 969 (D.C. Cir. 1949)). See also Order Execution Obligations, 
Securities Exchange Act Release No. 37619A (Sept. 6, 1996), 61 FR 
48290 (Sept. 12, 1996) (``Order Handling Rules Release''); 51808 
(June 9, 2005), 70 FR 37496, 37537-8 (June 29, 2005).
    \29\ Order Handling Rules Release, supra note 28 at 48322. See 
also Newton, 135 F.3d at 270. Failure to satisfy the duty of best 
execution can constitute fraud because a broker-dealer, in agreeing 
to execute a customer's order, makes an implied representation that 
it will execute it in a manner that maximizes the customer's 
economic gain in the transaction. See Newton, 135 F.3d at 273 
(``[T]he basis for the duty of best execution is the mutual 
understanding that the client is engaging in the trade--and 
retaining the services of the broker as his agent--solely for the 
purpose of maximizing his own economic benefit, and that the broker 
receives her compensation because she assists the client in reaching 
that goal.''); Marc N. Geman, Securities Exchange Act Release No. 
43963 (Feb. 14, 2001) (citing Newton, but concluding that respondent 
fulfilled his duty of best execution). See also Payment for Order 
Flow, Securities Exchange Act Release No. 34902 (Oct. 27, 1994), 59 
FR 55006, 55009 (Nov. 2, 1994) (``Payment for Order Flow Final 
Rules''). If the broker-dealer intends not to act in a manner that 
maximizes the customer's benefit when he accepts the order and does 
not disclose this to the customer, the broker-dealer's implied 
representation is false. See Newton, 135 F.3d at 273-274.
    \30\ Newton, 135 F.3d at 270. Newton also noted certain factors 
relevant to best execution--order size, trading characteristics of 
the security, speed of execution, clearing costs, and the cost and 
difficulty of executing an order in a particular market. Id. at 270 
n. 2 (citing Payment for Order Flow, Securities Exchange Act Release 
No. 33026 (Oct. 6, 1993), 58 FR 52934, 52937-38 (Oct. 13, 1993) 
(Proposed Rules)). See In re E.F. Hutton & Co., Securities Exchange 
Act Release No. 25887 (July 6, 1988). See also Payment for Order 
Flow Final Rules, 59 FR at 55008-55009.
    \31\ Order Handling Rules Release, supra note 28 48322-48333 
(``In conducting the requisite evaluation of its internal order 
handling procedures, a broker-dealer must regularly and rigorously 
examine execution quality likely to be obtained from different 
markets or market makers trading a security.''). See also Newton, 
135 F.3d at 271; Market 2000: An Examination of Current Equity 
Market Developments V-4 (SEC Division of Market Regulation January 
1994) (``Without specific instructions from a customer, however, a 
broker-dealer should periodically assess the quality of competing 
markets to ensure that its order flow is directed to markets 
providing the most advantageous terms for the customer's order.''); 
Payment for Order Flow Final Rules, 59 FR at 55009.
    \32\ Order Handling Rules, supra note 28 at 48323.
    \33\ Order Handling Rules, supra note 28 at 48323. For example, 
in connection with orders that are to be executed at a market 
opening price, ``[b]roker-dealers are subject to a best execution 
duty in executing customer orders at the opening, and should take 
into account the alternative methods in determining how to obtain 
best execution for their customer orders.'' Disclosure of Order 
Execution and Routing Practices, Securities Exchange Act Release No. 
43590 (Nov.17, 2000), 65 FR 75414, 75422 (Dec. 1, 2000) (adopting 
new Exchange Act Rules 11Ac1-5 and 11Ac1-6 and noting that 
alternative methods offered by some Nasdaq market centers for pre-
open orders included the mid-point of the spread or at the bid or 
offer).
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    For these reasons, the Commission believes that the proposal is 
consistent with the requirements of Section 6(b)(5) of the Act.\34\
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    \34\ 15 U.S.C. 78f(b)(5).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\35\ that the proposed rule change (SR-BOX-2014-28) be, and it 
hereby is, approved.
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    \35\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\36\
Brent J. Fields,
Secretary.
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    \36\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 2015-02748 Filed 2-10-15; 8:45 am]
BILLING CODE 8011-01-P
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