Document ID: SEC-2012-1370-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ OMX PHLX LLC
Posted Date: 2012-08-20T04:00Z

[Federal Register Volume 77, Number 161 (Monday, August 20, 2012)]
[Notices]
[Pages 50187-50189]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-20317]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67654; File No. SR-Phlx-2012-81]

Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Order 
Approving a Proposed Rule Change With Respect to the Authority of the 
Exchange or NASDAQ Execution Services To Cancel Orders When a Technical 
or Systems Issue Occurs on the Exchange's NASDAQ OMX PSX Facility and 
To Describe the Operation of an Error Account for NES

August 14, 2012.

I. Introduction

    On June 27, 2012, NASDAQ OMX PHLX LLC (``Exchange'' or ``Phlx'') 
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 
amend Phlx Rule 3315 by adding a new paragraph (d) that addresses the 
authority of the Exchange or Nasdaq Execution Services LLC (``NES'') to 
cancel orders when a technical or systems issue occurs on the 
Exchange's NASDAQ OMX PSX facility (``PSX'') and describes the 
operation of an error account for NES. The proposed

[[Page 50188]]

rule change was published for comment in the Federal Register on July 
10, 2012.\3\ The Commission received no comment letters regarding the 
proposed rule change. 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\ Securities Exchange Act Release No. 67343 (July 3, 2012), 77 
FR 40684 (July 10, 2012) (SR-Phlx-2012-81) (``Notice'').
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II. Description of the Proposal

    NES, a broker-dealer that is a facility and an affiliate of Phlx, 
provides outbound routing services from the Exchange to other market 
centers pursuant to Phlx rules.\4\ In its proposal, Phlx states that a 
technical or systems issue may occur at Phlx, NES, or a routing 
destination that causes the Exchange or NES to cancel orders, if the 
Exchange or NES determines that such action is necessary to maintain a 
fair and orderly market.\5\ Phlx also states that a technical or 
systems issue that occurs at the Exchange, NES, a routing destination, 
or a non-affiliate third-party Routing Broker \6\ may result in NES 
acquiring an error position that it must resolve.\7\
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    \4\ See Notice, 77 FR at 40685 n.3 and accompanying text, and 
text accompanying n.4. See also Phlx Rule 3315.
    The Exchange also has authority to receive equities orders 
routed inbound to PSX by NES from The NASDAQ Stock Market LLC 
(``NASDAQ'') and, on a pilot basis, NASDAQ OMX BX, Inc. (``BX''). 
See Notice, 77 FR at 40685 n.4. See also Securities Exchange Act 
Release No. 66178 (January 18, 2012), 77 FR 3539 (January 24, 2012) 
(SR-Phlx-2011-170); and 65553 (October 13, 2011) 76 FR 64987 
(October 19, 2011) (SR-Phlx-2011-138).
    \5\ See Notice, 77 FR at 40685. For examples of some of the 
circumstances in which the Exchange or NES may decide to cancel 
orders, see Notice, 77 FR at 40685-86.
    \6\ The Exchange states that, from time to time, it also uses 
non-affiliate third-party broker-dealers to provide outbound routing 
services. In its proposal, the Exchange refers to these broker-
dealers as ``third-party Routing Brokers.'' See Notice, 77 FR at 
40685 n.3.
    \7\ See Notice, 77 FR at 40685. Specifically, Phlx Rule 
3315(d)(2) defines ``error positions'' as ``positions that result 
from a technical or systems issue at Nasdaq Execution Services, the 
Exchange, a routing destination, or a non-affiliate third-party 
Routing Broker that affects one or more orders.''
    For examples of some of the circumstances that may lead to error 
positions, see Notice, 77 FR at 40685-86.
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    New paragraph (d) to Phlx Rule 3315 provides Phlx or NES with 
general authority to cancel orders to maintain fair and orderly markets 
when a technical or systems issue occurs at the Exchange, NES, or a 
routing destination. It also provides authority for NES to maintain an 
error account for the purpose of addressing, and sets forth the 
procedures for resolving, error positions. Specifically, paragraph 
(d)(1) of Phlx Rule 3315 authorizes Phlx or NES to cancel orders as 
either deems necessary to maintain fair and orderly markets if a 
technical or systems issue occurs at Phlx, NES, or a routing 
destination. Phlx or NES will be required to provide notice of the 
cancellation to all affected members as soon as practicable.\8\
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    \8\ See Phlx Rule 3315(d)(1).
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    Paragraph (d)(2) of Phlx Rule 3315 will allow NES to maintain an 
error account for the purpose of addressing error positions that result 
from a technical or systems issue at Phlx, NES, a routing destination, 
or a non-affiliate third-party Routing Broker.
    For purposes of Phlx Rule 3315(d), an error position will not 
include any position that results from an order submitted by a member 
to Phlx that is executed on the Exchange and automatically processed 
for clearance and settlement on a locked-in basis.\9\ NES will not be 
permitted to (i) accept any positions in its error account from a 
member's account or (ii) permit any member to transfer any positions 
from the member's account to NES's error account.\10\ In other words, 
NES may not accept from a member positions that are delivered to the 
member through the clearance and settlement process, even if those 
positions may have been related to a technical or systems issue at 
Phlx, NES, a routing destination, or a non-affiliate third-party 
Routing Broker.\11\ If a member receives locked-in positions in 
connection with a technical or systems issue and experiences a loss in 
unwinding those positions, that member may seek to rely on Phlx Rule 
3226, which provides members with the ability to file claims against 
Phlx ``for losses directly resulting from the [PSX] system's actual 
failure to correctly process an order, message, or other data, provided 
PSX has acknowledged receipt of the order, message, or data.'' \12\ If, 
however, a technical or systems issue results in the Exchange not 
having valid clearing instructions for a member to a trade, NES may 
assume that member's side of the trade so that the trade can be 
automatically processed for clearance and settlement on a locked-in 
basis.\13\
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    \9\ See Phlx Rule 3315(d)(2)(A).
    \10\ See Phlx Rule 3315(d)(2)(B).
    \11\ See Notice, 77 FR at 40686 n.11. This provision would not 
apply if NES incurred a short position to settle a member's 
purchase, as the member would not have had a position in its account 
as a result of the purchase at the time of NES's action. Similarly, 
if a systems issue occurs that causes one member to receive an 
execution for which there is not an available counterparty, action 
by NES would be required for the positions to settle into that 
member's account. See id.
     If error positions result in connection with the Exchange's use 
of a third-party Routing Broker for outbound routing and those 
positions are delivered to NES through the clearance and settlement 
process, NES would be permitted to resolve those positions. If, 
however, such positions were not delivered to NES through the 
clearance and settlement process, then the third-party Routing 
Broker would resolve the error positions itself, and NES would not 
be permitted to accept the positions. See Notice, 77 FR at 40685 
n.3.
    \12\ See Notice, 77 FR at 40686 n.11.
    \13\ See Phlx Rule 3315(d)(2)(C).
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    Paragraph (d)(3) of Phlx Rule 3315 permits the Exchange or NES, in 
connection with a particular technical or systems issue, to either (i) 
assign all resulting error positions to members or (ii) have all 
resulting error positions liquidated. Any determination to assign or 
liquidate error positions, as well as any resulting assignments, will 
be made in a nondiscriminatory fashion.\14\
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    \14\ See Phlx Rule 3315(d)(3).
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    Phlx and NES will be required to assign all error positions 
resulting from a particular technical or systems issue to the members 
affected by that technical or systems issue if Phlx or NES:
    (i) Determines that it has accurate and sufficient information 
(including valid clearing information) to assign the positions to all 
of the members affected by that technical or systems issue;
    (ii) Determines that it has sufficient time pursuant to normal 
clearance and settlement deadlines to evaluate the information 
necessary to assign the positions to all of the members affected by 
that technical or systems issue; and
    (iii) Has not determined to cancel all orders affected by that 
technical or systems issue in accordance with Phlx Rule 3315(d)(1).\15\
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    \15\ See Phlx Rule 3315(d)(3)(A)(i)-(iii).
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    If Phlx or NES is unable to assign all error positions resulting 
from a particular technical or systems issue to all of the affected 
members, or if Phlx or NES determines to cancel all orders affected by 
the technical or systems issue, then NES will be required to liquidate 
the error positions as soon as practicable.\16\ NES will be required to 
provide complete time and price discretion for the trading to liquidate 
the error positions to a third-party broker-dealer, and would be 
prohibited from attempting to exercise any influence or control over 
the timing or methods of such trading.\17\ Further, NES will be 
required to establish and enforce policies and procedures that are 
reasonably designed to restrict the flow of confidential and 
proprietary information between the third-party broker-dealer, on one 
hand, and the Exchange and NES, on the other, associated with the 
liquidation of the error positions.\18\
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    \16\ See Phlx Rule 3315(d)(3)(B).
    \17\ See Phlx Rule 3315(d)(3)(B)(i).
    \18\ See Phlx Rule 3315(d)(3)(B)(ii).
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    Finally, paragraph (d)(4) of Phlx Rule 3315 requires the Exchange 
and NES to

[[Page 50189]]

make and keep records to document all determinations to treat positions 
as error positions; all determinations to assign error positions to 
members or to liquidate error positions; and the liquidation of error 
positions through the third-party broker-dealer.

III. Discussion and Commission's Findings

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of Section 6(b) of the Act 
\19\ and the rules and regulations thereunder applicable to a national 
securities exchange.\20\ In particular, the Commission finds that the 
proposed rule change is consistent with Section 6(b)(5) of the Act,\21\ 
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, 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; and are not designed to permit unfair discrimination between 
customers, issuers, brokers, or dealers. In addition, the Commission 
believes the proposed rule change is consistent with Section 
11A(a)(1)(C) of the Act \22\ in that it seeks to assure economically 
efficient execution of securities transactions.
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    \19\ 15 U.S.C. 78f(b).
    \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)(5).
    \22\ 15 U.S.C. 78k-1(a)(1)(C).
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    The Commission recognizes that technical or systems issues may 
occur, and believes that Phlx Rule 3315, in allowing Phlx or NES to 
cancel orders affected by technical or systems issues, should provide a 
reasonably efficient means for Phlx to handle such orders, and appears 
reasonably designed to permit Phlx to maintain fair and orderly 
markets.\23\
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    \23\ The Commission notes that Phlx states that the proposed 
amendments to Phlx Rule 3315 are designed to maintain fair and 
orderly markets, ensure full trade certainty for market 
participants, and avoid disrupting the clearance and settlement 
process. See Notice, 77 FR at 40687. The Commission also notes that 
Phlx states that a decision to cancel orders due to a technical or 
systems issue is not equivalent to the Exchange declaring self-help 
against a routing destination pursuant to Rule 611 of Regulation 
NMS. See 17 CFR 242.611(b). See also Notice, 77 FR at 40686 n.10.
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    The Commission also believes that allowing the Exchange to resolve 
error positions through the use of an error account maintained by NES 
pursuant to the procedures set forth in the rule, and as described 
above, is consistent with the Act. The Commission notes that the rule 
establishes criteria for determining which positions are error 
positions,\24\ and that Phlx or NES, in connection with a particular 
technical or systems issue, will be required to either (i) assign all 
resulting error positions to members or (ii) have all resulting error 
positions liquidated.\25\ Also, Phlx or NES will assign error positions 
that result from a particular technical or systems issue to members 
only if all such error positions can be assigned to all of the members 
affected by that technical or systems issue.\26\ If Phlx or NES cannot 
assign all error positions to all members, NES will liquidate all of 
those error positions.\27\ In this regard, the Commission believes that 
the new rule appears reasonably designed to further just and equitable 
principles of trade and the protection of investors and the public 
interest, and to help prevent unfair discrimination, in that it should 
help assure the handling of error positions will be based on clear and 
objective criteria, and that the resolution of those positions will 
occur promptly through a transparent process.
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    \24\ See Phlx Rule 3315(d)(2).
    \25\ See Phlx Rule 3315(d)(3).
    \26\ See Phlx Rule 3315(d)(3)(A).
    \27\ See Phlx Rule 3315(d)(3)(B).
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    Additionally, the Commission notes that it has previously expressed 
concern about the potential for 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.\28\ The Commission is also concerned about the potential for 
misuse of confidential and proprietary information. The Commission 
believes that the requirement that NES provide complete time and price 
discretion for the liquidation of error positions to a third-party 
broker-dealer, including that NES not attempt to exercise any influence 
or control over the timing or methods of such trading, combined with 
the requirement that Phlx establish and enforce policies and procedures 
that are reasonably designed to restrict the flow of confidential and 
proprietary information to the third-party broker-dealer liquidating 
such positions, should help mitigate the Commission's concerns. In 
particular, the Commission believes that these requirements should help 
assure that none of Phlx, NES, or the third-party broker-dealer is able 
to misuse confidential or proprietary information obtained in 
connection with the liquidation of error positions for its own benefit. 
The Commission also notes that Phlx and NES would be required to make 
and keep records to document all determinations to treat positions as 
error positions; all determinations to assign error positions to 
members or liquidate error positions; and the liquidation of error 
positions through the third-party broker-dealer.\29\
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    \28\ See, e.g., Securities Exchange Act Release No. 65455 
(September 30, 2011), 76 FR 62119 (October 6, 2011) (SR-NYSEArca-
2011-61) at 62120 n.16 and accompanying text.
    \29\ See Phlx Rule 3315(d)(4).
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    Finally, the Commission notes that the proposed procedures for 
canceling orders and the handling of error positions are consistent 
with procedures the Commission has approved for other exchanges.\30\
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    \30\ See, e.g., Securities Exchange Act Release Nos. 67281 (June 
27, 2012), 77 FR 39543 (July 3, 2012) (SR-NASDAQ-2012-057); 66963 
(May 10, 2012), 77 FR 28919 (May 16, 2012) (SR-NYSEArca-2012-22); 
67010 (May 17, 2012), 77 FR 30564 (May 23, 2012) (SR-EDGX-2012-08); 
and 67011 (May 17, 2012), 77 FR 30562 (May 23, 2012) (SR-EDGA-2012-
09).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\31\ that the proposed rule change (SR-Phlx-2012-81) be, and it 
hereby is, approved.
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    \31\ 15 U.S.C. 78s(b)(2).
    \32\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\32\
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012-20317 Filed 8-17-12; 8:45 am]
BILLING CODE 8011-01-P