Document ID: SEC-2010-0389-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ OMX PHLX, Inc.
Posted Date: 2010-03-12T05:00Z

[Federal Register: March 12, 2010 (Volume 75, Number 48)]
[Notices]               
[Page 11964-11967]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr12mr10-173]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-61667; File No. SR-Phlx-2010-36]

 
Self-Regulatory Organizations; NASDAQ OMX PHLX, Inc.; Notice of 
Filing and Immediate Effectiveness of Proposed Rule Change To Establish 
Procedures To Prevent Informational Advantages Resulting From the 
Affiliation Between PHLX and NOS

March 5, 2010.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on February 26, 2010, NASDAQ OMX PHLX, Inc. (``Phlx'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I and II below, which Items 
have been prepared by the Exchange. The Exchange has designated the 
proposed rule change as constituting a non-controversial rule change 
under Rule 19b-4(f)(6) under the Act,\3\ which renders the proposal 
effective upon filing with the Commission. The Commission is publishing 
this notice to solicit comments on the proposed rule change from 
interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 17 CFR 240.19b-4(f)(6).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes a rule change to establish procedures 
designed to manage potential informational advantages resulting from 
the affiliation between the Exchange and NASDAQ Options Services, LLC 
(``NOS''), a registered broker-dealer and a Phlx member.
    The text of the proposed rule change is below. Proposed new 
language is italicized; proposed deletions are in [brackets].
Rule 985. Affiliation and Ownership Restrictions
    (a)-(b) No change.
    (c) The NASDAQ OMX Group, Inc., which owns NASDAQ Options Services, 
LLC and the Exchange, shall establish and maintain procedures and 
internal controls reasonably designed to ensure that NASDAQ Options 
Services, LLC does not develop or implement changes to its system on 
the basis of 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 
routing to the Exchange.
* * * * *
Rule 1080. Phlx XL and Phlx XL II
    (a)-(l) No change.
    (m) (i)-(ii) No change.
    (iii)(A)-(B) No change.
    (C) The Exchange shall establish and maintain procedures and 
internal controls reasonably designed to adequately restrict the flow 
of confidential and proprietary information between the Exchange and 
the Routing Facility, and any other entity, including any affiliate of 
the Routing Facility[, and, if the Routing Facility or any of its 
affiliates engages in any other business activities other than 
providing routing services to the Exchange, between the segment of the 
Routing Facility or affiliate that provides the other business 
activities and the routing services].
    (D) No change.
    (iv) No change.
* * * * *

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

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
Sections A, B, and C below, of the most significant aspects of such 
statements.

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

1. Purpose
a. Background
    The Exchange is a wholly-owned subsidiary of The NASDAQ OMX Group, 
Inc. (``NASDAQ OMX''), a Delaware corporation. NASDAQ OMX also 
indirectly owns NASDAQ Options Services, LLC (``NOS'' or the ``Routing 
Facility''), a registered broker-dealer and a Phlx member. Thus, NOS is 
deemed an affiliate of Phlx.
    The Exchange is proposing that NOS be permitted to route certain 
orders from The NASDAQ Option Market (``NOM'') to the Exchange without 
checking the NOM book prior to routing. NOM is an options market 
operated by The NASDAQ Stock Market (the ``NASDAQ Exchange'') and NOS 
is the approved outbound routing facility of the NASDAQ Exchange for 
NOM. With the exception of Exchange Direct Orders, all routable orders 
for options that are trading on NOM check the NOM book prior to 
routing. In addition, NOS also routes orders in options that are not 
trading on NOM (referred to in the NOM Rules as ``Non-System 
Securities''). When routing orders in options that are not listed and 
open for trading on NOM, NOS is not regulated as a facility of the 
NASDAQ Exchange but rather as a broker-dealer regulated by its 
designated examining authority. As provided by Chapter IV, Section 5 of 
the NOM Rules, all orders routed by NOS under these circumstances are 
routed to away markets that are at the best price, and solely on an 
immediate-or-cancel basis.
    Under NOM Rule Chapter VI, Section 11: (1) NOM routes orders in 
options via NOS, which serves as the sole ``routing facility'' of NOM; 
(2) the sole function of the routing facility is to route orders in 
options to away markets pursuant to NOM rules, solely on behalf of NOM; 
(3)

[[Page 11965]]

NOS is a member of an unaffiliated self-regulatory organization, which 
is the designated examining authority for the broker-dealer; (4) the 
routing facility is subject to regulation as a facility of the NASDAQ 
Exchange, including the requirement to file proposed rule changes under 
Section 19 of the Act; (5) NOM must establish and maintain procedures 
and internal controls reasonably designed to adequately restrict the 
flow of confidential and proprietary information between the NASDAQ 
Exchange and its facilities (including the routing facility), and any 
other entity; and (6) the books, records, premises, officers, 
directors, agents, and employees of the routing facility, as a facility 
of the NASDAQ Exchange, shall be deemed to be the books, records, 
premises, officers, directors, agents, and employees of the NASDAQ 
Exchange for purposes of and subject to oversight pursuant to the Act, 
and the books and records of the routing facility, as a facility of the 
NASDAQ Exchange, shall be subject at all times to inspection and 
copying by the NASDAQ Exchange and the Commission.
    The Commission has approved NOS's affiliation with the Exchange 
subject to the conditions that: (1) NOS is a facility of the NASDAQ 
Exchange; (2) use of NOS's routing function by NASDAQ Exchange members 
is optional \4\ and (3) NOS does not provide routing of orders in 
options from NOM to the Exchange or any trading facilities thereof, 
unless such orders first attempt to access any liquidity on the NOM 
book.\5\
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    \4\ Because only NASDAQ Exchange members who are Options 
Participants may enter orders into NOM, it also follows that routing 
by NOS is available only to NASDAQ Exchange members who are Options 
Participants. Pursuant to Chapter I, Section 1(a)(40) of the NOM 
Rules, the term ``Options Participant'' means a firm, or 
organization that is registered with the NASDAQ Exchange for 
purposes of participating in options trading on NOM as a ``Nasdaq 
Options Order Entry Firm'' or ``Nasdaq Options Market Maker''.
    \5\ See Securities Exchange Act Release No. 58179 (July 17, 
2008), 73 FR 42874 (July 23, 2008).
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    The NASDAQ Exchange has filed a proposed rule change to modify the 
last of these conditions to permit NOS to route Exchange Direct Orders 
in NOM system securities to the Exchange without checking the NOM book 
prior to routing.\6\ Exchange Direct Orders are orders that route 
directly to other options markets on an immediate-or-cancel basis 
without first checking the NOM book for liquidity.\7\ In addition, the 
proposed rule change would permit the routing by NOS of orders 
(including Exchange Direct Orders) in NOM non-system securities from 
NOM to the Exchange.
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    \6\ SR-NASDAQ-2010-028.
    \7\ See NOM Rule Chapter VI, Section 1(e)(7).
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    The principles that govern the routing of orders to an exchange by 
an affiliated broker-dealer are well-established. The Exchange and 
other exchanges previously have adopted rules that permit exchanges to 
accept routing of inbound orders from affiliates, subject to certain 
limitations and conditions intended to address the Commission's 
concerns regarding affiliation.\8\ In the orders approving these rule 
changes, the Commission noted its concerns about potential 
informational advantages 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, but determined that 
the limitations and conditions proposed in the rule changes were 
sufficient to mitigate its concerns.
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    \8\ See Securities Exchange Act Release Nos. 60354 (July 21, 
2009), 74 FR 37074 (July 27, 2009)(SR-NASDAQ-2009-065); 60349 (July 
20, 2009), 74 FR 37071 (July 27, 2009)(SR-BX-2009-035); 59153 
(December 23, 2008), 73 FR 80485 (December 31, 2008)(SR-NASDAQ-2008-
098); 59154 (December 23, 2008), 73 FR 80468 (December 31, 2008)(SR-
BSE-2008-48); 59010 (November 24, 2008), 73 FR 73373 (December 2, 
2008) (SR-NYSEArca-2008-130); 58681 (September 29, 2008), 73 FR 
58285 (October 6, 2008)(SR-NYSEArca-2008-90); 58680 (September 29, 
2008), 73 FR 58283 (October 6, 2008)(SR-NYSE-2008-76); 58673 
(September 29, 2008), 73 FR 57707 (October 3, 2008)(SR-Amex-2008-62) 
(collectively, the ``Affiliation Orders'').
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    To appropriately address the concerns raised by the Commission 
regarding the potential for conflicts of interest and informational 
advantages, the Exchange is proposing certain restrictions and 
undertakings. These commitments are consistent with the undertakings 
made by: (i) NASDAQ OMX BX (``BX'') in adopting rule changes to permit 
NOS, in its operation as a routing facility of NASDAQ Exchange, to 
route orders from NOM to the Boston Options Exchange, a facility of BX, 
which is an affiliate of the NASDAQ Exchange, and (ii) in the equities 
markets, by BX in adopting rule changes to permit NASDAQ Execution 
Services, Inc., in its operation as the routing facility of the NASDAQ 
Exchange, to route orders from NASDAQ Exchange to BX.\9\
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    \9\ See Securities Exchange Act Release Nos. 59154 (December 23, 
2008), 73 FR 80468 (December 31, 2008)(SR-BSE-2008-48); 60349 (July 
20, 2009), 73 FR 37071 (July 27, 2009)(SR-BX-2009-035).
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    In order to manage the concerns raised by the Commission regarding 
conflicts of interest in instances where a broker-dealer is affiliated 
with an exchange to which it is routing orders, the Exchange notes 
that, with respect to orders routed to the Exchange by NOS, NOS is 
subject to independent oversight and enforcement by FINRA, an 
unaffiliated SRO that is NOS's designated examining authority. In this 
capacity, FINRA is responsible for examining NOS with respect to its 
books and records and capital obligations and also has the 
responsibility for reviewing NOS's compliance with applicable trading 
rules. In addition, the Exchange has entered into a regulatory services 
agreement with FINRA under which FINRA staff will review NOS's 
compliance with the Exchange's rules through FINRA's examination 
program. FINRA and the Exchange will also monitor NOS for compliance 
with the Exchange's trading rules, subject, of course, to Commission 
oversight of the regulatory program of the Exchange and FINRA. The 
Exchange will, however, retain ultimate responsibility for enforcing 
its rules with respect to NOS except to the extent that they are 
covered by an agreement with FINRA pursuant to Rule 17d-2,\10\ in which 
case regulatory responsibility will be allocated to FINRA as provided 
in Rule 17d-2(d).\11\
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    \10\ 17 CFR 240.17d-2.
    \11\ The Exchange and FINRA are parties to the Industry Rule 
17d-2 Plan for the allocation of regulatory responsibilities 
relating to surveillance, investigation, and enforcement of insider 
trading rules and the Industry Rule 17d-2 Plan relating to certain 
options-related sales practice matters. See Securities Act Release 
Nos. 58536 (September 12, 2008), 73 FR 54646 (September 22, 2008) 
(File No. 4-566); 57987 (June 18, 2008), 73 FR 36156 (June 25, 2008) 
(File No. S7-966) (File No. 4-551). These plans, however, do not 
cover any responsibilities relating to NOS.
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    Furthermore, in order to minimize the potential for conflicts of 
interest, the Exchange and FINRA will collect and maintain all alerts, 
complaints, investigations and enforcement actions in which NOS (in 
routing orders to the Exchange) 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. FINRA 
will then provide a report to the Exchange's Chief Regulatory Officer, 
on at least a quarterly basis, which will list all investigations that 
identify NOS as a participant that has potentially violated an Exchange 
or Commission rule.\12\
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    \12\ The Exchange, FINRA and SEC staff may agree going forward 
to reduce the number of applicable or relevant surveillances that 
form the scope of the agreed upon report.
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    In order to address the Commission's concerns about potential for 
information advantages that could place an affiliated broker-dealer at 
a competitive advantage vis-[agrave]-vis other non-affiliated broker-

[[Page 11966]]

dealers, the Exchange is proposing to adopt Rule 985(c). Rule 985(c) 
will require the parent company of both the Exchange and NOS to 
implement policies and procedures that are reasonably designed to 
prevent NOS from acting on non-public information regarding the 
Exchange's systems prior to the time that such information is made 
available generally to all market participants of such entity 
performing inbound routing functions. These policies and procedures 
would include systems development protocols to facilitate an audit of 
the efficacy of these policies and procedures.
    Specifically, Rule 985(c) shall provide as follows:

    The NASDAQ OMX Group, Inc., which owns NASDAQ Options Services, 
LLC and the Exchange, shall establish and maintain procedures and 
internal controls reasonably designed to ensure that NASDAQ Options 
Services, LLC does not develop or implement changes to its system on 
the basis of 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 routing to the Exchange.

    In addition, existing rules require: (i) NOS to establish and 
maintain procedures and internal controls reasonably designed to 
adequately restrict the flow of confidential and proprietary 
information between the NASDAQ Exchange and its facilities (including 
NOS) and any other entity, and (ii) the Exchange to establish and 
maintain procedures and internal controls reasonably designed to 
adequately restrict the flow of confidential and proprietary 
information between the Exchange and NOS and any other entity, 
including any affiliate of NOS.\13\ The Exchange proposes to amend 
Exchange Rule 1080(m)(iii)(C) to conform the language to match the 
parallel commitments of NOS and NES to establish and maintain 
procedures and internal controls to restrict the flow of confidential 
and proprietary information.\14\ Furthermore, the Exchange proposes to 
delete language in Exchange Rule 1080(m)(iii)(C) that is more 
consistent with the use a non-affiliated third party for routing 
services since NOS, an affiliated entity, acts as the exclusive order 
router of the Exchange. The Exchange believes these measures will 
effectively address the concerns identified by the Commission regarding 
the potential for informational advantages favoring NOS vis-[agrave]-
vis other Exchange participants.
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    \13\ See NOM Rule Chapter VI, Section 11(e); Exchange Rule 
1080(m)(iii)(C).
    \14\ See NOM Rule Chapter VI, Section 11(e); NASDAQ Rule 
4758(b)(8).
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b. Pilot Period
    The Exchange proposes that the Commission authorize NOS to route 
Exchange Direct Orders and orders in NOM non-system securities inbound 
to the Exchange from NOM for a pilot period of 12 months from the 
effectiveness date of this rule filing. The Exchange believes that this 
pilot period is of sufficient length to permit both the Exchange and 
the Commission to assess the impact of the rule change described 
herein.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with the provisions of Section 6 of the Act,\15\ in general, and with 
Section 6(b)(5) of the Act,\16\ in particular, in that the proposal is 
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. The proposed 
rule change would permit inbound routing of orders from NOM to the 
Exchange through NOS while minimizing the potential for conflicts of 
interest and informational advantages involved where a broker-dealer is 
affiliated with an exchange facility to which it is routing orders.
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    \15\ 15 U.S.C. 78f.
    \16\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act, as amended.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Because the proposed rule change (i) Does not significantly affect 
the protection of investors or the public interest; (ii) does not 
impose any significant burden on competition; and (iii) does not become 
operative for 30 days after the date of the filing, or such shorter 
time as the Commission may designate if consistent with the protection 
of investors and the public interest, the proposed rule change has 
become effective pursuant to Section 19(b)(3)(A) of the Act \17\ and 
Rule 19b-4(f)(6) thereunder.\18\
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    \17\ 15 U.S.C. 78s(b)(3)(A).
    \18\ 17 CFR 240.19b-4(f)(6).
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    A proposed rule change filed under 19b-4(f)(6) normally may not 
become operative prior to 30 days after the date of filing.\19\ 
However, Rule 19b-4(f)(6)(iii) \20\ permits the Commission to designate 
a shorter time if such action is consistent with the protection of 
investors and the public interest. The Exchange has requested that the 
Commission waive the 30-day operative delay. The Commission notes that 
the Exchange's proposal is consistent with the rules of other national 
securities exchanges and does not raise any new substantive issues.\21\ 
For these reasons, the Commission believes that waiving the 30-day 
operative delay is consistent with the protection of investors and the 
public interest, and designates the proposed rule change to be 
operative upon filing with the Commission.\22\
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    \19\ 17 CFR 240.19b-4(f)(6)(iii). In addition, Rule 19b-
4(f)(6)(iii) requires that a self-regulatory organization submit to 
the Commission written notice of its intent to file the proposed 
rule change, along with a brief description and text of the proposed 
rule change, at least five business days prior to the date of filing 
of the proposed rule change, or such shorter time as designated by 
the Commission. The Exchange has satisfied this requirement.
    \20\ Id.
    \21\ See Affiliation Orders, supra notes 8 and 9.
    \22\ For the purposes only of waiving the 30-day operative 
delay, the Commission has considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
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    At any time within 60 days of the filing of the proposed rule 
change, the Commission may summarily abrogate such rule change if it 
appears to the Commission that such action is 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:

[[Page 11967]]

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-Phlx-2010-36 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-Phlx-2010-36. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/
sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street, NE., 
Washington, DC 20549 on official business days between the hours of 10 
a.m. and 3 p.m. Copies of the filing also will be available for 
inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-Phlx-2010-36 and should be 
submitted on or before April 2, 2010.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\23\
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    \23\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-5319 Filed 3-11-10; 8:45 am]
BILLING CODE 8011-01-P