Document ID: SEC-2011-0392-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ OMX BX LLC
Posted Date: 2011-03-23T04:00Z

[Federal Register Volume 76, Number 56 (Wednesday, March 23, 2011)]
[Notices]
[Pages 16462-16464]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-6785]

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-64090; File No. SR-BX-2011-007]

Self-Regulatory Organizations; NASDAQ OMX BX LLC; Order Approving 
a Proposed Rule Change Relating to Permanent Approval of the BX and NES 
Inbound Routing Relationship

March 17, 2011.

I. Introduction

    On January 28, 2011, NASDAQ OMX BX LLC (``BX'' 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

[[Page 16463]]

change requesting permanent approval of the Exchange's pilot program to 
permit the Exchange to accept inbound orders that Nasdaq Execution 
Services, LLC (``NES'') routes in its capacity as a facility of The 
NASDAQ Stock Market LLC (``Nasdaq''), with certain obligations and 
conditions. The proposed rule change was published for comment in the 
Federal Register on February 14, 2011.\3\ The Commission received no 
comment letters regarding the proposed rule change. This order approves 
the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 63859 (February 7, 
2011), 76 FR 8391 (``Notice'').
---------------------------------------------------------------------------

II. Background

    BX Equity Rule 2140(a) prohibits the Exchange or any entity with 
which it is affiliated from acquiring or maintaining an ownership 
interest in a member in the absence of an effective filing under 
Section 19(b) of the Act.\4\ NES is a broker-dealer that is a member of 
the Exchange, and currently provides to Nasdaq members optional routing 
services to other market centers. NES is owned by The NASDAQ OMX Group, 
Inc. (``NASDAQ OMX''), which also owns three registered securities 
exchanges--Nasdaq, the Exchange, and NASDAQ OMX PHLX LLC.\5\ Thus, NES 
is an affiliate of each of these exchanges. Absent an effective filing, 
BX Equity Rule 2140(a) would prohibit NES from being a member of the 
Exchange.
---------------------------------------------------------------------------

    \4\ 15 U.S.C. 78s(b).
    \5\ See Securities Exchange Act Release No. 58324 (August 7, 
2008), 73 FR 46936 (August 12, 2008) (SR-BSE-2008-02; SR-BSE-2008-
23; SR-BSE-2008-25; SR-BSECC-2008-01) (``BSE Approval Order''). See 
also Securities Exchange Act Release No. 58179 (July 17, 2008), 73 
FR 42874 (July 23, 2008) (order approving NASDAQ OMX's acquisition 
of Phlx.)
---------------------------------------------------------------------------

    On August 7, 2008, in connection with the acquisition of the 
Exchange by NASDAQ OMX, the Commission, approved an affiliation between 
the Exchange and NES for the limited purpose of permitting NES to 
provide routing services for Nasdaq for orders that first attempt to 
access liquidity on Nasdaq's system before routing to the Exchange, 
subject to certain other limitations and conditions.\6\ At the time of 
NASDAQ OMX's acquisition of the Exchange, the Exchange was not trading 
equity securities.\7\ On December 23, 2008, in connection with the 
Exchange's resumption of equity trading, the Commission approved a 
modification to the conditions for the affiliation between NES and the 
Exchange, to permit the Exchange to receive orders routed by NES in its 
capacity as a facility of Nasdaq (including ``Directed Orders''),\8\ on 
a one-year pilot basis.\9\ The Exchange is now proposing to make such 
approval permanent.\10\
---------------------------------------------------------------------------

    \6\ See BSE Approval Order, supra note 5.
    \7\ See BSE Approval Order, supra note 5, 73 FR at 46944, n.117.
    \8\ 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.
    \9\ See Securities Exchange Act Release No. 59154 (December 23, 
2008), 73 FR 80468 (December 31, 2008) (SR-BSE-2008-48) (``BSE 
Inbound Routing Order'').
    \10\ See Notice, supra note 3.
---------------------------------------------------------------------------

III. Discussion and Commission Findings

    After careful review, 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.\11\ Specifically, the Commission finds that the proposed rule 
change is consistent with Section 6(b)(1) of the Act,\12\ which 
requires, among other things, that a national securities exchange be so 
organized and have the capacity to carry out the purposes of the Act, 
and to comply and enforce compliance by its members and persons 
associated with its members, with the provisions of the Act, the rules 
and regulation thereunder, and the rules of the Exchange. Further, the 
Commission finds that the proposed rule change is consistent with 
Section 6(b)(5) of the Act,\13\ 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) also 
requires that the rules of an exchange not be designed to permit unfair 
discrimination among customers, issuers, brokers, or dealers.
---------------------------------------------------------------------------

    \11\ 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).
    \12\ 15 U.S.C. 78f(b)(1).
    \13\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    NES operates as a facility of Nasdaq that provides outbound routing 
from Nasdaq to other market centers, subject to certain conditions.\14\ 
NES's operation as a facility providing outbound routing services for 
Nasdaq is 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 self-regulatory organization 
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.\15\
---------------------------------------------------------------------------

    \14\ See Nasdaq Rule 4758. See also Notice, supra note 3, 76 FR 
at 8301, n.5.
    \15\ Id. See also BSE Inbound Routing Order, supra note 9, 73 FR 
at 80475.
---------------------------------------------------------------------------

    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.
    Recognizing that the Commission has previously expressed concern 
regarding the potential for conflicts of interest in instances where a 
member firm is affiliated with an exchange of which it is a member, the 
Exchange previously proposed, and the Commission approved, limitations 
and conditions on NES's affiliation with the Exchange.\16\ Also 
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 
previously proposed, and the Commission approved,\17\ 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, subject to the 
following limitations and conditions, which the Exchange states it has 
met: \18\
---------------------------------------------------------------------------

    \16\ See BSE Approval Order, supra note 5, 73 FR at 46944.
    \17\ See BSE Inbound Routing Order, supra note 9, 73 FR at 
80475.
    \18\ See Notice, supra note 3, 73 FR at 8391-8392.
---------------------------------------------------------------------------

     First, the Exchange and FINRA will enter into a Regulatory 
Contract, as well as an agreement pursuant to Rule 17d-2 under the Act 
(``17d-2 Agreement'').\19\ Pursuant to the Regulatory Contract and the 
17d-2 Agreement, FINRA will be allocated regulatory responsibilities to 
review NES's compliance with certain Exchange rules.\20\ Pursuant to 
the Regulatory Contract, however, BX

[[Page 16464]]

retains ultimate responsibility for enforcing its rules with respect to 
NES.
---------------------------------------------------------------------------

    \19\ 17 CFR 240.17d-2.
    \20\ 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, 76 FR at 8391, n.9.
---------------------------------------------------------------------------

     Second, FINRA will monitor NES for compliance with the 
Exchange's trading rules, and will collect and maintain certain related 
information.\21\
---------------------------------------------------------------------------

    \21\ Pursuant to the Regulatory Contract, 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 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. See Notice, supra note 3, 
76 FR at 8391, n.10
---------------------------------------------------------------------------

     Third, FINRA will provide a report to the Exchange's chief 
regulatory officer (``CRO''), on a quarterly basis, that: (i) 
Quantifies all alerts (of which FINRA is aware) that identify NES as a 
participant that has potentially violated Commission or Exchange rules, 
and (ii) lists all investigations that identify NES as a participant 
that has potentially violated Commission or Exchange rules.\22\
---------------------------------------------------------------------------

    \22\ See Notice, supra note 3, 76 FR at 8392.
---------------------------------------------------------------------------

     Fourth, the Exchange has adopted BX Equity Rule 2140(c), 
which requires 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 
obtained regarding planned changes to the Exchange's systems 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.\23\
---------------------------------------------------------------------------

    \23\ See BX Equity Rule 2140(c). See also Notice, supra note 3, 
76 FR at 8392.
---------------------------------------------------------------------------

     Fifth, routing of orders from NES to the Exchange, in 
NES's capacity as a facility of Nasdaq, was authorized for a pilot 
period of twelve months.\24\
---------------------------------------------------------------------------

    \24\ See Notice, supra note 3, 76 FR at 8392. The Commission 
notes that the original pilot period of twelve months was approved 
and began on December 23, 2008, but was extended several times. See 
Notice, supra note 3, 76 FR at 8391, n.6 and accompanying text.
---------------------------------------------------------------------------

    The Exchange believes that by meeting the above-listed conditions 
it has set up mechanisms that protect the independence of the 
Exchange's regulatory responsibility with respect to NES, and has 
demonstrated that NES cannot use any information advantage it may have 
because of its affiliation with the Exchange.\25\
---------------------------------------------------------------------------

    \25\ See Notice, supra note 3, 76 FR at 8392.
---------------------------------------------------------------------------

    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.\26\ 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 
permanent basis instead of a pilot basis, subject to the other 
conditions described above.
---------------------------------------------------------------------------

    \26\ 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.); 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); 59135 
(December 22, 2008), 73 FR 79954 (December 30, 2008) (SR-ISE-2009-
85) (order approving the purchase by ISE Holdings of an ownership 
interest in DirectEdge Holdings LLC); and 59281 (January 22, 2009), 
74 FR 5014 (January 28, 2009) (SR-NYSE-2008-120) (order approving a 
joint venture between NYSE and BIDS Holdings L.P.).
---------------------------------------------------------------------------

    The Exchange has proposed four ongoing 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,\27\ 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 BX Equity Rule 
2140(c) is designed to ensure that NES cannot use any information 
advantage it may have because of its affiliation with the Exchange.
---------------------------------------------------------------------------

    \27\ This oversight will be accomplished through the 17d-2 
Agreement between FINRA and the Exchange and the Regulatory 
Contract.
---------------------------------------------------------------------------

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\28\ that the proposed rule change (SR-BX-2011-007) be, and hereby 
is, approved.
---------------------------------------------------------------------------

    \28\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\29\
---------------------------------------------------------------------------

    \29\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Cathy H. Ahn,
Deputy Secretary.
[FR Doc. 2011-6785 Filed 3-22-11; 8:45 am]
BILLING CODE 8011-01-P