Document ID: SEC-2016-0554-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ PHLX, LLC
Posted Date: 2016-03-31T04:00Z

[Federal Register Volume 81, Number 62 (Thursday, March 31, 2016)]
[Notices]
[Pages 18665-18667]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-07203]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-77449; File No. SR-Phlx-2016-10]

Self-Regulatory Organizations; NASDAQ PHLX LLC; Notice of Filing 
of Amendment No. 1 and Order Granting Accelerated Approval of a 
Proposed Rule Change, as Modified by Amendment No. 1, Relating to the 
Professional Customer Definition

March 25, 2016.

I. Introduction

    On January 21, 2016, NASDAQ PHLX LLC (the ``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 amend the 
methodology for counting average daily order submissions in listed 
options to determine whether a person or entity meets the definition of 
a Professional \3\ (``Professional order counting''). The Commission 
published the proposed rule change for comment in the Federal Register 
on February 10, 2016.\4\ The Exchange filed Amendment No. 1 to the 
proposed rule change on March 21, 2016.\5\ The Commission received no 
comments on this proposal. This order provides notice of filing of 
Amendment No. 1 and approves the proposal, as modified by Amendment No. 
1, on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The term ``Professional'' means any person or entity that 
(i) is not a broker or dealer in securities, and (ii) places more 
than 390 orders in listed options per day on average during a 
calendar month for its own beneficial account(s). See Phlx Rule 
1000(b)(14); see also Securities Exchange Release 59287 (January 23, 
2009), 74 FR 5694 (January 30, 2009) (ISE-2006-26) (``ISE Approval 
Order'').
    \4\ See Securities Exchange Act Release No. 77054 (February 4, 
2016), 81 FR 7166 (``Notice'').
    \5\ In Amendment No. 1, the Exchange changed how complex orders 
will be counted with respect to Professional order counting. 
Amendment No. 1 modified the proposal to provide that a complex 
order compromised of nine legs or more will count as multiple orders 
with each option leg counting as its own separate order while 
complex orders with eight legs or less will count as a single order. 
The Exchange previously proposed that complex orders compromised of 
five legs or more count as multiple orders while complex orders with 
four legs or less count as a single order. In addition, any complex 
order with nine or more legs that is canceled and replaced would 
count as multiple new orders. The Exchange previously proposed that 
complex orders with five legs or more that were canceled and 
replaced would count as multiple new orders. Finally, Amendment No.1 
also added clarifying rule text to make clear that single-strike 
algorithms are treated the same as cancel and replace orders and 
therefore each cancel and replace order will count as a new order 
when tracking the NBBO. Finally, the Exchange clarified that an 
order that cancels and replaces a subordinate order on the same side 
and series as the parent order will count as one order. To promote 
transparency of its proposed amendment, when Phlx filed Amendment 
No. 1 with the Commission, it also submitted Amendment No. 1 as a 
comment letter to the file, which the Commission posted on its Web 
site and placed in the public comment file for SR-Phlx-2016-10 
(available at http://www.sec.gov/comments/sr-phlx-2016-10/phlx201610-1.pdf). The Exchange also posted a copy of its Amendment 
No. 1 on its Web site when it filed the amendment with the 
Commission.
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II. Description of the Proposal

    The Exchange proposes to amend the definition of Professional in 
Rule 1000(b)(14) to clarify the calculation of certain types of orders 
for purposes of Professional order counting.\6\
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    \6\ See Notice, supra note 4, at 7166.
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Background
    On Phlx, public customers are granted certain marketplace 
advantages over other market participant orders, including non-customer 
orders and quotes from specialists and Registered Options Traders 
(``ROTs'').\7\ These advantages include priority over other market 
participant orders at the same

[[Page 18666]]

price as well as no transaction fees for order execution.\8\ When 
representing orders on the Exchange, members must specify whether an 
order for the account of a non-broker-dealer is for the beneficial 
account of a Professional.\9\
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    \7\ See id. at 7169.
    \8\ See id.
    \9\ See id. at 7166. Phlx rules require members to review their 
customers' account activity on a quarterly basis to determine 
whether certain customers should be represented as Professionals. 
See id. at 7167. The Exchange also may conduct its own analysis and 
identify persons or entities that should be represented as 
Professionals. See id. at 7167, n.5.
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Proposal
    The Exchange's proposal is intended to provide additional guidance 
regarding the counting methodology when calculating average daily 
orders for Professional order counting purposes. As a general rule, for 
Professional order counting, the Exchange required the counting of 
orders regardless of which exchange they are routed to with the 
exception of FLEX orders.\10\
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    \10\ See id. at 7167. The term ``FLEX option'' means a FLEX 
option contract that is traded subject to Exchange Rule 1079.
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FLEX Orders
    Under new paragraph (a) of proposed Rule 1000(b)(14)(i), FLEX 
orders are not included in the Professional order counting methodology 
as they are non-electronic orders and not typically traded by retail 
customers.\11\ Therefore, according to the Exchange, these orders are 
not relevant to the distinction that it seeks to make between public 
customers and professional traders.\12\
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    \11\ See id.
    \12\ See id.
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Cancel and Replace/Complex Orders
    Under new Paragraph (b) of proposed Rule 1000(b)(14)(i), the 
Exchange will count as a new order any order that cancels and replaces 
a prior order.\13\ Additionally, single strike algorithms, which are a 
series of cancel and replace orders in an individual strike that tracks 
the NBBO, will also count as a new order for each cancel and replace 
order.\14\
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    \13\ See id. A cancel and replace order is one that removes a 
preexisting order and replaces it with a new order. See id. The 
Exchange notes that a cancel message alone is not an order. See id. 
at 7167, n.11. Similarly, the rule would count as multiple new 
orders any cancel/replace of a complex order of nine options legs or 
more. See Amendment No. 1, supra note 5.
    \14\ See Notice, supra note 4, at 7167. In Amendment No. 1, the 
Exchange clarified that ``single strike algorithms'' are included in 
this provision. See supra note 5.
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    Under new Paragraph (c) of proposed Rule 1000(b)(14)(i), a complex 
order of 9 legs \15\ or more will count as a new order per leg whereas 
a complex order of 8 legs or less will count as a single order for all 
its legs combined.\16\
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    \15\ See Amendment No. 1, supra note 5 (in which the Exchange 
increased the number of option legs from five to nine).
    \16\ For complex orders, stock orders do not count towards the 
number of legs. For example, a nine leg complex order with eight 
option legs and one stock leg will count as an eight leg complex 
order for the purposes of Professional order counting. See Notice, 
supra note 4, at 7167, n.10, as amended by Amendment No. 1, supra 
note 5.
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Parent/Child Orders
    Under new Paragraph (d) of proposed Rule 1000(b)(14)(i), an order 
that converts into multiple subordinate orders in order to achieve an 
execution strategy \17\ will be counted as one order per side and per 
series.\18\ Additionally, if one of those subordinate ``child'' orders 
is subsequently canceled and replaced by multiple orders on multiple 
sides/series, then each new replacement order is counted as a separate 
new order per each side and series.\19\ However, if a subordinate 
``child'' order is canceled and replaced by a new order(s) on the same 
side and series, then that new replacement order will not count as a 
separate new order.\20\
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    \17\ See id. at 7167 (noting that all strategies must comply 
with Rule 1080, Commentary .07(a)(ii)); see also id. at 7168 (for 
examples of cancel and replace, ``parent/child'' Professional order 
counting, and a chart detailing the rule).
    \18\ See id. For example, orders that are for a single side/
series but are broken up by the broker will count as one order, even 
if part of the order is routed away. See Proposed Rule 
1000(b)(14)(i)(d). If a member sends in multiple orders to the 
Exchange as separate orders then each will count as a separate 
order. See Notice, supra note 4, at 7167.
    \19\ See Notice, supra note 4, at 7167.
    \20\ See Amendment No. 1, supra note 5 (adding a sentence to 
paragraph (d)).
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    As the Exchange explained in its Notice, an order that is filled in 
parts by the Exchange's matching engine, without any intervention by 
the customer, will not count as separate order for each fill because 
the customer did not intervene to generate new orders.\21\ Along 
similar lines, if an order is repriced to avoid locking or crossing the 
market, that action will not cause a ``new'' order for Professional 
order counting purposes because the customer did not intervene in that 
process.\22\ The Exchange noted that the manner in which an order is 
ultimately executed, as one order or multiple orders, does not by 
itself determine whether the activity is that of a Professional.\23\ 
Rather, the distinction is whether the member exercised control and 
discretion over the order to an extent that could be characterized as 
non-retail customer trading activity.\24\
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    \21\ See Notice, supra note 4, at 7167.
    \22\ See id.
    \23\ See id.
    \24\ See id.
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Implementation
    The Exchange proposes to implement this rule on April 1, 2016, and 
will issue an Options Trader Alert in advance to inform market 
participants of such date.\25\
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    \25\ See id. at 7168.
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III. Discussion and Commission Findings

    After careful review of the proposed rule change, 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.\26\ In particular, the Commission finds 
that the proposed rule change is consistent with Section 6(b)(5) of the 
Act,\27\ 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 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 not be 
designed to permit unfair discrimination between customers, issuers, 
brokers, or dealers. In addition, the Commission finds that the 
proposed rule change is consistent with Section 6(b)(8) of the Act, 
which requires the rules of the exchange not to impose any burden on 
competition not necessary or appropriate in furtherance of the Act.\28\
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    \26\ 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).
    \27\ 15 U.S.C. 78f(b)(5).
    \28\ 15 U.S.C. 78f(b)(8).
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    The Commission previously has articulated its position regarding 
the application of Section 6 of the Act in evaluating distinctions 
among market participants proposed by exchanges and the discretion 
available to an exchange to set an appropriate level of advantages and 
responsibilities of persons trading on its market.\29\ In particular, 
the Commission previously indicated that it does not believe that 
priority for public customer orders is a statutorily-required attribute 
of an exchange and therefore the grant of such priority is within an 
exchange's prerogative and business judgement, as long as such 
provision is

[[Page 18667]]

otherwise consistent with the requirements of the Act.\30\
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    \29\ See ISE Approval Order, supra note 3, at 5699, n.59.
    \30\ See id. at 5700.
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    The Commission notes that the Exchange is not amending the 
threshold of 390 orders in listed options per day but is revising the 
method for counting Professional orders in the context of multi-part 
orders and cancel/replace activity. The Commission believes that the 
proposal is designed to set forth a reasonable and objective approach 
to determine Professional customer status. Specifically, the proposal 
addresses how to account for complex orders, parent/child orders, and 
cancel/replace orders. The Commission believes that distinguishing 
between complex orders with 9 or more options legs and those orders 
with 8 or fewer options legs is a reasonable and objective approach.
    In addition, the Commission believes that PHLX's proposal 
appropriately distinguishes between parent/child orders that are 
generated by a broker's efforts to obtain an execution on a larger size 
order while minimizing market impact and multi-part orders that are 
used by more sophisticated market participants. Similarly, the 
Commission believes that the proposed rule change under which cancel/
replace orders will count as separate orders with limited exceptions is 
a reasonable and objective approach to distinguish the orders of retail 
customers that are ``worked'' by a broker from orders generated by 
algorithms used by more sophisticated market participants. Similar to 
what it has noted in past Professional customer filings, the Commission 
believes that the line that Phlx now seeks to draw between ``priority'' 
customers and Professional customers reflects Phlx's belief that the 
orders of a person who submits, on average, more than one order every 
minute of the trading day need not (or should not) be granted the same 
benefit or incentive that is granted to customers who do not trade on 
such a scale.\31\ The Commission believes that the grant of priority to 
certain participants over others, in a manner that is consistent with 
the Act is most reasonably viewed as within the discretion of the 
Exchange.\32\ Thus, the Commission believes that PHLX's proposal, which 
establishes an objective methodology for counting average daily order 
submissions for Professional order counting purposes, is consistent 
with the Act.
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    \31\ See id. at 5701.
    \32\ See id. at 5700.
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V. Solicitation of Comments on Amendment No. 1 to the Proposed Rule 
Change

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether Amendment No. 1 
to the proposed rule change is consistent with the Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File No. SR-Phlx-2016-10 on the subject line.

Paper Comments

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

All submissions should refer to File No. SR-Phlx-2016-10. This file 
number should be included on the subject line if email 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 
10:00 a.m. and 3:00 p.m. Copies of such filing will also 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 No. SR-Phlx-2016-10 and should be 
submitted on or before April 21, 2016.

VI. Accelerated Approval of Proposed Rule Change, as Modified by 
Amendment No. 1

    The Commission finds good cause to approve the proposed rule 
change, as modified by Amendment No. 1, prior to the thirtieth day 
after the date of publication of notice of the amended proposal in the 
Federal Register. The revisions made to the proposal in Amendment No. 1 
provided clarifying language for how cancel and replace orders will be 
counted in addition to changing how complex orders will be counted with 
respect to Professional order counting. In particular, Amendment No. 1 
modified the proposal to provide that a complex order compromised of 9 
legs or more will count as multiple orders with each option leg 
counting as its own separate order instead of 5 legs or more as 
previously proposed by the Exchange.\33\ Amendment No. 1 effectively 
allows retail customers to use more advanced trading strategies (i.e., 
complex orders with up to 8 legs) without having that activity counted 
as multiple orders for purposes of Professional order counting. Thus, 
the Commission believes that the changes in Amendment No. 1 adopt a 
more permissive threshold for complex orders, and ultimately could 
decrease the number of persons or entities that will meet the 
definition of Professional under the new rule. Accordingly, the 
Commission finds good cause, pursuant to Section 19(b)(2) of the 
Act,\34\ to approve the proposed rule change, as modified by Amendment 
No. 1, on an accelerated basis.
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    \33\ See Amendment No. 1, supra note 5.
    \34\ 15 U.S.C. 78s(b)(2)
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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-Phlx-2016-10), as modified 
by Amendment No. 1, be, and hereby is, approved on an accelerated 
basis.
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    \35\ See id.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\36\
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    \36\ 17 CFR 200.30-3(a)(12).
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Robert W. Errett,
Deputy Secretary.
[FR Doc. 2016-07203 Filed 3-30-16; 8:45 am]
 BILLING CODE 8011-01-P