Document ID: SEC-2009-1217-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order Granting Approval of a Proposed Rule Change as Modified by Amendment No. 1 Thereto To Adopt Rules Implementing the Options Order Protection and Locked/Crossed Market Plan
Posted Date: 2009-08-26T04:00Z

[Federal Register: August 26, 2009 (Volume 74, Number 164)]
[Notices]               
[Page 43188-43191]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr26au09-127]                         

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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-60525; File No. SR-NASDAQ-2009-056]

 
Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order 
Granting Approval of a Proposed Rule Change as Modified by Amendment 
No. 1 Thereto To Adopt Rules Implementing the Options Order Protection 
and Locked/Crossed Market Plan

August 18, 2009.

I. Introduction

    On June 23, 2009, The NASDAQ Stock Market LLC (``Nasdasq'' 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 change to amend and adopt rules to implement the Options 
Order Protection and Locked/Crossed Market Plan. The proposed rule 
change was published for comment in the Federal Register on July 8, 
2009.\3\ On August 14, 2009, the Exchange filed Amendment No. 1 to the 
proposed rule change.\4\ The Commission received no comments on the 
proposal. This order approves the proposed rule change, as modified by 
Amendment No. 1.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 60186 (June 29, 
2009), 74 FR 32657 (``Notice'').
    \4\ Amendment No. 1 made technical corrections to the rule text 
proposed by Nasdaq. Because the amendment did not affect the 
substance of the rule filing, the amendment did not require notice 
and comment.
---------------------------------------------------------------------------

II. Description of the Proposal

    The Exchange proposes to amend and adopt new Nasdaq rules to 
implement the Options Order Protection and Locked/Crossed Market Plan 
(``Plan'').\5\ Specifically, the Exchange proposes to replace current 
Chapter XII of its rules with new rules implementing the Plan, amend 
other Exchange rules to reflect

[[Page 43189]]

the Plan, and delete rules rendered unnecessary by the Plan.
---------------------------------------------------------------------------

    \5\ The Plan is a national market system plan proposed by the 
seven existing options exchanges and approved by the Commission. See 
Securities Exchange Act Release No. 59647 (March 30, 2009), 74 FR 
15010 (April 2, 2009) (File No. 4-546) (``Plan Notice'') and 60405 
(July 30, 2009), 74 FR 39362 (August 6, 2009) (File No. 4-546) 
(``Plan Approval''). The seven options exchanges are: Chicago Board 
Options Exchange, Incorporated (``CBOE''); International Securities 
Exchange LLC (``ISE''); NASDAQ OMX BX, Inc. (``BOX''); NASDAQ OMX 
PHLX, Inc. (``Phlx''); NYSE Amex LLC (``NYSE Amex''); NYSE Arca, 
Inc. (``NYSE Arca''); and Nasdaq (each exchange individually a 
``Participant'' and, together, the ``Participating Options 
Exchanges'').
---------------------------------------------------------------------------

The Old Plan

    Each of the Participating Options Exchanges are signatories to the 
Plan for the Purpose of Creating and Operating an Intermarket Option 
Linkage (``Old Plan'').\6\ In pertinent part, the Old Plan generally 
requires its participants to avoid trading at a price inferior to the 
national best bid or offer (``trade-through''), although it provides 
for a number of exceptions to trade-through liability.\7\ The 
Participating Options Exchanges comply with this requirement of the Old 
Plan by utilizing a stand alone system (``Linkage Hub'') to send and 
receive specific order types,\8\ namely Principal Acting as Agent 
Orders (``P/A Orders''), Principal Orders, and Satisfaction Orders.\9\ 
The Old Plan also provided that dissemination of ``locked'' or 
``crossed'' markets should be avoided, and remedial actions that should 
be taken to unlock or uncross such market.\10\ Each of the 
Participating Options Exchanges, including the Exchange, has submitted 
an amendment to the Old Plan to withdraw from such Plan.\11\ The 
withdrawals will be effective upon approval by the Commission of such 
amendments pursuant to Rule 608 of Regulation NMS under the Act 
(``Regulation NMS'').\12\
---------------------------------------------------------------------------

    \6\ On July 28, 2000, the Commission approved the Old Plan as a 
national market system plan for the purpose of creating and 
operating an intermarket options market linkage proposed by the 
American Stock Exchange LLC (n/k/a NYSE Amex), CBOE, and ISE. See 
Securities Exchange Act Release No. 43086 (July 28, 2000), 65 FR 
48023 (August 4, 2000). Subsequently, Philadelphia Stock Exchange, 
Inc. (n/k/a Phlx), Pacific Exchange, Inc. (n/k/a NYSE Arca), Boston 
Stock Exchange, Inc. (n/k/a BOX), and Nasdaq joined the Linkage 
Plan. See Securities Exchange Act Release Nos. 43573 (November 16, 
2000), 65 FR 70851 (November 28, 2000); 43574 (November 16, 2000), 
65 FR 70850 (November 28, 2000); 49198 (February 5, 2004), 69 FR 
7029 (February 12, 2004); and 57545 (March 21, 2008), 73 FR 16394 
(March 27, 2008).
    \7\ Section 8(c) of the Old Plan.
    \8\ The Linkage Hub is a centralized data communications network 
that electronically links the Participating Options Exchanges to one 
another. The Options Clearing Corporation (``OCC'') operates the 
Linkage Hub.
    \9\ Section 2(16) of the Old Plan.
    \10\ Section 7(a)(i)(C) of the Old Plan.
    \11\ See Securities Exchange Act Release No. 60360 (July 21, 
2009) 74 FR 37265 (July 28, 2009) (File No. 4-429).
    \12\ 17 CFR 242.608.
---------------------------------------------------------------------------

The Plan

    The Plan does not require a central linkage mechanism akin to the 
Old Plan's Linkage Hub. Instead, the Plan includes the framework for 
routing orders via private linkages that exist for NMS stocks under 
Regulation NMS.\13\ The Plan requires the Participating Options 
Exchanges to adopt rules ``reasonably designed to prevent Trade-
Throughs.'' \14\ Participating Options Exchanges are also required to 
conduct surveillance of their respective markets on a regular basis to 
ascertain the effectiveness of the policies and procedures to prevent 
Trade-Throughs and to take prompt action to remedy deficiencies in such 
policies and procedures.\15\ As further described below, the Plan 
incorporates a number of exceptions to trade-through liability.\16\ 
Some of these exceptions are carried over from the Old Plan, including 
exceptions for trading rotations, non-firm quotes, and complex 
trades.\17\ Others are substantially similar to exceptions available 
for NMS stocks under Regulation NMS, such as exceptions for systems 
issues, crossed markets, quote flickering, customer stopped orders, 
benchmark trades and, notably, intermarket sweep orders (``ISOs'').\18\ 
In addition, the Plan contains a new exception for stopped orders and 
price improvement.\19\
---------------------------------------------------------------------------

    \13\ See Securities Exchange Act Release No. 51808 (June 9, 
2005), 70 FR 37496 (June 29, 2005) (File No. S7-10-04); 17 CFR 
242.600 et seq. For discussions of the similarities between the 
provisions of Regulation NMS and the provisions in the Plan, see the 
Plan Notice and Plan Approval, supra note 5.
    \14\ Under the Plan, a ``Trade-Through'' is generally defined as 
a transaction in an option series, either as principal or agent, at 
a price that is lower than a Protected Bid or higher than a 
Protected Offer.'' See Section 2(21) of the Plan. A ``Protected 
Bid'' and ``Protected Offer'' generally means a bid or offer in an 
option series, respectively, that is displayed by a Participant, is 
disseminated pursuant to the Options Price Reporting Authority 
(``OPRA'') Plan, and is the Best Bid or Best Offer. See Section 
2(17) of the Plan. A ``Best Bid'' or ``Best Offer'' means the 
highest bid price and the lowest offer price. Section (2)(1) of the 
Plan. ``Protected Bid'' and ``Protected Offer,'' together are 
referred to herein as ``Protected Quotation.'' See Section 2(18) of 
the Plan.
    \15\ Section 5(a)(ii) of the Plan.
    \16\ Section 5(b) of the Plan.
    \17\ Subparagraphs (ii), (vii), and (viii), respectively, of 
Section 5(b) of the Plan.
    \18\ Subparagraphs (i), (iii), (vi), (ix), (xi), and (iv)-(v), 
respectively, of Section 5(b) of the Plan.
    \19\ Subparagraph (x) of Section 5(b) of the Plan.
---------------------------------------------------------------------------

    The Plan also requires each Participant to establish, maintain, and 
enforce written rules that: require its members reasonably to avoid 
displaying locked and crossed markets; assure the reconciliation of 
locked and crossed markets; and prohibit its members from engaging in a 
pattern or practice of displaying locked and crossed markets; subject 
to exceptions as may be contained in the rules of the Participant, as 
approved by the Commission.\20\
---------------------------------------------------------------------------

    \20\ Section 6 of the Plan. The Plan also contains provisions 
relating to the operation of the Plan including, for example, 
provisions relating to the entry of new parties to the Plan; 
withdrawal from the Plan; and amendments to the Plan.
---------------------------------------------------------------------------

The Exchange's Proposal

    To implement the Plan, the Exchange proposes to replace its current 
rules relating to the Old Plan with new rules relating to the Plan, and 
makes amendments to other rules as necessary to conform to the 
requirements of the Plan.\21\ As such, the Exchange proposes to adopt 
all applicable definitions from the Plan into the Exchange's rules.\22\
---------------------------------------------------------------------------

    \21\ A more detailed description of the Exchange's proposed rule 
change may be found in the Notice, supra, note 3.
    \22\ Proposed Nasdaq Chapter XII, Section 1.
---------------------------------------------------------------------------

    In addition, the Exchange proposes to prohibit its members from 
effecting Trade-Throughs, unless an exception applies.\23\ Consistent 
with the Plan, the Exchange also proposes exceptions to the prohibition 
on trade throughs relating to: System issues; trading rotations; 
crossed markets; intermarket sweep orders; quote flickering; non-firm 
quotes; complex trades; customer stopped orders; stopped orders and 
price improvement; and benchmark trades.\24\
---------------------------------------------------------------------------

    \23\ Proposed Nasdaq Chapter XII, Section 2(a).
    \24\ Proposed Nasdaq Chapter XII, Section 2(b)(1)-(11). In 
addition, the Exchange proposes to add ISOs as a new type of order 
under proposed Nasdaq Chapter VI, Section 1(e)(8).
---------------------------------------------------------------------------

    The Exchange also proposes a rule to address locked and crossed 
markets, as required by the Plan.\25\ Specifically, the Exchange 
proposes that, except for quotations that fall within a stated 
exception, members shall reasonably avoid displaying, and shall not 
engage in a pattern or practice of displaying, any quotations that lock 
or cross a Protected Quote.\26\
---------------------------------------------------------------------------

    \25\ A ``locked market'' is defined as a quoted market in which 
a Protected Bid is equal to a Protected Offer. Proposed Nasdaq 
Chapter XII, Section 1(10). A ``crossed market'' is defined as a 
quoted market in which a Protected Bid is higher than a Protected 
Offer. Proposed Nasdaq Chapter XII, Section 1(5).
    \26\ Proposed Nasdaq Chapter XII, Section 3(a).
---------------------------------------------------------------------------

    The Exchange proposes three exceptions to the prohibition against 
locked and crossed markets: when the Exchange is experiencing a 
failure, material delay, or malfunction of its systems or equipment; 
when the locking or crossing quotation was displayed at a time where 
there is a crossed market; and when an Exchange member simultaneously 
routes an ISO to execute against the full displayed size of any locked 
or crossed Protected Bid or Protected Offer.\27\
---------------------------------------------------------------------------

    \27\ Proposed Nasdaq Chapter XII, Section 3(b).
---------------------------------------------------------------------------

    The Exchange also proposes rules to permit it to continue to accept 
P/A Orders and Principal Orders from Participating Options Exchanges 
that are

[[Page 43190]]

not able to send ISOs in order to avoid Trade-Throughs.\28\
---------------------------------------------------------------------------

    \28\ Proposed Nasdaq Chapter XII, Section 4.
---------------------------------------------------------------------------

    The Exchange proposes to amend certain other rules to reflect the 
Plan and delete terms related to the Old Plan. In particular, the 
Exchange proposes to amend Nasdaq Chapter IV, Section 5(b) and (c) and 
Nasdaq Chapter VII, Section 5(a)(viii) to modify language that is no 
longer applicable under the Plan and eliminate the ``Removal of 
Unreliable Quotes'' provision of Nasdaq Chapter 12, Section 3(e).\29\
---------------------------------------------------------------------------

    \29\ In addition, the Exchange proposes to rely upon the order 
routing arrangements already in place on its market.
---------------------------------------------------------------------------

    NASDAQ proposes to implement this proposed rule change upon 
withdrawal from the current Linkage Plan and effectiveness of the new 
Plan.

II. Discussion and Commission's Findings

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange.\30\ In particular, the Commission finds that the 
proposal is consistent with Section 6(b)(5) of the Act 9 \31\ which 
requires, among other things, that the rules of a national securities 
exchange be designed 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. The Commission also finds that the 
proposal is consistent with Rule 608(c) of Regulation NMS under the 
Act, which requires that each exchange comply with the terms of any 
effective national market system plan of which it is a participant.\32\ 
Finally, the Commission finds that the proposed rule change is 
consistent with the requirements of the Plan.\33\
---------------------------------------------------------------------------

    \30\ 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).
    \31\ 15 U.S.C. 78f(b)(5).
    \32\ 17 CFR 242.608(c). Section 1 of the Plan provides in 
pertinent part that, ``The Participants will submit to the 
[Commission] for approval their respective rules that will implement 
the framework of the Plan.''
    \33\ See supra note 5.
---------------------------------------------------------------------------

    Proposed Nasdaq Chapter XII, Section 1 would define applicable 
terms in a manner that are substantively identical to the defined terms 
of the Plan.\34\ As such, the Commission finds that proposed Nasdaq 
Chapter XII, Section 1 is consistent with the Act and the Plan.
---------------------------------------------------------------------------

    \34\ The Commission notes that the Exchange's proposed 
definition of ``Complex Trade'' under proposed Nasdaq Chapter XII, 
Section 1(4) is identical to the definition of ``Complex Trade'' 
under old Nasdaq Chapter XII, Section 1(c), which is being deleted.
---------------------------------------------------------------------------

    Proposed Nasdaq Chapter XII, Section 2(a) would prohibit members 
from effecting Trade-Throughs unless an exception applies. Proposed 
Nasdaq Chapter XII, Section 2(b) would provide for 11 exceptions to the 
general Trade-Through prohibition, relating to systems issues, trading 
rotations, crossed markets, ISOs, quote flickering, non-firm quotes, 
complex trades, customer stopped orders, stopped orders and price 
improvement, and benchmark trades.\35\ Aside from the proposed 
exception relating to systems issues, each proposed exception would be 
substantively identical to the parallel exception under Section 5(b) of 
the Plan.
---------------------------------------------------------------------------

    \35\ Proposed Nasdaq Chapter XII, Section 2(b)(1)-(11).
---------------------------------------------------------------------------

    The systems issues exception under proposed Nasdaq Chapter XII, 
Section 2(b)(1) would implement the parallel exception available under 
Section 5(b)(i) of the Plan and would permit the Exchange to bypass the 
Protected Quotation of another Participant if such other Participant 
repeatedly fails to respond within one second to incoming orders 
attempting to access its Protected Quotations. The Exchange's rule 
would require the Exchange to notify such non-responding Participant 
immediately after (or at the same time as) electing self-help, and 
assess whether the cause of the problem lies with the Exchange's own 
systems and, if so, take immediate steps to resolve the problem. 
Finally, the Exchange would be required to promptly document its 
reasons supporting any such determination to bypass a Protected 
Quotation. The Commission believes that this exception should provide 
the Exchange with the necessary flexibility for dealing with problems 
that occur on an away market during the trading day. At the same time, 
the exception's requirements to immediately notify such away market of 
its determination and also assess its own system should help prevent 
the use of this exception when there in fact is a problem with the 
Exchange's own systems, rather than those of an away market.
    The Commission notes that included among the exceptions in proposed 
Nasdaq Chapter XII, Section 2(b) would be exceptions for certain 
transactions involving ISOs.\36\ An order identified as an ISO would be 
immediately executable by the Exchange (or any other Plan Participant 
that received such an order) based on the premise that the market 
participant sending the ISO has already attempted to access all better-
priced Protected Quotations up to their displayed size. The Commission 
believes that this exception should help ensure more efficient and 
faster executions in the options markets.
---------------------------------------------------------------------------

    \36\ Proposed Nasdaq Chapter XII, Sections 2(b)(4) and (5).
---------------------------------------------------------------------------

    The Commission notes that, in addition to these rules regarding 
Trade-Throughs, the Plan requires that each Participant establish, 
maintain and enforce written policies and procedures that are 
reasonably designed to prevent Trade-Throughs in that Participant's 
market that do not fall within an applicable exception and, if relying 
on such exception, that are reasonably designed to assure compliance 
with the terms of the exception. In addition, the Commission notes that 
the Plan requires each Participant to conduct surveillance of its 
market on a regular basis to ascertain the effectiveness of such 
policies and procedures and to take prompt action to remedy any 
deficiencies in such policies and procedures.
    Accordingly, the Commission finds that proposed Nasdaq Chapter XII, 
Section 2 is consistent with Section 5 of the Plan and Section 6(b)(5) 
of the Act \37\ which requires, among other things, that the rules of a 
national securities exchange be designed 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.
---------------------------------------------------------------------------

    \37\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    Proposed Nasdaq Chapter XII, Section 3(a) would require Exchange 
members to reasonably avoid displaying, and not engage in a pattern or 
practice of displaying, any quotation that locks or crosses a Protected 
Quotation, subject to certain exceptions delineated in proposed Nasdaq 
Chapter XII, Section 3(b). The Commission recognizes that locked and 
crossed markets may occur accidentally and cannot always be avoided. 
However, the Commission believes that giving priority to the first-
displayed Protected Bid or Protected Offer, particularly when it 
includes a public customer's order, will encourage price discovery and 
contribute to fair and orderly markets. Therefore, the Commission 
believes that the proposed rule, which corresponds to the Plan's 
language, to require members to reasonably avoid displaying, and not 
engaging in a pattern or practice of, locks and crosses is appropriate.
    Proposed Nasdaq Chapter XII, Section 3(b) would permit three 
exceptions to

[[Page 43191]]

the Exchange's general rule relating to locked and crossed markets.\38\ 
These exceptions would be similar to analogous certain trade-through 
exceptions under proposed Nasdaq Chapter XII, Section 2(b), and relate 
to when the Exchange is experiencing systems issues, when there exists 
a crossed market, and when a member simultaneously routes ISOs against 
the full displayed size of any locked or crossed Protected Bid or 
Protected Offer.
---------------------------------------------------------------------------

    \38\ Section 6 of the Plan permits exceptions to the Plan's 
locked and crossed market rules as may be contained in the rules of 
a Participant approved by the Commission.
---------------------------------------------------------------------------

    The Commission believes that the Exchange's proposed rules relating 
to locked and crossed markets are consistent with the Plan and the Act 
and should help ensure that the display of locked or crossed markets 
will be limited and that any such display will be promptly reconciled. 
The Commission also believes that each of the proposed exceptions to 
locked and crossed markets relate to circumstances when it is 
appropriate to permit a limited, narrow exception to the general locked 
and crossed market rule.
    Therefore, the Commission finds that Exchange's rule regarding 
locked and crossed markets appropriately implements Section 6 of the 
Plan, and is consistent with Section 6(b)(5) of the Act \39\ which 
requires, among other things, that the rules of a national securities 
exchange be designed 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.
---------------------------------------------------------------------------

    \39\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    The Commission also finds that proposed Nasdaq Chapter XII, Section 
4, which facilitates the participation of certain Participating Options 
Exchanges who may require the use of P/A Orders and Principal Orders 
after implementation of the Plan, is consistent with the Act. Although 
the Commission has already approved the Plan,\40\ the Commission also 
recognizes that there may be one or more Participating Options 
Exchanges that may require a temporary transition period during which 
they may want to continue to utilize these order types that exist 
currently under the Old Plan.\41\ The Exchange and each of the other 
Participating Options Exchanges have proposed substantially identical 
temporary provisions to accommodate this possibility.\42\ Thus, the 
Commission finds that the proposed rule relating to the Exchange's 
receipt and handling of P/A Orders and Principal Orders, and imposing 
certain obligations on the Exchange with respect to such orders that 
are similar to those that exist under the Old Plan, is appropriate and 
consistent with Section 6(b)(5) of the Act \43\ which requires, among 
other things, that the rules of a national securities exchange be 
designed 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.
---------------------------------------------------------------------------

    \40\ See Plan Approval, supra, note 5.
    \41\ The Commission notes that any Participating Options 
Exchange that wishes to utilize such order types in a manner that 
would result in a Trade-Through would need to separately request an 
exemption from the Plan for such use.
    \42\ The Commission notes that the rules contained in Proposed 
Nasdaq Chapter XII, Section 4 are not required by the Plan, but 
rather are rules proposed by the Exchange in order to facilitate the 
participation in the Plan of certain exchanges during an initial 
transition period.
    \43\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    Finally, the Commission finds that Nasdaq's proposed amendments to 
certain other Nasdaq rules to modify and/or delete language that is no 
longer necessary under the Plan are appropriate and consistent with the 
Act and the Plan.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\44\ that the proposed rule change (SR-NASDAQ-2009-056), as 
modified by Amendment No. 1, be, and it hereby is, approved.
---------------------------------------------------------------------------

    \44\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\45\
---------------------------------------------------------------------------

    \45\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-20535 Filed 8-25-09; 8:45 am]

BILLING CODE 8010-01-P