Document ID: SEC-2009-0914-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Notice of Filing of a Proposed Rule Change To Adopt Rules To Implement the Options Order Protection and Locked/Crossed Market Plan
Posted Date: 2009-07-08T04:00Z

[Federal Register: July 8, 2009 (Volume 74, Number 129)]
[Notices]               
[Page 32657-32660]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr08jy09-117]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-60186; File No. SR-NASDAQ-2009-056]

 
Self-Regulatory Organizations; The NASDAQ Stock Market LLC; 
Notice of Filing of a Proposed Rule Change To Adopt Rules To Implement 
the Options Order Protection and Locked/Crossed Market Plan

June 29, 2009.
    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 June 23, 2009, The NASDAQ Stock Market LLC (``NASDAQ'') filed with 
the Securities and Exchange Commission (``Commission'') the proposed 
rule change as described in Items I, II, and III below, which Items 
have been prepared by NASDAQ. 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.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to adopt rules to implement the Options Order 
Protection and Locked/Crossed Market Plan (the ``Plan''), and to delete 
provisions which will no longer be applicable following adoption of the 
Plan. The text of the proposed rule change is available at http://
nasdaqomx.cchwallstreet.com/, at NASDAQ's principal office, and at the 
Commission's Public Reference Room.

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

    In its filing with the Commission, NASDAQ 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. NASDAQ 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
    On May 7, 2008, NASDAQ filed an executed copy of the Options Order 
Protection and Locked/Crossed Market Plan (``Plan''), joining all other 
approved options markets in proposing the Plan. The Plan requires each 
options exchange to adopt rules implementing various requirements 
specified in the Plan. This proposal is designed to fulfill that 
obligation.
Background
    The Plan will replace the current Plan for the Purpose of Creating 
and Operating an lntermarket Option Linkage (``Linkage Plan''). That 
plan requires its participant exchanges to operate a stand-alone system 
or ``Linkage'' for sending order-flow between exchanges to limit trade-
throughs. The Options Clearing Corporation (``OCC [sic]) operates the 
Linkage system (the ``System''). The Linkage rules provide for unique 
types of Linkage orders, with a complicated set of requirements as to 
who may send such orders and under what conditions. Before a market 
maker can trade through another exchange's quote, it first must send a 
Linkage order and then wait three seconds for a response.
    While the Linkage largely has operated satisfactorily, it is under 
significant strain. When the Commission approved the Linkage Plan in 
2000, average daily volume (``ADV'') in the options market was 
approximately 2.6 million contracts across all exchanges. Now the ADV 
has increased four-fold to more than 10.8 million contracts, putting 
added strain on the ability of market makers to comply with the complex 
Linkage rules. At the same time, the options markets have been moving 
towards quoting in pennies. This greatly increases the number of price 
changes in an option, giving rise to greater chances of trade-throughs 
and missing markets as market makers send Linkage orders and have to 
wait three seconds for a response.
    Based upon experience in the equities markets following the 
adoption of Regulation NMS in 2005, the options exchanges have 
determined to replace

[[Page 32658]]

the System with the Plan providing for a set of rules and procedures 
designed to avoid trade-throughs and locked markets. The key to 
Regulation NMS's price-protection provisions is the lntermarket Sweep 
Order, or ISO. Each equity exchange must adopt rules ``reasonably 
designed to prevent trade-throughs.'' Exempted from trade-through 
liability is an ISO, which is an order a member sends to an exchange 
displaying a price inferior to the national best bid and offer 
(``NBBO''), while simultaneously sending orders to trade against the 
full size of any other exchange that is displaying the NBBO. A simple 
prohibition against most trade-throughs, coupled with the ISO 
mechanism, has given the equities markets a straight-forward system to 
provide customers with price protection in a fast-moving, high-volume 
market that is quoted in pennies.
    The Proposed New Definitions. The proposed Plan incorporates a 
number of defined terms, some identical to definitions from the 
existing Linkage Plan and others that have been developed along with 
the proposed Plan itself. Accordingly, NASDAQ is proposing to adopt new 
Chapter XII, Section 1 which sets forth the defined terms for use under 
the proposed Plan.
    The Proposed Trade-Through Rule. The Plan essentially would apply 
the Regulation NMS price-protection provisions to the options markets. 
Similar to Regulation NMS, the Plan would require participants to adopt 
rules ``reasonably designed to prevent Trade-Throughs,'' while 
exempting ISOs from that prohibition.
    Accordingly, Nasdaq is proposing to adopt new Chapter XII, Section 
2 which codifies the requirement that Nasdaq and other Plan 
participants avoid trading through superior prices on other markets. 
Nasdaq is also proposing to add an ISO order in Chapter VI, Section 
1(e)(7) based upon the ISO order that Nasdaq currently uses for 
compliance with Regulation NMS when trading equities. The ISO order 
will be exempt from the prohibition against trading throughs. In 
addition, Nasdaq proposes to add several additional exceptions to the 
trade-through prohibition that track the exceptions under Regulation 
NMS or correspond to unique aspects of the options market,'' [sic] or 
both. Specifically:
     System Issues: Section 2(b)(1) of the NOM Rules tracks 
Section 5(b)(i) of the Plan which corresponds to the system-failure 
exception in Regulation NMS \3\ for equity securities and permits 
trading through an Eligible Exchange that is experiencing system 
problems.
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    \3\ See Rule 611(b)(1) under the Exchange Act.
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     Trading Rotations: Section 2(b)(2) of the NOM Rules tracks 
Section 5(b)(ii) of the Plan which carries forward the current Trade-
Through exception in the Old Plan \4\ and is the options equivalent to 
the single price opening exception in Regulation NMS for equity 
securities.\5\ Some Options exchanges (other than NOM) use a trading 
rotation to open an option for trading, or to reopen an option after a 
trading halt. The rotation is effectively a single price auction to 
price the option and there are no practical means to include prices on 
other exchanges in that auction.
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    \4\ See Linkage Plan Section 8(c)(iii)(E).
    \5\ See Rule 611(b)(3) under the Exchange Act.
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     Crossed Markets: Section 2(b)(3) of the NOM Rules tracks 
Section 5(b)(iii) of the Plan which corresponds to the crossed quote 
exception in Regulation NMS for equity securities.\6\ If a Protected 
Bid is higher than a Protected Offer, it indicates that there is some 
form of market dislocation or inaccurate quoting. Permitting 
transactions to be executed without regard to Trade-Throughs in a 
Crossed Market will allow the market to quickly return to equilibrium.
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    \6\ See Rule 611(b)(4) under the Exchange Act.
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     Intermarket Sweep Orders (``ISOs''): These two exceptions 
correspond to the ISO exceptions in Regulation NMS for equity 
securities.\7\ Section 2(b)(4) of the NOM Rules tracks Section 5(b)(iv) 
of the Plan which permits a Participant to execute orders it receives 
from other Participants or members that are marked as ISO even when it 
is not at the NBBO. Section 2(b)(5) of the NOM Rules tracks Section 
5(b)(v) of the Plan which allows a Participant to execute inbound 
orders when it is not at the NBBO, provided it simultaneously 
``sweeps'' all better-priced interest displayed by Eligible Exchanges.
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    \7\ See Rule 611(b)(5) and (6) under the Exchange Act.
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     Quote Flickering: Section 2(b)(6) of the NOM Rules tracks 
Section 5(b)(vi) of the Plan which corresponds to the flickering quote 
exception in Regulation NMS for equity securities.\8\ Options 
quotations change as rapidly, if not more rapidly, than equity 
quotations. Indeed, they track the price of the underlying security and 
thus change when the price of the underlying security changes. This 
exception provides a form of ``safe harbor'' to market participants to 
allow them to trade through prices that have changed within a second of 
the transaction causing a nominal Trade-Through.
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    \8\ See Rule 611(b)(8) under the Exchange Act.
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     Non-Firm Quotes: Section 2(b)(7) of the NOM Rules tracks 
Section 5(b)(vii) of the Plan which carries forward the current non-
firm quote Trade-Through exception in the Old Plan.\9\ By definition, 
an Eligible Exchange's quotations may not be firm for automatic 
execution during this trading state and thus should not be protected 
from Trade-Throughs. In effect, these quotations are akin to ``manual 
quotations'' under Regulation NMS.
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    \9\ See Linkage Plan Section 8(c)(iii)(C).
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     Complex Trades: Section 2(b)(8) of the NOM Rules tracks 
Section 5(b)(viii) of the Plan which carries forward the current 
complex trade exception in the Old Plan \10\ and will be implemented 
through rules adopted by the Participants and approved by the 
Commission. Complex trades consist of multiple transactions (``legs'') 
effected at a net price, and it is not practical to price each leg at a 
price that does not constitute a Trade-Through. Narrowly-crafted 
implementing rules will ensure that this exception does not undercut 
Trade-Through protections.
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    \10\ See Linkage Plan Section 8(c)(iii)(G).
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     Customer Stopped Orders: Section 2(b)(9) of the NOM Rules 
tracks Section 5(b)(ix) of the Plan which corresponds to the customer 
stopped order exception in Regulation NMS for equity securities.\11\ It 
permits broker dealers to execute large orders over time at a price 
agreed upon by a customer, even though the price of the option may 
change before the order is executed in its entirety.\12\
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    \11\ See Rule 611(b)(9) under the Exchange Act.
    \12\ For a further discussion on how this exemption operates, 
see Regulation NMS Adopting Release, Exchange Act Release No. 51808 
(June 9, 2005) at notes 322-325.
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     Stopped Orders and Price Improvement: Section 2(b)(10) of 
the NOM Rules tracks Section 5(b)(xi) of the Plan which would apply if 
an order is stopped at price that did not constitute a Trade-Through at 
the time of the stop. In this case, an exchange could seek price 
improvement for that order, even if the market moves in the interim, 
and the transaction ultimately is effected at a price that would trade 
through the then currently-displayed market.
     Benchmark Trades: Section 2(b)(11) of the NOM Rules tracks 
Section 5(b)(xii) of the Plan which would cover trades executed at a 
price not tied to the price of an option at the time of execution, and 
for which the material terms were not reasonably determinable at the 
time of the commitment to make the trade. An example would be a volume-
weighted average price trade, or

[[Page 32659]]

``VWAP.'' This corresponds to a Trade-Through exemption in Regulation 
NMS for equity trades.\13\ NOM does not currently permit these types of 
options trades, and any transaction-type relying on this exemption 
would require NOM to adopt implementing rules, subject to Commission 
review and approval.
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    \13\ See Rule 611(b)(7) under the Exchange Act.
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    The Proposed Locked and Crossed Markets Rule. Similar to Regulation 
NMS, the Plan requires its participants to adopt, maintain and enforce 
rules requiring members: To avoid displaying locked and crossed 
markets; to reconcile such markets; and to prohibit members from 
engaging in a pattern or practice of displaying locked and crossed 
markets. These provisions are subject to exceptions that are contained 
in the rules of each participant and that are to be approved by the 
Commission.
    Accordingly, NASDAQ has proposed to adopt Chapter XII, Section 3 of 
the NOM rules which would set forth the general prohibition against 
locking/crossing other eligible exchanges as well as several exceptions 
that the Plan participants approved that permit locked markets in 
limited circumstances. Specifically, the exceptions to the general 
prohibition on locking and crossing occur when (1) the locking or 
crossing quotation was displayed at a time when the Exchange was 
experiencing a failure, material delay, or malfunction of its systems 
or equipment; (2) the locking or crossing quotation was displayed at a 
time when there is a Crossed Market; or (3) the Member simultaneously 
routed an ISO to execute against the full displayed size of any locked 
or crossed Protected Bid or Protected Offer.
    NOM Routing Arrangements. NASDAQ is proposing to rely upon the 
order routing arrangements already in place on its market
    Proposed Temporary Linkage Rule. NASDAQ also proposes to adopt 
Chapter XII, Section 4 which provides that the Exchange will continue 
to accept Principal Acting as Agent (``P/A'') and Principal Orders from 
options exchanges that continue to use such orders to address trade-
throughs. [sic] via the existing linkage for a temporary period. NASDAQ 
is also proposing to modify Chapter VII, Section 5 to clarify the 
obligations of market makers to honor all trades routed pursuant to 
proposed Chapter XII of the NOM rules, regardless of whether it is 
routed via the Linkage or through a private linkage arrangement.
    Miscellaneous. NASDAQ is making several miscellaneous minor changes 
to its rules in connection with the new Plan. Specifically, NASDAQ is 
proposing modifications to Chapter IV, Section 5 to remove unnecessary 
references to the existing Linkage Plan, and also to Chapter 7, Section 
5 to remove references to ``P/A'' orders and also to the existing 
Linkage Plan.
    Fees. The Exchange is proposing no changes to the fees applicable 
to orders routed by NOM to away markets. The fee is the same whether 
the order is routed to NOM from an away market via the linkage or via a 
private routing arrangement. NASDAQ is retaining references to the 
current Linkage in NASDAQ Rule 7050(1) to assess fees for orders sent 
to NASDAQ via the Linkage during the temporary period.
    Implementation. NASDAQ proposes to implement this proposed rule 
change upon withdrawal from the current Linkage Plan and effectiveness 
of the new Plan. Implementation is currently scheduled for August 31, 
2009.
2. Statutory Basis
    NASDAQ believes that the proposed rule change is consistent with 
the provisions of Section 6 of the Act,\14\ in general, and with 
Sections 6(b)(5) of the Act,\15\ in particular. The proposal is 
consistent with Section 6(b)(5) in that it 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. In particular, the Exchange 
believes that adopting rules that implement the Plan will facilitate 
the trading of options in a national market system by establishing more 
efficient protection against trade-throughs and locked and crossed 
markets.
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    \14\ 15 U.S.C. 78f.
    \15\ 15 U.S.C. 78f(b)(4), (5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASDAQ 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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    A. By order approve such proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.

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:

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-NASDAQ-2009-056 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-NASDAQ-2009-056. 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

[[Page 32660]]

those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying 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 will also be available for 
inspection and copying at the principal office of the self-regulatory 
organization. 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-
NASDAQ-2009-056 and should be submitted on or before July 29, 2009.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. E9-15991 Filed 7-7-09; 8:45 am]

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