Document ID: SEC-2011-1296-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ OMX BX, Inc.
Posted Date: 2011-08-31T04:00Z

[Federal Register Volume 76, Number 169 (Wednesday, August 31, 2011)]
[Notices]
[Pages 54277-54279]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-22221]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-65199; File No. SR-BX-2011-045]

Self-Regulatory Organizations; NASDAQ OMX BX, Inc.; Order 
Approving a Proposed Rule Change Requesting Permanent Approval of the 
Pilot Program Permitting BOX To Accept Inbound Routes by NOS

August 25, 2011.

I. Introduction

    On July 13, 2011, NASDAQ OMX BX, Inc. (``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 change 
requesting permanent approval of the Exchange's pilot program to permit 
the Boston Options Exchange (``BOX'') to accept certain inbound orders 
that

[[Page 54278]]

Nasdaq Options Services, LLC (``NOS'') routes from Nasdaq Options 
Market (``NOM''). The proposed rule change was published for comment in 
the Federal Register on July 20, 2011.\3\ The Commission received no 
comment letters regarding the proposed rule change. This order approves 
the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 64896 (July 15, 
2011), 76 FR 43740 (``Notice'').
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II. Background

    BOX is an options trading facility of the Exchange under Section 
3(a)(2) of the Act.\4\ Chapter XXXIX, Section 2 of the Grandfathered 
Rules of the Exchange 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.\5\ NOS is a broker-dealer that is a member of the Exchange, 
and currently provides to members of the Nasdaq Stock Market LLC 
(``Nasdaq'') that are NOM participants optional routing services to 
other market centers.\6\ NOS 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.\7\ Thus, NOS 
is an affiliate of each of these exchanges. Absent an effective filing, 
Chapter XXXIX, Section 2 of the Grandfathered Rules of the Exchange 
would prohibit NOS from being a member of the Exchange.
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    \4\ See Chapter 1, Section 1(a)(6) of the Rules of the Boston 
Options Exchange Group LLC. See also Securities Exchange Act Release 
No. 60349 (July 20, 2009), 74 FR 37071 (July 27, 2009) (SR-BX-2009-
035) (``BOX Routing Pilot Release'').
    \5\ 15 U.S.C. 78s(b).
    \6\ NOS operates as a facility of Nasdaq that provides outbound 
routing from NOM to other market centers, subject to certain 
conditions. See NOM Rules Chapter VI, Section 11(e). See also BOX 
Routing Pilot Release, 74 FR at 37071.
    \7\ 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.)
    NASDAQ OMX acquired the Exchange in August 2008. Prior to the 
acquisition, the Exchange owned a 21.87% interest in Boston Options 
Exchange Group, LLC (``BOX LLC''), the operator of BOX. Boston 
Options Exchange Regulation, LLC (``BOXR'') is a wholly-owned 
subsidiary of the Exchange, to which the Exchange has delegated, 
pursuant to a delegation plan, certain self-regulatory 
responsibilities related to BOX.
    At the closing of the acquisition by NASDAQ OMX, the Exchange 
transferred its interest in BOX LLC to MX US, a wholly-owned 
subsidiary of the Montreal Exchange Inc. Although the Exchange no 
longer holds an ownership interest in BOX LLC, it continues to hold 
self-regulatory obligations with respect to BOX. The Exchange, 
together with BOXR, retains regulatory control over BOX, and the 
Exchange, as the SRO, remains responsible for ensuring compliance 
with the federal securities laws and all applicable rules and 
regulations.
    NASDAQ OMX also currently indirectly owns NOS, a registered 
broker-dealer and a BOX market participant. Thus, NOS is deemed an 
affiliate of the Exchange, BOX and BOXR. See BOX Routing Pilot 
Release, 76 FR at 37071. See also BSE Approval Order, 76 FR 46936.
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    On August 7, 2008, in connection with the acquisition of the 
Exchange by NASDAQ OMX, the Commission approved an affiliation between 
the Exchange and NOS for the limited purpose of permitting NOS 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.\8\ On July 17, 
2009, the Exchange filed an immediately effective proposed rule change 
to modify the conditions for the affiliation between NOS and the 
Exchange, to permit the Exchange to receive certain orders routed by 
NOS from NOM without first checking the NOM book for liquidity on a 
one-year pilot basis.\9\ Specifically, the Exchange proposed to permit 
NOS to route from NOM Exchange Direct Orders and orders in NOM Non-
System Securities (including Exchange Direct Orders).\10\ The Exchange 
now seeks permanent approval of this inbound routing pilot.\11\
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    \8\ See BSE Approval Order, 73 FR at 46944.
    \9\ See BOX Routing Pilot Release.
    \10\ NOS provides to NOM participants routing services to other 
market centers. Pursuant to Nasdaq's rules, NOS: (1) Routes orders 
in options currently trading on NOM, referred to as ``System 
Securities;'' and (2) routes orders in options that are not 
currently trading on NOM (``Non-System Securities''). See NOM Rules, 
Chapter VI, Section 1(b) and 11. When routing Non-System Securities, 
NOS is not regulated as a facility of Nasdaq, but as a broker-dealer 
regulated by its designated examining authority. See also BOX 
Routing Pilot Release, 74 FR at 37071. ``Exchange Direct Orders'' 
are orders that are directed to an exchange other than NOM as 
directed by the entering party without checking the NOM book. See 
NOM Rules Chapter VI, Section 1(e)(7).
    \11\ See Notice.
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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.\12\ Specifically, the Commission finds that the proposed rule 
change is consistent with Section 6(b)(1) of the Act,\13\ 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,\14\ 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.
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    \12\ 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).
    \13\ 15 U.S.C. 78f(b)(1).
    \14\ 15 U.S.C. 78f(b)(5).
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    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 NOS's affiliation with the Exchange.\15\ 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 implemented limitations and conditions to NOS's affiliation 
with the Exchange to permit the Exchange to accept orders routed 
inbound to BOX by NOS from NOM that do not first attempt to access 
liquidity on the NOM book.\16\ The Exchange states it has met these 
conditions: \17\
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    \15\ See BSE Approval Order, 73 FR at 46944.
    \16\ See BOX Routing Pilot Release, 74 FR at 37072.
    \17\ See Notice, 76 FR at 43741.
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     First, the Exchange and FINRA have entered into a 
Regulatory Contract. Pursuant to the Regulatory Contract, FINRA has 
been allocated regulatory responsibilities to review NOS's compliance 
with BOX's rules through FINRA's examination program.\18\ Also

[[Page 54279]]

pursuant to the Regulatory Contract, however, BX retains ultimate 
responsibility for enforcing its rules with respect to NOS, except to 
the extent they are covered by an agreement with FINRA pursuant to Rule 
17d-2 under the Act (``17d-2 Agreement''),\19\ in which case FINRA is 
allocated regulatory responsibility.
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    \18\ The Exchange also states that NOS is subject to independent 
oversight by FINRA, its Designated Examining Authority, for 
compliance with financial responsibility requirements. See Notice, 
76 FR at 43740, n.8.
    \19\ 17 CFR 240.17d-2.
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     Second, FINRA and BX will monitor NOS for compliance with 
the Exchange's trading rules, and will collect and maintain certain 
related information.\20\
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    \20\ Pursuant to the Regulatory Contract, both FINRA and the 
Exchange will collect and maintain all alerts, complaints, 
investigations and enforcement actions in which NOS (in its capacity 
as a facility of Nasdaq routing orders to BOX) 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, 76 FR at 43741, n.10.
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     Third, FINRA will provide a report to the BOXR'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.\21\
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    \21\ See id.
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     Fourth, the Exchange has adopted Chapter XXXIX, Section 
2(c) of the Grandfathered Rules of the Exchange, which requires NASDAQ 
OMX, as the holding company owning NOS and affiliated with BOX through 
the ownership of the Exchange, to establish and maintain procedures and 
internal controls reasonably designed to ensure that NOS 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.\22\
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    \22\ See chapter XXXIX, Section 2(c) of the Grandfathered Rules 
of the Exchange. See also Notice, 76 FR at 43741.
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     Fifth, NOS was authorized to route NOM Exchange Direct 
Orders without checking the NOM book, and orders in NOM non-system 
securities, inbound to the Exchange from NOM for a pilot period of 
twelve months, which was subsequently extended to September 15, 
2011.\23\
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    \23\ See Notice, 76 FR at 43741. See also Securities Exchange 
Act Release No. 65177 (August 19, 2011) (SR-BX-2011-058). The 
Commission notes that the original pilot period of twelve months 
began on August 16, 2009, but was extended several times. See 
Notice, 76 FR at 43740, n.5.; and SR-BX-2011-058, supra.

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 NOS, and has demonstrated 
that NOS cannot use any information advantage it may have because of 
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its affiliation with the Exchange.\24\

    \24\ See BOX Routing Pilot Release, 76 FR at 43741.
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    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.\25\ 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 NOS to provide inbound routing to the Exchange on a 
permanent basis instead of a pilot basis, subject to the other 
conditions described above.
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    \25\ 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.).
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    The Exchange has proposed four ongoing conditions applicable to 
NOS'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 NOS,\26\ combined 
with FINRA's monitoring of NOS's compliance with BOX's rules and 
quarterly reporting to the BOXR's CRO, will help to protect the 
independence of the Exchange's regulatory responsibilities with respect 
to NOS. The Commission also believes that Chapter XXXIX, Section 2(c) 
of the Exchange's Grandfathered Rules is designed to ensure that NOS 
cannot use any information advantage it may have because of its 
affiliation with the Exchange.
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    \26\ This oversight will be accomplished through the Regulatory 
Contract between the Exchange and FINRA, and, as applicable, a 17d-2 
Agreement.
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IV. Conclusion

    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\27\ that the proposed rule change (SR-BX-2011-045) be, and hereby 
is, approved.
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    \27\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-22221 Filed 8-30-11; 8:45 am]
BILLING CODE 8011-01-P