Document ID: SEC-2012-0110-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ OMX PHLX LLC
Posted Date: 2012-01-24T05:00Z

[Federal Register Volume 77, Number 15 (Tuesday, January 24, 2012)]
[Notices]
[Pages 3539-3541]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-1288]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-66178; File No. SR-Phlx-2011-170]

Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Order 
Approving a Proposed Rule Change Requesting Permanent Approval of the 
Pilot Program Permitting NASDAQ OMX PSX To Accept Inbound Orders That 
Nasdaq Execution Services, LLC Routes in Its Capacity as a Facility of 
the NASDAQ Stock Market LLC

January 18, 2012.

I. Introduction

    On December 1, 2011, NASDAQ OMX PHLX LLC (``Phlx'' 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 Exchange's NASDAQ OMX PSX system (``PSX'') to accept certain 
inbound orders that Nasdaq Execution Services, LLC (``NES'') routes in 
its capacity as a facility of the NASDAQ Stock Market LLC (``Nasdaq''). 
The proposed rule change was published for comment in the Federal 
Register on December 15, 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. 65934 (December 9, 
2011), 76 FR 78060 (``Notice'').
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II. Background

    Exchange Rule 985(b) prohibits the Exchange or any entity with 
which it is affiliated from, directly or indirectly, acquiring or 
maintaining an ownership interest in, or engaging in a business venture 
with, an Exchange member or an affiliate of an Exchange member in the 
absence of an effective filing under Section 19(b) of the Exchange 
Act.\4\ NES is a broker-dealer that is a member of the Exchange, and 
currently provides to members of Nasdaq optional routing

[[Page 3540]]

services to other market centers.\5\ NES is owned by The NASDAQ OMX 
Group, Inc. (``NASDAQ OMX''), which also owns three registered 
securities exchanges--Nasdaq, the Exchange, and NASDAQ OMX BX, Inc.\6\ 
Thus, NES is an affiliate of each of these exchanges. Absent an 
effective filing, Exchange Rule 985(b) would prohibit NES from being a 
member of the Exchange.
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    \4\ 15 U.S.C. 78s(b).
    \5\ NES operates as a facility of Nasdaq that provides outbound 
routing from Nasdaq to other market centers, subject to certain 
conditions. See Nasdaq Exchange Rule 4758(b).
    \6\ See Securities Exchange Act Release No. 58179 (July 17, 
2008), 73 FR 42874 (July 23, 2008) (SR-Phlx-2008-31) (``Phlx 
Approval Order''). See also 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).
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    On September 9, 2010, the Commission approved the Exchange's 
proposed rule change relating to the establishment of PSX as a platform 
for trading NMS stocks.\7\ As part of this approval, the Exchange was 
approved to receive inbound routes of cash equities orders by NES in 
its capacity as an order routing facility of Nasdaq on a pilot 
basis.\8\ The Exchange now seeks permanent approval of this inbound 
routing pilot.\9\
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    \7\ See Securities Exchange Act Release No. 62877 (September 9, 
2010), 75 FR 56633 (September 16, 2010) (SR-Phlx-2010-79) (``PSX 
Approval Order'').
    \8\ See PSX Approval Order. See also Securities Exchange Act 
Release No. 65552 (October 13, 2011), 76 FR 64989 (October 19, 2011) 
(SR-Phlx-2011-139) (extending the inbound routing pilot through 
April 8, 2012).
    \9\ 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.\10\ Specifically, the Commission finds that the proposed rule 
change is consistent with Section 6(b)(1) of the Act,\11\ 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,\12\ 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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    \10\ 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).
    \11\ 15 U.S.C. 78f(b)(1).
    \12\ 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 to which it is routing 
orders, the Exchange previously implemented limitations and conditions 
to 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, 
on a pilot basis.\13\ The Exchange now seeks to make this pilot 
permanent. Specifically, the Exchange states it is in compliance with 
the following limitations and conditions:\14\
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    \13\ See PSX Approval Order, 75 FR at 56637--56638.
    \14\ See Notice, 76 FR at 78061.
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     First, the Exchange and FINRA have entered into a 
regulatory services agreement (``FINRA RSA'') pursuant to which FINRA 
reviews NES's compliance with the Exchange's rules through FINRA's 
examination program.\15\ Pursuant to the FINRA RSA, however, the 
Exchange retains ultimate responsibility for enforcing its rules with 
respect to NES.
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    \15\ 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, 
76 FR at 78061, n.5.
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     Second, FINRA and the Exchange \16\ will monitor NES for 
compliance with PSX's trading rules, and collect and maintain certain 
related information.\17\
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    \16\ Personnel performing real-time oversight of equity trading 
on Nasdaq will also perform similar functions with respect to PSX 
pursuant to a regulatory services agreement among Nasdaq, the 
Exchange, NASDAQ OMX BX, Inc., and NASDAQ OMX (the ``Intercompany 
RSA'') under the direction, authority, and oversight of Phlx's Chief 
Regulatory Officer (``CRO'') and the Regulatory Oversight Committee 
(``ROC'') of its Board of Directors.
    \17\ Pursuant to the FINRA RSA, both the Exchange and FINRA 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, 76 FR at 78061, n.7.
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     Third, FINRA will provide a report to the Exchange's Chief 
Regulatory Officer (``CRO''), on at least a quarterly basis, that: (i) 
quantifies all alerts (of which the Exchange and FINRA become aware) 
that identify NES as a participant that has potentially violated 
Commission or Exchange rules and (ii) quantifies the number of 
investigations that identify NES as a participant that has potentially 
violated Exchange or Commission Rules.\18\
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    \18\ See id.
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     Fourth, the Exchange adopted Rule 985(c)(2), which 
requires NASDAQ OMX, as the holding company owning NES and the 
Exchange, to establish and maintain procedures and internal controls 
reasonably designed to ensure that NES does not develop or implement 
changes to its system on the basis of non-public information regarding 
planned changes to the Exchange's systems, obtained 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 routing to the Exchange.\19\
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    \19\ See Phlx Rule 985(c)(2). See also Notice, 76 FR at 78061.
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     Fifth, routing of orders from NES to the Exchange, in 
NES's capacity as a facility of Nasdaq, will be authorized for a pilot 
period of twelve months, as further extended to April 8, 2012.\20\
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    \20\ See Notice, 76 FR at 78061.

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 
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its affiliation with the Exchange.\21\

    \21\ See id.
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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.\22\ Although the Commission

[[Page 3541]]

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, in its capacity as a 
facility of Nasdaq, 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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    \22\ 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 
NES's inbound routing activities in its capacity as a facility of 
Nasdaq, 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,\23\ combined with FINRA's 
monitoring of NES's compliance with the Exchange's rules and quarterly 
reporting to Phlx's CRO, will help to protect the independence of the 
Exchange's regulatory responsibilities with respect to NES.
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    \23\ This oversight will be accomplished through the FINRA RSA 
between the Exchange and FINRA, and, as applicable, a 17d-2 
Agreement. See PSX Approval Order, 75 FR at 56638, n.80 and 
accompanying text.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule change (SR-Phlx-2011-170) be, and 
hereby is, approved.
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    \24\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\25\
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    \25\ 17 CFR 200.30-3(a)(12).

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-1288 Filed 1-23-12; 8:45 am]
BILLING CODE 8011-01-P