Document ID: SEC-2008-0416-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ Stock Market LLC
Posted Date: 2008-03-18T04:00Z

[Federal Register: March 18, 2008 (Volume 73, Number 53)]
[Notices]               
[Page 14521-14543]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr18mr08-131]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57478; File Nos. SR-NASDAQ-2007-004 and SR-NASDAQ-2007-
080]

 
Self-Regulatory Organizations; The NASDAQ Stock Market LLC; 
Notice of Filing of Amendment No. 2 to a Proposed Rule Change and Order 
Granting Accelerated Approval to a Proposed Rule Change, as Amended, To 
Establish Rules Governing the Trading of Options on the NASDAQ Options 
Market; Order Approving a Proposed Rule Change Relating to the LLC 
Agreement Establishing the NASDAQ Options Market LLC and Delegation 
Agreement Delegating to NOM LLC the Authority To Operate the NASDAQ 
Options Market; Order Granting an Application of The NASDAQ Stock 
Market LLC for an Exemption Pursuant to Section 36(a) of the Exchange 
Act from the Requirements of Section 19(b) of the Exchange Act; and 
Order Granting an Exemption for the NASDAQ Options Market LLC from 
Section 11A(b) of the Exchange Act

March 12, 2008.

I. Introduction

    On January 30, 2007, The NASDAQ Stock Market LLC (``Nasdaq'' 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 (``Trading Rules Proposal'') to adopt rules 
governing participation in and trading on The NASDAQ Options Market 
(``NOM''), which will be an options exchange facility of Nasdaq 
operated by The Nasdaq Options Market LLC (``NOM LLC''). The proposed 
rule change, as modified by Amendment No. 1, was published for comment 
in the Federal Register on May 1, 2007.\3\ The Commission received five 
comment letters regarding the proposed rule change.\4\ Nasdaq responded 
to the

[[Page 14522]]

commenters in a letter dated December 13, 2007,\5\ and filed Amendment 
No. 2 to the proposal on December 13, 2007. This notice and order 
provides notice and solicits comments from interested persons regarding 
Amendment No. 2 and approves the Trading Rules Proposal, as amended, on 
an accelerated basis.
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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. 55667 (April 25, 
2007), 72 FR 23869 (``Trading Rules Proposal Notice'').
    \4\ See letters to Nancy M. Morris, Secretary, Commission, from 
Stephen Schuler, Managing Member, Global Electronic Trading Company 
(``GETCO''), and Daniel Tierney, Managing Member, GETCO, dated July 
20, 2007 (``GETCO Letter''); Michael J. Simon, Secretary, The 
International Securities Exchange, LLC (``ISE''), dated June 15, 
2007 (``ISE Letter''); John C. Nagel, Director and Associate General 
Counsel, Citadel Investment Group L.L.C. (``Citadel''), dated June 
11, 2007 (``Citadel Letter''); Michael T. Bickford, Senior Vice 
President, Options, American Stock Exchange LLC (``Amex''), dated 
May 24, 2007 (``Amex Letter''); and Christopher Nagy, Chair, 
Securities Industry and Financial Markets Association (``SIFMA'') 
Options Committee, dated May 22, 2007 (``SIFMA Letter'').
    \5\ See letter from Jeffrey S. Davis, Vice President and Deputy 
General Counsel, Nasdaq, to Nancy M. Morris, Secretary, Commission, 
dated December 13, 2007 (``Nasdaq Response'').
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    Also, on September 17, 2007, the Exchange filed with the Commission 
a proposed rule change, pursuant to Section 19(b)(1) of the Act \6\ and 
Rule 19b-4 thereunder,\7\ to establish, through a limited liability 
company agreement, NOM LLC, and to delegate to NOM LLC the authority to 
operate NOM as a facility of Nasdaq (``Corporate Structure Proposal,'' 
and, with the Trading Rules Proposal, the ``Proposals''). The proposed 
rule change was published for comment in the Federal Register on 
October 12, 2007.\8\ The Commission received no comments on the 
proposal. This order approves the Corporate Structure Proposal.
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    \6\ 15 U.S.C. 78s(b)(1).
    \7\ 17 CFR 240.19b-4.
    \8\ See Securities Exchange Act Release No. 56604 (October 3, 
2007), 72 FR 58137 (``Corporate Structure Proposal Notice'').
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    On December 13, 2007, Nasdaq requested that the Commission grant 
NOM LLC a permanent exemption from the requirement under Section 11A(b) 
of the Act and Rule 609 thereunder that a securities information 
processor (``SIP'') acting as an exclusive processor register with the 
Commission.\9\ Further, on December 13, 2007, Nasdaq asked the 
Commission to exempt Nasdaq from the rule filing requirements of 
Section 19(b) of the Act for changes to NOM rules that are effected 
solely by virtue of a change to a Chicago Board Options Exchange 
(``CBOE''), New York Stock Exchange (``NYSE''), or Financial Industry 
Regulatory Authority (``FINRA'') rule that NOM has incorporated by 
reference. This order grants these exemptions.
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    \9\ 15 U.S.C. 78k-1(b). Rule 609 under the Act, 17 CFR 242.609, 
requires that the registration of a securities information processor 
be on Form SIP, 17 CFR 249.1001.
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II. Discussion and Commission Findings

    After careful review of the Trading Rule Proposal, as amended, and 
consideration of the comment letters and Nasdaq's response to the 
commenters, and the Corporate Structure Proposal, the Commission finds 
that the Trading Rules Proposal, as amended, and the Corporate 
Structure Proposal are 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 
Proposals are consistent with Section 6(b)(5) of the Act,\11\ 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. Further, the Commission finds that the Proposals 
are consistent with Sections 6(b)(1) of the Act,\12\ 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, and Section 
6(b)(2) of the Act,\13\ which requires, in part, that the rules of an 
exchange assure a fair representation of its members in the selection 
of its directors and administration of its affairs.
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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)(5).
    \12\ 15 U.S.C. 78f(b)(1).
    \13\ 15 U.S.C. 78f(b)(2).
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    Overall, the Commission believes that approving Nasdaq's Proposals 
could confer important benefits on the public and market participants. 
In particular, NOM's entry into the marketplace could provide market 
participants with an additional venue for executing orders in 
standardized options, enhance innovation, and increase competition 
between and among the options exchanges, resulting in better prices and 
executions for investors.
    This discussion does not review every detail of the proposed rule 
changes, but focuses on the comments received and the most significant 
rules and policy issues considered in review of the proposals.

A. Corporate Structure

    In connection with the establishment of NOM, Nasdaq has entered 
into a limited liability company agreement (``NOM LLC Agreement'') to 
establish NOM LLC as a Delaware limited liability company that will 
operate NOM as a facility of Nasdaq, as that term is defined in Section 
3(a)(2) of the Act.\14\ Nasdaq and NOM LLC also will enter into a 
delegation agreement (``NOM Delegation Agreement''), pursuant to which 
Nasdaq will delegate to NOM LLC certain limited responsibilities and 
obligations with respect to the operation of NOM as an options facility 
of Nasdaq.\15\
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    \14\ 15 U.S.C. 78c(a)(2). Pursuant to Section 3(a)(2), a 
``facility'' ``with respect to an exchange includes its premises, 
tangible or intangible property whether on the premises or not, any 
right to the use of such premises or property or any service thereof 
for the purpose of effecting or reporting a transaction on an 
exchange (including, among other things, any system of communication 
to or from the exchange, by ticker or otherwise, maintained by or 
with the consent of the exchange), and any right of the exchange to 
the use of any property or service.''
    \15\ The form of each of the NOM LLC Agreement and NOM 
Delegation Agreement are available at the Commission's Web site 
http://www.sec.gov.
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    Nasdaq, a registered national securities exchange, is the wholly-
owned subsidiary of The NASDAQ Stock Market, Inc. (``Nasdaq Holding 
Company''). NOM LLC will be a direct, wholly-owned subsidiary of 
Nasdaq, and, pursuant to the NOM LLC Agreement, Nasdaq may not transfer 
or assign, in whole or in part, its interest in NOM LLC.\16\ Further, 
NOM will be operated as a facility of the Exchange and Nasdaq will 
retain self-regulatory responsibility for NOM.
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    \16\ See NOM LLC Agreement, Section 19. Also, Nasdaq Holding 
Company may not transfer or assign its interest in Nasdaq, other 
than to an affiliate of Nasdaq Holding Company. See Limited 
Liability Company Agreement of The NASDAQ Stock Market LLC, Section 
20. Any change to Nasdaq's status as the sole member of NOM LLC, or 
to Nasdaq Holding Company's status as the sole member of Nasdaq, 
would have to be filed pursuant to Section 19(b) of the Act. 15 
U.S.C. 78s.
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1. Changes in Control of NOM; Ownership and Voting Limitations
    The Commission notes that the Nasdaq Holding Company's Restated 
Certificate of Incorporation imposes limits on direct and indirect 
changes in control, which are designed to prevent any shareholder from 
exercising undue control over the operation of the Exchange and to 
ensure that the

[[Page 14523]]

Exchange and the Commission are able to carry out their regulatory 
obligations under the Act. Specifically, no person who beneficially 
owns shares of common stock, preferred stock, or notes in excess of 
five percent of the securities generally entitled to vote may vote 
shares in excess of five percent.\17\
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    \17\ See Nasdaq Holding Company Restated Certificate of 
Incorporation, Article Fourth, C. The Nasdaq Holding Company board 
of directors may approve an exemption from the five percent voting 
limitation for any person that is not a broker-dealer, an affiliate 
of a broker-dealer, or a person subject to a statutory 
disqualification under Section 3(a)(39) of the Act. See id. Any such 
exemption from the five percent voting limitation would not be 
effective until approved by the Commission pursuant to Section 19 of 
the Act. See Nasdaq Holding Company By-Laws, Article XII, Section 
12.5.
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    The Exchange's rules also prohibit Exchange members and persons 
associated with Exchange members from beneficially owning more than 20 
percent of the then-outstanding voting securities of Nasdaq Holding 
Company.\18\ Members that trade on an exchange or through the facility 
of an exchange traditionally have ownership interests in such exchange 
or facility. The Commission has noted in the past, however, that a 
member's interest in an exchange could become so large as to cast doubt 
on whether the exchange can fairly and objectively exercise its self-
regulatory responsibilities with respect to that member.\19\ A member 
that is a controlling shareholder of an exchange might be tempted to 
exercise that controlling influence by directing the exchange to 
refrain from, or the exchange may hesitate to, diligently monitor and 
surveil the member's conduct or diligently enforce its rules and the 
federal securities laws with respect to conduct by the member that 
violates such provisions.
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    \18\ See Exchange Rule 2130.
    \19\ See Securities Exchange Act Release No. 53128 (January 13, 
2006), 71 FR 3550 (January 23, 2006) (order approving Nasdaq's 
application to register as a national securities exchange) 
(``Registration Approval Order'') at note 42 and accompanying text.
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    The Commission believes that the proposed corporate structure for 
NOM is consistent with the Act. The voting restrictions imposed on 
shareholders of Nasdaq Holding Company will flow through to NOM LLC by 
virtue of the fact that NOM LLC will be a wholly-owned subsidiary of 
Nasdaq, which is a wholly-owned subsidiary of Nasdaq Holding Company. 
The ownership limitation on members of Nasdaq will apply to NOM 
participants by virtue of the fact that all NOM participants must be 
members of the Exchange. These ownership and voting restrictions are 
designed to minimize the potential that a person could improperly 
interfere with or attempt to restrict the ability of the Commission or 
the Exchange to effectively carry out their regulatory oversight 
responsibilities under the Act.
2. Fair Representation
    NOM LLC will not have its own board of directors or committees 
separate from the board and committees of the Exchange. The Commission 
believes that because NOM LLC does not have a separate board, and 
because all NOM participants will be Exchange members, the composition 
of and selection process for the Exchange board continues to satisfy 
the requirement in Section 6(b)(3) of the Act that the rules of the 
Exchange provide for the fair representation of members in the 
selection of directors and the administration of the Exchange.\20\
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    \20\ See Registration Approval Order, supra note 19, at 3553.
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3. Regulatory Independence
    As noted above, NOM LLC will not have its own board or committees 
separate from those of the Exchange. Additionally, pursuant to the NOM 
LLC Agreement, management of the company is vested in the Exchange, and 
the officers of NOM LLC will be the officers of the Exchange.\21\ As a 
result, NOM LLC may only act through the Exchange and its officers and 
directors.
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    \21\ See NOM LLC Agreement, Sections 9 and 10, respectively. See 
also Section 9(b) of the NOM LLC Agreement which requires NOM LLC 
and the Exchange to comply with federal securities laws and the 
rules and regulations thereunder, and to cooperate with the 
Commission and NOM pursuant to their regulatory authority.
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    The Commission notes that certain provisions of the Exchange's and 
Nasdaq Holding Company's corporate documents are designed to maintain 
the independence of Nasdaq's self-regulatory function, enable the 
Exchange to operate in a manner that complies with federal securities 
laws, including the objectives of Sections 6(b) and 19(g) of the Act, 
and facilitate the ability of Nasdaq and the Commission to fulfill 
their regulatory and oversight obligations under the Act.\22\ As a 
facility of Nasdaq, the protections afforded by these provisions in the 
corporate documents of the Exchange and Nasdaq Holding Company extend 
to the operation of NOM.
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    \22\ A discussion of Nasdaq's corporate structure and the 
protections afforded by the corporate documents of Nasdaq and Nasdaq 
Holding Company, is set forth in the Registration Approval Order, 
supra note 19. The corporate documents of Nasdaq and Nasdaq Holding 
Company are not being amended by this proposed rule change.
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    Similar provisions also are included in the NOM Delegation 
Agreement. For example, NOM agrees: (1) To keep confidential non-public 
information relating to Nasdaq and not to use such information for any 
commercial purposes; (2) to provide the Commission and Nasdaq access to 
NOM's books and records at all times and to maintain such books and 
records within the United States; (3) that the books, records, 
premises, officers, and employees of NOM shall be deemed to be those of 
Nasdaq for purposes of the Act; and (4) to cooperate with, and take 
reasonable steps to cause its agents to cooperate with, the Commission 
and Nasdaq pursuant to their regulatory authority. In addition, NOM and 
its officers and employees submit to the jurisdiction of the Commission 
and agree to give due regard to the preservation of the self-regulatory 
function of Nasdaq.\23\ Further, the NOM Delegation Agreement may not 
be amended unless such amendment is filed with, or filed with and 
approved by, the Commission pursuant to Section 19 of the Act.\24\ The 
Commission believes that these provisions, which are designed to assist 
Nasdaq in fulfilling its self-regulatory obligations and in 
administering and complying with the requirements of the Act, are 
consistent with the Act, in particular Sections 6(b)(1) and 19(g).
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    \23\ See NOM Delegation Agreement, II.B.
    \24\ See NOM Delegation Agreement, III.
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B. Status of NOM as a Facility of Nasdaq and Delegation of Authority to 
NOM LLC

    As a facility of Nasdaq, NOM will be subject to the Commission's 
oversight and examination. Consequently, the Commission will have the 
same authority to oversee the premises, personnel, and records of NOM 
LLC as it currently has with respect to Nasdaq. In addition, Nasdaq 
will be fully responsible for all activity that takes place through 
NOM, and NOM participants will be subject to Nasdaq's rules and 
oversight.
    As described in detail in the Notice, the NOM Delegation Agreement 
provides that Nasdaq will delegate to NOM LLC performance of certain 
limited responsibilities and obligations of Nasdaq with respect to the 
operation of NOM as an options trading facility. Nasdaq, however, 
expressly retains ultimate responsibility for the fulfillment of its 
statutory and self-regulatory obligations under the Act. Accordingly, 
as described more fully below, Nasdaq will retain ultimate 
responsibility for such delegated responsibilities and functions, and 
any actions taken pursuant to delegated authority will remain subject 
to review, approval or rejections by Nasdaq's board

[[Page 14524]]

of directors in accordance with procedures established by Nasdaq's 
board of directors. Nasdaq has filed the NOM Delegation Agreement as 
part of its rules.
    Pursuant to the Delegation Agreement, Nasdaq expressly retains the 
authority to (1) delegate authority to NOM LLC to take actions on 
behalf of the Exchange, and (2) direct NOM LLC to take action necessary 
to effectuate the purposes and functions of Nasdaq, consistent with the 
independence of Nasdaq's regulatory functions, exchange rules, policies 
and procedures, and the federal securities laws.\25\ NOM LLC will have 
delegated authority to, among other things, operate NOM, develop and 
adopt governing listing standards applicable to options listed on NOM 
in consultation with Nasdaq, and establish and assess listing fees, 
transaction fees, market data fees and other fees for the products and 
services offered by NOM.\26\ In addition, NOM LLC will have the 
authority to act as a SIP for quotations and transaction information 
related to securities traded on NOM and any trading facilities operated 
by NOM LLC.\27\
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    \25\ See Corporate Structure Proposal Notice, supra note 8, at 
58140 and NOM Delegation Agreement, I.
    \26\ See Corporate Structure Proposal Notice, supra note 8, at 
58140 and NOM Delegation Agreement, II.A.
    \27\ See NOM Delegation Agreement, II.A.3.
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    NOM LLC also will have authority to develop, adopt, and administer 
rules governing participation in NOM,\28\ but the Exchange represents 
that it will have ultimate responsibility for the operations, rules and 
regulations developed by NOM LLC, as well as their enforcement. 
Further, the Exchange represents that actions taken by NOM LLC pursuant 
to its delegated authority will remain subject to review, approval or 
rejection by the Exchange's board of directors.\29\ In addition, NOM 
LLC will be responsible for referring to Nasdaq any complaints of a 
regulatory nature involving potential rule violations by member 
organizations or employees,\30\ and Nasdaq will retain overall 
responsibility for ensuring that the statutory and self-regulatory 
functions of the Exchange are fulfilled.\31\
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    \28\ Id.
    \29\ See Corporate Structure Proposal Notice, supra note 8, at 
58140.
    \30\ See NOM Delegation Agreement, II.A.9.
    \31\ See NOM Delegation Agreement, I.1.
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    The Commission finds that it is consistent with the Act for Nasdaq 
to delegate the operation of NOM to NOM LLC, while retaining ultimate 
responsibility for statutory and self-regulatory obligations and 
ensuring that NOM's business is conducted in a manner consistent with 
the requirements of the Act.

C. Access to NOM

    Only Options Participants (``Options Participants'' or 
``Participants'') may transact business on NOM via the System.\32\ 
There are two categories of Participants: (1) Options Order Entry Firms 
(``OEFs''), which represent customer orders as agent or conduct 
proprietary trading; and (2) Options Market Makers (``Options Market 
Makers'' or ``Market Makers''). A Participant must be a member of 
Nasdaq and of another registered options exchange that is not 
registered solely under Section 6(g) of the Act.\33\ As Nasdaq members, 
Participants must satisfy the requirements of the Nasdaq Rule 1000 
Series (Membership, Registration, and Qualification Requirements), as 
well as additional requirements set forth in the NOM rules.\34\ 
Further, an OEF may transact business with Public Customers only if it 
is a member of another registered national securities exchange or 
association with which Nasdaq has entered into an agreement under Rule 
17d-2 under the Act \35\ pursuant to which the other exchange or 
association is the designated options examining authority for the 
OEF.\36\ In addition, Options Participants that transact business with 
customers must be members of FINRA.\37\
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    \32\ See NOM Rules, Chapter II, Section 1(a). An Options 
Participant is a firm or organization registered with Nasdaq 
pursuant to Chapter II of the NOM Rules for purposes of 
participating in options trading on NOM as an Order Entry Firm or 
Options Market Maker. See NOM Rules, Chapter I, Section 1(a)(40).
    \33\ 15 U.S.C. 78f(g). See NOM Rules, Chapter II, Sections 
1(a)(iii) and 2(f). In Amendment No. 2, Nasdaq proposes to eliminate 
from Chapter II, Section 1(b)(iii) a provision stating that a Nasdaq 
member would automatically become a NOM Participant upon completing 
a NOM Application and paying the applicable fees. Nasdaq believes 
that this provision did not accurately reflect the intended scope of 
review of NOM applicants, and that eliminating the provision will 
improve the quality of regulation of NOM. The Commission finds that 
this change is consistent with the Act.
    \34\ See NOM Rules, Chapter II. Nasdaq's rules apply to 
Participants unless a specific NOM rule governs or unless the 
context otherwise requires. See NOM Rules, Chapter I, Section 2. 
Among others, Participants will be able to provide sponsored access 
to NOM to a non-member (``Sponsored Participant'') pursuant to 
Nasdaq Rule 4611(d), which Nasdaq adopted in 2007. See Securities 
Exchange Act Release Nos. 55061 (January 8, 2007), 72 FR 2052 
(January 17, 2007) (notice of filing and immediate effectiveness of 
File No. SR-Nasdaq-2006-061) (adopting Nasdaq Rule 4611(d)); and 
55550 (March 28, 2007), 72 FR 16389 (April 4, 2007) (notice of 
filing and immediate effectiveness of File No. SR-Nasdaq-2007-010) 
(revising Nasdaq Rule 4211(d)).
    \35\ 17 CFR 240.17d-2.
    \36\ See NOM Rules, Chapter XI, Section 1. See also notes 240 to 
241, infra, and accompanying text for a discussion of Rule 17d-2.
    \37\ See NOM Rules, Chapter II, Section 2(f).
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    Among other things, each Participant must be registered as a 
broker-dealer and have as the principal purpose of being a Participant 
the conduct of a securities business, which shall be deemed to exist if 
and so long as: (1) The Participant has qualified and acts in respect 
of its business on NOM as either an OEF or an Options Market Maker or 
both; and (2) all transactions effected by the Participant are in 
compliance with Section 11(a) of the Act \38\ and the rules and 
regulations thereunder.\39\ Participants may trade options for their 
own proprietary accounts or, if authorized to do so under applicable 
law, may conduct business on behalf of customers.\40\
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    \38\ 15 U.S.C. 78k(a).
    \39\ See NOM Rules, Chapter II, Section 2(e).
    \40\ See NOM Rules, Chapter II, Section 1(a).
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1. OEFs
    OEFs are Participants representing customer orders as agent on NOM 
or trading as principal on NOM.\41\ OEFs also may register as Market 
Makers. A Market Maker that engages in specified Other Business 
Activities, or that is affiliated with a broker-dealer that engages in 
Other Business Activities, including functioning as an OEF, must have 
an Information Barrier between the market making activities and the 
Other Business Activities.\42\
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    \41\ See NOM Rules, Chapter VII, Section 1.
    \42\ See NOM Rules, Chapter VII, Section 10.
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    One commenter believes that the ability of OEFs, like Market 
Makers, to enter orders on both sides of the market for the same 
customer raises questions concerning the rights and responsibilities of 
the OEF and the customer. In particular, the commenter asks whether 
Market Makers will have exclusive access to certain NOM systems or 
other tools, or otherwise have rights that differ from the rights of 
these customers. The commenter also asserts that NOM's proposal lacks 
clarity regarding its Participants' responsibility for surveillance of 
the activities of these market participants.\43\
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    \43\ See SIFMA Letter, supra note 4, at 2.
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    In response, Nasdaq stated its belief that the NOM market model is 
similar to Nasdaq's equity market structure and does not raise any 
unique or challenging issues for order entry firms and investors. 
Nasdaq further believes that most Participants will be familiar with 
the regulatory and surveillance requirements associated with access to 
NOM from their businesses in equity securities.\44\ Nasdaq represents 
that,

[[Page 14525]]

within the System, Market Makers will not have any special priorities 
or other privileges.\45\
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    \44\ See Nasdaq Response, supra note 5, at 2.
    \45\ 45 Id. at 5. Registered market makers do, however, receive 
certain benefits for carrying out their responsibilities. For 
example, a lender may extend credit to a broker-dealer without 
regard to the restrictions in Regulation T of the Board of Governors 
of the Federal Reserve System if the credit is used to finance the 
broker-dealer's activities as a specialist or market maker on a 
national securities exchange (see 12 CFR 221.5(c)(6)). In addition, 
market makers are excepted from the prohibition in Section 11(a) of 
the Act.
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    The Commission believes that it is consistent with the Act for an 
options exchange not to prohibit a user of its market from effectively 
operating as a market maker by holding itself out as willing to buy and 
sell options contracts on a regular or continuous basis without 
registering as a market maker.\46\ The Commission notes that although 
an entity that effectively acts as a market maker but is not registered 
as such will not be required to comply with any rules applicable to a 
Market Maker, it also will not be eligible to receive certain benefits 
of being a Market Maker.\47\ The Commission also agrees with Nasdaq's 
assertion that NOM does not raise any unique issues related to 
surveillance or the responsibilities of OEFs, and notes that all 
Options Participants must also be members of Nasdaq. Further, the 
Commission notes that an entity that acts as a ``dealer,'' as defined 
in Section 3(a)(5) of the Act,\48\ would be required to register with 
the Commission under Section 15 of the Act,\49\ and the rules and 
regulations thereunder, or qualify for any exception or exemption from 
registration.\50\
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    \46\ See Securities Exchange Act Release No. 38054 (December 16, 
1996), 61 FR 67365 (December 20, 1996) (order approving File No. SR-
CBOE-95-48).
    \47\ See infra notes 76 and 84 and accompanying text.
    \48\ 15 U.S.C. 78c(a)(5).
    \49\ 15 U.S.C. 78o.
    \50\ Activity that may cause a person to be deemed a dealer 
includes ``'quoting a market in or publishing quotes for securities 
(other than quotes on one side of the market on a quotations system 
generally available to non-broker-dealers, such as a retail screen 
broker for government securities).''' See Definition of Terms in and 
Specific Exemptions for Banks, Savings Associations, and Savings 
Banks Under Sections 3(a)(4) and 3(a)(5) of the Securities Exchange 
Act of 1934, Securities Exchange Act Release No. 47364, 68 FR 8685, 
8689, note 26 (February 24, 2003) (quoting OTC Derivatives Dealers, 
Securities Exchange Act Release No. 40594, 63 FR 59362, 59370, note 
61 (November 3, 1998)).
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2. Market Makers
a. Registration of Market Makers
    An Options Market Maker is a Participant registered with Nasdaq as 
a Market Maker.\51\ To register as a Market Maker, a Participant must 
file a written application with Nasdaq Regulation, which will consider 
an applicant's market making ability and other factors it deems 
appropriate in determining whether to approve an applicant's 
registration.\52\ All Market Makers are designated as specialists on 
NOM for all purposes under the Act or rules thereunder.\53\ The NOM 
Rules place no limit on the number of qualifying entities that may 
become Market Makers.\54\ The good standing of a Market Maker may be 
suspended, terminated, or withdrawn if the conditions for approval 
cease to be maintained or the Market Maker violates any of its 
agreements with Nasdaq or any provisions of the NOM Rules.\55\ A 
Participant that has qualified as a Market Maker may register to make 
markets in individual series of options.\56\
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    \51\ See NOM Rules, Chapter VII, Section 2.
    \52\ See NOM Rules, Chapter VII, Section 2(a).
    \53\ See NOM Rules, Chapter VII, Section 2.
    \54\ See NOM Rules, Chapter VII, Rule 2(c). However, Nasdaq may 
limit access to the System based on system constraints, capacity 
restrictions, or other factors relevant to protecting the integrity 
of the System, pending action required to address the issue of 
concern. To the extent that Nasdaq places limitations on access to 
the System on any Participant(s), such limits shall be objectively 
determined and submitted to the Commission for approval pursuant to 
a rule change filed under Section 19(b) of the Act. See NOM Rules, 
Chapter VII, Section 2(c).
    \55\ See NOM Rules, Chapter VII, Section 4(b).
    \56\ See NOM Rules, Chapter VII, Section 3(a).
---------------------------------------------------------------------------

    The Commission finds that NOM Market Maker qualifications 
requirements are consistent with the Act, and notes that they are 
similar to those of other options exchanges.\57\ Further, the 
Commission believes that allowing NOM Market Makers to register by 
series, rather than by class, will permit Market Makers to select the 
options series they are most interested in trading. This is designed to 
help to reduce the number of quotes submitted by such Market Makers, 
and therefore could help to mitigate NOM's quote message traffic and 
capacity.\58\
---------------------------------------------------------------------------

    \57\ See, e.g., BOX Rules, Chapter VI, Section 2 and ISE Rule 
804.
    \58\ See Securities Exchange Act Release No. See Securities 
Exchange Act Release No. 55027 (December 29, 2006), 72 FR 1358 
(January 11, 2007) (order approving File No. SR-Phlx-2006-53). 
Further, one commenter believes that series-by-series registration 
will allow market makers to target the series for which they are 
most apt to provide liquidity, which in turn will create greater 
liquidity across the entire market. See GETCO Letter, supra note 4, 
at 2.
---------------------------------------------------------------------------

b. Market Maker Obligations
    Pursuant to NOM rules, the transactions of a Market Maker in its 
market making capacity must constitute a course of dealings reasonably 
calculated to contribute to the maintenance of a fair and orderly 
market.\59\ Further, among other things, a Market Maker must: (1) On a 
daily basis participate in the pre-opening phase and maintain a two-
sided market on a continuous basis in at least 75% of the options 
series in which it is registered;\60\ (2) enter a size of at least ten 
contracts for its best bid and its best offer;\61\ and (3) maintain 
minimum net capital in accordance with Commission and Nasdaq rules.\62\ 
In addition, Nasdaq may call upon a Market Maker to submit a single bid 
or offer or to maintain continuous bids and offers in one or more of 
the series in which the Market Maker is registered if, in Nasdaq's 
judgment, it is necessary to do so in the interest of fair and orderly 
markets.\63\ If Nasdaq finds any substantial or continued failure by a 
Market Maker to engage in a course of dealings as specified in Chapter 
VII, Section 5(a) of the NOM Rules, such Market Maker will be subject 
to disciplinary action or suspension or revocation of registration in 
one or more of the securities in which the Market Maker is 
registered.\64\
---------------------------------------------------------------------------

    \59\ See NOM Rules, Chapter VII, Section 5(a). Amendment No. 2 
replaces the provisions in the NOM proposal related to the 
Exchange's ability to automatically cancel all bids and offers 
posted by a Market Maker under certain circumstances with provisions 
allowing any Options Participant to ask NOM staff to simultaneously 
cancel all of the Options Participant's bids, offers, and orders in 
all series. See NOM Rules, Chapter VII, Section 11. The Commission 
believes that the proposed change is reasonably designed to enable 
Participants to limit their risk and is consistent with the Act.
    \60\ See NOM Rules, Chapter VII, Section 6(d)(i).
    \61\ See NOM Rules, Chapter VII, Section 6(a).
    \62\ See NOM Rules, Chapter VII, Section 4(a)(i).
    \63\ See NOM Rules, Chapter VII, Section 6(d)(ii).
    \64\ See NOM Rules, Chapter VII, Section 5(c).
---------------------------------------------------------------------------

    One commenter notes that NOM's rules do not appear to assure that 
there will be continuous quotes in a particular series because a Market 
Maker could cease disseminating quotes for a series at any time during 
the trading day, and requests that Nasdaq clarify a market maker's 
continuous quoting obligations.\65\ In response, Nasdaq notes that 
other options markets face the possibility that a registered market 
maker will withdraw its quotes during the trading day, and that NOM's 
rules permit Nasdaq to require a market maker to quote continuously in 
a series in which it is registered.\66\ Nasdaq further notes that it 
intends to provide functionality that will allow its Market Makers to 
instruct the NOM System to automatically input a quotation on the side 
of the market that has been depleted. In addition, Nasdaq represents 
that it will bring an appropriate disciplinary action against a Market

[[Page 14526]]

Maker that fails to meet its quoting obligations.\67\
---------------------------------------------------------------------------

    \65\ See SIFMA Letter, supra note 4, at 1.
    \66\ See Nasdaq Response, supra note 5, at 3, and NOM Rules, 
Chapter VII, Section 6(d)(ii).
    \67\ See Nasdaq Response, supra note 5, at 3.
---------------------------------------------------------------------------

    This commenter also requests clarification of NOM's treatment of 
options series without a Market Maker. In particular, the commenter 
questions the actions NOM will take if a Market Maker withdraws from 
making markets in a series, including whether NOM will continue to 
match orders in the series.\68\ To the extent that the commenter is 
questioning what will happen if a Market Maker registered in a series 
does not have a quote in that series (as opposed to the Market Maker 
withdrawing from registration in the series),\69\ Nasdaq states that 
NOM will continue to route and execute orders in that series. In 
addition, Nasdaq states that, if an order is received by NOM when its 
quote is not at the NBBO, NOM will route the order automatically to a 
market at the NBBO. An order displayed on NOM that becomes marketable 
will be accessible through the Linkage.\70\
---------------------------------------------------------------------------

    \68\ See SIFMA Letter, supra note 4, at 2.
    \69\ See discussion infra notes 77 to 79 and accompanying text.
    \70\ See Nasdaq Response, supra note 5, at 3.
---------------------------------------------------------------------------

    The definition of a ``market maker'' includes a dealer who holds 
itself out as being willing to buy and sell a security for his account 
on a regular or continuous basis.\71\ Therefore, although under NOM's 
proposal certain series may not have continuous quotes disseminated by 
NOM, the Commission believes that the obligations imposed by the NOM 
Rules on Market Makers fall within the definition of market maker 
because they will require a NOM Market Maker to hold itself out as 
being willing to buy and sell a security for its account on a regular 
basis. The Commission therefore believes that the obligations imposed 
by the NOM Rules on Market Makers are consistent with the Act.\72\
---------------------------------------------------------------------------

    \71\ See 15 U.S.C. 78c(a)(38) (definition of ``market maker'').
    \72\ The Commission notes that in approving the rules of the 
Boston Options Exchange (``BOX''), the Commission acknowledged that 
certain options series might not have continuous quotes disseminated 
by BOX, but concluded that the obligations imposed on market makers 
under the BOX Rules were consistent with the Act. The Commission 
also noted that the CBOE's Hybrid trading system had market maker 
obligations comparable to those proposed for BOX and also did not 
require market makers to quote all series. See Securities Exchange 
Act Release No. 49068 (January 13, 2004), 69 FR 2775 (January 20, 
2004) (order approving File No. SR-BSE-2002-15) (``BOX Approval 
Order'').
---------------------------------------------------------------------------

    The commenter also asserts that other options exchanges generally 
require market makers to provide two-sided quotations for 80% of the 
classes in which a market maker is registered, and that uniform 
quotation requirements among the options markets would be 
desirable.\73\ In its response letter, Nasdaq states that NOM's Market 
Maker participation standard, which will allow Market Makers to 
register in particular options series rather than an entire class, 
should result in active participation in all series for which a Market 
Maker registers voluntarily.\74\ In addition, Nasdaq maintains that its 
approach is numerically superior to other options exchanges, noting 
that the BOX Rules effectively require market makers to maintain 
continuous two-sided quotes in only 72% of the series in which they are 
registered, or at times in only 60% of the series in which they are 
registered.\75\
---------------------------------------------------------------------------

    \73\ See SIFMA Letter, supra note 4, at 2.
    \74\ See Nasdaq Response, supra note 5, at 5.
    \75\ See id. and BOX Rules, Chapter VI, Section 6(d)(i).
---------------------------------------------------------------------------

    Market makers receive certain benefits for carrying out their 
responsibilities. For example, a lender may extend credit to a broker-
dealer without regard to the restrictions in Regulation T of the Board 
of Governors of the Federal Reserve System if the credit is used to 
finance the broker-dealer's activities as a specialist or market maker 
on a national securities exchange.\76\ In addition, market makers are 
excepted from the prohibition in Section 11(a) of the Act. The 
Commission believes that a market maker must have sufficient 
affirmative obligations, including the obligation to hold itself out as 
willing to buy and sell options for its own account on a regular or 
continuous basis, to justify this favorable treatment. The Commission 
further believes that the rules of all U.S. options markets need not 
provide the same standards for market maker participation, so long as 
they impose affirmative obligations that are consistent with the Act. 
The Commission believes that NOM's market maker participation 
requirements impose sufficient affirmative obligations on NOM Market 
Makers and, accordingly, that NOM's requirements are consistent with 
the Act.
---------------------------------------------------------------------------

    \76\ 12 CFR 221.5(c)(6).
---------------------------------------------------------------------------

    Nasdaq will open trading in an options series only if there is at 
least one Market Maker registered for trading in that series.\77\ One 
commenter requests clarification of NOM's treatment of options series 
without a Market Maker. In particular, the commenter questions the 
actions NOM will take if a Market Maker withdraws from making markets 
in a series, including whether NOM will continue to match orders in the 
series.\78\ In response, Nasdaq states that it is amending proposed 
Chapter IV, Section 5 to provide that, in the event a sole Market Maker 
for a series withdraws its registration and ceases making markets, NOM 
will place the series in a non-regulatory suspension and halt trading 
until such time as a member registers to make markets in that 
series.\79\
---------------------------------------------------------------------------

    \77\ See NOM Rules, Chapter IV, Section 5.
    \78\ See SIFMA Letter, supra note 4, at 2.
    \79\ See Nasdaq Response, supra note 5, at 3. Nasdaq further 
notes that, in Amendment No. 2, it proposes to clarify that in such 
circumstances, NOM will not execute orders on its book and will have 
no rights and privileges under the Linkage Plan to accept inbound 
orders from away markets. Nasdaq will continue to accept and route 
Participant orders that are designated for routing and execution at 
the best price in away markets. Id.
---------------------------------------------------------------------------

    In addition, the commenter notes that the proposal does not address 
a Market Maker's use of the matching system for new customer orders 
after it has withdrawn as a Market Maker.\80\ To the extent that the 
commenter is asking whether a Market Maker can enter a customer order 
when it is not quoting in a series in which it is registered, Nasdaq 
notes that the NOM Rules require that, if a Market Maker enters a bid 
in a series in which he is registered, he must also enter an offer,\81\ 
and that therefore a Market Maker will not be able to enter customer 
orders without submitting a quote on the other side of the market from 
the customer order.\82\ Further, Nasdaq notes that the NOM Rules 
prohibit a Market Maker from acting as an OEF without instituting 
appropriate information barriers.\83\ To the extent that the commenter 
is asking whether an entity that withdraws as a Market Maker in a 
series can then act as an OEF in that series, Nasdaq notes that a 
Participant that has withdrawn as a Market Maker and is participating 
in NOM as an OEF would not receive favorable margin treatment under 
Regulation T.\84\
---------------------------------------------------------------------------

    \80\ See SIFMA Letter, supra note 4, at 2.
    \81\ See NOM Rules, Chapter VII, Section 6(b), which states that 
a Market Maker that enters a bid (offer) in a series in which he is 
registered on NOM must enter an offer (bid).
    \82\ See Nasdaq Response, supra note 5, at 4.
    \83\ See NOM Rules, Chapter VII, Section 10.
    \84\ See Nasdaq Response, supra note 5, at 4.
---------------------------------------------------------------------------

    The Commission believes that Nasdaq has adequately clarified NOM's 
treatment of options series when either: (1) A registered Market Maker 
is not quoting in that series or (2) a registered Market Maker 
withdraws from registration in the series.
c. Single Market Maker Requirement
    One commenter believes that Nasdaq should require at least two 
market makers for an options series to be listed and traded on NOM so 
that adequate depth and liquidity will be available to market 
participants.\85\ The commenter

[[Page 14527]]

also believes that, in the context of the order exposure requirements 
established in Chapter VII, Section 14 of the NOM Rules,\86\ there will 
not be meaningful order exposure with a ``trading crowd'' of fewer than 
two market makers.\87\ In addition, the commenter believes that the 
term ``trading crowd'' may be a misnomer if the trading crowd consists 
of only one market maker.\88\
---------------------------------------------------------------------------

    \85\ See Amex Letter, supra note 4, at 2.
    \86\ Amendment No. 2 renumbers this provision as Chapter VII, 
Section 12 of the NOM Rules.
    \87\ See Amex Letter, supra note 4, at 1.
    \88\ Id. at 2. Amex also questions the meaning of the term 
``trading crowd'' in Chapter III, Section 4(f) of the NOM Rules. 
Nasdaq notes that it has deleted the term ``trading crowd'' from 
this rule to make clear that the electronic crowd will be composed 
of all NOM Participants, as is the case for other electronic 
markets. See Nasdaq Response, supra note 5, at note 9.
---------------------------------------------------------------------------

    In response, Nasdaq asserts that neither the Act nor Commission 
rules require a market to provide for more than one market maker, and, 
in fact, the specialist system is an example of a one market maker 
market model.\89\ Nasdaq believes that the NOM structure fulfills the 
objectives of Section 11A of the Act by providing a trading platform 
that will allow customer orders to meet without the intervention of a 
dealer.\90\ Nasdaq further maintains that lower barriers to 
participation will attract liquidity and market depth from order entry 
firms and other market participants. Nasdaq also notes that it intends 
to provide an environment whereby robust competition between multiple 
market makers will provide depth and liquidity, but that it does not 
believe market participants should be prevented from trading directly 
with one another due to the absence of multiple dealers.\91\
---------------------------------------------------------------------------

    \89\ See Nasdaq Response, supra note 5, at 8 to 9.
    \90\ Id. at 8.
    \91\ Id. at 9.
---------------------------------------------------------------------------

    The Commission agrees that the Act does not mandate a particular 
market model for national securities exchanges, and believes that many 
different types of market models could satisfy the requirements of the 
Act. The Commission does not believe that the Act requires an exchange 
to have market makers.\92\ Although Market Makers could be an important 
source of liquidity on NOM, they likely will not be the only source. In 
particular, the NOM System is designed to match buying and selling 
interest of all Participants on NOM. The Commission therefore believes 
that the NOM structure is consistent with the Act.
---------------------------------------------------------------------------

    \92\ In its release adopting Regulation ATS, the Commission 
rejected the suggestion that a guaranteed source of liquidity was a 
necessary component of an exchange. See Securities Exchange Act 
Release No. 40760 (December 8, 1998), 63 FR 70844 (December 22, 
1998) (``Regulation ATS Release''). See also Securities Exchange Act 
Release No. 44983 (October 25, 2001), 66 FR 55225 (November 1, 2001) 
(File No. SR-PCX-00-25) (order approving Archipelago Exchange as the 
equities trading facility of the Pacific Exchange), at Section IV.B.
---------------------------------------------------------------------------

D. NOM Trading System

1. Overview
    NOM will be a fully automated electronic system (``System'') for 
trading standardized options, and will be a facility of Nasdaq, as 
defined in Section 3(a)(2) of the Act.\93\ Participants will be able to 
enter Displayed Orders on NOM at single and multiple price levels for 
the following order types: \94\ Market Orders; Limit Orders; Reserve 
Orders; \95\ Minimum Quantity Orders; \96\ Discretionary Orders; \97\ 
and Price Improving Orders.\98\ Participants may designate orders to be 
routed to other market centers when trading interest is not present on 
NOM or to be executed only on NOM.\99\ Nasdaq also had originally 
proposed to allow Participants to enter Non-Displayed Orders.\100\ 
Commenters expressed concerns about the use of Non-Displayed Orders in 
the options markets.\101\ Nasdaq in Amendment No. 2 has proposed to 
eliminate Non-Displayed Orders.\102\ Because Nasdaq has proposed to 
eliminate this order type, this order does not make any findings with 
respect to Non-Displayed Orders.
---------------------------------------------------------------------------

    \93\ 15 U.S.C. 78c(a)(2). The System includes: (1) An order 
execution service that allows Participants to automatically execute 
transactions in securities listed and traded on NOM; (2) a trade 
reporting service that submits locked-in trades to a registered 
clearing agency for clearance and settlement, transmits last sale 
reports to the Options Price Reporting Authority, if required, for 
dissemination to the public and industry, and provides Participants 
with monitoring and risk management capabilities; and (3) a data 
feed(s) that can be used to display without attribution to 
Participants' MPIDs Displayed Orders on both the bid and offer side 
of the market for price levels within NOM using the minimum price 
variation applicable to the security. See NOM Rules, Chapter VI, 
Section 1(a). See Trading Rules Proposal Notice, supra note 3, for a 
more complete description of NOM operation and rules. The Commission 
notes that the Plan for Reporting of Consolidated Options Last Sale 
Reports and Quotation Information (``OPRA Plan'') requires each 
party to the plan to collect and promptly transmit to OPRA all last 
sale reports relating to its market. See OPRA Plan, Section V(a).
    \94\ NOM does not propose to trade complex orders at this time. 
Participants may enter orders with the following time-in-force 
designations: Expire Time; Immediate or Cancel (``IOC''); DAY; and 
Good Til Cancelled. See NOM Rules, Chapter VI, Section 1(g).
    \95\ A Reserve Order is a limit order with displayed size and an 
additional non-displayed amount, both of which are available for 
execution against incoming orders. If the displayed portion of a 
Reserve Order is executed fully, the System will replenish the 
display portion from reserve up to the size of the original display 
amount. The System creates a new time stamp for the replenished 
portion of an order each time it is replenished from reserve, while 
the reserve portion retains the time stamp of its original entry. 
See NOM Rules, Chapter VI, Section 1(e)(1).
    \96\ A Minimum Quantity Order must be designated as IOC and 
requires that a specified minimum number of contracts be traded. A 
Minimum Quantity Order received prior to the Opening Cross or after 
the market close will be cancelled. See NOM Rules, Chapter VI, 
Section 1(e)(3).
    \97\ A Discretionary Order has both a displayed price and size 
and a non-displayed discretionary price range at which the entering 
party is willing to buy or sell. The non-displayed interest is not 
entered into the System book but is converted, along with the 
displayed size, into an IOC buy (sell) order at the highest (lowest) 
price in the discretionary price range when displayed contracts 
become available on the opposite side of the market or an execution 
takes place at any price within the discretionary price range. If 
more than one Discretionary Order is available for conversion into 
an IOC order, the System will convert and process all such orders in 
the same order as they were entered. If an IOC order is not executed 
in full, the unexecuted portion of the order is reposted 
automatically and displayed in the System book with a new time stamp 
at its original displayed price and with its non-displayed 
discretionary price range. See NOM Rules, Chapter VI, Section 
1(e)(4).
    \98\ A Price Improving Order is an order to buy or sell an 
option at a specified price smaller than the minimum price variation 
(``MPV'') in the security. Price Improving Orders may be entered in 
increments as small as one cent. A Price Improving Order will be 
displayed at the MPV in that security and rounded up for sell orders 
and down for buy orders. See NOM Rules, Chapter VI, Section 1(e)(6).
    \99\ See NOM Rules, Chapter VI, Section 11(a). See also 
Amendment No. 2 and the Trading Rules Proposal Notice, supra note 3, 
at 23871.
    \100\ A Non-Displayed Order was defined as a limit order that is 
not displayed in the System but is available for execution against 
all incoming orders until executed in full or cancelled.
    \101\ See Citadel Letter, supra note 4, at 3, and Amex Letter, 
supra note 4, at 2.
    \102\ Nasdaq has made corresponding changes throughout the NOM 
Rules to reflect the deletion of this order type.
---------------------------------------------------------------------------

    All trading interest on NOM will be automatically executable. The 
NOM System and rules provide for the ranking, display, and execution of 
all orders in price/time priority without regard to the status of the 
entity entering an order.\103\ Displayed Orders will have priority over 
non-displayed interest at the same price.\104\ Any price improvement 
resulting from an execution in the System will accrue to the party 
taking liquidity.\105\
---------------------------------------------------------------------------

    \103\ See NOM Rules, Chapter VI, Section 10. In Amendment No. 2, 
Nasdaq made a technical change to Chapter VI, Section 10 to clarify 
that the System will execute trading interest at the best price in 
the System before executing trading interest at the next best price. 
This change does not alter the execution algorithm as it was 
proposed. See Amendment No. 2.
    \104\ See NOM Rules, Chapter VI, Section 10(1). At each price, 
trading interest will be executed in the following order: (A) 
Displayed Orders; (B) the Non-Displayed portion of Reserve Orders, 
in time priority among such interest; and (C) the discretionary 
portion of Discretionary Orders, in time priority among such 
interest.
    \105\ See NOM Rules, Chapter VI, Section 10. One commenter 
maintains that the original proposal did not define ``taker of 
liquidity'' and failed to specify how price improvement would accrue 
to the taker of liquidity. See Amex Letter, supra note 4, at 3. In 
response, Amendment No. 2 modifies NOM's rules to indicate that any 
price improvement will accrue to the party removing liquidity 
previously posted to the Book. See NOM Rules, Chapter VI, Section 
10(3). The Commission believes that this change clarifies NOM's 
rules and is consistent with the Act.

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

[[Page 14528]]

    The Commission believes that NOM's proposed execution priority 
rules are consistent with the Act. The Commission notes that one 
commenter specifically supported NOM's price/time priority algorithm, 
noting its belief that ``flat and open'' systems encourage better 
executions and provide increased liquidity to the market.\106\ The 
Commission also believes that NOM's proposed order types are consistent 
with the Act, and discusses several particular order types below.
---------------------------------------------------------------------------

    \106\ See GETCO Letter, supra note 4, at 1.
---------------------------------------------------------------------------

2. Attributable Orders
    A Displayed Order may be entered with attribution to a 
Participant's MPID (an Attributable Order) or on an anonymous basis (a 
Non-Attributable Order).\107\ One commenter expresses concern that 
Attributable Orders could result in discrimination against particular 
members.\108\ The commenter believes, for example, that it is 
beneficial for a firm to identify itself when facilitating customer 
order flow since an exchange and its members may want to allow 
particular members to trade against more than the minimum guaranteed 
amount of the order to encourage the member to send more order flow to 
that exchange.\109\
---------------------------------------------------------------------------

    \107\ See NOM Rules, Chapter VI, Section 1(d).
    \108\ See ISE Letter, supra note 4, at 2.
    \109\ Id. at note 3.
---------------------------------------------------------------------------

    The commenter also expressed concern that identifying the entering 
firm could encourage internalization. The commenter also asserts that 
Attributable Orders would defeat the anti-internalization function of 
the information barriers between a firm's market making and customer 
order entry activities.\110\ The commenter believes that the 
internalization concern is particularly significant in the context of 
Nasdaq's ``first-in-first-out'' market model, where orders at a given 
price will be executed in sequence, with no priority for customer 
orders at the best price or pro rata distribution among participants 
quoting at that price. With no customer priority or pro rata allocation 
among Participants quoting at the best price, the commenter believes 
that a Participant that sees its firm's order at the top of the book 
would be able to execute against, and internalize, all of the displayed 
order.\111\
---------------------------------------------------------------------------

    \110\ Id. at 2-3.
    \111\ Id. at 3.
---------------------------------------------------------------------------

    In its response letter, Nasdaq notes that Attributable Orders are a 
voluntary feature of the System, and that no firm will be required to 
reveal its identity.\112\ Nasdaq also argues that there is no selective 
disclosure; Nasdaq will publish the identity of the NOM Participant 
only when the order is posted on the NOM book, and that disclosure will 
be made simultaneously to all market participants in a proprietary data 
feed.\113\ Further, Nasdaq notes that information barriers are designed 
to prevent a Market Maker from obtaining and using information about 
customer orders prior to execution, and that OEFs must route customer 
orders to the best available market, even if that is the market 
displaying the firm's Attributable Order.\114\ Nasdaq also believes 
that its price/time algorithm allows less internalization than ISE's 
pro rata allocation, which guarantees 40% of the order to a market 
maker under certain conditions. Nasdaq further notes that there is 
always the possibility that an incoming order trades with a Price 
Improving Order, rather than a displayed Attributable Order.
---------------------------------------------------------------------------

    \112\ See Nasdaq Response, supra note 5, at 7.
    \113\ Id.
    \114\ Id.
---------------------------------------------------------------------------

    To the extent that a market participant is concerned that its order 
would be discriminated against, as Nasdaq notes, the market participant 
can choose to enter a Non-Attributable Order. In addition, the 
Commission does not believe that it is likely that participants in a 
fully electronic market, such as NOM, will refrain from trading with a 
particular Participant's Attributable Orders in order to allow that 
Participant to do so, particularly in light of their best execution 
obligations.
    Moreover, the Commission does not believe that a member's use of 
Attributable Orders, by itself, will cause a Market Maker to violate 
NOM's information barrier rule. The purpose of requiring information 
barriers is to prohibit the flow of material non-public information 
between the market making activities and other business activities of a 
firm. With respect to Attributable Orders, a Market Maker will learn 
the identity of an Attributable Order at the same time as all other 
Participants--that is, once it is displayed on NOM and disseminated 
over NOM's proprietary data feed. The Market Maker will not have any 
knowledge of the order prior to that time. The Commission does not 
believe that allowing Market Makers to see this information once it is 
posted on the book undermines the policy of having information 
barriers. The Commission might reach a different conclusion, however, 
if order attribution information were disclosed preferentially to 
certain Participants or if Market Makers had a systemic or other 
advantage that allowed them to receive this information in a more 
timely manner.
3. Reserve Orders and Price Improving Orders \115\
---------------------------------------------------------------------------

    \115\ Nasdaq has proposed in Amendment No. 2 to eliminate the 
Non-Displayed Order type. Therefore, this approval order does not 
discuss Non-Displayed Orders. See supra notes 100 to 102 and 
accompanying text.
---------------------------------------------------------------------------

    Nasdaq proposes to allow participants to enter Reserve Orders, 
which are limit orders with displayed size and an additional non-
displayed amount, both of which are available for execution against 
incoming orders. If the displayed portion of a Reserve Order is 
executed fully, the System will replenish the display portion from 
reserve up to the size of the original display amount. The non-
displayed portion of a Reserve Order has lower priority than any 
displayed order.
    In addition, Nasdaq proposes a new order type called a Price 
Improving Order. A Price Improving Order has a specified price smaller 
than the minimum price variation (``MPV'') in the option. Price 
Improving Orders may be entered in increments as small as one cent. 
Price Improving Orders will be displayed at the MPV in that security 
and rounded up for sell orders and down for buy orders. For the reasons 
discussed below, the Commission finds Reserve Orders and Price 
Improving Orders consistent with the Act.
a. Quote Rule
    One commenter argues that Price Improving Orders would violate Rule 
602 of Regulation NMS (the ``Quote Rule'') because Nasdaq will not 
disseminate its best bid or offer.\116\
---------------------------------------------------------------------------

    \116\ See ISE Letter, supra note 4, at 2 (incorporating by 
reference the commenter's June 1, 2007, letter from Michael J. 
Simon, Secretary, ISE, to Nancy M. Morris, Secretary, Commission, 
regarding File No. SR-CBOE-2007-39 (``ISE June 2007 Letter'')).
---------------------------------------------------------------------------

    The Quote Rule requires a national securities exchange to collect, 
process, and make available to vendors the best bid, the best offer, 
and aggregate quotation sizes for each subject security that is 
communicated on any national securities exchange by a responsible 
broker or dealer. A ``bid'' or ``offer'' is defined as ``the bid price 
or the offer price communicated by a member of a national securities 
exchange or member of a national securities association to any broker 
or dealer, or to any customer.

[[Page 14529]]

* * * '' \117\ Because the non-displayed size of a Reserve Order or the 
non-displayed price of a Price Improving Order is sent to NOM but not 
communicated to anyone, it is not a bid, offer, or quotation. Thus, the 
Quote Rule does not require this information to be disseminated.\118\
---------------------------------------------------------------------------

    \117\ 17 CFR 242.600(a)(8).
    \118\ See also Citadel Letter, supra note 4, at 4 supporting 
this analysis.
---------------------------------------------------------------------------

    The Quote Rule also requires responsible brokers and dealers to be 
firm for their quotes.\119\ In Amendment No. 2 Nasdaq has proposed to 
modify Chapter VII, Section 6(c)(1) of the NOM Rules to explicitly 
state that all quotes and orders entered into NOM by Options 
Participants, including the non-displayed portions of Reserve Orders 
and Price Improving Orders, must be firm under NOM rules and Rule 602 
of Regulation NMS.
---------------------------------------------------------------------------

    \119\ 17 CFR 242.602(b)(2) and (c)(3).
---------------------------------------------------------------------------

b. Transparency, Quote Competition, and Internalization
    Several commenters expressed concern about the impact of Price 
Improving Orders and Reserve Orders on market quality. In particular, 
one commenter believes such orders will undermine transparency in the 
options markets and that, because the prices and sizes of such orders 
are not disseminated, it will be impossible for market participants to 
know the true best trading interest on NOM.\120\ This commenter argues 
that Price Improving Orders will discourage market participants from 
quoting their best prices and submitting displayable limit orders 
because contra-side orders could be ``pennied'' by Price Improving 
Orders at opportune moments. The commenter believes that these 
disincentives ultimately will reduce price competition in the U.S. 
options markets.\121\ Another commenter expresses a concern that no one 
will know the actual prices communicated to the exchange, which are 
prices at which transactions can take place.\122\ This commenter is 
concerned that if other options markets adopted similar order types, 
there would be a trading environment in which there would be no way for 
customers to make intelligent pricing decisions or for broker-dealers 
to fulfill their best execution obligations.\123\
---------------------------------------------------------------------------

    \120\ See Citadel Letter, supra note 4, at 1-3.
    \121\ See Citadel Letter, supra note 4, at 3. The commenter 
further believes that the concerns raised by Hidden Orders exceed 
those raised by the auction facilities on other options exchanges 
(including BOX's PIP and the International Securities Exchange's 
PIM) because Hidden Orders would be a fundamental component of NOM 
rather than a separate auction facility operating parallel to the 
regular options market. Id.
    \122\ See ISE Letter, supra note 4, at note 1-2.
    \123\ Id. at 2.
---------------------------------------------------------------------------

    One commenter expresses the concern that Price Improving Orders 
will enable Participants to internalize their order flow without the 
possibility of real order interaction. This commenter argues that the 
purpose of the requirement that a member display a customer order and 
wait three seconds before trading against the order is to provide other 
market participants with a chance to trade with the order before the 
member internalizes it. The commenter argues that, because only the 
Participant that enters the Price Improving Order will know the true 
price of the order, only that member can accurately run its pricing 
model to determine whether it is economically viable to trade against 
the order. The commenter does not believe this is a level playing 
field.\124\ Similarly, another commenter asserts that permitting Price 
Improving Orders to satisfy NOM's order exposure requirement \125\ will 
``invite rampant internalization'' by Participants, who will be able to 
trade with their agency orders without the market having a meaningful 
opportunity to compete for the orders.\126\
---------------------------------------------------------------------------

    \124\ See ISE June 2007 Letter, supra note 116, at 3.
    \125\ See NOM Rules, Chapter VII, Section 12. Chapter VII, 
Section 12 of the NOM Rules prohibits a Participant from executing 
as principal an order it represents as agent unless (1) the order is 
exposed on NOM for at least three seconds, or (2) the Participant 
has been bidding or offering on NOM for at least three seconds prior 
to receiving the agency order that is executable against such bid or 
offer.
    \126\ See Citadel Letter, supra note 4, at 3. This commenter 
further argues that Nasdaq should amend Chapter VII, Section 12, 
Commentary .04 to provide that a Participant cannot inform another 
Options Participant or any other third party of the terms of an 
order submitted to NOM after, as well as prior to, submitting the 
order to NOM. Nasdaq has made this change in Amendment No. 2.
---------------------------------------------------------------------------

    On the other hand, another commenter asserts that the use of non-
displayed and reserve orders, which have been available for years in 
the equity markets, has not diminished competition or liquidity in 
these markets.\127\ This commenter believes that Reserve Orders will 
encourage liquidity providers to bring their interest to the market in 
a manner best suited to their trading requirements. The commenter 
further believes that the increased use of reserve orders in the 
options markets would help to mitigate concerns regarding the effect of 
penny increments on institutional investors.\128\
---------------------------------------------------------------------------

    \127\ See GETCO Letter, supra note 4, at 2-3.
    \128\ Id. at 3. The commenter also notes that the Commission 
previously approved a reserve order type for NYSE Arca Options, 
citing to NYSE Arca Options Rule 6.62(c)(3). Id. at note 6 and 
accompanying text.
---------------------------------------------------------------------------

    Price Improving Orders will allow market participants to submit an 
order priced between the MPV that will be rounded to the nearest MPV 
for display.\129\ Without this order type, market participants would 
not be able to submit orders priced between the MPV. Instead, orders, 
if submitted, would be priced (and displayed) at the MPV. Thus, the 
Price Improving Order type will not ``take away'' transparency that 
would already exist. The Commission recognizes that Price Improving 
Orders will not be displayed at their actual penny price. Price 
Improving Orders, however, will provide for investors the opportunity 
to trade at a better price than would otherwise be available--inside 
the disseminated best bid and offer for a security. The Commission 
believes that this opportunity for investors to receive executions 
inside the disseminated best bid or offer could result in better 
executions for investors, and that Price Improving Orders are 
consistent with the Act.
---------------------------------------------------------------------------

    \129\ Price Improving Orders are defined as orders to buy or 
sell at a specified increment smaller than the MPV in a security, 
and they may be entered in increments as small as one cent. See NOM 
Rules, Chapter VI, Section 1(e)(6). Because a Price Improving Order 
can only be entered in an increment smaller than the MPV in an 
options series, and cannot be entered in an increment smaller than 
one cent, Participants will not be able to enter Price Improving 
Orders in options series for which the MPV is a penny.
---------------------------------------------------------------------------

    In response to a commenter's concern about broker-dealers' ability 
to fulfill their best execution obligations,\130\ as just discussed, 
the Commission believes that Price Improving Orders likely will provide 
another opportunity for investors to receive executions inside the 
disseminated best bid or offer for a security, which could result in 
better executions for investors. The availability of this price 
improvement feature will be a factor to be considered in a broker-
dealer's best execution routing determination, similar to other factors 
a broker-dealer must consider in connection with its best execution 
obligation.
---------------------------------------------------------------------------

    \130\ See ISE Letter, supra note 4, at note 1-2.
---------------------------------------------------------------------------

    The duty of best execution requires a broker-dealer to seek the 
most favorable terms reasonably available under the circumstances for a 
customer's transaction.\131\ The Commission has not viewed the duty of 
best execution as requiring automated routing on an order-by-order 
basis to the market with the best quoted price at that time. Rather, 
the duty of best execution requires broker-dealers to periodically 
assess the quality of competing markets

[[Page 14530]]

to assure that order flow is directed to markets providing the most 
beneficial terms for their customer orders.\132\ Broker-dealers must 
examine their procedures for seeking to obtain best execution in light 
of market and technology changes and modify those practices if 
necessary to enable their customers to obtain the best reasonably 
available terms.\133\ In doing so, broker-dealers must take into 
account price improvement opportunities, and whether different markets 
may be more suitable for different types of orders or particular 
securities.\134\
---------------------------------------------------------------------------

    \131\ See, e.g., Securities Exchange Act Release No. 37619A 
(September 6, 1996), 61 FR 48290 (September 12, 1996) (``Order 
Handling Rules Release'').
    \132\ Order Handling Rules Release, 61 FR at 48322-48333 (``In 
conducting the requisite evaluation of its internal order handling 
procedures, a broker-dealer must regularly and rigorously examine 
execution quality likely to be obtained from different markets or 
market makers trading a security.''). See also Newton v. Merrill, 
Lynch, Pierce, Fenner & Smith, Inc., 135 F.3d 266, at 271, 274 (3d 
Cir.), cert. denied, 525 U.S. 811 (1998); Payment for Order Flow, 
Securities Exchange Act Release No. 34902 (October 27, 1994), 59 FR 
55006, at 55009 (November 2, 1994).
    \133\ Order Handling Rules, 61 FR at 48323.
    \134\ Order Handling Rules, 61 FR at 48323. For example, in 
connection with orders that are to be executed at a market opening 
price, ``[b]roker-dealers are subject to a best execution duty in 
executing customer orders at the opening, and should take into 
account the alternative methods in determining how to obtain best 
execution for their customer orders.'' Disclosure of Order Execution 
and Routing Practices, Securities Exchange Act Release No. 43590 
(November 17, 2000), 65 FR 75414, 75422 (December 1, 2000) (adopting 
new Exchange Act Rules 11Ac1-5 and 11Ac1-6 and noting that 
alternative methods offered by some Nasdaq market centers for pre-
open orders included the mid-point of the spread or at the bid or 
offer).
---------------------------------------------------------------------------

    The Commission also believes that Price Improving Orders will 
provide market participants with an additional tool to submit trading 
interest to the Exchange. This order type may serve to increase 
liquidity to the extent that market participants find the order type to 
be useful and result in better executions. Further, market participants 
may be incented to compete by putting forth their best price--priced in 
a penny increment--to potentially match or better any other Price 
Improving Orders resident in the System. This may result in more 
aggressive, rather than less aggressive, trading interest.
    The Commission also believes that Reserve Orders will provide 
market participants with an additional tool to submit trading interest 
to the exchange. Specifically, the ability to enter an order with a 
certain size displayed and additional size not displayed may provide 
market participants greater choice to submit trading interest in a 
manner best suited to their trading needs. This in turn may encourage 
market participants to bring liquidity to the exchange that they might 
not otherwise have submitted.
    Moreover, the Commission believes that the ability to ``fish'' 
inside the displayed quote, coupled with the restriction on the 
Participant that initially submitted the Price Improving Order from 
trading with that order until after three seconds has elapsed, will 
provide a meaningful opportunity for interaction prior to the time at 
which the submitting Participant can interact with the order. The 
Commission also notes that a Participant that would like to trade 
against its customer order runs the risk that the customer order, if 
entered as a Price Improving Order, will execute against another Price 
Improving Order (or Discretionary Order) resident in the system. The 
Commission does not believe that the availability and use of Price 
Improving Orders will reduce the quality or competitiveness of the 
options markets by increasing the level of internalization in the 
options markets.
c. Linkage Plan
    One commenter believes that the Trading Rules Proposal fails to 
address how Reserve Orders and Price Improving Orders will interact 
with the requirements of the Plan for the Purpose of Creating and 
Operating an Intermarket Options Linkage (``Linkage Plan'').\135\ 
Specifically, this commenter notes that, because such orders are not 
disseminated, they presumably will not trigger other options markets' 
obligations to avoid trading through or obligate other markets to send 
orders to NOM through the Linkage.\136\ Accordingly, the commenter 
believes that away markets will fail to benefit from superior prices 
available on NOM, and Non-Displayed Orders and Price Improving Orders 
will undermine market-wide trade-through protection.\137\
---------------------------------------------------------------------------

    \135\ See Citadel Letter, supra note 4, at 3. Another commenter 
generally states its belief that the concept of a Non-Displayed 
Order is inconsistent with the obligations required by the Linkage 
Plan. See Amex Letter, supra note 4, at 2.
    \136\ See Citadel Letter, supra note 4, at 3.
    \137\ Id.
---------------------------------------------------------------------------

    In its response, Nasdaq states that incoming orders from the 
intermarket linkage will interact with Price Improving Orders. Such 
incoming orders will automatically execute against any such order with 
a better price than the displayed bid or offer.\138\
---------------------------------------------------------------------------

    \138\ See Nasdaq Response, supra note 5, at 13.
---------------------------------------------------------------------------

    The Commission believes that NOM's Rules adequately address how its 
market will interact with the Linkage Plan. The Linkage Plan, and SRO 
rules adopted pursuant to the Plan, provide trade through protection to 
the national best bid and offer (``NBBO'').\139\ The NBBO will not 
include the non-displayed price of a Price Improving Order or the 
reserve size of a Reserve Order. Therefore, the non-displayed price of 
a Price Improving Order and the non-displayed size of a Reserve Order 
are not subject to trade through protection under the Linkage Plan.
---------------------------------------------------------------------------

    \139\ The national best bid or offer is defined in the Linkage 
Plan as the national best bid and offer in an options series 
calculated by a Participant. See Section 2(19) of the Linkage Plan.
---------------------------------------------------------------------------

d. Penny Pilot
    One commenter believes that the Trading Rules Proposal will 
circumvent the industry efforts with respect to the Penny Pilot Program 
by moving to hidden penny quoting without the benefit of careful study 
of the data yielded in the Pilot.\140\ Another commenter believes that 
the appropriate way to address penny pricing in options is through the 
current Penny Pilot. This commenter recommends that the Commission 
consider any expansion of penny quoting only through review of the 
experience under the Pilot.\141\
---------------------------------------------------------------------------

    \140\ See Citadel Letter, supra note 4, at 4.
    \141\ See ISE June 2007 Letter, supra note 116, at 3.
---------------------------------------------------------------------------

    As discussed above and below, the Commission finds that the Trading 
Rules Proposal, as amended, is consistent with the Act. The Commission 
previously has approved proposals by other options exchanges to trade 
in penny increments.\142\ The Commission does not believe it is 
appropriate to prohibit Nasdaq from implementing another initiative 
designed to allow limited trading, not quoting, in penny increments.
---------------------------------------------------------------------------

    \142\ See, e.g., Securities Exchange Act Release Nos. 54229 
(July 27, 2006), 71 FR 44508 (August 3, 2006) (File No. SRSR-CBOE-
2005-90) (order approving CBOE's Simple Auction Liaison system); 
50819 (December 8, 2004), 69 FR 75093 (December 15, 2004) (File No. 
SR-ISE-2003-06) (order approving ISE's Price Improvement Mechanism); 
and BOX Approval Order, supra note 72 (approving BOX's Price 
Improvement Period).
---------------------------------------------------------------------------

4. Opening and Halt Cross
    Nasdaq had originally proposed a single price opening and reopening 
via an electronic cross, modeled on the Opening and Halt Crosses Nasdaq 
developed for the trading of equities.\143\ Nasdaq in Amendment No. 2 
proposes to revise the procedures it will use to resume trading in an 
option following the conclusion of a trading halt in the underlying 
security. Specifically, rather than using a single price reopening 
following a trading halt, as originally

[[Page 14531]]

proposed, Nasdaq proposes to process orders in time priority according 
to the execution algorithm provided in the NOM Rules.\144\ According to 
Nasdaq, the proposal to use NOM's regular processing following a 
trading halt is designed to respond to comments from industry 
participants that options prices are based on the prices of the 
underlying security.\145\
---------------------------------------------------------------------------

    \143\ See NOM Rules, Chapter VI, Section 8. See Trading Rules 
Proposal Notice, supra note 3, for a detailed description of the 
proposed Opening and Halt Crosses.
    \144\ See NOM Rules, Chapter VI, Section 10(4).
    \145\ See Amendment No. 2 at 7.
---------------------------------------------------------------------------

    The Commission believes that NOM's rules for an Opening Cross will 
help to ensure that the opening of NOM is conducted in a fair and 
orderly fashion and is consistent with the Act. The Commission further 
believes that the proposed change to NOM's procedure for re-opening 
trading in an option following the conclusion of a trading halt in the 
underlying security is reasonably designed to provide for an orderly 
re-opening of trading in the option and is consistent with the Act.
5. Closing Cross
    At the close of trading, NOM will conduct a single price Closing 
Cross.\146\ One commenter notes that the rules, as originally proposed, 
provided that the Closing Cross for all options would occur at 4 p.m., 
although options on fund shares and broad-based indexes trade until 
4:15 p.m., and did not indicate when the Closing Cross would 
terminate.\147\ In response, Nasdaq in Amendment No. 2 revised Chapter 
VI, Section 9(b) of the NOM Rules to indicate that the Closing Cross 
for options on broad-based indexes and fund shares will occur at 4:15 
p.m. In addition, Nasdaq indicated that the Closing Cross occurs 
automatically and generally takes place in under one second, although 
the process may take several seconds on high-volume trading days.\148\ 
The Commission believes that these changes adequately clarify the 
timing of the Closing Cross.\149\
---------------------------------------------------------------------------

    \146\ See NOM Rules, Chapter VI, Section 9. See also Trading 
Rules Proposal Notice, supra note 3, for a more detailed description 
of the proposed Closing Cross.
    \147\ See Amex Letter, supra note 4, at 3.
    \148\ See Nasdaq Response, supra note 5, at 10.
    \149\ In Amendment No. 2, Nasdaq proposes changes to the 
definitions of Imbalance Only (``IO''), Market on Close (``MOC''), 
and Limit on Close (``LOC'') orders to replace certain times 
specified in the rules (e.g., 3:50:00 p.m.) with more general 
descriptions (e.g., 10 minutes prior to the close).
---------------------------------------------------------------------------

    One commenter notes that the NOM Rules indicate that an MOC order 
might not be executed. The commenter believes that an MOC order is a 
market order, and the operation of the Closing Cross will alter the 
nature of a market order as generally understood by market 
participants. The commenter further believes that Nasdaq should better 
explain the operation of MOC orders.\150\ In response, Nasdaq 
acknowledges that MOC orders are not guaranteed to execute during the 
Closing Cross but notes that MOC orders receive the highest execution 
priority during the Closing Cross process.\151\ Thus, Nasdaq states 
that MOC orders should execute at the cross price provided that there 
is adequate trading interest on the other side of the market.\152\
---------------------------------------------------------------------------

    \150\ See Amex Letter, supra note 4, at 3.
    \151\ See Nasdaq Response, supra note 5, at 10 to 11. See also 
NOM Rules, Chapter VI, Section 9(b)(3).
    \152\ See Nasdaq Response, supra note 5, at 11.
---------------------------------------------------------------------------

    As noted above, the NOM Closing Cross is modeled on the Closing 
Cross that Nasdaq uses in its equity market.\153\ Like the NOM Closing 
Cross, the Nasdaq Closing Cross includes MOC orders, which might not be 
executed during the Nasdaq Closing Cross.\154\ The Commission believes 
that NOM's rules adequately explain the operation of MOC orders.
---------------------------------------------------------------------------

    \153\ See Nasdaq Rule 4754.
    \154\ See Nasdaq Rule 4754(b)(3).
---------------------------------------------------------------------------

    Nasdaq proposes to disseminate in connection with the Opening Cross 
and Closing Cross an Order Imbalance Indicator.\155\ The Order 
Imbalance Indicator for the Closing Cross will disseminate, in part, 
the following information: (1) A Current Reference Price, which is the 
single price that is at or within the current NOM best bid and offer at 
which the maximum number of contracts of MOC, LOC, IO, and Close 
Eligible Interest \156\ can be paired; \157\ (2) a Far Clearing Price, 
which is an indicative price at which MOC, LOC, and IO orders would 
execute if the Closing Cross were to occur at that time; and (3) a Near 
Clearing Price, which is an indicative price at which MOC, LOC, IO, and 
Close Eligible Interest would execute if the Closing Cross were to 
occur at that time.\158\
---------------------------------------------------------------------------

    \155\ See proposed Chapter VI, Sections 8(a)(2) and 9(a)(7) of 
the NOM Rules. For the Opening Cross, Nasdaq will disseminate the 
Order Imbalance Indicator every five seconds beginning at 9:25 a.m. 
For the Closing Cross, Nasdaq will disseminate the Order Imbalance 
Indicator every five seconds for 10 minutes prior to the Closing 
Cross. See proposed NOM Rules, Chapter VI, Sections 8(a)(2) and 
8(b)(1) and 9(a)(7) and 9(b)(1) for a detailed description of the 
Order Imbalance Indicator.
    \156\ Close Eligible Interest is defined to mean any quotation 
or any order that may be entered into the system and designated with 
a time-in-force of DAY, GTC, or EXPR. See proposed Chapter VI, 
Section 9(a)(1) of NOM Rules.
    \157\ If more than one price exists pursuant to this 
calculation, the Current Reference Price is the price that minimizes 
any Imbalance. If more than one price exists under that calculation, 
the Current Reference Price is the entered price at which contracts 
will remain unexecuted in the cross. And, if more than one price 
exists under that calculation, the Current Reference Price is the 
price that minimizes the distance from the bid-ask midpoint of the 
inside quotation prevailing within the NOM System at the time of the 
order imbalance indicator dissemination. See proposed Chapter VI, 
Section 9(a)(7)(A) of the NOM Rules.
    \158\ For the Opening Cross, the Far Clearing Price and Near 
Clearing Price will be the same as the Current Reference Price. See 
proposed Chapter VI, Section 8(a)(2)(A) and (E) of the NOM Rules.
---------------------------------------------------------------------------

    One commenter notes that the Order Imbalance Indicator would show 
the price in penny increments at which certain orders would execute at 
the time the Order Imbalance Indicator is disseminated.\159\ The 
commenter believes that the Order Imbalance Indicator is inconsistent 
with the options Penny Pilot Program and that the Order Imbalance 
Indicator should be disseminated in the applicable minimum price 
variation for an option, rather than in penny increments.\160\
---------------------------------------------------------------------------

    \159\ See Amex Letter, supra note 4, at 2.
    \160\ Id. The Penny Pilot Program of the various options 
exchanges allows the exchanges to quote certain options classes in 
one-cent or five-cent increments, depending on the price of the 
option. See, e.g., Securities Exchange Act Release No. 56567 
(September 28, 2007), 72 FR 56396 (October 3, 2007) (order approving 
File No. SR-Amex-2007-96).
---------------------------------------------------------------------------

    In its response, Nasdaq states that the Order Imbalance Indicator 
will benefit investors and improve transparency by providing market 
participants with information that will allow them to route customer 
orders to the best market.\161\ To ensure that the Order Imbalance 
Indicator fully complies with Rule 602 of Regulation NMS, however, 
Nasdaq proposes in Amendment No. 2 to modify the proposed NOM Rules 
relating to the Closing Cross to state that the Current Reference Price 
and Near Clearing Price \162\ will be disseminated in the minimum price 
increment applicable to the option in question and never at a price 
that would expose undisplayed trading interest that is available for 
execution on the NOM Book. Nasdaq states that only the Current 
Reference Price and Near Clearing Price are affected by this 
restriction because they are the only aspects of the Order Imbalance 
Indicator that may include information based on non-displayed orders 
resting on the NOM book.\163\ Nasdaq further states that the remaining 
data elements of the Order Imbalance Indicator do not transmit 
information regarding the

[[Page 14532]]

pricing of specific orders and therefore do not implicate Rule 602 of 
Regulation NMS.\164\
---------------------------------------------------------------------------

    \161\ See Nasdaq Response, supra note 5, at 9.
    \162\ See NOM Rules, Chapter VI, Sections 9(a)(7)(A) and 
9(a)(7)(E)(ii).
    \163\ This is because the Current Reference Price and Near 
Clearing Price take into account the Close Eligible Interest, which 
is defined as any quotation or any order that may be entered into 
the System and designated with a time-in-force of DAY, GTC, or EXPR. 
Thus, Close Eligible Interest includes orders, including non-
displayed orders, on the NOM Book.
    \164\ See Nasdaq Response, supra note 5, at 6 and 9.
---------------------------------------------------------------------------

    The Commission agrees with Nasdaq's analysis and believes that the 
Order Imbalance Indicator, as proposed to be amended in Amendment No. 
2, is consistent with Rule 602 of Regulation NMS. Nasdaq will not 
disseminate the prices of non-displayed orders resting on the NOM book 
after the Opening Cross \165\ and therefore, such non-displayed orders 
will not be bids or offers \166\ required to be made available to 
vendors by the Exchange under Rule 602. Further, the Commission does 
not believe that the Order Imbalance Indicator, as amended, is 
inconsistent with the Penny Pilot because it will not make available 
during regular trading hours information in a pricing increment other 
than the MPV.
---------------------------------------------------------------------------

    \165\ The Commission does not believe that the Order Imbalance 
Indicator disseminated prior to the Opening Cross (and thus 
disseminated prior to the 9:30 a.m. EST) raises the same issues 
under the Quote Rule because the information will be disseminated 
prior to the commencement of trading on the exchange. See Rule 
602(a)(1)(i)(B) of Regulation NMS, 17 CFR 242.602(a)(1)(i)(B).
    \166\ See Rule 600(b)(8) of Regulation NMS, 17 CFR 
242.600(b)(8).
---------------------------------------------------------------------------

6. Obvious Errors
    The Commission believes that in most circumstances trades that are 
executed between parties should be honored. On rare occasions, the 
price of the executed trade indicates an ``obvious error'' may exist, 
suggesting that it is unlikely that the parties to the trade had come 
to a meeting of the minds regarding the terms of the transaction. In 
the Commission's view, the determination of whether an ``obvious 
error'' has occurred should be based on specific and objective criteria 
and subject to specific and objective procedures.\167\
---------------------------------------------------------------------------

    \167\ See, e.g., Securities Exchange Act Release Nos. 54608 
(October 16, 2006), 71 FR 62021 (October 20, 2006) (File No. SR-
Amex-2005-60) (order approving changes to Amex's obvious error 
rule); 47628 (April 3, 2003), 68 FR 17697 (April 10, 2003) (File No. 
SR-CBOE-00-55) (order approving CBOE Direct); and BOX Approval 
Order, supra note 72.
---------------------------------------------------------------------------

    In Amendment No. 2, Nasdaq revised its proposed rule dealing with 
options obvious errors. Specifically, Nasdaq amended Chapter V, Section 
6, Obvious Errors, to: (1) Apply the obvious error rule solely to 
obvious price errors and to series quoted no bid; (2) streamline the 
procedures governing review of obvious error requests by the Market 
Operations Review Committee (``MORC''); and (3) add a provision stating 
that the MORC must include representatives of one member engaged in 
market making and two industry representatives not engaged in market 
making, and that at no time shall members engaged in market making 
constitute more than 50% of the MORC. The Commission believes that the 
provisions of Nasdaq's obvious error rule, as revised by Amendment No. 
2, are consistent with the Act and, in particular, with Section 
6(b)(5), in that they provide clear and objective standards and 
procedures for determining whether an obvious error has occurred. The 
Commission also believes that the revised proposed rule is consistent 
with obvious error rules previously approved by the Commission for 
other exchanges.\168\
---------------------------------------------------------------------------

    \168\ See, e.g., Securities Exchange Release Nos. 54228 (July 
27, 2006), 71 FR 44066 (August 3, 2006) (File No. SR-ISE-2006-14) 
(approving current version of ISE Rule 7.20 (options obvious error 
rule)); 54070 (June 29, 2006), 71 FR 38441 (July 6, 2006) (File No. 
SR-Phlx-2005-73) (approving current version of Phlx Rule 1092 
(options obvious error rule)); and 56487 (September 20, 2007), 72 FR 
54956 (September, 27, 2007) (File No. SR-CBOE-2007-04) (approving 
current version of CBOE Rule 6.25 (options obvious error rule)).
---------------------------------------------------------------------------

    One commenter seeks clarification as to who will be responsible for 
trade errors in the context of the Linkage.\169\ Nasdaq states that 
NOM's Rules recognize only Obvious Errors, as defined in Chapter VI, 
Section 6 of the NOM Rules. If a trade does not meet the definition of 
an Obvious Error, NOM will take no action with respect to the trade. In 
the event of an Obvious Error on NOM involving an away market, the away 
market is authorized as a party to the transaction to file with NOM for 
review of the Obvious Error. In the event of an Obvious Error on an 
away market, NOM's Obvious Error rule authorizes NOM to file for review 
of that Obvious Error on behalf of the NOM Participant. If necessary, 
NOM will file for such review through NOS or the member of the away 
market which it used to route the order.\170\
---------------------------------------------------------------------------

    \169\ See SIFMA Letter, supra note 4 at 2.
    \170\ See Nasdaq Response, supra note 5, at 9, and Amendment No. 
2.
---------------------------------------------------------------------------

7. Miscellaneous
    One commenter believes that, under the NOM Rules, quotes are the 
same as orders and therefore reads Chapter VI, Section 5(b) of the NOM 
Rules to mean that Nasdaq proposes to trade all options series on NOM 
in penny increments, in violation of the Penny Pilot Program.\171\
---------------------------------------------------------------------------

    \171\ See Amex Letter, supra note 4, at 2.
---------------------------------------------------------------------------

    In response, Nasdaq states that the commenter has misread the 
proposal and that Nasdaq does not propose to quote all options on NOM 
in penny increments. In this regard, Nasdaq notes that Chapter VI, 
Section 5(a) of the NOM Rules governs quotation increments and is 
consistent with the Penny Pilot Program, while Section 5(b) specifies 
the minimum trading increment on NOM.\172\ The Commission believes that 
Nasdaq has clarified that it does not propose to quote all options on 
NOM in penny increments and that the NOM Rules are consistent with the 
Penny Pilot Program. The Commission also does not believe that trading 
in penny increments is inconsistent with the Penny Pilot Program.\173\
---------------------------------------------------------------------------

    \172\ See Nasdaq Response, supra note 5, at 7.
    \173\ See supra note 142 and accompanying text.
---------------------------------------------------------------------------

    In response to questions from commenters regarding the NOM closing 
time,\174\ Nasdaq in Amendment No. 2 proposes to modify the NOM Rules 
to provide that the NOM closing time will be 4 p.m. ET, except for 
options on broad-based indexes and Fund Shares, which will close at 
4:15 p.m. ET.\175\ The Commission believes that these modifications 
will make NOM's closing time consistent with the rules of the other 
U.S. options exchanges.\176\
---------------------------------------------------------------------------

    \174\ See Amex Letter, supra note 4, at 4, and SIFMA Letter, 
supra note 4, at 2.
    \175\ See NOM Rules, Chapter VI, Section 2.
    \176\ See, e.g., ISE Rule 700 and CBOE Rules 6.1 and 24.6. In 
addition, in Amendment No. 2 Nasdaq proposes to revise Chapter VI, 
Section 2 of the NOM Rules to indicate that the System will be 
available to accept bids, offers, and orders beginning at 9 a.m., 
rather than 8 a.m. Similarly, Nasdaq proposes in Amendment No. 2 to 
revise Chapter VI, Section 9 of the NOM Rules to indicate that IO 
orders, LOC orders, and MOC orders may be entered beginning at 9 
a.m., rather than 8 a.m.
---------------------------------------------------------------------------

E. Order Routing

    With respect to securities traded on NOM (``System Securities''), 
\177\ Participants may designate orders to be routed to another market 
center when trading interest is not available on NOM or to execute only 
on NOM.\178\ Orders that are designated to be routed will be routed to 
another options market when NOM is not at the NBBO, consistent with the 
locked and crossed market and trade through provisions of the Linkage 
Plan.\179\ Orders routed by the System to other markets do not retain 
time priority with respect to other orders in the System and the System 
will continue to execute other orders while routed orders are away at 
another market center.\180\ If a routed order is returned, in whole or 
in part, that order (or its remainder) will receive a new time stamp 
reflecting the time of its return to the System.\181\ Participants 
whose orders are routed to

[[Page 14533]]

away markets will be obligated to honor such trades to the same extent 
they will be obligated to honor a trade executed on NOM.\182\
---------------------------------------------------------------------------

    \177\ See NOM Rules, Chapter VI, Section 1(b).
    \178\ See NOM Rules, Chapter VI, Section 11(a) and Amendment No. 
2.
    \179\ See id. and infra note 195 and accompanying text.
    \180\ See NOM Rules, Chapter VI, Section 11(c).
    \181\ Id.
    \182\ See NOM Rules, Chapter VI, Section 11(d).
---------------------------------------------------------------------------

    One commenter believes that NOM's rules, as proposed, provided 
different order routing attributes for ``system'' and ``non-system'' 
securities, but failed to adequately define these terms, resulting in 
confusion regarding the operation of the order routing mechanism.\183\
---------------------------------------------------------------------------

    \183\ See Amex Letter, supra note 4, at 3.
---------------------------------------------------------------------------

    In response, Nasdaq, in Amendment No. 2, proposes to revise 
proposed Chapter VI, Section 1(b) of the NOM Rules to define ``System 
Securities'' as all options currently trading on NOM, and to define 
``Non-System Securities'' as all other options. Nasdaq states it will 
accept orders in Non-System Securities for routing but will not execute 
these orders in the System.\184\ Nasdaq represents that System and Non-
System Securities will be identified clearly via the NOM data feed and 
in a daily list posted on the NOM Web site.\185\ Nasdaq further states 
that the System will be programmed to differentiate between System 
Securities and Non-System Securities and will process each in 
accordance with the NOM Rules.\186\ The Commission believes that 
Nasdaq's proposed changes and response adequately clarify the operation 
of the order routing mechanism for ``System Securities'' and ``Non-
System Securities.''
---------------------------------------------------------------------------

    \184\ See Nasdaq Response, supra note 5, at 11. See also NOM 
Rules, Chapter VI, Section 11(a).
    \185\ See Nasdaq Response, supra note 5, at 11.
    \186\ Id.
---------------------------------------------------------------------------

    In Amendment No. 2, Nasdaq further proposes to amend proposed 
Chapter VI, Section 11(e) of the NOM Rules to establish Nasdaq Options 
Services LLC (``NOS'') as NOM's exclusive order router. NOS will 
perform only two functions, the routing of orders with respect to 
System Securities and the routing of orders with respect to Non-System 
Securities. Nasdaq states that NOS will be a facility of Nasdaq only 
with respect to the routing of orders for System Securities.\187\ NOS 
will be programmed to follow the algorithm and order type instructions 
established in the NOM Rules and will not have discretion to change the 
terms of an order or the order routing instructions.\188\
---------------------------------------------------------------------------

    \187\ See NOM Rules, Chapter VI, Section 11(e) and Nasdaq 
Response, supra note 5, at 11.
    \188\ See Nasdaq Response, supra note 5, at 11.
---------------------------------------------------------------------------

    NOS will be a member of an SRO unaffiliated with Nasdaq that is its 
designated examining authority, and NOM will establish and maintain 
procedures and internal controls reasonably designed to restrict the 
flow of confidential and proprietary information between Nasdaq and its 
facilities, including NOS, and any other entity.\189\ In addition, the 
books, records, premises, officers, directors, agents, and employees of 
NOS, as a facility of Nasdaq, will be deemed to be those of the 
Exchange for purposes of and subject to oversight pursuant to the 
Act.\190\ Further, Participants are not required to use NOS to route 
orders, and a Participant may route its orders through any available 
router it selects.\191\
---------------------------------------------------------------------------

    \189\ See NOM Rules, Chapter VI, Section 11(e).
    \190\ Id. In addition, the books and records of NOS, as a 
facility of the Exchange, will be subject at all times to inspection 
and copying by the Exchange and the Commission. Id.
    \191\ See Nasdaq Response, supra note 5, at 11. See also NOM 
Rules, Chapter VI, Section 1(b) (allowing Participants to designate 
orders as available for routing or not available for routing).
---------------------------------------------------------------------------

    The Commission agrees with the Exchange that routing with respect 
to System Securities will be a ``facility'' of the Exchange, and, 
consequently, the operation of NOS in this capacity will be subject to 
Exchange oversight, as well as Commission oversight. The Commission 
notes that the functionality to be provided by NOS is not the exclusive 
means for accessing better-priced orders in other market centers. 
Accordingly, NOS's routing services are optional, and a NOM Participant 
is free to route its orders to other market centers through alternative 
means. In light of the protections discussed above, including the 
regulation of NOS as a facility of the Exchange with respect to the 
routing of orders for System Securities, the Commission believes that 
Nasdaq's rules and procedures regarding the use of NOS to route orders 
to away markets are consistent with the Act.\192\
---------------------------------------------------------------------------

    \192\ In addition, the Commission notes that the Nasdaq rules 
and procedures applicable to NOS are similar to the rules and 
procedures adopted by other exchanges to govern their order routers. 
See, e.g., ISE Rule 2108; NYSE Rule 17; and Phlx Rule 185(g).
---------------------------------------------------------------------------

F. Linkage

    As described above, Nasdaq proposes to use NOS to route orders to 
other options exchanges. NOM will, however, participate in the Linkage 
Plan to receive orders from options exchanges that use the Linkage to 
route orders. To receive orders through the Linkage, Nasdaq proposes to 
adopt rules relating to the Linkage Plan that are substantially similar 
to the rules of the other options exchanges that participate in the 
Linkage Plan. In general, the proposed rules include relevant 
definitions; establish the conditions pursuant to which Market Makers 
may enter Linkage orders; impose obligations on the Exchange regarding 
how it must process incoming Linkage orders; establish a general 
standard that Participants should avoid trade-throughs; establish 
potential regulatory liability for Participants that engage in a 
pattern or practice of trading through other exchanges; and establish 
obligations with respect to locked and crossed markets.\193\
---------------------------------------------------------------------------

    \193\ See NOM Rules, Chapter XII.
---------------------------------------------------------------------------

    One commenter questioned how NOM will ensure that orders designated 
for execution solely on NOM will not create a trade-through or locked 
or crossed market. In particular, the commenter requests clarification 
regarding the treatment of an order that locks or crosses the NBBO, 
NOM's responsibility for such an order, and the action NOM will take if 
the market already is locked or crossed when it receives an order.\194\
---------------------------------------------------------------------------

    \194\ See Amex Letter supra note 4, at 3.
---------------------------------------------------------------------------

    In response, Nasdaq states that Chapter VI, Section 7(b)(3)(C) of 
the NOM Rules sets forth the procedures that NOM will use to ensure 
compliance with the trade through and locked and crossed market 
provisions of the Linkage Plan.\195\ Nasdaq proposes in Amendment No. 2 
to state explicitly in the NOM Rules that an order will not be executed 
at a price that trades through another market or displayed at a price 
that would lock or cross another market. Nasdaq further proposes to add 
in Amendment No. 2 that an order that is designated as routable will be 
routed in compliance with applicable trade through and locked and 
crossed markets restrictions.\196\ With respect to non-routable orders, 
Nasdaq notes that the System will re-price a Displayed Order that, at 
the time of entry, would cause a locked or crossed market or a trade 
through violation, to the current national best offer (for bids) or the 
current national best bid (for offers) and display the order at one 
minimum price variation below (for bids) or above (for offers) the 
national best price.\197\ These

[[Page 14534]]

do-not-ship orders will remain on Nasdaq's book until cancelled or 
executed by another NOM Participant or market center.\198\ Nasdaq 
states that the System, therefore, will systemically avoid executing an 
order at a price that would trade through a price on another market and 
will prevent Nasdaq from displaying a quotation that would lock or 
cross a quotation displayed by another market.\199\ In addition, Nasdaq 
represents that it will program the System to avoid joining a locked or 
crossed market when the market is already locked or crossed.\200\
---------------------------------------------------------------------------

    \195\ See Nasdaq Response, supra note 5, at 10.
    \196\ See NOM Rules, Chapter VI, Section 7(b)(3)(C).
    \197\ See NOM Rules, Chapter VI, Section 7(b)(3)(C). As 
originally proposed, Chapter VI, Section 7(b)(3)(C) of the NOM Rules 
provided that if a Displayed Order that the entering party has 
elected not to make eligible for routing would cause a locked or 
crossed market or a trade through violation at the time of entry, 
the System would re-price the order to one minimum price variation 
(``MPV'') below the current national best offer (for bids) or one 
MPV above the current national best bid (for offers). In Amendment 
No. 2, Nasdaq proposes to revise the rule to provide that the System 
will re-price such an order to the current national best offer (for 
bids) or the current national best bid (for offers) and display the 
order at one MPV below (for bids) or above (for offers) the national 
best price. Nasdaq believes that the procedure proposed in Amendment 
No. 2 is superior to the original procedure, which would have 
converted the re-priced order into a Non-Displayed Order.
    \198\ See Nasdaq Response, supra note 5, at 10.
    \199\ Id.
    \200\ Id.
---------------------------------------------------------------------------

    The Commission believes that Nasdaq has responded adequately to the 
commenter's questions regarding NOM's procedures and rules for 
complying with the Linkage Plan, and that NOM's rules, as amended, are 
reasonably designed to comply with the locked and crossed market and 
trade through provisions of the Linkage Plan.
    As noted above, Nasdaq intends to use NOS to route orders to other 
markets. To allow Nasdaq to use the Linkage to send orders to other 
markets, if it wanted to do so, NOM Rules provide that one Options 
Market Maker per eligible series will be designated as the 
``InterMarket Linkage Market Maker'' or ``ILM'' to be responsible for 
P/A and Satisfaction orders that would be sent to away markets through 
the Linkage for options trading on NOM. The ILM responsible for such 
orders will be required to adhere to the responsibilities of an 
Eligible Market Maker, as set forth in the Linkage Plan.\201\
---------------------------------------------------------------------------

    \201\ See NOM Rules, Chapter VII, Section 5(a)(ix). The ILM will 
perform substantially similar functions that the BOX InterMarket 
Linkage Market Maker performs on BOX. See BOX Rules, Chapter VI, 
Section 5(a)(ix), and Chapter XII.
---------------------------------------------------------------------------

    The ILM will be required to act with due diligence with regard to 
the interests of orders entrusted to it and fulfill other duties of an 
agent, including, but not limited to, ensuring that such orders, 
regardless of their size or source, receive proper representation and 
timely execution in accordance with the terms of the orders and the 
rules of the Exchange. The ILM must provide NOM with written 
instructions for the routing of any P/A orders it may send through the 
InterMarket Linkage. NOM will immediately route all P/A orders on 
behalf of the ILM according to these instructions.\202\
---------------------------------------------------------------------------

    \202\ The order would be generated automatically by NOM and 
routed to the away exchange with the required clearing information 
included. Each execution received from an away exchange would result 
in the automatic generation of a trade execution on NOM between the 
original order and the ILM.
---------------------------------------------------------------------------

    One commenter seeks clarification as to who would fulfill the role 
of the ILM if the ILM is excused temporarily from its responsibilities, 
and who would be responsible for trade throughs.\203\
---------------------------------------------------------------------------

    \203\ See SIFMA Letter, supra note 4, at 2.
---------------------------------------------------------------------------

    In response, Nasdaq states that it intends to use NOS to fulfill 
Nasdaq's order routing obligations under the Linkage Plan.\204\ 
Although Nasdaq believes that it therefore will rarely, if ever, need 
to appoint an ILM, Nasdaq notes that Chapter VII, Rule 5(a)(ix) of the 
NOM Rules provides Nasdaq with the ability to designate a market maker 
as the ILM for a particular series.\205\ In the event that the ILM 
substantially fails to engage in a course of dealings under this rule, 
Nasdaq Regulation may bring a disciplinary action.\206\ In addition, 
Nasdaq states that neither Nasdaq or any Participant will face 
liability for trade throughs because NOM is programmed to comply with 
the requirements of the Linkage Plan. If NOM has a System malfunction 
that results in a trade through, Nasdaq believes that such an 
occurrence would fall under the exception in Section 8(c)(iii) of the 
Linkage Plan. If Nasdaq receives a Satisfaction Order from an away 
market, NOM will execute the order against trading interest available 
on the NOM Book.\207\
---------------------------------------------------------------------------

    \204\ See Nasdaq Response, supra note 5, at 4.
    \205\ See Nasdaq Response, supra note 5, at 4. The Commission 
notes that if there is no Market Maker registered in a particular 
series, NOM will place that series in a non-regulatory suspension 
and halt trading until such time as a member registers to make 
markets in that series. See supra note 79 and accompanying text.
    \206\ See NOM Rules, Chapter VII, Section 5(c).
    \207\ See Nasdaq Response, supra note 5, at 4.
---------------------------------------------------------------------------

    The Commission notes that NOM's rules and the NOM System are 
designed to comply with the requirements of the Linkage Plan, including 
the trade through requirements. The Commission believes that the 
proposed NOM rules regarding the Intermarket Linkage are consistent 
with the requirements of the Linkage Plan and the Act. The Commission 
reminds Nasdaq, however, that to the extent trades are executed on NOM 
that do not comply with the trade through requirements of the Linkage 
Plan, Nasdaq, as a Plan Participant, will have the obligation to comply 
with the requirements of the Linkage Plan, including responding to 
Satisfaction Orders. Further, before Nasdaq can begin operating NOM, 
Nasdaq must become a participant in the Linkage Plan.

G. Strike Prices

    Nasdaq proposes to participate in the $2.50 Strike Price Program 
\208\ and in the $1 Strike Price Program.\209\ Amendment No. 2 proposes 
to amend the NOM Rules to reflect the expansion of the $2.50 Strike 
Price Program to include strike prices between $50 and $75 under 
certain conditions and to indicate that NOM's $1 Strike Price Program 
will expire on June 5, 2008, rather than June 5, 2007.\210\ These 
changes conform NOM's rules to the existing rules of the other options 
markets.\211\
---------------------------------------------------------------------------

    \208\ The $2.50 strike price program allows the options 
exchanges to list options in up to 200 classes at $2.50 strike price 
intervals for strike prices greater than $25 but less than $75. See, 
e.g., Securities Exchange Act Release Nos. 40662 (November 12, 
1998), 63 FR 64297 (November 19, 1998) (order approving File Nos. 
SR-Amex-98-21; SR-CBOE-98-29; SR-PCX-98-31; and SR-Phlx-98-26) 
(``1998 Order'') and 52893 (December 5, 2005), 70 FR 73488 (December 
12, 2005) (order approving File No. SR-Amex-2005-067). The 200 
classes eligible for the $2.50 Strike Price Program were allocated 
among the options exchanges pursuant to a formula approved by the 
Commission as part of the permanent approval of the program. Each 
options exchange may list options with $2.50 strike price intervals 
on any options class that another exchange selects as part of its 
program. Any modification to the $2.50 Strike Price Program would 
require the filing of a proposed rule change with the Commission 
pursuant to Section 19(b) of the Act.
    \209\ Under the $1 Strike Price Program, each options exchange 
may select a total of five individual stocks on which options series 
may be listed at $1 intervals, and each exchange may list $1 strikes 
on any options class designated by another exchange as part of its 
$1 Strikes Program. See, e.g., Securities Exchange Act Release No. 
55714 (May 7, 2007), 72 FR 26853 (May 11, 2007). See NOM Rules, 
Chapter IV, Section 6, Supplementary Material .03 and Supplementary 
Material .02. The Commission notes that several of the options 
exchanges have amended their rules, in part, to allow the exchanges 
to select a total of ten individual stocks on which options series 
may be listed at $1 intervals. See, e.g., Securities Exchange Act 
Release Nos. 57049 (December 27, 2007), 73 FR 528 (January 8, 2008) 
(order approving File No. SR-CBOE-2007-125) and 57110 (January 8, 
2008) (notice of filing and order granting accelerated approval of 
File No. SR-Amex-2007-141) (together, the ``1 Strike Price 
Orders'').
    \210\ See NOM Rules, Chapter IV, Section 6, Supplementary 
Material .03(b) and Supplementary Material .02.
    \211\ The Commission notes that several of the options exchanges 
have recently amended their rules to make the $1 Strike Price 
Program permanent. See, e.g., $1 Strike Price Orders, supra note 
209.
---------------------------------------------------------------------------

    One commenter believes that the terms of NOM's participation in the 
$2.50 Strike Price Program and the $1 Strike Price Program are 
unclear.\212\ In particular, the commenter questions whether NOM will 
trade only those classes currently included in the $2.50

[[Page 14535]]

Strike Price Program and in the $1 Strike Price Program.\213\ NOM's 
rules provide that it may list $1 strikes in options classes on five 
individual stocks, as designated by NOM, as well as any options class 
specifically designated by another exchange that employs a similar $1 
strike price program.\214\ NOM's rules also provide that Nasdaq may 
list series at $2.50 strike price intervals in any multiply traded 
option once another exchange has selected that option to be a part of 
the program.\215\ The Commission believes that Nasdaq's proposal, as 
amended, makes clear that NOM will participate in the $2.50 Strike 
Price Program and the $1 Strike Price Program on the same terms and 
conditions as the other options exchanges.\216\ The Commission also 
believes that Nasdaq's proposed rules relating to the $2.50 Strike 
Price and $1 Strike Price Programs will provide investors with 
flexibility in tailoring their options positions to meet their 
investment objectives while avoiding the unnecessary proliferation of 
illiquid options series.\217\
---------------------------------------------------------------------------

    \212\ See Amex Letter, supra note 4, at 3-4.
    \213\ Id. at 4.
    \214\ See NOM Rule, Chapter IV, Section 6, Supplementary 
Material .02(a).
    \215\ See NOM Rule, Chapter IV, Section 6, Supplementary 
Material .03(a).
    \216\ As noted above, several of the options exchanges have 
recently expanded and made permanent their $1 Strike Price Programs. 
See supra notes 209 and 211.
    \217\ See, e.g. 1998 Order, supra note 208, and Securities 
Exchange Act Release Nos. 47991 (June 5, 2003), 68 FR 35243 (June 
12, 2003) (File No. SR-CBOE-2001-60) (order approving CBOE's $1 
Strike Price Program through June 5, 2004) and 48024 (June 12, 
2003), 68 FR 36617 (June 18, 2003) (File No. SR-Amex-2003-36) (order 
approving Amex's $1 Strike Price Program through June 5, 2004).
---------------------------------------------------------------------------

H. Securities Traded on NOM

    Nasdaq proposes to adopt initial and continued listing standards 
for equity and index options \218\ that are substantially similar to 
the listing standards adopted by other options exchanges.\219\ In 
Amendment No. 2, Nasdaq proposes to revise proposed Chapter IV, Section 
3 of the NOM Rules to allow NOM to list and trade an option on an 
underlying equity security that does not satisfy certain of the 
criteria for initial listing in the NOM Rules provided that: (1) The 
underlying security meets the criteria for continued listing set forth 
in the NOM Rules; and (2) options on such underlying security are 
listed and traded on at least one other registered national securities 
exchange.\220\ This proposed change to the proposed NOM Rules, which is 
narrowly tailored to address the circumstances where an equity option 
class is currently ineligible for initial listing on NOM even though it 
meets NOM's continued listing standards and is trading on another 
options exchange, is substantially similar to rules adopted by other 
options exchanges.\221\
---------------------------------------------------------------------------

    \218\ See NOM Rules, Chapters IV and XIV.
    \219\ See, e.g., BOX Rules, Chapters IV and XIV. In response to 
a commenter's concern that its proposed definition of ``index 
option'' could have included exchange-traded funds, as well as index 
options (see Amex Letter, supra note 4, at 4), Nasdaq proposes in 
Amendment No. 2 to revise its definition ``index option'' to mean an 
option on a broad-based, narrow-based, or micro narrow-based index 
of equity securities prices. See NOM Rules, Chapter I, Section 
1(a)(21). The Commission finds that the proposed change is 
consistent with the Act because it clarifies the definition of 
``index option.'' In addition, Nasdaq proposes in Amendment No. 2 to 
revise Chapter IV, Section 5 of the NOM Rules to indicate that if an 
options class has been approved for listing on NOM and there is not 
at least one series in that class open for trading, the listing will 
be placed in a non-regulatory suspension until a series is opened in 
that class.
    \220\ See NOM Rules, Chapter IV, Section 3(k) and Amendment No. 
2. Nasdaq also proposes to state that it shall employ the same 
procedures to determine whether a particular underlying security 
meets NOM's continued equity options listing criteria in this 
instance as it employs when determining whether an underlying 
security meets NOM's initial listing criteria. See id.
    \221\ See, e.g., Amex Rule 915, Commentary .01(6); CBOE Rule 
5.3, Interpretation and Policy .01(c); and ISE Rule 502(b)(6).
---------------------------------------------------------------------------

    The Commission believes that NOM's proposed initial and continued 
listing standards, as amended, are consistent with the Act, including 
Section 6(b)(5), in that they are designed to protect investors and the 
public interest and to promote just and equitable principles of trade. 
Nasdaq's operation of NOM as an options exchange, however, is 
conditioned on Nasdaq becoming a Plan Sponsor in the Plan for the 
Purpose of Developing and Implementing Procedures Designed to 
Facilitate the Listing and Trading of Standardized Options Submitted 
Pursuant to Section 11A(a)(3)(B) of the Securities Exchange Act of 1934 
(``OLPP''). In addition, Nasdaq will need to become a participant in 
the Options Clearing Corporation.

I. Regulation of NOM and Options Participants

    Nasdaq represents that it has the ability to discharge all 
regulatory functions related to the facility that it has undertaken to 
perform by virtue of forming NOM as a facility of Nasdaq.\222\ In 
connection with its regulatory functions, the Exchange represents that 
its regulatory oversight committee and its chief regulatory officer 
(``CRO'') will assume responsibility for regulating quoting and trading 
on NOM and conduct by NOM participants.\223\ The Exchange's CRO has 
general supervision of the regulatory operations of the Exchange, 
including overseeing surveillance, examination, and enforcement 
functions, and administers a regulatory services agreement 
(``Regulatory Contract'') between the Exchange and FINRA.\224\
---------------------------------------------------------------------------

    \222\ See Corporate Structure Proposal Notice, supra note 8, at 
58138.
    \223\ See Corporate Structure Proposal Notice, supra note 8, at 
58139.
    \224\ Pursuant to the RSA, FINRA performs certain regulatory 
functions on behalf of the Exchange. In addition to performing 
certain membership functions for the Exchange, FINRA performs 
certain disciplinary and enforcement functions for the Exchange. 
Generally, FINRA investigates members, issue complaints, and 
conducts hearings pursuant to the Exchange's rules. Appeals of 
disciplinary hearings, however, will be handled by the Nasdaq Review 
Council. Id.
---------------------------------------------------------------------------

    Pursuant to the Regulatory Contract, FINRA will perform many of the 
initial disciplinary processes on behalf of the Exchange. Additionally, 
the Exchange's By-Laws and rules provide that it has disciplinary 
jurisdiction over its members so that it can enforce its members' 
compliance with its rules and the federal securities laws.\225\ The 
Exchange's rules also permit it to sanction members for violations of 
its rules and violations of the federal securities laws by, among other 
things, expelling or suspending members, limiting members' activities, 
functions, or operations, fining or censuring members, or suspending or 
barring a person from being associated with a member.\226\ Nasdaq's 
Rules also provide for the imposition of fines for minor rule 
violations in lieu of commencing disciplinary proceedings.\227\
---------------------------------------------------------------------------

    \225\ See e.g. Exchange By-Laws, Article IX, Section 2.
    \226\ See e.g. Exchange Rule 8310. Nasdaq rules apply to Options 
Participants and the trading of options contracts on NOM. See NOM 
Rules, Chapter I, Section 2. Prospective Options Participant must, 
among other things, be an existing member or become a member of the 
Exchange, pursuant to the Nasdaq 1000 Rule Series, as well as 
maintain a membership on at least one other options national 
securities exchange. See NOM Rules, Chapter II, Sections 1(b)(iii) 
and 2(f).
    \227\ See infra notes 243 to 250 and accompanying text.
---------------------------------------------------------------------------

    Furthermore, the Exchange has an independent regulatory department, 
Nasdaq Regulation, which carries out many of the Exchange's regulatory 
functions, including administering its membership and disciplinary 
rules, and is functionally separate from the Exchange's business lines. 
Nasdaq Regulation includes Market Watch, which performs real-time 
intraday surveillance over all Exchange-listed companies and all 
Exchange market participants. The Exchange represents that Nasdaq 
Regulation, including Market Watch, will perform the same

[[Page 14536]]

regulatory role with respect to NOM, including operating automated 
detection systems to perform real-time surveillance of quoting and 
trading on NOM and to maintain a fair and orderly market.\228\ 
Specifically, Nasdaq Regulation will perform options listing regulation 
and will monitor trading on the NOM on a real-time basis to identify 
unusual trading patterns and determine whether particular trading 
activity requires further regulatory investigation by FINRA. In 
addition, Nasdaq Regulation will oversee the process for determining 
and implementing trading halts, identifying and responding to unusual 
market conditions, and administering Nasdaq's process for identifying 
and remediating ``obvious errors'' by and among Options Participants. 
The NOM rules governing halts, unusual market conditions, extraordinary 
market volatility, and audit trail are modeled on the approved rules of 
BOX.\229\
---------------------------------------------------------------------------

    \228\ See Corporate Structure Proposal Notice, supra note 8, at 
58139.
    \229\ See BOX Rules, Chapter V.
---------------------------------------------------------------------------

    The Commission finds that the Exchange's proposed rules and 
regulatory structure with respect to NOM are consistent with the 
requirements of the Act, and in particular with Section 6(b)(1) of the 
Act, which requires an exchange to be so organized and have the 
capacity to be able to carry out the purposes of the Act and to comply, 
and to enforce compliance by its members and persons associated with 
its members, with the Act and the rules and regulations thereunder, and 
the rules of the Exchange,\230\ and with Sections 6(b)(6) and 6(b)(7) 
of the Act,\231\ which require an Exchange to provide fair procedures 
for the disciplining of members and persons associated with members.
---------------------------------------------------------------------------

    \230\ 15 U.S.C. 78f(b)(1).
    \231\ 15 U.S.C. 78f(b)(6) and (b)(7).
---------------------------------------------------------------------------

1. Regulatory Contract
    The Exchange represents that the Regulatory Contract between the 
Exchange and FINRA governs the Exchange and its facilities. Therefore, 
because NOM will be a facility of Nasdaq, the Regulatory Contract will 
govern NOM.\232\ The Exchange and FINRA, however, have modified the 
Regulatory Contract to capture certain aspects of regulation of NOM and 
the regulation and discipline of Options Participants.\233\ The 
Commission notes that Nasdaq will continue to bear ultimate regulatory 
responsibility for functions performed on Nasdaq's behalf under the 
Regulatory Contract. Further, the Exchange retains ultimate legal 
responsibility for the regulation of its members (including those 
members that are NOM Participants) and its market (including its 
facility, NOM).
---------------------------------------------------------------------------

    \232\ The Commission notes that the NOM Proposed Rules provide 
that ``NOM rules that refer to Nasdaq Regulation, Nasdaq Regulation 
staff, NOM staff, and NOM departments should be understood as also 
referring to [National Association of Securities Dealers, Inc. 
(``NASD'') (n/k/a Financial Industry Regulatory Authority, Inc. or 
FINRA)], NASD staff, NASD Regulation staff, and NASD departments 
acting on behalf of Nasdaq pursuant to the Regulatory Contract.'' 
See NOM Rules, Chapter 1, Article 3.
    \233\ Nasdaq and FINRA are parties to an agreement pursuant to 
Section 17(d) of the Act and Rule 17d-2 thereunder, dated July 11, 
2006 (``Bilateral 17d-2 Agreement''). A regulatory matter involving 
a NOM Participant that is also a FINRA member that is governed by 
both the Regulatory Contract and the Bilateral 17d-2 Agreement will 
be administered by FINRA pursuant to the Bilateral 17d-2 Agreement, 
not the Regulatory Contract. Telephone conversation between Jeffrey 
S. Davis, Vice President and Deputy General Counsel, Nasdaq, and 
Heather Seidel, Assistant Director, Division of Trading and Markets 
(``Division''), Commission, on December 21, 2007.
---------------------------------------------------------------------------

    The Commission believes that it is consistent with the Act to and 
the public interest to allow the Exchange to contract with FINRA to 
perform membership, disciplinary, and enforcement functions.\234\ 
Membership, discipline, and enforcement are fundamental elements to a 
regulatory program, and constitute core self-regulatory functions. It 
is essential to the public interest and the protection of investors 
that these functions are carried out in an exemplary manner. With 
respect to certain regulatory functions contracted to FINRA by the 
Exchange, including membership, disciplinary and enforcement functions, 
the Commission noted in the Registration Approval Order its belief that 
FINRA has the expertise and experience to perform such functions on 
behalf of the Exchange, and that the contracting of such functions to 
FINRA is consistent with the Act and the public interest.\235\ The 
Commission continues to believe this is true with respect to the 
inclusion in the Regulatory Contract of regulation of NOM and the 
conduct of NOM Participants.
---------------------------------------------------------------------------

    \234\ See e.g., Regulation ATS Release, supra note 92. See also 
Securities Exchange Act Release Nos. 50122 (July 29, 2004), 69 FR 
47962 (August 6, 2004) (order approving File No. SR-Amex-2004-32) 
(``Amex Approval Order''); 42455 (February 24, 2000), 65 FR 11388 
(March 2, 2000) (File No. 10-127) (approving ISE's registration as a 
national securities exchange) (``ISE Exchange Registration Order'') 
at III(D)(2); and Registration Approval Order, supra note 19.
    \235\ See Registration Approval Order, supra note 19, at notes 
10 and 11 and accompanying text.
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    At the same time, the Exchange, unless relieved by the Commission 
of its responsibility,\236\ bears the responsibility for self-
regulatory conduct and primary liability for self-regulatory failures, 
not the SRO retained to perform regulatory functions on the Exchange's 
behalf.\237\ In performing these functions, however, FINRA may 
nonetheless bear liability for causing or aiding and abetting the 
failure of the Exchange to perform its regulatory functions.\238\ 
Accordingly, although FINRA will not act on its own behalf under its 
SRO responsibilities in carrying out these regulatory services for 
Nasdaq relating to the operation of NOM, FINRA also may have secondary 
liability if, for example, the Commission finds the contracted 
functions are being performed so inadequately as to cause a violation 
of the federal securities laws by Nasdaq.\239\
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    \236\ See Section 17(d)(1) of the Act and Rule 17d-2 thereunder. 
15 U.S.C. 78q(d)(1); and 17 CFR 240.17d-2. See also infra note 240 
and accompanying text. The Commission notes that it is not approving 
the Regulatory Contract.
    \237\ See Registration Approval Order, supra note 19, at notes 
112 and 113 and accompanying text; Amex Approval Order, supra note 
234; and ISE Registration Approval Order, supra note 234, at 
III(D)(2).
    \238\ Id.
    \239\ Id.
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2. 17d-2 Agreement
    Rule 17d-2 allows SROs to file with the Commission plans under 
which the SROs allocate among themselves the responsibility to receive 
regulatory reports from, and examine and enforce compliance with, 
specified provisions of the Act and rules thereunder and SRO rules by 
firms that are members of more than one SRO (``common members''). An 
SRO that is a party to an effective 17d-2 plan is relieved of 
regulatory responsibility as to any common member for whom 
responsibility is allocated under the plan to another SRO.\240\
---------------------------------------------------------------------------

    \240\ Rule 17d-2 provides that any two or more SROs may file 
with the Commission a plan for allocating among such SROs the 
responsibility to receive regulatory reports from persons who are 
members or participants of more than one of such SROs to examine 
such persons for compliance, or to enforce compliance by such 
persons, with specified provisions of the Act, the rules and 
regulations thereunder, and the rules of such SROs, or to carry out 
other specified regulatory functions with respect to such persons. 
17 CFR 240.17d-2.
---------------------------------------------------------------------------

    All of the options exchanges, the NASD, and the NYSE have entered 
into the Options Sales Practices Agreement, a Rule 17d-2 agreement 
(``17d-2 Agreement'' or ``Agreement''). This Agreement allocates to 
certain SROs (``examining SROs'') regulatory responsibility for common 
members with respect to certain options-related sales practice matters. 
For example, the Agreement allocates responsibility to conduct options-
related sales practice examinations of a firm, and investigate

[[Page 14537]]

options-related customer complaints and terminations for cause of 
associated persons of that firm. The Commission notes that Nasdaq has 
become a party to the 17d-2 Agreement,\241\ which will cover Nasdaq 
members acting as Options Participants.\242\
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    \241\ The Commission today is approving an amendment to the 17d-
2 Agreement that adds Nasdaq as a party to the Agreement. See 
Securities Exchange Act Release No. 57481 (March 12, 2008) (File No. 
S7-966).
    \242\ NOM rules contemplate participation in this Agreement by 
requiring that any Options Participant that transacts business with 
Public Customers also be a member of at least one of the examining 
SROs. See NOM Rules, Chapter XI, Section 1.
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3. Minor Rule Violation Plan
    The Commission approved Nasdaq's Minor Rule Violation Plan 
(``MRVP'') in 2006.\243\ Nasdaq's MRVP specifies those uncontested 
minor rule violations with sanctions not exceeding $2,500 that would 
not be subject to the provisions of Rule 19d-1(c)(1) under the Act 
\244\ requiring that an SRO promptly file notice with the Commission of 
any final disciplinary action taken with respect to any person or 
organization.\245\ Nasdaq's MRVP includes the policies and procedures 
included in Nasdaq Rule 9216(b), ``Procedure for Violations under Plan 
Pursuant to SEC Rule 19d-1(c)(2),'' and the rule violations included in 
Nasdaq IM-9216, ``Violations Appropriate for Disposition Under Plan 
Pursuant to SEC Rule 19d-1(c)(2).''
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    \243\ See Securities Exchange Act Release No. 53623 (April 10, 
2006), 71 FR 19769 (April 17, 2006) (File No. 4-514) (``MRVP 
Order'').
    \244\ 17 CFR 240.19d-1(c)(1).
    \245\ The Commission adopted amendments to paragraph (c) of Rule 
19d-1 to allow SROs to submit for Commission approval plans for the 
abbreviated reporting of minor disciplinary infractions. See 
Securities Exchange Act Release No. 21013 (June 1, 1984), 49 FR 
23829 (June 8, 1984). Any disciplinary action taken by an SRO 
against any person for violation of a rule of the SRO which has been 
designated as a minor rule violation pursuant to such a plan filed 
with the Commission will not be considered ``final'' for purposes of 
Section 19(d)(1) of the Act if the sanction imposed consists of a 
fine not exceeding $2,500 and the sanctioned person has not sought 
an adjudication, including a hearing, or otherwise exhausted his 
administrative remedies.
---------------------------------------------------------------------------

    The Trading Rules Proposal, as originally filed, included Chapter 
X, Section 7 of the NOM Rules, ``Penalty for Minor Rule Violations,'' 
which lists the options rules that Nasdaq intended to include in its 
MRVP. However, the Trading Rules Proposal did not propose a 
corresponding amendment to Nasdaq IM-9216 to include the rules in 
proposed Chapter X, Section 7 of the NOM Rules in Nasdaq's MRVP. 
Accordingly, in Amendment No. 2, Nasdaq proposes to amend Nasdaq IM-
9216 to include proposed Chapter X, Section 7 of the NOM Rules.\246\ 
The Commission believes that this change is consistent with the Act 
because it clarifies that the proposed rules listed in Chapter X, 
Section 7 of the NOM Rules will be included in Nasdaq's MRVP.
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    \246\ In the MRVP Order, the Commission noted that Nasdaq 
proposed that any amendments to IM-9216 made pursuant to a rule 
filing submitted under Rule 19b-4 of the Act would automatically be 
deemed a request by Nasdaq for Commission approval of a modification 
to its MRVP. See MRVP Order, supra note 243, at note 6.
---------------------------------------------------------------------------

    The Commission notes that the rules included in Chapter X, Section 
7 of the NOM Rules are similar to the rules included in the MRVPs of 
other options exchanges.\247\ The Commission finds that Nasdaq's MRVP, 
as amended to include the rules listed in Chapter X, Section 7 of the 
NOM Rules, is consistent with Sections 6(b)(1), 6(b)(5) and 6(b)(6) of 
the Act, which require, in part, that an exchange have the capacity to 
enforce compliance with, and provide appropriate discipline for, 
violations of the rules of the Commission and of the exchange.\248\ In 
addition, because Nasdaq Rule 9216(b) will offer procedural rights to a 
person sanctioned for a violation listed in Chapter X, Section 7 of the 
NOM Rules, the Commission believes that Nasdaq's rules provides a fair 
procedure for the disciplining of members and associated persons, 
consistent with Section 6(b)(7) of the Act.\249\
---------------------------------------------------------------------------

    \247\ See, e.g., BOX Rules, Chapter X, Section 2, and ISE Rule 
1614.
    \248\ 15 U.S.C. 78f(b)(1), 78f(b)(5) and 78f(b)(6).
    \249\ 15 U.S.C. 78f(b)(7).
---------------------------------------------------------------------------

    The Commission also finds that the proposal to include the rules 
listed in Chapter X, Section 7 of the NOM Rules in Nasdaq's MRVP is 
consistent with the public interest, the protection of investors, or 
otherwise in furtherance of the purposes of the Act, as required by 
Rule 19d-1(c)(2) under the Act,\250\ because it should strengthen 
Nasdaq's ability to carry out its oversight and enforcement 
responsibilities as an SRO in cases where full disciplinary proceedings 
are unsuitable in view of the minor nature of the particular violation.
---------------------------------------------------------------------------

    \250\ 17 CFR 240.19d-1(c)(2).
---------------------------------------------------------------------------

    In approving the proposed change to Nasdaq's MRVP, the Commission 
in no way minimizes the importance of compliance with NOM rules and all 
other rules subject to the imposition of fines under Nasdaq's MRVP. The 
Commission believes that the violation of any SRO rules, as well as 
Commission rules, is a serious matter. However, the Nasdaq MRVP 
provides a reasonable means of addressing rule violations that do not 
rise to the level of requiring formal disciplinary proceedings, while 
providing greater flexibility in handling certain violations. The 
Commission expects that Nasdaq will continue to conduct surveillance 
with due diligence and make a determination based on its findings, on a 
case-by-case basis, whether a fine of more or less than the recommended 
amount is appropriate for a violation under Nasdaq's MRVP or whether a 
violation requires a formal disciplinary action under the Nasdaq Rule 
9200 Series.

J. Quote Mitigation

    Nasdaq originally proposed a rule that would provide for the 
bundling of certain order and quote updates sent to OPRA for low volume 
options that have been listed on NOM for more than ten trading 
days.\251\ In Amendment No. 2, Nasdaq proposes to eliminate the rule as 
proposed and provide that: (1) On a monthly basis, NOM will determine 
the average daily volume (``ADV'') of each series listed on NOM and 
delist the current series and not list the next series after expiration 
where the ADV is less than 100 contracts; \252\ (2) NOM will implement 
a ``replace on queue'' functionality that will monitor outgoing 
messages and will not send a message that is about to be sent if a more 
current message for the same series is available for sending; \253\ (3) 
NOM will prioritize price update messages and send out price updates 
before sending size update messages; and (4) when the size associated 
with a bid or offer increases by an amount less than or equal to a 
percentage (never to exceed 20%) of the size associated with a 
previously disseminated bid or offer, NOM will not disseminate the new 
bid or offer.\254\ Nasdaq also represents that when NOM detects that a 
Participant is disseminating significantly more quotes than is normal 
for that Participant, NOM will contact that Participant and alert it to 
such activity. Such monitoring may reveal that the Participant may have 
internal system issues or incorrectly-set system parameters that are 
not immediately apparent. NOM believes that, even without uncovering 
problems, alerting a Participant to possible excessive quoting will 
lead the

[[Page 14538]]

Participant to take steps to reduce the number of its quotes.\255\
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    \251\ The period for which updates would be bundled would not 
have exceeded one second. This rule was based on a similar rule of 
BOX. See BOX Rules, Chapter V, Section 32.
    \252\ The ADV refers to the ADV on NOM. Telephone conversation 
between Heather Seidel, Assistant Director, Division of Trading and 
Markets, and Jeffrey S. Davis, Vice President and Deputy General 
Counsel, Nasdaq, on January 9, 2008.
    \253\ This functionality will be applied in real time and will 
not delay the sending of any messages.
    \254\ See NOM Rules, Chapter VI, Section 17.
    \255\ See Amendment No. 2 at 9.
---------------------------------------------------------------------------

    The Commission notes that several of the options exchanges have 
adopted similar rules that provide for the delisting of options classes 
when the ADV of the class falls below a certain threshold.\256\ In 
addition, Nasdaq's proposal to not disseminate a new bid or offer when 
the size associated with a bid or offer increases by an amount less 
than or equal to a percentage (never to exceed 20%) of the size 
associated with a previously disseminated bid or offer is substantially 
similar to a Phlx rule previously approved by the Commission.\257\ 
Further, Nasdaq's monitoring strategy is substantially similar to a 
policy adopted by ISE.\258\ The Commission also believes that Nasdaq's 
proposed ``replace on queue'' functionality and its proposal to 
prioritize price update messages and send out price updates before 
sending size update messages are reasonable measures to attempt to 
mitigate quote message traffic because they will more efficiently 
provide for the dissemination of the most recent quote information.
---------------------------------------------------------------------------

    \256\ See Securities Exchange Act Release Nos. 55161 (January 
24, 2007), 72 FR 4754 (February 1, 2007) (File No. SR-ISE-2006-62) 
(ISE Penny Pilot Approval Order) (approving ISE policy to delist 
equity options with an ADV of less than 20 contracts, but noting 
that ISE's current policy is to do so for options with an ADV of 
less than 50 contracts); 55162 (January 24, 2007), 72 FR 4738 
(February 1, 2007) (File No. SR-Amex-2006-106) (Amex Penny Pilot 
Approval Order) (approving Amex policy to delist options classes 
with an ADV of less than 25 contracts); 55154 (January 23, 2007), 72 
FR 4743 (February 1, 2007) (File No. SR-CBOE-2006-92) (CBOE Penny 
Pilot Approval Order) (approving CBOE policy to delist equity option 
classes with an ADV of less than 20 contracts); and 56154 (July 27, 
2007), 72 FR 43303 (August 3, 2007) (File No. SR-CBOE-2007-85) 
(approving an exception to CBOE's delisting policy if the option 
class scheduled for delisting experiences a significant increase in 
trading volume).
    \257\ See Securities Exchange Act Release No. 55153 (January 23, 
2007), 72 FR 4553 (January 31, 2007) (File No. SR-Phlx-2006-74) 
(order approving, in part, a Phlx rule providing that it will 
disseminate an updated bid or offer when, among other things, the 
size associated with it's bid or offer increases by an amount 
greater than or equal to a percentage (never to exceed 20%)).
    \258\ See ISE Penny Pilot Approval Order, supra note 256. See 
also CBOE Penny Pilot Approval Order and Amex Penny Pilot Approval 
Order, supra note 256.
---------------------------------------------------------------------------

    Although Nasdaq's rules do not include a ``holdback timer'' or 
similar quote mitigation strategy like those adopted by four of the 
other options exchanges,\259\ the Commission believes that the totality 
of Nasdaq's proposed market structure, market making obligations, and 
quote mitigation strategies are comparable to the quote mitigation 
efforts of the other options markets. More specifically, Nasdaq has 
proposed to allow Market Makers to register by series, as opposed to 
class. As noted above, the Commission believes that this will permit 
Market Makers to select the options series in which they are most 
interested. This is designed to reduce the number of quotes submitted 
by such Market Makers, and therefore likely will help to mitigate NOM's 
quote message traffic and capacity.\260\ In addition, NOM Rules provide 
that a market maker's continuous quoting obligations will not be 
applicable in options series until the time to expiration is less than 
nine months.\261\
---------------------------------------------------------------------------

    \259\ See Amex Penny Pilot Approval Order, CBOE Penny Pilot 
Approval Order, and ISE Penny Pilot Approval Order, supra note 256; 
and Securities Exchange Act Release No. 55155 (January 23, 2007), 72 
FR 4741 (February 1, 2007) (File No. SR-BSE-2006-49) (approving 
BOX's Penny Pilot program).
    \260\ See supra notes 57 to 58 and accompanying text.
    \261\ See NOM Rules, Chapter IV, Section 8(a). See also CBOE 
Rule 8.7; PHLX Rule 1014(b)(ii)(D)(4); and Amex Rules 993-
ANTE(c)(ii) and 994-ANTE(c)(iv).
---------------------------------------------------------------------------

    Further, Nasdaq has proposed that it will open at least one 
expiration month for each class of option open for trading on NOM, and 
a minimum of one series of options in that class.\262\ These 
requirements provide for fewer mandatory expiration months and series 
than the rules of other options exchanges, and may therefore contribute 
to less quote message traffic on NOM to the extent that NOM has fewer 
series open for trading. And, as detailed above, Nasdaq has proposed 
four quote mitigation strategies, several of which are substantially 
similar to those in place at other markets.
---------------------------------------------------------------------------

    \262\ See NOM Rules, Chapter IV, Sections 6(b) and 6(e). In 
Amendment No. 2, Nasdaq proposes to revise Chapter IV, Section 6(b) 
of the NOM Rules to provide that at the commencement of trading of 
an options class, NOM will list a minimum of one options series in 
that class, rather than a minimum of three series for each 
expiration month in the class, as originally proposed.
---------------------------------------------------------------------------

K. Section 11(a) of the Act

    Section 11(a)(1) of the Act \263\ prohibits a member of a national 
securities exchange from effecting transactions on that exchange for 
its own account, the account of an associated person, or an account 
over which it or its associated person exercises discretion 
(collectively, ``covered accounts'') unless an exception applies. Rule 
11a2-2(T) \264\ under the Act, known as the ``effect versus execute'' 
rule, provides exchange members with an exemption from the Section 
11(a)(1) prohibition. Rule 11a2-2(T) permits an exchange member, 
subject to certain conditions, to effect transactions for covered 
accounts by arranging for an unaffiliated member to execute 
transactions on the exchange. To comply with Rule 11a2-2(T)'s 
conditions, a member: (i) Must transmit the order from off the exchange 
floor; (ii) may not participate in the execution of the transaction 
once it has been transmitted to the member performing the execution; 
\265\ (iii) may not be affiliated with the executing member; and (iv) 
with respect to an account over which the member has investment 
discretion, neither the member nor its associated person may retain any 
compensation in connection with effecting the transaction except as 
provided in the Rule.
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    \263\ 15 U.S.C. 78k(a)(1).
    \264\ 17 CFR 240.11a2-2(T).
    \265\ The member may, however, participate in clearing and 
settling the transaction.
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    In a letter to the Commission, Nasdaq requests that the Commission 
concur with Nasdaq's conclusion that Participants that enter orders 
into NOM satisfy the requirements of Rule 11a2-2(T).\266\ For the 
reasons set forth below, the Commission believes that Participants 
entering orders into NOM would satisfy the conditions of the Rule.
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    \266\ See letter from Jeffrey S. Davis, Vice President and 
Deputy General Counsel, Nasdaq, to Nancy M. Morris, Secretary, 
Commission, dated December 13, 2007 (``Nasdaq 11(a) Letter'').
---------------------------------------------------------------------------

    The Rule's first condition is that orders for covered accounts be 
transmitted from off the exchange floor. The NOM System receives orders 
electronically through remote terminals or computer-to-computer 
interfaces. In the context of other automated trading systems, the 
Commission has found that the off-floor transmission requirement is met 
if a covered account order is transmitted from a remote location 
directly to an exchange's floor by electronic means.\267\ Because the 
NOM System receives orders electronically through remote terminals or 
computer-to-computer interfaces, the Commission

[[Page 14539]]

believes that the NOM System satisfies the off-floor transmission 
requirement.
---------------------------------------------------------------------------

    \267\ See, e.g., Registration Approval Order, supra note 19; BOX 
Approval Order, supra note 72; and Securities Exchange Act Release 
Nos. 44983 (October 25, 2001), 66 FR 55225 (November 1, 2001) (order 
approving the Archipelago Exchange as an electronic trading facility 
of the Pacific Exchange (``PCX'')); 29237 (May 24, 1991), 56 FR 
24853 (May 31, 1991) (regarding NYSE's Off-Hours Trading Facility); 
15533 (January 29, 1979), 44 FR 6084 (January 31, 1979) (regarding 
the American Stock Exchange (``Amex'') Post Execution Reporting 
System, the Amex Switching System, the Intermarket Trading System, 
the Multiple Dealer Trading Facility of the Cincinnati Stock 
Exchange, the PCX Communications and Execution System, and the 
Philadelphia Stock Exchange's Automated Communications and Execution 
System (``1979 Release'')); and 14563 (March 14, 1978) 43 FR 11542 
(March 17, 1978) (regarding the NYSE's Designated Order Turnaround 
System (``1978 Release'')).
---------------------------------------------------------------------------

    Second, the Rule requires that the member not participate in the 
execution of its order. Nasdaq represented that at no time following 
the submission of an order is a Participant able to acquire control or 
influence over the result or timing of an order's execution. According 
to Nasdaq, the execution of a member's order is determined solely by 
what other orders, bids, or offers are present in the NOM System at the 
time the Participant submits the order and on the priority of those 
orders, bids, and offers.\268\ Accordingly, the Commission believes 
that a Participant does not participate in the execution of an order 
submitted to the NOM System.
---------------------------------------------------------------------------

    \268\ See Nasdaq 11(a) Letter, supra note 266, at 7. The 
Participant may cancel or modify the order, or modify the 
instruction for executing the order, but only from off the floor. 
The Commission has stated that the non-participation requirement is 
satisfied under such circumstances so long as such modifications or 
cancellations are also transmitted from off the floor. See 1978 
Release, supra note 267 (stating that the ``non-participation 
requirement does not prevent initiating members from canceling or 
modifying orders (or the instructions pursuant to which the 
initiating member wishes orders to be executed) after the orders 
have been transmitted to the executing member, provided that any 
such instructions are also transmitted from off the floor'').
---------------------------------------------------------------------------

    Third, Rule 11a2-2(T) requires that the order be executed by an 
exchange member who is unaffiliated with the member initiating the 
order. The Commission has stated that this requirement is satisfied 
when automated exchange facilities, such as the NOM System, are used, 
as long as the design of these systems ensures that members do not 
possess any special or unique trading advantages in handling their 
orders after transmitting them to the exchange.\269\ Nasdaq has 
represented that the design of the NOM System ensures that no member 
has any special or unique trading advantage in the handling of its 
orders after transmitting its orders to the Exchange.\270\ Based on 
Nasdaq's representation, the Commission believes that the NOM System 
satisfies this requirement.
---------------------------------------------------------------------------

    \269\ In considering the operation of automated execution 
systems operated by an exchange, the Commission noted that while 
there is not an independent executing exchange member, the execution 
of an order is automatic once it has been transmitted into the 
systems. Because the design of these systems ensures that members do 
not possess any special or unique trading advantages in handling 
their orders after transmitting them to the exchange, the Commission 
has stated that executions obtained through these systems satisfy 
the independent execution requirement of Rule 11a2-2(T). See 1979 
Release, supra note 267.
    \270\ See Nasdaq 11(a) Letter, supra note 266, at 8.
---------------------------------------------------------------------------

    Fourth, in the case of a transaction effected for an account with 
respect to which the initiating member or an associated person thereof 
exercises investment discretion, neither the initiating member nor any 
associated person thereof may retain any compensation in connection 
with effecting the transaction, unless the person authorized to 
transact business for the account has expressly provided otherwise by 
written contract referring to Section 11(a) of the Act and Rule 11a2-
2(T).\271\ Nasdaq represents that Participants trading for covered 
accounts over which they exercise investment discretion must comply 
with this condition in order to rely on the rule's exemption.\272\
---------------------------------------------------------------------------

    \271\ 17 CFR 240.11a2-2(T)(a)(2)(iv). In addition, Rule 11a2-
2(T)(d) requires a member or associated person authorized by written 
contract to retain compensation, in connection with effecting 
transactions for covered accounts over which such member or 
associated persons thereof exercises investment discretion, to 
furnish at least annually to the person authorized to transact 
business for the account a statement setting forth the total amount 
of compensation retained by the member in connection with effecting 
transactions for the account during the period covered by the 
statement. See 17 CFR 240.11a2-2(T)(d). See also 1978 Release, supra 
note 267 (stating ``[t]he contractual and disclosure requirements 
are designed to assure that accounts electing to permit transaction-
related compensation do so only after deciding that such 
arrangements are suitable to their interests'').
    \272\ See Nasdaq 11(a) Letter, supra note 266, at 8.
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III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 2, including whether Amendment No. 2 
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-2007-004 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.
    All submissions should refer to File Number SR-NASDAQ-2007-004. 
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 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 such filing also will be available for 
inspection and copying at the principal office of the Amex. 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-2007-004 and should 
be submitted on or before April 8, 2008.

IV. Exemption From Section 19(b) of the Act With Regard to CBOE, NYSE, 
and FINRA Rules Incorporated by Reference

    Nasdaq proposes to incorporate by reference as NOM Rules certain 
rules of the CBOE, NYSE, and FINRA.\273\ Thus, for certain NOM rules, 
NOM members will comply with a NOM rule by complying with the CBOE, 
NYSE, or FINRA rule referenced. In connection with its proposal to 
incorporate CBOE, NYSE, and FINRA rules by reference, Nasdaq requested, 
pursuant to Rule

[[Page 14540]]

240.0-12,\274\ an exemption under Section 36 of the Act from the rule 
filing requirements of Section 19(b) of the Act for changes to those 
NOM rules that are effected solely by virtue of a change to a cross-
referenced CBOE, NYSE, or FINRA rule.\275\ Nasdaq proposes to 
incorporate by reference categories of rules (rather than individual 
rules within a category) that are not trading rules. Nasdaq agrees to 
provide written notice to Participants prior to the launch of NOM of 
the specific CBOE, NYSE, and FINFRA rules that it will incorporate by 
reference.\276\ In addition, Nasdaq will notify Participants whenever 
CBOE, NYSE, or FINRA proposes a change to a cross-referenced CBOE, 
NYSE, or FINRA rule.\277\
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    \273\ Specifically, Nasdaq proposes to incorporate by reference: 
(1) CBOE rules governing position and exercise limits for equity and 
index options, which are cross-referenced in Chapter III, Sections 7 
and 9 of the NOM Rules and Chapter XIV, Sections 5 and 7 of the NOM 
Rules, respectively; (2) the margin rules of the CBOE or the NYSE, 
which are referenced in Chapter XIII, Section 3 of the NOM Rules; 
and (3) FINRA's rules governing communications with the public, 
which are referenced in Chapter XI, Section 22 of the NOM Rules. 
With respect to position limits, one commenter believes that each 
options exchange should be required to develop its own expertise and 
establish specific requirements in its own rules to provide for 
proper disclosure to members and to further the exchange's 
compliance and surveillance functions. See Amex Letter, supra note 
4, at 4. Nasdaq believes that its reliance on the position and 
exercise limit rules of CBOE assures equal regulation among markets. 
See Nasdaq Response, supra note 5, at 2. The Commission does not 
believe that requiring each options exchange to develop its own 
position limits would promote the efficient use of SRO and 
Commission resources. In addition, as discussed below, Nasdaq will 
notify Participants whenever the CBOE proposes to change a position 
limit rule that has been incorporated by reference into the NOM 
Rules.
    \274\ 17 CFR 240.0-12.
    \275\ See letter from Jeffrey S. Davis, Vice President and 
Deputy General Counsel, Nasdaq, to Nancy Morris, Secretary, 
Commission, dated December 13, 2007 (``Nasdaq 19(b) Exemption 
Letter'').
    \276\ See Nasdaq 19(b) Exemption Letter, supra note 275, at 2.
    \277\ NOM will provide such notice through a posting on the same 
web site location where NOM will post its own rule filings pursuant 
to Rule 19b-4(l) under Act, within the time frame required by that 
Rule. The web site posting will include a link to the location on 
the CBOE, NYSE, or FINRA web site where those SROs' proposed rule 
changes are posted. See Nasdaq 19(b) Exemption Letter, supra note 
275, at note 4 and accompanying text.
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    Using its authority under Section 36 of the Act, the Commission 
previously exempted certain SROs from the requirement to file proposed 
rule changes under Section 19(b) of the Act.\278\ Each such exempt SRO 
agreed to be governed by the incorporated rules, as amended from time 
to time, but is not required to file a separate proposed rule change 
with the Commission each time the SRO whose rules are incorporated by 
reference seeks to modify its rules.
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    \278\ See Securities Exchange Act Release No. 49260 (February 
17, 2004), 69 FR 8500 (February 24, 2004). See also Registration 
Approval Order, supra note 19.
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    In addition, each SRO incorporated by reference only regulatory 
rules (e.g., margin, suitability, arbitration), not trading rules, and 
incorporated by reference whole categories of rules (i.e., did not 
``cherry-pick'' certain individual rules within a category). Each 
exempt SRO had reasonable procedures in place to provide written notice 
to its members each time a change is proposed to the incorporated rules 
of another SRO in order to provide its members with notice of a 
proposed rule change that affects their interests, so that they would 
have an opportunity to comment on it.
    The Commission is granting Nasdaq's request for exemption, pursuant 
to Section 36 of the Act, from the rule filing requirements of Section 
19(b) of the Act with respect to the rules that Nasdaq proposes to 
incorporate by reference into NOM's Rules.\279\ This exemption is 
conditioned upon Nasdaq providing written notice to NOM participants 
whenever the CBOE, NYSE, or FINRA proposes to change a rule that NOM 
has incorporated by reference. The Commission believes that this 
exemption is appropriate in the public interest and consistent with the 
protection of investors because it will promote more efficient use of 
Commission and SRO resources by avoiding duplicative rule filings based 
on simultaneous changes to identical rule text sought by more than one 
SRO. Consequently, the Commission grants Nasdaq's exemption request for 
NOM.
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    \279\ As discussed above, Nasdaq has represented that it will 
notify Participants whenever the CBOE, NYSE, or FINRA proposes a 
change to a cross-referenced CBOE, NYSE, or FINRA rule. See supra 
note 277 and accompanying text.
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V. Exemption From the Requirement To Register as a SIP

    As described above, NOM LLC will be delegated the authority to act 
as a SIP for quotations and transaction information related to 
securities traded on NOM and any trading facilities operated by NOM 
LLC. In a letter dated December 13, 2007 (``Request Letter'') \280\ 
submitted in conjunction with Nasdaq's proposal, Nasdaq, on behalf of 
NOM LLC, requested that the Commission grant NOM LLC a permanent 
exemption from the requirement under Section 11A(b) of the Act and Rule 
609 thereunder that a securities information processor acting as an 
exclusive processor register with the Commission.\281\ For the reasons 
discussed below, the Commission grants the requested exemption, subject 
to the conditions specified in this order.
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    \280\ See letter from Edward S. Knight, Executive Vice President 
and General Counsel, Nasdaq, to Dr. Erik Sirri, Director, Division 
of Trading and Markets, Commission, dated December 13, 2007.
    \281\ 15 U.S.C. 78k-1(b). Rule 609 under the Act, 17 CFR 
242.609, requires that the registration of a securities information 
processor be on Form SIP, 17 CFR 249.1001.
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A. Overview

    Pursuant to Nasdaq's proposal being approved today, NOM LLC will be 
a wholly owned subsidiary, established for the purpose of operating a 
Nasdaq facility for the trading of options. Nasdaq will delegate the 
performance of certain of its market functions to NOM LLC with respect 
to the quoting and trading of options, including the authority to act 
as a securities information processor for quoting and trading 
information related to options traded on NOM and any trading facilities 
operated by NOM LLC. Because NOM LLC will be engaging, on an exclusive 
basis on behalf of Nasdaq, in collecting, processing, or preparing for 
distribution or publication information with respect to transactions or 
quotations on, or effected or made by means of, a facility of Nasdaq, 
it will be an exclusive processor required to register pursuant to 
Section 11A(b) of the Act. Nevertheless, as further described in the 
Request Letter, Nasdaq and NOM LLC believe that the purposes of Section 
11A(b) of the Act are not served by requiring NOM LLC to register as an 
exclusive processor under Section 11A(b) of the Act because Section 
11A(b) subjects registered securities information processor to a 
regulatory regime to which NOM will be subject in all material respects 
as a facility of a registered national securities exchange.

B. Discussion

    Sections 11A(b)(1) and (2) of the Act and Rule 609 thereunder 
(formerly Rule 11Ab2-1) provide that a securities information processor 
\282\ that is acting as an exclusive processor \283\ register with the 
Commission by filing an application for registration on Form SIP. 
Section 11A(b)(1) of the Act and Rule 609(c) thereunder allow the 
Commission, by rule or order, to conditionally or unconditionally 
exempt any securities information processor from any provision of 
Section 11A(b) of the Act or the rules or regulations thereunder, if 
the Commission finds that such exemption is consistent with the public 
interest, the protection of investors, and the purposes of Section 
11A(b).\284\
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    \282\ Section 3(a)(22) of the Act, 15 U.S.C. 78c(a)(22)(A), 
defines the term securities information processor to mean any person 
engaged in the business of (i) collecting, processing, or preparing 
for distribution or publication, or assisting, participating in, or 
coordinating the distribution or publication of, information with 
respect to transactions in or quotations for any security (other 
than an exempted security) or (ii) distributing or publishing 
(whether by means of a ticker tape, a communications network, a 
terminal display device, or otherwise) on a current and continuing 
basis, information with respect to such transactions or quotations.
    \283\ Under Section 3(a)(22)(B) of the Act, 15 U.S.C. 
78c(a)(22)(B), an exclusive processor is defined as any securities 
information processor or self-regulatory organization which, 
directly or indirectly, engages on an exclusive basis on behalf of 
any national securities exchange or registered securities 
association, or any national securities exchange or registered 
securities association which engages on an exclusive basis on its 
own behalf, in collecting, processing, or preparing for distribution 
or publication any information with respect to (i) transactions or 
quotations on or effected or made by means of any facility of such 
exchange or (ii) quotations distributed or published by means of any 
electronic system operated or controlled by such association.
    \284\ See 15 U.S.C. 78k-1(b)(1) and 17 CFR 242.609(c).

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[[Page 14541]]

    In its release adopting Rule 609, the Commission provides a 
framework for the consideration of exemption requests pursuant to 
Section 11A(b)(1) of the Act.\285\ Specifically, the Commission 
indicates that the need for registration of an exclusive processor 
should be considered in respect of Sections 11A(b)(1), (b)(3) and 
(b)(5) and Sections 17(a) and (b) of the Act, insofar as they provide a 
framework for the surveillance and regulation of registered securities 
information processors. The Commission stated that any application for 
an exemption from registration should show not only how such exemption 
would be consistent with the statutory purposes discussed in the 
release, but also should demonstrate why, by virtue of the applicant's 
organization, operation or other characteristics, the applicant should 
be exempted from registration, the requirements of Section 11A(b) and 
the Commission's authority under Sections 17(a) and 17(b) of the 
Act.\286\
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    \285\ See Securities Exchange Act Release No. 11673 (September 
23, 1975), 40 FR 45422 (October 2, 1975) (adopting Commission Rule 
11Ab2-1, which has been redesignated as Rule 609).
    \286\ Id. at 45423.
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    The Commission believes that NOM LLC will be acting as an exclusive 
processor as defined in Section 3(a)(22)(B) of the Act because it will 
engage on an exclusive basis on behalf of Nasdaq, in collecting, 
processing, or preparing for distribution or publication information 
with respect to transactions or quotations on, or effected or made by 
means of, a facility of Nasdaq. Further, NOM LLC, in carrying out 
market functions of Nasdaq, will operate (and will be regulated) as a 
facility of Nasdaq, which is a national securities exchange registered 
under Section 6 of the Act and the rules and regulations 
thereunder.\287\ In the Request Letter, Nasdaq represents that NOM LLC 
will not perform any exclusive processor functions other than in its 
capacity as a facility for Nasdaq.\288\
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    \287\ Section 3(a)(2) of the Act, 15 U.S.C. 78c(a)(2), defines 
the term facility, with respect to an exchange, to include its 
premises, tangible or intangible property whether on the premises or 
not, any right to use such premises or property or any service 
thereof for the purpose of effecting or reporting a transaction on 
an exchange (including, among other things, any system of 
communication to or from the exchange, by ticker or otherwise, 
maintained by or with the consent of the exchange), and any right of 
the exchange to the use of any property or service.
    \288\ Request Letter, supra note 280, at 3.
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    As discussed below, with respect to its operation as a facility of 
a registered national securities exchange, NOM LLC already will be 
subject to regulation and Commission oversight under the Act as a 
facility of a registered exchange.\289\ Oversight and regulation of 
registered exchanges encompass and exceed the oversight and regulation 
to which NOM LLC will be subject pursuant to registration under Section 
11A(b)(1) of the Act and the rules and regulations thereunder. 
Accordingly, the Commission believes that registration of NOM LLC as an 
exclusive processor under Section 11A(b)(1) of the Act with respect to 
those functions that it will carry out as a facility of Nasdaq would 
not further the purposes of the Act.
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    \289\ The definition of an exchange under the Act includes ``the 
market facilities maintained by such exchange.'' See Section 3(a)(1) 
of the Act, 15 U.S.C. 78c(a)(1). The functions and operation of a 
national securities exchange encompass the collection, processing, 
and dissemination of information related to securities trading.
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1. Denial of Access to Services Provided by a Securities Information 
Processor or a National Securities Exchange
    Section 11A(b)(5)(A) of the Act (1) requires a registered 
securities information processor to promptly file notice with the 
Commission if the processor prohibits or limits any person in respect 
of access to services offered, directly or indirectly, by the 
processor, and (2) provides that any such prohibition or limitation 
will be subject to Commission review, on its own motion or upon 
application by any person aggrieved.\290\ If the prohibition or 
limitation is reviewed, the Commission shall dismiss the proceeding if 
it finds (after notice and opportunity of a hearing) that such 
prohibition or limitation is consistent with the provisions of the Act 
and the rules and regulations thereunder and that such person has not 
been discriminated against unfairly. If the Commission does not make 
such a finding, or if it finds that such prohibition or limitation 
imposes any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act, the Commission shall set aside 
the prohibition or limitation and require the securities information 
processor to permit such person access to services offered by the 
processor.\291\
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    \290\ See 15 U.S.C. 78k-1(b)(5)(A).
    \291\ See Section 11A(b)(5)(B) under the Act, 15 U.S.C. 78k-
1(b)(5)(B).
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    NOM LLC, however, will be subject to similar Commission regulation 
and oversight pursuant to Sections 6(b)(7), 6(d), 19(d), and 19(f) of 
the Act with respect to its activities as a facility of Nasdaq.\292\ 
Section 19(d)(1) requires, in part, that an exchange promptly file 
notice with the Commission if the exchange prohibits or limits any 
person in respect to access to services offered by such exchange or 
member thereof.\293\ Any such action for which the exchange must file 
notice is subject to Commission review.\294\
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    \292\ 15 U.S.C. 78f(b)(7) and (d) and 78s(d) and (f).
    \293\ 15 U.S.C. 78s(d)(1).
    \294\ 15 U.S.C. 78s(d)(2). See also Section 19(f) of the Act, 15 
U.S.C. 78s(f).
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    Section 19(f) of the Act, among other things, allows the Commission 
to set aside an SRO's prohibition or limitation with respect to access 
to services offered by the SRO if the Commission finds that the 
prohibition or limitation imposes any burden on competition not 
necessary or appropriate in furtherance of the purposes of the Act.
    Section 6(b)(7) of the Act provides that the rules of an exchange, 
among other things, must provide a fair procedure for the prohibition 
or limitation by the exchange of any person with respect to access to 
services offered by the exchange or a member thereof.\295\
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    \295\ 15 U.S.C. 78f(b)(7). Section 6(d)(2), 15 U.S.C. 78f(d)(2), 
provides procedural requirements for any such proceeding by an 
exchange.
---------------------------------------------------------------------------

    Section 6(d) of the Act requires, among other things, that a 
national securities exchange that initiates a proceeding to determine 
whether to prohibit or limit a person's access to services offered by 
the exchange notify the person of the specific grounds for the 
prohibition or limitation and provide an opportunity to be heard. In 
addition, Section 6(d) provides that an exchange's determination to 
prohibit or limit a person's access to the exchange's services must be 
supported by a statement setting for the specific grounds on which the 
prohibition or limitation is based.
    The Commission therefore believes that regulation of Nasdaq as a 
national securities exchange provides for equivalent regulation and 
Commission oversight of actions that NOM LLC may take in its capacity 
as a facility to deny access to services as would be the case were it 
to register as an exclusive processor under Section 11A(b) of the Act.
2. Limitation on Activities of a Securities Information Processor or a 
National Securities Exchange
    Section 11A(b)(6) of the Act grants the Commission authority to 
censure or place limitations on the activities, functions, or 
operations of any registered securities information processor or 
suspend for a period not exceeding twelve months or revoke the 
registration of any such processor.\296\ Likewise, Section 19(h)(1) of 
the Act grants the Commission authority to

[[Page 14542]]

suspend for a period not exceeding twelve months or revoke the 
registration of an exchange, or to censure or impose limitations upon 
the activities, functions, and operations of an exchange.\297\ The 
Commission therefore has the authority to place limitations on the 
activities of NOM LLC as a facility of a registered national securities 
exchange.
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    \296\ 15 U.S.C. 78k-1(b)(6).
    \297\ 15 U.S.C. 78s(h)(1). See also Sections 19(h)(2), (h)(3), 
and (h)(4) of the Act, 15 U.S.C. 78s(h)(2), (h)(3), and (h)(4).
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3. Access to Books and Records of a Securities Information Processor or 
a National Securities Exchange
    Section 17(a)(1) of the Act requires that national securities 
exchanges and registered securities information processors make and 
keep for prescribed periods such records, furnish such copies thereof, 
and make and disseminate such reports as the Commission, by rule, 
prescribes as necessary or appropriate in the public interest, for the 
protection of investors, or otherwise in furtherance of the purposes of 
the Act.\298\ Section 17(b) of the Act requires that such records be 
subject at any time, or from time to time, to such reasonable periodic, 
special, or other examinations by representatives of the Commission and 
the appropriate regulatory agency for such persons.\299\
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    \298\ 15 U.S.C. 78q(a). The Commission has promulgated rules 
pursuant to Section 17(a) of the Act that apply to national 
securities exchanges, but not registered securities information 
processors. See, e.g., Rule 17a-1 under the Act, 17 CFR 240.17a-1 
(requiring in part a national securities exchange to preserve, for a 
period of not less than five years, the first two in an easily 
accessible place, at least one copy of all documents that are made 
or received by it in the course of its business as such and in the 
conduct of its self-regulatory activity, and to furnish copies of 
such records to any representative of the Commission upon request). 
Form SIP, the application for registration of a securities 
information processor, does require that a securities information 
processor provide the Commission with certain information relating 
to its business organization, financial information, operational 
capability, and access to services. 17 CFR 249.1001.
    \299\ 15 U.S.C. 78q(b).
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    The record retention and production requirements set out in 
Sections 17(a) and (b) of the Act therefore will be applicable to NOM 
LLC with respect to its activities as a facility of Nasdaq. Thus, 
requiring NOM LLC to register as an exclusive processor with respect to 
its activities as a facility of a registered exchange would serve no 
additional regulatory purpose in this instance.

C. Conclusion

    On the basis of the foregoing, the Commission finds that, with 
respect to its activities as a facility of Nasdaq, granting an 
exemption to NOM LLC from the requirement to register as a securities 
information processor pursuant to Section 11A(b) of the Act is 
consistent with the public interest, the protection of investors, and 
the purposes of Section 11A(b) of the Act, including maintenance of 
fair and orderly markets in securities and the removal of impediments 
to, and perfection of the mechanism of, a national market system. This 
exemption is limited only to the exclusive processor activities that 
NOM LLC performs as a facility of Nasdaq.

VI. Accelerated Approval of the Trading Rules Proposal, as Amended

    The Commission finds good cause for approving the Trading Rules 
Proposal, as amended, prior to the thirtieth day after the date of 
publication of notice of filing of the amended proposal in the Federal 
Register.
    As discussed above, the Commission believes that the changes 
proposed in Amendment No. 2 strengthen and clarify the Trading Rules 
Proposal. In addition to making non-substantive and technical changes, 
Amendment No. 2 incorporates changes designed to make NOM's rules 
consistent with or substantially similar to rules adopted by the other 
options exchanges or the provisions of the Linkage Plan.\300\ Other 
changes in Amendment No. 2 are designed to clarify NOM's rules,\301\ 
provide additional protections,\302\ address non-substantive issues or 
address concerns raised by commenters.\303\ For these reasons, the 
Commission finds good cause for approving the Trading Rules Proposal, 
as amended, on an accelerated basis, pursuant to Section 19(b)(2) of 
the Act.
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    \300\ See, e.g., the addition of rules in Chapter II providing 
for registration as a Limited Principal and as a Limited 
Representative in options and security futures; changes in Chapter 
IV, Section 3, to allow NOM to list an option that does not meet its 
initial listing standards if the option is listed on another 
national securities exchange and meets certain other conditions (see 
supra notes 220 to 221 and accompanying text); changes to Chapter 
IV, Commentaries .02 and .03, relating to the $1 Strike Price 
Program and the $2.50 Strike Price Program, respectively (see supra 
notes 208 to 213 and accompanying text); changes to the obvious 
error provisions of Chapter V, Section 6 (see supra note 168 and 
accompanying text); and changes to various provisions of the 
Intermarket Linkage Rules in Chapter XII to require a response time 
of five seconds rather than three seconds.
    \301\ See, e.g., revisions to Nasdaq IM-9216 to include Chapter 
X, Section 7 of the NOM Rules in Nasdaq's MRVP (see supra notes 243 
to 249 and accompanying text); changes to Chapter I, Section 1 to 
clarify the definition of ``primary market;'' changes to Chapter 
III, Section 15 to clarify that the provisions of the rule apply 
only to options clearing Participants; changes to Chapter VI, 
Section 10 to more clearly articulate NOM's price/time execution 
algorithm; the deletion of a proposed provision in Chapter VII 
relating to short sales by options market makers; and changes to 
Chapter VIII, Sections 1(b) and 1(d) to require Participants to 
submit contrary exercise advices to the Options Clearing Corporation 
rather than to NOM.
    \302\ See, e.g., changes to Chapter III, Section 4(f) to 
prohibit a Participant with knowledge of an order being facilitated 
or submitted to NOM for price improvement (e.g., price improving 
orders) from entering an order to buy or sell the underlying 
security, as provided in the rule; a modification to the position 
and exercise limits in Chapter III, Sections 7 and 9 to clarify that 
the incorporation of CBOE rules applies to the trading of options 
listed on both CBOE and Nasdaq; modifications to the Closing Cross 
procedures in Chapter VI, Section 9 that, among other things, 
provide that the Current Reference Price and the Near Clearing Price 
will be disseminated in an option's minimum price variation and 
never at a price that would expose undisplayed interest on the NOM 
book (see supra notes 162 to 164 and accompanying text); additions 
to Chapter VI, Section 11 relating to NOS as a facility of Nasdaq, 
which, among other things, require that an SRO other than Nasdaq be 
the designated examining authority for NOS, and that NOM establish 
procedures and controls designed to restrict the flow of 
confidential and proprietary information between Nasdaq and its 
facilities, including NOS (see supra notes 187 to 191 and 
accompanying text); the addition to Chapter VI, Section 11 of a 
requirement that Participants whose orders are routed to away 
markets honor such trades to the same extent that they would be 
obligated to honor a trade executed on NOM; a change to Chapter XI, 
Section 21 to state that a Participant must expedite the transfer of 
a customer's account pursuant to Nasdaq Rules IM-2110-7 and 11870; 
changes to Chapter XIV to add position limit provisions for Micro-
Narrow Based Index options and to refer to the applicable NOM rules 
for position limits on broad-based index options traded on NOM but 
not on the CBOE.
    \303\ See, e.g., the proposed change to eliminate Non-Displayed 
Orders (see supra notes 100 to 102 and accompanying text); the 
revised definition of ``index option'' (see supra note 219); the 
changes in Chapter IV, Section 5 to clarify NOM's procedures and 
status with respect to the Linkage Plan when an options class that 
has been approved for listing on NOM has no series open for trading, 
and when the sole Market Maker in a series withdraws its 
registration (see supra notes 78 to 79 and accompanying text); the 
changes in Chapter VI to clarify the definitions and order routing 
procedures for ``System Securities'' and ``Non-System Securities'' 
(see supra notes 183 to 186 and accompanying text); the 
clarification in Chapter VI, Section 9 of the time of the Closing 
Cross for options on fund shares and broad-based indexes (see supra 
notes 147 to 149 and accompanying text); the change in Chapter VI, 
Section 10, to identify the taker of liquidity as the party that 
removes liquidity previously posted to the Book; and the change in 
Chapter VII, Section 12, Commentary .04 to indicate that a 
Participant may not inform another Participant or other third party 
of any of the terms of an order after submitting the order to NOM.
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VII. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\304\ that the Trading Rules Proposal (SR-NASDAQ-2007-004), as 
amended, be, and hereby is, approved on an accelerated basis, except 
for the $1 Strike Price Program, which is approved on a pilot basis 
through June 5, 2008; and that the Corporate Structure Proposal (SR-

[[Page 14543]]

NASDAQ-2007-080) be, and hereby is, approved.
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    \304\ 15 U.S.C. 78s(b)(2).
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    Although the Commission's approval of the Trading Rules Proposal, 
as amended, and the Corporate Structure Proposal is final and the 
proposed rules are therefore effective,\305\ it is further ordered that 
the operation of NOM is conditioned on the satisfaction of the 
requirements below:
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    \305\ As noted above, the $1 Strike Price Program, which is part 
of the Trading Rules Proposal, is approved on a pilot basis through 
June 5, 2008.
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    A. Participation in National Market System Plans Relating to 
Options Trading. Nasdaq must join the Options Price Reporting 
Authority; the OLPP; the Linkage Plan; and the National Market System 
Plan of the Options Regulatory Surveillance Authority.
    B. Examination by the Commission. Nasdaq must have, and represent 
in a letter to the staff in the Commission's Office of Compliance 
Inspections and Examinations (``OCIE'') that it has, adequate 
surveillance procedures and programs in place to effectively regulate 
NOM.
    C. Delegation Agreement. Nasdaq and NOM LLC must enter into the 
Delegation Agreement as described above.\306\
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    \306\ See supra note 15 and accompanying text.
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    It is further ordered, pursuant to Section 11A(b) of the Act,\307\ 
that NOM LLC shall be exempt from registering as a securities 
information processor, subject to the conditions specified in this 
order.
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    \307\ 15 U.S.C. 78k-1(b).
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    It is further ordered, pursuant to Section 36 of the Act,\308\ that 
Nasdaq shall be exempt from the rule filing requirements of Section 
19(b) of the Act \309\ with respect to the rules that Nasdaq proposes 
to incorporate by reference into NOM's Rules, subject to the conditions 
specified in this order.
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    \308\ 15 U.S.C. 78mm.
    \309\ 15 U.S.C. 78s(b).

    By the Commission.
Nancy M. Morris,
Secretary.
[FR Doc. E8-5320 Filed 3-17-08; 8:45 am]

BILLING CODE 8011-01-P