Document ID: SEC-2011-1465-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ OMX PHLX
Posted Date: 2011-09-30T04:00Z

[Federal Register Volume 76, Number 190 (Friday, September 30, 2011)]
[Notices]
[Pages 60955-60957]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-25193]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-65399; File No. SR-Phlx-2011-111]

Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Order 
Approving a Proposed Rule Change Requesting Permanent Approval of the 
Pilot Program Permitting NASDAQ OMX PHLX to Receive Inbound Routes by 
NOS

September 26, 2011.

I. Introduction

    On August 8, 2011, NASDAQ OMX PHLX LLC (``Phlx'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``Commission''), 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule change 
requesting permanent approval of the Exchange's pilot program to permit 
the Exchange to accept certain inbound orders that Nasdaq Options 
Services, LLC (``NOS'') routes from Nasdaq Options Market (``NOM''). 
The proposed rule change was published for comment in the Federal 
Register on August 19, 2011.\3\ The Commission received no comment 
letters regarding the proposed rule change. This order approves the 
proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 65135 (August 15, 
2011), 76 FR 52030 (``Notice'').
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II. Background

    Exchange Rule 985(b) prohibits the Exchange or any entity with 
which it is affiliated from, directly or indirectly, acquiring or 
maintaining an ownership interest in, or engaging in a business venture 
with, an Exchange member or an affiliate of an Exchange member in the 
absence of an effective filing under Section 19(b) of the Exchange 
Act.\4\ NOS is a broker-dealer that is a member of the Exchange, and 
currently provides to members of The NASDAQ Stock Market LLC 
(``Nasdaq'') that are NOM participants optional routing services to 
other market centers.\5\ NOS is owned by The NASDAQ OMX Group, Inc. 
(``NASDAQ OMX''), which also owns three registered securities 
exchanges--Nasdaq, the Exchange, and NASDAQ OMX BX, Inc.\6\ Thus, NOS 
is an affiliate of each of these exchanges. Absent an effective filing, 
Exchange Rule 985(b) would prohibit NOS from being a member of the 
Exchange.
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    \4\ 15 U.S.C. 78s(b).
    \5\ NOS operates as a facility of Nasdaq that provides outbound 
routing from NOM to other market centers, subject to certain 
conditions. See NOM Rules Chapter VI, Section 11(e).
    \6\ See Securities Exchange Act Release No. 58179 (July 17, 
2008), 73 FR 42874 (July 23, 2008) (SR-Phlx-2008-31) (``Phlx 
Approval Order''). See also Securities Exchange Act Release No. 
58324 (August 7, 2008), 73 FR 46936 (August 12, 2008) (SR-BSE-2008-
02; SR-BSE-2008-23; SR-BSE-2008-25; SR-BSECC-2008-01).
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    On July 17, 2008, in connection with the acquisition of the 
Exchange by NASDAQ OMX, the Commission approved an affiliation between 
the Exchange and NOS for the limited purpose of permitting NOS to 
provide routing services for Nasdaq for orders that first attempt to 
access liquidity on Nasdaq's system before routing to the Exchange, 
subject to certain other limitations and conditions.\7\ On February 26, 
2010, the Exchange filed an immediately effective proposed rule change 
to modify the conditions for the affiliation between NOS and the 
Exchange, to permit the Exchange to receive certain orders routed by 
NOS from NOM without first checking the NOM book for liquidity on a 
one-year pilot basis.\8\ Specifically, the Exchange proposed to permit 
NOS to route from NOM Exchange Direct Orders and orders in NOM Non-
System Securities (including Exchange Direct Orders).\9\

[[Page 60956]]

The Exchange now seeks permanent approval of this inbound routing 
pilot.\10\
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    \7\ See Phlx Approval Order, 73 FR at 42887.
    \8\ See Securities Exchange Act Release No. 61667 (March 5, 
2010), 75 FR 11964 (March 12, 2010) (SR-Phlx-2010-36) (``Phlx 
Routing Pilot Release''). The inbound routing pilot was subsequently 
extended and is set to expire on November 25, 2011. See Securities 
Exchange Act Release Nos. 63873 (February 9, 2011), 76 FR 8798 
(February 15, 2011) (SR-Phlx-2011-16); and 65140 (August 16, 2011) 
76 FR 52374 (August 22, 2011) (SR-Phlx-2011-116).
    \9\ NOS provides to NOM participants routing services to other 
market centers. Pursuant to Nasdaq's rules, NOS: (1) Routes orders 
in options currently trading on NOM, referred to as ``System 
Securities;'' and (2) routes orders in options that are not 
currently trading on NOM (``Non-System Securities''). See NOM Rules, 
Chapter VI, Section 1(b) and 11. When routing Non-System Securities, 
NOS is not regulated as a facility of Nasdaq, but as a broker-dealer 
regulated by its designated examining authority. See also Phlx 
Routing Pilot Release, 75 FR at 11964. ``Exchange Direct Orders'' 
are orders that are directed to an exchange other than NOM as 
directed by the entering party without checking the NOM book. See 
NOM Rules Chapter VI, Section 1(e)(7).
    \10\ See Notice.
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III. Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\11\ Specifically, the Commission finds that the proposed rule 
change is consistent with Section 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. Further, the 
Commission finds that the proposed rule change is consistent with 
Section 6(b)(5) of the Act,\13\ which requires, among other things, 
that the rules of a national securities exchange be designed to prevent 
fraudulent and manipulative acts and practices; to promote just and 
equitable principles of trade; to foster cooperation and coordination 
with persons engaged in regulating, clearing, settling, and processing 
information with respect to, and facilitating transactions in 
securities; to remove impediments to and perfect the mechanism of a 
free and open market and a national market system; and, in general, to 
protect investors and the public interest. Section 6(b)(5) also 
requires that the rules of an exchange not be designed to permit unfair 
discrimination among customers, issuers, brokers, or dealers.
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    \11\ 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).
    \12\ 15 U.S.C. 78f(b)(1).
    \13\ 15 U.S.C. 78f(b)(5).
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    Recognizing that the Commission has previously expressed concern 
regarding the potential for conflicts of interest in instances where a 
member firm is affiliated with an exchange of which it is a member, the 
Exchange previously proposed, and the Commission approved, limitations 
and conditions on NOS's affiliation with the Exchange.\14\ Also 
recognizing that the Commission has expressed concern regarding the 
potential for conflicts of interest in instances where a member firm is 
affiliated with an exchange to which it is routing orders, the Exchange 
previously implemented limitations and conditions to NOS's affiliation 
with the Exchange to permit the Exchange to accept orders routed 
inbound to Phlx by NOS from NOM that do not first attempt to access 
liquidity on the NOM book.\15\ The Exchange states it has met these 
conditions:\16\
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    \14\ See Phlx Approval Order, 73 FR at 42886-42887.
    \15\ See Phlx Routing Pilot Release.
    \16\ See Notice, 76 FR at 52031.
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     First, the Exchange and FINRA have entered into a 
regulatory services agreement (``Regulatory Contract'') pursuant to 
which FINRA has been allocated regulatory responsibilities to review 
NOS's compliance with the Exchange's rules through FINRA's examination 
program.\17\ The Exchange, however, retained ultimate responsibility 
for enforcing its rules with respect to NOS except to the extent that 
they are covered by an agreement with FINRA pursuant to Rule 17d-2 
under the Act,\18\ in which case FINRA is allocated regulatory 
responsibility.
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    \17\ The Exchange also states that NOS is subject to independent 
oversight by FINRA, its Designated Examining Authority, for 
compliance with financial responsibility requirements. See Notice, 
76 FR at 52031, n.9.
    \18\ 17 CFR 240.17d-2.
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     Second, FINRA and the Exchange will monitor NOS for 
compliance with Phlx's trading rules, and collect and maintain certain 
related information;\19\
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    \19\ Pursuant to the Regulatory Contract, both the Exchange and 
FINRA will collect and maintain all alerts, complaints, 
investigations and enforcement actions in which NOS (in routing 
orders to the Exchange) is identified as a participant that has 
potentially violated applicable Commission or Exchange rules. The 
Exchange and FINRA will retain these records in an easily accessible 
manner in order to facilitate any potential review conducted by the 
Commission's Office of Compliance Inspections and Examinations. See 
Notice, 76 FR at 52031, n.11.
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     Third, FINRA will provide a report to the Exchange's Chief 
Regulatory Officer (``CRO''), on at least a quarterly basis, that: (i) 
Quantifies all alerts (of which the Exchange and FINRA become aware) 
that identify NOS as a participant that has potentially violated 
Commission or Exchange rules and (ii) quantifies the number of 
investigations that identify NOS as a participant that has potentially 
violated Exchange or Commission Rules;\20\
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    \20\ See id.
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     Fourth, the Exchange adopted Rule 985(c), which requires 
NASDAQ OMX, as the holding company owning NOS and the Exchange, to 
establish and maintain procedures and internal controls reasonably 
designed to ensure that NOS does not develop or implement changes to 
its system on the basis of non-public information regarding planned 
changes to the Exchange's systems, obtained as a result of its 
affiliation with the Exchange, until such information is available 
generally to similarly situated Exchange members in connection with the 
provision of inbound routing to the Exchange; \21\ and
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    \21\ See Phlx Rule 985(c)(1). See also Notice, 76 FR at 52031.
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     Fifth, the Exchange proposed that NOS be authorized to 
route (1) Exchange Direct Orders without checking the NOM book and (2) 
orders in NOM non-system securities inbound to the Exchange from NOM 
for a pilot period of twelve months, as further extended to November 
25, 2011.\22\
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    \22\ See Notice, 76 FR at 52031. See also supra note 8.

The Exchange believes that by meeting the above-listed conditions it 
has set up mechanisms that protect the independence of the Exchange's 
regulatory responsibility with respect to NOS, and has demonstrated 
that NOS cannot use any information advantage it may have because of 
its affiliation with the Exchange.\23\
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    \23\ See Notice, 76 FR at 52031-52032.
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    In the past, the Commission has expressed concern that the 
affiliation of an exchange with one of its members raises potential 
conflicts of interest, and the potential for unfair competitive 
advantage.\24\ Although the Commission continues to be concerned about 
potential unfair competition and conflicts of interest between an 
exchange's self-regulatory obligations and its commercial interest when 
the exchange is affiliated with one of its members, for the reasons 
discussed below, the Commission believes that it is consistent with the 
Act to permit NOS to provide inbound routing to the Exchange on a 
permanent basis instead of a pilot basis, subject to the other 
conditions described above.\25\
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    \24\ See, e.g., Securities Exchange Act Release Nos. 54170 (July 
18, 2006), 71 FR 42149 (July 25, 2006) (SR-NASDAQ-2006-006) (order 
approving Nasdaq's proposal to adopt Nasdaq Rule 2140, restricting 
affiliations between Nasdaq and its members); 53382 (February 27, 
2006), 71 FR 11251 (March 6, 2006) (SR-NYSE-2005-77) (order 
approving the combination of the New York Stock Exchange, Inc. and 
Archipelago Holdings, Inc.); 58673 (September 29, 2008), 73 FR 57707 
(October 8, 2008) (SR-Amex-2008-62) (order approving the combination 
of NYSE Euronext and the American Stock Exchange LLC); 59135 
(December 22, 2008), 73 FR 79954 (December 30, 2008) (SR-ISE-2009-
85) (order approving the purchase by ISE Holdings of an ownership 
interest in DirectEdge Holdings LLC); and 59281 (January 22, 2009), 
74 FR 5014 (January 28, 2009) (SR-NYSE-2008-120) (order approving a 
joint venture between NYSE and BIDS Holdings L.P.).
    \25\ The Commission notes that it recently issued an order 
granting permanent approval of NASDAQ OMX BX, Inc.'s pilot program 
permitting Boston Options Exchange to accept inbound routes by NOS 
of (1) NOM Exchange Direct Orders without checking the NOM book 
prior to routing, and (2) NOM non-system securities orders, 
including Exchange Direct Orders that NOS routes from NOM. See 
Securities Exchange Act Release No. 65199 (August 25, 2011), 76 FR 
54277 (August 31, 2011) (SR-BX-2011-045).

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[[Page 60957]]

    The Exchange has proposed four ongoing conditions applicable to 
NOS's routing activities, which are enumerated above. The Commission 
believes that these conditions mitigate its concerns about potential 
conflicts of interest and unfair competitive advantage. In particular, 
the Commission believes that FINRA's oversight of NOS,\26\ combined 
with FINRA's monitoring of NOS's compliance with the Exchange's rules 
and quarterly reporting to Phlx's CRO, will help to protect the 
independence of the Exchange's regulatory responsibilities with respect 
to NOS.
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    \26\ This oversight will be accomplished through the Regulatory 
Contract between the Exchange and FINRA, and, as applicable, a 17d-2 
Agreement.
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\27\ that the proposed rule change (SR-Phlx-2011-111) be, and 
hereby is, approved.
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    \27\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-25193 Filed 9-29-11; 8:45 am]
BILLING CODE 8011-01-P