Document ID: SEC-2012-0268-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ OMX PHLX LLC
Posted Date: 2012-02-15T05:00Z

[Federal Register Volume 77, Number 31 (Wednesday, February 15, 2012)]
[Notices]
[Pages 8931-8934]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-3469]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-66362; File No. SR-Phlx-2012-13]

Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Notice of 
Filing and Immediate Effectiveness of Proposed Rule Change Relating to 
Exchange Rule 705 (Fidelity Bonds)

February 9, 2012.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\, and Rule 19b-4 \2\ thereunder, notice is hereby given 
that on January 26, 2012, NASDAQ OMX PHLX LLC (``Phlx'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II and III, below, which Items have been substantially 
prepared by the Exchange. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend Exchange Rule 705, entitled 
``Members Must Carry,'' to create new requirements regarding fidelity 
bonds and also rename the Rule ``Fidelity Bonds.''
    The Exchange intends for this Rule to become operative on April 2, 
2012.
    The text of the proposed rule change is available on the Exchange's 
Web site at http://www.nasdaqtrader.com/micro.aspx?id=PHLXRulefilings, 
at the principal office of the Exchange, and at the Commission's Public 
Reference Room.

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

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, which are 
substantially set forth below in sections A, B, and C, of the most 
significant aspects of such statements.

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

1. Purpose
    The Exchange proposes to amend Exchange Rule 705, entitled 
``Members Must Carry,'' to create new requirements regarding fidelity 
bonds and also rename the Rule ``Fidelity Bonds,'' in substantially the 
same form as a rule at the Financial Industry Regulatory Authority, 
Inc. (``FINRA'').\3\
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    \3\ See FINRA Rule 4360 ``Fidelity Bonds.''
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    Currently, Exchange Rule 705 requires each member organization that 
is a partnership and is doing business with the public and each member 
organization that is a corporation to carry fidelity bonds covering its 
general partners and employees or covering its officers and employees 
in such form and in such amounts as the Exchange may require. The Rule 
does not apply to member organizations that are partnerships or 
corporations which are members of another exchange, which has 
comparable rules and regulations to

[[Page 8932]]

which such member organizations are subject and with which they comply.
    The Exchange proposes to adopt language similar to a FINRA Rule 
which would provide members and member organizations with more specific 
guidelines with respect to fidelity bonds and better reflect current 
industry practices.\4\ The purpose of a fidelity bond is to protect a 
member or member organization against certain types of losses, 
including, but not limited to, those caused by the malfeasance of its 
officers and employees, and the effect of such losses on the member or 
member organization's capital.
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    \4\ See Securities Exchange Act Release No. 63961 (February 24, 
2011), 76 FR 11542 (March 2, 2011) (SR-FINRA-2010-059) (a rule 
change to adopt a rule of the National Association of Securities 
Dealers, Inc. (``NASD'') as part of the consolidation of the FINRA 
rulebook).
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    The new proposed text would require each member and member 
organization that is required to join the Securities Investor 
Protection Corporation (``SIPC'') to maintain blanket fidelity bond 
coverage with specified amounts of coverage based on the member or 
member organization's net capital requirement, with certain exceptions. 
Proposed Rule 705 would require members and member organizations to 
maintain fidelity bond coverage that provides for per loss coverage 
without an aggregate limit of liability. Members or member 
organizations may apply for this level of coverage with any product 
that meets these requirements, including the Securities Dealer Blanket 
Bond or a properly endorsed Financial Institution Form 14 Bond. Most 
fidelity bonds contain a definition of the term ``loss'' (or ``single 
loss''), for purposes of the bond, which generally includes all covered 
losses resulting from any one act or a series of related acts. A 
payment by an insurer for covered losses attributed to a ``single 
loss'' does not reduce a member or member organization's coverage 
amount for losses attributed to other, separate acts. A fidelity bond 
with an aggregate limit of liability caps a member or member 
organization's coverage during the bond period at a certain amount if a 
loss (or losses) meets this aggregate threshold. The Exchange believes 
that per loss coverage without an aggregate limit of liability provides 
members and member organizations with the most beneficial coverage 
since the bond amount cannot be exhausted by one or more covered 
losses, so it will be available for future losses during the bond 
period.
    Under the proposed Rule, a member or member organization's fidelity 
bond must provide against loss and have Insuring Agreements covering at 
least the following: fidelity, on premises, in transit, forgery and 
alteration, securities and counterfeit currency. The Rule requires that 
coverage for all Insuring Agreements be equal to 100 percent of the 
member or member organization's minimum required bond coverage. Members 
and member organizations may elect to carry additional, optional 
Insuring Agreements not required by the proposed Rule for an amount 
less than 100 percent of the minimum required bond coverage. The 
proposed Rule would require that a member or member organization's 
fidelity bond include a cancellation rider providing that the insurer 
will use its best efforts to promptly notify the Exchange in the event 
the bond is cancelled, terminated or ``substantially modified.''
    The Exchange is proposing to add supplementary material to the 
proposed Rule text that would require members or member organizations 
that do not qualify for a bond with per loss coverage without an 
aggregate limit of liability to secure alternative coverage. 
Specifically, a member or member organization that does not qualify for 
blanket fidelity bond coverage as required by Rule 705(a)(3) would be 
required to maintain substantially similar fidelity bond coverage in 
compliance with all other provisions of the proposed Rule, provided 
that the member or member organization maintains written correspondence 
from two insurance providers stating that the member or member 
organization does not qualify for the coverage required by proposed 
Rule 705(a)(3). The member or member organization would be required to 
retain such correspondence for the period specified by Rule 17a-4(b)(4) 
of the Act.

Minimum Coverage

    Proposed Rule 705 would require each member or member organization 
to maintain, at a minimum, fidelity bond coverage for any person 
associated with the member or member organization, except directors or 
trustees of a member or member organization who are not performing acts 
within the scope of the usual duties of an officer or employee. 
Proposed Rule 705 would require a member or member organization with a 
net capital requirement that is less than $250,000 to maintain minimum 
coverage of the greater of 120 percent of the firm's required net 
capital under Rule 15c3-1 of the Act or $100,000. Members or member 
organizations with a net capital requirement of at least $250,000 would 
use a table in the rule to determine their minimum fidelity bond 
coverage requirement. Under the proposed Rule, the entire amount of a 
member or member organization's minimum required coverage must be 
available for covered losses and may not be eroded by the costs an 
insurer may incur if it chooses to defend a claim. Specifically, any 
defense costs for covered losses must be in addition to a member or 
member organization's minimum coverage requirements. A member or member 
organization may include defense costs as part of its fidelity bond 
coverage, but only to the extent that it does not reduce a member or 
member organization's minimum required coverage under the proposed 
Rule.

Deductible

    Proposed Rule 705 would provide for an allowable deductible amount 
of up to 25 percent of the fidelity bond coverage purchased by a member 
or member organization. Any deductible amount elected by the member or 
member organization that is greater than 10 percent of the coverage 
purchased by the member or member organization \5\ would be deducted 
from the member or member organization's net worth in the calculation 
of its net capital for purposes of Rule 15c3-1 of the Act.\6\ If the 
member or member organization is a subsidiary of another Exchange 
member or member organization, this amount may be deducted from the 
parent's rather than the subsidiary's net worth, but only if the parent 
guarantees the subsidiary's net capital in writing.
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    \5\ The Exchange notes that a member or member organization may 
elect, subject to availability, a deductible of less than 10 percent 
of the coverage purchased.
    \6\ Such deduction would be based on net worth on coverage 
purchased by the member or member organization.
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Annual Review

    The proposed Rule would require a member or member organization 
(including a member or member organization that signs a multi-year 
insurance policy), annually as of the yearly anniversary date of the 
issuance of the fidelity bond, to review the adequacy of its fidelity 
bond coverage and make any required adjustments to its coverage, as set 
forth in the proposed Rule. Under proposed Rule 705(d), a member or 
member organization's highest net capital requirement during the 
preceding 12-month period, based on the applicable method of computing 
net capital (dollar minimum, aggregate indebtedness or alternative 
standard), would be used as the basis for determining the member or 
member organization's minimum required fidelity bond coverage for the 
succeeding 12-month period. The ``preceding 12-month period'' includes

[[Page 8933]]

the 12-month period that ends 60 days before the yearly anniversary 
date of a member or member organization's fidelity bond. This would 
give a member or member organization time to determine its required 
fidelity bond coverage by the anniversary date of the bond.
    Rule 705 would allow a member or member organization that has only 
been in business for one year and elected the aggregate indebtedness 
ratio for calculating its net capital requirement to use, solely for 
the purpose of determining the adequacy of its fidelity bond coverage 
for its second year, the 15 to 1 ratio of aggregate indebtedness to net 
capital in lieu of the 8 to 1 ratio (required for broker-dealers in 
their first year of business) to calculate its net capital requirement. 
Notwithstanding the above, such member or member organization would not 
be permitted to carry less minimum fidelity bond coverage in its second 
year than it carried in its first year.
    A member or member organization would be required to immediately 
advise the Exchange in writing if its fidelity bond is cancelled, 
terminated or substantially modified.\7\
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    \7\ See Proposed Rule 705(e).
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Exemptions

    Proposed Rule 705 would exempt from the fidelity bond requirements 
members or member organizations in good standing with another national 
securities exchange or FINRA that maintain a fidelity bond subject to 
the requirements of such exchange that are equal to or greater than the 
requirements set forth in the proposed rule.\8\ Additionally, the Rule 
would exempt from the fidelity bond requirements any firm that acts 
solely as a Registered Options Trader (``ROT''),\9\ Specialist\10\ or 
Floor Broker and does not conduct business with the public.
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    \8\ In general, the notification provisions of the corresponding 
exchange rules (i.e., cancellation rider and notification upon 
cancellation, termination or substantial modification of the bond) 
require notification to the respective exchange rather than to the 
Exchange or FINRA. Accordingly, the practical effect for a member or 
member organization that avails itself of the proposed exemption is 
that such member or member organization must maintain a fidelity 
bond subject to the same or greater requirements as in proposed Rule 
705; however, such member or member organization would be exempt 
from the requirement that the Exchange be notified of changes to the 
bond and would alternatively comply with the notification provisions 
of the respective exchange or FINRA.
    \9\ An ROT includes a Streaming Quote Trader (``SQT''), a Remote 
Streaming Quote Trader (``RSQT'') and a Non-SQT, which by definition 
is neither a SQT or an RSQT. An ROT is defined in Exchange Rule 
1014(b) as a regular member of the Exchange located on the trading 
floor who has received permission from the Exchange to trade in 
options for his own account. See Exchange Rule 1014 (b)(i) and (ii). 
An SQT is defined in Exchange Rule 1014(b)(ii)(A) as an ROT who has 
received permission from the Exchange to generate and submit option 
quotations electronically in options to which such SQT is assigned. 
An RSQT is defined Exchange Rule in 1014(b)(ii)(B) as an ROT that is 
a member or member organization with no physical trading floor 
presence who has received permission from the Exchange to generate 
and submit option quotations electronically in options to which such 
RSQT has been assigned. An RSQT may only submit such quotations 
electronically from off the floor of the Exchange.
    \10\ A Specialist is an Exchange member who is registered as an 
options specialist pursuant to Rule 1020(a).
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    The Exchange intends for this Rule to become operative on April 2, 
2012.2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \11\ in general, and furthers the objectives of Section 
6(b)(5) of the Act \12\ in particular, in that it is designed to 
promote just and equitable principles of trade, 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.
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    \11\ 15 U.S.C. 78f(b).
    \12\ 15 U.S.C. 78f(b)(5).
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    The Exchange believes that its proposed amendment to Exchange Rule 
705 provides specificity to the Rule. The proposed amendment to the 
Rule requires members and member organizations to continue to carry 
fidelity bonds, but also provides additional specificity regarding the 
amount of coverage. This Rule will update and clarify the requirements 
governing fidelity bonds consistent with industry practice.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    No written comments were either solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Because the foregoing proposed rule change does not: (i) 
Significantly affect the protection of investors or the public 
interest; (ii) impose any significant burden on competition; and (iii) 
become operative for 30 days after the date of the filing, or such 
shorter time as the Commission may designate, it has become effective 
pursuant to 19(b)(3)(A) of the Act \13\ and Rule 19b-4(f)(6) \14\ 
thereunder.
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    \13\ 15 U.S.C. 78s(b)(3)(A).
    \14\ 17 CFR 240.19b-4(f)(6). In addition, Rule 19b-4(f)(6)(iii) 
requires the Exchange to give the Commission written notice of the 
Exchange's intent to file the proposed rule change, along with a 
brief description and text of the proposed rule change, at least 
five business days prior to the date of filing of the proposed rule 
change, or such shorter time as designated by the Commission. The 
Exchange has satisfied this requirement.
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    The Exchange intends for Rule 705 to become operative on April 2, 
2012. This operative delay will allow members or member organizations 
that are not exempt from the Rule to comply with the requirements set 
forth under the Rule.
    At any time within 60 days of the filing of the proposed rule 
change, the Commission summarily may temporarily suspend such rule 
change if it appears to the Commission that such action is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act. If the Commission 
takes such action, the Commission shall institute proceedings to 
determine whether the proposed rule should be approved or disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-Phlx-2012-13 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

[[Page 8934]]

    All submissions should refer to File Number SR-Phlx-2012-13. This 
file number should be included on the subject line if email 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 Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of the filing also will be available for 
inspection and copying at the principal office of the Exchange. 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-Phlx-2012-13 and 
should be submitted on or before March 7, 2012.
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    \15\ 17 CFR 200.30-3(a)(12).
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    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\15\

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-3469 Filed 2-14-12; 8:45 am]
BILLING CODE 8011-01-P