Document ID: SEC-2011-0666-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ OMX PHLX LLC
Posted Date: 2011-05-12T04:00Z

[Federal Register Volume 76, Number 92 (Thursday, May 12, 2011)]
[Notices]
[Pages 27732-27734]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-11584]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-64415; File No. SR-Phlx-2011-56]

Self-Regulatory Organizations; The NASDAQ OMX PHLX LLC; Notice of 
Filing of Proposed Rule Change To Establish a Qualified Contingent 
Cross Order for Execution on the Floor of the Exchange

May 5, 2011.
    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 May 4, 2011, 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 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 is filing with the Commission a proposal to amend PHLX 
Rule 1064(e) to establish a Floor Qualified Contingent Cross Order 
(``Floor QCC Order''). The Floor QCC Order will facilitate the 
execution of stock/option Qualified Contingent Trades that satisfy the 
requirements of the trade through exemption in connection with Rule 
611(d) of Regulation NMS (``QCT Trade Exemption'').\3\
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    \3\ See Securities Exchange Act Release No. 54389 (August 31, 
2006), 71 FR 52829 (September 7, 2006); Securities Exchange Act 
Release No. 57620 (April 4, 2008), 73 FR 19271 (April 9, 2008).
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    The text of the proposed rule change is available on the Exchange's 
Web site at http://nasdaqomxphlx.cchwallstreet.com/NASDAQOMXPHLX/Filings/, 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, set forth in 
Sections A, B, and C below, 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
    On February 24, 2011, the Commission issued an order approving SR-
ISE-2010-073, a proposal by the ISE to establish a Qualified Contingent 
Cross (``ISE QCC Proposal''). The ISE QCC Proposal was controversial, 
attracting opposition from multiple exchanges including PHLX. In its 
comment letter on the ISE QCC Proposal, PHLX asserted that the QCC 
Proposal deviated from ``long-held principles in the options market by 
permitting the crossing of orders without requiring prior exposure'' 
and that the ISE QCC Proposal failed adequately to protect customers 
with orders resting on the ISE limit order book.\4\
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    \4\ See Letter, dated August 13, 2010, from Thomas Wittman, 
President, NASDAQ OMX PHLX to Elizabeth Murphy, Secretary, U.S. 
Securities and Exchange Commission.
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    The Commission, in a thorough and thoughtful decision, concluded 
that the QCC Proposal--including the lack of prior order exposure--is 
consistent with the Act. With respect to order exposure, the Commission 
stated:
    While the Commission believes that order exposure is generally 
beneficial to options markets in that it provides an incentive to 
options market makers to provide liquidity and therefore plays an 
important role in ensuring competition and price discovery in the 
options markets, it also has recognized that contingent trades can be 
``useful trading tools for investors and other market participants, 
particularly those who trade the securities of issuers involved in 
mergers, different classes of shares of the same issuer, convertible 
securities, and equity derivatives such as options [italics added]'' 
and that ``[t]hose who engage in contingent trades can benefit the 
market as a whole by studying the relationships between the prices of 
such securities and executing contingent trades when they believe such 
relationships are out of line with what they believe to be fair 
value.'' As such, the Commission stated that transactions that meet the 
specified requirements of the NMS QCT Exemption could be of benefit to 
the market as a whole, contributing to the efficient functioning of the 
securities markets and the price discovery process.\5\
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    \5\ Approval Order at p. 28 (citing to Regulation NMS QCT 
Exemption).
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    The Approval Order succinctly sets forth the material elements of 
ISE's Qualified Contingent Cross:

    Thus, as modified, an ISE member effecting a trade pursuant to 
the NMS QCT Exemption could cross the options leg of the trade on 
ISE as a QCC Order immediately upon entry, without exposure, only if 
there are no Priority Customer orders on the Exchange's limit order 
book at the same price and if the order: (i) Is for at least 1,000 
contracts; (ii) meets the six requirements of the NMS QCT Exemption; 
and (iii) is executed at a price at or between the NBBO (``Modified 
QCC Order''). In the Notice, ISE stated that the modifications to 
the Original QCC Order (i.e., to prevent the execution of a QCC if 
there is a Priority Customer on its book and to increase the minimum 
size of a QCC Order) remove the appearance that such orders are 
trading ahead of Priority Customer orders or that the QCC Order 
could be used to disadvantage retail customers (citations 
omitted).\6\
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    \6\ Id. at p. 18.

    The Exchange believes that the Commission, having considered and 
addressed all arguments in favor and in opposition to the QCC, has 
established binding precedent under which other exchanges can establish 
a QCC Order that is also consistent with the Act.
    In keeping with that precedent, PHLX hereby proposes to add PHLX 
Rule 1064(e) to establish a Floor QCC Order based on the precedent of 
ISE's QCC Order.\7\ Specifically, PHLX proposes to amend Rule 1064 to 
provide that a PHLX member effectuating a trade on the floor of the 
Exchange pursuant to the Regulation NMS Qualified Contingent Trade 
Exemption to Rule 611(a) (``QCT Exemption'') can cross the options 
leg's of the trade on PHLX as a Floor QCC Order immediately upon entry 
and without order exposure if no Customer Orders \8\ exist on the

[[Page 27733]]

Exchange's order book at the same price. Floor QCC Orders will be 
electronically entered by a Floor Broker on the floor of the Exchange 
using the Floor Broker Management System and the execution will then be 
executed electronically. Only Floor Brokers will be permitted to enter 
Floor QCC Orders.
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    \7\ PHLX previously established an electronic QCC Order set 
forth in PHLX Rule 1080(o). See Securities Exchange Act Release No. 
64249 (April 7, 2011), 76 FR 20773 (April 13, 2011) (SR-Phlx-2011-
047).
    \8\ PHLX will reject QCC Orders that attempt to execute when any 
Customer orders are resting on the Exchange limit order book at the 
same price. ISE QCC Orders will be cancelled only when they 
encounter resting orders of Priority Customers. The Commission has 
previously approved the rejection of crossing transactions when 
there is a customer order on the book at the same price. See, e.g., 
ISE Rule 721(a); and CBOE Rule 6.74A, Interpretations and Policies 
.08.
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    The Commission in the Approval Order carefully considered the 
comparison between floor-based and electronic trading, including 
commissioning a study by the Division of Risk, Strategy and Financial 
Innovation (``RiskFin Study''). The RiskFin Study and the Approval 
Order compare electronic trading and floor trading, the similarities 
between the two forms of trading, and the ability of one to replicate 
the other. Additionally, the Commission received comment letters from 
multiple floor-based exchanges that challenged the comparison that ISE 
drew between floor-based and electronic trading.
    Despite facing direct comparisons between floor-based trading and 
electronic trading by multiple commenters, as well as by its own 
Division of RiskFin, the Commission Approval focuses on similarities 
between the two. On its face, the Commission Approval Order draws no 
distinctions and identifies no material differences between floor-based 
and electronic trading that would confound the comparison between cross 
orders executed electronically and those executed on an exchange floor. 
The Exchange believes that the Floor QCC Order is consistent with the 
requirements stated in the Approval Order and consistent with the Act. 
The Exchange also believes that the Commission, in writing the Approval 
Order assumed that QCC orders entered on the floor of an exchange that 
meet the requirements stated in the Approval Order are equally 
consistent with the Act.
    The Exchange has analyzed the application to Floor QCC Orders of 
Section 11(a) of the Act and the rules thereunder. Section 11(a) and 
the rules thereunder generally prohibit members of an exchange from 
effecting transactions on the exchange for their own account, the 
account of an associated person, or an account with respect to which it 
or an associated person thereof exercises investment discretion unless 
an exemption applies.\9\ Section 11(a) contains multiple exemptions, 
including exemptions for those acting in the capacity of market makers, 
as odd-lot dealers, and those engaged in stabilizing conduct; there are 
also rule-based exemptions such as the ``effect vs. execute'' exception 
under SEC Rule 11a2-2(T) under the Act.\10\
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    \9\ See 15 U.S.C. 78k(a).
    \10\ See 17 CFR 240.11a2-2(T).
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    The Exchange has in the past analyzed the application of Section 
11(a) to various Exchange systems and order types.\11\ In analyzing 
Floor QCC Orders, the Exchange has concluded that the entry and 
execution of Floor QCC Orders raises no novel issues under Section 
11(a) and the rules thereunder from a compliance, surveillance or 
enforcement perspective. In other words, Exchange Floor Brokers are 
currently required to comply and the Exchange surveils for compliance 
with Section 11(a) and the rules thereunder when using Exchange systems 
to effect transactions using existing order types, and they will be 
required to comply with Section 11(a) and the rules thereunder when 
using the Floor QCC Order.
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    \11\ See, e.g., Securities Exchange Act Release No. 63027 (Oct. 
1, 2010), 75 FR 62160 (Oct. 7, 2010) (order approving Price 
Improvement XL System).
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    Nonetheless, out of an abundance of caution, the Exchange has added 
subsection (e)(2) which prohibits Options Floor Brokers from entering 
Floor QCC Orders for their own accounts, the account of an associated 
person, or an account with respect to which it or an associated person 
thereof exercises investment discretion. This modification is designed 
to remove even a theoretical time and place advantage available to an 
Options Floor Broker on the Floor of the Exchange that is reflected in 
the prohibitions of Section 11(a) of the Exchange Act and the rules 
thereunder. The Exchange is prohibiting by rule certain conduct that 
runs afoul of Section 11(a) and the rules thereunder, and providing 
both a surveillance and enforcement mechanism to promote compliance. 
Thus, it would be incorrect to say that the Floor QCC Order differs 
from the electronic QCC Order due to the Options Floor Broker's 
presence on the Floor.
    These restrictions set forth in subsection (e)(2) do not limit in 
any way the obligation of Options Floor Brokers and other Exchange 
members to comply with Section 11(a) or the rules thereunder. For 
example, Options Floor Brokers cannot avoid or circumvent their 
obligations with respect to a Floor QCC Order that triggers a Section 
11(a) obligation by transmitting that order to another Options Floor 
Broker or to an Exchange member off the floor of the Exchange. 
Likewise, Exchange members off the floor must ensure that their Floor 
QCC Orders comply with Section 11(a) and the rules thereunder. In both 
cases, Exchange members must ensure compliance with Section 11(a) and 
the rules thereunder, including by relying upon an exemption such as 
those listed above.
    Additionally, to provide a mechanism for the Exchange to review 
whether Floor QCC Orders have been entered properly by Options Floor 
Brokers, the Exchange proposes to adopt proposed Rule 1064(e)(2). This 
provision would require Options Floor Brokers to maintain books and 
records demonstrating that no Floor Qualified Contingent Cross Order 
was entered by the Options Floor Broker in a prohibited account.\12\ 
Any Floor Qualified Contingent Cross Order that does not have a 
corresponding record required by this provision would be deemed to have 
been entered in violation of Rule 1064(e).
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    \12\ The Exchange System will also be programmed to require 
certain order entry parameters for submission of Floor QCC Orders. 
For example, a Floor QCC Order must include data reflecting the 
number of shares of stock sold/purchased in the stock leg of the QCT 
trade. Floor QCC Orders lacking this data will be rejected by the 
System. The order entry parameters will be included in the 
Exchange's published specifications and described in an Options 
Trader Alert prior to launch.
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    Finally, the Exchange proposes to modify subsections (a), (b), and 
(c) of Rule 1064. These changes are designed clearly to establish that 
the requirements applicable to Floor QCC Orders that are set forth in 
subsection (e) are different from those applicable to the orders 
described in subsections (a), (b) and (c).
    As set forth in proposed Rule 1064(e), the Floor QCC Order must: 
(i) Be for at least 1,000 contracts,\13\ (ii) meet the six requirements 
of Rule 1080(o)(3) which are modeled on the QCT Exemption, (iii) be 
executed at a price at or between the National Best Bid and Offer 
(``NBBO''); and (iv) be rejected if a Customer order is resting on the 
Exchange book at the same price.\14\ As a result, the PHLX Floor QCC 
Order proposed herein satisfies all of the

[[Page 27734]]

requirements the Commission enumerated in the Approval Order.
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    \13\ In order to satisfy the 1,000-contract requirement, a Floor 
QCC Order must be for 1,000 contracts and could not be, for example, 
two 500-contract orders or two 500-contract legs.
    \14\ While the Floor QCC would not provide exposure for price 
improvement for the options leg of a stock-option order, the options 
leg must be executed at the NBBO or better. The Commission has 
previously approved crossing transactions with no opportunity for 
price improvement. See, e.g., ISE Rule 721(a) and Chicago Board 
Options Exchange Rule 6.74A, Interpretations and Policies .08.
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    The Exchange's proposal addresses the mechanics of executing the 
stock and options components of a net-price transaction. The Exchange 
believes that it is necessary that it provide members and their 
customers with the same trading capabilities available on other 
exchanges with respect to QCCs, including the change proposed herein, 
which would permit members to execute the options legs of their 
customers' large complex orders on the Exchange.
 2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \15\ in general, and furthers the objectives of 
Sections 6(b)(5) \16\ and 6(b)(8) \17\of the Act 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 and the rules of an exchange do not 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act. In addition, the proposed rule 
change is consistent with Section 11A(a)(1)(C) of the Act,\18\ in which 
Congress found that it is in the public interest and appropriate for 
the protection of investors and the maintenance of fair and orderly 
markets to assure, among other things, the economically efficient 
execution of securities transactions. As described in detail above, the 
proposed rule change is also consistent with Section 11(a) of the Act 
and the rules thereunder.
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    \15\ 15 U.S.C. 78f(b).
    \16\ 15 U.S.C. 78f(b)(5).
    \17\ 15 U.S.C. 78f(b)(8).
    \18\ 15 U.S.C. 78k-1(a)(1)(C).
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    The statutory basis for PHLX's proposed Floor QCC Order is 
identical to the Commission's basis for finding that the ISE's QCC 
Proposal is consistent with the Act ``in that it would facilitate the 
execution of qualified contingent trades, for which the Commission 
found in the Original QCT Exemption to be of benefit to the market as a 
whole, contributing to the efficient functioning of the securities 
markets and the price discovery process. The Floor [sic] QCC Order 
would provide assurance to parties to stock-option qualified contingent 
trades that their hedge would be maintained by allowing the options 
component to be executed as a clean cross.'' In addition, like the 
ISE's QCC Order, the Exchange's Floor QCC Order ``is narrowly drawn to 
provide a limited exception to the general principle of exposure, and 
retains the general principle of customer priority.''
    PHLX's proposed Floor QCC Order promotes the same Commission goals 
as or more effectively, and it is as or more narrowly drawn than ISE's 
QCC Order. Accordingly, the Exchange believes that the proposed rule 
change must also be consistent with the Act.

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. To the contrary, the proposed 
Floor QCC Order is a competitive response to the ISE QCC Order and 
similar orders adopted by other exchanges.

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

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the Exchange consents, the Commission shall: (a) By order approve 
or disapprove such proposed rule change, or (b) institute proceedings 
to determine whether the proposed rule change should be 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 e-mail to rule-comments@sec.gov. Please include 
File Number SR-Phlx-2011-56 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.

All submissions should refer to File Number SR-Phlx-2011-56. 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 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 such 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 No. SR-Phlx-2011-56 and should be 
submitted on or before June 2, 2011.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-11584 Filed 5-11-11; 8:45 am]
BILLING CODE 8011-01-P