Document ID: SEC-2014-1709-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ OMX PHLX LLC
Posted Date: 2014-10-08T04:00Z

[Federal Register Volume 79, Number 195 (Wednesday, October 8, 2014)]
[Notices]
[Pages 60876-60879]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-23984]

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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-73291; File No. SR-Phlx-2014-23]

Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Order 
Approving Proposed Rule Change, as Modified by Amendment No. 1, Related 
to the Priority Afforded to In-Crowd Participants Respecting Crossing, 
Facilitation, and Solicited Orders in Open Outcry Trading

October 2, 2014.

I. Introduction

    On April 23, 2014, NASDAQ OMX PHLX LLC (``Exchange'' or ``Phlx'') 
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 to 
revise the priority afforded to in-crowd participants respecting 
crossing, facilitation, and solicited orders in open outcry trading 
(``Proposal''). The proposed rule change was published for comment in 
the Federal Register on May 13, 2014.\3\ On June 23, 2014, the 
Commission extended the time period in which to either approve the 
Proposal, disapprove the Proposal, or institute proceedings to 
determine whether to approve or disapprove the Proposal to August 11, 
2014.\4\ The Commission received two comment letters from one commenter 
regarding the Proposal \5\ and one response letter from Phlx.\6\ On 
July 30, 2014, the Exchange filed Amendment No. 1 to the Proposal 
(``Amendment No. 1'').\7\ On August 4, 2014, the Commission instituted 
proceedings

[[Page 60877]]

pursuant to Section 19(b)(2)(B) of the Act \8\ to determine whether to 
approve or disapprove the proposed rule change and published Amendment 
No. 1 for comment.\9\ The Order Instituting Proceedings was published 
for comment in the Federal Register on August 8, 2014.\10\ In response 
to the Order Instituting Proceedings, the Commission received no 
comment letters on the Proposal. This order approves the proposed rule 
change, as modified by Amendment No. 1.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 72119 (May 7, 2014), 
79 FR 27351 (``Notice'').
    \4\ See Securities Exchange Act Release No. 72447 (June 23, 
2014), 79 FR 36569 (June 27, 2014).
    \5\ See Letter from Michael J. Simon, Secretary and General 
Counsel, International Securities Exchange, LLC, dated June 3, 2014 
(``ISE Letter I''); Letter from Michael J. Simon, Secretary and 
General Counsel, International Securities Exchange, LLC, dated July 
8, 2014 (``ISE Letter II'').
    \6\ See Letter from Carla Behnfeldt, Associate General Counsel, 
The NASDAQ OMX Group, Inc., dated June 20, 2014 (``Phlx Response 
Letter'').
    \7\ In Amendment No. 1, the Exchange clarifies a reference to a 
previous Phlx filing and an example. Amendment No. 1 has been placed 
in the public comment file for SR-Phlx-2014-23 at http://www.sec.gov/comments/sr-phlx-2014-23/phlx201423.shtml (see letter 
from Carla Behnfeldt, Associate General Counsel, The NASDAQ OMX 
Group, Inc., to Secretary, Commission, dated July 30, 2014) and also 
is available on the Exchange's Web site at http://nasdaqomxphlx.cchwallstreet.com/NASDAQOMXPHLX/pdf/phlx-filings/2014/SR-Phlx-2014-23_Amendment_1.pdf.
    \8\ 15 U.S.C. 78s(b)(2)(B).
    \9\ See Securities Exchange Act Release No. 72751, (August 4, 
2014), 79 FR 46474 (August 8, 2014) (``Order Instituting 
Proceedings'').
    \10\ See Order Instituting Proceedings. The comment period 
closed on August 29, 2014, and the rebuttal period closed on 
September 12, 2014.
---------------------------------------------------------------------------

II. Description of the Proposal

    The Exchange proposes to amend Phlx Rule 1014, Commentary 
.05(c)(ii), to afford priority in open outcry trading to in-crowd 
participants over out-of-crowd Streaming Quote Traders (``SQTs''),\11\ 
Remote Specialists,\12\ and Remote Streaming Quote Traders (``RSQTs'') 
\13\ and over out-of-crowd broker-dealer limit orders on the limit 
order book (but not over public customer orders) in crossing,\14\ 
facilitation,\15\ and solicited \16\ orders, regardless of order size.
---------------------------------------------------------------------------

    \11\ An SQT is defined in Exchange Rule 1014(b)(ii)(A) as a 
Registered Options Trader (``ROT'') who has received permission from 
the Exchange to generate and submit option quotations electronically 
in options to which such SQT is assigned. Types of ROTs include 
SQTs, RSQTs and non-SQTs, which by definition are neither SQTs nor 
RSQTs. A Registered Options Trader is defined in Exchange Rule 
1014(b)(i) 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 Phlx Rules 1014(b)(i) and (ii).
    \12\ A Remote Specialist is a qualified RSQT approved by the 
Exchange to function as a specialist in one or more options if the 
Exchange determines that it cannot allocate such options to a floor 
based specialist. A Remote Specialist has all the rights and 
obligations of a specialist, unless Exchange rules provide 
otherwise. See Phlx Rules 501 and 1020.
    \13\ A RSQT is defined in Exchange Rule 1014(b)(ii)(B) as an ROT 
that is a member affiliated with a Remote Streaming Quote Trader 
Organization (``RSQTO'') 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. A qualified RSQT may function as a Remote Specialist 
upon Exchange approval. An RSQT may only submit such quotations 
electronically from off the floor of the Exchange. An RSQT may not 
submit option quotations in eligible options to which such RSQT is 
assigned to the extent that the RSQT is also approved as a Remote 
Specialist in the same options. An RSQT may only trade in a market 
making capacity in classes of options in which he is assigned or 
approved as a Remote Specialist. An RSQTO is a member organization 
in good standing that satisfies the RSQTO readiness requirements in 
Phlx Rule 507(a)(i).
    \14\ A crossing order occurs when an options Floor Broker holds 
orders (except for floor qualified contingent cross orders, as 
defined in Exchange Rule 1064(e)) to buy and sell the same option 
series. Such a Floor Broker may cross such orders, provided that the 
trading crowd is given an opportunity to bid and offer for such 
option series in accordance with Exchange rules. See Phlx Rule 
1064(a).
    \15\ A facilitation order occurs when an options Floor Broker 
holds an options order (except for floor qualified contingent cross 
orders, as defined in Exchange Rule 1064(e)) for a public customer 
and a contra-side order. Such a Floor Broker may execute such orders 
as a facilitation order, provided that such Floor Broker proceeds in 
accordance with Exchange rules concerning facilitation orders. See 
Phlx Rule 1064(b).
    \16\ A solicitation occurs whenever an order (except for floor 
qualified contingent cross orders, as defined in Exchange Rule 
1064(e)), other than a cross, is presented for execution in the 
trading crowd resulting from an away-from-the-crowd expression of 
interests to trade by one broker dealer to another. See Phlx Rule 
1064(c).
---------------------------------------------------------------------------

    Currently, Commentary .05(c)(i) to Phlx Rule 1014 provides that, in 
the event that a Floor Broker \17\ or specialist \18\ presents a non-
electronic order in which an RSQT is assigned or which is allocated to 
a Remote Specialist, and/or in which an SQT assigned in such option is 
not a crowd participant (collectively, ``Non-Crowd Participants''), 
such Non-Crowd Participant may not participate in trades stemming from 
such a non-electronic order unless the non-electronic order is executed 
at the price quoted by the Non-Crowd Participant at the time of 
execution. If the non-electronic order is executed at the price quoted 
by the Non-Crowd Participant, the Non-Crowd Participant may participate 
in the trade unless the order was a crossing, facilitation, or 
solicited order with a size of at least 500 contracts on each side.\19\ 
If the order is a crossing, facilitation, or solicited order with a 
size of at least 500 contracts on each side, Commentary .05(c)(ii) 
gives priority to in-crowd participants (including, for purposes of 
Commentary .05(c)(ii) only, Floor Brokers) over Non-Crowd Participants 
and over out-of-crowd broker-dealer limit orders on the limit order 
book, but not over public customer orders.\20\
---------------------------------------------------------------------------

    \17\ A ``Floor Broker'' is an individual who is registered with 
the Exchange for the purpose, while on the Exchange's options floor, 
of accepting and handling options orders received from members and 
member organizations. See Phlx Rule 1060.
    \18\ A ``Specialist'' is an Exchange member who is registered as 
an options specialist pursuant to Rule 1020(a).
    \19\ This in-crowd priority applies only to crossing, 
facilitation, and solicited orders represented in open outcry, and 
does not apply to orders submitted electronically via the Exchange's 
electronic options trading platform, to which other priority rules 
apply. See, e.g., Phlx Rules 1014(g)(vii) and (viii).
    \20\ According to the Exchange, public customer limit orders 
represented in the trading crowd and resting on the limit order book 
have, and will continue to have, priority over all other 
participants and accordingly must be executed up to the aggregate 
size of such orders before any in-crowd participant is entitled to 
priority. Public customer orders on the limit order book that are 
eligible for execution are required to be executed before a Floor 
Broker may execute its order in the crowd and/or with a contra-side 
order it holds. See Phlx Rule 1014, Commentary .05(c)(ii).
---------------------------------------------------------------------------

    The Exchange proposes to eliminate the 500 contract minimum order 
size from Phlx Rule 1014, Commentary .05(c)(ii). As amended, the rule 
would afford priority to in-crowd participants over Non-Crowd 
Participants and out-of-crowd broker-dealer limit orders in crossing, 
facilitation, and solicited orders regardless of the size of those 
orders. The Exchange states that it initially permitted Non-Crowd 
Participants to participate in Floor Broker crosses to foster 
electronic options trading.\21\ In 2006, the Exchange adopted the size 
requirement, which continued to permit Non-Crowd Participants to 
participate in smaller (under five hundred contracts) Floor Broker 
crosses.\22\ According to the Exchange, electronic options trading is 
well-established and there is no longer a need for such special rules 
and incentives to develop electronic trading further.\23\ The Exchange 
notes that another options exchange does not have the same 
differentiation of priority for orders of fewer than 500 contracts.\24\ 
The Exchange believes that its Proposal will encourage order flow 
providers to send additional crossing, facilitation, and solicited 
orders to the Exchange without concern that the order may not be 
completely executed by the trading crowd.\25\ The Exchange also 
believes that affording priority to in-crowd participants regardless of 
size will attract additional smaller cross orders to the Exchange and 
allow in-crowd market makers to compete for smaller orders.\26\
---------------------------------------------------------------------------

    \21\ See Amendment No. 1, supra note 7.
    \22\ See Notice, 79 FR at 27352. See also Amendment No. 1, supra 
note 7.
    \23\ See Notice, 79 FR at 27352. See also Amendment No. 1, supra 
note 7.
    \24\ See Notice, 79 FR at 27352-53. See also Chicago Board 
Options Exchange (``CBOE'') Rule 6.74, Crossing Orders.
    \25\ See Notice, 79 FR at 27353.
    \26\ See Notice, 79 FR at 27353-54.
---------------------------------------------------------------------------

III. Comment Letters and Phlx's Response

    As noted above, the Commission received two comment letters from 
one commenter \27\ and one response letter from Phlx.\28\
---------------------------------------------------------------------------

    \27\ See supra note 5.
    \28\ See supra note 6.
---------------------------------------------------------------------------

    In its first letter, the commenter opposes the Proposal and 
requests that the Commission institute proceedings to

[[Page 60878]]

disapprove the Proposal. The commenter argues that the Proposal 
unfairly denies electronic participants the ability to participate in 
the execution of open outcry orders along with in-crowd participants at 
the same price.\29\ The commenter states its view that the Exchange has 
not provided sufficient justification for allocating smaller trades 
negotiated on its floor to counterparties in the trading crowd ahead of 
same-priced orders from electronic participants.\30\ The commenter 
believes that the Proposal will encourage Phlx participants to bring 
more orders to the floor, where they may receive a higher trade 
allocation and may be able to internalize a trade, instead of executing 
those orders through electronic auction systems.\31\ The commenter 
argues that, even with the current 500 contract minimum, Phlx's 
priority rules disadvantage orders being internalized to the benefit of 
the internalizing brokers, as these orders receive relatively little 
price competition.\32\ The commenter suggests that giving priority to 
small orders on the floor will further skew participants' incentives to 
bring orders to the floor to achieve a frictionless ``clean cross'' and 
deprive customers of vigorous competition for these orders.\33\ The 
commenter states that most electronic auctions require that orders be 
exposed to all other participants trading on the exchange, and orders 
that are not exposed, such as qualified contingent crosses, are 
required to be for a large size.\34\
---------------------------------------------------------------------------

    \29\ See ISE Letter I.
    \30\ See ISE Letter I.
    \31\ See ISE Letter I.
    \32\ See ISE Letter I at 1-2.
    \33\ See ISE Letter I at 2.
    \34\ See ISE Letter I at 2.
---------------------------------------------------------------------------

    The commenter also argues that, because no trade information is 
disseminated about orders executed on the floor to electronic 
participants, who may be willing to provide liquidity to orders 
executed on the Exchange floor, such orders will not benefit from 
potential price improvement built into electronic auctions.\35\ The 
commenter believes that the Proposal will largely limit price 
competition for small orders to participants physically present in the 
crowd at the time a floor cross is announced and transacted.\36\ The 
commenter further argues that the Proposal would ignore electronic 
orders and quotes, especially for small orders, and cause more orders 
to be crossed at prices that have not been sufficiently vetted by the 
participants most likely to offer price improvement.\37\
---------------------------------------------------------------------------

    \35\ See ISE Letter I at 2.
    \36\ See ISE Letter I at 2.
    \37\ See ISE Letter I at 2. The commenter expressed its view 
that it is inappropriate to ignore electronic quotes, especially for 
smaller orders where substantial capital commitment or efforts to 
find liquidity are not necessary. See id.
---------------------------------------------------------------------------

    In response to the commenter's concerns regarding in-crowd 
liquidity, Phlx states that on-floor liquidity on Phlx in many issues 
exceeds the displayed wider electronic markets.\38\ Phlx argues that 
the Proposal merely removes the 500 contract minimum and that another 
options exchange, CBOE, does not have the same differentiation of 
priority for orders of fewer than 500 contracts.\39\ Phlx believes that 
attracting smaller orders to the trading floor fosters an environment 
for on-floor liquidity providers to continue to provide price 
improvement and size improvement.\40\ In response to the commenter's 
suggestion that the Proposal will facilitate internalization, Phlx 
states that priority will be afforded to all in-crowd participants, 
including market makers, not just Floor Brokers.\41\ Phlx also believes 
that the Proposal should encourage small participants, such as floor-
based market makers, to continue to make markets, which Phlx believes 
will improve the quality of execution for these smaller orders.\42\
---------------------------------------------------------------------------

    \38\ See Phlx Response Letter.
    \39\ See Phlx Response Letter (citing CBOE Rule 6.74, Crossing 
Orders).
    \40\ See Phlx Response Letter at 2.
    \41\ See Phlx Response Letter at 2.
    \42\ See Phlx Response Letter at 2.
---------------------------------------------------------------------------

    In its second letter, the commenter replies to the Phlx Response 
Letter and reiterates its request that the Commission institute 
proceedings to disapprove the Proposal. In response to Phlx's statement 
that, based on Phlx's experience, on-floor liquidity on Phlx in many 
issues exceeds the displayed wider electronic markets,\43\ the 
commenter requests that the Commission require Phlx to provide data 
that would allow the Commission to gauge the level of participation of 
floor-based market makers against orders represented in open outcry, 
and price improvement provided by these participants.\44\ The commenter 
questions whether Phlx needs to afford priority to in-crowd liquidity 
providers if they are offering active price improvement.\45\ The 
commenter states its view that to the extent that in-crowd participants 
provide price improvement to orders represented in open outcry, their 
orders are already entitled to priority over other orders at a worse 
price, including electronic quotes.\46\ The commenter asserts that the 
Proposal is intended to allow in-crowd participants to internalize 
orders without being subject to competition from active liquidity 
providers in the electronic markets.\47\ The commenter argues that 
Phlx's reliance on the CBOE rule is irrelevant as the Phlx Proposal 
must stand on its own, and, in any event, believes that the in-crowd 
priority rules of Phlx and CBOE are not in the public interest.\48\ The 
commenter argues that the proposed expansion of these rules would only 
foster internalization and curtail price improvement.\49\
---------------------------------------------------------------------------

    \43\ See Phlx Response Letter.
    \44\ See ISE Letter II.
    \45\ See ISE Letter II.
    \46\ See ISE Letter II at 1-2.
    \47\ See ISE Letter II at 2.
    \48\ See ISE Letter II at 2.
    \49\ See ISE Letter II at 2.
---------------------------------------------------------------------------

IV. Discussion and Commission Findings

    After careful review of the proposed rule change as well as the 
comment letters and the Phlx response letter received on the Proposal, 
the Commission finds that the proposed rule change, as modified by 
Amendment No. 1, is consistent with the requirements of the Act and the 
rules and regulations thereunder applicable to a national securities 
exchange and, in particular, with Section 6(b) of the Act.\50\ In 
particular, the Commission finds that the proposed rule change is 
consistent with Section 6(b)(5) of the Act,\51\ 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, 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; and not be 
designed to permit unfair discrimination between customers, issuers, 
brokers or dealers.
---------------------------------------------------------------------------

    \50\ 15 U.S.C. 78f(b). In approving this proposed rule change, 
the Commission has considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
    \51\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    As noted above, the Commission received two comment letters from 
one commenter in response to the proposed rule change.\52\ The 
commenter raised concerns about whether the Exchange's proposed 
revisions to its rules governing priority during open outcry were 
appropriate, as more fully described

[[Page 60879]]

above.\53\ In its review of the proposal, the Commission has carefully 
considered all of the comments received. The Commission acknowledges 
the concerns raised by the commenter, as detailed above,\54\ about the 
potential impact on competition resulting from the Proposal in the 
Exchange's rules governing priority and order allocation for open 
outcry transactions. At the same time, the Commission also acknowledges 
the Exchange's belief that this Proposal will encourage order flow 
providers to send additional crossing, facilitation, and solicited 
orders to the Exchange,\55\ as well as its belief that today, 
electronic options trading is well-established and no longer requires 
special rules and incentives to develop further.\56\
---------------------------------------------------------------------------

    \52\ See supra note 5.
    \53\ See ISE Letters I and II. See also notes 29-37 and 44-49 
and accompanying text describing the issues and concerns raised by 
these comments.
    \54\ See supra notes 29-37 and 44-49 and accompanying text.
    \55\ See Notice, 79 FR at 27353.
    \56\ See Amendment No. 1 at 4.
---------------------------------------------------------------------------

    Phlx Rule 1014, Commentary .05(c)(ii), as proposed to be revised, 
describes priority for crossing, facilitation, and solicited orders in 
open outcry transactions. The proposed rules governing open outcry 
during crossing, facilitation, and solicited transactions on the 
Exchange floor are similar to the rules governing priority in crossing 
transactions at other exchanges.\57\ Given that other options exchanges 
currently have rules that provide lower priority to non-priority 
customer orders on the electronic book during crossing transactions on 
those exchanges, the Exchange's proposed revisions to its priority 
scheme for floor transactions will allow Phlx to compete with other 
floor-based exchanges that have substantially similar rules. 
Accordingly, the Commission believes that it would be appropriate and 
consistent with the Act to approve the Exchange's proposed rule 
change.\58\
---------------------------------------------------------------------------

    \57\ See, e.g., CBOE Rule 6.74; NYSE MKT Rule 934NY; NYSE Arca 
Rule 6.47. CBOE Rule 6.74 provides that for purposes of establishing 
priority at the same price, bids and offers of In-Crowd Market 
Participants have first priority, except with respect to public 
customer orders resting in the electronic book; and all other bids 
and offers (including bids and offers of broker-dealer orders in the 
electronic book and electronic quotes of Market-Makers) have second 
priority. NYSE MKT Rule 934NY(b)(3) provides that, for a non-
facilitation cross, if there are bids or offers in the Consolidated 
Book better than the proposed execution price or Customer Orders in 
the Consolidated Book priced at the proposed execution price, the 
Floor Broker must trade against such bids or offers in the 
Consolidated Book. Once bids or offers in the Book are satisfied, 
the Floor Broker may cross the balance of the orders, if any, to be 
crossed. NYSE Arca Rule 6.47 provides that, for crossing orders, the 
Floor Broker must trade against: (i) Customer bids or offers on the 
Consolidated Book priced equal or better than the proposed execution 
price; and (ii) better-priced non-Customer bids or offers on the 
Consolidated book along with any equal-priced non-Customer bids and 
offers that are ranked ahead of any equal-priced Customer bids and 
offers.
    \58\ As noted above, the Exchange's proposal is intended to 
bring its floor priority rules for crossing, facilitation, and 
solicited orders in line with the floor priority rules of certain 
other options exchanges. However, the Commission is aware of the 
concerns, as expressed by the commenter, that the rules of an 
options trading floor should allow for sufficient competition for 
orders. This concern is one that the Commission staff intends to 
continue to evaluate in the context of its ongoing empirical 
consideration of market structure. For example, there currently is 
relatively little information available about the extent and nature 
of floor crossing transactions. The Commission staff, however, 
expects that an exchange with a trading floor, as part of its 
regulatory obligations, will monitor the extent to which competition 
is maintained in floor crossing transactions. One way an exchange 
could do so would be to assess periodically the level of 
participation in such crossing transactions by market makers and 
other market participants, aside from the firm that initiated the 
cross, and review whether its rules appropriately allow for such 
competition. In addition, the Commission reminds broker-dealers that 
the duty of best execution requires them to assess periodically the 
quality of competing markets to assure that order flow is directed 
to the markets providing the most beneficial terms for their 
customer orders. See, e.g., Order Execution Obligations, Securities 
Exchange Act Release No. 37619A (September 6, 1996), 61 FR 48290 at 
48322-33 (September 12, 1996). 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 
prices. See id. at 48323. 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. See id.
---------------------------------------------------------------------------

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act 
\59\ that the proposed rule change, as modified by Amendment No. 1, 
(SR-Phlx-2014-23) be, and it hereby is, approved.
---------------------------------------------------------------------------

    \59\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\60\
---------------------------------------------------------------------------

    \60\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-23984 Filed 10-7-14; 8:45 am]
BILLING CODE 8011-01-P