Document ID: SEC-2014-2045-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ OMX PHLX LLC
Posted Date: 2014-12-08T05:00Z

[Federal Register Volume 79, Number 235 (Monday, December 8, 2014)]
[Proposed Rules]
[Pages 72740-72743]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-28646]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-73719; File No. SR-Phlx-2014-76]

Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Notice of 
Filing and Immediate Effectiveness of Proposed Rule Change To Adopt 
Anti-Internalization Functionality for Registered Market Makers on the 
PHLX Options Market

December 2, 2014.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on November 28, 2014, NASDAQ OMX PHLX LLC (``Phlx,'' ``PHLX,'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') a 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 proposes to adopt anti-internalization functionality 
for registered market makers on the PHLX Options Market.
    While these amendments are effective upon filing, the Exchange has 
designated the proposed amendments to be operative on or before January 
15, 2015.
    The text of the proposed rule change is below; proposed new 
language is italicized; proposed deletions are in brackets.
* * * * *
Rule 1080. Phlx XL and Phlx XL II
    (a)-(o) No Change.
    (p) Execution Protections
    (1) Acceptable Trade Range.
    (A) After the opening, the System will calculate an Acceptable 
Trade Range to limit the range of prices at which an order or quote 
(except an All-or-none order) will be allowed to execute. The 
Acceptable Trade Range is calculated by taking the Reference Price, 
plus or minus a value to be determined by the Exchange. (i.e., the 
Reference Price - (x) for sell orders/quotes and the Reference Price + 
(x) for buy orders/quotes). Upon receipt of a new order/quote, the 
Reference Price is the National Best Bid (``NBB'') for sell orders and 
the National Best Offer (``NBO'') for buy orders/quotes or the last 
price at which the order/quote is posted whichever is higher for a buy 
order/quote or lower for a sell order/quote.
    (B) If an order/quote reaches the outer limit of the Acceptable 
Trade Range (the ``Threshold Price'') without being fully executed, it 
will be posted at the Threshold Price for a brief period, not to exceed 
one second (``Posting Period''), to allow more liquidity to be 
collected, unless a Quote Exhaust has occurred, in which case the Quote 
Exhaust process in Rule 1082(a)(ii)(B)(3) will ensue, triggering a new 
Reference Price. Upon posting, either the current Threshold Price of 
the order or an updated NBB for buy orders or the NBO for sell orders 
(whichever is higher for a buy order/lower for a sell order) then 
becomes the Reference Price for calculating a new Acceptable Trade 
Range. If the order/quote remains unexecuted, a New Acceptable Trade 
Range will be calculated and the order/quote will execute, route, or 
post up to the new Acceptable Trade Range Threshold Price, unless a 
member organization has requested that their orders be returned if 
posted at the outer limit of the Acceptable Trade Range (in which case, 
the order will be returned). This process will repeat until either (i) 
the order/quote is executed, cancelled, or posted at its limit price or 
(ii) the order has been subject to a configurable number of instances 
of the Acceptable Trade Range as determined by the Exchange (in which 
case it will be returned).
    (C) During the Posting Period, the Exchange will disseminate as a 
quotation: (i) The Threshold Price for the remaining size of the order 
triggering the Acceptable Trade Range and (ii) on the opposite side of 
the market, the best price will be displayed using the ``non-firm'' 
indicator message in accordance with the specifications of the network 
processor. Following the Posting Period, the Exchange will return to a 
normal trading state and disseminate its best bid and offer.
    (2) Anti-Internalization--Quotes and orders entered by Specialists 
and Registered Options Traders (as defined in Rule 1014) using the same 
Phlx badge will not be executed against quotes and orders entered on 
the opposite side of the market using the same badge. In such a case, 
the System will cancel the resting quote or order back to the entering 
party prior to execution. This functionality shall not apply in any 
auction or with respect to complex transactions.
    (3) Order Price Protection (``OPP''). OPP is a feature of Phlx XL 
that prevents certain day limit, good til cancelled, immediate or 
cancel, and all-or-none orders at prices outside of pre-set standard 
limits from being accepted by the system. OPP applies to all options 
but does not apply to market orders, stop limit orders, Intermarket 
Sweep Orders or complex orders.
    (A) OPP is operational each trading day after the opening until the 
close of trading, except during trading halts. The Exchange may also 
temporarily deactivate OPP from time to time on an intraday basis at 
its discretion if it determines that volatility warrants deactivation. 
Members will be notified of intraday OPP deactivation due to volatility 
and any subsequent intraday reactivation by the Exchange through the 
issuance of system status messages.
    (B) OPP will reject incoming orders that exceed certain parameters 
according to the following algorithm.

[[Page 72741]]

    (i) If the NBBO on the contra-side of an incoming order is greater 
than $1.00, orders with a limit more than 50% through such contra-side 
NBBO will be rejected by Phlx XL upon receipt. For example, if the NBBO 
on the offer side is $1.10, an order to buy options for more than $1.65 
would be rejected. Similarly, if the NBBO on the bid side is $1.10, an 
order to sell options for less than $0.55 will be rejected.
    (ii) If the NBBO on the contra-side of an incoming order is less 
than or equal to $1.00, orders with a limit more than 100% through such 
contra-side NBBO will be rejected by Phlx XL upon receipt. For example, 
if the NBBO on the offer side is $1.00, an order to buy options for 
more than $2.00 would be rejected. However, if the NBBO of the bid side 
of an incoming order to sell is less than or equal to $1.00, the OPP 
limits set forth above will result in all incoming sell orders being 
accepted regardless of their limit. To illustrate, if the NBBO on the 
bid side is equal to $1.00, the OPP limits provide protection such that 
all orders to sell with a limit less than $0.00 would be rejected.
    (iii) For purposes of this rule, the NBBO is defined as the PBBO 
for singly-listed issues.
    Commentary .01-.06 No Change.
    [Commentary .07--Order Price Protection (``OPP''). OPP is a feature 
of Phlx XL that prevents certain day limit, good til cancelled, 
immediate or cancel, and all-or-none orders at prices outside of pre-
set standard limits from being accepted by the system. OPP applies to 
all options but does not apply to market orders, stop limit orders, 
Intermarket Sweep Orders or complex orders.
    (a) OPP is operational each trading day after the opening until the 
close of trading, except during trading halts. The Exchange may also 
temporarily deactivate OPP from time to time on an intraday basis at 
its discretion if it determines that volatility warrants deactivation. 
Members will be notified of intraday OPP deactivation due to volatility 
and any subsequent intraday reactivation by the Exchange through the 
issuance of system status messages.
    (b) OPP will reject incoming orders that exceed certain parameters 
according to the following algorithm.
    (i) If the NBBO on the contra-side of an incoming order is greater 
than $1.00, orders with a limit more than 50% through such contra-side 
NBBO will be rejected by Phlx XL upon receipt. For example, if the NBBO 
on the offer side is $1.10, an order to buy options for more than $1.65 
would be rejected. Similarly, if the NBBO on the bid side is $1.10, an 
order to sell options for less than $0.55 will be rejected.
    (ii) If the NBBO on the contra-side of an incoming order is less 
than or equal to $1.00, orders with a limit more than 100% through such 
contra-side NBBO will be rejected by Phlx XL upon receipt. For example, 
if the NBBO on the offer side is $1.00, an order to buy options for 
more than $2.00 would be rejected. However, if the NBBO of the bid side 
of an incoming order to sell is less than or equal to $1.00, the OPP 
limits set forth above will result in all incoming sell orders being 
accepted regardless of their limit. To illustrate, if the NBBO on the 
bid side is equal to $1.00, the OPP limits provide protection such that 
all orders to sell with a limit less than $0.00 would be rejected.
    (iii) For purposes of this rule, the NBBO is defined as the PBBO 
for singly-listed issues.]
    Commentary .08--Renumbered as Commentary .07.
    Commentary .09--Renumbered as Commentary .08.
* * * * *

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
    PHLX is proposing to provide anti-internalization (``AIQ'') 
functionality to Specialists and Registered Options Traders on the PHLX 
Options Market.\3\ Anti-internalization functionality is widely 
available and has been for many years.\4\ It is designed to assist 
market participants in complying with certain rules and regulations of 
the Employee Retirement Income Security Act (``ERISA'') that preclude 
and/or limit managing broker-dealers of such accounts from trading as 
principal with orders generated for those accounts. It can also assist 
market makers in reducing trading costs from unwanted executions 
potentially resulting from the interaction of executable buy and sell 
trading interest from the same firm when performing the same market 
making function.
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    \3\ See PHLX Rule 1014. The category of Specialist and 
Registered Options Traders (``ROTs'') as defined in Rule 1014 are 
all considered market makers on the Exchange. This category includes 
the subcategories of Streaming Quote Traders (``SQTs''), Remote 
Streaming Quote Traders (``RSQTs''), and Non-SQT ROTs, all of which 
have market making obligations also defined in Rule 1014.
    \4\ See, e.g., NASDAQ Rule 4757(a)(4), NASDAQ Options Market 
Rule Chapter VI, Section 10(6), NYSE Arca Equities Rule 7.31(qq)(2), 
and BATS Rule 11.9(f)(2). PSX Rule 3307(c) governing trading on the 
PHLX equity facility provides similar self-match prevention for 
equities trading.
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    Under the proposal, quotes and orders entered by Specialists and 
Registered Options Traders using the same PHLX badge will automatically 
be prevented from interacting with each other in the System. Rather 
than executing quotes or orders from the same badge, the System will 
instead cancel the resting quotes and orders back to the entering 
party. PHLX uses ``badges'' to identify the party or parties entering 
trades into the System, similar to Market Participant Identifiers 
(MPIDs) and other mnemonic devices used at other exchanges. Because 
firms have multiple badges associated with multiple functions, linking 
AIQ to specific badges ensures that the functionality will be limited 
to the appropriate function, as explained in more detail below. Tying 
AIQ to specific PHLX badges will also enable market participants to 
carefully and systematically target the orders that should be prevented 
from interacting.
    AIQ will apply in the PHLX XL system with respect to simple orders 
only; it will not apply in any auction or with respect to complex 
transactions. AIQ is difficult to apply during auctions, and there is 
limited benefit in doing so. The difficulty stems from the need to 
freeze the order book and quickly arrange and match large quantities of 
orders based upon simple instructions. Even if that could be 
accomplished, there is limited benefit because, generally speaking, 
auctions do not raise the same policy concerns for wash sales and ERISA 
due to the semi-random manner in which trades are matched.\5\ AIQ is 
unnecessary with respect to complex orders due to the highly 
specialized nature of such orders and the high level of control that 
market participants exercise over complex orders. In addition, owing to 
the number of different legs involved in complex orders, applying AIQ 
to complex orders would also require freezing the book, which market 
participants and PHLX view as detrimental to the market.
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    \5\ See NYSE Arca Equities Rule 7.31(qq).
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    Anti-internalization functionality was requested by Specialists and 
Registered

[[Page 72742]]

Options Traders on PHLX. Anti-internalization processing is available 
only to market makers and only on an individual badge basis. 
Specialists and Registered Options Traders that conduct order entry 
business via alternative badges will not be afforded the protection of 
AIQ functionality with respect to such alternative badges. PHLX 
considered making AIQ functionality available to other participants, 
but rejected that approach. Limiting AIQ to Specialists and Registered 
Options Traders also helps to maintain simplicity of System 
processing.\6\
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    \6\ If demand should arise from other participants, PHLX will 
reconsider providing this functionality to all participants at that 
time.
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    PHLX notes that use of the functionality does not relieve or 
otherwise modify the duty of best execution owed to orders received 
from public customers. Options market makers generally do not display 
customer orders in market making quotations, opting instead to enter 
customer orders using separate identifiers. In the event that an 
options market maker opts to include a customer order within a market 
making quotation, the market maker must take appropriate steps to 
ensure that public customer orders that do not execute due to anti-
internalization functionality ultimately receive the same execution 
price (or better) they would have originally obtained if execution of 
the order was not inhibited by the functionality.
    Finally, the Exchange is proposing to combine several existing 
price protection mechanisms in Rule 1080(p) and to rename that 
subsection as ``Execution Protections, [sic] PHLX believes the rules 
will become clearer by adding AIQ and moving current Commentary .07 
governing Order Price Protection to existing Rule 1080(p) governing the 
Acceptable Trade Range. As a result, PHLX will renumber existing 
Commentaries .08 and .09 as Commentaries .07 and .08. The proposed 
changes will not impact the substance and operation of the existing 
functionality of the Acceptable Trade Range, Order Price Protection or 
Commentaries .08 and .09.
2. Statutory Basis
    PHLX believes that the proposed rule change is consistent with the 
provisions of Section 6 of the Act,\7\ in general, and with Section 
6(b)(5) of the Act \8\ in particular, in that the proposal is 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. Specifically, PHLX believes 
that the change, which is responsive to member input, will facilitate 
transactions in securities and perfect the mechanism of a free and open 
market by providing Specialists and Registered Options Traders with 
additional functionality that will assist them with managing the book 
of orders that they submit to PHLX and the associated execution costs.
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    \7\ 15 U.S.C. 78f.
    \8\ 15 U.S.C. 78f(b)(5).
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    PHLX believes the proposal is consistent with the Act because it 
provides tools for Specialists and Registered Options Traders to comply 
with existing rules against internalization in certain circumstances. 
Limiting AIQ to Specialists and Registered Options Traders is 
consistent with the Act because inadvertent internalization is much 
more likely to impact market makers than other participants and 
offering AIQ more broadly would burden the System and provide little or 
no offsetting regulatory benefit. Finally, PHLX believes that it is 
reasonable to limit AIQ to simple options orders, as opposed to complex 
options and auctions, because the execution risk is much lower with 
respect to complex options and auctions and because those functions 
operate quite differently than individual orders in simple options.

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

    PHLX does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended. Specifically, by 
providing market participants additional tools to prevent inadvertent 
internalization of orders submitted to PHLX, the change has the 
potential to improve the trading environment on the Exchange, which 
will enhance PHLX's competitiveness with respect to other trading 
venues, thereby promoting greater competition. Moreover, the change 
does not burden competition in that it will be provided at no 
additional cost to members.

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 from the date on which it was filed, or 
such shorter time as the Commission may designate, it has become 
effective pursuant to Section 19(b)(3)(A)(ii) [sic] of the Act \9\ and 
subparagraph (f)(6) of Rule 19b-4 thereunder.\10\
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    \9\ 15 U.S.C. 78s(b)(3)(a)(ii) [sic].
    \10\ 17 CFR 240.19b-4(f)(6). In addition, Rule 19b-4(f)(6) 
requires a self-regulatory organization to give the Commission 
written notice of its intent to file 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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    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: (i) 
Necessary or appropriate in the public interest; (ii) for the 
protection of investors; or (iii) 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-2014-76 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-Phlx-2014-76. This file

[[Page 72743]]

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 
10:00 a.m. and 3:00 p.m. Copies of such filing also will be available 
for inspection and copying at the principal offices 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-2014-76, 
and should be submitted on or before December 29, 2014.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-28646 Filed 12-5-14; 8:45 am]
BILLING CODE 8011-01-P