[Federal Register Volume 75, Number 179 (Thursday, September 16, 2010)]
[Notices]
[Pages 56633-56641]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-23104]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-62877; File No. SR-PHLX-2010-79]
Self-Regulatory Organizations; NASDAQ OMX PHLX, Inc.; Order
Approving a Proposed Rule Change, as Modified by Amendment No. 1,
Relating to the Establishment of NASDAQ OMX PSX as a Platform for
Trading NMS Stocks
September 9, 2010.
I. Introduction
On June 8, 2010, NASDAQ OMX PHLX, Inc. (``PHLX'' or ``Exchange''),
filed with the Securities and Exchange Commission (``Commission''),
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to
establish NASDAQ OMX PSX as a new electronic platform for trading NMS
stocks. The proposed rule change was published for comment in the
Federal Register on July 26, 2010.\3\ On August 5, 2010, the Exchange
filed Amendment No. 1 to the proposed rule change.\4\ The Commission
received no comment letters regarding the proposed rule change. This
order approves the proposed rule change, as modified by Amendment No.
1.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 62519 (July 16,
2010), 75 FR 43597 (``Notice'').
\4\ Amendment No. 1 clarifies that the proposal to accept orders
routed by Nasdaq Execution Services, LLC to the Exchange on a one-
year pilot basis is made by the Exchange, rather than by The NASDAQ
Stock Market, LLC (``Nasdaq''). This is a technical amendment and is
not subject to notice and comment.
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II. Background
The Exchange proposes to establish a new cash equities trading
platform, to be called NASDAQ OMX PSX (``PSX or ``System'').\5\ The
System will be an open-access fully electronic integrated order display
and execution system for NMS stocks. PSX will not list securities, but
rather will trade NMS stocks listed on other exchanges on an unlisted
trading privileges basis.
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\5\ The Exchange previously operated an electronic trading
facility, XLE, for the trading of cash equity securities. XLE ceased
its operations in October 2008 following the acquisition of the
Exchange by The NASDAQ OMX Group, Inc. (``NASDAQ OMX''), the parent
corporation of Nasdaq. See Securities Exchange Act Release No. 58613
(September 22, 2008), 73 FR 57181 (October 1, 2008) (SR-Phlx-2008-
65). Since ceasing operations of XLE, the Exchange has solely
operated an options market.
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The System will allow PSX participants to enter orders at multiple
price levels. Orders will be integrated and displayed via data feeds to
participants and other data subscribers. PSX participants will be able
to access the aggregated trading interest of all other PSX participants
in accordance with non-discretionary order execution algorithms. The
System will not route orders to other market centers.
In contrast with most markets, which employ a price/time execution
priority system (where the displayed order on the book that is first in
time at the best price is satisfied fully, then the next in time at
that price, and so on), PSX will use a price/pro rata execution
priority system,with displayed orders receiving priority over non-
displayed orders. Specifically, multiple orders displayed on the PSX
book at the best price would be allocated shares of an incoming order
pro rata based on the proportion of the size of the displayed order to
the total size of all displayed orders at that price. Once all
displayed size at any price level is exhausted, the same pro rata logic
would apply to non-displayed orders at that price level.
The Exchange proposes to adopt new rules governing trading on the
System. The proposed new rules are based to a substantial extent on the
rules of Nasdaq \6\ and NASDAQ OMX BX, Inc. (``BX''). In addition, the
Exchanges proposes to apply the PHLX rules listed in proposed PHLX Rule
3202, including certain rules that governed XLE when it was
operational, to PHLX members with respect to their activities on the
System.\7\ The Exchange also proposes to amend PHLX Rule 803 (Criteria
For Listing--Tier I) to support unlisted trading privileges for NMS
stocks on PSX and PHLX Rule 985 (Affiliate and Ownership Restrictions)
to address potential competitive advantage and conflict of interest
concerns regarding
[[Page 56634]]
inbound routing from Nasdaq to PSX. Finally, the Exchange proposes to
adopt rules governing Recommendations to Customers (Suitability) and
Best Execution and Interpositioning,\8\ and commentaries relating
thereto, which rules shall be applicable to all members of the
Exchange, including those trading on PSX.
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\6\ Unlike Nasdaq, PSX will not route orders to other exchanges
and will not have market makers. As a result, the PSX rules do not
contain provisions related to outbound routing or market makers that
are found in Nasdaq's rules.
\7\ The Exchange also proposes to delete two existing PHLX Rules
relating to XLE, PHLX Rule 160 (NMS Stock Execution on the Exchange)
and PHLX Rule 188 (Trade Execution and Reporting), and to move their
content to the proposed rules governing PSX. See proposed PHLX Rules
3301(a), 3305(a)(1) and 3309).
\8\ See proposed PHLX Rules 763 and 764.
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Pursuant to the terms of a regulatory services agreement (the
``FINRA RSA'') between PHLX and Financial Industry Regulatory
Authority, Inc. (``FINRA''), administration and enforcement of many of
the new rules applicable to the System will be supported by FINRA. In
addition, certain regulatory responsibilities of PHLX relating to PSX
may be administered by personnel employed by Nasdaq or ``BX'' \9\
pursuant to a regulatory services agreement (the ``Intercompany RSA'').
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\9\ Each of Nasdaq and BX is a self-regulatory organization
(``SRO'') owned by NASDAQ OMX and, therefore, an affiliate of the
Exchange.
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III. Discussion and Commission Findings
After careful review of the proposed rule change, the Commission
finds that the proposed rule change is consistent with the requirements
of the Act and the rules and regulations thereunder applicable to a
national securities exchange.\10\ Specifically, the Commission finds
that the proposed rule change is consistent with Section 6(b)(5) of the
Act,\11\ which requires, among other things, that the rules of a
national securities exchange be designed to prevent fraudulent and
manipulative acts and practices; to promote just and equitable
principles of trade; to foster cooperation and coordination with
persons engaged in regulating, clearing, settling, and processing
information with respect to, and facilitating transactions in
securities; to remove impediments to and perfect the mechanism of a
free and open market and a national market system; and, in general, to
protect investors and the public interest. Section 6(b)(5) of the Act
also requires that the rules of an exchange not be designed to permit
unfair discrimination among customers, issuers, brokers, or dealers.
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\10\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition and
capital formation. 15 U.S.C. 78c(f).
\11\ 15 U.S.C. 78f(b)(5).
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Overall, the Commission believes that approving the Exchange's
proposed rule change could benefit the public and market participants.
Approval of the proposal would establish rules for the operation of a
new electronic facility for the trading of cash equity securities that
is designed to encourage displayed orders of larger size, which could
foster best execution, price discovery, competition and innovation. The
discussion below does not review every detail of the proposed rule
change, but rather focuses on the most significant rules and policy
issues considered in review of the proposals.
A. Proposed New Rules for PSX
1. Access and Participation
The System will only have one class of membership and, unlike
Nasdaq, will not have a separate class of market makers.\12\ In
addition, PSX will make its facilities available to electronic
communications networks (``ECN'') and alternative trading systems
(``ATS'') that meet certain requirements, to allow such ECNs and/or
ATSs to display best prices and size of orders on PSX and members to
access such orders.\13\ PSX will provide authorized access for
Sponsored Participants on terms identical to those set forth in Nasdaq
Rule 4211(d) (Sponsored Participants).\14\
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\12\ See Notice, supra note 3, 75 FR at 43598.
\13\ See proposed Rule 3223. The ATS or ECN must be a PHLX
member organization, enter into and comply with applicable
agreements, agree that PHLX may disseminate the ECN's or ATS's best
priced orders, demonstrate that it is in compliance with applicable
regulatory requirements, and accept automated executions against
orders that it enters into the System.
\14\ See proposed Rule 3211(d). The Exchange has represented
that upon implementation by Nasdaq of recently approved changes to
its rule governing Sponsored Participants, the Exchange will adopt
and implement identical rules to govern sponsored access on PSX. See
Securities Exchange Act Release No. 61345 (January 13, 2010), 75 FR
32631 (January 20, 2010) (SR-NASDAQ-2008-104). If NASDAQ's rules are
superseded by rules adopted by the Commission, the Exchange has
represented that PSX will operate sponsored participant access in
accordance with such rules. See Notice, supra note 3, 75 FR at
43598.
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The System will be accessible to all PHLX members that meet the
registration, qualification and other membership requirements set forth
in the PHLX rules.\15\ In addition, in order to trade on PSX, a member
must comply with certain additional requirements set forth in proposed
PHLX Rule 3211 (PSX Participant Registration). Such requirements are
substantially similar to the requirements set forth in Nasdaq Rule 4611
(Nasdaq Market Center Participant Registration), and include, among
others, the execution of applicable agreements with the Exchange,
membership in or access to a registered clearing agency through which
PSX-compared trades may be settled, compliance with all applicable
rules and operating procedures of PHLX \16\ and the Commission in the
use of PSX, and maintenance of equipment to prevent the improper use of
and access to PHLX systems.\17\
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\15\ As discussed above, proposed PHLX Rule 3202 sets forth the
current PHLX Rules applicable to market participants trading on PSX,
and includes, among others, PHLX Rule 600 (Registration) and PHLX
Rule 604 (Registration and Termination of Registered Persons). In a
separate order, the Commission approved the amendment of PHLX Rule
604 to require all members trading on PSX to register
representatives and principals in accordance with rules similar to
those governing registration of associated persons of members of
Nasdaq. See Securities Exchange Act Release No. 62776 (August 26,
2010), 75 FR 53727 (September 1, 2010) (SR-Phlx-2010-91).
\16\ In addition to proposed rules specific to the operation of
PSX, members must comply with existing PHLX rules governing member
conduct, to the extent that they are relevant to trading on PSX. The
PHLX Rules applicable to activities of members on PSX are listed in
proposed PHLX Rule 3202.
\17\ See proposed PHLX Rule 3211(a).
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Each PSX participant will be under a continuing obligation to
inform PHLX of any noncompliance with any of the registration
requirements.\18\ Failure by a PSX participant to comply with any
registration requirements, including failure to comply with any PHLX
rules applicable to PSX, shall subject such participant to censure,
fine, suspension or revocation of its registration as a PSX
participant, or any other appropriate penalty under the rules of the
Exchange.\19\ The Exchange may terminate access to the System if a
participant fails to meet the participant eligibility
qualifications.\20\
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\18\ See proposed PHLX Rule 3211(b).
\19\ See proposed PHLX Rule 3228(a).
\20\ See proposed PHLX Rule 3222.
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The Commission finds that the Exchange's access and participation
requirements for the System are consistent with Section 6(b)(5) of the
Act, which requires, among other things, that the rules of a national
securities exchange be designed to prevent fraudulent and manipulative
acts and practices; to promote just and equitable principles of trade;
to foster cooperation and coordination with persons engaged in
regulating, clearing, settling, and processing information with respect
to, and facilitating transactions in securities; to remove impediments
to and perfect the mechanism of a free and open market and a national
market system; and, in general, to protect investors and the public
interest.\21\ Section 6(b)(5) also requires that the rules of an
exchange not be designed to permit unfair discrimination among
customers, issuers, brokers, or dealers. The Commission notes that the
access and participation requirements applicable to PSX are
substantially similar to rules of
[[Page 56635]]
Nasdaq previously approved by the Commission.\22\ The Commission also
notes that all PSX participants will participate on consistent terms
when entering orders into PSX for posting and accessing liquidity. In
addition, the Commission notes that the membership and registration
requirements applicable to PSX are set forth in the current rules of
the Exchange, which have been previously approved by the Commission.
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\21\ 15 U.S.C. 78f(b)(5).
\22\ See Securities Exchange Act Release No. 53128 (January 13,
2006), 71 FR 3550 (January 23, 2006) (order approving Nasdaq's
application to register as a national securities exchange) (``Nasdaq
Registration Approval Order'').
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2. Trading System and Regulation NMS Compliance
a. PSX Order Entry, Display and Execution
The System will operate, and orders can be entered into the System,
from 9 a.m. to 5 p.m., Eastern Time, on each business day.\23\ PSX will
not have any specialized opening or closing processes, and will begin
to process all eligible orders at 9 a.m.\24\
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\23\ See proposed PHLX Rules 3217 and 3306(a)(3).
\24\ See proposed PHLX Rule 3302.
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Participants may submit multiple orders at multiple price levels,
which PSX will manage and display, consistent with the parameters of
each order.\25\ PSX will time-stamp each order upon receipt, although,
as discussed below, the time stamp will not determine the order's
ranking for execution purposes.\26\ The System will not display orders
on an attributable basis.\27\ Orders may be entered either as Displayed
Orders or Non-Displayed Orders.\28\
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\25\ See proposed PHLX Rule 3306.
\26\ Id.
\27\ See proposed PHLX Rule 3301(a).
\28\ See proposed PHLX Rule 3301(e).
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Displayed Orders will be displayed anonymously to participants
through the System book feed and the aggregate size of all best-priced
Displayed Orders to buy and sell on the System will be transmitted for
display to the appropriate network processor (unless the aggregate size
is less than one round lot).\29\ Non-Displayed Orders and Reserve Size
will not be displayed, but will nevertheless remain available for
potential execution against incoming orders.\30\
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\29\ See proposed PHLX Rule 3306(c)(1) and (2).
\30\ See proposed PHLX Rule 3306(c)(3).
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Incoming marketable orders automatically execute against resting
orders on the PSX book, and the posted orders are decremented
accordingly.\31\ Incoming orders that are not marketable against posted
interest in the System book will be cancelled or posted to the book,
depending on the time-in-force for the order.\32\ An incoming order
with a price that crosses the price of an order posted on the book will
execute at the price of the posted order. Thus, any potential price
improvement resulting from an execution in the System will accrue to
the taker of liquidity.\33\
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\31\ See proposed PHLX Rule 3307(a)(2).
\32\ See proposed PHLX Rule 3301(h).
\33\ See proposed PHLX Rule 3307(a)(3).
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As provided by PHLX Rule 3309, executions occurring as a result of
orders matched on PSX shall be reported by PHLX to an appropriate
consolidated transaction reporting system. As transactions executed in
the System will be cleared and settled anonymously, the transaction
reports produced by the System will indicate the price and size of the
transaction, but will not reveal contra party identities.\34\
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\34\ See proposed PHLX Rule 3310.
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To determine the allocation of incoming marketable orders against
orders on the book, the System uses a price/pro-rata algorithm, with
Displayed Orders receiving priority over Non-displayed Orders and round
lot orders receiving priority over odd lot orders.\35\ The algorithm
executes trading interest in the System as follows:
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\35\ See proposed PHLX Rule 3307(a)(1).
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Better priced trading interest will be executed ahead of
inferior-priced trading interest;
Displayed Orders at a particular price with a size of at
least one round lot will be executed ahead of Non-Displayed Orders and
the reserve portion of Reserve Orders (collectively, ``non-displayed
interest'') at the same price;
Displayed Orders at a particular price with a size of at
least one round lot will be executed ahead of odd lot at the same
price; however, odd-lot Displayed Orders will execute ahead of non-
displayed interest of one round lot at the same price, as Displayed
Orders will always execute ahead of Non-Displayed Orders at the same
price; \36\
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\36\ See id.
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As among equally priced Displayed Orders with a size of at
least one round lot, the System will allocate round lot portions of
incoming executable orders to displayed trading interest within the
System pro rata based on the size of the Displayed Orders. Portions of
an order that would be executed in a size other than a round lot if
they were allocated on a pro rata basis will be allocated for execution
against available displayed trading interest on the basis of a random
function that assigns probability of execution based on the size of
displayed interest.\37\ As among equally priced Displayed Orders with a
size of less than one round lot, the System will allocate incoming
orders based on the size of the Displayed Orders, but not in pro rata
fashion.\38\ If there are two or more odd lot orders of equal size, the
System will determine the order of execution on the basis of a random
function that assigns each order an equal probability of execution.
This same allocation methodology applies to equally-priced non-
displayed interest with a size of at least one round lot or with a size
of less than one round lot, as the case may be.
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\37\ For example, if Displayed Orders to buy at 10 reside on the
PSX book with sizes of 6,000 (Participant A) and 4,000 (Participant
B), and an incoming order to sell 1,100 at 10 comes into the System,
the System will allocate 600 shares of the incoming order to
Participant A and 400 shares of the incoming order to Participant B.
The remaining 100 shares of the incoming order will be allocated on
the basis of a random function that assigns a 60% probability of
executing the 100 shares to Participant A and a 40% probability to
Participant B.
\38\ Thus, a resting displayed order with a size of 90 shares
would get filled in full before a displayed order with size of 50
shares.
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The Commission finds that the Exchange's trading rules for the
System, including PSX's execution priority rules, are consistent with
the Act. The Commission notes that, other than with respect to the
price/pro rata execution priority system, the Exchange' market model
for the trading of cash equity securities is substantially similar to
each of Nasdaq's and BX's equity market models and does not raise novel
issues. The Commission believes that PSX's price/pro rata execution
priority system may encourage participants, particularly those who wish
to execute orders of large size, to display liquidity on the System.
This in turn could facilitate the efficient execution of large orders,
and foster best execution and price discovery. A novel exchange
priority system that is designed to achieve these goals also may foster
competition and innovation. Accordingly, the Commission finds that the
price/pro rata execution priority system proposed by PHLX is consistent
with the Act.
b. Regulation NMS
The Exchange will implement such systems, procedures, and rules in
connection with the operation of PSX as are necessary to render it
capable of meeting the requirements for automated quotations.\39\
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\39\ See proposed PHLX Rule 3306(c)(4). As defined in PHLX Rule
600(b) of Regulation NMS under the Act, 17 CFR 242.600(b), the term
``quotation'' includes the ``bid price or the offer price
communicated by a member of a national securities exchange * * * to
any broker or dealer, or to any customer, at which it is willing to
buy or sell one or more round lots of an NMS security, either as
principal or agent.'' Thus, the term ``quotation'' includes orders
entered into the System by PSX participants, notwithstanding the
fact that PSX will not have market makers with obligations to
maintain continuous two-sided quotations. Under Rule 602 of
Regulation NMS, brokers and dealers are required to communicate to a
national securities exchange or national securities association
their best bids, best offers, and quotation sizes. By displaying
orders communicated to it by its members and complying with the
requirements for automation described in Rule 600(b)(3), PSX will
display ``automated quotations'' within the meaning of that rule,
and therefore its best bid and best offer will constitute
``protected quotations'' entitled to trade-through protection under
Regulation NMS.
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[[Page 56636]]
The Exchange has designed PSX's rules relating to orders,
modifiers, and order execution to comply with the requirements of
Regulation NMS. The proposed Rules are consistent with Regulation NMS
\40\ by requiring that all orders be processed in a manner that avoids
trading through protected quotations \41\ and avoids locked and crossed
markets.\42\ PSX will not route orders to other market centers.
Proposed PHLX Rule 3305(b) provides that in addition to such other
designations as may be chosen by a market participant,\43\ all orders
that are not entered with a time in force of ``System Hours Immediate
or Cancel'' \44\ must be designated as an Intermarket Sweep Order, a
Pegged Order, a Price to Comply Order, or a Post-Only Order.\45\ Any
orders that are entered into the System that would lock or cross
another order in the System will be execute d to avoid a lock or
cross.\46\
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\40\ 17 CFR 242.611.
\41\ See discussion of protected quotations supra note 39.
\42\ See proposed PHLX Rules 3305(b) and 3213(c).
\43\ As is the case with Nasdaq, different order designations
can be combined. Thus, for example, a Price to Comply Order could be
entered with reserve size or as a Non-displayed Order.
\44\ A ``System Hours Immediate or Cancel'' order is an
immediate or cancel order that may be entered between 9 a.m. and 5
p.m. Eastern Time, PSX's hours of operation. If a System Hours
Immediate or Cancel order (or a portion thereof) is not marketable,
the order (or unexecuted portion thereof) is canceled and returned
to the entering participant. See proposed PHLX Rule 3301(h)(1).
\45\ See proposed PHLX Rule 3305(b).
\46\ See proposed PHLX Rule 3213(c). In addition, members may
enter orders that are re-priced if they would lock or cross so as to
avoid executing.
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As described in the Notice, a System Hours Immediate or Cancel
Order is compliant with Regulation NMS because by its terms it would
not execute or post at a price that would result in a trade-through of
a protected quotation or lock or cross another market.\47\ A Pegged
Order similarly is compliant with Regulation NMS because it continually
re-prices to avoid locking or crossing.\48\
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\47\ See Notice, supra note 3, 75 FR at 43603; proposed PHLX
Rule 3301(h).
\48\ See Notice, supra note 3, 75 FR at 43603; proposed PHLX
Rule 3301(f)(4).
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The proposed rules also permit PSX participants to submit
Intermarket Sweep Orders to comply with Regulation NMS. Orders so
designated will be automatically matched and executed within the
System.\49\ As described in the Notice, when a participant enters an
Intermarket Sweep Order it is representing that it is also
simultaneously routing one or more additional limit orders (also marked
as Intermarket Sweep Orders), as necessary, to execute against the full
displayed size of any protected bid or offer (as defined in Rule 600(b)
of Regulation NMS) in the case of a limit order to sell or buy with a
price that is superior to the limit price of the order identified as an
Intermarket Sweep Order.\50\
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\49\ See proposed PHLX Rule 3301(f)(6).
\50\ See Notice, supra note 3, 75 FR at 43603. The Exchange has
represented that members will be responsible for ensuring that their
use of Intermarket Sweep Orders complies with Regulation NMS, and
the Exchange's T+1 surveillance program will monitor members' use of
Intermarket Sweep Orders.
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Both a Price to Comply and a Post-Only Order are also designed to
comply with the Regulation NMS.\51\ Specifically, if at the time of
entry, a Price to Comply Order will lock or cross the quotation of an
external market, the order will be priced to the current best offer
(for bids) or to the current best bid (for offers) but displayed at a
price one minimum price increment lower than the offer (for bids) or
higher than the bid (for offers).\52\ Thus, an incoming order priced to
execute against the displayed price will receive the superior
undisplayed price.\53\ If, at the time of entry, a Post-Only Order will
lock an order on the System, the order will be re-priced and displayed
on the System to one minimum price increment (i.e., $0.01 or $0.0001)
below the current best offer (for bids) or above the current best bid
(for offers).\54\
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\51\ See Notice, supra note 3, 75 FR at 43603.
\52\ See proposed PHLX Rule 3301(f)(8).
\53\ For example, if the national best bid and best offer is
$9.97x$10.00, and a participant enters a price to comply order to
buy 10,000 shares at $10.01, the order will display at $9.99, but
will reside on the System book at $10.00. If a seller then enters an
order at $9.99, it will execute at $10.00, up to the full 10,000
shares of the order.
\54\ See proposed PHLX Rule 3301(f)(10). For example, if the
System best bid and best offer is $9.97x$10.00, and a participant
enters a Post-Only Order to buy at $10.01, the order will be
repriced and displayed at $9.99. If a seller enters an order at
$9.96, the order will be repriced and displayed at $9.98.
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The Commission believes that by requiring all orders to be entered
with one of the designations described above, all PSX orders should
either be priced or cancelled in a manner consistent with the avoidance
of trade-throughs and locked and crossed markets. The Commission also
notes that, because PSX will not route orders to other market centers,
the Exchange's Regulation NMS policies and procedures under Rule 611(a)
will rely on information provided by Nasdaq for purposes of determining
whether another trading center is experiencing a failure, material
delay, or malfunction of its systems or equipment within the meaning of
Rule 611(b)(1).\55\
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\55\ See Notice, supra note 3, 75 FR at 43603-42604
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The Commission finds that the rules relating to orders, modifiers,
and order execution that are designed to comply with Regulation NMS are
consistent with the Act.
2. Section 11 of the Act
Section 11(a)(1) of the Act \56\ prohibits a member of a national
securities exchange from effecting transactions on that exchange for
its own account, the account of an associated person, or an account
over which it or its associated person exercises discretion
(collectively, ``covered accounts'') unless an exception applies. Rule
11a2-2(T) under the Act,\57\ known as the ``effect versus execute''
rule, provides exchange members with an exemption from the Section
11(a)(1) prohibition. Rule 11a2-2(T) permits an exchange member,
subject to certain conditions, to effect transactions for covered
accounts by arranging for an unaffiliated member to execute
transactions on the exchange. To comply with Rule 11a2-2(T)'s
conditions, a member: (i) Must transmit the order from off the exchange
floor; (ii) may not participate in the execution of the transaction
once it has been transmitted to the member performing the execution;
\58\ (iii) may not be affiliated with the executing member; and (iv)
with respect to an account over which the member has investment
discretion, may not, nor may its associated person, retain any
compensation in connection with effecting the transaction except as
provided in the Rule.
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\56\ 15 U.S.C. 78k(a)(1).
\57\ 17 CFR 240.11a2-2(T).
\58\ The member may, however, participate in clearing and
settling the transaction.
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In a letter to the Commission, the Exchange requests that the
Commission concur with PHLX's conclusion that members who enter orders
into the System satisfy the requirements of Rule 11a2-2(T).\59\ For the
reasons set forth
[[Page 56637]]
below, the Commission believes that Exchange members entering orders
into the System would satisfy the conditions of the Rule.
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\59\ See Letter from Charles Rogers, Chief Regulatory Officer,
PHLX, to Elizabeth M. Murphy, Secretary, Commission, dated August
18, 2010 (``PHLX 11(a) Letter'').
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The Rule's first condition is that orders for covered accounts be
transmitted from off the exchange floor. The System receives orders
electronically through remote terminals or computer-to-computer
interfaces. In the context of other automated trading systems, the
Commission has found that the off-floor transmission requirement is met
if a covered account order is transmitted from a remote location
directly to an exchange's floor by electronic means.\60\ Because PSX
receives orders electronically through remote terminals or computer-to-
computer interfaces, the Commission believes that the System satisfies
the off-floor transmission requirement.
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\60\ See, e.g., Securities Exchange Act Release Nos. 61419
(January 26, 2010), 75 FR 5157 (February 1, 2010) (SR-BATS-2009-031)
(approving BATS options trading); 59154 (December 23, 2008), 73 FR
80468 (December 31, 2008) (SR-BSE-2008-48) (approving equity
securities listing and trading on BSE); 57478 (March 12, 2008), 73
FR 14521 (March 18, 2008) (SR-NASDAQ-2007-004 and SR-NASDAQ-2007-
080) (approving NOM options trading) ; 53128 (January 13, 2006), 71
FR 3550 (January 23, 2006) (File No. 10-131) (approving The Nasdaq
Stock Market LLC); 44983 (October 25, 2001), 66 FR 55225 (November
1, 2001) (SR-PCX-00-25) (approving Archipelago Exchange); 29237 (May
24, 1991), 56 FR 24853 (May 31, 1991) (SR-NYSE-90-52 and SR-NYSE-90-
53) (approving NYSE's Off-Hours Trading Facility); and 15533
(January 29, 1979), 44 FR 6084 (January 31, 1979) (``1979
Release'').
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Second, the Rule requires that the member not participate in the
execution of its order. PHLX has represented that at no time following
the submission of an order is a member organization able to acquire
control or influence over the result or timing of an order's
execution.\61\ According to the Exchange, the execution of a member's
order is determined by what other orders are present in the System and
the priority of those orders.\62\ Accordingly, the Commission believes
that a member does not participate in the execution of an order
submitted to the System.
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\61\ See PHLX 11(a) Letter, supra note 59.
\62\ See id. A member may cancel or modify the order, or modify
the instruction for executing the order, but only from off the
floor. The Commission has stated that the non-participation
requirement is satisfied under such circumstances, so long as such
modifications or cancellations are also transmitted from off the
floor. See Securities Exchange Act Release No. 14713 (April 27,
1978), 43 FR 18557 (May 1, 1978) (``1978 Release'') (stating that
the ``non-participation requirement does not prevent initiating
members from canceling or modifying orders (or the instructions
pursuant to which the initiating member wishes orders to be
executed) after the orders have been transmitted to the executing
member, provided that any such instructions are also transmitted
from off the floor'').
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Third, Rule 11a2-2(T) requires that the order be executed by an
exchange member who is unaffiliated with the member initiating the
order. The Commission has stated that this requirement is satisfied
when automated exchange facilities, such as PSX, are used, as long as
the design of these systems ensures that members do not possess any
special or unique trading advantages in handling their orders after
transmitting them to the exchange.\63\ PHLX has represented that the
design of the System ensures that no member organization has any
special or unique trading advantage in the handling of its orders after
transmitting its orders to the System.\64\ Based on the Exchange's
representation, the Commission believes that PSX satisfies this
requirement.
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\63\ In considering the operation of automated execution systems
operated by an exchange, the Commission noted that, while there is
not an independent executing exchange member, the execution of an
order is automatic once it has been transmitted into the system.
Because the design of these systems ensures that members do not
possess any special or unique trading advantages in handling their
orders after transmitting them to the exchange, the Commission has
stated that executions obtained through these systems satisfy the
independent execution requirement of Rule 11a2-2(T). See 1979
Release, supra note 60.
\64\ See PHLX 11(a) Letter, supra note 59.
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Fourth, in the case of a transaction effected for an account with
respect to which the initiating member or an associated person thereof
exercises investment discretion, neither the initiating member nor any
associated person thereof may retain any compensation in connection
with effecting the transaction, unless the person authorized to
transact business for the account has expressly provided otherwise by
written contract referring to Section 11(a) of the Act and Rule 11a2-
2(T).\65\ PHLX represents that member organizations relying on Rule
11a2-2(T) for transactions effected through the System must comply with
this condition of the Rule.\66\
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\65\ See 17 CFR 240.11a2-2(T)(a)(2)(iv). In addition, Rule 11a2-
2(T)(d) requires a member or associated person authorized by written
contract to retain compensation, in connection with effecting
transactions for covered accounts over which such member or
associated persons thereof exercises investment discretion, to
furnish at least annually to the person authorized to transact
business for the account a statement setting forth the total amount
of compensation retained by the member in connection with effecting
transactions for the account during the period covered by the
statement. See 17 CFR 240.11a2-2(T)(d). See also 1978 Release, supra
note 62 (stating ``[t]he contractual and disclosure requirements are
designed to assure that accounts electing to permit transaction-
related compensation do so only after deciding that such
arrangements are suitable to their interests'').
\66\ See PHLX 11(a) Letter, supra note 59.
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B. Exception to Limitation on Affiliation Between PSX and Its Members
Although the Exchange will not route orders to other market
centers, it proposes to receive orders routed to it by other market
centers, including orders routed from Nasdaq.\67\ Nasdaq Execution
Services, LLC (``NES'') is the approved outbound routing facility of
Nasdaq for cash equities. NES is owned by NASDAQ OMX, which also owns
the Exchange.\68\ Thus, NES is an affiliate of the Exchange.
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\67\ See Notice, supra note 3, 75 FR at 43604.
\68\ See Securities Exchange Act Release No. 58179 (July 17,
2008), 73 FR 42874 (July 23, 2008) (order approving NASDAQ OMX's
acquisition of PHLX).
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Nasdaq is permitted to operate NES as a facility providing outbound
routing services from Nasdaq to other market centers, subject to the
conditions that: (1) NES is operated and regulated as a facility of
Nasdaq; (2) NES only provides outbound routing services unless
otherwise approved by the Commission; (3) the designated examining
authority of NES is a SRO unaffiliated with Nasdaq; and (4) the use of
NES for outbound routing is available only to Nasdaq members and the
use of NES remains optional.\69\ Currently, NES may not route Directed
Orders \70\ to a facility of an exchange that is an affiliate of
Nasdaq, other than BX.\71\ In connection with PHLX's resumption of
equity trading on PSX pursuant to this filing, Nasdaq has proposed a
rule change to permit NES to route all forms of orders, including
Directed Orders, to PSX.\72\
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\69\ Nasdaq Rule 4758.
\70\ Nasdaq Rule 4751(f)(9) defines Directed Orders as
immediate-or-cancel orders that are directed to an exchange other
than Nasdaq without checking the Nasdaq book.
\71\ Nasdaq Rule 4751(f)(9).
\72\ See Securities Exchange Act Release No. 62736 (August 17,
2010) (SR-Nasdaq-2010-100).
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Recognizing that the Commission has expressed concern regarding the
potential for conflicts of interest in instances where a member firm is
affiliated with an exchange to which it is routing orders, the Exchange
proposes the following limitations and conditions to NES's affiliation
with the Exchange to permit the Exchange to accept inbound orders that
NES routes in its capacity as a facility of Nasdaq:
First, the Exchange states that pursuant to the FINRA RSA,
FINRA will review NES's compliance with the Exchange's rules through
FINRA's examination program.\73\ Pursuant to the
[[Page 56638]]
FINRA RSA, however, PHLX retains ultimate responsibility for enforcing
its rules with respect to NES.
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\73\ The Exchange also states that NES is subject to independent
oversight by FINRA, its Designated Examining Authority, for
compliance with financial responsibility requirements. See Notice,
supra note 3, 75 FR at 43605.
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Second, FINRA and the Exchange \74\ will monitor NES for
compliance with the Exchange's trading rules, and will collect and
maintain certain related information.\75\
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\74\ The Exchange represents that personnel performing real-time
oversight of equity trading on Nasdaq will also perform similar
functions with respect to PSX pursuant to the Intercompany RSA,
under the direction, authority, and oversight of PHLX's Chief
Regulatory Officer (``CRO'') and the Regulatory Oversight Committee
(``ROC'') of its Board of Governors.
\75\ The Exchange represents that both FINRA and the Exchange
will collect and maintain all alerts, complaints, investigations and
enforcement actions in which NES (in its capacity as a facility of
Nasdaq routing orders to the PSX) is identified as a participant
that has potentially violated applicable Commission or Exchange
rules. The Exchange and FINRA will retain these records in an easily
accessible manner in order to facilitate any potential review
conducted by the Commission's Office of Compliance Inspections and
Examinations. See Notice, supra note 3, 75 FR at 43605.
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Third, the Exchange states that FINRA will provide a
report to the Exchange's CRO, on at least a quarterly basis, that: (i)
Quantifies all alerts (of which the Exchange and FINRA are aware) that
identify NES as a participant that has potentially violated Commission
or Exchange rules, and (ii) quantifies the number of all investigations
that identify NES as a participant that has potentially violated
Commission or Exchange rules.\76\
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\76\ See id.
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Fourth, the Exchange proposes Rule 985(c)(2), which will
require NASDAQ OMX, as the holding company owning both the Exchange and
NES, to establish and maintain procedures and internal controls
reasonably designed to ensure that NES does not develop or implement
changes to its system, based on non-public information regarding
planned changes to the Exchange's systems obtained as a result of its
affiliation with the Exchange, until such information is available
generally to similarly situated Exchange members, in connection with
the provision of inbound order routing to the Exchange.\77\
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\77\ See proposed PHLX Rule 985(c)(2); Notice, supra note 3, 75
FR at 43605.
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Fifth, the Exchange proposes that routing of orders from
NES to the Exchange, in NES's capacity as a facility of Nasdaq, be
authorized for a pilot period of one year.\78\
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\78\ See Amendment No. 1, supra note 4. In Amendment No. 1, the
Exchange clarified that its proposal, as opposed to Nasdaq's
corresponding proposal, be approved on a one year pilot basis.
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The operation of NES as a facility of Nasdaq providing outbound
routing services from that exchange will be subject to Nasdaq
oversight, as well as Commission oversight. Nasdaq will be responsible
for ensuring that NES's outbound routing function is operated
consistent with Section 6 of the Act and Nasdaq rules. In addition,
Nasdaq must file with the Commission rule changes and fees relating to
NES's outbound routing function.
In the past, the Commission has expressed concern that the
affiliation of an exchange with one of its members raises potential
conflicts of interest, and the potential for unfair competitive
advantage.\79\ Although the Commission continues to be concerned about
potential unfair competition and conflicts of interest between an
exchange's self-regulatory obligations and its commercial interest when
the exchange is affiliated with one of its members, for the reasons
discussed below, the Commission believes that it is consistent with the
Act to permit NES to provide inbound routing to the Exchange on a pilot
basis, subject to the conditions described above.
---------------------------------------------------------------------------
\79\ See, e.g., Securities Exchange Act Release Nos. 54170 (July
18, 2006), 71 FR 42149 (July 25, 2006) (SR-NASDAQ-2006-006) (order
approving Nasdaq's proposal to adopt Nasdaq Rule 2140, restricting
affiliations between Nasdaq and its members); 53382 (February 27,
2006), 71 FR 11251 (March 6, 2006) (SR-NYSE-2005-77) (order
approving the combination of the New York Stock Exchange, Inc. and
Archipelago Holdings, Inc.); and 58673 (September 29, 2008), 73 FR
57707 (October 8, 2008) (SR-Amex-2008-62) (order approving the
combination of NYSE Euronext and the American Stock Exchange LLC).
---------------------------------------------------------------------------
The Exchange has proposed five conditions applicable to NES's
routing activities, which are enumerated above. The Commission believes
that these conditions mitigate its concerns about potential conflicts
of interest and unfair competitive advantage. In particular, the
Commission believes that FINRA's oversight of NES,\80\ combined with
FINRA's monitoring of NES's compliance with the equity trading rules
and quarterly reporting to the Exchange's CRO, will help to protect the
independence of the Exchange's regulatory responsibilities with respect
to NES. The Commission also believes that the proposed addition of Rule
985(c) is designed to ensure that NES cannot use any information
advantage it may have because of its affiliation with the Exchange.
Furthermore, the Commission believes that the Exchange's proposal to
allow NES to route orders inbound to the Exchange from Nasdaq, on a
pilot basis, will provide the Exchange and the Commission an
opportunity to assess the impact of any conflicts of interest of
allowing an affiliated member of the Exchange to route orders inbound
to the Exchange and whether such affiliation provides an unfair
competitive advantage. The Commission notes that it previously approved
inbound routing by NES to an affiliate under substantially similar
conditions.\81\
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\80\ This oversight will be accomplished through the 17d-2
Agreement between FINRA and the FINRA RSA.
\81\ See Securities Exchange Act Release No. 59154 (December 23,
2008), 73 FR 80468, (December 31, 2008) (SR-BSE-2008-48) (``BX
Equities Market Approval Order'').
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C. Listing Standards/Unlisted Trading Privileges
The Exchange has represented that it will not resume its listings
business, and instead will trade all NMS stocks on the System pursuant
to unlisted trading privileges (``UTP''), consistent with Section 12(f)
of the Act \82\ and Rule 12f-5 thereunder.\83\ Rule 12f-5 requires an
exchange that extends unlisted trading privileges to securities to have
in effect a rule or rules providing for transactions in the class or
type of security to which the exchange extends unlisted trading
privileges.\84\
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\82\ 15 U.S.C. 78l(f).
\83\ 17 CFR 240.12f-5. See Notice, supra note 3, 75 FR at 43599.
\84\ 17 CFR 240.12f-5. See also Securities Exchange Act Release
No. 35737 (April 21, 1995), 60 FR 20891 (April 28, 1995) (adopting
Rule 12f-5).
---------------------------------------------------------------------------
In connection with its proposal to trade NMS stocks \85\ on PSX on
an unlisted trading privileges basis, the Exchange proposes several
amendments to PHLX Rule 803, including amending PHLX Rule 803(o)
(Unlisted Trading Privileges) to, among other things, (1) clearly state
that the Exchange will not list any securities, and that any provisions
of PHLX Rules 800 through 868 that permit listing of securities will
not be effective until the Exchange amends its rules to make any
changes needed to comply with Rule 10A-3 under the Act \86\ and to
incorporate additional qualitative listing standards, and (2) enhance
the listing requirements for new derivative securities products (as
defined in Rule 19b-4(e) under the Act \87\) trading on the Exchange.
In addition, the Exchange proposes to adopt new listing standards for
securities linked to the performance of
[[Page 56639]]
indexes and commodities (including currencies) and managed fund shares,
to allow such securities to trade on PSX pursuant to unlisted trading
privileges.\88\ The Exchange also proposes PHLX Rule 3230 to establish
additional rules to govern trading of Commodity-Related Securities on
PSX pursuant to unlisted trading privileges, including a requirement
that members provide all purchasers of a newly issued Commodity-Related
Securities with a prospectus.
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\85\ Proposed PHLX Rule 803(o) defines ``NMS Stocks'' for
purposes of the rule as having the meaning given such term by Rule
600 under Regulation NMS, including, but not limited to, common
stock, preferred stock and similar issues, shares or certificates of
beneficial interest of trusts, notes, limited partnership interests,
warrants, certificates of deposit for common stock, convertible debt
securities, American Depositary Receipts, contingent value rights,
Trust Shares, Trust Issued Receipts, Index Fund Shares, Equity
Index-Linked Securities, Commodity-Linked Securities, Equity-Linked
Notes, and Managed Fund Shares.
\86\ 17 CFR 240.10A-3.
\87\ 17 CFR 240.19b-4(e)
\88\ See proposed PHLX Rules 803(m) and (n). As with other
standards, PHLX represented that it will not list these securities
until the filing and approval of a proposed rule change to authorize
such listing. In connection with adopting these new standards, the
Exchange also proposed to (1) delete current PHLX Rules 803(m) and
(n), which contain listing standards for products that are covered
by the new listing standards and (2) amend PHLX Rule 803(f) (Other
Securities) to adopt continued listing requirement provisions that
are complementary to the new standards for securities linked to
commodities.
---------------------------------------------------------------------------
The Commission finds that these rules are consistent with the Act.
The Commission notes that the Exchange will not list any securities for
trading on PSX until it amends its rules to make any changes needed to
comply with Rule 10A-3 under the Act \89\ and to incorporate additional
qualitative listing standards. The Commission also notes that these
rules are similar to the rules of other Exchanges.\90\
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\89\ 17 CFR 240.10A-3.
\90\ As proposed to be amended, the requirements of PHLX Rule
803(o) are substantially similar to the requirements set forth in
Rule 14.1 (Unlisted Trading Privileges) of EDGX Exchange, Inc.
(``Direct Edge''). Proposed PHLX Rule 3230 substantially mirrors the
requirements of Nasdaq Rule 4630 (Trading in Commodity-Related
Securities). Proposed Rules 803(m) and (n) are substantially similar
to those set forth in Nasdaq Rules 5710 (Securities Linked to
Performance of Indexes and Commodities (Including Currencies)) and
5735 (Managed Fund Shares).
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D. Regulation of the Exchange and its Members
As a facility of the Exchange, PSX will be subject to the
Exchange's SRO functions and the Exchange will have regulatory
responsibility for the activities of the System. Notwithstanding the
delegation of such responsibilities via contract, the Exchange retains
ultimate legal responsibility for the regulation of its members and its
market activities, including activities on PSX.
1. Disciplinary Rules
Trading on PSX is subject to the Exchange's disciplinary rules set
forth in PHLX Rules 960.1 through 960.12.\91\ Such rules provide the
Exchange with disciplinary jurisdiction over its members so that it can
enforce members' compliance with its rules and the Act and the rules
and regulations thereunder. The Exchange's rules also permit it to
sanction members for violations of its rules and violations of the Act
by, among other things, expelling or suspending members, limiting or
terminating members' activities, functions, or operations, fining or
censuring members, or suspending or barring a person from being
associated with a member.\92\
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\91\ See proposed PHLX Rule 3202.
\92\ See PHLX Rule 960.10 and proposed PHLX Rule 3221.
---------------------------------------------------------------------------
2. Order Audit Trail System
PHLX proposes rules requiring FINRA members trading on PSX to
comply with FINRA's Order Audit Trail System (``OATS'')
requirements,\93\ which rules are substantially similar to Nasdaq Rules
Series 6950 (``Order Audit Trail System).\94\ Like Nasdaq, OATS data
will be used by PHLX for regulatory purposes only.\95\
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\93\ See proposed PHLX Rule 3400 Series.
\94\ As is the case for Nasdaq members under the Nasdaq rules,
PHLX members that are not FINRA members must compile and maintain
audit trail information for securities listed on Nasdaq, but are
required to transmit this information to FINRA only if requested.
See proposed PHLX Rule 3405. If PHLX resumes operations as a listing
market in the future, all members will be required to maintain audit
trail information for securities listed on PHLX, and to transmit the
information to FINRA upon request, but daily OATS reporting for such
securities would not be required. Id.
\95\ See Securities Exchange Act Release No. 53128 (January 13,
2006); 71 FR 3350 (January 23, 2006) (File No. 10-131).
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3. Trading Halts; Clearly Erroneous Transactions
PSX's proposed rule relating to trading halts is substantially
similar to Nasdaq Rule 4120 (Trading Halts), except that the PSX rule
includes only those provisions relevant to securities traded on an
unlisted trading privileges basis.\96\ Proposed PHLX Rule 3100 provides
that PSX will participate in the circuit breaker pilot program for
stocks included in the S&P 500[supreg] Index, which ends on December
10, 2010.\97\ Current PHLX Rule 133 (Trading Halts Due to Extraordinary
Market Volatility) will also apply to trading on PSX.\98\
---------------------------------------------------------------------------
\96\ See proposed PHLX Rule 3100.
\97\ See proposed PHLX Rule 3100(a)(4). See also Securities
Exchange Act Release No. 62252 (June 10, 2010), 75 FR 34186 (June
16, 2010) (order approving rules relating to the circuit breaker
pilot program adopted by other national securities exchanges).
Nasdaq and the other equities exchanges have proposed to expand the
circuit breaker pilot program to include securities in the Russell
1000 Index and certain exchange traded products. See, e.g.,
Securities Exchange Act Release Nos. 62414 (June 30, 2010), 75 FR
39081 (July 7, 2010) and 62415 (June 30, 2010), 75 FR 39086 (July 7,
2010). The Exchange has represented that it will promptly submit a
proposed rule change in accordance with Section 19(b) of the Act and
Rule 19b-4(f)(6) thereunder to adopt corresponding changes to the
rules governing PSX if and when the Commission approves the
corresponding Nasdaq rule. See Letter from John Yetter, Vice
President and Deputy General Counsel, The NASDAQ OMX Group, to David
Shillman, Associate Director, Division of Trading and Markets,
Commission, dated September 8, 2010 (``Yetter Letter'').
\98\ See proposed PHLX Rule 3202.
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PHLX has proposed a rule which is substantially similar to Nasdaq
Rule 11890 (Clearly Erroneous Transactions) to govern the breaking of
clearly erroneous transactions.\99\ Appeals from determinations
regarding trades made by PHLX staff will be made to a committee of
industry and non-industry experts established under the PHLX By-Laws,
which committee is subject to identical compositional requirements
\100\ as NASDAQ's Market Operations Review Committee, which performs a
comparable function under NASDAQ rules.\101\
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\99\ See proposed PHLX Rule 3312. As a result of precipitous
declines in the prices of certain securities on May 6, 2010,
however, the Commission and the national securities exchanges are
currently evaluating the advisability of further changes to clearly
erroneous rules. As a result of this evaluation, Nasdaq and the
other equities exchanges have proposed to amend their clearly
erroneous execution rules to set forth clearer standards and curtail
their discretion with respect to breaking erroneous trades. See,
e.g., Securities Exchange Act Release Nos. 62334 (June 21, 2010), 75
FR 36732 (June 28, 2010) and 62342 (June 21, 2010), 75 FR 36752
(June 28, 2010). The Exchange has represented that it will promptly
file a proposed rule change to amend its clearly erroneous rule in a
manner consistent with Nasdaq's clearly erroneous rule, in
accordance with Section 19(b) of the Act and Rule 19b-4(f)(6)
thereunder, if and when the Commission approves the corresponding
Nasdaq rule. See Yetter Letter, supra note 97.
\100\ See Section 10-10 of the PHLX By-Laws, which requires that
20% of the members of the committee represent PHLX members, and
prohibits more than 50% of the committee's members from being
employed by firms that are market makers or that derive more than
10% of their revenues from market making.
\101\ By-Laws of Nasdaq, Article III, Section 6.
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The Commission finds that the Exchange's proposed rules relating to
the regulation of PSX and its members are consistent with the
requirements of the Act. The Commission notes that the proposed rules
relating to the regulation of PSX are substantially similar to rules of
Nasdaq previously approved by the Commission.\102\ In addition, the
disciplinary rules applicable to PSX are set forth in the current rules
of the Exchange, which have been previously approved by the Commission.
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\102\ See Nasdaq Registration Approval Order, supra note 22.
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4. Regulatory Contracts
The Exchange represents that it is a party to two regulatory
services agreements (the ``Regulatory Contracts'').\103\ Pursuant to
the FINRA
[[Page 56640]]
RSA, FINRA will provide a range of regulatory services to the Exchange
and its facilities, including PSX, including T+1 surveillance,
investigation, and enforcement with respect to the Exchange's rules,
arbitration services, and membership services.\104\ Under the FINRA
RSA, FINRA will conduct T+1 market surveillance and examine members to
monitor compliance with applicable PHLX rules and securities laws and
regulations.\105\ The Intercompany RSA provides that employees and
contractors of each party may perform regulatory services for the
Exchange.\106\ All regulatory services performed for the Exchange under
the Intercompany RSA, including those performed with respect to the
System, are subject to the direction, authority, and oversight of the
Exchange's CRO and the ROC, and all personnel performing services for
the Exchange under the Intercompany RSA are subject to the
jurisdiction, authority and oversight of the Exchange's CRO and
ROC.\107\ The Exchange represents that any personnel performing real-
time oversight of equity trading on Nasdaq will also perform similar
functions with respect to PSX, under the direction, authority, and
oversight of the Exchange's CRO and the ROC.\108\ The Exchange
represents that the Exchange retains ultimate legal responsibility for,
and control of, functions performed for PHLX under the Regulatory
Contracts.\109\
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\103\ See Notice, supra note 3, 75 FR at 43604.
\104\ Id.
\105\ Id.
\106\ Id.
\107\ Id.
\108\ Id.
\109\ Id.
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The Exchange has represented that many aspects of compliance with
PSX rules, such as avoidance of locked and crossed markets and trade
throughs, will be enforced by the System itself, and the Exchange will
periodically test operations of PSX to determine that the System is
operating in accordance with applicable rules.\110\
---------------------------------------------------------------------------
\110\ Id.
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The Commission notes that the Exchange will continue to bear
ultimate regulatory responsibility for functions performed on its
behalf under the Regulatory Contracts. Further, the Exchange retains
ultimate legal responsibility for the regulation of its members and its
markets (including PSX).
The Commission believes that it is consistent with the Act and the
public interest to allow the Exchange to contract with FINRA to perform
surveillance, disciplinary, and enforcement functions.\111\
Surveillance, discipline, and enforcement are fundamental elements to a
regulatory program, and constitute core self-regulatory functions. It
is essential to the public interest and the protection of investors
that these functions are carried out in an exemplary manner. With
respect to certain regulatory functions contracted to FINRA by the
Exchange, including surveillance, disciplinary and enforcement
functions, the Commission previously noted its belief that FINRA has
the expertise and experience to perform such functions on behalf of an
exchange, and that the contracting of such functions to FINRA is
consistent with the Act and the public interest.\112\ The Commission
continues to believe that this is true with respect to FINRA's
regulation of the Exchange and the conduct of its members pursuant to
the FINRA RSA.
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\111\ See, e.g., Securities Exchange Act Release No. 40760
(December 8, 1998), 63 FR 70844 (December 22, 1998). See also
Securities Exchange Act Release Nos. 57478 (March 12, 2008) 73 FR
14521, (March 18, 2008) (order approving rules governing the trading
of options on the NASDAQ Options Market) (``NOM Approval Order'');
50122 (July 29, 2004), 69 FR 47962 (August 6, 2004) (order approving
File No. SR-Amex-2004-32) (``Amex Approval Order''); 42455 (February
24, 2000), 65 FR 11388 (March 2, 2000) (File No. 10-127) (order
approving ISE's registration as a national securities exchange)
(``ISE Registration Approval Order''); Nasdaq Registration Approval
Order, supra note 22.
\112\ See Nasdaq Registration Approval Order, supra note 22; BX
Equities Market Approval Order, supra note 81.
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The Commission believes that it is consistent with the Act and the
public interest to allow the Exchange to enter into the Intercompany
RSA. Nasdaq and BX have self-regulatory obligations similar to those of
the Exchange, and it is beneficial to the public interest and the
protection of investors that these functions are carried out in an
exemplary manner. The Commission notes that the Exchange has
represented that all regulatory services performed for the Exchange
under the Intercompany RSA are subject to the direction, authority, and
oversight of the Exchange's CRO and ROC, and any personnel performing
such services for the Exchange are subject to the jurisdiction,
authority and oversight of the Exchange's CRO and ROC. In this way, the
Exchange will maintain control over the performance of regulatory
services with respect to the Exchange.
The Exchange, unless relieved by the Commission of its
responsibility,\113\ shall bear the responsibility for self-regulatory
conduct and primary liability for self-regulatory failures, not the SRO
retained to perform regulatory functions on the Exchange's behalf.\114\
In performing these functions, however, an SRO may nonetheless bear
liability for causing or aiding and abetting the failure of the
Exchange to perform its regulatory functions.\115\ Accordingly,
although FINRA, Nasdaq and BX will not act on their own behalf under
their respective SRO responsibilities in carrying out regulatory
services for the Exchange pursuant to the FINRA RSA or Intercompany
RSA, as applicable, such SROs may have secondary liability if, for
example, the Commission finds that the contracted functions are being
performed so inadequately as to cause a violation of the federal
securities laws by the Exchange.\116\
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\113\ See Section 17(d)(1) of the Act and Rule 17d-2 thereunder.
15 U.S.C. 78q(d)(1); and 17 CFR 240.17d-2. The Commission notes that
it is not approving or declaring effective the FINRA RSA or the
Intercompany RSA.
\114\ See NOM Approval Order, supra note 111; Nasdaq
Registration Approval Order, supra note 22; Amex Approval Order,
supra note 111; and ISE Registration Approval Order, supra note 111.
\115\ Id.
\116\ Id.
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E. Additional Proposed Rules for the Exchange
PHLX proposes to adopt rules addressing recommendations to
customers (or suitability) and best execution and
interpositioning,\117\ which mirror the requirements of NASD Rules 2310
and 2320. Although members would become subject to these rules by
virtue of being members of FINRA, PHLX believes that the requirements
set forth in these rules are sufficiently important that they should be
explicitly set forth in the PHLX rulebook.\118\
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\117\ See proposed PHLX Rules 763 and 764.
\118\ See Notice, supra note 3, 75 FR at 43604.
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The Commission finds that the proposed rules regarding suitability
and best execution and interpositioning are consistent with the Act.
The Commission notes that rules are substantially similar to the
requirements of NASD Rules 2310 and 2320.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\119\ that the proposed rule change (SR-PHLX-2010-79), as modified
by Amendment No. 1, be, and it hereby is, approved, except for (1) the
circuit breaker pilot program, which is approved on a pilot basis
through December 10, 2010, and (2) the inbound routing of orders from
NES to PSX, which is approved on a pilot basis through September 9,
2011.
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\119\ 15 U.S.C. 78s(b)(2).
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Although the Commission's approval of the rule proposal, as
amended, is final and the proposed rules are therefore effective, it is
further ordered
[[Page 56641]]
that the operation of PSX is conditioned on the satisfaction of the
following requirements:
A. Examination by the Commission. The Exchange must have, and must
represent in a letter to the staff in the Commission's Office of
Compliance Inspections and Examinations that it has adequate
surveillance procedures and programs in place to effectively regulate
PSX.
B. Trade Processing and Exchange Systems. The Exchange must have,
and must represent in a letter to the staff in the Commission's
Division of Trading and Markets that it has adequate procedures and
programs in place, as noted in Commission Automation Review Policy
guidelines,\120\ to effectively process trades and maintain the
confidentiality, integrity, and availability of the Exchange's systems.
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\120\ On November 16, 1989, the Commission published its first
Automation Review Policy (``ARP I''), in which it created a
voluntary framework for self-regulatory organizations to establish
comprehensive planning and assessment programs to determine systems
capacity and vulnerability. On May 9, 1991, the Commission published
its second Automation Review Policy (``ARP II'') to clarify the
types of review and reports that were expected from self-regulatory
organizations. See Securities Exchange Act Release Nos. 27445
(November 16, 1989), 54 FR 48703 (November 24, 1989); and 29185 (May
9, 1991), 56 FR 22490 (May 15, 1991).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\121\
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\121\ 17 CFR 200.30-3(a)(12).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010-23104 Filed 9-15-10; 8:45 am]
BILLING CODE 8010-01-P