[Federal Register Volume 76, Number 56 (Wednesday, March 23, 2011)]
[Notices]
[Pages 16462-16464]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-6785]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-64090; File No. SR-BX-2011-007]
Self-Regulatory Organizations; NASDAQ OMX BX LLC; Order Approving
a Proposed Rule Change Relating to Permanent Approval of the BX and NES
Inbound Routing Relationship
March 17, 2011.
I. Introduction
On January 28, 2011, NASDAQ OMX BX LLC (``BX'' 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
[[Page 16463]]
change requesting permanent approval of the Exchange's pilot program to
permit the Exchange to accept inbound orders that Nasdaq Execution
Services, LLC (``NES'') routes in its capacity as a facility of The
NASDAQ Stock Market LLC (``Nasdaq''), with certain obligations and
conditions. The proposed rule change was published for comment in the
Federal Register on February 14, 2011.\3\ The Commission received no
comment letters regarding the proposed rule change. This order approves
the proposed rule change.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 63859 (February 7,
2011), 76 FR 8391 (``Notice'').
---------------------------------------------------------------------------
II. Background
BX Equity Rule 2140(a) prohibits the Exchange or any entity with
which it is affiliated from acquiring or maintaining an ownership
interest in a member in the absence of an effective filing under
Section 19(b) of the Act.\4\ NES is a broker-dealer that is a member of
the Exchange, and currently provides to Nasdaq members optional routing
services to other market centers. NES is owned by The NASDAQ OMX Group,
Inc. (``NASDAQ OMX''), which also owns three registered securities
exchanges--Nasdaq, the Exchange, and NASDAQ OMX PHLX LLC.\5\ Thus, NES
is an affiliate of each of these exchanges. Absent an effective filing,
BX Equity Rule 2140(a) would prohibit NES from being a member of the
Exchange.
---------------------------------------------------------------------------
\4\ 15 U.S.C. 78s(b).
\5\ See Securities Exchange Act Release No. 58324 (August 7,
2008), 73 FR 46936 (August 12, 2008) (SR-BSE-2008-02; SR-BSE-2008-
23; SR-BSE-2008-25; SR-BSECC-2008-01) (``BSE Approval Order''). See
also Securities Exchange Act Release No. 58179 (July 17, 2008), 73
FR 42874 (July 23, 2008) (order approving NASDAQ OMX's acquisition
of Phlx.)
---------------------------------------------------------------------------
On August 7, 2008, in connection with the acquisition of the
Exchange by NASDAQ OMX, the Commission, approved an affiliation between
the Exchange and NES for the limited purpose of permitting NES to
provide routing services for Nasdaq for orders that first attempt to
access liquidity on Nasdaq's system before routing to the Exchange,
subject to certain other limitations and conditions.\6\ At the time of
NASDAQ OMX's acquisition of the Exchange, the Exchange was not trading
equity securities.\7\ On December 23, 2008, in connection with the
Exchange's resumption of equity trading, the Commission approved a
modification to the conditions for the affiliation between NES and the
Exchange, to permit the Exchange to receive orders routed by NES in its
capacity as a facility of Nasdaq (including ``Directed Orders''),\8\ on
a one-year pilot basis.\9\ The Exchange is now proposing to make such
approval permanent.\10\
---------------------------------------------------------------------------
\6\ See BSE Approval Order, supra note 5.
\7\ See BSE Approval Order, supra note 5, 73 FR at 46944, n.117.
\8\ 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.
\9\ See Securities Exchange Act Release No. 59154 (December 23,
2008), 73 FR 80468 (December 31, 2008) (SR-BSE-2008-48) (``BSE
Inbound Routing Order'').
\10\ See Notice, supra note 3.
---------------------------------------------------------------------------
III. Discussion and Commission Findings
After careful review, 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.\11\ Specifically, the Commission finds that the proposed rule
change is consistent with Section 6(b)(1) of the Act,\12\ which
requires, among other things, that a national securities exchange be so
organized and have the capacity to carry out the purposes of the Act,
and to comply and enforce compliance by its members and persons
associated with its members, with the provisions of the Act, the rules
and regulation thereunder, and the rules of the Exchange. Further, the
Commission finds that the proposed rule change is consistent with
Section 6(b)(5) of the Act,\13\ 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) also
requires that the rules of an exchange not be designed to permit unfair
discrimination among customers, issuers, brokers, or dealers.
---------------------------------------------------------------------------
\11\ 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).
\12\ 15 U.S.C. 78f(b)(1).
\13\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
NES operates as a facility of Nasdaq that provides outbound routing
from Nasdaq to other market centers, subject to certain conditions.\14\
NES's operation as a facility providing outbound routing services for
Nasdaq is 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 self-regulatory organization
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.\15\
---------------------------------------------------------------------------
\14\ See Nasdaq Rule 4758. See also Notice, supra note 3, 76 FR
at 8301, n.5.
\15\ Id. See also BSE Inbound Routing Order, supra note 9, 73 FR
at 80475.
---------------------------------------------------------------------------
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.
Recognizing that the Commission has previously expressed concern
regarding the potential for conflicts of interest in instances where a
member firm is affiliated with an exchange of which it is a member, the
Exchange previously proposed, and the Commission approved, limitations
and conditions on NES's affiliation with the Exchange.\16\ Also
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
previously proposed, and the Commission approved,\17\ 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, subject to the
following limitations and conditions, which the Exchange states it has
met: \18\
---------------------------------------------------------------------------
\16\ See BSE Approval Order, supra note 5, 73 FR at 46944.
\17\ See BSE Inbound Routing Order, supra note 9, 73 FR at
80475.
\18\ See Notice, supra note 3, 73 FR at 8391-8392.
---------------------------------------------------------------------------
First, the Exchange and FINRA will enter into a Regulatory
Contract, as well as an agreement pursuant to Rule 17d-2 under the Act
(``17d-2 Agreement'').\19\ Pursuant to the Regulatory Contract and the
17d-2 Agreement, FINRA will be allocated regulatory responsibilities to
review NES's compliance with certain Exchange rules.\20\ Pursuant to
the Regulatory Contract, however, BX
[[Page 16464]]
retains ultimate responsibility for enforcing its rules with respect to
NES.
---------------------------------------------------------------------------
\19\ 17 CFR 240.17d-2.
\20\ 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, 76 FR at 8391, n.9.
---------------------------------------------------------------------------
Second, FINRA will monitor NES for compliance with the
Exchange's trading rules, and will collect and maintain certain related
information.\21\
---------------------------------------------------------------------------
\21\ Pursuant to the Regulatory Contract, 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 Exchange) 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,
76 FR at 8391, n.10
---------------------------------------------------------------------------
Third, FINRA will provide a report to the Exchange's chief
regulatory officer (``CRO''), on a quarterly basis, that: (i)
Quantifies all alerts (of which FINRA is aware) that identify NES as a
participant that has potentially violated Commission or Exchange rules,
and (ii) lists all investigations that identify NES as a participant
that has potentially violated Commission or Exchange rules.\22\
---------------------------------------------------------------------------
\22\ See Notice, supra note 3, 76 FR at 8392.
---------------------------------------------------------------------------
Fourth, the Exchange has adopted BX Equity Rule 2140(c),
which requires 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
obtained regarding planned changes to the Exchange's systems 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.\23\
---------------------------------------------------------------------------
\23\ See BX Equity Rule 2140(c). See also Notice, supra note 3,
76 FR at 8392.
---------------------------------------------------------------------------
Fifth, routing of orders from NES to the Exchange, in
NES's capacity as a facility of Nasdaq, was authorized for a pilot
period of twelve months.\24\
---------------------------------------------------------------------------
\24\ See Notice, supra note 3, 76 FR at 8392. The Commission
notes that the original pilot period of twelve months was approved
and began on December 23, 2008, but was extended several times. See
Notice, supra note 3, 76 FR at 8391, n.6 and accompanying text.
---------------------------------------------------------------------------
The Exchange believes that by meeting the above-listed conditions
it has set up mechanisms that protect the independence of the
Exchange's regulatory responsibility with respect to NES, and has
demonstrated that NES cannot use any information advantage it may have
because of its affiliation with the Exchange.\25\
---------------------------------------------------------------------------
\25\ See Notice, supra note 3, 76 FR at 8392.
---------------------------------------------------------------------------
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.\26\ 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
permanent basis instead of a pilot basis, subject to the other
conditions described above.
---------------------------------------------------------------------------
\26\ 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.); 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); 59135
(December 22, 2008), 73 FR 79954 (December 30, 2008) (SR-ISE-2009-
85) (order approving the purchase by ISE Holdings of an ownership
interest in DirectEdge Holdings LLC); and 59281 (January 22, 2009),
74 FR 5014 (January 28, 2009) (SR-NYSE-2008-120) (order approving a
joint venture between NYSE and BIDS Holdings L.P.).
---------------------------------------------------------------------------
The Exchange has proposed four ongoing 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,\27\ 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 BX Equity Rule
2140(c) is designed to ensure that NES cannot use any information
advantage it may have because of its affiliation with the Exchange.
---------------------------------------------------------------------------
\27\ This oversight will be accomplished through the 17d-2
Agreement between FINRA and the Exchange and the Regulatory
Contract.
---------------------------------------------------------------------------
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\28\ that the proposed rule change (SR-BX-2011-007) be, and hereby
is, approved.
---------------------------------------------------------------------------
\28\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\29\
---------------------------------------------------------------------------
\29\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
Cathy H. Ahn,
Deputy Secretary.
[FR Doc. 2011-6785 Filed 3-22-11; 8:45 am]
BILLING CODE 8011-01-P