
[Federal Register: February 2, 2010 (Volume 75, Number 21)]
[Notices]               
[Page 5360-5362]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr02fe10-113]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-61426; File No. SR-Phlx-2010-05]

 
Self-Regulatory Organizations; NASDAQ OMX PHLX, Inc.; Notice of 
Filing of Proposed Rule Change Relating to Professional Orders

 January 26, 2010.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 \2\ thereunder, notice is hereby given 
that on January 12, 2010, NASDAQ OMX PHLX, Inc. (``Phlx'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II, and III, below, which Items have been prepared by the 
Exchange. The Commission is publishing this notice to solicit comments 
on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend its priority rules to give certain 
non-broker-dealer orders the same priority as broker-dealer orders.
    The text of the proposed rule change is available on the Exchange's 
Web site at http://nasdaqomxphlx.cchwallstreet.com/NASDAQOMXPHLX/
Filings/, at the principal office of the Exchange, and at the 
Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
sections A, B, and C below, of the most significant aspects of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The purpose of the proposed rule change is to adopt the new term 
``professional'' for purposes of the Exchange's priority rules. 
Currently, pursuant to Rule 1014(g), a customer account is an account 
other than a controlled account; a controlled account is an account 
controlled by or under common control with a broker-dealer. Rule 
1014(g) governs, among other things, the allocation of orders and, 
thus, the priority over and parity among orders and quotations.
    Customer priority is one of the marketplace advantages provided to 
customer orders on the Exchange; customer priority means that customer 
orders are given execution priority over non-customer orders and 
quotations of specialists and Registered Options Traders (``ROTs'') at 
the same price. Another marketplace advantage afforded to customer 
orders on the Exchange is that member organizations are generally not 
charged transaction fees for the execution of customer orders. The 
purpose of these marketplace advantages is to attract retail order flow 
to the Exchange by leveling the playing field for retail investors over 
market professionals.\3\
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    \3\ Market professionals have access to sophisticated trading 
systems that contain functionality not available to retail 
customers, including things such as continuously updated pricing 
models based upon real-time streaming data, access to multiple 
markets simultaneously and order and risk management tools.
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    With respect to these Phlx marketplace advantages, the Exchange 
does not believe that the current definition of customer account versus 
controlled account properly distinguishes between non-professional 
retail investors and certain professionals. According to the Exchange, 
providing marketplace advantages based upon whether the order is for 
the account of a participant that is a registered broker-dealer is no 
longer appropriate in today's marketplace, because some non-broker-
dealer individuals and entities have access to information and 
technology that enables them to professionally trade listed options in 
the same manner as a broker or dealer in securities.\4\ These

[[Page 5361]]

individual traders and entities (collectively, ``professionals'') have 
the same technological and informational advantages over retail 
investors as broker-dealers trading for their own account, which 
enables them to compete effectively with broker-dealer orders and 
market maker quotes for execution opportunities in the Phlx 
marketplace.\5\
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    \4\ For example, some broker-dealers provided their professional 
customers with multi-screened trading stations equipped with trading 
technology that allows the trader to monitor and place orders on all 
six options exchanges simultaneously. These trading stations also 
provide compliance filters, order managements tools, the ability to 
place orders in the underlying securities, and market data feeds. 
See Securities Exchange Act Release Nos. 59287 (January 23, 2009), 
74 FR 5964 (January 30, 2009) (SR-ISE-2006-26) (order approving 
International Securities Exchange (``ISE'') proposal to introduce 
priority customer and professional orders) and 57254 (February 1, 
2008), 73 FR 7345 (February 7, 2008) (SR-ISE-2006-26) (notice of ISE 
proposal to introduce priority customer and professional orders) at 
note 8.
    \5\ Specialists and ROTs enter quotes based upon the theoretical 
value of the option, which moves with various factors in their 
pricing models, such as the value of the underlying security. 
Professional customers place and cancel orders in relation to an 
option's theoretical value in much the same manner as specialists 
and ROTs. This is evidenced by the entry of limit orders that join 
the best bid or offer and by a very high rate of orders that are 
cancelled. In contrast, retail customers who enter orders as part of 
an investment strategy (such as covered write or directional trade) 
most frequently enter marketable orders or limit orders that they do 
not cancel and replace. See, e.g. Securities Exchange Act Release 
No. 57254 at note 9.
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    Therefore, the Exchange does not believe it is consistent with fair 
competition for the professional account holders to continue to receive 
the same marketplace advantages as retail investors over broker-dealers 
trading on the Phlx. Moreover, because customer orders at the same 
price are executed in time priority, retail investors are prevented 
from benefitting fully from the priority advantage when professionals 
are afforded customer priority.
    Accordingly, the Exchange is seeking to adopt a new term that will 
be used to more appropriately provide Phlx marketplace advantages to 
retail investors on the Phlx. Under the proposal, a ``professional'' 
will be defined in Rule 1000 as a person or entity that (i) is not a 
broker or dealer in securities, and (ii) places more than 390 orders in 
listed options per day on average during a calendar month for its own 
beneficial account(s). Under the proposal, a professional account will 
be treated in the same manner as an off-floor broker-dealer (controlled 
account) for purposes of Phlx Rule 1014(g)(except with respect to all-
or-none orders, which will be treated like customer orders), 1064(b), 
1064.02, and 1080.08.
    The proposal will not otherwise affect non-broker-dealer 
individuals or entities under Phlx rules, and all customer orders will 
continue to be treated equally for purposes of the linkage-related 
rules, including non-broker-dealer orders included in the definition of 
``professional'' orders.\6\ The Exchange, which currently routes only 
eligible customer orders, would route eligible professional orders.
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    \6\ See Phlx Rule 1080(m), 1083, 1084, and 1086. These rules are 
not included by the proposed rule change in the list of rules, 
supra, for which the professional designation would apply.
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    In order to properly represent orders entered on the Exchange 
according to the new definition, member organizations will be required 
to indicate whether customer orders are ``professional'' orders.\7\ To 
comply with this requirement, member organizations will be required to 
review their customers' activity on at least a quarterly basis to 
determine whether orders that are not for the account of a broker-
dealer should be represented as customer orders or professional 
orders.\8\
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    \7\ See proposed Rule 1000(b)(14). The Exchange intends to 
utilize a special order origin code for professional orders. The 
Exchange also proposes to disseminate the professional designator 
over its new Top of Phlx Options Plus Orders (``TOPO Plus Orders''), 
which includes disseminated Exchange top-of-market data (including 
orders, quotes and trades) together with all of the data currently 
available on the Specialized Order Feed (``SOF''). See Securities 
Exchange Act Release No. 60877 (October 26, 2009), 74 FR 56255 
(October 30, 2009) (SR-Phlx-2009-92).
    \8\ Orders for any customer that had an average of more than 390 
orders per day during any month of a calendar quarter must be 
represented as professional orders for the next calendar quarter. 
Member organizations will be required to conduct a quarterly review 
and make any appropriate changes to the way in which they are 
representing orders within five days after the end of each calendar 
quarter. While member organizations will only be required to review 
their accounts on a quarterly basis, if during a quarter the 
Exchange identifies a customer for which orders are being 
represented as customer orders but that has averaged more than 390 
orders per day during a month, the Exchange will notify the member 
organization and the member organization will be required to change 
the manner in which it is representing the customer's orders within 
five days.
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    The Exchange is also proposing to amend Rule 1063(e) and the 
corresponding Options Floor Procedure Advice (``Advice'') C-3, Options 
Floor Broker Management System, to require Floor Brokers to record the 
``professional'' designator in the Floor Broker Management System. 
Advice C-3 is part of the Exchange's minor rule plan.\9\
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    \9\ See Rule 970.
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    With respect to the fees applicable to professional orders, the 
Exchange is not proposing to charge differently for professionals at 
this time, such that professional orders would be subject to the same 
transaction fees as customers today.
    The Exchange believes that identifying professional accounts based 
upon the average number of orders entered for a beneficial account is 
an appropriately objective approach that will reasonably distinguish 
such persons and entities from retail investors. The Exchange proposes 
the threshold of 390 orders per day on average over a calendar month, 
because it believes that this number far exceeds the number of orders 
that are entered by retail investors in a single day,\10\ while being a 
sufficiently low number of orders to cover the professional account 
holders that are competing with broker-dealers in the Phlx marketplace. 
In addition, basing the standard on the number of orders that are 
entered in listed options for a beneficial account(s) assures that 
professional account holders cannot inappropriately avoid the purpose 
of the rule by spreading their trading activity over multiple 
exchanges, and using an average number over a calendar month will 
prevent gaming of the 390 order threshold.
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    \10\ 390 orders is equal to the total number of orders that a 
person would place in a day if that person entered one order every 
minute from market open to market close. Many of the largest retail-
oriented electronic brokers offer lower commission rates to 
customers they define as ``active traders.'' Publicly available 
information from the Web sites of Charles Schwab, Fidelity, TD 
Ameritrade and optionsXpress all define ``active trader'' as someone 
who executes only a few options trades per month. The highest 
required trading activity to qualify as an active trader among these 
four firms was 35 trades per quarter. See Securities Exchange Act 
Release No. 57254 at note 11 (which also notes that a study of one 
of the largest retail-oriented options brokerage firms indicated 
that on a typical trading day, options orders were entered with 
respect to 5,922 different customer accounts. There was only one 
order entered with respect to 3,765 of the 5,922 different customer 
accounts on this day, and there were only 17 customer accounts with 
respect to which more than ten orders were entered. The highest 
number of orders entered with respect to any one account over the 
course of an entire week was 27.).
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2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \11\ in general, and furthers the objectives of Section 
6(b)(5) of the Act \12\ in particular, in that it is designed to 
promote just and equitable principles of trade, to remove impediments 
to and perfect the mechanism of a free and open market and a national 
market system, and, in general to protect investors and the public 
interest. In particular, the proposal should assure that retail 
investors continue to receive the appropriate marketplace advantages in 
the Phlx marketplace, while furthering fair competition among 
marketplace professionals.
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    \11\ 15 U.S.C. 78f(b).
    \12\ 15 U.S.C. 78f(b)(5).

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[[Page 5362]]

    In addition, Section 11(a) of the Act prohibits any 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 persons exercises 
discretion, unless an exemption applies.\13\ Section 11(a)(1) contains 
a number of exceptions for principal transactions by members and their 
associated persons. One such exception, set forth in subparagraph (G) 
of Section 11(a)(1) and in Rule 11a1-1(T),\14\ permits any transaction 
for a member's own account provided, among other things, that the 
transaction yields priority, parity, and precedence to orders for the 
account of persons who are not members or associated with members of 
the exchange. Exchange rules, therefore, may require members to yield 
priority to non-members, including public customers, to satisfy this 
exception to Section 11(a).\15\ Another exception, found in Section 
11(a)(1)(A), permits market makers to effect transactions on exchanges 
in which they are members.\16\
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    \13\ 15 U.S.C. 78k(a).
    \14\ 17 CFR 240.11a1-1(T).
    \15\ See Phlx Rule 1014.
    \16\ 15 U.S.C. 78k(a)(1)(A).
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    In addition to the exceptions noted above, Rule 11a2-2(T) under the 
Act \17\ provides exchange members with an exception from the 
prohibitions in Section 11(a). Rule 11a2-2(T), known as the ``effect 
versus execute'' rule, permits an exchange member, subject to certain 
conditions, to effect transactions for his own account, the account of 
an associated person or an account with respect to which it or an 
associated person thereof exercises investment discretion 
(collectively, ``covered accounts'') by arranging for an unaffiliated 
member to execute the transaction on the exchange.
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    \17\ 17 CFR 240.11a2-2(T).
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    To comply with the ``effect versus execute'' rule'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; \18\ (iii) may 
not be affiliated with the executing member; and (iv) with respect to 
an account over which the member has investment discretion, neither the 
member nor its associated person may retain any compensation in 
connection with effecting the transaction except as provided in the 
rule.\19\
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    \18\ The member may, however, participate in clearing and 
settling the transaction. See Securities Exchange Act Release No. 
14563 (March 14, 1978), 43 FR 11542 (March 17, 1978).
    \19\ 17 CFR 240.11a2-2(T).
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    As applied to the Exchange's electronic trading platform, Phlx XL 
II, the Exchange does not believe that the proposal relating to 
professional orders would affect the availability of the exceptions to 
Section 11(a) of the Act, including the exceptions in subparagraph (G) 
of Section 11(a) and in Rules 11a1-1(T) and 11a2-2(T), as are currently 
available.\20\
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    \20\ See Securities Exchange Act Release No. 59995 (May 28, 
2009), 74 FR 26750 (June 3, 2009) (SR-Phlx-2009-32).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    No written comments were either solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-Phlx-2010-05 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-Phlx-2010-05. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/
sro.shtml). Copies of the submission,\21\ 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 inspection 
and copying in the Commission's Public Reference Room, 100 F Street, 
NE., Washington, DC 20549, on official business days between the hours 
of 10 a.m. and 3 p.m. Copies of the filing also will be available for 
inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-Phlx-2010-05 and should be 
submitted on or before February 23, 2010.
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    \21\ The text of the proposed rule change is available on Phlx's 
Web site at http://nasdaqomxphlx.cchwallstreet.com/NASDAQOMXPHLX/
Filings, on the Commission's Web site at http://www.sec.gov, at 
Phlx, and at the Commission's Public Reference Room.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\22\
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    \22\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-2092 Filed 2-1-10; 8:45 am]
BILLING CODE 8011-01-P

