
[Federal Register Volume 76, Number 160 (Thursday, August 18, 2011)]
[Notices]
[Pages 51453-51457]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-21034]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-65125; File No. SR-NASDAQ-2011-105]


Self-Regulatory Organizations; The NASDAQ Stock Market LLC; 
Notice of Filing of Proposed Rule Change To Establish an Acceptable 
Trade Range for Quotes and Orders Entered on the NASDAQ Options Market

August 12, 2011.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on August 2, 2011, The NASDAQ Stock Market LLC (``NASDAQ'') filed with 
the Securities and Exchange Commission (``Commission'') the proposed 
rule change as described in Items I and II below, which Items have been 
prepared by NASDAQ. 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 the 
Substance of the Proposed Rule Change

    NASDAQ proposes to establish an Acceptable Trade Range for quotes 
and orders entered on the NASDAQ Options Market (``NOM''). Similar 
mechanisms are used successfully on other exchanges to protect 
investors and members by limiting volatility and obvious errors.
    The text of the proposed rule change is available at http://NASDAQ.cchwallstreet.com/, at NASDAQ's principal office, 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, NASDAQ 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. NASDAQ 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
    Background. In the current high-speed electronic market 
environment, various trading centers grapple with issues associated 
with thinly traded securities such as price dislocations, wide quotes, 
and erroneous executions that can result in trade cancellations. Though 
these situations are not overly prevalent, they can produce confusion 
and frustration among market participants. As a custodian and operator 
of several U.S. exchanges, NASDAQ believes that it is always prudent 
and appropriate to consider system enhancements that will preclude 
potential future issues with or unforeseen gaps in the existing 
structure of its trading systems.
    Accordingly, NASDAQ is proposing to adopt a mechanism that will 
prevent the NOM trading system (``System'') from experiencing dramatic 
price swings. This circumstance can exist if, for example, a market 
order or aggressively priced limit order is entered that is larger than 
the total volume of contracts quoted at the top-of-book across all U.S. 
options exchanges. Currently, without any protections in place, this 
could result in options executing at prices that have little or no 
relation to the theoretical price of the option.
    For example, in a thinly traded option:
    Away Exchange Quotes:

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                    Exchange                         Bid size        Bid price      Offer price     Offer size
----------------------------------------------------------------------------------------------------------------
PHLX............................................              10           $1.00           $1.05              10
NYSE Arca.......................................              10            1.00            1.05              10
NYSE Amex.......................................              10            1.00            1.10              10
BOX.............................................              10            1.00            1.15              10
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    NOM Price Levels:

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                    Exchange                         Bid size        Bid price      Offer price     Offer size
----------------------------------------------------------------------------------------------------------------
NOM.............................................              10           $1.00           $1.05              10

[[Page 51454]]

 
NOM.............................................  ..............  ..............            1.10              10
NOM.............................................  ..............  ..............            1.40              10
NOM.............................................  ..............  ..............            5.00              10
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    If NOM receives a routable market order to buy 80 contracts, the 
System will respond as described below:

--10 contracts will be executed at $1.05 against NOM
--10 contracts will be executed at $1.05 against PHLX
--10 contracts will be executed at $1.05 against NYSE Arca.
--10 contracts will be executed at $1.10 against NOM
--10 contracts will be executed at $1.10 against NYSE AMEX
--10 contracts will be executed at $1.15 against BOX
    After these executions, there are no other known valid away 
exchange quotes. The NBBO is therefore comprised of the remaining 
interest on the NOM book, specifically 10 contracts at $1.40 and 10 
contracts at $5.00. In the absence of an Acceptable Trade Range 
mechanism, the order would execute against the remaining interest at 
$1.40 and $5.00, resulting in potential harm to investors.
    To bolster the normal resilience and market behavior that 
persistently produces robust reference prices, NOM is proposing to 
create a level of protection that prevents the market from moving 
beyond set thresholds. The thresholds consist of a reference price plus 
(minus) set dollar amounts based on the nature of the option and the 
premium of the option. The exchange is not introducing a new concept. 
In fact, The NASDAQ Stock Market, NASDAQ OMX PSX, and NASDAQ OMX BX all 
place a limit on the prices at which market orders will be allowed to 
execute.\3\
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    \3\ NASDAQ believes that the proposed Acceptable Trade Range 
mechanism is superior to the market collar orders currently used in 
equity markets because the Acceptable Trade Range will apply to all 
orders rather than just unpriced orders. Additionally, rather than 
immediately cancelling the order, the market would continue to work 
the order for execution. See NASDAQ Stock Market rule 4751(f)(13), 
NASDAQ OMX BX 4751(f)(10), and NASDAQ OMX PSX 3301(f)(9).
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    System Operation. The proposed Acceptable Trade Range would work as 
follows: Prior to executing orders received by the exchange, an 
Acceptable Trade Range is calculated to determine the range of prices 
at which orders may be executed. When an order is initially received, 
the threshold is calculated by adding (for buy orders) or subtracting 
(for sell orders) a value,\4\ as discussed below, to the National Best 
Offer for buy orders or the National Best Bid for sell orders to 
determine the range of prices that are valid for execution. A buy 
(sell) order will be allowed to execute up (down) to and including the 
maximum (minimum) price within the Acceptable Trade Range. The 
Acceptable Trade Range threshold becomes the reference price for the 
next Acceptable Trade Range calculation. If an order cannot be 
completely executed within the Acceptable Trade Range, and the limit 
price of the order is greater (for buy orders) or less (for sell 
orders) than the Acceptable Trade Range threshold, the unexecuted 
portion of the original order will be posted at the Acceptable Trade 
Range threshold. The order will remain posted for a brief period, not 
to exceed one second, to allow the market to refresh and to determine 
whether or not more liquidity will become available (on NOM or any 
other exchange if the order is designated as routable) within the 
posted price of the order before moving on to a new Threshold Price. 
The Acceptable Trade Range threshold, at which the order is posted, 
then becomes the new reference price \5\ and a new threshold is 
calculated. Once the brief pause has expired, if the order has not been 
fully executed, it will be allowed to execute up to and including the 
new Acceptable Trade Range Threshold Price.
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    \4\ The value that is to be added to the reference price will be 
set by the exchange and posted on the exchange Web site: http://www.nasdasqtrader.com.
    \5\ If a new NBB is received that is greater than a buy order 
posted at the Acceptable Trade Range threshold, or a new NBO is 
received that is lower than a sell order posted at the Acceptable 
Trade Range threshold, the new NBB (for buy orders) or NBO (for sell 
orders) will be the new reference price.
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    During the brief pause, NOM will display the Acceptable Trade Range 
Threshold Price on one side of the market and the best available price 
on the opposite side of the market using a ``non-firm'' indicator.\6\ 
This allows the order setting the Acceptable Trade Range Threshold 
Price to retain price/time priority in the NOM book and also prevents 
any later-entered order from accessing liquidity ahead of it. If NOM 
were to display trading interest available on the opposite side of the 
market, that trading interest would be automatically accessible to 
later-entered orders during the period when the order triggering the 
Acceptable Trade Range is paused. Following the Posting Period, the 
Exchange will return to a normal trading state and disseminate its best 
bid and offer.
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    \6\ Non-firm quote indication values are described on page 18 of 
the specifications disseminated by the Options Price Regulatory 
Authority. See http://www.opradata.com/specs/participant_interface_specification.pdf.
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    NASDAQ believes that disseminating a non-firm quotation message as 
described above is consistent with its obligations under the SEC Quote 
Rule.\7\ The fact that NASDAQ is experiencing volatility that is strong 
enough to trigger the Acceptable Trade Range mechanism qualifies as an 
unusual market condition. NASDAQ expects such situations to be rare, 
and as described below it will set the parameters of the mechanism at 
levels that will ensure that it is triggered quite infrequently. In 
addition, the Acceptable Trade Range mechanism will cause the market to 
pause for no more than one second, a briefer pause than occurs in other 
markets that are experiencing and attempting to dampen volatility.\8\ 
Importantly, the brief pause only occurs after the Exchange has already 
executed transactions--potentially at multiple price levels--rather 
than pausing before executing any transactions in the hopes of 
attracting initial liquidity.
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    \7\ 17 CFR 242.602.
    \8\ For example, the NASDAQ Acceptable Trade Range mechanism 
will pause for a briefer period than the Liquidity Replenishment 
Point or ``LRP'' employed by the New York Stock Exchange. The LRP 
resembles the Acceptable Trade Range in that it also is designed to 
dampen volatility under similar circumstances, it pauses the market 
in the affected security, and it disseminates to the network 
processor a non-firm quote condition during the resulting pause. See 
NYSE Rules 1000(a)(iv) and 60(e)(ii). Unlike the Acceptable Trade 
Range mechanism, the LRP can exceed one second in duration.
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    Importantly, the Acceptable Trade Range is neutral with respect to 
away markets. The order may route to other destinations to access 
liquidity priced within the Acceptable Trade Range provided the order 
is designated as routable. If the order still remains unexecuted, this 
process will repeat until the order is executed, cancelled, or posted 
at its limit price. If after an order is routed to the full size of an 
away exchange and additional size remains available, the remaining 
contracts will be posted on NOM at a price that

[[Page 51455]]

assumes the away market has executed the routed order. This practice of 
routing and then posting is consistent with the national market system 
plan governing trading and routing of options orders and the NOM 
policies and procedures that implement that plan.\9\
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    \9\ See Options Order Protection and Locked/Crossed Markets 
Plan; Securities Exchange Act Release No. 60405 (July 30, 2009), 74 
FR 39362 (August 6, 2009); NOM Rules Chapter VI, Section 7(b)(3)(C). 
Section 5(b)(v) of the Plan provides an exception from trade through 
prevention when: ``[t]he transaction that constituted the Trade-
Through was effected by a Participant that simultaneously routed an 
Intermarket Sweep Order to execute against the full displayed size 
of any Protected Quotation that was traded through;'' [sic]
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    For example, assume that the Acceptable Trade Range is set for 
$0.05 and the following quotations are posted in all markets:
    Away Exchange Quotes:

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                    Exchange                         Bid size        Bid price      Offer price     Offer size
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ISE.............................................              10           $0.75           $0.90              10
AMEX............................................              10            0.75            0.92              10
PHLX............................................              10            0.75            0.94              10
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    NOM Price Levels:

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                    Exchange                         Bid size        Bid price      Offer price     Offer size
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NOM.............................................              10           $0.75           $0.90              10
NOM.............................................  ..............  ..............            0.95              10
NOM.............................................  ..............  ..............            0.97              10
NOM.............................................  ..............  ..............            1.00              20
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    NOM receives a routable order to buy 70 contracts at $1.10. The 
Acceptable Trade Range is $0.05 and the reference price is the National 
Best Offer--$0.90. The Acceptable Trade Range threshold is then $0.90 + 
$0.05 = $0.95. The order is allowed to execute up to and including 
$0.95. The System then pauses for a brief period not to exceed one 
second to allow the market (including other exchanges) to refresh and 
to determine whether additional liquidity will become available within 
the order's posted price. If additional liquidity becomes available on 
NOM or any away market, that liquidity will be accessed and executed.
     10 contracts will be executed at $0.90 against NOM
     10 contracts will be executed at $0.90 against ISE
     10 contracts will be executed at $0.92 against AMEX
     10 contracts will be executed at $0.94 against PHLX
     10 contracts will be executed at $0.95 against NOM
     Then, after executing at multiple price levels, the order 
is posted at $0.95 for a brief period not to exceed one second to 
determine whether additional liquidity will become available.
     A new Acceptable Trade Range Threshold Price of $1.00 is 
determined (new reference price of $0.95 + $0.05 = $1.00)
     If, during the brief pause not to exceed 1 second, no 
liquidity becomes available within the order's posted price of $0.95, 
the System will then execute 10 contracts at $0.97, and 10 contracts at 
$1.00 \10\
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    \10\ The brief pause described above will not disadvantage 
customers seeking the best price in any market. For example, if in 
the example above an NYSE ARCA quote of $0.75 x $0.96 with size of 
10 x 10 is received, a routable order would first route to NYSE ARCA 
at $0.96, then execute against NOM at $0.97.
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    Similarly, if a new order is received when a previous order has 
reached the Acceptable Trade Range threshold, the Threshold Price will 
be used as the reference price for the new Acceptable Trade Range 
threshold. Both orders would then be allowed to execute up (down) to 
the new Threshold Price.
    For example:
    Away Exchange Quotes:

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                    Exchange                         Bid size        Bid price      Offer price     Offer size
----------------------------------------------------------------------------------------------------------------
ISE.............................................              10           $0.75           $0.90              10
AMEX............................................              10           $0.75           $0.92              10
PHLX............................................              10           $0.75           $0.94              10
----------------------------------------------------------------------------------------------------------------

    NOM Price Levels:

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                    Exchange                         Bid size        Bid price      Offer price     Offer size
----------------------------------------------------------------------------------------------------------------
NOM.............................................              10           $0.75           $0.90              10
NOM.............................................  ..............  ..............           $0.95              10
NOM.............................................  ..............  ..............           $1.05              20
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     NOM receives a routable order to buy 60 contracts at 
$1.10. The Acceptable Trade Range is $0.05 and the reference price is 
the National Best Offer--$0.90. The Acceptable Trade Range threshold is 
then $0.90 + $0.05 = $0.95. The order is allowed to execute up to and 
including $0.95.
     10 contracts will be executed at $0.90 against NOM
     10 contracts will be executed at $0.90 against ISE

[[Page 51456]]

     10 contracts will be executed at $0.92 against AMEX
     10 contracts will be executed at $0.94 against PHLX
     10 contracts will be executed at $0.95 against NOM
     Then, after executing at multiple price levels, the order 
is posted at $0.95 for a brief period not to exceed one second to 
determine whether additional liquidity will become available.
     A new Acceptable Trade Range Threshold Price of $1.00 is 
determined (new reference price of $0.95 + $0.05 = $1.00)
     If, during the brief period not to exceed one second, a 
second order is received to buy 10 contracts at $1.25, the two orders 
would then post at the new Acceptable Trade Range Threshold price of 
$1.00 for a brief period not to exceed one second to determine whether 
additional liquidity will become available.
     A new Acceptable Trade Range threshold of $1.05 will be 
calculated.
     If no additional liquidity becomes available within the 
posted price of the orders ($1.00) during the brief period not to 
exceed one, the orders would execute 10 contracts each against the 
order on the NOM book at $1.05
    Setting Acceptable Range Values. The options class premium will be 
the dominant factor in determining the Acceptable Trade Range. 
Generally, options with lower premiums tend to be more liquid and have 
tighter bid/ask spreads; options with higher premiums have wider 
spreads and less liquidity. Accordingly, a table consisting of several 
steps based on the premium of the option will be used to determine how 
far the market for a given option will be allowed to move. This table 
or tables would be listed on the NASDAQTrader.com Web site and any 
periodic updates to the table would be announced via an Options Trader 
Alert.
    For example, looking at some SPY January 2011 Call options on 
December 27th of 2010:
    Bid/Offer of SPY Jan 126 Call (at or near-the-money): $1.78 x $1.79 
(several hundred contracts on bid and offer)
    Bid/Offer of SPY Jan 80 Call (deep in-the-money): $45.61 x $45.87 
(20 contracts on each side)
    The deep in-the-money calls (Jan 80 calls) have a wider spread 
($45.87-$45.61 = $0.26) compared to a spread of $0.01 for the at-the-
money calls (Jan 126 calls). Therefore, it is appropriate to have 
different thresholds for the two options. For instance, it may make 
sense to have a $0.05 threshold for the at-the-money strikes (Premium < 
$2) and a $0.50 threshold for the deep in-the-money strikes (Premium > 
$10).
    To consider another example, the January 2011 CSCO put options on 
December 27th of 2010:
    Bid/Offer of CSCO 20 Jan Put (at or near-the-money): $0.11 x $0.12 
(300x550)
    Bid/Offer of CSCO 35 Jan Put (deep in-the-money): $14.35 x $15.20 
(48x18)
    Even though CSCO has a much lower share price than SPY, and is a 
different type of security (it is a common stock of a technology 
company whereas SPY is an ETF based on the S&P 500 Index), the pattern 
is the same. The option with the lower premium has a very narrow spread 
of $0.01 with significant size displayed whereas the higher premium 
option has a wide spread ($0.85) and less size displayed.
    The Acceptable Trade Range settings will be tied to the option 
premium. However, other factors will be considered when determining the 
exact settings. For example, Acceptable Ranges may change if market-
wide volatility is as high as it was during the financial crisis in 
2008 and 2009, or if overall liquidity is low based on historical 
trends. These different market conditions may present the need to 
adjust the threshold amounts from time to time to ensure a well-
functioning market. Without adjustments, the market may become too 
constrained or conversely, prone to wide price swings. As stated above, 
the Exchange would publish the Acceptable Trade Range table or tables 
on the NASDAQTrader.com Web site. The Exchange does not foresee 
updating the table(s) often or intraday. The Exchange will provide 
sufficient advanced notice of changes to the Acceptable Trade Range 
table to its membership via Options Trader Alerts.
    The Acceptable Trade Range settings would generally be the same 
across all options traded on NOM, although NASDAQ proposes to maintain 
flexibility to set them separately based on characteristics of the 
underlying security. For instance, Google is a stock with a high share 
price ($602.38 closing price on December 27th). Google options 
therefore may require special settings due to the risk involved in 
actively quoting options on such a high-priced stock. Option spreads on 
Google are wider and the size available at the best bid and offer is 
smaller. Google could potentially need a wider threshold setting 
compared to other lower-priced stocks. There are other options that fit 
into this category (e.g. AAPL) which makes it necessary to have 
threshold settings that have flexibility based on the underlying 
security. Additionally, it is generally observed that options subject 
to the Penny Pilot program quote with tighter spreads than options not 
subject to the Penny Pilot. Currently, NASDAQ expects to set Acceptable 
Trade Ranges for three categories of options: Standard Penny Pilot, 
Special Penny Pilot (IWM, QQQQ, SPY), and Non-Penny Pilot.\11\
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    \11\ NASDAQ notes that the Acceptable Range Test in place at 
NASDAQ OMX PHLX--PHLX Rule 1082(a)(ii)(B)(3)(f)--currently provides 
for this flexibility.
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2. Statutory Basis
    NASDAQ believes the proposed rule change is consistent with the 
provisions of Section 6 of the Act,\12\ in general and with Section 
6(b)(5) of the Act,\13\ in particular, which requires that the rules of 
an exchange be designed to prevent fraudulent and manipulative acts and 
practices, promote just and equitable principles of trade, foster 
cooperation and coordination with persons engaged in regulating, 
clearing, settling, processing information with respect to, and 
facilitating transactions in securities, remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system, and, in general, protect investors and the public interest. The 
proposed rule change is consistent with these requirements in that it 
will reduce the negative impacts of sudden, unanticipated volatility in 
individual NOM options, and serve to preserve an orderly market in a 
transparent and uniform manner, enhance the price-discovery process, 
increase overall market confidence, and promote fair and orderly 
markets and the protection of investors.
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    \12\ 15 U.S.C. 78f.
    \13\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASDAQ does not believe that the proposed rule change will result 
in any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

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

    Written comments were neither solicited nor received.

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

    Within 45 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

[[Page 51457]]

publishes its reasons for so finding or (ii) as to which the self-
regulatory organization consents, the Commission will:
    (A) By order approve or disapprove the 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-NASDAQ-2011-105 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-NASDAQ-2011-105. 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, all subsequent amendments, 
all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for Web site 
viewing and printing in the Commission's Public Reference Room on 
official business days between the hours of 10 a.m. and 3 p.m. Copies 
of such filing also will be available for inspection and copying at the 
principal office of NASDAQ. 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-NASDAQ-2011-105 and should be submitted on or before 
September 8, 2011.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-21034 Filed 8-17-11; 8:45 am]
BILLING CODE 8011-01-P


