
[Federal Register Volume 77, Number 129 (Thursday, July 5, 2012)]
[Notices]
[Pages 39771-39773]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-16373]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67294; File No. SR-PHLX-2012-68]


Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Order 
Approving a Proposed Rule Change, as Modified by Amendment No. 1, To 
Accept Inbound Orders From NASDAQ OMX BX's New Options Market

June 28, 2012.

I. Introduction

    On May 15, 2012, NASDAQ OMX PHLX LLC (``Exchange'' or ``PHLX'') 
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 
accept inbound options orders routed by NASDAQ Options Services LLC 
(``NOS'') from NASDAQ OMX BX (``BX'') on a one year pilot basis in 
connection with the establishment of a new options market by BX. The 
proposed rule change was published for comment in the Federal Register 
on May 24, 2012.\3\ The Commission received no comment letters 
regarding the proposed rule change. This order approves the proposed 
rule change.
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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. 67026 (May 18, 
2012), 77 FR 31053 (``Notice''). The Commission notes that on May 
17, 2012, the Exchange submitted Amendment No. 1 to the proposed 
rule change, to make technical amendments to Item 3.a of the Form 
19b-4 and Item II of Exhibit 1.
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II. Background

    PHLX Rule 985(b) prohibits the Exchange or any entity with which it 
is affiliated from, directly or indirectly, acquiring or maintaining an 
ownership interest in, or engaging in a business venture with, an 
Exchange member or an affiliate of an Exchange member in the absence of 
an effective filing under Section 19(b) of the Act.\4\ NOS is a 
registered broker-dealer that is a member of the Exchange, and 
currently provides to members of the Exchange optional routing services 
to other markets.\5\ NOS is owned by NASDAQ OMX Group, Inc. (``NASDAQ 
OMX''), which also owns three registered securities exchanges--the 
Exchange, BX, and the NASDAQ Stock Market LLC (``NASDAQ'').\6\ Thus, 
NOS is an affiliate of these exchanges.\7\ Absent an effective filing, 
PHLX Rule 985(b) would prohibit NOS from being a member of the 
Exchange. The Commission initially approved NOS's affiliation with PHLX 
and its affiliated exchanges in connection with NASDAQ OMX's 
acquisition of PHLX and BX,\8\ and NOS currently performs certain 
limited activities for each.\9\ With the current proposed rule change, 
the Exchange seeks approval to permit NOS to perform a new function.
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    \4\ 15 U.S.C. 78s(b). PHLX Rule 985 also prohibits a PHLX member 
from being or becoming an affiliate of PHLX, or an affiliate of an 
entity affiliated with PHLX, in the absence of an effective filing 
under Section 19(b). See PHLX Rule 958(b)(1)(B).
    \5\ See PHLX Rule 1080(m)(iii). See also Notice, supra note 3, 
at 31054 n.5 and accompanying text.
    \6\ 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) (order approving NASDAQ OMX's 
acquisition of BX) (``BX Acquisition Order''); Securities Exchange 
Act Release No. 58179 (July 17, 2008), 73 FR 42874 (July 23, 2008) 
(SR-PHLX-2008-31) (order approving NASDAQ OMX's acquisition of PHLX) 
(``PHLX Acquisition Order'').
    \7\ See id. See also Notice, supra note 3, at 31054.
    \8\ See PHLX Acquisition Order, supra note 6, at 42877; and BX 
Acquisition Order, supra note 6, at 46944. See also Securities 
Exchange Act Release No. 57478 (March 12, 2008), 73 FR 14521, 14532-
14533 (March 18, 2008) (SR-NASDAQ-2007-004 and SR-NASDAQ-2007-080) 
(initially approving NASDAQ's affiliation with NOS in connection 
with the establishment of the NASDAQ Options Market (``NOM'') (``NOM 
Approval Order'').
    \9\ See, e.g., PHLX Rule 1080(m) (governing order routing by 
PHLX); and Securities Exchange Act Release No. 65399 (September 26, 
2011), 76 FR 60955 (September 30, 2011) (SR-PHLX-2011-111) 
(approving routing of orders by NOS inbound to PHLX from NOM) 
(``PHLX Routing Order'').
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    On May 1, 2012, BX filed a proposed rule change to establish a new 
BX options market (``BX Options''), which will be an electronic trading 
system that trades options.\10\ As part of its proposal, BX proposed 
that NOS provide BX with outbound options routing services to other 
markets, including its affiliate PHLX. On May 15, 2012, the Exchange 
filed the instant proposal to allow the Exchange to accept such options 
orders routed inbound by NOS from BX on a one year pilot basis subject 
to certain limitations and conditions.\11\
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    \10\ See Securities Exchange Act Release No. 66983 (May 14, 
2012), 77 FR 29730 (May 18, 2012) (SR-BX-2012-030) (notice of 
propose rule change to adopt rules for the new BX options market) 
(``BX Options Proposal'') On June 26, 2012, the Commission approved 
the BX Options Proposal. See Securities Exchange Act Release No. 
67256 (June 26, 2012) (``BX Options Approval'').
    \11\ See Notice, supra note 3.
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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.\12\ Specifically, the

[[Page 39772]]

Commission finds that the proposed rule change is consistent with 
Section 6(b)(1) of the Act,\13\ 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,\14\ 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.
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    \12\ 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).
    \13\ 15 U.S.C. 78f(b)(1).
    \14\ 15 U.S.C. 78f(b)(5).
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    NOS will operate as a facility of BX that provides outbound options 
routing from BX Options to other market centers, subject to certain 
conditions.\15\ The operation of NOS as a facility of BX providing 
outbound routing services from BX Options will be subject to BX 
oversight, as well as Commission oversight. BX will be responsible for 
ensuring that NOS's outbound options routing service is operated 
consistent with Section 6 of the Act and BX rules. In addition, BX must 
file with the Commission rule changes and fees relating to BX's 
outbound options routing services.
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    \15\ See BX Options Approval, supra note 10, at Section II.D.
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    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 NOS's affiliation with the Exchange.\16\ Also 
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 to which it is routing 
orders, the Exchange proposed the following limitations and conditions 
to NOS's affiliation with the Exchange to permit the Exchange to accept 
inbound options orders that NOS routes in its capacity as a facility of 
BX: \17\
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    \16\ See PHLX Acquisition Order, supra note 6, at 42887. See 
also Notice, supra note 3, at 31054 n.10 and accompanying text. In 
addition, the Exchange has authority to accept inbound orders that 
NOS routes in its capacity as a facility of NASDAQ, subject to 
certain limitations and conditions. See PHLX Routing Order, supra 
note 9, at 60956.
    \17\ See Notice, supra note 3, at 31054.
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     First, the Exchange and the Financial Industry Regulatory 
Authority (``FINRA'') will maintain a Regulatory Contract, as well as 
an agreement pursuant to Rule 17d-2 under the Act (``17d-2 
Agreement'').\18\ Pursuant to the Regulatory Contract and the 17d-2 
Agreement, FINRA will be allocated regulatory responsibilities to 
review NOS's compliance with certain PHLX rules.\19\ Pursuant to the 
Regulatory Contract, however, the Exchange retains ultimate 
responsibility for enforcing its rules with respect to NOS.
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    \18\ 17 CFR 240.17d-2.
    \19\ NOS is also subject to independent oversight by FINRA, its 
designated examining authority, for compliance with financial 
responsibility requirements.
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     Second, FINRA will monitor NOS for compliance with PHLX's 
trading rules, and will collect and maintain certain related 
information.\20\
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    \20\ Pursuant to the Regulatory Contract, both FINRA and the 
Exchange will collect and maintain all alerts, complaints, 
investigations and enforcement actions in which NOS (in its capacity 
as a facility of BX 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, at 31054 
n.14.
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     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 the Exchange or FINRA is aware) that 
identify NOS as a participant that has potentially violated Commission 
or Exchange rules, and (ii) lists all investigations that identify NOS 
as a participant that has potentially violated Commission or PHLX 
rules.
     Fourth, the Exchange has in place PHLX Rule 985, which 
requires NASDAQ OMX, as the holding company owning both the Exchange 
and NOS, to establish and maintain procedures and internal controls 
reasonably designed to ensure that NOS 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 options order routing to the Exchange.
     Fifth, the Exchange proposes that the routing of options 
orders from NOS to the Exchange, in NOS's capacity as a facility of BX 
be authorized for a pilot period of one year.
    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.\21\ 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 NOS, in its capacity as a facility of BX, to route 
options orders inbound to the Exchange on a pilot basis, subject to the 
limitations and conditions described above.\22\
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    \21\ 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 3, 2008) (SR-Amex-2008-62 and SR-NYSE-2008-60) (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 Direct Edge Holdings LLC); 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.); 58375 (August 18, 2008), 73 FR 49498 (August 21, 2008) (File 
No. 10-182) (order granting the exchange registration of BATS 
Exchange, Inc.); 61698 (March 12, 2010), 75 FR 13151 (March 18, 
2010) (File Nos. 10-194 and 10-196) (order granting the exchange 
registration of EDGX Exchange, Inc. and EDGA Exchange, Inc.); and 
62716 (August 13, 2010), 75 FR 51295 (August 19, 2010) (File No. 10-
198) (order granting the exchange registration of BATS-Y Exchange, 
Inc.).
    \22\ The Commission notes that these limitations and conditions 
are consistent with those previously approved by the Commission for 
other exchanges. See, e.g., BX Options Approval, supra, note 10, at 
Section II.D.2.
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    The Commission believes that these limitations and conditions 
enumerated above will mitigate its concerns about potential conflicts 
of interest and unfair competitive advantage. In particular, the 
Commission believes that a non-

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affiliated SRO's oversight of NOS,\23\ combined with a non-affiliated 
SRO's monitoring of NOS's compliance with the Exchange's rules and 
quarterly reporting to the Exchange, will help to protect the 
independence of the Exchange's regulatory responsibilities with respect 
to NOS. The Commission also believes that the Exchange's proposed 
amendments to PHLX Rule 985(b) are designed to ensure that NOS 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 NOS to route options orders inbound to the 
Exchange from BX, 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.
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    \23\ This oversight will be accomplished through the 17d-2 
Agreement between FINRA and the Exchange and the Regulatory 
Contract. See Notice, supra note 3, at 31054 n.12 and accompanying 
text.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\24\ that the proposed rule change, as modified by Amendment No. 1 
(SR-PHLX-2012-68), be, and hereby is, approved.
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    \24\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\25\
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    \25\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-16373 Filed 7-3-12; 8:45 am]
BILLING CODE 8011-01-P


