
[Federal Register Volume 77, Number 164 (Thursday, August 23, 2012)]
[Notices]
[Pages 51073-51076]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-20711]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67680; File No. SR-Phlx-2012-106]


Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Notice of 
Filing of Proposed Rule Change To Modify Exchange Rule 3307 To 
Institute a Five Millisecond Delay in the Execution Time of Marketable 
Orders on NASDAQ OMX PSX

August 17, 2012.
    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 9, 2012, NASDAQ OMX PHLX LLC (``Phlx'' or ``Exchange'') filed 
with the Securities and Exchange Commission (``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 modify Exchange Rule 3307 to institute a 
five millisecond delay in the execution time of marketable orders on 
NASDAQ OMX PSX (``PSX''). The Exchange proposes to implement the 
proposed rule change within 30 days of Commission approval. The text of 
the proposed rule change is available at http://nasdaqomxphlx.cchwallstreet.com/nasdaqomxphlx/phlx, at Phlx'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, 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 modify Exchange Rule 
3307 to institute a five millisecond delay in the execution time of 
marketable orders. The proposal will be implemented initially on a one-
year pilot basis with respect to the trading of securities listed on 
the NASDAQ Stock Market (``Tape C Securities''). The Exchange 
introduced PSX, which features a unique price/size/pro-rata execution 
algorithm, in order to encourage market participants to display more 
liquidity in a transparent market environment. As among equally priced 
orders on the PSX book, PSX allocates execution opportunities in 
proportion to the size of the posted order, rather than its time of 
entry. Thus, the Exchange's market model is intended to deemphasize the 
importance of speed in realizing trading opportunities.
    Although PSX has enjoyed a measure of success, the Exchange is 
concerned that slower liquidity providers that post on PSX are 
sometimes subject to suboptimal executions due to disparities in the 
speed with which market participants are able to react to market

[[Page 51074]]

information. Thus, in a circumstance where a broker posts a large order 
on PSX and changes in market conditions render the price of the order 
stale, a market participant with superior capabilities to process 
information may be able to route an order before the broker can change 
its price, thereby obtaining a fill at a price that is out of line with 
the price that will prevail in the market generally once the changes in 
the market conditions are fully digested. While the potential for a 
posted order to interact with orders entered by market participants 
with faster reaction capabilities responding to short-term 
information--sometimes referred to as ``toxic order flow''--exists on 
all markets, the larger posted sizes and pro rata allocation model on 
PSX may make the impact more pronounced, since fills are allocated 
among all market participants posting orders at a particular price.
    It should also be noted that liquidity providers face asymmetric 
risks as compared with firms that seek to access liquidity 
opportunistically. To illustrate this point, consider the following 
example. Firm A is providing liquidity in 1,000 securities while Firm B 
is seeking opportunistically to access liquidity if it perceives a 
quote is mispriced. Both firms receive information (e.g., index market 
data from a futures market) simultaneously that causes both to re-
evaluate the fair value of all 1,000 securities quoted by Firm A. Firm 
A immediately seeks to update its quotes to reflect the change in fair 
value, while Firm B seeks to access those quotes before they are 
updated. If Firm B's orders are able to access a quote before it is 
updated, Firm A faces the risk of executing at stale prices in up to 
1,000 securities. If, on the other hand, Firm A's updates are processed 
before Firm B's orders, Firm B faces the opportunity cost of failing to 
execute at the opportunistic price, but otherwise has no exposure as a 
result of its relative latency. As this illustrates, the risk of being 
technologically inferior is substantially higher for liquidity 
providers (Firm A is exposed to up to 1,000 mispriced executions) than 
for liquidity removers (Firm B has no executions).
    In an effort to address these issues, the Exchange is proposing to 
institute a five millisecond delay in the time between when a 
marketable order is received by the PSX system and when it is presented 
for execution against the PSX book.\3\ No information about the receipt 
of an incoming marketable order will be provided to any market 
participant before the order is presented for execution.\4\ However, 
any updates or cancellations of resting orders that are received during 
the five millisecond period will be processed before the incoming order 
is presented for execution. After an order has been presented for 
execution, any unexecuted shares will be cancelled back to the member, 
routed, or posted to the book as applicable. As is the case with all 
orders on PSX, any price improvement will be allocated to the party 
that entered the incoming order. If the incoming order becomes non-
marketable while it is being held, it will nevertheless continue to be 
held until the end of the five-millisecond period. In addition, the 
market participant entering the order may not cancel or modify it until 
the order has been presented at the end of the period.
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    \3\ Post-only orders and non-marketable orders with a time-in-
force other than ``Immediate-or-Cancel'' will not be subject to the 
five millisecond delay.
    \4\ Because the incoming order will not be presented for 
execution against the resting quote until after the end of the five 
millisecond period, and no market participants will receive notice 
of the existence of the order during that time, the delay will not 
cause any compliance issues under SEC Rule 602(b), 17 CFR 
242.602(b).
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    With the change, the overall processing time for incoming 
marketable orders will still be extremely rapid--in most cases, about 
5.075 milliseconds--and will be faster than the processing time for 
several existing exchange markets. However, the Exchange believes that 
the additional time will be sufficient to allow liquidity providers to 
make adjustments if they believe them to be warranted. Accordingly, the 
change will ``level the playing field'' between liquidity providers and 
opportunistic traders, consistent with the Exchange's goal of making 
PSX a market that rewards investors for the size of their trading 
interest rather than the speed of their trading algorithms.
    Although the proposal will allow liquidity providers to adjust 
their quotes during the delay period after an order is received by PSX, 
the Exchange does not believe that the proposal presents any issues 
under the provisions of SEC Rule 602(b),\5\ generally known as the 
``firm quote rule.'' Subject to certain exceptions, paragraph (b)(2) of 
the rule provides:
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    \5\ 17 CFR 242.602(b).

    [E]ach responsible broker or dealer shall be obligated to 
execute any order to buy or sell a subject security, other than an 
odd-lot order, presented to it by another broker or dealer, or any 
other person belonging to a category of persons with whom such 
responsible broker or dealer customarily deals, at a price at least 
as favorable to such buyer or seller as the responsible broker's or 
dealer's published bid or published offer (exclusive of any 
commission, commission equivalent or differential customarily 
charged by such responsible broker or dealer in connection with 
execution of any such order) in any amount up to its published 
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quotation size.

    However, paragraph (b)(3) provides that ``[n]o responsible broker 
or dealer shall be obligated to execute a transaction for any subject 
security as provided in paragraph (b)(2) of this section if * * * 
[b]efore the order sought to be executed is presented, such responsible 
broker or dealer has communicated to its exchange or association 
pursuant to paragraph (b)(1) of this section, a revised bid or offer.'' 
The application of these provisions to the proposed rule change hinges 
on the word ``presented'': if an order executable against a quote is 
presented to a broker-dealer, it must be executed unless a revised 
quote has been communicated to the exchange before the order is 
presented. The rule does not define the term ``presented,'' nor do the 
relevant proposing and adopting releases shed extensive light on its 
interpretation.\6\ The relevant dictionary definition of ``present''--
to ``show or offer (something) for others to scrutinize or consider'' 
\7\--suggests the need for awareness of a recipient of the thing that 
is presented. As a matter of logic, moreover, a broker-dealer should 
not be held responsible for executing an order of which it is not 
aware. Indeed, this would appear to be the purpose of the exception 
provided by paragraph (b)(3): a broker-dealer that has updated its 
quote before receiving a previously marketable order should not be 
required to provide an execution against its prior quote. Because, in 
the case of the proposed rule change, an incoming order will not 
attempt to execute until after the end of the five millisecond period, 
and no market participants will receive notice of the existence of the 
order during that time, the Exchange believes that it would be contrary 
to the purpose of this exception if a broker-dealer were required to 
honor its prior quote merely because the Exchange was temporarily 
holding an order of which the broker-dealer had no awareness.
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    \6\ Securities Exchange Act Release No. 12670 (July 29, 1976), 
41 FR 32856 (August 5, 1976); Securities Exchange Act Release No. 
13626 (June 14, 1977), 42 FR 32418 (June 24, 1977); Securities 
Exchange Act Release No. 14415 (January 26, 1978), 43 FR 4342 
(February 1, 1978).
    \7\ See www.oxforddictionaries.com.
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    Under Regulation NMS, a trading center that displays an ``automated 
quotation'' must ``immediately and

[[Page 51075]]

automatically'' execute an incoming order that is ``marked as 
immediate-or- cancel,'' up to the full size of the displayed 
quotation.\8\ Moreover, the Commission stated that ``immediately'' 
means that ``a trading center's systems should provide the fastest 
response possible without any programmed delay.'' \9\ Thus, although 
PSX's response time will remain extremely rapid, the Exchange will mark 
PSX's quotations for Tape C Securities as ``manual quotations'' within 
the meaning of Regulation NMS. The Exchange notes, however, that in 
adopting Regulation NMS, the Commission ``emphasize[d] that adoption of 
Rule 611\10\ in no way lessens a broker-dealer's duty of best 
execution.* * * The duty of best execution requires broker-dealers to 
execute customers' trades at the most favorable terms reasonably 
available under the circumstances, i.e., at the best reasonably 
available price.'' Accordingly, it is the Exchange's belief that market 
participants will be required to consider the price, size, 
accessibility, and cost of PSX's quotations in determining whether they 
have satisfied their best execution obligations.
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    \8\ 17 CFR 242.600(b)(3).
    \9\ Securities Exchange Act Release No. 51808 (June 9, 2005), 70 
FR 37496, 37519 (June 29, 2005) (File No. S7-10-04).
    \10\ 17 CFR 242.611. Rule 611 provides that trading centers must 
establish, maintain, and enforce written policies and procedures 
that are reasonably designed to prevent trade-throughs on that 
trading center of protected quotations in NMS stocks.
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    The Exchange proposes adopting the change on a one-year pilot basis 
with respect to Tape C Securities only. This approach will allow the 
Exchange to compare trading patterns and market performance with 
respect to stocks subject to the pilot and those that are not. Based on 
this information, the Exchange will determine whether to expand the 
pilot, seek permanent approval for it, or allow it to lapse. The 
Exchange has selected Tape C Securities for the pilot because it 
believes that PSX's overall share volumes in Tape C (roughly comparable 
to its volumes for Tape A Securities and higher than for Tape B 
Securities \11\) and its percentage market share (higher than for Tape 
A Securities) will provide more useful data for assessing the 
effectiveness of the pilot. The Exchange reserves the right to submit a 
proposed rule change prior to the end of the pilot period in order to 
make such changes as it believes warranted.
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    \11\ Tape A Securities are listed on the New York Stock Exchange 
and Tape B Securities are listed on NYSE MKT and other ``regional'' 
exchanges.
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2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \12\ in general, and furthers the objectives of Section 
6(b)(5) of the Act \13\ 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, and is not designed to permit unfair discrimination between 
customers, issuers, brokers, or dealers. The Exchange believes that the 
rule change will promote these goals by providing broker-dealers and 
investors that post liquidity with a better opportunity to adjust the 
prices of their orders to reflect changed market circumstances, thereby 
enhancing their ability to avoid so-called toxic order flow. The 
Exchange believes that firms willing to provide liquidity in large 
numbers of stocks provide benefits to investors and listed companies by 
supporting active markets in those stocks and dampening volatility. 
Specifically, the Exchange believes that widespread quoting activity 
benefits retail and institutional investors that have longer investment 
horizons and do not calibrate their purchases or sales to intraday 
variations in prices. As discussed above, however, as a firm becomes 
active in providing liquidity in a larger number of stocks, it faces 
greater challenges in ensuring that its quoted prices are up-to-date. 
If firms that wish to actively quote are unable to mitigate the 
asymmetric risks created by opportunistic traders, they are likely to 
decrease their quoting activity, rather than incur losses. Accordingly, 
the Exchange believes that it is appropriate to adopt the proposed rule 
change as a means to assist liquidity providers in mitigating these 
risks, and thereby encourage greater levels of liquidity provision in a 
wider range of stocks.
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    \12\ 15 U.S.C. 78f(b).
    \13\ 15 U.S.C. 78f(b)(5).
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    The Exchange does not believe that the proposal is unfairly 
discriminatory. Although the change may be seen as diminishing the 
ability of opportunistic traders to access quotes before they are 
updated to reflect changed market information, the Exchange believes 
that the anticipated benefits of the proposal in supporting liquidity 
provision and the interests of investors with longer trading horizons 
outweigh the potentially diminished profit opportunities for traders 
with shorter trading horizons. Moreover, because the Exchange's market 
share is small, the change will have little effect on the ability of 
traders to continue trading actively with a short-term focus on 
numerous other venues.

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. Although the change will delay 
the execution time for incoming marketable orders, the Exchange 
believes that the extremely fast overall processing time of 5.075 
milliseconds should not be considered a burden on the ability of market 
participants to compete for order executions. Moreover, the Exchange 
believes that the change is appropriate in furtherance of the purposes 
of the Act because it will help liquidity providers to mitigate the 
asymmetric risks associated with opportunistic traders. The Exchange 
further believes that any burden on the ability of opportunistic 
traders to realize short-term trading opportunities on the Exchange 
will be minimal, because such opportunities will continue to exist on 
other trading venues. Moreover, the Exchange believes that any such 
burden will be outweighed by the benefits that it seeks to provide to 
support liquidity provision and the interests of investors with longer-
term trading horizons.

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 publishes its reasons for so finding or (ii) as to 
which the Exchange consents, the Commission shall: (a) by order approve 
or disapprove 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.

[[Page 51076]]

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 email to rule-comments@sec.gov. Please include 
File Number SR-Phlx-2012-106 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-2012-106. This file 
number should be included on the subject line if email 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, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 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-2012-106 and should be 
submitted on or before September 13, 2012.
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    \14\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\14\
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012-20711 Filed 8-22-12; 8:45 am]
BILLING CODE 8011-01-P


