
[Federal Register Volume 79, Number 131 (Wednesday, July 9, 2014)]
[Notices]
[Pages 39019-39024]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-16047]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-72534; File No. SR-NYSE-2014-12]


Self-Regulatory Organizations; New York Stock Exchange LLC; Order 
Approving Proposed Rule Change Amending Rule 98 To Adopt a Principles-
based Approach To Prohibit the Misuse of Material Nonpublic Information 
and Make Conforming Changes to Other Exchange Rules

July 3, 2014.
    On March 18, 2014, New York Stock Exchange LLC (``NYSE'' or the 
``Exchange''), pursuant to Section 19(b)(1) of the Securities Exchange 
Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ filed with the 
Securities and Exchange Commission (the ``Commission'') a proposed rule 
change to amend Rule 98. The proposed rule change was published for 
public comment in the Federal Register on April 7, 2014.\3\ On May 21, 
2014, the Commission designated a longer period for Commission action 
on the proposed rule change.\4\ The Commission received one comment on 
the proposal.\5\ 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\ Securities Exchange Act Release No. 71837 (Apr. 1, 2014), 75 
FR 19146.
    \4\ See Securities Exchange Act Release No. 72203, 79 FR 30667 
(May 28, 2014).
    \5\ See E-mail from Dr. Leee Jackson, Esq. (Apr. 15, 2014) 
(``Jackson Comment''). The Commission does not believe the Jackson 
Comment raises any material or substantive issues.
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I. Background and Introduction

    The Exchange adopted Rule 98 in 1986, when NYSE specialist firms, 
which had been independent member-owned entities, increasingly became 
affiliates of larger member organizations. Because of the specialists'' 
position in the market, Rule 98 required an organizational separation 
between a specialist and its affiliates. The purpose of that separation 
was to eliminate or control conflicts of interest between the business 
activities of affiliates of the specialist and the specialist's 
responsibilities to the market and to any customer orders the 
specialist represented as agent.\6\
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    \6\ See Securities Exchange Act Release No. 23768 (Nov. 3, 
1986), 51 FR 41183 (Nov. 13, 1986) (SR-NYSE-85-25).
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    In 2008, the NYSE amended Rule 98 to adopt a more flexible, 
principles-based approach that among other things: (1) Redefined the 
persons to whom the rule applied; (2) allowed DMM operations to be 
integrated into better-capitalized member organizations; (3) permitted 
a DMM unit to share non-trading-related services with its parent member 
organization or approved persons; and (4) provided flexibility to 
member organizations and their approved persons in conducting risk 
management of DMM operations.\7\ The principal effect of the 2008 
Amendments was that affiliates of a DMM unit that were walled-off from 
the DMM unit were no longer prohibited from acting as an options market 
maker in a security in which the affiliated DMM was registered. 
However, the amended Rule 98 continued to prohibit the integrated unit 
from coordinating market making between its DMM and its options market 
maker.
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    \7\ See Securities Exchange Act Release No. 58328 (Aug. 7, 
2008), 34 FR 58328 (Aug. 18, 2008) (SR-NYSE-2008-45) (``2008 
Amendments'').
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    The Exchange now proposes to further amend Rule 98 in order to 
provide DMM units with greater flexibility in structuring their 
operations and to move further toward a principles-based approach and 
away from prescribing particular structures for DMM units. Under this 
proposed rule change, certain information barriers would continue to be 
required (for example, between a DMM unit and an affiliated investment-
banking desk), and other required protections, in addition to 
information barriers, would address the role of DMMs and the trading 
floor in the NYSE's market. Proposed Rule 98 would, however, contain 
fewer prescriptions relating to the structure of DMM units, and it 
would instead--like similar rules relating to market-making firms on 
other exchanges \8\--impose a more general requirement that a member 
organization operating a DMM unit maintain and enforce written policies 
and procedures reasonably designed, taking into consideration the 
nature of the member organization's business, (i) to prevent the misuse 
of material, non-public information by the member organization or 
persons associated with it and (ii) to ensure compliance with 
applicable federal laws and regulations and with Exchange rules.
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    \8\ See, e.g., NYSEArca Equities Rule 6.3 and BATS Rule 5.5.
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    The Exchange asserts that the instant proposal should provide 
member organizations operating DMM units with the means to better 
manage risk across a firm--for example, by integrating DMM unit 
positions and quoting information with other quotes and positions by 
other units within the firm. The Exchange posits that a member 
organization operating a DMM unit, in the context of risk management 
\9\ and consistent with protections against the misuse of material non-
public information,\10\ should be able to consider the outstanding 
quotes of the DMM unit as well as traded positions for purposes of 
calculating net positions consistent with Rule 200 of Regulation SHO 
\11\ and calculating intra-day net capital positions. Further, the 
Exchange asserts that a member organization should be able to integrate 
its DMM unit operations with its customer-facing operations because the 
instant proposal, in tandem with existing NYSE conduct rules,\12\ 
FINRA's ongoing surveillances for manipulative conduct, and FINRA's 
program to examine member firms that act as DMMs and to review and 
approve their policies and procedures for complying with Rule 98, 
should provide a regulatory framework that guards customer interests 
and protects against the misuse of material non-public information, 
while increasing the operational flexibility of member organizations.
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    \9\ See, e.g., 17 CFR part 240.15c3-5 (Risk Management Controls 
for Brokers or Dealers with Market Access).
    \10\ See, e.g., 15 U.S.C. 78o(g). Section 15(g) of the Act 
requires every registered broker or dealer to ``establish, maintain, 
and enforce written policies and procedures reasonably designed, 
taking into consideration the nature of such broker's or dealer's 
business, to prevent the misuse . . . of material, nonpublic 
information by such broker or dealer or any person associated with 
such broker or dealer.''
    \11\ 17 CFR 242.200. Under Regulation SHO, determination of a 
seller's net position is based on the seller's positions in the 
security in all proprietary accounts. See Exchange Act Release No. 
50103 (July 28, 2004), 69 FR 48008, 48010 n.22 (Aug. 6, 2004); see 
also Exchange Act Release No. 48709 (Oct. 29, 2003), 68 FR 62972, 
62991 and 62994 (Nov. 6, 2003); Letter from Richard R. Lindsey, 
Director, Division of Market Regulation, to Roger D. Blanc, Wilkie 
Farr & Gallagher, SEC No-Action Letter, 1998 SEC No-Act. LEXIS 1038, 
p. 5 (Nov. 23, 1998); Exchange Act Release No. 30772 (June 3, 1992), 
57 FR 24415, 24419 n.47 (June 9, 1992); Exchange Act Release No. 
27938 (Apr. 23, 1990), 55 FR 17949, 17950 (Apr. 30, 1990).
    \12\ See, e.g., NYSE Rule 5320 (``Manning Rule'').
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II. Description of the Proposed Amendments to Rule 98

    Proposed Rule 98(a)(1) provides that the rule shall apply to all 
member organizations seeking to operate a DMM unit at the Exchange and 
to any approved person that may provide services to a DMM unit.

[[Page 39020]]

    Proposed Rule 98(b) revises, deletes, and adds certain definitions 
to provide member organizations operating a DMM unit with the 
flexibility to integrate their DMM operations with other units of the 
firm. Currently, Rule 98 defines the terms ``non-public order 
information'' and ``DMM confidential information'' separately. Non-
public order information captures any information relating to order 
flow at the Exchange--including verbal indications of interest made 
with an expectation of privacy, electronic order interest, e-quotes, 
reserve interest, and information about imbalances at the Exchange--
that is not publicly-available on a real-time basis via an Exchange-
provided datafeed, such as NYSE OpenBook,\13\ or otherwise publicly 
available. ``DMM confidential information'' refers to principal or 
proprietary trading activity of a DMM unit at the Exchange in the 
securities allocated to it pursuant to Rule 103B, including the unit's 
positions in those securities, decisions relating to trading or quoting 
in those securities, and any algorithm or computer system that is 
responsible for such trading activity and that interfaces with Exchange 
systems.
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    \13\ NYSE OpenBook provides aggregated limit-order volume that 
has been entered on the Exchange at price points for all NYSE-traded 
securities.
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    The Exchange proposes to replace the term ``non-public 
information'' with ``Floor-based non-public information.'' As discussed 
in more detail below, the Exchange proposes to maintain restrictions in 
proposed Rule 98(c)(3) to address the Floor-based activities of DMM 
units, and it proposes to use the term ``Floor-based non-public order 
information'' to identify the information those provisions are intended 
to protect.\14\ The Exchange also proposes to delete the definition of 
``DMM confidential information,'' arguing that proposed Rule 98(c)(2) 
would sufficiently protect against the misuse of material non-public 
information. Further the Exchange notes that, to the extent a DMM on 
the Floor may have access to Floor-based non-public order information, 
proposed Rule 98(c)(3) would continue to specify required protections 
against the misuse of such information by the member organization.
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    \14\ The Exchange proposes non-substantive changes to this 
definition that it believes better reflect how its systems currently 
operate. Specifically, the Exchange asserts that concept of trading 
in ``slow mode'' is duplicative of the remaining rule text, which 
covers any order information that is made available to DMMs but that 
is not available to other market participants.
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    The Exchange proposes to amend the term ``DMM unit'' to mean a 
trading unit within a member organization that is approved pursuant to 
Rule 103 to act as a DMM unit, and it proposes to eliminate the 
requirement that a DMM unit be an ``aggregation unit,'' which is 
currently defined to mean any trading or market-making department, 
division, or desk that meets the requirements of the definition of 
``independent trading unit'' pursuant to Rule 200 of Regulation 
SHO.\15\ The Exchange proposes to decouple the Rule 98 definition from 
Regulation SHO, in part because the two rules have different regulatory 
purposes.\16\ Similarly, the Exchange proposed to delete the term 
``integrated proprietary aggregation unit'' because this term 
contemplates a DMM unit being part of an aggregation unit that only 
engages in proprietary trading activity, which, under the proposal, 
would be an organizational structure that is permitted, but not 
required. The Exchange also proposes to delete the definitions for 
``DMM API,'' ``DMM account,'' ``customer-facing department,'' \17\ and 
``non-trading related services.'' \18\ The Exchange asserts that the 
terms ``DMM API'' and ``DMM account'' are obsolete as they were based 
on NYSE Rule 104 before it was amended in 2008.\19\
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    \15\ The Exchange proposes to delete rule provisions that 
reference the terms ``aggregation unit'' and ``integrated 
proprietary aggregation unit.'' See, e.g., Rule 98(c)(2)(B).
    \16\ See 17 CFR 242.200(f). Rule 200(f) of Regulation SHO sets 
forth the requirements for qualifying as an ``independent trading 
unit'' for the purpose of order marking requirements under Rule 200. 
The Commission notes that a member organization must comply with the 
requirements of Regulation SHO regardless of how its operations are 
structured for purposes of compliance with Rule 98.
    \17\ The Exchange asserts that, because the proposed rule 
changes are intended to provide principles-based requirements for 
the operation of a DMM unit, the amended rule would no longer need 
to define terms, such as ``customer-facing department,'' that 
support the current, more prescriptive rule text.
    \18\ Because these protections for Floor-based non-public order 
information are retained in the proposed revisions to Rule 98 and 
are applicable to approved persons pursuant to proposed amended Rule 
98(a)(1), the Exchange asserts that current Rule 98(e), which 
concerns the sharing of non-trading related services, is redundant 
of existing regulatory requirements governing the operations of a 
broker-dealer.
    \19\ The Exchange also proposes to delete the definitions of 
``DMM'' and ``approved person'' as duplicative of the definitions 
set forth in Rules 2(i) and 2(c). The Exchange proposes to make non-
substantive edits to the definition of ``related products'' and make 
conforming amendments to Rule 2(j).
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    Proposed Rule 98(c) would govern the operation of a DMM unit. 
Proposed Rule 98(c)(1) provides that a member organization will be 
permitted to operate a DMM unit, provided that the member organization 
has obtained prior written approval from the Exchange.\20\ The Exchange 
notes that all member organizations currently operating DMM units 
already have written policies and procedures to comply with Rule 98 in 
its current form, and such policies and procedures have been approved 
by NYSE Regulation.\21\ In addition, FINRA has an exam program that 
reviews member organizations operating DMM units for compliance with 
such policies and procedures. Because proposed Rule 98(a) would 
continue to require Exchange approval of any policies and procedures to 
protect against the misuse of material nonpublic information, if a 
member organization chose to modify its DMM operations consistent with 
proposed Rule 98, its revised policies and procedures would be subject 
to Exchange review before implementation. In addition, the Exchange 
represents that FINRA would continue to monitor a member organization's 
compliance with those policies and procedures consistent with the 
current exam-based regulatory program associated with Rule 98.\22\
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    \20\ Pursuant to NYSE Rule 0, the term ``Exchange'' may also 
mean FINRA staff working on behalf of the Exchange and NYSE 
Regulation, Inc. pursuant to a regulatory services agreement. The 
Exchange also proposes to revise Rule 98(c)(1) to replace the term 
``NYSE Regulation, Inc.'' with the term ``Exchange.''
    \21\ FINRA currently approves Rule 98 procedures on behalf of 
NYSE Regulation, Inc. pursuant to a regulatory services agreement.
    \22\ The Exchange represents that FINRA currently has 
surveillances designed to monitor for manipulative activity, and the 
Exchange asserts that, because DMM market-making activity is not 
materially different from market-making on other exchanges, these 
existing programs are reasonably designed to address any concerns 
that may be raised by a DMM unit being integrated with market-making 
operations.
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    Proposed Rule 98(c)(2) specifies that a member organization seeking 
approval to operate a DMM unit pursuant to Rule 98 must maintain and 
enforce written policies and procedures reasonably designed, taking 
into consideration the nature of such member organization's business, 
(i) to prevent the misuse of material, non-public information by such 
member organizations or persons associated with such member 
organization and (ii) to ensure compliance with applicable federal laws 
and regulations and with Exchange rules.\23\ Proposed Rule 98(c)(2) 
also provides examples of conduct that would constitute the misuse of 
material, non-public information, including, but not limited to: (A) 
trading in any securities issued by a corporation, or in any related 
products, while in possession of material-non-public information 
concerning the issuer; (B)

[[Page 39021]]

trading in a security or related product, while in possession of 
material non-public information concerning imminent transactions in the 
security or related product; or (C) disclosing to another person or 
entity any material, non-public information involving a corporation 
whose shares are publicly traded or an imminent transaction in an 
underlying security or related product for the purpose of facilitating 
the possible misuse of such material, non-public information.
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    \23\ Proposed Rule 98(c)(2) is based on NYSE Arca Equities Rule 
6.3 (Prevention of the Misuse of Material Nonpublic Information) and 
BATS Rule 5.5 (Prevention of the Misuse of Material, Non-Public 
Information).
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    Proposed Rule 98(c)(3) pertains to restrictions on trading for 
member organizations operating a DMM unit. Proposed Rule 98(c)(3)(A) 
would generally provide that a member organization shall protect 
against the misuse of Floor-based non-public order information. The 
rule would further specify that only the Floor-based employees of the 
DMM unit and individuals responsible for the direct supervision of the 
DMM unit's Floor-based operations may have access (as permitted 
pursuant to Rule 104) to Floor-based non-public order information.
    Proposed Rule 98(c)(3)(B) specifies the restrictions applicable to 
employees of the DMM unit while on the trading floor. Proposed Rule 
98(c)(3)(B)(i) provides that, while on the trading floor of the 
Exchange, employees of the DMM unit, except as provided for in Rule 
36.30, may trade only DMM securities and may do so only on or through 
the systems and facilities of the Exchange, as permitted by Exchange 
Rules. Proposed Rule 98(c)(3)(B)(ii) would specify that, while on the 
trading floor, Floor-based employees may not communicate with 
individuals or systems responsible for making trading decisions for 
related products or for away-market trading in DMM securities. Proposed 
Rule 98(c)(3)(B)(iii) adds a new restriction that, while on the trading 
floor, employees of the DMM unit shall not have access to customer 
information or the DMM unit's position in related products.
    Proposed Rule 98(c)(3)(C) would provide that a Floor-based employee 
of a DMM unit who moves to a location off the trading floor of the 
Exchange, or any person who provides risk management oversight or 
supervision of the Floor-based operations of the DMM unit and becomes 
aware of Floor-based non-public order information, shall not (1) make 
such information available to customers, (2) make such information 
available to individuals or systems responsible for making trading 
decisions in DMM securities in away markets or related products, or (3) 
use any such information in connection with making trading decisions in 
DMM securities in away markets or related products. The proposed rule 
would cover an individual that leaves the trading floor, as well as a 
manager providing oversight or supervision of the Floor-based 
operations of the DMM unit. The Exchange's proposed amendments to Rule 
98 would replace the concept of a person having ``access to'' 
information with that of a person being ``aware of'' information,\24\ 
asserting that the change will clarify the governing standard for 
member organizations and make Rule 98 generally more consistent with 
federal rules.\25\ The Exchange also argues that a person cannot misuse 
material, non-public information unless the person is ``aware of'' the 
information. Proposed Rule 98(c)(3)(C) would also maintain and 
consolidate the Exchange's current ``wall-crossing'' provisions related 
to a non-Floor based individual who becomes aware of Floor-based non-
public order information.
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    \24\ The concept of a person having ``access to'' information is 
incorporated into several subsections of current Rule 98. See, e.g., 
current Rule 98(c)(2)(E)(i), (d)(2)(B), and (f)(1)(A)(3).
    \25\ See 17 CFR 240.10b5-1(b) (specifying that a purchase or 
sale of securities constitutes trading on the basis of material 
nonpublic information when the person making the purchase or sale 
was aware of the material nonpublic information when the person made 
the purchase or sale).
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    Proposed Rule 98(c)(3)(D) would provide that a DMM unit may make 
available to a Floor broker associated or affiliated with an approved 
person or member organization any information that the DMM would be 
permitted under Exchange rules to provide to an unaffiliated Floor 
Broker.
    Proposed Rule 98(c)(4) would provide that any interest entered by 
the DMM unit in DMM securities at the Exchange must be entered through 
systems that identify such interest as DMM interest. The Exchange 
asserts that it is unnecessary to prescribe or require specific systems 
that a DMM unit must use, but this rule would require that the DMM 
unit's interest be identifiable and available for Exchange review 
through the system that the DMM unit elects to use.
    Proposed Rule 98(c)(5) would require that a member organization 
provide the Exchange with real-time unit position information for any 
trading in DMM securities by the DMM unit and any independent trading 
unit.\26\ The Exchange represents that this provision should enhance 
its ability to monitor for Rule 104 compliance.\27\ For example, if a 
DMM unit is part of an independent trading unit that engages in trading 
on other markets in DMM securities, the member organization's real-time 
position update would need to incorporate any away-market transactions 
in DMM securities by that independent trading unit.
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    \26\ The Exchange proposes to delete Rule 98(d)(4) from the rule 
both because the Exchange does not believe it needs to separately 
identify DMM audit trail requirements and because Rule 132B no 
longer exists.
    \27\ NYSE Rule 104 obligations relate to whether a DMM is long 
or short and are applicable to the DMM unit's position in DMM 
securities, together with any position of a Regulation SHO 
independent trading unit of which the DMM unit may be included.
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    Proposed Rule 98(c)(6) would specify that a DMM unit may not 
operate as a specialist or market maker on the Exchange or the NYSE MKT 
LLC (``NYSE MKT'') equities or options trading floors in related 
products, unless specifically permitted in Exchange rules.\28\ The 
Exchange notes that a member organization that operates a DMM unit may 
be a specialist or market maker on NYSE MKT, provided that it maintains 
appropriate information barriers. Currently, Rule 98 permits an 
integrated proprietary aggregation unit to engage in options market 
making (electronic only), provided that the DMM unit is walled off from 
the options market making trading desk.
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    \28\ Currently, the Exchange represents, the only time that a 
DMM unit may engage in market making in a related products under 
Exchange rules is on the NYSE MKT exchange, pursuant to NYSE MKT 
Rule 504(b)(5)--Equities. NYSE does not have a similar exception.
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    Proposed Rule 98(c)(7) would maintain the existing requirement that 
the member organization maintain information barriers between the DMM 
unit and any investment banking or research departments. Proposed Rule 
98(c)(7) would also continue to provide that no DMM or DMM unit may be 
directly supervised or controlled by an individual associated with an 
approved person or the member organization who is assigned to any 
investment banking or research departments.
    Proposed Rule 98(d) would specify that DMM rules would only apply 
to the DMM unit's quoting or trading in their DMM securities for their 
own accounts at the Exchange. The Exchange represents that this 
provision is intended to clarify that DMM rule restrictions are not 
applicable to any customer orders routed to the Exchange by that member 
organization as agent.
    The Exchange proposes to delete in its entirety Rule 98(e), which 
concerns the sharing of non-trading related services. The Exchange 
states that the focus of proposed Rule 98 on protecting against the 
misuse of material non-public information obviates the need to specify 
how a member organization or an

[[Page 39022]]

approved person provides back-office support operations, such as 
clearing, stock loan, and compliance, for the DMM unit. Rather, the 
Exchange asserts that how a member organization or approved person 
provides back-office operations to the DMM unit should not differ from 
how such services are provided to other trading units within that 
member organization or approved person. The Exchange also notes that, 
if a person in the member organization or an approved person is 
providing non-trading related services to the DMM unit and, as a result 
of such relationship, becomes aware of Floor-based non-public order 
information, such person would be subject to the wall-crossing 
provisions of proposed Rule 98(c)(3)(C), which is applicable to any 
person who is aware of such information. In addition, the Exchange 
notes that the protections for Floor-based non-public order information 
are retained in the proposed revisions to Rule 98 and are applicable to 
approved persons pursuant to proposed amended Rule 98(a)(1). The 
Exchange proposes conforming amendments to Rule 36.30.
    As part of the proposed restructuring of Rule 98, current Rule 
98(g) would be renumbered as proposed Rule 98(e), existing Rule 98(h) 
would be renumbered as proposed Rule 98(f), and existing Rule 98(j) 
would be renumbered as proposed Rule 98(g). The Exchange proposes 
conforming changes to these sections, such as updating cross-references 
and changing the rule's reference to ``the Division of Market 
Surveillance'' and ``NYSE Regulation'' to a reference to ``the 
Exchange.'' \29\
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    \29\ Pursuant to Rule 0, the reference to the Exchange in this 
rule may also mean FINRA.
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    The Exchange proposes to delete Rule 98 Former, as well as any 
references thereto, because it is obsolete: All DMM firms operate 
pursuant to the current Rule 98.\30\ In addition, the Exchange proposes 
to amend Rule 105 to delete Rule 105(b)-(d) and the Guidelines for 
DMM's Registered Security Option and Single Stock Futures Transactions 
Pursuant to Rule 105 (``Rule 105 Guidelines'') and to make conforming 
amendments to Rule 36.30.\31\ Rule 105 currently sets forth hedging 
guidelines to permit a DMM to trade from the trading floor listed 
options or single-stock futures that overlie DMM securities. Under Rule 
98(f)(1), a DMM unit can obtain an exemption from the Rule 105 
Guidelines to trade options or futures, provided that such trading is 
conducted by a walled-off, off-Floor trading desk.
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    \30\ See, e.g., NYSE Rules 98A Former, 99 Former, and 
104T(a)(Former) and supplementary material .13 (Former), Rule 900, 
Rule 98(a) and 105.
    \31\ The Exchange proposes to amend Rule 105(a) to clarify that 
the restriction on pool dealing applies to the DMM unit for 
securities registered to that unit.
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    Under the proposed revisions to Rule 98, a DMM unit would no longer 
need to apply for an exemption from Rule 105 trading restrictions 
because, as discussed above, while on the trading floor, Floor-based 
employees may trade only DMM securities (i.e., they may not trade in 
related products) and may trade only on or through the systems and 
facilities of the Exchange. Because there would not be any Floor-based 
trading in listed options or single-stock futures, the Rule 105 
Guidelines specifying how such Floor-based trading may occur would be 
moot. Accordingly, the Exchange proposes to delete these rules. To 
conform other Exchange rules to this proposal, the Exchange also 
proposes to delete section (b) from each of Rules 1300 (streetTRACKS 
Gold Shares), 1300A (Currency Trust Shares), and 1300B (Commodity Trust 
Shares). Each of these subsections cross-references Rule 105 Guidelines 
subsection (m) and would similarly be mooted by proposed Rule 
98(c)(2)(B)(i). The Exchange proposes further conforming amendments to 
Rules 900(b) and (d).
    In addition, because DMM units no longer have customer 
relationships, the Exchange proposes to delete in its entirety the DMM 
Booth Wire Policy, which is set forth in Rule 123B and which is now 
obsolete.

III. Commission Findings

    After careful consideration, 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.\32\ The Commission believes that the proposal is consistent 
with Section 6(b)(5) \33\ in particular in that it is 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 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.
    Generally, the Exchange proposes to amend Rule 98 in order to 
provide DMM units with greater flexibility in structuring their 
operations, moving further toward a principles-based approach and away 
from prescribing particular structures. Under the proposed rule change, 
certain information barriers would continue to be required,\34\ but 
amended Rule 98 would generally contain fewer prescriptions than 
current Rule 98 and would instead require that a member organization 
operating a DMM unit maintain and enforce written policies and 
procedures reasonably designed, taking into consideration the nature of 
the member organization's business, (i) to prevent the misuse of 
material, non-public information by the member organization or persons 
associated with it and (ii) to ensure compliance with applicable 
federal laws and regulations and with Exchange rules.\35\ The Exchange 
represents that the instant proposed rule change prescribes specific 
protections that reflect the unique role of DMMs and the trading floor 
at the Exchange, while treating the off-floor market-making activity of 
member organizations with DMM units similarly to the rules that govern 
equity market makers on NYSE Arca, Nasdaq, and BATS.\36\
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    \32\ In approving this rule change, the Commission notes that it 
has considered the proposed rule's impact on efficiency, 
competition, and capital formation. See 15 U.S.C. 78c(f).
    \33\ 15 U.S.C. 78f(b)(5).
    \34\ See proposed Rules 98(c)(3) and 98(c)(7).
    \35\ See proposed Rule 98(c)(2).
    \36\ See Securities Exchange Act Release No. 60604 (Sept. 2, 
2009), 76 FR 46272 (Sept. 8, 2009) (SR-NYSEArca-2009-78) (Order 
approving elimination of NYSE Arca rule that required market makers 
to establish and maintain specifically prescribed information 
barriers, including discussion of NYSE Arca and Nasdaq rules) 
(``NYSE Arca Order''). See also Securities Exchange Act Release No. 
61574 (Feb. 23, 2010), 75 FR 9455 (Mar. 2, 2010) (SR-BATS-2010-003) 
(Order approving amendments to BATS Exchange, Inc. (``BATS'') Rule 
5.5 to move to a principles-based approach to protecting against the 
misuse of material, non-public information, and noting that the 
proposed change is consistent with the approaches of NYSE Arca and 
Nasdaq) (``BATS Order'').
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    In patricular, proposed Rule 98(a) provides that a member 
organization will be permitted to operate a DMM unit provided that the 
member organization has obtained prior written approval from the 
Exchange. The Exchange represents that, although all member 
organizations currently operating DMM units under Rule 98 have written 
policies and procedures that have been approved by NYSE Regulation, 
Inc., the policies and procedures of member organizations that choose 
to modify their DMM operations consistent with proposed Rule 98 would 
be subject to Exchange review prior to implementation. In addition, the 
Exchange represents that FINRA would continue to monitor member 
organizations for compliance with such policies and procedures 
consistent with the current exam-based regulatory program associated 
with Rule 98.

[[Page 39023]]

    Proposed Rule 98(c)(2) would replace the current, more prescriptive 
approach of current Rule 98 and would provide member organizations 
operating a DMM unit with greater organizational and operational 
flexibility, while still requiring that member organizations comply 
with their existing regulatory obligations. Specifically, proposed NYSE 
Rule 98(c)(2) would require a member organization seeking approval to 
operate a DMM unit to maintain and enforce written policies and 
procedures reasonably designed, taking into consideration the nature of 
such member organization's business, (i) to prevent the misuse of 
material, non-public information by such member organizations or 
persons associated with such member organization and (ii) to ensure 
compliance with applicable federal laws and regulations and with 
Exchange rules. In addition, proposed Rule 98(c)(2) would specify that 
conduct constituting the misuse of material, non-public information 
includes, but is not limited to: (A) trading in any securities issued 
by a corporation, or in any related product, while in possession of 
material-non-public information concerning the issuer; or (B) trading 
in a security or related product, while in possession of material non-
public information concerning imminent transactions in the security or 
related product; or (C) disclosing to another person or entity any 
material, non-public information involving a corporation whose shares 
are publicly traded or an imminent transaction in an underlying 
security or related product for the purpose of facilitating the 
possible misuse of such material, non-public information. Although the 
Exchange proposes to move to a more principles-based approach, and 
although certain information barriers may no longer be required, the 
Commission notes, and the Exchange acknowledges, that a member 
organization's business model or business activities may dictate that 
an information barrier or functional separation be part of the 
appropriate set of policies and procedures that would be reasonably 
designed to achieve compliance with applicable securities laws and 
regulations and with applicable Exchange rules.\37\ In addition, the 
Commission notes that all member organizations of the Exchange are 
subject to the requirements of Section 15(g) of the Act, regardless of 
how their operations are structured.\38\
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    \37\ This aspect of Exchange's proposal and of the Commission's 
findings is consistent with similar rules at other exchanges. See 
NYSE Arca Order at 46275 and BATS Order at 9459.
    \38\ 15 U.S.C. 78o(g). Section 15(g) of the Act requires brokers 
and dealers to ``establish, maintain, and enforce written policies 
and procedures reasonably designed, taking into consideration the 
nature of such broker's or dealer's business, to prevent the misuse 
. . . of material, nonpublic information by such broker or dealer or 
any person associated with such broker or dealer.''
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    The Commission notes that amended Rule 98 would delete the defined 
term ``DMM confidential information'' and would replace the defined 
term ``non-public information'' with the term ``Floor-based non-public 
information.'' In the Commission's view, these definitional 
modifications should not reduce investor protections or market 
integrity. Instead, consistent with proposed Rule 98(c)(2) and Section 
15(g) of the Act,\39\ member organizations will continue to have 
obligations to implement reasonably designed policies and procedures to 
prevent the misuse of material, non-public information, and they will 
continue to be subject to Exchange rules regarding front-running, 
limit-order display, and trading ahead, as well as FINRA surveillances 
to detect violations of these rules.
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    \39\ 15 U.S.C. 78o(g).
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    The Commission notes that proposed Rule 98(c)(2) is substantially 
similar to and expressly based on NYSE Arca Rule 6.3 and BATS Rule 5.5. 
NYSE's market structure, however differs from that of NYSE Arca and 
BATS, in that the Exchange continues to have a physical trading floor. 
Accordingly, the Commission believes that it is appropriate that 
proposed Rule 98 continues to include certain prescriptions that 
address the role of the DMM and the trading floor in its market. 
Specifically, as described above, proposed Rule 98(c)(3) relates to 
restrictions on trading for member organizations operating a DMM unit; 
proposed Rule 98(c)(4) would provide that any interest entered by the 
DMM unit in DMM securities at the Exchange must be entered through 
systems that identify such interest as DMM interest; proposed Rule 
98(c)(5) would require that a member organization provide the Exchange 
with real-time unit position information for any trading in DMM 
securities by the DMM unit and any independent trading unit; proposed 
Rule 98(c)(6) would specify that a DMM unit may not operate as a 
specialist or market maker on the Exchange or the NYSE MKT equities or 
options trading floors in related products, unless specifically 
permitted in Exchange rules; and proposed Rule 98(c)(7) would maintain 
the existing requirement that the member organization maintain 
information barriers between the DMM unit and any investment banking or 
research departments.
    Under this proposed rule change, member organizations could 
integrate DMM units with other trading operations within the member 
organization, including, if applicable, a customer-facing operation. 
The Commission notes that a DMM unit that is integrated with other 
market-making operations would be subject to existing rules that 
prohibit member organizations from disadvantaging their customers or 
other market participants by improperly capitalizing on a member 
organization's access to the receipt of material, non-public 
information. For instance, NYSE Rule 5320 generally prohibits a member 
organization from trading for its own account ahead of customer orders, 
which means that a member organization operating both a DMM unit, which 
engages in trading for its own account, and customer-facing operations 
would need to comply with the Manning Rule \40\ or meet one of the 
specified exceptions.\41\ Moreover, the Commission notes that (1) the 
Exchange has represented that FINRA currently has surveillances 
designed to monitor for manipulative activity, that DMM market-making 
activity off the trading floor is not materially different from market-
making on other exchanges, and that, therefore, the existing regulatory 
framework is reasonably designed to address any concerns that may be 
raised by a DMM unit being integrated with market-making operations and 
(2) the Exchange has represented that FINRA currently conducts a 
program that approves and examines Rule 98 policies and procedures.
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    \40\ See Manning Rule, supra, note 12.
    \41\ NYSE Rule 5320 further provides that, if a member 
organization trades at a price for its own account ahead of the 
customer order, it must execute the customer order up to the size 
and at a price that is the same as, or better than, the price at 
which the organization traded for its own account.
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    The Commission believes that the proposed rule change is consistent 
with the Act. The principles-based regulatory approach in the proposal 
is substantially similar to the existing regulatory approach of NYSE 
Arca and BATS, while also accounting for the market structure 
differences (i.e., the role of DMM units and the trading floor on the 
Exchange) that raise additional regulatory and policy considerations. 
While proposed Rule 98 permits member organizations greater flexibility 
in structuring their business and compliance operations, the rule 
continues to require the maintenance of certain appropriate information 
barriers,

[[Page 39024]]

and it clearly requires that all member organizations have policies and 
procedures that are reasonably designed to prevent the misuse of 
material, non-public information.\42\
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    \42\ The Commission notes that such policies and procedures may 
include the programming and operation of a member organization's 
trading algorithms to protect against the misuse of material non-
public information.
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    The Commission notes that the policies and procedures required 
proposed Rule 98 will be subject to oversight by the Exchange and 
review by FINRA, and the Commission emphasizes that a member 
organization operating a DMM unit should be proactive in assuring that 
its policies and procedures reflect the current state of its business 
and continue to be reasonably designed to achieve compliance with 
applicable federal securities law and regulations and with applicable 
Exchange and FINRA rules. Finally, the Commission notes that existing 
Exchange rules also prohibit particular misuses of material, non-public 
information--for example, front-running customer orders--and that FINRA 
surveillances seek to detect violations of those rules.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (SR-NYSE-2014-012), is hereby approved.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\43\
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    \43\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
 [FR Doc. 2014-16047 Filed 7-8-14; 8:45 am]
BILLING CODE 8011-01-P


