
[Federal Register Volume 79, Number 239 (Friday, December 12, 2014)]
[Notices]
[Pages 73930-73938]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-29109]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-73784; File No. SR-BX-2014-049]


Self-Regulatory Organizations; NASDAQ OMX BX, Inc.; Notice of 
Filing of Proposed Rule Change Relating to Directed Market Makers

December 8, 2014.
    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 November 25, 2014, NASDAQ OMX BX, Inc. (``BX'' or ``Exchange'') 
filed with the Securities and Exchange Commission (``SEC'' or 
``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the Exchange. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to add definitions of Directed Order and 
Directed Market Maker (``DMM''), as well as provisions concerning the 
designation of an order as a Directed Order and DMM market making 
obligations. The proposal also revises priority rules to provide for a 
DMM participation entitlement. Finally, the rule makes certain 
clarifications to the text of rules governing Lead Market Makers 
(``LMMs''). The proposal seeks to enable BX to compete with the many 
options exchanges that offer directed orders in their respective 
markets.
    The text of the proposed rule change is available on the Exchange's 
Web site at http://nasdaqomxbx.cchwallstreet.com, at the principal 
office of the Exchange, and at the Commission's Public Reference Room.

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

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

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

1. Purpose
    The purpose of the proposed rule change is to adopt rules to permit 
BX Market Makers to act as Designated Market Makers, or DMMs, in their 
appointed options classes, provided the DMM meets certain obligations 
and quoting requirements as provided for in the new proposed Exchange 
Rules. The Exchange proposes to provide DMMs with certain participation 
entitlements. The Exchange believes that these amendments, described 
below in greater detail, will enhance competition by affording the BX 
Options market the opportunity to compete for directed order flow.
Current Categories of BX Options Participants
    Today on BX there are three types of Options Participants: Options 
Order Entry Firms, Options market makers and LMMs. Options Order Entry 
Firms, or OEFs, are Options Participants who represent customer orders 
as agent on BX Options and non-market maker Participants conducting 
proprietary trading as principal.
    Options market makers are Options Participants registered with the 
Exchange as options market makers in one or more listed options on 
BX.\3\ BX Options market makers are required to electronically engage 
in a course of dealing to enhance liquidity available on BX and to 
assist in the maintenance of fair and orderly markets.\4\ Among

[[Page 73931]]

other things, Options market makers must quote 60 percent of the 
trading day (as a percentage of the total number of minutes in such 
trading day) or such higher percentage as BX may announce in 
advance.\5\
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    \3\ See BX Options Rules at Chapter VII.
    \4\ Options market makers receive certain benefits for carrying 
out their duties. For example, a lender may extend credit to a 
broker-dealer without regard to the restrictions in Regulation T of 
the Board of Governors of the Federal Reserve System if the credit 
is to be used to finance the broker-dealer's activities as market 
maker on a national securities exchange. Thus, an Options market 
maker has a corresponding obligation to hold itself out as willing 
to buy and sell options for its own account on a regular or 
continuous basis to justify this favorable treatment.
    \5\ BX Regulation may consider exceptions to the requirement to 
quote 60 percent (or higher) of the trading day based on 
demonstrated legal or regulatory requirements or other mitigating 
circumstances. Market makers are not required to make two-sided 
markets pursuant to Section 5(a)(i) of Chapter VII in any Quarterly 
Option Series, adjusted option series, or any option series until 
the time to expiration for such series is less than nine months. 
Accordingly, the continuous quotation obligations set forth in this 
rule do not apply to market makers respecting Quarterly Option 
Series, adjusted option series, or any series with an expiration of 
nine months or greater. If a technical failure or limitation of a 
system of BX prevents a market maker from maintaining, or prevents a 
market maker from communicating to BX Options, timely and accurate 
quotes, the duration of such failure or limitation shall not be 
included in any of these calculations with respect to the affected 
quotes. Substantial or continued failure by an Options market maker 
to meet any of its obligations and duties, will subject the Options 
market maker to disciplinary action, suspension, or revocation of 
the Options market maker's registration in one or more options 
series. See obligations of Options market makers in Chapter VII, 
Section 6.
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    Recently, the Exchange adopted rules providing that an approved BX 
Options market maker may become an LMM in one or more listed options, 
provided that each class is limited to one LMM.\6\ BX does not limit 
the number of entities that may become LMMs. LMMs are subject to more 
extensive obligations than other BX Options market makers, including an 
obligation to provide continuous two-sided quotations meeting certain 
quote width requirements throughout the trading day in its appointed 
issues for 90 percent of the time the Exchange is open for trading in 
each issue.\7\ The Exchange provides LMMs with specific participation 
entitlements in Chapter VI (Trading Systems) at Section 10, entitled 
``Book Processing.''
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    \6\ See Chapter VII, Section 13.
    \7\ See Chapter VII, Section 14.
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DMM Designation and Directed Orders
    The Exchange is now proposing to define Directed Orders and to 
provide for another category of market maker, the DMM. A ``Directed 
Order'' would be defined as an order to buy or sell which has been 
directed (pursuant to the Exchange's instructions on how to direct an 
order) to a particular market maker (the DMM with respect to that 
Directed Order).\8\ Pursuant to a proposed amendment to Chapter VI, 
Section 6(a)(2), Limit Orders,\9\ Minimum Quantity Orders,\10\ Market 
Orders,\11\ Price Improving Orders,\12\ All-or-None Orders \13\ and 
Post-Only Orders \14\ may all be designated as Directed Orders. A 
Directed Order may also be designated as Immediate or Cancel 
(``IOC''),\15\ Good-till-Cancelled (``GTC''),\16\ Day (``DAY'') \17\ or 
a WAIT \18\ order pursuant to Chapter VI, Section 6(a)(1) as proposed 
to be amended. New Section 15, DMMs, of Chapter VII, Market 
Participants, provides that market makers may receive Directed Orders 
in their appointed classes as provided therein, provided they indicated 
to the Exchange, in a form specified, that they will receive Directed 
Orders. Directed Orders may be available only in certain options.\19\
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    \8\ See proposed Chapter VI, Section 1(e)(1), which replaces a 
Reserved section with a definition of Directed Order. The new 
provision also states that Directed Orders are handled within the 
System pursuant to Chapter VI, Section 10.
    \9\ See Chapter VI, Section 1(e)(2). ``Limit Orders'' are orders 
to buy or sell an option at a specified price or better. A limit 
order is marketable when, for a limit order to buy, at the time it 
is entered into the System, the order is priced at the current 
inside offer or higher, or for a limit order to sell, at the time it 
is entered into the System, the order is priced at the inside bid or 
lower.
    \10\ See Chapter VI, Section 1(e)(3). ``Minimum Quantity 
Orders'' are orders that require that a specified minimum quantity 
of contracts be obtained, or the order is cancelled. Minimum 
Quantity Orders are treated as having a time-in-force designation of 
Immediate or Cancel. Minimum Quantity Orders received prior to the 
opening cross or after market close will be rejected.
    \11\ See Chapter VI, Section 1(e)(5). ``Market Orders'' are 
orders to buy or sell at the best price available at the time of 
execution. Participants can designate that their Market Orders not 
executed after a pre-established period of time, as established by 
the Exchange, will be cancelled back to the Participant.
    \12\ See Chapter VI, Section 1(a)(6). ``Price Improving Orders'' 
are orders to buy or sell an option at a specified price at an 
increment smaller than the minimum price variation in the security. 
Price Improving Orders may be entered in increments as small as one 
cent. Price Improving Orders that are available for display shall be 
displayed at the minimum price variation in that security and shall 
be rounded up for sell orders and rounded down for buy orders.
    \13\ See Chapter VI, Section 1(e)(10). ``All-or-none'' shall 
mean a market or limit order which is to be executed in its entirety 
or not at all. All-or-None Orders are treated as having a time-in-
force designation of Immediate or Cancel. All-or-None Orders 
received prior to the opening cross or after market close will be 
rejected.
    \14\ See Chapter VI, Section 1(e)(11). ``Post-Only Orders'' are 
orders that will not remove liquidity from the System. Post-Only 
Orders are to be ranked and executed on the Exchange or cancelled, 
as appropriate, without routing away to another market. Post-Only 
Orders are evaluated at the time of entry with respect to locking or 
crossing other orders as follows: (i) If a Post-Only Order would 
lock or cross an order on the System, the order will be re-priced to 
$.01 below the current low offer (for bids) or above the current 
best bid (for offers) and displayed by the System at one minimum 
price increment below the current low offer (for bids) or above the 
current best bid (for offers); and (ii) if a Post-Only Order would 
not lock or cross an order on the System but would lock or cross the 
NBBO as reflected in the protected quotation of another market 
center, the order will be handled pursuant to Chapter VI, Section 
7(b)(3)(C). Participants may choose to have their Post-Only Orders 
returned whenever the order would lock or cross the NBBO or be 
placed on the book at a price other than its limit price. Post-Only 
Orders received prior to the opening cross or after market close 
will be rejected. Post-Only Orders may not have a time-in-force 
designation of Good Til Cancelled or Immediate or Cancel. Although a 
Post-Only Order may be designated as a Directed Order, because it is 
not executed immediately upon receipt it will never result in the 
awarding of a DMM participation entitlement as discussed below.
    \15\ See Chapter VI, Section 1(g)(2). ``Immediate Or Cancel'' or 
``IOC'' shall mean for orders so designated, that if after entry 
into the System a marketable order (or unexecuted portion thereof) 
becomes non-marketable, the order (or unexecuted portion thereof) 
shall be canceled and returned to the entering participant. IOC 
Orders shall be available for entry from the time prior to market 
open specified by the Exchange on its Web site until market close 
and for potential execution from 9:30 a.m. until market close. IOC 
Orders entered between the time specified by the Exchange on its Web 
site and 9:30 a.m. Eastern Time will be held within the System until 
9:30 a.m. at which time the System shall determine whether such 
orders are marketable. IOC orders can be routed if designated as 
routable.
    \16\ See Chapter VI, Section 1(g)(4). ``Good Til Cancelled'' or 
``GTC'' shall mean for orders so designated, that if after entry 
into System, the order is not fully executed, the order (or 
unexecuted portion thereof) shall remain available for potential 
display and/or execution unless cancelled by the entering party, or 
until the option expires, whichever comes first. GTC Orders shall be 
available for entry from the time prior to market open specified by 
the Exchange on its Web site until market close and for potential 
execution from 9:30 a.m. until market close.
    \17\ See Chapter VI, Section 1(g)(3). ``DAY'' shall mean for 
orders so designated, that if after entry into the System, the order 
is not fully executed, the order (or unexecuted portion thereof) 
shall remain available for potential display and/or execution until 
market close, unless canceled by the entering party, after which it 
shall be returned to the entering party. DAY Orders shall be 
available for entry from the time prior to market open specified by 
the Exchange on its Web site until market close and for potential 
execution from 9:30 a.m. until market close.
    \18\ See Chapter VI, Section 1(g)(5). ``WAIT'' shall mean for 
orders so designated, that upon entry into the System, the order is 
held for one second without processing for potential display and/or 
execution. After one second, the order is processed for potential 
display and/or execution in accordance with all order entry 
instructions as determined by the entering party.
    \19\ The Exchange would specify via an Options Trader Alert 
which options would be subject to the Directed Orders provisions 
specified herein.
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    Pursuant to new Chapter VII, Market Participants, Section 15, when 
the Exchange's disseminated price is the NBBO at the time of receipt of 
the Directed Order, and the DMM is quoting at or improving \20\ the 
Exchange's

[[Page 73932]]

disseminated price, the Directed Order will be automatically executed 
and allocated in accordance with Chapter VI, Section 10 such that the 
DMM will receive a DMM participation entitlement provided for in 
Chapter VI, Section 10, discussed below.\21\ If the DMM participation 
entitlement is not awarded at the time of receipt of the Directed 
Order, no DMM participation entitlement will apply and the order will 
be handled as though it were not a Directed Order for the remainder of 
the life of the order. However, when (a) the Exchange's disseminated 
price is the NBBO, and the quotation disseminated by the DMM on the 
opposite side of the market from the Directed Order is inferior to the 
NBBO at the time of receipt of the Directed Order, or (b) the 
Exchange's disseminated price is not the NBBO at the time of receipt of 
the Directed Order, the Directed Order will be processed as though it 
were not a Directed Order.\22\
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    \20\ Today, BX Options Participants enter Price Improving 
Orders, which orders have a specified price smaller than the minimum 
price variation (``MPV'') in the option. Price Improving Orders may 
be entered in increments as small as one cent. Price Improving 
Orders will be displayed at the MPV in that security and rounded up 
for sell orders and down for buy orders. Without this order type, 
market participants would not be able to submit orders priced 
between the MPV. Instead, orders, if submitted, would be priced (and 
displayed) at the MPV. The treatment of Price Improving Orders is 
not altered by this rule change. It is consistent to account for the 
possibility that the DMM improves the Exchange's disseminated price 
by submitting a marketable order in a non-standard increment, which 
in this case, would aggressively improve the NBBO. Awarding a 
participation entitlement to a DMM will not otherwise change the 
manner in which Price Improving Orders will be displayed at the MPV 
and available to be executed at price improving increments.
    \21\ Chapter VII, Market Participants, Section 15, Directed 
Market Makers, subsection (i) Price Improving Orders from a DMM 
participant which are reflected on OPRA at the NBBO retain price 
priority and are eligible for a DMM participation entitlement.
    \22\ See Chapter VII, Market Participants, Section 15, Directed 
Market Makers, subsection (ii).
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    New Section 15 requires a DMM to provide continuous two-sided 
quotations throughout the trading day in all options issues in which 
the DMM is assigned for 90 percent of the time the Exchange is open for 
trading in each issue. Such quotations must meet the legal quote width 
requirements of Chapter VII, Section 6. These obligations will apply 
collectively to all series in all of the issues, rather than on an 
issue-by-issue basis once the market maker has indicated to the 
Exchange that the market maker will be receiving Directed Orders. While 
the Market Maker's quoting requirement is a daily obligation, the 
Exchange is able to determine compliance with these obligations on a 
monthly basis. BX Regulation may consider exceptions to the requirement 
to quote 90% (or higher) of the trading day based on demonstrated legal 
or regulatory requirements or other mitigating circumstances.\23\ If a 
technical failure or limitation of a system of the Exchange prevents a 
DMM from maintaining, or prevents a DMM from communicating to the 
Exchange, timely and accurate electronic quotes in an issue, the 
duration of such failure shall not be considered in determining whether 
the DMM has satisfied the 90 percent quoting standard with respect to 
that option issue. Further, these obligations shall not apply to DMMs 
with respect to Quarterly Options Series, adjusted option series,\24\ 
or any series with a time to expiration of nine months or greater. 
However, a DMM may still receive a participation entitlement in such 
series if it elects to quote in such series and otherwise satisfies the 
requirements of Chapter VI, Section 10.
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    \23\ Chapter VII, Market Participants, Section 15, Directed 
Market Makers, subsection (iii).
    \24\ An adjusted option series is an option series wherein, as a 
result of a corporate action by the issuer of the underlying 
security, one option contract in the s [sic]
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LMM and New DMM Participation Entitlements
    By way of background, Chapter VI, Trading System, Section 10, Book 
Processing, currently provides that the Exchange will determine to 
apply, for each option, either a Price/Time or a Size Pro-Rata 
execution algorithm. In addition to describing each execution 
algorithm, Chapter VI, Section 10 also describes certain priority 
overlays applicable to each of those algorithms.
    Currently, under both Price/Time and Size Pro-Rata algorithms, 
Public Customer Priority is always in effect and provides that the 
highest bid and lowest offer have priority except that Public Customer 
orders have priority over non-Public Customer orders at the same price. 
If there are two or more Public Customer orders for the same options 
series at the same price, priority is afforded to such Public Customers 
orders in the sequence in which they are received by the System. For 
purposes of the Public Customer Priority overlay, a Public Customer 
order does not include a Professional \25\ order.
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    \25\ See Chapter I, Section 1(a)(49). The term ``Professional'' 
means any person or entity that (i) is not a broker or dealer in 
securities, and (ii) places more than 390 orders in listed options 
per day on average during a calendar month for its own beneficial 
account(s). A Participant or a Public Customer may, without 
limitation, be a Professional. All Professional orders shall be 
appropriately marked by Participants.
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    Chapter VI, Section 10 also currently provides for a LMM priority 
overlay after all Public Customer orders have been fully executed, upon 
receipt of an order, provided the LMM's bid/offer is at the Exchange's 
disseminated price. The LMM priority overlay applies under both the 
Price/Time and the Size Pro-Rata execution algorithms, if applicable.
    Specifically, with respect to Size Pro-Rata executions, the 
Exchange affords an LMM a participation entitlement if the LMM's bid/
offer is at or better than the Exchange's disseminated price and all 
Public Customer \26\ orders have been fully executed.\27\ The LMM is 
not entitled to receive a number of contracts that is greater than the 
displayed size associated with such LMM. LMM participation entitlements 
are considered after the opening process. The LMM participation 
entitlement provides a BX Options LMM with the greater of: The LMM's 
Size Pro-Rata share; 50 percent of remaining interest if there is one 
or no other market maker at that price; 40 percent of remaining 
interest if there are two other market makers at that price; or 30 
percent of remaining interest if there are more than two other market 
makers at that price; or if rounding would result in an allocation of 
less than one contract, a BX Options LMM receives one contract. 
Rounding is up or down to the nearest integer.\28\ After all Public 
Customer orders have been fully executed and LMM participation 
entitlements applied, if applicable, BX Options market makers then have 
priority over all other Participant orders at the same price.\29\
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    \26\ See Chapter I, Section 1(50). The term ``Public Customer'' 
means a person that is not a broker or dealer in securities.
    \27\ Price Improving Orders retain price priority before an LMM 
participation entitlement is provided at the Exchange's disseminated 
price. See Chapter VI, Sections 1(a)(6) and 7(b)(3)(B).
    \28\ When the decimal is exactly 0.5, the rounding direction is 
up to the nearest integer.
    \29\ Chapter VI, Trading Systems, Section 10, Book Processing, 
subsection (C)(2)(ii)(1).
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    For symbols trading under the Price/Time algorithm, the Public 
Customer Priority Overlay is always in effect. Chapter VI, Section 10 
also currently provides for a LMM priority overlay after all Public 
Customer orders have been fully executed, upon receipt of an order, 
provided the LMM's bid/offer is at or better than the Exchange's 
disseminated price, the LMM is afforded a participation 
entitlement.\30\ The LMM is not entitled to receive a number of 
contracts that is greater than the displayed size associated with such 
LMM. After Public Customers orders have been executed, a BX Options LMM

[[Page 73933]]

receives the greater of: (a) Contracts the LMM would receive if the 
allocation was based on time priority with Public Customer priority; 
(b) 50 percent of remaining interest if there is one or no other market 
maker at that price; (c) 40 percent of remaining interest if there are 
two other market makers at that price; or (d) 30 percent of remaining 
interest if there are more than two other market makers at that price 
or if rounding would result in an allocation of less than one contract, 
a BX Options LMM receives one contract. Rounding is up or down to the 
nearest integer.\31\
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    \30\ As is the case with Size Pro-Rata executions discussed 
above, Price Improving Orders retain price priority before an LMM 
participation entitlement is provided at the Exchange's disseminated 
price. See Chapter VI, Sections 1(a)(6) and 7(b)(3)(B).
    \31\ Chapter VI, Trading Systems, Section 10, Book Processing, 
subsection (C)(1)(b)(1).
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    Under both the Price/Time algorithm and the Size Pro-Rata 
algorithm, Orders for 5 contracts or fewer are allocated to the LMM. 
The Exchange reviews this provision quarterly and maintains the small 
order size at a level that will not allow orders of 5 contracts or less 
executed by the LMM to account for more than 40 percent of the volume 
executed on the Exchange.\32\
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    \32\ Chapter VI, Trading Systems, Section 10, Book Processing, 
subsections (C)(1)(b)(2) and (C)(2)(ii)(2).
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    The Exchange is now proposing to amend its rules to provide for a 
DMM priority entitlement under both the Price/Time and the Size Pro-
Rata algorithm, and to make certain corresponding changes and 
clarifications to the current LMM participation entitlements. Under 
both Price/Time and Size Pro-Rata algorithms, a market maker which 
receives a Directed Order is a DMM with respect to that Directed Order. 
After all Public Customer orders at a given price point have been fully 
executed, upon receipt of a Directed Order, provided the DMM's bid/
offer is at or improves the NBBO, the DMM will be afforded a 
participation entitlement \33\ at the last execution price, which is 
equal to or better than the NBBO if the DMM executed the order at such 
price. The DMM shall not be entitled to receive a number of contracts 
that is greater than the displayed size at a given price point 
associated with such DMM. DMM participation entitlements will be 
considered after the opening process. Chapter VI, Section 10(C)(1)(c) 
specifies that under the Price/Time execution algorithm, DMM 
participant entitlements (like LMM participation entitlements) \34\ 
shall only be in effect when the Public Customer Priority Overlay is 
also in effect.
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    \33\ As with the LMM participation entitlements discussed above, 
Price Improving Orders retain price priority. A DMM participation 
entitlement will only be provided at the last price executed which 
is equal to or better than the Exchange's disseminated price. See 
Chapter VI, Sections 1(a)(6) and 7(b)(3)(B).
    \34\ Chapter VI, Trading Systems, Section 10, Book Processing, 
subsection (C)(1)(b).
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    Pursuant to the DMM participation entitlement in effect under the 
Price/Time algorithm, the DMM would receive, with respect to a Directed 
Order, the greater of: (1) Contracts the DMM would receive if the 
allocation was based on time priority pursuant to subparagraph 
(C)(1)(a) with Public Customer priority; (2) after Public Customer 
orders are executed, 40 percent of remaining interest; or (3) the LMM 
participation entitlement (if the DMM is also the LMM). If there are 
multiple DMM quotes at the same price which are at or improve the NBBO 
when the Directed Order is received, the DMM participation entitlement 
would apply only once to the one which has the highest time priority at 
the last price executed upon receipt of the Directed Order which is 
equal to or better than the NBBO. If rounding would result in an 
allocation of less than one contract, the DMM would receive one 
contract. Rounding would be up or down to the nearest integer.\35\ 
Under no circumstances would the DMM receive an allocation of greater 
than 40% of an order at a price at which they receive a directed 
entitlement, unless it resulted from rounding.
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    \35\ Chapter VI, Trading Systems, Section 10, Book Processing, 
subsections (C)(1)(c).
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    Pursuant to the DMM participation entitlement in effect under the 
Size Pro-Rata algorithm, the DMM would receive, with respect to a 
Directed Order, the greater of: (1) The DMM's Size Pro-Rata share under 
subsection (1)(C)(2)(iv); (2) after Public Customer orders are 
executed, 40 percent of remaining interest; or (3) the LMM 
participation entitlement (if the DMM is also the LMM). If there are 
multiple DMM quotes at the same price which are at or improve the NBBO 
when the Directed Order is received, the DMM participation entitlement 
would apply only to the one which has the highest time priority at the 
last price executed upon receipt of the Directed Order which is equal 
to or better than the NBBO. Additional DMM quotes at such price will 
receive no further allocation of the Directed Order. Like the DMM 
participation entitlement applicable to executions under the Price/Time 
algorithm, if rounding would result in an allocation of less than one 
contract, the DMM would receive one contract, and rounding would be up 
or down to the nearest integer.\36\ Under no circumstances would the 
DMM receive an allocation of greater than 40% of an order at a price at 
which they receive a directed entitlement, unless it resulted from 
rounding.
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    \36\ Chapter VI, Trading Systems, Section 10, Book Processing, 
subsection (C)(2)(iii).
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    As noted above, under both execution algorithms only one 
participation entitlement, LMM or DMM, may be applied on a given order. 
The Exchange is amending the current LMM entitlements under each 
algorithm to provide with respect to a Directed Order that if the LMM 
is also the DMM, the LMM shall receive the DMM participation 
entitlement applicable to that algorithm, if any, if such DMM 
participation entitlement is greater than the LMM participation 
entitlement the LMM would otherwise receive pursuant to Chapter VI, 
Section 10, subsections (C)(1)(b)(1)(a)-(d) (in the case of Price/Time 
symbols) or (C)(2)(ii)(1)(a)-(d) (in the case of Size Pro-Rata 
symbols). The Exchange is also modifying the LMM priority rules so that 
the LMM participation entitlement will not apply to a Directed Order if 
when it is received the DMM's bid/offer is at or improves \37\ the NBBO 
and the LMM is at the same price level and the LMM is not the DMM.\38\
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    \37\ See note 20.
    \38\ Chapter VI, Trading Systems, Section 10, Book Processing, 
subsections (C)(1)(b)(1) (with respect to Price/Time symbols) and 
(C)(2)(ii)(1) (with respect to Size Pro-Rata Symbols).
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    The Exchange is also proposing to revise the current allocation to 
the LMM of orders for five contracts or fewer (which applies under both 
algorithms). As revised, the provision would not apply if the order of 
5 contracts or fewer is directed to a DMM who is quoting at the 
NBBO.\39\
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    \39\ Chapter VI, Trading Systems, Section 10, Book Processing, 
subsections (C)(1)(b)(2) (with respect to Price/Time symbols) and 
(C)(2)(ii)(2) (with respect to Size Pro-Rata Symbols).
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    Currently, with respect to executions under the Size Pro-Rata 
algorithm, BX Options market makers have priority over all other 
Participant orders at the same price after all Public Customer orders 
have been fully executed and LMM participation entitlements applied. 
The Exchange proposes to amend this provision so that this BX Options 
market maker priority applies only after any DMM participation 
entitlements have been applied as well.\40\
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    \40\ Chapter VI, Trading Systems, Section 10, Book Processing, 
subsection (C)(2)(iv).
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    Finally, the Exchange proposes to clarify with respect to LMMs 
under both execution algorithms that after all Public Customer orders 
have been fully executed, upon receipt of an order, the LMM will be 
afforded a participation entitlement provided that LMM's bid/offer is 
at or improves upon the

[[Page 73934]]

Exchange's disseminated price. The addition of the reference to an 
improved bid/offer will conform the LMM provision to the corresponding 
new DMM provision.\41\ The Exchange is also making a clarifying change 
in Chapter VI, Section 10(1)(C)(1)(b)(1)(a) by changing ``subparagraph 
(1)(a) above'' to ``subparagraph (C)(1)(a) above.''
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    \41\ See note 20.
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Examples of DMM Participation Entitlement Under Price/Time Algorithm
    Examples 1 through 3 below illustrate the manner in which a DMM 
will be allocated pursuant to the Price/Time model.

Example Number 1

    Assume an LMM has been assigned and that the DMM is not the LMM.

ABBO = 1.00-1.10
BX BBO = 1.00-1.10 comprised of the following in order of receipt

    Market Maker 1 (``MM1'') 1.00 (10)-1.10 (10)
    Customer A 5 offered at 1.10
    Firm 5 offered at 1.10
    DMM 1.00 (10)-1.10 (20)
    LMM 1.00 (10)-1.10 (10)
    Customer B 2 offered at 1.10

    Incoming Directed Order to pay 1.10 for 40 contracts.
    Determination of Allocation:
    Price/Time with Customer Priority would result in Customer A 
trading 5, Customer B trading 2, MM1 trading 10, Firm trading 5, and 
DMM trading 18.
    The DMM allocation would result in Customer A trading 5, Customer B 
trading 2, and DMM trading 40% of remaining 33 = 13 (13.2 rounded 
down); then normal price/time would resume and MM1 would trade 10, Firm 
would trade 5, and LMM would trade 5.
    The LMM allocation is not calculated.
    In this example, Price/Time with Customer Priority would prevail 
since the DMM would receive a greater allocation this way.

Example Number 2

    Assume an LMM is assigned and that the DMM is not the LMM.

ABBO = 1.00-1.10
BX BBO = 1.00-1.10 comprised of the following in order of receipt

    MM1 1.00 (10)-1.10 (10)
    Customer A 5 offered at 1.10
    Firm 5 offered at 1.10
    Market Maker 2 (``MM2'') 1.00 (10)-1.10 (10)
    DMM 1.00 (10)-1.10 (20)
    Customer B 2 offered at 1.10

    Incoming Directed Order to pay 1.10 for 40 contracts.
    Determination of Allocation:
    Price/Time with Customer Priority would result in Customer A 
trading 5, Customer B trading 2, MM1 trading 10, Firm trading 5, MM2 
trading 10 and DMM trading 8.
    The DMM allocation would result in Customer A trading 5, Customer B 
trading 2, DMM trading 40% of remaining 33 = 13 (13.2 rounded down); 
then normal price/time would resume with MM1 trading 10, Firm trading 5 
and MM2 trading 5.
    The LMM allocation would not be calculated.
    In this example, the DMM allocation would prevail since the DMM 
receives a greater allocation this way.

Example Number 3

    Assume an LMM is assigned and that the DMM is also the LMM.

ABBO = 1.00-1.10
BX BBO = 1.00-1.10 comprised of the following in order of receipt:

    MM1 1.00 (10)-1.10 (10)
    Firm 25 offered at 1.10
    DMM/LMM 1.00 (10)-1.10 (20)
    Customer B 2 offered at 1.10

    Incoming Directed Order to pay 1.10 for 40 contracts.
    Determination of Allocation:
    Price/Time with Customer Priority would result in Customer B 
trading 2, MM1 trading 10, Firm trading 25, and DMM/LMM trading 3.
    DMM allocation would result in Customer B trading 2 and DMM/LMM 
trading 40% of remaining 38 = 15 (15.2 rounded down); then normal 
price/time would resume and MM1 would trade 10 and Firm would trade 13.
    LMM allocation would result in Customer B trading 2 and DMM/LMM 
trading 50% of remaining 38 = 19; then normal price time would resume 
and MM1 would trade 10 and Firm would trade 9.
    In this example, the LMM allocation would prevail since the DMM/LMM 
would receive a greater allocation this way.
Examples of DMM Participation Entitlement Under Size Pro-Rata Algorithm
    Examples 4 through 6 below illustrate the manner in which a DMM 
will be allocated pursuant to the Size Pro-Rata model.

Example Number 4

    Assume an LMM is assigned and the DMM is not the LMM.

ABBO = 1.00-1.10
BX BBO = 1.00-1.10 comprised of the following in order of receipt:

    LMM 1.00 (10)-1.10 (15)
    Customer A 5 offered at 1.10
    Firm 5 offered at 1.10
    DMM 1.00 (10)-1.10 (20)
    MM1 1.00 (10)-1.10 (10)
    Customer B 2 offered at 1.10

    Incoming Directed Order to pay 1.10 for 40 contracts.
    Determination of Allocation:
    Size Pro-Rata would result in Customer A trading 5, Customer B 
trading 2, LMM trading 11 (15/45*33remaining), DMM trading 14 (20/
45*33), MM1 trading 7 (10/45*33), and then LMM based on time receiving 
the residual 1 lot.
    The DMM allocation would result in Customer A trading 5, Customer B 
trading 2, and DMM trading 40% of remaining 33 = 13 (13.2 rounded 
down); then normal Size Pro-Rata for remaining with the LMM trading 12 
(15/25*20) and MM1 trading 8 (10/25*20).
    The LMM allocation would not be calculated.
    In this example, the Size Pro-Rata allocation would prevail since 
the DMM would receive the greater allocation this way.

Example Number 5

    Assume that no LMM is assigned.

ABBO = 1.00-1.10
BX BBO = 1.00-1.10 comprised of the following in order of receipt:

    DMM 1.00 (10)-1.10 (15)
    Customer A 5 offered at 1.10
    Firm 5 offered at 1.10
    MM1 1.00 (10)-1.10 (20)
    MM2 1.00 (10)-1.10 (10)
    Customer B 2 offered at 1.10

    Incoming Directed Order to pay 1.10 for 40 contracts.
    Determination of Allocation:
    Size Pro-Rata would result in Customer A trading 5, Customer B 
trading 2, DMM trading 11 (15/45*33remaining), MM1 trading 14 (20/
45*33), MM2 trading 7 (10/45*33), and the DMM based on time receiving 
the residual 1 lot.
    The DMM allocation would result in Customer A trading 5, Customer B 
trading 2, and DMM trading 40% of remaining 33 = 13 (13.2 rounded 
down); then normal Size Pro-Rata for remaining with MM1 trading 13 (20/
30*20) and MM2 trading 6 (10/30*20), and the DMM based on time 
receiving the residual 1 lot.
    The LMM allocation would not be calculated.
    In this example, the DMM allocation would prevail since the DMM 
would receive the greater allocation this way.

Example Number 6

    Assume that an LMM is assigned and that the DMM is also the LMM.


[[Page 73935]]


ABBO = 1.00-1.10
BX BBO = 1.00-1.10 comprised of the following in order of receipt:

    DMM/LMM 1.00 (10)-1.10 (15)
    Customer A 5 offered at 1.10
    Firm 5 offered at 1.10
    MM1 1.00 (10)-1.10 (30)
    Customer B 2 offered at 1.10

    Incoming Directed Order to pay 1.10 for 40 contracts.
    Determination of Allocation:
    Size Pro-Rata would result in Customer A trading 5, Customer B 
trading 2, DMM/LMM trading 11 (15/45*33 remaining), MM1 trading 22 (30/
45*33).
    The DMM allocation would result in Customer A trading 5, Customer B 
trading 2, and DMM/LMM trading 40% of remaining 33 = 13 (13.2 rounded 
down); then Size Pro-Rata for remaining with MM1 trading full size of 
20.
    The LMM allocation would result in Customer A trading 5, Customer B 
trading 2, and DMM/LMM entitled to 50% of remaining 33 = 17 (16.5 
rounded up) but capped at his size of 15 thus trading 15; then normal 
Size Pro-Rata for remaining with MM1 trading 18.
    In this example, the LMM allocation would prevail since the DMM is 
the LMM and would receive a greater allocation this way.
Examples of Price Improving Orders

Example Number 1

    For this scenario assume the NBBO is at 1.00 (bid) and 1.20 
(offer).
    Assume a Price Improving Order (O1) from a Customer is present on 
BX to sell 20 contracts at 1.18. Also assume a Directed Market Maker 
(DMM1) and two other Market Makers (MM2 and MM3) are each quoting 1.00-
1.20 with a size of 50 contracts on each side. O1 and the Market Maker 
quotes are reflected in the BX BBO as 1.00-1.20 with a size of 150 
contracts on the bid and 170 contracts on the offer. If an order (O2) 
is received to buy 50 contracts at a limit of 1.20 which is directed to 
DMM1, the order will execute upon receipt with 20 contracts trading 
against O1 at 1.18, 12 contracts trading against DMM1 at 1.20 (40% of 
remaining 30 contracts), 9 contracts trading against MM2 at 1.20, and 9 
contracts trading against MM3 at 1.20.

Example Number 2

    For this scenario assume the NBBO is at 1.00 (bid) and 1.20 
(offer).
    Assume two Price Improving Orders (O1 and O2) from a Customer (C1) 
and Directed Market Maker (DMM1), respectively, are present on BX to 
sell 10 contracts each at 1.18. Also assume the Directed Market Maker 
(DMM1) and two other Market Makers (MM2 and MM3) are each quoting 1.00-
1.20 with a size of 50 contracts on each side. O1, O2, and the Market 
Maker quotes are reflected in the BX BBO as 1.00-1.20 with a size of 
150 contracts on the bid and 170 contracts on the offer. If an order 
(O3) is received to buy 50 contracts at a limit of 1.20 which is 
directed to DMM1, the order will execute upon receipt with 10 contracts 
trading against O1 at 1.18 and 10 contracts trading against DMM1's 
Price Improving Order (O2) at 1.18. The remaining 30 contracts will 
trade at 1.20 with 12 contracts trading against DMM1 (40% of remaining 
30 contracts), 9 contracts trading against MM2, and 9 contracts trading 
against MM3.

Example Number 3

    Assume the following orders exist in the Order book for Market 
Maker 2 and 3 (MM2 and MM3 respectively) and the following DMM quotes:

1.19 offer 10 MM2 (Price Improving Order)
1.20 offer 20 MM3
1.20 offer 10 DMM Quote 1
1.20 offer 10 DMM Quote 2

    If an order was directed to the DMM to buy 15 contracts at 1.20, 10 
contracts would be executed at 1.19 contra MM2. The DMM would receive 
40% of the remaining 5 contracts (2 contracts) which would be allocated 
to DMM Quote 1. The remaining 3 contracts would be allocated as per 
Price Time priority to MM3.

Example Number 4

    Assume the following orders exist in the Order book for Market 
Maker 2 and 3 (MM2 and MM3 respectively) and the following DMM quotes:

1.18 offer 10 MM2 (Price Improving Order)
1.19 offer 20 MM3
1.19 offer 10 DMM Quote 1
1.19 offer 10 DMM Quote 2
1.20 offer 10 MM3

    If an order directed to the DMM to buy 15 contracts for 1.20, 10 
contracts would be executed at 1.18 contra MM2. The DMM would receive 
40% of remaining 5 contracts (2 contracts), because it was the last 
price executed pursuant to Chapter VI, Section 10(1)(C)(1)(c), which 
would be allocated to DMM Quote 1. The remaining 3 contracts would be 
allocated as per Price Time priority to MM3.
Priority Overlays
    The Exchange is proposing to amend language in Chapter VI, Section 
10(1)(C)(2) which applies to priority overlays. The language currently 
states that ``the Exchange will apply the following designated 
Participant priority overlays, which are always in effect when the Size 
Pro-Rata execution algorithm is in effect.'' The priority overlays 
which are references are Public Customer, LMM, DMM and market maker 
priority. The Exchange is proposing to amend the sentence to state, 
``the Exchange may apply the following designated Participant priority 
overlays, when the Size Pro-Rata execution algorithm is in effect.'' 
The amendment is intended to provide more specificity to the rule text 
as Public Customer priority will be in effect always for Size Pro-Rata, 
but may be in effect for the other types of priorities. The amendment 
also conforms the language to the Price/Time rule text in Chapter VI, 
Section 10(1)(C)(1).
Implementation.
    Within thirty (30) days the Exchange will begin to implement the 
proposal and will issue an Options Trader Alert in advance to inform 
market participants of such date.
2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \42\ in general, and furthers the objectives of Section 
6(b)(5) of the Act \43\ 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, because it will establish a 
Directed Order process similar to what operates on other exchanges, as 
explained herein, which will provide Participants with additional 
choices among the many competing exchanges with regard to their 
execution needs and strategies. BX Options operates in an intensely 
competitive environment and seeks to offer the same services that its 
competitors offer and in which its customers find value.
---------------------------------------------------------------------------

    \42\ 15 U.S.C. 78f(b).
    \43\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    In its approval of other options exchange directed order programs, 
the Commission has, like proposals to amend a specialist guarantee, 
focused on whether the percentage of the ``entitlement'' would rise to 
a level that could have a material adverse impact on quote competition 
within a particular

[[Page 73936]]

exchange, and concluded that such programs do not jeopardize market 
integrity or the incentive for market participants to post competitive 
quotes.\44\ BX's proposed DMM participation entitlement of 40 percent, 
is consistent with the directed order allocations of other options 
exchanges. BX notes that the remaining portion of each order will 
continue to be allocated based on the competitive bids/offers of market 
participants. In addition, at the time of receipt of the Directed 
Order, a DMM will have to be quoting at or improving \45\ the NBBO 
which is intended to incent the DMM to quote aggressively. BX also 
notes that DMMs will have heightened quoting obligations as compared to 
other BX Options market makers.
---------------------------------------------------------------------------

    \44\ See Securities Exchange Act Release No. 51759 (May 27, 
2005), 70 FR 32860 (June 6, 2005) (SR-Phlx-2004-91).
    \45\ See note 20. Price Improving Orders, provide for investors 
the opportunity to trade at a better price than would otherwise be 
available--inside the disseminated best bid and offer for a 
security. The opportunity for investors to receive executions inside 
the disseminated best bid or offer could result in better executions 
for investors.
---------------------------------------------------------------------------

    A DMM will have to be quoting at or improving the NBBO at the time 
the order is received to capitalize on the guarantee and will only 
receive a participation entitlement at one such price point. The DMM 
must be publicly quoting at that price when the order is received. In 
this regard, the proposal prohibits an order flow provider from 
notifying a DMM regarding its intention to submit a Directed Order so 
that such DMM could change its quotation immediately prior to 
submission of the directed order. The Exchange's rules already provide 
the necessary protections against coordinated action as between a DMM 
and an order entry firm.\46\ Furthermore, BX will proactively conduct 
surveillance for, and enforce against, such violations.\47\
---------------------------------------------------------------------------

    \46\ See BX Chapter III, Section 4, Prevention of the Misuse of 
Material Nonpublic Information. BX prohibits an order flow provider 
from notifying a DMM of its intention to submit a directed order so 
that the DMM could change its quotation to match the national best 
bid or offer (``NBBO'') immediately prior to the submission of the 
directed order.
    \47\ The Exchange will submit a letter detailing its 
surveillance and enforcement to the Commission.
---------------------------------------------------------------------------

    In addition, this proposal does not affect a broker-dealer's duty 
of best execution. A broker-dealer has a legal duty to seek to obtain 
best execution of customer orders, and any decision to preference a 
particular DMM must be consistent with this duty.\48\ A broker-dealer's 
duty of best execution derives from common law agency principles and 
fiduciary obligations, and is incorporated in SRO rules and, through 
judicial and Commission decisions, the antifraud provisions of the 
federal securities laws.\49\ The duty of best execution requires 
broker-dealers to execute customer trades at the most favorable terms 
reasonably available under the circumstances, i.e., at the best 
reasonably available price.\50\ The duty of best execution requires 
broker-dealers to periodically assess the quality of competing markets 
to assure that order flow is directed to the markets providing the most 
beneficial terms for their customer orders.\51\ Broker-dealers must 
examine their procedures for seeking to obtain best execution in light 
of market and technology changes and modify those practices if 
necessary to enable their customers to obtain the best reasonably 
available prices.\52\ In doing so, broker-dealers must take into 
account price improvement opportunities, and whether different markets 
may be more suitable for different types of orders or particular 
securities.\53\
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    \48\ See, e.g., Newton v. Merrill, Lynch, Pierce, Fenner & 
Smith, Inc., 135 F.3d 266, 269-70, 274 (3d Cir.), cert. denied, 525 
U.S. 811 (1998); Certain Market Making Activities on Nasdaq, 
Securities Exchange Act Release No. 40900 (January 11, 1999) 
(settled case) (citing Sinclair v. SEC, 444 F.2d 399 (2d Cir. 1971); 
Arleen Hughes, 27 SEC 629, 636 (1948), aff'd sub nom. Hughes v. SEC, 
174 F.2d 969 (D.C. Cir. 1949)). See also Order Execution 
Obligations, Securities Exchange Act Release No. 37619A (September 
6, 1996), 61 FR 48290 (September 12, 1996) (``Order Handling Rules 
Release'').
    \49\ Order Handling Rules Release, 61 FR at 48322. See also 
Newton, 135 F.3d at 270. Failure to satisfy the duty of best 
execution can constitute fraud because a broker-dealer, in agreeing 
to execute a customer's order, makes an implied representation that 
it will execute it in a manner that maximizes the customer's 
economic gain in the transaction. See Newton, 135 F.3d at 273 
(``[T]he basis for the duty of best execution is the mutual 
understanding that the client is engaging in the trade--and 
retaining the services of the broker as his agent--solely for the 
purpose of maximizing his own economic benefit, and that the broker 
receives her compensation because she assists the client in reaching 
that goal.''); Marc N. Geman, Securities Exchange Act Release No. 
43963 (February 14, 2001) (citing Newton, but concluding that 
respondent fulfilled his duty of best execution). See also Payment 
for Order Flow, Securities Exchange Act Release No. 34902 (October 
27, 1994), 59 FR 55006, 55009 (Nov. 2, 1994) (``Payment for Order 
Flow Final Rules''). If the broker-dealer intends not to act in a 
manner that maximizes the customer's benefit when he accepts the 
order and does not disclose this to the customer, the broker-
dealer's implied representation is false. See Newton, 135 F.3d at 
273-274.
    \50\ Newton, 135 F.3d at 270. Newton also noted certain factors 
relevant to best execution--order size, trading characteristics of 
the security, speed of execution, learning costs, and the cost and 
difficulty of executing an order in a particular market. Id. at 270 
n. 2 (citing Payment for Order Flow, Securities Exchange Act Release 
No. 33026 (October 6, 1993), 58 FR 52934, 52937-38 (October 13, 
1993) (Proposed Rules)). See In re E.F. Hutton & Co. (``Manning''), 
Securities Exchange Act Release No. 25887 (July 6, 1988). See also 
Payment for Order Flow Final Rules, 59 FR at 55008-55009.
    \51\ Order Handling Rules Release, 61 FR at 48322-48333 (``In 
conducting the requisite evaluation of its internal order handling 
procedures, a broker-dealer must regularly and rigorously examine 
execution quality likely to be obtained from different markets or 
market makers trading a security.''). See also Newton, 135 F.3d at 
271; Market 2000: An Examination of Current Equity Market 
Developments V-4 (SEC Division of Market Regulation January 1994) 
(``Without specific instructions from a customer, however, a broker-
dealer should periodically assess the quality of competing markets 
to ensure that its order flow is directed to markets providing the 
most advantageous terms for the customer's order.''); Payment for 
Order Flow Final Rules, 59 FR at 55009.
    \52\ Order Handling Rules, 61 FR at 48323.
    \53\ Order Handling Rules, 61 FR at 48323. For example, in 
connection with orders that are to be executed at a market opening 
price, ``[b]roker-dealers are subject to a best execution duty in 
executing customer orders at the opening, and should take into 
account the alternative methods in determining how to obtain best 
execution for their customer orders.'' Disclosure of Order Execution 
and Routing Practices, Securities Exchange Act Release No. 43590 
(November 17, 2000), 65 FR 75414, 75422 (December 1, 2000) (adopting 
new Exchange Act Rules 11Ac1-5 and 11Ac1-6 and noting that 
alternative methods offered by some Nasdaq market centers for pre-
open orders included the mid-point of the spread or at the bid or 
offer).
---------------------------------------------------------------------------

    With respect to a DMM's obligations, the Exchange would require 
DMMs be subject to heightened standards as compared to other market 
makers. A DMM must provide continuous two-sided quotations throughout 
the trading day in all options classes in which the DMM is assigned, 
once the market maker indicates to the Exchange an intent to receive 
Directed Orders, for 90% of the time the Exchange is open for trading 
in each issue. Such quotations must meet the legal quote width 
requirements herein. These obligations will apply to all of the DMM's 
option issues collectively, rather than on an option-by-option basis. 
While the Market Maker's quoting requirement is a daily obligation, the 
Exchange is able to determine compliance with these obligations on a 
monthly basis. BX Regulation may consider exceptions to the requirement 
to quote 90% (or higher) of the trading day based on demonstrated legal 
or regulatory requirements or other mitigating circumstances. However, 
determining compliance with the continuous quoting requirement on a 
monthly basis does not relieve a DMM of the obligation to provide 
continuous two-sided quotes on a daily basis, nor will it prohibit the 
Exchange from taking disciplinary action against a DMM for failing to 
meet the continuous quoting obligation each trading day.
    The Exchange believes that offering DMMs participation entitlements 
promotes just and equitable principles of trade because DMMs will be 
held to a higher standard as compared to other

[[Page 73937]]

market participants including market makers. A market maker would be 
required, pursuant to this proposal, to quote 60% of the trading day. 
DMMs are being held to a higher obligation and therefore are being 
rewarded with participation entitlements. Similar to market makers, 
DMMs add value through continuous quoting \54\ and the commitment of 
capital. In addition, the DMM quoting requirements promote liquidity 
and continuity in the marketplace in requiring DMMs to be held to a 
higher standard of quoting. The Exchange also believes that the 
proposed rule change supports the quality of the Exchange's markets 
because it maintains the quoting obligations of market makers as DMMs 
at 90%. DMM transactions must constitute a course of dealings 
reasonably calculated to contribute to the maintenance of a fair and 
orderly market. Accordingly, the proposed rule change supports the 
quality of the Exchange's trading markets by helping to ensure that 
DMMs will be required to meet a higher quoting standard in order to 
reap the benefits of the participation entitlements. The Exchange 
believes this proposed change to offer participation entitlements to 
DMMs is offset by DMMs' continued responsibilities to provide 
significant liquidity to the market to the benefit of market 
participants.
---------------------------------------------------------------------------

    \54\ Pursuant to Chapter VII (Market Participants), Section 5 
(Obligations of Market Makers), in registering as a market maker, an 
Options Participant commits himself to various obligations. 
Transactions of a market maker in its market making capacity must 
constitute a course of dealings reasonably calculated to contribute 
to the maintenance of a fair and orderly market, and market makers 
should not make bids or offers or enter into transactions that are 
inconsistent with such course of dealings. See Chapter VII, Section 
5. Further, all market makers are designated as specialists on BX 
for all purposes under the Act or rules thereunder. See Chapter VII, 
Section 2.
---------------------------------------------------------------------------

    The Exchange also notes that it believes that while rounding is up 
or down to the nearest integer, thereby having the potential to result 
in an allocation that is slightly greater than 40% of the remaining 
interest, this concept is not novel. Today, the rounding is computed in 
the same manner for LMM allocations, thereby resulting in the potential 
for slightly greater than 40% of remaining allocation for the LMM. It 
is also important to note that if the rounding results in computing the 
nearest lower integer, the DMM would receive slightly less than the 
percentages noted herein. The Exchange believes that the manner in 
which it rounds is not an impediment to a free and open market and a 
national market system. The rounding computation described herein is 
consistent with the manner in which rounding is computed on BX's 
System, where appropriate. The Exchange applies the rounding 
methodology in all BX functionality related to allocation computations, 
not just in relation to DMM allocation computations. The Exchange 
believes that its method of rounding is transparent, just and 
equitable. The rounding provisions, unlike the allocation provisions, 
are not a guarantee but simply the result of a mathematical computation 
that can only be computed after the transactions are executed. The 
Exchange's proposal is focused on the guarantees that a DMM could 
expect as a result of quoting competitively, that is, quoting at or 
better than the NBBO. The rounding outcome is not guaranteed and is 
only the result of necessity of allocating shares in a just, equitable 
and transparent manner to market participants.
    The proposed rule change also removes impediments to and allows for 
a free and open market, while protecting investors, by promoting 
transparency regarding DMMs' obligations and benefits in the Exchange 
Rules. In addition, the Exchange believes that the proposed rule change 
is designed to not permit unfair discrimination among DMMs.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The proposed rule change does not impose any burden on competition 
that is not necessary or appropriate in furtherance of the purposes of 
the Act. The competition among the options exchanges is vigorous and 
this proposal is intended to afford the BX Options market the 
opportunity to compete for directed order flow. In that regard, the 
proposal is pro-competitive and will offer market participants an 
additional venue for the execution of Directed Orders. The Exchange 
does not believe the proposal imposes a burden on intra-market 
competition not necessary or appropriate in furtherance of the purposes 
of the Act, because the ability to send Directed Orders is available to 
all Participants, and the ability to become a DMM is available to all 
market makers. Further, the Exchange does not believe the proposal will 
negatively impact quote competition on BX and create an unfair burden 
on competition. The directed order will be allocated based on the 
competitive bidding of market participants. A DMM will have to be 
quoting at the NBBO at the time the order is received to capitalize on 
the guarantee.
    DMMs will be subject to enhanced quoting obligations and the 
obligations would apply to all options classes, once the market maker 
indicates to the Exchange an intent to receive Directed Orders, for 90% 
of the time the Exchange is open for trading in each issue collectively 
to all appointed issues, rather than on an option-by-option basis and 
compliance with this obligation will be determined on a monthly basis. 
Further, the proposal will not diminish, and in fact may increase, 
market making activity on the Exchange and thereby enhance intermarket 
competition. Moreover, the proposed rule change will not impose any 
burden on intra-market competition because it will affect all DMMs the 
same. DMMs will be subject to heightened quoting obligations as 
compared to other BX market makers. All market makers may become DMMs.
    The Exchange does not believe the proposed rule change will cause 
any unnecessary burden on intra-market competition because it provides 
all market makers the opportunity to benefit from participation 
entitlements as a DMM. The Exchange believes that the proposed rule 
change will promote competition among market participants to the 
benefit of the Exchange, its Members, and market participants. This 
proposal puts in place a structure by which all Options Participants 
can both compete for order flow by contributing to price and size 
discovery for the entire market. Further, market makers must enter 
orders that assume the risk of trading with all participants at NBBO 
without knowing the details of the particular order. Market makers are 
incentivized to aggressively quote at the NBBO with this proposal to 
the benefit of all market participants, while maintaining their quoting 
obligations. The Exchange believes the proposal will encourage greater 
order flow to be sent to the Exchange through Directed Orders and that 
this increased order flow will benefit all market participants on the 
Exchange. The Exchange is not limiting the class of market participants 
that can be directed orders, any market maker may apply to receive 
directed orders and those market participants would be required to meet 
the heightened standards for quoting. DMMs must meet additional quoting 
and other regulatory obligations compared to certain other Exchange 
Participants and have thus demonstrated a commitment to providing 
liquidity on the Exchange. The Exchange believes that limiting the 
benefit of the participation entitlement to DMMs is fair and reasonable 
because

[[Page 73938]]

these DMMs must satisfy additional quoting and other obligations.
    The Exchange does not believe the proposed change will cause any 
unnecessary burden on inter-market competition because all market 
makers are entitled to receive participation entitlements provided they 
direct orders and those orders are executed by those DMMs. In addition, 
the Exchange believes that the proposed rule change will in fact 
promote competition. The Exchange believes allowing DMMs to receive 
participation entitlements will promote trading activity on the 
Exchange because it will provide incentives to DMMs to quote in series 
which they are not obligated to do so, to the benefit of the Exchange, 
its Members, and market participants.
    The Exchange does not believe that the method in which it rounds up 
or down to the nearest integer creates an undue burden on competition. 
The rounding outcome is not guaranteed and is only the result of 
necessity of allocating shares in a just, equitable and transparent 
manner to market participants.

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

    No written comments were either solicited or received.

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

    Within 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. 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-BX-2014-049 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-BX-2014-049. 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-BX-2014-049, and should be 
submitted on or before January 2, 2015.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\55\
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    \55\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-29109 Filed 12-11-14; 8:45 am]
BILLING CODE 8011-01-P


