[Federal Register Volume 77, Number 127 (Monday, July 2, 2012)]
[Notices]
[Pages 39277-39287]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-16079]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-67256; File No. SR-BX-2012-030]
Self-Regulatory Organizations; NASDAQ OMX BX, Inc.; Order
Granting Approval of a Proposed Rule Change, as Modified by Amendment
Nos. 1 and 2, Relating to the Establishment of a New Options Market,
NASDAQ OMX BX Options
June 26, 2012.
I. Introduction
On May 1, 2012, NASDAQ OMX BX, Inc. (``Exchange'' or ``BX'') filed
with the Securities and Exchange Commission (``Commission'') a proposed
rule change pursuant to Section 19(b)(1) of the Securities Exchange Act
of 1934 (``Act''),\1\ and Rule 19b-4 thereunder,\2\ to adopt rules
governing the trading of options on NASDAQ OMX BX Options (``BX
Options''), which will be an options trading facility of the Exchange.
On May 8, 2012, BX filed Amendment No. 1 to the proposed rule
change.\3\ The proposed rule change, as modified by Amendment No. 1,
was published for comment in the Federal Register on May 18, 2012.\4\
The Commission received one comment letter on the proposal.\5\ The
Exchange responded to the comment letter on June 15, 2012.\6\ On June
22, 2012, BX filed Amendment No. 2 to the proposed rule change.\7\ This
order approves the proposed rule change, as modified by Amendment Nos.
1 and 2 thereto.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Amendment No. 1 made several technical and clarifying
changes to the proposal, as well as minor changes to the definition
of the terms ``primary market'' and ``Intermarket Sweep Order.''
\4\ See Securities Exchange Act Release No. 66983 (May 14,
2012), 77 FR 29730. (``Notice'').
\5\ See Letter from Edward T. Tilly, President and Chief
Operating Officer, Chicago Board Options Exchange, Incorporated
(``CBOE''), to Elizabeth M. Murphy, Secretary, Commission, dated
June 5, 2012 (``CBOE Letter'').
\6\ See Letter from Thomas Wittman, Senior Vice President,
NASDAQ OMX, to Elizabeth M. Murphy, Secretary, Commission, dated
June 15, 2012 (``BX Response'').
\7\ Amendment No. 2 clarified the Exchange's status with respect
to its participation in various national market system plans, and
clarified representations with respect to its regulatory agreements.
Because Amendment No. 2 is technical in nature, the Commission is
not required to publish it for public comment.
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II. Discussion and Commission Findings
After careful review of the proposal, as modified by Amendment Nos.
1 and 2, and consideration of the comment letter and the Exchange's
response thereto, the Commission finds that the proposed rule change,
as modified by Amendment Nos. 1 and 2, is consistent with the
requirements of the Act and the rules and regulations thereunder
applicable to a national securities exchange.\8\ Specifically, the
Commission finds that the proposal is consistent with Section 6(b)(5)
of the Act,\9\ which requires, among other things, that the rules of a
national securities exchange be designed to prevent fraudulent and
manipulative acts and practices; to promote just and equitable
principles of trade; to foster cooperation and coordination with
persons engaged in regulating, clearing, settling, and processing
information with respect to, and facilitating transactions in
securities; to remove impediments to and perfect the mechanism of a
free and open market and a national market system; and, in general, to
protect investors and the public interest. Section 6(b)(5) also
requires that the rules of an exchange not be designed to permit unfair
discrimination among customers, issuers, brokers, or dealers. Further,
the Commission finds that the proposal is consistent with Sections
6(b)(1) of the Act,\10\ which requires, among other things, that a
national securities exchange be so organized and have the capacity to
carry out the purposes of the Act, and to comply and enforce compliance
by its members and persons associated with its members, with the
provisions of the Act, the rules and regulation thereunder, and the
rules of the exchange.
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\8\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
\9\ 15 U.S.C. 78f(b)(5).
\10\ 15 U.S.C. 78f(b)(1).
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This discussion does not review every detail of the proposal, but
focuses on the most significant rules and policy issues considered in
review of the proposal.
A. BX Options Participants
BX Options will operate a fully automated electronic trading system
for trading options (``System'' or ``BX Options System'').\11\ BX
Options will have only one category of members, known as ``Options
Participants'' or ``Participants.'' \12\ Only Options Participants will
be permitted to transact business on the BX Options System.\13\ There
will be two categories of Options Participants: (1) Options Order Entry
Firms (``OEFs'') and (2) Options Market Makers. An Options Participant
must be a member of the Exchange and another registered options
exchange that is not registered solely under Section 6(g) of the Act
\14\ or the Financial Industry Regulatory Authority (``FINRA'').\15\
Further, an OEF may only transact business with public customers if
such Options Participant also is a member of another registered
national securities exchange or association with which the Exchange has
entered into an agreement under Rule 17d-2 under the Act pursuant to
which such other exchange or association shall be the designated
options examining authority for the OEF.\16\ In addition, Options
Participants that transact business with Public Customers must at all
times be members of FINRA.\17\
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\11\ The proposed rules of BX Options are based on, and
virtually identical to, the rules of the NASDAQ Options Market
(``NOM''), the options trading facility of The NASDAQ Stock Market
LLC (``NASDAQ''). See Notice, supra note 4, at 29731.
\12\ The term ``Options Participant'' or ``Participant'' means a
firm, or organization that is registered with the Exchange pursuant
to Chapter II of BX Options proposed rules for purposes of
participating in options trading on BX Options as a BX Options Order
Entry Firm or BX Options Market Maker. See proposed BX Options
Rules, Chapter I, Section 1(a)(41). All BX members will be eligible
to participate in BX Options provided that BX specifically
authorizes them to trade in the System and they become Options
Participants. Existing BX members that will become Options
Participants will be required to comply with the incremental
requirements of the proposed BX Options Rules. New BX members will
be required to fulfill the requirements of the BX Rule 1000 Series
to become a BX member as well as the incremental requirements set
forth in the proposed BX Options Rules to become an Options
Participant.
\13\ See proposed BX Options Rules, Chapter II and Chapter V,
Section 1.
\14\ 15 U.S.C. 78f(g).
\15\ See proposed BX Options Rules, Chapter II, Section 2(f).
\16\ See proposed BX Options Rules, Chapter XI, Section 1.
\17\ See proposed BX Options Rules, Chapter II, Section 2(f).
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Among other things, each Options Participant must be registered as
a broker-dealer and have as the principal purpose of being an Options
Participant the conduct of a securities business, which shall be deemed
to exist if and so
[[Page 39278]]
long as: (1) The Options Participant has qualified and acts in respect
of its business on BX Options as either an OEF or an Options Market
Maker or both; and (2) all transactions effected by the Options
Participant are in compliance with Section 11(a) of the Act \18\ and
the rules and regulation adopted thereunder.\19\ Options Participants
may trade options for their own proprietary accounts or, if authorized
to do so under applicable law, may conduct business on behalf of
customers.\20\
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\18\ 15 U.S.C. 78k(a).
\19\ See proposed BX Options Rules, Chapter II, Section 2(e).
\20\ See proposed BX Options Rules, Chapter II, Section 1(a).
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OEFs are Options Participants representing customer orders as agent
on BX Options or trading as principal on BX Options.\21\ Options Market
Makers are Options Participants registered with the Exchange as Options
Market Makers and registered with the Exchange in one or more options
listed on BX Options.\22\ A Market Maker that engages in specified
Other Business Activities, or that is affiliated with a broker-dealer
that engages in Other Business Activities, including functioning as an
OEF, must have an Information Barrier between the market making
activities and the Other Business Activities.\23\ To become an Options
Market Maker, an Options Participant is required to register by filing
a written application with BX Regulation, which will consider an
applicant's market making ability and such other factors as it deems
appropriate in determining whether to approve an applicant's
registration as a Market Maker.\24\ BX Options will not place any limit
on the number of entities that may become Options Market Makers.\25\ BX
Regulation, which is a department of the Exchange that supervises and
administers the regulatory functions of the Exchange, may suspend or
terminate any registration of an Options Market Maker when, in BX's
judgment, the interest of a fair and orderly market are best served by
such action.\26\
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\21\ See proposed BX Options Rules, Chapter VII, Section 1.
\22\ See proposed BX Options Rules, Chapter VII. All Market
Makers are designated as specialists on BX Options for all purposes
under the Act or the rules thereunder. See proposed BX Options
Rules, Chapter VII, Section 2.
\23\ See proposed BX Options Rules, Chapter VII, Section 10(a).
\24\ See proposed BX Options Rules, Chapter VII, Section 2(a).
\25\ See proposed BX Options Rules, Chapter VII, Section 2(c).
However, the Board of Directors of BX may limit access to the System
based on system constraints, capacity restrictions, or other factors
relevant to protecting the integrity of the System, pending action
required to address the issue of concern. To the extent the Exchange
places limitations on access to the System on any Participant(s),
such limits shall be objectively determined and submitted to the
Commission for approval pursuant to a rule change filed under
Section 19(b) of the Act. See proposed BX Options Rules, Chapter
VII, Section 2(c).
\26\ See proposed BX Options Rules, Chapter VII, Section 2(b).
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Options Market Makers are required to electronically engage in a
course of dealings to enhance liquidity available on BX Options and to
assist in the maintenance of fair and orderly markets.\27\ Among other
things, an Options Market Maker must: (1) On a daily basis participate
in the pre-opening phase and thereafter maintain a two-sided market on
a continuous basis in at least 60% of the options series in which it is
registered; (2) enter a size of at least one contract for its best bid
and its best offer; and (3) maintain minimum net capital in accordance
with Commission and Exchange rules.\28\ Substantial or continued
failure by an Options Market Maker to meet any of its obligations and
duties would subject the Options Market Maker to disciplinary action,
suspension, or revocation of the Options Market Maker's registration in
one or more options series.\29\
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\27\ See proposed BX Options Rules, Chapter VII, Section 5(a).
\28\ See, e.g., proposed BX Options Rules, Chapter VII, Sections
5 and 6.
\29\ See proposed BX Options Rules, Chapter VII, Section 4(b).
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The Commission finds that the BX Options Market Maker qualification
requirements are consistent with the Act and notes that they are
similar to those of other options exchanges.\30\ The Commission also
finds that the BX Options Market Maker participation requirements are
consistent with the Act. Market makers receive certain benefits for
carrying out their responsibilities. For example, a broker-dealer or
other lender may extend ``good faith'' credit to a member of a national
securities exchange or registered broker-dealer to finance its
activities as a market maker or specialist.\31\ In addition, market
makers are exempted from the prohibition in Section 11(a) of the Act.
The Commission believes that a market maker must have sufficient
affirmative obligations, including the 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. The Commission
believes that BX Options Market Maker participation requirements impose
sufficient affirmative obligations on BX Options Market Makers and,
accordingly, that these BX Options requirements are consistent with the
Act.\32\
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\30\ See, e.g., Rules of NOM, Chapter VII, Sections 4, 5, and 6;
and BATS Rules 22.4, 22.5 and 22.6.
\31\ See 12 CFR 221.5 and 12 CFR 220.7; see also 17 CFR
240.15c3-1(a)(6) (capital requirements for market makers).
\32\ The Commission notes that the participation requirements
are similar to those of other options exchanges. See, e.g., NOM
Rules, Chapter VII, Sections 5 and 6; and BATS Rules 22.5 and 22.6.
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B. BX Options Trading System
The BX Options System will leverage current technology, including
customer connectivity, messaging protocols, quotation and execution
engine, order router, data feeds, and network infrastructure of the
various markets owned by The NASDAQ OMX Group, Inc. (``NASDAQ OMX'').
As a result, BX Options System will closely resemble NOM.\33\ As noted
above, the BX Options System will be an electronic trading system to
trade options that will provide for the electronic display and
automatic execution of orders in price/time priority, without regard to
the status of the entities that are entering orders.\34\ The System
will include two proprietary data feeds. BX Depth of Market (``BX
Depth'') will be a data feed that provides quotation information for
individual orders on the BX Options book, last-sale information for
trades executed on BX Options, and order imbalance information as set
forth in BX Options Rules Chapter VI, Section 8.\35\ In addition, BX
Top of Market (``BX Top'') will be a data feed that provides the BX
Options best bid and offer and last-sale information for trades
executed on BX Options.\36\
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\33\ See Notice, supra note 4, at 29731.
\34\ The System includes: (1) An order execution service that
enables Options Participants to automatically execute transactions
in securities listed and traded on BX Options; (2) a trade reporting
service that submits ``locked-in'' trades for clearing to a
registered clearing agency for clearance and settlement, transmits
last-sale reports of transactions automatically to the Options Price
Reporting Authority (``OPRA'') for dissemination to the public and
industry, and provides participants with monitoring and risk
management capabilities to facilitate participation in a ``locked-
in'' trading environment; and (3) two proprietary data feeds. See
proposed BX Options Rules, Chapter VI, Section 1(a). See Notice,
supra note 4, for a more complete description of BX Options
operation and rules. The Commission notes that the Plan for
Reporting of Consolidated Options Last Sale Reports and Quotation
Information (``OPRA Plan'') requires each party to the Plan to
collect and promptly transmit to the OPRA all last sale reports
relating to its market. See OPRA Plan, Article V, Section 5.2(a).
\35\ See proposed BX Options Rules, Chapter VI, Section
(1)(a)(3). See also proposed BX Options Rules, Chapter VI, Section
8.
\36\ See proposed BX Options Rules, Chapter VI, Section
(1)(a)(3).
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Options Participants will be able to enter the following types of
orders into
[[Page 39279]]
the System: Limit Orders; \37\ Minimum Quantity Orders; \38\ Market
Orders; \39\ Price Improving Orders; \40\ Intermarket Sweep Orders;
\41\ One-cancels-the-other Orders; \42\ All-or-none Orders; \43\ and
Post Only Orders; \44\ with characteristics and functionality identical
to what is currently approved for use on NOM.\45\ Orders entered into
the System will be designated for display (price and size) on an
anonymous basis in the order display service of the System.\46\ Options
Participants will be permitted to enter multiple orders at single or
multiple price levels.\47\
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\37\ 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. See proposed BX Options
Rules, Chapter VI, Section 1(e)(2).
\38\ 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. See proposed BX Options Rules, Chapter VI, Section
1(e)(3).
\39\ Market Orders are orders to buy or sell at the best price
available at the time of execution. Options 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. See proposed BX Options Rules,
Chapter VI, Section 1(e)(5).
\40\ 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. See proposed BX Options Rules,
Chapter VI, Section 1(e)(6).
\41\ Intermarket Sweep Orders (``ISOs'') means a limit order for
an options series that: (1) when routed to an eligible exchange, the
order is identified as an ISO; and (2) simultaneously with the
routing of the order, one or more additional ISOs, as necessary, are
routed to execute against the full displayed size of any protected
bid, in the case of a limit order to sell, or any protected offer,
in the case of a limit order to buy, for the options series with a
price that is superior to the limit price of the ISO, which such
additional orders also marked as ISOs. See proposed BX Options
Rules, Chapter XII, Section 1(9). ISOs may have any time-in-force
designation except WAIT. See Amendment No. 1. ISOs with a time-in-
force designation of Good Til canceled (``GTC'') are treated as
having a time-in-force designation of DAY. See id. ISOs that are
marked as Day or GTC lose the ISO designation once posted on the BX
Options book. See id. If an entering firm cancel/replaces that
resting Day or GTC ISO order, the replacement order cannot be marked
as ISO. See id.
\42\ One-cancels-the-other Orders are orders entered by a Market
Maker that consists of a buy order and a sell order treated as a
unit; the full execution of one of the orders causes the other to be
canceled. See proposed BX Options Rules, Chapter VI, Section
1(e)(9).
\43\ All-or-none Orders are market or limit orders which are 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. See proposed BX Options Rules,
Chapter VI, Section 1(e)(10).
\44\ 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 proposed BX Options, Chapter VI, Section
7(b)(3)(C). 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. See proposed BX Options Rules, Chapter VI, Section 1(e)(10).
\45\ See proposed BX Options Rules, Chapter VI, Section (1)(e).
Options Participants entering orders into the System may designate
such orders to remain in force and available for display and/or
potential execution for varying periods of time. Unless cancelled
earlier, once these time periods expire, the order (or the
unexecuted portion thereof) is returned to the entering party. See
proposed BX Options Rules, Chapter VI, Section (1)(g).
\46\ See Notice, supra note 4, at 29733.
\47\ See id.
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All trading interest on the System will be automatically
executable. The System will have a single execution algorithm based on
price/time priority. The System and BX Options Rules provide for the
ranking, display, and execution of all orders in price/time priority
without regard to the status of the entity entering an order. For each
order, among equally-priced or better-priced trading interest, the
System executes against available contra-side contract amounts in full,
in price/time priority.\48\ Any price improvement resulting from an
execution in the System will accrue to the party taking liquidity.\49\
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\48\ See proposed BX Options Rules, Chapter VI, Section 10.
\49\ See proposed BX Options Rules, Chapter VI, Section 10(3).
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Quotes and orders entered by Options Market Makers will not be
executed against quotes and orders entered on the opposite side of the
market by the same market maker using the same identifier.\50\ In such
a case, the System will cancel the oldest of the quotes or orders back
to the entering party prior to execution.\51\
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\50\ See proposed BX Options Rules, Chapter VI, Section 10(6).
\51\ See id.
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The Commission believes that BX Options' proposed execution
priority rules and order types are consistent with the Act, and in
particular, with the requirements in Section 6(b)(5) of the Act, which
requires an exchange's rules be, among other things, designed to
promote just and equitable principles of trade, to remove impediments
to and perfect the mechanism of a free and open market and a national
market system, and, in general, to protect investors and the public
interest, and are not designed to permit unfair discrimination between
customers, issuers, brokers, or dealers. The Commission further finds
that BX Options' proposed trading rules are consistent with the
requirements of the Options Order Protection and Locked/Crossed Market
Plan (``Linkage Plan''). Specifically, subject to the exceptions
contained in proposed BX Options Rules, Chapter XII, the System will
ensure that an order is not executed at a price that trades through
another options exchange.\52\ In this regard, the Commission notes that
BX is required under Rule 608(c) of Regulation NMS to comply with and
enforce compliance by its members with the Linkage Plan, including the
requirement to avoid trading through better prices available on other
markets.\53\ Further, any order entered with a price that would lock or
cross a protected quotation that is not eligible for routing, will be
re-priced to the current national best offer (for bids) or the current
national best bid (for offers) and displayed at one minimum price
variance above (for offers) or below (for bids) the national best
price.\54\
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\52\ See proposed BX Options Rules, Chapter XII, Section 2.
\53\ See 17 CFR 242.608(c). See also proposed BX Options Rules,
Chapter XII, Section 2(b).
\54\ See proposed BX Options Rules, Chapter VI, Section
7(b)(3)(C).
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One commenter expressed concern with the timing of the proposal and
requested that the Commission grant CBOE and C2 Options Exchange,
Incorporated (``C2'') temporary relief from the Linkage Plan.\55\
Specifically, the commenter noted that CBOE and C2 will not be able to
complete required systems work by BX Options' anticipated launch date
of June 29, 2012 to allow these exchanges to identify better-priced
quotations on BX Options and then cancel or route orders to BX Options
in compliance with the Linkage Plan. Consequently, the commenter stated
that these exchanges may not be able to comply with the Linkage Plan
because their systems will potentially trade through better-priced
quotations on BX Options. The commenter requested temporary relief from
the Linkage Plan so that CBOE and C2 will
[[Page 39280]]
be able to continue to operate consistent with the terms of the Linkage
Plan until it can implement the necessary systems changes. While BX
believes that the notice provided to CBOE and the marketplace in
general was sufficient and consistent with customary timeframes
respecting systems changes of this sort, BX acknowledged the
commenter's concerns and stated that temporary relief from the Linkage
Plan warrants consideration.\56\
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\55\ See CBOE Letter, supra note 5.
\56\ See BX Response, supra note 6.
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As noted below, BX will be a participant in the Linkage Plan. To
meet their regulatory responsibilities under the Linkage Plan,
including the requirement to avoid trading through better-priced
protected quotations available on other markets, other options
exchanges that are Linkage Plan participants must have sufficient
notice of new protected quotations, as well as all necessary
information (such as final technical specifications). Therefore, the
Commission believes that it would be a reasonable policy and procedure
under the Linkage Plan for options exchanges to begin treating BX
Options' best bid and best offer as a protected quotation within 60
days after the date of this order.
Proposed BX Options Rules, Chapter VII, Section 12, prohibits
Options Participants from executing, as principal, orders they
represent as agent unless the agency order is first exposed on BX
Options for at least one second or the Options Participant has been
bidding or offering on BX Options for at least one second prior to
receiving an agency order that is executable against such bid or offer.
The Commission believes that in the electronic environment of BX
Options, a one second exposure period could facilitate the prompt
execution of orders while continuing to provide Options Participants
with an opportunity to compete for exposed bids and offers. In
addition, the BX Options System is identical to the trading system
currently used for NOM today and this order exposure requirement is
comparable to that which currently applies on other registered options
exchanges.\57\ Accordingly, the Commission believes this proposed rule
of BX Options is consistent with the Act.
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\57\ See, e.g., Rules of NOM, Chapter VII, Section 12.
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C. Opening and Halt Cross
The System will support a single price opening or re-opening via an
electronic cross.\58\ The auctions at the opening and at the resumption
of trading following a halt are identical to those that exist on NOM.
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\58\ See proposed BX Options Rules, Chapter VI, Section 8.
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Specifically, BX Options will operate a pre-opening phase that will
begin prior to the opening of the market at a time to be determined by
the Exchange. Orders may be submitted, modified, and cancelled
throughout the pre-opening phase. Prior to opening the market (or
resuming trading in the case of a halt), the Exchange will calculate
and disseminate certain indicative information: Opening price; order
imbalance; and the size and direction of any imbalance.\59\ Thereafter,
the Exchange will determine, using an algorithm, a single price at
which a particular options series will open and will match, using an
algorithm, the maximum number of available orders. After the cross
concludes, orders will be cancelled, routed, or posted depending on the
instructions on the orders and open trading will commence.
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\59\ See proposed BX Options Rules, Chapter VI, Section 8.
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The Commission believes that the proposed BX Options Rules
regarding the opening of trading on BX Options are reasonably designed
to provide for an orderly opening and are consistent with the Act. The
Commission further believes that the procedure for re-opening trading
in an option following the conclusion of a trading halt in the
underlying security is reasonably designed to provide for an orderly
re-opening of trading in the option and is consistent with the Act.
D. Routing
BX Options Participants may designate orders to be routed to
another options exchange when trading interest is not available on BX
Options or to execute only on BX Options. The Exchange proposed that
its routing functionality will be limited to only routing System
securities, which are options listed for trading on BX.\60\ The
Exchange has proposed to offer two System routing options: SEEK \61\
and SRCH,\62\ which may be combined with all available order types and
time-in-force designations, with the exception of order types and time-
in-force designations whose terms are inconsistent with the terms of a
particular routing option.\63\ An order that is designated as routable
will be routed to other options exchanges to be executed when BX
Options is not at the NBBO consistent with the Linkage Plan. Orders
routed to other options exchanges do not retain time priority with
respect to orders in the System, and the System will continue to
execute orders while routed orders are away at another exchange.\64\ If
a routed order is returned, in whole or in part, that order (or its
remainder) will receive a new time stamp reflecting the time of its
return to the System.\65\ Options Participants whose orders are routed
away will be obligated to honor trades executed on other options
exchanges to the same extent they would be obligated to honor a trade
executed on BX Options.\66\
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\60\ See proposed BX Options Rules, Chapter VI, Section 11(a).
\61\ SEEK is a routing option pursuant to which an order will
first check the System for available contracts for execution. After
checking the System for available contracts, orders are sent to
other available market centers for potential execution, per the
entering firm's instructions. When checking the book, the System
will seek to execute at the price at which it would send the order
to a destination market center. If contracts remain un-executed
after routing, they are posted on the book. Once on the book, should
the order subsequently be locked or crossed by another market
center, the System will not route the order to the locking or
crossing market center. See proposed BX Options Rules, Chapter VI,
Section 11(a)(1)(A).
\62\ SRCH is a routing option pursuant to which an order will
first check the System for available contracts for execution. After
checking the System for available contracts, orders are sent to
other available market centers for potential execution, per the
entering firm's instructions. When checking the book, the System
will seek to execute at the price at which it would send the order
to a destination market center. If contracts remain un-executed
after routing, they are posted on the book. Once on the book, should
the order subsequently be locked or crossed by another market
center, it will re-route. See proposed BX Options Rules, Chapter VI,
Section 11(a)(1)(B).
\63\ See proposed BX Options Rules, Chapter VI, Section 11(a).
\64\ See proposed BX Options Rules, Chapter VI, Section 11(c).
\65\ See id.
\66\ See proposed BX Options Rules, Chapter VI, Section 11(d).
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The Exchange will route options orders using Nasdaq Options
Services LLC (``NOS''), which is a registered broker-dealer and a
member of the Exchange.\67\ NOS is owned by NASDAQ OMX, which also owns
three registered securities exchanges--the Exchange, NASDAQ, and NASDAQ
OMX PHLX LLC (``PHLX'').\68\ Therefore, NOS is an affiliate of these
exchanges.\69\
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\67\ See Notice, supra note 4, at 29733. The Exchange
represented that NOS has developed policies and procedures designed
to reject an order or series of orders that violate applicable pre-
trade requirements of Rule 15c3-5 under the Act prior to routing
such orders, and would seek to cancel any orders that had been
routed. See Notice, supra note 4, at 29734.
\68\ See Securities Exchange Act Release No. 58324 (August 7,
2008), 73 FR 46936 (August 12, 2008) (SR-BSE-2008-02; SR-BSE-2008-
23; SR-BSE-2008-25; SR-BSECC-2008-01) (order approving NASDAQ OMX's
acquisition of BX); Securities Exchange Act Release No. 58179 (July
17, 2008), 73 FR 42874 (July 23, 2008) (order approving NASDAQ OMX's
acquisition of PHLX).
\69\ See id. See also Notice, supra note 4, at 29734.
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Exchange Rule 2140(a)(1) provides generally that, absent an
effective filing
[[Page 39281]]
under Section 19(b) of the Act, the Exchange may not, directly or
indirectly, acquire or maintain an ownership interest in, or engage in
a business venture with, an Exchange member or an affiliate of an
Exchange member. However, the Exchange proposes that NOS, a member of
the Exchange, provide other members of the Exchange options routing
services to other markets, including two affiliates of the Exchange--
NASDAQ \70\ and PHLX.\71\ In addition, the Exchange intends to receive
through NOS options orders routed inbound to the Exchange from its
affiliated exchanges. Accordingly, the Exchange seeks Commission
approval to permit the Exchange to engage in the business venture of
outbound routing using NOS as its routing broker, as well as receiving
inbound orders from its affiliates, NASDAQ \72\ and PHLX, through
NOS.\73\
---------------------------------------------------------------------------
\70\ NASDAQ's options trading facility is NOM.
\71\ See id.
\72\ See supra note 70
\73\ See Notice, supra note 4, at 29734.
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Recognizing that the Commission has previously expressed concern
regarding the potential for conflicts of interest in instances where a
member firm is affiliated with an exchange, particularly where a member
is routing orders to such affiliated exchange,\74\ the Exchange has
proposed limitations and conditions on NOS's affiliation with the
Exchange. Specifically, the Exchange proposes that NOS operate as
outbound router and inbound router subject to certain limitations and
conditions, as described below.
---------------------------------------------------------------------------
\74\ See Notice, supra note 4, at 29733-29734.
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1. NOS as Outbound Router
The Exchange proposes that NOS will operate as a facility (as
defined in section 3(a)(2) of the Act) of the Exchange to provide
outbound options routing services from the Exchange to other options
exchanges. NOS's operation as a facility providing outbound options
routing services for the Exchange is subject to the following
limitations and conditions:
NOS will route orders to other market centers as directed
by the Exchange. NOS will be programmed to follow the algorithm and
order type instructions established in the BX Options Rules and will
not have discretion to change the terms of an order or the order
routing instructions.\75\
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\75\ See supra note 67.
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NOS will not engage in any business other than: (a) as an
outbound router for the Exchange; and (b) any other activities it may
engage in as approved by the Commission.\76\
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\76\ The Exchange also proposed that, immediately prior to the
commencement of operations of NOS as an outbound router for the
Exchange, the Exchange be approved to use NOS to conduct a test of
its routing functionality. See Notice, supra note 4, at 29733-34.
The Exchange represented that it will use NOS to perform test trades
in an actual security to track the performance of its systems from
order entry to clearance and settlement. See id. The Exchange
represented that the test will be performed by entering a buy or
sell order and then, upon execution of each, entering an offsetting
buy and sell order in the same security for the same quantity to
close out the test position and minimize financial impact on the
Exchange. See id. The Exchange represented that it will deliver the
test orders to NOS, as the routing broker, which will route to the
designated away market and receive an execution back. See id. The
Exchange represented that, to the extent that the offsetting trades
require the Exchange to pay out funds, the funds will be provided
out of the cash accounts of the Exchange; and, to the extent that
the trades result in a profit, the funds will be deposited in the
cash accounts of the Exchange. See id.
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For purposes of Commission Rule 17d-1, the designated
examining authority of NOS will be a self-regulatory organization
(``SRO'') unaffiliated with the Exchange or any of its affiliates.
The Exchange will be responsible for filing with the
Commission proposed rule changes related to the operation of, and fees
for services provided by, NOS and NOS shall be subject to exchange
nondiscrimination requirements.
The books, records, premises, officers, agents, directors
and employees of NOS as a facility of the Exchange will be deemed to be
the books, records, premises, officers, agents, directors and employees
of the Exchange for purposes of, and subject to oversight pursuant to,
the Act. The books and records of NOS as a facility of the Exchange
will be subject at all times to inspection and copying by the
Commission.
The use of NOS to route options orders to other market
centers will be optional. Parties who do not desire to use NOS must
enter orders into the System as ineligible for routing.
NOS will establish and maintain procedures and internal
controls reasonably designed to adequately restrict the flow of
confidential and proprietary information between the Exchange and its
facilities (including NOS as its routing facility) and any other
entity.
As a facility of the Exchange, NOS will be subject to the
Exchange's and the Commission's regulatory oversight; and the Exchange
will be responsible for ensuring that NOS's outbound routing function
is operated consistent with Section 6 of the Act and the Exchange's
rules. In addition, the Exchange will be required to file with the
Commission proposed rule changes and fees relating to NOS's outbound
routing function. Any such rules and fees relating to NOS's outbound
router function will be subject to exchange nondiscrimination
requirements. Further, the proposed limitations and conditions for the
operation of NOS as an affiliated outbound router on behalf of each
Exchange are consistent with conditions the Commission has approved for
other exchanges.\77\ The Commission therefore finds the proposed
operation of NOS as an affiliated outbound router of the Exchange to be
consistent with the Act.
---------------------------------------------------------------------------
\77\ See, e.g., Securities Exchange Act Release No. 62716
(August 13, 2010), 75 FR 51295 (August 19, 2010) (File No. 10-198)
(order granting the exchange registration of BATS-Y Exchange, Inc.).
---------------------------------------------------------------------------
2. NOS as an Inbound Router
The Exchange also proposes to permit BX to accept inbound orders
that NOS routes in its capacity as a facility of NASDAQ \78\ and PHLX,
subject to the following conditions and limitations:
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\78\ See supra note 70.
---------------------------------------------------------------------------
The Exchange and FINRA will maintain a regulatory contract
and an agreement pursuant to Rule 17d-2 under the Act (``17d-2
Agreement'').\79\ Pursuant to the regulatory contract and the 17d-2
Agreement, FINRA will be allocated regulatory responsibilities to
review NOS's compliance with certain Exchange rules. Pursuant to the
regulatory contract, however, the Exchange retains ultimate
responsibility for enforcing its rules with respect to NOS.\80\
---------------------------------------------------------------------------
\79\ 17 CFR 240.17d-2.
\80\ NOS also is subject to independent oversight by FINRA, its
designated examining authority, for compliance with financial
responsibility requirements. See Notice, supra note 4, at 29734.
---------------------------------------------------------------------------
FINRA will monitor NOS for compliance with the Exchange's
trading rules, and will collect and maintain certain related
information. Pursuant to the regulatory contract, both FINRA and the
Exchange will collect and maintain all alerts, complaints,
investigations and enforcement actions in which NOS (in its capacity as
a facility of NASDAQ \81\ and PHLX routing orders to the Exchange) is
identified as a participant that has potentially violated applicable
Commission or the Exchange's rules. The Exchange and FINRA will retain
these records in an easily accessible manner.
---------------------------------------------------------------------------
\81\ See supra note 70.
---------------------------------------------------------------------------
FINRA will provide a report to the Exchange's chief
regulatory officer (``CRO''), on a quarterly basis, that: (i)
Quantifies all alerts (of which FINRA is aware) that identify NOS as a
participant that has potentially violated Commission or the Exchange's
rules; and (ii) lists all investigations that
[[Page 39282]]
identify NOS as a participant that has potentially violated Commission
or the Exchange's rules.
The Exchange has in place BX Rule 2140(c), which requires
NASDAQ OMX, as the holding company owning both the Exchange and NOS, to
establish and maintain procedures and internal controls reasonably
designed to ensure that NOS does not develop or implement changes to
its system, based on nonpublic information obtained regarding planned
changes to the Exchange's systems as a result of its affiliation with
the Exchange, until such information is available generally to
similarly situated Exchange members, in connection with the provision
of inbound order routing to the Exchange.
Routing of orders from NOS to the Exchange, in NOS's
capacity as a facility of NASDAQ \82\ and PHLX, be authorized for a
pilot period of one year.
---------------------------------------------------------------------------
\82\ See supra note 70.
---------------------------------------------------------------------------
Although the Commission continues to be concerned about potential
unfair competition and conflicts of interest between an exchange's
self-regulatory obligations and its commercial interest when the
exchange is affiliated with one of its members, for the reasons
discussed below, the Commission believes that it is consistent with the
Act to permit NOS, in its capacity as a facility of NASDAQ \83\ and
PHLX, to route options orders inbound to the Exchange on a pilot basis,
subject to the limitations and conditions described above.
---------------------------------------------------------------------------
\83\ See supra note 70.
---------------------------------------------------------------------------
The Exchange has proposed the above limitations and conditions
applicable to NOS's inbound options routing activities. The Commission
believes that these limitations and conditions mitigate its concerns
about potential conflicts of interest and unfair competitive advantage.
In particular, the Commission believes that a non-affiliated SRO
oversight of NOS,\84\ combined with a non-affiliated SRO's monitoring
of NOS's compliance with the Exchange's rules and quarterly reporting
to the Exchange, will help to protect the independence of the
Exchange's regulatory responsibilities with respect to NOS. The
Commission also believes that the requirement that the Exchange
establish and maintain procedures and internal controls reasonably
designed to ensure that NOS does not develop or implement changes to
its systems based on non-public information obtained as a result of its
affiliation with the Exchange, until such information is available
generally to similarly situated members of the Exchange, is reasonably
designed to ensure that NOS cannot misuse any information advantage it
may have because of its affiliation with the Exchange. Furthermore, the
Commission believes that the Exchange's proposal to allow NOS to route
options orders inbound to the Exchange from its affiliated exchanges
(i.e., NASDAQ \85\ and PHLX), on a pilot basis, will provide the
Exchange and the Commission with an opportunity to assess the impact of
any conflicts of interest of allowing an affiliated members of an
Exchange to route options orders inbound to the Exchange and whether
such affiliation provides an unfair competitive advantage.
---------------------------------------------------------------------------
\84\ This oversight will be accomplished through a 17d-2
Agreement and Regulatory Contract.
\85\ See supra note 70.
---------------------------------------------------------------------------
Further, the Commission notes that the proposed conditions for the
operation of NOS as the affiliated inbound router on behalf of the
Exchange are consistent with conditions the Commission has approved for
other exchanges.\86\ The Commission therefore finds the proposed
operation of NOS as an affiliate inbound router of the Exchange is
consistent with the Act.
---------------------------------------------------------------------------
\86\ See, e.g., Securities Exchange Act Release No. 62877
(September 9, 2011), 75 FR 56633 (September 16, 2011) (SR-PHLX-2010-
79).
---------------------------------------------------------------------------
E. Minimum Quoting and Trading Increments
The Exchange is proposing to apply the following minimum quoting
increments: (1) If the option price is less than $3.00, five (5) cents;
and (2) if the option price is $3.00 or higher, ten (10) cents.\87\ In
addition, the Exchange proposes to participate in a pilot program,
until June 30, 2012, to allow quoting in certain options in smaller
increments (``Pilot Program'').\88\ The Exchange will include in the
Pilot Program all classes that are, on that date, included by other
options exchanges in substantially similar pilot programs. If an
options class is included in the Pilot Program, the Exchange will allow
quoting in one (1) cent increments any option priced less than $3.00 or
options on QQQQs, IWM, and SPY.\89\ Options priced at $3.00 or higher
that are in the Pilot Program will be quoted in five (5) cent
increments.\90\ In addition, the Exchange is proposing that the minimum
trading increment for options contracts traded on BX Options would be
one (1) cent for all series.\91\
---------------------------------------------------------------------------
\87\ See proposed BX Options Rules, Chapter VI, Section 5(a)(1).
\88\ See proposed BX Options Rules, Chapter VI, Section 5(a)(3).
\89\ See id.
\90\ See id.
\91\ See proposed BX Options Rules, Chapter VI, Section 5(b).
---------------------------------------------------------------------------
The Commission believes that the Exchange's proposed minimum
quoting and trading increments, including its proposal to commence
quoting pursuant to the Pilot Program, which are consistent with the
rules of the other options exchanges,\92\ are consistent with the Act.
As the Commission noted in approving the latest expansion of the Pilot
Program, allowing market participants to quote in smaller increments in
Pilot options has been shown to reduce spreads, thereby lowering costs
to investors.\93\ In addition, permitting options to be quoted in
smaller increments pursuant to the Pilot Program provides the
opportunity for reduced spreads for a significant amount of trading
volume.\94\ Further, although the Commission anticipates that the
Exchange's proposal will contribute to further increases in quotation
message traffic, the Commission believes that the Exchange's proposal
is sufficiently limited such that it is unlikely on its own to increase
quotation message traffic beyond the capacity of market participants'
systems.
---------------------------------------------------------------------------
\92\ See Rules of NOM, Chapter VI, Section 5.
\93\ See Securities Exchange Act Release No. 60711 (September
23, 2009), 74 FR 49419, 49424 (September 28, 2009) (SR-NYSEArca-
2009-44) (partially approving a proposed rule change to expand the
Pilot Program).
\94\ See id.
---------------------------------------------------------------------------
F. Securities Traded on BX Options
The Exchange proposes to adopt initial and continued listing
standards for equity and index options traded on BX Options that are
substantially similar to the listing standards adopted by other options
exchanges.\95\ The Commission believes that the Exchange's proposed
initial and continued listing standards are consistent with the Act,
including Section 6(b)(5), in that they are designed to protect
investors and the public interest and to promote just and equitable
principles of trade.
---------------------------------------------------------------------------
\95\ See, e.g., Rules of NOM, Chapters IV and XIV.
---------------------------------------------------------------------------
G. Participation in National Market System Plans
The Exchange represented that it is a participant of various
national market system plans for options trading established under
Section 11A of the Act.\96\ Specifically, the Exchange represented that
it is a participant of the Linkage Plan, the OPRA Plan, the Plan for
the Selection and Reservation of
[[Page 39283]]
Securities Symbols, and the Plan of the Options Regulatory Surveillance
Authority.\97\ BX represented that it will join the Plan for the
Purpose of Developing and Implementing Procedures Designed to
Facilitate the Listing and Trading of Standardized Options Submitted
Pursuant to Section 11A(a)(3)(B) of the Act (``OLPP'').\98\
---------------------------------------------------------------------------
\96\ See Notice, supra note 4, at 29737.
\97\ See Amendment No. 2, supra note 7.
\98\ See Amendment No. 2, supra note 7. According to the
Exchange, the Exchange's membership in the OLPP lapsed because the
Exchange ceased to operate an options market when the Boston Options
Exchange became a national securities exchange. Id.
---------------------------------------------------------------------------
H. Regulation
According to the Exchange, the Exchange will regulate BX Options
using the existing BX regulatory structure. The Exchange's CRO will
have general supervision of the regulatory operations of BX Options,
including responsibility for overseeing the surveillance, examination,
and enforcement functions and for administering all regulatory services
agreements applicable to BX Options.\99\ Similarly, the Exchange's
existing Regulatory Oversight Committee (``ROC'') will be responsible
for overseeing the adequacy and effectiveness of the Exchange's
regulatory and SRO responsibilities, including those applicable to BX
Options.\100\
---------------------------------------------------------------------------
\99\ See Notice, supra note 4, at 29737.
\100\ See Exchange By-laws, Article IV, Section 4.13(c) and
Notice, supra note 4, at 29737. Pursuant to a regulatory services
agreement, FINRA would perform certain regulatory functions on
behalf of the Exchange. See infra note 109 and accompanying text.
---------------------------------------------------------------------------
As members of the Exchange, the Exchange's existing rules governing
members will apply to Options Participants. The Exchange's By-laws
provide that it has disciplinary jurisdiction over its members,
including Options Participants, so that it can enforce its members'
compliance with its rules and the federal securities laws.\101\ The
Exchange's rules also permit it to sanction members, including Options
Participants, for violations of its rules and of the federal securities
laws by, among other things, expelling or suspending members, limiting
members' activities, functions, or operations, fining or censuring
members, or suspending or barring a person from being associated with a
member.\102\ The Exchange's rules also provide for the imposition of
fines for minor rule violations in lieu of commencing disciplinary
proceedings.\103\
---------------------------------------------------------------------------
\101\ See, e.g., Exchange By-laws Article XII, Section 12.2.
\102\ See, e.g., BX Rule 8310.
\103\ See proposed BX Options Rules, Chapter X, Section 7. See
infra notes 121-128 and accompanying text.
---------------------------------------------------------------------------
Moreover, the Exchange will: (1) Join the existing options industry
agreements pursuant to Section 17(d) of the Act; (2) amend, as
necessary, the Exchange's existing Regulatory Services Agreement
(``RSA'') with FINRA to cover many aspects of the regulation and
discipline of the Exchange's Options Participants that participate in
options trading on BX Options; (3) perform options listing regulation,
as well as authorize Options Participants to trade on BX Options; and
(4) perform automated surveillance of trading on BX Options for the
purpose of maintaining a fair and orderly market at all times.\104\
---------------------------------------------------------------------------
\104\ See Notice, supra note 4, at 29736. BX Regulation will
monitor BX Options to identify unusual trading patterns and
determine whether particular trading activity requires further
regulatory investigation by FINRA. See id.
---------------------------------------------------------------------------
In addition, BX Regulation will oversee the process for determining
and implementing trading halts, identifying and responding to unusual
market conditions, and administering the Exchange's process for
identifying and remediating ``obvious errors'' by and among its
Participants.\105\ The proposed BX Options rules (Chapter V) regarding
halts, unusual market conditions, extraordinary market volatility,
obvious errors, and audit trail are identical to the rules of NOM.\106\
---------------------------------------------------------------------------
\105\ See Notice, supra note 4, at 29736.
\106\ See Rules of NOM, Chapter V.
---------------------------------------------------------------------------
The Commission finds that the Exchange's proposed rules and
regulatory structure with respect to BX Options are consistent with the
requirements of the Act, and in particular with Section 6(b)(1) of the
Act, which requires an exchange to be so organized and have the
capacity to be able to carry out the purposes of the Act and to comply,
and to enforce compliance by its members and persons associated with
its members, with the Act and the rules and regulations thereunder, and
the rules of the Exchange,\107\ and with Section 6(b)(6) and 6(b)(7) of
the Act,\108\ which require an Exchange to provide fair procedures for
the disciplining of members and persons associated with members.
---------------------------------------------------------------------------
\107\ 15 U.S.C. 78f(b)(1).
\108\ 15 U.S.C. 78f(b)(6) and (b)(7).
---------------------------------------------------------------------------
1. Regulatory Services Agreement
Currently, the Exchange and FINRA are parties to an existing RSA,
pursuant to which FINRA personnel operate as agents for the Exchange in
performing certain functions. According to the Exchange, FINRA performs
certain membership, disciplinary, and enforcement functions for the
Exchange.\109\ The Exchange represented that the Exchange and FINRA
have modified the RSA to capture aspects of regulation specifically
applicable to BX Options and the regulation and discipline of Options
Participants.\110\ The Exchange will continue to bear ultimate
regulatory responsibility for functions performed on the Exchange's
behalf under the RSA. Further, the Exchange retains ultimate legal
responsibility for the regulation of its Options Participants and its
market.
---------------------------------------------------------------------------
\109\ See Notice, supra note 4, at 29736.
\110\ See Amendment No. 2, supra note 7.
---------------------------------------------------------------------------
The Commission believes that it is consistent with the Act to allow
the Exchange to contract with FINRA to perform examination,
enforcement, and disciplinary functions.\111\ These functions are
fundamental elements to a regulatory program and constitute core self-
regulatory functions. The Commission believes that FINRA has the
expertise and experience to perform these functions on behalf of the
Exchange.\112\
---------------------------------------------------------------------------
\111\ See, e.g., Regulation of Exchanges and Alternative Trading
Systems, Securities Exchange Act Release No. 40760 (December 8,
1998), 63 FR 70844 (December 22, 1998). See also, e.g., Securities
Exchange Act Release Nos. 50122 (July 29, 2004), 69 FR 47962 (August
6, 2004) (SR-Amex-2004-32) (approving rule that allowed Amex to
contract with another SRO for regulatory services) (``Amex
Regulatory Services Approval Order''); 57478 (March 12, 2008), 73 FR
14521 (March 18, 2008) (SR-NASDAQ-2007-004) (``NOM Approval
Order''); 53128 (January 13, 2006), 71 FR 3550 (January 23, 2006)
(File No. 10-131) (``Nasdaq Exchange Registration Order''); and
61419 (January 26, 2010), 75 FR 5157 (February 1, 2010) (SR-BATS-
2009-031) (``BATS Options Approval Order'').
\112\ See Amex Regulatory Services Approval Order; NOM Approval
Order; Nasdaq Exchange Registration Order, and BATS Options Approval
Order, id. The Commission notes that the RSA is not before the
Commission and, therefore, the Commission is not acting on it.
---------------------------------------------------------------------------
As noted, unless relieved by the Commission of its
responsibility,\113\ the Exchange bears the responsibility for self-
regulatory conduct and primary liability for self-regulatory failures,
not the SRO retained to perform regulatory functions on the Exchange's
behalf. In performing these functions, however, FINRA may nonetheless
bear liability for causing or aiding and abetting the failure of the
Exchange to perform its regulatory functions.\114\ Accordingly,
[[Page 39284]]
although FINRA will not act on its own behalf under its SRO
responsibilities in carrying out these regulatory services for the
Exchange relating to the operation of BX Options, FINRA also may have
secondary liability if, for example, the Commission finds the
contracted functions are being performed so inadequately as to cause a
violation of the federal securities laws by the Exchange.\115\
2. 17d-2 Agreements
---------------------------------------------------------------------------
\113\ See Section 17(d)(1) of the Act and Rule 17d-2 thereunder
(15 U.S.C. 78q(d)(1) and 17 CFR 240.17d-2).
\114\ For example, if failings by FINRA have the effect of
leaving the Exchange in violation of any aspect of the Exchange's
self-regulatory obligations, the Exchange would bear direct
liability for the violation, while FINRA may bear liability for
causing or aiding and abetting the violation. See Nasdaq Exchange
Registration Order, supra note 111. See also Securities Exchange Act
Release No. 42455 (February 24, 2000), 65 FR 11388 (March 2, 2000)
(File No. 10-127) (approving the International Securities Exchange
LLC's application for registration as a national securities
exchange).
\115\ See id.
---------------------------------------------------------------------------
Rule 17d-2 under the Act permits SROs to file with the Commission
plans under which the SROs allocate among each other the responsibility
to receive regulatory reports from, and examine and enforce compliance
with specified provisions of the Act and rules thereunder and SRO rules
by, firms that are members of more than one SRO (``common members'').
If such a plan is declared effective by the Commission, an SRO that is
a party to the plan is relieved of regulatory responsibility as to any
common member for whom responsibility is allocated under the plan to
another SRO.\116\
---------------------------------------------------------------------------
\116\ Rule 17d-2 provides that any two or more SROs may file
with the Commission a plan for allocating among such SROs the
responsibility to receive regulatory reports from persons who are
members or participants of more than one of such SROs to examine
such persons for compliance, or to enforce compliance by such
persons, with specified provisions of the Act, the rules and
regulations thereunder, and the rules of such SROs, or to carry out
other specified regulatory functions with respect to such persons.
See 17 CFR 240.17d-2.
---------------------------------------------------------------------------
Pursuant to Rule 17d-2 under the Act, all of the options exchanges,
FINRA, and the New York Stock Exchange LLC (``NYSE'') have entered into
the Options Sales Practices Agreement, a Rule 17d-2 Agreement, which
allocates to certain SROs (``examining SROs'') regulatory
responsibility for common members with respect to certain options-
related sales practice matters.\117\ Under this Agreement, the
examining SROs would examine firms that are common members of the
Exchange and the particular examining SRO for compliance with certain
provisions of the Act, certain of the rules and regulations adopted
thereunder, certain examining SRO rules, and certain Exchange Rules.
The Exchange's rules contemplate participation in this Agreement by
requiring that any Options Participant also be a member of at least one
of the examining SROs.\118\
---------------------------------------------------------------------------
\117\ See Securities Exchange Act Release No. 57987 (June 18,
2008), 73 FR 36156 (June 25, 2008) (File No. S7-966).
\118\ See proposed BX Options Rules, Chapter II, Section 2(f).
---------------------------------------------------------------------------
Moreover, pursuant to Rule 17d-2 under the Act, all of the options
exchanges and FINRA have entered into the Options Related Market
Surveillance Agreement, which allocates regulatory responsibility for
certain options-related market surveillance matters among the
participants.\119\ Under this agreement, the examining SRO would assume
regulatory responsibility with respect to firms that are common members
of the Exchange and the particular examining SRO for compliance with
applicable common rules for certain accounts.
---------------------------------------------------------------------------
\119\ See Securities Exchange Act Release No. 58765 (October 9,
2008), 73 FR 62344 (October 20, 2008) (File No. 4-551).
---------------------------------------------------------------------------
As a condition to operation, the Exchange must be a party to each
of these 17d-2 Agreements, which will cover BX members that are Options
Participants. The Exchange represented that it is a party to each of
these 17d-2 Agreements.\120\
---------------------------------------------------------------------------
\120\ See Amendment No. 2, supra note 7.
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3. Minor Rule Violation Plan
The Commission approved the Exchange's Minor Rule Violation Plan
(``MRVP'') in 1989.\121\ The Exchange's MRVP specifies those
uncontested minor rule violations with sanctions not exceeding $2,500
that would not be subject to the provisions of Rule 19d-1(c)(1) under
the Act \122\ requiring that an SRO promptly file notice with the
Commission of any final disciplinary action taken with respect to any
person or organization.\123\ The Exchange's MRVP includes the policies
and procedures included in BX Rule 9216(b), ``Procedures for Violations
under Plan Pursuant to SEC Rule 19d-1(c)(2),'' and the rule violations
included in BX IM-9216, ``Violations Appropriate for Disposition Under
Plan Pursuant to SEC Rule 19d-1(c)(2).''
---------------------------------------------------------------------------
\121\ See Securities Exchange Act Release No. 26737 (April 17,
1989), 54 FR 16438-I (April 24, 1989) (SR-BSE-88-2) (``BX MRVP
Order'').
\122\ 17 CFR 240.19d-1(c)(1).
\123\ The Commission adopted amendments to paragraph (c) of Rule
19d-1 to allow SROs to submit for Commission approval plans for the
abbreviated reporting of minor disciplinary infractions. See
Securities Exchange Act Release No. 21013 (June 1, 1984), 49 FR
23828 (June 8, 1984) (File No. S7-983A). Any disciplinary action
taken by an SRO against any person for violation of a rule of the
SRO which has been designated as a minor rule violation pursuant to
such a plan filed with and declared effective by the Commission
would not be considered ``final'' for purposes of Section 19(d)(1)
of the Act if the sanction imposed consists of a fine not exceeding
$ 2,500 and the sanctioned person has not sought an adjudication,
including a hearing, or otherwise exhausted his administrative
remedies.
---------------------------------------------------------------------------
The Exchange proposes to amend its MRVP and BX IM-9216 to include
references to proposed BX Options Rules, Chapter X, Section 7,
``Penalty for Minor Rule Violations for Options Trading.'' \124\ The
Commission believes that this change is consistent with the Act because
it clarifies that the proposed rules listed in Chapter X, Section 7 of
the proposed BX Options Rules will be included in BX's MRVP.
---------------------------------------------------------------------------
\124\ See Notice, supra note 4, at 29736-37.
---------------------------------------------------------------------------
The Commission notes that the rules included in proposed BX Options
Rules, Chapter X, Section 7 are similar to rules included in the MRVPs
of other options exchanges.\125\ The Commission finds that the BX MRVP,
as amended to include the rules listed in proposed BX Options Rules,
Chapter X, Section 7, is consistent with Sections 6(b)(1), 6(b)(5), and
6(b)(6) of the Act, which require, in part, that an exchange have the
capacity to enforce compliance with, and provide appropriate discipline
for, violations of the rules of the Commission and of the
exchange.\126\ In addition, because BX Rule 9216(b) will offer
procedural rights to a person sanctioned for a violation listed in
proposed BX Options Rules, Chapter X, Section 7, the Commission
believes that the Exchange's rules provide a fair procedure for the
disciplining of members and associated persons, consistent with Section
6(b)(7) of the Act.\127\
---------------------------------------------------------------------------
\125\ See, e.g., Rules of NOM, Chapter X, Section 7.
\126\ 15 U.S.C. 78f(b)(1), 78f(b)(5), and 78f(b)(6).
\127\ 15 U.S.C. 78f(b)(7).
---------------------------------------------------------------------------
The Commission also finds that the proposal to include the
provisions in proposed BX Options Rules, Chapter X, Section 7 in BX's
MRVP is consistent with the public interest, the protection of
investors, or otherwise in furtherance of the purposes of the Act, as
required by Rule 19d-1(c)(2) under the Act,\128\ because it should
strengthen the Exchange's ability to carry out its oversight and
enforcement responsibilities as an SRO in cases where full disciplinary
proceedings are unsuitable in view of the minor nature of the
particular violation.
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\128\ 17 CFR 240.19d-1(c)(2).
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In approving the proposed change to the Exchange's MRVP, the
Commission in no way minimizes the importance of compliance with the
Exchange's rules and all other rules subject to the imposition of fines
under the Exchange's MRVP. The Commission believes that the violation
of any SRO rules, as well as Commission rules, is a serious matter.
However, the Exchange's MRVP provides a reasonable means of addressing
rule violations that do not rise to the level of requiring formal
[[Page 39285]]
disciplinary proceedings, while providing greater flexibility in
handling certain violations. The Commission expects that the Exchange
will continue to conduct surveillance with due diligence and make a
determination based on its findings, on a case-by-case basis, whether a
fine of more or less than the recommended amount is appropriate for a
violation under the Exchange's MRVP or whether a violation requires a
formal disciplinary action.
I. Section 11(a) of the Act
Section 11(a)(1) of the Act \129\ prohibits a member of a national
securities exchange from effecting transactions on that exchange for
its own account, the account of an associated person, or an account
over which it or its associated person exercises discretion
(collectively, ``covered accounts'') unless an exception applies. Rule
11a2-2(T) under the Act,\130\ known as the ``effect versus execute''
rule, provides exchange members with an exemption from the Section
11(a)(1) prohibition. Rule 11a2-2(T) permits an exchange member,
subject to certain conditions, to effect transactions for covered
accounts by arranging for an unaffiliated member to execute
transactions on the exchange. To comply with Rule 11a2-2(T)'s
conditions, a member: (i) Must transmit the order from off the exchange
floor; (ii) may not participate in the execution of the transaction
once it has been transmitted to the member performing the execution;
\131\ (iii) may not be affiliated with the executing member; and (iv)
with respect to an account over which the member has investment
discretion, neither the member nor its associated person may retain any
compensation in connection with effecting the transaction except as
provided in the Rule.
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\129\ 15 U.S.C. 78k(a)(1).
\130\ 17 CFR 240.11a2-2(T).
\131\ The member may, however, participate in clearing and
settling the transaction.
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In a letter to the Commission, the Exchange requests that the
Commission concur with the Exchange's conclusion that Options
Participants that enter orders into the System satisfy the requirements
of Rule 11a2-2(T).\132\ For the reasons set forth below, the Commission
believes that Options Participants entering orders into the System
would satisfy the conditions of the Rule.
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\132\ See Letter from Jeffrey S. Davis, Vice President and
Deputy General Counsel, NASDAQ OMX, to Heather Seidel, Associate
Director, Division of Trading and Markets, Commission, dated June
19, 2012 (``BX 11(a) Letter'').
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The Rule's first condition is that orders for covered accounts be
transmitted from off the exchange floor. The BX Options System will
receive orders electronically through remote terminals or computer-to-
computer interfaces. In the context of other automated trading systems,
the Commission has found that the off-floor transmission requirement is
met if a covered account order is transmitted from a remote location
directly to an exchange's floor by electronic means.\133\ Because the
BX Options System receives orders electronically through remote
terminals or computer-to-computer interfaces, the Commission believes
that the System satisfies the off-floor transmission requirement.
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\133\ See, e.g., NOM Approval Order, supra note 111; Securities
Exchange Act Release Nos. 53128 (January 13, 2006), 71 FR 3550
(January 23, 2006) (File No. 10-131) (approving Nasdaq Stock Market
LLC); 44983 (October 25, 2001), 66 FR 55225 (November 1, 2001) (SR-
PCX-00-25) (approving Archipelago Exchange); 29237 (May 24, 1991),
56 FR 24853 (May 31, 1991) (SR-NYSE-90-52 and SR-NYSE-90-53)
(approving NYSE's Off-Hours Trading Facility); and 15533 (January
29, 1979), 44 FR 6084 (January 31, 1979) (``1979 Release'').
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Second, the Rule requires that the member not participate in the
execution of its order once it has been transmitted to the member
performing the execution. The Exchange represented that at no time
following the submission of an order is an Options Participant able to
acquire control or influence over the result or timing of an order's
execution.\134\ According to the Exchange, the execution of a member's
order is determined solely by what other orders, bids, or offers are
present in the System at the time the Options Participant submits the
order and on the priority of those orders, bids, and offers.\135\
Accordingly, the Commission believes that an Options Participant does
not participate in the execution of an order submitted to the System.
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\134\ See BX 11(a) Letter, supra note 132, at 7.
\135\ See id. An Options Participant may cancel or modify the
order, or modify the instruction for executing the order, but only
from off the floor. The Commission has stated that the non-
participation requirement is satisfied under such circumstances, so
long as such modifications or cancellations are also transmitted
from off the floor. See Securities Exchange Act Release No. 14713
(April 27, 1978), 43 FR 18557 (May 1, 1978) (``1978 Release'')
(stating that the ``non-participation requirement does not prevent
initiating members from canceling or modifying orders (or the
instructions pursuant to which the initiating member wishes orders
to be executed) after the orders have been transmitted to the
executing member, provided that any such instructions are also
transmitted from off the floor'').
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Third, Rule 11a2-2(T) requires that the order be executed by an
exchange member who is unaffiliated with the member initiating the
order. The Commission has stated that this requirement is satisfied
when automated exchange facilities are used, as long as the design of
these systems ensures that members do not possess any special or unique
trading advantages in handling their orders after transmitting them to
the exchange.\136\ BX represented that the design of the System ensures
that no Options Participant has any special or unique trading advantage
in the handling of its orders after transmitting its orders to the
Exchange.\137\ Based on the Exchange's representation, the Commission
believes that the BX Options System satisfies this requirement.
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\136\ In considering the operation of automated execution
systems operated by an exchange, the Commission has noted that while
there is not an independent executing exchange member, the execution
of an order is automatic once it has been transmitted into the
system. Because the design of these systems ensures that members do
not possess any special or unique trading advantages in handling
their orders after transmitting them to the exchange, the Commission
has stated that executions obtained through these systems satisfy
the independent execution requirement of Rule 11a2-2(T). See 1979
Release, supra note 133.
\137\ See BX 11(a) Letter, supra note 132, at 8.
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Fourth, in the case of a transaction effected for an account with
respect to which the initiating member or an associated person thereof
exercises investment discretion, neither the initiating member nor any
associated person thereof may retain any compensation in connection
with effecting the transaction, unless the person authorized to
transact business for the account has expressly provided otherwise by
written contract referring to Section 11(a) of the Act and Rule 11a2-
2(T)(a)(2)(iv).\138\ The Exchange represents that Options Participants
trading for covered accounts over which they exercise investment
discretion must comply with this condition in order to rely on the
rule's exemption.\139\
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\138\ 17 CFR 240.11a2-2(T)(a)(2)(iv). In addition, Rule 11a2-
2(T)(d) requires a member or associated person authorized by written
contract to retain compensation, in connection with effecting
transactions for covered accounts over which such member or
associated persons thereof exercises investment discretion, to
furnish at least annually to the person authorized to transact
business for the account a statement setting forth the total amount
of compensation retained by the member in connection with effecting
transactions for the account during the period covered by the
statement. See 17 CFR 240.11a2-2(T)(d). See also 1978 Release, supra
note 135 (stating ``[t]he contractual and disclosure requirements
are designed to assure that accounts electing to permit transaction-
related compensation do so only after deciding that such
arrangements are suitable to their interests'').
\139\ See BX 11(a) Letter, supra note 132, at 8.
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[[Page 39286]]
III. Exemption From Section 19(b) of the Act With Regard to CBOE, NYSE,
and FINRA Rules Incorporated by Reference
The Exchange proposes to incorporate by reference as BX Options
Rules certain rules of the CBOE, NYSE, and FINRA.\140\ Thus, for
certain BX Options rules, Exchange members will comply with a BX
Options rule by complying with the CBOE, NYSE, or FINRA rule
referenced. In connection with its proposal to incorporate CBOE, NYSE,
and FINRA rules by reference, the Exchange requested, pursuant to Rule
240.0-12 under the Act,\141\ an exemption under Section 36 of the Act
from the rule filing requirements of Section 19(b) of the Act for
changes to those BX Options rules that are effected solely by virtue of
a change to a cross-referenced CBOE, NYSE, or FINRA rule.\142\ The
Exchange proposes to incorporate by reference categories of rules
(rather than individual rules within a category) that are not trading
rules. The Exchange agrees to provide written notice to Options
Participants prior to the launch of BX Options of the specific CBOE,
NYSE, and FINRA rules that it will incorporate by reference.\143\ In
addition, the Exchange will notify Options Participants whenever CBOE,
NYSE, or FINRA proposes a change to a cross-referenced CBOE, NYSE, or
FINRA rule.\144\
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\140\ Specifically, the Exchange proposes to incorporate by
reference: (1) CBOE rules governing position and exercise limits for
equity and index options, which are cross-referenced in Chapter III,
Sections 7 and 9 of the proposed BX Options Rules and Chapter XIV,
Sections 5 and 7 of the proposed BX Options Rules, respectively; (2)
the margin rules of the CBOE or the NYSE, which are referenced in
Chapter XIII, Section 3 of the proposed BX Options Rules; and (3)
FINRA's rules governing communications with the public, which are
referenced in Chapter XI, Section 22 of the proposed BX Options
Rules.
\141\ 17 CFR 240.0-12.
\142\ See Letter from Jeffrey S. Davis, Vice President and
Deputy General Counsel, NASDAQ OMX, to Elizabeth M. Murphy,
Secretary, Commission, dated June 21, 2012.
\143\ See id.
\144\ The Exchange will provide such notice through a posting on
the same Web site location where the Exchange will post its own rule
filings pursuant to Rule 19b-4(l) under Act, within the time frame
required by that Rule. The Web site posting will include a link to
the location on the CBOE, NYSE, or FINRA Web site where those SROs'
proposed rule changes are posted. See id.
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Using its authority under Section 36 of the Act, the Commission
previously exempted certain SROs from the requirement to file proposed
rule changes under Section 19(b) of the Act.\145\ Each such exempt SRO
agreed to be governed by the incorporated rules, as amended from time
to time, but is not required to file a separate proposed rule change
with the Commission each time the SRO whose rules are incorporated by
reference seeks to modify its rules. In addition, each SRO incorporated
by reference only regulatory rules (e.g., margin, suitability,
arbitration), not trading rules, and incorporated by reference whole
categories of rules (i.e., did not ``cherry-pick'' certain individual
rules within a category). Each exempt SRO had reasonable procedures in
place to provide written notice to its members each time a change is
proposed to the incorporated rules of another SRO in order to provide
its members with notice of a proposed rule change that affects their
interests, so that they would have an opportunity to comment on it.
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\145\ See Securities Exchange Act Release No. 49260 (February
17, 2004), 69 FR 8500 (February 24, 2004). See also Securities
Exchange Act Release Nos. 57478 (March 12, 2008), 73 FR 14521,
14539-40 (March 18, 2008) (order approving SR-NASDAQ-2007-004 and
SR-NASDAQ-2007-080) and 53128 (January 13, 2006), 71 FR 3550, 3565-
66 (January 23, 2006) (File No. 10-131) (approving The NASDAQ Stock
Market LLC's exchange application).
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The Commission is granting the Exchange's request for exemption,
pursuant to Section 36 of the Act, from the rule filing requirements of
Section 19(b) of the Act with respect to the rules that the Exchange
proposes to incorporate by reference into BX Options Rules. The
Commission believes that this exemption is appropriate in the public
interest and consistent with the protection of investors because it
will promote more efficient use of Commission and SRO resources by
avoiding duplicative rule filings based on simultaneous changes to
identical rule text sought by more than one SRO. Consequently, the
Commission grants the Exchange's exemption request for BX Options. This
exemption is conditioned upon the Exchange providing written notice to
Options Participants whenever the CBOE, NYSE, or FINRA proposes to
change a rule that BX Options has incorporated by reference.\146\
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\146\ As discussed above, the Exchange has represented that it
will notify Options Participants whenever the CBOE, NYSE, or FINRA
proposes a change to a cross-referenced CBOE, NYSE, or FINRA rule.
See supra note 144 and accompanying text.
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IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\147\ that the proposed rule change (SR-BX-2012-030), as modified
by Amendment Nos. 1 and 2 thereto, be, and hereby is, approved.
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\147\ 15 U.S.C. 78s(b)(2).
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Although the Commission's approval of the proposed rule change is
final, and the proposed rules are therefore effective, it is further
ordered that the operation of BX Options is conditioned on the
satisfaction of the requirements below:
A. Participation in National Market System Plans Relating to
Options Trading. BX must join: (1) the OPRA Plan; (2) the OLPP; (3) the
Linkage Plan; and (4) the Plan of the Options Regulatory Surveillance
Authority.
B. RSA and Rule 17d-2 Agreements. BX must ensure that all necessary
changes are made to its Regulatory Services Agreement with FINRA and
must be a party to the multi-party Rule 17d-2 agreements concerning
options sales practice regulation and market surveillance.\148\
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\148\ See supra notes 117 and 119 and accompanying text. See
also 17 CFR 240.17d-2.
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C. Participation in the Options Clearing Corporation. BX must join
the Options Clearing Corporation.
D. Participation in the Intermarket Surveillance Group. BX must be
a member of the Intermarket Surveillance Group.
E. Effective Regulation. BX must have, and represent in a letter to
the staff in the Commission's Office of Compliance Inspections and
Examinations that it has, adequate procedures and programs in place to
effectively regulate BX Options.
F. Trade Processing and Exchange Systems. The Exchange must have,
and represent in a letter to the staff in the Commission's Division of
Trading and Markets that it has, adequate procedures and programs in
place, as detailed in Commission Automation Policy Review guidelines,
to effectively process trades and maintain the confidentiality,
integrity, and availability of the Exchange's systems.\149\
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\149\ On November 16, 1989, the Commission published its first
Automation Review Policy (``ARP I''), in which the Commission
created a voluntary framework for SROs to establish comprehensive
planning and assessment programs to determine systems capacity and
vulnerability. On May 9, 1991, the Commission published its second
Automation Review Policy (``ARP II'') to clarify the types of review
and reports expected from SROs. See Securities Exchange Act Release
No. 27445 (November 16, 1989), 54 FR 48703 (November 24, 1989) and
29185 (May 9, 1991), 56 FR 22490 (May 15, 1991).
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It is further ordered, pursuant to Section 36 of the Act,\150\ that
BX shall be exempted from the rule filing requirements of Section 19(b)
of the Act with respect to the CBOE, FINRA, and NYSE rules that BX
proposes to incorporate by reference, subject to the conditions
specified in this Order.
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\150\ 15 U.S.C. 78mm.
[[Page 39287]]
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For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\151\
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\151\ 17 CFR 200.30(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-16079 Filed 6-29-12; 8:45 am]
BILLING CODE 8011-01-P