[Federal Register Volume 77, Number 220 (Wednesday, November 14, 2012)]
[Notices]
[Pages 67851-67856]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-27600]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-68177; File No. SR-BOX-2012-003]
Self-Regulatory Organizations; BOX Options Exchange LLC; Order
Approving Proposed Rule Change To Amend the Price Improvement Period
November 7, 2012.
I. Introduction
On July 25, 2012, BOX Options Exchange LLC (``Exchange'' or
``BOX'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) \1\ of the Securities
Exchange Act of 1934 (``Act''),\2\ and Rule 19b-4 thereunder,\3\ a
proposed rule change to amend Rule 7150, which relates to the
Exchange's Price Improvement Period (``PIP''), by modifying the order
of execution of quotes and orders that are on the BOX Book prior to the
start of a PIP. The proposed rule change was published for comment in
the Federal Register on August 9, 2012.\4\ The Commission received one
comment letter on the proposed rule change \5\ and a response to the
comment letter from the Exchange.\6\ This order approves the proposed
rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 15 U.S.C. 78a.
\3\ 17 CFR 240.19b-4.
\4\ See Securities Exchange Act Release No. 67592 (August 3,
2012), 77 FR 47681 (``Notice'').
\5\ See Letter to Elizabeth M. Murphy, Secretary, Commission,
from Kurt Eckert, Principal, Wolverine Trading, LLC dated August 30,
2012 (``Wolverine Letter'').
\6\ See Letter to Elizabeth M. Murphy, Secretary, Commission,
from Anthony D. McCormick, Chief Executive Officer, Exchange, dated
October 4, 2012 (``Exchange Response'').
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II. Description of the Proposal
Currently, Rule 7150(f) permits a PIP to begin at or better than
the National Best Bid or Offer (``NBBO''). Further, Rule 7150(f)(1)
provides that, at the commencement of the PIP, all quotes and orders on
the BOX Book prior to the PIP Broadcast that are equal to or better
than (i) the Single-Priced Primary Improvement Order price, or (ii) the
PIP Start Price of a Max Improvement Primary Improvement Order, except
any proprietary quote or order from the Initiating Participant, will be
executed immediately against the customer order designated for the PIP
(``PIP Order'') in price/time priority.\7\ As a result, if an order is
submitted to the PIP and there is sufficient quantity on the BOX Book
prior to the PIP Broadcast to execute the
[[Page 67852]]
PIP Order, the PIP does not commence. The Exchange proposes to delete
the provision in Rule 7150(f)(1) relating to the execution of quotes
and orders on the BOX Book prior to the PIP's commencement and to amend
Rules 7150(f)(1) \8\ and (f)(4) to specify the priority for executing
such quotes and orders at the conclusion of the PIP.
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\7\ Capitalized terms that are not otherwise defined herein are
defined as in the Exchange's Rules.
\8\ The Exchange proposes to amend Rule 7150(f)(1) to specify
that at the conclusion of the PIP, the PIP Order shall be executed
as set forth in paragraphs (f)(3), (f)(4), (g), and (j).
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Rule 7150(f)(4) sets forth exceptions to time priority in the
execution of the PIP Order. The Rule currently provides that no order
for a non-market maker broker-dealer account of an Options Participant
may be executed before all Public Customer order(s), whether an
Improvement Order, including a Customer PIP Order (``CPO''), or an
Unrelated Order,\9\ and all non-BOX Options participant broker-dealer
order(s) at the same price have been filled. The Exchange proposes to
amend Rule 7150(f)(4)(i) to specify further that all quotes and orders
on the BOX Book prior to the PIP Broadcast, excluding any proprietary
quote or order from the Initiating Participant, will be filled in time
priority before any other order at the same price.
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\9\ The Exchange proposes a technical change to Rule
7150(f)(4)(i) to correct the current reference to ``unrelated'' by
replacing it with the term ``Unrelated Order.''
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The Exchange also proposes to add new Rule 7150(g)(3). New Rule
7150(g)(3) provides that the Primary Improvement Order follows in time
priority all quotes and orders on the BOX Book prior to the PIP
Broadcast that are equal to the (i) Single-Priced Primary Improvement
Order price; or (ii) execution price of a Max Improvement Primary
Improvement Order that results in the balance of the PIP Order being
fully executed, except any proprietary quote or order from the
Initiating Participant. Any such proprietary quote or order from the
Initiating Participant will not be executed against the PIP Order
during or at the conclusion of the PIP.
The Exchange noted that, among the quotes or orders on the BOX Book
prior to the PIP Broadcast at the final execution price level, the PIP
Order will be matched against the best prevailing quotes or orders on
BOX (except any pre-PIP Broadcast proprietary quote or order from the
Initiating Participant) in accordance with price/time priority, as set
forth in Rule 7130.\10\
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\10\ See Notice, supra note 4, for examples of how quotes and
orders on the BOX Book prior to the PIP Broadcast would be executed
at the PIP's conclusion.
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Under the proposal, Unrelated Orders submitted to BOX will continue
to execute as they do currently under Rules 7150(i) and 7150(j).
Accordingly, Unrelated Orders received after a PIP Broadcast will
execute in time priority after quotes and orders at the same price that
were on the BOX Book prior to the PIP Broadcast.
The Exchange stated that in connection with this proposed rule
change, it will provide to the Commission the following monthly data,
and corresponding analysis, related to the PIP:\11\ (1) The number of
orders of 50 contracts or greater entered into the PIP auction; (2) the
percentage of all orders of 50 contracts or greater sent to BOX that
are entered into the PIP auction; (3) the spread in the option at the
time an order of 50 contracts or greater is submitted to the PIP
auction; (4) the percentage of PIP trades executed at the NBBO plus
$.01, plus $.02, plus $.03, etc.; and (5) the number of orders
submitted by Order Flow Providers (``OFPs'') and Market Makers when the
spread was at a particular increment (e.g., $.05, $.10, $.15, etc.).
Also, relative to item (5) above, for each spread, the Exchange will
provide the percentage of contracts in orders of fewer than 50
contracts and for orders of 50 contracts or greater submitted to the
PIP that were traded by: (a) the OFP or Market Maker that submitted the
order to the PIP; (b) BOX Market Makers assigned to the class; (c)
other BOX Participants; (d) Public Customer Orders (including CPOs);
(e) Unrelated Orders (orders in standard increments entered during the
PIP), and (f) quotes and orders on the BOX Book prior to the PIP
Broadcast.
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\11\ See id. For orders of less than 50 contracts, the PIP is
currently operating on a pilot basis. See Securities Exchange Act
Release Nos. 49068 (January 13, 2004), 69 FR 2775 (January 20, 2004)
(Order Approving Proposed Rule Change Establishing Trading Rules for
Boston Options Exchange facility) and 66871 (April 27, 2012), 77 FR
26323 (May 3, 2012) (File No.10-206, In the Matter of the
Application of BOX Options Exchange LLC for Registration as a
National Securities Exchange Findings, Opinion, and Order of the
Commission) (``BOX Exchange Application Order''). The pilot program
is currently set to expire on July 18, 2013. See Securities Exchange
Act Release No. 67255 (June 26, 2012), 77 FR 39315 (July 2, 2012).
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Further, BOX will provide, for the first and third Wednesday of
each month, the: (a) Total number of PIP auctions on that date; (b)
number of PIP auctions where the order submitted to the PIP was fewer
than 50 contracts; (c) number of PIP auctions where the order submitted
to the PIP was 50 contracts or greater; (d) number of PIP auctions
where the number of Participants (excluding the Initiating Participant)
was zero, one, two, three, four, etc. Finally, the Exchange will
provide information each month with respect to situations in which the
PIP is terminated prematurely or a Market Order, Limit Order, or BOX-
Top Order immediately execute with a PIP Order before the PIP's
conclusion. The following information will be provided: (1) The number
of times that a Market Order, Limit Order, or BOX-Top Order in the same
series on the same side of the market as the PIP Order prematurely
terminated the PIP, and (a) the number of times such orders were
entered by the same (or affiliated) firm that initiated the PIP that
was terminated, and (b) the number of times such orders were entered by
a firm (or an affiliate of such firm) that participated in the
execution of the PIP Order; (2) for the orders addressed in each of
items (1)(a) and (1)(b) above, the percentage of PIP premature
terminations due to the receipt, during the PIP, of a Market Order,
Limit Order, or BOX-Top Order in the same series on the same side of
the market as the PIP Order, and the average amount of price
improvement provided to the PIP Order where the PIP is prematurely
terminated; (3) the number of times that a Market Order, Limit Order,
or BOX-Top Order in the same series on the opposite side of the market
as the PIP Order immediately executed against the PIP Order, and (a)
the number of times such orders were entered by the same (or
affiliated) firm that initiated the PIP, and (b) the number of times
such orders were entered by a firm (or an affiliate of such firm) that
participated in the execution of the PIP Order; (4) for the orders
addressed in each of items (3)(a) and (3)(b) above, the percentage of
PIP early executions due to the receipt, during the PIP, of a Market
Order, Limit Order, or BOX-Top Order in the same series on the opposite
side of the market as the PIP Order; and the average amount of price
improvement provided to the PIP Order where the PIP Order is
immediately executed; and (5) the average amount of price improvement
provided to the PIP Order when the PIP runs for 100 milliseconds.
BOX stated that, upon Commission approval of the proposal and at
least one week prior to implementation of the proposed rule change, it
will issue an Informational Circular to Options Participants informing
them of the proposal's implementation date.
III. Discussion and Commission Findings
After careful review of the proposal, the comment letter, and the
Exchange Response, the Commission finds that the proposed rule change
is consistent with the requirements of the Act and the
[[Page 67853]]
rules and regulations thereunder applicable to a national securities
exchange and, in particular with Section 6(b)(5) \12\ of the Act, which
requires the rules of an exchange be designed, among other things, to
prevent fraudulent and manipulative acts and practices, to promote just
and equitable principles of trade, to remove impediments to and to
perfect the mechanism for a free and open market and a national market
system, and, in general, to protect investors and the public interest.
In addition, the Commission finds the proposed rule change consistent
with Section 6(b)(8) \13\ of the Act, which requires that the rules of
the exchange do not impose any burden on competition not necessary or
appropriate in furtherance of the purposes of the Act.\14\
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\12\ 15 U.S.C. 78f(b)(5).
\13\ 15 U.S.C. 78f(b)(8).
\14\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
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The Commission believes that the proposal is designed to provide
additional opportunities for customers to receive price improvement for
their PIP Orders. Under the current rule, if an order is submitted to
the PIP and there is sufficient quantity on the BOX Book prior to the
PIP Broadcast to execute the PIP Order at the PIP Start Price, the PIP
Order will execute against the BOX Book (assuming it is at the NBBO),
and the PIP will never commence.\15\ The Exchange's proposal to modify
the handling of such pre-existing quotes and orders on the BOX Book
will provide customers with a greater opportunity to receive price
improvement above the NBBO on BOX for their PIP Order because those
pre-existing quotes and orders on the BOX Book no longer will execute
against the PIP Order before the PIP can begin. Thus, the proposal may
benefit customers who submit PIP Orders priced at the NBBO by allowing
their orders to be exposed to competition in the PIP. The PIP Order
will continue to be guaranteed an execution price of at least the NBBO
and, as a result of the Exchange's proposal, will be given an
opportunity for execution at a price better than the NBBO. At the same
time, all quotes and orders on the BOX Book prior to the PIP Broadcast
at the PIP Start Price (excluding any proprietary quote or order from
the Initiating Participant) will be filled in time priority before any
other order at the same price at the conclusion of the PIP, assuming
they have not already been executed.
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\15\ If the quotes and orders on the BOX Book at the PIP Start
Price are smaller in size than the PIP Order, then the portion of
the PIP Order that does not execute against such pre-existing quotes
and orders on the BOX Book will be submitted to the PIP auction.
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The Commission received one comment letter from a BOX Options
Participant opposing the proposed rule change.\16\ According to the
commenter, the current requirement that the top of the BOX Book be
``swept'' prior to the PIP's commencement incentivizes market
participants to quote aggressively on BOX and allows retail orders to
interact with quotes on the Exchange. In addition, the commenter noted
that market participants could initiate a PIP without having a quote
either at the NBBO on any exchange or at the BBO on BOX.\17\ Therefore,
according to the commenter, the proposal diminishes the incentive for
robust quoting on BOX or the resting of public customer limit orders on
the BOX Book.\18\ The commenter suggested that the proposal be amended
to require that BOX must sweep the top of the BOX Book if the PIP
starts at the BOX BBO and that the Initiating Participant must be
quoting at the BOX BBO.\19\
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\16\ See Wolverine Letter, supra note 5.
\17\ With respect to the comment that market participants could
initiate a PIP without having a quote either at the NBBO on any
exchange or at the BBO on BOX, the Commission notes that this
feature is currently part of the PIP. The Exchange has not proposed
to revise this aspect of the PIP, and thus this issue is not before
the Commission.
\18\ See Wolverine Letter, supra note 5, at 1-2.
\19\ See Wolverine Letter, supra note 5, at 2.
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The Exchange responded that, in its view, a customer's entire PIP
Order should have the opportunity for competing market participants to
provide price improvement to that customer order.\20\ The Exchange
stated that that if ``competing participants step up to provide a
better price for the customer order, it is appropriate, and consistent
with the federal securities laws, for that customer to receive an
execution at the best price available (price improvement through the
PIP auction) rather than the market maker quote on the book that is no
longer the best bid or offer.'' \21\
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\20\ See Exchange Response, supra note 6, at 1.
\21\ See Exchange Response, supra note 6, at 2.
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The Commission recognizes the concern regarding the impact of the
proposed rule change on the overall incentives for market participants
to rest liquidity on the BOX Book. However, as discussed above, the
Commission also recognizes the potential benefit from the proposed rule
change with respect to customer PIP Orders priced at the NBBO by
providing customers with a greater opportunity to receive price
improvement on BOX for their PIP Orders by allowing those orders to be
exposed to competition in the PIP, before interacting with pre-existing
quotes and orders on the BOX Book at the PIP Start Price. In the
Commission's view, the Exchange's proposal is reasonably designed to
balance the potential for customers to receive price improvement in the
PIP, rather than to have their orders immediately executed against a
pre-existing quote on the BOX Book at the NBBO, with the potential to
impact Market Makers' or other market participants' incentives to quote
aggressively because they no longer will have the assurance that their
quotes at the NBBO will execute against the PIP Order before the PIP
begins. Quotes and orders that are on the BOX Book prior to the PIP
Broadcast will continue to be able to interact with non-PIP order flow
during the auction period. In addition, under the proposal, such quotes
and orders will have priority to interact with any PIP order flow at
the end of the auction period, unless the entire PIP order is price
improved. Moreover, Market Makers or other market participants that
wish to interact with the PIP Order can do so by submitting their own
Improvement Orders into the PIP auction. For these reasons, the
Commission believes that the proposal is consistent with the Act.
The commenter also remarked that the proposal is defective because
it would allow a PIP auction to begin at the NBBO rather than requiring
at least a penny of price improvement over the BOX BBO.\22\ The
commenter suggested that the proposal be amended so that the PIP start
price would be at least a penny better than the BOX BBO.\23\ The
Commission notes, however, that instant proposal relates solely to the
priority and allocation of quotes and orders that are on the BOX Book
prior to a PIP's commencement. The Exchange has not proposed to revise
the start price of the PIP and thus this issue is not before the
Commission.\24\ Further, as discussed above, the Commission believes
that the proposed rule change, as submitted, is consistent with the
Act.
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\22\ See Wolverine Letter, supra note 5, at 2.
\23\ Id.
\24\ Under Rule 7150(f), the PIP start price must be equal to or
better than the NBBO at the time of commencement of the PIP.
Accordingly, if the BOX BBO does not equal the NBBO, then the PIP
must start at a price that is better than the BOX BBO. See
Securities Exchange Act Release No. 59654 (March 30, 2009), 74 FR
15551 (April 6, 2009).
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In addition, the commenter stated its belief that the proposal has
the potential to harm retail investors.\25\ According to the commenter,
the proposal serves ``to remove real orders from interaction with
[[Page 67854]]
lit markets at exchanges'' and reduces the NBBO to ``little more than a
reference price that is not the best available for retail investors.''
\26\ The commenter further noted that, to the extent price competition
decreases on an exchange, the NBBO increasingly loses value as a
reference price.\27\ The commenter stated its view that the proposal is
harmful to market efficiency in that it ``turns the exchange into an
internalization facilitator rather than a bona fide market with
multiple participants competing to offer the best prices to
customers.'' \28\
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\25\ See Wolverine Letter, supra note 5, at 2.
\26\ Id.
\27\ Id.
\28\ See Wolverine Letter, supra note 5, at 2.
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The Exchange responded that the proposal promotes transparent
competition to ensure that customer orders receive the best price
possible.\29\ The Exchange noted that the PIP Broadcast is sent to any
Options Participant that wishes to receive it. According to the
Exchange, the PIP permits Market Makers to submit competing orders into
the PIP auction for their own account, and all non-market maker Options
Participants also may submit competing orders into the PIP auction for
their own account or for their customer accounts. The Exchange also
responded that Options Participants are actively competing for customer
orders in the PIP.\30\ Moreover, the Exchange noted that its Market
Makers are the Options Participants most likely to compete for
execution against customer orders in the PIP, even though their quotes
that are on the BOX Book at the NBBO currently execute prior to a PIP's
start.\31\ Any Options Participant (except for the Initiating
Participant), including Options Participants that have placed quotes
and orders on the BOX Book, may choose to submit Improvement Orders
into the PIP and compete for the PIP Order.\32\
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\29\ See Exchange Response, supra note 6, at 2.
\30\ According to the Exchange, for the eight-plus years that
the PIP has been in effect, approximately 70% of PIP auctions have
included competition for execution (i.e., at least one other Options
Participant has competed with the Initiating Participant for
execution of a customer order). The Exchange stated that almost 50%
of all PIP auctions included three or more Participants competing
for the PIP execution. Id.
\31\ Id.
\32\ Id.
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The Commission believes that these features of the PIP are designed
to provide the opportunity for a competitive auction, which benefits
customers by giving them the chance for price improvement better than
the NBBO and thus the Exchange's proposal should not result in a
harmful impact on market efficiency. As discussed above, the proposal
is intended to provide increased opportunities for price improvement of
customer PIP Orders priced at the NBBO by permitting a PIP to go
forward without those quotes and orders on the BOX Book at the PIP
start price being executed against the PIP Order before the PIP auction
commences. Quotes and orders on the BOX Book prior to a PIP Broadcast
will retain their priority at the same price at the conclusion of the
PIP (assuming they have not already been executed on the BOX Book).
However, as noted above, the Exchange has committed to provide the
Commission with monthly data and corresponding analysis related to the
PIP, including statistics with respect to the execution of quotes and
orders on the BOX Book prior to the start of the PIP.\33\ This data
will assist the Commission and the Exchange in monitoring the impact of
the proposed rule change.
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\33\ See supra note 11.
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IV. Section 11(a) of the Act
Section 11(a)(1) of the Act \34\ 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. The
Exchange represents that the proposed rule change is consistent with
Section 11(a) of the Act. Specifically, the Exchange believes that the
PIP is generally consistent with Section 11(a)(1)(G) of the Act and
Rule 11a1-1(T) thereunder because Options Participants that are not
Market Makers must yield priority in the PIP to all non-member orders
(i.e., to all Public Customer Orders and non-BOX Participant broker-
dealer orders) at the same price.\35\ In addition, the Exchange
believes that the proposed change to execute, against the PIP Order and
at the end of a PIP auction, those quotes and orders on the BOX Book
prior to the PIP Broadcast (if at the PIP Start Price) satisfies the
conditions of Rule 11a2-2(T) under the Act. For the reasons set forth
below, the Commission believes that the proposed rule change is
consistent with the requirements of Section 11(a) of the Act and the
rules thereunder.
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\34\ 15 U.S.C. 78k(a)(1).
\35\ See Notice, supra note 4 at n.12.
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A. Section 11(a)(1)(G) of the Act and Rule 11a1-1(T) Thereunder
Section 11(a)(1)(G) of the Act provides an exception from the
general prohibition set forth in Section 11(a)(1) for any transaction
for a member's own account, provided that: (i) such member is primarily
engaged in the business of underwriting and distributing securities
issued by other persons, selling securities to customers, and acting as
broker, or any one or more of such activities, and whose gross income
normally is derived principally from such business and related
activities; and (ii) the transaction is effected in compliance with the
rules of the Commission, which, at a minimum, assure that the
transaction is not inconsistent with the maintenance of fair and
orderly markets and yields priority, parity, and precedence in
execution to orders for the account of persons who are not members or
associated with members of the exchange.\36\ In addition, Rule 11a1-
1(T) under the Act specifies that a transaction effected on a national
securities exchange for the account of a member which meets the
requirements of Section 11(a)(1)(G)(i) of the Act is deemed, in
accordance with the requirements of Section 11(a)(1)(G)(ii), to be not
inconsistent with the maintenance of fair and orderly markets and to
yield priority, parity, and precedence in execution to orders for the
account of non-members or persons associated with non-members of the
exchange, if such transaction is effected in compliance with certain
requirements.\37\
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\36\ See 15 U.S.C. 78k(a)(1)(G).
\37\ Rule 11a1-1(T)(a)(1)-(3) provides that each of the
following requirements must be met: (1) A member must disclose that
a bid or offer for its account is for its account to any member with
whom such bid or offer is placed or to whom it is communicated, and
any member through whom that bid or offer is communicated must
disclose to others participating in effecting the order that it is
for the account of a member; (2) immediately before executing the
order, a member (other than the specialist in such security)
presenting any order for the account of a member on the exchange
must clearly announce or otherwise indicate to the specialist and to
other members then present for the trading in such security on the
exchange that he is presenting an order for the account of a member;
and (3) notwithstanding rules of priority, parity, and precedence
otherwise applicable, any member presenting for execution a bid or
offer for its own account or for the account of another member must
grant priority to any bid or offer at the same price for the account
of a person who is not, or is not associated with, a member,
irrespective of the size of any such bid or offer or the time when
entered. See 17 CFR 240.11a1-1(T)(a)(1)-(3).
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With respect to the PIP, the rules of the Exchange currently
prohibit any orders for the accounts of non-Marker Maker Options
Participants from being executed prior to the execution of Public
Customer Orders, whether an Improvement Order, including a Customer PIP
Order, or Unrelated Order, and non-BOX Participant broker-
[[Page 67855]]
dealer orders at the same price.\38\ The current proposed rule change
revises the treatment of quotes and orders on the BOX Book prior to the
PIP Broadcast, which orders will now be executed against the PIP Order
at the end of the PIP (if at the same price). However, the execution of
these quotes and orders against the PIP Order qualifies for a separate
exception to the Section 11(a) restrictions.\39\ Thus, because current
Exchange rules require Options Participants that are not Market Makers
\40\ to yield priority in the PIP to all non-member orders, the
Commission believes that the proposal with respect to transactions
effected through the PIP, other than for quotes and orders on the BOX
Book prior to the PIP Broadcast, is consistent with the requirements in
Section 11(a) of the Act and Rule 11a1-1(T) thereunder.\41\ The
Commission reminds exchanges and their members, however, that, in
addition to yielding priority to non-member orders at the same price,
members must also meet the other requirements under Section 11(a)(1)(G)
of the Act and Rule 11a1-1(T) thereunder (or satisfy the requirements
of another exception) to effect transactions for their own accounts.
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\38\ See BOX Rules 7150(f)(4) and 7150(g)(3)(i).
\39\ See infra Section IV. B.
\40\ Section 11(a)(1)(A) of the Act provides an additional
exception to the general prohibition in Section 11(a) on an exchange
member effecting transactions for its own account if such member is
a dealer acting in the capacity of a market maker. See 15 U.S.C.
78k(a)(1)(A).
\41\ The Commission has previously found that transactions
effected through the PIP are consistent with the requirements in
Section 11(a) of the Act and Rule 11a1-1(T) thereunder because
Options Participants that are not Market Makers are required to
yield priority in the PIP to all non-member orders, (i.e., to all
Public Customer Orders and non-Options Participant broker-dealer
orders) at the same price. See BOX Exchange Application Order, supra
note 11. The Commission believes that transactions effected through
the PIP, as amended by the proposed rule change, remain consistent
with the requirements Section 11(a) of the Act and Rule 11a1-1(T)
thereunder.
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B. ``Effect versus Execute'' and Rule 11a2-2(T) under the Act
Rule 11a2-2(T) under the Act,\42\ known as the ``effect versus
execute'' rule, provides exchange members with another exception 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 the
transactions on the exchange. To comply with Rule 11a2-2(T)'s
conditions, a member: (1) May not be affiliated with the executing
member; (2) must transmit the order from off the exchange floor; (3)
may not participate in the execution of the transaction once it has
been transmitted to the member performing the execution; \43\ and (4)
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. The Exchange believes that the execution of
quotes and orders that are on the BOX Book prior to a PIP Broadcast
against a PIP Order will satisfy the requirements of Rule 11a2-
2(T).\44\ For the reasons set forth below, the Commission believes
that, under the proposed rule change, such executions will satisfy the
conditions of Rule 11a2-2(T).\45\
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\42\ 17 CFR 240.11a2-2(T).
\43\ The member may, however, participate in clearing and
settling the transaction. See Securities Exchange Act Release No.
14563 (March 14, 1978), 43 FR 11542 (March 17, 1978) (regarding the
NYSE's Designated Order Turnaround System (``1978 Release'')).
\44\ For a more detailed discussion, see the description of the
proposed rule change in the Notice, supra note 4 and supra Section
II.
\45\ See BOX Exchange Application Order, supra note 11.
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Rule 11a2-2(T)'s first condition is that the order be executed by
an exchange member who is unaffiliated with the member initiating the
order. The Commission has stated that the requirement is satisfied when
automated exchange facilities, such as the Trading Host, are used, as
long as the design of these systems ensures that members do not possess
any special or unique trading advantages over non-members in handling
their orders after transmitting them to the Exchange.\46\ The Exchange
represents that the design of the BOX Book, including the mechanism
that executes quotes and orders resting on the Book prior to a PIP
against the PIP order at the conclusion of a PIP auction, ensures that
broker-dealers do not have any special or unique trading advantages in
handling their orders after transmission. Accordingly, the Exchange
believes that a member effecting a transaction through the BOX Book,
even where the quote or order on the Book prior to a PIP executes
against the PIP Order, satisfies the requirement for execution through
an unaffiliated member.
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\46\ In considering the operation of automated execution systems
operated by an exchange, the Commission has noted that, while there
is no independent executing exchange member, the execution of an
order is automatic once it has been transmitted into each 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 Securities
Exchange Act Release No. 15533 (January 29, 1979), 44 FR 6084
(January 31, 1979) (regarding the American Stock Exchange (``Amex'')
Post Execution Reporting System, the Amex Switching System, the
Intermarket Trading System, the Multiple Dealer Trading Facility of
the Cincinnati Stock Exchange, the PCX Communications and Execution
System, and the Philadelphia Stock Exchange (``Phlx'') Automated
Communications and Execution System (``1979 Release'')).
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According to the Exchange, the design of BOX ensures that no
Options Participant would enjoy any special control over the timing of
execution or special order handling advantages after order transmission
to the BOX Book. All orders on the BOX Book are centrally processed and
executed automatically by BOX. Orders sent to BOX would be transmitted
from remote terminals directly to the system by electronic means. Once
an order is submitted to the BOX Book, the order would be executed
against another order based on the established matching algorithms for
the BOX Book. In addition, as proposed, those quotes and orders on the
BOX Book prior to a PIP may trade with the PIP Order, or would execute
when orders or quotations on BOX match one another based on price/time
priority. The execution would not depend on the Options Participant but
rather upon what other orders are entered into BOX at or around the
same time as the subject order, what orders are on the BOX Book, or if
a PIP is initiated and what responses are received in response to the
PIP, and where the order is ranked based on the priority ranking
algorithm. At no time following the submission of an order to the BOX
Book would an Options Participant be able to acquire control or
influence over the result or timing of order execution, including
whether it is executed against an order in the PIP. Accordingly,
Options Participants could not control or influence the result or
timing of orders submitted to the BOX Book, even if such an order were
to match with the PIP Order. Based on the Exchange's representations,
the Commission believes that the proposal satisfies this requirement of
Rule 11a2-2(T).
Second, Rule 11a2-2(T) requires orders for covered accounts be
transmitted from off the exchange floor. 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.\47\ The Exchange
[[Page 67856]]
states that orders sent to the BOX Book, regardless of where it
executes within the BOX system, including the Book or the PIP, would be
transmitted from remote terminals directly to BOX by electronic means.
OFPs and Market Makers would only submit orders and quotes to BOX from
electronic systems from remote locations, separate from BOX. The
Exchange further represents that there are no other Options
Participants that would be able to submit orders to BOX other than OFPs
or Market Makers. Accordingly, the Commission believes that Options
Participants' orders electronically received by BOX satisfy the off-
floor transmission requirement for the purposes of the Rule.
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\47\ See, e.g., Securities Exchange Act Release Nos. 61419
(January 26, 2010), 75 FR 5157 (February 1, 2010) (SR-BATS-2009-031)
(approving BATS options trading); 59154 (December 28, 2008), 73 FR
80468 (December 31, 2008) (SR-BSE-2008-48) (approving equity
securities listing and trading on BSE); 53128 (January 13, 2006), 71
FR 3550 (January 23, 2006) (File No. 10-131) (approving The 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). See also 1978
Release and 1979 Release.
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Third, Rule 11a2-2(T) 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 represents that, at no time
following the submission of an order to the BOX Book, would an Options
Participant be able to acquire control or influence over the result or
timing of order execution, even if its order on the BOX Book may
execute with a PIP Order.\48\ According to the Exchange, upon
submission to BOX, an order would be executed against another order on
the BOX Book or against the PIP Order based on an established matching
algorithm. The execution would not depend on the Options Participant,
but rather upon what other orders are entered into BOX at or around the
same time as the subject order, what orders are on the BOX Book,
whether a PIP is initiated and what responses are received in response
to the PIP, and where the order is ranked based on the priority ranking
algorithm. As such, the Commission believes that the non-participation
requirement is met when orders are executed automatically on the BOX
Book, including if they execute against a PIP order.
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\48\ The member may only cancel or modify the order, or modify
the instructions for executing the order, but only from off the
Exchange 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 1978 Release (stating that the ``non-participation
requirement does not prevent initiating members from canceling of
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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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).\49\ The Exchange has represented that, as a prerequisite for BOX
usage, if an Options Participant is to rely on Rule 11a2-2(T) for a
covered account transaction, the Options Participant must comply with
the limitations on compensation set forth in Rule 11a2-2(T).
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\49\ 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 person 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
(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'').
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\50\ that the proposed rule change (SR-BOX-2012-003) be, and hereby
is, approved.
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\50\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\51\
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\51\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-27600 Filed 11-13-12; 8:45 am]
BILLING CODE 8011-01-P