[Federal Register Volume 77, Number 222 (Friday, November 16, 2012)]
[Notices]
[Pages 68856-68861]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-27819]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-68202; File Nos. SR-Phlx-2012-27; SR-Phlx-2012-54]
Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Notice of
Filing of Amendments No. 1, and Order Granting Accelerated Approval for
Proposed Rule Changes as Modified by Amendments No. 1 Relating to
Complex Order Fees and Rebates for Adding and Removing Liquidity in
Select Symbols
November 9, 2012.
I. Introduction
On March 1, 2012 and April 23, 2012, NASDAQ OMX PHLX LLC (``Phlx''
or ``Exchange'') filed with the Securities and Exchange Commission (the
``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Exchange Act'' or ``Act'') \1\ and Rule 19b-4
thereunder,\2\ two proposed rule changes relating to the transaction
fees for certain complex order (``Complex Order'') transactions.\3\ The
notice of filing of Phlx-2012-27 was published for comment in the
Federal Register on March 15, 2012,\4\ and the notice of filing of
Phlx-2012-54 was published for comment in the Federal Register on May
4, 2012.\5\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ A Complex Order is any order involving the simultaneous
purchase and/or sale of two or more different options series in the
same underlying security, priced at a net debit or credit based on
the relative prices of the individual components, for the same
account, for the purpose of executing a particular investment
strategy. A Complex Order may also be a stock-option order, which is
an order to buy or sell a stated number of units of an underlying
stock or exchange-traded fund (``ETF'') coupled with the purchase or
sale of options contract(s). See Exchange Rule 1080, Commentary
.08(a)(i).
\4\ See Securities Exchange Act Release No. 66551 (March 9,
2012), 77 FR 15400 (SR-Phlx-2012-27) (``Notice I'').
\5\ See Securities Exchange Act Release No. 66883 (April 30,
2012), 77 FR 26591 (SR-Phlx-2012-54) (``Notice II'').
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On April 30, 2012, the Commission suspended the proposals and
instituted proceedings to determine whether to approve or disapprove
the proposals.\6\ Following the institution of the proceedings, the
Commission received a letter from the Exchange in support of its
proposals.\7\ On September 11, 2012, the Commission issued a notice of
designation of a longer period for Commission action on the proceedings
to determine whether to disapprove the proposed rule changes.\8\ On
October 24, 2012, the Exchange filed Amendment No. 1 to each of the
proposed rule changes. In the amendments, the Exchange proposed to put
certain of the fees (for Complex Order executions by Directed
Participants \9\ and Market Makers) \10\ on a one-year pilot program,
and stated that the proposed fees would be operative on December 3,
2012. The Exchange committed to provide publicly available data and
data analyses of those fees to the Commission during the pilot.\11\ The
Exchange also represented that, prior to and at the time of a complex
order transaction, Market Makers, including Directed Participants, are
unaware of the identity of the contra-party to the transaction. The
Exchange stated that Rule 707 is intended to prohibit coordinated
actions between Directed Participants and order flow providers
(``OFPs''), and that the Exchange proactively conducts surveillance
for, and enforces against, such violations.\12\
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\6\ See Securities Exchange Act Release No. 66884 (April 30,
2012), 77 FR 26595 (May 4, 2012) (``Order Instituting
Proceedings''). The Order Instituting Proceedings suspended the fees
adopted in SR-Phlx-2012-27 and SR-Phlx-2012-54. Consequently, these
fees were in effect for only two months, from March 1, 2012 to April
30, 2012.
\7\ See Letter from Joan C. Conley, Senior Vice President and
Corporate Secretary, Nasdaq OMX, to Elizabeth M. Murphy, Secretary,
Commission, dated July 26, 2012 (``Response'').
\8\ See Securities Exchange Act Release No. 67825 (September 11,
2012), 77 FR 57168 (September 17, 2012).
\9\ The term ``Directed Participant'' applies to transactions
for the account of a Specialist, Streaming Quote Trader (``SQT'') or
Remote Streaming Quote Trader (``RSQT'') resulting from a Customer
order that is (1) directed to the Specialist, SQT or RSQT by an
order flow provider, and (2) executed by that Specialist, SQT or
RSQT electronically on Phlx XL II. See Phlx Fee Schedule at 3.
\10\ A ``Market Maker'' includes Specialists (see Exchange Rule
1020) and Registered Options Traders (``ROTs'') (see Exchange Rule
1014(b)(i) and (ii), which includes SQTs (see Exchange Rule
1014(b)(ii)(A)) and RSQTs (see Exchange Rule 1014(b)(ii)(B)).
\11\ See Amendment No. 1 to SR-Phlx-2012-27 and SR-Phlx-2012-54,
filed October 24, 2012.
\12\ See Amendment No. 1 to each filing, supra note 11.
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The Commission received no comment letters on the proposals. This
order approves the proposed rule changes, as modified by Amendments No.
1, and approves, as a one-year pilot program, those fees which the
Exchange proposes to implement on a pilot basis.
II. Description of the Proposals
The Exchange's first proposal amended Complex Order fees and
rebates for adding and removing liquidity in its Select Symbols.\13\
Specifically, Phlx's proposal: (1) Increased the customer rebate for
adding liquidity from $0.30 per contract to
[[Page 68857]]
$0.32 per contract; (2) created a new rebate for removing liquidity of
$0.06 per contract for each contract of liquidity removed by an order
designated as a customer Complex Order; (3) amended the fee for
removing liquidity for all participants who are assessed such a fee;
and (4) created a volume incentive for certain market participants that
transact significant volumes of Complex Orders on the Exchange.
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\13\ The Select Symbols are listed in Section I of the Phlx Fee
Schedule.
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Phlx's proposal to amend the Fee for Removing Liquidity increased
the Complex Order Fees for Removing Liquidity for the Directed
Participant, Market Maker, Firm, Broker-Dealer, and Professional \14\
categories of market participants. The fee for Directed Participant
transactions increased from $0.30 to $0.32 per contract; the fee for
Market Makers increased from $0.32 to $0.37 per contract; and the fee
for Firms, Broker-Dealers, and Professionals increased from $0.35 to
$0.38 per contract.
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\14\ The term ``Professional'' means any person or entity that
(i) is not a broker or dealer in securities, and (ii) places more
than 390 orders in listed options per day on average during a
calendar month for its own beneficial account(s). See Exchange Rule
1000(b)(14).
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The proposal also provided a new volume incentive to Market Makers.
The Exchange has four categories of Market Makers--Specialists,\15\
ROTs,\16\ SQTs \17\and RSQTs\18\--that would all be eligible to receive
the volume incentive. Under this proposal, if a Market Maker executes
more than 25,000 contracts of Complex Orders each day in a given month,
the fees charged for all of that Market Maker's transactions in Complex
Orders that remove liquidity, both as a Directed Participant and as a
Market Maker, would be reduced by $0.01 per contract for that month.
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\15\ A Specialist is an Exchange member who is registered as an
options specialist pursuant to Exchange Rule 1020(a).
\16\ A ROT includes a SQT, a RSQT and a Non-SQT ROT, which by
definition is neither a SQT nor a RSQT, and therefore cannot
generate and submit quotes electronically. A Registered Option
Trader is defined in Rule 1014(b) as a regular member of the
Exchange located on the trading floor who has received permission
from the Exchange to trade in options for his own account. See
Exchange Rule 1014(b)(i) and (ii).
\17\ An SQT is defined in Exchange Rule 1014(b)(ii)(A) as an ROT
who has received permission from the Exchange to generate and submit
option quotations electronically in options to which such SQT is
assigned.
\18\ An RSQT is defined Exchange Rule in 1014(b)(ii)(B) as an
ROT that is a member or member organization with no physical trading
floor presence who has received permission from the Exchange to
generate and submit option quotations electronically in options to
which such RSQT has been assigned. An RSQT may only submit such
quotations electronically from off the floor of the Exchange.
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In its second proposal, the Exchange did not propose to amend any
of the fees for the Complex Order Directed Participant and Market Maker
Fees for Removing Liquidity in Select Symbols. Rather, the Exchange
provided further justification for the differential between the fees
paid by Directed Participants and Market Makers.
As discussed more fully below, in its proposals and in its
subsequent letter in support of its proposals, the Exchange advanced
several arguments as to why the proposal to increase the fee for
removing liquidity for Complex Orders to $0.32 per contract for
Directed Participants, and to $0.37 per contract for non-directed
Market Makers, and the corresponding increase in the differential
between these two fees from $0.02 to $0.05 per contract, was not
unreasonable or unfairly discriminatory. First, the Exchange stated
that Directed Participants enter into payment for order flow agreements
(``PFOF'') with OFPs so that OFPs will direct order flow to them to
execute against.\19\ According to the Exchange, the reduced fee for
Directed Participants recognizes the cost that such Market Makers incur
by entering into such PFOF agreements, and the fact that such
arrangements bring additional order flow to the Exchange, to the
benefit of all Exchange market participants. The Exchange also argued
that Directed Participants have higher quoting obligations, and that
unlike in the leg markets (i.e., the market for the individual orders
that make up a complex order) they do not have a guaranteed allocation
for Complex Orders, and that these facts justify the fees. Second, the
Exchange stated that the frequency with which Directed Participants
execute against orders that are directed to them is such that the
effective fee actually paid by such Market Makers is closer to the
higher Market Maker rate.\20\ Third, the Exchange stated that the
proposed increase in the fee differential from $0.02 to $0.05 per
contract will have a negligible impact on Directed Participants and
non-directed Market Makers, given the average level of price
improvement for customer Complex Orders. Fourth, the Exchange argued
that a higher fee differential currently exists on another options
exchange that is directly comparable to the Directed Participant/Market
Maker differential at issue here. Finally, the Exchange argued that,
given the stated policies of the Commission and applicable case law,
the Commission should allow competition to determine whether the fees
are fair and reasonable.
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\19\ The PFOF agreements at issue here differ from PFOF fees
charged pursuant to Exchange rules, in that the PFOF agreements here
were entered into outside of the purview of the Exchange.
\20\ A Market Maker that has order flow directed to it will be
assessed the lower Directed Participant fee rate only if it actually
executes against such order flow; otherwise, it will be assessed the
higher Market Maker rate.
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In its order suspending the two proposals and instituting
proceedings to determine whether to approve or disapprove the
proposals, the Commission noted several areas of concern. For example,
the Commission questioned whether discrimination on the basis of
whether a Market Maker has an off-exchange arrangement to pay an OFP to
direct its orders to that Market Maker is a ``fair'' basis for
discrimination among exchange members with respect to the fees charged
by the Exchange, and whether a flat $0.05 fee differential
appropriately reflects potential differences that may exist in payment
for order flow arrangements between Market Makers and OFPs.\21\ The
Commission also questioned whether the proposed fees and fee
differential would have an impact on competition, especially as between
Directed Participants and Market Makers.\22\ Finally, the Commission
questioned whether the proposed fee changes will affect the quality of
execution of customer Complex Orders or broader market quality, and, if
so, how and what type of impact will they have.\23\
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\21\ See Order Instituting Proceedings, supra note 6, 77 FR
26598.
\22\ Id.
\23\ Id.
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During the course of the proceedings, the Exchange amended its
filings to implement the fee for removing liquidity for Directed
Participants and other Market Makers on a one-year pilot basis, and to
state that the proposed fees would be operative on December 3, 2012.
The Exchange also represented that it would provide the Commission with
certain publicly available data and data analyses, on a monthly basis,
over the course of the pilot program that would enable the Commission
to better evaluate the effects of the fee proposals. As part of the
amendment, the Exchange also represented that, prior to and at the time
of a complex order transaction, Market Makers, including Directed
Participants, are unaware of the identity of the contra-party to the
transaction. The Exchange stated that Rule 707 is intended to prohibit
coordinated actions between Directed Participants and OFPs, and that
the Exchange proactively
[[Page 68858]]
conducts surveillance for, and enforces against, such violations.\24\
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\24\ See Amendment No. 1 to each filing, supra note 11.
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III. Discussion and Commission Findings
After careful consideration, and as discussed below, the Commission
finds that the proposed rule changes are consistent with the
requirements of the Act and the rules and regulations thereunder
applicable to a national securities exchange. In particular, the
Commission finds that the proposals are consistent with Section 6(b)(4)
of the Act, which requires that the rules of a national securities
exchange ``provide for the equitable allocation of reasonable dues,
fees, and other charges among its members and issuers and other persons
using its facilities;''\25\ Section 6(b)(5) of the Act, which requires,
among other things, that the rules of a national securities exchange
not be ``designed to permit unfair discrimination between customers,
issuers, brokers, or dealers;''\26\ and Section 6(b)(8) of the Act,
which requires that the rules of a national securities exchange ``not
impose any burden on competition not necessary or appropriate in
furtherance of the purposes of [the Exchange Act].''\27\ The Commission
has also considered, pursuant to Section 3(f) of the Act, the
proposals' impact on efficiency, competition and capital formation.\28\
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\25\ 15 U.S.C. 78f(b)(4).
\26\ 15 U.S.C. 78f(b)(5).
\27\ 15 U.S.C. 78f(b)(8).
\28\ See 15 U.S.C. 78c(f).
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Phlx argues in part that the Commission should rely on competitive
forces to determine whether the proposed fees are reasonable and not
unfairly discriminatory. Phlx states that competition should determine
fee changes, noting that the ``Congress directed that exchanges' fee
changes be deemed immediately effective for the expressed purpose of
promoting price competition between markets.'' \29\ In support of this
argument, Phlx states that the Commission has ``a statutory duty to
promote competition, including price competition.'' \30\ Phlx also
notes that the DC Circuit Court of Appeals has ``blessed'' the
Commission practice of relying on competitive forces, where possible,
to assess the reasonableness of proposed rules,\31\ and that
intervention here would contravene the Commission's ``stated policy''
in this respect.\32\
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\29\ See Response, supra note 7, at 12.
\30\ Id. at 12.
\31\ Id. at 11 (citing NetCoalition v. SEC, 615 F.3d 525 (DC
Cir. 2010)).
\32\ Id. at 10.
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Phlx represents that the options markets operate in an intensely
competitive environment, and that it and the other options exchanges
are engaged in an intense competition on price (and other dimensions of
competition) to attract order flow from directed and other order flow
providers.\33\ As an example, the Exchange notes that it and the Nasdaq
Options Market (``NOM,'' a sister exchange) have modified options
trading fees monthly or even bi-monthly to attract new order flow,
retain existing order flow, and regain order flow lost to competitor's
price cuts.\34\ Phlx further states that price incentives are the
essence of competition, in that they encourage market participants to
provide attractive offerings to consumers, they benefit market
participants who trade on the Exchange, and, in turn, they benefit
consumers who enjoy greater price transparency and execution at lower
prices.\35\
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\33\ Id. at 1, 2, 11.
\34\ Id. at 11. The Exchange represents that in 2011 it and NOM
filed 71 execution fee changes and all of the options exchanges
together filed 173 fee changes (excluding market data, connectivity,
colocation, and other fees). Id.
\35\ Id. at 1-2.
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Phlx asserts that, in vibrant markets such as the options markets,
participants who view one pricing scheme as unpalatable are free to
move to another market or markets with favorable pricing.\36\ Phlx
states that, given the competitive nature of the options markets, no
one exchange has sufficient market power to ``raise prices for
competitively-traded options in an unreasonable or unfairly
discriminatory manner in violation of the* * * Act.'' \37\ According to
Phlx, it is the member firms that have market power, as these market
participants control the order flow that the options markets compete to
attract.\38\
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\36\ Id. at 12.
\37\ Id. at 12.
\38\ Id. at 12.
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The Commission disagrees with the Exchange's assertion that the
existence of competition alone is adequate to determine whether the
fees are reasonable, not unfairly discriminatory, and an equitable
allocation of fees among members under the Exchange Act. The
Commission's market-based approach to evaluating whether certain market
data fees are consistent with the Exchange Act incorporates two
parts.\39\ First, the Commission examines whether the exchange making
the proposal was subject to significant competitive forces in setting
the terms of its proposal, including the level of any fees. If the
exchange was subject to significant competitive forces in setting the
terms of a proposal, the Commission will approve the proposal unless it
determines that there is a substantial countervailing basis to find
that the terms nevertheless fail to meet an applicable requirement of
the Exchange Act or the rules thereunder. The Commission has cited an
unfair or unreasonably discriminatory proposal as an example of one
such countervailing basis.
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\39\ See Securities Exchange Act Release No. 59039 (December 2,
2008), 73 FR 74770 (December 9, 2008) (SR-NYSEArca-2006-21); vacated
and remanded, NetCoalition v. SEC, 615 F.3d 525 (DC Cir. 2010)). In
the NetCoalition decision, the court held that the Commission's
market-based approach to the market data fees in question was
consistent with the Exchange Act, but reversed because the
Commission had not adequately explained how competition would
adequately constrain pricing in the particular case before it and
that the record in the case did not contain sufficient evidence to
support the Commission's conclusions.
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Applying this approach to the Exchange's proposal, the Commission
finds under the first part of the analysis that the Exchange was
subject to significant competitive forces in setting the terms of its
proposal. There currently are ten registered national securities
exchanges that trade listed options. The Commission has previously
found that there is significant competition for order flow in the
options markets.\40\ The Exchange provided representations and data
supporting the existence of intense competition for order flow among
the options exchanges. In particular, the Exchange stated that the
trading of options is a highly competitive environment, and that the
ability to attract order flow is driven largely by price
competition.\41\ The Exchange also stated that member firms control the
order flow that options markets compete to attract, and that exchange
members, rather than the exchanges, drive competition.\42\ The Exchange
produced data showing the market share, based on contract volume, among
the options exchanges, which, as of 2012, ranged from approximately
less than 1% to 22% for equity options.\43\ Similarly, monthly volume
data published by the
[[Page 68859]]
Options Clearing Corporation indicates that market share for equity
options for September 2012 ranged from 0.70% (for NOBO) to 22.97% (for
Phlx).\44\ Further, six of the ten options exchanges have rules that
provide for the trading of complex orders.\45\ The Exchange produced
data regarding market share among the options exchanges for complex
orders on a monthly basis from November 2011 to June 2012. For June 1,
2012, the Exchange stated that the market share for complex orders
ranged from 3.39% for NYSE Arca, which had 74,486 complex order trades,
to 43.79% for ISE, which had 961,040 complex order trades.\46\
Moreover, the volume for complex orders has been increasing over the
past few years.\47\ Further, the Commission's finding is based on the
representation by the Exchange that the fees at issue apply only to the
Select Symbols, which are all equity options that are able to be listed
and traded on more than one options exchange, and are therefore subject
to competition among the market for order flow.\48\
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\40\ See Securities Exchange Act Release No. 61317 (January 8,
2010), 75 FR 2915 (January 19, 2010) (SR-ISE-2009-103) (finding that
the exchange was subject to significant competitive forces in
setting the terms of its proposal, including fees, and noting that
``the Exchange has a compelling need to attract order flow to
maintain its share of trading volume, imposing pressure on the
Exchange to act reasonably in establishing fees for these data
offerings'').
\41\ See Response, supra note 7, at 11.
\42\ Id. at 12.
\43\ See Response, supra note 7, at 12.
\44\ See Options Clearing Corporation, Options Volume by
Exchange, September 2012, at http://www.optionsclearing.com/webapps/exchange-volume.
\45\ See C2 Rule 6.13; CBOE Rules 6.42, 6.45, 6.53C; ISE Rule
722; NYSE Arca Rules 6.62(e), 6.91; NYSE MKT Rules 900.3NY(e),
963NY, 980NY.
\46\ See Phlx Supporting Data, at http://www.sec.gov/comments/sr-phlx-2012-27/phlx201227-2.pdf. Similarly, market share for
complex orders in November 2011 ranged from 1.64% for C2, which had
33,406 trades, to 39.50% for ISE, which had 804,845 trades. Market
share for complex orders in February 2012 ranged from 2.78% for NYSE
Arca, which had 69,498 trades, to 37.97% for ISE, which had 950,368
trades.
\47\ See Complex Orders Surge, Traders Magazine, March 2012
(noting increase in use of customer orders by customers at one
broker-dealer in 2011); see also BATS February 2012 Options Market
Update, at http://www.batstrading.com/resources/fee_schedule/2012/BATS-February-2012-US-Market-Update.pdf (noting that more volume is
being done through complex strategies, and that volume in the
complex order book has increased).
\48\ See Response, supra note 7, at 11.
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Under the second part of the analysis, the Commission does not at
this time find that there is a substantial countervailing basis to find
that the terms of the fees and fee differential fail to meet the
requirements of the Exchange Act or the rules thereunder. The
Commission notes that it received no comments in opposition to the
proposed rule changes. The fees for removing liquidity as proposed
distinguish between Directed Participants and all other Market Makers
(or other members), and would provide the Directed Participants a lower
fee than other Market Makers when the Directed Participants interact
with order flow that has been directed to them. The Exchange argues in
part that Directed Participants that execute against order flow in the
complex market that has been directed to them do not have a 40%
guaranteed allocation, unlike in the leg market,\49\ and that the
reduced fee for Directed Participants is an attempt to confer an
additional benefit on Directed Participants for the value they provide
in bringing order flow to the Exchange. The Exchange also argues that
increased order flow provides better execution quality on the Exchange
because customers enjoy greater price transparency and executions at
lower prices, and that Market Makers to whom order flow is directed
still must compete with other Exchange participants to interact with
that order flow to receive the benefits of such arrangements.\50\
According to the Exchange, this increased order flow, and corresponding
greater execution quality, benefits all market participants.\51\
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\49\ See Response, supra note 7, at 17. Orders in the leg market
are allocated pursuant to Exchange Rule 1014. Specifically, Directed
Orders that are executed electronically are allocated first to
customer limit orders resting on the limit order book at the
execution price. For orders involving Directed Specialists, the
contracts remaining in the Directed Order, if any, shall be
allocated automatically as follows: The Directed Specialist shall be
allocated a number of contracts that is the greater of: (a) The
proportion of the aggregate size at the NBBO associated with such
Directed Specialist's quote, SQT and RSQT quotes, and non-SQT ROT
limit orders entered on the book at the disseminated price
represented by the size of the Directed Specialist's quote; (b) the
Enhanced Specialist Participation as described in Rule 1014(g)(ii);
or (c) 40% of the remaining contracts. See Exchange Rule
1014(g)(viii).
For orders involving Directed RSQTs or SQTs, the contacts
remaining in the Directed Order, if any, shall be allocated
automatically as follows: The Directed RSQT or SQT shall be
allocated a number of contracts that is the greater of the
proportion of the aggregate size at the NBBO associated with such
Directed SQT or RSQT's quote, the specialist's quote, other SQT and
RSQT quotes, and non-SQT ROT limit orders entered on the book via
electronic interface at the disseminated price represented by the
size of the Directed RSQT or SQT's quote at the NBBO, or 40% of the
remaining contracts. See Exchange Rule 1014(g)(viii).
\50\ See Notice I, supra note 4, at 15404 and Response, supra at
note 7, at 2.
\51\ See Notice I, supra note 4, at 15404.
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The Commission has previously approved as consistent with the Act
rules of exchanges that provide directed Market Makers a 40% guaranteed
allocation when they interact with directed order flow, based upon
their status as directed Market Makers.\52\ Likewise, pursuant to the
proposals at issue here, Directed Participants on Phlx would be charged
a lower fee when they interact with order flow directed to them, based
on their status as Directed Participants.
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\52\ See, e.g., Securities Exchange Act Release No. 51759 (May
27, 2005), 70 FR 32860 (June 6, 2005) (order approving SR-Phlx-2004-
91). In that order, the Commission noted that the Directed
Participant would have to be quoting at the NBBO at the time the
directed order was received to capitalize on the guarantee, and that
Directed Participants have greater quoting obligations than other
Phlx Market Makers that cannot be Phlx Directed Participants. Id.
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When approving the proposals that provided a guaranteed allocation
to directed market makers, the Commission found that the guaranteed
allocation for directed market makers would not affect the incentives
of the trading crowd to compete aggressively for orders based on
price.\53\ Here, the Commission believes that the potential impact of a
guaranteed allocation on competition may be distinguished from the
potential impact of the reduced transaction fee on competition.
Specifically, the guaranteed allocation does not provide directed
market makers an explicit subsidy--in the form of lesser per contract
fees--over other market makers that are competing to execute against
the same order flow. Rather, the guaranteed allocation scheme allocates
portions of orders to other Market Makers who are at the same price as
the directed market maker, thus protecting the incentive of other
market makers to compete with directed market makers on price. In
contrast, assessing a lesser transaction fee on Directed Participants
than other Market Makers when the Directed Participants interact with
order flow directed to them may allow Directed Participants to execute
against Complex Orders at more aggressive prices than other market
makers, which may reduce the incentive and ability of such other market
makers to compete with Directed Participants on price.
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\53\ Id. See also Securities Exchange Act Release No. 34606
(August 26, 1994), 59 FR 45741 (September 2, 1994) (SR-Phlx-94-12)
(approving 40% specialist guarantee).
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The Commission has carefully considered the potential impact of the
fees for removing liquidity on Directed Participants and other Market
Makers and the $0.05 fee differential on competition between Directed
Participants and other Market Makers that are competing to execute
against the same order flow, and on the extent of price improvement
provided to directed customer Complex Orders. The data provided by Phlx
does not show any statistical significant adverse impact of the
proposed fee and fee differential on the competitiveness of the market
for directed customer Complex Orders on Phlx, or the extent of price
improvement for directed customer Complex Orders.\54\
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\54\ For purposes of studying the competitive impact of the fees
for Directed Participants and other Market Makers, Phlx provided
data on the rate of interaction with directed customer Complex
Orders by both Directed Participants and non-directed Market Makers.
This data was provided, on a weekly basis, for the twelve months
prior to the time the suspended fees were in effect, in addition to
the two months the suspended fees were in place. Phlx also provided
data on rates of price improvement for directed customer Complex
Orders that received price improvement by both Directed Participants
and non-directed markers. This data was provided for the four months
prior to the time the suspended fees were in effect, in addition to
the two months the suspended fees were in place. Phlx also produced
data on the percentage of directed and non-directed customer Complex
Orders that received price improvement, and the average price
improvement for such orders. This data was provided for the four
months prior to the time the suspended fees were in effect, in
addition to the two months the suspended fees were in place.
With respect to rates of customer Complex Order interaction, for
the period prior to the introduction of the new fees (March 2011-
February 2012), the average order interaction by Directed
Participants was 14.98%. For March and April 2012, when the lower
Directed Participant (as compared to the fee assessed to other
Market Makers) fee was in effect, the statistics show that order
interaction by Directed Participants averaged 14.02% and 15.64%,
respectively. These figures reflect the rates of Complex Order
interaction as averaged among Directed Participants, i.e., the rate
of Complex Order interaction for any given Directed Participant
could, in fact, be much higher.
With respect to price improvement data, Phlx produced data for
directed customer Complex Orders receiving price improvement,
showing the breakdown by contra side participant type, and the
average amount of price improvement for such order flow, also by
contra side participant type. This data was produced for November
2011 to May 2012, using the week before the standard expirations in
each month. The data that has been submitted shows that, for
directed customer Complex Orders that received price improvement,
Directed Participants interacted with those orders 7.8% of the time,
and provided average price improvement of $7.90 per contract, during
the time that the suspended fees were not in effect (November 2011-
February 2012, and May 2012), and 11.8% of the time, with an average
price improvement amount of $4.70 per contract, during the time that
the suspended fees were in effect (March-April 2012). For directed
customer Complex Orders that received price improvement, other
Market Makers interacted with those orders 86.74% during the time
that the suspended fees were not in effect (November 2011-February
2012, and May 2012) and 7.8% of the time during the time that the
suspended fees were in effect (March-April 2012), and provided
average price improvement of $6.14 and $5.15 per contract,
respectively, for the same respective time periods.
Phlx also produced data showing the percentage of directed and
non-directed customer Complex Orders that received price
improvement, and the average amount of price improvement. This data
was produced for November 2011 to May 2012, using the week before
the standard expirations in each month. The data that has been
submitted shows that non-directed customer Complex Orders received
price improvement 17.2% of the time while the suspended fees were
not in effect (November 2011-February 2012, and May 2012), with an
average price improvement of $3.29 per contract. During the time the
suspended fees were in effect (March-April 2012), non-directed
Customer Complex orders received price improvement 13% of the time,
with an average price improvement of $3.39 per contract. Directed
customer Complex Orders received price improvement 29.6% of the time
while the suspended fees were not in effect (November 2011-February
2012, and May 2012), with an average price improvement of $6.26 per
contract. During the time the suspended fees were in effect (March-
April 2012), directed Customer Complex orders received price
improvement 30.5% of the time, with an average price improvement of
$5.10 per contract.
In providing this data, Phlx used a definition of price
improvement that compared the execution price with the limit price
of the incoming order. In the data to be provided by Phlx as part of
the pilot, Phlx will measure price improvement by comparing the Phlx
best bid or offer at the time of the incoming order to the execution
price of the order.
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[[Page 68860]]
However, the suspended fees that are at issue were only in place
for two months and thus were only analyzed over that period.\55\ Phlx
has filed an amendment to its filing to, among other things, specify
that the portion of the proposed rule change relating to execution fees
for Complex Orders for Directed Participants and other Market Makers,
and the accompanying $0.05 fee differential, will be operative on a
one-year pilot basis, and that such fees will be operative on December
3, 2012. Phlx also has committed to provide the Commission, on a
monthly basis, with publicly available data and data analyses studying
the impact of the fees for removing liquidity for complex orders for
Directed Participants and other Market Makers upon inter and intra-
market competition, and upon market quality. The Exchange has
represented that it would provide such information as the Commission
may request regarding this fee pilot, including information with
respect to rates of order interaction by Directed Participants and
Market Makers with Customer Complex Orders and rates of price
improvement for Complex Orders.
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\55\ See supra note 6.
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This data and analysis will allow the Exchange and the Commission
to further evaluate during the course of the pilot program the impact
of the fees for removing liquidity for Directed Participants and other
Market Makers and the $0.05 fee differential on competition between
Directed Participants and other Market Makers and the extent of price
improvement for Complex Orders over a longer time period with a larger
data set.\56\ For these reasons, the Commission finds that the proposed
rule changes, each as modified by Amendment No. 1, are consistent with
the Act. The Commission's finding takes into account that Directed
Participants are subject to heightened quoting obligations compared to
other Market Makers that are not Directed Participants,\57\ and that
the fact that whether a customer Complex Order is a directed order or
not is not known to any Market Maker, including Directed Participants,
prior to execution.\58\
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\56\ See Securities Exchange Act Release No. 66278 (January 30,
2012), 77 FR 5590 (SR-BX-2011-046) (approving a fee change to the BX
Price Improvement Period (``PIP'') upon finding, in part, that the
data provided by the exchange did not ``suggest any significant
adverse impact of the proposed PIP fee change on the competitiveness
of the PIP auction or the extent of price improvement for orders
executed in the PIP in those series.'').
\57\ The Commission recognizes that, given the structure of the
Complex Order market on Phlx, there currently are no quoting
obligations on Phlx specific to Complex Orders. However, quotations
in the leg markets are relevant to the Complex Order market, as
Complex Orders are priced based on the leg markets, and executions
on the Complex Order market must take into account the prices in the
leg markets. Additionally, Directed Participants must be at the best
price for a complex order to execute against the Complex Order.
\58\ Phlx Rule 707 prohibits Directed Participants and order
flow providers from coordinating actions involving Directed Orders.
See also Securities Exchange Act Release No. 51759 May 27, 2005), 70
FR 32860 (June 6, 2005) (SR-Phlx-2004-91) (noting the applicability
of Rule 707 to this scenario). Thus, an order flow provider cannot
let a Directed Participant know when it is sending a directed
customer Complex Order to Phlx, or that it has such an order resting
on Phlx's Complex Order book. In Amendment No. 1 to the proposals,
Phlx noted that Rule 707 is intended to prohibit coordinated actions
between Directed Participants and OFPs, and that the Exchange
proactively conducts surveillance for, and enforces against, such
violations. See Amendment No. 1 to SR-Phlx-2012-27 and SR-Phlx-2012-
54, supra note 11.
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In its original filing, the Exchange also pointed to the existence
of non-exchange sponsored PFOF arrangements as a basis for the fees and
fee differential. Specifically, Phlx argued that the fee differential
is fair, equitable and not unfairly discriminatory because it is
intended ``to * * * reflect the increased costs that are incurred by
such Market Makers that enter into order flow arrangements at a cost
and without the benefit of a guaranteed allocation.'' \59\
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\59\ See Notice I, 77 FR 15402.
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In support of its argument, Phlx has represented that it is aware
that non-exchange-sponsored PFOF arrangements exist, and that the rates
paid by Market Makers under these arrangements, in many cases, ``exceed
[Phlx's] own exchange-sponsored payment for order flow fee and also
exceed the rebates that [Phlx] provides for adding or removing
liquidity from the exchange.'' \60\ However, Phlx also represented that
it ``does not compile data on the exact prices that Market Makers pay
third-party order flow providers for directed order flow * * *.'' \61\
Phlx has not produced any data with respect to non-exchange-sponsored
payment for order flow arrangements, and has represented to Commission
staff that it does not have such data.\62\
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\60\ See Response, supra note 7, at 14.
\61\ Id.
\62\ Phlx did provide links to the Web sites of two order flow
providers, Interactive Brokers and Wedbush. The Interactive Brokers
link generally describes its PFOF practices, and states that it
receives PFOF payments from Timber Hill ``consistent with SEC-
approved'' PFOF plans. Since the Commission does not approve non-
exchange-sponsored PFOF arrangements, this sentence presumably
refers to exchange-sponsored PFOF payments, which are not relevant
here. The Wedbush link notes that PFOF payments with respect to the
options exchanges range from $0-$0.75 per contract.
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[[Page 68861]]
The Commission does not believe that this argument provides a
reasonable basis to find that the fees and fee differential are
consistent with the Act. As outlined above, pursuant to this argument,
Phlx would be setting its fees, and discriminating among market
participants, based on the existence of non-exchange sponsored PFOF
arrangements. The record, however, does not contain any representations
regarding the amounts of payments made by Directed Participants
pursuant to such arrangements or whether such payments are made,
whether these off-exchange PFOF arrangements are standardized, and
whether the terms and amounts are the same between different OFPs and
Directed Participants. As such, the Exchange has not substantiated the
details of such off-exchange PFOF arrangements. The Commission believes
it is likely that the terms of such arrangements could vary
considerably between different Directed Participants and OFPs.
Essentially, pursuant to this argument, Phlx could be discriminating in
its fees for a specified amount based on payments potentially made off-
exchange that may vary widely. The Commission therefore does not
believe that this argument provides a basis to support a finding that
the fees and fee differential are reasonable, equitably allocated, and
not unfairly discriminatory. Nevertheless, for the reasons discussed
above, the Commission finds that the proposed rule changes are
consistent with the Act.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Numbers SR-Phlx-2012-27 and SR-Phlx-2012-54 on the subject line.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.
All submissions should refer to File Numbers SR-Phlx-2012-27 and SR-
Phlx-2012-54. This file number should be included on the subject line
if email is used. To help the Commission process and review your
comments more efficiently, please use only one method. The Commission
will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent
amendments, all written statements with respect to the proposed rule
change that are filed with the Commission, and all written
communications relating to the proposed rule change between the
Commission and any person, other than those that may be withheld from
the public in accordance with the provisions of 5 U.S.C. 552, will be
available for Web site viewing and printing in the Commission's Public
Reference Room, 100 F Street NE., Washington, DC 20549, on official
business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of
the filing also will be available for inspection and copying at the
principal office of the Exchange. All comments received will be posted
without change; the Commission does not edit personal identifying
information from submissions. You should submit only information that
you wish to make available publicly. All submissions should refer to
File Numbers SR-Phlx-2012-27 and SR-Phlx-2012-54 and should be
submitted on or before December 7, 2012.
V. Accelerated Approval of Proposed Rule Changes, as Modified by
Amendments No. 1
Amendments No. 1 revised the proposed rule changes to, among other
things, specify that the portion of the proposed rule change relating
to fees for removing liquidity for Complex Orders for Directed
Participants and other Market Makers, and the accompanying $0.05 fee
differential, will be operative on a one-year pilot basis, and that
such fees would be operative on December 3, 2012. Phlx also committed
to provide the Commission, on a monthly basis, with publicly available
data and data analyses studying the impact of the fees for removing
liquidity for complex orders for Directed Participants and other Market
Makers upon inter and intra-market competition, and upon market
quality. The Exchange represented that it would provide such
information as the Commission may request regarding this fee pilot,
including information with respect to rates of order interaction with
Customer Complex Orders and rates of price improvement. Receiving data
and analysis from the Exchange during the duration of the pilot period
will allow the Commission (and the Exchange) to continue to assess the
impact, if any, of the proposed rule changes during the pilot period.
Accordingly, the Commission finds good cause, pursuant to Section
19(b)(2) of the Act,\63\ for approving the proposed rule changes, as
modified by Amendments No. 1, prior to the 30th day after the date of
publication of notice in the Federal Register.
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\63\ 15 U.S.C. 78s(b)(2).
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VI. Conclusion
For the foregoing reasons, the Commission finds that the proposed
rule changes, as modified by Amendments No. 1, are consistent with the
Act and the rules and regulations thereunder applicable to a national
securities exchange, and, in particular, with Sections 6(b)(4),
6(b)(5), and 6(b)(8) of the Act.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\64\ that the proposed rule changes (SR-Phlx-2012-27 and SR-Phlx-
2012-54), as modified by Amendments No. 1, be, and hereby are,
approved. With respect to the fees for executions of Complex Orders by
Directed Participants and Market Makers, such fees are approved on a
one-year pilot basis, with such fees being operative on December 3,
2012.
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\64\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\65\
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\65\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-27819 Filed 11-15-12; 8:45 am]
BILLING CODE 8011-01-P