[Federal Register Volume 79, Number 140 (Tuesday, July 22, 2014)]
[Notices]
[Pages 42578-42588]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-17156]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-72633; File No. SR-Phlx-2013-113]
Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Order
Disapproving Proposed Rule Change To Offer a Rebate Based on Members'
Aggregate Customer Volume in Multiply-Listed Options Transacted on
NASDAQ OMX PHLX LLC or Its Affiliated Options Exchanges
July 16, 2014.
I. Introduction
On October 31, 2013, NASDAQ OMX PHLX LLC (``Phlx'' or ``Exchange'')
filed with the Securities and Exchange Commission (``Commission''),
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule
[[Page 42579]]
19b-4 thereunder,\2\ a proposed rule change to amend the Customer
Rebate Program in Section B of the Exchange's Pricing Schedule to
increase customer rebates available to certain market participants that
transact electronically-delivered customer orders on Phlx (the
``Proposal'') or its affiliated options exchanges. Phlx designated the
proposed rule change as immediately effective upon filing with the
Commission pursuant to Section 19(b)(3)(A) of the Act.\3\ The
Commission published notice of filing of the proposed rule change in
the Federal Register on November 19, 2013.\4\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ 15 U.S.C. 78s(b)(3)(A).
\4\ See Securities Exchange Act Release No. 70866 (November 13,
2013), 78 FR 69472 (``Notice'').
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The Commission initially received two comment letters on the
Proposal.\5\ On November 25, 2013, the Commission temporarily suspended
and initiated proceedings to determine whether to approve or disapprove
the proposed rule change.\6\ In response to the Order Instituting
Proceedings, the Commission received four additional comment letters on
the Proposal.\7\ On January 24, 2014, Phlx submitted a letter
responding to the commenters and to the Order Instituting
Proceedings.\8\
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\5\ See letters to Elizabeth M. Murphy, Secretary, Commission
from: Michael J. Simon, Secretary, International Securities
Exchange, LLC (``ISE''), dated November 11, 2013 (``ISE Letter'');
and William O'Brien, Chief Executive Officer, Direct Edge Holdings
LLC, dated November 13, 2013 (``DirectEdge Letter'').
\6\ See Securities Exchange Act Release No. 70940 (November 25,
2013), 78 FR 71700 (November 29, 2013) (``Order Instituting
Proceedings'').
\7\ See letters to Elizabeth M. Murphy, Secretary, Commission
from: Brian O'Neill, Vice President and Senior Counsel, Miami
International Securities Exchange, LLC (``MIAX''), dated November
27, 2013 (``MIAX Letter''); John C. Nagel, Managing Director and
General Counsel, Citadel LLC, dated December 18, 2013 (``Citadel
Letter''); Angelo Evangelou, Associate General Counsel, Chicago
Board Options Exchange, Inc. (``CBOE''), dated December 20, 2013
(``CBOE Letter''); and Michael J. Simon, Secretary, ISE, dated
December 20, 2013 (``ISE Letter II'').
\8\ See letter to Elizabeth M. Murphy, Secretary, Commission,
from Joan C. Conley, Senior Vice President & Corporate Secretary,
Phlx, dated January 24, 2014 (``Phlx Response Letter''). In the Phlx
Response Letter, Phlx included an evaluation of the Proposal by
economists Drs. Robert Willig and Gustavo Bamberger (``Willig and
Bamberger Statement''). On January 24, 2014, Phlx also submitted a
request to make an oral presentation in the proceeding. The
Commission denied Phlx's request. See letter from Lynn M. Powalski,
Deputy Secretary, Commission, to Eugene Scalia, Partner, Gibson,
Dunn & Crutcher LLP, dated June 30, 2014.
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On April 7, 2014, the Commission sought additional comment on the
proposed rule change and extended the time period for Commission action
to July 17, 2014.\9\ On April 18, 2014, Phlx submitted a letter
responding to questions from the Commission staff.\10\ In response to
the request for additional comment in the Extension Notice, the
Commission received two additional comment letters on the Proposal.\11\
On May 9, 2014, Phlx submitted a letter responding to the request for
additional comment in the Extension Notice.\12\ On May 20, 2014, Phlx
submitted a letter responding to the Normann Letter.\13\ On May 30,
2014, Phlx submitted a letter responding to ISE's May 20, 2014 comment
letter.\14\ This order disapproves the proposed rule change.
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\9\ See Securities Exchange Act Release No. 71891 (April 7,
2014), 79 FR 20287 (April 11, 2014) (``Extension Notice''). In the
Extension Notice, the Commission requested comment from market
participants on the potential impact the Proposal would have on,
among other things, fragmentation of the options market.
\10\ See letter to Elizabeth M. Murphy, Secretary, Commission,
from Jeffrey S. Davis, Vice President & Deputy General Counsel,
Phlx, dated April 18, 2014 (``Phlx Response Letter II'').
\11\ See letters to Elizabeth M. Murphy, Secretary, Commission,
from Michael J. Simon, Secretary, ISE, dated May 20, 2014 (``ISE
Letter III'') and Parker M. Normann, Ph.D., Partner, Edgeworth
Economics LLC, dated May 8, 2014, on behalf of the CBOE, ISE, and
MIAX (``Normann Letter'').
\12\ See letter to Elizabeth M. Murphy, Secretary, Commission,
from Jeffrey S. Davis, Vice President & Deputy General Counsel,
Phlx, dated May 9, 2014 (``Phlx Response Letter III'').
\13\ See letter to Elizabeth M. Murphy, Secretary, Commission,
from Joan C. Conley, Senior Vice President & Corporate Secretary,
Phlx, dated May 20, 2014 (``Phlx Response Letter IV''). In Phlx
Response Letter IV, Phlx included a statement by economists Drs.
Robert Willig and Gustavo Bamberger in response to the Normann
Letter (``Willig and Bamberger Reply'').
\14\ See letter to Elizabeth M. Murphy, Secretary, Commission,
from Joan C. Conley, Senior Vice President & Corporate Secretary,
Phlx, dated May 30, 2014 (``Phlx Response Letter V'').
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II. Summary of the Proposal
Under the Phlx's existing Customer Rebate Program in its Pricing
Schedule, the Exchange pays tiered rebates to members for executions of
customer option orders on Phlx. The different tiers are based on a
member organization's (and its affiliates under common ownership) \15\
total monthly volume in electronically-delivered customer orders
executed on Phlx as a percentage of the total national customer volume
in multiply-listed options that are transacted monthly on Phlx. These
rebates apply separately to both the execution of simple orders and
complex orders on Phlx.\16\
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\15\ Phlx defines common ownership as a member or member
organization under 75% common ownership or control. See Notice,
supra note 4, at 69472 n.3.
\16\ To determine the applicable rebate, the Exchange totals
customer volume in multiply-listed options (including options
overlying the SPDR S&P 500) that are electronically-delivered and
executed, except volume associated with electronically Qualified
Contingent Cross Orders. Pursuant to the Phlx Pricing Schedule, the
term ``Customer'' applies to any transaction that is identified by a
member or member organization for clearing in the Customer range at
The Options Clearing Corporation which is not for the account of a
broker or dealer or for the account of a ``Professional'' (as that
term is defined in Rule 1000(b)(14)).
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Phlx proposed amending its Customer Rebate Program in two ways.
First, the Proposal would allow a Phlx member organization to aggregate
its (and its affiliates under common ownership) customer volume in
multiply-listed options that is electronically delivered and executed
across Phlx and its two affiliated NASDAQ OMX exchanges, The NASDAQ
Options Market LLC (``NOM''), and/or NASDAQ OMX BX, Inc. (``BX
Options'') (collectively, the ``NASDAQ OMX exchanges''), for purposes
of determining whether it meets the volume tiers on Phlx. Second, the
Proposal would increase the customer rebates offered for these
transactions executed on Phlx by $0.02 per contract,\17\ provided the
member organization, together with any affiliate under common
ownership, transacts customer volume on the NASDAQ OMX exchanges in
multiply-listed options that is electronically delivered and executed
equal to or greater than 2.5% of national customer volume in multiply-
listed options in a month.
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\17\ Phlx would pay the additional $0.02 per contract rebate,
above and beyond other existing customer rebates, on all eligible
orders transacted on Phlx by the qualifying member organization.
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The Exchange believes the additional rebate would lower costs to
transact business on Phlx and increase the volume of customer orders
directed to and executed on Phlx, to the benefit of all market
participants on Phlx.\18\ According to Phlx, the aspect of the Proposal
under which a member organization's eligibility for the volume tiers is
determined by taking into account customer volume executed on all of
the NASDAQ OMX exchanges broadens the potential availability of a
higher rebate to market participants that spread volume across multiple
exchanges, rather than requiring a concentration of activity on
Phlx.\19\ Phlx also argues that the Proposal would benefit investors
and the national market system by reducing costs, increasing the
incentives for exchanges to compete for order flow, and encouraging
market participants to direct more liquidity to the Exchange.\20\
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\18\ See Notice, supra note 4, at 69473.
\19\ See id. at 69477.
\20\ See Phlx Response Letter, supra note 8, at 4.
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III. Summary of Comments
As noted above, the Commission received thirteen comment letters on
the proposed rule change,\21\ including five
[[Page 42580]]
supplemental submissions from Phlx responding to comment letters.\22\
The Commission received seven comment letters opposing the proposed
rule change,\23\ and one comment letter supporting the proposed rule
change.\24\ Comments on the Proposal generally addressed four areas,
namely whether the Proposal: (1) Is an equitable allocation of
reasonable fees; (2) is not designed to permit unfair discrimination
between customers, issuers, brokers, or dealers; (3) imposes a burden
on competition not necessary or appropriate in furtherance of the
purposes of the Act; and (4) impacts market structure and efficiency.
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\21\ See supra notes 5, 7 and 11.
\22\ See supra notes 8, 10, 12, 13 and 14.
\23\ See ISE Letter; DirectEdge Letter; MIAX Letter; CBOE
Letter; ISE Letter II; ISE Letter III; and Normann Letter, supra
notes 5, 7 and 11.
\24\ See Citadel Letter, supra note 7.
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A. Equitable Allocation of Reasonable Dues, Fees, and Other Charges
Among Members and Issuers Using Its Facility
Several commenters who do not support the Proposal argue that it is
inconsistent with the statutory language of Section 6(b)(4) of the Act,
which requires that the rules of a registered 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'' (emphasis added).\25\ One commenter asserts that
such dues, fees, and other charges are intended to be allocated only
with respect to the volume on the facilities of the exchange imposing
such charges, not the volume executed on another exchange.\26\ This
commenter believes that imposing a fee or charge based on some activity
other than use of the fee-imposing exchange's own facilities would be
impossible to allocate in an ``equitable'' way and could never be
``reasonable.'' \27\ Another commenter believes that the Act's focus on
an equitable allocation of reasonable dues, fees, and other charges
among its members using its facilities underscores the ArcaBook Order
\28\ conclusion that the Commission must analyze an exchange's rules
and fees on an exchange-by-exchange basis, and argues that imposing a
cross-exchange fee, by its very nature, cannot be an equitable
allocation of fees for the members of just one of the exchanges.\29\
This commenter believes that exchange fees tied to activity conducted
on competing exchanges are impermissible regardless of whether they
increase or lower the overall fees that joint exchange members may
pay.\30\
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\25\ See ISE Letter II, supra note 7, at 4; DirectEdge Letter,
supra note 5, at 1; MIAX Letter, supra note 7, at 2; and CBOE
Letter, supra note 7, at 2-3.
\26\ See CBOE Letter, supra note 7, at 2.
\27\ See id. at 3.
\28\ See Securities Exchange Act Release No. 59039 (December 2,
2008), 73 FR 74770 (December 9, 2008) (SR-NYSEArca-2006-21) (Order
Setting Aside Action by Delegated Authority and Approving Proposed
Rule Change Relating to NYSE Arca Data), vacated and remanded sub
nom by NetCoalition v. SEC, 615 F.3d 525 (D.C. Cir. 2010) but on
other grounds (the ``ArcaBook Order'').
\29\ See ISE Letter II, supra note 7, at 4.
\30\ See id. at 5. ISE states that the Commission has always
required a self-regulatory organization (``SRO'') to justify its
fees by reference solely to that SRO's operation and governing
documents. See id. at 2.
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The commenter that supports the Proposal believes that if an
exchange is subject to significant competitive forces in setting the
terms of its proposed fees, the exchange's fees are presumed to be
equitable, fair, reasonable and not unfairly discriminatory.\31\ This
commenter states that reduced fees and rebates based on volume, in
general, have been accepted by the Commission and have not been
considered inequitable, despite the rebate benefits applying to one
member class over another.\32\ The commenter also asserts that, while
the direct benefits flow to only some members, the rebate tiers will
benefit all members and customer orders by providing greater liquidity
on the exchange and spreading other fees across a larger number of
transactions and members.\33\ Furthermore, this commenter states that
the Commission has approved a proposal in which rebate volume tiers are
calculated based on a market participant's aggregate activity on two
markets operated by the same SRO.\34\ In this regard, the commenter
believes that there is no distinction in differentiating between
separately affiliated markets operated by the same SRO, on the one
hand, and separate affiliated exchanges operated by affiliated SROs, on
the other hand.\35\
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\31\ See Citadel Letter, supra note 7, at 3.
\32\ See id. at 4.
\33\ See id. at 4.
\34\ See id. at 7 (citing Securities Exchange Act Release No.
50787 (December 2, 2004), 69 FR 71459 (December 9, 2004) (SR-NASD-
2004-170)) (approving a National Association of Securities Dealers,
Inc. (``NASD'') proposed rule change, through its subsidiary The
Nasdaq Stock Market (``Nasdaq''), to establish a price and rebate
schedule for non-NASD members based on multiple volume-based usage
tiers that takes into account the non-NASD member's combined volume
activity on the Nasdaq Market Center and Nasdaq's BRUT facility).
See also Phlx Response Letter IV, supra note 13, at 3. The
Commission believes that the proposed rule change regarding the Brut
ECN involved unique circumstances in which the Nasdaq Market Center
and Brut were facilities of one SRO, a national securities
association. See Securities Exchange Act Release No. 50311
(September 3, 2004), 69 FR 54818 (September 10, 2004) (Order
Granting Application for a Temporary Conditional Exemption Pursuant
To Section 36(a) of the Exchange Act by the National Association of
Securities Dealers, Inc. Relating to the Acquisition of an ECN By
The NASDAQ Stock Market, Inc.). The Commission also notes that the
proposed rule change was a temporary conditional exemption and,
after Nasdaq's acquisition of the Brut ECN, the Nasdaq Market
Center, the Brut ECN, and the Nasdaq INET system were fully
integrated into a single pool of liquidity. See also Securities
Exchange Act Release No. 54155 (July 14, 2006), 71 FR 41291 (July
20, 2006) (SR-NASDAQ-2006-001) (order approving NASDAQ's proposed
rule change to combine the operations of the existing Nasdaq Market
Center with NASDAQ's Brut and INET facilities into one single
integrated system).
\35\ See id.
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Phlx also responds to the commenters opposing the Proposal by
arguing that the phrase ``persons using its facilities'' in Section
6(b)(4) of the Act only refers to one category of market participant
that is bound by an exchange's rules.\36\ Phlx asserts that the phrase
does not describe the basis on which exchange fees may be determined,
or restrict the right of an exchange to offer market participants a
discount that is based in part on their trading activity on an
affiliated exchange.\37\ Moreover, Phlx argues that the proposed rebate
is consistent with Section 6(b)(4) of the Act because the proposed
rebate is limited to market participants who transact business on Phlx
and only applies to orders executed on Phlx.\38\ Phlx also states its
view that the Proposal should be considered ``presumptively
reasonable'' because it provides an opportunity for market participants
to receive enhanced rebates and to lower the costs passed on to
investors.\39\
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\36\ See Phlx Response Letter, supra note 8, at 14.
\37\ See id.
\38\ See id.
\39\ See id.
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B. Unfair Discrimination Between Customer, Issuers, Brokers, or Dealers
Several commenters believe the Proposal is inconsistent with
Section 6(b)(5) of the Act, which requires the rules of a national
securities exchange to, among other things, not be ``designed to permit
unfair discrimination between customers, issuers, brokers, or
dealers.'' \40\ In particular, these commenters believe that the
Proposal unfairly discriminates between Phlx members because it
advantages Phlx members that are also members of NOM and/or BX Options,
while disadvantaging Phlx members who are otherwise similarly situated,
but who do not have such memberships.\41\ As a
[[Page 42581]]
result, several commenters believe that the Proposal could trigger
relatively higher costs for the Phlx members who are not members on NOM
and/or BX Options, but who otherwise have the same purchasing profile
on Phlx as members who do hold such memberships.\42\
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\40\ See ISE Letter II, supra note 7, at 2-3; MIAX Letter, supra
note 7, at 2; and CBOE Letter, supra note 7, at 3.
\41\ See ISE Letter II, supra note 7, at 2-3; ISE Letter III,
supra note 11, at 2; MIAX Letter, supra note 7, at 2; CBOE Letter,
supra note 7, at 3; and Normann Letter, supra note 11, at 5. One
commenter states that maintaining multiple exchange memberships
requires significant one-time and continuing costs, which include
membership and regulatory fees, and connectivity and line charges.
See ISE Letter III, supra note 11, at 2. This commenter states its
view that requiring members to absorb these additional costs to
qualify for the rebate is not reasonable and is discriminatory, as
the requirement adds significant costs to the member, but benefits
Phlx and its affiliates. See id.
\42\ See CBOE Letter, supra note 7, at 3; and Normann Letter,
supra note 11, at 5-6 (noting that a likely result of the Phlx
proposal would be that ``two otherwise identical customers with
identical volume on Phlx, using identical services, will pay
different net fees due to differences in purchasing patterns at
exchanges other than Phlx.''). See id. at 6. One commenter also
believes that the Proposal does not comport with rebate practices
that the Commission has allowed in the past as an acceptable means
of seeking to attract additional order flow. See CBOE Letter, supra
note 7, at 3. Specifically, this commenter states its view that the
discriminatory nature of the proposed rebate could distort a
brokers' best execution responsibilities and ``present a new threat
to public confidence in brokerage services and market integrity''
contrary to the public interest and inconsistent with the protection
of investors. Id. at 3-4.
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The commenter that supports the Proposal argues that the Proposal
is not unfairly discriminatory, noting that the Proposal does not
require a Phlx member to become a member of NOM or BX Options to meet
the rebate eligibility threshold.\43\ In addition, this commenter
believes that most Phlx members with sufficient customer order flow to
reach the eligibility threshold are already members of NOM and BX
Options.\44\ The commenter further believes that becoming a member of
Phlx affiliate exchanges is not an unreasonably discriminatory burden
in exchange for the greater ability to meet the volume threshold under
the Proposal.\45\
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\43\ See Citadel Letter, supra note 7, at 5. The commenter notes
that a Phlx member may meet the eligibility threshold by transacting
sufficient volume on Phlx alone. See id.
\44\ See id.
\45\ See id. This commenter states that, for example, the
Commission has approved fees as not unfairly discriminatory where
the fee is tied to a service made available to all members on the
same terms, even if only some voluntarily elect to use the service
and pay the fee. See id.
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In response to commenters opposing the Proposal, Phlx asserts that
the Proposal is not unfairly discriminatory because the proposed rebate
is available on equal terms to any market participant that may qualify
for the rebate by executing the required volume on Phlx alone.\46\ Phlx
argues that members have an incentive to transact volume on Phlx alone
because only qualifying customer orders executed on Phlx are entitled
to the proposed rebate.\47\ Phlx also argues that the Proposal cannot
be unfairly discriminatory because it will extend the availability of
an exchange rebate to more market participants.\48\ Additionally, Phlx
asserts that there are no significant barriers for market participants
to participate in the proposed rebate program because market
participants can easily register as members of Phlx and its affiliated
exchanges.\49\ Given these results, Phlx believes the Proposal would
benefit not only market participants receiving the proposed rebate, but
all other Phlx market participants as well.\50\
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\46\ See Phlx Response Letter, supra note 8, at 5; and Phlx
Response Letter V, supra note 14, at 2 and 6.
\47\ See Phlx Response Letter, supra note 8, at 6; and Phlx
Response Letter V, supra note 14, at 2. One commenter notes that
there could be situations where customers earn rebates on Phlx due
to purchases on NOM and/or BX Options because the Proposal
aggregates volume from Phlx, NOM and BX Options. As a result, a
customer may see its net pricing change from incremental purchases
on NOM or BX Options and not on Phlx. See Normann Letter, supra note
11, at 8-9.
\48\ See Phlx Response Letter, supra note 8, at 4.
\49\ See id. at 5; and Phlx Response Letter V, supra note 14, at
2. Phlx asserts that most of its members are already members of its
two affiliated NASDAQ OMX exchanges. See Phlx Response Letter V,
supra note 14, at 2. Additionally, Phlx states that of the Phlx
members that directed electronic customer orders to Phlx for
execution in May 2014, 100% are members of NOM, and 88.6% are
members of all of the NASDAQ OMX exchanges. See id.
\50\ See id. at 4-5.
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One commenter, MIAX, believes that the Proposal would cause
``disparate treatment'' between two similarly positioned market
participants on Phlx.\51\ MIAX offers the following example to
demonstrate how it believes the Proposal would unfairly discriminate
against similarly positioned market participants on Phlx: BD1 and BD2
are both the same class of market participant and execute 2% of the
national customer volume on Phlx.\52\ However, BD1 sends the balance of
their customer order flow of 1% to MIAX while BD2 sends the balance of
their customer order flow of 1% to NOM.\53\ MIAX believes that an
equitable allocation of reasonable fees and dues that was not unfairly
discriminatory would result in charging BD1 and BD2 the exact same fees
for the identical trading activity on Phlx.\54\ In contrast, MIAX
argues that the Proposal would result in BD1 and BD2 being charged
different fees even though BD1 and BD2 are performing the same activity
on Phlx.\55\
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\51\ See MIAX Letter, supra note 7, at 2.
\52\ See id.
\53\ See id.
\54\ See id. and see also Norman Letter, supra note 11, at 6.
\55\ See MIAX Letter, supra note 7, at 2. In the MIAX example,
under the Proposal, BD1 would be eligible for a $0.14 rebate, while
BD2 would be eligible for a $0.17 rebate for executing the identical
2% of the national customer volume on Phlx. See id.
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Phlx does not directly respond to MIAX's example, but asserts that
the MIAX example of price differentiation between two market
participants who trade the same volume on Phlx does not mean that a
rebate is unfairly discriminatory because ``all rebates predicated on
volume or some other condition differentiate between customers who meet
the condition and those who do not.'' \56\
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\56\ Phlx Response Letter, supra note 8, at 5. For example, Phlx
points to several pricing structures that the Commission has
historically approved that result in differential pricing,
including, among others, volume tiers and fee caps. See id. at 5-6.
However, two commenters respond that the services and/or products
cited by Phlx refer to product types or offerings only on a single
exchange. See Normann Letter, supra note 11, at 5-6; and ISE Letter
III, supra note 11, at 7-8. See also ISE Letter II, supra note 7, at
5-6.
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Two commenters also note that the ArcaBook Order \57\ provides
precedent to disapprove the proposed rule change.\58\ One commenter
argues that the Proposal is inconsistent with the Act because,
according to the ArcaBook Order, ``the Exchange Act precludes anti-
competitive tying of the liquidity pools of separately registered
securities exchanges even if they are under common control.'' \59\
Another commenter argues that Phlx misreads the ArcaBook Order to
incorrectly stand for the proposition that ``as long as exchanges are
subject to competitive forces, any fee is acceptable.'' \60\ This
commenter states its view that, in the ArcaBook Order, the Commission
determined that it must apply the Act's provision regarding rule and
fee changes to individual exchanges, and not to exchanges as a
group.\61\ The commenter asserts that ``[s]ince the Commission has held
that the Act requires exchanges to compete at the individual level,
Phlx unfairly discriminates by favoring members that route order flow
to its affiliated exchanges rather than to other exchanges that also
offer differing market and fee structures.'' \62\ As a
[[Page 42582]]
result, this commenter argues that, while Phlx can attempt to attract
order flow by adjusting the market structure and fees on Phlx, Phlx
cannot base its fees on factors related to other markets.\63\
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\57\ See ArcaBook Order, supra note 28.
\58\ See CBOE Letter, supra note 7, at 4-5; and ISE Letter III,
supra note 11, at 4-7.
\59\ CBOE Letter, supra note 7, at 5 (citing ArcaBook Order at
74790).
\60\ ISE Letter II, supra note 7, at 4. The commenter believes
that the ArcaBook Order ``deals solely with the pricing of a
monopoly or unique service . . . by one exchange of its own market
data,'' which is distinguishable from the context of the proposed
rebate. Id. at 5.
\61\ See ISE Letter III, supra note 11, at 6.
\62\ ISE Letter II, supra note 7, at 3. This commenter also
asserts that the Proposal would create confusion for investors
because Phlx's fee schedule would not fully encompass the costs of
trading on Phlx, because the fees are dependent on trading on
different exchanges. See id. at 4.
\63\ See id. at 3.
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Phlx disagrees with commenters who assert that the ArcaBook Order
demonstrates that exchanges cannot cooperate with each other on
fees.\64\ Phlx states that the ArcaBook Order ``presupposes that
affiliated exchanges will at times act jointly and that they will not
violate the requirements of the Exchange Act by doing so.'' \65\ Phlx
argues that because market participants on Phlx will benefit from the
proposed rebate by achieving lower costs and because more liquidity
will be directed to the Exchange, nothing in the ArcaBook Order calls
the proposed rebate into question.\66\ Furthermore, even if the
Commission accepts the interpretation of the ArcaBook Order explained
by commenters, Phlx believes that the Proposal meets all relevant
requirements of the Act.\67\ Phlx states that the Act does not forbid
Phlx from preferring its own affiliated exchanges over other competing
exchanges.\68\ Phlx also believes that the Proposal does not unfairly
discriminate against other exchanges that compete with Phlx and its
affiliated exchanges for liquidity because single exchanges could match
Phlx's proposed rebate or employ lower prices without establishing a
new exchange to compete.\69\ Phlx also argues that the Commission has
previously permitted ``materially similar pricing arrangements.'' \70\
However, several commenters argue that the fee precedents Phlx cites
are distinguishable from the current Proposal because, among other
things, those fees are not based on an affiliated group of
exchanges.\71\
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\64\ Phlx asserts that the ArcaBook Order ``at most stands for
the proposition that an exchange cannot justify a harm imposed on a
market participant on one exchange by referring to an offsetting
benefit that the market participant will receive on another
exchange.'' Phlx Response Letter, supra note 8, at 13.
\65\ Id. at 12; and Phlx Response Letter V, supra note 14, at 4.
One commenter argues that this statement is irrelevant because the
primary issue is whether the proposed rebate violates the Act, not
whether there are theoretical situations in which such actions would
not violate the Act. See ISE Letter III, supra note 11, at 6 n.18.
\66\ See Phlx Response Letter, supra note 8, at 13. In response,
one commenter argues that Phlx is improperly attempting to condone
its discrimination by citing commercial reasons for favoring its
affiliates. See ISE Letter III, supra note 11, at 6. This commenter
argues that while there may be valid commercial reasons for an
exchange to want to favor its own affiliated exchanges, that does
not mean that such proposals are consistent with the Act. See id.
\67\ See Phlx Response Letter V, supra note 14, at 4. One
commenter states that Phlx has failed to justify the discriminatory
proposal on an individual exchange basis regarding the effects of
proposed rebate. See ISE Letter III, supra note 11, at 6-7.
\68\ See Phlx Response Letter V, supra note 14, at 5. Phlx
states that Section 6(b)(5) of the Act ``prohibits an exchange from
`unfair[ly] discriminat[ing] between customers, issuers, brokers, or
dealers'--not other exchanges.'' Id.
\69\ See Phlx Response Letter, supra note 8, at 7. Phlx also
makes a similar argument in response to comments received on whether
the Proposal would not impose any burden on competition not
necessary or appropriate in furtherance of the Act. See infra
Section III.C. Phlx also believes that there are no significant
barriers to creating affiliated exchanges. See id. However, one
commenter states that Phlx provides no support for this assertion.
See ISE Letter III, supra note 11, at 3.
\70\ Phlx Response Letter, supra note 8, at 15. See also Notice,
supra note 4 at 69480.
\71\ See CBOE Letter, supra note 7, at 3; ISE Letter II, supra
note 7, at 5-6; and ISE Letter III, supra note 11, at 7-8. ISE
Letter II lists the following exchange fee structures from the
Notice: (1) The NASDAQ Stock Market LLC basing fees on combined
equity and options volume; (2) the options regulatory fee (``ORF'')
that some options exchanges charge; (3) listing exchanges providing
discounts on listing fees for companies moving from one listed
exchange to an affiliated listed exchange; and (4) exchanges
treating specific products, such as options on the S&P 500 ETF,
differently for volume and rebate purposes. See ISE Letter II, supra
note 7, at 5-6. ISE explains that, of the four fees that Phlx cites
in support of its proposed rebate, only the ORF is relevant as it
relates to activity on multiple exchanges. ISE, however, believes
that the ORF structure is distinguishable from the proposed rebate.
Specifically, ISE states that ``the ORF structure is almost an exact
opposite of the Phlx fee'' because the purpose of the ORF is ``to
remove any incentive by members to avoid the fee by trading off that
exchange,'' whereas the purpose of the proposed rebate is ``to
encourage trading on the Phlx, the exchange collecting the fee.''
Id. at 6. Furthermore, ISE states that the ORF ``is not a fee based
on an affiliated group of exchanges, it is not a variable fee based
on the volume of transactions across exchanges, and most
importantly, the choice of exchange or exchanges to which a broker-
dealer sends its order flow has absolutely no effect on the level of
fee the broker-dealer pays.'' ISE Letter III, supra note 11, at 8.
---------------------------------------------------------------------------
One commenter argues that Phlx has not provided any support that
additional volume transacted at either NOM or BX Options generates
efficiencies at Phlx that would justify, on efficiency grounds, the
enhanced rebates.\72\ Additionally, the commenter states that it would
expect Phlx to include ``substantive analysis of efficiencies generated
for Phlx that would warrant passing these efficiencies down to Phlx
customers.'' \73\ The absence of such analysis suggests to this
commenter that the Proposal is ``motivated by a form of price
discrimination based on preferences for purchasing volume on a
particular exchange, and not on efficiency grounds.'' \74\ The
commenter believes that the Proposal is likely a form of price
discrimination which would result in otherwise identical Phlx customers
paying different relative prices for substantially the same use of
Phlx's facilities.\75\
---------------------------------------------------------------------------
\72\ See Normann Letter, supra note 11, at 7. This commenter
states that ``an economic justification for quantity discounting can
be based on factors such as high fixed costs, scale economies or
better scheduling of order flow.'' Id.
\73\ Id.
\74\ Id. at 8.
\75\ See id. at 9. This commenter states its view that the
effect of the Proposal likely would be to pay rebates to Phlx
customers based on purchases made at other exchanges. See id.
---------------------------------------------------------------------------
Phlx disagrees with the commenter's conclusion that the enhanced
rebate is not an efficiency-based volume discount and believes that the
commenter does not contend that the Proposal constitutes unfair
discrimination under the Act.\76\ Phlx states that the commenter's
efficiency discussion is based on the ``misguided assumption that
differential pricing is only justified where it results in
`efficiencies related to the customer or transaction.' '' \77\ However,
Phlx states that the Proposal will allow Phlx to increase its trading
volume and spread its substantial fixed and common costs over more
trades, which will help Phlx cover its fixed and common costs to the
benefit of market participants.\78\ Furthermore, Phlx states that the
Commission has previously approved a number of similar forms of
efficiency-based volume discounts that price discriminate, including
cross-exchange pricing on equities exchanges,\79\ discounted fees for
proprietary trading products linked to volume in multiply-listed
products, fee caps and enterprise licenses that favor heavy users of a
system over other users, and differentiated pricing for data fees.\80\
---------------------------------------------------------------------------
\76\ See Phlx Response Letter IV, supra note 13, at 1. Phlx
notes that the commenter ``does not offer an opinion that the
[p]roposal will be harmful in any way.'' Id.
\77\ Id.
\78\ See id. at 2.
\79\ See supra note 34.
\80\ See Phlx Response Letter IV, supra note 13, at 3.
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C. Burden on Competition Not Necessary or Appropriate
Several commenters oppose the proposed rebate because they believe
it is inconsistent with 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
Act.\81\ The commenters opposing the Proposal believe that an exchange
with a single market structure and fee
[[Page 42583]]
schedule cannot fairly compete against a fee structure that leverages
the execution volume and fees across affiliated options exchanges.\82\
One commenter asserts that the Proposal would establish a precedent
that would allow existing affiliated exchange groups to leverage the
execution volume across their multiple independent SROs to the
detriment of options exchanges that do not have such affiliated options
exchanges.\83\ Another commenter argues that exchange operators with
multiple exchanges will be able to operate their exchanges with a
single, integrated fee structure, cross-subsidizing various offerings
in a way that exchanges with only one market will not be able to
match.\84\
---------------------------------------------------------------------------
\81\ See ISE Letter II, supra note 7, at 3; MIAX Letter, supra
note 7, at 3; and CBOE Letter, supra note 7, at 4.
\82\ See id. Two commenters argue that the Proposal is an undue
burden on competition among market participants on Phlx because Phlx
members that do not have the capacity to be members of multiple
options exchanges will be unable to leverage additional customer
trading volume on a Phlx affiliate exchange to lower their fees. See
CBOE Letter, supra note 7, at 4; and MIAX Letter, supra note 7, at
3.
\83\ See MIAX Letter, supra note 7, at 3.
\84\ See ISE Letter III, supra note 11, at 9.
---------------------------------------------------------------------------
In response, Phlx states its belief that a single-exchange operator
can compete by increasing its own volume-based rebate or offering its
own differentiated products, even if those services do not precisely
match those offered by Phlx or any other exchange.\85\ Phlx also
asserts that CBOE, ISE, and NYSE each operate two options
exchanges,\86\ and can adopt pricing mechanisms similar to the proposed
rebate.\87\ Thus, Phlx argues that, even if one of the current single-
exchange operators were unable to match the proposed discount, Phlx
would still face competition from five other exchange operators and
eight other exchanges, including three exchange operators that
themselves operate multiple exchanges.\88\ As a result, Phlx argues
that the price competition from the Proposal would benefit consumers
and would itself outweigh any purported harm to competing exchanges
that could result from the proposed rebate.\89\
---------------------------------------------------------------------------
\85\ See Phlx Response Letter II, supra note 10, at 9-10. Phlx
asserts, for example, that CBOE offers larger rebates for trades for
proprietary options contracts to members who meet certain volume
thresholds for multiply-listed options contracts. See id. at 10.
Phlx states that it cannot offer a similar pricing Proposal, since
it does not execute trades for CBOE's proprietary contracts. See id.
\86\ The Commission notes that CBOE, ISE, and NYSE do not
themselves operate two exchanges, but are each part of separate
affiliated groups of exchanges operating under common holding
companies. The Commission assumes that Phlx is arguing that the
parent holding companies could offer pricing mechanisms similar to
the pricing mechanism in the Proposal.
\87\ See Phlx Response Letter II, supra note 10, at 10.
\88\ See Phlx Response Letter, supra note 8, at 10. Phlx states
that seven exchanges have commenced operation since 2003, and all
have been able to increase their market share due to the competitive
nature of the options exchange marketplace. See Phlx Response Letter
II, supra note 10, at 2. Phlx asserts that exchanges have proven
viable even at a small scale. See id.
\89\ See Phlx Response Letter, supra note 8, at 10-11.
---------------------------------------------------------------------------
Phlx also argues that single market exchanges can compete with the
Proposal by registering multiple exchanges and offering competing
multi-exchange fees.\90\ However, one commenter argues that the overall
cost of initiating operation of an exchange ``runs into the multiple
millions of dollars.'' \91\ Furthermore, this commenter states that the
cost and timing of such registrations impose ``unacceptable competitive
impediments.''\92\
---------------------------------------------------------------------------
\90\ See Notice, supra note 4, at 69482.
\91\ ISE Letter II, supra note 7, at 3. This commenter also
states that allowing an exchange to combine trading volume with
competitors removes incentives for that exchange to broaden its
offerings to attract more order flow, which leads to ``greater
Balkanization of the exchange community.'' ISE Letter II, supra note
7, at 4.
\92\ ISE Letter III, supra note 11, at 11. In response, Phlx
states the fact that ISE recently registered a new exchange
demonstrates that the barriers to entry are not prohibitively high.
See Phlx Response Letter V, supra note 14, at 4.
---------------------------------------------------------------------------
The commenter that supports the Proposal believes that the Proposal
would not place any undue burden on competition.\93\ This commenter
reasons that the Proposal should be presumed to be pro-competitive
because the proposed rebate lowers fees and forces competing exchanges
to ``innovate to maintain customers and market share.'' \94\ The
commenter notes that ``not all exchanges have affiliated exchanges
through which they could structure a program similar to the
[p]roposal.'' \95\ The commenter further states its belief that not
having an affiliated exchange ``does not constitute an undue burden on
competition, but rather a potential for its enhancement.'' \96\
---------------------------------------------------------------------------
\93\ See Citadel Letter, supra note 7, at 5.
\94\ Id. at 5.
\95\ Id. at 6.
\96\ Id. at 6.
---------------------------------------------------------------------------
Phlx argues that the Proposal does not constitute anti-competitive
tying because Phlx member organizations are not required to use NOM or
BX Options to receive the enhanced rebate.\97\ One commenter argues
that the antitrust ``tying'' arguments by Phlx are irrelevant to
provide a basis for approval of the Proposal because tying would be
dispositive in this context only if there was a combination in the
pricing of a competitive product and a monopoly product, which is not
present in the Proposal.\98\ In response, Phlx states that the
Commission routinely cites and discusses antitrust cases in support of
its orders approving proposed rule changes.\99\ For example, Phlx
points to the ArcaBook Order, where the Commission cited to an economic
analysis of monopolies and pricing.\100\
---------------------------------------------------------------------------
\97\ See Notice, supra note 4, at 69476-77.
\98\ See ISE Letter II, supra note 7, at 5. ISE notes that
``[i]n basing fees on trading volume on multiple venues, Phlx argues
that it will not be illegally tying services because there is no
requirement that the `purchaser' buy any two products together.''
Id.
\99\ See Phlx Response Letter V, supra note 14, at 2.
\100\ See id. at 3.
---------------------------------------------------------------------------
In its response, Phlx argues that the Proposal is simply a price
cut and there is no evidence that low prices harm competition.\101\
Phlx asserts that the Proposal will benefit all Phlx market
participants, including those who do not obtain the proposed rebates,
through increased customer liquidity and tighter spreads.\102\ In
addition, Phlx believes that market participants and investors will
benefit under the Proposal because it is designed to attract Directed
Orders (i.e., customer orders directed to particular market makers for
execution).\103\ Phlx also states that members who choose to qualify
for the enhanced rebates by maintaining volume on NOM or BX Options (as
opposed to shifting their volume to Phlx, as would be required to
qualify for a Phlx-only rebate) will have the flexibility to route
their orders to NOM or BX Options without reducing the rebates that
they accrue on Phlx.\104\ Additionally, Phlx explains that the Proposal
offers several benefits beyond those available from a Phlx-only rebate,
most notably, a significant price cut to members, additional volume,
and increased flexibility for market
[[Page 42584]]
participants.\105\ Moreover, Phlx believes that employing bundled
pricing in this manner can induce new trading and prompt members to
shift volume from competing exchanges.\106\
---------------------------------------------------------------------------
\101\ See Phlx Response Letter, supra note 8, at 7-8. Phlx
anticipates that the Proposal will increase its trading volume,
decrease the transaction fee revenue per contract, and improve its
competitive position. See Phlx Response Letter II, supra note 10, at
4.
\102\ See id. at 5; Phlx Response Letter III, supra note 12, at
1-2; Phlx Response Letter IV, supra note 13, at 2; and Phlx Response
Letter V, supra note 14, at 4-5. One commenter asserts that firms
that do not also trade on NOM or BX Options may lose order flow to
larger firms that consolidate order flow to meet the rebate
thresholds. See ISE Letter III, supra note 11, at 10. In response,
Phlx states that this possibility exists today under any rebate
program based on volume tiers. See Phlx Response Letter V, supra
note 14, at 6.
\103\ See Phlx Response Letter II, supra note 10, at 5.
According to Phlx, under Phlx trading rules, a particular market
maker (the ``Directed Participant'') can execute as much as 40% of
the Directed Order. See id. In practice, however, Phlx states that
Directed Participants only execute around 9% of Directed Orders on
average. See id. Phlx states that the remainder of the order is
executed by other market participants. See id.
\104\ See id. at 6 and 9; and Phlx Response Letter IV, supra
note 13, at 2.
\105\ See Phlx Response Letter II, supra note 10, at 8; and Phlx
Response Letter IV, supra note 13, at 2.
\106\ See Phlx Response Letter II, supra note 10, at 6. Phlx has
not made projections as to the amount of volume that might shift as
a result of the Proposal or the effect that the Proposal would have
on overall options industry volume. See id. at 7. However, Phlx
expects that ``the [p]roposal could lead to an increase in total
options exchange industry volume, but the belief is pricing alone
will not have a material impact on industry volume.'' Id.
---------------------------------------------------------------------------
D. Impact on Options Market Structure
In its response to the request for additional comment in the
Extension Notice, Phlx states that it does not believe the Proposal
will have a material effect on the structure of the options or equities
markets or lead to a change in the total number of options
exchanges.\107\ Phlx believes that its competitors can respond to the
Proposal in several ways, including by offering better pricing on a
single exchange, which would reduce the incentive for exchanges or new
entities to create additional options exchanges.\108\ Phlx also
believes that the decision to open a new exchange is influenced by
other factors, primarily by whether ``opening a new exchange will allow
them to offer a new market model that will provide a different value
proposition to market participants than is available through their
existing exchanges.'' \109\ Phlx notes that in the past five years, as
the number of exchanges have increased, the revenue per contract of
CBOE, NASDAQ and NYSE has decreased or remained relatively flat, which
suggests that trading costs do not necessarily increase when additional
markets open.\110\ Furthermore, Phlx believes that the enhanced rebate
will not create a sufficient incentive to prompt existing exchanges or
exchange groups to consolidate due to the significant transaction costs
involved.\111\ Phlx argues that the decision whether to consolidate
entities is driven by considerations other than those raised by the
Proposal, including whether consolidation would help exchanges better
serve the interest of market participants.\112\
---------------------------------------------------------------------------
\107\ See Phlx Response Letter III, supra note 12, at 2, 4 and
6. Thus, Phlx believes the Proposal should not generate any costs or
benefits associated with a change in the number of exchanges. See
id. at 7. Phlx also believes that the Proposal will not materially
affect order interaction, liquidity, volatility, or execution. See
id. at 6.
\108\ See id. at 7. Phlx believes that its competitors can match
the enhanced rebates by increasing the rebates on a single exchange
or developing other strategies for offering differentiated pricing,
products, or services that could appeal to market participants. See
Phlx Response Letter III, supra note 12, at 4; and Phlx Response
Letter V, supra note 14, at 3.
\109\ Phlx Response Letter III, supra note 12, at 4-5. See also
Phlx Response Letter V, supra note 14, at 4.
\110\ See id. at 5.
\111\ See id. at 7.
\112\ See id.
---------------------------------------------------------------------------
Moreover, Phlx believes that the Proposal should not be held to
violate the Act merely because it creates an incentive for another
market operator to open a new exchange.\113\ Phlx notes that the
Commission has expressed concern in the past that a multiplicity of
trading venues could lead to fragmentation if market participants are
unable to interact with order flow on each exchange to ensure that they
are obtaining the best available price.\114\ However, Phlx does not
believe the Commission has ever expressed an opinion that the
possibility of future order fragmentation is a sufficient reason to
discourage the creation of new exchanges.\115\
---------------------------------------------------------------------------
\113\ See id. at 2. Phlx cites to prior Commission rulemaking to
argue that the ``Commission historically has praised the increase in
securities exchanges in the United States as critical to enhancing
competition for order flow and promoting consumer choice.'' Id.
\114\ See id.
\115\ See id.
---------------------------------------------------------------------------
Finally, Phlx argues that the Commission's concern over the
expansion of the number of exchanges presupposes that the Proposal will
be successful and encourage other exchanges to respond by offering
similar enhanced rebates to investors.\116\ Phlx believes that the
Proposal should not be disapproved based on the presumption that
investors will respond favorably to it and encourage other exchanges to
offer additional market-based incentives.\117\ Phlx reiterates its view
that because the Proposal enhances competition and offers a price cut
to Phlx members, it is presumptively valid under the Act and ``[t]here
would need to be significant countervailing evidence supporting any
conclusion that the [p]roposal conflicts with the purposes underlying
the Act.'' \118\ Phlx believes that no such evidence exists in the
Proposal and the Commission therefore should ``permit market forces to
determine both the optimal number of exchanges and the manner in which
exchanges offer and respond to pro-competitive price discounts.'' \119\
---------------------------------------------------------------------------
\116\ See id. at 3. Phlx anticipates that the Proposal will
increase its trading volume, decrease transaction fee revenue per
contract, and improve its competitive position. See Phlx Response
Letter II, supra note 10, at 4. Furthermore, Phlx does not expect
the Proposal to result in substantial total cost savings in the near
term. See id. at 6. Phlx explains that most of its costs are fixed
and are not affected by modest changes in volume. See id. While
large increases in volume may require Phlx, NOM, or BX Options to
incur significant expenses to increase capacity, Phlx does not
expect the Proposal to result in volume increases sufficient to
require such expenditures. See id.
\117\ See Phlx Response Letter III, supra note 12, at 3. Phlx
states that one firm would have qualified for the enhanced rebate at
the time the Proposal was first implemented based on its pre-
existing trading volume. See Phlx Response Letter II, supra note 10,
at 2-3. Phlx also states that during the month in which the Proposal
was in effect prior to the Order Instituting Proceedings, there was
a modest increase in Phlx's customer volume. See id. at 3. In
addition to the one firm that qualified for the enhanced rebate
based on its pre-existing trading volume, two firms qualified for
the enhanced rebate by shifting volume to NOM from rival exchanges.
See id.
\118\ Phlx Response Letter III, supra note 12, at 3.
\119\ Id.
---------------------------------------------------------------------------
One commenter responded to the request for additional comment in
the Extension Notice arguing that the Proposal will lead to an increase
in the number of exchange registrations resulting in unnecessary market
fragmentation.\120\ The commenter believes that the options market
structure currently reflects an appropriate balance between competition
and fragmentation.\121\ The commenter believes that if the Proposal is
approved, single exchange operators will view exchange registration as
a defensive measure against exchange operators with multiple markets,
rather than register exchanges to offer value to the market.\122\ This
commenter concludes that exchange operators will register multiple
exchanges just to match competitive offerings, ``rather than providing
any real benefit to the market,'' leading to increased fragmentation
without any corresponding benefit.\123\
---------------------------------------------------------------------------
\120\ See ISE Letter III, supra note 11, at 8-9.
\121\ See id. at 8.
\122\ See id. at 9. This commenter notes that such value could
be new order types, a new fee structure, enhanced technology, or
services complementary to the exchange operator's other offerings.
See id.
\123\ Id.
---------------------------------------------------------------------------
Furthermore, two commenters raised concern about the potential
impact of the Proposal on a market-wide basis. One commenter believes
that the Proposal imposes obstacles to the development of a national
market system for securities and that ignoring the precedent in the
ArcaBook Order would require a major change to the underlying
assumptions regarding a national market system, a change that could
have significant unintended consequences.\124\ This commenter states
[[Page 42585]]
its view that the Proposal raises important questions about the
foundation of the national market system and competition in the
securities markets \125\ and suggests that if the Commission ever
determines to make such a change, it should be addressed either through
Commission rulemaking or Congressional action--not through an
individual exchange's rule proposal.\126\ Similarly, another commenter
believes that the Proposal raises significant legal and policy issues
and suggests that--if a reconsideration of policy must be undertaken--
such reconsideration should be conducted on a market-wide basis and not
in the context of a single proposed rule change.\127\
---------------------------------------------------------------------------
\124\ See ISE Letter III, supra note 11, at 4. The commenter
adds that each exchange competes for order flow through a variety of
means, including execution quality, speed of execution, customer
service, and fees. See id. Citing to the Act and the ArcaBook Order,
this commenter explains its view that the national market system for
options transactions has been built on the basis of competition
between individual exchange markets, not groups of exchange markets.
See id.
\125\ See ISE Letter II, supra note 7, at 1-2.
\126\ See ISE Letter III, supra note 11, at 4.
\127\ See CBOE Letter, supra note 7, at 1 and 4.
---------------------------------------------------------------------------
IV. Discussion and Commission Findings
Under Section 19(b)(2)(C) of the Act, the Commission shall approve
a proposed rule change of a self-regulatory organization if it finds
that such proposed rule change is consistent with the requirements of
the Act, and the rules and regulations thereunder that are applicable
to such organization.\128\ The Commission shall disapprove a proposed
rule change if it does not make such a finding.\129\ The Commission's
Rules of Practice, under Rule 700(b)(3), state that the ``burden to
demonstrate that a proposed rule change is consistent with the Exchange
Act and the rules and regulations issued thereunder . . . is on the
self-regulatory organization that proposed the rule change'' and that a
``mere assertion that the proposed rule change is consistent with those
requirements . . . is not sufficient.'' \130\
---------------------------------------------------------------------------
\128\ See 15 U.S.C. 78s(b)(2)(C)(i).
\129\ See 15 U.S.C. 78s(b)(2)(C)(ii); and see also 17 CFR
201.700(b)(3).
\130\ See 17 CFR 201.700(b)(3). ``The description of a proposed
rule change, its purpose and operation, its effect, and a legal
analysis of its consistency with applicable requirements must all be
sufficiently detailed and specific to support an affirmative
Commission finding. Any failure of a self-regulatory organization to
provide the information elicited by Form 19b-4 may result in the
Commission not having a sufficient basis to make an affirmative
finding that a proposed rule change is consistent with the Exchange
Act and the rules and regulations issued thereunder that are
applicable to the self-regulatory organization.'' Id.
---------------------------------------------------------------------------
After careful consideration, the Commission does not find that the
proposed rule change is consistent with the requirements of the Act and
the rules and regulations thereunder applicable to a national
securities exchange. In particular, the Commission does not find that
the proposed rule change is consistent with: (1) 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;'' \131\ and (2) Section 6(b)(5) of the Act, which, among
other things, requires that the rules of a national securities exchange
not be ``designed to permit unfair discrimination between customers,
issuers, brokers, or dealers[.]'' \132\ Because either of these
determinations under the Act independently necessitates disapproving
the Proposal, the Commission does so.
---------------------------------------------------------------------------
\131\ 15 U.S.C. 78f(b)(4).
\132\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
In the Order Instituting Proceedings, the Commission highlighted
the statutory provisions referenced above, and noted that the
Commission intended to further assess whether this additional customer
rebate on Phlx, which is based on execution volume across the NASDAQ
OMX exchanges, is consistent with the statutory requirements applicable
to a national securities exchange under the Act.\133\ The Commission
invited interested persons to submit written views with respect to
these concerns. The Commission received eleven comment letters in
response to the Order Instituting Proceedings, of which five were from
Phlx.
---------------------------------------------------------------------------
\133\ See Order Instituting Proceedings, supra note 6, at 71701-
02.
---------------------------------------------------------------------------
To evaluate whether a fee, such as Phlx's proposed rebate, is
consistent with the Act, the Commission applies a ``market-based
approach.'' \134\ The Commission examines whether the exchange making
the proposal is subject to significant competitive forces in setting
the terms of its proposal, including the level of any fee.\135\ If the
exchange is 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 proposal nevertheless fails to meet an applicable requirement
of the Act or the rules thereunder.\136\ If the exchange is not subject
to significant competitive forces in setting the terms of the proposal,
the Commission will require the exchange to provide a substantial
basis, other than competitive forces, to demonstrate that the terms of
the proposal are equitable, fair, reasonable, and not unreasonably
discriminatory.\137\ For reasons discussed below, although we base our
analysis on the assumption that Phlx is subject to significant
competitive forces in setting the terms of the Proposal, there is a
substantial countervailing basis to find that those terms do not meet
the Act's requirements that an exchange's rules be equitable, fair,
reasonable, and not unreasonably discriminatory: namely, the Proposal
could result in two similarly situated Phlx members being charged
different fees for transacting the same amount and type of customer
option volume on the Phlx exchange.
---------------------------------------------------------------------------
\134\ See ArcaBook Order, supra note 28, at 74781-82. See also
Securities Exchange Act Release No. 68202 (November 9, 2012), 77 FR
68856, 68858-61 (November 16, 2012) (SR-Phlx-2012-27 and SR-Phlx-
2012-54) (``Phlx Fees Order'') (applying the market-based approach
analysis in connection with a Phlx transaction fee proposal. The
Commission found, pursuant to delegated authority, that the proposed
rule changes were consistent with the requirements of the Act and
rules and regulations thereunder applicable to a national securities
exchange.). Notably, one commenter on this Proposal applied the
Commission's market-based approach to analyzing the Proposal. See
Citadel Letter, supra note 7, at 3.
\135\ See ArcaBook Order, supra note 28, at 74781. See also Phlx
Fees Order, supra note 134, at 68858.
\136\ See ArcaBook Order, supra note 28, at 74781. See also Phlx
Fees Order, supra note 134, at 68858.
\137\ See ArcaBook Order, supra note 28, at 74781.
---------------------------------------------------------------------------
As discussed more fully below and as explained in the ArcaBook
Order, the Commission historically has reviewed whether a proposed
exchange rule is consistent with the provisions of Section 6 of the Act
on an exchange-by-exchange basis--that is, an exchange's proposed rule
change is analyzed at the individual level of the registered securities
exchange and not at the group level of exchanges.\138\ With respect to
the first part of a market-based approach, the Commission previously
has found and continues to believe that there is significant
competition for order flow in the options market at the individual
exchange level.\139\ This
[[Page 42586]]
Proposal adds complexity to the first part of a market-based approach
analysis because it raises a question of whether we also should analyze
competition at the group level of exchanges in addition to the
individual exchange level.\140\ The Commission does not believe it is
necessary to resolve that issue here because, even assuming that the
Exchange were subject to significant competitive forces at the group
level under the first part of a market-based approach, the Commission
believes that, under the second part of the market-based analysis,
there is a substantial countervailing basis to find that the terms of
the proposed rebate fail to meet the requirements of the Act.
---------------------------------------------------------------------------
\138\ See id. at 74793; and infra notes 143-145. Specifically,
in the ArcaBook Order, the Commission stated:
Section 6 of the Exchange Act . . . prohibits a national
securities exchange from adopting rules that are designed to permit
unfair discrimination among its customers or that would impose an
unnecessary or inappropriate burden on competition. All of these
requirements are applied at the level of the individual registered
securities exchange, not at the group level of exchanges that are
under common control. In particular, a proposed exchange rule must
stand or fall based, among other things, on the interests of
customers, issuers, broker-dealers, and other persons using the
facility of that exchange.
\139\ See Securities Exchange Act Release No. 61317 (January 8,
2010), 75 FR 2915 (January 19, 2010) (SR-ISE-2009-103). The
Commission found, pursuant to delegated authority, 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.'' Id. at 2917. With
respect to this Proposal, commenters and the Exchange have both
provided representations and data regarding the existence of
competition for order flow among options exchanges. See Notice,
supra note 4, at 69474; Phlx Response Letter, supra note 8, at 10
and 12; Phlx Response Letter II, supra note 10, at 2; Citadel
Letter, supra note 7, at 3 (stating that ``it is clear that Phlx and
all options exchanges are subject to significant competitive forces
in setting their fees'' and ``the Commission recently found that
there is significant competition for order flow in the options
markets''); and ISE Letter II, supra note 7, at 3 (stating that
``every exchange operates in a competitive environment, seeking to
maximize the order flow on that exchange''). In particular, the
Exchange has stated that the trading of options is a highly
competitive environment and the ability to attract order flow is
driven largely by price competition. See Notice, supra note 4, at
69474; Phlx Response Letter, supra note 8, at 12; and Phlx Response
Letter II, supra note 10, at 2. 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. See Notice, supra note 4, at 69474.
\140\ See Notice, supra note 4, at 69481-82.
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Specifically, the Commission believes that providing a rebate for
transactions on Phlx based on the aggregate amount of customer volume
transacted across all three of the NASDAQ OMX exchanges would be
inconsistent with Section 6(b)(4) of the Act \141\ because it would not
provide for the equitable allocation of reasonable dues, fees, and
other charges among Phlx members and issuers and other persons using
Phlx facilities. The Commission also believes that the Proposal would
be inconsistent with Section 6(b)(5) of the Act \142\ because it would
permit unfair discrimination between customers, issuers, brokers, or
dealers.
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\141\ 15 U.S.C. 78f(b)(4).
\142\ 15 U.S.C. 78f(b)(5).
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As outlined above, the Proposal would allow market participants to
aggregate volume across Phlx, NOM, and BX Options for purposes of
determining whether they meet the volume tiers on Phlx. However, the
Commission historically has reviewed whether a proposed exchange rule
is consistent with the provisions of Section 6 of the Act on an
exchange-by-exchange basis.\143\ As the Commission articulated in the
ArcaBook Order, the regulatory structure of Section 6 ``limits the
potential for related exchanges to act jointly[,]'' \144\ and reading
the statute to require the application of (and assessment of compliance
with) the requirements of Section 6 of the Act on an exchange-by-
exchange basis is consistent with that purpose. While the Commission
recognizes that there are other plausible approaches to the
interpretation of the Act, we do not believe a sufficiently compelling
case has been made for the Commission to alter its historical position
at this time.
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\143\ See ArcaBook Order, supra note 28, at 74793.
\144\ Id.
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Thus, as articulated by the Commission in the ArcaBook Order, the
Commission has analyzed whether this proposed rule change is consistent
with the Act at the level of the individual registered securities
exchange--not the group level. In applying this principle, it is
notable that the Proposal could result in the Exchange charging
different fees to Phlx members that are similarly situated and transact
the same amount and type (electronically delivered) of customer volume
on the Phlx exchange. For example, a Phlx member who transacts 2.3% of
national customer volume in multiply-listed options in a month on Phlx
would not qualify for the additional rebate. However, another Phlx
member who also transacts 2.3% of national customer volume in multiply-
listed options in a month on Phlx and who transacts an additional 0.5%
of national customer volume in multiply-listed options in a month on
NOM would qualify for the rebate. Further, given the second Phlx
member's customer volume transacted on NOM, this second Phlx member
need only transact 2.0% of national customer volume in multiply-listed
options in that month on Phlx to qualify for the enhanced rebate.\145\
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\145\ Several commenters also raised this concern and argued
that it renders the Proposal inequitable. See, e.g., Normann Letter,
supra note 11, at 6-9; and MIAX Letter, supra note 7, at 2. See also
CBOE Letter, supra note 7, at 3 (noting that ``imposition of a fee
or charge by an exchange based on some activity other than use of
the fee-imposing exchange's own facilities necessarily would be
impossible to allocate in an `equitable' way and could never be
`reasonable.' ''); and ISE Letter II, supra note 7, at 2-3.
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Thus, under the Proposal, a Phlx member that transacts less
national customer volume in multiply-listed options in a month on Phlx
than other members would qualify for the additional proposed rebate
while those other Phlx members with higher national customer volume
percentages on Phlx--the exchange proposing the rebate--would not
qualify. The Commission does not believe that the arguments put forth
by Phlx provide a basis consistent with the Act as to why this
disparity is equitable or not unfairly discriminatory when analyzing
the treatment of Phlx members using the Phlx exchange.
Phlx argues that the Proposal provides for the equitable
allocations of fees because the proposed rebate is limited to market
participants who transact business on Phlx and only applies to orders
actually executed on the Phlx exchange.\146\ But this ignores the
effect of the proposed rebate on those market participants. Because the
Proposal is based in part on the activity of Phlx members outside the
Phlx exchange, the Proposal could result in the Exchange charging
different fees to members that are similarly situated and execute the
same amount and type of customer orders on the Phlx exchange. Further,
Phlx has not shown that, when analyzed at the level of the individual
exchange, such differential treatment is equitable.
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\146\ Phlx Response Letter, supra note 8, at 14; and Section
III.A, supra. In addition, Phlx argues that the proposed rebate
should be considered ``presumptively reasonable'' because it would
reduce transaction costs of doing business on the Exchange, which
the Exchange believes would ultimately reduce the costs passed on to
investors. See Phlx Response Letter, supra note 8, at 14. See also
Notice, supra note 4 at 69477. The Commission notes that it is not
making a finding as to whether the proposed rebate is reasonable
because the Commission finds that the Proposal is inconsistent with
the Act on other grounds. See supra notes 138-143 and accompanying
text.
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Phlx believes that the resulting lower costs will incentivize
market participants to increase the amount of customer orders sent to
the Exchange, thereby enhancing the quality of its markets by narrowing
quote spreads and further increasing customer volume to Phlx.\147\ The
Commission does not believe that any of the potential benefits of the
Proposal cure its inequitable effect because, when analyzing the
activity of members on the Phlx exchange alone, the Proposal could
result in two Phlx members that are similarly situated and transact the
same amount and type of customer volume on Phlx being charged different
fees.
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\147\ See Notice, supra note 4, at 69482.
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Finally, Phlx argues that the proposed rebate is structured as a
volume-based discount and is similar to the existing rebate tiers in
Section B of the Pricing Schedule, which the Commission has previously
accepted.\148\ But the
[[Page 42587]]
Commission believes that the Proposal is distinguishable from the
volume-based tiers and discounts that currently exist on Phlx and other
registered securities exchanges. Current volume based discounts are
based on the volume transacted on the registered securities exchange
charging the fee and not volume transacted on a separate registered
securities exchange. Thus, under current volume-based discounts, two
similarly situated members executing the same amount and type of
transaction volume on a registered securities exchange should be
charged the same transaction fee (or given the same transaction
rebate).\149\
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\148\ See Phlx Response Letter, supra note 8, at 15; and Notice,
supra note 4 at 69480.
\149\ See, e.g., the existing Phlx Pricing Schedule B, Customer
Rebate Program. In the Notice, Phlx also discusses other examples of
differences in fees and rebates for exchange services. See Notice,
supra note 4, at 69477-80. The Proposal is similarly distinguishable
from those examples because only under the Proposal could two
similarly situated market participants who transact the same amount
of the same type of volume on Phlx be charged differing levels of
transaction fees by that exchange.
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Given the principle articulated by the Commission in its ArcaBook
Order, and based on the record, the Commission therefore does not
believe that the proposed fee structure, which as commenters noted,
would allow the Exchange to charge different fees to Phlx members that
are similarly situated and transact the same amount and type of
customer volume on Phlx, is consistent with Section 6(b)(4) of the Act
which, requires that the rules of a registered 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.''
Phlx also argues that the Proposal is not unfairly discriminatory
under Section 6(b)(5) of the Act, asserting that because any market
participant could qualify for the proposed rebate by transacting the
required amount of customer volume on Phlx alone and thus market
participants are not required to become members of NASDAQ OMX exchanges
to qualify for the proposed rebate.\150\ The Commission believes that
this argument fails to address, when analyzing the activity of members
on the Phlx exchange alone, the result of two Phlx members that are
similarly situated and transact the same amount and type of customer
volume on Phlx but could be charged different fees.\151\
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\150\ See Phlx Response Letter, supra note 8, at 4-7; and Phlx
Response Letter V, supra note 14, at 2. See also supra Section
III.B.
\151\ See infra note 156.
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Phlx argues that market participants can easily register as members
of Phlx and its affiliated exchanges at minimal cost, which will expand
the pool of market participants who can receive the rebate.\152\ Phlx
also argues that the Proposal would reduce fees and benefit market
participants by way of reduced transaction costs.\153\ In addition, the
Exchange argues that the Proposal would enhance efficient trading
activity by allowing market participants to route customer orders to
other NASDAQ OMX exchanges and count transactions as a result of those
orders towards the proposed rebate on Phlx.\154\ The Exchange believes
that this efficiency would improve execution quality while at the same
time potentially lowering the cost for their customers.\155\ But the
Commission does not believe that any of the potential benefits of the
Proposal put forth by Phlx--such as to expand the rebate to more market
participants resulting in lower costs to market participants without
compromising their execution obligations, and improved market quality
through increased liquidity to the Exchange \156\-- cures its unfair
discriminatory effects on Phlx-only members, who could be charged a
higher fee for the same volume on Phlx than Phlx members that have
multiple NASDAQ OMX exchange memberships. Thus, the Commission does not
believe that Phlx has provided a sufficient basis to support the
assertion that the potential discrimination among Phlx members
resulting from the Proposal would not be unfair. Consequently, the
Commission does not believe that the proposed fee structure is
consistent with Section 6(b)(5) of the Act which, among other things,
requires that the rules of a registered national securities exchange be
``not designed to permit unfair discrimination between customers,
issuers, brokers, or dealers[.]''
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\152\ See Phlx Response Letter, supra note 8, at 4-5.
\153\ See Notice, supra note 4, at 69473.
\154\ See Phlx Response Letter II, supra note 10, at 6 and 9;
and Phlx Response Letter IV, supra note 13, at 2.
\155\ See Phlx Response Letter II, supra note 10, at 6 and 9;
and Phlx Response Letter IV, supra note 13, at 2.
\156\ The Proposal potentially could lead to order flow shifting
away from the Phlx exchange to other options exchanges because a
member could still qualify for the rebate by aggregating the amount
of customer volume that it transacts across one or more of the
exchanges in the NASDAQ OMX exchange group. According to the
Exchange, during the month the proposed rebate was in effect on
Phlx, customer volume on Phlx experienced a modest increase;
however, two of the three firms that qualified for the proposed
rebate did so by shifting customer volume from rival exchanges to
NOM. See Phlx Response Letter II, supra note 10, at 3-4. Phlx data
shows that Phlx Member A's customer volume on NOM increased from
0.59% on October 1, 2013 to 1.67% on November 1, 2013 and Phlx
Member C's customer volume on NOM increased from 0.58% on October 1,
2013 to 1.44% on November 1, 2013. See id.
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In analyzing this Proposal and in making its determination to
disapprove the rule change, the Commission has considered whether the
action will promote efficiency, competition, and capital
formation.\157\ As part of this consideration, the Commission has
considered comments regarding efficiency and competition, including
literature cited in those comments, and how any effects on competition
or efficiency could affect capital formation. For example, some
commenters assert that the Proposal does not provide efficiency gains
on Phlx,\158\ while Phlx contends that some market participants who
transact customer orders on Phlx could experience efficiency gains from
improved execution choices.\159\ Phlx contends the following effects
may result from the Proposal: More efficient allocation of order flow
between Phlx and its affiliated exchanges; \160\ more efficient use of
the services associated with the substantial fixed, sunk costs shared
among the three exchanges in the Nasdaq OMX group; \161\ more efficient
price discrimination; \162\ increased trading volume on Phlx; \163\
and, in principle, a potential increase in total options exchange
industry volume.\164\ The Commission notes that these efficiency gains,
if realized, could potentially promote capital formation.
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\157\ Whenever pursuant to the Act the Commission is engaged in
rulemaking or the review of a rule of a self-regulatory
organization, and is required to consider or determine whether an
action is necessary or appropriate in the public interest, the
Commission shall also consider, in addition to the protection of
investors, whether the action will promote efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
\158\ See ISE Letter III, supra note 11, at 8-9; Normann Letter,
supra note 11, at 7.
\159\ See Phlx Response Letter, supra note 8, at 4.
\160\ See id.; and Willig and Bamberger Statement, supra note 8,
at 19. See also Citadel Letter, supra note 7, at 2-3, 7.
\161\ See Willig and Bamberger Reply, supra note 13, at 4.
\162\ See Willig and Bamberger Statement, supra note 8, at 15-
20; Willig and Bamberger Reply, supra note 13, at 4.
\163\ See Willig and Bamberger Statement, supra note 8, at 26;
and Phlx Response Letter IV, supra note 13, at 2.
\164\ See Phlx Response Letter II, supra note 10, at 7.
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Additionally, commenters assert that the Proposal would lead to
adverse effects on competition by placing burdens on competing
exchanges \165\ that may face loss of business to Phlx and on competing
market participants that are not entitled to the proposed
[[Page 42588]]
rebate.\166\ Phlx contends that the Proposal would have a beneficial
effect on competition by providing competitors with incentives to match
the proposed rebate--by developing their own pricing strategies or
increasing the quality of their execution services, thereby creating a
more efficient, less costly national market system.\167\ Phlx
anticipates such enhanced competition, with or without the launch of
new exchanges, while a commenter asserts that barriers to the creation
of new exchanges could affect the competitive response and that the
Proposal will lead to the inefficient proliferation of new
exchanges.\168\
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\165\ See ISE Letter III, supra note 11, at 3, MIAX Letter,
supra note 7, at 3; and CBOE Letter, supra note 7, at 4.
\166\ See CBOE Letter, supra note 7, at 4; MIAX Letter, supra
note 7, at 3.
\167\ See Phlx Response Letter, supra note 8, at 2.
\168\ See ISE Letter III, supra note 11, at 3, 8-9.
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The Commission has considered whether the action will promote
efficiency, competition, and capital formation, but, as discussed
above, the Commission does not find that the Proposal is consistent
with Sections 6(b)(4) and 6(b)(5) of the Act.
V. Conclusion
For the foregoing reasons, the Commission does not find that the
proposed rule change is consistent with the Act and the rules and
regulations thereunder applicable to a national securities exchange,
and, in particular, with Sections 6(b)(4) and 6(b)(5) of the Act.
It Is Therefore Ordered, pursuant to section 19(b)(2) of the Act,
that the proposed rule change (SR-Phlx-2013-113) be, and hereby is,
disapproved.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\169\
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\169\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-17156 Filed 7-21-14; 8:45 am]
BILLING CODE 8011-01-P