[Federal Register Volume 80, Number 126 (Wednesday, July 1, 2015)]
[Notices]
[Pages 37672-37685]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-16088]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-75300; File No. SR-Phlx-2014-66]
Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Order
Disapproving a Proposed Rule Change, as Modified by Amendment No. 2, To
Adopt New Exchange Rule 1081, Solicitation Mechanism, To Introduce a
New Electronic Solicitation Mechanism
June 25, 2015.
I. Introduction
On October 14, 2014, NASDAQ OMX PHLX LLC (``Exchange'' or ``Phlx'')
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 19b-4 thereunder,\2\ a proposed rule change to
adopt new Exchange Rule 1081, Solicitation Mechanism, to introduce a
new electronic solicitation mechanism pursuant to which a member can
electronically submit all-or-none orders of 500 contracts or more (or,
in the case of mini options, 5000 contracts or more) that the member
represents as agent against contra orders that the member solicited.
The proposed rule change was published for comment in the Federal
Register on October 31, 2014.\3\ On December 8, 2014, the Commission
extended the time period
[[Page 37673]]
in which to either approve the proposed rule change, disapprove the
proposed rule change, or institute proceedings to determine whether to
approve or disapprove the proposed rule change to January 29, 2015.\4\
On January 28, 2015, the Commission instituted proceedings under
Section 19(b)(2)(B) of the Act \5\ to determine whether to approve or
disapprove the proposed rule change.\6\ The Commission received two
comment letters from the same commenter regarding the proposal,\7\ as
well as a response from the Exchange to the commenter's first
letter.\8\ On April 9, 2015, the Exchange filed Amendment No. 2 to the
proposed rule change.\9\ The proposed rule change, as modified by
Amendment No. 2, was published for comment in the Federal Register on
April 22, 2015, on which date the Commission also designated a longer
period for Commission action on the proposed rule change.\10\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 73441 (October 27,
2014), 79 FR 64862 (``Notice'').
\4\ See Securities Exchange Act Release No. 73791 (December 8,
2014), 79 FR 73924 (December 12, 2014).
\5\ 15 U.S.C. 78s(b)(2)(B).
\6\ See Securities Exchange Act Release No. 74167 (January 28,
2015), 80 FR 5865 (February 3, 2015) (``Order Instituting
Proceedings'').
\7\ See Letters from Michael J. Simon, Secretary and General
Counsel, International Securities Exchange LLC (``ISE''), dated
February 25, 2015 (``ISE Letter'') and dated June 15, 2015 (``Second
ISE Letter''). The Second ISE Letter notes that ISE reiterates its
original comments.
\8\ See Letter from Carla Behnfeldt, Associate General Counsel,
Nasdaq, dated March 11, 2015 (``Phlx Response Letter'').
\9\ The Exchange filed Amendment No. 1 on April 1, 2015.
Amendment No. 1 was withdrawn on April 8, 2015. Amendment No. 2
amends and replaces the original filing in its entirety. In
Amendment No. 2, the Exchange: (1) Makes certain changes to Exchange
Rule 1080(n) regarding the PIXL auction process; (2) clarifies that
the trading system does not currently accept all-or-none Complex
Orders; (3) provides that the side of the Agency Order will be
disseminated at the commencement of an auction; (4) clarifies the
treatment of responsive all-or-none interest in the auction; (5)
adds examples regarding the operation of the solicitation mechanism;
and (6) makes certain other technical and clarifying changes.
\10\ See Securities Exchange Act Release No. 74746 (April 16,
2015), 80 FR 22569 (April 22, 2015) (``Notice of Amendment No. 2'').
The comment period for the Notice of Amendment No. 2 closed on May
7, 2015.
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This Order disapproves the proposed rule change, as modified by
Amendment No. 2.
II. Description of the Proposal
The Exchange proposes to adopt new Rule 1081, Solicitation
Mechanism, to introduce a new electronic solicitation mechanism
pursuant to which a member would be able to electronically submit all-
or-none orders of 500 contracts or more (or, in the case of mini
options, 5000 contracts or more) that the member represents as agent
against contra orders that the member had solicited. Currently, under
Phlx Rule 1080(c)(ii)(C)(2), Order Entry Firms \11\ must expose orders
they represent as agent for at least one second before such orders may
be automatically executed, in whole or in part, against orders
solicited from members and non-member broker-dealers to transact with
such orders.\12\ The proposed rule change would provide an alternative
method, to enable a member to electronically execute orders it
represents on behalf of a public customer, broker-dealer, or any other
entity (an ``Agency Order'') \13\ against solicited limit orders of a
public customer, broker-dealer, or any other entity (a ``Solicited
Order'') through a solicitation mechanism designed for this
purpose.\14\
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\11\ Rule 1080(c)(ii)(A)(1) defines ``Order Entry Firm'' as a
member organization of the Exchange that is able to route orders to
AUTOM. (AUTOM is the Exchange's electronic quoting and trading
system, which has been denoted in Exchange rules as XL II, XL and
AUTOM.)
\12\ According to the Exchange, Section (c), Solicited Orders,
of Exchange Rule 1064, Crossing Facilitation and Solicited Orders,
governs execution of solicited orders by open outcry, on the
Exchange's trading floor, and would not be affected by proposed Rule
1081. The Exchange states that many aspects of the functionality of
the proposed solicitation mechanism are similar to those provided
for in Rule 1080(n), PIXL, and certain of the proposed rules
correspond to the existing PIXL rules. For information about
specific provisions of proposed Rule 1081 that correspond to the
PIXL rule and that have been omitted in the description of the
proposal herein, see Notice of Amendment No. 2, supra note 10.
\13\ The Exchange notes that the capitalized and defined term
``Agency Order'' as used in proposed Rule 1081 differs from the term
``agency order'' as used in Phlx Rule 1080(b)(i)(A). See Notice of
Amendment No. 2, supra note 10, 80 FR at 22570 n. 17.
\14\ The Exchange states that participants would be required to
ensure that their records adequately demonstrate the solicitation of
an order that is entered into the mechanism for execution against an
Agency Order as a Solicited Order prior to entry of such order into
this mechanism.
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The proposed mechanism would be a process by which a member (the
``Initiating Member'') would be able to electronically submit an all-
or-none Agency Order of 500 contracts or more (or, in the case of mini
options,\15\ 5000 contracts or more) against a Solicited Order, and to
initiate an auction (the ``Solicitation Auction'').\16\ As noted below,
at the end of the Solicitation Auction, allocation would occur with all
contracts of the Agency Order trading at an improved price against non-
solicited contra-side interest or at the stop price, defined below,
against the Solicited Order. The solicitation mechanism would
accommodate both simple orders and Complex Orders.\17\ Prior to the
first time a member enters an Agency Order into the solicitation
mechanism on behalf of a customer, the member would be required to
deliver to the customer a written notification informing the customer
that its Agency Orders may be executed using Phlx's solicitation
mechanism. Such written notification would be required to disclose the
terms and conditions contained in proposed Rule 1081 and to be in a
form approved by the Exchange.\18\
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\15\ A given Solicitation Auction could be for options contracts
exclusively or for mini options contracts exclusively, but could not
be used for a combination of both options contracts and mini options
contracts.
\16\ The Exchange notes that similar electronic functionality is
offered today by other option exchanges. See Chicago Board Options
Exchange (``CBOE'') Rule 6.74B, Solicitation Auction Mechanism, and
ISE Rule 716(e), Solicited Order Mechanism.
\17\ 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). Complex Orders on Phlx are discussed in
Commentary .07 to Rule 1080.
\18\ See proposed Rule 1081(i)(H). The rule would require
delivery of this disclosure only prior to the first submission of an
Agency Order on behalf of a customer rather than prior to the
submission of each and every Agency Order on behalf of such
customer.
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Solicitation Auction Eligibility Requirements
All options traded on the Exchange, including mini options, would
be eligible for the Solicitation Auction. Proposed Rule 1081(i)
describes the circumstances under which an Initiating Member would be
permitted to initiate a Solicitation Auction.
Proposed Rule 1081(i)(A) provides that the Agency Order and the
Solicited Order must each be limit orders for at least 500 contracts
(or, in the case of mini options, at least 5000 contracts) and must be
designated as all-or-none. The orders must match in size, and their
limit prices must match or cross in price.\19\ If the orders cross in
price, the price at which the Agency Order and the Solicited Order
would be considered for submission pursuant to proposed Rules
1081(i)(B) and (C) would be the limit price of the Solicited Order.\20\
The orders would not be able to be stop or stop limit orders; would
need to be marked with a time in force of day, good
[[Page 37674]]
`til cancelled or immediate or cancel; and would not be routed
regardless of routing strategy indicated on the order.\21\
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\19\ In the case of Complex Orders, the underlying components of
both Complex Orders would also need to match. Additionally, all the
option legs of each Complex Order would need to consist entirely of
options or entirely of mini options.
\20\ As noted below, under Rule 1081(i)(B), the limit price of
the Solicited Order must also be equal to or better than the
National Best Bid/Offer.
\21\ According to the Exchange, whether an order is marked with
a time in force of day as opposed to, for example, good till
cancelled or immediate or cancel is irrelevant to the manner in
which they would be treated once they are entered into the
solicitation mechanism.
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Pursuant to proposed Rule 1081(i)(B), the Initiating Member would
need to stop the entire Agency Order at a price (the ``stop price'')
that is equal to or better than the National Best Bid/Offer (``NBBO'')
on both sides of the market, provided that such price would need to be
at least $0.01 better than any public customer non-contingent limit
order on the Phlx order book and would need to be equal to the Agency
Order's limit price or provide the Agency Order with a better price
than its limit price. Stop prices could be submitted in $0.01
increments, regardless of the applicable Minimum Price Variation (the
``MPV''). Contingent orders (including all-or-none, stop or stop-limit
orders) on the order book would not be considered when checking the
acceptability of the stop price. The Exchange states that contingent
orders are not represented as part of the Exchange Best Bid/Offer since
they may only be executed if specific conditions are met. Given that
these orders are not represented as part of the Exchange Best Bid/
Offer, they are not included in the NBBO and thus would not be
considered when checking the acceptability of the stop price.\22\
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\22\ Proposed Rule 1081(i)(B) would not apply if the Agency
Order is a Complex Order (a ``Complex Agency Order''). Rather,
proposed Rule 1081(i)(C) would apply to Complex Agency Orders and
would require them to be of a conforming ratio, as defined in
Commentary .07(a)(ix) to Rule 1080. A Complex Agency Order which is
not of a conforming ratio would be rejected. The Exchange represents
that PIXL operates in the same manner. See Amendment No. 2, supra
note 9 (citing Rule 1080(n)(i)(C)). Proposed Rule 1081(i)(C) would
require all component option legs of the order to be for at least
500 contracts (or, in the case of mini options, at least 5000
contracts). It also would provide that the Initiating Member must
stop the entire Complex Agency Order at a price that is better by at
least $0.01 than the best net price (debit or credit) (i) available
on the Complex Order book regardless of the Complex Order book size;
and (ii) achievable from the best Phlx bids and offers for the
individual options (an ``improved net price'') regardless of size,
provided in either case that such price is equal to or better than
the Complex Agency Order's limit price. Stop prices for Complex
Agency Orders would be submitted in $0.01 increments, regardless of
MPV, and contingent orders on the order book would not be considered
when checking the acceptability of the stop price. See proposed Rule
1081(i)(C).
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Orders that are submitted but that do not comply with the
eligibility requirements set forth in proposed Rule 1081(i)(A) through
(C) would be rejected upon receipt and would be ineligible to initiate
a Solicitation Auction.\23\ In addition, Agency Orders submitted at or
before the opening of trading would not be eligible to initiate a
Solicitation Auction and would be rejected.\24\ Agency Orders that are
not Complex Orders received while another electronic auction (including
any Solicitation Auction, PIXL auction, or any other kind of auction)
involving the same option series is in progress would not be eligible
to initiate a Solicitation Auction and would be rejected.\25\
Similarly, a Complex Agency Order received while another auction in the
same Complex Order strategy is in progress would not be eligible to
initiate a Solicitation Auction and would be rejected.\26\
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\23\ See proposed Rule 1081(i)(D).
\24\ See proposed Rule 1081(i)(E). Orders submitted during a
specified period of time, as determined by the Exchange and
communicated to Exchange membership on the Exchange's Web site,
prior to the end of the trading session in the affected series
(including, in the case of Complex Orders, in any series that is a
component of the Complex Order) also would not be eligible to
initiate a Solicitation Auction and would be rejected. See proposed
Rule 1081(i)(F).
\25\ The Exchange notes that a similar restriction currently
applies with respect to PIXL auctions. See PIXL Rule 1080(n)(ii),
which provides that ``[o]nly one Auction may be conducted at a time
in any given series or strategy.'' The Exchange proposes to revise
this provision to make clear that only one electronic auction may be
conducted at a time in any given series or strategy. The Exchange
proposes to amend the PIXL rule by adding Rule 1080(n)(i)(H) to
provide that PIXL Orders that are received while another electronic
auction involving the same option series or the same Complex Order
strategy is in progress would not be eligible to initiate a PIXL
Auction and would be rejected. See Amendment No. 2, supra note 9.
\26\ According to the Exchange, a simple Agency Order in one
series that is submitted while an electronic auction is already in
process with respect to a Complex Agency Order that includes the
same series would not be rejected. Instead, a Solicitation Auction
would be initiated for that incoming Agency Order offering each
unique strategy or individual series the same opportunity to
initiate an auction. Any Legging Orders would automatically be
removed from the order book upon receipt of an Agency or Complex
Agency Order that consists of a component in which there is a
Legging Order (whether a buy order or a sell order) that initiates a
Solicitation Auction. See Amendment No. 2, supra note 9, 80 FR at
22571, n. 34 (noting that this feature of proposed Rule 1081
comports with a feature of PIXL). Complex Orders submitted during
normal trading hours in a strategy that has not yet opened under
Commentary .07 of Rule 1080 would cause the strategy to immediately
open and permit a Solicitation Auction to be initiated. See proposed
Rule 1081(i)(E). In addition, neither a Solicitation Auction for a
simple Agency Order or for Complex Agency Order may be initiated
prior to the regular opening of the individual option in the case of
a simple Agency Order, or the regular opening of all individual
components in the case of a Complex Agency Order. See Notice of
Amendment No. 2, supra note 10, 80 FR at 22571 n. 34.
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Finally, a solicited order may not be for the account of any
Exchange specialist, streaming quote trader (``SQT''), remote streaming
quote trader (``RSQT'') or non-streaming registered options trader
(``ROT'') assigned in the affected series.\27\ The Exchange believes
that in order to maintain fair and orderly markets, a market maker
assigned in an option should not be solicited for participation in a
Solicitation Auction by an Initiating Member. The Exchange believes
that a market maker interested in participating in transactions on the
Exchange should do so by way of his or her quotations, and should
respond to Solicitation Auction notifications rather than create them
by having an Initiating Member submitting Solicited Orders on the
market maker's behalf.
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\27\ See proposed Rule 1081(i)(G). See also Notice of Amendment
No. 2, supra note 10, 80 FR at 22571 n. 35, for a description of
each of these types of market participants.
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Solicitation Auction Process
Pursuant to proposed Rule 1081(ii)(A)(1), to begin the Solicitation
Auction process, the Initiating Member would need to mark the Agency
Order and the Solicited Order for Solicitation Auction processing, and
specify the stop price at which it seeks to cross the Agency Order with
the Solicited Order. The system would determine the stop price based
upon the submitted limit prices, if such prices for the Agency Order
and Solicited Order do not match as discussed above.\28\ Once the
Initiating Member has submitted an Agency Order and Solicited Order for
processing in the Solicitation Auction, the Agency Order and the
Solicitation Order could not be modified or cancelled.\29\
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\28\ See Notice of Amendment No. 2, supra note 10, 80 FR at
22571, n 36.
\29\ Rule 1081(ii)(A)(l) would not apply to Complex Agency
Orders. Rather, a parallel provision, proposed Rule 1081(ii)(A)(2)
would provide that to initiate a Solicitation Auction in the case of
a Complex Agency Order and Complex Solicited Order (a ``Complex
Solicitation Auction''), the Initiating Member would need to mark
the orders for Solicitation Auction processing, and specify the
price (``stop price'') at which it seeks to cross the Complex Agency
Order with the Complex Solicited Order. The system would determine
the stop price based upon the submitted limit prices if such prices
do not match as discussed above. See Notice of Amendment No. 2,
supra note 10, 80 FR at 22571, n. 36. Once the Initiating Member has
submitted the Complex Agency Order and the Complex Solicited Order
for processing pursuant to proposed Rule 1081(ii)(A)(1)-(2), the
Complex Agency Order and Complex Solicited Order could not be
modified or cancelled.
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Crossing Two Public Customer Orders Without a Solicitation Auction
As noted above, the proposed rule change would enable a member to
electronically execute an Agency Order, which is an order it represents
on behalf of a public customer, broker-dealer, or any other entity,
against a Solicited Order, which is a solicited limit order
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of a public customer, broker-dealer, or any other entity through the
solicitation mechanism.\30\
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\30\ However, the Solicited Order may not be for the account of
any Exchange specialist, SQT, RSQT or ROT assigned in the affected
series. See note 27, supra and accompanying text.
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However, pursuant to proposed Rule 1081(v), if a member were to
enter an Agency Order for the account of a public customer paired with
a Solicited Order for the account of public customer and if the paired
orders adhered to the eligibility requirements of proposed Rule
1081(i), such paired orders would be executed automatically without a
Solicitation Auction.\31\ The execution price for such paired public
customer orders (except if they are Complex Orders) would need to be
expressed in the minimum quoting increment applicable to the affected
series.\32\ Such an execution would not be permitted to trade through
the NBBO or at the same price as any resting public customer order. If
all-or-none orders are on the order book in the affected series, the
public customer-to-public customer order may not be executed at a price
at which the all-or-none order would be eligible to trade based on its
limit price and size.\33\
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\31\ Rule 1080(c)(ii)(C)(2), which states that Order Entry Firms
must expose orders they represent as agent for at least one second
before such orders may be automatically executed against solicited
orders, would be amended to clarify that it would not apply to Rule
1081, Solicitation Mechanism. See also Rule 1081(ii)(A)(4).
\32\ The execution price for a Complex Order would be permitted
to be in $.01 increments.
\33\ All-or-none orders can be submitted on the Exchange only
for non-broker-dealer customers. As stated above, the mechanism
would not consider all-or-none orders when checking the
acceptability of the stop price of an Agency Order.
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In the case of a Complex Order, a public customer-to-public
customer cross would be permitted to occur only at a price that would
improve the calculated Phlx Best Bid/Offer or ``cPBBO'' and would
improve upon the net limit price of any Complex Orders (excluding all-
or-none) on the Complex Order book in the same strategy.\34\ If all-or-
none Complex Orders \35\ are on the Complex Order book in the same
strategy, the public customer-to-public customer Complex Order would
not be permitted to be executed at a price at which the all-or-none
Complex Order would be eligible to trade based on its limit price and
size.
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\34\ The term ``cPBBO'' means the best net debit or credit price
for a Complex Order Strategy based on the PBBO for the individual
options components of such Complex Order Strategy, and, where the
underlying security is a component of the Complex Order, the
National Best Bid and/or Offer for the underlying security. See Rule
1080.07(a)(iv).
\35\ According to the Exchange, its trading system is capable of
accepting all-or-none Complex Orders, but such orders are not
affirmatively permitted to be submitted under Exchange rules. Rule
1080.07(b)(v) provides in part that ``Complex Orders may be
submitted as: All-or-none orders--to be executed in its [sic]
entirety or not at all.'' See Securities Exchange Act Release No.
72351 (June 9, 2014), 79 FR 33977 (June 13, 2014) (SR-Phlx-2014-39).
The Exchange states, however, that all-or-none Complex Orders may
not be submitted at this time. To make this clear, the Exchange
proposes to add a sentence at the end of Rule 1080.07(b)(v) stating
that ``[n]otwithstanding the above, the trading system does not
currently accept all-or-none Complex Orders.'' See Amendment No. 2,
supra note 9, 80 FR at 22571, n. 40. The Exchange states that it
anticipates that it will file a proposed rule change to provide for
the handling and execution of all-or-none Complex Orders and
thereafter permit the trading system to accept them. The Exchange
therefore states that it intends to delete this new sentence to be
added to Rule 1080.07(b)(v) if the Exchange submits, and the
Commission approves, a proposed rule change that provides for all-
or-none Complex Orders to be submitted through the trading system.
See id. The proposed rule change describes how the solicitation
mechanism would handle all-or-none Complex Orders once they are
permitted under Exchange rules. According to the Exchange, the
Complex Agency Orders and Complex Solicited Orders that would be
permitted to be entered into the Solicitation Auction, however, are
unique to the mechanism and their acceptability is mandated by it,
despite the requirement that these orders must be entered with an
all-or-none contingency. Thus, the Exchange states that it would not
need to file a proposed rule change in order to allow Complex Agency
Orders and Complex Solicited Orders to be submitted into the system.
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The Exchange believes that permitting public customer to public
customer crosses for simple orders and Complex Orders through use of
the solicitation mechanism would benefit public customers on both sides
of the crossing transaction by providing speedy and efficient
executions to public customer orders in this circumstance while
maintaining the priority of public customer interest on the book.
Solicitation Auction Notification
Pursuant to proposed Rule 1081(ii)(A)(3), when the Exchange
receives an order for Solicitation Auction processing, a Request for
Response with the option details (name of security, strike price, and
expiration date), size, side,\36\ and stop price of the Agency Order
and the Solicitation Auction start time would then be sent over the
PHLX Orders data feed and Specialized Quote Feed (``SQF'').\37\ The
Exchange believes that providing option details, size, side, and stop
price is sufficient information for participants to determine whether
to submit responses to the Solicitation Auction.\38\
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\36\ See Notice of Amendment No. 2, supra note 10, 80 FR at
22572.
\37\ SQF is an interface that allows specialists and market
makers to connect and send quotes into Phlx XL and assists them in
responding to auctions and providing liquidity to the market.
\38\ See Notice of Amendment No. 2, supra note 10, 80 FR at
22572. In the case of a Complex Agency Order, the Request for
Response will include the strategy, side, size, and stop price of
the Agency Order, as well as the Solicitation Auction start time.
See id.
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Solicitation Auction
The proposed Solicitation Auction process is described in proposed
Rules 1081(ii)(A)(4) through 1081(ii)(A)(10). Following the issuance of
the Request for Response, the Solicitation Auction would last for a
period of 500 milliseconds,\39\ unless the auction was concluded as the
result of any of the circumstances of early termination described
below.\40\
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\39\ In April/May 2014, to determine whether the proposed
Solicitation Auction timer would provide sufficient time to respond
to a Request for Response, the Exchange polled all Phlx market
makers, 20 of which responded. Of those that responded to the
survey, 15 are currently responding to auctions on Phlx or intend to
do so. 100% of those respondents indicated that their firm could
respond to auctions with a duration of at least 50 milliseconds.
Thus, the Exchange states that it believes that the proposed
Solicitation Auction duration of 500 milliseconds would provide a
meaningful opportunity for participants on Phlx to respond to a
Solicitation Auction, whether initiated by an Agency Order or a
Complex Agency Order, while at the same time facilitating the prompt
execution of orders. The Exchange notes that both ISE and Miami
International Securities Exchange LLC (``MIAX'') rules provide for a
500 millisecond response time. See ISE Rule 716, Supplementary
Material .04 and MIAX Rule 515A(b)(2)(i)(C).
\40\ Rule 1080(c)(ii)(C)(2), which states that Order Entry Firms
must expose orders they represent as agent for at least one second
before such orders may be automatically executed against solicited
orders, would be amended by the proposed rule change to clarify that
it would not apply to proposed Rule 1081, Solicitation Mechanism.
See also proposed Rule 1081(ii)(A)(4).
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Any person or entity would be permitted to submit Responses to the
Request for Response, provided each such Response is properly marked
specifying the price, size and side of the market at which it would be
willing to participate in the execution of the Agency Order.\41\ The
Exchange believes that permitting any person or entity to submit
Responses to the Request for Response should attract Responses from all
sources, maximizing the potential for liquidity in the Solicitation
Auction and thus affording the Agency Order the best opportunity for
price improvement. Responses would not be visible to Solicitation
Auction participants, and would not be disseminated to the Options
Price Reporting Authority (``OPRA''). A Response would be permitted to
be for any size up to the size of the Agency Order.\42\ The
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minimum price increment for Responses would be $0.01. A Response would
need to be equal to or better than the NBBO on both sides of the market
at the time of receipt of the Response. A Response with a price that is
outside the NBBO at the time of receipt would be rejected.\43\ Multiple
Responses at different prices from the same member would be permitted
during the Solicitation Auction.\44\ Responses would be permitted to be
modified or cancelled during the Solicitation Auction.
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\41\ In the case of a Complex Agency Order, the Response would
need to specify the price, size and side of the market at which the
person submitting the Response would be willing to participate in
the execution of the Complex Agency Order. See Notice of Amendment
No. 2, supra note 10.
\42\ The Exchange's proposal would not permit Responses to be
submitted with an all-or-none contingency. The Exchange states that
an all-or-none contingency included as a Response is not available
for any type of auction in the Phlx market because all-or-none
orders may be submitted only for Customer accounts under Exchange
rules, and Customers typically do not respond to auctions in any
event. See Notice of Amendment No. 2, supra note 10, 80 FR at 22572.
(However, all-or-none orders entered and present on the Exchange
book at the end of the Solicitation Auction would be considered for
execution, as discussed below.)
\43\ Similarly, in the case of Complex Order Responses, the
Response would need to be equal to or better than the cPBBO on both
sides, as defined in Commentary .07(a)(iv) of Rule 1080, at the time
of receipt of the Complex Order Response. However, the Responses
would not need to improve upon the limit of orders on the Complex
Order book because, the Exchange states, the Complex Order book is
not displayed on OPRA and would not necessarily be known to the
responding participant. If a Complex Order Response was received
that was equal to or crossed the limit of orders on the Complex
Order book, the Response would only be executed at a price that
improves the resting order's limit price by at least $0.01. See
proposed rule 1081(ii)(H). See also Notice of Amendment No. 2, supra
note 10, 80 FR at 22572, n. 50. A Complex Order Response submitted
with a price that is outside the cPBBO at the time of receipt would
be rejected. See proposed Rule 1081(ii)(A)(9).
\44\ See Notice of Amendment No. 2, supra note 10, 80 FR at
22572.
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Conclusion of the Solicitation Auction
Proposed Rules 1081(ii)(B)(1) through (B)(4) describe a number of
circumstances that would cause the Solicitation Auction to conclude.
Generally, it would conclude at the end of the Solicitation Auction
period, except that it would conclude earlier: (i) Any time the Phlx
Best Bid/Offer (``PBBO'') on the same side of the market as the Agency
Order crosses the stop price \45\ (because, the Exchange states,
further price improvement would be unlikely and any Responses offering
improvement would likely be cancelled); \46\ or (ii) any time there is
a trading halt on the Exchange in the affected series (or, in the case
of a Complex Solicitation Auction, any time there is a trading halt on
the Exchange in any component of a Complex Agency Order).\47\
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\45\ See proposed Rule 1081(ii)(B)(2).
\46\ In the case of a Complex Solicitation Auction, the auction
would end any time the cPBBO or the Complex Order book, excluding
all-or-none Complex Orders, on the same side of the market as the
Complex Agency Order, crosses the stop price. See proposed Rule
1081(ii)(B)(3). The Exchange believes that, when either the cPBBO or
Complex Order interest, excluding all-or-none interest, is present
on the Exchange on the same side as the Complex Agency Order and
crosses the stop price, further price improvement would be unlikely
and Responses offering improvement would likely be cancelled. The
Exchange also states that an all-or-none Complex Order crossing the
stop price should not end the Complex Solicitation Auction since the
order would be contingent and might not actually be able to trade
based on its size contingency. The Exchange believes that continuing
to run the Complex Solicitation Auction in this instance for the
duration of the auction timer would benefit the Agency Order in
allowing interest that may offer price improvement over the stop
price to continue to be collected. This approach would be consistent
with the proposed rules for Solicitation Auctions involving simple
orders. Under the proposal, Simple Solicitation Auctions would
conclude early when the PBBO on the same side of the market as the
Agency Order crossed the stop price. All-or-none orders are not part
of the PBBO as they are contingent and not displayed on OPRA. See
Amendment No. 2, supra note 9, 80 FR at 22572, n.52.
\47\ See proposed Rule 1081(ii)(B)(4). Trading on the Exchange
in any option contract is halted whenever trading in the underlying
security has been paused or halted by the primary listing market.
See Rule 1047(e). See also Securities Exchange Act Release No. 62269
(June 10, 2010), 75 FR 34491 (June 17, 2010) (SR-Phlx-2010-82). The
Exchange states that any executions that occur during any latency
between the pause or halt in the underlying security and the
processing of the halt on the Exchange would be nullified pursuant
to Exchange Rule 1092(c)(iv)(B).
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Pursuant to proposed Rule 1081(ii)(C), if the Solicitation Auction
concluded before the expiration of the Solicitation Auction period
because of the PBBO, cPBBO or Complex Order book (excluding all-or-none
Complex Orders) crossed the stop price, as described above, the entire
Agency Order would be executed using the allocation algorithm set forth
in proposed Rule 1081(ii)(E). The algorithm is described below under
the heading ``Order Allocation''.
In addition, pursuant to proposed Rule 1081(ii)(C), if the
Solicitation Auction concluded before the expiration of the
Solicitation Auction period as the result of a trading halt, the entire
Agency Order or Complex Agency Order would be executed solely against
the Solicited Order or Complex Solicited Order at the stop price and
any unexecuted Responses would be cancelled.\48\ Responses and other
interest present in the system would not be considered for trading
against the Agency Order in the case of a trading halt. The Exchange
believes that this result is appropriate since the participants
representing tradable interest in the Solicitation Auction have not
``stopped'' the Agency Order in its entirety and would have no means
after the auction executions occur to offset the trading risk that they
otherwise would incur because the market is halted, if they were
permitted to execute against the Agency Order in this instance. By
contrast, the Solicited Order ``stopped'' the Agency Order when the
order was submitted into the Solicitation Auction and, in the
Exchange's view, therefore should execute against the Agency Order, if
the Solicitation Auction concludes before the expiration of the
Solicitation Auction period as the result of a trading halt.
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\48\ Pursuant to Exchange Rule 1080(n)(ii)(C), in the case of a
trading halt on the Exchange in the affected series, a PIXL Order
will be executed solely against the Initiating Order at the stop
price and any unexecuted PAN responses will be cancelled.
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Furthermore, the Exchange notes, when an Agency Order and Solicited
Order are submitted into the Solicitation Auction, the stop price would
need to be equal to or improve the NBBO and be at least $0.01 better
than any public customer non-contingent limit orders on the Phlx order
book. The Exchange believes that public customer interest submitted to
Phlx after submission of the Agency Order and Solicited Order but prior
to the trading halt should not prevent the Agency Order from being
executed at the stop price since such public customer interest was not
present at the time the Agency Order was ``stopped'' by the Solicited
Order.
Entry of an unrelated market or marketable limit order on the
opposite side of the market from the Agency Order received during the
Solicitation Auction would not cause the Solicitation Auction to end
early. Rather, the unrelated order would execute against interest
outside the Solicitation Auction (if marketable against the PBBO) or
would post to the order book and then route if eligible for routing (in
the case of an order marketable against the NBBO but not against the
PBBO), pursuant to proposed Rule 1081(ii)(D). If contracts remain from
such unrelated order at the time the Solicitation Auction ends, the
total unexecuted volume of such unrelated interest would be considered
for participation in the order allocation process set forth in proposed
Rule 1081(ii)(E) (described below), regardless of the number of
contracts in relation to the Solicitation Auction size.\49\ The
[[Page 37677]]
Exchange states that unrelated opposite side interest received during
the Solicitation Auction is handled in this manner because participants
submitting such unrelated interest may not be aware that an auction is
in progress and should therefore be able to access firm quotes that
comprise the NBBO without delay. The Exchange further believes that
considering such unrelated interest that remains unexecuted upon
receipt for participation in the order allocation process would
increase the number of contracts against which an Agency Order could be
executed, and should therefore create more opportunities for the Agency
Order to be executed at better prices.
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\49\ Similarly, pursuant to proposed Rule 1081(ii)(D), in the
case of a Complex Solicitation Auction, an unrelated market or
marketable limit Complex Order on the opposite side of the market
from the Complex Agency Order as well as orders for the individual
components of the unrelated Complex Order received during the
Complex Solicitation Auction would not cause the Complex
Solicitation Auction to end early and would execute against interest
outside of the Complex Solicitation Auction. If contracts remain
from such unrelated Complex Order at the time the Complex
Solicitation Auction ends, the total unexecuted volume of such
unrelated interest would be considered for participation in the
order allocation process, regardless of the number of contracts in
relation to the Complex Solicitation Auction size, described in
proposed Rule 1081(ii)(E).
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Order Allocation
The allocation of orders executed upon the conclusion of a
Solicitation Auction would depend upon whether the Solicitation Auction
has yielded sufficient improving interest to improve the price of the
entire Agency Order. As noted above, all contracts of the Agency Order
would trade at an improved price against non-solicited contra-side
interest or, in the event of insufficient improving interest to improve
the price of the entire Agency Order, at the stop price against the
Solicited Order.
Consideration of All-or-None Interest. The Exchange states that the
treatment of all-or-none interest in assessing the presence of
sufficient improving interest would not always be the same for Complex
Solicitation Auctions as it would be for simple Solicitation Auctions.
In all Solicitation Auctions, whether simple or complex, the system
would not consider an all-or-none order when determining if there is
sufficient size to execute the Agency Order (or Complex Agency Order)
at a price(s) better than the stop price if it would not be possible to
satisfy the all-or-or none contingency in the execution.\50\ However,
in the case of simple Solicitation Auctions, all-or-none interest of a
size that could potentially be executed consistent with its all-or-none
contingency would be considered when determining whether there is
sufficient size to execute the Agency Orders at a price(s) better than
the stop price.\51\
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\50\ See Amendment No. 2, supra note 9.
\51\ The Exchange provided an example of assessing the
sufficiency of improving interest in a simple Solicitation Auction.
See Notice of Amendment No. 2, supra note 10, 80 FR at 22574.
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By contrast, in the case of Complex Solicitation Auctions, pursuant
to proposed Rule 1081(ii)(E)(5), when determining if there is
sufficient size to execute the Complex Agency Orders at a price(s)
better than the stop price, no all-or-none interest of any size would
be considered. Phlx states that this difference is due to a system
limitation relating to all-or-none Complex Orders.\52\ The Exchange
believes that the difference in the treatment of all-or-none Complex
Orders would not be impactful since, according to a study it made of
the matter, all-or-none Complex Orders are rare.\53\ Moreover, the
Exchange notes, if sufficient size exists in other non-solicited
interest to execute the entire Complex Agency Order at an improved
price, the all-or-none Complex Order would be considered for trade and
executed if possible.\54\
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\52\ Phlx explains that all-or-none simple orders reside with
simple orders on the book. By contrast, all-or-none Complex Orders
reside in a separate book, in a different part of the trading
system. According to the Exchange, the aggregation of all-or-none
Complex Orders with other Complex Orders in order to determine the
presence of sufficient improving interest would be a more difficult
process than aggregation of all-or-none simple orders with other
simple orders. See also Amendment No. 2, supra note 9.
\53\ The Exchange reviewed six months of data which showed that
all-or-none Complex Orders represented only 0.12% of all Complex
Orders. See Notice of Amendment No. 2, supra note 10.
\54\ The Exchange provided the following example of assessing
the sufficiency of improving interest in a Complex Solicitation
Auction. Assume a Complex Agency Order to buy 1000 contracts that
was stopped by a Complex Solicited Order at $2.00 is entered when
the cPBBO is $1.90-$2.10. Assume that during the Solicitation
Auction a Response is received to sell 900 contracts at $1.98 and an
all-or-none Complex Order is received to sell 100 contracts at
$1.99. At the end of the Solicitation Auction involving a Complex
Order, the system would not consider all-or-none interest in
determining whether it can execute the Complex Agency Order at a
better price than the stop price. In this example, by excluding the
all-or-none Complex Order, only 900 contracts would be available to
sell at a better price than the stop price. Therefore, the Complex
Agency Order would trade against the Solicited Order at the $2.00
stop price. See Notice of Amendment No. 2, supra note 10.
---------------------------------------------------------------------------
In both simple Solicitation Auctions and Complex Solicitation
Auctions, once a determination is made that sufficient improving
interest exists, all-or-none interest would be executed at the
auction's conclusion pursuant to normal priority rules, except in a
case where the all-or-none contingency could not be satisfied. If an
execution that can adhere to the all-or-none contingency would not be
possible, the all-or-none interest would be ignored and would remain on
the order book.\55\
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\55\ As discussed above, however, if without the size of the
all-or-none order there would be insufficient interest to satisfy
the Agency Order at an improved price, the Agency Order would be
executed against the Solicited Order, and the responding interest
would be cancelled.
---------------------------------------------------------------------------
Solicitation Auction with Sufficient Improving Interest. Pursuant
to the proposed Rule 1081(ii)(E)(1) algorithm, if there is sufficient
size (considering all resting orders, quotes and Responses) to execute
the entire Agency Order at a price or prices better than the stop
price, the Agency Order would be executed against such better priced
interest, with public customers having priority in the allocation at
each price level. After public customer interest at a particular price
level has been satisfied, including all-or-none orders with a size
which can be satisfied, remaining contracts would be allocated among
all Exchange quotes, orders and Responses in accordance with Phlx Rules
1014(g)(vii)(B)(1)(b) and (d), and the Solicited Order would be
cancelled.\56\ The Exchange provided an example of allocation in a
Solicitation Auction with sufficient improving interest.\57\
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\56\ Similarly, pursuant to proposed Rule 1081(ii)(E)(3), in the
case of a Complex Solicitation Auction, if there is sufficient size
(considering resting Complex Orders and Responses) to execute the
entire Complex Agency Order at a price(s) better than the stop
price, the Complex Agency Order would be executed against better
priced Complex Orders, Responses, as well as quotes and orders which
comprise the cPBBO at the end of the Complex Solicitation Auction.
(The Exchange states that the cPBBO is not considered in determining
whether there is sufficient improving size because the market and/or
size of the individual components can change between the calculation
of sufficient size and the actual execution.) Such interest would be
allocated at a given price in the following order: (i) To public
customer Complex Orders and Responses in time priority; (ii) to SQT,
RSQT, and non-SQT ROT Complex Orders and Responses on a size pro-
rata basis; (iii) to non-market maker off-floor broker-dealer
Complex Orders and Responses on a size pro-rata basis, and (iv) to
quotes and orders that comprise the cPBBO at the end of the Complex
Solicitation Auction with public customer interest being satisfied
first in time priority, then to SQT, RSQT, and non-SQT ROT interest
satisfied on a size pro-rata basis, and lastly to non-market maker
off-floor broker-dealers on a size pro-rata basis. This allocation
methodology is consistent with the allocation methodology utilized
for a Complex Order executed in PIXL. In addition, providing public
customer's with priority over SQT, RSQT, and non-SQT ROTs, who in
turn have priority over non-market maker off-floor broker-dealers is
the same priority scheme used for regular orders. See Rule 1014(g).
When determining if there would be sufficient size to execute
the entire Complex Agency Order at a price(s) better than the stop
price, if the short sale price test in Rule 201 of Regulation SHO
would be triggered for a covered security, Complex Orders and
Responses marked ``short'' would not be considered because of the
possibility that a short sale price restriction may apply during the
interval between assessing for adequate size and the execution of
the Complex Agency Order. However, if there was sufficient size to
execute the entire Complex Agency Order at a price(s) better than
the stop price irrespective of any covered securities for which the
price test would be triggered that might be present, then all
Complex Orders and Responses marked ``short'' would be considered
for allocation in accordance with proposed Rule 1081(ii)(J)(3).
\57\ See Notice of Amendment No. 2, supra note 10, at 80 FR
22574. The Exchange also provided an example of allocation in a
Complex Solicitation Auction with sufficient improving interest. See
Notice of Amendment No. 2, supra note 10, 80 FR 22575 n.62.
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[[Page 37678]]
Solicitation Auction with Insufficient Improving Interest. Pursuant
to proposed Rule 1081(ii)(E)(2), if there was not sufficient size
(considering all resting orders, quotes and Responses) to execute the
entire Agency Order at a price(s) better than the stop price, the
Agency Order would be executed against the Solicited Order at the stop
price, provided such price is better than the limit of any public
customer order (excluding all-or-none) on the limit order book, on
either the same side as or the opposite side of the Agency Order, and
equal to or better than the contra-side PBBO.\58\ Otherwise, both the
Agency Order and Solicited Order would be cancelled without a trade
occurring.\59\ The Exchange believes that this proposed provision would
ensure that non-contingent public customer orders on the limit order
book would maintain priority. The Exchange notes that ``at least one
other solicitation mechanism offered by another exchange considers
public customer orders on the limit order book at the stop price when
determining if there is sufficient improving interest to satisfy the
Agency Order . . . .'' \60\ In contrast, the Exchange points out that
the proposed solicitation mechanism offered on Phlx would not consider
such interest.\61\ The Exchange states that requiring the stop price to
be at least $0.01 better than any public customer interest on the limit
order book would ensure public customer priority of existing interest
and in turn provide the Solicited Order participant certainty that if
an execution occurs at the stop price, such execution would represent
the Solicited Order and not interest that arrived after the Solicited
Order participant stopped the Agency Order for its entire size.
---------------------------------------------------------------------------
\58\ Proposed Rule 1081(ii)(E)(2) would not apply to Complex
Solicitation Auctions. Rather, a parallel provision, proposed Rule
1081(ii)(E)(4), would provide that, in a Complex Solicitation
Auction, if there is not sufficient size (considering resting
Complex Orders and Responses) to execute the entire Complex Agency
Order at a price(s) better than the stop price, the Complex Agency
Order would be executed against the Solicited Order at the stop
price, provided such stop price was better than the limit of any
public customer Complex Order (excluding all-or-none) on the Complex
Order book, better than the cPBBO when a public customer order
(excluding all-or-none) is resting on the book in any component of
the Complex Agency Order, and equal to or better than the cPBBO on
the opposite side of the Complex Agency Order. The Exchange states
that this proposed behavior would ensure that non-contingent public
customers on the limit order book maintain priority. Otherwise, both
the Complex Agency Order and the Solicited Order would be cancelled
with no trade occurring.
\59\ The Exchange provided examples of allocation in a
Solicitation Auction with insufficient improving interest. With
respect to simple Solicitation Auctions, see Notice of Amendment No.
2, supra note 10, 80 FR at 22575. With respect to Complex
Solicitation Auctions, see Notice of Amendment No. 2, supra note 10,
80 FR at 22575 n.63.
\60\ See Notice of Amendment No. 2, supra note 10, at 80 FR
22575.
\61\ See ISE Rule 716(e)(2)(i) which provides in part that in
the case of insufficient improving interest ``[i]f there are
Priority Customer Orders on the Exchange on the opposite side of the
Agency Order at the proposed execution price and there is sufficient
size to execute the entire size of the Agency Order, the Agency
Order will be executed against the bid or offer, and the solicited
order will be cancelled.''
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Proposed Rule 1081(ii)(E)(6) would provide that a single quote,
order or Response may not be allocated a number of contracts that is
greater than its size.
Finally, proposed Rule 1081(ii)(E)(7) provides that a Complex
Agency Order consisting of a stock/ETF component would not execute
against interest comprising the cPBBO at the end of the Complex
Solicitation Auction.\62\ Legging of a stock/ETF component would
introduce the risk of a participant not receiving an execution on all
components of the Complex Order and would therefore not be considered
as a means of executing a Complex Order that includes a stock/ETF
component. The Exchange states that introducing the risk of inability
to fully execute a complex strategy is counterproductive to, and
inconsistent with, the effort to allow Complex Orders in the
solicitation mechanism.
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\62\ The Exchange states that this provision, which parallels
Phlx Rule 1080(n)(ii)(E)(2)(g) concerning Complex Orders in its PIXL
auction, is being proposed for the same reasons explained in its
File No. SR-Phlx- 2013-46 with respect to that rule. See Securities
Exchange Act Release No. 69845 (June 25, 2013), 78 FR 39429 (July 1,
2013) (Order Granting Approval To Proposed Rule Change, as Modified
by Amendment No. 1, Regarding Complex Order PIXL) (for purposes of
this Order, the ``Complex PIXL Filing''). The Exchange states that
this limitation is also consistent with the handling of Complex
Orders that include a stock/ETF component and are entered into the
Phlx XL system, noting that Commentary .08(a)(i) to Phlx Rule 1080
states, for example, that stock-option orders can only be executed
against other stock-option orders and cannot be executed by the
System against orders for the individual components.
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Miscellaneous Provisions
Proposed Rules 1081(ii)(F) through (I) would address the handling
of the Agency Order and other orders, quotes and Responses when certain
conditions are present. Pursuant to proposed Rule 1081(ii)(F), if the
market moves following the receipt of a Response, such that there are
Responses that cross the then-existing NBBO (provided such NBBO is not
crossed) at the time of the conclusion of the Solicitation Auction,
such Responses would be executed, if possible, at their limit price(s).
Although Exchange Rule 1084, Order Protection, generally prohibits
trade-throughs, the Exchange notes that an exception to the prohibition
exists, pursuant to Rule 1084(b)(x), when the transaction that
constituted the trade-through was the execution of an order that was
stopped at a price that did not trade-through at the time of the
stop.\63\
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\63\ See Notice of Amendment No. 2, supra note 10, at 80 FR at
22575.
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In addition, the Exchange believes that, since the proposal would
permit Responses to be cancelled at any time prior to the conclusion of
the Solicitation Auction, Responses being executed at a price trading
through the market is, at best, highly unlikely as participants would
cancel Responses when better priced interest that they could trade
against is present in the marketplace.
Proposed Rule 1081(ii)(G) would provide that if, the Solicitation
Auction price when trading against non-solicited interest (except if it
was a Complex Solicitation Auction), would be the same as or would
cross the limit of an order (excluding an all-or-none order) resting on
the limit order book on the same side of the market as the Agency
Order, the Agency Order could be executed only at a price that is at
least $0.01 better than the resting order's limit price.\64\ However,
if such execution price would be equal to or would not improve the stop
price, the Agency Order would be executed against the non-solicited
interest at a price that is $0.01 better for the Agency Order than the
stop price, provided the price would not equal or cross a public
customer order and would be equal to or improved upon the PBBO on the
opposite side of the Agency Order.\65\ If
[[Page 37679]]
such price is not possible, the Agency Order and Solicited Order would
be cancelled with no trade occurring.\66\ The Exchange states that the
system would permit only the Solicited Order and no other interest to
trade against the Agency Order at the stop price since the Solicited
Order stopped the entire size Agency Order at a price which was
required upon receipt to be equal to or improve the NBBO and to be at
least $0.01 improvement over any public customer orders resting on the
order book, thereby establishing priority at the stop price. The
Exchange further states that this system logic ensures that the Agency
Order would receive a better priced execution than the stop price when
trading against interest other than the Solicited Order.
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\64\ The system would not consider the origin of the resting
order but would seek to ensure the priority of all resting orders on
the order book by requiring that any execution occur at a price
which would improve upon the limit of a resting order by at least
$0.01, if possible. If an execution could not occur at least $0.01
better than the limit of a resting order on the book, the system
would permit the Solicited Order to trade against the Agency Order
at the resting limit order price provided the resting order is not
for a public customer. See Notice of Amendment No. 2, supra note 10,
at 80 FR at 22576.
\65\ See also Phlx Rule 1080(n)(ii)(H). Proposed Rule
1081(ii)(G) would not apply to Complex Solicitation Auctions.
Rather, a parallel provision, proposed Rule 1081(ii)(H), would
provide that if the Complex Solicitation Auction price when trading
against non-solicited interest was the same as or would cross the
limit of that of a Complex Order (excluding all-or-none) on the
Complex Order book on the same side of the market as the Complex
Agency Order, the Complex Agency Order would be permitted to be
executed only at a price that improves the resting order's limit
price by at least $0.01, provided such execution price would improve
the stop price. If such execution price would be equal to or would
not improve the stop price, the Agency Order would be executed $0.01
better than the stop price provided the price does not equal or
cross a non-all-or-none public customer Complex Order or a non-all-
or-none public customer order present in the cPBBO on the same side
as the Complex Agency Order in a component of the Complex Order
Strategy and would be equal to or better than the cPBBO on the
opposite side of the Complex Agency Order. If such price would not
be possible, the Agency Order and Solicited Order would be cancelled
with no trade occurring. The Exchange noted that this functionality
is consistent with the operation of PIXL auctions.
\66\ The Exchange provided an example of the operation of
proposed Rule 1081(ii)(G). See Notice of Amendment No. 2, supra note
10 (adding clarifying language to the example).
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Proposed Rule 1081(ii)(I) would provide that any unexecuted
Responses or Solicited Orders would be cancelled at the end of the
Solicitation Auction. The Exchange notes that because both Responses
and Solicited Orders would be specifically entered into the
Solicitation Auction to trade against the Agency Order, and then
cancelling the unexecuted portion of Responses and Solicited Orders
would be consistent with the expected behavior of such interest by the
submitting participants.
Complex Agency Orders With Stock/ETF Components
Proposed Rule 1081(ii)(J) deals with Complex Agency Orders with
stock or ETF components. Proposed Rule 1081(ii)(J)(1) provides that
member organizations would be permitted to submit Complex Agency
Orders, Complex Solicited Orders, Complex Orders and/or Responses with
a stock/ETF component only if such orders/Responses comply with the
Qualified Contingent Trade Exemption from Rule 611(a) of Regulation NMS
\67\ pursuant to the Act. Member organizations submitting such orders
with a stock/ETF component represent that such orders comply with the
Qualified Contingent Trade Exemption.\68\ Members of FINRA or the
NASDAQ Stock Market (``NASDAQ'') are required to have a Uniform Service
Bureau/Executing Broker Agreement (``AGU'') with Nasdaq Execution
Services LLC (``NES'') in order to trade orders containing a stock/ETF
component; firms that are not members of FINRA or NASDAQ are required
to have a Qualified Special Representative (``QSR'') arrangement with
NES in order to trade orders containing a stock/ETF component.
---------------------------------------------------------------------------
\67\ 17 CFR 242.611(a).
\68\ See, e.g., Securities Exchange Act Release No. 54389
(August 31, 2006), 71 FR 52829 (September 7, 2006) (order granting
an exemption for each NMS stock component of certain qualified
contingent trades from Rule 611(a) of Regulation NMS).
---------------------------------------------------------------------------
Proposed Rule 1081(ii)(J)(2) provides that where one component of a
Complex Agency Order, Complex Solicited Order, Complex Order or
Response is the underlying stock or ETF share,\69\ the Exchange would
be required to electronically communicate the underlying security
component of the Complex Agency Order (together with the Complex
Solicited Order, Complex Order or Response, as applicable) to NES, its
designated broker-dealer, for immediate execution. The Exchange states
that such execution and reporting would occur otherwise than on the
Exchange and would be handled by NES pursuant to applicable rules
regarding equity trading.
---------------------------------------------------------------------------
\69\ See text of proposed Rule 1081(ii)(J)(2), Amendment No. 2,
supra note 9.
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Finally, proposed Rule 1081(ii)(J)(3) states that when the short
sale price test in Rule 201 of Regulation SHO \70\ would be triggered
for a covered security, NES would not execute a short sale order in the
underlying covered security component of a Complex Agency Order,
Complex Solicited Order, Complex Order or Response if the price was
equal to or below the current national best bid.\71\ However, NES would
execute a short sale order in the underlying covered security component
of a Complex Agency Order, Complex Solicited Order, Complex Order or
Response if such order was marked ``short exempt,'' regardless of
whether it was at a price that was equal to or below the current
national best bid.\72\ If NES could not execute the underlying covered
security component of a Complex Agency Order, Complex Solicited Order,
Complex Order or Response in accordance with Rule 201 of Regulation
SHO, the Exchange would cancel back the Complex Agency Order, Complex
Solicited Order, Complex Order or Response to the entering member
organization. For purposes of proposed Rule 1081(ii)(J)(3), the term
``covered security'' would have the same meaning as in Rule 201(a)(1)
of Regulation SHO.\73\
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\70\ 17 CFR 242.201. See Securities Exchange Act Release No.
61595 (February 26, 2010), 75 FR 11232 (March 10, 2010). See also
Division of Trading and Markets: Responses to Frequently Asked
Questions Concerning Rule 201 of Regulation SHO, January 20, 2011
(``SHO FAQs'') at www.sec.gov/divisions/marketreg/mrfaqregsho1204.htm.
\71\ The term ``national best bid'' is defined in SEC Rule
201(a)(4). 17 CFR 242.201(a)(4).
\72\ The Exchange notes that a broker or dealer may mark a sell
order ``short exempt'' only if the provisions of SEC Rule 201(c) or
(d) are met. 17 CFR 242.200(g)(2). Since NES and the Exchange do not
display the stock or ETF portion of a Complex Order, however, a
broker-dealer should not mark the short sale order ``short exempt''
under Rule 201(c). See SHO FAQs Question and Answer Nos. 4.2, 5.4,
and 5.5. See also Securities Exchange Act Release No. 63967
(February 25, 2011), 76 FR 12206 (March 4, 2011) (SR-Phlx-2011-27)
(discussing, among other things, Complex Orders marked ``short
exempt'') and the Complex PIXL Filing. The system would handle short
sales of the orders and Responses described herein the same way it
handles the short sales discussed in the Complex PIXL Filing.
\73\ 17 CFR 242.201(a)(4).
---------------------------------------------------------------------------
The Exchange states that this approach is consistent with Rule 201
of Regulation SHO. Under this proposal, the Exchange and NES, as
trading centers, would prevent the execution or display of a short sale
of the stock/ETF component of a Complex Order priced at or below the
current national best bid when the short sale price test restriction is
triggered. Specifically, while the Exchange and NES are determining,
respectively, the prices of the options component and of the stock or
ETF component of the Complex Order, as described above, NES would check
the current national best bid of the stock or ETF component at the time
of execution. The execution of one component is contingent upon the
execution of all other components and once a Complex Order is accepted
and validated by the Phlx trading System, the entire package would be
processed as a single transaction and both the option leg and stock/ETF
components would be simultaneously processed.\74\
---------------------------------------------------------------------------
\74\ See Notice of Amendment No. 2, supra note 10, at 80 FR
22577.
---------------------------------------------------------------------------
Regulatory Issues
The proposed rule change contains two paragraphs describing
prohibited practices when participants use the solicitation mechanism.
Proposed Rule 1081(iii) states that the Solicitation Auction could
be used only where there is a genuine intention to execute a bona fide
transaction. It would be considered a violation of proposed Rule 1081
and would be deemed conduct inconsistent with just and equitable
principles of trade and a
[[Page 37680]]
violation of Rule 707 \75\ if an Initiating Member submitted an Agency
Order (thereby initiating a Solicitation Auction) and also submitted
its own Response in the same Solicitation Auction. The Exchange states
that the purpose of this provision is to prevent Solicited Members from
submitting an inaccurate or misleading stop price or trying to improve
their allocation entitlement by participating with multiple expressions
of interest.
---------------------------------------------------------------------------
\75\ Phlx Rule 707 states, ``[a] member, member organization, or
person associated with or employed by a member or member
organization shall not engage in conduct inconsistent with just and
equitable principles of trade.''
---------------------------------------------------------------------------
Proposed Rule 1081(iv) states that a pattern or practice of
submitting unrelated orders or quotes that cross the stop price causing
a Solicitation Auction to conclude before the end of the Solicitation
Auction period would be deemed conduct inconsistent with just and
equitable principles of trade and a violation of Rule 707.
Definition of Professional in Rule 1000(b)(14)
In addition to proposing Rule 1081, the Exchange also proposes an
amendment to Rule 1000(b)(14). In 2010, the Exchange amended its
priority rules to give certain non-broker-dealer orders the same
priority as broker-dealer orders. In so doing, the Exchange adopted a
new defined term, the ``professional,'' for certain persons or
entities.\76\ Rule 1000(b)(14) defines professional as a person or
entity that (i) is not a broker or dealer in securities, and (ii)
places more than 390 orders in listed options per day on average during
a calendar month for its own beneficial account(s). A professional
account is treated in the same manner as an off-floor broker-dealer for
purposes of Phlx Rule 1014(g), to which the trade allocation algorithm
described in proposed Rule 1081(ii)(E)(1) refers. However, Rule
1000(b)(14) also currently states that all-or-none professional orders
are to be treated like customer orders. The Exchange proposes to amend
Rule 1000(b)(14) by (i) specifying that orders submitted pursuant to
Rule 1081 for the accounts of professionals be treated in the same
manner as off-floor broker-dealer orders for purposes of Rule 1014(g),
and (ii) adding proposed Rule 1081 to the list of rules for the purpose
of which a professional would be treated in the same manner as an off-
floor broker-dealer. The effect of these proposed changes to Rule 1014
would be that professionals would not receive the same priority
afforded to public customers in a Solicitation Auction under proposed
Rule 1081, and instead would be treated as broker-dealers in this
regard. Therefore, an Agency Order or Solicited Order submitted for a
professional would not be considered a public customer order eligible
to be paired with a public customer order or another professional order
and these would not be automatically executed without a Solicitation
Auction pursuant to Rule 1081(v), discussed above. In addition,
unrelated professional orders, excluding all-or-none orders, or
Responses for the account of a professional would be treated under the
proposed rule as broker-dealer orders for purposes of execution
priority. Unrelated professional all-or-none orders would continue to
receive customer priority as stipulated in Rule 1000(b)(14).\77\
---------------------------------------------------------------------------
\76\ See Securities Exchange Act Release No. 61802 (March 30,
2010), 75 FR 17193 (April 5, 2010) (approving SR-Phlx-2010-05).
\77\ See Amendment No. 2, supra note 9.
---------------------------------------------------------------------------
III. 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.\78\ The Commission shall disapprove a proposed
rule change if it does not make such a finding.\79\ 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.'' \80\
---------------------------------------------------------------------------
\78\ See 15 U.S.C. 78s(b)(2)(C)(i).
\79\ See 15 U.S.C. 78s(b)(2)(C)(ii); and see also 17 CFR
201.700(b)(3).
\80\ 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. See also
General Instructions to Form 19b-4, Item 3(b), 17 CFR 249.819.
---------------------------------------------------------------------------
After careful consideration, the Commission does not find that the
proposed rule change, as modified by Amendment No. 2, 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, as modified
by Amendment No. 2, is consistent with Section 6(b)(5) of the Act,
which, among other things, requires that the rules of a national
securities exchange be designed ``to promote just and equitable
principles of trade, to remove impediments to and perfect the mechanism
of a free and open market and a national market system and, in general,
to protect investors and the public interest . . . .'' \81\ Because
this determination under the Act necessitates disapproving the proposed
rule change, as modified by Amendment No. 2, the Commission does
so.\82\
---------------------------------------------------------------------------
\81\ 15 U.S.C. 78f(b)(5).
\82\ The Commission notes that, other than as discussed below,
this order makes no findings with respect to whether other aspects
of the proposed rule change are consistent with the Act.
---------------------------------------------------------------------------
The Commission recognizes that it has previously approved rules of
other national securities exchanges that provide for solicited order
mechanisms.\83\ Phlx's proposed solicitation mechanism rules, however,
would deviate from the solicited order mechanism rules of other
exchanges that previously were approved by the Commission.
---------------------------------------------------------------------------
\83\ See, e.g., ISE Rule 716(e), Solicited Order Mechanism; CBOE
Rule 6.74B, Solicitation Auction Mechanism; BOX Rule 7270(b),
Solicitation Auction; and MIAX Rule 515A(b), PRIME Solicitation
Mechanism.
---------------------------------------------------------------------------
In the Order Instituting Proceedings, the Commission invited the
views of interested persons concerning whether the Exchange's proposal
is consistent with Section 6 or any other provision of the Act, or the
rules and regulations thereunder. The Commission also highlighted
specific features of the Exchange's proposal and requested the views of
interested persons on those features.\84\ In particular, the Commission
noted that, under the Exchange's proposal, if at the conclusion of the
Solicitation Auction period there is a public customer order on the
order book at the stop price, the auction would be cancelled.\85\ The
Commission stated that this result is consistent with the rule of
another exchange's solicited order mechanism.\86\ The Commission
remarked that the Exchange's proposed rule differs from
[[Page 37681]]
the other exchange's rule in a case where, in addition to the public
customer order at the stop price, there is sufficient price-improving
interest along with the public customer order at the stop price to fill
the Agency Order.\87\ The Commission pointed out that, on the other
exchange, the public customer order at the stop price and the price-
improving interest would trade against the Agency Order.\88\ The
Commission noted that, under Phlx's proposal, the Agency Order and the
Solicited Order would be cancelled.\89\
---------------------------------------------------------------------------
\84\ See Order Instituting Proceedings, supra note 6, 80 FR at
5874-5875.
\85\ See Order Instituting Proceedings, supra note 6, 80 FR at
5874.
\86\ See id., citing to ISE Rule 716(e), Solicited Order
Mechanism.
\87\ See Order Instituting Proceedings, supra note 6, 80 FR at
5874.
\88\ See Order Instituting Proceedings, supra note 6, 80 FR at
5875, citing to proposed Rule 1081(ii)(E)(1).
\89\ See Order Instituting Proceedings, supra note 6, 80 FR at
5875.
---------------------------------------------------------------------------
The Commission also sought comment on a similar feature of the
Exchange's proposal.\90\ The Commission noted that, under Phlx's
proposal, generally, if, upon the conclusion of an auction, a public
customer order is resting on the book opposite the Agency Order at the
Solicited Order's stop price, both the Solicited Order and the Agency
Order are canceled. However, if the public customer order was an all-
or-none order, the proposal provides that the execution of the
Solicited Order against the Agency Order can take place.\91\ The
Commission understands this result to apply even if the size of the
all-or-none public customer order was such that it otherwise would be
eligible to trade against the Agency Order.\92\
---------------------------------------------------------------------------
\90\ See Order Instituting Proceedings, supra note 6, 80 FR at
5874.
\91\ See id.
\92\ See id.
---------------------------------------------------------------------------
The Commission further sought comment on another feature of the
Exchange's proposal.\93\ The Commission noted that, under Phlx's
proposal, in the case of a Solicitation Auction for simple orders, all
interest on the opposite side of the Agency Order would be considered
in determining whether the price can be improved for the full size of
the Agency Order.\94\ The Commission noted that, in the case of a
Complex Order Solicitation Auction, all-or-none interest would not be
considered.\95\ The Commission pointed to the Exchange's explanation
that this difference was due to a system limitation relative to all-or-
none Complex Orders: ``All-or-none simple orders reside with simple
orders on the book. By contrast, all-or-none Complex Orders reside in a
separate book, in a different part of the trading system. Thus
aggregation of all-or-none Complex Orders with other Complex Orders in
order to determine the presence of sufficient improving interest is a
more difficult process than aggregation of all-or-none simple orders
with other simple orders.'' \96\
---------------------------------------------------------------------------
\93\ See Order Instituting Proceedings, supra note 6, 80 FR at
5874.
\94\ See Order Instituting Proceedings, supra note 6, 80 FR at
5874, citing to proposed Rule 1081(ii)(E)(1).
\95\ Id., citing to proposed Rule 1081(ii)(E)(5).
\96\ See Order Instituting Proceedings, supra note 6, 80 FR at
5870 n.48 and accompanying text.
---------------------------------------------------------------------------
As noted above, the Commission received two comment letters, each
letter from ISE, on the proposed rule change and a response from the
Exchange to ISE's first comment letter.\97\ The Commission below
discusses the issues raised in ISE's comment letters and the Exchange's
response to ISE's first comment letter and sets forth the Commission's
consideration of the arguments made by both the ISE and the Exchange.
---------------------------------------------------------------------------
\97\ See supra notes 7 and 8.
---------------------------------------------------------------------------
A. Cancellation of the Solicitation Auction when the Agency Order Could
Be Satisfied by a Public Customer Order at the Stop Price and Improving
Interest
In its first letter, ISE notes that it operates a solicitation
mechanism. ISE expresses concern that the Phlx proposal would not
contain appropriate safeguards to ensure that customer orders on the
book would be protected and that agency orders would be adequately
exposed to all potential price improvement.\98\ ISE states that Phlx's
proposed solicitation mechanism would not serve the public interest and
the protection of investors, maintaining that it ``fails to provide
important protections guaranteed by competing markets.'' \99\ In its
response, Phlx states that it strongly disagrees with ``ISE's negative
characterization'' of its proposed rule change,\100\ and concludes that
ISE's concerns are ``misguided and raised no valid concerns.'' \101\
---------------------------------------------------------------------------
\98\ See ISE Letter at 1.
\99\ See ISE Letter at 2.
\100\ See Phlx Response Letter at 1.
\101\ See Phlx Response Letter at 4.
---------------------------------------------------------------------------
ISE notes that Phlx would cancel a solicitation auction if there
was customer interest on the order book at the stop price that,
combined with other available price improving interest, would be of
sufficient size to trade with the Agency Order.\102\ ISE states that
Phlx does not provide any policy justification for this ``change from
established customer protections.'' \103\ ISE also states that Phlx's
``weakened protections'' would enable regulatory arbitrage by broker-
dealers seeking to reduce the likelihood that their crosses will be
broken up.\104\ ISE suggests that ISE and other competing exchanges
``would be forced to match these changes in order to maintain
competitive standing.'' \105\ ISE urges that the Commission hold Phlx
to ``the same standards guaranteed by other options exchanges,''
maintaining that the Commission would thereby uphold ``principles of
customer protection that were central to the approval of solicitation
mechanisms operated by ISE and other markets.'' \106\
---------------------------------------------------------------------------
\102\ See ISE Letter at 1. ISE noted that other options
exchanges, including ISE, would execute the agency order against the
customer order and the other price improving interest, thereby
providing an execution for the customer on the book as well as an
improved price for the agency order. Id.
\103\ See ISE Letter at 1.
\104\ Id.
\105\ Id.
\106\ See ISE Letter at 1-2.
---------------------------------------------------------------------------
In response, Phlx states that ISE's argument is ``without merit.''
\107\ Phlx notes that it ``will not allow a solicitation auction to be
initiated at a price where there is non-contingent customer interest on
the PHLX book and will continue to prevent customers from being traded
through.'' \108\ In addition, Phlx notes, customer interest that
arrives after an order is submitted into the solicitation mechanism
would still be protected, ``but in a different manner than on ISE.''
\109\
---------------------------------------------------------------------------
\107\ See Phlx Response Letter at 2.
\108\ Id. (emphasis in original).
\109\ Id.
---------------------------------------------------------------------------
Phlx states that its protection of customer interest at the stop
price would not result in regulatory arbitrage. Rather, Phlx argues,
its proposal would represent ``merely a different process for customer
protection.'' Phlx points out that its proposal ``would not permit
trading through the customer, nor would it allow trading ahead of the
customer.'' \110\ Phlx describes its proposal as ``simply not providing
customer interest (or any other interest)'' that arrives after the
solicited order is stopped with the unfair advantage of trading against
the agency order ahead of the solicited contra order at a price that
does not offer price improvement,\111\ adding that ``there is no
justification for permitting any market participant to step ahead of
the solicited contra order at a price which does not offer price
improvement.'' \112\
---------------------------------------------------------------------------
\110\ Id.
\111\ Id.
\112\ See Phlx Response Letter at 2 (emphasis in original).
---------------------------------------------------------------------------
Phlx notes that ISE cancels a solicitation auction with no trade
resulting when there is a customer order at the stop price that,
together with any improving interest, cannot satisfy the agency order.
``Whether ISE `protects' a customer order at the stop price,'' Phlx
[[Page 37682]]
asserts, ``evidently depends upon the size of that customer order (or
the absence of other orders sufficient to aggregate into a size
sufficient for the agency order to execute against),'' arguing that
ISE's approach ``cannot really be considered customer `protection.' ''
\113\
---------------------------------------------------------------------------
\113\ See Phlx Response Letter at 2.
---------------------------------------------------------------------------
Further, Phlx observes that, in its PIXL auction mechanism,
customers rarely submit interest priced at the stop price after the
auction has been initiated, with that interest being executed in the
auction.\114\ Phlx states that there is ``no reason to expect that
customer orders would be received at the stop price more frequently in
solicitation auctions than in PIXL Auctions.'' Specifically, Phlx
represents that in February 2015, customer executions at the stop price
occurred only 70 times out of 474,388 PIXL auctions, or approximately
.015% of the time. The Exchange observes that cancellations caused by
customer orders arriving at the stop price after a Solicitation Auction
was initiated might occur only roughly 0.015% more often in its
solicitation mechanism than in ISE's solicitation mechanism.\115\ Phlx
states that, ``[g]iven how rarely a customer order can be expected to
be received during a solicitation auction at the stop price, the PHLX's
proposal to cancel a solicitation order with no trade occurring when a
customer order is received at the stop price during the auction does
not pose a significant risk to the protection of customer interest nor
to the opportunity for price improvement.'' \116\
---------------------------------------------------------------------------
\114\ Id.
\115\ Id.
\116\ See Phlx Response Letter at 2.
---------------------------------------------------------------------------
The Second ISE Letter reiterates the comments that ISE made in its
initial letter.\117\ ISE states that ``Phlx should instead be held to
the same high standard required of other markets that guarantee an
execution for the customer order by allowing the solicitation auction
to be broken up. This remains the case even when dealing with customer
orders that are received after an auction has been initiated, and
regardless of how rare Phlx anticipates such orders may be.'' \118\
---------------------------------------------------------------------------
\117\ See Second ISE Letter at 1.
\118\ See Second ISE Letter at 2.
---------------------------------------------------------------------------
The Commission notes that solicited order mechanisms generally are
designed to enable a member firm to assist a customer that wishes to
buy or sell 500 or more contracts (i.e., an agency order) by finding a
counterparty (i.e., a solicited order) to execute against the full size
of the customer's interest at the NBBO or better.\119\ The agency order
must be exposed to the broader market in a solicitation auction so that
it has the possibility of obtaining a better price, before the
solicited order is permitted to be crossed with the agency order.\120\
In a solicited order mechanism, the trading crowd to which the agency
order is exposed does not have the right to trade against the agency
order at the price proposed by the solicited party.\121\ Unless the
trading crowd provides (i) a better price and (ii) enough interest at
that better price for the entire size of the order, the solicited order
is permitted to trade against the agency order for its full size, with
all other participants excluded.\122\
---------------------------------------------------------------------------
\119\ See supra note 83.
\120\ Id.
\121\ Id.
\122\ Id.
---------------------------------------------------------------------------
The exchanges that currently feature a solicited order mechanism
include provisions that address, among other scenarios, the
circumstance where there is a public customer order on the order book
at the stop price that, when combined with price-improving interest
that otherwise could not fill the agency order on its own, would be
able to fill the agency order.\123\ In that circumstance, those
exchanges' rules provide that the public customer order and the
available price-improving interest would be executed against the agency
order. By contrast, under its proposal, Phlx would cancel the Agency
Order rather than permit it to be executed against a public customer at
the stop price that, when combined with available price-improving
interest, would be of sufficient size to fill the Agency Order.
---------------------------------------------------------------------------
\123\ Id.
---------------------------------------------------------------------------
In view of the fact that the purpose of the Phlx's proposed
solicitation mechanism is to enable the Agency Order to be executed,
the Commission believes that the Agency Order should be given the
opportunity to receive an execution in the above-described
circumstance. Moreover, to the extent that the Agency Order could
execute against the customer order at the stop price, along with
available price-improving interest that otherwise could not fill the
Agency Order on its own, the composite price that the Agency Order
would receive would be at a better price than the Solicited Order's
stop price. In addition, the public customer order and any available
price-improving interest that arrived on the order book after the
auction's commencement also would receive an execution, rather than
simply remaining on the book.
In explaining its approach, Phlx notes that, under its proposal, at
the initiation of the auction, the stop price must be at least $0.01
better than any public customer interest on the limit order book at
that time. According to Phlx, this ``ensures public customer priority
of existing interest and in turn provides the Solicited Order
participant certainty that if an execution occurs at the stop price, it
will be against the Solicited Order rather than against interest
(including public customer orders) that arrived after the solicited
party had already stopped the Agency Order for its entire size at that
price.'' \124\ Phlx also states that it is ``simply not providing
customer interest (or any other interest) which arrives after the
solicited order is stopped with the unfair advantage of trading against
the solicited agency order ahead of the solicited contra order at a
price which does not offer price improvement.'' \125\
---------------------------------------------------------------------------
\124\ See Notice of Amendment No. 2, supra note 10, 80 FR at
22575.
\125\ See Phlx Response Letter at 2 (emphasis in original).
---------------------------------------------------------------------------
The Commission does not view a public customer order at the stop
price that arrives after the auction has commenced as trading ``ahead
of'' the Solicited Order and thereby as receiving an ``unfair
advantage'' when the Solicited Order would be required to be cancelled
in any event under the Phlx's proposal. On the contrary, the Commission
believes that the Agency Order should be given the opportunity to
execute against the later-arriving public customer interest at the stop
price, together with sufficient price-improving interest to satisfy the
size of the Agency Order, and thus benefit from a measure of price
improvement, rather than being cancelled as under the Exchange's
proposal.
In making the argument that its proposal ``does not pose a
significant risk to the protection of customer interest nor to the
opportunity for price improvement,'' Phlx cites to data from its PIXL
auction showing that public customer orders arrive on the order book at
the stop price very infrequently.\126\ The Commission notes that this
data also could be cited to argue, on the other side of the issue, that
the incentive for solicited parties to provide liquidity through the
proposed solicitation mechanism would be little affected by later-
arriving public customer orders. In any event, the Commission believes
that data showing the potential infrequency of a situation should not
be dispositive of the Commission's consideration regarding
[[Page 37683]]
the Exchange's proposed treatment of public customer orders at the stop
price that arrive during the auction and that otherwise could satisfy
the size of the Agency Order when combined with price-improving
interest.
---------------------------------------------------------------------------
\126\ See Phlx Response Letter at 2.
---------------------------------------------------------------------------
For the reasons stated above, the Commission believes that Phlx's
proposed approach not to execute the Agency Order against a public
customer order at the stop price, that when combined with price-
improving interest could fulfill the Agency Order, would result in an
outcome that does not appear to be consistent with the Act.
Specifically, cancelling the Agency Order and leaving the public
customer order on the order book unexecuted would disadvantage both of
these orders. It would also disadvantage any price-improving interest
that arrived on the book during the auction (but was insufficient in
size to trade against the Agency Order without taking into account the
public customer order), which, under the other exchanges' rules, also
would receive an execution. While such a result may be expedient for
the firm that entered the Agency Order and Solicited Order into the
Solicitation Auction and for the solicited party, it would raise
concerns under Section 6(b)(5) of the Act, which, among other things,
requires that the rules of a national securities exchange be designed
``to promote just and equitable principles of trade, to remove
impediments to and perfect the mechanism of a free and open market and
a national market system and, in general, to protect investors and the
public interest . . .'' \127\ In light of these observations, the
Commission cannot find that the proposed rule change is consistent with
the Act.
---------------------------------------------------------------------------
\127\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
B. Execution of the Solicitation Auction at the Stop Price When There
Is a Contingent Public Customer Order at the Stop Price
In addition, ISE expresses a concern regarding Phlx's handling of
all-or-none customer orders on the book. ISE notes that the Exchange's
proposal would allow a Solicited Order to cross with the Agency Order
when there is a resting customer all-or-none order at the stop price of
the Solicited Order, even if the customer order is eligible to trade
based on its size contingency.\128\ ISE maintains that customer
protection was ``a central principle in the approval of solicitation
mechanisms of other markets.'' \129\ ISE does not believe that Phlx
should be permitted to ``eliminate this protection'' without providing
a policy rationale.\130\
---------------------------------------------------------------------------
\128\ See ISE Letter at 2; The Second ISE Letter reiterates
comments ISE included in its first letter.
\129\ Id.
\130\ Id.
---------------------------------------------------------------------------
In response, Phlx notes that all-or-none orders ``continue to be
protected from being traded through when their all-or-none contingency
can be satisfied.'' However, Phlx explains, due to the contingency,
such orders are offered a ``less robust protection'' than non-
contingent orders.\131\ Phlx states that a customer seeking the same
protection could submit the order without this contingency, since the
contingency is within the discretion and control of the customer.\132\
Further, Phlx notes that ISE does not provide priority to all-or-none
orders on ISE's book \133\ and cited to ISE Rule 713.
---------------------------------------------------------------------------
\131\ See Phlx Response Letter at 3.
\132\ Id.
\133\ Id.
---------------------------------------------------------------------------
The Commission believes that Phlx's proposed approach to permit the
Agency Order and Solicited Order to cross when an all-or-none customer
order at the stop price exists on Phlx's order book would result in an
outcome that is not consistent with the Act. Specifically, rather than
protecting the all-or-none public customer order at the stop price,
Phlx's proposal to allow the Solicited Order to execute against the
Agency Order and leave the all-or-none public customer order on the
order book would disadvantage the public customer order. While such a
result may be expedient for the firm that entered the Agency Order and
Solicited Order into the Solicitation Auction and for the solicited
party, it would raise concerns under Section 6(b)(5) of the Act, which,
among other things, requires that the rules of a national securities
exchange be designed ``to promote just and equitable principles of
trade, to remove impediments to and perfect the mechanism of a free and
open market and a national market system and, in general, to protect
investors and the public interest . . .'' \134\ In light of these
observations, the Commission cannot find that the proposed rule change
is consistent with the Act.
---------------------------------------------------------------------------
\134\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
C. No Consideration of All-or-None Complex Orders When Determining
Whether the Price Has Been Improved for the Full Size of the Agency
Order
The ISE Letter expresses a concern regarding the provision of the
Phlx proposal that would allow all-or-none orders in the Complex Order
Book to be ignored when determining whether there would be sufficient
interest to execute the Agency Order at a better price.\135\ ISE states
that Phlx does not cite any relevant policy considerations to justify
this provision, but ``simply reasons that it should be exempted from
providing this functionality due to `systems limitations' that make it
more difficult to aggregate complex orders with all-or-none orders.''
\136\ ISE contends that other options exchanges ``have spent the
necessary time and resources to overcome such obstacles in the interest
of maintaining a fair and orderly market where agency orders are
adequately exposed to potential price improvement.'' \137\ ISE remarks
that ``Phlx should not be singled out for favorable treatment simply
because it was unwilling to invest in appropriate safeguards offered by
its competitors.'' \138\
---------------------------------------------------------------------------
\135\ See ISE Letter at 2.
\136\ Id.
\137\ Id.
\138\ Id.
---------------------------------------------------------------------------
In response, Phlx reiterates its position that aggregation of all-
or-none complex orders with other complex orders was a more difficult
process than aggregation of all-or-none simple orders with other simple
orders, because all-or-none complex orders reside in a separate book
that is in a different part of the trading system.\139\ Citing data
that it had reviewed to demonstrate that all-or-none complex orders are
rare,\140\ Phlx responds that it must carefully weigh the costs and
benefits of changes to its trading system and deploy resources in the
manner it determines most beneficial to its market participants.\141\
In this case, Phlx states that it has elected to ``enhance the
efficiency and effectiveness of its markets'' rather than to ``overhaul
the trading system to include a mere 0.12% of all Complex Orders in the
calculation of sufficiency of improving interest.'' \142\ Phlx does not
believe that such an overhaul would advance the interests of market
participants.\143\
---------------------------------------------------------------------------
\139\ See Phlx Response Letter at 3.
\140\ Id. The Exchange noted that it had reviewed six months of
data which showed that all-or-none complex orders represented only
0.12% of all Complex Orders. Id.
\141\ Id.
\142\ See Phlx Response Letter at 3-4.
\143\ See Phlx Response Letter at 4.
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The Second ISE Letter states that ``[b]y ignoring all-or-none
complex orders, Phlx would allow the execution of an agency order
against the solicited order at a worse price than available from other
market participants.'' \144\ ISE notes that ``Phlx attempts to equate
their proposal with ISE's rules regarding the priority of all-or-none
orders. To clarify this here, all-or-none orders on ISE have
[[Page 37684]]
no priority over other orders at the same price (emphasis in original).
Our rules make clear, however, that all-or-none orders are available
for execution after other trading interest at the same price has been
exhausted. All-or-none orders on ISE decidedly may not be ignored when
such orders would result in a better price for the other side of the
trade.'' \145\ ISE further remarks that ``[i]t is fundamental to the
solicitation process that the agency order be fully exposed to all
other price improving interest, including all-or-none orders.'' \146\
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\144\ See Second ISE Letter at 2.
\145\ Id.
\146\ See Second ISE Letter at 3.
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As described above, under Phlx's proposal, at the conclusion of a
Solicitation Auction involving Complex Orders, the Exchange's system
would not consider all-or-none complex interest in determining whether
such interest could execute against the Complex Agency Order at a
better price than the stop price. Therefore, when the determination of
whether there is sufficient improving interest to execute against the
Complex Agency Order otherwise would require the inclusion of such all-
or-none complex interest, the Complex Agency Order simply would trade
against the Solicited Order at the stop price, rather than against the
sufficient improving interest that could be available on the Exchange
at a better price.
The Commission notes that the solicited order mechanisms of other
exchanges that accommodate complex orders provide for the consideration
of all-or-none complex order interest in determining whether there is
sufficient improving interest.\147\ ISE Rule 722 Supplementary Material
.08 permits complex orders in ISE's solicited order mechanism and
provides no carve-out for the consideration of all-or-none complex
orders.\148\ CBOE Rule 6.74B Interpretation .01 permits complex orders
in CBOE's solicited order mechanism and provides no carve-out for the
consideration of all-or-none complex orders.\149\
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\147\ See ISE Rule 716(e) and Supplementary Material .08 and
CBOE Rule 6.74B, Solicitation Auction Mechanism. Neither BOX Rule
7270(b), Solicitation Auction, or MIAX Rule 515A(b), PRIME
Solicitation Mechanism, permit solicitation auctions for complex
orders.
\148\ See ISE Rule 716(e) and Supplementary Material .08; see
also ISE Rule 722(b)(4) (permitting complex orders to be entered as
all-or-none).
\149\ See CBOE Rule 6.74B and Interpretation .01; see also CBOE
Rule 6.53C(b) (permitting complex orders to be entered as all-or-
none).
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Similar to these other exchanges' solicitation mechanisms, under
Phlx's proposal, when there is sufficient improving interest that is
not all-or-none interest to satisfy a Complex Agency Order at a better
price than the stop price, any resting all-or-none Complex Orders would
participate in the execution pursuant to normal priority rules, so long
as the all-or-none contingency can be satisfied. However, Phlx's
proposal differs when there is sufficient improving interest to satisfy
the Complex Agency Order at a better price than the stop price only
when all-or-none Complex Order interest is included. In those
circumstances, Phlx's proposal would deny the all-or-none Complex Order
resting elsewhere on the Exchange a potential execution and it would
not provide the Complex Agency Order with an execution at a better
price than the stop price, even though there was, in fact, sufficient
improving interest available.
Phlx has provided data indicating that participants infrequently
submit all-or-none Complex Orders. However, Phlx has not provided
sufficient information in its proposal to overcome the Commission's
fundamental concerns about the impact that the proposal could have on
exchanges' incentives to maintain a fair and orderly market where
agency orders are adequately exposed to potential price improvement.
The Commission believes that data showing the infrequency of a
situation should not be dispositive of the Commission's consideration
regarding whether the Exchange has met its burden to demonstrate that
its proposal is consistent with the Act.
Further, Phlx has stated that it must weigh the costs and benefits
of changes to its trading system, and has determined not to overhaul
the trading system to include infrequently submitted all-or-none
Complex Orders in the calculation of assessing the extent of price-
improving interest that could interact with the Complex Agency Order.
The Commission notes that other exchanges have overcome such obstacles
in the interest of maintaining a fair and orderly market where agency
orders are adequately exposed to potential price improvement.\150\
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\150\ See supra notes 151-153.
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The Commission believes that Phlx's failure to provide a potential
execution to all-or-none Complex Orders and to provide meaningful
opportunity for price improvement to Complex Agency Orders would result
in an execution allocation that is inconsistent with Section 6(b)(5) of
the Act,\151\ which requires that the rules of an exchange must be
designed, among other things, to promote just and equitable principles
of trade, to remove impediments to and perfect the mechanism of a free
and open market and a national market system and, in general, to
protect investors and the public interest. Specifically, rather than
including all-or-none Complex Order interest in its consideration of
whether there is sufficient improving Complex Order interest, Phlx's
proposal, by ignoring all-or-none Complex Orders on one of its systems,
would disadvantage both the resting all-or-none Complex Orders and the
Complex Agency Order. As discussed above, the Commission does not
believe the Exchange has sufficiently demonstrated why its proposal,
which fails to take into account interest available in its market,
would satisfy the requirements of Section 6(b)(5) of the Act.\152\
Accordingly, the Commission cannot find that the proposed rule change
is consistent with the Act.
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\151\ 15 U.S.C. 78f(b)(5).
\152\ 15 U.S.C. 78f(b)(5).
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D. Efficiency, Competition and Capital Formation
In analyzing the proposed rule change, as modified by Amendment No.
2, and in making its determination to disapprove the rule change, the
Commission has considered whether the action will promote efficiency,
competition, and capital formation,\153\ but, as discussed above, the
Commission does not find that the proposed rule change, as modified by
Amendment No. 2, is consistent with Section 6(b)(5) of the Act.
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\153\ 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).
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IV. Conclusion
For the foregoing reasons, the Commission does not believe that
Phlx has met its burden to demonstrate that the proposed rule change,
as modified by Amendment No. 2, is consistent with the Act and the
rules and regulations thereunder applicable to a national securities
exchange, and, in particular, with Section 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-2014-66), as modified by
Amendment No. 2, be, and hereby is, disapproved.
[[Page 37685]]
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\154\
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\154\ 17 CFR 200.30-3(a)(12).
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Robert W. Errett,
Deputy Secretary.
[FR Doc. 2015-16088 Filed 6-30-15; 8:45 am]
BILLING CODE 8011-01-P