[Federal Register: June 3, 2009 (Volume 74, Number 105)]
[Notices]
[Page 26750-26761]
[DOCID:fr03jn09-123]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59995; File No. SR-Phlx-2009-32]

Self-Regulatory Organizations; NASDAQ OMX PHLX, Inc; Notice of
Filing of Amendment No. 3 and Order Granting Accelerated Approval of
Proposed Rule Change, as Modified by Amendment Nos. 1, 2, and 3
Thereto, Relating to the Exchange's Enhanced Electronic Trading
Platform for Options, Phlx XL II

May 28, 2009.

I. Introduction

    On April 3, 2009, NASDAQ OMX PHLX, Inc. (``Phlx'' or ``Exchange'')
filed with the Securities and Exchange Commission (``Commission''),
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to
implement several enhancements to its electronic options trading
system, Phlx XL, the enhanced system being called Phlx XL II. The
proposed rule change was published for comment in the Federal Register
on April 14, 2009.\3\ On April 15, 2009, Phlx filed with the
Commission, pursuant to Section 19(b)(1) of the Act \4\ and Rule 19b-4
thereunder,\5\ Amendment No. 1 to the proposed rule change. Amendment
No. 1 to the proposed rule change was published for comment in the
Federal Register on April 23, 2009.\6\ The Commission received two
comment letters on the proposed rule change and

one comment response letter from Phlx.\7\ On May 20, 2009, the Exchange
submitted Amendment No. 2 to the proposed rule change.\8\ On May 28,
2009, the Exchange submitted Amendment No. 3 to the proposed rule
change.\9\ This order grants accelerated approval to the proposed rule
change, as modified by Amendment Nos. 1, 2, and 3.
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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. 59721 (April 7,
2009), 74 FR 17245 (April 14, 2009) (``Notice'').
    \4\ 15 U.S.C. 78s(b)(1).
    \5\ 17 CFR 240.19b-4.
    \6\ See Securities Exchange Act Release No. 59779 (April 16,
2009), 74 FR 18600 (April 23, 2009) (``Amendment Notice'').
    \7\ See Letters from Janet M. Kissane, Senior Vice President--
Legal and Corporate Secretary, Office of the General Counsel, NYSE
Euronext, to Elizabeth M. Murphy, Secretary, Commission, dated May
14, 2009 (``NYSE Euronext Letter''); Angelo Evangelou, Assistant
General Counsel, Chicago Board Options Exchange, Incorporated
(``CBOE''), to Elizabeth M. Murphy, Secretary, Commission, dated May
20, 2009 (``CBOE Letter''); and Richard S. Rudolph, Assistant
General Counsel, Phlx, to Elizabeth M. Murphy, Secretary,
Commission, dated May 28, 2009 (``Response Letter'').
    \8\ In Amendment No. 2, the Exchange updated the proposed rule
text contained in Exhibit 5 to reflect changes that were approved as
part of SR-Phlx-2009-23. See Securities Exchange Act Release No.
59924 (May 14, 2009), 74 FR 23759 (May 20, 2009). Because Amendment
No. 2 is technical in nature, the Commission is not publishing it
for comment.
    \9\ The text of Amendment No. 3 is available on the Exchange's
Web site at http://nasdaqomxphlx.cchwallstreet.com/NASDAQOMXPHLX/
Filings/, at the principal office of the Exchange, and at the
Commission's Public Reference Room.
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II. Description of the Proposed Rule Change, as Modified by Amendment
Nos. 1, 2, and 3 to the Proposed Rule Change

    The Exchange proposes to implement several enhancements to its
electronic options trading system, Phlx XL.\10\ The enhanced system
would be known as Phlx XL II and would reflect enhancements to the
opening, linkage and routing, quoting, and order management
processes.\11\ These enhancements are intended to improve execution
quality for Phlx users by improving a number of processes, including
those related to the opening, order handling and order execution.
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    \10\ The following description incorporates changes proposed by
Phlx in Amendment Nos. 1, 2, and 3. See text accompanying notes 90-
96, infra, for a discussion of the changes proposed in Amendment No.
3.
    \11\ The Exchange acknowledges that the proposed Options Order
Protection and Locked/Crossed Market Plan may necessitate
modifications to its proposed rules. See Securities Exchange Act
Release No. 59647 (March 30, 2009), 74 FR 15010 (April 2, 2009).
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    According to Phlx, the changes to the opening process are intended
to provide better executions to users, more consistent prices on
executions and a smoother transition from the opening to the regular
trading day. The changes to the order handling process are intended
improve routing to liquidity available at other exchanges while
preventing non-exempt trade-throughs of other markets, and provide
users with increased flexibility and control in how their orders are
handled. The Exchange expects that order processing should be more
consistent, with greater continuity in prices as a result of these
changes, because several of the changes are intended to introduce a
price check to limit executions at far away prices. The Exchange
believes that these changes should benefit investors and users through
better and more consistent system behavior and resulting prices. A
brief summary of these modifications and enhancements is outlined
below.\12\
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    \12\ For a more detailed description of the proposed rule
change, see Notice and Amendment No. 3, supra, notes 3 and 9.
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New Opening Process \13\
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    \13\ For a more detailed description of the proposed opening
process, see Notice at 17245-49 and Amendment No. 3.
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    Phlx proposes to introduce opening process enhancements under Phlx
XL II that would, in general, operate as described below.
    If there are no opening quotes or orders that lock or cross each
other, the system would open by disseminating the Exchange's best bid
and offer among quotes and orders that exist in the Phlx XL II system
at that time. If there are opening quotes or orders that lock or cross
each other, the Phlx XL II system would take the lowest bid and the
highest offer among quotations received to determine the lowest quote
bid and highest quote offer and would then determine the price at which
the maximum number of contracts can trade. If that price is within the
lowest quote bid and highest quote offer and leaves no imbalance, Phlx
would open at that price.\14\
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    \14\ See proposed Rule 1017(l)(ii).
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    If such opening price includes interest other than solely Phlx
interest, the system would initiate a ``Route Timer,'' \15\ not to
exceed one second. If no new interest is received during the Route
Timer, the Phlx XL II system would route to other markets disseminating
prices better than Phlx's opening price, execute marketable interest at
the opening price on Phlx, and route to other markets disseminating
prices equal to the Phlx opening price if necessary. Orders would be
routed as Immediate or Cancel (``IOC'') orders with a limit price equal
to the Exchange's opening price. If interest is received during the
Route Timer, the Phlx XL II system would recalculate the opening price
taking such new interest into account. Then, if there is no imbalance,
the system would execute marketable interest at the opening price on
the Phlx and route the remainder to other markets.
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    \15\ See proposed Rule 1017(l)(ii)(C)-(D). All references to a
``Route Timer'' in the Phlx XL II system and in the proposed rules
mean a system pause for a brief period. Phlx XL II participants
would not receive any notification that a Route Timer has been
initiated.
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    Where there is an imbalance at the price at which the maximum
number of contracts can trade that is also at or within the lowest
quote bid and highest quote offer, the Phlx XL II system would
calculate an Opening Quote Range (``OQR'') for a particular series.\16\
If there is sufficient size on the Exchange and on away markets on the
opposite side of the market from the imbalance to execute all opening
marketable interest at a price that is at or within the established OQR
and the Away Best Bid/Offer (``ABBO'') without leaving an imbalance,
the Phlx XL II system would open the affected series for trading at
that price by executing opening marketable interest on the Phlx XL II
system, as long as the system does not trade through the ABBO.\17\ If
it would trade through the ABBO, the Phlx XL II system would initiate a
Route Timer, not to exceed one second. If no new interest is received
during the Route Timer, the Phlx XL II system would then route to other
markets disseminating prices better than Phlx's opening price, execute
marketable interest at the opening price on Phlx and, route to other
markets disseminating prices equal to the Phlx opening price if
necessary. If all opening marketable size cannot be completely executed
at or within the OQR without trading through the ABBO, the Phlx XL II
system would automatically institute an imbalance process.\18\ During
the imbalance process Phlx XL II may submit additional opening quotes,
opening sweeps and orders. Phlx XL II would then determine if the
imbalance amount can then trade on the Exchange at or within the OQR.
If it cannot, the Exchange would seek to route remaining interest away
after initiating a Route Timer.
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    \16\ See proposed Rule 1017(l)(iii).
    \17\ If the ABBO is crossed, it would not be taken into
consideration by the system and the system would immediately
execute.
    \18\ See proposed Rule 1017(l)(iv).
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    If the imbalance process does not satisfy the number of marketable
contracts on the Exchange, the Phlx XL II system would repeat the
Imbalance Process up to three times (as established by the Exchange).
If after that number of times, the Phlx XL II system still cannot route
and/or trade the entire imbalance amount, the Phlx XL II system would
conduct a Provisional Opening by routing to other markets at prices
better

than the Exchange opening price for their disseminated size, trading
available contracts on the Exchange at the Exchange opening price, and
routing contracts to other markets at prices equal to the Phlx opening
price at their disseminated size.\19\
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    \19\ See proposed Rule 1017(l)(iv)(C)(7).
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    The opening process would then be complete. Unexecuted Opening
Sweeps\20\ would be cancelled. Any unexecuted contracts from the
imbalance not traded or routed would be displayed in the Exchange quote
at the opening price for the remaining size for a period not to exceed
ten seconds and subsequently cancelled back to the entering participant
if they remain unexecuted and priced through the opening price. During
this display time period, the Phlx XL II system would disseminate, if
the imbalance is a buy imbalance, an offer that is $200,000, with a
size of one or, if the imbalance is a sell imbalance, a bid that is
$0.00, with a size of one, on the opposite side of the market from
remaining unexecuted contracts.
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    \20\ ``Opening Sweeps'' are one-sided electronic quotations
submitted for execution against opening trading interest in the Phlx
XL II system. See proposed Rule 1017(l)(v). Opening Sweeps may be
entered at any price with a minimum price variation applicable to
the affected series, on either side of the market, at single or
multiple price level(s), and may be cancelled and re-entered. See
proposed Rule 1017(l)(v)(B). In addition to the Opening Sweep, the
Phlx would also introduce other new sweep capabilities. For a more
detailed discussion of the proposed sweeps, see Notice at 17257 and
Amendment No. 3.
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Amendments to the Exchange's Firm Quote Rule

    The Exchange also proposes to amend its Rule 1082, Firm Quotations,
to enhance the ability for Phlx XL II participants to refresh, and
potentially improve, their quotations when their option quotation size
is exhausted at a particular price level, and that would reflect the
Exchange's ability to refresh its disseminated market following the
exhaustion of the Exchange's disseminated size.\21\ The Exchange has
proposed two functionalities to accomplish this goal: Quote Exhaust and
Market Exhaust.
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    \21\ See proposed Rule 1066(c)(8), which clarifies the
definition of an Immediate-or-Cancel (``IOC'') order as a limit
order that is to be executed in whole or in part upon receipt. Any
portion not so executed shall be cancelled. IOC orders are not
routable and would not be subject to any routing process or timer
described in the Exchange's rules. If not executed immediately, an
IOC order would be cancelled by the Phlx XL II system. Contracts
remaining in an IOC order following a partial execution would be
cancelled. The Exchange represents that IOC orders would not be
subject to any Route Timer and would not be included in the Quote
Exhaust and Market Exhaust processes.
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Quote Exhaust\22\
    Quote Exhaust occurs when the Exchange's disseminated market at a
particular price level includes a quote, and such market is exhausted
by an inbound contra-side quote or order (``initiating quote or
order''), and following such exhaustion, contracts remain to be
executed from the initiating quote or order.\23\ Rather than
immediately executing at the next available price, the Phlx XL II would
employ a timer not to exceed one second in order to allow market
participants to refresh their quotes. During the Quote Exhaust Timer,
the Exchange would disseminate the reference price for the remaining
size, provided that such price does not lock an away market, in which
case, the Exchange would disseminate a bid and offer that is one
Minimum Price Variation (``MPV'') from the away market price, and if
the remaining size is a buyer, an offer that is $200,000, with a size
of one or, if the remaining size is a seller, a bid that is $0.00, with
a size of one, on the opposite side of the market from remaining
unexecuted contracts. If the remaining contracts in the initiating
quote or order are either traded or cancelled during the Quote Exhaust
Timer, the Quote Exhaust Timer would terminate and normal trading would
resume.
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    \22\ For a more detailed description of the proposed Quote
Exhaust feature, see Notice at 17249-52 and Amendment No. 3.
    \23\ See proposed Rule 1082(a)(ii)(B)(3). The initial execution
price is known as the ``reference price.''
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    If the Exchange receives an order, quote or sweep on the opposite
side of the market from the initiating quote or order during the Quote
Exhaust Timer that locks or crosses the reference price at any time
during the Quote Exhaust Timer, it would execute immediately against
the initiating quote or order at the reference price.\24\ If the
initiating quote or order that caused the Quote Exhaust is exhausted,
the Quote Exhaust Timer would be terminated. With respect to any order,
quote or sweep received on the opposite side of the market from the
initiating quote or order during the Quote Exhaust Timer that is
inferior to the reference price, the system would place any non-IOC
order onto the book. Such new interest would be included in the first
PBBO calculation and available to be traded immediately following the
end of the Quote Exhaust Timer. All non-marketable sweeps and IOC
orders would be cancelled immediately if not executed and would not
participate in the Quote Exhaust process.
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    \24\ See proposed Rule 1082(a)(ii)(B)(3)(c).
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    If the Exchange receives an order, quote or sweep on the same side
of the market as the initiating quote or order during the Quote Exhaust
Timer, the Phlx XL II system would cancel any sweep or IOC order.\25\
If such new quote or order, other than an IOC order, is a market or
marketable limit order or marketable quote (i.e., priced at or through
the reference price) the Phlx XL II system would display it at the
reference price, with a disseminated size that is the sum of such order
and/or quote plus the remaining contracts in the initiating order or
quote. According to Phlx, the purpose of this provision is to enhance
liquidity on the Exchange by adding all available liquidity received
during the Quote Exhaust Timer to the PBBO at the reference price.
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    \25\ See proposed Rule 1082(a)(ii)(B)(3)(d).
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    If there are still unexecuted contracts remaining in the initiating
quote or order or any new interest on the same side of the market, the
Phlx XL II system would calculate a new PBBO.\26\ The Phlx XL II system
would conduct an Acceptable Range price ``test'' to determine whether
there is a valid next available price at which the Phlx XL II system
may execute the remaining unexecuted contracts.\27\
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    \26\ See proposed Rule 1082(a)(ii)(B)(3)(e).
    \27\ See proposed Rule 1082(a)(ii)(B)(3)(f). The Acceptable
Range for the next available price would be calculated by the Phlx
XL II system by taking the reference price, plus or minus a value to
be determined by the Exchange (i.e., the reference price-(x) for
sell orders and the reference price + (x) for buy orders).
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    The Phlx XL II system then conducts a Quote Exhaust Resolution,\28\
determining whether to trade at the next available Phlx price by
comparing it to the Acceptable Range price and the ABBO price to
establish a Best Price. The Phlx XL II system then considers whether
the price of the initiating quote or order locks or crosses the Best
Price, which, in turn, determines whether the initiating quote or order
trades, is routed or is posted.\29\
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    \28\ See proposed Rule 1082(a)(ii)(B)(3)(g).
    \29\ For further details regarding the Quote Exhaust Resolution,
including how the Phlx XL II system would determine whether to
route, trade and/or post interest, see Notice at 17250 and Amendment
No. 3.
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Initiating Quote or Order Locks the Best Price
    If the initiating quote or order locks the Best Price, the system
would execute, route if a routable order, and/or post the initiating
quote or order as follows:
    If the Best Price is the next Phlx price, the system would execute
a trade up to

its disseminated size. If this Best Price (next Phlx price) is equal to
the ABBO price, any remaining unexecuted routable order volume from the
execution on the Phlx would be routed away. After such routing, any
remaining unexecuted contracts would be posted on the Exchange at the
ABBO price. If this Best Price (next Phlx price) is equal to the
Acceptable Range price, any remaining unexecuted routable order volume
from the execution on the Phlx would be posted on the Exchange at the
Acceptable Range price. Lastly, if this Best Price (next Phlx price) is
equivalent to both the ABBO and the Acceptable Range price, any
remainder order volume from the execution on the Phlx would be routed
away, and if after routing there still remains open contracts, the
remainder would be posted on the Phlx at the Acceptable Range price.
    If the Best Price is the ABBO, where the ABBO is not equal to the
next Phlx price, the initiating order would be routed away up to the
size of the ABBO and, after routing, any remaining unexecuted contracts
from the initiating order would be posted on the Exchange at the ABBO
price. If the Best Price (ABBO is not equal to the next Phlx price)
equals the Acceptable Range price, the initiating order would be routed
away and after such routing, any remaining unexecuted contracts would
be posted on the Exchange at the ABBO price.
    If the Best Price is the Acceptable Range Price, where the
Acceptable Range Price is not equal to either the next Phlx price or
the ABBO, the initiating order or quote would be posted at the
Acceptable Range Price.
Initial Quote or Order Crosses Best Price
    If the initiating quote or order crosses the Best Price, the Phlx
XL II system would execute, route, and/or post the initiating quote or
order as described below:
    If the Best Price is the next Phlx price, the Phlx XL II system
would execute a trade at the Exchange's next available price up to the
Exchange's disseminated size. If this Best Price (next Phlx price) is
equal to the ABBO price, any remaining order volume from the execution
on the Exchange would be routed away and, after such routing, any
remainder volume would be posted on the Exchange at the ABBO price. If
this Best Price (next Phlx price) is equal to the Acceptable Range
price, any remaining volume from the execution on the Phlx would be
posted at the Acceptable Range Price or if locking or crossing the away
market price, one minimum variation from the away market price for the
remaining size for a period not to exceed ten seconds and cancelled
after this time has elapsed. During this period, the Phlx XL system
would disseminate if the remaining size is a buyer, an offer that is
$200,000, with a size of one or, if the remaining size is a seller, a
bid that is $0.00, with a size of one, on the opposite side of the
market from remaining unexecuted contracts.
    Lastly, if this Best Price (next Phlx price) is equal to both the
ABBO and the Acceptable Range price, any remainder order volume from
the execution on the Phlx would be routed away, and if after routing
there still remain unexecuted contracts, the remainder would be posted
on the Phlx at the Acceptable Range price for a period not to exceed
ten seconds, and cancelled after this time has elapsed. During this
period, the Phlx XL system would disseminate if the remaining size is a
buyer, an offer that is $200,000, with a size of one or, if the
remaining size is a seller, a bid that is $0.00, with a size of one, on
the opposite side of the market from remaining unexecuted contracts.
    If the Best Price is the ABBO, where the ABBO is not equal to the
next Phlx price, the initiating order would be routed away and if after
routing there remain unexecuted contracts, the remainder of the
initiating order would be posted on the Phlx at the ABBO price. If this
Best Price (ABBO is not equal to the next Phlx price) equals the
Acceptable Range price, the initiating order would be routed away and
if after routing there remain unexecuted contracts, the remainder of
the order would be posted on the Phlx at the ABBO price for a period
not to exceed ten seconds, and cancelled after this time has elapsed.
During this period, the Phlx XL II system would disseminate if the
remaining size is a buyer, an offer that is $200,000, with a size of
one or, if the remaining size is a seller, a bid that is $0.00, with a
size of one, on the opposite side of the market from remaining
unexecuted contracts.
    If the Best Price is the Acceptable Range price, where the
Acceptable Range price is not equal to either the next Phlx price or
the ABBO, the initiating quote or order would be posted on the Exchange
at the Acceptable Range price for a period not to exceed ten seconds,
and cancelled after this time has elapsed. During this period, the Phlx
XL II system would disseminate if the remaining size is a buyer, an
offer that is $200,000, with a size of one or, if the remaining size is
a seller, a bid that is $0.00, with a size of one, on the opposite side
of the market from remaining unexecuted contracts.
    If the initiating order is non-routable, when the order would
otherwise route according to the process described above, the order
would be posted on the Phlx at a price one minimum trading increment
inferior to the Best Price so as not to lock an away market.\30\
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    \30\ See proposed Rule 1082(a)(ii)(B)(3)(g)(v).
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Exchange Generate Quote
    If the Exchange's disseminated size in a particular series is
exhausted at that particular price level, and no specialist, SQT or
RSQT has revised their quotation immediately following the exhaustion
of the Exchange's disseminated size at such price level, in Phlx XL II,
the Exchange would disseminate a bid of $0.00 and an offer of $200,000,
each for a size of one contract.\31\
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    \31\ See proposed Rule 1082(a)(ii)(B)(4)(a). The Exchange
represents that it would, as it does today, surveil for compliance
on the part of specialists (and SQTs and RSQTs) with the Exchange's
continuous quoting requirements. See Exchange Rule 1014(b)(ii)(D).
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Market Exhaust \32\

    Market Exhaust occurs when there are no Phlx XL II participant
quotations in the Exchange's disseminated market for a particular
series and an initiating order in the series is received. In such a
circumstance, the Phlx XL II system, using Market Exhaust, would
initiate a Market Exhaust Auction for the initiating order.\33\ When an
initiating order is received when there are no quotations in the
Exchange market, the Phlx XL II system would determine if the PBBO on
the opposite side of the market from the initiating order is
represented by an order on the Phlx order book which is priced equal to
or better than the ABBO on that same side of the market.
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    \32\ For a more detailed discussion of the terms of the proposed
Market Exhaust, see the Notice at 17252-55 and Amendment No. 3.
    \33\ See proposed Rule 1082(a)(ii)(B)(4).
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    If that Phlx market represented by an order on the Phlx order book
is the NBBO, then the initiating order would immediately trade with the
order at the PBBO price. If there are still unexecuted contracts
remaining in the initiating order, the XL II system would initiate a
Quote Exhaust Timer. The price at which the initiating order traded
becomes the reference price. During the Quote Exhaust Timer, the
Exchange would disseminate the reference price for the remaining size,
provided that such price does not lock an away market, in which case,
the Exchange would disseminate a bid and offer that is one Minimum
Price Variation

(``MPV'') from the away market price, and if the remaining size is a
buyer, an offer that is $200,000, with a size of one or, if the
remaining size is a seller, a bid that is $0.00, with a size of one, on
the opposite side of the market from remaining unexecuted contracts.
    If that Phlx market is not at the NBBO, then the Phlx XL II system
would immediately broadcast a notification (an ``Auction
Notification'') to Phlx XL II participants; the purpose of the auction
is to seek participation and determine the best price at which the
contracts in the initiating order may be executed (the ``Auction
Price''). The Auction Notification would include the series, size and
side of the market of the initiating order. The Auction Notification
would not include a price. The Auction would be for a period of time
not to exceed three seconds (the ``Auction Period'').
    During the Auction Period, Phlx XL II participants may submit bids
and offers in response to the Auction Notification into the system
until the end of the Auction Period.\34\ Such responsive bids and
offers may be submitted to the system via (1) a two-sided quote; (2) a
single-sided, single-priced quotation for the auction to be known as
``Auction Sweep'' that would be effective only for the Auction Period
and cancelled at the end of that period if not executed,\35\ and (3)
limit orders. IOC Orders would be cancelled immediately if not executed
and would not participate in the Market Exhaust process. In addition,
incoming orders from non-Phlx XL II participants and existing orders on
the book would be eligible to participate at the end of the Auction
Period, together with responses to the Auction Notification.
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    \34\ See proposed Rule 1082(a)(ii)(B)(4)(c).
    \35\ See proposed Rule 1082(a)(ii)(B)(4)(c)(i). The Auction
Sweep may be entered only during the auction process and would
remain in effect only until the auction is completed. A single Phlx
XL II participant may enter multiple Auction Sweeps, with each
Auction Sweep at a different price level. If a Phlx XL II
participant submits multiple Auction Sweeps, the Phlx XL II system
would consider only the most recent Auction Sweep at each price
level submitted by such Phlx XL II participant in determining the
Auction Price. The Phlx XL II system would aggregate the size of all
Auction Sweeps (i.e., for all Phlx XL II participants) at a
particular price level for trade allocation purposes.
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    If at the end of the Auction Period, there are no valid-width
auction quotes\36\ in the Exchange market, the initiating order, plus
all other Auction Sweeps and orders received during the Auction Period
would be cancelled.\37\ Quotes that are not valid-width auction quotes
would remain and a new PBBO would be calculated and disseminated. If at
the end of the Auction Period there are valid-width auction quotes, the
Phlx XL II system would determine the allowable executable price range
from the lowest valid-width auction quote bid and the highest valid-
width auction quote ask; this is the Auction Quote Range (``AQR'').
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    \36\ A valid-width auction quote is a quote that has a bid/ask
differential that complies with the parameters set forth in a table
developed by the Exchange which would be published in an Options
Trader Alert and posted on the Exchange's website.
    \37\ See proposed Rule 1082(a)(ii)(B)(4)(d).
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    If the initiating order can be completely executed at or within the
AQR and the ABBO, using contracts available from all available quotes,
Auction Sweeps or orders priced at or within the AQR, a trade would be
executed at the Exchange at the Auction Price.
    If quotes, Auction Sweeps and orders submitted during the Auction
Period would not allow the entire initiating order to trade at a price
within the AQR without trading through the ABBO, the Phlx XL II system
would determine if the total number of contracts displayed at the ABBO
price on away markets would satisfy the number of marketable contracts
available on the Exchange. If it does, the Phlx XL II system would
route a number of contracts that would satisfy interest at other
markets at the ABBO price, and determine a PBBO that reflects the
remaining Phlx interest without locking the away market. In this
situation, the Phlx XL II system would price any contracts routed to
other markets at the ABBO price.
    If the total number of contracts priced at the ABBO would not
satisfy the number of marketable contracts the Exchange has, the Phlx
XL II system would determine how many contracts it has available on the
Exchange at a price equal to the ABBO. If the total number of ABBO
contracts plus the number of contracts available on the Exchange at the
ABBO price would satisfy the number of marketable contracts the
Exchange has, the ABBO price becomes the Exchange Auction Price and the
Phlx XL II system would trade available contracts on the Exchange at
the Exchange Auction Price and contemporaneously route a number of
contracts that would satisfy interest at other markets at prices better
than the Exchange Auction Price. In this situation, the Phlx XL II
system would price any contracts routed to other markets at the away
market price. The Exchange Auction Price would always be at or within
the AQR.
    If the total number of ABBO contracts plus the number of contracts
available on the Exchange at the ABBO price would not satisfy the
number of marketable contracts the Exchange has, the Phlx XL II system
would determine how many contracts are available on the Exchange at a
price that is one MPV through the ABBO price. If the total number of
ABBO contracts plus the number of contracts available on the Exchange
at the ABBO price plus the number of contracts available on the
Exchange at a price that is one MPV through the ABBO price would
satisfy the number of marketable contracts the Exchange has, the price
that is one MPV through the ABBO becomes the Exchange Auction Price.
The system would contemporaneously route a number of contracts that
would satisfy interest at the ABBO and trade a number of contracts that
would satisfy interest on the Exchange at the Exchange Auction
Price.\38\ In this situation, the Phlx XL II system would price any
contracts routed to other markets at the Exchange Auction Price.
---------------------------------------------------------------------------

    \38\ The Phlx XL II system would route contracts to the ABBO
when the next Phlx price is greater than one MPV through the ABBO.
---------------------------------------------------------------------------

    If the total number of ABBO contracts plus the number of contracts
available on the Exchange at the ABBO price plus the number of
contracts available on the Exchange at a price that is one MPV through
the ABBO price would not satisfy the number of marketable contracts the
Exchange has, the system may repeat the auction process up to three
times.
    If after that number of times, the Phlx XL II system still cannot
either route and/or trade the entire initiating order, the Phlx XL II
system would conduct a Provisional Auction by routing to markets at the
ABBO for their disseminated size, and trading as many contracts as
possible on the Exchange at the ABBO price and at a price that is one
MPV through the ABBO price. In this situation, the Phlx XL II system
would price any contracts routed to other markets at the ABBO price.
    The Auction would then be complete. Any unexecuted contracts from
the initiating order would be displayed in the Exchange quote at the
Auction Price for the remaining size for a brief period not to exceed
ten seconds and subsequently cancelled back to the entering participant
if they remain unexecuted and priced through the Auction Price. During
the brief period, the Phlx XL II system would disseminate if the
remaining size is a buyer, an offer that is $200,000, with a size of
one or, if the remaining size is a seller, a bid that is $0.00, with a
size of one, on the opposite side of the market from remaining
unexecuted contracts.
    In sum, the Exchange states that the automated auction process
logic seeks to first route away all contracts executable

at a better price than the Exchange's Auction Price, then executes all
contracts available on the Exchange at the Auction Price or one MPV
through the NBBO and, lastly, routes away all contracts available at
other exchanges at the Exchange's Auction Price.
    The foregoing processes occur contemporaneously.

Expanded Order Types \39\

    The Exchange has proposed three new order types: Do-Not-Route
(``DNR'') order, a FIND order, and a SRCH order.
---------------------------------------------------------------------------

    \39\ For a more detailed discussion of the proposed new order
types, see Notice at 17255-57 and Amendment No. 3.
---------------------------------------------------------------------------

DNR Orders
    A DNR order may execute on the Exchange at a price equal to or
better than, but not inferior to, the best away market price but, if
that best away market remains, the DNR order would remain in the Phlx
book and be displayed at a price one minimum price variation inferior
to that away best bid/offer.\40\ A DNR order would never be routed
outside of Phlx regardless of the prices displayed by away markets. Any
incoming order interacting with such a resting DNR order would receive
the best away market price. Should the best away market change its
price, or move to an inferior price level, the DNR order would
automatically re-price from its one minimum price variation inferior to
the original away best bid/offer price to one minimum trading increment
away from the new away best bid/offer price or its original limit
price. Once priced at its original limit price, it would remain at that
price until executed or cancelled. Should the best away market improve
its price such that it locks or crosses the DNR order limit price, the
Exchange would execute the resulting incoming order that is routed from
the away market that locked or crossed the DNR order limit price.
---------------------------------------------------------------------------

    \40\ See proposed Rule 1080(m)(iv)(A).
---------------------------------------------------------------------------

FIND Orders
    A FIND order is an order that would be routable upon receipt, or
any time the option goes through an opening process.\41\ A FIND order
on the Phlx XL II book during an opening would be routed as part of the
Opening Process. Once the Opening Process is complete, the FIND order
would either be eligible to trade at the Phlx price or placed on the
Phlx book either at its limit price or at a price that is one MPV from
the ABBO price if it would otherwise lock or cross the ABBO. A FIND
order would not be eligible for routing until the next time the option
series is subject to a new Opening Process. A FIND order received
during open trading that is not marketable against the PBBO or the ABBO
would be entered into the Phlx XL II book at its limit price. The FIND
order would not be eligible for routing until the next time the option
series is subject to a new Opening Process.
---------------------------------------------------------------------------

    \41\ See proposed Rule 1080(m)(iv)(B).
---------------------------------------------------------------------------

    A FIND order received during open trading that would be marketable
against the PBBO when the ABBO is inferior to the PBBO would be traded
at the Exchange at the PBBO price. If the FIND order has size remaining
after exhausting the PBBO, it may (1) trade at the next PBBO price (or
prices) if the order price is locking or crossing that price (or
prices) up to and including the ABBO price, or (2) be entered into the
Phlx XL II book at its limit price, or entered into the Phlx XL II book
at one MPV away from the ABBO if locking or crossing the ABBO. The FIND
order would not be eligible for routing until the next time the option
series is subject to a new Opening Process.
    A FIND order received during open trading that is marketable
against the PBBO when the ABBO is equal to the PBBO would be traded at
the Exchange at the PBBO. If the FIND order has size remaining after
exhausting the PBBO, it would initiate a Route Timer not to exceed one
second in order to allow Phlx XL II participants and other market
participants an opportunity to interact with the remainder of the FIND
order. During the Route Timer, the FIND order would be included in the
PBBO at a price one MPV away from the ABBO. If, during the Route Timer,
any new interest arrives opposite the FIND order that is equal to or
better than the ABBO price, the FIND order would trade against such new
interest at the ABBO price. What happens to a FIND order after the
Route Timer expires depends on the ABBO price at that time.\42\
---------------------------------------------------------------------------

    \42\ See id. For further details regarding FIND orders,
including what happens to a FIND order after the Route Timer expires
in the situation described above, see Notice at 17256 and Amendment
No. 3.
---------------------------------------------------------------------------

    A FIND order received during open trading that is marketable
against the ABBO when the ABBO is better than the PBBO would initiate a
Route Timer not to exceed one second in order to allow Phlx XL II
participants and other market participants an opportunity to interact
with the FIND order. During the Route Timer, the FIND order would be
included in the PBBO at a price one MPV away from the ABBO. If, during
the Route Timer, any new interest arrives opposite the FIND order that
is equal to or better than the ABBO price, the FIND order would trade
against such new interest at the ABBO price. What happens to a FIND
order after the Route Timer expires depends on the ABBO price at that
time.\43\
---------------------------------------------------------------------------

    \43\ See id. For further details regarding FIND orders,
including what happens to a FIND order after the Route Time expires
in the situation described above, see Notice at 17256 and Amendment
No. 3.
---------------------------------------------------------------------------

SRCH Orders
    A SRCH order is an order that would be routable at any time.\44\ A
SRCH order on the Phlx XL II book during an opening, whether it is
received prior to the opening or it is a GTC SRCH order from a prior
day, would be routed as part of the Opening Process. Once the Opening
Process is complete, a SRCH order would be eligible either to: (1)
Trade at the Phlx price, if that price is equal to or better than the
ABBO or, if the ABBO is better than the Phlx price, orders have been
routed to the ABBO markets for their full size; or (2) be routed to the
ABBO if the ABBO price is the best price, and/or (3) be placed on the
Phlx XL II book at its limit price if not participating in the Phlx
opening at the opening price and not locking or crossing the ABBO. Once
on the book, the SRCH order would be eligible for routing if it is
locked or crossed by an away market.
---------------------------------------------------------------------------

    \44\ See proposed Rule 1080(m)(v)(C).
---------------------------------------------------------------------------

    A SRCH order received during open trading that is not marketable
against the PBBO or the ABBO would be entered into the Phlx XL II book.
Once on the book, the SRCH order is eligible for routing if it is
locked or crossed by an away market. A SRCH order received during open
trading that is marketable against the PBBO when the ABBO is inferior
to the PBBO would be traded at the Exchange at the PBBO price. If the
SRCH order has size remaining after exhausting the PBBO, it may (1)
trade at the next PBBO price (or prices) if the order price is locking
or crossing that price (or prices) up to and including the price equal
to the ABBO price, and/or (2) be routed, subject to a Route Timer not
to exceed one second, to the ABBO markets if all Phlx interest at
better or equal prices has been exhausted, and/or (3) be entered into
the Phlx XL II book at its limit price if not locking or crossing the
Phlx price or the ABBO. Once on the book, the SRCH order would be
eligible for routing if it is locked or crossed by an away market.
    A SRCH order received during open trading that is marketable
against the PBBO when the ABBO is equal to the PBBO would be traded at
the Exchange at the PBBO. If the SRCH order has size remaining after
exhausting the PBBO, it would initiate a Route Timer not to exceed one
second in order to allow

Phlx XL II participants and other market participants an opportunity to
interact with the SRCH order. During the Route Timer, the SRCH order
would be included in the PBBO at a price one MPV away from the ABBO.
If, during the Route Timer, any new interest arrives opposite the SRCH
order that is equal to or better than the ABBO price, the SRCH order
would trade against such new interest at the ABBO price. What happens
to a SRCH order after the Route Timer expires depends on the ABBO price
at that time.\45\
---------------------------------------------------------------------------

    \45\ See id. For further details regarding SRCH orders,
including what happens to a SRCH order after the Route Timer expires
in the situation described above, see Notice at 17257 and Amendment
No. 3.
---------------------------------------------------------------------------

    A SRCH order received during open trading that is marketable
against the ABBO when the ABBO is better than the PBBO would initiate a
Route Timer not to exceed one second in order to allow Phlx XL II
participants and other market participants an opportunity to interact
with the remainder of the SRCH order. During the Route Timer, the SRCH
order would be included in the PBBO at a price one MPV inferior to the
ABBO. If, during the Route Timer, any new interest arrives opposite the
SRCH order that is equal to or better than the ABBO price, the SRCH
order would trade against such new interest at the ABBO price. What
happens to a SRCH order after the Route Timer expires depends on the
ABBO price at that time.\46\
---------------------------------------------------------------------------

    \46\ See id. For further details regarding SRCH orders,
including what happens to a SRCH order after the Route Timer expires
in the situation described above, see Notice at 17257 and Amendment
No. 3.
---------------------------------------------------------------------------

    A SRCH order on the Phlx XL II book may be routed to an away market
if it is locked or crossed by an away market. If an ABBO locks or
crosses the PBBO which includes a SRCH order, the Phlx XL II system
would initiate a Route Timer not to exceed one second in order to allow
Phlx users an opportunity to interact with the SRCH order. During the
Route Timer, the SRCH order would remain in the PBBO at its posted
price. If, during the Route Timer, any new interest arrives opposite
the SRCH order that is equal to or better than the ABBO price, the SRCH
order would trade against such new interest at the ABBO price. What
happens to a SRCH order after the Route Timer expires depends on the
ABBO price at that time.\47\
---------------------------------------------------------------------------

    \47\ See id. For further details regarding SRCH orders,
including what happens to a SRCH order after the Route Timer expires
in the situation described above, see Notice at 17257 and Amendment
No. 3.
---------------------------------------------------------------------------

Order Routing \48\

    The Phlx XL II system would route only customer FIND and SRCH
orders with no other contingencies. Customer FIND and SRCH orders would
first be checked by the Phlx XL II system for available contracts for
potential execution, then orders are sent to other available market
centers for potential execution. When checking the book, the Phlx XL II
system would seek to execute at the price at which it would send the
order to a destination market center. In situations where the
Exchange's disseminated bid or offer is one MPV inferior to the NBBO
price, the Phlx XL II system would contemporaneously route to the away
market(s) disseminating the NBBO at such away market's size, and
execute remaining contracts at the Exchange's disseminated bid or offer
up to its disseminated size. If contracts remain unexecuted after
routing, they are posted on the book. Once on the book, should the
order subsequently be locked or crossed by another market center, the
Phlx XL II system would not route the order to the locking or crossing
market center, except as specified.
---------------------------------------------------------------------------

    \48\ For a more detailed discussion of the terms of the proposed
routing functions, see Notice at 17255 and Amendment No. 3.
---------------------------------------------------------------------------

    Orders sent to other markets do not retain time priority with
respect to other orders in the Phlx XL II system and the Phlx XL II
system would continue to execute other orders while routed orders are
away at another market center. Once routed by the Phlx XL II system, an
order becomes subject to the rules and procedures of the destination
market including, but not limited to, order cancellation. If a routed
order is subsequently returned, in whole or in part, that order, or its
remainder, would receive a new time stamp reflecting the time of its
return to the Phlx XL II system.\49\ Entering member organizations
whose orders are routed to away markets would be obligated to honor
such trades that are executed on away markets to the same extent they
would be obligated to honor a trade executed on the Exchange.\50\
---------------------------------------------------------------------------

    \49\ See proposed Rule 1080(m)(i).
    \50\ See proposed Rule 1080(m)(ii).
---------------------------------------------------------------------------

    In addition, the Exchange proposes to establish Nasdaq Options
Services LLC (``NOS'') as the Exchange's exclusive order router.\51\
NOS will serve as the routing facility of the Exchange (``Routing
Facility''), and the sole use of NOS by the Exchange\52\ will be to
route orders in options listed and open for trading on the Phlx XL II
system to away market centers pursuant to Exchange rules.\53\ Also, NOS
will be a member of an SRO unaffiliated with Phlx that is its
designated examining authority.\54\
---------------------------------------------------------------------------

    \51\ See proposed Rule 1080(m)(iii)(A).
    \52\ The Commission notes that if NOS were to perform any other
functions for Phlx, Phlx would have to file a proposed rule change
with the Commission pursuant to Section 19 of the Act and the rules
and regulations thereunder.
    \53\ See Rule 1080(m)(iii)(A). The Commission notes that because
the routing services provided by NOS will be pursuant to Exchange
rules, they will be available only to Exchange members. Further, the
Commission notes that the two order types that would be available
for routing--FIND and SRCH--would both first check the Phlx XL II
system for available liquidity before routing to other market
centers.
    \54\ See id.
---------------------------------------------------------------------------

    The use of NOS to route orders to other market centers would be
optional. Parties that do not desire to use NOS must designate orders
as not available for routing.\55\ The Exchange would establish and
maintain procedures and internal controls reasonably designed to
adequately restrict the flow of confidential and proprietary
information between the Exchange and the Routing Facility, and any
other entity, including any affiliate of the Routing Facility, and, if
the Routing Facility or any of its affiliates engages in any other
business activities other than providing routing services to the
Exchange, between the segment of the Routing Facility or affiliate that
provides the other business activities and the routing services.\56\ In
addition, the books, records, premises, officers, directors, agents,
and employees of the Routing Facility, as a facility of the Exchange,
would be deemed to be the books, records, premises, officers,
directors, agents, and employees of the Exchange, for purposes of and
subject to oversight pursuant to the Act, and such books and records of
the Routing Facility would be subject at all times to inspection and
copying by the Exchange and the Commission.\57\
---------------------------------------------------------------------------

    \55\ See proposed Rule 1080(m)(iii)(B).
    \56\ See proposed Rule 1080(m)(iii)(C).
    \57\ See 1080(m)(iii)(D).
---------------------------------------------------------------------------

    Exchange Rule 985(b) generally prohibits the Phlx or an entity with
which it is affiliated from acquiring or maintaining an ownership
interest in, or engaging in a business venture with a Phlx member or an
affiliate of a Phlx member in the absence of an effective filing with
the Commission under Section 19(b) of the Act. NOS is a member of Phlx,
and also an indirect, wholly owned subsidiary of Phlx's parent company,
and therefore an affiliate of Phlx. In July 2008, the Commission
approved NOS as an affiliate of Phlx for the limited purpose of
providing routing services for NASDAQ Exchange for orders that first

attempt to access liquidity on NASDAQ Exchange's systems before routing
to Phlx, and subject to certain conditions.\58\ The Exchange now
requests that the Commission provide a further exemption from the
restrictions on affiliation by allowing Phlx to use NOS to provide
routing services for orders that first attempt to access liquidity on
the Phlx's systems before routing to other exchanges.
---------------------------------------------------------------------------

    \58\ See Securities Exchange Act Release No. 58179 (July 17,
2008), 73 FR 42874 (July 23, 2008) (SR-Phlx-2008-31).
---------------------------------------------------------------------------

Miscellaneous Rule Changes

    The Exchange proposes to make various additional changes and
updates to delete obsolete provisions and generally update the relevant
rules. \59\
---------------------------------------------------------------------------

    \59\ For a more detailed discussion of these additional changes,
see Notice at 17257-58 and Amendment No. 3.
---------------------------------------------------------------------------

Pilot

    In the situations described above where the Exchange proposes to
disseminate quotations on one side of the market with a price of $0.00
or $200,000 and a size of one contract, the relevant rule provisions
would be subject to a pilot period scheduled to end on November 30,
2009.

Rollout and Deployment

    The Exchange expects to roll out the Phlx XL II system over a
period of 12 weeks following Commission approval of this proposal (the
``rollout period''), beginning with one single option traded on the
Phlx XL II system, while other options traded on the Exchange would
continue to trade on the original Phlx XL system (the ``legacy
system'') during the rollout period. By the end of the rollout period,
all options traded on the Exchange would be traded on the Phlx XL II
system, and no options would be traded on the legacy system.
Accordingly, the Exchange proposes to distinguish the proposed rules
applicable to options traded on the Phlx XL II system from existing
Exchange rules applicable to options traded on the legacy system.
    Within 90 days following the completion of the rollout of the Phlx
XL II system, the Exchange has represented that it will offer a data
feed to all market participants, which would include disseminated
Exchange top-of-market data (including orders, quotes and trades). The
new data feed would also include all information that is included in
the Exchange's Specialized Order Feed (``SOF''), which provides
information concerning simple orders, complex orders and complex
strategies to Exchange quoting members. The Exchange has also
represented that, with respect to the speed with which users would
receive this information, SOF users would receive this information no
sooner than users of the new data feed.

III. Summary of Comments Received and Phlx's Response

    The Commission received two comment letters objecting to certain
aspects of Phlx's proposed rule change.\60\ Both commenters object to
Phlx's original proposal with regard to its proposed changes to Phlx's
Firm Quote Rule, with NYSE Euronext believing that Phlx would not be
displaying its best priced quotation, in violation of Rule 602 under
the Act.\61\ NYSE Euronext argues that this aspect of Phlx's proposal
erodes investor confidence and adds unnecessary confusion to the
marketplace.\62\
---------------------------------------------------------------------------

    \60\ See NYSE Euronext Letter and CBOE Letter, supra at footnote
7.
    \61\ See 17 CFR 242.602 (Dissemination of Quotations in NMS
Securities).
    \62\ See NYSE Euronext Letter at 2.
---------------------------------------------------------------------------

    In its initial filing, in certain situations in the Opening, Quote
Exhaust and Market Exhaust Processes, Phlx proposed to disseminate the
reference price at a zero-size quotation on one side of the market.
NYSE Euronext argues that Phlx's proposed zero-size quotation would
mask its true best available price and also fall short of Rule 602's
minimum size requirements. NYSE Euronext argues that disseminating
zero-size quotes in this manner would also raise issues for ``smart
routers'' which are generally programmed to route to the NBBO, which
NYSE Euronext believes would result in increased order processing
latency and might prevent customers an opportunity for execution
because routers might be delayed in sending orders to other market
centers that actually had liquidity at their displayed best bid or
offer.\63\ The commenters state that market participants, including
options exchanges, market makers and routers, would encounter
operational difficulties with the zero-size quotation, in that it would
require systems to be reprogrammed or otherwise adjusted to work around
the Phlx-generated quote.\64\
---------------------------------------------------------------------------

    \63\ See NYSE Euronext Letter at 1-2.
    \64\ See NYSE Euronext Letter at 2 and CBOE Letter at 2.
---------------------------------------------------------------------------

    Both commenters also point to conflicts of the Phlx zero-size
proposal with The Plan for the Purpose of Creating and Operating an
Intermarket Option Linkage (``Current Linkage Plan''),\65\ with NYSE
Euronext noting that markets may not be able to avail themselves of
certain provisions of the plan that require a Linkage Order to be sent
to the exchange at the NBBO. CBOE states that the proposed quotation
would undermine the objectives of the Current Linkage Plan and impact
the willingness of CBOE members and traders across the industry to post
bids or offers when Phlx was displaying the zero-sized quotation, if
they might create or contribute to a locked market.
---------------------------------------------------------------------------

    \65\ See NYSE Euronext Letter at 2-3 and CBOE Letter at 1-2.
---------------------------------------------------------------------------

    Finally, NYSE Euronext also argues that disseminating prices with
no associated size to the Options Price Reporting Authority (``OPRA'')
for dissemination to vendor is inconsistent with the provisions of the
OPRA plan as it would not ``reflect the current state of the market.''
\66\
---------------------------------------------------------------------------

    \66\ See Plan for Reporting of Consolidated Options Last Sale
Reports and Quotation Information, Section V(b).
---------------------------------------------------------------------------

    In its comment letter, CBOE also raises concerns regarding
execution at the end of the Market Exhaust Auction.\67\ Specifically,
CBOE notes that, at the end of the auction if Phlx has an order that
could be filled within the AQR, it would trade at the best price in
which the entire order can be executed. CBOE questions why, under this
framework, ``better priced auction responses are ignored just because
they are not large enough to fill the entire order, when the order, by
its terms, is eligible for a partial fill'' and how customer orders
benefit from this process.\68\
---------------------------------------------------------------------------

    \67\ See CBOE Letter at 2-3.
    \68\ See CBOE Letter at 3.
---------------------------------------------------------------------------

    CBOE also expresses concern that the proposed rule change may
contemplate certain entitlements (e.g., directed order, preferred, and
specialist entitlements) extending to the final execution in a Market
Exhaust Auction \69\ and is specifically concerned about how Phlx's
matching rules regarding order allocation would apply to a situation
where the aggregate contra-interest at the final auction price is
greater in size than the initiating order. CBOE requested clarification
on whether such entitlements would be applied when the potential
recipient of the entitlement (i.e., the specialist or directed Market
Maker) was not quoting the series at the time the initiating order was
received.
---------------------------------------------------------------------------

    \69\ See id.
---------------------------------------------------------------------------

    Finally, CBOE notes that the auction appears to take place even if
there are orders on the Phlx book.\70\ CBOE questions whether those
existing orders are allowed to participate in the auction,

as CBOE interprets the proposed rule change as providing the auction
notification only to Phlx market makers.
---------------------------------------------------------------------------

    \70\ See id.
---------------------------------------------------------------------------

    In its Response Letter, Phlx noted that, in Amendment No. 3, it
responded to many of the concerns raised by CBOE, as well as all of
NYSE Euronext's comments.\71\
---------------------------------------------------------------------------

    \71\ See Response Letter at 1.
---------------------------------------------------------------------------

    In responding to CBOE's comment relating to the end of the Market
Exhaust Auction, when the XL II system would trade at the at the best
price (within an established AQR) that the entire order can be
executed, Phlx explains that its Market Exhaust Auction would function
in the same manner as its proposed opening process, in that it would
result in a single price where the entire incoming order can be filled
with normal NBBO protection.\72\ Phlx disputes CBOE's contention that
contra-side bids or offers received during the auction at a better
price than the execution price would be ``ignored,'' and notes that
such bids or offers would have price priority and would be executed at
the single execution price.\73\
---------------------------------------------------------------------------

    \72\ See id.
    \73\ See id.
---------------------------------------------------------------------------

    Phlx further explains that, if the PBBO includes marketable limit
orders on the Phlx limit order book at the time the incoming order is
received that are priced at or within the NBBO, such orders would be
executed immediately by its XL II system before the auction begins,
while limit orders that are not at the PBBO and are at or within the
NBBO would participate in the auction.\74\ Finally, Phlx states that
its XL II system would not execute any trade at a price through the
NBBO unless it had routed contracts to the NBBO markets
contemporaneously (consistent with the ``trade and ship'' concept).\75\
---------------------------------------------------------------------------

    \74\ See id.
    \75\ See id at 1-2.
---------------------------------------------------------------------------

    Finally, in response to CBOE's request for clarification regarding
participation entitlements under the proposed exhaust auctions, Phlx
explains that for specialists that receive Directed Orders in trade
allocations stemming from trade executions following an exhaust
auction, the trade allocation algorithm set forth in Phlx Rule
1014(g)(vii) would apply.\76\ Phlx further notes that to receive its
entitlement, a specialist must have submitted a quote at the execution
price and is not entitled to receive a number of contracts that is
greater than his or her disseminated size.\77\ Phlx states that, for
Directed Orders, the trade allocation algorithm set forth in Phlx Rule
1014(g)(viii) would apply and clarifies that, in order for a Directed
Specialist, Directed SQT or Directed RSQT participant to receive their
entitlement, they must be quoting at the Phlx disseminated price (which
must be at the NBBO) at the time of receipt of the Directed Order.
Therefore, if a Directed Specialist, Directed SQT or Directed RSQT does
not submit a quotation at the NBBO execution price until the auction is
initiated, they would not receive the entitlement described in Phlx
Rule 1014(g)(viii).\78\
---------------------------------------------------------------------------

    \76\ See id at 2.
    \77\ See id.
    \78\ See id.
---------------------------------------------------------------------------

IV. Discussion

    After carefully reviewing the proposed rule change, as amended, the
Commission finds that the proposal is consistent with the requirements
of the Act and the rules and regulations thereunder applicable to a
national securities exchange.\79\ In particular, the Commission finds
that the proposed rule change, as amended, is consistent with Section
6(b)(5) of the Act,\80\ which, among other things, requires that the
rules of a national securities exchange be designed to promote just and
equitable principles of trade, to foster cooperation and coordination
with persons engaged in regulating transactions in securities, to
remove impediments to and perfect the mechanism of a free and open
market and a national market system and, in general, to protect
investors and the public interest. The Commission also finds that the
proposed rule change, as amended, is consistent with the provisions of
Section 6(b)(8) of the Act,\81\ which requires that the rules of an
exchange not impose any burden on competition not necessary or
appropriate in furtherance of the purposes of the Act.
---------------------------------------------------------------------------

    \79\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
    \80\ 15 U.S.C. 78f(b)(5).
    \81\ 15 U.S.C. 78f(b)(8).
---------------------------------------------------------------------------

    The Commission notes that while it believes the proposed rule
change, as amended, is consistent with the Current Linkage Plan, the
Exchange acknowledges that, should the Commission approve the proposed
Options Order Protection and Locked/Crossed Market Plan,\82\
modifications to certain proposed rules may be necessary to ensure
compliance with that plan.
---------------------------------------------------------------------------

    \82\ See Securities Exchange Act Release No. 59647 (March 30,
2009), 74 FR 15010 (April 2, 2009) (File No. 4-546).
---------------------------------------------------------------------------

Opening Process

    The Exchange has proposed a new opening process that is designed,
in general, to: (1) Ensure that an option would open within a
reasonable period of time after the underlying security is open and do
so within an appropriate Phlx opening price range; (2) allow Phlx to
route,\83\ if necessary, to other same or better-priced markets
contemporaneously with its opening of an option series so as to
maximize the number of contracts executing at the open; and (3) allow
quoting market participants to enter trading interest at multiple price
levels.
---------------------------------------------------------------------------

    \83\ Similar to the Exchange's current routing methodology under
the Current Linkage Plan the Exchange would only route customer,
non-contingency orders.
---------------------------------------------------------------------------

    The Commission believes that the proposed rules governing the
opening procedures on Phlx XL II provide for a reasonable process for
the Exchange to conduct its opening. The Commission believes that the
proposed opening process may provide better executions to users, as
well as more consistent prices on executions and a smoother transition
from the opening to the regular trading day. Accordingly, the
Commission believes that the proposed opening process is consistent
with the Act.

Amendments to the Firm Quote Rule

    Changes to Rule 1082 include the addition of two new
functionalities that are intended to enhance the ability for Phlx XL II
participants to refresh, and potentially improve, their quotations when
their option quotation size is exhausted at a particular price level,
and that would reflect the Exchange's ability to refresh its
disseminated market following the exhaustion of the Exchange's
disseminated size.
    The purpose of Quote Exhaust is to enhance the process for
refreshing a participant's quote that has been fully exhausted by an
incoming quote or order that has, after exhausting the Phlx quote at a
particular price level, remaining size to be executed at a price
through the reference price. The Quote Exhaust functionality provides
an opportunity for remaining portions of incoming quotes or orders to
be executed on the Exchange at prices that are equal to or better than
away markets by allowing Phlx XL II participants to refresh their
quotes before routing away, thus potentially providing better prices at
which to execute such remaining portions. In addition, Quote Exhaust is
intended to provide an opportunity for such quote or order to receive a
price for that order better than the next price that would otherwise be
available on Phlx whether by executing on the Phlx or by routing to
applicable away markets. In

addition, the Commission notes that market participants may utilize IOC
orders if they do not wish their order to be included in the Quote
Exhaust process.
    The Market Exhaust is intended to provide Phlx XL II participants
an opportunity to participate in the Market Exhaust Auction when an
initiating order is received by the Phlx XL II system when no Phlx XL
II participant is quoting in a given series. The Commission notes that,
as with the Quote Exhaust process, market participants may utilize IOC
orders if they do not wish their order included in the Market Exhaust
process.
    The Commission believes that these changes to the order handling
process should assist with routing to liquidity available at other
exchanges while preventing non-exempt trade-throughs of other markets
in compliance with the Current Linkage Plan. The Commission further
believes that the Quote Exhaust and Market Exhaust functionalities
should result in greater continuity in prices as they introduce a price
check to limit executions at far away prices. The Commission finds that
the proposed amendments to Phlx's firm quote rule, including its
proposed Quote Exhaust and Market Exhaust procedures, are consistent
with the Act.

Expanded Order Types

    The Exchange has proposed FIND and SRCH orders, as outlined above,
which are designed to utilize route timers prior to routing to
applicable away markets in order to provide Phlx XL II participants an
opportunity to interact with such orders prior to routing away as
needed. In addition, Phlx XL II provides for a DNR order type for those
users that only want executions on Phlx. Phlx has represented that IOC
orders would never go through the exposure period outlined for the FIND
and SRCH order types in the proposed rules.
    The Commission believes that these new order types may improve
routing to liquidity available at other exchanges while preventing non-
exempt trade-throughs of other markets in compliance with the Current
Linkage Plan, and provide users with increased flexibility and control
in how their orders are handled. The Commission believes that the
proposed order types are consistent with the Act.

Routing

    With respect to order routing, the Phlx XL II system would route
only customer FIND and SRCH orders with no other contingencies.
Customer FIND and SRCH orders would first be checked by the Phlx XL II
system for available contracts for potential execution, then orders
would be sent to other available market centers for potential
execution. When checking the book, the Phlx XL II system would seek to
execute at the price at which it would send the order to a destination
market center. In situations where the Exchange's disseminated bid or
offer is one MPV inferior to the NBBO price, the Phlx XL II system
would contemporaneously route to the away market(s) disseminating the
NBBO at such away market's size, and execute remaining contracts at the
Exchange's disseminated bid or offer up to its disseminated size. If
contracts remain unexecuted after routing, they are posted on the book.
Once on the book, should the order subsequently be locked or crossed by
another market center, the Phlx XL II system would not route the order
to the locking or crossing market center, except as specified below.
Orders sent to other markets do not retain time priority with respect
to other orders in the Phlx XL II system and the Phlx XL II system
would continue to execute other orders while routed orders are away at
another market center. Once routed by the Phlx XL II system, an order
becomes subject to the rules and procedures of the destination market
including, but not limited to, order cancellation. If a routed order is
subsequently returned, in whole or in part, that order, or its
remainder, shall receive a new time stamp reflecting the time of its
return to the Phlx XL II system. Entering member organizations whose
orders are routed to away markets shall be obligated to honor such
trades that are executed on away markets to the same extent they would
be obligated to honor a trade executed on the Exchange.
    Additionally, Phlx has proposed that NOS serve as the Routing
Facility of the Exchange. The sole use of NOS by the Exchange will be
to route orders in options listed and trading on the Phlx XL II system
to away markets pursuant to Exchange rules and on behalf of the
Exchange. If NOS were to perform any other functions for Phlx, Phlx
would have to file a proposed rule change with the Commission pursuant
to Section 19 of the Act and the rules and regulations thereunder.
    As a facility, NOS will be subject to Exchange oversight, as well
as Commission oversight.\84\ NOS will also be a member of an SRO
unaffiliated with Phlx that is its designated examining authority, and
Phlx will establish and maintain procedures and internal controls
reasonably designed to restrict the flow of confidential and
proprietary information between Phlx and its facilities, including NOS,
and any other entity, including any affiliate of NOS, and, if NOS or
any of its affiliates engages in any other business activities other
than providing routing services to the Exchange, between the segment of
NOS or its affiliate that provides the other business activity and the
routing services.\85\ In addition, the books, records, premises,
officers, directors, agents, and employees of NOS, as a facility of
Phlx, will be deemed to be those of the Exchange for purposes of and
subject to oversight pursuant to the Act.\86\ The Commission notes that
NOS's routing services are optional, and therefore not the exclusive
means for accessing better priced orders in other market centers.
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    \84\ Further, the Commission notes that the Exchange will be
responsible for filing with the Commission proposed rule changes and
fees relating to NOS's outbound routing function and NOS's outbound
routing function will be subject to exchange non-discrimination
requirements.
    \85\ See Phlx Rule 1080(m)(iii)(C).
    \86\ See Phlx Rule 1080(m)(iii)(D).
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    A participant in the PHLX XL II system would be free to route its
orders to other market centers through alternative means. In light of
the protections discussed above, including the regulation of NOS as a
facility of the Exchange with the respect to routing of orders, the
Commission believes that Phlx's proposed rules and procedures regarding
the use of NOS to route orders to away markets are consistent with the
Act.\87\
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    \87\ In addition, the Commission notes that the Phlx rules and
procedures applicable to NOS are similar to the rules and procedures
adopted by other exchange to govern their routing of orders to other
market centers. See, e.g., NYSE Rule 17, NYSE Amex Rule 17, and
Nasdaq Rules 4758.
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    Phlx has requested that the Commission approve its affiliation with
NOS for the purpose of NOS providing routing services to the Exchange
for orders that first attempt to access liquidity on Phlx's system.
Previously, the Commission approved Phlx's affiliation with NOS for the
limited purpose of receipt of orders from NASDAQ Exchange that first
attempt to access liquidity on NASDAQ Exchange's systems before routing
to Phlx.\88\ In the past, the Commission has expressed concern that the
affiliation of an exchange with one of its members raises potential
conflicts of interest, and the potential for unfair competitive
advantage.\89\ Although the Commission

continues to be concerned about potential unfair competition and
conflict of interest between an exchange's self-regulatory obligations
and its commercial interest when the exchange is affiliated with one of
its members, the Commission believes that it is appropriate and
consistent with the Act to allow NOS to be an affiliate of Phlx to
provide routing services for orders that first attempt to access
liquidity on Phlx's systems before routing to other exchanges in light
of the protections afforded by the conditions described above.
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    \88\ See Securities Exchange Act Release No. 58179, supra note
58.
    \89\ See Securities Exchange Act Release No. 53382 (February 27,
2006), 71 FR 11251 (March 6, 2006) (SR-NYSE-2005-77); Securities
Exchange Act Release No. 54170 (July 18, 2006), 71 FR 42149 (July
25, 2006) (SR-NASDAQ-2006-006).
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Miscellaneous Changes

    The Exchange also proposed several changes to its rules to delete
obsolete provisions and generally update other relevant rules. The
Commission believes that these clarifications and deletions should
assist Phlx members in better understanding Phlx's rules, thus
promoting greater compliance with such rules. The Commission believes
that these proposed rule changes are consistent with the Act.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and
arguments concerning Amendment No. 3, including whether Amendment No. 3
is consistent with the Act. Comments may be submitted by any of the
following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to<EMAIL_ADDRESS>Please include
File Number SR-Phlx-2009-32 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.

All submissions should refer to File Number SR-Phlx-2009-32. This file
number should be included on the subject line if e-mail is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/
sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for inspection and
copying in the Commission's Public Reference Room, 100 F Street, NE.,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. Copies of the filing also will be available for
inspection and copying at the principal office of the Exchange. All
comments received will be posted without change; the Commission does
not edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly.
    All submissions should refer to File Number SR-Phlx-2009-32 and
should be submitted on or before June 24, 2009.

VI. Accelerated Approval of Proposed Rule Change, as Modified by
Amendment Nos. 1, 2, and 3

    The Commission finds good cause to approve the proposed rule
change, as modified by Amendment Nos. 1, 2, and 3, prior to the
thirtieth day after publication for comment in the Federal Register.
    In Amendment No. 3, the Exchange responded to comments submitted by
NYSE Arca and CBOE \90\ with regard to its use of a zero size bid or
offer during certain situations in the opening process, the Quote
Exhaust and the Market Exhaust.\91\ These commenters argued that
dissemination of a zero size quotation violated the Quote Rule,\92\ was
inconsistent with Linkage Plan and OPRA Plan, and would pose
operational problems for market participants.
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    \90\ See supra notes 60-70 and accompanying text.
    \91\ See supra notes 13-38 and accompanying text.
    \92\ 17 CFR 242.602.
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    In Amendment No. 3, the Exchange proposed several changes to its
proposed rules governing the opening process, Quote Exhaust and Market
Exhaust to address these concerns.\93\ Specifically, in those
situations where Phlx initially proposed to disseminate a quote that
would contain the balance of an inbound order and an exchange generated
quote for a size of zero on the other side of the market, the XL II
system would instead disseminate, on the opposite side of the market
from any remaining unexecuted contracts: (i) A bid price of $0.00, with
a size of one contract if the remaining size is a seller; or (ii) an
offer price of $200,000, with a size of one contract if the remaining
size is a buyer. In Amendment No. 3, Phlx states that the fact that
there is no quote from any XL II participant is an unusual market
condition which Phlx believes requires it to disseminate via OPRA such
a quote to indicate that there is a non-firm condition on the side of
the market that is exhausted.
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    \93\ See proposed Rules 1017(l)(iv)(C)(7),
1082(a)(1)(B)(3)(b),1082(a)(ii)(B)(3)(g)(iv)(A)(3),
1082(a)(ii)(B)(3)(g)(iv)(A)(4), 1082(a)(ii)(B)(3)(g)(iv)(B)(2),
1082(a)(ii)(B)(3)(g)(iv)(B)(3), 1082(a)(ii)(B)(4)(b), and
1082(a)(ii)(B)(4)(d)(iv)(D). See also Response Letter at 1.
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    The Commission believes that this change would allow Phlx to
effectively post a non-firm quote on one side of the market, while
attempting to attract interest to fill an order on the other side of
the market. The Commission believes that this proposal is consistent
with the Quote Rule's provisions regarding non-firm quotations.\94\
Specifically, Rule 602(a)(3)(i) provides that if, at any time a
national securities exchange is open for trading, the exchange
determines, pursuant to rules approved by the Commission, that the
level of trading activities or the existence of unusual market
conditions is such that the exchange is incapable of collecting,
processing, and making available to vendors the data for a subject
security required to be made available in a manner that accurately
reflects the current state of the market on such exchange, such
exchange shall immediately notify all specified persons of that
determination and, upon such notification, the exchange is relieved of
its obligations under paragraphs (a)(1) and (2) of Rule 602 relating to
collecting and disseminating quotations, subject to certain other
provisions of Rule 602(a)(3).
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    \94\ See 17 CFR 242.602(a)(3)(i) and (ii).
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    By proposing to disseminate a bid of $0.00 for one contract or an
offer of $200,000 for one contract in certain situations delineated in
it rules, the Commission believes that Phlx is adequately communicating
that it is non-firm on that side of the market in compliance with the
Quote Rule. Further, the Commission believes that these changes
proposed by Phlx in Amendment No. 3 would be consistent with the
Current Linkage Plan in that they would not result in a locked market
situation. Finally, these changes should address the commenter's
concerns relating to the operational issues associated with Phlx's
originally proposed zero-size quotation.
    The Commission notes that this aspect of the proposal is being
approved on a pilot basis with the pilot period to end on November 30,
2009. The

Commission understands that, currently, there is no mechanism for OPRA
to identify only one side of a quote as non-firm. During this pilot
period, the Commission expects that the Exchange will work with OPRA to
develop the capability to identify such a mechanism. Once that
capability is developed, there should no longer be a need to use a
$0.00 bid or $200,000 offer to reflect a non-firm status on one-side of
the market.
    In addition, in response to CBOE's comment letter, Phlx amended
proposed Rule 1082(a)(ii)(B)(4), Market Exhaust, to clarify that, if an
order is received when there are no quotations available in the Phlx
market, but Phlx has an order on its book at the NBBO, Phlx would
immediately execute the incoming order against the order on its book at
the NBBO.
    The Commission believes that Phlx's proposal to disseminate a non-
firm quote on one side of the market with size for a limited period of
time, and to execute orders during a Market Exhaust situation if there
limit order resting on Phlx at the NBBO, responds to the concerns
raised by commenters and, as discussed above, is consistent with the
Act. Therefore, the Commission finds good cause, consistent with
Section 19(b)(2) of the Act,\95\ to approve the proposed rule change,
as modified by Amendment Nos. 1, 2, and 3, on an accelerated basis.
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    \95\ 15 U.S.C. 78s(b)(2).
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    The Commission believes that, with regard to the additional
comments made by CBOE relating to the proposed rules for order handling
following the Market Exhaust Auction and the circumstances under which
specialists and other Phlx XL II participants would receive
entitlements,\96\ Phlx has sufficiently responded to and clarified
these aspects of its proposal.
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    \96\ See supra note 7.
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VII. Conclusion

    For the foregoing reasons, the Commission finds that the proposed
rule change, as amended, 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.\97\
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    \97\ 15 U.S.C. 78f(b)(5).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\98\ that the proposed rule change (SR-Phlx-2009-32), as amended,
be, and it hereby is, approved on an accelerated basis.
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    \98\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\99\
Florence E. Harmon,
Deputy Secretary.
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    \99\ 17 CFR 200.30-3(a)(12).
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[FR Doc. E9-12918 Filed 6-2-09; 8:45 am]

BILLING CODE 8010-01-P