[Federal Register Volume 75, Number 240 (Wednesday, December 15, 2010)]
[Notices]
[Pages 78320-78327]
[FR Doc No: 2010-31487]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-63509; File No. SR-Phlx-2010-157]

Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Notice of
Filing of Proposed Rule Change, as Modified by Amendment No. 1,
Relating to Complex Orders

December 9, 2010.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4\2\ thereunder, notice is hereby given that
on November 29, 2010, NASDAQ OMX PHLX LLC (``Phlx'' or ``Exchange'')
filed with the Securities and Exchange Commission (``SEC'' or
``Commission'') the proposed rule change as described in Items I, II,
and III, below, which Items have been prepared by the Exchange. On
December 6, 2010, the Exchange filed Amendment No. 1 to the proposed
rule change. The Commission is publishing this notice to solicit
comments on the proposed rule change, as modified by Amendment No. 1,
from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.

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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

    The Exchange, pursuant to Section 19(b)(1) of the Act \3\ and Rule
19b-4 thereunder,\4\ proposes to amend Rule 1080.08 to change the
following aspects of its Complex Orders System: (i) Permit Complex
Orders where one of the components of the Complex Order is the
underlying security (stock or Exchange Traded Fund Share (``ETF''));
(ii) permit Complex Orders with more than two components; (iii) add a
``Do Not Auction'' condition for Complex Orders that prevents orders so
marked from triggering (or joining) a Complex Order Live Auction; \5\
(iv) permit day orders to be sent by certain participants; (v) add an
execution priority provision that clarifies execution priority
respecting current Complex Orders and establishes the execution
priority of the proposed new Complex Orders; and (vi) revise the
definition section.
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    \3\ 15 U.S.C. 78s(b)(1).
    \4\ 17 CFR 240.19b-4.
    \5\ See Rule 1080.08(e).
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    The text of the proposed rule change is available on the Exchange's
Website at http://www.nasdaqtrader.com/micro.aspx?id=PHLXRulefilings,
at the principal office of the Exchange, and at the Commission's Public
Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The Exchange has prepared summaries, set forth in
sections A, B, and C below, of the most significant aspects of such
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

1. Purpose
    In 2008, the Exchange automated the handling of Complex Orders on
its electronic trading platform for options, Phlx XL.\6\ Currently, the
Exchange's Complex Orders functionality is limited to Complex Orders
consisting solely of two option components. The Exchange proposes to
add Complex Orders where one component is the underlying stock or ETF.
The Exchange also proposes to permit Complex Orders consisting of up to
six components. The purpose of the proposed rule change is to more
efficiently handle these new Complex Orders on the Exchange by
establishing rules and systems that would enable the Exchange to handle
such orders electronically.\7\
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    \6\ Securities Exchange Act Release No. 58361 (August 14, 2008),
73 FR 49529 (August 21, 2008) (SR-Phlx-2008-50). Since that time,
the Exchange has enhanced its options trading platform, now known as
Phlx XL II. See Securities Exchange Act Release No. 59995 (May 28,
2009), 74 FR 26750 (June 3, 2009) (SR-Phlx-2009-32).
    \7\ Currently, complex orders also trade on the floor of the
Exchange pursuant to various rules, including Rule 1033; this
proposal does not impact such manual trading.
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Definitions
    The Exchange is proposing to revise the definition of Complex Order
in Rule 1080.08(a)(i) to provide that 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.\8\ Furthermore, a Complex Order can
also be a stock-option order, which is an order to buy or sell a stated
number of units of an underlying stock or ETF coupled with the purchase
or sale of options contract(s).\9\ Accordingly, the Exchange is now
permitting one component of a Complex Order to consist of the
underlying stock or ETF.\10\ A Complex Order with one component that is
the underlying stock or ETF is also referred to as a stock-option
order. The underlying stock or ETF must be the deliverable for the
options component of that Complex Order and represent exactly 100
shares per option for regular way delivery.\11\ In the case of Complex
Orders with a stock or ETF component, these cannot be executed against
orders for the individual legs; stock-option orders in the System can
only be executed against other stock-option orders. The Exchange is
proposing to state that the maximum number of components will be six,
including both options and stock components. For example, under the
proposal, a Complex Order could consist of up to five options series
plus the underlying security. Or, a Complex Order could consist of up
to six options series.
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    \8\ This includes additional language that provides that a
Complex Order is priced at a net debit or credit based on the
relative prices of the individual components, which is currently in
the definition of Complex Order Strategy in Rule 1080.08(a)(ii), but
fits better in the definition of Complex Order.
    \9\ This definition is similar to ISE Rule 722(a).
    \10\ The term ``stock'' is used interchangeably with
``underlying security'' herein. In addition, in the case of foreign
currency options and index options, the underlying cannot be a
component of a Complex Order, because such underlying instrument is
not a security and instead consists of actual foreign currency and
an index, respectively, which are not currently included in the
program the Exchange has developed.
    \11\ Because it must represent exactly 100 shares, there can be
no cash component. For example, XRX bought ACS, resulting in an
adjusted option trading under the symbol AGY; AGY options settle
into 4.935 XRX shares plus $18.60 cash. See e.g., http://www.theocc.com/components/docs/market-data/infomemos/2010/feb/26947.pdf. Accordingly, because AGY options settle through delivery
of XRX shares and cash rather than AGY shares, it would not possible
to enter a AGY stock-option order. Instead, AGY Complex Orders can
only consist of options components to be traded on the Exchange.
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    This revision of the definition of a Complex Order is intended to
simplify the rule and recognizes that there are many types and
permutations possible, as strategies develop and become more
sophisticated.\12\ As a result of this revision of the definition of a
Complex Order, several subparagraphs are being deleted because they are
too specific and no longer needed, as they are covered under the new,
broader definition; these include the definition of a spread order, a
straddle order, a combination order, a ratio order, a collar order, and
a tied hedge order.\13\
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    \12\ The ISE has adopted a similar generic provision. See
Securities Exchange Act Release No. 59021 (November 26, 2008), 73 FR
74545 (December 8, 2008) (SR-ISE-2008-91).
    \13\ See current Phlx Rule 1080.08(a)(i)(A)-(F).
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    In Rule 1080.08(a)(ii), the Exchange is also revising the
definition of Complex Order Strategy, in addition to moving the pricing
language, as explained above, to expressly state in the rule that each
such strategy is assigned a strategy identifier by the System.\14\ This
is intended to make the program clearer in the rules. The Exchange is
also proposing to better state that a Complex Order Strategy means a
particular combination of components and their ratios to one another.
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    \14\ For example, a Complex Order Strategy might be ``buy one
XYZ January 20 call, sell one XYZ January 20 put.'' The System would
assign this Complex Order Strategy a specific identification number
or code that would be used in the System to identify this Complex
Order Strategy. Hypothetically, the identification number for this
particular Complex Order Strategy could be ``Complex Order Strategy
12345.'' Complex Order Strategy 12345 would have a
bid price and an offer price. If an investor wishes to purchase or
sell, for example, 10 Complex Order Strategy 12345, such an investor
would be bidding for or offering to buy 10 XYZ January 20 calls and
sell 10 XYZ January 20 puts. This is not a new feature and was
included in the original proposal. See Securities Exchange Act
Release No. 58361 (August 14, 2008), 73 FR 49529 (August 21, 2008)
(SR-Phlx-2008-50).
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    In conjunction with permitting one of the components of a Complex
Order to be the underlying security, the

Exchange proposes to amend subparagraphs (a)(iv) and (vi) to update the
definitions of cPBBO and cNBBO, respectively, to include the underlying
security. Specifically, both would be amended to state that the best
net debit or credit price for a Complex Order Strategy that includes a
stock/ETF component includes the national best bid or offer for the
underlying security.
    The Exchange also proposes to adopt, in new subparagraph (a)(viii),
a new order condition called ``Do Not Auction,'' or DNA, which causes
an order to not be eligible to begin a Complex Order Live Auction
(``COLA'').\15\ DNA Orders cannot join a COLA in progress. These orders
can avoid an auction and, instead, be either executed immediately or
cancelled.\16\ DNA Orders received prior to the opening or when the
Complex Order Strategy is not available for trading will be cancelled.
DNA Orders will initially only be available for Complex Orders
consisting of more than two option components or where the underlying
security is a component; once the Exchange has fully rolled out its
enhanced Complex Order System, which will be announced in an Options
Trader Alert, DNA Orders will also become available for Complex Orders
consisting of two option components.
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    \15\ See Rule 1080.08(e).
    \16\ DNA orders can be marked IOC, which means that the order
cannot start an auction (whereas an IOC order can), and get rejected
if there is an auction in progress.
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Priority
    The Exchange proposes to clarify and expand upon the trade-through
and execution priority provisions applicable to Complex Orders,
including the expanded definition of Complex Orders. Accordingly, the
Exchange, first, proposes to add to the definitions section of the
rule, Rule 1080.08(a), the definition of a conforming ratio. A
conforming ratio, in proposed Rule 1080.08(a)(ix), is essentially a
permissible ratio, renamed. Specifically, it is where the ratio between
the sizes of the options components of a Complex Order is equal to or
greater than one-to-three (.333) and less than or equal to three-to-one
(3.00). For example, a one-to-two (.5) ratio, a two-to-three (.667)
ratio, or a two-to-one (2.00) ratio is a conforming ratio,\17\ whereas
a one-to-four (.25) ratio or a four-to-one (4.0) ratio is not.\18\
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    \17\ One example of a conforming five-legged ratio is: B 100 GE
Dec 12.50 calls for 4.00, S 200 GE Dec 15.00 calls for 2.00, B 100
GE Dec 17.50 calls for .60 and also S 100 Dec 17.50/Dec 16.50 put
spreads at .60; because the highest volume to the lowest volume is
in a ratio of 2:1 (200 versus 100 options), this order is
conforming.
    \18\ One example of a non-conforming five-legged ratio is: B 100
GE Dec 12.50 calls for 4.00, S 200 GE Dec 15.00 calls for 2.00, B
100 GE Dec 17.50 calls for .60 and also S 400 Dec 17.50/Dec 16.50
put spreads at .60; because the highest volume to the lowest volume
is in a ratio of 4:1 (400 versus 100 options), this order is not
conforming.
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    Where one component of the Complex Order is the underlying
security, the ratio between any options component and the underlying
security component must be eight contracts to 100 shares of the
underlying security or less.\19\ One example of a two-legged ratio
order with a stock component that is conforming is: B 400 GE Dec 16.50
calls, S 400 Dec 17.50 calls and S 12,000 shares of GE at 16.50; after
comparing the largest option leg (400) to each 100 lot of shares (100 x
120 = 12,000 shares, or 120 lots of 100), the ratio is 3.33 (400
divided by 120) options per 100 shares, which is less than the maximum
allowable 8 options per 100 shares, which is a conforming ratio. In
contrast, B 200 GE Dec 16.50 calls, S 400 GE Dec 17.50 calls and S
3,000 shares of GE at 16.50 is a nonconforming ratio, because comparing
the largest leg of the options trade (400) to 30 lots of 100 (3,000
shares) equals 13.33 (400 divided by 30) options per 100 shares, which
is greater than the maximum allowable 8 options per 100 shares and thus
nonconforming. Currently, the same ratio appears in Rule
1080.08(a)(i)(D), within the definition of a Ratio Order; that
provision is proposed to be deleted and replaced by the new definition
of conforming ratio to make the rule clearer.\20\
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    \19\ These are the same ratios found in ISE Rule 722(a)(4). If
the largest option leg versus stock meets the conforming ratio,
then, necessarily, all smaller legs would also meet the definition
of conforming ratio.
    \20\ Complex orders consisting of a nonconforming ratio will not
be accepted.
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    Today, Complex Orders consisting of permissible (now called
conforming) ratios are excepted from the trade-through prohibitions of
the Options Order Protection and Locked/Crossed Market Plan (``Options
Linkage Plan''), because the Plan contains an exception for Complex
Orders with a certain ratio. Accordingly, these orders can be executed
without regard to prices for the individual legs on other exchanges,
meaning trading through possibly better prices.\21\ The Exchange now
proposes to codify this in new subparagraph (c)(iii)(C).
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    \21\ See Securities Exchange Act Release No. 60405 (July 30,
2009), 74 FR 39362 (August 6, 2009) Options Linkage Plan at Section
5(b)(viii), which prohibits trading through a better price of
another exchange unless an exception applies. Phlx Rule
1084(b)(viii) provides an exception for complex orders. This
exception applies to Complex Orders executed as such, and not those
executed by legging, such as pursuant to Rule 1080.08(e)(vi)(A).
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    In addition to trade-through provisions, whether a Complex Order
has a conforming ratio is also relevant in determining how the
Exchange's spread priority rules apply. Today, Rule 1033(d) applies to
executions of Complex Orders.\22\ Throughout Rule 1080.08, there are
cross references to Rule 1033(d), which will now be deleted and
replaced with new paragraph (c)(iii), which is the spread priority
provision applicable to Complex Orders executed on Phlx XL II. The
spread priority provisions in new subparagraph (c)(iii) provide the
same priority under the same conditions to a broader class of Complex
Orders under this proposal.
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    \22\ Exchange Rule 1033(d) affords priority to spread type
orders over either the bid or the offer established in the
marketplace that is not better than the bids or offers comprising
such total credit or debit, provided that, the member executes at
least one option leg at a better price than established bid or offer
for that option contract AND no option leg is executed at a price
outside of the established bid or offer for that option contract.
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    Spread priority refers to the priority of orders and quotes on the
Exchange's own market and permits part of an eligible Complex Order to
have priority over other bids and offers in the marketplace. Today, for
a Complex Order consisting of two options components, if the ratio
between those options components is a permissible (now called
conforming) ratio, then if one option ``leg'' or component improves the
Exchange's market for that option series, then the other option leg can
be executed with priority over existing bids/offers (including
customers), provided that neither option leg is executed at a price
outside of the established bid or offer for that option contract.\23\
For example, if a Complex Order is received to buy one option A
contract and sell one option B contract for a net debit of .65, where
option A has a PBBO of 1.00-1.20 with a 1.00 customer limit order to
buy on the book and option B has a PBBO of .45-.50 with a .50 customer
limit order to sell on the book, permissible trade prices could be 1.15
for option A and .50 for option B. Option B is allowed to execute at
.50 because option A executed at a price that improved the Exchange's
market in that option. The application of spread priority to Complex
Orders consisting only of options is not changing and will now be
covered by new Rule 1080.08(c)(iii)(A).
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    \23\ This applies to both trading in the complex orders
automated functionality as well as manual trading on the floor. See
Rule 1033(d).
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    Furthermore, under this proposal, because Complex Orders with a
stock

component will now be permitted on Phlx XL II, priority provisions
similar to Rule 1033 will now also apply to Complex Orders on Phlx XL
II where one component is the underlying stock or ETF. Today, this is
true for Complex Orders with a stock component executed manually on the
trading floor, which are subject to Rule 1033(e). Thus, new
subparagraph (c)(iii)(B) will govern the execution priority of the new
stock-option Complex Orders on Phlx XL II. Specifically, it provides
that where a conforming Complex Order consists of the underlying stock
or ETF and one options leg, such options leg does not have priority
over bids and offers established in the marketplace, including customer
orders. Where a conforming Complex Order consists of the underlying
stock or ETF and more than one options leg, the options legs have
priority over bids and offers established in the marketplace, including
customer orders, if at least one options leg improves the existing
market for that option.
    For example, where there is a conforming Complex Order to buy 1
option A, sell 1 option B, and sell 50 shares of the underlying stock
for a net debit of 9.55 where the PBBO of option A is 1.00-1.20 with a
customer 1.00 bid, the PBBO of option B is .40-.50, and the stock NBBO
is 20.10-20.20, the following trade prices would be permissible: Option
A could execute at 1.00, option B at .45, and the stock at 20.20.
Option A is able to trade on the PBBO at the same price as the customer
because option B improved the PBBO. The price of the stock portion is
not relevant in applying the Exchange's option execution priority
rules. As a second example, if a conforming Complex Order consists of
only one option component and stock, then the option component may not
be allowed to be executed at the same price as any existing bid/offer
including customer bids/offers. For example, a conforming Complex Order
to sell 1 option A and buy 100 shares, with option A having a PBBO of
2.00-2.20 and the stock having a NBBO of 10.00-10.20, for a net debit
of 7.90 could receive the following permissible trade prices: Option A
could execute at 2.10 with the stock execution occurring at 10.00.
Option A could not execute at 2.20, because the option component does
not have priority over existing bids/offers.
Order Entry
    Currently, under subparagraph (b)(ii), Streaming Quote Traders
(``SQTs''),\24\ Remote Streaming Quote Traders (``RSQTs''),\25\ non-SQT
ROTs,\26\ specialists and non-Phlx market makers on another exchange
are permitted to enter Complex Orders as IOC only. However, for Complex
Orders consisting of more than two option components or where the
underlying security is a component, SQTs, RSQTs, non-SQT ROTs,
specialists and non-Phlx market makers on another exchange may also
enter Day orders; \27\ once the Exchange has fully rolled out its
enhanced Complex Order System, which will be announced in an Options
Trader Alert, Day orders will become available for Complex Orders
consisting of two option components. The Exchange expects that adding
Day orders here should encourage more orders from this group of
participants.
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    \24\ An SQT is a Registered Options Trader (``ROT'') who has
received permission from the Exchange to generate and submit options
quotations electronically through an electronic interface via an
Exchange approved proprietary electronic quoting device in eligible
options to which such SQT is assigned. See Rule 1014(b)(ii)(A).
    \25\ An RSQT is an ROT that is a member or member organization
with no physical trading floor presence who has received permission
from the Exchange to generate and submit options quotations
electronically in eligible options to which such RSQT has been
assigned. An RSQT may only submit such quotations electronically
from off the floor of the Exchange. See Rule 1014(b)(ii)(B).
    \26\ A non-SQT ROT is an ROT who is neither an SQT nor an RSQT.
See Rule 1014(b)(ii)(C).
    \27\ As a result of adding Day orders for this category of
users, the Exchange also proposes to amend Rule 1080.08(f)(i) to
eliminate reference to the types of orders on the Complex Limit
Order Book, because it is too specific.
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    Currently, pursuant to subparagraph (b)(iii), Floor Brokers using
the Options Floor Broker Management System may enter Complex Orders
into the Exchange's electronic Complex Orders System as Day, GTC or IOC
on behalf of non-broker-dealer customers and non-market maker off-floor
broker-dealers, and as IOC only on behalf of broker-dealers or
affiliates of broker-dealers. The Exchange proposes to amend this
subparagraph to reflect that DNA orders and orders with more than two
legs or a stock/ETF component (which are new) cannot be entered by
Floor Brokers at this time. The Exchange believes that Floor Brokers
are able to and use other, non-Exchange systems to access Phlx XL II,
such that the FBMS, which is primarily intended to capture brokered
orders into the options audit trail system, is not the sole method for
them to submit orders to the Exchange. In addition, complex orders can
be handled manually on the Exchange trading floor today. The Exchange
believes that Floor Brokers are not likely to need or request these
changes to FBMS, because they execute far more complex orders in the
trading crowd today than through FBMS.
    Rule 1080.08(c) currently provides that a Complex Order is eligible
to trade only when each component of the Complex Order is open for
trading on the Exchange. The Exchange proposes to add the word
``option'' in certain places in this provision, because one component
of a Complex Order can now be the underlying security. The Exchange
also proposes to require that the underlying security be open for
trading on its primary market \28\ if such underlying security is a
component of a Complex Order.
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    \28\ The Exchange intends to consider the primary market for the
underlying security to be the listing market; if the Exchange
determines to use a market other than the listing market, the
Exchange will issue an Options Trader Alert announcing any such
change.
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Complex Order Processing and Execution
    Currently, pursuant to Rule 1080.08(e)(i)(B)(2), a Complex Order
that would otherwise be a COLA-eligible order that is received in the
System during the final ten seconds of any trading session shall not be
COLA-eligible. The Exchange proposes to make this time configurable,
not to exceed the current ten seconds. The Exchange will issue an
Options Trader Alert when the number of seconds changes.
    COLA-eligible orders, COLA Sweeps, and responsive Complex Orders
trade first based on the best price or prices available at the end of
the COLA Timer. If no COLA Sweeps or responsive Complex Orders for the
same Complex Order Strategy as the COLA-eligible order that improve the
initial cPBBO were received during the COLA Timer, each component of
the COLA-eligible order may trade at the PBBO with existing quotes and/
or limit orders on the limit order book for the individual components
of the Complex Order, provided that each component is executed such
that the components comprise the Complex Order Strategy with the
correct ratio for the desired net debit or credit. This is known as
``legging,'' and the Exchange proposes to label subparagraph
(e)(vi)(A)(1) as such. The Exchange is proposing to add that legging
only occurs where there is no underlying security as a component of the
Complex Order. If a COLA-eligible order cannot be filled in its
entirety, any remaining balance would be placed on the CBOOK unless the
COLA-eligible order has been submitted with other instructions (i.e.,
cancel).
    Currently, Complex Orders are automatically executed against orders
on the CBOOK in price priority and in

time priority at the same price, as described in subparagraph (f)(iii).
Specifically, a Complex Order resting on the CBOOK will execute
automatically against: (i) Quotes or orders on the limit order book for
the individual components of the order (allocated in accordance with
Exchange Rule 1014(g)(vii), and an SQT or RSQT quoting on all
components of the Complex Order will have priority over SQTs and RSQTs
quoting a single component, but not over customer orders); or (ii) an
incoming marketable Complex Order that does not trigger a COLA Timer,
whichever arrives first. At this time, the Exchange proposes to delete
the provision that an SQT or RSQT quoting on all components of the
Complex Order will have priority over SQTs and RSQTs quoting a single
component in order to simplify the allocation process as the Exchange
begins to accept more Complex Order types. Instead, an SQT or RSQT
quoting on all components of the Complex Order will be on parity with
SQTs and RSQTs quoting a single component.\29\ This is being deleted
from Rule 1080.08(e)(vi)(A)(1), (f)(iii)(A) and (f)(iii)(B)(1). The
Exchange is deleting this provision to simplify system processing and
does not believe, currently, that the benefits are material or being
realized intentionally by participants. Furthermore, in Rule
1080.08(f)(iii), the Exchange proposes to state that the execution
against orders on the limit order book for the individual components
means the options components, such that ``legging'' will not occur
where any of the components is the underlying security.
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    \29\ This change will initially only apply to Complex Orders
consisting of more than two options components or where the
underlying stock/ETF is a component; once the Exchange has fully
rolled out its enhanced Complex Order System, which will be
announced in an Options Trader Alert, it will apply to Complex
Orders consisting of two options components.
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    The Exchange proposes to add the word ``options'' in various places
where the provision clearly applies only to the options component. For
example, in subparagraph (c)(ii), most of the reasons why Complex
Orders would not trade on the System relate to the options components.
Similarly, in subparagraph (f)(i) governing what orders go on the
CBOOK, ``options'' is being added to several of the provisions.
Underlying Stock/ETF Component
    In addition to making the various new references to the underlying
stock/ETF as a component of a Complex Order, the Exchange also proposes
to adopt new subparagraph (h), which will state that where one
component of a Complex Order is the underlying stock/ETF, the Exchange
shall electronically communicate the underlying stock/ETF component of
a Complex Order to Nasdaq Options Services LLC (``NOS''), its
designated broker-dealer, for execution; this occurs once the Phlx
trading System determines that a Complex Order trade is possible and at
what prices. Specifically, NOS will act as agent for such stock/ETF
orders; NOS will match those orders, which always consist of both a buy
and sell order for the stock/ETF, because the System has determined
that two Complex Orders can trade with each other.\30\ NOS will match
these orders not on an exchange, but rather ``over-the-counter.''
Accordingly, the Exchange proposes to permit NOS to perform this
function, in addition to its approved routing functions.\31\
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    \30\ This is because Complex Orders consisting of the underlying
stock or ETF can only trade with other Complex Orders. See proposed
Rule 1080.08(a)(i), which reads as follows: 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.
    \31\ Securities Exchange Act Release Nos. 57478 (March 12,
2008), 73 FR 14521 (March 18, 2008) (SR-NASDAQ-2007-004 and SR-
NASDAQ-2007-080); and 59995 (May 28, 2009), 74 FR 26750 (June 3,
2009) (SR-Phlx-2009-32).
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    NOS is a broker-dealer and member of various exchanges and the
Financial Industry Regulatory Authority (``FINRA''). As discussed in
detail below, NOS, under this proposal, would be responsible for the
proper execution, trade reporting and submission to clearing of the
stock/ETF trade that is part of a Complex Order. Because these trades
will occur off-exchange, the principal regulator is FINRA, rather than
Phlx or NASDAQ. Furthermore, NOS is responsible for compliance with
FINRA rules generally and is subject to examination by FINRA.
Specifically, NOS is subject to NASD Rule 3010,\32\ which generally
requires that the policies and procedures and supervisory systems be
reasonably designed to achieve compliance with applicable securities
laws and regulations and with applicable NASD and FINRA rules,
including those relating to the misuse of material non-public
information. To this end, NOS intends to have in place policies related
to confidentiality and the potential for informational advantages
relating to its affiliates, intended to protect against the misuse of
material nonpublic information.\33\
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    \32\ FINRA was created in July 2007 through the consolidation of
NASD and the member regulation, enforcement and arbitration
functions of the NYSE. The FINRA rulebook currently consists of both
NASD Rules and certain NYSE Rules that FINRA has incorporated
(``Incorporated NYSE Rules'').
    \33\ Similarly, pursuant to Phlx Rule 1080(m)(iii)(C), the
Exchange must 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.
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    In addition, because the execution and reporting of the stock/ETF
piece will occur otherwise than on this Exchange or any other exchange,
it will be handled by NOS pursuant to applicable rules regarding equity
trading,\34\ including the rules governing trade reporting, trade
throughs and short sales. Specifically, NOS will report the trades to
the Trade Reporting Facility.\35\ Firms that are members of FINRA or
the NASDAQ Stock Market (``NASDAQ'') are required to have a Uniform
Service Bureau/Executing Broker Agreement (``AGU'') with NOS in order
to trade Complex 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 NOS in order to trade
Complex Orders containing a stock/ETF component. This requirement is
codified in proposed Rule 1080.08(a)(i). Accordingly, this process is
available to all Phlx member organizations and the stock/ETF component
of a Complex Order, once executed, will be properly processed for trade
reporting purposes.
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    \34\ See Securities Exchange Act Release No. 49023 (January 5,
2004) (SR-ISE-2003-37) (``Once the orders are communicated to the
broker-dealer for execution, the broker-dealer has complete
responsibility for determining whether the orders may be executed in
accordance with all of the rules applicable to execution of equity
orders, * * *'').
    \35\ Specifically, the trades will be reported to the FINRA/
Nasdaq TRF, which is a facility of FINRA that is operated by The
NASDAQ OMX Group, Inc. (``NASDAQ OMX'') and utilizes Automated
Confirmation Transaction (``ACT'') Service technology. See e.g.,
Securities Exchange Act Release No. 61817 (March 31, 2010) (SR-
FINRA-2010-011).
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    With respect to trade throughs, the Exchange believes that the
stock/ETF component of a Complex Order is eligible for the Qualified
Contingent Trade Exemption from Rule 611(a) of Regulation NMS. A
Qualified Contingent Trade is a transaction consisting of two or more
component orders, executed as agent or principal, that satisfy the six
elements in the Commission's order exempting Qualified Contingent
Trades (``QCTs'') from the requirements of Rule 611(a),\36\ which
requires trading centers to establish, maintain, and enforce written
policies and procedures that are reasonably designed to prevent trade-

throughs.\37\ The Exchange believes that the stock/ETF portion of a
Complex Order under this proposal complies with all six requirements.
Moreover, as explained below, the Phlx trading System will validate
compliance with each requirement such that any matched order received
by NOS under this proposal has been checked for compliance with the
exemption, as follows:
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    \36\ 17 CFR 242.611(a).
    \37\ See Securities Exchange Act Release No. 57620 (April 4,
2008), 73 FR 19271 (April 9, 2008) (``QCT Release''). See also
Securities Exchange Act Release No. 54389 (August 31, 2006), 71 FR
52829 (September 7, 2006).
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    (1) At least one component order is in an NMS stock: The stock/ETF
component must be an NMS stock, which is validated by the System;
    (2) all components are effected with a product or price contingency
that either has been agreed to by the respective counterparties or
arranged for by a broker-dealer as principal or agent: A Complex Order,
by definition consists of a single net/debit price and this price
contingency applies to all the components of the order, such that the
stock price computed and sent to NOS allows the stock/ETF order to be
executed at the proper net debit/credit price based on the execution
price of each of the option legs, which is determined by the Phlx
System;
    (3) the execution of one component is contingent upon the execution
of all other components at or near the same time: Once a Complex Order
is accepted and validated by the System, the entire package is
processed as a single transaction and each of the option leg and stock/
ETF components are simultaneously processed;
    (4) the specific relationship between the component orders (e.g.,
the spread between the prices of the component orders) is determined at
the time the contingent order is placed: Complex Orders, upon entry,
must have a size for each component and a net debit/credit, which the
System validates and processes to determine the ratio between the
components; an order is rejected if the net debit/credit price and size
are not provided on the order;
    (5) the component orders bear a derivative relationship to one
another, represent different classes of shares of the same issuer, or
involve the securities of participants in mergers or with intentions to
merge that have been announced or since cancelled: under this proposal,
the stock/ETF component must be the underlying security respecting the
option legs, which is validated by the System; and
    (6) the transaction is fully hedged (without regard to any prior
existing position) as a result of the other components of the
contingent trade: Under this proposal, the ratio between the options
and stock/ETF must be a conforming ratio (8 contracts per 100 shares),
which the System validates, and which under reasonable risk valuation
methodologies, means that the stock/ETF position is fully hedged.\38\
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    \38\ A trading center may demonstrate that an Exempted NMS Stock
Transaction is fully hedged under the circumstances based on the use
of reasonable risk-valuation methodologies. The release approving
the original exemption stated: To effectively execute a contingent
trade, its component orders must be executed in full or in ratio at
its predetermined spread or ratio * * * ``In ratio'' clarifies that
component orders of a contingent trade do not necessarily have to be
executed in full, but any partial executions must be in a
predetermined ratio.

Furthermore, proposed Rule 1080.08(a)(i) provides that member
organizations may only submit Complex Orders with a stock/ETF component
if such orders comply with the Qualified Contingent Trade Exemption.
Member organizations submitting such Complex Orders with a stock/ETF
component represent that such orders comply with the Qualified
Contingent Trade Exemption.\39\ Thus, the Exchange believes that
Complex Orders consisting of a stock/ETF component will comply with the
exemption and that the Phlx trading System will validate such
compliance to assist NOS in carrying out its responsibilities as agent
for these orders.
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    \39\ See Amendment No. 1.
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    With respect to short sale regulation, the proposed handling of the
stock/ETF component of a Complex Order under this proposal does not
raise any issues of compliance with the currently operative provisions
of Regulation SHO.\40\ When a Complex Order has a stock/ETF component,
member organizations must indicate, pursuant to Regulation SHO, whether
that order involves a long or short sale. The System will accept
Complex Orders with a stock/ETF component marked to reflect either a
long or short position; specifically, orders not marked as buy, sell or
sell short will be rejected by the Phlx trading System. The Phlx
trading System will electronically deliver the stock/ETF component to
NOS for execution. Simultaneous to the options execution on the Phlx
trading System, NOS will execute and report the stock/ETF component,
which will contain the long or short indication as it was delivered by
the member organization to the Phlx trading System. Accordingly, NOS,
as a trading center under Rule 201, will be compliant with the
requirements of Regulation SHO. Of course, broker-dealers, including
both NOS and the member organizations submitting orders to the Phlx
with a stock/ETF component, must comply with Regulation SHO; various
surveillance and examination regulatory programs check for compliance
thereto.
---------------------------------------------------------------------------

    \40\ 17 CFR 242.200 et seq.
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    Earlier this year, the Commission amended Rule 201 and Rule 200(g)
of Regulation SHO under the Act to adopt a short sale-related circuit
breaker that, if triggered, imposes a restriction on the price at which
securities may be sold short (``short sale price test restriction'');
the amendments to Rule 200(g) provide that a broker-dealer may mark
certain qualifying short sale orders ``short exempt.'' \41\ Recently,
the Commission extended the compliance date for the amendments to Rule
201 and Rule 200(g) until February 28, 2011.\42\ Once the new
provisions of Regulation SHO become operative, NOS will accept orders
marked ``short exempt.'' The Exchange intends to file a proposed rule
change addressing the new provisions.
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    \41\ See Securities Exchange Act Release No. 61595 (February 26,
2010), 75 FR 11232 (March 10, 2010) (``Rule 201 Adopting Release'').
    \42\ See Securities Exchange Act Release No. 63247 (November 4,
2010), 75 FR 68702 (November 9, 2010) (File No. S7-08-09) (Order
extending the compliance date until February 28, 2011).
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    For these reasons, the processing of the stock/ETF component of a
Complex Order under this proposal will comply with applicable rules
regarding equity trading, including the rules governing trade
reporting, trade throughs and short sales. NOS' responsibilities
respecting these equity trading rules will be documented in NOS'
written policies and procedures. NOS compliance with these policies and
procedures is monitored, reviewed, and updated as part of NOS' regular
and routine regulatory program.
    As part of the execution of the stock/ETF component, the Exchange
intends to ensure that the execution price is within the intraday high-
low range in that stock at the time the Complex Order is processed and
within a certain price range from the current market, which the
Exchange will establish in an Options Trader Alert. If the stock price
is not within these parameters, the Complex Order is not executable.
    The Exchange believes that electronic submission of the stock/ETF
piece of the Complex Order should help ensure that the Complex Order,
as a whole, is executed timely and at the desired price.\43\ In
addition, electronic communication eliminates the need for each party
to separately manually submit the stock component to a broker-dealer
for execution. The Exchange

emphasizes that the execution of the stock/ETF portion of a Complex
Order will be immediate; the Exchange's System will calculate the stock
price based on the net debit/credit price of the Complex Order,\44\
while also calculating and determining the appropriate options
price(s), all electronically and immediately. The Exchange believes
that this is a superior approach and would not require the Exchange to
later nullify options trades if the stock price cannot be achieved.
Accordingly, the Exchange is not proposing to adopt a rule permitting
such option trade nullification, like other exchange rules, because the
trade would not occur at a price that required later nullification due
to the unavailability of the stock/ETF price.\45\ The Exchange further
believes that the certainty associated with such electronic
calculations and processing should be an attractive feature for users
of Complex Orders with a stock or ETF component.
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    \43\ For a similar process, see ISE Rule 722.02.
    \44\ The stock/ETF price is, of course, included within the net
debit/credit price of the Complex Order. See e.g. examples, infra,
at 36.
    \45\ See e.g., ISE Rule 722.02 (A trade of a stock-option order
will be automatically cancelled if market conditions prevent the
execution of the stock or option leg(s) at the prices necessary to
achieve the agreed upon net price.).
---------------------------------------------------------------------------

    The Exchange also believes that it is appropriate to construct a
program wherein its affiliate, NOS, is the exclusive conduit for the
execution of the stock/ETF component of a Complex Order under this
proposal, similar to the routing functionality of several options and
equities exchanges.\46\ As a practical matter, complex order programs
on other exchanges necessarily involve specific arrangements with a
broker-dealer to facilitate prompt execution. NOS does not intend to
charge a fee for the execution of the stock/ETF component of a Complex
Order, nor does Phlx.\47\ The Exchange believes that is consistent with
the Act for such an arrangement to involve one broker-dealer, even one
that is an affiliate, particularly to offer the aforementioned benefits
of a prompt, electronic execution for Complex Orders involving stock/
ETFs. Specifically, offering a seamless, automatic execution for both
the options and stock/ETF components of a Complex Order is an important
feature that should promote just and equitable principles of trade and
remove impediments to and perfect the mechanism of a free and open
market and a national market system by deeply enhancing the sort of
complex order processing available on options exchanges today.
Nevertheless, users of Phlx's proposed new Complex Orders system could,
in lieu of this proposed arrangement with NOS, choose, instead, the
following alternatives: (i) Avoid using Complex Orders that involve
stock/ETFs, (ii) use the trading floor manual method of executing
complex orders with stock, or (iii) go to another venue, several of
which offer a similar feature, as described further below.
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    \46\ See also Phlx Rule 985(c)(1), which provides that The
NASDAQ OMX Group, Inc., which owns NOS and the Exchange, shall
establish and maintain procedures and internal controls reasonably
designed to ensure that NOS does not develop or implement changes to
its system on the basis of non-public information regarding planned
changes to the Exchange's systems, obtained as a result of its
affiliation with the Exchange, until such information is available
generally to similarly situated Exchange members and member
organizations in connection with the provision of inbound routing to
the Exchange.
    \47\ However, Trade Reporting Facility and clearing fees, not
charged by Phlx or NOS, may result. NSCC and ACT will bill firms
directly for their use of the NSCC and ACT systems, respectively. To
the extent that NOS is billed by NSCC or ACT, it will not pass
through such fees to firms for the stock/ETF portion of a Complex
Order under this proposal. Phlx's fees applicable to Complex Orders
appear in its Fee Schedule and may change from time to time.
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2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section
6(b) of the Act \48\ in general, and furthers the objectives of Section
6(b)(5) of the Act \49\ in particular, in that it is 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, by enhancing its System and rules governing Complex Orders,
by adding additional order types and components. These additional order
types and components should provide market participants with trading
opportunities more closely aligned with their investment or risk
management strategies. Noting that complex orders, including those with
a stock/ETF component are widely recognized and utilized by market
participants, this proposal to offer new order types and components on
an electronic system should provide a more efficient mechanism for
carrying out these strategies.
---------------------------------------------------------------------------

    \48\ 15 U.S.C. 78f(b).
    \49\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The proposed rule change does not impose any burden on competition
not necessary or appropriate in furtherance of the purposes of the Act.
Rather, this proposal enhances competition by providing an additional
alternative to the existing methods of trading complex orders,
including the stock/ETF component, in a single, seamless transaction.
Member use of the Exchange's proposed Complex Order processing is
entirely voluntary.
    The Exchange competes vigorously for complex orders among several
options exchanges that offer a stock-option order type. The Exchange's
proposed new alternative differs from and competes against existing
Complex Order mechanisms by offering fully electronic processing.
Existing Complex Order mechanisms at Chicago Board Options Exchange,
Incorporated (``CBOE'') and International Securities Exchange, LLC
(``ISE'') offer a similar end result--execution of paired option and
stock orders--using different, less automated means.
    Market participants that prefer not to use the stock/ETF
functionality offered herein through NOS have a variety of
alternatives; stock-option orders can be executed on other options
exchanges via various electronic methods, on various options trading
floors or on the Exchange, without employing a stock/ETF component.
    Accordingly, in light of these various alternatives and the keen
competition among options exchanges for complex order flow, the
processing method selected by the Exchange, including the use of NOS,
presents no burden on competition. In fact, the Exchange's proposal
will likely promote competition for the most efficient means to execute
complex orders with a stock/ETF component. The Exchange fully expects
that other exchanges will mimic the proposed processing if it succeeds
in attracting order flow for which many markets compete.

C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others

    No written comments were either solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action

    Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the Exchange consents, the Commission shall: (a) By order approve
or disapprove such proposed rule change, or (b) institute proceedings
to determine whether the proposed rule change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change, as modified by Amendment No. 1, 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-2010-157 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-2010-157. 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 website viewing and
printing in the Commission's Public Reference Room, 100 F Street, NE.,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. Copies of such 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-2010-157 and should be
submitted on or before January 5, 2011.

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\50\
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    \50\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-31487 Filed 12-14-10; 8:45 am]
BILLING CODE 8011-01-P