[Federal Register Volume 77, Number 129 (Thursday, July 5, 2012)]
[Notices]
[Pages 39758-39760]
[FR Doc No: 2012-16374]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67295; File No. SR-NASDAQ-2012-061]

Self-Regulatory Organizations; The NASDAQ Stock Market LLC.;
Order Approving a Proposed Rule Change for the NASDAQ Options Market To
Accept Inbound Orders From NASDAQ OMX BX's New Options Market

June 28, 2012.

I. Introduction

    On May 15, 2012, The NASDAQ Stock Market LLC (``Exchange'' or
``NASDAQ'') 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 for the NASDAQ Options Market
(``NOM'') \3\ to accept inbound options orders routed by NASDAQ Options
Services LLC (``NOS'') from NASDAQ OMX BX (``BX'') on a one year pilot
basis in connection with the establishment of a new options market by
BX. The proposed rule change was published for comment in the Federal
Register on May 24, 2012.\4\ The Commission received no comment letters
regarding the proposed rule change. This order approves the proposed
rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ NOM is the Exchange's options trading facility.
    \4\ See Securities Exchange Act Release No. 67027 (May 18,
2012), 77 FR 31057 (``Notice'').
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II. Background

    NASDAQ Rule 2160(a) prohibits the Exchange or any entity with which
it is affiliated from, directly or indirectly, acquiring or maintaining
an ownership interest in, or engaging in a business venture with, a
NASDAQ member or an affiliate of a NASDAQ member in the absence of an
effective filing under Section 19(b) of the Act.\5\ NOS is a registered
broker-dealer that is a member of the Exchange, and currently provides
to members of the Exchange optional routing services to other
markets.\6\ NOS is owned by NASDAQ OMX Group, Inc. (``NASDAQ OMX''),
which also owns three registered securities exchanges--the Exchange,
BX, and NASDAQ OMX PHLX LLC (``PHLX'').\7\ Thus, NOS is an affiliate of
these exchanges.\8\ Absent an effective filing, NASDAQ Rule 2160(a)
would prohibit NOS from being a member of the Exchange. The Commission
initially approved NOS's affiliation with NASDAQ and its affiliated
exchanges in connection with the establishment of NOM and NASDAQ OMX's
acquisition of BX and PHLX,\9\ and NOS currently performs certain
limited activities for each.\10\ With the current proposed rule change,
the Exchange seeks approval to permit NOS to perform a new function.
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    \5\ 15 U.S.C. 78s(b). NASDAQ Rule 2160 also prohibits a NASDAQ
member from being or becoming an affiliate of NASDAQ, or an
affiliate of an entity affiliated with NASDAQ, in the absence of an
effective filing under Section 19(b). See NASDAQ Rule 2160(b).
    \6\ See Notice, supra note 4, at 31057 n.4 and accompanying
text.
    \7\ See Securities Exchange Act Release No. 58324 (August 7,
2008), 73 FR 46936 (August 12, 2008) (SR-BSE-2008-02; SR-BSE-2008-
23; SR-BSE-2008-25; SR-BSECC-2008-01) (order approving NASDAQ OMX's
acquisition of BX) (``BX Acquisition Order''); Securities Exchange
Act Release No. 58179 (July 17, 2008), 73 FR 42874 (July 23, 2008)
(SR-PHLX-2008-31) (order approving NASDAQ OMX's acquisition of PHLX)
(``PHLX Acquisition Order'').
    \8\ See id. See also Notice, supra note 4, at 31058.
    \9\ See Securities Exchange Act Release No. 57478 (March 12,
2008), 73 FR 14521, 14532-14533 (March 18, 2008) (SR-NASDAQ-2007-004
and SR-NASDAQ-2007-080) (``NOM Approval Order''); BX Acquisition
Order, supra note 7, at 46944; and PHLX Acquisition Order, supra
note 7, at 42877.
    \10\ See, e.g., NASDAQ Options Rule Chapter VI, Section 11(e)
(governing order routing on NOM); and Securities Exchange Act
Release No. 59948 (May 20, 2009), 74 FR 25784 (May 29, 2009) (SR-
NASDAQ-2009-047) (relating to the routing of orders by NOS inbound
to NOM from PHLX) (``PHLX Inbound Release'').
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    On May 1, 2012, BX filed a proposed rule change to establish a new
BX options market (``BX Options''), which will be an electronic trading
system that trades options.\11\ As part of its proposal, BX proposed
that NOS provide BX with outbound options routing services to other
markets, including its affiliate NASDAQ. On May 15, 2012, the Exchange
filed the instant proposal to allow the Exchange to accept such options
orders routed inbound by NOS from BX, on a one year pilot basis,
subject to certain limitations and conditions.\12\
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    \11\ See Securities Exchange Act Release No. 66983 (May 14,
2012), 77 FR 29730 (May 18, 2012) (SR-BX-2012-030) (notice of
propose rule change to adopt rules for the new BX options market)
(``BX Options Proposal'').
    On June 26, 2012, the Commission approved the BX Options
Proposal. See Securities Exchange Act Release No. 67256 (June 26,
2012) (``BX Options Approval'').
    \12\ See Notice, supra note 4.
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III. Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule
change is consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a national securities
exchange.\13\ Specifically, the Commission finds that the proposed rule
change is consistent with Section 6(b)(1) of the Act,\14\ which
requires, among other things, that a national securities exchange be so
organized and have the capacity to carry out the purposes of the Act,
and to comply and enforce compliance by its members and persons
associated with its members, with the provisions of the Act, the rules
and regulation thereunder, and the rules of the Exchange. Further, the
Commission finds that the proposed rule change is consistent with
Section 6(b)(5) of the Act,\15\ which requires, among other things,
that the rules of a national securities exchange be designed to prevent
fraudulent and manipulative acts and practices; to promote just and
equitable principles of trade; to foster cooperation and coordination
with persons engaged in regulating, clearing, settling, and processing
information with respect to, and facilitating 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. Section 6(b)(5) also
requires that the rules of an exchange not be designed to permit unfair
discrimination among customers, issuers, brokers, or dealers.
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    \13\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition and
capital formation. 15 U.S.C. 78c(f).
    \14\ 15 U.S.C. 78f(b)(1).
    \15\ 15 U.S.C. 78f(b)(5).
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    NOS will operate as a facility of BX that provides outbound options
routing from BX Options to other market centers, subject to certain
conditions.\16\ The operation of NOS as a facility of BX providing
outbound routing services from BX Options will be subject to BX
oversight, as well as Commission oversight. BX will be responsible for
ensuring that NOS's outbound options routing service is operated
consistent with Section 6 of the Act and BX rules. In addition, BX must
file with the Commission rule changes and fees relating to BX's
outbound options routing services.
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    \16\ See BX Options Approval, supra note 7, at Section II.D.
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    Recognizing that the Commission has previously expressed concern
regarding the potential for conflicts of interest in instances where a
member firm is affiliated with an exchange of which it is a member, the
Exchange previously proposed, and the Commission approved, limitations
and conditions on NOS's affiliation with the Exchange.\17\ Also
recognizing that the Commission has previously expressed concern
regarding the potential for conflicts of interest in instances where a
member firm is affiliated with an exchange to which it is routing
orders, the Exchange proposed the following limitations and conditions
to NOS's affiliation with the Exchange to permit the Exchange to accept
inbound options orders that NOS routes in its capacity as a facility of
BX:\18\
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    \17\ See NOM Approval Order, supra note 9, at 14521. See also
Notice, supra note 4, at 31058 n.9 and accompanying text. In
addition, the Exchange has authority to accept inbound orders that
NOS routes in its capacity as a facility of PHLX, subject to certain
limitations and conditions. See PHLX Inbound Release, supra note 10,
at 25784. See also Notice, supra note 4, at 31058 n.10 and
accompanying text.
    \18\ See Notice, supra note 4, at 31058.
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     First, the Exchange and the Financial Industry Regulatory
Authority (``FINRA'') will maintain a Regulatory Contract, as well as
an agreement pursuant to Rule 17d-2 under the Act

(``17d-2 Agreement'').\19\ Pursuant to the Regulatory Contract and the
17d-2 Agreement, FINRA will be allocated regulatory responsibilities to
review NOS's compliance with certain Exchange rules.\20\ Pursuant to
the Regulatory Contract, however, the Exchange retains ultimate
responsibility for enforcing its rules with respect to NOS.
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    \19\ 17 CFR 240.17d-2.
    \20\ NOS is also subject to independent oversight by FINRA, its
designated examining authority, for compliance with financial
responsibility requirements.
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     Second, FINRA will monitor NOS for compliance with the
Exchange's trading rules, and will collect and maintain certain related
information.\21\
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    \21\ Pursuant to the Regulatory Contract, both FINRA and the
Exchange will collect and maintain all alerts, complaints,
investigations and enforcement actions in which NOS (in its capacity
as a facility of BX routing orders to the Exchange) is identified as
a participant that has potentially violated applicable Commission or
Exchange rules. The Exchange and FINRA will retain these records in
an easily accessible manner in order to facilitate any potential
review conducted by the Commission's Office of Compliance
Inspections and Examinations. See Notice, supra note 4, at 31058
n.14.
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     Third, FINRA will provide a report to the Exchange's chief
regulatory officer (``CRO''), on a quarterly basis, that: (i)
Quantifies all alerts (of which the Exchange or FINRA is aware) that
identify NOS as a participant that has potentially violated Commission
or Exchange rules, and (ii) lists all investigations that identify NOS
as a participant that has potentially violated Commission or Exchange
rules.
     Fourth, the Exchange is amending NASDAQ Rule 2160(c) to
require NASDAQ OMX, as the holding company owning both the Exchange and
NOS, to establish and maintain procedures and internal controls
reasonably designed to ensure that NOS does not develop or implement
changes to its system, based on non-public information obtained
regarding planned changes to the Exchange's systems as a result of its
affiliation with the Exchange, until such information is available
generally to similarly situated Exchange members, in connection with
the provision of inbound options order routing to the Exchange.\22\
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    \22\ The Commission notes that prior to this proposed rule
change, NASDAQ Rule 2160(c) only applied with respect to the
Exchange's equity order routing facility, NASDAQ Execution Services
LLC. As a result of this proposed rule change, NASDAQ Rule 2160(c)
will be applicable to NOS.
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     Fifth, the Exchange proposes that the routing of options
orders from NOS to the Exchange, in NOS's capacity as a facility of BX,
be authorized for a pilot period of one year.
    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.\23\ Although the Commission continues to be concerned about
potential unfair competition and conflicts of interest between an
exchange's self-regulatory obligations and its commercial interest when
the exchange is affiliated with one of its members, for the reasons
discussed below, the Commission believes that it is consistent with the
Act to permit NOS, in its capacity as a facility of BX, to route
options orders inbound to the Exchange on a pilot basis, subject to the
limitations and conditions described above.\24\
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    \23\ See, e.g., Securities Exchange Act Release Nos. 54170 (July
18, 2006), 71 FR 42149 (July 25, 2006) (SR-NASDAQ-2006-006) (order
approving NASDAQ's proposal to adopt NASDAQ Rule 2140, restricting
affiliations between NASDAQ and its members); 53382 (February 27,
2006), 71 FR 11251 (March 6, 2006) (SR-NYSE-2005-77) (order
approving the combination of the New York Stock Exchange, Inc. and
Archipelago Holdings, Inc.); 58673 (September 29, 2008), 73 FR 57707
(October 3, 2008) (SR-Amex-2008-62 and SR-NYSE-2008-60) (order
approving the combination of NYSE Euronext and the American Stock
Exchange LLC); 59135 (December 22, 2008), 73 FR 79954 (December 30,
2008) (SR-ISE-2009-85) (order approving the purchase by ISE Holdings
of an ownership interest in Direct Edge Holdings LLC); 59281
(January 22, 2009), 74 FR 5014 (January 28, 2009) (SR-NYSE-2008-120)
(order approving a joint venture between NYSE and BIDS Holdings
L.P.); 58375 (August 18, 2008), 73 FR 49498 (August 21, 2008) (File
No. 10-182) (order granting the exchange registration of BATS
Exchange, Inc.); 61698 (March 12, 2010), 75 FR 13151 (March 18,
2010) (File Nos. 10-194 and 10-196) (order granting the exchange
registration of EDGX Exchange, Inc. and EDGA Exchange, Inc.); and
62716 (August 13, 2010), 75 FR 51295 (August 19, 2010) (File No. 10-
198) (order granting the exchange registration of BATS-Y Exchange,
Inc.).
    \24\ The Commission notes that these limitations and conditions
are consistent with those previously approved by the Commission for
other exchanges. See, e.g., BX Options Approval, supra note 11, at
II.D.2.
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    The Commission believes that these limitations and conditions
enumerated above will mitigate its concerns about potential conflicts
of interest and unfair competitive advantage. In particular, the
Commission believes that a non-affiliated SRO's oversight of NOS,\25\
combined with a non-affiliated SRO's monitoring of NOS's compliance
with the Exchange's rules and quarterly reporting to the Exchange, will
help to protect the independence of the Exchange's regulatory
responsibilities with respect to NOS. The Commission also believes that
the Exchange's proposed amendments to NASDAQ Rule 2160(c) are designed
to ensure that NOS cannot use any information advantage it may have
because of its affiliation with the Exchange. Furthermore, the
Commission believes that the Exchange's proposal to allow NOS to route
options orders inbound to the Exchange from BX, on a pilot basis, will
provide the Exchange and the Commission an opportunity to assess the
impact of any conflicts of interest of allowing an affiliated member of
the Exchange to route orders inbound to the Exchange and whether such
affiliation provides an unfair competitive advantage.
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    \25\ This oversight will be accomplished through the 17d-2
Agreement between FINRA and the Exchange and the Regulatory
Contract. See Notice, supra note 4, at 31058 n.12 and accompanying
text.
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\26\ that the proposed rule change (SR-NASDAQ-2012-061) be, and
hereby is, approved.
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    \26\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\27\
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    \27\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-16374 Filed 7-3-12; 8:45 am]
BILLING CODE 8011-01-P