[Federal Register: June 15, 2006 (Volume 71, Number 115)]
[Notices]
[Page 34660-34672]
[DOCID:fr15jn06-72]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53963, File No. SR-NSX-2006-03]

Self-Regulatory Organizations; National Stock ExchangeSM; Order
Approving Proposed Rule Change and Amendment Nos. 1 and 2 Thereto
Relating to the Demutualization of the National Stock Exchange

June 8, 2006.

I. Introduction

    On April 5, 2006, the National Stock ExchangeSM (``NSX''
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 effect a series of proposed changes to the
Exchange's corporate structure that would allow for the demutualization
of the Exchange. On April 19, 2006, the NSX submitted Amendment No. 1
to the proposed rule change.\3\ On April 25, 2006, the NSX submitted
Amendment No. 2 to the proposed rule change, as amended.\4\ The
proposed rule change, as amended, was published for comment in the
Federal Register on May 3, 2006.\5\ The Commission has received one
comment on the proposal.\6\ The NSX submitted a response to the comment
on June 5, 2006.\7\ This order approves the proposed rule change, as
amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 (``Amendment No. 1'') made revisions to the
proposed: Holdings Certificate of Incorporation, Sections
(b)(iii)(B) and (C); Holdings By-Laws, Article III, Sections 3.1 and
3.4; NSX By-Laws, Article III, Section 3.2(b); and NSX Rule 2.10. In
addition, Amendment No. 1 added new proposed Section 3.6 to Article
III of the Holdings By-Laws, requiring Holdings to take reasonable
steps necessary to cause its officers, directors, and employees to
consent to the applicability to them of Article III of the Holdings
By-Laws. Finally, Amendment No. 1 made corresponding changes to Item
3 of Form 19b-4 and Exhibit 1 to describe the effect of the
foregoing Exhibit 5 revisions and also add a description of proposed
NSX Rule 2.10.
    \4\ Amendment No. 2 (``Amendment No. 2'') made changes to Item 3
of Form 19b-4 and Exhibit 1, which changes were incorporated into
the notice; see infra, note 5.
    \5\ See Securities Exchange Act Release No. 53721 (April 25,
2006), 71 FR 26155 (May 3, 2006) (''Demutualization Notice'').
    \6\ See Letter from Ann Yerger, Executive Director, Council of
Institutional Investors to Nancy M. Morris, Secretary, Commission,
dated May 11, 2006 (``CII Letter'').
    \7\ See Letter from James C. Yong, Chief Regulatory Officer,
Exchange to Nancy M. Morris, Secretary, Commission, dated June 5,
2006 (``NSX Response'').
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II. Description of Proposed Rule Change

a. Description of Demutualization Transaction

    Currently, NSX is a non-stock nonprofit Ohio corporation. NSX
proposes to demutualize by reorganizing as a Delaware for-profit stock
corporation that would be a direct and wholly-owned subsidiary of a new
Delaware for-profit stock holding company (``Holdings''). To accomplish
the demutualization, NSX has established (i) two new Delaware stock
for-profit corporations: Holdings, a direct and wholly-owned subsidiary
of NSX, and NSX Delaware Merger Sub, Inc. (``NSX Delaware Merger
Sub''), a direct and wholly-owned subsidiary of Holdings, and (ii) one
transitory Ohio stock for-profit corporation, NSX Ohio Merger Sub, Inc.
(``NSX Ohio Merger Sub''), also a direct and wholly-owned subsidiary of
Holdings.\8\
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    \8\ The Exchange stated that the establishment of NSX Ohio
Merger Sub and the process of demutualization through two mergers
(as described more fully in this document) are necessitated because
under Ohio law, NSX, as an Ohio nonprofit corporation, may not merge
directly with and into a foreign for-profit corporation, such as NSX
Delaware Merger Sub.
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    Pursuant to an agreement and plan of merger, NSX would merge
(``Merger 1'') with and into NSX Ohio Merger Sub, with NSX
Ohio Merger Sub surviving the merger as an Ohio for-profit stock
corporation that is a direct and wholly-owned subsidiary of Holdings.
As a result of Merger 1, NSX Ohio Merger Sub will be the
initial successor-in-interest to NSX. Immediately following Merger
1, pursuant to a second agreement and plan of merger, NSX Ohio
Merger Sub would merge (``Merger 2'') with and into NSX
Delaware Merger Sub, with NSX Delaware Merger Sub renamed National
Stock Exchange, Inc. surviving the merger as a Delaware for-profit
stock

corporation that is a direct and wholly-owned subsidiary of
Holdings.\9\
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    \9\ The term ``NSX'' in this document will also refer to the
Exchange as a Delaware for-profit stock corporation after the
demutualization.
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    In the Demutualization Notice, the Exchange stated that upon
completion of Merger 2, NSX, the Delaware for-profit stock
corporation, would be, in effect, the successor-in-interest to NSX, the
current Ohio non-stock nonprofit corporation, and would assume all of
the assets and liabilities of the Exchange, including, without
limitation, the adherence to, and the performance of, the undertakings
under the Order Instituting Administrative and Cease-and-Desist
Proceedings Pursuant to Sections 19(b) and 21C of the Securities
Exchange Act of 1934, Making Findings and Imposing Sanctions, entered
by the Commission on May 19, 2005 \10\ (the ``Order'').\11\ NSX stated
that it would continue to engage in the business of operating a
national securities exchange registered under Section 6 of the Act.\12\
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    \10\ See Securities Exchange Act Release No. 51714.
    \11\ See Demutualization Notice.
    \12\ 15 U.S.C. 78f. Following the demutualization, the Exchange
stated that earnings of NSX not retained in its business may be
distributed to its parent, Holdings, and Holdings would be
authorized to pay dividends to the stockholders of Holdings as and
when they are declared by the Board of Directors of Holdings, but
subject to the limitation under the proposed NSX By-Laws that any
revenues received by NSX from regulatory fees or penalties may not
be used to pay dividends. See proposed NSX By-Laws, Section 10.4.
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    Presently, the members of NSX hold certificates of proprietary
membership in NSX and have a right to trade on the exchange operated by
NSX. On the effective date of the demutualization (the ``Effective
Date''), each member of NSX would receive 1,000 shares of Holdings
Class A common stock \13\ for the first certificate of proprietary
membership of NSX held by the member and would receive a modestly
discounted number of shares of Class A common stock (determined by a
formula set forth in the Merger 1 merger agreement) for each
additional certificate held. If, however, the total number of Class A
shares to be received by a member that would hold an equity trading
permit entitling it to trading access on the Exchange after the
demutualization (an ``ETP Holder''), together with any Class A shares
to be received by that member's Related Persons,\14\ would exceed 20%
of the total number of Class A shares issued (and thus be in violation
of an ownership limitation under the proposed Holdings Certificate of
Incorporation \15\), that member would receive shares of Class C common
stock \16\ (which would generally not be entitled to the right to vote)
in lieu of the shares of Class A common stock that are in excess of the
20% ownership limitation (and that the member would have received were
the 20% ownership limitation not in effect under the proposed Holdings
Certificate of Incorporation).
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    \13\ Holdings would be authorized to issue 1,100,000 shares of
common stock having a par value of $.0001 per share (of which
900,000 shares will be designated as Class A common stock, 100,000
shares will designated as Class B common stock and 100,000 shares
will be designated as Class C common stock) and 100,000 shares of
preferred stock having a par value of $.0001 per share. The Class A
common stock would be entitled to one vote per share, absent a
provision in the Holdings Certificate of Incorporation fixing or
denying voting rights. Neither the Class B nor Class C common stock
would be entitled to vote, unless the matter at issue would the
alter the rights, preferences, privileges or limitations (other than
the right to vote) of that stock, respectively, without also
altering the rights, preferences, privileges and limitations of the
Class A common stock in an identical manner. See proposed Holdings
Certificate of Incorporation, Article Fourth, and proposed Holdings
By-Laws, Section 4.10.
    \14\ Under the proposed Holdings Certificate of Incorporation,
Article Fifth, paragraph (a)(ii), ``Related Persons'' means, with
respect to any Person: (A) Any ``affiliate'' of such Person (as such
term is defined in Rule 12b-2 under the Act); (B) any other Person
with which such first Person has any agreement, arrangement or
understanding (whether or not in writing) to act together for the
purpose of acquiring, voting, holding or disposing of shares of the
capital stock of the Corporation; (C) in the case of a Person that
is a company, corporation or similar entity, any executive officer
(as defined under Rule 3b-7 under the Act) or director of such
Person and, in the case of a Person that is a partnership or limited
liability company, any general partner, managing member or manager
of such Person, as applicable; (D) in the case of an ETP Holder, any
Person that is associated with the ETP Holder (as determined using
the definition of ``person associated with a member'' as defined
under Section 3(a)(21) of the Act); (E) in the case of a Person that
is an individual, any relative or spouse of such Person, or any
relative of such spouse who has the same home as such Person or who
is a director or officer of the Corporation or any of its parents or
subsidiaries; (F) in the case of a Person that is an executive
officer (as defined under Rule 3b-7 under the Act) or a director of
a company, corporation or similar entity, such company, corporation
or entity, as applicable; and (G) in the case of a Person that is a
general partner, managing member or manager of a partnership or
limited liability company, such partnership or limited liability
company, as applicable.
    \15\ See infra subsection II.b.(1)(a)(iv).
    \16\ Each share of Class C common stock issued would be
convertible, at the option of its holder, to one share of Class A
common stock upon the satisfaction of certain notification and other
requirements under the Holdings Certificate of Incorporation, but
only to the extent that the conversion does not violate the
limitations on ownership, transfer and voting applicable to Class A
common stock under the Holdings Certificate of Incorporation, as
more fully described in this document. See proposed Holdings
Certificate of Incorporation, Article Fourth, paragraph (d).
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    The Chicago Board Options Exchange, Incorporated (``CBOE'') owns
certificates of proprietary membership in NSX but is not a member of
NSX. In the demutualization, CBOE would receive shares of Holdings
Class B common stock (which is generally not entitled to the right to
vote) in exchange for its certificates of proprietary membership in NSX
that are subject to put and call rights under a Termination of Rights
Agreement between NSX and CBOE dated September 27, 2004 (the
``TORA''),\17\ and would receive shares of Holdings Class A common
stock in exchange for the remainder of its certificates of proprietary
membership.\18\ The number of Class A and Class B shares received by
CBOE would be based on the discount formula set forth in the Merger
1 merger agreement.
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    \17\ In 1986, NSX and CBOE entered into an agreement of
affiliation pursuant to which CBOE obtained certificates of
proprietary membership in NSX and certain rights associated with
NSX, including the right to hold certain seats on the Board of
Directors of NSX and certain put rights in connection with its
certificates of proprietary membership in NSX. Under the TORA, CBOE
agreed to relinquish, upon certain terms, certain of these rights in
exchange for cash payments and other undertakings. See Securities
Exchange Act Release No. 34-51033 (January 13, 2005), 70 FR 3085
(January 19, 2005) (File No. SR-NSX-2004-12). See also infra
subsection II.b.(1)(b)(ii).
    \18\ Each share of Class B common stock would automatically
convert to one share of Class A common stock upon its transfer, in
accordance with the TORA, to a bona fide third party purchaser
unaffiliated with CBOE. See proposed Holdings Certificate of
Incorporation, Article Fourth, paragraph (c). NSX stated that the
Class B shares would be transferable only under extraordinary
circumstances.
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    Following the demutualization, persons and entities who have been
qualified for membership under the Exchange's current Rules and, as a
result, have access to the Exchange's trading facilities would
separately receive NSX equity trading permits (``ETPs'') entitling them
to maintain their trading access to NSX and, as noted above, would be
referred to as ``ETP Holders.'' Shares of Holdings capital stock and
ETPs would not be tied together. Following the demutualization, former
NSX members would be able to sell the shares of Holdings capital stock
they receive in connection with the demutualization, subject to the
applicable restrictions in the proposed Holdings Certificate of
Incorporation and Holdings By-Laws (as described more fully below),
while retaining the ability to trade and operate on the Exchange
pursuant to their ETPs. Any other person or entity that satisfies the
regulatory requirements set forth in the NSX Rules also would be able
to obtain an ETP without regard to whether such person is a stockholder
of Holdings.

b. Summary of Proposed Rule Change

    The proposed rule change, as amended, consists of the proposed

Holdings Certificate of Incorporation and Holdings By-Laws and the
proposed changes to the Articles of Incorporation and By-Laws of the
Exchange that reflect governance and corporate form changes. In
addition, the proposed rule change includes proposed changes to the
Rules of the Exchange that are necessary to implement the proposed
equity trading permit structure. NSX also proposes to move certain
provisions in the current By-Laws of NSX respecting members, listing
standards, and other matters not relating to the Exchange's corporate
governance to the NSX Rules.
(1) Corporate Structure

(a) Holdings

    Following the demutualization, Holdings would be the parent company
and sole stockholder of NSX. NSX stated that all of the issued and
outstanding stock of Holdings initially would be owned by the former
owners of certificates of proprietary membership in the Exchange.
    As sole stockholder of NSX, Holdings would have the right to elect
the Board of Directors of NSX, subject to certain provisions in the
Holdings By-Laws that require Holdings to vote for certain persons
nominated for ETP Holder Director positions and certain persons
nominated for CBOE Director positions, in each case in accordance with
the revised governance documents of NSX. The Holdings Certificate of
Incorporation and the Holdings By-Laws would govern the activities of
Holdings.

(i) Holdings Board of Directors

    The business and affairs of Holdings would be managed by its Board
of Directors (``Holdings Board''). The Holdings Board would consist of
between 10 and 16 persons, as determined by the Holdings Board, one of
which shall be the Chief Executive Officer (``CEO'') of Holdings. The
Holdings Board would initially have 13 directors after the
demutualization. No person that is subject to any ``statutory
disqualification'' (within the meaning of Section 3(a)(39) of the Act)
may be a director of Holdings.\19\
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    \19\ See proposed Holdings Certificate of Incorporation, Article
Sixth, Section (a), and proposed Holdings By-Laws, Sections 2.2(a)
and (b).
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    The directors of Holdings would be divided into three classes,
which would be as nearly equal in number as the total number of
directors then constituting the entire Holdings Board. After completion
of an initial phase-in schedule, the directors of Holdings would serve
staggered three-year terms, with the term of office of one class
expiring each year.\20\
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    \20\ See proposed Holdings Certificate of Incorporation, Article
Sixth, Section (b), and proposed Holdings By-Laws, Section 2.2(c).
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    The Holdings Board would elect its Chairman from among the
directors on the Holdings Board, and may elect a vice-chairman to
perform the functions of the Chairman in his or her absence.\21\
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    \21\ See proposed Holdings By-Laws, Section 2.3(a).
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    At each annual meeting of the stockholders of Holdings at which a
quorum is present, the individuals receiving a plurality of the votes
cast of the Class A shares would be elected directors of Holdings.\22\
At an election of directors, each Holdings stockholder would be
entitled to one vote for each share of Class A common stock owned by
that stockholder.\23\ Class B and Class C shares shall not be entitled
to vote at an election of directors.\24\
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    \22\ See proposed Holdings By-Laws, Section 4.8.
    \23\ See proposed Holdings Certificate of Incorporation, Article
Fourth, paragraph (b), and proposed Holdings By-Laws, Section 4.10.
    \24\ See proposed Holdings Certificate of Incorporation, Article
Fourth, paragraphs (c) and (d).
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    In most cases, vacancies on the Holdings Board would be filled by
the remaining directors of Holdings. If the vacancy has resulted from a
director being removed for cause by the stockholders of Holdings,
however, that vacancy may be filled by the stockholders of Holdings at
the same meeting at which the director was removed. Any director
appointed to fill a vacancy will serve until the expiration of the term
of office of the replaced director or until the end of the term for a
newly-created directorship.\25\
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    \25\ See proposed Holdings By-Laws, Section 2.4.
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(ii) Committees of Holdings

    The Holdings Board would have an Audit Committee, a Governance and
Nominating Committee, and such other committees that the Holdings Board
establishes.\26\ The Chairman of the Holdings Board would appoint the
members of all committees of the Holdings Board, and may remove any
member so appointed, subject to the approval of the Holdings Board.\27\
Each committee would have the authority and duties prescribed for it in
the Holdings By-Laws or by the Holdings Board.\28\
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    \26\ See proposed Holdings By-Laws, Section 5.1.
    \27\ See proposed Holdings By-Laws, Section 5.2.
    \28\ See proposed Holdings By-Laws, Section 5.3.
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(iii) Officers of Holdings

    The officers of Holdings would be a CEO, a President, a Secretary,
a Treasurer, and such other officers as the Holdings Board
determines.\29\ The CEO would be responsible to the Holdings Board for
management of the business affairs of Holdings.\30\ The officers of
Holdings would have the duties and authority set forth in the Holdings
By-Laws or given to them by the Holdings Board, and in the case of the
President, the Secretary, and the Treasurer, given to them by the Chief
Executive Officer.\31\ Any two or more offices may be held by the same
person, except that the Secretary may not also serve as the CEO or the
President. No person that is subject to any ``statutory
disqualification'' (within the meaning of Section 3(a)(39) of the Act)
may be an officer of Holdings.\32\
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    \29\ See proposed Holdings By-Laws, Section 6.1.
    \30\ See proposed Holdings By-Laws, Section 6.4.
    \31\ See proposed Holdings By-Laws, Sections 6.1, 6.4, 6.5, 6.6,
and 6.7.
    \32\ See proposed Holdings By-Laws, Section 6.1.
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(iv) Stockholder Restrictions

    The Holdings Certificate of Incorporation and the Holdings By-Laws
place certain restrictions on the ability to transfer, own, and vote
the capital stock of Holdings.

(1) Restrictions on Voting

    The Holdings Certificate of Incorporation prohibits any Person,\33\
either alone or together with its Related Persons, from (a) voting or
giving a proxy or consent with respect to shares representing more than
20% of the voting power of the then-issued and outstanding capital
stock of Holdings; or (b) entering into any agreement, plan, or
arrangement that would result in the shares of Holdings subject to that
agreement, plan, or arrangement not being voted on a matter, or any
proxy relating thereto being withheld, where the effect of that
agreement, plan, or arrangement would be to enable any Person, alone or
together with its Related Persons, to obtain more than 20% of the
voting power of the then-issued and outstanding capital stock of
Holdings.\34\
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    \33\ Article Fifth of the proposed Holdings Certificate of
Incorporation defines a ``Person'' to mean ``an individual,
partnership (general or limited), joint stock company, corporation,
limited liability company, trust or unincorporated organization, or
any governmental entity or agency or political subdivision
thereof.''
    \34\ See proposed Holdings Certificate of Incorporation, Article
Fifth, paragraph (b)(ii)(C).
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    This restriction would not apply to the Class B or Class C common
stock and, as to the Class A common stock owned by Persons other than
ETP Holders and their Related Persons, may be waived by Holdings Board
pursuant to a resolution adopted by the Holdings

Board.\35\ Before adopting such resolution, however, the Holdings Board
must determine that, among other things, the waiver of the voting
limitation will not impair the ability of NSX to carry out its
functions and responsibilities under the Act and the rules and
regulations promulgated thereunder, and will not impair the
Commission's ability to enforce the Act and the rules and regulations
promulgated thereunder.\36\ In addition, the Holdings Board also must
determine that a Person and its Related Persons that would vote more
than 20% of the outstanding stock of Holdings are not subject to an
applicable ``statutory disqualification'' (within the meaning of
Section 3(a)(39) of the Act).\37\ Finally, any resolution of the
Holdings Board that would permit a Person to vote more than 20% of the
outstanding stock of Holdings must be filed with and approved by the
Commission before it becomes effective.\38\
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    \35\ See proposed Holdings Certificate of Incorporation, Article
Fifth, paragraphs (b)(iii)(A) and (B). See Amendment No. 1, supra
note 3.
    \36\ See proposed Holdings Certificate of Incorporation, Article
Fifth, paragraph (b)(iii)(B).
    \37\ 15 U.S.C. 78c(a)(39); see proposed Holdings Certificate of
Incorporation, Article Fifth, paragraph (b)(iv).
    \38\ See proposed Holdings Certificate of Incorporation, Article
Fifth, paragraph (b)(iii)(B).
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(2) Restrictions on Ownership

    Under the proposed Holdings Certificate of Incorporation, no
Person, either alone or together with its Related Persons, may own
shares constituting more than 40% of any class of capital stock of
Holdings (other than a class of stock without general voting
rights).\39\ The Holdings Board may waive this ownership limitation
pursuant to a resolution adopted by the Holdings Board. Before adopting
such resolution, however, the Holdings Board must determine that, among
other things, the waiver of the ownership limitation would not impair
the ability of NSX to carry out its functions and responsibilities
under the Act and the rules and regulations promulgated thereunder and
would not impair the Commission's ability to enforce the Act and the
rules and regulations promulgated thereunder.\40\
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    \39\ See proposed Holdings Certificate of Incorporation, Article
Fifth, paragraphs (b)(ii)(A) and (b)(iii)(A).
    \40\ See proposed Holdings Certificate of Incorporation, Article
Fifth, paragraph (b)(iii)(B).
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    In addition, the Holdings Board also must determine that any Person
and its Related Persons that would own more than 40% of any class of
capital stock of Holdings are not subject to any applicable ``statutory
disqualification'' (within the meaning of Section 3(a)(39) of the
Act).\41\ Finally, any Holdings Board resolution that would permit
ownership of Holdings capital stock in excess of the ownership
limitation described above must be filed with and approved by the
Commission before it becomes effective.\42\
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    \41\ 15 U.S.C. 78c(a)(39); see proposed Holdings Certificate of
Incorporation, Article Fifth, paragraph (b)(iv).
    \42\ See proposed Holdings Certificate of Incorporation, Article
Fifth, paragraphs (b)(iii)(B) and (C).
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    In addition to the ownership restriction described above, no ETP
Holder, whether alone or together with its Related Persons, may own
shares constituting more than 20% of any class of capital stock of
Holdings.\43\ However, this ownership restriction would not apply to
any ETP Holder, with respect to shares of Class C common stock of
Holdings issued to the ETP Holder in connection with, and from the date
of, the demutualization of NSX so long as the ETP Holder becomes
compliant with the ownership limitation promptly after such
issuance.\44\
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    \43\ See proposed Holdings Certificate of Incorporation, Article
Fifth, paragraph (b)(ii)(B).
    \44\ See proposed Holdings Certificate of Incorporation, Article
Fifth, paragraph (b)(iii)(C). See Amendment No. 1, supra note 3.
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(3) Other Stockholder Ownership and Voting Restriction Requirements

    The proposed Holdings Certificate of Incorporation contains several
provisions that would enable Holdings to enforce restrictions on the
ownership and voting of Holdings capital stock described in the
preceding section. Specifically, if a stockholder purports to sell,
transfer, assign, or pledge to any Person (other than Holdings) any
shares of Holdings that would violate the ownership restrictions,
Holdings would record on its books the transfer of only the number of
shares that would not violate the restrictions and would treat the
remaining shares as owned by the purported transferor, for all
purposes, including, without limitation, voting, payment of dividends,
and distributions.\45\
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    \45\ See proposed Holdings Certificate of Incorporation, Article
Fifth, paragraph (d).
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    In addition, if any stockholder purports to vote, or to grant any
proxy or enter into any agreement, plan, or arrangement relating to the
voting of shares that would violate the voting restrictions, Holdings
would not honor such vote, proxy, or agreement, plan, or other
arrangement to the extent that the restrictions would be violated, and
any shares subject to that arrangement would not be entitled to be
voted to the extent of the violation.\46\ Further, if any stockholder
purports to sell, transfer, assign, pledge, vote, or own any shares
that would violate the ownership and voting restrictions, Holdings
would have the right to, and would generally be required to promptly,
redeem such shares at a price equal to the par value of the shares.\47\
Also, a stockholder that alone or together with its Related Persons
owns five percent or more of the then outstanding shares of the capital
stock of Holdings entitled to vote in an election of directors must,
upon acquiring knowledge of such ownership, immediately give the
Holdings Board written notice of such ownership.\48\ Holdings may also
require any Person reasonably believed to be subject to and in
violation of the voting and ownership restrictions to provide to
Holdings information relating to such potential violation.\49\
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    \46\ Id.
    \47\ See proposed Holdings Certificate of Incorporation, Article
Fifth, paragraph (e).
    \48\ See proposed Holdings Certificate of Incorporation, Article
Fifth, paragraph (c)(i). Such notice must also be updated under
certain circumstances. See proposed Holdings Certificate of
Incorporation, Article Fifth, paragraph (c)(ii).
    \49\ See proposed Holdings Certificate of Incorporation, Article
Fifth, paragraph (c)(iii).
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(4) Restrictions on Transfer

    Members, former members, and other equity owners of NSX who receive
shares of capital stock of Holdings in the demutualization may not
sell, transfer, or otherwise dispose of those shares for the first
thirty days following their issuance, unless the Holdings Board waives
this transfer restriction.\50\
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    \50\ See proposed Holdings Certificate of Incorporation, Article
Fifth, paragraph (b)(i).
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    Also, unless waived by the Holdings Board or pursuant to a
redemption of shares by Holdings, each stockholder of Holdings would be
prohibited from selling, transferring, or otherwise disposing of common
shares of Holdings except in amounts of at least 1,000 shares (unless
the stockholder is transferring all shares owned), and no stockholder
would be permitted to transfer any capital stock of Holdings (other
than pursuant to a redemption of shares by Holdings) until all amounts
due and owing from that stockholder to NSX have been paid.\51\
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    \51\ See proposed Holdings By-Laws, Sections 9.4 and 9.5(b).
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    In the event that a stockholder desires to transfer shares of
capital stock of Holdings to any person (other than an affiliate of the
stockholder or to another holder of the same class of capital stock)
prior to January 1, 2011, Holdings would have a right of first refusal
permitting it to purchase those shares,

except for transfers by bequest, operation of law, or judicial decree
under certain circumstances.\52\
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    \52\ See proposed Holdings By-Laws, Section 9.6.
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    In addition to these transfer restrictions, shares of Holdings
would be ``restricted securities'' under the Securities Act of 1933
(``Securities Act'') and only may be transferred pursuant to an
effective registration statement under the Securities Act and in
accordance with applicable state securities laws or, if an exemption
from registration is available, upon delivery to Holdings of a
satisfactory opinion of counsel that such transfer may be effected
pursuant to the exemption. In addition, counsel to Holdings may require
delivery of documentation to ensure that the transfer complies with the
Securities Act and state securities laws before such transfer is
effected.\53\ In the Demutualization Notice, the Exchange stated that
Holdings had no intention to register its common stock under the
Securities Act or the Act, and, unless waived in writing by the
Holdings Board, no transfer would be honored by Holdings that would
cause Holdings to have to do so or to become subject to the reporting
requirements of the Act.\54\
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    \53\ See proposed Holdings By-Laws, Section 9.5(a).
    \54\ See proposed Holdings By-Laws, Section 9.5(c).
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(v) Self-Regulatory Function and Oversight

    The Holdings By-Laws contain various provisions designed to protect
the independence of the self-regulatory function of NSX. For example,
under the Holdings By-Laws, for as long as Holdings controls NSX, the
Holdings Board and the directors, officers, and employees of Holdings
must give due regard to the preservation of the independence of the
self-regulatory function of NSX and to its obligations to investors and
the general public, and are prohibited from taking actions that would
interfere with the effectuation of decisions by the Board of Directors
of NSX (``NSX Board'') relating to NSX's regulatory functions,
including disciplinary matters, or which would interfere with NSX's
ability to carry out its responsibilities under the Act.\55\
---------------------------------------------------------------------------

    \55\ See proposed Holdings By-Laws, Section 3.1.
---------------------------------------------------------------------------

    The Holdings By-Laws also contain a specific requirement that all
books and records of NSX, and the information contained therein, that
reflect confidential information pertaining to the self-regulatory
function of NSX, which come into the possession of Holdings, must be
retained in confidence by Holdings and its Board, officers, employees,
and agents, and must not be used for any non-regulatory purposes.\56\
In addition, the Holdings By-Laws provide that, to the extent they are
related to the activities of NSX, the books, records, premises,
officers, directors, agents, and employees of Holdings are deemed to be
the books, records, premises, officers, directors, agents, and
employees of NSX for the purposes of, and subject to oversight pursuant
to, the Act.\57\
---------------------------------------------------------------------------

    \56\ See proposed Holdings By-Laws, Section 3.2.
    \57\ See proposed Holdings By-Laws, Section 3.3. This provision
also requires Holdings to maintain its books and records in the
United States.
---------------------------------------------------------------------------

    Pursuant to the Holdings By-Laws, Holdings must comply with the
Federal securities laws and the rules and regulations promulgated
thereunder. The Holdings By-Laws also provide that Holdings must
cooperate with the Commission and NSX pursuant to and to the extent of
their respective regulatory authority, and that the officers,
directors, employees, and agents of Holdings, by virtue of their
acceptance of such position, are deemed to agree to cooperate with the
Commission and NSX in respect of the Commission's oversight
responsibilities regarding NSX and the self-regulatory function and
responsibilities of NSX.\58\ In addition, the Holdings By-Laws provide
that Holdings, its officers, directors, employees, and agents, by
virtue of their acceptance of such positions, are deemed to irrevocably
submit to the jurisdiction of the U.S. federal courts, the Commission
and NSX, for the purpose of any suit, action, or proceeding pursuant to
the U.S. federal securities laws, and the rules and regulations
promulgated thereunder, arising out of, or relating to, the activities
of NSX.\59\
---------------------------------------------------------------------------

    \58\ See proposed Holdings By-Laws, Section 3.4. See Amendment
No. 1, supra note 3.
    \59\ See proposed Holdings By-Laws, Section 3.5. Pursuant to the
Holdings By-Laws, Holdings would be required to take reasonable
steps necessary to cause its officers, directors, and employees,
prior to accepting a position as an officer, director, or employee,
as applicable, of Holdings, to consent in writing to the
applicability to them of the provisions described in this and the
preceding two paragraphs with respect to their activities related to
NSX; see Amendment No. 1, supra note 3.
---------------------------------------------------------------------------

    Finally, the Holdings Certificate of Incorporation and the Holdings
By-Laws provide that, as long as Holdings controls NSX, before any
change to the Holdings Certificate of Incorporation or the Holdings By-
Laws, respectively, will be effective, such change must be submitted to
the NSX Board, and if the NSX Board determines that the change must be
filed with or filed with and approved by the Commission before it may
be effective, the change will not be effective until it is filed with,
or filed with and approved by, the Commission, as the case may be.\60\
---------------------------------------------------------------------------

    \60\ See proposed Holdings Certificate of Incorporation, Article
Twelfth, and proposed Holdings By-Laws, Article VIII. These
provisions additionally state, respectively, that (i) any change to
the proposed Holdings Certificate of Incorporation must also be
first approved by the Holdings Board and (ii) any change to the
proposed Holdings By-Laws may be made by either the stockholders of
Holdings or the Holdings Board. In addition, under Article Fourth,
paragraph (e) of the proposed Holdings Certificate of Incorporation,
holders of preferred stock (voting separately as single class) must
approve any change to the Holdings Certificate of Incorporation that
would change the terms of that preferred stock. No preferred stock
is currently issued and outstanding.
---------------------------------------------------------------------------

(b) NSX

    Following the demutualization, NSX would become a Delaware for-
profit stock corporation, with the authority to issue 1,000 shares of
common stock. At all times, all of the voting stock of NSX would be
owned by Holdings.\61\ NSX would continue to be the entity registered
as a national securities exchange under Section 6 of the Act \62\ and,
accordingly, NSX would continue to be a self-regulatory organization
(``SRO'').\63\
---------------------------------------------------------------------------

    \61\ See proposed NSX Certificate of Incorporation, Article
Fourth.
    \62\ 15 U.S.C. 78f.
    \63\ In addition, NSX stated that it would continue to adhere to
the undertakings in the Order (see supra note 10) including, without
limitation, the structure provisions of a Regulatory Oversight
Committee, the separation of the regulatory functions from the
commercial interests of the Exchange, and the retention of third
parties to review the Exchange's regulatory functions.
---------------------------------------------------------------------------

(i) Governing Documents and NSX Rules

    The proposed NSX Certificate of Incorporation,\64\ NSX By-Laws, and
NSX Rules (with the proposed changes described in this document) would
govern the activities of NSX. NSX stated that these rules and
governance documents reflect, among other things, NSX's status as a
wholly-owned subsidiary of Holdings, its management by the NSX Board
and its designated officers, and its self-regulatory responsibilities
pursuant to NSX's registration under Section 6 of the Act. NSX's
proposed governance documents are designed to be consistent with its
current governance structure, with certain changes based upon its
proposed new corporate form.
---------------------------------------------------------------------------

    \64\ Due to differences in terminology between Ohio and Delaware
law, the Exchange's Articles of Incorporation are proposed to be
renamed its ``Certificate of Incorporation.''
---------------------------------------------------------------------------

(ii) Board of Directors

    After the demutualization, the NSX Board would initially consist of
13 directors. The NSX Board would be initially comprised of the CEO of
NSX,

3 ETP Holder Directors,\65\ 7 Independent Directors,\66\ and 2
directors who are executive officers of CBOE, its members,\67\ or
executive officers of CBOE member organizations.\68\ Currently, the
Exchange's Board of Directors consists of the CEO of NSX, 3 proprietary
members or executive officers of proprietary members, 7 independent
directors, and 2 executive officers of CBOE, CBOE members, or executive
officers of CBOE member organizations.
---------------------------------------------------------------------------

    \65\ An ETP Holder Director is defined under the proposed NSX
By-Laws as a director who is an ETP Holder or a director, officer,
managing member or partner of an entity that is an ETP Holder. See
proposed NSX By-Laws, Section 1.1(E)(2).
    \66\ An Independent Director is defined under the proposed NSX
By-Laws as a member of the NSX Board that the NSX Board has
determined to have no material relationship with NSX or any
affiliate of NSX, or any ETP Holder or any affiliate of any such ETP
Holder, other than as a member of the NSX Board. See proposed NSX
By-Laws, Section 1.1(I)(1). This definition is consistent with the
definition of Independent Director in the current By-Laws of NSX.
NSX states that at least one Independent Director will be
representative of investors; see Amendment No. 1, supra note 3.
    \67\ A CBOE member is defined under the proposed NSX By-Laws as
an individual CBOE member or a CBOE member organization that is a
regular member or special member of CBOE (as such terms are
described in the Constitution of the CBOE), as such CBOE members may
exist from time to time. See proposed NSX By-Laws, Section
1.1(C)(2).
    \68\ See proposed NSX By-Laws, Section 3.2(a).
---------------------------------------------------------------------------

    Under the proposed rule change, the NSX Board may by resolution
increase its size to up to 20 directors. Directors added to the NSX
Board to fill these new director positions will be (i) Independent
Directors, to the extent necessary for the NSX Board to include at
least 50% Independent Directors; (ii) ETP Holder Directors, to the
extent necessary for the NSX Board to include at least 20% ETP Holder
Directors; and (iii) persons who do not qualify as Independent
Directors (``At-Large Directors''), for the remainder of the positions
added to the NSX Board that are not filled with Independent Directors
or ETP Holder Directors pursuant to clauses (i) and (ii) above. At all
times, the NSX Board must include the CEO of NSX, at least 50%
Independent Directors and 3 ETP Holder Directors (or such greater
number of ETP Holder Directors as is necessary to comprise at least 20%
of the NSX Board).\69\
---------------------------------------------------------------------------

    \69\ See proposed NSX By-Laws, Section 3.2(b); see Amendment No.
1, supra note 3.
---------------------------------------------------------------------------

    No two or more directors under the proposed NSX By-Laws may be
partners, officers, or directors of the same person or be affiliated
with the same person, unless such affiliation is with a national
securities exchange or Holdings.\70\ Directors of NSX other than the
CEO and the CBOE Directors would be divided into three classes,
consisting as nearly as possible of equal numbers of directors.\71\
After completion of an initial phase-in schedule, these directors would
serve for staggered three-year terms, with the term of one class
expiring each year. The CEO's appointment as a director would coincide
with his or her term as CEO of NSX.\72\ The CBOE Directors would each
serve a one year term.\73\
---------------------------------------------------------------------------

    \70\ See proposed NSX By-Laws, Section 3.2(c).
    \71\ See proposed NSX By-Laws, Section 3.4.
    \72\ See proposed NSX By-Laws, Section 3.4(a).
    \73\ See proposed NSX By-Laws, Section 3.4(d).
---------------------------------------------------------------------------

    Under the proposed NSX By-Laws, the NSX Board is subject to change
upon certain events in accordance with the TORA between CBOE and
NSX.\74\ Under the TORA, CBOE was provided with 4 put rights to
transfer its equity interests in NSX to NSX and NSX was provided with 4
call rights on those equity interests. According to NSX, as of March
10, 2006, the first of these put rights was exercised by CBOE,
decreasing the number of director positions of NSX filled by a
representative of CBOE from 3 to 2 and increasing the number of
positions filled by independent directors from 6 to 7. Under the
proposed NSX By-Laws:
---------------------------------------------------------------------------

    \74\ See generally proposed NSX By-Laws, Section 3.3.
---------------------------------------------------------------------------

     On the second closing of a put or call under the TORA, the
number of positions on the NSX Board filled by representatives of CBOE
will be reduced from 2 to 1. The vacant director position must be
filled by an At-Large Director, unless an Independent Director is
needed to maintain at least 50% Independent Directors on the NSX
Board.\75\
---------------------------------------------------------------------------

    \75\ See proposed NSX By-Laws, Section 3.3(a).
---------------------------------------------------------------------------

     On the earlier of the date CBOE owns less than 5% of the
outstanding capital stock of Holdings or the third anniversary of the
fourth closing of a put or call under the TORA, CBOE's appointed
positions on the NSX board will decrease to zero. The vacant director
position must be filled with an At-Large Director, unless an
Independent Director is needed to maintain at least 50% Independent
Directors on the NSX Board.\76\
---------------------------------------------------------------------------

    \76\ See proposed NSX By-Laws, Section 3.3(b).
---------------------------------------------------------------------------

    The NSX Board would elect its Chairman from among the directors of
the NSX Board. The Chairman of the NSX Board may also serve as the CEO
and President of NSX, but may hold no other offices in NSX. Unless the
Chairman also serves as the CEO of NSX, the NSX Board must elect the
Chairman from among the Independent Directors of the NSX Board.\77\
---------------------------------------------------------------------------

    \77\ See proposed NSX By-Laws, Section 3.6.
---------------------------------------------------------------------------

    In most cases, vacancies on the NSX Board would be filled by the
remaining directors of NSX. If the vacancy has resulted from a director
being removed for cause by the stockholders of NSX, however, that
vacancy may be filled by the stockholder of NSX (i.e., Holdings) at the
same meeting at which the director was removed. Any director appointed
to fill a vacancy would serve until the expiration of the term of
office of the replaced director or until the end of the term for a
newly-created directorship.\78\
---------------------------------------------------------------------------

    \78\ See proposed NSX By-Laws, Section 3.7(a).
---------------------------------------------------------------------------

(iii) Nomination and Election of Directors

    After the formation of the initial NSX Board, the NSX Governance
and Nominating Committee would nominate directors for each director
position (other than CBOE director positions) standing for election at
the annual meeting of stockholders that year. Candidates for CBOE
Directors would be nominated by the Board of Directors of CBOE at its
annual meeting or within 20 days of NSX's annual stockholders' meeting.
Because ETPs are not equity interests in NSX, ETP Holders are not
entitled to directly elect members of the NSX Board. Rather, Holdings,
as the sole stockholder of NSX, would have the sole right and the
obligation to vote for the directors of the NSX Board.\79\
---------------------------------------------------------------------------

    \79\ Under Section 10.5(a) of the proposed By-Laws of Holdings,
the power to vote the stock of NSX held by Holdings would be with
the CEO of Holdings, unless the Holdings Board instructs otherwise
or unless the Holdings Board or the CEO of Holdings confers such
power on another person.
---------------------------------------------------------------------------

    Specifically, the ETP Holder Director Nominating Committee of NSX
(which would be composed solely of ETP Holder Directors and/or ETP
Holder representatives) would consult with the NSX Governance and
Nominating Committee, the Chairman, and the CEO of NSX and solicit
comments from ETP Holders for the purpose of approving and submitting
names of ETP Holder Director candidates.\80\ These initial candidates
for nomination would be announced to ETP Holders, who would then have
the opportunity to identify additional candidates for nomination to ETP
Holder Director positions by submitting a petition signed by at least
ten percent of the ETP Holders. An ETP Holder may endorse as many
candidates as there are ETP Holder Director positions to be filled. If
no petitions are submitted within the time frame prescribed by the NSX
By-Laws, the initial candidates approved and submitted by the ETP
Holder Director Nominating Committee would be

nominated. If one or more valid petitions are submitted, the ETP
Holders would vote on the entire group of potential candidates, and the
individuals receiving the largest number of votes would be the ETP
Holder Director nominees.\81\
---------------------------------------------------------------------------

    \80\ See proposed NSX By-Laws, Section 3.5.
    \81\ Under Section 3.5(e) of the proposed NSX By-Laws, each ETP
Holder, regardless of its affiliation with other ETP Holders, will
have one vote with respect to each ETP Holder Director position to
be filled, but may not cast such votes cumulatively. The CBOE
directors are elected by the Board of Directors of CBOE at its
January meeting or as soon thereafter as possible. The current By-
Laws of NSX also contain a procedure for proprietary member director
nominations, whereby one proprietary member director candidate is
nominated by the Nominating Committee and additional proprietary
member director candidates may be nominated by a petition signed by
ten percent or more of the proprietary members. At an annual
election during the annual meeting of members, the proprietary
members vote for the proprietary member directors among the
nominated candidates.
---------------------------------------------------------------------------

(iv) Committees

    The NSX Board would have the following committees: (1) A Business
Conduct Committee; (2) a Securities Committee; (3) an Appeals
Committee; (4) a Governance and Nominating Committee; (5) an ETP Holder
Director Nominating Committee; (6) a Regulatory Oversight Committee;
(7) a Compensation Committee; (8) an Executive Committee; and (9) an
Audit Committee.\82\ The NSX Board may establish other committees from
time to time. Each committee would have the authority and
responsibilities prescribed for it in the NSX By-Laws, the rules of the
Exchange, or by the NSX Board.\83\
---------------------------------------------------------------------------

    \82\ See proposed NSX By-Laws, Section 5.1.
    \83\ See proposed NSX By-Laws, Sections 5.1 and 5.3.
---------------------------------------------------------------------------

    The Chairman of the NSX Board would appoint, and may remove, the
members of the committees, subject to the approval of the NSX
Board.\84\ Each committee must have at least 3 members.\85\ The
Executive Committee would have the powers that the NSX Board delegates
to it, except the power to change the membership of, or fill vacancies
in, the Executive Committee.\86\ The ETP Holder Director Nominating
Committee would have the power to approve and submit names of
candidates for election to the position of ETP Holder Director in
accordance with the NSX By-Laws.\87\ The Regulatory Oversight Committee
would oversee all of the regulatory functions and responsibilities of
NSX and advise the NSX Board on regulatory matters.\88\ The Regulatory
Oversight Committee's duties and responsibilities are outlined in its
charter.\89\
---------------------------------------------------------------------------

    \84\ Under Section 5.2 of the proposed NSX By-Laws, the terms of
committee members are subject to the appointment and removal process
of the Chairman and NSX Board.84
    \85\ See proposed NSX By-Laws, Section 5.2.
    \86\ See proposed NSX By-Laws, Section 5.5.
    \87\ See proposed NSX By-Laws, Section 5.7.
    \88\ See proposed NSX By-Laws, Section 5.6.
    \89\ NSX stated that the Regulatory Oversight Committee's
charter following demutualization would be the same as the charter
previously filed with the Commission, and is consistent with the
terms of the Order. See Securities Exchange Act Release No. 34-52573
(October 7, 2005), 70 FR 60113 (October 14, 2005) (File No. SR-NSX-
2005-07). strategies of the Exchange's ETP Holders.
---------------------------------------------------------------------------

(v) Management

    The officers of NSX would be a CEO, a President, a Chief Regulatory
Officer, a Secretary, and a Treasurer, and such other officers as the
NSX Board may determine.\90\ Any two or more offices may be held by the
same person, except that the Chief Regulatory Officer and the Secretary
may not be the CEO or the President.\91\ The Chairman of the NSX Board,
subject to approval of the NSX Board, may designate one or more
officers or other employees of NSX to serve as an Arbitration Director,
who would perform or delegate all ministerial duties in connection with
matters submitted for arbitration pursuant to the rules of NSX.\92\
---------------------------------------------------------------------------

    \90\ See proposed NSX By-Laws, Section 6.1.
    \91\ See proposed NSX By-Laws, Section 6.1.
    \92\ See proposed NSX By-Laws, Section 6.6.
---------------------------------------------------------------------------

(vi) Self-Regulatory Function and Oversight

    Following the demutualization, NSX would continue to be registered
as a national securities exchange under Section 6 of the Act and thus
would continue to be an SRO.\93\ As an SRO, NSX would be obligated to
carry out its statutory responsibilities, including enforcing
compliance by ETP Holders with the provisions of the Federal securities
laws and the applicable rules of NSX. Further, it would retain the
responsibility to administer and enforce the rules that govern NSX and
the activities of its ETP Holders. In addition, it would continue to be
required to file with the Commission, pursuant to Section 19(b) of the
Act \94\ and Rule 19b-4 thereunder,\95\ any changes to its rules and
governing documents. The structural protections adopted by NSX pursuant
to the Order help to ensure that NSX's regulatory functions are
independent from the commercial interests of NSX and its members would
remain in effect following demutualization.
---------------------------------------------------------------------------

    \93\ See 15 U.S.C. 78c(a)(26).
    \94\ 15 U.S.C. 78s(b).
    \95\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

    Like the proposed Holdings By-Laws, the proposed NSX By-Laws
contain specific provisions relating to the self-regulatory function of
NSX.\96\ For example, the proposed NSX By-Laws require the NSX Board to
consider applicable requirements under Section 6(b) of the Act in
connection with the management of the Exchange.\97\ In addition,
meetings of the NSX Board and of the committees of NSX that pertain to
the self-regulatory function of NSX must be closed to persons who are
not members of the NSX Board or NSX officers, staff, counsel, or other
advisors whose participation is necessary or appropriate to the self-
regulatory function of NSX, or representatives of the Commission.\98\
---------------------------------------------------------------------------

    \96\ See proposed NSX By-Laws, Article X.
    \97\ See proposed NSX By-Laws, Section 10.1. Section 6(b) of the
Act requires, among other things, that the Exchange's rules be
designed to protect investors and the public interest. It also
requires that the Exchange be so organized that it has the capacity
to carry out the purposes of the Act and to enforce compliance by
its members with the Act, the rules and regulations promulgated
thereunder, and the rules of the Exchange.
    \98\ See proposed NSX By-Laws, Section 10.2. In addition,
members of the Holdings Board who are also not members of the NSX
Board and any officers, staff, counsel, or advisors of Holdings who
do not hold similar positions with respect to NSX would not be
allowed to participate in any meeting of the NSX Board (or any
committee of NSX) that pertains to the self-regulatory function of
NSX. These requirements and the requirements relating to the
confidentiality of records are not, however, designed to prevent the
Exchange from sharing with Holdings the type of information about
the Exchange's business that would ordinarily be shared with a
parent corporation, including information relating to the Exchange's
compliance with applicable laws, reports from the Commission or
others evaluating the Exchange's self-regulatory programs, and
information about the trading activities and business strategies of
the Exchange's ETP Holders.
---------------------------------------------------------------------------

    Further, the NSX books and records reflecting confidential
information relating to the self-regulatory function of NSX must be
kept confidential, must not be used for non-regulatory purposes, and
must not be made available to any person other than those directors,
officers, and agents of NSX to the extent necessary or appropriate to
properly discharge NSX's self-regulatory responsibilities, and the
books and records of NSX must be maintained in the U.S.\99\ The
proposed NSX By-Laws also provide that any revenues received by NSX
from fees derived from its regulatory function or regulatory penalties
must be applied to fund the legal and regulatory operations of NSX or
to pay restitution and disgorgement of funds intended for NSX
customers, and may not be used to pay dividends.\100\
---------------------------------------------------------------------------

    \99\ See proposed NSX By-Laws, Sections 10.3.
    \100\ See proposed NSX By-Laws, Section 10.4.

---------------------------------------------------------------------------

(vii) Restrictions on Ownership and Transfer

    Although there are no percentage-based restrictions on the
ownership of NSX, the proposed NSX Certificate of Incorporation
confirms that Holdings will own all of the voting stock of NSX at all
times.\101\
---------------------------------------------------------------------------

    \101\ See proposed NSX Certificate of Incorporation, Article
Fourth.
---------------------------------------------------------------------------

(viii) Changes to Certificate of Incorporation and By-Laws

    Under the proposed NSX Certificate of Incorporation, any change to
that document must first be approved by the NSX Board and, if required
to be approved or filed with the Commission before it may become
effective, cannot take effect until the procedures of the Commission
necessary to make it effective have been satisfied.\102\
---------------------------------------------------------------------------

    \102\ See proposed NSX Certificate of Incorporation, Article
Eleventh.
---------------------------------------------------------------------------

    Similarly, under the proposed NSX By-Laws, any change to that
document that is required to be approved by or filed with the
Commission before it may become effective cannot take effect until the
procedures of the Commission necessary to make it effective have been
satisfied.\103\ Changes to the NSX By-Laws as proposed may be made by
either the stockholders of NSX or the NSX Board, except that certain
provisions relating to the NSX Board, and to the voting of NSX
stockholders may not be changed without the approval of the stockholder
of NSX.\104\
---------------------------------------------------------------------------

    \103\ See proposed NSX Certificate of Incorporation, Article
Seventh.
    \104\ See proposed NSX Certificate of Incorporation, Article
Seventh and proposed NSX By-Laws, Section 8.1. In addition, Sections
3.1(b) and 8.2 of the proposed NSX By-Laws permit the NSX Board to
amend, repeal, and adopt new Rules of the Exchange.
---------------------------------------------------------------------------

(c) Other Provisions in the Certificates of Incorporation and By-Laws

    The proposed Holdings By-Laws, Holdings Certificate of
Incorporation, NSX Certificate of Incorporation, and NSX By-Laws
contain other customary provisions of for-profit corporations, such as
provisions relating to corporate offices and corporate purposes; \105\
director meetings, voting, removal, compensation and limitation of
liability; \106\ indemnification of, and insurance for, directors,
officers, employees and agents, and advancement of expenses related to
defending certain actions; \107\ stock certificate procedures; \108\
stockholder ownership, including provisions relating to the timing and
conduct of meetings, record dates, quorum requirements, proxies, and
other matters; \109\ and other general provisions.\110\
---------------------------------------------------------------------------

    \105\ See proposed NSX Certificate of Incorporation, Articles
Second and Third, and proposed NSX By-Laws, Article II; see proposed
Holdings Certificate of Incorporation, Articles Second and Third,
and proposed Holdings By-Laws, Article I.
    \106\ See proposed NSX Certificate of Incorporation, Articles
Fifth and Eighth, and proposed NSX By-Laws, Article III and Section
7.1; see proposed Holdings Certificate of Incorporation, Articles
Sixth and Ninth, and proposed Holdings By-Laws, Article II and
Section 7.1.
    \107\ See proposed NSX By-Laws, Article VII, and proposed
Holdings By-Laws, Article VII. In addition, under these provisions,
neither corporation is liable for any loss or damage sustained by a
current or former member of NSX or ETP Holder relating to such
person's use of the facilities of the Exchange or its subsidiaries.
    \108\ See proposed NSX By-Laws, Article IX, and proposed
Holdings By-Laws, Article IX.
    \109\ See proposed NSX Certificate of Incorporation, Article
Ninth, and proposed NSX By-Laws, Article IV; See proposed Holdings
Certificate of Incorporation, Article Tenth, and proposed Holdings
By-Laws, Article IV.
    \110\ See, for example, proposed NSX Certificate of
Incorporation, Article Tenth, and proposed NSX By-Laws, Article XI;
See, e.g., proposed Holdings Certificate of Incorporation, Article
Eleventh, and proposed Holdings By-Laws, Article X.
---------------------------------------------------------------------------

(2) National Market System Plans

    NSX currently is a participant in various National Market System
(``NMS'') plans, including, but not limited to, the Consolidated Tape
Association Plan, the Consolidated Quotation System Plan, the
Intermarket Trading System Plan, the Intermarket Surveillance Group,
and the Reporting Plan for Nasdaq-Listed Securities Traded on Exchanges
on an Unlisted Trading Privileges Basis (``Nasdaq UTP'') Plan. These
plans are joint industry plans entered into by SROs for the purpose of
addressing last sale reporting, quotation reporting, and intermarket
equities trading. Following the completion of the demutualization, NSX,
in its continuing role as the SRO, would continue to serve as the
voting member of these NMS plans, and a representative of NSX would
continue to serve as the Exchange's representative with respect to
dealing with these plans.

(3) Equity Trading Permits; Administrative Changes

    The proposed rule change includes proposed changes to the Rules of
the Exchange that are necessary to implement the proposed ETP
structure. Following NSX's demutualization, persons and firms who have
been qualified for membership pursuant to the Exchange's current Rules
and By-Laws and, as a result, have access to the Exchange's trading
facilities would receive ETPs entitling them to maintain their trading
access to NSX and would be referred to as ETP Holders. References to
``members,'' ``member organizations,'' and similar terms in the current
Rules of the Exchange would be replaced with references to ``ETP
Holders'' and similar terms in the NSX Rules.
    Each ETP would constitute a revocable license allowing the holder
of the permit access to the Exchange's trading facilities in the same
manner as previously authorized for NSX's qualified trading
members.\111\ The demutualization and the implementation of the use of
ETPs would not change current NSX member access to the Exchange or
their ability to execute transactions. Persons holding ETPs of NSX
would be ``members'' of the Exchange for purposes of the Act and, as
noted above, would be characterized as ETP Holders subject to NSX's
regulatory jurisdiction.\112\ ETP Holders would not have any ownership
interest in NSX or in Holdings by virtue of their ETPs.
---------------------------------------------------------------------------

    \111\ See proposed NSX Rules, Chapter II, Rules 2.1 and 2.2, and
proposed NSX Rules, Chapter I, Rule 1.5 (definition of ``ETP'').
    \112\ See proposed NSX Rules, Chapter I, Rule 1.5 (definition of
``ETP Holder'').
---------------------------------------------------------------------------

    Provisions of the current By-Laws of NSX relating to members would
be moved to a single chapter in the NSX Rules regarding ETP Holders,
with certain changes based upon the fact that ETP Holders would be
subject to different application processes and would not have to
purchase and own a certificate of proprietary membership.\113\
Following the demutualization, the Exchange would require persons
seeking ETPs to complete appropriate application materials and
registration forms, satisfy regulatory requirements, and pay processing
charges and application fees as designated by the Exchange. Unlike
NSX's current membership application process, ETP Holders would not be
required to be approved by NSX's Membership Committee, ETP Holders
would be subject to the financial responsibility requirements of Rule
15c3-1 under the Act (but would not be subject to a separate net
capital requirement), and ETP applicants would not need to purchase
shares of either NSX or Holdings.\114\
---------------------------------------------------------------------------

    \113\ Currently, applicants for membership are required to
purchase and own a certificate of proprietary membership in order to
become a member of NSX. See Article II, Section 5.2 of the current
By-Laws of NSX. In connection with the demutualization, all
outstanding certificates of proprietary membership would be
cancelled and no other certificates of proprietary membership would
be issued by NSX following the demutualization.
    \114\ See proposed NSX Rules, Chapter II.
---------------------------------------------------------------------------

    Once issued, an ETP would be effective until voluntarily terminated
by the ETP Holder or until revoked by NSX

for, among other things, noncompliance with the NSX Rules.\115\ NSX
would have the ability to revoke an ETP for the same reasons that it is
currently entitled to revoke a membership.\116\ An ETP could not be
sold, leased, or otherwise transferred.\117\ There would be nominal
processing charges and application fees relating to the issuance of
ETPs. In addition, ETP Holders would be subject to such fees as are
designated by NSX or set forth in the NSX Rules.\118\
---------------------------------------------------------------------------

    \115\ See proposed NSX Rules, Chapter II, Rules 2.6 and 2.7.
    \116\ See proposed NSX Rules, Chapter II, Rule 2.6.
    \117\ See proposed NSX Rules, Chapter II, Rule 2.8.
    \118\ See, generally proposed NSX Rules, Chapter XI, Rule
11.10(B).
---------------------------------------------------------------------------

    Certain other provisions of the current By-Laws of NSX respecting
listing standards and other matters not relating to the Exchange's
corporate governance would be moved to the NSX Rules. The provisions
contained in Article IV of the current By-Laws of NSX (relating to
Securities Listed on the Exchange) would be moved to a new Chapter XV
of the NSX Rules. In addition, current Rules 13.6 and 13.7 (relating to
Listing Standards) would be moved to this new Chapter XV of the NSX
Rules.\119\
---------------------------------------------------------------------------

    \119\ In addition, NSX also proposes to move to the NSX Rules,
and make technical changes to, certain provisions under the current
By-Laws of NSX relating to Exchange Membership (Article II), Dues,
Assessments and Other Charges (Article III), Securities Listed on
the Exchange (Article IV), Commissions (Article XI) and Off-Exchange
Transactions (Article XII).
---------------------------------------------------------------------------

    Finally, new NSX Rule 2.10 would prohibit, without prior Commission
approval, either (i) NSX or any NSX affiliate from directly or
indirectly acquiring or maintaining an ownership interest in an ETP
Holder, or (ii) an ETP Holder being or becoming an affiliate of NSX or
any affiliate of NSX. Under proposed Rule 2.10, the term ``affiliate''
has the meaning specified in Rule 12b-2 of the Act. Proposed Rule 2.10
would not prohibit any ETP Holder or its affiliate from acquiring or
holding an equity interest in Holdings that is permitted by the
ownership and voting limitations in the Holdings Certificate of
Incorporation, and would not prohibit an ETP Holder or an officer,
director, manager, managing member, partner, or affiliate of an ETP
Holder being or becoming an ETP Holder Director or an At-Large Director
on the NSX Board, or a member of the Holdings Board.\120\
---------------------------------------------------------------------------

    \120\ See Amendment No. 1, supra note 3.
---------------------------------------------------------------------------

III. Summary of Comments

    The Council of Institutional Investors (``CII'') wrote to express
its concern over the potential conflict of interest that could arise
when an exchange is responsible for regulating its members and at the
same time operating as a for-profit entity. The CII believes that this
conflict of interest is ``untenable'' and has created problems in the
past and will continue to create problems in the future.\121\ To
address this conflict, the CII recommends that: (1) Regulatory
operations of NSX should be made independent of the Exchange and
adequately funded; and (2) listing standard requirements should be made
a regulatory responsibility rather than the responsibility of the
Exchange.\122\
---------------------------------------------------------------------------

    \121\ See CII Letter, supra note 6.
    \122\ CII Letter at 1.
---------------------------------------------------------------------------

    NSX responded to the CII comment letter on June 5, 2006.\123\ The
Exchange asserted that the two concerns raised by CII have already been
addressed by the Exchange prior to the filing of this proposed rule
change. The NSX noted that it created a Regulatory Oversight Committee
(``ROC'') that is charged with overseeing all regulatory functions and
responsibilities, including recommending an adequate operating budget
for the Exchange's regulatory functions. The Exchange also created the
position of Chief Regulatory Officer who reports directly to the ROC
and not the Chief Executive Officer. This structure separates the
regulatory operations from the Exchange. NSX stated that this structure
assured that listing standard requirements are a regulatory rather than
an Exchange responsibility as they are the function of the Regulatory
Services Division.
---------------------------------------------------------------------------

    \123\ See NSX Response, supra note 7.
---------------------------------------------------------------------------

IV. Discussion

    After careful review, the Commission finds that the proposed rule
change, as amended, is consistent with the requirements of the Act and
the rules and regulations thereunder applicable to a national
securities exchange.\124\ In particular, the Commission finds that the
proposed rule change, as amended, is consistent with Section 6(b)(1) of
the Act,\125\ which requires a national securities exchange to be so
organized and have the capacity to carry out the purposes of the Act
and to enforce compliance by its members and persons associated with
its members with the provisions of the Act. The Commission also finds
that the proposed rule change, as amended, is consistent with Section
6(b)(3) of the Act,\126\ which requires that the rules of a national
securities exchange assure the fair representation of its members in
the selection of its directors and administration of its affairs, and
provide that one or more directors shall be representative of issuers
and investors and not be associated with a member of the exchange,
broker, or dealer. Further, the Commission finds that the proposed rule
change, as amended, is consistent with Section 6(b)(5) of the Act,\127\
in that it is designed, among other things, to prevent fraudulent and
manipulative acts and practices, 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.
---------------------------------------------------------------------------

    \124\ 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).
    \125\ 15 U.S.C. 78f(b)(1).
    \126\ 15 U.S.C. 78f(b)(3).
    \127\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

A. Holdings as Sole Shareholder

    Following completion of the demutualization, Holdings would be the
sole shareholder of NSX. Section 19(b) of the Act \128\ and Rule 19b-4
thereunder \129\ require an SRO to file proposed rule changes with the
Commission. Although Holdings is not an SRO, certain provisions of its
Certificate of Incorporation and By-Laws may be rules of an exchange
\130\ if they are the stated policies, practices, or interpretations,
as defined in Rule 19b-4 of the Act, of NSX. Any proposed rule or any
proposed change in, addition to, or deletion from, the rules of an
exchange must be filed with the Commission pursuant to Section 19(b) of
the Act and Rule 19b-4 thereunder. Accordingly, NSX has filed the
Holdings Certificate of Incorporation Holdings By-Laws with the
Commission. If Holdings decides to change its Certificate of
Incorporation or By-Laws, it must submit such changes to the NSX Board
so that it can determine if the changes must be filed with, and
approved by, the Commission.\131\ The Commission believes that these
provisions would assist NSX in fulfilling its self-regulatory
obligations and in administrating and complying with the requirements
under the Act.
---------------------------------------------------------------------------

    \128\ 15 U.S.C. 78s(b).
    \129\ 17 CFR 240.19b-4.
    \130\ Section 3(a)(27) of the Act defines the rules of an
exchange to be the constitution, articles of incorporation, By-Laws,
and rules, or instruments corresponding to the foregoing, of an
exchange, and such stated policies, practices, or interpretations of
such exchange as the Commission, by rule, may determine to be
necessary or appropriate in the public interest or for the
protection of investors to be deemed to be rules of such exchange.
15 U.S.C. 78c(a)(27).
    \131\ See proposed Holdings Certificate of Incorporation,
Article Twelfth and Holdings By-Laws Article VIII.

---------------------------------------------------------------------------

B. Changes in Control of NSX

    The Commission believes that the restrictions in the Holdings
Certificate of Incorporation on direct and indirect changes in control
of Holdings are sufficient to enable NSX to carry out its self-
regulatory responsibilities and to enable the Commission to fulfill its
responsibilities under the Act.\132\
---------------------------------------------------------------------------

    \132\ The Commission notes that it is in the process of
reviewing issues related to new ownership structures of SROs and has
proposed rules relating to the ownership of SROs, including limiting
the restrictions on ownership and voting to members of an SRO or a
facility of an SRO. See Securities Exchange Act Release No. 50699
(November 18, 2004), 69 FR 71126 (December 8, 2004) (``Proposed
Rulemaking''). See also Securities Exchange Act Release No. 51019
(January 11, 2005), 70 FR 2829 (January 18, 2005) (extending the
comment period for the Proposed Rulemaking until March 8, 2005).
---------------------------------------------------------------------------

    Specifically, as proposed, NSX would be wholly-owned subsidiary of
Holdings, i.e., Holdings would own all of the shares of NSX. The NSX
Certificate of Incorporation identifies this ownership structure.\133\
Any changes to the NSX Certificate of Incorporation, including any
change to the provision that identifies NSX shareholders, must be filed
with, and approved by, the Commission pursuant to Section 19(b) of the
Act.\134\
---------------------------------------------------------------------------

    \133\ See proposed NSX Certificate of Incorporation, Article
Fourth.
    \134\ 15 U.S.C. 78s(b); see proposed NSX Certificate of
Incorporation, Article Eleventh.
---------------------------------------------------------------------------

    In addition, the Holdings Certificate of Incorporation imposes
limitations on direct and indirect changes in control of Holdings
through voting and ownership limitations placed on the capital stock of
Holdings and allows Holdings to monitor potential changes in control
through a notification requirement once a threshold percentage of
ownership of capital stock is reached.\135\ Specifically, the Holdings
Certificate of Incorporation prohibits any Person, either alone or
together with its Related Persons, from voting or giving a proxy or
consent with respect to shares representing more than 20% of the voting
power of the issued and outstanding capital stock of Holdings.\136\
This restriction would not apply to the Class B or Class C common stock
and, as to the Class A common stock owned by Persons other than ETP
Holders and their Related Persons, may be waived by Holdings Board
pursuant to a resolution adopted by the Holdings Board.\137\ Before
adopting such resolution, however, the Holdings Board must determine
that, among other things, the waiver of the voting limitation would not
impair the ability of NSX to carry out its functions and
responsibilities under the Act and the rules and regulations
promulgated thereunder, and would not impair the Commission's ability
to enforce the Act and the rules and regulations promulgated
thereunder.\138\ In addition, the Holdings Board also must determine
that a Person and its Related Persons that would vote more than 20% of
the outstanding stock of Holdings are not subject to an applicable
``statutory disqualification'' (within the meaning of Section 3(a)(39)
of the Act).\139\ Finally, any resolution of the Holdings Board that
would permit a Person to vote more than 20% of the outstanding stock of
Holdings must be filed with and approved by the Commission before it
becomes effective.\140\
---------------------------------------------------------------------------

    \135\ The proposed Holdings Certificate of Incorporation
requires that any person, either alone or together with its
affiliates or associates or any other person, who at any time owns
five percent or more of then outstanding shares of capital stock and
who has the right to vote in the election of the NSX Holdings Board,
shall, immediately upon so owning five percent or more of the then
outstanding shares of such stock, give the NSX Holdings Board a
written notice of such ownership and update that notice promptly
after an ownership change of a specified percentage. See proposed
Holdings Certificate of Incorporation, Article Fifth, paragraph (c).
    \136\ See proposed Holdings Certificate of Incorporation,
Article Fifth, paragraph (b)(ii)(C); see also proposed Holdings
Certificate of Incorporation, Article Fifth, paragraph (a) for
definitions of ``Person'' and ``Related Person.''
    \137\ See proposed Holdings Certificate of Incorporation,
Article Fifth, paragraphs (b)(iii)(A) and (B). See Amendment No. 1,
supra note 3.
    \138\ See proposed Holdings Certificate of Incorporation,
Article Fifth, paragraph (b)(iii)(B).
    \139\ 15 U.S.C. 78c(a)(39); see proposed Holdings Certificate of
Incorporation, Article Fifth, paragraph (b)(iv).
    \140\ See proposed Holdings Certificate of Incorporation,
Article Fifth, paragraph (b)(iii)(B).
---------------------------------------------------------------------------

    Furthermore, the Holdings Certificate of Incorporation limits the
right of any Person, either alone or together with its Related Persons,
to enter into any agreement with respect to the withholding of any vote
or proxy where the effect of the agreement would be to enable any
person or group to obtain more than 20% of the outstanding voting
power.\141\ The Holdings Certificate of Incorporation also restricts
the ability of any Person, either alone or together with its Related
Persons, from owning, directly or indirectly, shares constituting more
than 40% of any class of the outstanding shares of capital stock of
Holdings.\142\
---------------------------------------------------------------------------

    \141\ See proposed NSX Holdings Certificate of Incorporation,
Article Fifth, paragraph (b)(ii)(C).
    \142\ See proposed Holdings Certificate of Incorporation,
Article Fifth, paragraph (b)(ii)(A).
---------------------------------------------------------------------------

    If any shareholder votes, sells, transfers, assigns, or pledges any
shares in violation of the voting and ownership limitations, Holdings
would treat those shares as owned by the transferor for all purposes,
including, without limitation, voting, payment of dividends, and
distributions.\143\ In addition, if any shareholder votes, sells,
transfers, assigns, or pledges any shares in violation of the voting
and ownership limitations, Holdings has the right to redeem those
shares at a price equal to the par value thereof, upon the approval of
the Holdings Board.\144\
---------------------------------------------------------------------------

    \143\ See proposed Holdings Certificate of Incorporation,
Article Fifth, paragraph (d).
    \144\ See proposed Holdings Certificate of Incorporation,
Article Fifth, paragraph (e).
---------------------------------------------------------------------------

    NSX has also proposed to require Holdings shareholders that own, of
record or beneficially, five percent or more of the then outstanding
shares to give the Holdings Board written notice of such ownership.
This notice should enable Holdings to monitor the ownership of its
stock to ensure that no limitation is reached.\145\
---------------------------------------------------------------------------

    \145\ The Commission believes that NSX Holdings should disclose
periodically, or otherwise make available upon request, information
regarding the number of outstanding shares of its capital stock, so
that persons that own stock of Holdings can determine whether they
are reaching or have reached any of the thresholds that restrict
that person's ability to vote or own the shares or require that
person to provide written notice under the Article Fifth, paragraph
(c) of the Holdings Certificate of Incorporation.
---------------------------------------------------------------------------

    The Holdings Certificate of Incorporation also provides that no
Person, either alone or together with its Related Persons, who is a ETP
Holder may own, directly or indirectly, shares constituting more than
20% of any class of capital stock of Holdings.\146\ However, this
ownership restriction would not apply to any ETP Holder with respect to
shares of Class C common stock of Holdings (which is not entitled to
the right to vote) issued to the ETP Holder in connection with, and
from the date of, the demutualization of NSX so long as the ETP Holder
becomes compliant with the ownership limitation promptly after such
issuance.\147\
---------------------------------------------------------------------------

    \146\ See proposed Holdings Certificate of Incorporation,
Article Fifth, paragraph (b)(ii)(B). Unlike the 40% ownership and
20% voting limitations discussed above, the NSX Holdings Board may
not waive the 20% ownership limitation applicable to NSX trading
permit holders.
    \147\ See proposed proposed Holdings Certificate of
Incorporation, Article Fifth, paragraph (b)(iii)(C). See Amendment
No. 1, supra note 3.
---------------------------------------------------------------------------

    The Commission finds that the limitation on ownership of shares of
Holdings by NSX ETP Holders is consistent with the Act. Under the
member-owned exchange model, a member who trades securities through the
facilities of an exchange can have an ownership interest in the
exchange. A regulatory concern can arise if a member's interest becomes
so large as to cast doubt on whether the exchange can fairly and
objectively exercise its self-regulatory responsibilities with respect

to that member. For example, a member that directly or indirectly
controls an exchange might be tempted to exercise that controlling
influence by directing the exchange to refrain from diligently
monitoring the member's conduct or from punishing any conduct that
violates the rules of the exchange or the federal securities laws. An
exchange also might be reluctant to diligently monitor and conduct
surveillance of trading conduct and to enforce its rules and the
federal securities laws against a member that the exchange relies on
for a large source of capital. The Commission believes that the
proposed limitation would help mitigate the conflicts of interest that
could occur if a member were to control a significant stake in the
Exchange through ownership in shares in the Exchange's parent company
and are necessary and appropriate to help ensure that the Exchange can
effectively carry out its statutory obligations under Section 6(b) of
the Act.\148\
---------------------------------------------------------------------------

    \148\ 15 U.S.C. 78f(b).
---------------------------------------------------------------------------

C. Regulatory Jurisdiction Over Holdings

    The Commission believes that the terms of Holdings By-Laws provide
the Commission with sufficient regulatory jurisdiction over the
controlling parties of the Exchange to carry out its oversight
responsibilities under the Act. The Holdings By-Laws provide that, to
the extent that they are related to the activities of NSX, the books,
records, premises, officers, directors, agents, and employees of
Holdings are deemed to be the books, records, premises, officers,
directors, agents, and employees of NSX for purposes of and subject to
oversight pursuant to the Act.\149\ This provision would enable the
Commission to exercise its authority under Section 19(h)(4) of the Act
\150\ with respect to officers and directors of Holdings, because all
such officers and directors, to the extent that they are acting on
matters related to NSX activities, would be deemed to be officers and
directors of NSX. Furthermore, the books and records of Holdings, to
the extent that they are related to the activities of NSX, are subject
to the Commission's examination authority under Section 17(b)(1) of the
Act,\151\ as these records would be deemed to be the records of NSX
itself.
---------------------------------------------------------------------------

    \149\ See proposed Holdings By-Laws, Article III, Section 3.3.
    \150\ 15 U.S.C. 78s(h)(4). Section 19(h)(4) authorizes the
Commission, by order, to remove from office or censure any officer
or director of a national securities exchange if it finds, after
notice and an opportunity for hearing, that such officer or
director: (1) has willfully violated any provision of the Act or the
rules and regulations thereunder, or the rules of a national
securities exchange; (2) willfully abused his or her authority; or
(3) without reasonable justification or excuse, has failed to
enforce compliance with any such provision by a member or person
associated with a member of the national securities exchange.
    \151\ 15 U.S.C. 78q(b)(1).
---------------------------------------------------------------------------

    In addition, pursuant to the Holdings By-Laws, Holdings officers,
directors, employees, and agents, by virtue of their acceptance of such
position, are deemed to irrevocably submit to the jurisdiction of the
U.S. Federal courts, the Commission, and NSX for the purposes of any
suit, action, or proceeding pursuant to the U.S. federal securities
laws and the rules and regulations thereunder, arising out of, or
relating to, the activities of the Exchange.\152\ Moreover, Holdings
and such officers, directors, employees, and agents, by virtue of their
acceptance of any such position, are deemed to waive and agree not to
assert by way of motion as a defense or otherwise in any such suit,
action, or proceeding any claims that it or they are not personally
subject to the jurisdiction of the U.S. Federal courts, the Commission,
or NSX, that the suit, action, or proceeding is an inconvenient forum,
or that the venue of the suit, action, or proceeding is improper, or
that the subject matter of that suit, action, or proceeding may not be
enforced in or by such courts or agency.\153\ Finally, the Holdings By-
Laws provide that the officers, directors, employees, and agents of
Holdings, by virtue of their acceptance of such position, are deemed to
agree to cooperate with the Commission and NSX in respect of the
Commission's oversight responsibilities regarding NSX and the self-
regulatory functions and responsibilities of NSX.\154\
---------------------------------------------------------------------------

    \152\ See proposed NSX Holdings By-Laws, Article III, Section
3.5.
    \153\ See proposed NSX Holdings By-Laws, Article III, Section
3.5.
    \154\ See proposed NSX Holdings By-Laws, Article III, Section
3.4.
---------------------------------------------------------------------------

    The Commission also notes that, even in the absence of these
provisions of the Holdings By-Laws, Section 20(a) of the Act \155\
provides that any person with a controlling interest in NSX would be
jointly and severally liable with and to the same extent that NSX is
liable under any provision of the Act, unless the controlling person
acted in good faith and did not directly or indirectly induce the act
or acts constituting the violation or cause of action. In addition,
Section 20(e) of the Act \156\ creates aiding and abetting liability
for any person who knowingly provides substantial assistance to another
person in violation of any provision of the Act or rule thereunder, and
Section 21C of the Act \157\ authorizes the Commission to enter a
cease-and-desist order against any person who has been ``a cause of'' a
violation of any provision of the Act through an act or omission that
the person knew or should have known would contribute to the violation.
The Commission believes that, taken together, these provisions grant
the Commission sufficient jurisdictional authority over the controlling
persons of NSX. Moreover, NSX is required to enforce compliance with
these provisions because they are ``rules of the exchange'' within the
meaning of Section 3(a)(27) of the Act.\158\ A failure on the part of
NSX to enforce its rules could result in suspension or revocation of
NSX's registration under Section 19(h)(1) of the Act.\159\
---------------------------------------------------------------------------

    \155\ 15 U.S.C. 78t(a).
    \156\ 15 U.S.C. 78t(e).
    \157\ 15 U.S.C. 78u-3.
    \158\ 15 U.S.C. 78c(a)(27).
    \159\ 15 U.S.C. 78s(h)(1).
---------------------------------------------------------------------------

D. Self-Regulatory Function of NSX

    Following the demutualization, the rules and By-Laws of NSX would
reflect its status as a wholly-owned subsidiary of Holdings, under
management of the NSX Board and its designated officers and with self-
regulatory obligations pursuant to NSX's registration as a national
securities exchange under Section 6 of the Act.\160\
---------------------------------------------------------------------------

    \160\ See 15 U.S.C. 78c(a)(26).
---------------------------------------------------------------------------

    As the sole shareholder of NSX, the Commission believes that
Holdings' activities with respect to its ownership of NSX must be
consistent with NSX's obligations under the Act. The Commission
recognizes that the ownership structure of for-profit exchanges could
present potential conflicts of interest.\161\ However, the Commission
believes that NSX has taken steps to address this conflict.\162\ Under
the Holdings By-Laws, the Holdings Board and the officers, employees,
and agents of Holdings must give due regard to the preservation of the
independence of the self-regulatory function of NSX and to its
obligations to investors and the general public and not take any
actions that would interfere with the effectuation of any decisions by
the NSX Board relating to its regulatory functions or the structure of
the market it regulates or which would interfere with the ability of
NSX to carry out its responsibilities under the Act.\163\ In addition,
all books and records of NSX reflecting confidential information
pertaining to its self-regulatory function (including but not limited
to disciplinary matters, trading data,

trading practices, and audit information) which come into the
possession of Holdings, and the information contained therein, must be
retained in confidence by Holdings and its directors, officers,
employees, and agents and must not be used for any non-regulatory
purposes.\164\ The Commission believes that these provisions, which are
designed to acknowledge the need to maintain the independence of the
self-regulatory role of NSX following the demutualization and protect
from improper use information pertaining to its self-regulatory
function, are appropriate.
---------------------------------------------------------------------------

    \161\ See CII Letter. See also supra note 132.
    \162\ See also supra, note 132.
    \163\ See proposed NSX Holdings By-Laws, Article III, Section
3.1.
    \164\ See proposed NSX Holdings By-Laws, Article III, Section
3.2.
---------------------------------------------------------------------------

    Further, the Commission notes that the NSX By-Laws expressly
require that the NSX Board consider applicable requirements for
registration as a national securities exchange under Section 6(b) of
the Act,\165\ including the requirement that the rules of the Exchange
be designed to protect investors and the public interest and the
requirement that the Exchange be so organized and have the capacity to
carry out the purposes of the Act and to enforce compliance by its
members and persons associated with members with the provisions of the
Act, the rules and regulations thereunder and with the rules of the
Exchange.\166\ In the Commission's view, this provision should serve to
remind the NSX Board that it must consider the interests of the
Exchange's constituents and the requirements of the Act when taking
action on behalf of the Exchange.
---------------------------------------------------------------------------

    \165\ 15 U.S.C. 78f(b).
    \166\ See proposed NSX By-Laws, Article X, Section 3.1.
---------------------------------------------------------------------------

E. Fair Representation

    Section 6(b)(3) of the Act \167\ requires that the rules of an
exchange assure fair representation of its members in the selection of
its directors and administration of its affairs and provide that one or
more directors be representative of issuers and investors and not be
associated with a member of the exchange or with a broker or dealer. In
addition, Section 6(b)(1) of the Act \168\ requires that an exchange be
so organized and have the capacity to be able to carry out the purposes
of the Act.
---------------------------------------------------------------------------

    \167\ 15 U.S.C. 78f(b)(3).
    \168\ 15 U.S.C. 78f(b)(1).
---------------------------------------------------------------------------

    After the demutualization, the NSX Board would initially consist of
13 directors. The NSX Board would be initially comprised of the CEO of
NSX, 3 ETP Holder Directors,\169\ 7 Independent Directors,\170\ and 2
directors who are executive officers of CBOE, its members,\171\ or
executive officers of CBOE member organizations.\172\ Under the
proposed rule change, the NSX Board may by resolution increase its size
to up to 20 directors. Directors added to the NSX Board to fill these
new director positions would be (i) Independent Directors, to the
extent necessary for the NSX Board to include at least 50% Independent
Directors; (ii) ETP Holder Directors, to the extent necessary for the
NSX Board to include at least 20% ETP Holder Directors; and (iii)
persons who do not qualify as Independent Directors (``At-Large
Directors''), for the remainder of the positions added to the NSX Board
that are not filled with Independent Directors or ETP Holder Directors
pursuant to clauses (i) and (ii) above. At all times, the NSX Board
must include the CEO of NSX, at least 50% Independent Directors and 3
ETP Holder Directors (or such greater number of ETP Holder Directors as
is necessary to comprise at least 20% of the NSX Board).\173\
---------------------------------------------------------------------------

    \169\ An ETP Holder Director is defined under the proposed NSX
By-Laws as a director who is an ETP Holder or a director, officer,
managing member or partner of an entity that is an ETP Holder. See
proposed NSX By-Laws, Section 1.1(E)(2).
    \170\ An Independent Director is defined under the proposed NSX
By-Laws as a member of the NSX Board that the NSX Board has
determined to have no material relationship with NSX or any
affiliate of NSX, or any ETP Holder or any affiliate of any such ETP
Holder, other than as a member of the NSX Board. See proposed NSX
By-Laws, Section 1.1(I)(1). The Commission notes that NSX has stated
that at least one Independent Director will be representative of
investors; see Amendment No. 1, supra note 3.
    \171\ A CBOE member is defined under the proposed NSX By-Laws as
an individual CBOE member or a CBOE member organization that is a
regular member or special member of CBOE (as such terms are
described in the Constitution of the CBOE), as such CBOE members may
exist from time to time. See proposed NSX By-Laws, Section
1.1(C)(2). See also supra subsection II.b.(1)(b)(ii) for a
discussion of CBOE's equity interest in the Exchange.
    \172\ See proposed NSX By-Laws, Section 3.2(a). See also supra
note 20.
    \173\ See proposed NSX By-Laws, Section 3.2(b); see Amendment
No. 1, supra note 3.
---------------------------------------------------------------------------

    Because NSX ETP Holders would not be shareholders of NSX, they
would not directly elect members of the NSX Board. As the sole
shareholder of NSX, Holdings would have the sole right and obligation
to vote for the director nominees nominated by the NSX Governance and
Nominating Committee. The NSX By-Laws, however, establish a procedure
that would allow ETP Holders to be involved in the selection of
candidates to fill ETP Director positions on the NSX Board.\174\ Each
participant would have one vote per trading permit with respect to each
Participant Director position to be filled.\175\
---------------------------------------------------------------------------

    \174\ See proposed NSX By-Laws, Section 3.5; see discussion of
nominating process in Discussion section supra.
    \175\ Under Section 3.5(e) of the proposed NSX By-Laws, each ETP
Holder, regardless of its affiliation with other ETP Holders, will
have one vote with respect to each ETP Holder Director position to
be filled, but may not cast such votes cumulatively.
---------------------------------------------------------------------------

    The ETP Holder Director Nominating Committee, comprised entirely of
ETP Holders Directors and/or ETP Holder representatives would consult
with the Governance and Nominating Committee, the Chairman of the Board
and the Chief Executive Officer, and solicit comments from the ETP
Holders and submit a list of candidates for election to the position of
ETP Holder Director to the Governance and Nominating Committee. ETP
Holder may petition in a timely manner to add additional nominees
provided that the petition is signed by 10 or more percent of all ETP
Holders. The ETP Holder Director candidates receiving the most votes
from ETP Holders shall be the directors elected to the NSX Board as ETP
Directors by NSX Holdings. If no timely petitions are received, the
slate of candidates put forth by the ETP Holder Director Nominating
Committee shall be the ETP Directors elected to the NSX Board by NSX
Holdings.\176\
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    \176\ See proposed NSX By-Laws, Sections 3.5 and 5.1.
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    The Commission finds that the requirement that at least one-half of
the directors of the NSX Board be Independent Directors is consistent
with Sections 6(b)(1) and 6(b)(3) of the Act, which requires that one
or more directors be representative of issuers and investors. The
Commission also finds that the requirement that at least 20% of the
directors be ETP Directors and the manner in which such directors would
be nominated and elected, satisfies the fair representation
requirements in Section 6(b)(3) of the Act. The Commission notes,
however, that after the demutualization trading privileges would be
separated from corporate ownership of NSX and would be available
exclusively through trading permits. Therefore, the Commission expects
that trading permits would not be issued in a manner that would
undermine or circumvent the requirement in Section 6(b)(3) of the Act
for fair representation of members. The Commission also notes that
participants would retain a voice in the administration of the affairs
of NSX following the demutualization, including rulemaking and the
disciplinary process, through participants' participation on the NSX
Board.

    Finally, the Commission notes that it is in the process of
reviewing a range of governance issues relating to SROs, including
possible steps to strengthen the framework for the governance of SROs
and ways to improve the transparency of the governance procedures of
all SROs and has proposed rules in furtherance of this goal.\177\
Depending on the results of the proposed rules, NSX may be required to
make further changes to strengthen its governance structure. The
Commission also believes that the NSX Board should continue to monitor
and evaluate its governance structure and process on an ongoing basis
and propose further changes as appropriate.
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    \177\ See Proposed Rulemaking, supra note 134.
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F. Dividends

    With the demutualization, the holders of capital stock of NSX, in
this case Holdings, would have the dividend and other distribution
rights of a shareholder in a Delaware stock corporation. The NSX By-
Laws allow the NSX Board to declare dividends.\178\ However, the NSX
By-Laws further provide that any revenues received by NSX from
regulatory fees or regulatory penalties would be applied to fund the
legal and regulatory operations, including the surveillance and
enforcement activities, of NSX and would not be used to pay
dividends.\179\ This limitation would preclude NSX from providing
dividends derived from regulatory fees or penalties to the sole
shareholder of NSX, i.e., Holdings. As a result, Holdings would not be
able to provide dividends derived from regulatory fees or penalties
belonging to NSX to the shareholders of Holdings. The Commission finds
that the prohibition on the use of regulatory fees or penalties to fund
dividends is consistent with Section 6(b)(1) of the Act because it
would ensure that the regulatory authority of NSX is not used
improperly to benefit Holdings and its shareholders.
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    \178\ See proposed NSX By-Laws, Section 11.2.
    \179\ For purposes of this provision, regulatory penalties
include restitution and disgorgement of funds intended for
customers. See proposed NSX By-Laws, Section 10.4.
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G. Other Changes

    Following the demutualization, NSX would continue to serve as a
voting member of various NMS plans addressing last sale reporting,
quotation reporting, and intermarket equities trading. In addition,
following the demutualization, NSX will put into effect certain rule
changes necessary to implement its proposed ETP structure, including
referring to persons and firms who are currently qualified for Exchange
membership under its current Rules and By-Laws as ETP Holders,
entitling them to maintain their trading access to the Exchange;
corresponding changes to references in the Exchange's Rules to
``members,'' ``member organizations,'' and similar terms would also be
made. ETP Holders would have revocable licenses allowing them to access
the Exchange's trading facilities in the same manner currently
authorized for qualified trading members. In addition, ETP Holders
would be ``members'' of the Exchange for purposes of the Act and would
be subject to NSX's regulatory jurisdiction and oversight. However, ETP
Holders would not have any ownership interest in the Exchange or in
Holdings by virtue of their ETPs. The Exchange would subject potential
ETP Holders to an application process, and ETP Holders would be subject
to the financial responsibility requirements of Rule 15c3-1 under the
Act. ETPs would be effective until voluntarily terminated by the ETP
Holder or until revoked by the Exchange. ETPs could not be sold,
leased, or otherwise transferred.
    As part of the demutualization, the Exchange would move certain
non-corporate governance-related provisions currently in the NSX By-
Laws to the NSX Rules. Finally, new NSX Rule 2.10 would prohibit,
without prior Commission approval, either (i) NSX or any NSX affiliate
from directly or indirectly acquiring or maintaining an ownership
interest in an ETP Holder, or (ii) an ETP Holder being or becoming an
affiliate of NSX or any affiliate of NSX. The term ``affiliate'' would
have the meaning specified in Rule 12b-2 of the Act. Proposed Rule 2.10
would not prohibit any ETP Holder or its affiliate from acquiring or
holding an equity interest in Holdings that is permitted by the
ownership and voting limitations in the Holdings Certificate of
Incorporation, and would not prohibit an ETP Holder or an officer,
director, manager, managing member, partner, or affiliate of an ETP
Holder being or becoming an ETP Holder Director or an At-Large Director
on the NSX Board, or a member of the Holdings Board.
    The Commission finds that these proposed rule changes are
consistent with the requirements of the Acts and the rules and
regulations thereunder. In particular, the Commission finds that the
proposed rule changes relating to ETP Holders and their affiliates are
consistent with Section 6(b)(1) of the Act,\180\ which requires a
national securities exchange to be so organized and have the capacity
to carry out the purposes of the Act.
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    \180\ 15 U.S.C. 78f(b)(1).
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\181\ that the proposed rule change (SR-NSX-2006-03), as amended,
is approved.
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    \181\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\182\
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    \182\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
 [FR Doc. E6-9354 Filed 6-14-06; 8:45 am]

BILLING CODE 8010-01-P