[Federal Register Volume 76, Number 92 (Thursday, May 12, 2011)]
[Notices]
[Pages 27732-27734]
[FR Doc No: 2011-11584]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-64415; File No. SR-Phlx-2011-56]

Self-Regulatory Organizations; The NASDAQ OMX PHLX LLC; Notice of
Filing of Proposed Rule Change To Establish a Qualified Contingent
Cross Order for Execution on the Floor of the Exchange

May 5, 2011.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 \2\ thereunder, notice is hereby given
that on May 4, 2011, NASDAQ OMX PHLX LLC (``Phlx'' or ``Exchange'')
filed with the Securities and Exchange Commission (``SEC'' or
``Commission'') the proposed rule change as described in Items I, II,
and III below, which Items have been prepared by the Exchange. The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

    The Exchange is filing with the Commission a proposal to amend PHLX
Rule 1064(e) to establish a Floor Qualified Contingent Cross Order
(``Floor QCC Order''). The Floor QCC Order will facilitate the
execution of stock/option Qualified Contingent Trades that satisfy the
requirements of the trade through exemption in connection with Rule
611(d) of Regulation NMS (``QCT Trade Exemption'').\3\
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    \3\ See Securities Exchange Act Release No. 54389 (August 31,
2006), 71 FR 52829 (September 7, 2006); Securities Exchange Act
Release No. 57620 (April 4, 2008), 73 FR 19271 (April 9, 2008).
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    The text of the proposed rule change is available on the Exchange's
Web site at http://nasdaqomxphlx.cchwallstreet.com/NASDAQOMXPHLX/Filings/, at the principal office of the Exchange, and at the
Commission's Public Reference Room.

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

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

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

1. Purpose
    On February 24, 2011, the Commission issued an order approving SR-
ISE-2010-073, a proposal by the ISE to establish a Qualified Contingent
Cross (``ISE QCC Proposal''). The ISE QCC Proposal was controversial,
attracting opposition from multiple exchanges including PHLX. In its
comment letter on the ISE QCC Proposal, PHLX asserted that the QCC
Proposal deviated from ``long-held principles in the options market by
permitting the crossing of orders without requiring prior exposure''
and that the ISE QCC Proposal failed adequately to protect customers
with orders resting on the ISE limit order book.\4\
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    \4\ See Letter, dated August 13, 2010, from Thomas Wittman,
President, NASDAQ OMX PHLX to Elizabeth Murphy, Secretary, U.S.
Securities and Exchange Commission.
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    The Commission, in a thorough and thoughtful decision, concluded
that the QCC Proposal--including the lack of prior order exposure--is
consistent with the Act. With respect to order exposure, the Commission
stated:
    While the Commission believes that order exposure is generally
beneficial to options markets in that it provides an incentive to
options market makers to provide liquidity and therefore plays an
important role in ensuring competition and price discovery in the
options markets, it also has recognized that contingent trades can be
``useful trading tools for investors and other market participants,
particularly those who trade the securities of issuers involved in
mergers, different classes of shares of the same issuer, convertible
securities, and equity derivatives such as options [italics added]''
and that ``[t]hose who engage in contingent trades can benefit the
market as a whole by studying the relationships between the prices of
such securities and executing contingent trades when they believe such
relationships are out of line with what they believe to be fair
value.'' As such, the Commission stated that transactions that meet the
specified requirements of the NMS QCT Exemption could be of benefit to
the market as a whole, contributing to the efficient functioning of the
securities markets and the price discovery process.\5\
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    \5\ Approval Order at p. 28 (citing to Regulation NMS QCT
Exemption).
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    The Approval Order succinctly sets forth the material elements of
ISE's Qualified Contingent Cross:

    Thus, as modified, an ISE member effecting a trade pursuant to
the NMS QCT Exemption could cross the options leg of the trade on
ISE as a QCC Order immediately upon entry, without exposure, only if
there are no Priority Customer orders on the Exchange's limit order
book at the same price and if the order: (i) Is for at least 1,000
contracts; (ii) meets the six requirements of the NMS QCT Exemption;
and (iii) is executed at a price at or between the NBBO (``Modified
QCC Order''). In the Notice, ISE stated that the modifications to
the Original QCC Order (i.e., to prevent the execution of a QCC if
there is a Priority Customer on its book and to increase the minimum
size of a QCC Order) remove the appearance that such orders are
trading ahead of Priority Customer orders or that the QCC Order
could be used to disadvantage retail customers (citations
omitted).\6\
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    \6\ Id. at p. 18.

    The Exchange believes that the Commission, having considered and
addressed all arguments in favor and in opposition to the QCC, has
established binding precedent under which other exchanges can establish
a QCC Order that is also consistent with the Act.
    In keeping with that precedent, PHLX hereby proposes to add PHLX
Rule 1064(e) to establish a Floor QCC Order based on the precedent of
ISE's QCC Order.\7\ Specifically, PHLX proposes to amend Rule 1064 to
provide that a PHLX member effectuating a trade on the floor of the
Exchange pursuant to the Regulation NMS Qualified Contingent Trade
Exemption to Rule 611(a) (``QCT Exemption'') can cross the options
leg's of the trade on PHLX as a Floor QCC Order immediately upon entry
and without order exposure if no Customer Orders \8\ exist on the

Exchange's order book at the same price. Floor QCC Orders will be
electronically entered by a Floor Broker on the floor of the Exchange
using the Floor Broker Management System and the execution will then be
executed electronically. Only Floor Brokers will be permitted to enter
Floor QCC Orders.
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    \7\ PHLX previously established an electronic QCC Order set
forth in PHLX Rule 1080(o). See Securities Exchange Act Release No.
64249 (April 7, 2011), 76 FR 20773 (April 13, 2011) (SR-Phlx-2011-
047).
    \8\ PHLX will reject QCC Orders that attempt to execute when any
Customer orders are resting on the Exchange limit order book at the
same price. ISE QCC Orders will be cancelled only when they
encounter resting orders of Priority Customers. The Commission has
previously approved the rejection of crossing transactions when
there is a customer order on the book at the same price. See, e.g.,
ISE Rule 721(a); and CBOE Rule 6.74A, Interpretations and Policies
.08.
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    The Commission in the Approval Order carefully considered the
comparison between floor-based and electronic trading, including
commissioning a study by the Division of Risk, Strategy and Financial
Innovation (``RiskFin Study''). The RiskFin Study and the Approval
Order compare electronic trading and floor trading, the similarities
between the two forms of trading, and the ability of one to replicate
the other. Additionally, the Commission received comment letters from
multiple floor-based exchanges that challenged the comparison that ISE
drew between floor-based and electronic trading.
    Despite facing direct comparisons between floor-based trading and
electronic trading by multiple commenters, as well as by its own
Division of RiskFin, the Commission Approval focuses on similarities
between the two. On its face, the Commission Approval Order draws no
distinctions and identifies no material differences between floor-based
and electronic trading that would confound the comparison between cross
orders executed electronically and those executed on an exchange floor.
The Exchange believes that the Floor QCC Order is consistent with the
requirements stated in the Approval Order and consistent with the Act.
The Exchange also believes that the Commission, in writing the Approval
Order assumed that QCC orders entered on the floor of an exchange that
meet the requirements stated in the Approval Order are equally
consistent with the Act.
    The Exchange has analyzed the application to Floor QCC Orders of
Section 11(a) of the Act and the rules thereunder. Section 11(a) and
the rules thereunder generally prohibit members of an exchange from
effecting transactions on the exchange for their own account, the
account of an associated person, or an account with respect to which it
or an associated person thereof exercises investment discretion unless
an exemption applies.\9\ Section 11(a) contains multiple exemptions,
including exemptions for those acting in the capacity of market makers,
as odd-lot dealers, and those engaged in stabilizing conduct; there are
also rule-based exemptions such as the ``effect vs. execute'' exception
under SEC Rule 11a2-2(T) under the Act.\10\
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    \9\ See 15 U.S.C. 78k(a).
    \10\ See 17 CFR 240.11a2-2(T).
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    The Exchange has in the past analyzed the application of Section
11(a) to various Exchange systems and order types.\11\ In analyzing
Floor QCC Orders, the Exchange has concluded that the entry and
execution of Floor QCC Orders raises no novel issues under Section
11(a) and the rules thereunder from a compliance, surveillance or
enforcement perspective. In other words, Exchange Floor Brokers are
currently required to comply and the Exchange surveils for compliance
with Section 11(a) and the rules thereunder when using Exchange systems
to effect transactions using existing order types, and they will be
required to comply with Section 11(a) and the rules thereunder when
using the Floor QCC Order.
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    \11\ See, e.g., Securities Exchange Act Release No. 63027 (Oct.
1, 2010), 75 FR 62160 (Oct. 7, 2010) (order approving Price
Improvement XL System).
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    Nonetheless, out of an abundance of caution, the Exchange has added
subsection (e)(2) which prohibits Options Floor Brokers from entering
Floor QCC Orders for their own accounts, the account of an associated
person, or an account with respect to which it or an associated person
thereof exercises investment discretion. This modification is designed
to remove even a theoretical time and place advantage available to an
Options Floor Broker on the Floor of the Exchange that is reflected in
the prohibitions of Section 11(a) of the Exchange Act and the rules
thereunder. The Exchange is prohibiting by rule certain conduct that
runs afoul of Section 11(a) and the rules thereunder, and providing
both a surveillance and enforcement mechanism to promote compliance.
Thus, it would be incorrect to say that the Floor QCC Order differs
from the electronic QCC Order due to the Options Floor Broker's
presence on the Floor.
    These restrictions set forth in subsection (e)(2) do not limit in
any way the obligation of Options Floor Brokers and other Exchange
members to comply with Section 11(a) or the rules thereunder. For
example, Options Floor Brokers cannot avoid or circumvent their
obligations with respect to a Floor QCC Order that triggers a Section
11(a) obligation by transmitting that order to another Options Floor
Broker or to an Exchange member off the floor of the Exchange.
Likewise, Exchange members off the floor must ensure that their Floor
QCC Orders comply with Section 11(a) and the rules thereunder. In both
cases, Exchange members must ensure compliance with Section 11(a) and
the rules thereunder, including by relying upon an exemption such as
those listed above.
    Additionally, to provide a mechanism for the Exchange to review
whether Floor QCC Orders have been entered properly by Options Floor
Brokers, the Exchange proposes to adopt proposed Rule 1064(e)(2). This
provision would require Options Floor Brokers to maintain books and
records demonstrating that no Floor Qualified Contingent Cross Order
was entered by the Options Floor Broker in a prohibited account.\12\
Any Floor Qualified Contingent Cross Order that does not have a
corresponding record required by this provision would be deemed to have
been entered in violation of Rule 1064(e).
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    \12\ The Exchange System will also be programmed to require
certain order entry parameters for submission of Floor QCC Orders.
For example, a Floor QCC Order must include data reflecting the
number of shares of stock sold/purchased in the stock leg of the QCT
trade. Floor QCC Orders lacking this data will be rejected by the
System. The order entry parameters will be included in the
Exchange's published specifications and described in an Options
Trader Alert prior to launch.
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    Finally, the Exchange proposes to modify subsections (a), (b), and
(c) of Rule 1064. These changes are designed clearly to establish that
the requirements applicable to Floor QCC Orders that are set forth in
subsection (e) are different from those applicable to the orders
described in subsections (a), (b) and (c).
    As set forth in proposed Rule 1064(e), the Floor QCC Order must:
(i) Be for at least 1,000 contracts,\13\ (ii) meet the six requirements
of Rule 1080(o)(3) which are modeled on the QCT Exemption, (iii) be
executed at a price at or between the National Best Bid and Offer
(``NBBO''); and (iv) be rejected if a Customer order is resting on the
Exchange book at the same price.\14\ As a result, the PHLX Floor QCC
Order proposed herein satisfies all of the

requirements the Commission enumerated in the Approval Order.
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    \13\ In order to satisfy the 1,000-contract requirement, a Floor
QCC Order must be for 1,000 contracts and could not be, for example,
two 500-contract orders or two 500-contract legs.
    \14\ While the Floor QCC would not provide exposure for price
improvement for the options leg of a stock-option order, the options
leg must be executed at the NBBO or better. The Commission has
previously approved crossing transactions with no opportunity for
price improvement. See, e.g., ISE Rule 721(a) and Chicago Board
Options Exchange Rule 6.74A, Interpretations and Policies .08.
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    The Exchange's proposal addresses the mechanics of executing the
stock and options components of a net-price transaction. The Exchange
believes that it is necessary that it provide members and their
customers with the same trading capabilities available on other
exchanges with respect to QCCs, including the change proposed herein,
which would permit members to execute the options legs of their
customers' large complex orders on the Exchange.
 2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section
6(b) of the Act \15\ in general, and furthers the objectives of
Sections 6(b)(5) \16\ and 6(b)(8) \17\of the Act in particular, in that
it is designed to promote just and equitable principles of trade, to
remove impediments to and perfect the mechanism of a free and open
market and a national market system, and, in general to protect
investors and the public interest and the rules of an exchange do not
impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Act. In addition, the proposed rule
change is consistent with Section 11A(a)(1)(C) of the Act,\18\ in which
Congress found that it is in the public interest and appropriate for
the protection of investors and the maintenance of fair and orderly
markets to assure, among other things, the economically efficient
execution of securities transactions. As described in detail above, the
proposed rule change is also consistent with Section 11(a) of the Act
and the rules thereunder.
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    \15\ 15 U.S.C. 78f(b).
    \16\ 15 U.S.C. 78f(b)(5).
    \17\ 15 U.S.C. 78f(b)(8).
    \18\ 15 U.S.C. 78k-1(a)(1)(C).
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    The statutory basis for PHLX's proposed Floor QCC Order is
identical to the Commission's basis for finding that the ISE's QCC
Proposal is consistent with the Act ``in that it would facilitate the
execution of qualified contingent trades, for which the Commission
found in the Original QCT Exemption to be of benefit to the market as a
whole, contributing to the efficient functioning of the securities
markets and the price discovery process. The Floor [sic] QCC Order
would provide assurance to parties to stock-option qualified contingent
trades that their hedge would be maintained by allowing the options
component to be executed as a clean cross.'' In addition, like the
ISE's QCC Order, the Exchange's Floor QCC Order ``is narrowly drawn to
provide a limited exception to the general principle of exposure, and
retains the general principle of customer priority.''
    PHLX's proposed Floor QCC Order promotes the same Commission goals
as or more effectively, and it is as or more narrowly drawn than ISE's
QCC Order. Accordingly, the Exchange believes that the proposed rule
change must also be consistent with the Act.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will
impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Act. To the contrary, the proposed
Floor QCC Order is a competitive response to the ISE QCC Order and
similar orders adopted by other exchanges.

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

    No written comments were either solicited or received.

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

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

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to<EMAIL_ADDRESS>Please include
File Number SR-Phlx-2011-56 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-Phlx-2011-56. This file
number should be included on the subject line if e-mail is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street, NE.,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. Copies of such filing also will be available for
inspection and copying at the principal office of the Exchange. All
comments received will be posted without change; the Commission does
not edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly. All
submissions should refer to File No. SR-Phlx-2011-56 and should be
submitted on or before June 2, 2011.

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-11584 Filed 5-11-11; 8:45 am]
BILLING CODE 8011-01-P


[Federal Register Volume 78, Number 12 (Thursday, January 17, 2013)]
[Notices]
[Pages 3928-3931]
[FR Doc No: 2013-00871]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-68629; File No. SR-NASDAQ-2012-059]

Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order
Disapproving Proposed Rule Change To Establish ``Benchmark Orders''
Under NASDAQ Rule 4751(f)

January 11, 2013.

I. Introduction

    On May 1, 2012, The NASDAQ Stock Market LLC (``NASDAQ'' 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 establish various ``Benchmark Orders'' under
NASDAQ Rule 4751(f). The proposed rule change was published for comment
in the Federal Register on May 17, 2012.\3\ On June 26, 2012, the
Commission extended to August 15, 2012, the time period in which to
approve the proposed rule change, disapprove the proposed rule change,
or institute proceedings to determine whether to disapprove the
proposed rule change.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 66972 (May 11,
2012), 77 FR 29435 (May 17, 2012) (``Notice'').
    \4\ See Securities Exchange Act Release No. 67258 (June 26,
2012), 77 FR 39314 (July 2, 2012).
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    On August 14, 2012, the Commission instituted proceedings to
determine whether to approve or disapprove the proposed rule change.\5\
The Commission thereafter received two comment letters on the
proposal.\6\ On November 9, 2012, the Commission issued a notice of
designation of a longer period for Commission action on proceedings to
determine whether to approve or disapprove the proposed rule change.\7\
On December 17, 2012, NASDAQ submitted a response letter to the
comments on the proposal.\8\ This order disapproves the proposed rule
change.
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    \5\ See Securities Exchange Act Release No. 67655 (August 14,
2012), 77 FR 50191 (August 20, 2012) (``Order Instituting
Proceedings'').
    \6\ See Letters to the Commission from Theodore R. Lazo,
Managing Director and Associate General Counsel, SIFMA, dated
October 5, 2012 (``SIFMA Letter''); and James J. Angel, dated August
16, 2012 (``Angel Letter'').
    \7\ See Securities Exchange Act Release No. 68199 (November 9,
2012), 77 FR 68873 (November 16, 2012).
    \8\ See Letter to the Commission from Jeffrey S. Davis, Vice
President and Deputy General Counsel, NASDAQ, dated December 17,
2012 (``NASDAQ Letter'').
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II. Description of the Proposal

    As set forth in more detail in the Notice, the Exchange has
proposed to offer Benchmark Orders that would seek to achieve the
performance of a specified benchmark--Volume Weighted Average Price
(``VWAP''), Time Weighted Average Price (``TWAP''), or Percent of
Volume (``POV'')--over a specified period of time for a specified
security.\9\ The entering party would specify the benchmark, period of
time, and security, as well as the other order information common to
all order types, such as buy/sell side, shares and price.\10\
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    \9\ See proposed NASDAQ Rule 4751(f)(15).
    \10\ Id.; see also Notice, 77 FR at 29436.
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    Benchmark Orders would be received by NASDAQ but by their terms
would not be executable by the NASDAQ matching engine upon entry.\11\
Rather, NASDAQ would direct them to a system application
(``Application'') that is licensed from a third-party provider and
dedicated to processing Benchmark Orders.\12\ The Application would
process Benchmark Orders by generating ``Child Orders'' in a manner
designed to achieve the desired benchmark performance, i.e., VWAP, TWAP
or POV, in accordance with the member's instructions.\13\ Child Orders
would be executed within the NASDAQ system under NASDAQ's existing
rules, or made available for routing under NASDAQ's current routing
rules.\14\ The Application would not be capable of executing Child
Orders, but instead would send Child Orders, using the proper system
protocol, to the NASDAQ matching engine or to the NASDAQ router as
needed to complete the Benchmark Order.\15\ Child Orders would be
processed in an identical manner to orders generated independently of a
Benchmark Order.\16\ NASDAQ states that the third-party provider of the
Application would have no actionable advantage over NASDAQ members with
respect to the NASDAQ system.\17\
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    \11\ See proposed NASDAQ Rule 4751(f)(15); see also Notice, 77
FR at 29435-36.
    \12\ See Notice, 77 FR at 29436.
    \13\ See proposed NASDAQ Rule 4751(f)(15); see also Notice, 77
FR at 29435-36.
    \14\ See Notice, 77 FR at 29435. Child Orders that require
routing would be routed by NASDAQ Execution Services, NASDAQ's
wholly-owned routing broker-dealer. Id. at 29436 n.8. In addition,
fees applicable to existing orders and trades would apply to Child
Orders. Id. at 29436.
    \15\ Id. at 29435-36.
    \16\ Id. at 29436.
    \17\ Id.
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    NASDAQ represents that it would test the Application rigorously and
regularly, monitor the Application performance on a real-time and
continuous basis, and have access to the technology, employees, books
and records of the third-party provider that are related to the
Application and its interaction with NASDAQ.\18\ NASDAQ states that it
considers the Application to be a functional offering of the NASDAQ
Stock Market, and that it would be integrated closely with the NASDAQ
system and provided to members subject to NASDAQ's obligations and
responsibilities as a self-regulatory organization.\19\ In addition,
NASDAQ represents that it would maintain control of and responsibility
for the Application.\20\
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    \18\ Id.
    \19\ Id.
    \20\ Id. at 29437.
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III. Discussion

    Under Section 19(b)(2)(C) of the Act, the Commission shall approve
a proposed rule change of a self-regulatory organization if it finds
that such proposed rule change is consistent with the requirements of
the Act, and the rules and regulations thereunder that are applicable
to such organization.\21\ The Commission shall disapprove a proposed
rule change if it does not make such a finding.\22\ The Commission's
Rules of Practice, under Rule 700(b)(3), state that the ``burden to
demonstrate that a proposed rule change is consistent with the Exchange
Act and the rules and regulations issued thereunder * * * is on the
self-regulatory organization that proposed the rule change'' and that a
``mere assertion that the proposed rule change is consistent with those
requirements * * * is not sufficient.'' \23\
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    \21\ See 15 U.S.C. 78s(b)(2)(C)(i).
    \22\ See 15 U.S.C. 78s(b)(2)(C)(ii).
    \23\ See 17 CFR 201.700. The description of a proposed rule
change, its purpose and operation, its effect, and a legal analysis
of its consistency with applicable requirements must all be
sufficiently detailed and specific to support an affirmative
Commission finding. See id. Any failure of a self-regulatory
organization to provide the information elicited by Form 19b-4 may
result in the Commission not having a sufficient basis to make an
affirmative finding that a proposed rule change is consistent with
the Act and the rules and regulations issued thereunder that are
applicable to the self-regulatory organization. Id.

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    After careful consideration, the Commission does not find that the
proposed rule change is consistent with the requirements of the Act and
the rules and regulations thereunder applicable to a national
securities exchange.\24\ In particular, the Commission does not find
that the proposed rule change is consistent with: (i) Section 6(b)(5)
of the Act,\25\ which requires, among other things, that the rules of a
national securities exchange be designed to promote just and equitable
principles of trade, to remove impediments to and perfect the mechanism
of a free and open market and a national market system, to protect
investors and the public interest, and not to permit unfair
discrimination between customers, issuers, brokers, or dealers; and
(ii) Section 6(b)(8) of the Act,\26\ which requires that the rules of a
national securities exchange not impose any burden on competition not
necessary or appropriate in furtherance of the Act.
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    \24\ In disapproving the proposed rule change, the Commission
has considered the proposed rule's impact on efficiency,
competition, and capital formation. See 15 U.S.C. 78c(f).
    \25\ 15 U.S.C. 78f(b)(5).
    \26\ 15 U.S.C. 78f(b)(8).
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    In the Order Instituting Proceedings, the Commission stressed,
among other things, that the application of appropriate risk controls
under the Market Access Rule, Rule 15c3-5 under the Act,\27\ is
critically important to maintaining a robust market infrastructure.\28\
The Commission expressed concern as to whether Child Orders, which
would be generated solely by the Application and presumably outside the
control and supervision of the broker-dealer firm that entered the
initial Benchmark Order, would be subject to adequate pre-trade risk
checks, and noted that NASDAQ's proposal did not indicate how or
whether pre-trade controls would be applied to Child Orders generated
by the Application.\29\
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    \27\ 17 CFR 240.15c3-5. Rule 15c3-5 is designed to ensure that
broker-dealers appropriately control the risks associated with
market access, so as not to jeopardize their own financial
condition, that of other market participants, the integrity of
trading on the securities markets, or the stability of the financial
system. See Securities Exchange Act Release No. 63241 (November 3,
2010), 75 FR 69792 at 69794 (November 15, 2010).
    \28\ See Order Instituting Proceedings, 77 FR at 50192.
    \29\ Id.
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    The Commission received two comment letters on the proposed rule
change and a response from NASDAQ.\30\ In its comment letter, SIFMA
objects to, and urges the Commission to disapprove, the proposed rule
change.\31\ SIFMA expresses the belief that NASDAQ's proposed rule
change would create a regulatory disparity giving NASDAQ an
inappropriate advantage with respect to the Market Access Rule over
broker-dealers that provide the same services that NASDAQ proposes.\32\
SIFMA notes that NASDAQ is not subject to the Market Access Rule, and
its affiliated routing broker-dealer benefits from significant
exceptions to the Market Access Rule, whereas broker-dealers
unaffiliated with NASDAQ are subject to all of the requirements of the
Market Access Rule when they offer similar algorithmic trading services
to those NASDAQ proposes to offer, and such requirements are reinforced
through regulatory examination and oversight.\33\ Accordingly, SIFMA
``urge[s] the Commission to assure that the same regulatory
requirements and obligations would apply to Benchmark Orders and Child
Orders effected by Nasdaq that would apply to those orders if they were
effected by a broker-dealer.'' \34\
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    \30\ See SIFMA Letter and Angel Letter, supra note 6; NASDAQ
Letter, supra note 8.
    \31\ See SIFMA Letter, supra note 6.
    \32\ Id. at 2.
    \33\ Id. at 5.
    \34\ Id. at 2.
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    SIFMA further states that it shares the concern raised by the
Commission in the Order Instituting Proceedings that Child Orders would
not be subject to appropriate controls to manage risk, and that NASDAQ
has not adequately addressed how or whether the Child Orders would be
subject to adequate pre-trade risk controls.\35\ SIFMA states that,
given that Child Orders would be generated by a third-party Application
and outside of the control and supervision of the broker-dealer that
submitted the Benchmark Order, Child Orders would not be subject to the
risk controls that the entering firm is required to have in place
pursuant to the Market Access Rule.\36\ SIFMA notes that, while NASDAQ
has stated in the proposal that Child Orders will comport with existing
NASDAQ rules, including those intended to enforce the Market Access
Rule, NASDAQ has provided no details regarding how Child Orders will
meet these requirements.\37\ According to SIFMA, this lack of detail
raises concerns about the potential for market disruptions that
NASDAQ's proposed algorithmic functionality could cause.\38\ According
to the other commenter, Angel, NASDAQ's assurances in the proposal that
it will have adequate risk controls are credible.\39\
---------------------------------------------------------------------------

    \35\ Id. at 4.
    \36\ Id. at 4-5.
    \37\ Id. at 5.
    \38\ Id.
    \39\ See Angel Letter, supra note 6, at 2.
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    NASDAQ responds by, among other things, committing to provide
additional risk management safeguards for Benchmark Orders.\40\
Specifically, NASDAQ states that, unlike existing order types, which
are subjected only once to NASDAQ's suite of standardized, system-
enforced risk-management checks, including but not limited to
duplicative and erroneous order and credit threshold checks, Benchmark
Orders will trigger such checks twice--once with respect to the
Benchmark Order itself at the time of entry and a second time with
respect to each Child Order attributable to the Benchmark Order.\41\ In
addition, NASDAQ states that it will provide new safeguards,
specifically designed for Benchmark Orders, that compare each Child
Order to its parent Benchmark Order to ensure that the system cannot
mistakenly create excess Child Orders or otherwise ``spray'' orders to
the detriment of market participants.\42\ According to NASDAQ, if any
of these checks fail at any stage in the process, the entire order will
be cancelled.\43\
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    \40\ See NASDAQ Letter, supra note 8, at 3.
    \41\ Id.
    \42\ Id. According to NASDAQ, there are four such ``comparison''
checks: (i) Child Order limit price cannot violate the Parent Order
limit price; (ii) Child Order quantity cannot exceed the original
Parent Order quantity; (iii) Child Order quantity cannot exceed the
``leaves'' balance of the Parent Order; and (iv) Child Order
quantity cannot be greater than the eligible routing quantity. Id.
at 3-4. NASDAQ represents that it will conduct these checks at four
stages of the Benchmark Order process: (i) at the point of entry;
(ii) during the processing of any Child Orders; (iii) after the
processing of Child Orders; and (iv) when Child Orders are sent to
be booked on NASDAQ or routed to an away destination. Id. at 4.
    \43\ Id.
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    As the Commission noted in the Order Instituting Proceedings, the
application of appropriate risk controls under Rule 15c3-5 is
critically important to maintaining a robust market infrastructure
supporting the protection of investors, investor confidence, and fair,
orderly, and efficient markets for all participants.\44\ Under the
proposal, the risk controls required by Rule 15c3-5 would not be
applicable to Child Orders generated by the proposed Application--a
facility of NASDAQ--but NASDAQ represents that it would nevertheless
impose substantial risk controls to govern its proposed Benchmark
Orders, and in particular with respect to the Child Orders to which
Rule 15c3-5 would not directly apply. The representations

made in NASDAQ's response letter, if appropriately developed and
reflected in NASDAQ's proposed rule change, could potentially address
the concerns regarding the risk controls surrounding Benchmark Orders,
and whether in this regard the proposal imposes an undue burden on
competition under the Act or whether it is designed to promote just and
equitable principles of trade, to remove impediments to and perfect the
mechanism of a free and open market and a national market system, to
protect investors and the public interest, and not to permit unfair
discrimination between customers, issuers, brokers, or dealers. NASDAQ,
however, has not amended its proposed rule change to address this issue
or detail its proposed commitments with respect to the risk controls it
proposes to implement with respect to Benchmark Orders. Accordingly,
the Commission does not believe that it can make the finding that
NASDAQ's proposal is consistent with the requirements of Sections
6(b)(5) and 6(b)(8) of the Act.\45\
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    \44\ See Order Instituting Proceedings, 77 FR at 50192.
    \45\ 15 U.S.C. 78f(b)(5) and (b)(8).
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    In the Order Instituting Proceedings, the Commission also expressed
concern that NASDAQ's proposed Benchmark Order functionality could
permit unfair discrimination or impose an unnecessary burden on
competition.\46\ In this regard, SIFMA notes, among other things, that
the proposed Benchmark Order functionality would compete with
algorithms that broker-dealers and other market participants currently
use and offer, and questions whether it is appropriate for NASDAQ, as a
national securities exchange, to offer that functionality.\47\ SIFMA
states that NASDAQ's proposal could create regulatory disparities that
would give NASDAQ an inappropriate advantage over broker-dealers
providing the same services, both in terms of the Market Access Rule
\48\ and other regulatory requirements that apply to broker-
dealers.\49\ Specifically, SIFMA observes that NASDAQ has characterized
the Benchmark Order as part of its function as a self-regulatory
organization, and states that this characterization is cause for
concern that NASDAQ would use the doctrine of regulatory immunity to
shield the Exchange from any liability that could arise out of the use
of the Benchmark Order functionality.\50\ SIFMA suggests that the
proposed functionality is not part of NASDAQ's role as a market
regulator, but rather is a commercial offering of the Exchange that
should not enjoy immunity from liability that is not available to
broker-dealers providing identical services.\51\ SIFMA further opines
that ``it would be an incongruous result if NASDAQ were permitted to
use regulatory immunity as a shield against liability, while competing
algorithm providers offering the same services may assume unlimited
liability [without an] arms-length agreement.'' \52\ SIFMA believes
that exchanges should not enjoy regulatory immunity that is not
available to broker-dealers in providing the same services.\53\
---------------------------------------------------------------------------

    \46\ See Order Instituting Proceedings, 77 FR at 50192.
    \47\ See SIFMA Letter, supra note 6, at 2. In addition, SIFMA
notes that it shares an additional concern raised by the Commission
in the Order Instituting Proceedings regarding whether Benchmark
Orders and Child Orders could receive preferential treatment as
compared to orders generated by broker-dealers that choose to use a
competing algorithm. See SIFMA Letter, supra note 6, at 3. The other
commenter, Angel, opines that there could be a small time advantage
from the proximity of the Benchmark Order application to the order
entry gateway of NASDAQ's matching engine, but the amount of time
gained by such proximity would not likely result in a major
advantage. See Angel Letter, supra note 6, at 3. In response to
SIFMA, NASDAQ states that, as a self-regulatory organization, it is
not permitted to give and would not give Benchmark Orders any
preferential treatment vis a vis other orders entered into NASDAQ
systems. See NASDAQ Letter, supra note 8, at 4.
    \48\ 17 CFR 240.15c3-5.
    \49\ See SIFMA Letter, supra note 6, at 2.
    \50\ Id. at 3.
    \51\ Id. at 4.
    \52\ Id. at 3.
    \53\ Id. at 4.
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    NASDAQ's response letter takes the position that, as a self-
regulatory organization, the doctrine of regulatory immunity would
apply to the services that it proposes to offer.\54\ NASDAQ believes
that the proposal would not give NASDAQ an inappropriate advantage over
broker-dealers, and that the Application would be a functional offering
of the NASDAQ Stock Market similar to other functions, including order
types, that process member trading interest.\55\ NASDAQ states that it
has taken steps to ensure that the Application performs to the
standards that the Commission sets for all self-regulatory
organizations and complies with applicable SEC regulations and NASDAQ
rules.\56\ According to NASDAQ, it is beyond dispute that NASDAQ is
subject to regulation by the Commission in providing access to a
facility of the Exchange such as Benchmark Orders and that NASDAQ must
regulate its members' use of such facilities.\57\ NASDAQ states that,
as a national securities exchange under the Act, it is, by definition,
a self-regulatory organization, and that SIFMA's contention that
NASDAQ, in making the proposal, is not acting as a self-regulatory
organization is illogical and inconsistent with the plain language of
the Act.\58\ Further, according to NASDAQ, common law immunity is not
at issue in connection with the Commission's review of the proposal and
there is no need for the Commission to discuss such immunity in
analyzing the consistency of the proposal with the Act.\59\
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    \54\ See NASDAQ Letter, supra note 8, at 8.
    \55\ Id. at 2, 4, 7-8.
    \56\ Id. at 8.
    \57\ Id.
    \58\ Id.
    \59\ Id. at 7.
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    NASDAQ also contends that the proposed Benchmark Orders will
operate much like NASDAQ's already-approved order types, and that SIFMA
has identified no salient feature of Benchmark Orders that distinguish
them from NASDAQ's already-approved order types, nor has SIFMA
explained how Benchmark Orders would compete with broker systems any
differently than certain features of NASDAQ's system that already
compete with broker systems, such as routing and order execution.\60\
NASDAQ further argues that Benchmark Orders possess no characteristics
that the Commission has described as belonging to broker-dealer
functions, and that Benchmark Orders bear little or no resemblance to
traditional brokerage functions as defined and applied by the
Commission.\61\
---------------------------------------------------------------------------

    \60\ Id. at 2, 4.
    \61\ Id. at 7.
---------------------------------------------------------------------------

    NASDAQ has acknowledged, however, that Benchmark Orders are
designed to compete with services currently offered by broker-dealers,
noting that ``the establishment of Benchmark Orders on NASDAQ will
enhance NASDAQ's ability to compete with similar functionality that
already is widely dispersed in the industry both among members and
trading venues.'' \62\ In addition, NASDAQ has stated that ``[t]he
Benchmark Order will not itself be available for execution, but instead
will be used by a sub-system of the trading system to generate a series
of `Child Orders' of the types that already exist in the current NASDAQ
rules.'' \63\ NASDAQ has further articulated that ``Benchmark Orders
will not be executed by the NASDAQ matching engine, but will upon entry
be directed

to [the Application] dedicated to processing Benchmark Orders.'' \64\
---------------------------------------------------------------------------

    \62\ See Notice, 77 FR at 29437. In addition, Angel notes that
brokerage firms typically offer their clients the ability to place
orders designed to match the VWAP, TWAP or POV, and that NASDAQ's
proposal represents another example of the blurring borders between
exchanges and broker-dealers, and states that there is nothing
inherently wrong with competition between the two. See Angel Letter,
supra note 6, at 2.
    \63\ See Notice, 77 FR at 29435.
    \64\ Id. at 29436.
---------------------------------------------------------------------------

    The Commission believes that one significant difference between
Benchmark Orders and existing NASDAQ or other exchange orders is that
the Benchmark Order is not initially directed to the NASDAQ matching
engine for potential execution, but instead is directed to the
Application for further processing and the generation of Child Orders,
to be routed to the NASDAQ matching engine or another trading center.
Thus, NASDAQ's proposed Benchmark Order is not an exchange order in the
traditional sense, in that it would not immediately enter the
Exchange's order book (i.e., NASDAQ Market Center) \65\ for potential
execution. Instead, it essentially is an instruction that would reside
outside of the matching engine and be processed by an Application,
which would then route orders to NASDAQ, or another trading venue,
using a selected algorithm, over a particular period of time, to
achieve a particular objective.
---------------------------------------------------------------------------

    \65\ The term ``NASDAQ Market Center'' is defined in pertinent
part as the ``automated system for order execution and trade
reporting owned and operated by The NASDAQ Stock Market LLC * * *
[comprising] an order execution service that enables Participants to
automatically execute transactions in System Securities; and
provides Participants with sufficient monitoring and updating
capability to participate in an automated execution environment.''
See NASDAQ Rule 4751(a)(1).
---------------------------------------------------------------------------

    Because NASDAQ is proposing to offer a novel order type designed to
compete with services offered by broker-dealers, the Commission must
consider, among other things, whether the proposed rule change would
impose an unnecessary or inappropriate burden on competition under
Section 6(b)(8) of the Act.\66\ As noted above, SIFMA is concerned that
NASDAQ's proposal could create regulatory disparities that would give
NASDAQ an inappropriate advantage over broker-dealers providing the
same services, and that NASDAQ ``would use the doctrine of regulatory
immunity to protect itself from any liability that arises out of the
Benchmark Order functionality, through systems issues or otherwise.''
\67\ In addition, the Commission notes that NASDAQ Rule 4626 generally
provides that ``Nasdaq and its affiliates shall not be liable for any
losses, damages, or other claims arising out of the Nasdaq Market
Center or its use.'' \68\
---------------------------------------------------------------------------

    \66\ 15 U.S.C. 78f(b)(8).
    \67\ See SIFMA Letter, supra note 6, at 3.
    \68\ See NASDAQ Rule 4626.
---------------------------------------------------------------------------

    NASDAQ does not respond to concerns raised by SIFMA with any
substantive analysis of whether regulatory immunity, or exchange rules
limiting liability, in the context of NASDAQ's proposal to offer a
service traditionally provided by broker-dealers, would impose an undue
burden on competition under the Act. NASDAQ simply responds that this
``judicially recognized doctrine is not at issue in connection with the
Commission's review of NASDAQ's Benchmark Order Proposal'' and that
``[t]here is no need for the Commission to discuss immunity in
analyzing the consistency of NASDAQ's Proposal with the Exchange Act.''
\69\ Accordingly, the Commission does not believe that it can make the
finding that NASDAQ's proposal is consistent with the requirements of
Section 6(b)(8) of the Act.\70\
---------------------------------------------------------------------------

    \69\ See NASDAQ Letter, supra note 8, at 7.
    \70\ 15 U.S.C. 78f(b)(8).
---------------------------------------------------------------------------

    As noted above, Rule 700(b)(3) of the Commission's Rules of
Practice states that ``[t]he burden to demonstrate that a proposed rule
change is consistent with the Exchange Act and the rules and
regulations thereunder * * * is on the self-regulatory organization
that proposed the rule change'' and that a ``mere assertion that the
proposed rule change is consistent with those requirements * * * is not
sufficient.'' \71\ For the reasons set forth above, the Commission does
not believe that NASDAQ has met its burden to demonstrate that the
proposed rule change is consistent with the requirements of the Act and
the rules and regulations thereunder.
---------------------------------------------------------------------------

    \71\ 17 CFR 201.700(b)(3).
---------------------------------------------------------------------------

IV. Conclusion

    For the foregoing reasons, the Commission does not find that the
proposed rule change is consistent with the Act and the rules and
regulations thereunder applicable to a national securities exchange,
and, in particular, with Sections 6(b)(5) and 6(b)(8) of the Act.\72\
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    \72\ 15 U.S.C. 78f(b)(5) and (b)(8).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\73\ that the proposed rule change (SR-NASDAQ-2012-059) be, and
hereby is, disapproved.
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    \73\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\74\
---------------------------------------------------------------------------

    \74\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-00871 Filed 1-16-13; 8:45 am]
BILLING CODE 8011-01-P