Self-Regulatory Organizations; Proposed Rule Changes: NASDAQ Stock Market LLC

Federal Register: August 26, 2009 (Volume 74, Number 164)

Notices

Page 43188-43191

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

DOCID:fr26au09-127

SECURITIES AND EXCHANGE COMMISSION

Release No. 34-60525; File No. SR-NASDAQ-2009-056

Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order

Granting Approval of a Proposed Rule Change as Modified by Amendment

No. 1 Thereto To Adopt Rules Implementing the Options Order Protection and Locked/Crossed Market Plan

August 18, 2009.

  1. Introduction

    On June 23, 2009, The NASDAQ Stock Market LLC (``Nasdasq'' 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 amend and adopt rules to implement the Options

    Order Protection and Locked/Crossed Market Plan. The proposed rule change was published for comment in the Federal Register on July 8, 2009.\3\ On August 14, 2009, the Exchange filed Amendment No. 1 to the proposed rule change.\4\ The Commission received no comments on the proposal. This order approves the proposed rule change, as modified by

    Amendment No. 1.

    \1\ 15 U.S.C. 78s(b)(1).

    \2\ 17 CFR 240.19b-4.

    \3\ See Securities Exchange Act Release No. 60186 (June 29, 2009), 74 FR 32657 (``Notice'').

    \4\ Amendment No. 1 made technical corrections to the rule text proposed by Nasdaq. Because the amendment did not affect the substance of the rule filing, the amendment did not require notice and comment.

  2. Description of the Proposal

    The Exchange proposes to amend and adopt new Nasdaq rules to implement the Options Order Protection and Locked/Crossed Market Plan

    (``Plan'').\5\ Specifically, the Exchange proposes to replace current

    Chapter XII of its rules with new rules implementing the Plan, amend other Exchange rules to reflect

    Page 43189

    the Plan, and delete rules rendered unnecessary by the Plan.

    \5\ The Plan is a national market system plan proposed by the seven existing options exchanges and approved by the Commission. See

    Securities Exchange Act Release No. 59647 (March 30, 2009), 74 FR 15010 (April 2, 2009) (File No. 4-546) (``Plan Notice'') and 60405

    (July 30, 2009), 74 FR 39362 (August 6, 2009) (File No. 4-546)

    (``Plan Approval''). The seven options exchanges are: Chicago Board

    Options Exchange, Incorporated (``CBOE''); International Securities

    Exchange LLC (``ISE''); NASDAQ OMX BX, Inc. (``BOX''); NASDAQ OMX

    PHLX, Inc. (``Phlx''); NYSE Amex LLC (``NYSE Amex''); NYSE Arca,

    Inc. (``NYSE Arca''); and Nasdaq (each exchange individually a

    ``Participant'' and, together, the ``Participating Options

    Exchanges'').

    The Old Plan

    Each of the Participating Options Exchanges are signatories to the

    Plan for the Purpose of Creating and Operating an Intermarket Option

    Linkage (``Old Plan'').\6\ In pertinent part, the Old Plan generally requires its participants to avoid trading at a price inferior to the national best bid or offer (``trade-through''), although it provides for a number of exceptions to trade-through liability.\7\ The

    Participating Options Exchanges comply with this requirement of the Old

    Plan by utilizing a stand alone system (``Linkage Hub'') to send and receive specific order types,\8\ namely Principal Acting as Agent

    Orders (``P/A Orders''), Principal Orders, and Satisfaction Orders.\9\

    The Old Plan also provided that dissemination of ``locked'' or

    ``crossed'' markets should be avoided, and remedial actions that should be taken to unlock or uncross such market.\10\ Each of the

    Participating Options Exchanges, including the Exchange, has submitted an amendment to the Old Plan to withdraw from such Plan.\11\ The withdrawals will be effective upon approval by the Commission of such amendments pursuant to Rule 608 of Regulation NMS under the Act

    (``Regulation NMS'').\12\

    \6\ On July 28, 2000, the Commission approved the Old Plan as a national market system plan for the purpose of creating and operating an intermarket options market linkage proposed by the

    American Stock Exchange LLC (n/k/a NYSE Amex), CBOE, and ISE. See

    Securities Exchange Act Release No. 43086 (July 28, 2000), 65 FR 48023 (August 4, 2000). Subsequently, Philadelphia Stock Exchange,

    Inc. (n/k/a Phlx), Pacific Exchange, Inc. (n/k/a NYSE Arca), Boston

    Stock Exchange, Inc. (n/k/a BOX), and Nasdaq joined the Linkage

    Plan. See Securities Exchange Act Release Nos. 43573 (November 16, 2000), 65 FR 70851 (November 28, 2000); 43574 (November 16, 2000), 65 FR 70850 (November 28, 2000); 49198 (February 5, 2004), 69 FR 7029 (February 12, 2004); and 57545 (March 21, 2008), 73 FR 16394

    (March 27, 2008).

    \7\ Section 8(c) of the Old Plan.

    \8\ The Linkage Hub is a centralized data communications network that electronically links the Participating Options Exchanges to one another. The Options Clearing Corporation (``OCC'') operates the

    Linkage Hub.

    \9\ Section 2(16) of the Old Plan.

    \10\ Section 7(a)(i)(C) of the Old Plan.

    \11\ See Securities Exchange Act Release No. 60360 (July 21, 2009) 74 FR 37265 (July 28, 2009) (File No. 4-429).

    \12\ 17 CFR 242.608.

    The Plan

    The Plan does not require a central linkage mechanism akin to the

    Old Plan's Linkage Hub. Instead, the Plan includes the framework for routing orders via private linkages that exist for NMS stocks under

    Regulation NMS.\13\ The Plan requires the Participating Options

    Exchanges to adopt rules ``reasonably designed to prevent Trade-

    Throughs.'' \14\ Participating Options Exchanges are also required to conduct surveillance of their respective markets on a regular basis to ascertain the effectiveness of the policies and procedures to prevent

    Trade-Throughs and to take prompt action to remedy deficiencies in such policies and procedures.\15\ As further described below, the Plan incorporates a number of exceptions to trade-through liability.\16\

    Some of these exceptions are carried over from the Old Plan, including exceptions for trading rotations, non-firm quotes, and complex trades.\17\ Others are substantially similar to exceptions available for NMS stocks under Regulation NMS, such as exceptions for systems issues, crossed markets, quote flickering, customer stopped orders, benchmark trades and, notably, intermarket sweep orders (``ISOs'').\18\

    In addition, the Plan contains a new exception for stopped orders and price improvement.\19\

    \13\ See Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496 (June 29, 2005) (File No. S7-10-04); 17 CFR 242.600 et seq. For discussions of the similarities between the provisions of Regulation NMS and the provisions in the Plan, see the

    Plan Notice and Plan Approval, supra note 5.

    \14\ Under the Plan, a ``Trade-Through'' is generally defined as a transaction in an option series, either as principal or agent, at a price that is lower than a Protected Bid or higher than a

    Protected Offer.'' See Section 2(21) of the Plan. A ``Protected

    Bid'' and ``Protected Offer'' generally means a bid or offer in an option series, respectively, that is displayed by a Participant, is disseminated pursuant to the Options Price Reporting Authority

    (``OPRA'') Plan, and is the Best Bid or Best Offer. See Section 2(17) of the Plan. A ``Best Bid'' or ``Best Offer'' means the highest bid price and the lowest offer price. Section (2)(1) of the

    Plan. ``Protected Bid'' and ``Protected Offer,'' together are referred to herein as ``Protected Quotation.'' See Section 2(18) of the Plan.

    \15\ Section 5(a)(ii) of the Plan.

    \16\ Section 5(b) of the Plan.

    \17\ Subparagraphs (ii), (vii), and (viii), respectively, of

    Section 5(b) of the Plan.

    \18\ Subparagraphs (i), (iii), (vi), (ix), (xi), and (iv)-(v), respectively, of Section 5(b) of the Plan.

    \19\ Subparagraph (x) of Section 5(b) of the Plan.

    The Plan also requires each Participant to establish, maintain, and enforce written rules that: require its members reasonably to avoid displaying locked and crossed markets; assure the reconciliation of locked and crossed markets; and prohibit its members from engaging in a pattern or practice of displaying locked and crossed markets; subject to exceptions as may be contained in the rules of the Participant, as approved by the Commission.\20\

    \20\ Section 6 of the Plan. The Plan also contains provisions relating to the operation of the Plan including, for example, provisions relating to the entry of new parties to the Plan; withdrawal from the Plan; and amendments to the Plan.

    The Exchange's Proposal

    To implement the Plan, the Exchange proposes to replace its current rules relating to the Old Plan with new rules relating to the Plan, and makes amendments to other rules as necessary to conform to the requirements of the Plan.\21\ As such, the Exchange proposes to adopt all applicable definitions from the Plan into the Exchange's rules.\22\

    \21\ A more detailed description of the Exchange's proposed rule change may be found in the Notice, supra, note 3.

    \22\ Proposed Nasdaq Chapter XII, Section 1.

    In addition, the Exchange proposes to prohibit its members from effecting Trade-Throughs, unless an exception applies.\23\ Consistent with the Plan, the Exchange also proposes exceptions to the prohibition on trade throughs relating to: System issues; trading rotations; crossed markets; intermarket sweep orders; quote flickering; non-firm quotes; complex trades; customer stopped orders; stopped orders and price improvement; and benchmark trades.\24\

    \23\ Proposed Nasdaq Chapter XII, Section 2(a).

    \24\ Proposed Nasdaq Chapter XII, Section 2(b)(1)-(11). In addition, the Exchange proposes to add ISOs as a new type of order under proposed Nasdaq Chapter VI, Section 1(e)(8).

    The Exchange also proposes a rule to address locked and crossed markets, as required by the Plan.\25\ Specifically, the Exchange proposes that, except for quotations that fall within a stated exception, members shall reasonably avoid displaying, and shall not engage in a pattern or practice of displaying, any quotations that lock or cross a Protected Quote.\26\

    \25\ A ``locked market'' is defined as a quoted market in which a Protected Bid is equal to a Protected Offer. Proposed Nasdaq

    Chapter XII, Section 1(10). A ``crossed market'' is defined as a quoted market in which a Protected Bid is higher than a Protected

    Offer. Proposed Nasdaq Chapter XII, Section 1(5).

    \26\ Proposed Nasdaq Chapter XII, Section 3(a).

    The Exchange proposes three exceptions to the prohibition against locked and crossed markets: when the Exchange is experiencing a failure, material delay, or malfunction of its systems or equipment; when the locking or crossing quotation was displayed at a time where there is a crossed market; and when an Exchange member simultaneously routes an ISO to execute against the full displayed size of any locked or crossed Protected Bid or Protected Offer.\27\

    \27\ Proposed Nasdaq Chapter XII, Section 3(b).

    The Exchange also proposes rules to permit it to continue to accept

    P/A Orders and Principal Orders from Participating Options Exchanges that are

    Page 43190

    not able to send ISOs in order to avoid Trade-Throughs.\28\

    \28\ Proposed Nasdaq Chapter XII, Section 4.

    The Exchange proposes to amend certain other rules to reflect the

    Plan and delete terms related to the Old Plan. In particular, the

    Exchange proposes to amend Nasdaq Chapter IV, Section 5(b) and (c) and

    Nasdaq Chapter VII, Section 5(a)(viii) to modify language that is no longer applicable under the Plan and eliminate the ``Removal of

    Unreliable Quotes'' provision of Nasdaq Chapter 12, Section 3(e).\29\

    \29\ In addition, the Exchange proposes to rely upon the order routing arrangements already in place on its market.

    NASDAQ proposes to implement this proposed rule change upon withdrawal from the current Linkage Plan and effectiveness of the new

    Plan.

  3. Discussion and Commission's Findings

    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.\30\ In particular, the Commission finds that the proposal is consistent with Section 6(b)(5) of the Act 9 \31\ 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, and, in general, to protect investors and the public interest. The Commission also finds that the proposal is consistent with Rule 608(c) of Regulation NMS under the

    Act, which requires that each exchange comply with the terms of any effective national market system plan of which it is a participant.\32\

    Finally, the Commission finds that the proposed rule change is consistent with the requirements of the Plan.\33\

    \30\ In approving this proposed rule change, the Commission has considered the proposed rule's impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f).

    \31\ 15 U.S.C. 78f(b)(5).

    \32\ 17 CFR 242.608(c). Section 1 of the Plan provides in pertinent part that, ``The Participants will submit to the

    Commission

    for approval their respective rules that will implement the framework of the Plan.''

    \33\ See supra note 5.

    Proposed Nasdaq Chapter XII, Section 1 would define applicable terms in a manner that are substantively identical to the defined terms of the Plan.\34\ As such, the Commission finds that proposed Nasdaq

    Chapter XII, Section 1 is consistent with the Act and the Plan.

    \34\ The Commission notes that the Exchange's proposed definition of ``Complex Trade'' under proposed Nasdaq Chapter XII,

    Section 1(4) is identical to the definition of ``Complex Trade'' under old Nasdaq Chapter XII, Section 1(c), which is being deleted.

    Proposed Nasdaq Chapter XII, Section 2(a) would prohibit members from effecting Trade-Throughs unless an exception applies. Proposed

    Nasdaq Chapter XII, Section 2(b) would provide for 11 exceptions to the general Trade-Through prohibition, relating to systems issues, trading rotations, crossed markets, ISOs, quote flickering, non-firm quotes, complex trades, customer stopped orders, stopped orders and price improvement, and benchmark trades.\35\ Aside from the proposed exception relating to systems issues, each proposed exception would be substantively identical to the parallel exception under Section 5(b) of the Plan.

    \35\ Proposed Nasdaq Chapter XII, Section 2(b)(1)-(11).

    The systems issues exception under proposed Nasdaq Chapter XII,

    Section 2(b)(1) would implement the parallel exception available under

    Section 5(b)(i) of the Plan and would permit the Exchange to bypass the

    Protected Quotation of another Participant if such other Participant repeatedly fails to respond within one second to incoming orders attempting to access its Protected Quotations. The Exchange's rule would require the Exchange to notify such non-responding Participant immediately after (or at the same time as) electing self-help, and assess whether the cause of the problem lies with the Exchange's own systems and, if so, take immediate steps to resolve the problem.

    Finally, the Exchange would be required to promptly document its reasons supporting any such determination to bypass a Protected

    Quotation. The Commission believes that this exception should provide the Exchange with the necessary flexibility for dealing with problems that occur on an away market during the trading day. At the same time, the exception's requirements to immediately notify such away market of its determination and also assess its own system should help prevent the use of this exception when there in fact is a problem with the

    Exchange's own systems, rather than those of an away market.

    The Commission notes that included among the exceptions in proposed

    Nasdaq Chapter XII, Section 2(b) would be exceptions for certain transactions involving ISOs.\36\ An order identified as an ISO would be immediately executable by the Exchange (or any other Plan Participant that received such an order) based on the premise that the market participant sending the ISO has already attempted to access all better- priced Protected Quotations up to their displayed size. The Commission believes that this exception should help ensure more efficient and faster executions in the options markets.

    \36\ Proposed Nasdaq Chapter XII, Sections 2(b)(4) and (5).

    The Commission notes that, in addition to these rules regarding

    Trade-Throughs, the Plan requires that each Participant establish, maintain and enforce written policies and procedures that are reasonably designed to prevent Trade-Throughs in that Participant's market that do not fall within an applicable exception and, if relying on such exception, that are reasonably designed to assure compliance with the terms of the exception. In addition, the Commission notes that the Plan requires each Participant to conduct surveillance of its market on a regular basis to ascertain the effectiveness of such policies and procedures and to take prompt action to remedy any deficiencies in such policies and procedures.

    Accordingly, the Commission finds that proposed Nasdaq Chapter XII,

    Section 2 is consistent with Section 5 of the Plan and Section 6(b)(5) of the Act \37\ 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, and, in general, to protect investors and the public interest.

    \37\ 15 U.S.C. 78f(b)(5).

    Proposed Nasdaq Chapter XII, Section 3(a) would require Exchange members to reasonably avoid displaying, and not engage in a pattern or practice of displaying, any quotation that locks or crosses a Protected

    Quotation, subject to certain exceptions delineated in proposed Nasdaq

    Chapter XII, Section 3(b). The Commission recognizes that locked and crossed markets may occur accidentally and cannot always be avoided.

    However, the Commission believes that giving priority to the first- displayed Protected Bid or Protected Offer, particularly when it includes a public customer's order, will encourage price discovery and contribute to fair and orderly markets. Therefore, the Commission believes that the proposed rule, which corresponds to the Plan's language, to require members to reasonably avoid displaying, and not engaging in a pattern or practice of, locks and crosses is appropriate.

    Proposed Nasdaq Chapter XII, Section 3(b) would permit three exceptions to

    Page 43191

    the Exchange's general rule relating to locked and crossed markets.\38\

    These exceptions would be similar to analogous certain trade-through exceptions under proposed Nasdaq Chapter XII, Section 2(b), and relate to when the Exchange is experiencing systems issues, when there exists a crossed market, and when a member simultaneously routes ISOs against the full displayed size of any locked or crossed Protected Bid or

    Protected Offer.

    \38\ Section 6 of the Plan permits exceptions to the Plan's locked and crossed market rules as may be contained in the rules of a Participant approved by the Commission.

    The Commission believes that the Exchange's proposed rules relating to locked and crossed markets are consistent with the Plan and the Act and should help ensure that the display of locked or crossed markets will be limited and that any such display will be promptly reconciled.

    The Commission also believes that each of the proposed exceptions to locked and crossed markets relate to circumstances when it is appropriate to permit a limited, narrow exception to the general locked and crossed market rule.

    Therefore, the Commission finds that Exchange's rule regarding locked and crossed markets appropriately implements Section 6 of the

    Plan, and is consistent with Section 6(b)(5) of the Act \39\ 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, and, in general, to protect investors and the public interest.

    \39\ 15 U.S.C. 78f(b)(5).

    The Commission also finds that proposed Nasdaq Chapter XII, Section 4, which facilitates the participation of certain Participating Options

    Exchanges who may require the use of P/A Orders and Principal Orders after implementation of the Plan, is consistent with the Act. Although the Commission has already approved the Plan,\40\ the Commission also recognizes that there may be one or more Participating Options

    Exchanges that may require a temporary transition period during which they may want to continue to utilize these order types that exist currently under the Old Plan.\41\ The Exchange and each of the other

    Participating Options Exchanges have proposed substantially identical temporary provisions to accommodate this possibility.\42\ Thus, the

    Commission finds that the proposed rule relating to the Exchange's receipt and handling of P/A Orders and Principal Orders, and imposing certain obligations on the Exchange with respect to such orders that are similar to those that exist under the Old Plan, is appropriate and consistent with Section 6(b)(5) of the Act \43\ 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, and, in general, to protect investors and the public interest.

    \40\ See Plan Approval, supra, note 5.

    \41\ The Commission notes that any Participating Options

    Exchange that wishes to utilize such order types in a manner that would result in a Trade-Through would need to separately request an exemption from the Plan for such use.

    \42\ The Commission notes that the rules contained in Proposed

    Nasdaq Chapter XII, Section 4 are not required by the Plan, but rather are rules proposed by the Exchange in order to facilitate the participation in the Plan of certain exchanges during an initial transition period.

    \43\ 15 U.S.C. 78f(b)(5).

    Finally, the Commission finds that Nasdaq's proposed amendments to certain other Nasdaq rules to modify and/or delete language that is no longer necessary under the Plan are appropriate and consistent with the

    Act and the Plan.

  4. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the

    Act,\44\ that the proposed rule change (SR-NASDAQ-2009-056), as modified by Amendment No. 1, be, and it hereby is, approved.

    \44\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.\45\

    \45\ 17 CFR 200.30-3(a)(12).

    Florence E. Harmon,

    Deputy Secretary.

    FR Doc. E9-20535 Filed 8-25-09; 8:45 am

    BILLING CODE 8010-01-P

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