Self-Regulatory Organizations; Proposed Rule Changes:
Federal Register: March 23, 2011 (Volume 76, Number 56)
Notices
Page 16462-16464
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
DOCID:fr23mr11-134
SECURITIES AND EXCHANGE COMMISSION
Release No. 34-64090; File No. SR-BX-2011-007
Self-Regulatory Organizations; NASDAQ OMX BX LLC; Order Approving a Proposed Rule Change Relating to Permanent Approval of the BX and NES
Inbound Routing Relationship
March 17, 2011.
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Introduction
On January 28, 2011, NASDAQ OMX BX LLC (``BX'' 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
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change requesting permanent approval of the Exchange's pilot program to permit the Exchange to accept inbound orders that Nasdaq Execution
Services, LLC (``NES'') routes in its capacity as a facility of The
NASDAQ Stock Market LLC (``Nasdaq''), with certain obligations and conditions. The proposed rule change was published for comment in the
Federal Register on February 14, 2011.\3\ The Commission received no comment letters regarding the proposed rule change. This order approves the proposed rule change.
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 63859 (February 7, 2011), 76 FR 8391 (``Notice'').
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Background
BX Equity Rule 2140(a) prohibits the Exchange or any entity with which it is affiliated from acquiring or maintaining an ownership interest in a member in the absence of an effective filing under
Section 19(b) of the Act.\4\ NES is a broker-dealer that is a member of the Exchange, and currently provides to Nasdaq members optional routing services to other market centers. NES is owned by The NASDAQ OMX Group,
Inc. (``NASDAQ OMX''), which also owns three registered securities exchanges--Nasdaq, the Exchange, and NASDAQ OMX PHLX LLC.\5\ Thus, NES is an affiliate of each of these exchanges. Absent an effective filing,
BX Equity Rule 2140(a) would prohibit NES from being a member of the
Exchange.
\4\ 15 U.S.C. 78s(b).
\5\ See Securities Exchange Act Release No. 58324 (August 7, 2008), 73 FR 46936 (August 12, 2008) (SR-BSE-2008-02; SR-BSE-2008- 23; SR-BSE-2008-25; SR-BSECC-2008-01) (``BSE Approval Order''). See also Securities Exchange Act Release No. 58179 (July 17, 2008), 73
FR 42874 (July 23, 2008) (order approving NASDAQ OMX's acquisition of Phlx.)
On August 7, 2008, in connection with the acquisition of the
Exchange by NASDAQ OMX, the Commission, approved an affiliation between the Exchange and NES for the limited purpose of permitting NES to provide routing services for Nasdaq for orders that first attempt to access liquidity on Nasdaq's system before routing to the Exchange, subject to certain other limitations and conditions.\6\ At the time of
NASDAQ OMX's acquisition of the Exchange, the Exchange was not trading equity securities.\7\ On December 23, 2008, in connection with the
Exchange's resumption of equity trading, the Commission approved a modification to the conditions for the affiliation between NES and the
Exchange, to permit the Exchange to receive orders routed by NES in its capacity as a facility of Nasdaq (including ``Directed Orders''),\8\ on a one-year pilot basis.\9\ The Exchange is now proposing to make such approval permanent.\10\
\6\ See BSE Approval Order, supra note 5.
\7\ See BSE Approval Order, supra note 5, 73 FR at 46944, n.117.
\8\ Nasdaq Rule 4751(f)(9) defines Directed Orders as immediate- or-cancel orders that are directed to an exchange other than Nasdaq without checking the Nasdaq book.
\9\ See Securities Exchange Act Release No. 59154 (December 23, 2008), 73 FR 80468 (December 31, 2008) (SR-BSE-2008-48) (``BSE
Inbound Routing Order'').
\10\ See Notice, supra note 3.
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Discussion and Commission Findings
After careful review, the Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange.\11\ Specifically, the Commission finds that the proposed rule change is consistent with Section 6(b)(1) of the Act,\12\ which requires, among other things, that a national securities exchange be so organized and have the capacity to carry out the purposes of the Act, and to comply and enforce compliance by its members and persons associated with its members, with the provisions of the Act, the rules and regulation thereunder, and the rules of the Exchange. Further, the
Commission finds that the proposed rule change is consistent with
Section 6(b)(5) of the Act,\13\ which requires, among other things, that the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices; to promote just and equitable principles of trade; to foster cooperation and coordination with persons engaged in regulating, clearing, settling, and processing information with respect to, and facilitating transactions in securities; to remove impediments to and perfect the mechanism of a free and open market and a national market system; and, in general, to protect investors and the public interest. Section 6(b)(5) also requires that the rules of an exchange not be designed to permit unfair discrimination among customers, issuers, brokers, or dealers.
\11\ 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).
\12\ 15 U.S.C. 78f(b)(1).
\13\ 15 U.S.C. 78f(b)(5).
NES operates as a facility of Nasdaq that provides outbound routing from Nasdaq to other market centers, subject to certain conditions.\14\
NES's operation as a facility providing outbound routing services for
Nasdaq is subject to the conditions that: (1) NES is operated and regulated as a facility of Nasdaq; (2) NES only provides outbound routing services unless otherwise approved by the Commission; (3) the designated examining authority of NES is a self-regulatory organization unaffiliated with Nasdaq; and (4) the use of NES for outbound routing is available only to Nasdaq members and the use of NES remains optional.\15\
\14\ See Nasdaq Rule 4758. See also Notice, supra note 3, 76 FR at 8301, n.5.
\15\ Id. See also BSE Inbound Routing Order, supra note 9, 73 FR at 80475.
The operation of NES as a facility of Nasdaq providing outbound routing services from that exchange will be subject to Nasdaq oversight, as well as Commission oversight. Nasdaq will be responsible for ensuring that NES's outbound routing function is operated consistent with Section 6 of the Act and Nasdaq rules. In addition,
Nasdaq must file with the Commission rule changes and fees relating to
NES's outbound routing function.
Recognizing that the Commission has previously expressed concern regarding the potential for conflicts of interest in instances where a member firm is affiliated with an exchange of which it is a member, the
Exchange previously proposed, and the Commission approved, limitations and conditions on NES's affiliation with the Exchange.\16\ Also recognizing that the Commission has expressed concern regarding the potential for conflicts of interest in instances where a member firm is affiliated with an exchange to which it is routing orders, the Exchange previously proposed, and the Commission approved,\17\ NES's affiliation with the Exchange to permit the Exchange to accept inbound orders that
NES routes in its capacity as a facility of Nasdaq, subject to the following limitations and conditions, which the Exchange states it has met: \18\
\16\ See BSE Approval Order, supra note 5, 73 FR at 46944.
\17\ See BSE Inbound Routing Order, supra note 9, 73 FR at 80475.
\18\ See Notice, supra note 3, 73 FR at 8391-8392.
First, the Exchange and FINRA will enter into a Regulatory
Contract, as well as an agreement pursuant to Rule 17d-2 under the Act
(``17d-2 Agreement'').\19\ Pursuant to the Regulatory Contract and the 17d-2 Agreement, FINRA will be allocated regulatory responsibilities to review NES's compliance with certain Exchange rules.\20\ Pursuant to the Regulatory Contract, however, BX
Page 16464
retains ultimate responsibility for enforcing its rules with respect to
NES.
\19\ 17 CFR 240.17d-2.
\20\ The Exchange also states that NES is subject to independent oversight by FINRA, its Designated Examining Authority, for compliance with financial responsibility requirements. See Notice, supra note 3, 76 FR at 8391, n.9.
Second, FINRA will monitor NES for compliance with the
Exchange's trading rules, and will collect and maintain certain related information.\21\
\21\ Pursuant to the Regulatory Contract, both FINRA and the
Exchange will collect and maintain all alerts, complaints, investigations and enforcement actions in which NES (in its capacity as a facility of Nasdaq routing orders to the Exchange) is identified as a participant that has potentially violated applicable
Commission or Exchange rules. The Exchange and FINRA will retain these records in an easily accessible manner in order to facilitate any potential review conducted by the Commission's Office of
Compliance Inspections and Examinations. See Notice, supra note 3, 76 FR at 8391, n.10
Third, FINRA will provide a report to the Exchange's chief regulatory officer (``CRO''), on a quarterly basis, that: (i)
Quantifies all alerts (of which FINRA is aware) that identify NES as a participant that has potentially violated Commission or Exchange rules, and (ii) lists all investigations that identify NES as a participant that has potentially violated Commission or Exchange rules.\22\
\22\ See Notice, supra note 3, 76 FR at 8392.
Fourth, the Exchange has adopted BX Equity Rule 2140(c), which requires NASDAQ OMX, as the holding company owning both the
Exchange and NES, to establish and maintain procedures and internal controls reasonably designed to ensure that NES does not develop or implement changes to its system, based on non-public information obtained regarding planned changes to the Exchange's systems as a result of its affiliation with the Exchange, until such information is available generally to similarly situated Exchange members, in connection with the provision of inbound order routing to the
Exchange.\23\
\23\ See BX Equity Rule 2140(c). See also Notice, supra note 3, 76 FR at 8392.
Fifth, routing of orders from NES to the Exchange, in
NES's capacity as a facility of Nasdaq, was authorized for a pilot period of twelve months.\24\
\24\ See Notice, supra note 3, 76 FR at 8392. The Commission notes that the original pilot period of twelve months was approved and began on December 23, 2008, but was extended several times. See
Notice, supra note 3, 76 FR at 8391, n.6 and accompanying text.
The Exchange believes that by meeting the above-listed conditions it has set up mechanisms that protect the independence of the
Exchange's regulatory responsibility with respect to NES, and has demonstrated that NES cannot use any information advantage it may have because of its affiliation with the Exchange.\25\
\25\ See Notice, supra note 3, 76 FR at 8392.
In the past, the Commission has expressed concern that the affiliation of an exchange with one of its members raises potential conflicts of interest, and the potential for unfair competitive advantage.\26\ Although the Commission continues to be concerned about potential unfair competition and conflicts of interest between an exchange's self-regulatory obligations and its commercial interest when the exchange is affiliated with one of its members, for the reasons discussed below, the Commission believes that it is consistent with the
Act to permit NES to provide inbound routing to the Exchange on a permanent basis instead of a pilot basis, subject to the other conditions described above.
\26\ See, e.g., Securities Exchange Act Release Nos. 54170 (July 18, 2006), 71 FR 42149 (July 25, 2006) (SR-NASDAQ-2006-006) (order approving Nasdaq's proposal to adopt Nasdaq Rule 2140, restricting affiliations between Nasdaq and its members); 53382 (February 27, 2006), 71 FR 11251 (March 6, 2006) (SR-NYSE-2005-77) (order approving the combination of the New York Stock Exchange, Inc. and
Archipelago Holdings, Inc.); 58673 (September 29, 2008), 73 FR 57707
(October 8, 2008) (SR-Amex-2008-62) (order approving the combination of NYSE Euronext and the American Stock Exchange LLC); 59135
(December 22, 2008), 73 FR 79954 (December 30, 2008) (SR-ISE-2009- 85) (order approving the purchase by ISE Holdings of an ownership interest in DirectEdge Holdings LLC); and 59281 (January 22, 2009), 74 FR 5014 (January 28, 2009) (SR-NYSE-2008-120) (order approving a joint venture between NYSE and BIDS Holdings L.P.).
The Exchange has proposed four ongoing conditions applicable to
NES's routing activities, which are enumerated above. The Commission believes that these conditions mitigate its concerns about potential conflicts of interest and unfair competitive advantage. In particular, the Commission believes that FINRA's oversight of NES,\27\ combined with FINRA's monitoring of NES's compliance with the equity trading rules and quarterly reporting to the Exchange's CRO, will help to protect the independence of the Exchange's regulatory responsibilities with respect to NES. The Commission also believes that BX Equity Rule 2140(c) is designed to ensure that NES cannot use any information advantage it may have because of its affiliation with the Exchange.
\27\ This oversight will be accomplished through the 17d-2
Agreement between FINRA and the Exchange and the Regulatory
Contract.
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Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\28\ that the proposed rule change (SR-BX-2011-007) be, and hereby is, approved.
\28\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.\29\
\29\ 17 CFR 200.30-3(a)(12).
Cathy H. Ahn,
Deputy Secretary.
FR Doc. 2011-6785 Filed 3-22-11; 8:45 am
BILLING CODE 8011-01-P
