October 2, 2014.
On April 23, 2014, NASDAQ OMX PHLX LLC (“Exchange” or “Phlx”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) 
and Rule 19b-4 thereunder,
a proposed rule change to revise the priority afforded to in-crowd participants respecting crossing, facilitation, and solicited orders in open outcry trading (“Proposal”). The proposed rule change was published for comment in the Federal Register on May 13, 2014.
On June 23, 2014, the Commission extended the time period in which to either approve the Proposal, disapprove the Proposal, or institute proceedings to determine whether to approve or disapprove the Proposal to August 11, 2014.
The Commission received two comment letters from one commenter regarding the Proposal 
and one response letter from Phlx.
On July 30, 2014, the Exchange filed Amendment No. 1 to the Proposal (“Amendment No. 1”).
On August 4, 2014, the Commission instituted proceedings Start Printed Page 60877pursuant to Section 19(b)(2)(B) of the Act 
to determine whether to approve or disapprove the proposed rule change and published Amendment No. 1 for comment.
The Order Instituting Proceedings was published for comment in the Federal Register on August 8, 2014.
In response to the Order Instituting Proceedings, the Commission received no comment letters on the Proposal. This order approves the proposed rule change, as modified by Amendment No. 1.
II. Description of the Proposal
The Exchange proposes to amend Phlx Rule 1014, Commentary .05(c)(ii), to afford priority in open outcry trading to in-crowd participants over out-of-crowd Streaming Quote Traders (“SQTs”),
and Remote Streaming Quote Traders (“RSQTs”) 
and over out-of-crowd broker-dealer limit orders on the limit order book (but not over public customer orders) in crossing,
and solicited 
orders, regardless of order size.
Currently, Commentary .05(c)(i) to Phlx Rule 1014 provides that, in the event that a Floor Broker 
or specialist 
presents a non-electronic order in which an RSQT is assigned or which is allocated to a Remote Specialist, and/or in which an SQT assigned in such option is not a crowd participant (collectively, “Non-Crowd Participants”), such Non-Crowd Participant may not participate in trades stemming from such a non-electronic order unless the non-electronic order is executed at the price quoted by the Non-Crowd Participant at the time of execution. If the non-electronic order is executed at the price quoted by the Non-Crowd Participant, the Non-Crowd Participant may participate in the trade unless the order was a crossing, facilitation, or solicited order with a size of at least 500 contracts on each side.
If the order is a crossing, facilitation, or solicited order with a size of at least 500 contracts on each side, Commentary .05(c)(ii) gives priority to in-crowd participants (including, for purposes of Commentary .05(c)(ii) only, Floor Brokers) over Non-Crowd Participants and over out-of-crowd broker-dealer limit orders on the limit order book, but not over public customer orders.
The Exchange proposes to eliminate the 500 contract minimum order size from Phlx Rule 1014, Commentary .05(c)(ii). As amended, the rule would afford priority to in-crowd participants over Non-Crowd Participants and out-of-crowd broker-dealer limit orders in crossing, facilitation, and solicited orders regardless of the size of those orders. The Exchange states that it initially permitted Non-Crowd Participants to participate in Floor Broker crosses to foster electronic options trading.
In 2006, the Exchange adopted the size requirement, which continued to permit Non-Crowd Participants to participate in smaller (under five hundred contracts) Floor Broker crosses.
According to the Exchange, electronic options trading is well-established and there is no longer a need for such special rules and incentives to develop electronic trading further.
The Exchange notes that another options exchange does not have the same differentiation of priority for orders of fewer than 500 contracts.
The Exchange believes that its Proposal will encourage order flow providers to send additional crossing, facilitation, and solicited orders to the Exchange without concern that the order may not be completely executed by the trading crowd.
The Exchange also believes that affording priority to in-crowd participants regardless of size will attract additional smaller cross orders to the Exchange and allow in-crowd market makers to compete for smaller orders.
III. Comment Letters and Phlx's Response
As noted above, the Commission received two comment letters from one commenter 
and one response letter from Phlx.
In its first letter, the commenter opposes the Proposal and requests that the Commission institute proceedings to Start Printed Page 60878disapprove the Proposal. The commenter argues that the Proposal unfairly denies electronic participants the ability to participate in the execution of open outcry orders along with in-crowd participants at the same price.
The commenter states its view that the Exchange has not provided sufficient justification for allocating smaller trades negotiated on its floor to counterparties in the trading crowd ahead of same-priced orders from electronic participants.
The commenter believes that the Proposal will encourage Phlx participants to bring more orders to the floor, where they may receive a higher trade allocation and may be able to internalize a trade, instead of executing those orders through electronic auction systems.
The commenter argues that, even with the current 500 contract minimum, Phlx's priority rules disadvantage orders being internalized to the benefit of the internalizing brokers, as these orders receive relatively little price competition.
The commenter suggests that giving priority to small orders on the floor will further skew participants' incentives to bring orders to the floor to achieve a frictionless “clean cross” and deprive customers of vigorous competition for these orders.
The commenter states that most electronic auctions require that orders be exposed to all other participants trading on the exchange, and orders that are not exposed, such as qualified contingent crosses, are required to be for a large size.
The commenter also argues that, because no trade information is disseminated about orders executed on the floor to electronic participants, who may be willing to provide liquidity to orders executed on the Exchange floor, such orders will not benefit from potential price improvement built into electronic auctions.
The commenter believes that the Proposal will largely limit price competition for small orders to participants physically present in the crowd at the time a floor cross is announced and transacted.
The commenter further argues that the Proposal would ignore electronic orders and quotes, especially for small orders, and cause more orders to be crossed at prices that have not been sufficiently vetted by the participants most likely to offer price improvement.
In response to the commenter's concerns regarding in-crowd liquidity, Phlx states that on-floor liquidity on Phlx in many issues exceeds the displayed wider electronic markets.
Phlx argues that the Proposal merely removes the 500 contract minimum and that another options exchange, CBOE, does not have the same differentiation of priority for orders of fewer than 500 contracts.
Phlx believes that attracting smaller orders to the trading floor fosters an environment for on-floor liquidity providers to continue to provide price improvement and size improvement.
In response to the commenter's suggestion that the Proposal will facilitate internalization, Phlx states that priority will be afforded to all in-crowd participants, including market makers, not just Floor Brokers.
Phlx also believes that the Proposal should encourage small participants, such as floor-based market makers, to continue to make markets, which Phlx believes will improve the quality of execution for these smaller orders.
In its second letter, the commenter replies to the Phlx Response Letter and reiterates its request that the Commission institute proceedings to disapprove the Proposal. In response to Phlx's statement that, based on Phlx's experience, on-floor liquidity on Phlx in many issues exceeds the displayed wider electronic markets,
the commenter requests that the Commission require Phlx to provide data that would allow the Commission to gauge the level of participation of floor-based market makers against orders represented in open outcry, and price improvement provided by these participants.
The commenter questions whether Phlx needs to afford priority to in-crowd liquidity providers if they are offering active price improvement.
The commenter states its view that to the extent that in-crowd participants provide price improvement to orders represented in open outcry, their orders are already entitled to priority over other orders at a worse price, including electronic quotes.
The commenter asserts that the Proposal is intended to allow in-crowd participants to internalize orders without being subject to competition from active liquidity providers in the electronic markets.
The commenter argues that Phlx's reliance on the CBOE rule is irrelevant as the Phlx Proposal must stand on its own, and, in any event, believes that the in-crowd priority rules of Phlx and CBOE are not in the public interest.
The commenter argues that the proposed expansion of these rules would only foster internalization and curtail price improvement.
IV. Discussion and Commission Findings
After careful review of the proposed rule change as well as the comment letters and the Phlx response letter received on the Proposal, the Commission finds that the proposed rule change, as modified by Amendment No. 1, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange and, in particular, with Section 6(b) of the Act.
In particular, the Commission finds that the proposed rule change is consistent with Section 6(b)(5) of the Act,
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, 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; and not be designed to permit unfair discrimination between customers, issuers, brokers or dealers.
As noted above, the Commission received two comment letters from one commenter in response to the proposed rule change.
The commenter raised concerns about whether the Exchange's proposed revisions to its rules governing priority during open outcry were appropriate, as more fully described Start Printed Page 60879above.
In its review of the proposal, the Commission has carefully considered all of the comments received. The Commission acknowledges the concerns raised by the commenter, as detailed above,
about the potential impact on competition resulting from the Proposal in the Exchange's rules governing priority and order allocation for open outcry transactions. At the same time, the Commission also acknowledges the Exchange's belief that this Proposal will encourage order flow providers to send additional crossing, facilitation, and solicited orders to the Exchange,
as well as its belief that today, electronic options trading is well-established and no longer requires special rules and incentives to develop further.
Phlx Rule 1014, Commentary .05(c)(ii), as proposed to be revised, describes priority for crossing, facilitation, and solicited orders in open outcry transactions. The proposed rules governing open outcry during crossing, facilitation, and solicited transactions on the Exchange floor are similar to the rules governing priority in crossing transactions at other exchanges.
Given that other options exchanges currently have rules that provide lower priority to non-priority customer orders on the electronic book during crossing transactions on those exchanges, the Exchange's proposed revisions to its priority scheme for floor transactions will allow Phlx to compete with other floor-based exchanges that have substantially similar rules. Accordingly, the Commission believes that it would be appropriate and consistent with the Act to approve the Exchange's proposed rule change.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act 
that the proposed rule change, as modified by Amendment No. 1, (SR-Phlx-2014-23) be, and it hereby is, approved.
For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.
Kevin M. O'Neill,
[FR Doc. 2014-23984 Filed 10-7-14; 8:45 am]
BILLING CODE 8011-01-P