February 9, 2017.
On December 9, 2016, NASDAQ BX, Inc. (“BX”), The NASDAQ Stock Market LLC (“Nasdaq”), and NASDAQ PHLX LLC (“Phlx” and, each of BX, Nasdaq, and Phlx a “NASDAQ Exchange” or “Exchange”) 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,
proposed rule changes to permit BX, Phlx, and The NASDAQ Options Market LLC (“NOM”) 
to accept options orders routed inbound from the International Stock Exchange, LLC (“ISE”), ISE Gemini, LLC (“ISE Gemini”), and ISE Mercury, LLC (“ISE Mercury” and, together with ISE and ISE Gemini, the “ISE Exchanges”) by Nasdaq Execution Services, LLC (“NES”), an affiliate of both the NASDAQ Exchanges and the ISE Exchanges (the NASDAQ Exchanges, together with the ISE Exchanges, the “Affiliated Exchanges”).
On December 20, 2016, each of the NASDAQ Exchanges filed an Amendment No. 1 to its respective proposed rule change. The proposed rule changes, each as modified by Amendment No. 1 thereto, were published for comment in the Federal Register on December 29, 2016.
The Commission received no comments on the proposals. This order approves the proposed rule changes, as modified by their respective Amendment No. 1s.
Phlx Rule 985(b)(i)(A) prohibits Phlx or any entity with which it is affiliated from, directly or indirectly, acquiring or maintaining an ownership interest in, or engaging in a business venture with, an Exchange member or an affiliate of an Exchange member in the absence of an effective filing under Section 19(b) of the Act.
Nasdaq's and BX's rules include similar prohibitions.
NES is a registered broker-dealer that is a member of NOM,
and currently provides to members of each, optional routing services to other markets.
NES is owned by Nasdaq, Inc.,
which also owns all of the Affiliated Exchanges.
Thus, NES is an affiliate of the NASDAQ Exchanges, as well as an affiliate of the ISE Exchanges. Absent an effective filing, the rules of Nasdaq, BX, and Phlx would prohibit NES from being a member of each of those Exchanges. Today, NES is a member of each of the NASDAQ Exchanges and performs certain limited activities for each, pursuant to effective filings pursuant to Section 19(b).
Among other activities, each of the NASDAQ Exchanges accepts options orders routed inbound from each of the other NASDAQ Exchanges pursuant to certain limitations and conditions.
With the current proposed rule changes, the NASDAQ Exchanges seek approval to permit NES to also route options orders inbound from the ISE Exchanges pursuant to those same limitations and conditions.
III. Discussion and Commission Findings
After careful review, the Commission finds that the proposed rule changes, each as modified by Amendment No. 1, Start Printed Page 10845are consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange.
Specifically, the Commission finds that the proposed rule changes are consistent with Section 6(b)(1) of the Act,
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 changes are 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, 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.
For each of the ISE Exchanges, NES will operate as a facility that provides outbound options routing from the respective ISE Exchange to other market centers, subject to certain conditions.
The operation of NES as a facility of each of the ISE Exchanges providing outbound routing services will be subject to oversight by each of the ISE Exchanges, respectively, as well as Commission oversight. Each of the ISE Exchanges will be responsible for ensuring that NES's outbound options routing services are operated consistent with Section 6 of the Act and ISE, ISE Gemini, and ISE Mercury's rules, respectively. In addition, the ISE Exchanges must each file with the Commission rule changes and fees relating to their outbound options routing services provided by NES.
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, each NASDAQ Exchange previously implemented limitations and conditions on its affiliation with NES to permit the Exchange to accept inbound options orders that NES routes in its capacity as a facility of the other NASDAQ Exchanges.
Again recognizing the concern previously expressed by the Commission, each NASDAQ Exchange now proposes that it be permitted 
to accept inbound options orders that NES routes in its capacity as a facility of ISE, ISE Gemini, and ISE Mercury, subject to those same limitations and conditions, as follows: 
- First, each NASDAQ Exchange and the Financial Industry Regulatory Authority (“FINRA”) will maintain a Regulatory Services Agreement (“RSA”), as well as an agreement pursuant to Rule 17d-2 under the Act (“17d-2 Agreement”).
Pursuant to the RSA and the 17d-2 Agreement, FINRA will be allocated regulatory responsibilities to review NES's compliance with certain Nasdaq, BX, and Phlx rules, respectively.
Pursuant to the RSA, however, each Exchange retains ultimate responsibility for enforcing its rules with respect to NES.
- Second, FINRA will monitor NES for compliance with each of the Exchange's trading rules, and will collect and maintain certain related information.
- Third, FINRA will provide a report to each Exchange's chief regulatory officer (“CRO”), on a quarterly basis, that: (i) Quantifies all alerts (of which the Exchange or FINRA is aware) that identify NES as a participant that has potentially violated Commission, or the respective Exchange's, rules, and (ii) lists all investigations that identify NES as a participant that has potentially violated Commission, or the respective Exchange's, rules.
- Fourth, Nasdaq, BX, and Phlx each have in place a rule that requires Nasdaq, Inc., 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 routing to the Exchange.
Each of the NASDAQ Exchanges has stated that it has met all of the above-listed conditions in connection with NES routing in its capacity as a facility of the other NASDAQ Exchanges, and will comply with these conditions in connection with NES routing in its capacity as a facility of the ISE Exchanges. By meeting such conditions, each NASDAQ Exchange believes that 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 each NASDAQ Exchange.
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.
Although the Commission Start Printed Page 10846continues 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, in its capacity as a facility of each of the ISE Exchanges, to route options orders inbound to each of the NASDAQ Exchanges, subject to the limitations and conditions described above.
The Commission believes that these limitations and conditions will mitigate its concerns about potential conflicts of interest and unfair competitive advantage. In particular, the Commission believes that a non-affiliated SRO's oversight of NES,
combined with a non-affiliated SRO's monitoring of NES's compliance with each of the NASDAQ Exchange's rules and quarterly reporting to each NASDAQ Exchange, will help to protect the independence of Nasdaq's, BX's, and Phlx's regulatory responsibilities with respect to NES. The Commission also believes that the Exchanges' rules are designed to ensure that NES cannot use any information advantage it may have because of its affiliation with Nasdaq, BX, or Phlx, respectively.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule changes (SR-BX-2016-068; SR-NASDAQ-2016-169; SR-Phlx-2016-120), each as modified by their respective Amendment No. 1, be, and hereby is, approved.
For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.
Eduardo A. Aleman,
[FR Doc. 2017-02993 Filed 2-14-17; 8:45 am]
BILLING CODE 8011-01-P