\67\ See id.

The Commission finds that the Exchange's execution priority rules and trading rules 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.\68\ 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. The Exchange market model for the trading of cash equity securities is similar to Nasdaq's equity market model and does not raise novel issues.
\68\ 15 U.S.C. 78f(b)(5).

b. Regulation NMS

The Exchange has designed its rules relating to orders, modifiers, and order execution to comply with requirements of Regulation NMS. Unlike Nasdaq, the Exchange will not route orders in equity securities to other market centers. The Equity Rules are consistent with Regulation NMS \69\ by requiring that all orders be processed in a manner that avoids trading through protected quotations and avoids locked and crossed markets.\70\ Specifically, Equity Rule 4755 provides that in addition to such other designations as may be chosen by a market participant,\71\ all orders that are not entered with a time in force of ``System Hours Immediate or Cancel'' \72\ must be designated as an
[[Page 80473]]
Intermarket Sweep Order, a Pegged Order, a Price to Comply Order, or a Price to Comply Post Order.\73\
\69\ 17 CFR 242.611.
\70\ See Equity Rule 4755(b).
\71\ As is the case with Nasdaq, different order designations can be combined. Thus, for example, a Price to Comply Order could be entered with reserve size or as a nondisplayed order.
\72\ A ``System Hours Immediate or Cancel'' order is an immediate or cancel order that may be entered between 8 a.m. and 7 p.m. Eastern Time, the hours of operation of the BX Equities Market. If a System Hours Immediate or Cancel order (or a portion thereof) is not marketable, the order (or unexecuted portion thereof) is canceled and returned to the entering participant. See Equity Rule 4751(h)(1).

\73\ See Equity Rule 4755(a)(2).

As described in the Notice, a System Hours Immediate or Cancel Order is compliant with Regulation NMS because by its terms it would not execute or post at a price that would result in a tradethrough of a protected quotation or lock or cross another market.\74\ A Pegged Order similarly is compliant with Regulation NMS because it continually reprices to avoid locking or crossing.\75\
\74\ See Notice, supra note 3, 73 FR at 69688; Equity Rule 4751(h)(1).

\75\ See Equity Rule 4751(f).

The Equity Rules also permit BX Equities Market participants to submit Intermarket Sweep Orders to comply with Regulation NMS, which will allow orders so designated to be automatically matched and executed within the System.\76\ As described in the Notice, when a market participant enters an Intermarket Sweep Order it is representing that it is also simultaneously routing one or more additional limit orders (also marked as Intermarket Sweep Orders), as necessary, to execute against the full displayed size of any protected bid or offer (as defined in Rule 600(b) of Regulation NMS) in the case of a limit order to sell or buy with a price that is superior to the limit price of the order identified as an Intermarket Sweep Order.\77\
\76\ See Equity Rules 4751(f)(6) and 4757.
\77\ The Exchange represented that members will be responsible for ensuring that their use of Intermarket Sweep Orders complies with Regulation NMS, and the Exchange's T+1 surveillance program will monitor members' use of Intermarket Sweep Orders. See Notice, supra note 3, 73 FR at 69688.

Both a Price to Comply and a Price Comply Post Order are designed to comply with the Regulation NMS.\78\ Specifically, if at the time of entry, a Price to Comply Order will lock or cross the quotation of an external market, the order will be priced to the current low offer (for bids) or to the current best bid (for offers) but displayed at a price one minimum price increment lower than the offer (for bids) or higher than the bid (for offers).\79\ Thus, an incoming order priced to execute against the displayed price will receive the superior undisplayed price.\80\ If, at the time of entry, a Price to Comply Post Order will lock or cross the protected quote of an external market or will cause a violation of Rule 611 of Regulation NMS, the order will be repriced and displayed to one minimum price increment (i.e., $0.01 or $0.0001) below the current low offer (for bids) or to one penny above the current best bid (for offers).\81\
\78\ See Notice, supra note 3, 73 FR at 6968869689.
\79\ See Rule 4751(f)(7).
\80\ For example, if the national best bid and best offer is $9.97 x $10.00, and a participant enters a Price to Comply Order to buy 10,000 shares at $10.01, the order will display at $9.99, but will reside on the System book at $10.00. If a seller then enters an order at $9.99, it will execute at $10.00, up to the full 10,000 shares of the order. The displayed and undisplayed prices of a Price to Comply Order may be adjusted once or multiple times depending upon the method of order entry and changes to the prevailing national best bid/best offer.
\81\ See Equity Rule 4751(f)(8). For example, if the national best bid and best offer is $9.97 x $10.00, and a participant enters a Price to Comply Post Order to buy at $10.01, the order will be repriced and displayed at $9.99. If a seller enters an order at $9.99, it will execute at that price.

The Commission believes that by requiring all orders to be entered with one of the designations described above, all Exchange orders should either be priced or cancelled in a manner consistent with the avoidance of tradethroughs and locked and crossed markets. The Commission also notes that, because the Exchange will not route orders to other market centers, the Exchange's Regulation NMS policies and procedures under Rule 611(a) will rely on information provided by Nasdaq for purposes of determining whether another trading center is experiencing a failure, material delay, or malfunction of its systems or equipment within the meaning of Rule 611(b)(1).

The Commission finds that the rules relating to orders, modifiers, and order execution that are designed to comply with Regulation NMS 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.

4. Section 11 of the Act

Section 11(a)(1) of the Act \82\ prohibits a member of a national securities exchange from effecting transactions on that exchange for its own account, the account of an associated person, or an account over which it or its associated person exercises discretion (collectively, ``covered accounts''), unless an exception applies. Rule 11a22(T) under the Act,\83\ known as the ``effect versus execute'' rule, provides exchange members with an exemption from the Section 11(a)(1) prohibition. Rule 11a22(T) permits an exchange member, subject to certain conditions, to effect transactions for covered accounts by arranging for an unaffiliated member to execute the transactions on the exchange. To comply with Rule 11a22(T)'s conditions, a member: (i) Must transmit the order from off the exchange floor; (ii) may not participate in the execution of the transaction once it has been transmitted to the member performing the execution; \84\ (iii) may not be affiliated with the executing member; and (iv) with respect to an account over which the member has investment discretion, neither the member nor its associated person may retain any compensation in connection with effecting the transaction except as provided in the Rule.
\82\ 15 U.S.C. 78k(a)(1).
\83\ 17 CFR 240.11a22(T).
\84\ The member may, however, participate in clearing and settling the transaction.

In a letter to the Commission,\85\ the Exchange requested that the Commission concur with its conclusion that Exchange members that enter orders into the System satisfy the requirements of Rule 11a22(T). For the reasons set forth below, the Commission believes that Exchange members entering orders into the System would satisfy the conditions of the Rule.
\85\ See letter from John Zecca, Chief Regulatory Officer, Exchange, to Florence Harmon, Acting Secretary, Commission, dated December 23, 2008 (``BSE 11(a) Request Letter'').

The Rule's first condition is that orders for covered accounts be transmitted from off the exchange floor. The System receives orders electronically through remote terminals or computertocomputer interfaces. In the context of other automated trading systems, the Commission has found that the offfloor transmission requirement is met if a covered account order is transmitted from a remote location directly to an exchange's floor by electronic means.\86\ Since the System
[[Page 80474]]
receives orders electronically through remote terminals or computerto computer interfaces, the Commission believes that the System satisfies the offfloor transmission requirement.
\86\ See, e.g., Nasdaq Registration Approval Order, supra note 50 Securities Exchange Act Release Nos. 49068 (January 13, 2004), 69 FR 2775 (January 20, 2004) (order approving the Boston Options Exchange as an options trading facility of the Boston Stock Exchange); 44983 (October 25, 2001), 66 FR 55225 (November 1, 2001) (order approving Archipelago Exchange as electronic trading facility of the Pacific Exchange (``PCX'')); 29237 (May 24, 1991), 56 FR 24853 (May 31, 1991) (regarding NYSE's OffHours Trading Facility); 15533 (January 29, 1979), 44 FR 6084 (January 31, 1979) (regarding the American Stock Exchange (``Amex'') Post Execution Reporting System, the Amex Switching System, the Intermarket Trading System, the Multiple Dealer Trading Facility of the Cincinnati Stock Exchange, the PCX Communications and Execution System, and the Philadelphia Stock Exchange (``Phlx'') Automated Communications and Execution System (``1979 Release'')); and 14563 (March 14, 1978), 43 FR 11542 (March 17, 1978) (regarding the NYSE's Designated Order Turnaround System (``1978 Release'')).

Second, the rule requires that the member not participate in the execution of its order. The Exchange represented that at no time following the submission of an order is a member able to acquire control or influence over the result or timing of an order's execution.\87\ According to the Exchange, the execution of a member's order is determined solely by what orders, bids, or offers are present in the System at the time the member submits the order and on the priority of those orders, bids and offers. Accordingly, the Commission believes that an Exchange member does not participate in the execution of an order submitted into the System.
\87\ See BSE 11(a) Request Letter, supra note 85. The member may only cancel or modify the order, or modify the instructions for executing the order, but only from off the Exchange floor. The Commission has stated that the nonparticipation requirement is satisfied under such circumstances so long as such modifications or cancellations are also transmitted from off the floor. See Securities Exchange Act Release No. 14563 (March 14, 1978), 43 FR 11542 (March 17, 1978) (stating that the ``nonparticipation requirement does not prevent initiating members from canceling or modifying orders (or the instructions pursuant to which the initiating member wishes orders to be executed) after the orders have been transmitted to the executing member, provided that any such instructions are also transmitted from off the floor'').

Third, Rule 11a22(T) requires that the order be executed by an exchange member who is unaffiliated with the member initiating the order. The Commission has stated that the requirement is satisfied when automated exchange facilities, such as the System, are used, as long as the design of these systems ensures that members do not possess any special or unique trading advantages in handling their orders after transmitting them to the Exchange.\88\ The Exchange has represented that the design of the System ensures that no member has any special or unique trading advantage in the handling of its orders after transmitting its orders to the Exchange.\89\ Based on the Exchange's representation, the Commission believes that the System satisfies this requirement.
\88\ In considering the operation of automated execution systems operated by an exchange, the Commission noted that while there is no independent executing exchange member, the execution of an order is automatic once it has been transmitted into the systems. Because the design of these systems ensures that members do not possess any special or unique trading advantages in handling their orders after transmitting them to the exchange, the Commission has stated that executions obtained through these systems satisfy the independent execution requirement of Rule 11a22(T). See 1979 Release, supra note 86.

\89\ See BSE 11(a) Request Letter, supra note 85.

Fourth, in the case of a transaction effected for an account with respect to which the initiating member or an associated person thereof exercises investment discretion, neither the initiating member nor any associated person thereof may retain any compensation in connection with effecting the transaction, unless the person authorized to transact business for the account has expressly provided otherwise by written contract referring to Section 11(a) of the Act and Rule 11a2 2(T).\90\ The Exchange represented that Exchange members trading for covered accounts over which they exercise investment discretion must comply with this condition in order to rely on the rule's
exemption.\91\
\90\ 17 CFR 240.11a22(T)(a)(2)(iv). In addition, Rule 11a2 2(T)(d) requires a member or associated person authorized by written contract to retain compensation, in connection with effecting transactions for covered accounts over which such member or associated person thereof exercises investment discretion, to furnish at least annually to the person authorized to transact business for the account a statement setting forth the total amount of compensation retained by the member in connection with effecting transactions for the account during the period covered by the statement. See 17 CFR 240.11a22(T)(d). See also 1978 Release, supra note 86 (stating ``[t]he contractual and disclosure requirements are designed to assure that accounts electing to permit transaction related compensation do so only after deciding that such
arrangements are suitable to their interests'').
\91\ See BSE 11(a) Request Letter, supra note 85.
C. Exception to Limitation on Affiliation Between BX and its Members

Although the Exchange will not route orders to other market centers, it proposes to receive orders routed to it by other market centers, including orders routed from Nasdaq.\92\ BSE Rule Chapter XXXIX, Section 2 prohibits BSE members from being affiliated with BSE.\93\ Proposed Equity Rule 2140(a) is identical to BSE Rule Chapter XXXIX, Section 2, and prohibits the Exchange or any entity with which it is affiliated, from acquiring or maintaining an ownership interest in a member without prior Commission approval.
\92\ See Notice, supra note 3, 73 FR at 69689.
\93\ See BSE Approval Order, supra note 7, 73 FR at 4694349644. The Exchange proposed, and the Commission approved, that the affiliation also be subject to the following conditions and limitations: (1) NES is operated as a facility of Nasdaq; (2) for purposes of Commission Rule 17d1 under the Act, 17 CFR 240.17d1, the designated examining authority of NES is a selfregulatory organization unaffiliated with Nasdaq; and (3) use of NES to route orders to other market centers is optional. Id.

NES is a brokerdealer that is a member of the Exchange, and currently provides to Nasdaq members optional routing services to other market centers. NES is owned by NASDAQ OMX, which also owns three registered securities exchangesNasdaq, the Exchange, and Phlx.\94\ Thus, NES is an affiliate of each of these exchanges. Absent Commission approval, Equity Rule 2140(a) would prohibit NES from being a member of the Exchange.
\94\ See BSE Approval Order, supra note 7, 73 FR at 46943. 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.)

In connection with NASDAQ OMX's acquisition of the Exchange, the Commission approved the current 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.\95\ At the time of NASDAQ OMX's acquisition of the Exchange, the Exchange was not trading equity securities.\96\ Now, in connection with the Exchange's resumption of equity trading pursuant to the instant proposed rule change, the Exchange proposes to modify the conditions for the affiliation between NES and the Exchange, previously approved by the Commission, to permit the Exchange to receive orders routed by NES in its capacity as a facility of Nasdaq (including ``Directed Orders''),\97\ on a oneyear pilot basis.\98\
\95\ BSE Rule Chapter XXXIX, Section 2 was adopted in the BSE Approval Order (see supra note 7, 73 FR at 46944), and is proposed to be replaced by Equity Rule 2140(a).
\96\ See BSE Approval Order, supra note 7, 73 FR at 49644, n.117.
\97\ Nasdaq Rule 4751(f)(9) defines Directed Orders as immediateorcancel orders that are directed to an exchange other than Nasdaq without checking the Nasdaq book. Pursuant to Nasdaq Rule 4751(f)(9), Nasdaq currently may not route Directed Orders to a facility of an exchange that is an affiliate of Nasdaq.

\98\ See Notice, supra note 3, 73 FR at 69689.

NES operates as a facility of Nasdaq that provides outbound routing from Nasdaq to other market centers, subject to certain conditions.\99\ 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
[[Page 80475]]
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. Currently, NES may not route Directed Orders to a facility of an exchange that is an affiliate of Nasdaq.\100\ Nasdaq has proposed, and the Commission approved today, a rule change to permit NES to route all forms of orders, including Directed Orders, to the BX Equities Market.\101\
\99\ See Nasdaq Rules 4751 and 4758. See also Notice, supra note 3, 73 FR at 69689.
\100\ Id. See also supra note 7.
\101\ See Securities Exchange Act Release No. 59154 (December 23, 2008) (SRNasdaq2008091).

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 \102\ 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 now proposes to revise the conditions to 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:
\102\ See BSE Approval Order, supra note 7, 73 FR at 49644.

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.\109\ Although the Commission continues to be concerned about potential unfair competition and conflicts of interest between an exchange's selfregulatory 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 pilot basis, subject to the conditions described above.
\109\ See, e.g., Securities Exchange Act Release Nos. 54170 (July 18, 2006), 71 FR 42149 (July 25, 2006) (SRNASDAQ2006006) (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) (SRNYSE200577) (order approving the combination of the New York Stock Exchange, Inc. and Archipelago Holdings, Inc.); and 58673 (September 29, 2008), 73 FR 57707 (October 8, 2008) (SRAmex200862) (order approving the combination of NYSE Euronext and the American Stock Exchange LLC).

The Exchange has proposed five 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,\110\ 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 the proposed addition of 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. Furthermore, the Commission believes that the Exchange's proposal to allow NES to route orders inbound to the Exchange from Nasdaq, on a pilot basis, will provide the Exchange and the Commission an opportunity to assess the impact of any conflicts of interest of allowing an affiliated member of the Exchange to route orders inbound to the Exchange and whether such affiliation provides an unfair competitive advantage.
\110\ This oversight will be accomplished through the 17d2 Agreement between FINRA and the Exchange and the Regulatory Contract.

D. Securities Traded on the Exchange

The Equity Rule 4000 series includes the rules governing listing and trading of cash equity securities on the Exchange. The Exchange proposes to adopt initial and continued listing standards for primary and secondary classes of common stock, preferred stock, convertible debt, rights and warrants, shares or certificates of beneficial interest of trusts, foreign securities, American Depositary [[Page 80476]]
Receipts (``ADRs''), and limited partnership interests that are identical to Nasdaq's listing standards for the Nasdaq Capital Market, Nasdaq's most permissive listing standards.\111\ The standards for initial and continued listing of these securities are set forth in the proposed Equity Rule 4300 Series.\112\
\111\ Nasdaq has three progressively higher listing tiersthe Nasdaq Capital Market, the Nasdaq Global Market, and the Nasdaq Global Select Market. Securities listed on the Nasdaq Capital Market are ``covered securities'' for purposes of Section 18 of the Securities Act of 1933, 15 U.S.C. 77r (``Securities Act''), and are therefore exempt from state law registration requirements. See Securities Act Release No. 8791 (April 18, 2007), 72 FR 20410 (April 24, 2008) (File No. S71806). In the Notice, the Exchange stated that it anticipates petitioning the Commission to amend Rule 146 under the Securities Act to recognize securities listed on the Exchange as covered securities. See Notice, supra note 3, 73 FR at 69688.

\112\ See Equity Rules 4310 and 4320.

In addition, the Exchange proposes to adopt, in Equity Rules 4420 and 4450, initial and continued listing standards for Selected Equity linked Debt Securities (``SEEDS''), units, index warrants, portfolio depository receipts, index fund shares, trust issued receipts, linked securities, managed fund shares, and ``other securities'' that would be substantively identical to those of the Nasdaq Global Market.\113\ The listing standards for SEEDS and ``other securities'' would differ slightly from the comparable Nasdaq standards, in that they require issuers of securities listed thereunder to be eligible for listing on the Nasdaq or the New York Stock Exchange (``NYSE'') or to be affiliates of companies that are so eligible, rather than being required to be actually so listed. This difference recognizes the fact that an issuer seeking to list a SEED or ``other security'' on the Exchange would not necessarily also have a security listed on Nasdaq or the NYSE, but it would nevertheless be required to demonstrate ability to meet such other listing standards before listing the SEED or ``other security.'' The proposed equity rules do not include the provisions of Nasdaq Rules 4426 and 4427, which establish standards for Nasdaq's Global Select Market tier.\114\ The Commission finds the Exchange's proposed initial and continued listing standards are consistent with the Act, including Section 6(b)(5), in that they are designed to protect investors and the public interest and to promote just and equitable principles of trade.\115\
\113\ See Equity Rules 4420 and 4450. The Exchange's proposed listing standards for units combine elements of the standards of the Nasdaq Capital Market and the Nasdaq Global Market, in that they require the equity component of a unit to satisfy standards equivalent to Nasdaq Capital Market standards but allow the inclusion of a debt component that is not itself eligible for listing but that meets the requirements of Equity Rule
4420(h)(1)(B).
\114\ The Equity Rule 4600 series is being reserved for the Exchange's listing fees, which will be included in a separate filing.
\115\ 15 U.S.C. 78f(b)(5). The Commission notes that the Exchange's initial and continued listing standards for primary and secondary classes of common stock, preferred stock, convertible debt, rights and warrants, shares or certificates of beneficial interest of trusts, foreign securities, ADRs and limited partnership interests are identical to the existing standards for the Nasdaq Capital Market, which the Commission pr

SUMMARY:

Boston Stock Exchange, Inc.,

DOCUMENT BODY 2:

December 23, 2008.

I. Introduction

On November 3, 2008, the Boston Stock Exchange (``BSE'' 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 19b4 thereunder,\2\ a proposed rule change to: (i) Adopt new rules governing membership, the regulatory obligations of members, listing, and equity trading (``Equity Rules''); (ii) amend its certificate of incorporation (``Certificate'') and bylaws (``Bylaws'') to reflect the proposed change in the name of the Exchange to NASDAQ OMX BX, Inc; (iii) amend and restate the Operating Agreement of BSX Group LLC (``Operating Agreement''), which will operate the Exchange's cash equities trading business, and which will be renamed NASDAQ OMX BX Equities LLC (``BX Equities LLC''); and (iv) to adopt a Delegation Agreement (``Delegation Agreement'') between the Exchange and BX Equities LLC (formerly, BSX Group LLC). The proposed rule change was published for comment in the Federal Register on November 19, 2008.\3\ On November 12, 2008, the Exchange filed Amendment No. 1 to the proposed rule change.\4\ On December 23, 2008, the Exchange filed Amendment No. 2 to the proposed rule change.\5\ Because Amendment Nos. 1 and 2 make technical modifications to the original rule proposal, the Commission is not publishing them for comment. The Commission received no comment letters regarding the proposed rule change. This order approves the proposed rule change, as modified by Amendment Nos. 1 and 2.
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b4.
\3\ See Securities Exchange Act Release No. 58927 (November 10, 2008), 73 FR 69685 (``Notice'').
\4\ Amendment No. 1 states that the Board of Directors of the Exchange and the Board of Directors of BSX Group LLC have completed all action required to be taken in connection with the proposed rule change.
\5\ Amendment No. 2 clarifies that: (1) Confidential information pertaining to the selfregulatory function of the Exchange or any market responsibility delegated by the Exchange to BX Equities LLC that comes into the possession of BX Equities LLC shall not be used for any nonregulatory purposes; and (2) the proposal to accept orders routed by Nasdaq Execution Services, LLC (``NES'') to the Exchange on a oneyear pilot basis is made by the Exchange, rather than by The NASDAQ Stock Market, LLC (``Nasdaq'').

On December 23, 2008, the Exchange requested that the Commission grant BX Equities LLC a permanent exemption from the requirement under Section 11A(b) of the Act, and Rule 609 thereunder, that a securities information processor (``SIP'') acting as an exclusive processor register with the Commission.\6\ This order grants the requested exemption.
\6\ See letter from John Zecca, Chief Regulatory Officer, Exchange, to Dr. Erik Sirri, Director, Division of Trading and Markets, Commission, dated December 23, 2008 (``SIP Exemption Request Letter''). See also 15 U.S.C. 78k1(b). Rule 609 under the Act, 17 CFR 242.609, requires that the registration of a securities information processor be on Form SIP, 17 CFR 249.1001.

II. Background

On August 7, 2008, the Commission approved, along with related proposals, a BSE proposed rule change relating to governing documents and certain rules of the Exchange to accommodate the acquisition of the Exchange by The NASDAQ OMX Group, Inc. (``NASDAQ OMX''), the parent corporation of Nasdaq.\7\ Among other things, the BSE Approval Order: (i) Amended and restated BSE's Certificate to reflect the Exchange's status as a wholly owned subsidiary of NASDAQ OMX; (ii) established new Bylaws that are similar to the bylaws of Nasdaq; (iii) amended the Operating Agreement of BSX Group LLC, the entity that operated the Exchange's cash equities trading business prior to the Exchange's acquisition by NASDAQ OMX; \8\ (iv) prohibited an Exchange member or its associated persons from beneficially owning more than 20% of the outstanding voting securities of NASDAQ OMX; and (v) limited the circumstances under which the Exchange may be affiliated with a member, and approved the affiliation
[[Page 80469]]
between the Exchange and certain brokerdealer subsidiaries of NASDAQ OMX that would become members of the Exchange.
\7\ See Securities Exchange Act Release No. 58324, 73 FR 46936 (August 12, 2008) (SRBSE200802; SRBSE200823; SRBSE200825;
SRBSECC200801) (``BSE Approval Order'').
\8\ BSX Group LLC was formed in 2004 as a joint venture between BSE and several investors to operate an electronic trading facility, the Boston Equities Exchange (``BeX''), for the trading of cash equity securities. BeX ceased its operations in September 2007. See Securities Exchange Act Release No. 57757 (May 1, 2008), 73 FR 26159.

On August 29, 2008, the Exchange was acquired by NASDAQ OMX. At the time of this acquisition, the Exchange was not operating a venue for trading cash equities. The Exchange is now proposing to adopt a new rulebook with rules governing membership, the regulatory obligations of members, listing, and equity trading. The proposed new Equity Rules are based to a substantial extent on the rules of Nasdaq. As is the case with Nasdaq, administration and enforcement of many of the rules will be supported by the Financial Industry Regulatory Authority, Inc. (``FINRA'') through a regulatory services agreement (``Regulatory Contract''). Other rules, such as listing rules, will be administered by personnel who will be dually employed by the Exchange and Nasdaq, or solely by the Exchange.

The Exchange's existing rules are divided between the rules currently denominated as the ``Rules of the Board of Governors'' and the ``Rules of the Boston Options Exchange Group LLC'' (``BOX Rules''). Certain of the Rules of the Board of Governors that are cross referenced in the BOX Rules (``Grandfathered Rules'') will continue to apply to trading on the Exchange's Boston Options Exchange facility (``BOX''). The Grandfathered Rules and the BOX Rules collectively constitute the ``Options Rules.'' The Options Rules, together with the new Equity Rules will constitute the ``Rules of the Exchange.'' Unless an Exchange member is also an ``Options Participant,'' however, it will be subject only to the Equity Rules.\9\
\9\ At present, a brokerdealer that is authorized for trading on BOX (an ``Options Participant'') is not required to become a member of the Exchange, but is nevertheless subject to the Options Rules as if it were a member. Under the revised Rules of the Exchange, this principle will continue to apply. Thus, the Equity Rules will apply to members, which will be authorized to engage in equity trading on the Exchange, and the Options Rules will apply to Options Participants, which will be authorized to engage in options trading. If a member opts to become an Options Participant (or vice versa), it will be subject to both sets of rules. Members must comply with the application requirements of the Option Rules in order to become Options Participants, and conversely, Options Participants must comply with the membership application procedures of the Equity Rules in order to become members and engage in equity trading. See Equity Rules 1013 and 1014; Chapter II of the BOX Rules.

III. Discussion and Commission Findings

After careful review of the rule proposal, the Commission finds that the rule proposal is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange.\10\ Specifically, the Commission finds that the proposed rule change is consistent with Section 6(b)(1) of the Act,\11\ 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 regulations thereunder, and Section 6(b)(2) of the Act,\12\ which requires that a national securities exchange have rules that provide that any registered broker or dealer or natural person associated with a registered broker or dealer may become a member, and any person may become associated with a member thereof. Further, the Commission finds that the rule proposal 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. In addition, the Commission finds that the proposed rule change is consistent with Section 6(b)(6) \14\ and Section 6(b)(7) of the Act,\15\ which require, in part, that the rules of an exchange provide a fair procedure for disciplining members and persons associated with members.
\10\ 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).
\11\ 15 U.S.C. 78f(b)(1).
\12\ 15 U.S.C. 78f(b)(2).
\13\ 15 U.S.C. 78f(b)(5).
\14\ 15 U.S.C. 78f(b)(6).

\15\ 15 U.S.C. 78f(b)(7).

Overall, the Commission believes that approving the Exchange's proposed rule change could confer important benefits on the public and market participants. Approval of the proposal would establish the Equity Rules for the operation of an electronic facility for the trading of cash equity securities.\16\ In particular, the entry into the marketplace of a new trading facility would provide market participants with an additional venue for executing orders in cash equity securities, which could enhance innovation and increase competition between and among the equities exchanges, resulting in better prices and executions for investors.
\16\ The Exchange previously operated an electronic trading facility, BeX, for the trading of cash equity securities. BeX ceased its operations in September 2007. See supra note 8.

The discussion below does not review every detail of the proposed rule change, but rather focuses on the most significant rules and policy issues considered in review of the proposals.

A. Corporate Structure

In the BSE Approval Order, the Commission approved a change in control of BSX Group LLC, the entity that operated BeX as a facility of BSE prior to the Exchange's acquisition by NASDAQ OMX. The Exchange now proposes to change the name of BSX Group LLC to BX Equities LLC and amend the Operating Agreement. The amended Operating Agreement would establish that BX Equities LLC will operate the NASDAQ OMX BX Equities Market (``BX Equities Market'') as a cash equities trading facility, as that term is defined in Section 3(a)(2) of the Act,\17\ of the Exchange. In addition, the Exchange and BX Equities LLC will enter into a Delegation Agreement, pursuant to which the Exchange will delegate to BX Equities LLC certain limited responsibilities and obligations with respect to the operation of the BX Equities Market as a facility of the Exchange.\18\
\17\ 15 U.S.C. 78(c)(2).
\18\ The form of the Delegation Agreement is available at the Commission's Web site http://www.sec.gov. 1. Ownership and Management of BX Equities LLC

The Operating Agreement will reflect that BX Equities LLC is a closely held subsidiary of the Exchange, whose only owners and members are the Exchange and the Exchange's parent corporation, NASDAQ OMX.\19\ Although NASDAQ OMX will maintain a 46.79% ownership interest in BX Equities LLC and the Exchange will maintain a 53.21% ownership interest, the Operating Agreement provides that management of BX Equities LLC will be vested solely in Exchange.\20\ The Exchange will be
[[Page 80470]]
designated as the sole manager of BX Equities LLC and will have the power to do any and all acts necessary, convenient or incidental to or for the furtherance of the purposes described in the Operating Agreement.\21\ As a result, the Exchange will have control over substantially all of the activities of BX Equities LLC.\22\ \19\ See Section 1.1, Operating Agreement.
\20\ In the Notice, the Exchange represented that NASDAQ OMX would remain a member of BX Equities LLC to avoid certain adverse tax consequences that would be associated with contributing its ownership interest to the Exchange. See Notice, supra note 3, 73 FR at 69691.
\21\ See Section 4.1, Operating Agreement.
\22\ NASDAQ OMX approval would be required for: (i) Converting loans made by a Member to BX Equities LLC into an increase in such Member's Capital Contribution; (ii) an election to dissolve BX Equities LLC; and (iii) any amendment to the Operating Agreement. See Sections 7.4, 11.1 and 18, respectively, Operating Agreement.

The Commission believes that the proposal to have the managerial powers vested solely in the Exchange is designed to preserve the Exchange's regulatory authority over BX Equities LLC, and any facility for the trading of cash equity securities that BX Equities LLC operates, and is consistent with the Act because these provisions will grant the Exchange the ability to direct BX Equities LLC to perform any required, necessary, or appropriate act. In particular, the Commission believes that the ownership and management provisions of the Operating Agreement are consistent with Section 6(b)(1) of the Act,\23\ 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 regulations thereunder, and the rules of the exchange.
\23\ 15 U.S.C. 78f(b)(1).

a. Transfers

The Commission notes that the amended Operating Agreement contains restrictions on the transfer of interests in BX Equities LLC that are designed to prevent any person from exercising undue control over the operation of the Exchange and to ensure that the Exchange and the Commission are able to carry out their regulatory obligations under the Act. Specifically, the amended Operating Agreement prohibits any person from transferring or assigning its interest in BX Equities LLC, unless such transfer is filed with and approved by the Commission.\24\ In addition, the Operating Agreement currently contains a provision that requires any amendment to be submitted to the Exchange's Board of Directors (``Board'') for review, and, if such amendment is required to be filed, or filed with and approved by, the Commission before such amendment may be effective, then the amendment will not be effective until filed with, or filed with and approved by, the Commission.\25\ \24\ See Section 8.1, Operating Agreement.

\25\ See Section 18.1, Operating Agreement.

The Operating Agreement no longer will require the Exchange to provide the Commission with written notice ten days prior to the closing date of any acquisition that results in a BX Equities LLC member's percentage ownership interest in BX Equities LLC, alone or with any affiliate, meeting or exceeding the 5%, 10%, or 15% thresholds. Nor will it provide that any transfer of BX Equities LLC interests that result in the acquisition and holding by any person, alone or together with an affiliate, of an interest that meets or crosses the 20% threshold or any successive 5% threshold (i.e., 25%, 30%, etc.) triggers the requirement to file an amendment with the Commission under Section 19(b) of the Act.\26\ Further, the Operating Agreement no longer will require that any person that acquires a controlling interest (i.e., an interest of 25% or greater) in a BX Equities LLC member that holds 20% or more of BX Equities LLC interests to become a party to the Operating Agreement.

\26\ 15 U.S.C. 78f(b).

Although proposed changes to provisions in the Operating Agreement on transfer eliminate some of the protections previously contained in the Operating Agreement, the Commission finds that because any transfer of BX Equities LLC interests must be filed with and approved by the Commission,\27\ the elimination of the current notice and ownership restrictions in the Operating Agreement would not adversely affect the ability of the Exchange to carry out its selfregulatory
responsibilities or the ability of the Commission to fulfill its responsibilities under the Act. The Commission finds that the proposed revisions to the Operating Agreement discussed above are consistent with the Act.
\27\ See id.

b. Confidentiality Provisions

The Operating Agreement provides that all confidential information pertaining to the selfregulatory function of the Exchange or the business of the Exchange related to the trading of U.S. equities (including disciplinary matters, trading data, trading practices and audit information) in the books and records of BX Equities LLC may not be made available to any persons.\28\ The rule proposal will allow such information to be made available to officers, employees and agents of BX Equities LLC who have a reasonable need to know the contents thereof. However, such confidential information shall be required to be retained in confidence by BX Equities LLC and its officers, employees and agents and shall not be used for any nonregulatory purposes.\29\ The Commission believes that the revised confidentiality provisions would not impair the Exchange's selfregulatory obligations with respect to BX Equities LLC and finds that this provision is consistent with the Act.
\28\ See Article 16, Operating Agreement. The Exchange also proposes that the provision would not be interpreted to limit or impede the ability of any officers, directors, employees or agents of BX Equities LLC to disclose confidential information to the Commission or the Exchange.
\29\ See id.
2. Status of the BX Equities Market as a Facility of BX and Delegation of Authority to BX Equities LLC

As a facility of the Exchange, the BX Equities Market will be subject to the Commission's oversight and examination. Consequently, the Commission will have the same authority to oversee the premises, personnel, and records of BX Equities LLC as it currently has with respect to the Exchange. In addition, the Exchange will be fully responsible for all activity that takes place through the BX Equities Market, and BX Equities Market participants will be subject to the Exchange's rules applicable to the BX Equities Market and to Exchange oversight.

As described in detail in the Notice, the Delegation Agreement provides that the Exchange will delegate to BX Equities LLC performance of certain limited responsibilities and obligations of the Exchange with respect to the operation of the BX Equities Market as a cash equities trading facility.\30\ The Exchange, however, expressly retains ultimate responsibility for the fulfillment of its statutory and self regulatory obligations under the Act. Accordingly, as described more fully below, the Exchange will retain ultimate responsibility for such delegated responsibilities and functions, and any actions taken pursuant to delegated authority will remain subject to review, approval or rejections by the Exchange's Board in accordance with procedures established by the Board. The Delegation Agreement will be a part of the Exchange's rules.
\30\ See Notice, supra note 3, 73 FR at 69691.

[[Page 80471]]

Pursuant to the Delegation Agreement, the Exchange expressly will retain the authority to: (1) Delegate authority to BX Equities LLC to take actions on behalf of the Exchange; and (2) direct BX Equities LLC to take action necessary to effectuate the purposes and functions of the Exchange, consistent with the independence of the Exchange's regulatory functions, exchange rules, policies and procedures, and the federal securities laws.\31\ BX Equities LLC will have delegated authority to, among other things, operate the BX Equities Market, and establish and assess access fees, transaction fees, market data fees and other fees for the products and services offered by BX Equities LLC.\32\ In addition, BX Equities LLC will have the authority to act as a SIP for quotations and transaction information related to securities traded on the BX Equities Market and any trading facilities operated by BX Equities LLC.\33\
\31\ See Notice, supra note 3, 73 FR at 69694 and Delegation Agreement, Section I.
\32\ See Notice, supra note 3, 73 FR at 69694 and Delegation Agreement, Section II.A.

\33\ See Delegation Agreement, Section II.A.3.

BX Equities LLC will also have authority to develop, adopt, and administer rules governing participation in the BX Equities Market,\34\ but the Exchange represents that it will have ultimate responsibility for the operations, rules and regulations developed by BX Equities LLC, as well as their enforcement.\35\ Further, the Exchange represents that actions taken by BX Equities LLC pursuant to its delegated authority will remain subject to review, approval or rejection by the Exchange's Board.\36\ In addition, BX Equities LLC will be responsible for referring to the Exchange any complaints of a regulatory nature involving potential rule violations by member organizations or employees,\37\ and the Exchange will retain overall responsibility for ensuring that the statutory and selfregulatory functions of the Exchange are fulfilled.\38\
\34\ See Delegation Agreement, Section II.A.7.
\35\ See Notice, supra note 3, 73 FR at 69694.
\36\ See id.
\37\ See Delegation Agreement, Section II.A.8.

\38\ See Delegation Agreement, Section I.1.

The Commission finds that it is consistent with the Act for the Exchange to delegate the operation of the BX Equities Market to BX Equities LLC, while retaining ultimate responsibility for statutory and selfregulatory obligations and ensuring that BX Equities Market business is conducted in a manner consistent with the requirements of the Act.

B. Proposed Equity Rules

The proposed new Equity Rules are based to a substantial extent on the rules of Nasdaq.\39\ In the Notice, the Exchange highlighted the differences between the proposed new Equity Rules and Nasdaq rules. \39\ See Notice, supra note 3, 73 FR at 69686. The Equity Rules also have the same rule numbers as the corresponding Nasdaq rules. 1. Membership, Registration and Qualifications

The Exchange proposes that the criteria for membership in the Exchange be substantially the same as the criteria currently applicable to firms applying for membership in Nasdaq. As indicated in the Notice, the Equity Rules 1000 series governs membership, registration and qualification and is substantively identical to the corresponding rules for Nasdaq, with a few exceptions to account for the BX Equities Market's structure.\40\

\40\ See Notice, supra note 3, 73 FR at 69686.

Like Nasdaq rules, the Equity Rules will require a brokerdealer to be a member at all times of at least one other selfregulatory organization (``SRO'') before applying for membership in the Exchange.\41\ The Equity Rules provide that a registered brokerdealer that was a member organization in good standing of the Exchange on the date immediately prior to the acquisition of the Exchange by NASDAQ OMX is eligible for continued membership if it continues to satisfy the membership requirements of the Equity Rule 1000 Series.\42\ Continuing members are required to sign a revised membership agreement and maintain registrations of their associated persons, as required under the Equity Rules.\43\ Associated persons already registered with the Exchange likewise will be eligible for continued registration if they satisfy the requirements under the Equity Rules.\44\ Unlike members in the Exchange prior to the Exchange's acquisition by NASDAQ OMX, members under the Equity Rules do not possess an ownership interest in the Exchange.
\41\ See Equity Rules 1002 and 1014(a)(3).
\42\ See Equity Rule 1002(f).
\43\ Id.

\44\ Id.

Several registration requirements and categories set forth in Nasdaq rules are not carried over to the BX Equities Market. Equity Rules 1022 and 1032 provide only for principal registration and representative registration categories, as these are the only types of preexisting BSE membership categories that will be relevant to the future operation and market structure of the Exchange.\45\ In addition, because the Equity Rules are modeled on Nasdaq and FINRA rules, approved Nasdaq and FINRA members and their associated persons may apply for membership and registration in a category of registration recognized by the Exchange through an expedited process by submitting a Short Form Membership Application and Agreement.\46\
\45\ See Equity Rules 1022 and 1032.
\46\ See Equity Rule 1013(a)(5)(C). The Exchange represents that the requirements for maintaining membership in the Exchange, including compliance with Exchange and Commission rules and submission to examinations, are the same for all members, regardless of the means by which they became members. Moreover, both waivein members and continuing members are subject to review by FINRA to determine if any information available to FINRA about the member would present concerns regarding the member's standing under FINRA rules. If any such information were presented by FINRA, the Exchange would evaluate it in determining appropriate steps to take with regard to the member. See email from John Yetter, Vice President and Deputy General Counsel, NASDAQ OMX, to Heidi Pilpel, Attorney Advisor, Division of Trading and Markets, Commission, on December 23, 2008.

The Commission finds that the membership rules contained in the Equity Rules are consistent with Section 6 of the Act,\47\ specifically Section 6(b)(2) of the Act,\48\ which requires that a national securities exchange have rules that provide that any registered broker or dealer or natural person associated with a registered broker or dealer may become a member and any person may become associated with a member thereof. The Commission notes that pursuant to Section 6(c) of the Act,\49\ an exchange must deny membership to nonregistered broker dealers and registered brokerdealers that do not satisfy certain standards, such as financial responsibility or operational capacity. In addition, the Commission notes that the membership, registration and qualifications, and access requirements are substantially similar to rules of Nasdaq previously approved by the Commission.\50\ The Commission further notes that, as a registered exchange, the Exchange must continue to determine independently if an applicant satisfies the standards set forth in the Act, regardless of whether an applicant is a member of another SRO.
\47\ 15 U.S.C. 78f(b).
\48\ 15 U.S.C. 78f(b)(2).
\49\ 15 U.S.C. 78f(c).
\50\ See Securities Exchange Act Release No. 53128 (January 13, 2006), 71 FR 3550 (January 23, 2006) (order approving Nasdaq's application to register as a national securities exchange) (``Nasdaq Registration Approval Order'').

2. Participation and Access

The rules governing access to and participation on the BX Equities Market
[[Page 80472]]
also are substantively identical to the corresponding rules of Nasdaq.\51\ BX Equities Market participants may include Equities Market Makers, Equities ECNs and Order Entry Firms.\52\ The Exchange also will provide authorized access for Sponsored Participants.\53\ However, only Equities Market Makers, or participants acting in a market making capacity, will be permitted to submit quotes.\54\ In addition, like Nasdaq market makers, Equities Market Makers will be obligated to submit firm, continuous, twosided quotations, with a minimum quotation increment of $0.01.\55\
\51\ See, e.g., Equity Rules 4610 et seq.
\52\ See Equity Rule 4611.
\53\ See Securities Exchange Act Release Nos. 55061 (January 8, 2007), 72 FR 2052 (January 17, 2007) (notice of filing and immediate effectiveness of File No. SRNasdaq2006061) (adopting Nasdaq Rule 4611(d)); and 55550 (March 28, 2007), 72 FR 12 16389 (April 4, 2007) (notice of filing and immediate effectiveness of File No. SRNasdaq 2007010) (revising Nasdaq Rule 4211(d)).
\54\ See Equity Rule 4612.

\55\ See Equity Rule 4613.

The Commission notes that the access and participation requirements in the Equity Rules are substantially similar to Nasdaq's access and participation requirements, and, accordingly, finds that they are consistent with the Act. In particular, the BX Equities Market system (``System'') is designed to match buying and selling interest of all Exchange participants. In addition, the Commission believes that the access and participation rules should help to ensure that Equities Market Makers perform their obligations in a manner that promotes just and equitable principles of trade.
3. BX Trading System and Regulation NMS Compliance

a. BX Trading System

The Exchange's System for trading cash equity securities will operate using technology and rules similar to Nasdaq. Accordingly, the BX Equities Market will feature an electronic central limit order book, with executions occurring in price/time priority (but with displayed orders receiving priority over nondisplayed orders).\56\ While the BX Equities Market and Nasdaq will operate similarly in most aspects, there will be certain differences between the two markets. In particular:
\56\ See Notice, supra note 3, 73 FR at 69688.

\67\ See id.

The Commission finds that the Exchange's execution priority rules and trading rules 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.\68\ 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. The Exchange market model for the trading of cash equity securities is similar to Nasdaq's equity market model and does not raise novel issues.
\68\ 15 U.S.C. 78f(b)(5).

b. Regulation NMS

The Exchange has designed its rules relating to orders, modifiers, and order execution to comply with requirements of Regulation NMS. Unlike Nasdaq, the Exchange will not route orders in equity securities to other market centers. The Equity Rules are consistent with Regulation NMS \69\ by requiring that all orders be processed in a manner that avoids trading through protected quotations and avoids locked and crossed markets.\70\ Specifically, Equity Rule 4755 provides that in addition to such other designations as may be chosen by a market participant,\71\ all orders that are not entered with a time in force of ``System Hours Immediate or Cancel'' \72\ must be designated as an
[[Page 80473]]
Intermarket Sweep Order, a Pegged Order, a Price to Comply Order, or a Price to Comply Post Order.\73\
\69\ 17 CFR 242.611.
\70\ See Equity Rule 4755(b).
\71\ As is the case with Nasdaq, different order designations can be combined. Thus, for example, a Price to Comply Order could be entered with reserve size or as a nondisplayed order.
\72\ A ``System Hours Immediate or Cancel'' order is an immediate or cancel order that may be entered between 8 a.m. and 7 p.m. Eastern Time, the hours of operation of the BX Equities Market. If a System Hours Immediate or Cancel order (or a portion thereof) is not marketable, the order (or unexecuted portion thereof) is canceled and returned to the entering participant. See Equity Rule 4751(h)(1).

\73\ See Equity Rule 4755(a)(2).

As described in the Notice, a System Hours Immediate or Cancel Order is compliant with Regulation NMS because by its terms it would not execute or post at a price that would result in a tradethrough of a protected quotation or lock or cross another market.\74\ A Pegged Order similarly is compliant with Regulation NMS because it continually reprices to avoid locking or crossing.\75\
\74\ See Notice, supra note 3, 73 FR at 69688; Equity Rule 4751(h)(1).

\75\ See Equity Rule 4751(f).

The Equity Rules also permit BX Equities Market participants to submit Intermarket Sweep Orders to comply with Regulation NMS, which will allow orders so designated to be automatically matched and executed within the System.\76\ As described in the Notice, when a market participant enters an Intermarket Sweep Order it is representing that it is also simultaneously routing one or more additional limit orders (also marked as Intermarket Sweep Orders), as necessary, to execute against the full displayed size of any protected bid or offer (as defined in Rule 600(b) of Regulation NMS) in the case of a limit order to sell or buy with a price that is superior to the limit price of the order identified as an Intermarket Sweep Order.\77\
\76\ See Equity Rules 4751(f)(6) and 4757.
\77\ The Exchange represented that members will be responsible for ensuring that their use of Intermarket Sweep Orders complies with Regulation NMS, and the Exchange's T+1 surveillance program will monitor members' use of Intermarket Sweep Orders. See Notice, supra note 3, 73 FR at 69688.

Both a Price to Comply and a Price Comply Post Order are designed to comply with the Regulation NMS.\78\ Specifically, if at the time of entry, a Price to Comply Order will lock or cross the quotation of an external market, the order will be priced to the current low offer (for bids) or to the current best bid (for offers) but displayed at a price one minimum price increment lower than the offer (for bids) or higher than the bid (for offers).\79\ Thus, an incoming order priced to execute against the displayed price will receive the superior undisplayed price.\80\ If, at the time of entry, a Price to Comply Post Order will lock or cross the protected quote of an external market or will cause a violation of Rule 611 of Regulation NMS, the order will be repriced and displayed to one minimum price increment (i.e., $0.01 or $0.0001) below the current low offer (for bids) or to one penny above the current best bid (for offers).\81\
\78\ See Notice, supra note 3, 73 FR at 6968869689.
\79\ See Rule 4751(f)(7).
\80\ For example, if the national best bid and best offer is $9.97 x $10.00, and a participant enters a Price to Comply Order to buy 10,000 shares at $10.01, the order will display at $9.99, but will reside on the System book at $10.00. If a seller then enters an order at $9.99, it will execute at $10.00, up to the full 10,000 shares of the order. The displayed and undisplayed prices of a Price to Comply Order may be adjusted once or multiple times depending upon the method of order entry and changes to the prevailing national best bid/best offer.
\81\ See Equity Rule 4751(f)(8). For example, if the national best bid and best offer is $9.97 x $10.00, and a participant enters a Price to Comply Post Order to buy at $10.01, the order will be repriced and displayed at $9.99. If a seller enters an order at $9.99, it will execute at that price.

The Commission believes that by requiring all orders to be entered with one of the designations described above, all Exchange orders should either be priced or cancelled in a manner consistent with the avoidance of tradethroughs and locked and crossed markets. The Commission also notes that, because the Exchange will not route orders to other market centers, the Exchange's Regulation NMS policies and procedures under Rule 611(a) will rely on information provided by Nasdaq for purposes of determining whether another trading center is experiencing a failure, material delay, or malfunction of its systems or equipment within the meaning of Rule 611(b)(1).

The Commission finds that the rules relating to orders, modifiers, and order execution that are designed to comply with Regulation NMS 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.

4. Section 11 of the Act

Section 11(a)(1) of the Act \82\ prohibits a member of a national securities exchange from effecting transactions on that exchange for its own account, the account of an associated person, or an account over which it or its associated person exercises discretion (collectively, ``covered accounts''), unless an exception applies. Rule 11a22(T) under the Act,\83\ known as the ``effect versus execute'' rule, provides exchange members with an exemption from the Section 11(a)(1) prohibition. Rule 11a22(T) permits an exchange member, subject to certain conditions, to effect transactions for covered accounts by arranging for an unaffiliated member to execute the transactions on the exchange. To comply with Rule 11a22(T)'s conditions, a member: (i) Must transmit the order from off the exchange floor; (ii) may not participate in the execution of the transaction once it has been transmitted to the member performing the execution; \84\ (iii) may not be affiliated with the executing member; and (iv) with respect to an account over which the member has investment discretion, neither the member nor its associated person may retain any compensation in connection with effecting the transaction except as provided in the Rule.
\82\ 15 U.S.C. 78k(a)(1).
\83\ 17 CFR 240.11a22(T).
\84\ The member may, however, participate in clearing and settling the transaction.

In a letter to the Commission,\85\ the Exchange requested that the Commission concur with its conclusion that Exchange members that enter orders into the System satisfy the requirements of Rule 11a22(T). For the reasons set forth below, the Commission believes that Exchange members entering orders into the System would satisfy the conditions of the Rule.
\85\ See letter from John Zecca, Chief Regulatory Officer, Exchange, to Florence Harmon, Acting Secretary, Commission, dated December 23, 2008 (``BSE 11(a) Request Letter'').

The Rule's first condition is that orders for covered accounts be transmitted from off the exchange floor. The System receives orders electronically through remote terminals or computertocomputer interfaces. In the context of other automated trading systems, the Commission has found that the offfloor transmission requirement is met if a covered account order is transmitted from a remote location directly to an exchange's floor by electronic means.\86\ Since the System
[[Page 80474]]
receives orders electronically through remote terminals or computerto computer interfaces, the Commission believes that the System satisfies the offfloor transmission requirement.
\86\ See, e.g., Nasdaq Registration Approval Order, supra note 50 Securities Exchange Act Release Nos. 49068 (January 13, 2004), 69 FR 2775 (January 20, 2004) (order approving the Boston Options Exchange as an options trading facility of the Boston Stock Exchange); 44983 (October 25, 2001), 66 FR 55225 (November 1, 2001) (order approving Archipelago Exchange as electronic trading facility of the Pacific Exchange (``PCX'')); 29237 (May 24, 1991), 56 FR 24853 (May 31, 1991) (regarding NYSE's OffHours Trading Facility); 15533 (January 29, 1979), 44 FR 6084 (January 31, 1979) (regarding the American Stock Exchange (``Amex'') Post Execution Reporting System, the Amex Switching System, the Intermarket Trading System, the Multiple Dealer Trading Facility of the Cincinnati Stock Exchange, the PCX Communications and Execution System, and the Philadelphia Stock Exchange (``Phlx'') Automated Communications and Execution System (``1979 Release'')); and 14563 (March 14, 1978), 43 FR 11542 (March 17, 1978) (regarding the NYSE's Designated Order Turnaround System (``1978 Release'')).

Second, the rule requires that the member not participate in the execution of its order. The Exchange represented that at no time following the submission of an order is a member able to acquire control or influence over the result or timing of an order's execution.\87\ According to the Exchange, the execution of a member's order is determined solely by what orders, bids, or offers are present in the System at the time the member submits the order and on the priority of those orders, bids and offers. Accordingly, the Commission believes that an Exchange member does not participate in the execution of an order submitted into the System.
\87\ See BSE 11(a) Request Letter, supra note 85. The member may only cancel or modify the order, or modify the instructions for executing the order, but only from off the Exchange floor. The Commission has stated that the nonparticipation requirement is satisfied under such circumstances so long as such modifications or cancellations are also transmitted from off the floor. See Securities Exchange Act Release No. 14563 (March 14, 1978), 43 FR 11542 (March 17, 1978) (stating that the ``nonparticipation requirement does not prevent initiating members from canceling or modifying orders (or the instructions pursuant to which the initiating member wishes orders to be executed) after the orders have been transmitted to the executing member, provided that any such instructions are also transmitted from off the floor'').

Third, Rule 11a22(T) requires that the order be executed by an exchange member who is unaffiliated with the member initiating the order. The Commission has stated that the requirement is satisfied when automated exchange facilities, such as the System, are used, as long as the design of these systems ensures that members do not possess any special or unique trading advantages in handling their orders after transmitting them to the Exchange.\88\ The Exchange has represented that the design of the System ensures that no member has any special or unique trading advantage in the handling of its orders after transmitting its orders to the Exchange.\89\ Based on the Exchange's representation, the Commission believes that the System satisfies this requirement.
\88\ In considering the operation of automated execution systems operated by an exchange, the Commission noted that while there is no independent executing exchange member, the execution of an order is automatic once it has been transmitted into the systems. Because the design of these systems ensures that members do not possess any special or unique trading advantages in handling their orders after transmitting them to the exchange, the Commission has stated that executions obtained through these systems satisfy the independent execution requirement of Rule 11a22(T). See 1979 Release, supra note 86.

\89\ See BSE 11(a) Request Letter, supra note 85.

Fourth, in the case of a transaction effected for an account with respect to which the initiating member or an associated person thereof exercises investment discretion, neither the initiating member nor any associated person thereof may retain any compensation in connection with effecting the transaction, unless the person authorized to transact business for the account has expressly provided otherwise by written contract referring to Section 11(a) of the Act and Rule 11a2 2(T).\90\ The Exchange represented that Exchange members trading for covered accounts over which they exercise investment discretion must comply with this condition in order to rely on the rule's
exemption.\91\
\90\ 17 CFR 240.11a22(T)(a)(2)(iv). In addition, Rule 11a2 2(T)(d) requires a member or associated person authorized by written contract to retain compensation, in connection with effecting transactions for covered accounts over which such member or associated person thereof exercises investment discretion, to furnish at least annually to the person authorized to transact business for the account a statement setting forth the total amount of compensation retained by the member in connection with effecting transactions for the account during the period covered by the statement. See 17 CFR 240.11a22(T)(d). See also 1978 Release, supra note 86 (stating ``[t]he contractual and disclosure requirements are designed to assure that accounts electing to permit transaction related compensation do so only after deciding that such
arrangements are suitable to their interests'').
\91\ See BSE 11(a) Request Letter, supra note 85.
C. Exception to Limitation on Affiliation Between BX and its Members

Although the Exchange will not route orders to other market centers, it proposes to receive orders routed to it by other market centers, including orders routed from Nasdaq.\92\ BSE Rule Chapter XXXIX, Section 2 prohibits BSE members from being affiliated with BSE.\93\ Proposed Equity Rule 2140(a) is identical to BSE Rule Chapter XXXIX, Section 2, and prohibits the Exchange or any entity with which it is affiliated, from acquiring or maintaining an ownership interest in a member without prior Commission approval.
\92\ See Notice, supra note 3, 73 FR at 69689.
\93\ See BSE Approval Order, supra note 7, 73 FR at 4694349644. The Exchange proposed, and the Commission approved, that the affiliation also be subject to the following conditions and limitations: (1) NES is operated as a facility of Nasdaq; (2) for purposes of Commission Rule 17d1 under the Act, 17 CFR 240.17d1, the designated examining authority of NES is a selfregulatory organization unaffiliated with Nasdaq; and (3) use of NES to route orders to other market centers is optional. Id.

NES is a brokerdealer that is a member of the Exchange, and currently provides to Nasdaq members optional routing services to other market centers. NES is owned by NASDAQ OMX, which also owns three registered securities exchangesNasdaq, the Exchange, and Phlx.\94\ Thus, NES is an affiliate of each of these exchanges. Absent Commission approval, Equity Rule 2140(a) would prohibit NES from being a member of the Exchange.
\94\ See BSE Approval Order, supra note 7, 73 FR at 46943. 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.)

In connection with NASDAQ OMX's acquisition of the Exchange, the Commission approved the current 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.\95\ At the time of NASDAQ OMX's acquisition of the Exchange, the Exchange was not trading equity securities.\96\ Now, in connection with the Exchange's resumption of equity trading pursuant to the instant proposed rule change, the Exchange proposes to modify the conditions for the affiliation between NES and the Exchange, previously approved by the Commission, to permit the Exchange to receive orders routed by NES in its capacity as a facility of Nasdaq (including ``Directed Orders''),\97\ on a oneyear pilot basis.\98\
\95\ BSE Rule Chapter XXXIX, Section 2 was adopted in the BSE Approval Order (see supra note 7, 73 FR at 46944), and is proposed to be replaced by Equity Rule 2140(a).
\96\ See BSE Approval Order, supra note 7, 73 FR at 49644, n.117.
\97\ Nasdaq Rule 4751(f)(9) defines Directed Orders as immediateorcancel orders that are directed to an exchange other than Nasdaq without checking the Nasdaq book. Pursuant to Nasdaq Rule 4751(f)(9), Nasdaq currently may not route Directed Orders to a facility of an exchange that is an affiliate of Nasdaq.

\98\ See Notice, supra note 3, 73 FR at 69689.

NES operates as a facility of Nasdaq that provides outbound routing from Nasdaq to other market centers, subject to certain conditions.\99\ 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
[[Page 80475]]
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. Currently, NES may not route Directed Orders to a facility of an exchange that is an affiliate of Nasdaq.\100\ Nasdaq has proposed, and the Commission approved today, a rule change to permit NES to route all forms of orders, including Directed Orders, to the BX Equities Market.\101\
\99\ See Nasdaq Rules 4751 and 4758. See also Notice, supra note 3, 73 FR at 69689.
\100\ Id. See also supra note 7.
\101\ See Securities Exchange Act Release No. 59154 (December 23, 2008) (SRNasdaq2008091).

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 \102\ 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 now proposes to revise the conditions to 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:
\102\ See BSE Approval Order, supra note 7, 73 FR at 49644.

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.\109\ Although the Commission continues to be concerned about potential unfair competition and conflicts of interest between an exchange's selfregulatory 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 pilot basis, subject to the conditions described above.
\109\ See, e.g., Securities Exchange Act Release Nos. 54170 (July 18, 2006), 71 FR 42149 (July 25, 2006) (SRNASDAQ2006006) (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) (SRNYSE200577) (order approving the combination of the New York Stock Exchange, Inc. and Archipelago Holdings, Inc.); and 58673 (September 29, 2008), 73 FR 57707 (October 8, 2008) (SRAmex200862) (order approving the combination of NYSE Euronext and the American Stock Exchange LLC).

The Exchange has proposed five 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,\110\ 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 the proposed addition of 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. Furthermore, the Commission believes that the Exchange's proposal to allow NES to route orders inbound to the Exchange from Nasdaq, on a pilot basis, will provide the Exchange and the Commission an opportunity to assess the impact of any conflicts of interest of allowing an affiliated member of the Exchange to route orders inbound to the Exchange and whether such affiliation provides an unfair competitive advantage.
\110\ This oversight will be accomplished through the 17d2 Agreement between FINRA and the Exchange and the Regulatory Contract.

D. Securities Traded on the Exchange

The Equity Rule 4000 series includes the rules governing listing and trading of cash equity securities on the Exchange. The Exchange proposes to adopt initial and continued listing standards for primary and secondary classes of common stock, preferred stock, convertible debt, rights and warrants, shares or certificates of beneficial interest of trusts, foreign securities, American Depositary [[Page 80476]]
Receipts (``ADRs''), and limited partnership interests that are identical to Nasdaq's listing standards for the Nasdaq Capital Market, Nasdaq's most permissive listing standards.\111\ The standards for initial and continued listing of these securities are set forth in the proposed Equity Rule 4300 Series.\112\
\111\ Nasdaq has three progressively higher listing tiersthe Nasdaq Capital Market, the Nasdaq Global Market, and the Nasdaq Global Select Market. Securities listed on the Nasdaq Capital Market are ``covered securities'' for purposes of Section 18 of the Securities Act of 1933, 15 U.S.C. 77r (``Securities Act''), and are therefore exempt from state law registration requirements. See Securities Act Release No. 8791 (April 18, 2007), 72 FR 20410 (April 24, 2008) (File No. S71806). In the Notice, the Exchange stated that it anticipates petitioning the Commission to amend Rule 146 under the Securities Act to recognize securities listed on the Exchange as covered securities. See Notice, supra note 3, 73 FR at 69688.

\112\ See Equity Rules 4310 and 4320.

In addition, the Exchange proposes to adopt, in Equity Rules 4420 and 4450, initial and continued listing standards for Selected Equity linked Debt Securities (``SEEDS''), units, index warrants, portfolio depository receipts, index fund shares, trust issued receipts, linked securities, managed fund shares, and ``other securities'' that would be substantively identical to those of the Nasdaq Global Market.\113\ The listing standards for SEEDS and ``other securities'' would differ slightly from the comparable Nasdaq standards, in that they require issuers of securities listed thereunder to be eligible for listing on the Nasdaq or the New York Stock Exchange (``NYSE'') or to be affiliates of companies that are so eligible, rather than being required to be actually so listed. This difference recognizes the fact that an issuer seeking to list a SEED or ``other security'' on the Exchange would not necessarily also have a security listed on Nasdaq or the NYSE, but it would nevertheless be required to demonstrate ability to meet such other listing standards before listing the SEED or ``other security.'' The proposed equity rules do not include the provisions of Nasdaq Rules 4426 and 4427, which establish standards for Nasdaq's Global Select Market tier.\114\ The Commission finds the Exchange's proposed initial and continued listing standards are consistent with the Act, including Section 6(b)(5), in that they are designed to protect investors and the public interest and to promote just and equitable principles of trade.\115\
\113\ See Equity Rules 4420 and 4450. The Exchange's proposed listing standards for units combine elements of the standards of the Nasdaq Capital Market and the Nasdaq Global Market, in that they require the equity component of a unit to satisfy standards equivalent to Nasdaq Capital Market standards but allow the inclusion of a debt component that is not itself eligible for listing but that meets the requirements of Equity Rule
4420(h)(1)(B).
\114\ The Equity Rule 4600 series is being reserved for the Exchange's listing fees, which will be included in a separate filing.
\115\ 15 U.S.C. 78f(b)(5). The Commission notes that the Exchange's initial and continued listing standards for primary and secondary classes of common stock, preferred stock, convertible debt, rights and warrants, shares or certificates of beneficial interest of trusts, foreign securities, ADRs and limited partnership interests are identical to the existing standards for the Nasdaq Capital Market, which the Commission pr