SEC Division of Trading and Markets no-action letter: Boston Stock Exchange

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

DIVISION OF
TRADING AND MARKETS
December 23,2008
Mr. John Zecca
Chief Regulatory Officer
Boston Stock Exchange, Incorporated
9600 Blackwell Road
Rockville, MD 20850
Dear Mr. Zecca:
Based on the facts and representations set forth in your letter dated December 23,2008, we find that it is appropriate in the public interest, and consistent with the protection of investors to grant, and hereby grant, to ~embers' that execute trades for their customers on the Exchange using the NASDAQ OMX BX Equities System, a limited exemption pursuant to Rule lob-10(f) under the Act from the requirement in Rule lob- 1 O(a)(2)(i)(A) to disclose to their customers the name of the person from whom a security was purchased, or to whom it was sold, or the fact that such information will be provided upon the customer's written request. This exemption is limited to trades that Members execute on the Exchange using the post trade anonymity feature described in your letter. * In granting this exemption, we note in particular, your representation that all orders submitted to the System will automatically match against each other in strict price￾time priority. You also request assurance that the Staff will not recommend enforcement action to the Commission under paragraph (a) of Rule lob-1 0 under the Act if a Member confirms its capacity as "agent" when the Member submits a customer's order to the Exchange, in its role as the customer's agent, and the order is executed on the Exchange in a trade with an anonymous contra-party that hulls out to be the Member trading in a principal (including proprietary) capacity. Your request is limited to those situations in which both: (1) the No Knowledge Requirement; and (2) the Parity Requirement are satisfied. 1 Unless otherwise noted, each defined term in this letter has the same meaning as defined, directly or by reference, in your letter. 2 In this respect, we note your representation that the System will not route orders to other markets centers and that all orders will be processed by the System in a manner that avoids trading through protected quotations and avoids locked and crossed markets.

Mr. John Zecca
December 23,2008
Based on the facts and representations set forth in your letter, the Staff will not recommend enforcement action to the Commission under paragraph (a) of Rule lob-1 0 if a Member indicates on confirmations to its customers that the Member acted as agent on a customer's behalf when a representative of the Member submits a customer order to the Exchange on an agency basis and that order is executed on the Exchange in a trade with an anonymous contra-party that turns out to be the Member trading in a principal (including proprietary) capacity, provided that the Member complies with all other requirements of Rule lob-10 in confirming the customer's order, including paragraph (a)(2)(i) thereof, and provided that the handling and execution of the customer order complies with the No Knowledge and Parity ~e~uirements.~ In taking this position, we note in particular your representation regarding your expectation that Same Firm Volume, as a percentage of Total Volume, will not be material for either high or low trading volume ~ecurities.~ We also note that Members continue to have a duty of best exe~ution.~ The Office of Financial Responsibility has instructed us to inform you that the Staff will not recommend enforcement action to the Commission if, in lieu of making and preserving a separate record, Members rely on the Exchange's retention of the identities of the Members that execute anonymous trades on the Exchange, for the period specified Rule 17a-4(a), to satisfy the requirements of Rules 17a-3(a)(l) and 17a-4(a) under the Act. The Staff notes, however, that a Member has the responsibility to make, keep current, and preserve records of all purchases and sales of securities in accordance with Rules 17a-3 and 17a-4 of the Act for trades on the Exchange if the Member knows the identity of the contra-party. These exemptive and no-action positions are subject to modification or revocation if at any time the Commission or Staff determines that such action is necessary or appropriate in furtherance of the purposes of the Act. In addition, these positions are based solely upon the representations you have made and are limited strictly to the facts and conditions described in your incoming letter. Any different facts or circumstances, including any change to the 3 This Staff position applies only to trades that Members execute on the Exchange's System. 4 In this regard, we note your representation that, one year after the Trading System becomes fully operational, you will review trade data to determine the actual percentage of same firm volume versus total volume in high and low volume securities to confirm that this number is not material, and that you will create and maintain a record of your determination. 5 See, e.g., Regulation NMS, Exchange Act Rel. No. 49325 (February 26,2004), 69 Fed. Reg. 11 126, 1 1137 (March 9,2004) ("A broker-dealer still must seek the most advantageous terms reasonably available under the circumstances for all customer orders. A
broker-dealer must cany out a regular and rigorous review of the quality of market centers to evaluate its best execution policies, including the determination as to which markets it routes customer order flow.").

Mr. John Zecca
December 23,2008 operation of the Exchange, may require a different response.6 Finally, we express no view with respect to other questions the proposed activities of the Exchange or any Members relying on this relief may raise, including the applicability of any other federal or state laws or the applicability of self-regulatory organization rules concerning customer account statements or confirmations. For the Commission,

by the Division of Trading and Markets,

pursuant to delegated authority,7

Paula Jenson

Deputy Chief Counsel

6 In this regard, we note your representation that the Exchange's Equity Rules do not provide for any special order types that would be an exception to the strict price-time priority handling of orders as set forth in proposed Rule 4757 of the Exchange. ' 17 CFR 5 200.30-3(a)(32).

Mr. James L.Eastrnan
Associate Director and Chief C'ounscl
Division of Trading and Markets
Securities and Exchange Comanissit,n
I00 F Street, N.E.
Washington, DC 20519-000i
Re: Request for a LititedExemption fi-orn Paragraph (a)(2)(i)(A) of Rule 10b-10 Under the Sccuntiei; E~changc:.let of 1934 (the '"xchange Act") and Request for No-Action Reircf frol;? R~lcslOb - 1O(a~(2).I 7a-3ja)(l), and 17a-4(a) Under the Exchange Act Dear Mr. Eastman:
Boston Stock Exchange. Izicayorated (rhc "'~xclaate")' respectfully requests a limited exemption i'som ;xu-agsup~l(~)(."litil:(.:, j ,;;':i~.';i ;;;:-:-10' ;~ilCIt.y~ the Sc'curities Exchange Act of ' 1 1934 (the "Act") on behalf ~i'i~~~in;~c;.~ oi tlli. i:i~li..tngcthat execute trades on the Exchange's system for trading cash c.qilit:e.<;i,s !I.$,:! . ~*iqIt.*r+t,i-+, {"91i:mbers"). On November 3, 2008, the Exchange submitted a proposal 90 ad~ptrules to govern the operation of a fully automated electronic book ("order book") fi1r c~rdcrstra h~i)cjr 41 securities ("orders") with a continuous, automated rnatcklng ft'iuactrctun tlx? u 1;: proxy1;3c a;,r itrrct price-f me priority execution (the Equities System dcscribci 1; I The Exchange has prcapc~scdcl~ang;ilgI(&; i;iaii:to -'NASDAQOMX BX, Inc." The name change will take eiFcct prlvr te. ihc connrnc,lccll:mt of trading on the NASDAQ OMX BX 1111slct+esa 2 Paragraph jf) of kuic lob-; 0 t:n82cr,h; f xchtmge Act pro\ ides the Securities and Exchange glomm~isni~ni'SEC'\jr "?c~rnrz\i:ofl authority to issue exe~nptions from the requirements contained in p~rsgrnphs(a) 2nd (k)of tlte rules promulgated under the Exchangc Ace. - See SR-BSE-2008-48 (".Io\c~~~ber 3.33033 011Nolember 11.2008. the Exchange submitted Alnendmeni '"ij~i.i to 11'. ~mp)sil?:, and on December 22,2008, the Exchange submitted Aane~adrnet~rho.3 rp 11s pri,,;;o~.ii. The NASDAQ OMX Group * 9600 Blackwell Road * Rockvilie, Maryland 20850 - USA www.nasdaqomx.com

Mr. James L.Eastnnan
"NASDAQ OMX RX Equities System" or the in stem").' The order book and the rules governing operation of the System will also provide for post trade anonymity through settlement for trades executed through the System.' The Exchange also requests, on behalf of its Members, your assurance that the staff of the Division of Trading and Markets (""Staft?') will not recornmend that the Commission take any enforcement action under paragraph (a) of Ruie IOb-1O under the Exchange Act in connection with the activities of Men~bers executing orders tits their customers in the circumstances described below. Specifically. rl-re Excl-range requests this relief to permit a Member to indicate on a customer confilmation that the Member acted as agent (where the Member submits a customer's order on the Exchange in the Member's role as the customer's agent (hereinafter "Customer Order")) and the order is executed in a trade with an anonymous contra-party that turns out to be the Member or one of its affiliates trading in a principal (including proprietary) capacity (hereinafter "Princ~pai Order"), so long as tile conditions set out below are met and the Member otherwise complies with all other requirements of Rule lob-1 0 in confirming the customerfs order, including pal-agrapl~ (a)(2)(1) thereof. This request for no-action relief is Limited, however, to those situations in which the following requirelents are met: (1) the representatives of the Member or its affiliates submitting Principal Orders do not have knowledge about Customer Orders submitted by the Member and the Member representatii es subn?itring Custo,ncr Orders do not ha\ e knowledge about Principal Orders submltteti by the blcrrl~e;.or I:, af'fi1i;i.c; (11-c"Yo Knowledge Requirement"); and (2) the Member does not dcternii!-,c' or *iltlc.:~~: the .clc,t~on of thc contra-party(ies) against which such Customer Orders will be executzd (the "Parity Requirelnent"). Finally, the Exchange requests certain no-action relief from the requirements of Rules 2 7a-3(a)(l) and I. 7a-4(a) under the Exchange Act. as described below. A. The Exchange The Exchange is a registered natiot~alsccurlties exchange under Section 6 of the Exchange Act. The Members of the Exchange ("Members") consist of those broker-dealers admitted to Inembership and e~~titled to enter orders in, and receive executions througb, the Exchange's order book or otherwise. 4 - See proposed Equity Rule 4757.The Exchange's Equity Rules do not provide for any special order type that would be an exception to the strict price time priority handling of orders set forth in Equil~Rule 4757.Ifsuch an order type were to be offered in the future, the Exchange understands that the relief requested by this letter would not apply to this fuilctionality. 5 As explained herein. the Exchange does not request an exemption with respect to revealing the identity of a Meinber or a Member's clearing firm under the circumstances provided in proposed Equlrq Ruie 1760.

Mr. James L. Eastman
The Exchange uiiIl operate an order book for orders with a continuous, automated matching function, in conlpliance with the Exci~amige's rules and Rebwlation NMS under the Exchange Act ("Reg NIVIS"). Liquidity will be derived kern quotations and orders to buy and to sell submitted to the Exchange electronically by its Me~nbers from remote locations. The order book and the Exchange's rules will provide for strict price-time priority execution. Under proposed Equity Rule 4757, the System will have a single execution algorithm based on price/time priority, For each order. among equally-priced or better-priced trading interest, the System executes against available contra-side displayed orders in full, in price/time priority, before then moving to any 11orr-displayed orders which are likewise executed in pricehime priority. All trades will he excellled through the System on an anonymous basis. The transaction reports produced by the System will Indicate the details of transactions executed in the System but shall not reveal contra party icientit~es. Transactions executed in the System will also be cleared and settled anonynously." The System will not route orders to other market centers. Rather. all orders will he processed by the System in a manner that avoids trading through protected quotations and avoids locked and crossed markets.' The order book's lnatching system algorithm pelmits orders originated by a Member to execute against other orders from the same participant on the same basis as orders from other Members. In the order book's handling of displayed orders, which is based on strict price-time priority, a Member could rccoi\ c an c\cccuc!on :~g;~inst irszlf, and under the Exchange's Rules, the Member would not know that it \.:IS ti12 contra-cictc oi'th~trade at the time of execution. B. Rule I Ob- 10 Rule IOb- 10, among other tl-i~ngs.,rsqti~rc\a broker-dealer to disclose to its customers the identity of the pasty tile broker-daler sold ti) o; I?o;ight ~~OIII to fjiill the customer's order. Specifically. under paragraph (i)i4)of Rule IOb-?O(a)(2), when a broker-dealer is acting as agent for a customer, some other person., or for both tilt. custol~ler and some other person, the broker￾dealer must disciose "frjhenaanc of the pifrso11 fro111 u holm the security was purchased, or to whom it was sold, fix such cuctorncr or the fxt that the inf'omation will be furnished upon written request of such customer" (the "Ccntra-Parly Identity Requirement"). A broker-dealer can provide this infomation on the confirrnat~on, or it has the option to provide the infomation to a customer at a later tin~e after recel\ing a .ixmt"ien request from the customer. A broker-dealer 6 Limited exceptions to at~cmyrnityarc prin iided in proposed Equity Rule 4760. 7 The Exchange understands Ihai if it routes i.irt?iersin the fkture, the exeqtive and no￾action relief requested 1n this letter would not apply to any situation in which the System routes an order to an au
ay trading center for execution, as such executions would be governed by the rules of the away tradrng center.

Mr. James L. Eastillan has this option as long as it discloses on the confirnation that the contra-party infomation is available upon written request. Trades will he executed nitb total anonyrn~tyat the Exchan e, where the identity of the S actual contra-party will not be revealed when the trade is executed. Therefore, Members will not know the identity of the party "ro wko~~il the) sold securities or from whom they purchased securities. Without this infomatlon, Members cannokomply with the Contra-Party Identity Requirement. To pemit Exchange Me~nbers to utilize the Exchange without violating Rule 10b￾10, the Exchange is seeking an exemption, on hehaif of such Members, from the Contra-Party Identity Requireinent when Memkrs execute transactions on the Exchange. The Contra-Party Identity Requirement. in conjunction with the other requirements of paragraph (a)(2) of Rule 1%- 10. i3 designed to provide customers with information that could alert them to potential conflicts of interest their broker-dealer may have had when handling their order^.^ The Exchange belie\ es an eveinplirtn finrai the Contra-Party Identity Requirement when Member trades through the Exchange would not diminish the public policy and investor protection objectives of the Contra-Party Ident~tyRequirement of Rule 10b-10. The Exchange believes the potential for a confllet of interest is less likely in those circumstances when a Member trades through the Exchange because the trades are executed at the best price available on the Exchange and the contra-party is deter~~~ir~ed base upon multiple factors not controlled by the Member. In such situations. blcinncrs are not pa-mitted the discretion in executing the order that \trould nonnall!. yi.e rise ;(. the onpol-t~tnityfor a conflict of interest. The Exchange requests no-act~onrelief. or? hzhlilf of its Members, to pemit Meinbers to indicate on a custcsmitr confinnat~onthclt the Meanber has acted as agent where the Member submits a customer's order through the electronic trading i'aciiities of the Exchange, in the Member" role as the eusti~rnzr'~ agcnt, anJ the order is executed in a trade with an anonymous contra-party that turns out to be the Member or one of its affiliates trading in a principal (including proprietary) capacit!. 8 - Id. 9 Paragraph (a)(2) of Rule 1%- i 0requires a broker-dealer to disclose on a confirnation to a custolner the capacity in nl~rchthe brokcr-dealer handled the customer's order (i.e., as agent or pincipal), and whether the broker-dealer acted as agent for some other person, or as agent for both the customer and some other person. Paragraph (i)(D) of Rule 1Ob￾10(a)(2) requires a broker-dealer to disclose to its custo~ner the source and amount of remuneration received. or to be received. b~ the broker-dealer in connection with the trade.

10
Mr. James L. Eastman
This request is limited ro those circumstances in which the representatives of a Member and its affiliates submitting Principal Orders do nothave knowledge about Customer Orders submitted by the Member, and the Mernber representatives submitting Customer Orders have no knowledge about Principal Orders submitted by "re Me~nberor its affiliates. A Member will be able to satisfy the No Knowledge Require~nent if it implements and utilizes an effective system of internal controls such as appropri;ile ~nrfomation barriers, that operate to prevent the representatives of the Member or its af51iates suhi~~it"rng Principal Orders from obtaining knowledge about the Customer Orderc submitted by the Mennber, and the representative of the Members submitting Custo~vler Orders from obtaining knowledge about the Principal Orders submitted by the Member or ~ts affiliates. To be effective, such a system of internal controls must include specific policies and procedures that prevent each Principal Order submitter separated by the information barriers Ci-,n~ obtaining knowledge regarding Customer Orders submitted by the Member. and each Custo~ner Orcter submitter separated by the information barriers from obtaining knowledge regarding Principal Orders submitted by the Member or its affiliates. will not support functionality that would zllow a broker-dealer to select or influence against whom its orders u.ill be executed." Where the Custo~ner Order and the Principal Order are executed against each other by the order book, a Member inilicatln~in the confinmatron ~halthe film has acted as agent does not The SEC has previously I.;Pu~Jno-action relief for Rule 10b-10 under these circumstances. Letter from Brian A. Busscg., Assistant Chief Counsel, Division of Trading and Markets, to Llr. 3. Crarg Long, boley &i. Lardner LLP (October 23,2008) (BATS Exchange); Letter ii-oan Brian A. Bussey. Assistant Chief Counsel, Division of Market Regulation, to 'i,"t'~ElirzmC, Meekan. fiimer General Counsel of the Exchange (November 8, 2006): Letter from Briar? A. Bussey, Assistant Chief Counsel, Division of Market Regulation, to James C.Uong. Chief Regulatory Officer, National Stock Exchange (October 13. 2006):Letter from Br~an A. Bussey, Assistant Chief Counsel, Division of R4arket Regulation, to Edward S. Knight, Executive Vice President and General Counsel, NaccPaq [Januarj 26, 2005): and Letter ti-om Brian A. Bussey, Assistant Chief Counsel, Div~sic\nof Market Rcguiatron, to Aleksandra Radakovic, Vice President, 3.P Morgan Secunh~es Inc. (,"igust 3, 3005). '"f such functionahty '~vere to be offered in the future, the Exchange understands that the relief requested by this letter r;;ould notapply to this functionality.

Mr. James L. Easlrnan increase the risk of fraud against the customer, where the No Knowledge Requirement and the Parity Requirement are met. To the contra-y. the matelling of the agency and the proprietary trading interests occurs at the best price a\ aiiabie and the contra-side is determined based upon priority factors established by the rules of thc Exchange." Moreover. the proposed action does not di~ninish investor protection because rt does not relieve a Member's duty of best execution.
C. Books and Record Rete~tior,
Rule 17a-3(a)(l) under the Exchange Acr requires that broker-dealers make and keep current records of all purchases and sales ofsecurities, illcluding "the name or other designation of the person from whom purchaseti or receil eci or to whom sold or delivered." Rule 17a-4(a) under the Exchange Act requires that the records be prese~ved for six (6) years, the first two (2) years "in an easily accessi"ole place.'" The Exchange asks that the Coiarrnission staE not reco~nmend enforcement action to the Commission if, in lieu of making and preserving a separate record, a broker-dealer relies on the Exchange's retention of the identities of Mei-nbers that execute anonymous trades through the Exchange to satisfy requirelnents of Rule> i 7a-3(a)(T) and 17a-4(a) under the Exchange Act. A broker-dealer would retain the responsibility to make, keep current and preserve records of all purchase and sales of securities in accordance with Exchange Act Rules 17a-3 and 17a-4 for trades th1-ough the Exchange it'!iic broker-dealt.!. Knows of the contra-party, including those instances where the Exck-ngc c!isc!oi;.~sti:: r.c,:;:ril-?u:.t~. to a trttde. The Exchange expects that same firm ~;olume. i.e., an execution in which a firm's agency order is matched agalnsl: the saxe f7rn1.s pr:ncir;al (including proprietary) trading interest, as a percentage of total ~,O~UIT~C mrI a securi~ythrough the System, will not be material for either high or low lrad~ng-\iolumes~euntres.The Exchange represents that one year afier the System becornes t'ulii, nperarlonal, rhc Exchange will review trade data to detemine the actual percentage of samt tinn volume versus total volume in high and low volume securities to confilm1 that thib number 1s not material. The Exchange will create and ~naintai~l a record of the &el-minatror~. 12

Mr. Jarnes L.Easttnan
In view of the %regoing, the Exc1i:rnge respectfully requests that the Commission issue an exemption and such other relief as reflected in this letter. If you have any questions, please contact me at (301) 978-8498. or John Vefter a!: (301) 978-8497. ~hu~e~ulatory Officer Boston Stock Exchange, Incorporated cc: Brian A. Bussey (via electron~cmail Ignacio A. Sandoval (via electronic mail)