[Federal Register Volume 71, Number 173 (Thursday, September 7, 2006)]
[Notices]
[Pages 52836-52841]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-14808]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54391; File No. SR-NSX-2006-08]


Self-Regulatory Organizations; National Stock Exchange, Inc.; 
Order Approving a Proposed Rule Change and Amendment No. 1 Thereto and 
Notice of Filing and Order Granting Accelerated Approval to Amendment 
Nos. 2 and 3 Thereto to Amend Its Trading Rules to Provide for a Price-
Time Priority Market and Other Related Changes

August 31, 2006.

I. Introduction

    On June 6, 2006, the National Stock Exchange, Inc. (``NSX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to amend its rules in order to incorporate a 
price-time priority automatic execution trading system (``System'') to 
replace the Exchange's current system, the National Securities Trading 
System (``NSTS''). On June 22, 2006, the Exchange filed Amendment No. 1 
to the proposed rule change. The proposed rule change, as amended, was 
published for comment in the Federal Register on July 6, 2006.\3\ The 
Commission received one comment letter on the proposal.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 54044 (June 26, 
2006), 71 FR 38452 (``Trading Rules Notice'').
    \4\ See letter from Michael A. Barth, Senior Vice President, 
Exchanges and Market Centers, Order Execution Services Holdings, 
Inc. (``OES''), to Nancy M. Morris, Secretary, Commission, dated 
July 19, 2006 (``OES Letter'').
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    On August 11, 2006, the Exchange filed Amendment No. 2 to the 
proposed rule change.\5\ On August 18, 2006, the Exchange filed 
Amendment No. 3 to the proposed rule change.\6\ This order approves the 
proposed rule change, as amended by Amendment No. 1. Simultaneously, 
the Commission is providing notice of filing of Amendment Nos. 2 and 3 
and granting accelerated approval of Amendment Nos. 2 and 3.
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    \5\ The text of Amendment No. 2 is available on NSX's Web site 
(http://www.nsx.com), at the principal office of NSX, and at the 
Commission's Public Reference Room. See Section II, infra, for a 
discussion of Amendment No. 2.
    \6\ The text of Amendment No. 3 is available on NSX's Web site 
(http://www.nsx.com), at the principal office of NSX, and at the 
Commission's Public Reference Room. See Section II, infra, for a 
discussion of Amendment No. 3.
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II. Description

    The Exchange proposes to amend its rules in order to implement a 
new trading System to replace the Exchange's current NSTS. 
Specifically, the proposed System would provide a new trading platform 
and structure for the Exchange with price-time priority execution 
without any priority of execution distinction made for principal or 
agency orders.\7\ The Exchange proposes to substantially revise Chapter 
XI (Trading Rules) of its rules in order to incorporate new priority 
rules and other features within the System. These rules relate to: 
hours of trading; units of trading; price variations; securities 
eligible for trading; registration of market makers; obligations of 
market maker authorized traders; registration of market makers in a 
security; obligations of market makers; access; authorized traders; 
orders and modifiers; cross messages; proprietary and agency orders, 
and modes of order interaction; priority of orders; order execution; 
trade execution and reporting; clearance and settlement; limitation of 
liability; clearly erroneous executions; trading halts due to 
extraordinary market volatility; short sales; locking or crossing 
quotations in NMS stocks; and riskless principal transactions.\8\
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    \7\ See proposed NSX Rules 11.13 and 11.14.
    \8\ See proposed NSX Rules 11.1-11.23.
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    Under proposed NSX Rule 11.11, the System would include a number of 
new order types, including different types of sweep orders (e.g., 
Protected Sweep Orders, Full Sweep Orders, Destination Sweep Orders) 
\9\ that direct the Exchange to route an order, or a relevant portion 
thereof, to away trading centers. In addition, once the relevant 
compliance date for Regulation NMS under the Act (``Regulation NMS'') 
\10\ has been reached, the System would permit orders to be marked as 
intermarket sweep orders (``ISOs'') pursuant to Regulation NMS and also 
permit incoming ISOs from other trading centers.\11\ Proposed NSX Rule 
11.12 sets forth restrictions for cross messages (``Crosses'') 
generally, as well as additional requirements for Midpoint Crosses,\12\ 
Clean Crosses,\13\ and Cross/Sweeps.\14\
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    \9\ See proposed NSX Rule 11.11(c)(7).
    \10\ 17 CFR 242.600 et seq. See 17 CFR 242.610 and 17 CFR 
242.611.
    \11\ See proposed NSX Rule 11.11(c)(7)(iv) and (c)(8).
    \12\ See proposed NSX Rule 11.12(c).
    \13\ See proposed NSX Rule 11.12(d).
    \14\ See proposed NSX Rule 11.12(f).
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    Proposed NSX Rule 11.13 would permit participation in the System 
via automatic execution or order delivery. To be eligible for the order 
delivery functionality, a participant would have to demonstrate to the 
Exchange that it could automatically process an inbound order and 
respond immediately. Proposed Interpretation and Policy .01 to Rule 
11.13 would define ``immediately'' as having system response times 
``that generally meet or exceed industry standards,'' which NSX 
believes currently to be 100 milliseconds.\15\
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    \15\ See Amendment No. 2, supra, note 5.
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    In its proposed revisions to Chapter XI of its rules, the Exchange 
also incorporated a number of provisions relating to Regulation NMS--in 
addition to ISOs--including proposed NSX Rule 11.22 relating to locking 
or crossing quotations in NMS stocks. Also, proposed NSX Rule 11.15(d) 
provides that the System would be operated as an ``automated market 
center'' (as defined by Regulation NMS) and would display ``automated 
quotations'' (as defined by Regulation NMS) at all times except in the 
event that a systems malfunction renders the System incapable of 
displaying automated quotations. In such a case, the Exchange would 
communicate to ETP Holders its procedures concerning a change from 
automated to manual quotations.
    In addition to substantially revising Chapter XI, the Exchange also 
made revisions and proposed new rules in other chapters of its rules. 
Proposed NSX Rule 1.4 details the effective time for certain rules 
while proposed NSX Rule 1.5 includes new definitions for a number of 
terms including, among others, ``Authorized Trader,'' ``Protected 
NBBO,'' ``protected quotation,'' ``Sponsored Participants,'' and 
``Sponsoring ETP Holder.''

[[Page 52837]]

    The Trading Rules Notice also included a request by the Exchange 
for the Commission to approve its wholly-owned subsidiary, NSX 
Securities, LLC (``NSX Securities''), as a facility of the Exchange. 
NSX Securities' only function would be to route orders to other 
securities exchanges, facilities of securities exchanges, automated 
trading systems, electronic communications networks (``ECNs''), or 
other brokers or dealers (collectively, ``Trading Centers'') from the 
Exchange (such function referred to as the ``Outbound Router''). 
Proposed NSX Rule 2.11 contains the undertakings of NSX Securities 
including, among other things, that: NSX would regulate the Outbound 
Router as a facility of the Exchange that is subject to Section 6 of 
the Act, and would be responsible for filing with the Commission rules 
and fees relating to the Outbound Router; the NASD would be responsible 
for regulatory oversight and enforcement as the Outbound Router's 
Designated Examining Authority (``DEA'') pursuant to Rule 17d-1 of the 
Act; use of NSX Securities by ETP Holders would be optional; and NSX 
Securities would not engage in any business other than its Outbound 
Router function, unless approved by the Commission.
    On August 11, 2006, the Exchange filed Amendment No. 2 to the 
proposed rule change, which made certain revisions to the original 
proposal, as amended by Amendment No. 1. NSX revised proposed NSX Rule 
11.13's requirements for order delivery functionality eligibility. 
Under subsection (b)(2), a User (i.e., an ETP Holder or Sponsored 
Participant) must demonstrate to the Exchange that the User's system 
can automatically process inbound orders and respond immediately; new 
Interpretation and Policy .01 to proposed NSX Rule 11.13 would define 
``immediately'' as having system response times ``that generally meet 
or exceed industry standards,'' which NSX believes currently to be 100 
milliseconds. NSX also amended its rules to make certain revisions 
relating to cross messages. The Exchange revised proposed NSX Rule 
11.12(d) to delete the requirement that a Clean Cross be executed only 
if neither side of the Cross is for the account of the User entering 
the Cross, and amended proposed NSX Rule 11.3(b) to permit Cross 
executions in subpenny increments so long as they improve the 
Exchange's top of book (``Top of Book'') by at least a penny per share, 
as well as Clean Cross executions in subpenny increments. In addition, 
the Exchange clarified that its customer priority rules found in NSX 
Rule 12.6 applied to Cross/Sweep messages.
    In Amendment No. 2, NSX also stated that it would review its 
current regulatory allocation plan with NASD (as permitted by Rule 17d-
2 under the Act \16\) to ensure that the NASD, and not the Exchange, 
has responsibility for such regulatory functions for NSX Securities. 
NSX also added new proposed NSX Rule 2.11(b) which states that the 
books, records, premises, officers, agents, directors and employees of 
NSX Securities as a facility of the Exchange would be deemed to be the 
books, records, premises, officers, agents, directors and employees of 
the Exchange for purposes of, and subject to oversight pursuant to, the 
Act, and that the books and records of NSX Securities as a facility of 
the Exchange would be subject at all times to inspection and copying by 
the Exchange and the Commission.
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    \16\ 17 CFR 240.17d-2.
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    In addition, in Amendment No. 2, NSX revised its rules to reflect 
the extension of certain compliance dates relating to Regulation NMS. 
NSX proposed to modify certain rules such that their effectiveness 
would coincide with the Regulation NMS compliance dates announced by 
the Commission. The Exchange also modified other rules to include 
different rule provisions applicable prior to and following the 
relevant Regulation NMS compliance dates.\17\ NSX also proposed a new 
NSX Rule 11.16(b) which requires the Exchange to, following the 
compliance date for Rule 611 of Regulation NMS, ``identify all trades 
executed pursuant to an exception or exemption from Rule 611 of 
Regulation NMS in accordance with specifications approved by the 
operating committee of the relevant national market system plan for an 
NMS stock.'' In addition, the Exchange revised proposed NSX Rule 11.15 
to indicate that it intends to take advantage of the self-help 
provisions of Regulation NMS.
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    \17\ For example, NSX revised the proposed definition of 
``protected quotation'' to mean, prior to the compliance date for 
Rule 611 of Regulation NMS, a bid or offer in a stock that is the 
best bid or best offer of a national securities exchange or 
association; provided, however, that the term ``protected 
quotation'' would not include a bid or offer in a stock that is 
subject to the ITS Plan if trading through such bid or offer would 
be permitted under NSX Rule 14.9(b) or by an exemption available 
under the securities laws or otherwise granted by the Commission or 
its staff. Following the compliance date for Rule 611 of Regulation 
NMS, the definition of ``protected quotation'' would mean a bid or 
offer in a stock that (i) is displayed by an automated trading 
center; (ii) is disseminated pursuant to a national market system 
plan approved by the Commission; and (iii) is an automated quotation 
that is the best bid or best offer of a national securities exchange 
or association.
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    In Amendment No. 2, the Exchange also described its proposed phase-
in plan for the new System. According to the Exchange, the System is 
currently undergoing testing and is scheduled to become operational on 
or about September 5, 2006. NSX stated that it plans to phase-in the 
System as follows: first, beginning the week of September 5, 2006, a 
small group of Nasdaq-listed stocks would be transitioned to the System 
from NSTS. Several additional groups of Nasdaq-listed stocks would be 
transitioned to the System over the following five weeks, so that all 
Nasdaq-listed stocks would have been transitioned to the System by 
approximately mid-October, 2006. Following the transition of Nasdaq-
listed stocks, NSX plans to transition all non-Nasdaq-listed securities 
to the System. NSX stated that it plans to monitor implementation and 
adjust the schedule as needed to maintain an orderly transition. 
Amendment No. 2 also contained a number of non-substantive changes and 
technical corrections to clarify the original proposal, as amended by 
Amendment No. 1. Finally, Amendment No. 2 contained a response to the 
comment letter received on the original proposal, as amended by 
Amendment No. 1.\18\
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    \18\ See Section III.B., infra.
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    On August 18, 2006, the Exchange filed Amendment No. 3 to the 
proposed rule change. Amendment No. 3 revised proposed NSX Rule 
11.16(b) to clarify that trades executed pursuant to both the 
intermarket sweep order exception of Rule 611(b)(5) or (6) of 
Regulation NMS and the self-help exception of Rule 611(b)(1) of 
Regulation NMS would be identified as executed pursuant to the 
intermarket sweep order exception.

III. Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange \19\ and, in particular, the requirements of 
Section 6 of the Act \20\ and the rules and regulations thereunder. The 
Commission finds that the proposed rule change, as amended, is 
consistent with Section 6(b)(5) of the Act \21\ in that it is designed 
to prevent fraudulent and manipulative acts and practices, to

[[Page 52838]]

promote just and equitable principles of trade, 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.
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    \19\ The Commission has considered the proposed rule's impact on 
efficiency, competition and capital formation. 15 U.S.C. 78c(f).
    \20\ 15 U.S.C. 78f.
    \21\ 15 U.S.C. 78f(b)(5).
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    As previously stated, NSX proposes to replace its current trading 
system, NSTS, with a new trading System that would provide for price-
time priority execution. The Exchange proposes to revise its rules, 
including Chapter XI (relating to trading rules), in connection with 
this new market structure.

A. Order Types

    Pursuant to proposed NSX Rule 11.11, Users would be able to enter 
market orders and limit orders into the System with various time-in-
force terms and other modifiers. Specific order types permitted by the 
System include: ITS Orders, Reserve Orders, Odd Lot Orders, Mixed Lot 
Orders, Post Only Orders, NSX Only Orders, Sweep Orders (including 
Protected Sweep Orders, Full Sweep Orders, and Destination Sweep 
Orders), Destination Specific Orders, and, following the compliance 
date for Rule 611 of Regulation NMS, Incoming Intermarket Sweep Orders.
    The Exchange's proposed Sweep Orders would allow a User to 
``sweep'' the market by matching the order for execution in the NSX 
Book, and simultaneously converting the order into one or more limit 
orders and routing such orders to away trading centers for execution 
against quotations in accordance with the terms of the Sweep Order. 
Specifically, a Protected Sweep Order would only execute against orders 
in the NSX Book and protected quotations at away trading centers. A 
Full Sweep Order would execute against the best available quotations in 
the NSX Book and at away trading centers (automated and manual 
quotations). A Destination Sweep Order would first be matched for 
execution against the NSX Book and then routed to a User-specified 
trading center for execution. The Commission believes that the proposed 
order types are consistent with the Act. The Commission notes that a 
number of the proposed order types will have different definitions 
prior to and following the relevant Regulation NMS compliance dates, 
which should enable Users to make use of the trading and routing 
strategies of such order types prior to when full compliance with Rules 
610 and 611 of Regulation NMS is required.
    Pursuant to proposed NSX Rule 11.12, Users may post a Cross on the 
System if the price of such trade is better than the best bid and offer 
on NSX, and (following the compliance date for Rule 611 of Regulation 
NMS) if it is equal to or better than the Protected NBBO. Crosses must 
improve each side of the Top of Book by at least one penny a share, 
except in the cases of Midpoint Crosses and Clean Crosses. A Midpoint 
Cross may improve the Top of Book by as little as one-half the minimum 
increment provided in NSX Rule 11.3(a), if it is priced at the midpoint 
of the Protected NBBO (or, prior to the compliance date for Rule 611 of 
Regulation NMS, if it is priced at the midpoint of the best bid and 
offer on the Exchange).\22\ A Clean Cross may be executed on the System 
at a price equal to or better than the Top of Book if (i) it is for at 
least 5,000 shares and has an aggregate value of at least $100,000, 
(ii) the size of the Cross is greater than the size of the total 
interest on NSX at the Cross price, and (iii) following the compliance 
date for Rule 611 of Regulation NMS, it is at a price equal to or 
better than the Protected NBBO.\23\
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    \22\ See proposed NSX Rule 11.12(c).
    \23\ See proposed NSX Rule 11.12(d).
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    Proposed NSX Rule 11.12(e) requires that all Users entering a 
Proprietary Cross comply with the Exchange's Customer Priority rule 
(i.e., the price of the Cross must be better than any customer order 
the User is holding by at least $0.01). A User may also post a ``Cross/
Sweep'' message that enters a Sweep Order for the account of the User 
sweeping all protected quotations that are superior to the Cross price, 
and simultaneously executes the Cross. In connection with any Cross/
Sweep, the User must fully disclose the material facts relating to the 
Sweep Order to any customer for whose account either side of the Cross 
is being executed.\24\ In addition, proposed NSX Rule 11.12(f) makes 
clear that NSX Rule 12.6, which restricts trading ahead of customer 
orders, applies to the entire Cross/Sweep transaction. The Commission 
notes that the User must provide the customer with the benefit of any 
superior price received by executing such Sweep Order against NSX 
quotations for the corresponding portion of the Cross.
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    \24\ See proposed NSX Rule 11.12(f).
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    The Commission finds that the proposed rules relating to cross 
messages are consistent with the Act and should provide Users 
flexibility in executing transactions which meet the specified 
requirements of each type of Cross, while still ensuring that customer 
priority principles are upheld. The Commission notes that it has 
approved rules substantially similar to those proposed by the Exchange 
relating to Clean Crosses.\25\
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    \25\ See, e.g., Securities Exchange Act Release No. 46568 
(September 27, 2002), 67 FR 62276 (October 4, 2002) (approving File 
No. SR-Amex-2002-23).
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B. Order Interaction and Order Delivery

    Pursuant to proposed NSX Rule 11.13, the System offers two modes of 
order interaction: (1) Automatic execution and (2) order delivery and 
automated response. Every User would be eligible to use the automatic 
execution mode to participate in the System, in which the System would 
match and execute like-priced orders. However, to be eligible for the 
order delivery functionality, a User would have to demonstrate to the 
Exchange that it could automatically process an inbound order and 
respond immediately. In new Interpretation and Policy .01 to proposed 
NSX Rule 11.13, NSX defines ``immediately'' as having system response 
times ``that generally meet or exceed industry standards,'' which NSX 
believes currently to be 100 milliseconds. In addition, if the Exchange 
does not receive a response to an inbound order within 500 
milliseconds, the User's displayed order will be cancelled.
    The industry standard for such response times will undoubtedly 
change over time and become shorter and, therefore, the Commission 
notes that NSX must periodically review inbound order response time to 
determine what constitutes the current industry standard and update its 
parameters accordingly. The Commission believes that the Exchange's 
order delivery functionality, as proposed, is consistent with the Act.

C. Priority of Orders and Order Execution

    Proposed NSX Rules 11.14 and 11.15 set forth the priority and 
execution parameters of the System. Pursuant to NSX Rule 11.14, orders 
are prioritized on a price-time basis, first by price and then by 
time.\26\ Incoming orders (other than Sweep Orders) are first matched 
for execution against orders in the NSX Book.\27\ Proposed NSX Rule 
11.15 reflects the requirements of Rule 611 of Regulation NMS \28\ by 
requiring that, for any execution on NSX to occur during Regular 
Trading Hours (i.e., between 8:30 a.m. and 3 p.m. Central Time), the 
price must be equal to or better than the Protected NBBO unless the 
order is marked as an intermarket sweep order or unless another 
exception to Rule 611(b) of Regulation NMS is available. Orders that 
cannot be executed within

[[Page 52839]]

these parameters are eligible for routing to away trading centers for 
execution at the Protected NBBO.
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    \26\ See proposed NSX Rule 11.14(a).
    \27\ See proposed NSX Rule 11.15(a)(i).
    \28\ 17 CFR 242.611.
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    Unless the terms of the order direct otherwise, any order other 
than a Sweep Order that cannot be executed on the Exchange would be 
converted into one or more limit orders, as necessary, to match the 
price of each protected quotation at the Protected NBBO available at 
away markets, and these limit orders would be routed to the applicable 
market for execution against the applicable protected quotation at the 
Protected NBBO.\29\ Unless the terms of the order direct otherwise, any 
order not executed in full on the Exchange which by its terms is not 
eligible for routing away, or which is not executed in full when routed 
away, would be ranked in the NSX Book in accordance with order priority 
rules of proposed NSX Rule 11.14.\30\
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    \29\ See proposed NSX Rule 11.15(a)(ii).
    \30\ See proposed NSX Rule 11.15(a)(iii).
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    Sweep Orders would be matched for execution in the NSX Book, and 
simultaneously converted into one or more limit orders and routed to 
away markets to be matched for execution against quotations in 
accordance with the terms of the Sweep Order.\31\ In addition, pursuant 
to proposed NSX Rule 11.15(d), NSX intends to operate the System as an 
``automated market center'' within the meaning of Regulation NMS, such 
that the System would display automated quotations at all times except 
in the event that a systems malfunction renders it incapable of 
displaying automated quotations. The Exchange would communicate to its 
ETP Holders its procedures relating to any change from automated to 
manual quotations in the event of such a systems malfunction.
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    \31\ See proposed NSX Rule 11.15(b).
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    The Commission believes that the proposed rules relating to order 
priority and order execution are consistent with the Act. The 
Commission believes that the System's price-time priority and automatic 
execution functionality may encourage Users to participate in the new 
System, which should promote competition and efficiencies on the new 
System and in the national market system in general.

D. Outbound Router

    In the Trading Rules Notice, NSX requested that the Commission 
approve its wholly-owned subsidiary, NSX Securities, as a facility of 
the Exchange. NSX Securities would be subject to several conditions and 
undertakings which are reflected in proposed NSX Rule 2.11. First, the 
Exchange would regulate the Outbound Router function of NSX Securities 
as a facility, subject to Section 6 of the Act. In particular, and 
without limitation, under the Act, the Exchange would be responsible 
for filing with the Commission rule changes and fees relating to the 
Outbound Router function of NSX Securities and NSX Securities would be 
subject to exchange non-discrimination requirements. Second, NASD, a 
self-regulatory organization unaffiliated with the Exchange or any of 
its affiliates, would carry out oversight responsibilities as the 
Designated Examining Authority designated by the Commission pursuant to 
Rule 17d-1 of the Act with the responsibility for examining NSX 
Securities for compliance with the applicable financial responsibility 
rules.\32\ In addition, NSX has stated that it would review its current 
regulatory allocation agreement with NASD to ensure that the NASD, and 
not the Exchange, has responsibility for regulatory functions for NSX 
Securities under such regulatory allocation agreement, including the 
responsibility to receive regulatory reports from NSX Securities, to 
examine NSX Securities for compliance, and to enforce compliance by NSX 
Securities with, specified provisions of the Act, the rules and 
regulations thereunder, and the rules of the Exchange and the NASD, and 
to carry out other specified regulatory functions with respect to NSX 
Securities. Third, an ETP Holder's use of NSX Securities to route 
orders to another Trading Center would be optional. Any ETP Holder that 
does not wish to use NSX Securities would be able to utilize other 
routers to route orders to other trading centers.\33\ Fourth, NSX 
Securities would not engage in any business other than (1) its Outbound 
Router function and (2) any other activities it may engage in as 
approved by the Commission. Finally, the books, records, premises, 
officers, agents, directors and employees of NSX Securities as a 
facility of the Exchange would be deemed to be the books, records, 
premises, officers, agents, directors and employees of the Exchange for 
purposes of, and subject to oversight pursuant to, the Act, and the 
books and records of NSX Securities as a facility of the Exchange would 
be subject at all times to inspection and copying by the Exchange and 
the Commission.
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    \32\ NSX has stated that NSX Securities is in the process of 
registering as a broker-dealer, has applied for membership in the 
NASD, and is applying to become an ETP Holder. See Trading Rules 
Notice at 38479. The Commission expects NSX to complete this process 
prior to beginning operation of its new System.
    \33\ For example, an ETP Holder may choose to enter an 
Immediate-or-Cancel Order, which provides that, if the order is not 
executable on the System, the order would be cancelled and returned 
to the ETP Holder, at which time the ETP Holder could choose to 
route the order to another market. See proposed NSX Rule 
11.11(b)(1).
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    The Commission received one comment letter regarding the proposed 
rule change, as amended.\34\ In its comment letter, OES questioned 
whether NSX Securities' routing functionality should be part of the 
Exchange.\35\ In addition, OES believed that the Exchange, through its 
direct affiliation with NSX Securities, would be in direct competition 
with other broker-dealer participants of NSX that provide similar 
routing services and would ``potentially be positioned to hold unfair 
competitive advantages through its regulatory and operational positions 
as a [self-regulatory organization] and an exchange.'' \36\
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    \34\ 34 OES Letter, supra note 4.
    \35\ Id. at 1.
    \36\ Id.
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    In Amendment No. 2, NSX responded to the OES Letter. NSX stated 
that the undertakings set forth in proposed NSX Rule 2.11 are 
specifically designed to mitigate potential conflicts of interest the 
Exchange might have with regard to NSX Securities. NSX noted that, 
under its proposed rules, an ETP Holder's use of NSX Securities to 
route orders to another trading center would be optional, and the only 
function of NSX Securities would be to act as an outbound router unless 
the Commission approves otherwise. In addition, NSX noted that the 
Commission has previously approved a similar arrangement between an 
exchange and an affiliated broker-dealer for outbound routing with 
substantially similar undertakings.\37\
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    \37\ See Securities Exchange Act Release No. 52497 (September 
22, 2005), 70 FR 56949 (September 29, 2005) (relating to the use of 
Archipelago Securities, LLC as an outbound router for NYSE Arca, 
Inc. (f/k/a the Pacific Exchange, Inc.)).
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    The Commission notes that, because NSX Securities is a facility of 
the Exchange, the operation of the router is a function of the 
Exchange. Although the Commission is concerned about potential unfair 
competition and conflicts of interest between an exchange's self-
regulatory obligations and its commercial interests when the exchange 
is affiliated with one of its members, the Commission believes that it 
is appropriate and consistent with the Act to permit NSX to own NSX 
Securities in its capacity as a facility of NSX that routes orders from 
NSX to other trading centers, in light of the protections afforded by 
the conditions

[[Page 52840]]

described above. Accordingly, the Commission approves the proposed 
rules regarding NSX Securities.

E. Transition to New System

    NSX proposes to phase the new System into its market structure as 
follows: First, beginning the week of September 5, 2006, a small group 
of Nasdaq-listed stocks would be transitioned to the System from NSTS. 
Several additional groups of Nasdaq-listed stocks would be transitioned 
to the System over the following five weeks, so that all Nasdaq-listed 
stocks would have been transitioned to the System by mid-October 2006. 
Following the transition of Nasdaq-listed stocks, NSX would transition 
all non-Nasdaq-listed securities (i.e., securities listed on the New 
York Stock Exchange, American Stock Exchange, and other exchanges) to 
the System. NSX has stated that it plans to monitor this implementation 
and adjust the schedule as needed to maintain an orderly transition. 
The Commission believes that the Exchange's phased approach to 
transitioning from NSTS to the new System should provide it with time 
to test its System in a real trading environment while only trading a 
limited number of securities. The Commission believes that this 
approach is appropriate and should help maintain an orderly transition 
to the System.

F. Regulation NMS

    The Commission believes that the proposed rule change is consistent 
with the requirements of Regulation NMS.\38\ In proposed NSX Rule 
11.22, NSX proposes to adopt a rule with regard to locked and crossed 
markets, as required by Rule 610(d) of Regulation NMS.\39\ The Exchange 
has also designed its proposed rules relating to orders, modifiers, and 
order execution \40\ rules to comply with the requirements of 
Regulation NMS. These proposed rules include marking certain orders 
meeting the requirements of Rule 600(b)(30) of Regulation NMS \41\ as 
intermarket sweep orders and accepting orders marked as intermarket 
sweep orders, which would allow orders so designated to be 
automatically matched and executed without reference to protected 
quotations at other trading centers. In addition, as mentioned above in 
Section III.B., NSX has designed its trading rules so that the Exchange 
would display only automated quotations and qualify as an automated 
trading center under Rule 600(b)(3) of Regulation NMS.\42\ The 
Commission believes that NSX's proposed immediate-or-cancel 
functionality \43\ is consistent with Rule 600(b)(3) of Regulation NMS. 
The Commission also notes that proposed NSX Rule 11.15(d) addresses 
situations where NSX has reason to believe it is not capable of 
displaying automated quotations, including communicating to ETP Holders 
its procedures concerning a change from automated to manual quotations.
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    \38\ See supra note 10.
    \39\ 17 CFR 242.610(d).
    \40\ See proposed NSX Rules 11.11 and 11.15.
    \41\ 17 CFR 242.600(b)(30).
    \42\ 17 CFR 242.600(b)(3).
    \43\ See proposed NSX Rule 11.11(b)(1).
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G. Other Rules

    In addition to the rules described in detail above, the proposed 
rule change would amend a number of other Exchange rules that address, 
among other things, the effective time of certain rules, hours of 
trading, units of trading, price variations, securities eligible for 
trading, market makers, authorized traders, access, trade execution and 
reporting, clearance and settlement, limitation of liability, clearly 
erroneous executions trading halts, short sales, and riskless principal 
transactions. The Commission believes that these rules are appropriate 
and consistent with the Act.

IV. Accelerated Approval of Amendment Nos. 2 and 3

    As set forth below, the Commission finds good cause to approve 
Amendment No. 2 to the proposed rule change prior to the thirtieth day 
after Amendment No. 2 is published for comment in the Federal Register 
pursuant to Section 19(b)(2) of the Act.\44\ Many of the revisions in 
Amendment No. 2 are modeled on existing rules of other exchanges or are 
intended to clarify the proposal. The Commission believes that 
accelerating approval of these rules is appropriate because the 
revisions do not raise new regulatory issues.
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    \44\ 15 U.S.C. 78s(b)(2).
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    In Amendment No. 2, NSX modifies the proposed rule language to 
reflect the Commission's extension of certain compliance dates relating 
to Regulation NMS. Specifically, NSX is modifying proposed rules to 
reflect that such rules would not become effective until the compliance 
date for the applicable sections of Regulation NMS. The Commission 
notes that February 5, 2007 represents the beginning of the ``Trading 
Phase'' and the final date for full operation of Regulation NMS-
compliant trading systems of all automated trading centers, including 
SRO trading facilities, that intend to qualify their quotations for 
trade-through protection under Rule 611 of Regulation NMS during the 
Pilots Stock Phase and All Stocks Phase.\45\ Such rules include 
proposed NSX Rule 1.4(c) (pertaining to the effective time of certain 
NSX rules, including order execution, locking and crossing quotations 
in NMS stocks, and display of automated quotations), and proposed NSX 
Rule 1.5(P)(3) (pertaining to protected quotations). The Commission 
finds good cause to accelerate approval of these changes prior to the 
thirtieth day after publication in the Federal Register. The Commission 
believes this is a reasonable approach in light of the extension of 
Regulation NMS compliance dates and should help to ensure that the 
appropriate NSX rules are in place at the time that Regulation NMS 
compliance is required.
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    \45\ See Securities Exchange Act Release No. 53829 (May 18, 
2006), 71 FR 30038 (May 24, 2006).
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    In Amendment No. 2, NSX modifies the proposed rule language 
regarding the requirements for order delivery functionality 
eligibility. Specifically, NSX is modifying proposed NSX Rule 11.13 to 
require Users to demonstrate to the Exchange that the User's system can 
automatically process inbound orders and respond immediately; new 
Interpretation and Policy .01 to proposed NSX Rule 11.13 would define 
``immediately'' as having system response times ``that generally meet 
or exceed industry standards,'' which NSX believes currently to be 100 
milliseconds. The Commission finds good cause to accelerate approval of 
this change prior to the thirtieth day after publication in the Federal 
Register. The Commission notes that NSX had originally proposed a 
response time of 500 milliseconds for Users using the Exchange's order 
delivery functionality. In Amendment No. 2, NSX modifies its proposal 
to require immediate responses.
    In Amendment No. 2, NSX modifies certain proposed rule language 
relating to cross messages. Specifically, NSX deletes the requirement 
from proposed NSX Rule 11.12(d) that a Clean Cross be executed only if 
neither side of the Cross is for the account of the User entering the 
Cross, and amends proposed NSX Rule 11.3(b) to permit Cross executions 
in subpenny increments so long as they improve the Top of Book by at 
least a penny per share, as well as Clean Cross executions in subpenny 
increments. In Amendment No. 2, NSX also clarifies that its customer 
priority rules found in NSX Rule 12.6 applies to Cross/Sweep messages. 
The Commission finds good cause to accelerate approval of these changes 
prior to the thirtieth day after

[[Page 52841]]

publication in the Federal Register because they clarify the 
application of NSX Rule 12.6 to Cross, Clean Cross, and Cross/Sweep 
messages, all of which were published for comment in the Trading Rules 
Notice.
    In Amendment No. 2, NSX states that it would review its current 
regulatory allocation plan with NASD (as permitted by Rule 17d-2 under 
the Act \46\) to ensure that NASD, and not the Exchange, would be 
responsible for such regulatory functions with respect to NSX 
Securities. In addition, NSX adds new subsection (b) to proposed NSX 
Rule 2.11 regarding the Exchange's relationship with NSX Securities for 
purposes of the Act. The Commission finds good cause to accelerate 
approval of these changes prior to the thirtieth day after publication 
in the Federal Register because allocation of NSX's regulatory 
functions with regard to NSX Securities to NASD would be an extension 
of this current plan permitted under Rule 17d-2 of the Act. In 
addition, NSX modified its proposed rule language to provide that the 
books, records, premises, officers, agents, directors and employees of 
NSX Securities as a facility of the Exchange would be deemed to be the 
books, records, premises, officers, agents, directors and employees of 
the Exchange for purposes of, and subject to oversight pursuant to, the 
Act, and that the books and records of NSX Securities as a facility of 
the Exchange would be subject at all times to inspection and copying by 
the Exchange and the Commission. The Commission finds good cause to 
accelerate approval of these changes prior to the thirtieth day after 
publication in the Federal Register because they are substantially 
similar to rules relating to the administration of facilities of other 
national securities exchanges.
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    \46\ 17 CFR 240.17d-2.
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    In Amendment No. 2, NSX describes a phase-in plan for the new 
System. The Exchange states that the System is currently undergoing 
testing and is scheduled to become operational on or about September 5, 
2006. NSX would initially transition a small group of Nasdaq-listed 
stocks to the System, followed by several additional groups of Nasdaq-
listed stocks over the next five weeks, leading to the inclusion of all 
Nasdaq-listed stocks by mid-October. Following the transition of 
Nasdaq-listed stocks, NSX would transition all non-Nasdaq-listed 
securities (i.e., New York Stock Exchange, American Stock Exchange, and 
regional exchange-listed stocks) to the System. The Commission finds 
good cause to accelerate approval of this change prior to the thirtieth 
day after publication in the Federal Register because the phase-in 
period should help to ensure that there is an orderly transition to the 
new System.
    In Amendment No. 2, NSX also makes technical corrections to the 
proposed rule change, for example, fixing incorrect rule citations. 
These changes are non-substantive and technical in nature and are 
necessary to clarify the proposal. The Commission finds good cause to 
accelerate approval of these changes prior to the thirtieth day after 
publication in the Federal Register because they better clarify NSX's 
proposal.
    The Commission also finds good cause to approve Amendment No. 3 to 
the proposed rule change prior to the thirtieth day after Amendment No. 
3 is published for comment in the Federal Register pursuant to Section 
19(b)(2) of the Act.\47\ Amendment No. 3 revises proposed NSX Rule 
11.16(b) to clarify that trades executed pursuant to both the 
intermarket sweep order exception of Rule 611(b)(5) or (6) of 
Regulation NMS and the self-help exception of Rule 611(b)(1) of 
Regulation NMS would be identified as executed pursuant to the 
intermarket sweep order exception. The Commission finds good cause to 
accelerate approval of this change prior to the thirtieth day after 
publication in the Federal Register because it clarifies the 
identification of trades which are executed pursuant to both the 
intermarket sweep order and self-help exceptions of Rule 611(b) of 
Regulation NMS.
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    \47\ 15 U.S.C. 78s(b)(2).
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V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 2 and 3, including whether 
Amendment Nos. 2 and 3 are consistent with the Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-NSX-2006-08 on the subject line.[FEDREG][VOL]*[/
VOL][NO]*[/NO][DATE]*[/DATE][NOTICES][NOTICE][PREAMB][AGENCY]*[/
AGENCY][SUBJECT]*[/SUBJECT]

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-NSX-2006-08. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of the filing 
also will be available for inspection and copying at the principal 
office of NSX. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-NSX-
2006-08 and should be submitted on or before September 28, 2006.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\48\ that the proposed rule change (File No. SR-NSX-2006-08), as 
amended by Amendment No. 1, be, and hereby is, approved, and that 
Amendment Nos. 2 and 3 to the proposed rule change be, and hereby 
are,\49\ approved on an accelerated basis.
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    \48\ 15 U.S.C. 78s(b)(2).
    \49\ 17 CFR 200.30-3(a)(12).
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    For the Commission, by the Division of Market Regulation, pursuant 
to delegated authority.

Nancy M. Morris,
Secretary.
[FR Doc. E6-14808 Filed 9-6-06; 8:45 am]
BILLING CODE 8010-01-P[FEDREG][VOL]*[/VOL][NO]*[/NO][DATE]*[/
DATE][NOTICES]