[Federal Register Volume 77, Number 87 (Friday, May 4, 2012)]
[Notices]
[Pages 26595-26598]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-10755]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-66884; File Nos. SR-Phlx-2012-27; SR-Phlx-2012-54]


Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Suspension of 
and Order Instituting Proceedings To Determine Whether To Approve or 
Disapprove Proposed Rule Changes Relating to Complex Order Fees and 
Rebates for Adding and Removing Liquidity in Select Symbols

April 30, 2012.

I. Introduction

    On March 1, 2012 and April 23, 2012, NASDAQ OMX PHLX LLC (``Phlx'' 
or ``Exchange'') filed with the Securities and Exchange Commission (the 
``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Exchange Act'' or ``Act'') \1\ and Rule 19b-4 
thereunder,\2\ two proposed rule changes relating to the transaction 
fees for certain Complex Order transactions.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b 4.
    \3\ A Complex Order is any order involving the simultaneous 
purchase and/or sale of two or more different options series in the 
same underlying security, priced at a net debit or credit based on 
the relative prices of the individual components, for the same 
account, for the purpose of executing a particular investment 
strategy. A Complex Order may also be a stock-option order, which is 
an order to buy or sell a stated number of units of an underlying 
stock or exchange-traded fund (``ETF'') coupled with the purchase or 
sale of options contract(s). See Exchange Rule 1080, Commentary 
.08(a)(i).
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    In SR-Phlx-2012-27 (filed on March 1, 2012), Phlx proposed to amend 
the Exchange's Fee Schedule to increase the transaction fees and 
rebates for certain Complex Order transactions and create a new rebate 
for certain Complex Orders. The proposed rule change was immediately 
effective upon filing with the Commission pursuant to Section 
19(b)(3)(A) of the Act.\4\ Notice of filing of the proposed rule change 
was published in the Federal Register on March 15, 2012.\5\
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    \4\ 15 U.S.C. 78s(b)(3)(A).
    \5\ See Securities Exchange Act Release No. 66551 (March 9, 
2012) 77 FR 15400 (``Notice'').
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    In SR-Phlx-2012-54 (filed on April 23, 2012), Phlx proposed to 
replace a portion of SR-Phlx-2012-27 to provide additional information 
concerning the Directed Participant and Market Maker fees for removing 
liquidity in Complex orders (``Second Proposal,'' and, together with 
SR-Phlx-2012-27, the ``Phlx Proposals'').\6\ The proposed rule change 
was immediately effective upon filing with the Commission pursuant to 
Section 19(b)(3)(A) of the Act.\7\
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    \6\ See Securities Exchange Act Release No. 66883 (April 30, 
2012) (SR-Phlx-2012-54) (notice of filing of the proposed rule 
change).
    \7\ 15 U.S.C. 78s(b)(3)(A).
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    To date, the Commission has not received any comment letters on the 
Exchange's proposed rule changes.
    Under Section 19(b)(3)(C) of the Act, the Commission is: (1) Hereby 
temporarily suspending the Phlx Proposals; and (2) instituting 
proceedings to determine whether to approve or disapprove the Phlx 
Proposals.

II. Summary of the Proposed Rule Changes

SR-Phlx-2012-27

    The Exchange's proposal amended Complex Order fees and rebates for 
adding and removing liquidity in its Select Symbols.\8\ Specifically, 
Phlx's proposal: (1) Increased the Customer Rebate for Adding Liquidity 
from $0.30 per contract to $0.32 per contract; (2) created a new Rebate 
for Removing Liquidity of $0.06 per contract for each contract of 
liquidity removed by an order designated as a Customer Complex Order; 
(3) amended the Fee for Removing Liquidity for all participants who are 
assessed such a fee; and (4) created a volume incentive for certain 
market participants that transact significant volumes of Complex Orders 
on the Exchange.
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    \8\ The Select Symbols are listed in Section I of the Phlx Fee 
Schedule.
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    Phlx's proposal to amend the Fee for Removing Liquidity increased 
the Complex Order Fees for Removing Liquidity for the Directed 
Participant,\9\ Market Maker,\10\ Firm, Broker-Dealer, and Professional 
\11\ categories of market participants. The fee for Directed 
Participant transactions increased from $0.30 to $0.32 per contract; 
the fee for Market Makers increased from $0.32 to $0.37 per contract; 
and the fee for Firms, Broker-Dealers, or Professionals

[[Page 26596]]

increased from $0.35 to $0.38 per contract.
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    \9\ The term ``Directed Participant'' applies to transactions 
for the account of a Specialist, Streaming Quote Trader (``SQT'') or 
Remote Streaming Quote Trader (``RSQT'') resulting from a Customer 
order that is (1) directed to it by an order flow provider, and (2) 
executed by it electronically on Phlx XL II. See Phlx Fee Schedule 
at 3.
    \10\ A ``Market Maker'' includes Specialists (see Exchange Rule 
1020) and Registered Options Traders (``ROTs'') (see Exchange Rule 
1014(b)(i) and (ii), which includes SQTs (see Exchange Rule 
1014(b)(ii)(A)) and RSQTs (see Exchange Rule 1014(b)(ii)(B)).
    \11\ The term ``professional'' means any person or entity that 
(i) is not a broker or dealer in securities, and (ii) places more 
than 390 orders in listed options per day on average during a 
calendar month for its own beneficial account(s). See Exchange Rule 
1000(b)(14).
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    The proposal also provided a new volume incentive to Market Makers. 
The Exchange has four categories of market makers--Specialists,\12\ 
ROTs,\13\ SQTs \14\ and RSQTs \15\--that would all be eligible to 
receive the volume incentive. If the Market Maker executes more than 
25,000 contracts of Complex Orders each day in a given month, all of 
that Market Maker's transactions in Complex Orders that remove 
liquidity, both as a Directed Participant and as a Market Maker, shall 
be reduced by $0.01 per contract for that month.
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    \12\ A Specialist is an Exchange member who is registered as an 
options specialist pursuant to Exchange Rule 1020(a).
    \13\ A ROT includes a SQT, a RSQT and a Non-SQT ROT, which by 
definition is neither a SQT nor a RSQT. A Registered Option Trader 
is defined in Rule 1014(b) as a regular member of the Exchange 
located on the trading floor who has received permission from the 
Exchange to trade in options for his own account. See Exchange Rule 
1014(b)(i) and (ii).
    \14\ An SQT is defined in Exchange Rule 1014(b)(ii)(A) as an ROT 
who has received permission from the Exchange to generate and submit 
option quotations electronically in options to which such SQT is 
assigned.
    \15\ An RSQT is defined in Exchange Rule 1014(b)(ii)(B) as an 
ROT that is a member or member organization with no physical trading 
floor presence who has received permission from the Exchange to 
generate and submit option quotations electronically in options to 
which such RSQT has been assigned. An RSQT may only submit such 
quotations electronically from off the floor of the Exchange.
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SR-Phlx-2012-54

    The Exchange's proposal replaced a portion of SR-Phlx-2012-27 to 
provide additional information concerning the current Complex Order 
Directed Participant and Market Maker Fees for Removing Liquidity in 
Select Symbols. The Exchange did not propose to amend any of the fees 
for the Complex Order Directed Participant and Market Maker Fees for 
Removing Liquidity in Select Symbols, but rather included additional 
justification for the differential between the fees paid by Directed 
Participants and Market Makers.

III. Suspension of the Phlx Proposals

    Pursuant to Section 19(b)(3)(C) of the Act,\16\ at any time within 
60 days of the date of filing of a proposed rule change pursuant to 
Section 19(b)(1) of the Act,\17\ the Commission summarily may 
temporarily suspend the change in the rules of a self-regulatory 
organization if it appears to the Commission that such action is 
necessary or appropriate in the public interest, for the protection of 
investors, or otherwise in furtherance of the purposes of the Act.
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    \16\ 15 U.S.C. 78s(b)(3)(C).
    \17\ 15 U.S.C. 78s(b)(1).
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    The Commission believes it is appropriate to further evaluate the 
potential effect of the proposed rule changes on competition among 
different types of market participants and on market quality, 
particularly with respect to the fee differential between Directed 
Participants and Market Makers, and the basis for such differential put 
forth by the Exchange. Under the proposed rule changes, the Exchange 
increased the differential between the fee charged to Directed 
Participants and Market Makers from $0.02 to $0.05. As a result, if a 
Market Maker that is a Directed Participant executes against a Customer 
order directed to that Market Maker for execution by an Order Flow 
Provider (``OFP''),\18\ it will be charged $0.05 less per contract than 
another Market Maker to whom the order is not directed would have been 
charged for executing against that same order.
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    \18\ The term ``Order Flow Provider'' (``OFP'') means any member 
or member organization that submits, as agent, orders to the 
Exchange. See Exchange Rule 1080(l)(i)(B).
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    In the Notice for SR-Phlx-2012-27, the Exchange stated that the 
changes to the Complex Order taker fees in the Select Symbols for 
Market Makers and Directed Participants are reasonable, equitable, and 
not unfairly discriminatory.\19\ The Exchange did not specifically 
analyze the impact, if any, of the changes to the Complex Order taker 
fees on competition.\20\ The Exchange argued that the proposed fee 
change is reasonable, equitable, and not unfairly discriminatory 
because:
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    \19\ See Notice, supra note 5, at 15403.
    \20\ See Section 6(b)(8) of the Act, which requires that the 
rules of a national securities exchange ``not impose any burden on 
competition not necessary or appropriate in furtherance of the 
purposes of [the Exchange Act].''

    (i) Market Makers are not entitled to guaranteed allocations for 
directed Complex Orders; (ii) all Market Makers have an equal 
opportunity to incentivize an OFP to direct an order to it for 
execution on the Exchange; (iii) only Customer orders that are 
directed by an OFP and executed by the intended Market Maker receive 
the Complex Order Directed Participant fee; (iv) the proposed 
Directed Participant and Market Maker Complex Order fees are less 
than the fees assessed to Firms, Professionals and Broker-Dealers 
because of obligations carried by those Market Makers which do not 
burden other participants; (v) Market Makers are unaware of the 
identity of the contra-party at the time of the trade and are also 
required to execute at the best price, pursuant to Exchange Rules, 
against an order intended for them by an OFP in order to be assessed 
the Directed Participant Complex Order Fee for Removing Liquidity 
(the only benefit) which does not happen more than 80% of the time; 
(vi) order flow arrangements benefit all market participants equally 
through added liquidity * * * \21\
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    \21\ See id. at 15404.

    In support of this argument, the Exchange noted that ``an average 
of 14.5% of Customer Complex Orders trade with the Market Maker to 
which they are directed.'' \22\ It also provided an analysis for the 
week of October 10, 2011 of the level of price improvement received by 
Customer Complex Order trading in an auction process on the Exchange. 
Phlx noted that, based on its analysis, ``Customer Complex Orders 
received price improvement 29% of the time and the average level of 
price improvement was $0.059 per option or $5.90 per contract for 
options receiving price improvement.'' \23\ The Exchange stated that 
difference between the proposed fee differential and the price 
improvement levels ``supports the Exchange's belief that the proposed 
fee is reasonable and will have a negligible impact on Directed and 
non-Directed Market Makers,'' \24\ given that the fee differential 
between Directed Participants and Market Makers rose by $0.03 per 
contract, while the average level of price improvement, for options 
receiving price improvement, is $5.90 per contract.
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    \22\ See id. at 15403.
    \23\ See id.
    \24\ Id.
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    The Exchange also noted the justification for the existing $0.02 
differential between Directed Participants and Market Makers is that 
Market Makers that receive Directed Orders have higher quoting 
obligations than Market Makers who do not.\25\
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    \25\ See id. at 15402.
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    The Exchange further stated that increasing this differential is 
intended ``to also reflect the increased costs that are incurred by 
such Market Makers that enter into order flow arrangements at a cost 
and without the benefit of a guaranteed allocation.'' \26\ Phlx stated 
that it wants to encourage Market Makers to enter into order flow 
arrangements and that ``[t]he benefit that a Market Maker brings to the 
Exchange when it pays for order flow is not an insignificant one and 
this benefit should not go unrewarded.'' \27\ The competition for order 
flow, according to the Exchange, provides better execution quality on 
the Exchange, which benefits all participants.\28\
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    \26\ See id.
    \27\ See id. at 15404.
    \28\ See id.
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    In the Second Proposal, Phlx replaced a portion of SR-Phlx-2012-27 
to provide additional justification for the

[[Page 26597]]

differential between the Complex Order Directed Participant and Market 
Maker Fees for Removing Liquidity in Select Symbols (as modified by SR-
Phlx-2012-27). The Exchange argued that the $0.05 per contract 
differential is reasonable, equitable and not unfairly discriminatory 
because: (i) It is consistent with the fee structures at other options 
exchanges; (ii) Market Makers do not receive guaranteed allocations for 
directed Complex Orders; (iii) the only executions that receive the 
reduced Complex Order Directed Participant fee are Market Maker 
executions against Customer orders that are directed by an OFP to the 
executing Market Maker; (iv) Market Makers do not know the identity of 
the contra-party at the time of a trade and must execute at the best 
price; (v) Market Makers compete to offer price improvement in 
auctions; and (vi) the fees for removing liquidity in Complex Orders 
allow the Exchange to offer increased Customer rebates, which attracts 
additional Customer order flow to the Exchange and benefits all market 
participants.
    The Exchange also provided data for the time period from September 
1, 2011 through April 19, 2012, showing the percentage of Customer 
Complex directed orders that traded with the Market Maker to which the 
order was directed, as follows:

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                                                                 October      November     December     January      February                April 1-19,
                       September  2011                             2011         2011         2011         2012         2012     March  2012      2012
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17.02%.......................................................       16.16%       17.94%       14.01%        6.19%       11.47%       14.19%       17.13%
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    The Exchange maintained that ``in a given month the effective 
Complex Order Fee for Removing Liquidity for a Market Maker that also 
has executions subject to the Directed Participant rate is 
approximately $0.02 below the Market Maker Complex Order Fee for 
Removing Liquidity.'' The Exchange also updated the price improvement 
statistics described above to note that the average level of price 
improvement during the week of April 9, 2012 was $5.60 per contract for 
options receiving price improvement.
    The Commission intends to further assess whether the resulting fee 
disparity between Directed Participants and Market Makers ($0.05 per 
contract) is consistent with the statutory requirements applicable to a 
national securities exchange under the Act, as described below. In 
particular, the Commission will assess whether the Phlx Proposals 
satisfy the standards under the Exchange Act and the rules thereunder 
requiring, among other things, that an exchange's rules: provide for 
the equitable allocation of reasonable fees among members, issuers, and 
other persons using its facilities; not be designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers; and do 
not impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Exchange Act.
    Therefore, the Commission finds that it is appropriate in the 
public interest, for the protection of investors, and otherwise in 
furtherance of the purposes of the Act, to temporarily suspend the 
proposed rule changes.

IV. Proceedings To Determine Whether To Approve or Disapprove the Phlx 
Proposals

    The Commission is instituting proceedings pursuant to Sections 
19(b)(3)(C) \29\ and 19(b)(2) of the Act \30\ to determine whether the 
Exchange's proposed rule changes should be approved or disapproved. 
Pursuant to Section 19(b)(2)(B) of the Act,\31\ the Commission is 
providing notice of the grounds for disapproval under consideration. As 
discussed above, under the proposal, a Market Maker that is a Directed 
Participant pays a lower fee than a Market Maker that is not a Directed 
Participant when executing against a Complex Order in a Select Symbol 
that was directed to the Directed Participant. The Exchange Act and the 
rules thereunder require that an exchange's rules: Provide for the 
equitable allocation of reasonable fees among members, issuers, and 
other persons using its facilities; not be designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers; and do 
not impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Exchange Act. The Commission intends 
to further assess whether the Phlx Proposals are consistent with these 
Exchange Act standards.
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    \29\ 15 U.S.C. 78s(b)(3)(C). Once the Commission temporarily 
suspends a proposed rule change, Section 19(b)(3)(C) of the Act 
requires that the Commission institute proceedings under Section 
19(b)(2)(B) to determine whether a proposed rule change should be 
approved or disapproved.
    \30\ 15 U.S.C. 78s(b)(2).
    \31\ 15 U.S.C. 78s(b)(2)(B). Section 19(b)(2)(B) of the Act also 
provides that proceedings to determine whether to disapprove a 
proposed rule change must be concluded within 180 days of the date 
of publication of notice of the filing of the proposed rule change. 
Id. The time for conclusion of the proceedings may be extended for 
up to 60 days if the Commission finds good cause for such extension 
and publishes its reasons for so finding. Id.
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    The Commission believes it is appropriate and in the public 
interest to institute disapproval proceedings at this time in view of 
the significant legal and policy issues raised by the Phlx 
Proposals.\32\ Institution of disapproval proceedings does not 
indicate, however, that the Commission has reached any conclusions with 
respect to the issues involved. The sections of the Act and the rules 
thereunder that are applicable to the proposed rule changes include:
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    \32\ See also Securities Exchange Act Release No. 61547 
(February 19, 2010) 75 FR 8762 (February 25, 2010) (Order of Summary 
Abrogration, in which the Commission abrogated several Phlx fee 
filings, including a fee that would have instituted a $0.16 
differential between certain classes of market makers depending on 
whether they had orders directed to them).
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     Section 6(b)(4) of the Act, which requires that the rules 
of a national securities exchange ``provide for the equitable 
allocation of reasonable dues, fees, and other charges among its 
members and issuers and other persons using its facilities;'' \33\
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    \33\ 15 U.S.C. 78f(b)(4).
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     Section 6(b)(5) of the Act, which requires, among other 
things, that the rules of a national securities exchange not be 
``designed to permit unfair discrimination between customers, issuers, 
brokers, or dealers;'' \34\ and
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    \34\ 15 U.S.C. 78f(b)(5).
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     Section 6(b)(8) of the Act, which requires that the rules 
of a national securities exchange ``not impose any burden on 
competition not necessary or appropriate in furtherance of the purposes 
of [the Exchange Act].'' \35\
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    \35\ 15 U.S.C. 78f(b)(8).
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V. Commission's Solicitation of Comments

    The Commission requests written views, data, and arguments with 
respect to the concerns identified above as well as any other relevant 
concerns. Such comments should be submitted by May 25, 2012. Rebuttal 
comments should be submitted by June 8, 2012. Although there do not 
appear to be any issues relevant to approval or disapproval which would 
be facilitated by an oral presentation of views, data, and

[[Page 26598]]

arguments, the Commission will consider, pursuant to Rule 19b-4, any 
request for an opportunity to make an oral presentation.\36\
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    \36\ 15 U.S.C. 78s(b)(2). Section 19(b)(2) of the Act grants the 
Commission flexibility to determine what type of proceeding--either 
oral or notice and opportunity for written comments--is appropriate 
for consideration of a particular proposal by a self-regulatory 
organization. See Securities Acts Amendments of 1975, Report of the 
Senate Committee on Banking, Housing and Urban Affairs to Accompany 
S. 249, S. Rep. No. 75, 94th Cong., 1st Sess. 30 (1975).
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    The Commission asks that commenters address the sufficiency and 
merit of the Exchange's statements in support of the proposals, in 
addition to any other comments they may wish to submit about the 
proposed rule changes. The Commission is focusing its request for 
comment on the fee for removing liquidity assessed on Directed 
Participants as compared to the fee for removing liquidity assessed on 
Market Makers, not the other fee changes that were included in Phlx-
2012-27. In particular, the Commission seeks comment on the following:
     As noted above, Section 6(b)(5) of the Act requires, among 
other things, that the rules of a national securities exchange not be 
``designed to permit unfair discrimination between customers, issuers, 
brokers or dealers.'' The Commission seeks comment on whether 
discrimination on the basis of whether a market maker has an off-
exchange arrangement to pay an OFP to direct its orders to that market 
maker is a ``fair'' basis for discrimination among its members with 
respect to the fees charged by the exchange. Do commenters' views 
change depending on whether the payment for order flow is pursuant to 
exchange rules or an off-exchange payment for order flow arrangement?;
     The Commission seeks comment on whether the filing for SR-
Phlx-2012-27 or for SR-Phlx-2012-54 was sufficient under Section 19(b) 
of the Act in addressing issues regarding the basis for discrimination 
between Market Makers and Directed Participants in Complex Order 
transaction fees, and whether the basis for such discrimination is 
fair, and why or why not;
     As noted above, Section 6(b)(4) requires that the rules of 
a national securities exchange ``provide for the equitable allocation 
of reasonable dues, fees, and other charges among its members and 
issuers and other persons using its facilities.'' The Commission seeks 
comment on whether the filing for SR-Phlx-2012-27 or for SR-Phlx-2012-
54 was sufficient under Section 19(b) of the Act in addressing issues 
regarding the reasonableness of the proposed fees (and thus the 
proposed fee differential), and whether the amount of the proposed fees 
(and thus the amount of the proposed fee differential), are reasonable, 
and why or why not. Does a flat $0.05 fee differential appropriately 
reflect potential differences that may exist in payment for order flow 
arrangements between market makers and OFPs?;
     Section 6(b)(8) of the Act requires that the rules of a 
national securities exchange ``not impose any burden on competition not 
necessary or appropriate in furtherance of the purposes of [the 
Exchange Act]. The Commission seeks comment on whether the filing for 
SR-Phlx-2012-27 or for SR-Phlx-2012-54 was sufficient under Section 
19(b) of the Act in addressing issues regarding the effects of the 
proposed fee change on competition, and what, if any, impact the 
proposed fee change has or will have on competition, especially as 
between Directed Participants and Market Makers; and
     Whether the proposed fee changes will affect the quality 
of execution of Customer Complex Orders or broader market quality; and 
if so, how and what type of impact will they have.
    Interested persons are invited to submit written data, views, and 
arguments concerning the proposed rule changes, including whether the 
proposed rule changes 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 email to [email protected]. Please include 
File Number SR-Phlx-2012-27 and/or SR-Phlx-2012-54 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-Phlx-2012-27 and/or SR-
Phlx-2012-54. The file number should be included on the subject line if 
email 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 changes that 
are filed with the Commission, and all written communications relating 
to the proposed rule changes 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 Web site 
viewing and printing in the Commission's Public Reference Room, 100 F 
Street NE., Washington, DC 20549, on official business days between the 
hours of 10:00 a.m. and 3:00 p.m. Copies of such filing also will be 
available for inspection and copying at the principal office of the 
Exchange. 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 
publicly available. All submissions should refer to File Number SR-
Phlx-2012-27 and SR-Phlx-2012-54 and should be submitted on or before 
May 25, 2012. Rebuttal comments should be submitted by June 8, 2012.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(3)(C) of the 
Act,\37\ that File Nos. SR-Phlx-2012-27 and SR-Phlx-2012-54, be and 
hereby are, temporarily suspended. In addition, the Commission is 
instituting proceedings to determine whether the proposed rule changes 
should be approved or disapproved.
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    \37\ 15 U.S.C. 78s(b)(3)(C).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\38\
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    \38\ 17 CFR 200.30-3(a)(57) and (58).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-10755 Filed 5-3-12; 8:45 am]
BILLING CODE 8011-01-P