Daily Rules, Proposed Rules, and Notices of the Federal Government
Under sections 6(b) and 19(a) of the Act,
As discussed in greater detail below, the Commission finds that the Exchanges' Form 1 Applications for exchange registration meet the requirements of the Act and the rules and regulations thereunder. Further, the Commission finds that the proposed rules of the Exchanges are consistent with Section 6 of the Act in that, among other things, they are designed to: (1) Assure fair representation of an exchange's members in the selection of its directors and administration of its affairs and provide that, among other things, one or more directors shall be representative of investors and not be associated with the exchange, or with a broker or dealer; (2) prevent fraudulent and manipulative acts and practices, promote just and equitable principles of trade, foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, remove impediments to and perfect the mechanisms of a free and open market and a national market system; and (3) protect investors and the public interest. The Commission also believes that the rules of the Exchanges are consistent with section 11A of the Act.
EDGX and EDGA each have applied to the Commission to register as a national securities exchange. EDGX and EDGA currently operate as separate trading platforms of Direct Edge ECN LLC ("DECN"), an electronic communications network ("ECN") that is a registered broker-dealer. Direct Edge Holdings LLC ("DE Holdings"), a Delaware limited liability company, wholly owns EDGX, EDGA, and DECN. Following EDGX's and EDGA's commencement of operations as national securities exchanges, DECN will cease operations as an ECN and DECN (doing business as DE Route) will begin to operate as a facility of the Exchanges that provides outbound order routing for the Exchanges. DECN also will provide inbound routing services to EDGX from EDGA, and to EDGA from EDGX.
As a limited liability company, DE Holdings is overseen by a Board of Managers ("DE Holdings Board") and ownership in DE Holdings is represented by limited liability membership interests. The Fourth Amended and Restated Limited Liability Company Operating Agreement of DE Holdings ("DE Holdings Operating Agreement") refers to the holders of such interests as "Members."
ISE Holdings, the owner of a 31.54% equity interest in DE Holdings, is also the parent company of International Securities Exchange, LLC ("ISE LLC"), a national securities exchange registered under section 6 of the Exchange Act. Following a corporate transaction in 2007 (the "2007 Transaction"),
In connection with the 2007 Transaction, each of the non-U.S. Upstream Owners adopted corporate resolutions (collectively, the "2007 Resolutions") designed to maintain the independence of the regulatory functions of ISE LLC.
The 2007 Resolutions and the corporate governing documents of U.S. Exchange Holdings and ISE Holdings related to ISE LLC and, by their terms, did not apply to additional national securities exchanges, such as EDGX and EDGA, that the Upstream Owners and ISE Holdings might control, directly or indirectly, as a result of a subsequent transaction. To maintain the independence of the regulatory function of EDGX and EDGA, each of the non-U.S. Upstream Owners has adopted supplemental resolutions (the "Supplemental Resolutions") that apply the 2007 Resolutions to EDGX and EDGA in the same manner and to the same extent as the 2007 Resolutions apply to ISE LLC.
In addition, the Commission has approved changes to the U.S. Exchange Holdings Certificate and U.S. Exchange Holdings Bylaws, and to the ISE Holdings Certificate and ISE Holdings Bylaws, that apply these governing documents to any national securities exchange, or facility thereof, that U.S. Exchange Holdings or ISE Holdings, as applicable, controls, directly or indirectly, including EDGX and EDGA.
The Commission believes that the Supplemental Resolutions, the U.S. Exchange Holdings Certificate and U.S. Exchange Holdings Bylaws, as amended, and the ISE Holdings Certificate and ISE Holdings Bylaws, as amended, will assist EDGX and EDGA in fulfilling their self-regulatory obligations and in administering and complying with the requirements of the Act, as discussed in greater detail below.
As discussed more fully in the Eurex Order,
By its terms, the 2007 Procedure applied solely to information of the Swiss Upstream Owners related to the activities of ISE LLC, including books and records related to the activities of ISE LLC. To accommodate the Swiss Upstream Owners' indirect ownership and voting interest in EDGX and EDGA, the Commission and FINMA (the successor to the SFBC) have developed a procedure (the "2009 Procedure") that is substantially similar to the 2007 Procedure, except that it will apply to any U.S. securities exchange, or facility thereof, that ISE Holdings controls, directly or indirectly, including EDGX and EDGA. The 2009 Procedure, which will become effective upon the Commission's approval of the Exchanges' Form 1 applications, will supersede the 2007 Procedure.
Under the 2009 Procedure, FINMA would serve as a conduit for the delivery of information of the Swiss Upstream Owners related to the activities of any registered national securities exchange controlled, directly or indirectly, by ISE Holdings, including EDGX and EDGA. The Commission's usual practice is to have direct access to books and records related to the activities of a U.S. securities exchange. However, subject to the condition that the Swiss Upstream Owners will promptly deliver such information to the Commission,
In connection with the 2007 Transaction, ISE implemented a Delaware statutory Trust (the "Trust") pursuant to a Trust Agreement ("2007 Trust Agreement") among ISE Holdings, U.S. Exchange Holdings, trustees (the "Trustees"), and a Delaware trustee.
The Trust serves two general purposes. First, for as long as ISE Holdings controls, directly or indirectly, a national securities exchange, including EDGA or EDGA, the Trust would hold capital stock of ISE Holdings in the event that a person obtains an ownership or voting interest in ISE Holdings in excess of the ownership and voting limits established in the ISE Holdings Certificate of Incorporation.
For the reasons discussed in the Eurex Order in connection with the 2007 Trust Agreement,
Although DE Holdings itself will not itself carry out regulatory functions, its activities with respect to the operation of EDGX and EDGA must be consistent with, and not interfere with, the self-regulatory obligations of EDGX and EDGA. The DE Holdings corporate documents include certain provisions that are designed to maintain the independence of the Exchanges' self-regulatory function from DE Holdings, enable EDGX and EDGA to operate in a manner that complies with the federal securities laws, including the objectives of Sections 6(b) and 19(g) of the Act, and facilitate the ability of the Exchanges and the Commission to fulfill their regulatory and oversight obligations under the Act.
For example, DE Holdings submits to the Commission's jurisdiction with respect to activities relating to EDGX and EDGA,
Although the Upstream Owners and ISE Holdings will not carry out any regulatory functions, the activities of each of the Upstream Owners and of ISE Holdings with respect to the operation of EDGX and EDGA must be consistent with, and not interfere with, the self-regulatory obligations of EDGX and EDGA. The 2007 Resolutions, as supplemented by the Supplemental Resolutions, the ISE Holdings Bylaws, the ISE Holdings Certificate, the U.S. Exchange Holdings Certificate, and the U.S. Exchange Holdings Bylaws include certain provisions designed to maintain the independence of the self-regulatory function of EDGX and EDGA, enable EDGX and EDGA to operate in a manner that complies with the U.S. federal securities laws, including the objectives and requirements of Sections 6(b) and 19(g) of the Act,
For example, the Upstream Owners and ISE Holdings provide that each such Upstream Owner, and ISE Holdings, will comply with the U.S. federal securities laws and the rules and regulations thereunder and cooperate with the Commission and EDGX and EDGA.
Further, the non-U.S. Upstream Owners (along with their respective board members, officers, and employees), U.S. Exchange Holdings, and ISE Holdings agree to keep confidential, to the fullest extent permitted by applicable law, all confidential information pertaining to the self-regulatory function of EDGX and EDGA, including, but not limited to, confidential information regarding disciplinary matters, trading data, trading practices, and audit information, contained in the books and records of EDGX or EDGA and not use such information for any commercial
To the extent involved in the activities of EDGX or EDGA, each of the non-U.S. Upstream Owners, its board members, officers, and employees, irrevocably submit to the jurisdiction of the U.S. federal courts and the Commission for purposes of any action arising out of, or relating to, the activities of EDGX or EDGA.
Finally, the 2007 Resolutions, as supplemented by the Supplemental Resolutions, the U.S. Exchange Holdings Certificate, the U.S. Exchange Holdings Bylaws, the ISE Holdings Certificate, and the ISE Holdings Bylaws each require that any change to the applicable document (including any action by the non-U.S. Upstream
Under Section 20(a) of the Act, any person with a controlling interest in EDGX or EDGA would be jointly and severally liable with and to the same extent that EDGX or EDGA is liable under any provision of the Act, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action. In addition, Section 20(e) of the Act creates aiding and abetting liability for any person who knowingly provides substantial assistance to another person in violation of any provision of the Act or rule thereunder. Further, section 21C of the Act authorizes the Commission to enter a cease-and-desist order against any person who has been "a cause of" a violation of any provision of the Act through an act or omission that the person knew or should have known would contribute to the violation. These provisions are applicable to all entities controlling the Exchanges, including the Trust, DE Holdings, ISE Holdings, and the Upstream Owners.
The DE Holdings Certificate includes restrictions on the ability to own and vote shares of the capital stock of DE Holdings.
Generally, no person, other than ISE Holdings, either alone or together with its related persons,
The DE Holdings Board may waive the 40% ownership limitation applicable to persons who are not Exchange members and the 20% voting limitation pursuant to an amendment to the DE Holdings Operating Agreement adopted by the DE Holdings Board if the DE Holdings Board makes certain findings.
Exchange members that trade on an exchange traditionally have ownership interests in such exchange. As the Commission has noted in the past, however, a member's interest in an exchange could become so large as to cast doubt on whether the exchange can fairly and objectively exercise its self-regulatory responsibilities with respect to that member.
In addition, as proposed, the Exchanges will be wholly-owned subsidiaries of DE Holdings. The Amended and Restated Bylaws of EDGX and EDGA (together, the "Exchanges Amended and Restated Bylaws") identify this ownership structure.
The Commission believes that these provisions are consistent with the Act. These requirements should minimize the potential that a person could improperly interfere with or restrict the ability of the Commission or the Exchanges to effectively carry out their regulatory oversight responsibilities under the Act.
In its comment letter, Nasdaq raises questions relating to the ownership and control of EDGX and EDGA, in particular, and of national securities exchanges in general. In this regard, Nasdaq urges the Commission to re-examine the voting and ownership limits applicable to owners of national securities exchanges and to adopt consistent rules that would apply to all national securities exchanges and alternative trading systems.
As discussed above,
Nasdaq also expresses concern regarding potential unfair advantages resulting from exchanges of information between the Exchanges and their Member/owners.
The governing documents of ISE Holdings also include ownership and voting limitations that apply for so long as ISE Holdings controls, directly or indirectly, a national securities exchange (a "Controlled National Securities Exchange"), or facility thereof, including EDGX or EDGA. In particular, the ISE Holdings Certificate provides that, for so long as ISE Holdings controls, directly or indirectly, a Controlled National Securities exchange, no person, either alone or together with its related persons, may own, directly or indirectly, of record or beneficially, more than 40% (or 20% if the person is a member of an exchange controlled by ISE Holdings) of the capital stock of ISE Holdings that has the right by its terms to vote in the election of the Board of Directors of ISE Holdings ("ISE Holdings Board") or on other matters (other than matters affecting the rights, preferences, or
Article XI of the ISE Holdings Bylaws, which originally was adopted in connection with the Eurex Transaction, waives the ISE Holdings Ownership Limits and the ISE Holdings Voting Limits to allow the Upstream Owners to own and vote all of the common stock of ISE Holdings.
Because Article XI, Section 11.1(b) requires the ISE Holdings Board, in waiving the ISE Holdings Ownership Limit and the ISE Holdings Voting Limit, to have determined, with respect to each Upstream Owner, that, among other things, such waiver will not impair the ability of EDGX and EDGA to carry out their functions and responsibilities under the Act, or impair the Commission's ability to enforce the Act, the Commission believes that the Upstream Owners' exercise of ownership and voting control of ISE Holdings will not impair the ability of the Commission or of EDGX and EDGA to discharge their respective responsibilities under the Act.
To facilitate compliance with the ISE Holdings Ownership Limit and the ISE Holdings Voting Limit, the Resolutions of the non-U.S. Upstream Owners, as supplemented by the Supplemental Resolutions, provide that each such owner will take reasonable steps necessary to cause ISE Holdings to be in compliance with the ISE Holdings Ownership Limit and the ISE Holdings Voting Limit.
EDGX and EDGA each have applied to the Commission to register as a national securities exchange. As part of their exchange applications, EDGX and EDGA have filed their Certificates of Incorporation (together, the "Exchange Certificates") and the Exchanges Amended and Restated Bylaws.
Each Exchange Board will be the governing body of its Exchange and will possess all of the powers necessary for the management of the business and affairs of the Exchange and the execution of the Exchange's responsibilities as a self-regulatory organization ("SRO"). Under the Exchanges Amended and Restated Bylaws, each Exchange Board initially will be composed of 19 Directors, including:
* The Chief Executive Officer ("CEO") of EDGX or EDGA, as applicable;
* Four Owner Directors;
* Ten Independent Directors;
* Four Exchange Member Directors.
In addition, at all times, at least 20% of the Directors of each Exchange Board will be Exchange Member Directors and the majority of the Directors of each Exchange Board will be Independent Directors.
Following approval of the Form 1 Applications, DE Holdings, as the sole owner of the common stock of the Exchanges, will elect Directors in accordance with the Exchange Certificates and the Exchanges Amended and Restated Bylaws.
DE Holdings will appoint the initial Nominating Committee
Each Exchange's Nominating Committee will nominate candidates for each director position (other than Owner Directors, Exchange Member Directors, and the director position filled by the CEO), and DE Holdings, as the sole shareholder, will elect those directors. Each Exchange's Member Nominating Committee will nominate candidates for each Exchange Member Director on the Exchange Board.
The Commission believes that the requirement in the Exchanges Amended and Restated By-Laws that 20% of the directors be Exchange Member Directors and the means by which they are chosen by Members provides for the fair representation of members in the selection of directors and the administration of the Exchanges consistent with the requirement in Section 6(b)(3) of the Act.
The Commission has previously stated its belief that the inclusion of public, non-industry representatives on exchange oversight bodies is critical to an exchange's ability to protect the public interest.
In the Exchanges Amended and Restated Bylaws, the Exchanges have proposed to establish several committees. Specifically, each Exchange has proposed to establish the following committees whose members the Exchange Boards, after consultation with the Chairman, may designate: a Compensation Committee;
As a prerequisite for the Commission's approval of an exchange's application for registration, an exchange must be organized and have the capacity to carry out the purposes of the Act.
Membership on the Exchanges will be open to any registered broker or dealer that is a member of another registered national securities exchange or association, or any natural person associated with such a registered broker or dealer.
For a temporary 90-day period after approval of the Exchanges' Form 1 Applications, an applicant that is an active member of another registered national securities exchange or the Financial Industry Regulatory Authority, Inc. ("FINRA") and is a current or former subscriber to DECN will be able to apply through an expedited process to become a member of one or both Exchanges, and to register with the Exchange(s) all of its associated persons whose registrations are active at the time the Exchanges are approved as national securities exchanges, by submitting waive-in application forms, including membership agreements.
All other applicants (and after the 90-day period has ended, those that could have waived in through the expedited process) may apply for membership in one or both Exchanges by submitting a full membership application to the Exchange(s).
Each Exchange will receive and review all applications for membership in the Exchange. If an Exchange is satisfied that the applicant is qualified for membership, the Exchange will promptly notify the applicant, in writing, of such determination, and the applicant will be a member of the Exchange.
Appeal of a staff denial, suspension, or termination of membership will be heard by the Appeals Committee of EDGX or EDGA, as applicable.
The Commission finds that the membership rules of EDGX and EDGA
Each Exchange has proposed several measures to help ensure the independence of its regulatory function from its market operations and other commercial interests. The regulatory operations of each Exchange will be supervised by the Exchange's CRO and monitored by its Regulatory Oversight Committee.
Each Exchange proposes that its CRO have general supervision of the regulatory operations of the Exchange, including overseeing surveillance, examination, and enforcement functions.
In addition, each Exchange has taken steps designed to provide sufficient funding for the Exchange to carry out its responsibilities under the Act. Specifically, each Exchange has represented that: (1) DE Holdings will allocate sufficient operational assets and make a capital contribution to the Exchange's capital account prior to the launch of the Exchange; (2) such an allocation and contribution will be adequate to operate the Exchange, including the regulation of the Exchange; and (3) there will be an explicit agreement between the Exchange and DE Holdings that requires DE Holdings to provide adequate funding for each Exchange's operations, including the regulation of the Exchange.
Although the Exchanges will be SROs with all of the attendant regulatory obligations under the Act, EDGX and EDGA each have stated that they entered into a regulatory contract with FINRA and a regulatory contract with ISE LLC (each, a "Regulatory Contract," and, together, the "Regulatory Contracts"), under which FINRA and ISE will perform certain regulatory functions on behalf of EDGX and EDGA.
The Commission believes that it is consistent with the Act to allow the Exchanges to contract with FINRA and ISE to perform examination, enforcement, and disciplinary functions.
At the same time, each Exchange, unless relieved by the Commission of its responsibility,
Because the exhibits to the Regulatory Contacts, including the Exchange and Commission rules covered by the Regulatory Contracts, have not yet been finalized, the Commission is conditioning the operation of EDGX and EDGA as exchanges on the finalization of the provisions in the Regulatory Contracts that will specify the Exchange and Commission rules for which FINRA and ISE will provide regulatory functions.
Section 19(g)(1) of the Act
EDGX and EDGA each have represented to the Commission that each Exchange and FINRA intend to file Rule 17d-2 agreements with the Commission covering common members of EDGX or EDGA, as applicable, and FINRA. These agreements would allocate to FINRA regulatory responsibility, with respect to common members, for the following:
* FINRA will examine common members of EDGX or EDGA, as applicable, and FINRA for compliance with federal securities laws, rules and regulations, and rules of the Exchange that the Exchange has certified as identical or substantially similar to FINRA rules.
* FINRA will investigate common members of EDGX or EDGA, as applicable, and FINRA for violations of federal securities laws, rules or regulations, or Exchange rules that the Exchange has certified as identical or substantially identical to a FINRA rule.
* FINRA will enforce compliance by common members with the federal securities laws, rules and regulations, and the rules of EDGX or EDGA, as applicable, that the Exchange has certified as identical or substantially similar to FINRA rules.
Because EDGX and EDGA anticipate entering into this Rule 17d-2 agreement, they have not made provision to fulfill the regulatory obligations that would be undertaken by FINRA under these agreements with respect to common members of EDGX or EDGA, as applicable, and FINRA.
As noted above, as a prerequisite for Commission approval of an exchange's application for registration, an exchange must be organized and have the capacity to carry out the purposes of the Act. Among other requirements, an exchange must be able to enforce compliance by its members and persons associated with its members with federal securities laws and the rules of the exchange.
The Exchanges Amended and Restated Bylaws and the Exchanges' rules provide that each Exchange has disciplinary jurisdiction over its members so that it can enforce its members' compliance with its rules and the federal securities laws.
The Commission finds that the Exchanges Amended and Restated By-Laws and the rules of each Exchange concerning the Exchange's disciplinary and oversight programs are consistent with the requirements of sections 6(b)(6) and 6(b)(7)