Self-Regulatory Organizations; BATS Exchange, Inc.; Notice of Filing of Amendment No. 2 and Order Granting Accelerated Approval to Proposed Rule Change, as Modified by Amendment Nos. 1 and 2 Thereto, to Create, on a Six-Month Pilot Basis, a Directed Order Program, 39953-39958 [2011-16922]
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Federal Register / Vol. 76, No. 130 / Thursday, July 7, 2011 / Notices
B. Self-Regulatory Organization’s
Statement on Burden on Competition
The Exchange does not believe that
the proposed rule change will impose
any burden on competition that is not
necessary or appropriate in furtherance
of the purposes of the Act.
C. Self-Regulatory Organization’s
Statement on Comments on the
Proposed Rule Change Received From
Members, Participants, or Others
No written comments were solicited
or received with respect to the proposed
rule change.
III. Date of Effectiveness of the
Proposed Rule Change and Timing for
Commission Action
The Exchange has filed the proposed
rule change pursuant to Section
19(b)(3)(A)(iii) of the Act 14 and Rule
19b–4(f)(6) thereunder.15 Because the
proposed rule change does not: (i)
Significantly affect the protection of
investors or the public interest; (ii)
impose any significant burden on
competition; and (iii) become operative
prior to 30 days from the date on which
it was filed, or such shorter time as the
Commission may designate, if
consistent with the protection of
investors and the public interest, the
proposed rule change has become
effective pursuant to Section 19(b)(3)(A)
of the Act and Rule 19b–4(f)(6)(iii)
thereunder.
A proposed rule change filed under
Rule 19b–4(f)(6) normally does not
become operative prior to 30 days after
the date of the filing.16 However,
pursuant to Rule 19b–4(f)(6)(iii),17 the
Commission may designate a shorter
time if such action is consistent with the
protection of investors and the public
interest. The Exchange has asked the
Commission to waive the 30-day
operative delay so that the proposal may
become operative immediately upon
filing. In its filing, the Exchange notes
that the proposal to add new NYSE Rule
2232 is substantially similar to the rule
that the Commission approved for
FINRA,18 and the proposal conforms the
Exchange’s Rules with those of FINRA,
in furtherance of the consolidation of
14 15
15 17
U.S.C. 78s(b)(3)(A)(iii).
CFR 240.19b–4(f)(6).
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16 Id.
17 17 CFR 240.19b–4(f)(6)(iii). In addition, Rule
19b–4(f)(6)(iii) requires that a self-regulatory
organization submit to the Commission written
notice of its intent to file the proposed rule change,
along with a brief description and text of the
proposed rule change, at least five business days
prior to the date of filing of the proposed rule
change, or such shorter time as designated by the
Commission. The Exchange has satisfied this
requirement.
18 See note 6, supra.
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the member firm regulation functions of
NYSE, NYSE Amex Equities, and
FINRA. Furthermore, the proposed
deletion of the Rule Interpretations to
NYSE Rule 346 would remove
interpretations to an NYSE Rule that no
longer exists and would therefore
eliminate any potential confusion
among members or member
organizations regarding the applicability
of such Rule Interpretations. For these
reasons, the Commission believes that
waiving the 30-day operative delay is
consistent with the protection of
investors and the public interest, and
designates the proposed rule change to
be operative upon filing with the
Commission.19
At any time within 60 days of the
filing of such proposed rule change, the
Commission summarily may
temporarily suspend such rule change 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.
IV. Solicitation of Comments
Interested persons are invited to
submit written data, views, and
arguments concerning the foregoing,
including whether the proposed rule
change is consistent with the Act.
Comments may be submitted by any of
the following methods:
39953
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 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
a.m. and 3 p.m. Copies of the filing will
also be available for inspection and
copying at the NYSE’s principal office
and on its Internet Web site at https://
www.nyse.com. 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–NYSE–
2011–26 and should be submitted on or
before July 28, 2011.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.20
Cathy H. Ahn,
Deputy Secretary.
[FR Doc. 2011–16930 Filed 7–6–11; 8:45 am]
BILLING CODE 8011–01–P
Electronic Comments
• Use the Commission’s Internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
• Send an e-mail to rulecomments@sec.gov. Please include File
Number SR–NYSE–2011–26 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–NYSE–2011–26. 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 (https://www.sec.gov/
rules/sro.shtml). Copies of the
submission, all subsequent
amendments, all written statements
19 For purposes only of waiving the 30-day
operative delay, the Commission has considered the
proposed rule’s impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
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SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–64781; File No. SR–BATS–
2011–009]
Self-Regulatory Organizations; BATS
Exchange, Inc.; Notice of Filing of
Amendment No. 2 and Order Granting
Accelerated Approval to Proposed
Rule Change, as Modified by
Amendment Nos. 1 and 2 Thereto, to
Create, on a Six-Month Pilot Basis, a
Directed Order Program
June 30, 2011.
I. Introduction
On March 16, 2011, BATS Exchange,
Inc. (the ‘‘Exchange’’ or ‘‘BATS’’) 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 proposal to
establish, on a six-month pilot basis, a
directed order (‘‘Directed Order’’)
program on its options facility (‘‘BATS
20 17
CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
1 15
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Options’’). On March 24, 2011, BATS
filed Amendment No. 1 to the proposed
rule filing. The proposed rule change, as
modified by Amendment No. 1, was
published for comment in the Federal
Register on April 1, 2011.3 The
Commission received 13 comment
letters from 8 commenters on the
proposal,4 and a letter from BATS
responding to the comment letters.5 On
June 2, 2011, BATS filed Amendment
No. 2 to the proposed rule change.6 The
Commission is publishing this notice to
solicit comments on Amendment No. 2
from interested persons, and is
approving the proposal, as modified by
Amendment Nos. 1 and 2, on an
accelerated basis, for a six-month pilot
period ending January 30, 2012.
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II. Description of the Proposed Rule
Change, as Modified by Amendment
Nos. 1 and 2
The Exchange proposes to allow
members of BATS Options (‘‘Options
Members’’) to direct orders to BATS
Options market makers under certain
conditions. Specifically, the proposal
would establish two new order types—
a ‘‘Directed Order’’ and a ‘‘Market
Maker Price Improving Order’’
(MMPIO). A Directed Order would be an
3 See Securities Exchange Act Release No. 64132
(March 28, 2011), 76 FR 18280 (‘‘Notice’’).
4 See Letters to Elizabeth M. Murphy, Secretary,
Commission, from Jennifer M. Lamie, Assistant
General Counsel, Legal Division, Chicago Board
Options Exchange (‘‘CBOE’’), dated June 29, 2011
(‘‘CBOE II Letter’’); Tom Wittman, The NASDAQ
OMX PHLX, Inc. and The NASDAQ Options Market
(together ‘‘Nasdaq’’), dated June 24, 2011 (‘‘Nasdaq
II Letter’’); Janet L. McGinness, SVP & Corporate
Secretary, Legal & Government Affairs, NYSE
Euronext, dated June 17, 2011 (‘‘NYSE Euronext II
Letter’’); Michael J. Simon, Secretary, International
Securities Exchange, LLC (‘‘ISE’’), dated June 17,
2011 (‘‘ISE II Letter’’); Anthony D. McCormick,
Chief Executive Officer, BOX Options Exchange
Group, LLC (‘‘BOX’’)), dated June 13, 2011 (‘‘BOX
II Letter’’); Angelo Evangelou, Assistant General
Counsel, Legal Division, CBOE, dated April 27,
2011 (‘‘CBOE I Letter’’); John C. Nagel, Managing
Director and General Counsel, Asset Management
and Markets, Citadel LLC, dated April 25, 2011
(‘‘Citadel Letter’’); Andrew Stevens, Legal Counsel,
IMC Chicago, LLC d/b/a IMC Financial Markets,
dated April 21, 2011 (‘‘IMC Letter’’); Janet L.
McGinness, SVP & Corporate Secretary, Legal &
Government Affairs, NYSE Euronext, dated April
21, 2011 (‘‘NYSE Euronext I Letter’’); Kurt Eckert,
Principal, Wolverine Trading, LLC, dated April 21,
2011 (‘‘Wolverine Letter’’); Tom Wittman, Nasdaq,
dated April 21, 2011 (‘‘Nasdaq I Letter’’); Michael
J. Simon, Secretary, ISE, dated April 21, 2011 (‘‘ISE
I Letter’’); and Anthony D. McCormick, Chief
Executive Officer, BOX, dated March 29, 2011
(‘‘BOX I Letter’’).
5 See Letter to Elizabeth M. Murphy, Secretary,
Commission, from Jeromee Johnson, BATS, dated
June 2, 2011 (‘‘BATS Letter’’).
6 In response to comments received on the
proposed rule change, as modified by Amendment
No. 1 thereto, the Exchange filed Amendment No.
2 to revise the proposed rule change to permit
BATS Options Members to send Directed Orders to
more than one BATS Options market maker.
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order directed by an Options Member to
one or more BATS Options market
makers for possible execution against
the MMPIO of the BATS Options market
maker(s).7 To direct an order to a
particular BATS Options market maker,
the Options Member must be on a list
of eligible Options Members provided to
the Exchange by the BATS Options
market maker.8
To be eligible to receive a Directed
Order, a BATS Options market maker
must enter a MMPIO. The MMPIO
would contain both a displayed price, as
well as a better non-displayed price at
which the market maker is willing to
trade with a Directed Order. The
MMPIO would be ranked on the BATS
Options book at its displayed price. The
non-displayed price would not be
entered on the BATS Options book, but
instead would be converted to a buy or
sell order at the non-displayed price in
response to a Directed Order directed to
the market maker, up to the full
displayed size of the MMPIO. Thus, an
incoming marketable non-Directed
Order would execute against the market
maker’s displayed quote, not its nondisplayed better price. To be able to
participate in an execution against a
Directed Order: (i) The market maker
must be quoting on BATS with a
MMPIO that contains a displayed price
at the NBBO at the time the Directed
Order arrives on BATS; (ii) the nondisplayed price of the MMPIO must be
at a price better than the NBB (for sell
Directed Orders) or the NBO (for buy
Directed Orders) and marketable against
the Directed Order; 9 and (iii) as noted
above, the Directed Order must have
come from an Options Member on the
market maker’s list of eligible Options
Members.
If the above conditions in (i), (ii), and
(iii) are met, and if there are no other
non-displayed orders at prices equal to
or better than the non-displayed price of
the MMPIO, the Directed Order will
trade with the MMPIO up to the full size
of the MMPIO. If there are nondisplayed orders on the BATS Options
book at prices equal to or better than the
non-displayed price of the MMPIO,
those other non-displayed orders will in
all cases have priority over the nondisplayed price of the MMPIO. In such
circumstances, the MMPIO may still
execute at its non-displayed price
7 As originally proposed, Options Members could
only send Directed orders to one BATS Options
market maker. In Amendment No. 2, BATS revised
the proposal to permit Options Members to send
Directed Orders to more than one BATS Options
market maker.
8 BATS Rule 21.1(d)(14).
9 The non-displayed price also must be at least
one cent better than the NBB or NBO, as applicable.
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against the Directed Order to the extent
of any remaining contracts of the
Directed Order. If a Directed Order is
directed to more than one BATS
Options market maker, such Directed
Order will execute in price/time priority
based on the non-displayed price of
such orders, to the extent the Directed
Order can execute against any
MMPIO.10
BATS notes that, if an Options
Member notifies a BATS Options market
maker of its intention to submit a
Directed Order so that the BATS
Options market maker could change its
quotation to match the NBB or NBO
immediately prior to submission of the
Directed Order, the parties would be
engaging in conduct inconsistent with
just and equitable principles of trade in
violation of BATS Rules 3.1 and 18.4(f).
In addition, BATS notes that a BATS
Options market maker who becomes
aware of a customer order from an
affiliated broker-dealer or desk within
the same broker-dealer and acts on such
information to change its quotations to
match the NBB or NBO immediately
prior to submission of a Directed Order
would be in violation of the BATS Rule
22.10, ‘‘Limitations on Dealings.’’ BATS
represents that it will proactively
conduct surveillance for such conduct
and enforce against such violations.11
BATS proposes to establish its
Directed Order program on a six-month
pilot basis. BATS represents that, during
the pilot period, it will study the impact
of the rules and will provide the
Commission with monthly reports
detailing its ongoing review of the pilot.
Such reports would include statistics
with respect to:
• The number of Directed Orders
submitted to BATS Options;
10 See
Amendment No. 2.
commenter on the proposal believes that
the proposed rule change does not address whether
it would be permissible for a BATS Options market
maker to share the details of its MMPIO, whether
existing or prospective, with an order flow provider
(affiliated or otherwise) so that the order flow
provider could make routing decisions based on
this information. See NYSE Euronext I Letter at 5–
6. If a BATS Options market maker informs an order
entry firm of its intention to modify its quotation
or details about its MMPIO so that the BATS
Options Member could send a Directed Order to the
BATS Options market maker, BATS would view
this as pre-arranged trading and would consider
this to be a violation of BATS Rules 3.1 (just and
equitable principles of trade) and 18.4(f) (misuse of
material non-public information). See E-mail to
David Hsu, Assistant Director, Division of Trading
and Markets, Commission, from Anders Franzon,
BATS, dated June 27, 2011. If the order entry firm
was an affiliate or a desk within the same firm as
the BATS Options market maker, and the BATS
Options market maker shared information regarding
its planned quoting activities or details about the
market maker’s MMPIO, then BATS would consider
this to be a violation of BATS Rule 22.10
(Limitation on Dealings). Id.
11 One
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• The number of MMPIOs submitted
to BATS Options;
• Information regarding the types of
market participants that sent Directed
Orders;
• The number of Market Makers that
participated in the directed order
program;
• The percentage of time that Market
Makers participating in the directed
order program were at the NBBO when
a Directed Order arrived at BATS
Options;
• The number of orders, excluding
MMPIOs, against which an incoming
Directed Order executed;
• The proportion of each Directed
Order that was executed against a
MMPIO;
• The percentage of Directed Orders
that received price improvement over
the NBBO;
• The average amount of price
improvement for Directed Orders; and
• Data related to the quality of the
best bid and offer on BATS Options.
commenters argue that other market
participants will not be able to
effectively compete with a BATS
Options market maker with a MMPIO
because, although other market
participants also can enter orders that
have a non-displayed price on the BATS
book at a price equal to or better than
the non-displayed price of the
MMPIO,15 that non-displayed price
would be at risk to all incoming
marketable orders, not just Directed
Orders from a select list of eligible
customers.16 Commenters further argue
that other market participants are at a
`
further competitive disadvantage vis-avis BATS options market makers with
MMPIOs in one cent MPV options
because BATS Options market makers
would be able to enter MMPIOs with
non-displayed prices in penny
increments, but other market
participants could not enter orders with
non-displayed prices in penny
increments.17 Several commenters argue
that BATS Options market makers will
III. Summary of Comments
that enjoyment should be the requirement that
directed orders be exposed on the market or subject
to a specific auction mechanism so that customers
enjoy the greatest amount of opportunity for price
improvement’’) and IMC Letter at 2 (stating that the
structure of the BATS Directed Order program
‘‘unduly limits competition as such does not
contribute to price discovery.’’). In addition, BOX
states that, because the proposal permits only BATS
Options market maker(s) designated by the Options
Member to compete for the Directed Order, and
such designation is at the discretion of the Options
Member, a ‘‘substantial conflict of interest may
arise,’’ incenting BATS Options market makers to
significantly increase payment for order flow
payments so that they can be the sole destination
for the Option Member’s customer orders. See BOX
II Letter at 1–2. This commenter also argues that,
although the rule would allow an Options Member
to submit Directed Orders to multiple BATS
Options Market Makers, competition for the order
is still limited because the order would be exposed
to some—but not all—market participants. See BOX
II Letter at 1–2.
15 In options with a five or ten cent minimum
price variation (‘‘MPV’’), other market participants
would be able to enter a non-displayed price using
a Price Improving Order to compete with MMPIOs
for Directed Orders. A Price Improving Order would
receive priority over MMPIOs at the same nondisplayed price. However, the non-displayed price
of a Price Improving Order would be available to
all incoming marketable orders, in contrast to the
non-displayed price of an MMPIO, which would
only be available to incoming Directed Orders.
16 See, e.g., CBOE I Letter at 2; CBOE II Letter at
4; Citadel Letter at 2; IMC Letter at 2; ISE I Letter
at 3; ISE Letter II at 1–2; Nasdaq I Letter at 2,
Nasdaq II Letter at 1, and NYSE Euronext II Letter
at 4.
17 See CBOE I Letter at 2; CBOE II Letter at 2;
Citadel Letter at 2; IMC Letter at 2; and Nasdaq I
Letter at 2. These commenters believe that, because
the orders of these market participants would be
displayed in options with a one cent MPV, they
would be at greater risk of being executed against
informed order flow. On the other hand, because
MMPIOs may be entered in increments as small as
one cent and are not displayed, BATS Options
market makers with MMPIOs are not subject to the
same risk. Id. See also NYSE Euronext II Letter at
4.
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The Commission received 13
comment letters from 8 commenters
opposing the proposal.12 These
commenters generally argue that,
because Directed Orders will not be
exposed to meaningful competition, the
proposal will disincent market makers
from quoting aggressively and
negatively impact the price at which the
Directed Orders are executed.13
Several commenters argue that the
lack of a requirement that the Directed
Order be exposed to all market
participants or be subject to a separate
auction mechanism will prevent other
market participants from any
opportunity to provide further price
improvement to the Directed Order, and
thus harm the Directed Order.14 Several
12 See supra note 4. In addition, the Commission
notes that in response to an earlier Directed Order
proposal filed and later withdrawn by the Exchange
(SR–BATS–2010–034) that was substantially similar
to the instant proposal (the ‘‘Prior Proposal’’), one
commenter had stated that the proposal would be
beneficial to retail investors by providing firms with
competitive opportunities to seek price
improvement on client option orders. See Letter to
Elizabeth M. Murphy, Secretary, Commission, from
Christopher Nagy, Managing Director, Order
Strategy, TD Ameritrade, dated December 23, 2010
(‘‘Ameritrade Letter’’).
13 See BOX I Letter at 1; BOX II Letter at 1–2;
CBOE I Letter at 2; Citadel Letter at 2; IMC Letter
at 2; ISE I Letter at 3; ISE II Letter at 3; Nasdaq I
Letter at 3; NYSE Euronext I Letter at 3; NYSE
Euronext II Letter at 4; and Wolverine Letter at 1.
14 See BOX I Letter at 1–2; CBOE I Letter at 2–
3; CBOE II Letter at 3–5; IMC Letter at 2; ISE I Letter
at 4; Nasdaq I Letter at 3; NYSE Euronext I Letter
at 4, and NYSE Euronext II Letter at 3–4. See also
BOX II Letter at 2 (arguing that, if BATS Options
market makers receive Directed Orders from only
their list of eligible Options Members, the ‘‘cost of
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39955
be able to enter MMPIOs with better
non-displayed prices than other
competing market participants, thus
effectively resulting in 100 percent
internalization of Directed Orders
(assuming the participating market
maker is always willing to provide
prices better than the NBBO) without
the opportunity for exposure.18 In
addition, a few commenters argue that
price discovery will be negatively
impacted by the perpetuation of a twotiered market for customers—one
market reflecting publicly available
prices and sizes, and another market
reflecting a non-public pool of liquidity
available for only certain approved
customers.19
In response to commenters, BATS
countered that certain order flow
sending firms today have order flow,
which by its very nature, is more
valuable to some market participants
than the flow of other order flow
sending firms.20 BATS notes market
makers already retain the discretion to
pay certain firms non-transparent
payment for order flow amounts.21
BATS asserts that its proposal similarly
retains that existing discretion for
market makers, but provides a
mechanism for such payments, or at
least a portion of such payments, to be
provided in a transparent fashion to the
Directed Order in the form of price
improvement over the NBBO.22
According to BATS, the proposal puts
in place a structure by which all
members can both compete for that flow
by contributing to price and size
discovery for the entire market and
reward that flow with price
improvement above and beyond the
NBBO.23
Further, BATS notes that BATS
Options market makers must enter
orders that assume the risk of trading
with all participants at NBBO, and must
commit to price improvement over the
NBBO without knowing the details of
the particular order and being
guaranteed an allocation.24 BATS notes
that other directed order programs on
other exchanges do not impose this
18 See Citadel Letter at 2–3; Nasdaq I Letter at 2–
3; and Nasdaq II Letter at 2.
19 See Citadel Letter at 2; ISE I Letter at 2; and
Wolverine Letter at 2. See also CBOE I Letter at 3
and CBOE II Letter at 2, wherein CBOE argues that
the MMPIO is inconsistent with Rule 602 of
Regulation NMS, 17 CFR 242.602 (the ‘‘Quote
Rule’’), because the BATS proposal would only
require the MMPIO to be firm for pre-selected
Directed Order participants (as opposed to all
incoming interest received by BATS).
20 See BATS Letter at 6–7.
21 See Notice, supra note 3, at 18283.
22 Id.
23 See BATS Letter at 6–7.
24 See BATS Letter at 3–4.
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requirement to provide price
improvement.25 In addition, BATS
argues that by not providing allocation
guarantees, the proposed Directed Order
program provides incentives to BATS
Options market makers as well as
Options Members to aggressively quote,
both at the NBBO and at non-displayed
prices better than the NBBO.26
Several commenters state that,
because Directed Orders on BATS are
not exposed to all market participants,
BATS Options market makers will not
be motivated to offer more than the
minimum amount of price improvement
($0.01) to a customer.27 In its response
letter, BATS states that the proposed
rule does not cap the price improvement
opportunities available to Options
Members in the price-time priority
market of BATS Options; rather the
proposed rule merely provides a
minimum amount of price improvement
that must be offered to a Directed
Order.28 Another commenter, however,
argues that although the BATS proposal
does not cap price improvement, the
lack of competition at the non-displayed
prices combined with the burden of
quoting at the NBBO will depress the
amount of price improvement offered by
BATS Options market makers.29
Commenters further argue that the
proposal will disincent market makers
that do not have arrangements with
Options Members from aggressively
quoting and posting liquidity.30
According to one of these commenters,
BATS Options market makers to whom
orders are not directed would have little
to no incentive to quote at the NBBO
because they would not be rewarded
with trade executions, as Directed
Orders would execute against nondisplayed interest one increment better
rather than the NBBO.31 Another
25 Id.
26 See
Notice, supra note 3, at 18282.
BOX I Letter at 2; NYSE Euronext I Letter
at 4 and NYSE Euronext II Letter at 4. See also
Citadel Letter at 2.
28 See BATS Letter at 6.
29 See ISE II Letter at 2–3.
30 See BOX I Letter at 1 and Wolverine Letter at
1. See also BOX II Letter at 2 (arguing that the high
probability that an Options Member will designate
only one BATS Options market maker to receive a
Directed Order will mean internalization rates are
likely to reach 100 percent and have the ‘‘additional
effect of discouraging competition on the regular
order book across all of the options market,
resulting in further degradation of NBBO spreads,
to the detriment of all customers.’’); ISE Letter at 6
(stating that the lack of competition for a Directed
Order would result in a 100 percent execution
guarantee for BATS Options market makers, which
would be a significant departure from Commission
policy that limits the level of allocation guarantees
at 40 percent of the order to assure that such
guarantees do not remove the incentive for other
market participants to compete); NYSE Euronext II
Letter at 5 (arguing similarly).
31 See Wolverine Letter at 1.
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27 See
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commenter also contends that, if the
proposed rule change is approved,
market participants that do not receive
Directed Orders would be forced to
quote less aggressively to account for
adverse selection because MMPIOs
would cherry-pick the most desirable
order flow from the market with private
hidden quotes.32 As a result, according
to this commenter, market liquidity
would be damaged and average publicly
quoted spreads would widen in some
options contracts, particularly those that
trade with wider than average spreads.33
Some commenters argue that the
proposal would result in inferior
executions for customer orders when a
BATS Options market maker with a
MMPIO at the best price is not selected
by an Options Member to receive its
Directed Order.34 One of these
commenters argues that the proposal is
inconsistent with the Act because, if
two MMPIOs have different nondisplayed prices, a Directed Order could
be directed to the MMPIO with the
inferior price, resulting in a tradethrough of a better price that is available
to other participants.35 BATS
acknowledges that this factual scenario
could be the case, but states that in the
same way that the Directed Order
proposal empowers BATS Options
market makers to select which order
flow providing firms to whom they wish
to offer price improvement for the
customers of that firm, the proposal also
empowers Options Members to select
which market making firms they wish to
preference.36 BATS believes that this is
an important distinction that provides
Options Members with competitive
opportunities to seek price
improvement on customer orders.37
Further, BATS has amended its
proposal to clarify that Options
Members can enter into arrangements
with, and elect to direct an order to,
multiple market makers.38 In such case,
the incoming Directed Order would
execute against the Directed Order
market maker with the best nondisplayed price (assuming that the
Directed Order would execute against
an MMPIO).
Citadel Letter at 2.
id.
34 See BOX II Letter at 2; Nasdaq I Letter at 1;
Nasdaq Letter II at 2–3; NYSE Euronext I Letter at
2; and NYSE Euronext II Letter at 5.
35 See Nasdaq I Letter at 1. See also NYSE
Euronext II Letter at 5.
36 See BATS Letter at 4–5.
37 See id.
38 See Amendment No. 2.
PO 00000
32 See
33 See
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Sfmt 4703
IV. Discussion and Commission
Findings
After careful consideration of the
proposal and the comments received,
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 39 and, in particular, the
requirements of Section 6 of the Act.40
Specifically, the Commission finds that
the proposed rule change, as amended,
is consistent with Section 6(b)(5) of the
Act,41 which requires, among other
things, that the rules of a national
securities exchange be designed to
prevent fraudulent and manipulative
acts and practices, to promote just and
equitable principles of trade, to foster
cooperation and coordination with
persons engaged in regulating, clearing,
settling, processing information with
respect to, and facilitating transactions
in securities, to remove impediments to
and perfect the mechanism of a free and
open market and a national market
system, and, in general, to protect
investors and the public interest and are
not designed to permit unfair
discrimination between customers,
issuers, brokers or dealers.
The Commission notes that the
proposed rule change is designed to
enhance opportunities in the market for
BATS Options market makers to
provide, and Options Members to
obtain, price improvement for their
customer orders. Specifically, to be
eligible to trade with a Directed Order,
the proposal requires a BATS Options
market maker to have entered a MMPIO
with a displayed price equal to the NBB
(for sell Directed Orders) or the NBO
(for buy Directed Orders), as well as a
non-displayed price at least one cent
better than the NBB or NBO, as
applicable.42 Thus, the Directed Order
would receive price improvement over
the NBB or NBO, as applicable.
However, as discussed above,
commenters expressed concern that the
lack of exposure of the Directed Orders
would negatively impact quote
competition and deny other market
participants meaningful opportunities to
provide further price improvement to a
Directed Order.43
The Commission has carefully
considered the arguments expressed by
39 In approving this proposed rule change the
Commission has considered the proposed rule’s
impact on efficiency, competition, and capital
formation. 15 U.S.C. 78c(f).
40 15 U.S.C. 78f.
41 15 U.S.C. 78f(b)(5).
42 BATS Rule 21.1(d)(13).
43 See supra notes 14–33 and accompanying text.
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commenters and by the Exchange. The
Commission recognizes the concerns
expressed and the difficult issues
involved. The Commission believes that
order exposure generally is beneficial to
options markets in that it provides an
incentive to options market makers to
provide liquidity and therefore plays an
important role in ensuring competition
in the options markets.44 The
Commission also recognizes, however,
the importance of providing effective
opportunities for customer order flow in
listed options to receive executions at
prices better than the NBBO. In
evaluating the proposal, the
Commission has weighed the relative
merits of each for the options markets.
On the options markets, specialists
and market makers often compete for
order flow by offering cash or non-cash
inducements, known as payment for
order flow (‘‘PFOF’’),45 to brokers to
send their orders to a particular market
maker or exchange.46 PFOF
arrangements are prevalent in today’s
market.47 These arrangements likely
impact the incentives for market makers
(or others) to quote aggressively to trade
with order flow covered by such PFOF
arrangements because market
participants know that the market
44 See Securities Exchange Act Release No. 63955
(February 24, 2011), 76 FR 11533 at 11540 (March
2, 2011) (SR–ISE–2010–73).
45 The Commission has defined PFOF broadly as
‘‘any monetary payment, service, property, or other
benefit that results in remuneration, compensation,
or consideration to a broker or dealer from any
broker or dealer, national securities exchange,
registered securities association, or exchange
member in return for the routing of customer orders
by such broker or dealer to any broker or dealer,
national securities exchange, registered securities
association, or exchange member for execution,
including but not limited to: research, clearance,
custody, products or services; reciprocal agreements
for the provision of order flow; adjustment of a
broker or dealer’s unfavorable trading errors; offers
to participate as underwriter in public offerings;
stock loans or shared interest accrued thereon;
discounts, rebates, or any other reductions of or
credits against any fee to, or expense or other
financial obligation of, the broker or dealer routing
a customer order that exceeds that fee, expense or
financial obligation.’’ 17 CFR 240.10b–10(d)(9).
46 Under a typical payment for order flow
arrangement, a specialist or market maker offers an
order entry firm cash or other economic
inducement to route its customer orders to that
specialist’s or market maker’s exchange because the
specialist or market maker knows it will be able to
trade with a portion of all incoming orders,
including those from firms with which it has
payment for order flow arrangements. For further
discussion of PFOF and its impact on the options
markets, see Securities Exchange Act Release No.
49175 (February 3, 2004), 69 FR 6124 (February 9,
2004).
47 Reports under Rule 606 of Regulation NMS
indicate that nearly all retail broker-dealers
participate in PFOF arrangements. Regulation NMS
Rule 606 reports posted by broker-dealers for the
fourth quarter of 2010 indicate PFOF amounts that
generally are around $0.30 per contract and can
range up to $0.85 per contract.
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makers will be able to trade with some
or all of the captured order flow as long
as they match the NBBO (whether by
displaying quotes that match the NBBO
set by others or by matching better
quotes elsewhere pursuant to
mechanisms that provide market makers
with the opportunity to step-up and
trade with orders that are exposed for
one second).
The BATS proposal offers an
alternative mechanism to enable market
makers to compete for order flow by
providing better prices directly to
customers 48 rather than through
payments to the customer’s broker.49
The proposal allows market makers to
differentiate between orders from
traders that are relatively more informed
about the short-term direction of prices
(e.g., professional traders) and orders
from less informed traders (e.g., retail
investors). In this way, it may enable
BATS Options market makers to provide
better prices to less informed order flow
that they otherwise would not be
willing or able to provide if they had to
make those prices available to all
incoming order flow.50 The Commission
recognizes that other exchanges have
adopted different mechanisms that
include an order exposure element to
provide price improvement to customer
48 See also discussion of Ameritrade Letter on the
Prior Proposal, supra note 12.
49 The Commission views the BATS proposal as
an alternative mechanism to PFOF, as it provides
a means to benefit customers directly through price
improvement, rather than the customer’s broker
through PFOF. The Commission is approving the
BATS proposal in the context of the existence of
PFOF arrangements in the options markets. Should
such arrangements no longer be present in the
options market, the Commission expects the
Exchange to re-evaluate, and the Commission may
re-evaluate, whether the Directed Order program is
appropriate.
The Commission acknowledges, however, that
the BATS proposal does not preclude an Options
Member from separately entering into a PFOF
arrangement with a BATS Options market maker
but believes that, even if such arrangements occur,
executions occurring pursuant to this proposal
would receive prices better than the NBBO, thus
providing a direct benefit to customers in the form
of price improvement.
50 It is well known in academic literature and
industry practice that prices tend to move against
market makers after trades with informed traders,
often resulting in losses for market makers. See
Stoll, H. R., ‘‘The supply of dealer services in
securities of markets,’’ Journal of Finance 33 (1978),
at 1133–51; Glosten, L. and P. Milgrom, ‘‘Bid ask
and transaction prices in a specialist market with
heterogeneously informed agents,’’ Journal of
Financial Economics 14 (1985), at 71–100; and
Copeland, T., and D. Galai, ‘‘Information effects on
the bid-ask spread,’’ Journal of Finance 38 (1983),
at 1457–69. Thus, there is a strong economic
rationale for market makers not providing informed
traders price improvement. Uninformed investors
end up bearing the cost of these market maker
losses through wider spreads that market makers
need to quote to uninformed investors due to
informed order flow. Id.
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39957
orders.51 The Commission questions,
however, the extent to which these
mechanisms are utilized. In the context
of this options market structure, the
Commission believes that the proposal
to provide an alternative mechanism for
BATS options market makers to provide
executions for customer orders at prices
better than the NBBO is consistent with
the Act.52
In response to commenters’ concerns
that the proposal would perpetuate a
two-tiered market for customers—one
market reflecting publicly available
prices and sizes, and another reflecting
a non-public pool of liquidity available
for only certain approved customers 53—
the Commission notes that the Act does
not prohibit exchange members or other
broker-dealers from discriminating
among customers, so long as their
activities are not otherwise inconsistent
with the federal securities laws.54 The
Commission also notes that the Act does
not require exchanges to preclude
discrimination by broker-dealers.
Indeed, the Commission notes that
broker-dealers commonly differentiate
between customers based on the nature
51 The Commission notes that market makers on
two other exchanges are not required to provide
price improvement to Directed Orders using their
price improvement auctions, whereas the BATS
Directed Order program requires that a BATS
Options market maker provide price improvement
when entering the MMPIO over the NBBO to be
able to trade with the Directed Order. See BOX
Rules, Chapters V, Section 18 (The Price
Improvement Period) and VI, Section 5(c)
(Obligations of Market Makers) and ISE Rules 723
(Price Improvement Mechanism for Crossing
Transactions) and 811 (Directed Orders). The
Commission further notes that orders are not
exposed for possible price improvement on other
exchanges with ‘‘preferenced’’ order programs.
Under the ‘‘preferenced’’ order programs on other
exchanges, orders are sent to certain market makers,
who, if quoting at the NBBO at the time the
preferenced order is received, are guaranteed up to
40% of the order at that price, after resting customer
orders at that price, if any, are executed. See, e.g.,
CBOE Rule 8.13; ISE Rule 713, Supplementary
Material .03; NYSE Amex Rule 964NY and
964.1NY.
52 In response to comments that, because Directed
Orders on BATS are not exposed to all market
participants, BATS Options market makers would
not be motivated to offer more than the minimum
amount of price improvement to a customer, the
Commission notes that, under the proposed rule, as
amended, an Options Member may encourage
competition for its Directed Orders by submitting
them to more than one BATS Options market maker
that has put that member on its eligible customer
list, thereby potentially encouraging such market
makers to provide more than a minimum amount
of price improvement.
53 See supra note 19 and accompanying text.
54 The Commission further notes that it does not
agree with the comment that an MMPIO is
inconsistent with the Quote Rule (see supra note
19). An MMPIO is firm and available to all market
makers at its displayed price. The non-displayed
price of a MMPIO, however, is not communicated
to market participants and thus is not a bid or offer
for which a market maker is required to be firm
pursuant to the Quote Rule.
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sroberts on DSK5SPTVN1PROD with NOTICES
and profitability of their business.
Further, in general, investors as a class
tend to have an opinion on the longterm prospects of a company, and are
less informed about the intraday price
movements that affect the profitability
of market makers. Thus, market makers
often view less informed order flow as
desirable, and there is intense
competition for this order flow.
Allowing market makers to differentiate
between customers may further
encourage market makers to provide
price improvement to less informed
customer order flow, which would inure
to the benefit of investors. One of the
core principles of the Act, and Section
6(b)(5) thereof, is the protection of
investors. Accordingly, the Commission
does not believe that it would be
inconsistent with the Act for the
Exchange to provide, under the
circumstances and facts set forth in this
proposal, BATS Options market makers
the ability to differentiate between
customers in providing price
improvement in the form of MMPIOs.55
The Exchange has proposed that the
Directed Order program operate on a
six-month pilot basis so that the
Commission and the Exchange can
monitor the effects of the pilot on the
markets and investors, and consider
appropriate adjustments, as necessary.
To help the Commission and the
Exchange evaluate the Directed Order
program during the pilot, the Exchange
proposes to provide to the Commission
monthly data regarding price
improvement and competition in the
Directed Order program.56 In addition,
the Exchange has also represented to the
Commission that it will provide a
regulatory study regarding how it tests
to determine whether the appropriate
information barriers are in place to
protect against an order flow provider
giving a market maker advance notice of
an incoming Directed Order or a BATS
Options market maker providing
information regarding its planned
quoting activities or details about its
MMPIO to an order flow provider.
Approving the proposal on a pilot basis
and requiring submission of monthly
55 See, e.g., Securities Exchange Act Release No.
64097 (March 18, 2011), 76 FR 16650 (March 24,
2011) (SR–BX–2010–079) (eliminating the
anonymity of Directed Orders on a permanent
basis). In its order approving a proposal to remove
anonymity from the BOX Directed Order process,
the Commission stated that it ‘‘does not believe that
it would be inconsistent with the federal securities
laws for the Exchange to provide, under the
circumstances set forth in this proposal, the means
for its Market Makers to differentiate between
customers in providing price improvement or other
non-required advantages to certain customers.’’
56 See supra Section II for the statistics to be
provided by the Exchange in monthly reports
detailing its ongoing review of the pilot.
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data will allow the Commission to
analyze the Directed Order program and
its impact, if any, on the marketplace.
VI. Accelerated Approval of Proposed
Rule Change, as Modified by
Amendment Nos. 1 and 2
V. Solicitation of Comments
Amendment No. 2 revised the
proposed rule change to permit Options
Members to send Directed Orders to
more than one BATS Options market
maker. Amendment No. 2 also amended
the proposed rule change to state that if
a Directed Order is directed to more
than one BATS Options market maker,
such Directed Order will execute in
price/time priority based on the nonElectronic Comments
displayed price of such orders, to the
• Use the Commission’s Internet
extent the Directed Order can execute
comment form https://www.sec.gov/
against any MMPIO. These revisions are
rules/sro.shtml); or
designed to respond to certain of the
• Send an e-mail to rulecommenters’ concerns regarding
comments@sec.gov. Please include File
competition in the Directed Order
Number SR–BATS–2011–009 on the
program and clarify aspects of the
subject line.
proposal. In addition, the Commission
Paper Comments
notes that the proposed revisions may
encourage an Options Member to submit
• Send paper comments in triplicate
a Directed Order to more than one BATS
to Elizabeth M. Murphy, Secretary,
Options market maker, thereby
Securities and Exchange Commission,
potentially encouraging such market
100 F Street, NE., Washington, DC
makers to compete with respect to the
20549–1090.
amount of price improvement they
All submissions should refer to File
provide. Accordingly, the Commission
Number SR–BATS–2011–009. This file
finds good cause, pursuant to Section
number should be included on the
57
subject line if e-mail is used. To help the 19(b)(2) of the Act, for approving the
proposed rule change, as modified by
Commission process and review your
Amendment Nos. 1 and 2, prior to the
comments more efficiently, please use
only one method. The Commission will 30th day after the date of publication of
post all comments on the Commission’s notice in the Federal Register.
Internet Web site (https://www.sec.gov/
VII. Conclusion
rules/sro.shtml). Copies of the
submission, all subsequent
It Is Therefore Ordered, pursuant to
amendments, all written statements
Section 19(b)(2) of the Exchange Act,58
with respect to the proposed rule
that the proposed rule change (SR–
change that are filed with the
BATS–2011–009), as modified by
Commission, and all written
Amendment Nos. 1 and 2, be, and
communications relating to the
hereby is, approved on an accelerated
proposed rule change between the
basis, for a pilot period ending January
Commission and any person, other than 30, 2012.
those that may be withheld from the
For the Commission, by the Division of
public in accordance with the
Trading and Markets, pursuant to delegated
provisions of 5 U.S.C. 552, will be
authority.59
available for Web site viewing and
Cathy H. Ahn,
printing in the Commission’s Public
Reference Room, 100 F Street, NE.,
Deputy Secretary.
Washington, DC 20549, on official
[FR Doc. 2011–16922 Filed 7–6–11; 8:45 am]
business days between the hours of 10
BILLING CODE 8011–01–P
a.m. and 3 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
available publicly. All submissions
57 15 U.S.C. 78s(b)(2).
should refer to File Number SR–BATS–
58 15 U.S.C. 78s(b)(2).
2011–009 and should be submitted on
59 17 CFR 200.30–3(a)(12).
or before July 28, 2011.
Interested persons are invited to
submit written data, views, and
arguments concerning the foregoing,
including whether the proposed rule
change, as modified by Amendment
Nos. 1 and 2, is consistent with the Act.
Comments may be submitted by any of
the following methods:
PO 00000
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]]>Agencies
[Federal Register Volume 76, Number 130 (Thursday, July 7, 2011)]
[Notices]
[Pages 39953-39958]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-16922]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-64781; File No. SR-BATS-2011-009]
Self-Regulatory Organizations; BATS Exchange, Inc.; Notice of
Filing of Amendment No. 2 and Order Granting Accelerated Approval to
Proposed Rule Change, as Modified by Amendment Nos. 1 and 2 Thereto, to
Create, on a Six-Month Pilot Basis, a Directed Order Program
June 30, 2011.
I. Introduction
On March 16, 2011, BATS Exchange, Inc. (the ``Exchange'' or
``BATS'') 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
proposal to establish, on a six-month pilot basis, a directed order
(``Directed Order'') program on its options facility (``BATS
[[Page 39954]]
Options''). On March 24, 2011, BATS filed Amendment No. 1 to the
proposed rule filing. The proposed rule change, as modified by
Amendment No. 1, was published for comment in the Federal Register on
April 1, 2011.\3\ The Commission received 13 comment letters from 8
commenters on the proposal,\4\ and a letter from BATS responding to the
comment letters.\5\ On June 2, 2011, BATS filed Amendment No. 2 to the
proposed rule change.\6\ The Commission is publishing this notice to
solicit comments on Amendment No. 2 from interested persons, and is
approving the proposal, as modified by Amendment Nos. 1 and 2, on an
accelerated basis, for a six-month pilot period ending January 30,
2012.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 64132 (March 28,
2011), 76 FR 18280 (``Notice'').
\4\ See Letters to Elizabeth M. Murphy, Secretary, Commission,
from Jennifer M. Lamie, Assistant General Counsel, Legal Division,
Chicago Board Options Exchange (``CBOE''), dated June 29, 2011
(``CBOE II Letter''); Tom Wittman, The NASDAQ OMX PHLX, Inc. and The
NASDAQ Options Market (together ``Nasdaq''), dated June 24, 2011
(``Nasdaq II Letter''); Janet L. McGinness, SVP & Corporate
Secretary, Legal & Government Affairs, NYSE Euronext, dated June 17,
2011 (``NYSE Euronext II Letter''); Michael J. Simon, Secretary,
International Securities Exchange, LLC (``ISE''), dated June 17,
2011 (``ISE II Letter''); Anthony D. McCormick, Chief Executive
Officer, BOX Options Exchange Group, LLC (``BOX'')), dated June 13,
2011 (``BOX II Letter''); Angelo Evangelou, Assistant General
Counsel, Legal Division, CBOE, dated April 27, 2011 (``CBOE I
Letter''); John C. Nagel, Managing Director and General Counsel,
Asset Management and Markets, Citadel LLC, dated April 25, 2011
(``Citadel Letter''); Andrew Stevens, Legal Counsel, IMC Chicago,
LLC d/b/a IMC Financial Markets, dated April 21, 2011 (``IMC
Letter''); Janet L. McGinness, SVP & Corporate Secretary, Legal &
Government Affairs, NYSE Euronext, dated April 21, 2011 (``NYSE
Euronext I Letter''); Kurt Eckert, Principal, Wolverine Trading,
LLC, dated April 21, 2011 (``Wolverine Letter''); Tom Wittman,
Nasdaq, dated April 21, 2011 (``Nasdaq I Letter''); Michael J.
Simon, Secretary, ISE, dated April 21, 2011 (``ISE I Letter''); and
Anthony D. McCormick, Chief Executive Officer, BOX, dated March 29,
2011 (``BOX I Letter'').
\5\ See Letter to Elizabeth M. Murphy, Secretary, Commission,
from Jeromee Johnson, BATS, dated June 2, 2011 (``BATS Letter'').
\6\ In response to comments received on the proposed rule
change, as modified by Amendment No. 1 thereto, the Exchange filed
Amendment No. 2 to revise the proposed rule change to permit BATS
Options Members to send Directed Orders to more than one BATS
Options market maker.
---------------------------------------------------------------------------
II. Description of the Proposed Rule Change, as Modified by Amendment
Nos. 1 and 2
The Exchange proposes to allow members of BATS Options (``Options
Members'') to direct orders to BATS Options market makers under certain
conditions. Specifically, the proposal would establish two new order
types--a ``Directed Order'' and a ``Market Maker Price Improving
Order'' (MMPIO). A Directed Order would be an order directed by an
Options Member to one or more BATS Options market makers for possible
execution against the MMPIO of the BATS Options market maker(s).\7\ To
direct an order to a particular BATS Options market maker, the Options
Member must be on a list of eligible Options Members provided to the
Exchange by the BATS Options market maker.\8\
---------------------------------------------------------------------------
\7\ As originally proposed, Options Members could only send
Directed orders to one BATS Options market maker. In Amendment No.
2, BATS revised the proposal to permit Options Members to send
Directed Orders to more than one BATS Options market maker.
\8\ BATS Rule 21.1(d)(14).
---------------------------------------------------------------------------
To be eligible to receive a Directed Order, a BATS Options market
maker must enter a MMPIO. The MMPIO would contain both a displayed
price, as well as a better non-displayed price at which the market
maker is willing to trade with a Directed Order. The MMPIO would be
ranked on the BATS Options book at its displayed price. The non-
displayed price would not be entered on the BATS Options book, but
instead would be converted to a buy or sell order at the non-displayed
price in response to a Directed Order directed to the market maker, up
to the full displayed size of the MMPIO. Thus, an incoming marketable
non-Directed Order would execute against the market maker's displayed
quote, not its non-displayed better price. To be able to participate in
an execution against a Directed Order: (i) The market maker must be
quoting on BATS with a MMPIO that contains a displayed price at the
NBBO at the time the Directed Order arrives on BATS; (ii) the non-
displayed price of the MMPIO must be at a price better than the NBB
(for sell Directed Orders) or the NBO (for buy Directed Orders) and
marketable against the Directed Order; \9\ and (iii) as noted above,
the Directed Order must have come from an Options Member on the market
maker's list of eligible Options Members.
---------------------------------------------------------------------------
\9\ The non-displayed price also must be at least one cent
better than the NBB or NBO, as applicable.
---------------------------------------------------------------------------
If the above conditions in (i), (ii), and (iii) are met, and if
there are no other non-displayed orders at prices equal to or better
than the non-displayed price of the MMPIO, the Directed Order will
trade with the MMPIO up to the full size of the MMPIO. If there are
non-displayed orders on the BATS Options book at prices equal to or
better than the non-displayed price of the MMPIO, those other non-
displayed orders will in all cases have priority over the non-displayed
price of the MMPIO. In such circumstances, the MMPIO may still execute
at its non-displayed price against the Directed Order to the extent of
any remaining contracts of the Directed Order. If a Directed Order is
directed to more than one BATS Options market maker, such Directed
Order will execute in price/time priority based on the non-displayed
price of such orders, to the extent the Directed Order can execute
against any MMPIO.\10\
---------------------------------------------------------------------------
\10\ See Amendment No. 2.
---------------------------------------------------------------------------
BATS notes that, if an Options Member notifies a BATS Options
market maker of its intention to submit a Directed Order so that the
BATS Options market maker could change its quotation to match the NBB
or NBO immediately prior to submission of the Directed Order, the
parties would be engaging in conduct inconsistent with just and
equitable principles of trade in violation of BATS Rules 3.1 and
18.4(f). In addition, BATS notes that a BATS Options market maker who
becomes aware of a customer order from an affiliated broker-dealer or
desk within the same broker-dealer and acts on such information to
change its quotations to match the NBB or NBO immediately prior to
submission of a Directed Order would be in violation of the BATS Rule
22.10, ``Limitations on Dealings.'' BATS represents that it will
proactively conduct surveillance for such conduct and enforce against
such violations.\11\
---------------------------------------------------------------------------
\11\ One commenter on the proposal believes that the proposed
rule change does not address whether it would be permissible for a
BATS Options market maker to share the details of its MMPIO, whether
existing or prospective, with an order flow provider (affiliated or
otherwise) so that the order flow provider could make routing
decisions based on this information. See NYSE Euronext I Letter at
5-6. If a BATS Options market maker informs an order entry firm of
its intention to modify its quotation or details about its MMPIO so
that the BATS Options Member could send a Directed Order to the BATS
Options market maker, BATS would view this as pre-arranged trading
and would consider this to be a violation of BATS Rules 3.1 (just
and equitable principles of trade) and 18.4(f) (misuse of material
non-public information). See E-mail to David Hsu, Assistant
Director, Division of Trading and Markets, Commission, from Anders
Franzon, BATS, dated June 27, 2011. If the order entry firm was an
affiliate or a desk within the same firm as the BATS Options market
maker, and the BATS Options market maker shared information
regarding its planned quoting activities or details about the market
maker's MMPIO, then BATS would consider this to be a violation of
BATS Rule 22.10 (Limitation on Dealings). Id.
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BATS proposes to establish its Directed Order program on a six-
month pilot basis. BATS represents that, during the pilot period, it
will study the impact of the rules and will provide the Commission with
monthly reports detailing its ongoing review of the pilot. Such reports
would include statistics with respect to:
The number of Directed Orders submitted to BATS Options;
[[Page 39955]]
The number of MMPIOs submitted to BATS Options;
Information regarding the types of market participants
that sent Directed Orders;
The number of Market Makers that participated in the
directed order program;
The percentage of time that Market Makers participating in
the directed order program were at the NBBO when a Directed Order
arrived at BATS Options;
The number of orders, excluding MMPIOs, against which an
incoming Directed Order executed;
The proportion of each Directed Order that was executed
against a MMPIO;
The percentage of Directed Orders that received price
improvement over the NBBO;
The average amount of price improvement for Directed
Orders; and
Data related to the quality of the best bid and offer on
BATS Options.
III. Summary of Comments
The Commission received 13 comment letters from 8 commenters
opposing the proposal.\12\ These commenters generally argue that,
because Directed Orders will not be exposed to meaningful competition,
the proposal will disincent market makers from quoting aggressively and
negatively impact the price at which the Directed Orders are
executed.\13\
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\12\ See supra note 4. In addition, the Commission notes that in
response to an earlier Directed Order proposal filed and later
withdrawn by the Exchange (SR-BATS-2010-034) that was substantially
similar to the instant proposal (the ``Prior Proposal''), one
commenter had stated that the proposal would be beneficial to retail
investors by providing firms with competitive opportunities to seek
price improvement on client option orders. See Letter to Elizabeth
M. Murphy, Secretary, Commission, from Christopher Nagy, Managing
Director, Order Strategy, TD Ameritrade, dated December 23, 2010
(``Ameritrade Letter'').
\13\ See BOX I Letter at 1; BOX II Letter at 1-2; CBOE I Letter
at 2; Citadel Letter at 2; IMC Letter at 2; ISE I Letter at 3; ISE
II Letter at 3; Nasdaq I Letter at 3; NYSE Euronext I Letter at 3;
NYSE Euronext II Letter at 4; and Wolverine Letter at 1.
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Several commenters argue that the lack of a requirement that the
Directed Order be exposed to all market participants or be subject to a
separate auction mechanism will prevent other market participants from
any opportunity to provide further price improvement to the Directed
Order, and thus harm the Directed Order.\14\ Several commenters argue
that other market participants will not be able to effectively compete
with a BATS Options market maker with a MMPIO because, although other
market participants also can enter orders that have a non-displayed
price on the BATS book at a price equal to or better than the non-
displayed price of the MMPIO,\15\ that non-displayed price would be at
risk to all incoming marketable orders, not just Directed Orders from a
select list of eligible customers.\16\ Commenters further argue that
other market participants are at a further competitive disadvantage
vis-[agrave]-vis BATS options market makers with MMPIOs in one cent MPV
options because BATS Options market makers would be able to enter
MMPIOs with non-displayed prices in penny increments, but other market
participants could not enter orders with non-displayed prices in penny
increments.\17\ Several commenters argue that BATS Options market
makers will be able to enter MMPIOs with better non-displayed prices
than other competing market participants, thus effectively resulting in
100 percent internalization of Directed Orders (assuming the
participating market maker is always willing to provide prices better
than the NBBO) without the opportunity for exposure.\18\ In addition, a
few commenters argue that price discovery will be negatively impacted
by the perpetuation of a two-tiered market for customers--one market
reflecting publicly available prices and sizes, and another market
reflecting a non-public pool of liquidity available for only certain
approved customers.\19\
---------------------------------------------------------------------------
\14\ See BOX I Letter at 1-2; CBOE I Letter at 2-3; CBOE II
Letter at 3-5; IMC Letter at 2; ISE I Letter at 4; Nasdaq I Letter
at 3; NYSE Euronext I Letter at 4, and NYSE Euronext II Letter at 3-
4. See also BOX II Letter at 2 (arguing that, if BATS Options market
makers receive Directed Orders from only their list of eligible
Options Members, the ``cost of that enjoyment should be the
requirement that directed orders be exposed on the market or subject
to a specific auction mechanism so that customers enjoy the greatest
amount of opportunity for price improvement'') and IMC Letter at 2
(stating that the structure of the BATS Directed Order program
``unduly limits competition as such does not contribute to price
discovery.''). In addition, BOX states that, because the proposal
permits only BATS Options market maker(s) designated by the Options
Member to compete for the Directed Order, and such designation is at
the discretion of the Options Member, a ``substantial conflict of
interest may arise,'' incenting BATS Options market makers to
significantly increase payment for order flow payments so that they
can be the sole destination for the Option Member's customer orders.
See BOX II Letter at 1-2. This commenter also argues that, although
the rule would allow an Options Member to submit Directed Orders to
multiple BATS Options Market Makers, competition for the order is
still limited because the order would be exposed to some--but not
all--market participants. See BOX II Letter at 1-2.
\15\ In options with a five or ten cent minimum price variation
(``MPV''), other market participants would be able to enter a non-
displayed price using a Price Improving Order to compete with MMPIOs
for Directed Orders. A Price Improving Order would receive priority
over MMPIOs at the same non-displayed price. However, the non-
displayed price of a Price Improving Order would be available to all
incoming marketable orders, in contrast to the non-displayed price
of an MMPIO, which would only be available to incoming Directed
Orders.
\16\ See, e.g., CBOE I Letter at 2; CBOE II Letter at 4; Citadel
Letter at 2; IMC Letter at 2; ISE I Letter at 3; ISE Letter II at 1-
2; Nasdaq I Letter at 2, Nasdaq II Letter at 1, and NYSE Euronext II
Letter at 4.
\17\ See CBOE I Letter at 2; CBOE II Letter at 2; Citadel Letter
at 2; IMC Letter at 2; and Nasdaq I Letter at 2. These commenters
believe that, because the orders of these market participants would
be displayed in options with a one cent MPV, they would be at
greater risk of being executed against informed order flow. On the
other hand, because MMPIOs may be entered in increments as small as
one cent and are not displayed, BATS Options market makers with
MMPIOs are not subject to the same risk. Id. See also NYSE Euronext
II Letter at 4.
\18\ See Citadel Letter at 2-3; Nasdaq I Letter at 2-3; and
Nasdaq II Letter at 2.
\19\ See Citadel Letter at 2; ISE I Letter at 2; and Wolverine
Letter at 2. See also CBOE I Letter at 3 and CBOE II Letter at 2,
wherein CBOE argues that the MMPIO is inconsistent with Rule 602 of
Regulation NMS, 17 CFR 242.602 (the ``Quote Rule''), because the
BATS proposal would only require the MMPIO to be firm for pre-
selected Directed Order participants (as opposed to all incoming
interest received by BATS).
---------------------------------------------------------------------------
In response to commenters, BATS countered that certain order flow
sending firms today have order flow, which by its very nature, is more
valuable to some market participants than the flow of other order flow
sending firms.\20\ BATS notes market makers already retain the
discretion to pay certain firms non-transparent payment for order flow
amounts.\21\ BATS asserts that its proposal similarly retains that
existing discretion for market makers, but provides a mechanism for
such payments, or at least a portion of such payments, to be provided
in a transparent fashion to the Directed Order in the form of price
improvement over the NBBO.\22\ According to BATS, the proposal puts in
place a structure by which all members can both compete for that flow
by contributing to price and size discovery for the entire market and
reward that flow with price improvement above and beyond the NBBO.\23\
---------------------------------------------------------------------------
\20\ See BATS Letter at 6-7.
\21\ See Notice, supra note 3, at 18283.
\22\ Id.
\23\ See BATS Letter at 6-7.
---------------------------------------------------------------------------
Further, BATS notes that BATS Options market makers must enter
orders that assume the risk of trading with all participants at NBBO,
and must commit to price improvement over the NBBO without knowing the
details of the particular order and being guaranteed an allocation.\24\
BATS notes that other directed order programs on other exchanges do not
impose this
[[Page 39956]]
requirement to provide price improvement.\25\ In addition, BATS argues
that by not providing allocation guarantees, the proposed Directed
Order program provides incentives to BATS Options market makers as well
as Options Members to aggressively quote, both at the NBBO and at non-
displayed prices better than the NBBO.\26\
---------------------------------------------------------------------------
\24\ See BATS Letter at 3-4.
\25\ Id.
\26\ See Notice, supra note 3, at 18282.
---------------------------------------------------------------------------
Several commenters state that, because Directed Orders on BATS are
not exposed to all market participants, BATS Options market makers will
not be motivated to offer more than the minimum amount of price
improvement ($0.01) to a customer.\27\ In its response letter, BATS
states that the proposed rule does not cap the price improvement
opportunities available to Options Members in the price-time priority
market of BATS Options; rather the proposed rule merely provides a
minimum amount of price improvement that must be offered to a Directed
Order.\28\ Another commenter, however, argues that although the BATS
proposal does not cap price improvement, the lack of competition at the
non-displayed prices combined with the burden of quoting at the NBBO
will depress the amount of price improvement offered by BATS Options
market makers.\29\
---------------------------------------------------------------------------
\27\ See BOX I Letter at 2; NYSE Euronext I Letter at 4 and NYSE
Euronext II Letter at 4. See also Citadel Letter at 2.
\28\ See BATS Letter at 6.
\29\ See ISE II Letter at 2-3.
---------------------------------------------------------------------------
Commenters further argue that the proposal will disincent market
makers that do not have arrangements with Options Members from
aggressively quoting and posting liquidity.\30\ According to one of
these commenters, BATS Options market makers to whom orders are not
directed would have little to no incentive to quote at the NBBO because
they would not be rewarded with trade executions, as Directed Orders
would execute against non-displayed interest one increment better
rather than the NBBO.\31\ Another commenter also contends that, if the
proposed rule change is approved, market participants that do not
receive Directed Orders would be forced to quote less aggressively to
account for adverse selection because MMPIOs would cherry-pick the most
desirable order flow from the market with private hidden quotes.\32\ As
a result, according to this commenter, market liquidity would be
damaged and average publicly quoted spreads would widen in some options
contracts, particularly those that trade with wider than average
spreads.\33\
---------------------------------------------------------------------------
\30\ See BOX I Letter at 1 and Wolverine Letter at 1. See also
BOX II Letter at 2 (arguing that the high probability that an
Options Member will designate only one BATS Options market maker to
receive a Directed Order will mean internalization rates are likely
to reach 100 percent and have the ``additional effect of
discouraging competition on the regular order book across all of the
options market, resulting in further degradation of NBBO spreads, to
the detriment of all customers.''); ISE Letter at 6 (stating that
the lack of competition for a Directed Order would result in a 100
percent execution guarantee for BATS Options market makers, which
would be a significant departure from Commission policy that limits
the level of allocation guarantees at 40 percent of the order to
assure that such guarantees do not remove the incentive for other
market participants to compete); NYSE Euronext II Letter at 5
(arguing similarly).
\31\ See Wolverine Letter at 1.
\32\ See Citadel Letter at 2.
\33\ See id.
---------------------------------------------------------------------------
Some commenters argue that the proposal would result in inferior
executions for customer orders when a BATS Options market maker with a
MMPIO at the best price is not selected by an Options Member to receive
its Directed Order.\34\ One of these commenters argues that the
proposal is inconsistent with the Act because, if two MMPIOs have
different non-displayed prices, a Directed Order could be directed to
the MMPIO with the inferior price, resulting in a trade-through of a
better price that is available to other participants.\35\ BATS
acknowledges that this factual scenario could be the case, but states
that in the same way that the Directed Order proposal empowers BATS
Options market makers to select which order flow providing firms to
whom they wish to offer price improvement for the customers of that
firm, the proposal also empowers Options Members to select which market
making firms they wish to preference.\36\ BATS believes that this is an
important distinction that provides Options Members with competitive
opportunities to seek price improvement on customer orders.\37\
Further, BATS has amended its proposal to clarify that Options Members
can enter into arrangements with, and elect to direct an order to,
multiple market makers.\38\ In such case, the incoming Directed Order
would execute against the Directed Order market maker with the best
non-displayed price (assuming that the Directed Order would execute
against an MMPIO).
---------------------------------------------------------------------------
\34\ See BOX II Letter at 2; Nasdaq I Letter at 1; Nasdaq Letter
II at 2-3; NYSE Euronext I Letter at 2; and NYSE Euronext II Letter
at 5.
\35\ See Nasdaq I Letter at 1. See also NYSE Euronext II Letter
at 5.
\36\ See BATS Letter at 4-5.
\37\ See id.
\38\ See Amendment No. 2.
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IV. Discussion and Commission Findings
After careful consideration of the proposal and the comments
received, 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
\39\ and, in particular, the requirements of Section 6 of the Act.\40\
Specifically, the Commission finds that the proposed rule change, as
amended, is consistent with Section 6(b)(5) of the Act,\41\ which
requires, among other things, that the rules of a national securities
exchange be designed to prevent fraudulent and manipulative acts and
practices, to promote just and equitable principles of trade, to foster
cooperation and coordination with persons engaged in regulating,
clearing, settling, processing information with respect to, and
facilitating transactions in securities, to remove impediments to and
perfect the mechanism of a free and open market and a national market
system, and, in general, to protect investors and the public interest
and are not designed to permit unfair discrimination between customers,
issuers, brokers or dealers.
---------------------------------------------------------------------------
\39\ In approving this proposed rule change the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
\40\ 15 U.S.C. 78f.
\41\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
The Commission notes that the proposed rule change is designed to
enhance opportunities in the market for BATS Options market makers to
provide, and Options Members to obtain, price improvement for their
customer orders. Specifically, to be eligible to trade with a Directed
Order, the proposal requires a BATS Options market maker to have
entered a MMPIO with a displayed price equal to the NBB (for sell
Directed Orders) or the NBO (for buy Directed Orders), as well as a
non-displayed price at least one cent better than the NBB or NBO, as
applicable.\42\ Thus, the Directed Order would receive price
improvement over the NBB or NBO, as applicable. However, as discussed
above, commenters expressed concern that the lack of exposure of the
Directed Orders would negatively impact quote competition and deny
other market participants meaningful opportunities to provide further
price improvement to a Directed Order.\43\
---------------------------------------------------------------------------
\42\ BATS Rule 21.1(d)(13).
\43\ See supra notes 14-33 and accompanying text.
---------------------------------------------------------------------------
The Commission has carefully considered the arguments expressed by
[[Page 39957]]
commenters and by the Exchange. The Commission recognizes the concerns
expressed and the difficult issues involved. The Commission believes
that order exposure generally is beneficial to options markets in that
it provides an incentive to options market makers to provide liquidity
and therefore plays an important role in ensuring competition in the
options markets.\44\ The Commission also recognizes, however, the
importance of providing effective opportunities for customer order flow
in listed options to receive executions at prices better than the NBBO.
In evaluating the proposal, the Commission has weighed the relative
merits of each for the options markets.
---------------------------------------------------------------------------
\44\ See Securities Exchange Act Release No. 63955 (February 24,
2011), 76 FR 11533 at 11540 (March 2, 2011) (SR-ISE-2010-73).
---------------------------------------------------------------------------
On the options markets, specialists and market makers often compete
for order flow by offering cash or non-cash inducements, known as
payment for order flow (``PFOF''),\45\ to brokers to send their orders
to a particular market maker or exchange.\46\ PFOF arrangements are
prevalent in today's market.\47\ These arrangements likely impact the
incentives for market makers (or others) to quote aggressively to trade
with order flow covered by such PFOF arrangements because market
participants know that the market makers will be able to trade with
some or all of the captured order flow as long as they match the NBBO
(whether by displaying quotes that match the NBBO set by others or by
matching better quotes elsewhere pursuant to mechanisms that provide
market makers with the opportunity to step-up and trade with orders
that are exposed for one second).
---------------------------------------------------------------------------
\45\ The Commission has defined PFOF broadly as ``any monetary
payment, service, property, or other benefit that results in
remuneration, compensation, or consideration to a broker or dealer
from any broker or dealer, national securities exchange, registered
securities association, or exchange member in return for the routing
of customer orders by such broker or dealer to any broker or dealer,
national securities exchange, registered securities association, or
exchange member for execution, including but not limited to:
research, clearance, custody, products or services; reciprocal
agreements for the provision of order flow; adjustment of a broker
or dealer's unfavorable trading errors; offers to participate as
underwriter in public offerings; stock loans or shared interest
accrued thereon; discounts, rebates, or any other reductions of or
credits against any fee to, or expense or other financial obligation
of, the broker or dealer routing a customer order that exceeds that
fee, expense or financial obligation.'' 17 CFR 240.10b-10(d)(9).
\46\ Under a typical payment for order flow arrangement, a
specialist or market maker offers an order entry firm cash or other
economic inducement to route its customer orders to that
specialist's or market maker's exchange because the specialist or
market maker knows it will be able to trade with a portion of all
incoming orders, including those from firms with which it has
payment for order flow arrangements. For further discussion of PFOF
and its impact on the options markets, see Securities Exchange Act
Release No. 49175 (February 3, 2004), 69 FR 6124 (February 9, 2004).
\47\ Reports under Rule 606 of Regulation NMS indicate that
nearly all retail broker-dealers participate in PFOF arrangements.
Regulation NMS Rule 606 reports posted by broker-dealers for the
fourth quarter of 2010 indicate PFOF amounts that generally are
around $0.30 per contract and can range up to $0.85 per contract.
---------------------------------------------------------------------------
The BATS proposal offers an alternative mechanism to enable market
makers to compete for order flow by providing better prices directly to
customers \48\ rather than through payments to the customer's
broker.\49\ The proposal allows market makers to differentiate between
orders from traders that are relatively more informed about the short-
term direction of prices (e.g., professional traders) and orders from
less informed traders (e.g., retail investors). In this way, it may
enable BATS Options market makers to provide better prices to less
informed order flow that they otherwise would not be willing or able to
provide if they had to make those prices available to all incoming
order flow.\50\ The Commission recognizes that other exchanges have
adopted different mechanisms that include an order exposure element to
provide price improvement to customer orders.\51\ The Commission
questions, however, the extent to which these mechanisms are utilized.
In the context of this options market structure, the Commission
believes that the proposal to provide an alternative mechanism for BATS
options market makers to provide executions for customer orders at
prices better than the NBBO is consistent with the Act.\52\
---------------------------------------------------------------------------
\48\ See also discussion of Ameritrade Letter on the Prior
Proposal, supra note 12.
\49\ The Commission views the BATS proposal as an alternative
mechanism to PFOF, as it provides a means to benefit customers
directly through price improvement, rather than the customer's
broker through PFOF. The Commission is approving the BATS proposal
in the context of the existence of PFOF arrangements in the options
markets. Should such arrangements no longer be present in the
options market, the Commission expects the Exchange to re-evaluate,
and the Commission may re-evaluate, whether the Directed Order
program is appropriate.
The Commission acknowledges, however, that the BATS proposal
does not preclude an Options Member from separately entering into a
PFOF arrangement with a BATS Options market maker but believes that,
even if such arrangements occur, executions occurring pursuant to
this proposal would receive prices better than the NBBO, thus
providing a direct benefit to customers in the form of price
improvement.
\50\ It is well known in academic literature and industry
practice that prices tend to move against market makers after trades
with informed traders, often resulting in losses for market makers.
See Stoll, H. R., ``The supply of dealer services in securities of
markets,'' Journal of Finance 33 (1978), at 1133-51; Glosten, L. and
P. Milgrom, ``Bid ask and transaction prices in a specialist market
with heterogeneously informed agents,'' Journal of Financial
Economics 14 (1985), at 71-100; and Copeland, T., and D. Galai,
``Information effects on the bid-ask spread,'' Journal of Finance 38
(1983), at 1457-69. Thus, there is a strong economic rationale for
market makers not providing informed traders price improvement.
Uninformed investors end up bearing the cost of these market maker
losses through wider spreads that market makers need to quote to
uninformed investors due to informed order flow. Id.
\51\ The Commission notes that market makers on two other
exchanges are not required to provide price improvement to Directed
Orders using their price improvement auctions, whereas the BATS
Directed Order program requires that a BATS Options market maker
provide price improvement when entering the MMPIO over the NBBO to
be able to trade with the Directed Order. See BOX Rules, Chapters V,
Section 18 (The Price Improvement Period) and VI, Section 5(c)
(Obligations of Market Makers) and ISE Rules 723 (Price Improvement
Mechanism for Crossing Transactions) and 811 (Directed Orders). The
Commission further notes that orders are not exposed for possible
price improvement on other exchanges with ``preferenced'' order
programs. Under the ``preferenced'' order programs on other
exchanges, orders are sent to certain market makers, who, if quoting
at the NBBO at the time the preferenced order is received, are
guaranteed up to 40% of the order at that price, after resting
customer orders at that price, if any, are executed. See, e.g., CBOE
Rule 8.13; ISE Rule 713, Supplementary Material .03; NYSE Amex Rule
964NY and 964.1NY.
\52\ In response to comments that, because Directed Orders on
BATS are not exposed to all market participants, BATS Options market
makers would not be motivated to offer more than the minimum amount
of price improvement to a customer, the Commission notes that, under
the proposed rule, as amended, an Options Member may encourage
competition for its Directed Orders by submitting them to more than
one BATS Options market maker that has put that member on its
eligible customer list, thereby potentially encouraging such market
makers to provide more than a minimum amount of price improvement.
---------------------------------------------------------------------------
In response to commenters' concerns that the proposal would
perpetuate a two-tiered market for customers--one market reflecting
publicly available prices and sizes, and another reflecting a non-
public pool of liquidity available for only certain approved customers
\53\--the Commission notes that the Act does not prohibit exchange
members or other broker-dealers from discriminating among customers, so
long as their activities are not otherwise inconsistent with the
federal securities laws.\54\ The Commission also notes that the Act
does not require exchanges to preclude discrimination by broker-
dealers. Indeed, the Commission notes that broker-dealers commonly
differentiate between customers based on the nature
[[Page 39958]]
and profitability of their business. Further, in general, investors as
a class tend to have an opinion on the long-term prospects of a
company, and are less informed about the intraday price movements that
affect the profitability of market makers. Thus, market makers often
view less informed order flow as desirable, and there is intense
competition for this order flow. Allowing market makers to
differentiate between customers may further encourage market makers to
provide price improvement to less informed customer order flow, which
would inure to the benefit of investors. One of the core principles of
the Act, and Section 6(b)(5) thereof, is the protection of investors.
Accordingly, the Commission does not believe that it would be
inconsistent with the Act for the Exchange to provide, under the
circumstances and facts set forth in this proposal, BATS Options market
makers the ability to differentiate between customers in providing
price improvement in the form of MMPIOs.\55\
---------------------------------------------------------------------------
\53\ See supra note 19 and accompanying text.
\54\ The Commission further notes that it does not agree with
the comment that an MMPIO is inconsistent with the Quote Rule (see
supra note 19). An MMPIO is firm and available to all market makers
at its displayed price. The non-displayed price of a MMPIO, however,
is not communicated to market participants and thus is not a bid or
offer for which a market maker is required to be firm pursuant to
the Quote Rule.
\55\ See, e.g., Securities Exchange Act Release No. 64097 (March
18, 2011), 76 FR 16650 (March 24, 2011) (SR-BX-2010-079)
(eliminating the anonymity of Directed Orders on a permanent basis).
In its order approving a proposal to remove anonymity from the BOX
Directed Order process, the Commission stated that it ``does not
believe that it would be inconsistent with the federal securities
laws for the Exchange to provide, under the circumstances set forth
in this proposal, the means for its Market Makers to differentiate
between customers in providing price improvement or other non-
required advantages to certain customers.''
---------------------------------------------------------------------------
The Exchange has proposed that the Directed Order program operate
on a six-month pilot basis so that the Commission and the Exchange can
monitor the effects of the pilot on the markets and investors, and
consider appropriate adjustments, as necessary. To help the Commission
and the Exchange evaluate the Directed Order program during the pilot,
the Exchange proposes to provide to the Commission monthly data
regarding price improvement and competition in the Directed Order
program.\56\ In addition, the Exchange has also represented to the
Commission that it will provide a regulatory study regarding how it
tests to determine whether the appropriate information barriers are in
place to protect against an order flow provider giving a market maker
advance notice of an incoming Directed Order or a BATS Options market
maker providing information regarding its planned quoting activities or
details about its MMPIO to an order flow provider. Approving the
proposal on a pilot basis and requiring submission of monthly data will
allow the Commission to analyze the Directed Order program and its
impact, if any, on the marketplace.
---------------------------------------------------------------------------
\56\ See supra Section II for the statistics to be provided by
the Exchange in monthly reports detailing its ongoing review of the
pilot.
---------------------------------------------------------------------------
V. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change, as modified by Amendment Nos. 1 and 2, is consistent with the
Act. Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form https://www.sec.gov/rules/sro.shtml); or
Send an e-mail to rule-comments@sec.gov. Please include
File Number SR-BATS-2011-009 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-BATS-2011-009. 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 (https://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 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
a.m. and 3 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 available publicly. All
submissions should refer to File Number SR-BATS-2011-009 and should be
submitted on or before July 28, 2011.
VI. Accelerated Approval of Proposed Rule Change, as Modified by
Amendment Nos. 1 and 2
Amendment No. 2 revised the proposed rule change to permit Options
Members to send Directed Orders to more than one BATS Options market
maker. Amendment No. 2 also amended the proposed rule change to state
that if a Directed Order is directed to more than one BATS Options
market maker, such Directed Order will execute in price/time priority
based on the non-displayed price of such orders, to the extent the
Directed Order can execute against any MMPIO. These revisions are
designed to respond to certain of the commenters' concerns regarding
competition in the Directed Order program and clarify aspects of the
proposal. In addition, the Commission notes that the proposed revisions
may encourage an Options Member to submit a Directed Order to more than
one BATS Options market maker, thereby potentially encouraging such
market makers to compete with respect to the amount of price
improvement they provide. Accordingly, the Commission finds good cause,
pursuant to Section 19(b)(2) of the Act,\57\ for approving the proposed
rule change, as modified by Amendment Nos. 1 and 2, prior to the 30th
day after the date of publication of notice in the Federal Register.
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\57\ 15 U.S.C. 78s(b)(2).
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VII. Conclusion
It Is Therefore Ordered, pursuant to Section 19(b)(2) of the
Exchange Act,\58\ that the proposed rule change (SR-BATS-2011-009), as
modified by Amendment Nos. 1 and 2, be, and hereby is, approved on an
accelerated basis, for a pilot period ending January 30, 2012.
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\58\ 15 U.S.C. 78s(b)(2).
\59\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\59\
Cathy H. Ahn,
Deputy Secretary.
[FR Doc. 2011-16922 Filed 7-6-11; 8:45 am]
BILLING CODE 8011-01-P
