Self-Regulatory Organizations; BATS Y-Exchange, Inc.; Order Granting Approval to Proposed Rule Change, as Modified by Amendment No. 2, To Adopt a Retail Price Improvement Program, 71652-71658 [2012-29078]
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proposed rule change prior to the
thirtieth day after the date of
publication of the notice of filing in the
Federal Register. Currently, CBOE’s
electronic systems and its floor are
housed in close proximity to one
another and, as a result, in the event
that one is rendered inoperable or
inaccessible, it is possible that the other
could be compromised as well. As
CBOE notes above, CBOE’s current Rule
6.18 acknowledges this by presuming
that if the Disaster Recovery Facility is
used, no open outcry trading would be
available. However, CBOE now plans to
relocate its primary electronic systems
to a different location on the East coast
of the United States, and thus the
primary electronic systems and the
physical floor will be in separate
locations. Accordingly, CBOE is
proposing to clarify Rule 6.18 to reflect
that it may, to the extent possible,
continue to operate its physical trading
floor in Chicago in the event that it
needs to operate in disaster recovery
mode on account of its primary data
systems on the East coast being
unavailable.
CBOE also has proposed to eliminate
paragraph (e) of Rule 6.18, as its new
back-up systems will no longer
necessitate that it retain the ability to
restrict access to its back-up data
facility. Other than the elimination of
paragraph (e), CBOE has not proposed
any material changes to Rule 6.18, or
how it would operate in recovery mode.
Finally, CBOE’s Rule 6.18 will
continue to require TPHs to take action
to be able to accommodate CBOE’s
ability to trade options through the
back-up data center in the event that
CBOE operates in disaster recovery
mode.
Accordingly, the Commission believes
that accelerated approval of the
proposed rule change to clarify the
operation of CBOE Rule 6.18 in light of
CBOE’s planned relocation of its
primary data facility to the East coast
will allow CBOE to effectively revise its
disaster recovery rule without delay and
thereby avoid any potential interruption
to CBOE’s exchange operations. CBOE’s
proposed changes to Rule 6.18 are not
material and consist of technical
updates to its rule to allow for CBOE to
resume operations on its physical floor
in Chicago (along with its back-up data
center in Chicago) in the event of a
disruption to its primary data center on
the East coast. Thus, accelerated
approval of this proposed rule change
will grant CBOE the ability to continue
its operations to the fullest extent
possible under its rules if a disaster
recovery situation were to occur
between the time of transfer of its
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primary data center to the East coast on
December 3, 2012 and the time that
CBOE would have otherwise been able
to obtain Commission action on its
proposed rule change under Section
19(b)(2) of the Act 11 had the
Commission not granted accelerated
approval to its proposal.
V. Conclusion
It is therefore ordered, pursuant to
Section 19(b)(2) of the Act,12 that the
proposed rule change (SR–CBOE–2012–
111) be, and hereby is, approved on an
accelerated basis.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.13
Kevin M. O’Neill,
Deputy Secretary.
[FR Doc. 2012–29076 Filed 11–30–12; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–68303; File No. SR–BYX–
2012–019]
Self-Regulatory Organizations; BATS
Y-Exchange, Inc.; Order Granting
Approval to Proposed Rule Change, as
Modified by Amendment No. 2, To
Adopt a Retail Price Improvement
Program
November 27, 2012.
I. Introduction
On August 14, 2012, BATS YExchange, Inc. (the ‘‘Exchange’’ or
‘‘BYX’’) filed with the Securities and
Exchange Commission (‘‘Commission’’)
pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Act’’) 1 and Rule 19b–4 thereunder,2 a
proposed rule change to establish a
Retail Price Improvement Program
(‘‘Program’’) on a pilot basis for a period
of one year from the date of
implementation, if approved. The
proposed rule change was published for
comment in the Federal Register on
11 15 U.S.C. 78s(b)(2). As provided by Section
19(b)(2) of the Act, the Commission must, within
45 days of the date of publication of notice of a
proposed rule change in the Federal Register
(unless such period is extended by the Exchange or
the Commission) either: (1) By order approve or
disapprove such proposed rule change, or (2)
institute proceedings to determine whether the
proposed rule change should be disapproved. See
id. Section 19(b)(2) also provides that the
Commission may not approve a proposed rule
change earlier than 30 days after the date of
publication unless it finds good cause for doing so
and publishes the reason for the finding. See id.
12 Id.
13 17 CFR 200.30–3(a)(12).
1 15 U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
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August 31, 2012.3 The Commission
received one comment on the BYX
proposal.4 On October 12, 2012, the
Commission extended the time for
Commission action on the proposed rule
change until November 29, 2012.5 The
Exchange submitted a response letter on
November 13, 2012.6 On October 4,
2012, the Exchange filed Amendment
No. 1 to its proposal.7 On November 13,
2012, the Exchange filed Amendment
No. 2 to its proposal.8
In connection with the proposal, the
Exchange requested exemptive relief
from Rule 612 of Regulation NMS,9
which, among other things, prohibits a
national securities exchange from
accepting or ranking orders priced
greater than $1.00 per share in an
increment smaller than $0.01.10 On
November 19, 2012, the Exchange
submitted a letter requesting that the
staff of the Division of Trading and
Markets not recommend any
enforcement action under Rule 602 of
Regulation NMS (‘‘Quote Rule’’) based
on the Exchange’s and its members’
participation in the Program (‘‘NoAction Request Letter’’).11
3 See Securities Exchange Act Release No. 67734
(August 27, 2012), 77 FR 53242 (SR–BYX–2012–
019) (‘‘Notice’’).
4 See Letter from Theodore R. Lazo, Managing
Director and Associate General Counsel, Securities
Industry and Financial Markets Association, to
Elizabeth M. Murphy, Secretary, Commission, dated
September 26, 2012 (‘‘SIFMA Letter’’).
5 See Securities Exchange Act Release No. 68049,
77 FR 64180 (October 18, 2012).
6 See Letter from Eric Swanson, Senior Vice
President and General Counsel, BATS Global
Markets, to Elizabeth M. Murphy, Secretary,
Commission, dated November 13, 2012 (‘‘Exchange
Response to Comments’’).
7 The Exchange withdrew Amendment No. 1 on
October 4, 2012.
8 In Amendment No. 2, the Exchange proposes to
delete a statement explaining that a Retail Liquidity
Identifier for Tape C securities would not be
published until after October 1, 2012. The Exchange
is deleting this statement because the processor is
currently able to disseminate the identifier. The
Exchange also proposes to clarify that the securities
will be phased into the Program, and modify its
statutory basis discussion to support this change.
Finally, the Exchange proposes to modify the Rule
Text to state that the Exchange will notify its
membership regarding the securities included in
the Program through an information circular
(‘‘Amendment No. 2’’). Because the changes made
in Amendment No. 2 do not materially alter the
substance of the proposed rule change or raise any
novel regulatory issues, Amendment No. 2 is not
subject to notice and comment.
9 17 CFR 242.612 (‘‘Sub-Penny Rule’’).
10 See Letter from Eric Swanson, Senior Vice
President and General Counsel, BATS Global
Markets, to Elizabeth M. Murphy, Secretary,
Commission, dated August 14, 2012 (‘‘Request for
Sub-Penny Rule Exemption’’).
11 See Letter from Eric J. Swanson, Senior Vice
President and General Counsel, BATS Global
Markets, to Robert Cook, Division of Trading and
Markets, Commission, dated November 19, 2012
(‘‘No-Action Letter’’).
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This order approves the proposed rule
change, as modified by Amendment No.
2, and grants the exemption from the
Sub-Penny Rule sought by the Exchange
in relation to the proposed rule change.
II. Description of the Proposal
The Exchange is proposing a one-year
pilot program to attract additional retail
order flow to the Exchange, while also
providing the potential for price
improvement to such order flow. The
Program would be limited to trades
occurring at prices equal to or greater
than $1.00 per share.
All securities traded on the Exchange
would be eligible for inclusion in the
Program. As proposed in Amendment
No. 2, for the first 90 days of the pilot
program, a group of up to 25 securities
would participant in the program. These
securities would represent those
securities traded most heavily by retail
investors. After the initial 90 day
period, the Program will be expanded
gradually until all securities traded on
the Exchange are included. The
Exchange will notify Members in an
information circular of the securities
that are subject to the Program both
initially and as additional securities
become eligible for inclusion.12
Under the Program, a new class of
market participants called Retail
Member Organizations (‘‘RMOs’’) 13
would be eligible to submit certain retail
order flow (‘‘Retail Orders’’) to the
Exchange. All Exchange Users 14 would
be permitted to provide potential price
improvement for Retail Orders in the
form of non-displayed interest that is
better than the national best bid that is
a Protected Quotation (‘‘Protected
NBB’’) or the national best offer that is
a Protected Quotation (‘‘Protected
NBO,’’ and together with the Protected
NBB, the ‘‘Protected NBBO’’) 15 called a
12 See
Amendment No. 2, supra note 8.
RMO would be a Member (or a division
thereof) that has been approved by the Exchange to
submit Retail Orders. A ‘‘Member’’ is any registered
broker or dealer that has been admitted to
membership in the Exchange. See BYX Rule 1.5(n).
14 A ‘‘User’’ is any Member or sponsored
participant of the Exchange who is authorized to
obtain access to the System. See BYX Rule 1.5(cc).
15 The term Protected Quotation has the same
meaning as defined in Rule 600(b)(58) of Regulation
NMS. See BYX Rule 1.5(t). Rule 600(b)(58) of
Regulation NMS defines ‘‘protected quotation’’ as
‘‘a protected bid or a protected offer.’’ 17 CFR
242.600(b)(58). The Protected NBB is the bestpriced protected bid and the Protected NBO is the
best-priced protected offer. See BYX Rule 1.5(s).
The Exchange represents that, generally, the
Protected NBB and Protected NBO, and the national
best bid (‘‘NBB’’) and national best offer (‘‘NBO,’’
together with the NBB, the ‘‘NBBO’’), will be the
same. However, it further represents that a market
center is not required to route to the NBB or NBO
if that market center is subject to an exception
under Regulation NMS Rule 611(b)(1) or if such
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Retail Price Improvement Order (‘‘RPI
Order’’). When an RPI Order priced at
least $0.001 better than the Protected
Bid or Protected Offer for a particular
security is available in the System, the
Exchange would disseminate an
identifier, known as the Retail Liquidity
Identifier, indicating that such interest
exists. A Retail Order would interact, to
the extent possible, with available
contra-side RPI Orders.16
The Exchange represents that its
proposed rule change is based on New
York Stock Exchange LLC’s (‘‘NYSE’’)
Rule 107C, which governs NYSE’s
previously approved Retail Liquidity
Program,17 with three distinctions. First,
the NYSE’s Retail Liquidity Program
creates a category of members, Retail
Liquidity Providers, who are required to
maintain an RPI that betters the
protected best bid or offer at least 5% of
the trading day in each assigned
security. Under the BYX’s proposal, the
Exchange would not create such a
category of users. Second, NYSE’s Retail
Liquidity Program does not permit the
execution of Retail Orders against other
resting non-displayed liquidity. BYX’s
proposal would permit such executions.
Finally, under the NYSE’S Retail
Liquidity Program, Retail Orders
execute at the single price at which the
order will be fully executed. Pursuant to
the BYX’s proposal, Retail Orders
execute at multiple price levels rather
than a single price level.18
Types of Orders and Identifier
A Retail Order would be an agency
order that originates from a natural
person and is submitted to the Exchange
by a RMO, provided that no change is
made to the terms of the order with
respect to price or side of market, and
the order does not originate from a
trading algorithm or any other
NBB or NBO is otherwise not available for an
automatic execution. In such case, the Exchange
states that the Protected NBB or Protected NBO
would be the best-priced protected bid or offer to
which a market center must route interest pursuant
to Rule 611 of Regulation NMS.
16 As explained further below, the Exchange has
proposed two types of Retail Orders, one of which
could execute against other interest if it was not
completely filled by contra-side RPI Interest or
other price-improving liquidity. All Retail Orders
would first execute against available contra-side RPI
Orders or other price-improving liquidity. Any
remaining portion of the Retail Order would then
either cancel, be executed as an immediate-orcancel order, or be routed to another market for
execution, depending on the type of Retail Order.
17 See Securities Exchange Act Release No. 67347
(July 3, 2012), 77 FR 40673 (July 10, 2012) (SR–
NYSE–2011–55; SR–NYSEAmex–2011–84) (‘‘RLP
Approval Order’’). In the RLP Approval Order, the
Commission also approved a Retail Liquidity
Program for NYSE Amex LLC (now known as NYSE
MKT LLC) (‘‘NYSE MKT’’).
18 See Notice, supra note 3, 77 FR at 53245–46
(explaining the three distinctions in detail).
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computerized methodology. Users and
RMOs could enter odd lots, round lots,
or mixed lots as RPI Orders and as
Retail Orders, respectively.
A RPI Order would be non-displayed
interest on the Exchange that is better
than the Protected NBB or Protected
NBO by at least $0.001 and that is
identified as a RPI Order in a manner
prescribed by the Exchange. An RPI
Order may also be entered in a subpenny increment with an explicit limit
price. When such an order is available
in the System in a particular security,
the Exchange would disseminate an
identifier, known as the Retail Liquidity
Identifier, indicating that such interest
exists. The Exchange would implement
the Program in a manner that allowed
the dissemination of the identifier
through consolidated data streams (i.e.,
pursuant to the Consolidated Tape
Association Plan/Consolidated
Quotation Plan (‘‘CTA/CQ Plan’’) for
Tape A and Tape B securities, and the
Nasdaq UTP Plan for Tape C securities
as well as through proprietary Exchange
data feeds. The Retail Liquidity
Identifier would reflect the symbol and
the side (buy or sell) of the RPI Order,
but it would not include the price or
size. In particular, CQ and UTP quoting
outputs would include a field for codes
related to the Retail Liquidity Identifier.
The codes will indicate RPI Orders that
are priced better than the Protected Bid
or Protected Offer by at least the
minimum level of price improvement as
required by the Program.
Retail Member Organizations
In order to become a RMO, a Member
must conduct a retail business or handle
retail orders on behalf of another brokerdealer. Any Member that wishes to
obtain RMO status would be required to
submit: (1) An application form; (2) an
attestation, in a form prescribed by the
Exchange, that any order submitted by
the Member as a Retail Order would
meet the qualifications for such orders;
and (3) supporting documentation
sufficient to demonstrate the retail
nature and characteristics of the
applicant’s order flow.19 If the Exchange
disapproves the application, it would
provide a written notice to the Member.
The disapproved applicant could appeal
the disapproval as provided below and/
or re-apply 90 days after the disapproval
19 For example, a prospective RMO could be
required to provide sample marketing literature,
Web site screenshots, other publicly disclosed
materials describing the retail nature of their order
flow, and such other documentation and
information as the Exchange may require to obtain
reasonable assurance that the applicant’s order flow
would meet the requirements of the Retail Order
definition.
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notice is issued by the Exchange. An
RMO also could voluntarily withdraw
from such status at any time by giving
written notice to the Exchange.
The Exchange would require a RMO
to have written policies and procedures
reasonably designed to assure that it
will only designate orders as Retail
Orders if all the requirements of a Retail
Order are met. Such written policies
and procedures would have to require
the Member to exercise due diligence
before entering a Retail Order to assure
that entry as a Retail Order is in
compliance with the proposed rule, and
monitor whether orders entered as
Retail Orders meet the applicable
requirements. If the RMO represents
Retail Orders from another broker-dealer
customer, the RMO’s supervisory
procedures must be reasonably designed
to assure that the orders it receives from
such broker-dealer customer that it
designates as Retail Orders meet the
definition of a Retail Order. The RMO
must obtain an annual written
representation, in a form acceptable to
the Exchange, from each broker-dealer
customer that sends it orders to be
designated as Retail Orders that entry of
such orders as Retail Orders will be in
compliance with the requirements of
this rule, and monitor whether its
broker-dealer customer’s Retail Order
flow continues to meet the applicable
requirements.20
Retail Order Designations
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Under the proposal, a RMO
submitting a Retail Order could choose
one of two designations dictating how it
would interact with available contraside interest. First, a Retail Order could
interact only with available contra-side
RPI Orders and other price-improving
liquidity. The Exchange would label
this a Type 1 Retail Order and such
orders would not interact with available
non-price-improving, contra-side
interest in Exchange systems or route to
other markets. Portions of a Type 1
Retail Order that are not executed
would be cancelled immediately and
automatically.
Second, a Retail Order could interact
first with available contra-side RPI
Orders and other price-improving
liquidity, and any remaining portion
would be eligible to interact with other
interest in the System 21 and, if
20 The Exchange represents that it or another selfregulatory organization on behalf of the Exchange
will review a RMO’s compliance with these
requirements through an exam-based review of the
RMO’s internal controls. See Notice, supra note 3,
77 FR at 53244 n.9.
21 The System is ‘‘the electronic communications
and trading facility designated by the Board through
which securities orders of Users are consolidated
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designated as eligible for routing, would
route to other markets in compliance
with Regulation NMS.22 The Exchange
would label this a Type 2 Retail Order,
and it could either be submitted as a
BATS Only Order 23 or as an order
eligible for routing.
review the facts and render a decision
within the timeframe prescribed by the
Exchange. The RPI Panel could overturn
or modify an action taken by the
Exchange and all determinations by the
RPI Panel would constitute final action
by the Exchange on the matter at issue.
Priority and Allocation
The Exchange would follow pricetime priority, ranking RPI Orders in the
same security according to price and
then time of entry into the System. Any
remaining unexecuted RPI Orders
would remain available to interact with
other incoming Retail Orders if such
interest is at an eligible price. Any
remaining unexecuted portion of a
Retail Order would cancel or execute in
accordance with the proposed rule.24
III. Comment Letters and the
Exchange’s Responses
As noted above, the Commission
received one comment letter that raised
concerns about the BYX proposal.25 The
main areas of concern expressed therein
were: (1) Whether the proposal impedes
fair access; (2) the proposal’s impact on
the Sub-Penny Rule; and (3) the
dissemination of quotations.26
The commenter argued that the BYX’s
proposal would result in a two-tiered
market wherein market participants
could only access available interest
identified by the Retail Liquidity
Identifier if they were seeking to interact
with an order placed by a retail
customer. The commenter believes that
this is inconsistent with the
requirements of Section 6(b)(5) of the
Exchange Act as it would allow for
unfair discrimination against
institutional investors. The commenter
expressed concern that approval of the
NYSE Retail Liquidity Program, coupled
with approval of the BYX proposal,
would set a precedent for other
exchanges to discriminate among
members.27
In response, the Exchange explained
that it believes that the differential
treatment proposed in connection with
the Program is not designed to permit
unfair discrimination, but instead to
promote a competitive process through
which retail investors would receive
better prices than they currently do in
light of bilateral internalization
arrangements currently utilized to
execute such orders. The Exchange
argued the Program is consistent with
Section 6(b)(5) of the Exchange Act as
it is designed to attract retail order flow
to the Exchange and help ensure that
retail investors benefits from the better
prices that liquidity providers are
willing to give such orders.
The commenter also express concern
that under the BYX proposal, priority
Failure of RMO To Abide by Retail
Order Requirements
The proposed rule addresses an
RMO’s failure to abide by Retail Order
requirements. If a RMO were to
designate orders submitted to the
Exchange as Retail Orders and the
Exchange determined, in its sole
discretion, that those orders failed to
meet any of the requirements of Retail
Orders, the Exchange could disqualify a
Member from its status as a RMO. When
disqualification determinations are
made, the Exchange would provide a
written disqualification notice to the
Member. A disqualified RMO could
appeal the disqualification as provided
below and/or re-apply 90 days after the
disqualification notice is issued by the
Exchange.
Appeal Process
Under the proposal, the Exchange
would establish a Retail Price
Improvement Program Panel (‘‘RPI
Panel’’) to review disapproval or
disqualification decisions. If a Member
disputes the Exchange’s decision to
disapprove or disqualify it as a RMO,
such Member could request, within five
business days after notice of the
decision is issued by the Exchange, that
the RPI Panel review the decision to
determine if it was correct. The RPI
Panel would consist of the Exchange’s
Chief Regulatory Officer or his or her
designee, and two officers of the
Exchange designated by the Exchange’s
Chief Operating Officer, and it would
for ranking, execution and, when applicable,
routing away.’’ BYX rule 1.5(aa).
22 See BYX Rule 11.9(b)(1).
23 A BATS Only Order is an order that is not
eligible for routing to other trading centers. See
BYX Rule 11.9(c)(4).
24 The Exchange provides three examples of how
the priority and ranking of RPI Orders would
operate. See Notice, supra note 3, 77 FR at 53245.
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25 See
note 4, supra.
SIFMA Letter, p. 3–4. In addition to
commenting on the proposal, the commenter
suggested that the Commission, rather than the staff
by delegated authority, should consider whether to
approve or disapprove BYX’s proposed rule change
because of the important issues it raises. The
commenter further stated that the Commission
should consider and resolve market structure issues
through the formal rulemaking process, as opposed
to allowing such issues to be addressed in rule
changes. See SIFMA Letter, p. 1–2.
27 See SIFMA Letter, p. 3.
26 See
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would be given based on sub-penny
increments, and tick size would be
reduced to $.001 even though Rule 612
of Regulation NMS prohibits national
securities exchanges from accepting or
ranking certain order based on an
increment smaller than the minimum
price increment. The commenter noted
that quoting in sub-penny increments
does not contribute to the maintenance
of orderly markets and that it
encourages market participants to step
ahead of competing limit orders to gain
an insignificant price improvement. The
commenter suggested that if the
Commission has determined that the
protections of Rule 612 are no longer
necessary, it should address this in a
rulemaking, rather than granting
individual exchange exemptions.28
In response, the Exchange noted that
Rule 612 was adopted to address the
Commission’s concern that sub-penny
increments could erode the incentives
of investors to display limit orders. The
Exchange argued that its Program would
not reduce such incentives. The
Exchange explained that market
participants currently are not able to
interact with retail order flow because it
is routinely routed to internalizing OTC
market makers that offer sub-penny
executions. The Exchange believes that
allowing the Exchange to compete for
this retail order flow through the
Program should not materially detract
from current incentives to display limit
orders, and could result in greater order
interaction and price improvement for
market retail orders on the Exchange.
Further, the Exchange explained that its
Program would not encourage market
participants to step ahead of competing
limit orders to gain an insignificant
price improvement because pursuant to
the Program, neither Retail Orders nor
RPI Orders will be displayed by the
Exchange.
Finally, the commenter argued that
the Exchange’s Retail Liquidity
Identifier that would be disseminated
through the consolidated data stream is
an indication of interest that is a
quotation, and encouraged the
Commission to conduct its own analysis
of whether these identifiers are
quotations. The commenter also
questioned whether broker-dealers
would be required to consider these
identifiers in making routing decisions
consistent with their best execution
obligations and expressed concern that
a proliferation of the use of identifiers
such as that proposed by BYX would
increase broker-dealers’ compliance
burdens because they would be required
continuously to evaluate these
28 See
SIFMA Letter, p. 4.
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identifiers on multiple exchanges and it
could pose obligations under the order
protection rule of Regulation NMS.29
In response, the Exchange explained
that it believes that neither the
Program’s RPI Orders nor the retail
liquidity identifiers meet the definition
of a ‘‘bid’’ or ‘‘offer’’ in Rule 600(b)(8)
of Regulation NMS, and therefore are
not quotations, because they do not
communicate a specific price. Because
the Exchange does not believe that RPI
are quotations pursuant to Rule 602, it
argues that they are not subject the Rule
611of Regulation NMS (Order Protection
Rule). Finally, the Exchange stated that
it believes that a broker-dealer should
consider the Program when conducting
its best execution analysis, but does not
believe that the Program would create
any best execution challenges for
broker-dealer’s that do not already exist
in today’s market.
IV. Discussion and Commission
Findings
After careful review of the proposal,
the comment letter received, and the
Exchange’s response, the Commission
finds that the proposed rule change is
consistent with the requirements of the
Act and the rules and regulations
thereunder that are applicable to a
national securities exchange. In
particular, the Commission finds that
the proposed rule change, subject to its
term as a pilot, is consistent with
Section 6(b)(5) of the Act,30 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 not be designed to
permit unfair discrimination between
customers, issuers, brokers or dealers.
The Commission finds that the
Program, as it is proposed on a pilot
basis, is consistent with the Act because
it is reasonably designed to benefit retail
investors by providing price
improvement to retail order flow.31 The
Commission also believes that the
Program could promote competition for
29 See
SIFMA Letter, p. 4–5.
30 15 U.S.C. 78f(b)(5).
31 The Commission recently approved similar
Retail Liquidity Programs for NYSE and NYSE
MKT. See RLP Approval Order, supra note 17.
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71655
retail order flow among execution
venues, and that this could benefit retail
investors by creating additional price
improvement opportunities for their
order flow. Currently, most marketable
retail order flow is executed in the OTC
markets, pursuant to bilateral
agreements, without ever reaching a
public exchange. The Commission has
noted that ‘‘a very large percentage of
marketable (immediately executable)
order flow of individual investors’’ is
executed, or ‘‘internalized,’’ by brokerdealers in the OTC markets.32 A review
of the order flow of eight retail brokers
revealed that nearly 100% of their
customer market orders were routed to
OTC market makers.33 The same review
found that such routing is often done
pursuant to arrangements under which
retail brokers route their order flow to
certain OTC market makers in exchange
for payment for such order flow.34 To
the extent that the Program may provide
price improvement to retail orders that
equals what would be provided under
such OTC internalization arrangements,
the Program could benefit retail
investors. To better understand the
Program’s potential impact, the
Exchange represents that it ‘‘will
produce data throughout the pilot,
which will include statistics about
participation, the frequency and level of
price improvement provided by the
Program, and any effects on the broader
market structure, and would be
reviewed by the Commission prior to
any extension of the Program beyond
the proposed one-year pilot term, or
permanent approval of the Program.’’ 35
The Program proposes to create
additional price improvement
opportunities for retail investors by
segmenting retail order flow on the
Exchange and requiring liquidity
providers that want to interact with
such retail order flow to do so at a price
at least $0.001 per share better than the
Protected Best Bid or Offer. As noted
above, the commenter questioned the
fairness of treating retail order flow
differently from other order flow on an
exchange by offering price improvement
opportunities only to retail orders. The
Commission finds that, while the
Program would treat retail order flow
differently from order flow submitted by
other market participants, such
segmentation would not be inconsistent
with Section 6(b)(5) of the Act, which
requires that the rules of an exchange
32 See Securities Exchange Act Release No. 61358
(Jan. 14, 2010), 75 FR 3594, 3600 (Jan. 21, 2010)
(‘‘Concept Release on Equity Market Structure’’).
33 See id.
34 See id.
35 See Notice, supra note 3, 77 FR at 53245.
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are not designed to permit unfair
discrimination.36 The Commission has
previously recognized that the markets
generally distinguish between
individual retail investors, whose orders
are considered desirable by liquidity
providers because such retail investors
are presumed on average to be less
informed about short-term price
movements, and professional traders,
whose orders are presumed on average
to be more informed.37 The Commission
has further recognized that, because of
this distinction, liquidity providers are
generally more inclined to offer price
improvement to less informed retail
orders than to more informed
professional orders.38 Absent
opportunities for price improvement,
retail investors may encounter wider
spreads that are a consequence of
liquidity providers interacting with
informed order flow. By creating
additional competition for retail order
flow, the Program is reasonably
designed to attract retail order flow to
the exchange environment, while
helping to ensure that retail investors
benefit from the better price that
liquidity providers are willing to give
their orders.
The commenter also expressed
concern that the Program could create a
36 The comment letter discussed whether the
Program’s proposed Retail Liquidity Identifier
constitutes a ‘‘quote’’ which would be subject to
Rule 610 of Regulation NMS. That rule, known as
the ‘‘Fair Access Rule,’’ contains a similar
prohibition on unfair discrimination. The
Commission finds that the Program is not unfairly
discriminatory under both Section 6(b)(5) of the Act
and Rule 610 of Regulation NMS. Because the
Commission has determined that the Program is not
unfairly discriminatory pursuant to Rule 610, it
need not determine whether the Retail Liquidity
Identifier is a ‘‘quote’’ for purposes of Rule 610.
37 See also Concept Release on Equity Market
Structure, supra note 32; Securities Exchange Act
Release No. 64781 (June 30, 2011), 76 FR 39953
(July 7, 2011) (approving a program proposed by an
options exchange that would provide price
improvement opportunities to retail orders based,
in part, on questions about execution quality of
retail orders under payment for order flow
arrangements in the options markets). The
commenter expressed concern that institutional
investors would not be able to submit RMOs. The
Commission notes that institutional investors tend
to be more informed than retail investors. See supra
note 29 and accompanying text.
38 See also Securities Exchange Act Release No.
64781 (June 30, 2011), 76 FR 39953 (July 7, 2011)
(noting that ‘‘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,’’
and that such losses are often borne by uninformed
retail investors through wider spreads (citing H.R.
Stoll, ‘‘The supply of dealer services in securities
markets,’’ Journal of Finance 33 (1978), at 1133–51;
L. Glosten & 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 T. Copeland & D. Galai,
‘‘Information effects on the bid-ask spread,’’ Journal
of Finance 38 (1983), at 1457–69)).
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two-tiered market and questioned the
fairness of preventing institutional
investors from submitting Retail Orders,
and thus receiving price improvement
on their orders.39 The Commission notes
that the Program might create a
desirable opportunity for institutional
investors to interact with retail order
flow that they are not able to reach
currently. Today, institutional investors
often do not have the chance to interact
with marketable retail orders that are
executed pursuant to internalization
arrangements. Thus, by submitting RPI
Orders, institutional investors may be
able to reduce their possible adverse
selection costs by interacting with retail
order flow.
When the Commission is engaged in
rulemaking or the review of a rule filed
by a self-regulatory organization, and is
required to consider or determine
whether an action is necessary or
appropriate in the public interest, the
Commission shall also consider, in
addition to the protection of investors,
whether the action will promote
efficiency, competition, and capital
formation.40 As discussed above, the
Commission believes this Program will
promote competition for retail order
flow by allowing Exchange members to
submit RPI Orders to interact with
Retail Orders. Such competition may
promote efficiency by facilitating the
price discovery process. Moreover, the
Commission does not believe that the
Program will have a significant effect on
market structure, or will create any new
inefficiencies in current market
structure. Finally, to the extent the
Program is successful in attracting retail
order flow, it may generate additional
investor interest in trading securities,
thereby promoting capital formation.
The Commission also believes that the
Program is sufficiently tailored to
provide the benefits of potential price
improvement only to bona fide retail
order flow originating from natural
persons.41 The Commission finds that
the Program provides an objective
process by which a member
organization could become a RMO, and
for appropriate oversight by the
Exchange to monitor for continued
compliance with the terms of these
provisions. The Exchange has limited
the definition of Retail Order to an
agency order that originates from a
natural person and not a trading
algorithm or any other computerized
39 See
supra note 29 and accompanying text.
15 U.S.C. 78c(f).
41 In addition, the Commission believes that the
Program’s provisions concerning the approval and
potential disqualification of RMOs are not
inconsistent with the Act. See RLP Approval Order,
supra note 17, 77 FR at 40680 & n.77.
40 See
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methodology. Furthermore, a Retail
Order must be submitted by a RMO that
is approved by the Exchange. In
addition, RMOs would be required to
maintain written policies and
procedures to help ensure that they
designate as Retail Orders only those
orders which qualify under the Program.
If a member’s application to become a
RMO is denied by the Exchange, that
member may appeal the determination
or re-apply. The Commission believes
that these standards should help ensure
that only retail order flow is submitted
into the Program and thereby promote
just and equitable principles of trade
and protect investors and the public
interest, while also providing an
objective process through which
members may become RMOs.
In addition, the Commission finds
that the Program’s proposed
dissemination of a Retail Liquidity
Identifier would increase the amount of
pricing information available to the
marketplace and is consistent with the
Act. The identifier would be
disseminated through the consolidated
public market data stream to advertise
the presence of a RPI Order with which
Retail Orders could interact. The
identifier would reflect the symbol for a
particular security and the side of the
RPI Order interest, but it would not
include the price or size of such
interest. The identifier would alert
market participants to the existence of a
RPI Order and should provide market
participants with more information
about the availability of price
improvement opportunities for retail
orders than is currently available.
The commenter questioned whether
the Retail Liquidity Identifier is a
‘‘quotation’’. 42 As we note above,
because the Commission has
determined that the Program is not
unfairly discriminatory pursuant to Rule
610, it need not determine whether the
Retail Liquidity Identifier 43 is a ‘‘quote’’
for purposes of Rule 610. Furthermore,
the Commission notes that the staff
granted the no-action requests of the
New York Stock Exchange LLC and
NYSE MKT concerning Rule 602 of
Regulation NMS with respect to the
Retail Liquidity Identifier.44
42 ‘‘Quotation’’ means a bid or an offer. 17 CFR
242.601(62).
43 The Commission notes that the Retail Liquidity
Identifier proposed by the Exchange is identical to
that used by NYSE and NYSE MKT.
44 In that letter, the staff recognized the
representations made by NYSE and NYSE MKT that
the Retail Liquidity Identifier does not meet the
definition of ‘‘bid’’ or ‘‘offer’’ in Rule 600(b)(8) of
Regulation NMS because it does not communicate
a specific price. See Letter from David Shillman,
Associate Director, Division of Trading and
Markets, to Janet McGinness, Senior Vice President-
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The commenter also raised concerns
about the additional burdens brokerdealers would face in evaluating the
information contained in the identifiers
to determine their routing obligations.
The Commission believes that the
Program will not create any best
execution challenges that are not
already present in today’s markets. A
broker’s best execution obligations are
determined by a number of facts and
circumstances, including: (1) The
character of the market for the security
(e.g., price, volatility, relative liquidity,
and pressure on available
communications): (2) the size and type
of transaction; (3) the number of markets
checked; (4) accessibility of the
quotation; and (5) the terms and
conditions of the order which result in
the transaction.45 A broker would
consider the Program when conducting
this analysis. Given the benefits of
adding this information to the
marketplace, the Commission believes
that the Retail Liquidity Identifier is an
appropriate part of the Program.
The Exchange believes that the
proposed distinctions between its
Program and the approved programs for
NYSE and NYSE MKT will both
enhance competition amongst market
participants and encourage competition
amongst exchange venues.46
Specifically, the Exchange believes that:
allowing all Exchange Users to enter RPI
Orders, as opposed to adopting a special
category of retail liquidity provider, will
result in a higher level of competition
and maximize price improvement to
incoming Retail Orders; the Program
will provide the maximum price
improvement available to incoming
Retail Orders because they will always
interact with available contra-side RPI
Orders and any other price-improving
contra-side interest; and the Program
Legal and Corporate Secretary, Office of the General
Counsel, NYSE Euronext, dated July 3, 2012.
A ‘‘bid’’ or ‘‘offer’’ means the bid price or the
offer price communicated by a member of a national
securities exchange or member of a national
securities association to any broker or dealer, or to
any customer, at which it is willing to buy or sell
one or more round lots of an NMS security, as
either principal or agent, but shall not include
indications of interest. 17 CFR 242.601(8).
The Exchange similarly requested that the staff of
the Commission not recommend enforcement
action to the Commission against the Exchange
under the Quote Rule relating to the kind of
information disseminated through Retail Liquidity
Identifier. See No-Action Letter, supra note 13. The
staff has determined to grant the Exchange’s NoAction request pursuant to a letter which is also
being issued today. See Letter from David Shillman,
Associate Director, Division of Trading and
Markets, to Eric Swanson, Senior Vice President
and General Counsel, BATS, dated November 27,
2012.
45 See FINRA Rule 5310.
46 See Notice, supra note 3, 77 FR at 52346.
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will provide all of the price
improvement available to incoming
Retail Orders by allowing executions at
multiple price levels, as opposed to a
single clearing price level.47 The
Commission finds that the Program is
reasonably designed to enhance
competition amongst market
participants and encourage competition
amongst exchange venues. The
Commission also finds that the
distinctions between the Exchange’s
Program and the approved NYSE and
NYSE MKT programs are reasonably
designed to enhance the Program’s
price-improvement benefits to retail
investors and, therefore, are consistent
with the Act.
The Commission notes that it is
approving the Program on a pilot basis.
Approving the Program on a pilot basis
will allow the Exchange and market
participants to gain valuable practical
experience with the Program during the
pilot period. This experience should
allow the Exchange and the Commission
to determine whether modifications to
the Program are necessary or
appropriate prior to any Commission
decision to approve the Program on a
permanent basis. The Exchange also has
agreed to provide the Commission with
a significant amount of data that should
assist the Commission in its evaluation
of the Program. Specifically, the
Exchange has represented that it ‘‘will
produce data throughout the pilot,
which will include statistics about
participation, the frequency and level of
price improvement provided by the
Program, and any effects on the broader
market structure.’’ 48 The Commission
expects that the Exchange will monitor
the scope and operation of the Program
and study the data produced during that
time with respect to such issues, and
will propose any modifications to the
Program that may be necessary or
appropriate.
The Commission also welcomes
comments, and empirical evidence, on
the Program during the pilot period to
further assist the Commission in its
evaluation of the Program. The
Commission notes that any permanent
approval of the Program would require
a proposed rule change by the
Exchange, and such rule change will
provide an opportunity for public
comment prior to further Commission
action.
V. Exemption From the Sub-Penny Rule
Pursuant to its authority under Rule
612(c) of Regulation NMS,49 the
47 See
Notice, supra note 3, 77 at 53245–46.
supra note 37 and accompanying text.
49 17 CFR 242.612(c).
48 See
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71657
Commission hereby grants the Exchange
a limited exemption from the SubPenny Rule to operate the Program.50
For the reasons discussed below, the
Commission determines that such
action is necessary or appropriate in the
public interest, and is consistent with
the protection of investors. The
exemption shall operate for a period of
12 months, coterminous with the
effectiveness of the proposed rule
change approved today.
When the Commission adopted the
Sub-Penny Rule in 2005, it identified a
variety of problems caused by subpennies that the Sub-Penny Rule was
designed to address:
• If investors’ limit orders lose
execution priority for a nominal
amount, investors may over time
decline to use them, thus depriving the
markets of liquidity.
• When market participants can gain
execution priority for a nominal
amount, important customer protection
rules such as exchange priority rules
and the Manning Rule could be
undermined.
• Flickering quotations that can result
from widespread sub-penny pricing
could make it more difficult for brokerdealers to satisfy their best execution
obligations and other regulatory
responsibilities.
• Widespread sub-penny quoting
could decrease market depth and lead to
higher transaction costs.
• Decreasing depth at the inside
could cause institutions to rely more on
execution alternatives away from the
exchanges, potentially increasing
fragmentation in the securities
markets.51
At the same time, the Commission
‘‘acknowledge[d] the possibility that the
balance of costs and benefits could shift
in a limited number of cases or as the
markets continue to evolve.’’ 52
Therefore, the Commission also adopted
Rule 612(c), which provides that the
Commission may grant exemptions from
the Sub-Penny Rule, either
unconditionally or on specified terms
and conditions, if it determined that
such an exemption is necessary or
appropriate in the public interest, and is
50 The commenter opined that if the Commission
believes that the protections afforded by sub-penny
rule are no longer necessary, the Commission
should address that change in policy through a
formal rulemaking rather than individual
exemptions. See supra note 30. For the reasons
expressed in this section, the Commission believes
that granting an exemption from Rule 612 for
purposes of the BYX RLP as proposed is
appropriate.
51 See Securities Exchange Act Release No. 51808
(June 9, 2005), 70 FR 37496, 37551–52 (June 29,
2005).
52 Id. at 37553.
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consistent with the protection of
investors.
The Commission believes that the
Exchange’s proposal raises such a case.
As described above, under the current
market structure, few marketable retail
orders in equity securities are routed to
exchanges. The vast majority of
marketable retail orders are internalized
by OTC market makers, who typically
pay retail brokers for their order flow.
Retail investors can benefit from such
arrangements to the extent that OTC
market makers offer them price
improvement over the NBBO. Price
improvement is typically offered in subpenny amounts.53 An internalizing
broker-dealer can offer sub-penny
executions, provided that such
executions do not result from
impermissible sub-penny orders or
quotations. Accordingly, OTC market
makers typically select a sub-penny
price for a trade without quoting at that
exact amount or accepting orders from
retail customers seeking that exact price.
Exchanges—and exchange member
firms that submit orders and quotations
to exchanges—cannot compete for
marketable retail order flow on the same
basis, because it would be impractical
for exchange electronic systems to
generate sub-penny executions without
exchange liquidity providers or retail
brokerage firms having first submitted
sub-penny orders or quotations, which
the Sub-Penny Rule expressly prohibits.
The limited exemption granted today
should promote competition between
exchanges and OTC market makers in a
manner that is reasonably designed to
minimize the problems that the
Commission identified when adopting
the Sub-Penny Rule. Under the Program,
sub-penny prices will not be
disseminated through the consolidated
quotation data stream, which should
avoid quote flickering and its reduced
depth at the inside quotation.
Furthermore, while the Commission
remains concerned about providing
enough incentives for market
participants to display limit orders, the
Commission does not believe that
granting this exemption (and approving
the accompanying proposed rule
change) will reduce such incentives.
Market participants that display limit
orders currently are not able to interact
with marketable retail order flow
53 When adopting the Sub-Penny Rule, the
Commission considered certain comments that
asked the Commission to prohibit broker-dealers
from offering sub-penny price improvement to their
customers, but declined to do so. The Commission
stated that ‘‘trading in sub-penny increments does
not raise the same concerns as sub-penny quoting’’
and that ‘‘sub-penny executions due to price
improvement are generally beneficial to retail
investors.’’ Id. at 37556.
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because it is almost entirely routed to
internalizing OTC market makers that
offer sub-penny executions.
Consequently, enabling the Exchanges
to compete for this retail order flow
through the Program should not
materially detract from the current
incentives to display limit orders, while
potentially resulting in greater order
interaction and price improvement for
marketable retail orders. To the extent
that the Program may raise Manning and
best execution issues for broker-dealers,
these issues are already presented by the
existing practices of OTC market
makers.
The exemption being granted today is
limited to a one-year pilot. The
Exchange has stated that ‘‘sub-penny
trading and pricing could potentially
result in undesirable market behavior,’’
and, therefore, it will ‘‘monitor the
Program in an effort to identify and
address any such behavior.’’ 54
Furthermore, the Exchange has
represented that it ‘‘will produce data
throughout the pilot, which will include
statistics about participation, the
frequency and level of price
improvement provided by the Program,
and any effects on the broader market
structure.’’ 55 The Commission expects
to review the data and observations of
the Exchange before determining
whether and, if so, how to extend the
exemption from the Sub-Penny Rule.56
VI. Conclusion
It is therefore ordered, pursuant to
Section 19(b)(2) of the Act,57 that the
proposed rule change (SR–BYX–2012–
019), as modified by Amendment No. 2,
be and hereby is, approved on a oneyear pilot basis.
It is also hereby ordered that,
pursuant to Rule 612(c) of Regulation
NMS, the Exchange is given a limited
exemption from Rule 612 of Regulation
NMS allowing it to accept and rank
orders priced equal to or greater than
$1.00 per share in increments of $0.001,
in the manner described in the proposed
rule change above, on a one-year pilot
basis coterminous with the effectiveness
of the proposed rule change.
54 See Request for Sub-Penny Rule Exemption,
supra note 10, at 3, n.7.
55 See supra note 37 and accompanying text.
56 In particular, the Commission expects the
Exchange to observe how maker/taker transaction
charges, whether imposed by the Exchange or by
other markets, might impact the use of the Program.
Market distortions could arise where the size of a
transaction rebate, whether for providing or taking
liquidity, is greater than the size of the minimum
increment permitted by the Program ($0.001 per
share).
57 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.58
Kevin O’Neill,
Deputy Secretary.
[FR Doc. 2012–29078 Filed 11–30–12; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–68302; File No. SR–NYSE–
2012–65]
Self-Regulatory Organizations; New
York Stock Exchange LLC; Notice of
Filing and Immediate Effectiveness of
Proposed Rule Change Moving the
Rule Text That Provides for Pegging
on the Exchange From Supplementary
Material .26 of NYSE Rule 70 to NYSE
Rule 13 and Amending Such Text to (i)
Permit Designated Market Maker
Interest To Be Set as Pegging Interest;
(ii) Change References From National
Best Bid, National Best Offer and
National Best Bid or Offer to Best
Protected Bid, Best Protected Offer
and Best Protected Bid or Offer,
Respectively; (iii) Permit Pegging
Interest To Peg to the Opposite Side of
the Market; and (iv) Provide for An
Offset Value To Be Specified for
Pegging Interest
November 27, 2012.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (the
‘‘Act’’),1 and Rule 19b–4 thereunder,2
notice is hereby given that on November
13, 2012, New York Stock Exchange
LLC (the ‘‘Exchange’’ or ‘‘NYSE’’) filed
with the Securities and Exchange
Commission (the ‘‘Commission’’) the
proposed rule change as described in
Items I and II below, which Items have
been prepared by the Exchange. The
Exchange filed the proposal as a ‘‘noncontroversial’’ proposed rule change
pursuant to Section 19(b)(3)(A)(iii) of
the Act 3 and Rule 19b–4(f)(6)
thereunder.4 The Commission is
publishing this notice to solicit
comments on the proposed rule change
from interested persons.
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
The Exchange proposes to move the
rule text that provides for pegging on
the Exchange from Supplementary
Material .26 of NYSE Rule 70 (‘‘Rule
58 17 CFR 200.30–3(a)(12); 17 CFR 200.30–
3(a)(83).
1 15 U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
3 15 U.S.C. 78s(b)(3)(A)(iii).
4 17 CFR 240.19b–4(f)(6).
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]]>Agencies
[Federal Register Volume 77, Number 232 (Monday, December 3, 2012)]
[Notices]
[Pages 71652-71658]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-29078]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-68303; File No. SR-BYX-2012-019]
Self-Regulatory Organizations; BATS Y-Exchange, Inc.; Order
Granting Approval to Proposed Rule Change, as Modified by Amendment No.
2, To Adopt a Retail Price Improvement Program
November 27, 2012.
I. Introduction
On August 14, 2012, BATS Y-Exchange, Inc. (the ``Exchange'' or
``BYX'') filed with the Securities and Exchange Commission
(``Commission'') pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change to establish a Retail Price Improvement Program
(``Program'') on a pilot basis for a period of one year from the date
of implementation, if approved. The proposed rule change was published
for comment in the Federal Register on August 31, 2012.\3\ The
Commission received one comment on the BYX proposal.\4\ On October 12,
2012, the Commission extended the time for Commission action on the
proposed rule change until November 29, 2012.\5\ The Exchange submitted
a response letter on November 13, 2012.\6\ On October 4, 2012, the
Exchange filed Amendment No. 1 to its proposal.\7\ On November 13,
2012, the Exchange filed Amendment No. 2 to its proposal.\8\
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 67734 (August 27,
2012), 77 FR 53242 (SR-BYX-2012-019) (``Notice'').
\4\ See Letter from Theodore R. Lazo, Managing Director and
Associate General Counsel, Securities Industry and Financial Markets
Association, to Elizabeth M. Murphy, Secretary, Commission, dated
September 26, 2012 (``SIFMA Letter'').
\5\ See Securities Exchange Act Release No. 68049, 77 FR 64180
(October 18, 2012).
\6\ See Letter from Eric Swanson, Senior Vice President and
General Counsel, BATS Global Markets, to Elizabeth M. Murphy,
Secretary, Commission, dated November 13, 2012 (``Exchange Response
to Comments'').
\7\ The Exchange withdrew Amendment No. 1 on October 4, 2012.
\8\ In Amendment No. 2, the Exchange proposes to delete a
statement explaining that a Retail Liquidity Identifier for Tape C
securities would not be published until after October 1, 2012. The
Exchange is deleting this statement because the processor is
currently able to disseminate the identifier. The Exchange also
proposes to clarify that the securities will be phased into the
Program, and modify its statutory basis discussion to support this
change. Finally, the Exchange proposes to modify the Rule Text to
state that the Exchange will notify its membership regarding the
securities included in the Program through an information circular
(``Amendment No. 2''). Because the changes made in Amendment No. 2
do not materially alter the substance of the proposed rule change or
raise any novel regulatory issues, Amendment No. 2 is not subject to
notice and comment.
---------------------------------------------------------------------------
In connection with the proposal, the Exchange requested exemptive
relief from Rule 612 of Regulation NMS,\9\ which, among other things,
prohibits a national securities exchange from accepting or ranking
orders priced greater than $1.00 per share in an increment smaller than
$0.01.\10\ On November 19, 2012, the Exchange submitted a letter
requesting that the staff of the Division of Trading and Markets not
recommend any enforcement action under Rule 602 of Regulation NMS
(``Quote Rule'') based on the Exchange's and its members' participation
in the Program (``No-Action Request Letter'').\11\
---------------------------------------------------------------------------
\9\ 17 CFR 242.612 (``Sub-Penny Rule'').
\10\ See Letter from Eric Swanson, Senior Vice President and
General Counsel, BATS Global Markets, to Elizabeth M. Murphy,
Secretary, Commission, dated August 14, 2012 (``Request for Sub-
Penny Rule Exemption'').
\11\ See Letter from Eric J. Swanson, Senior Vice President and
General Counsel, BATS Global Markets, to Robert Cook, Division of
Trading and Markets, Commission, dated November 19, 2012 (``No-
Action Letter'').
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[[Page 71653]]
This order approves the proposed rule change, as modified by
Amendment No. 2, and grants the exemption from the Sub-Penny Rule
sought by the Exchange in relation to the proposed rule change.
II. Description of the Proposal
The Exchange is proposing a one-year pilot program to attract
additional retail order flow to the Exchange, while also providing the
potential for price improvement to such order flow. The Program would
be limited to trades occurring at prices equal to or greater than $1.00
per share.
All securities traded on the Exchange would be eligible for
inclusion in the Program. As proposed in Amendment No. 2, for the first
90 days of the pilot program, a group of up to 25 securities would
participant in the program. These securities would represent those
securities traded most heavily by retail investors. After the initial
90 day period, the Program will be expanded gradually until all
securities traded on the Exchange are included. The Exchange will
notify Members in an information circular of the securities that are
subject to the Program both initially and as additional securities
become eligible for inclusion.\12\
---------------------------------------------------------------------------
\12\ See Amendment No. 2, supra note 8.
---------------------------------------------------------------------------
Under the Program, a new class of market participants called Retail
Member Organizations (``RMOs'') \13\ would be eligible to submit
certain retail order flow (``Retail Orders'') to the Exchange. All
Exchange Users \14\ would be permitted to provide potential price
improvement for Retail Orders in the form of non-displayed interest
that is better than the national best bid that is a Protected Quotation
(``Protected NBB'') or the national best offer that is a Protected
Quotation (``Protected NBO,'' and together with the Protected NBB, the
``Protected NBBO'') \15\ called a Retail Price Improvement Order (``RPI
Order''). When an RPI Order priced at least $0.001 better than the
Protected Bid or Protected Offer for a particular security is available
in the System, the Exchange would disseminate an identifier, known as
the Retail Liquidity Identifier, indicating that such interest exists.
A Retail Order would interact, to the extent possible, with available
contra-side RPI Orders.\16\
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\13\ A RMO would be a Member (or a division thereof) that has
been approved by the Exchange to submit Retail Orders. A ``Member''
is any registered broker or dealer that has been admitted to
membership in the Exchange. See BYX Rule 1.5(n).
\14\ A ``User'' is any Member or sponsored participant of the
Exchange who is authorized to obtain access to the System. See BYX
Rule 1.5(cc).
\15\ The term Protected Quotation has the same meaning as
defined in Rule 600(b)(58) of Regulation NMS. See BYX Rule 1.5(t).
Rule 600(b)(58) of Regulation NMS defines ``protected quotation'' as
``a protected bid or a protected offer.'' 17 CFR 242.600(b)(58). The
Protected NBB is the best-priced protected bid and the Protected NBO
is the best-priced protected offer. See BYX Rule 1.5(s). The
Exchange represents that, generally, the Protected NBB and Protected
NBO, and the national best bid (``NBB'') and national best offer
(``NBO,'' together with the NBB, the ``NBBO''), will be the same.
However, it further represents that a market center is not required
to route to the NBB or NBO if that market center is subject to an
exception under Regulation NMS Rule 611(b)(1) or if such NBB or NBO
is otherwise not available for an automatic execution. In such case,
the Exchange states that the Protected NBB or Protected NBO would be
the best-priced protected bid or offer to which a market center must
route interest pursuant to Rule 611 of Regulation NMS.
\16\ As explained further below, the Exchange has proposed two
types of Retail Orders, one of which could execute against other
interest if it was not completely filled by contra-side RPI Interest
or other price-improving liquidity. All Retail Orders would first
execute against available contra-side RPI Orders or other price-
improving liquidity. Any remaining portion of the Retail Order would
then either cancel, be executed as an immediate-or-cancel order, or
be routed to another market for execution, depending on the type of
Retail Order.
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The Exchange represents that its proposed rule change is based on
New York Stock Exchange LLC's (``NYSE'') Rule 107C, which governs
NYSE's previously approved Retail Liquidity Program,\17\ with three
distinctions. First, the NYSE's Retail Liquidity Program creates a
category of members, Retail Liquidity Providers, who are required to
maintain an RPI that betters the protected best bid or offer at least
5% of the trading day in each assigned security. Under the BYX's
proposal, the Exchange would not create such a category of users.
Second, NYSE's Retail Liquidity Program does not permit the execution
of Retail Orders against other resting non-displayed liquidity. BYX's
proposal would permit such executions. Finally, under the NYSE'S Retail
Liquidity Program, Retail Orders execute at the single price at which
the order will be fully executed. Pursuant to the BYX's proposal,
Retail Orders execute at multiple price levels rather than a single
price level.\18\
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\17\ See Securities Exchange Act Release No. 67347 (July 3,
2012), 77 FR 40673 (July 10, 2012) (SR-NYSE-2011-55; SR-NYSEAmex-
2011-84) (``RLP Approval Order''). In the RLP Approval Order, the
Commission also approved a Retail Liquidity Program for NYSE Amex
LLC (now known as NYSE MKT LLC) (``NYSE MKT'').
\18\ See Notice, supra note 3, 77 FR at 53245-46 (explaining the
three distinctions in detail).
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Types of Orders and Identifier
A Retail Order would be an agency order that originates from a
natural person and is submitted to the Exchange by a RMO, provided that
no change is made to the terms of the order with respect to price or
side of market, and the order does not originate from a trading
algorithm or any other computerized methodology. Users and RMOs could
enter odd lots, round lots, or mixed lots as RPI Orders and as Retail
Orders, respectively.
A RPI Order would be non-displayed interest on the Exchange that is
better than the Protected NBB or Protected NBO by at least $0.001 and
that is identified as a RPI Order in a manner prescribed by the
Exchange. An RPI Order may also be entered in a sub-penny increment
with an explicit limit price. When such an order is available in the
System in a particular security, the Exchange would disseminate an
identifier, known as the Retail Liquidity Identifier, indicating that
such interest exists. The Exchange would implement the Program in a
manner that allowed the dissemination of the identifier through
consolidated data streams (i.e., pursuant to the Consolidated Tape
Association Plan/Consolidated Quotation Plan (``CTA/CQ Plan'') for Tape
A and Tape B securities, and the Nasdaq UTP Plan for Tape C securities
as well as through proprietary Exchange data feeds. The Retail
Liquidity Identifier would reflect the symbol and the side (buy or
sell) of the RPI Order, but it would not include the price or size. In
particular, CQ and UTP quoting outputs would include a field for codes
related to the Retail Liquidity Identifier. The codes will indicate RPI
Orders that are priced better than the Protected Bid or Protected Offer
by at least the minimum level of price improvement as required by the
Program.
Retail Member Organizations
In order to become a RMO, a Member must conduct a retail business
or handle retail orders on behalf of another broker-dealer. Any Member
that wishes to obtain RMO status would be required to submit: (1) An
application form; (2) an attestation, in a form prescribed by the
Exchange, that any order submitted by the Member as a Retail Order
would meet the qualifications for such orders; and (3) supporting
documentation sufficient to demonstrate the retail nature and
characteristics of the applicant's order flow.\19\ If the Exchange
disapproves the application, it would provide a written notice to the
Member. The disapproved applicant could appeal the disapproval as
provided below and/or re-apply 90 days after the disapproval
[[Page 71654]]
notice is issued by the Exchange. An RMO also could voluntarily
withdraw from such status at any time by giving written notice to the
Exchange.
---------------------------------------------------------------------------
\19\ For example, a prospective RMO could be required to provide
sample marketing literature, Web site screenshots, other publicly
disclosed materials describing the retail nature of their order
flow, and such other documentation and information as the Exchange
may require to obtain reasonable assurance that the applicant's
order flow would meet the requirements of the Retail Order
definition.
---------------------------------------------------------------------------
The Exchange would require a RMO to have written policies and
procedures reasonably designed to assure that it will only designate
orders as Retail Orders if all the requirements of a Retail Order are
met. Such written policies and procedures would have to require the
Member to exercise due diligence before entering a Retail Order to
assure that entry as a Retail Order is in compliance with the proposed
rule, and monitor whether orders entered as Retail Orders meet the
applicable requirements. If the RMO represents Retail Orders from
another broker-dealer customer, the RMO's supervisory procedures must
be reasonably designed to assure that the orders it receives from such
broker-dealer customer that it designates as Retail Orders meet the
definition of a Retail Order. The RMO must obtain an annual written
representation, in a form acceptable to the Exchange, from each broker-
dealer customer that sends it orders to be designated as Retail Orders
that entry of such orders as Retail Orders will be in compliance with
the requirements of this rule, and monitor whether its broker-dealer
customer's Retail Order flow continues to meet the applicable
requirements.\20\
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\20\ The Exchange represents that it or another self-regulatory
organization on behalf of the Exchange will review a RMO's
compliance with these requirements through an exam-based review of
the RMO's internal controls. See Notice, supra note 3, 77 FR at
53244 n.9.
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Retail Order Designations
Under the proposal, a RMO submitting a Retail Order could choose
one of two designations dictating how it would interact with available
contra-side interest. First, a Retail Order could interact only with
available contra-side RPI Orders and other price-improving liquidity.
The Exchange would label this a Type 1 Retail Order and such orders
would not interact with available non-price-improving, contra-side
interest in Exchange systems or route to other markets. Portions of a
Type 1 Retail Order that are not executed would be cancelled
immediately and automatically.
Second, a Retail Order could interact first with available contra-
side RPI Orders and other price-improving liquidity, and any remaining
portion would be eligible to interact with other interest in the System
\21\ and, if designated as eligible for routing, would route to other
markets in compliance with Regulation NMS.\22\ The Exchange would label
this a Type 2 Retail Order, and it could either be submitted as a BATS
Only Order \23\ or as an order eligible for routing.
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\21\ The System is ``the electronic communications and trading
facility designated by the Board through which securities orders of
Users are consolidated for ranking, execution and, when applicable,
routing away.'' BYX rule 1.5(aa).
\22\ See BYX Rule 11.9(b)(1).
\23\ A BATS Only Order is an order that is not eligible for
routing to other trading centers. See BYX Rule 11.9(c)(4).
---------------------------------------------------------------------------
Priority and Allocation
The Exchange would follow price-time priority, ranking RPI Orders
in the same security according to price and then time of entry into the
System. Any remaining unexecuted RPI Orders would remain available to
interact with other incoming Retail Orders if such interest is at an
eligible price. Any remaining unexecuted portion of a Retail Order
would cancel or execute in accordance with the proposed rule.\24\
---------------------------------------------------------------------------
\24\ The Exchange provides three examples of how the priority
and ranking of RPI Orders would operate. See Notice, supra note 3,
77 FR at 53245.
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Failure of RMO To Abide by Retail Order Requirements
The proposed rule addresses an RMO's failure to abide by Retail
Order requirements. If a RMO were to designate orders submitted to the
Exchange as Retail Orders and the Exchange determined, in its sole
discretion, that those orders failed to meet any of the requirements of
Retail Orders, the Exchange could disqualify a Member from its status
as a RMO. When disqualification determinations are made, the Exchange
would provide a written disqualification notice to the Member. A
disqualified RMO could appeal the disqualification as provided below
and/or re-apply 90 days after the disqualification notice is issued by
the Exchange.
Appeal Process
Under the proposal, the Exchange would establish a Retail Price
Improvement Program Panel (``RPI Panel'') to review disapproval or
disqualification decisions. If a Member disputes the Exchange's
decision to disapprove or disqualify it as a RMO, such Member could
request, within five business days after notice of the decision is
issued by the Exchange, that the RPI Panel review the decision to
determine if it was correct. The RPI Panel would consist of the
Exchange's Chief Regulatory Officer or his or her designee, and two
officers of the Exchange designated by the Exchange's Chief Operating
Officer, and it would review the facts and render a decision within the
timeframe prescribed by the Exchange. The RPI Panel could overturn or
modify an action taken by the Exchange and all determinations by the
RPI Panel would constitute final action by the Exchange on the matter
at issue.
III. Comment Letters and the Exchange's Responses
As noted above, the Commission received one comment letter that
raised concerns about the BYX proposal.\25\ The main areas of concern
expressed therein were: (1) Whether the proposal impedes fair access;
(2) the proposal's impact on the Sub-Penny Rule; and (3) the
dissemination of quotations.\26\
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\25\ See note 4, supra.
\26\ See SIFMA Letter, p. 3-4. In addition to commenting on the
proposal, the commenter suggested that the Commission, rather than
the staff by delegated authority, should consider whether to approve
or disapprove BYX's proposed rule change because of the important
issues it raises. The commenter further stated that the Commission
should consider and resolve market structure issues through the
formal rulemaking process, as opposed to allowing such issues to be
addressed in rule changes. See SIFMA Letter, p. 1-2.
---------------------------------------------------------------------------
The commenter argued that the BYX's proposal would result in a two-
tiered market wherein market participants could only access available
interest identified by the Retail Liquidity Identifier if they were
seeking to interact with an order placed by a retail customer. The
commenter believes that this is inconsistent with the requirements of
Section 6(b)(5) of the Exchange Act as it would allow for unfair
discrimination against institutional investors. The commenter expressed
concern that approval of the NYSE Retail Liquidity Program, coupled
with approval of the BYX proposal, would set a precedent for other
exchanges to discriminate among members.\27\
---------------------------------------------------------------------------
\27\ See SIFMA Letter, p. 3.
---------------------------------------------------------------------------
In response, the Exchange explained that it believes that the
differential treatment proposed in connection with the Program is not
designed to permit unfair discrimination, but instead to promote a
competitive process through which retail investors would receive better
prices than they currently do in light of bilateral internalization
arrangements currently utilized to execute such orders. The Exchange
argued the Program is consistent with Section 6(b)(5) of the Exchange
Act as it is designed to attract retail order flow to the Exchange and
help ensure that retail investors benefits from the better prices that
liquidity providers are willing to give such orders.
The commenter also express concern that under the BYX proposal,
priority
[[Page 71655]]
would be given based on sub-penny increments, and tick size would be
reduced to $.001 even though Rule 612 of Regulation NMS prohibits
national securities exchanges from accepting or ranking certain order
based on an increment smaller than the minimum price increment. The
commenter noted that quoting in sub-penny increments does not
contribute to the maintenance of orderly markets and that it encourages
market participants to step ahead of competing limit orders to gain an
insignificant price improvement. The commenter suggested that if the
Commission has determined that the protections of Rule 612 are no
longer necessary, it should address this in a rulemaking, rather than
granting individual exchange exemptions.\28\
---------------------------------------------------------------------------
\28\ See SIFMA Letter, p. 4.
---------------------------------------------------------------------------
In response, the Exchange noted that Rule 612 was adopted to
address the Commission's concern that sub-penny increments could erode
the incentives of investors to display limit orders. The Exchange
argued that its Program would not reduce such incentives. The Exchange
explained that market participants currently are not able to interact
with retail order flow because it is routinely routed to internalizing
OTC market makers that offer sub-penny executions. The Exchange
believes that allowing the Exchange to compete for this retail order
flow through the Program should not materially detract from current
incentives to display limit orders, and could result in greater order
interaction and price improvement for market retail orders on the
Exchange. Further, the Exchange explained that its Program would not
encourage market participants to step ahead of competing limit orders
to gain an insignificant price improvement because pursuant to the
Program, neither Retail Orders nor RPI Orders will be displayed by the
Exchange.
Finally, the commenter argued that the Exchange's Retail Liquidity
Identifier that would be disseminated through the consolidated data
stream is an indication of interest that is a quotation, and encouraged
the Commission to conduct its own analysis of whether these identifiers
are quotations. The commenter also questioned whether broker-dealers
would be required to consider these identifiers in making routing
decisions consistent with their best execution obligations and
expressed concern that a proliferation of the use of identifiers such
as that proposed by BYX would increase broker-dealers' compliance
burdens because they would be required continuously to evaluate these
identifiers on multiple exchanges and it could pose obligations under
the order protection rule of Regulation NMS.\29\
---------------------------------------------------------------------------
\29\ See SIFMA Letter, p. 4-5.
---------------------------------------------------------------------------
In response, the Exchange explained that it believes that neither
the Program's RPI Orders nor the retail liquidity identifiers meet the
definition of a ``bid'' or ``offer'' in Rule 600(b)(8) of Regulation
NMS, and therefore are not quotations, because they do not communicate
a specific price. Because the Exchange does not believe that RPI are
quotations pursuant to Rule 602, it argues that they are not subject
the Rule 611of Regulation NMS (Order Protection Rule). Finally, the
Exchange stated that it believes that a broker-dealer should consider
the Program when conducting its best execution analysis, but does not
believe that the Program would create any best execution challenges for
broker-dealer's that do not already exist in today's market.
IV. Discussion and Commission Findings
After careful review of the proposal, the comment letter received,
and the Exchange's response, the Commission finds that the proposed
rule change is consistent with the requirements of the Act and the
rules and regulations thereunder that are applicable to a national
securities exchange. In particular, the Commission finds that the
proposed rule change, subject to its term as a pilot, is consistent
with Section 6(b)(5) of the Act,\30\ 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 not be designed to
permit unfair discrimination between customers, issuers, brokers or
dealers.
---------------------------------------------------------------------------
\30\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
The Commission finds that the Program, as it is proposed on a pilot
basis, is consistent with the Act because it is reasonably designed to
benefit retail investors by providing price improvement to retail order
flow.\31\ The Commission also believes that the Program could promote
competition for retail order flow among execution venues, and that this
could benefit retail investors by creating additional price improvement
opportunities for their order flow. Currently, most marketable retail
order flow is executed in the OTC markets, pursuant to bilateral
agreements, without ever reaching a public exchange. The Commission has
noted that ``a very large percentage of marketable (immediately
executable) order flow of individual investors'' is executed, or
``internalized,'' by broker-dealers in the OTC markets.\32\ A review of
the order flow of eight retail brokers revealed that nearly 100% of
their customer market orders were routed to OTC market makers.\33\ The
same review found that such routing is often done pursuant to
arrangements under which retail brokers route their order flow to
certain OTC market makers in exchange for payment for such order
flow.\34\ To the extent that the Program may provide price improvement
to retail orders that equals what would be provided under such OTC
internalization arrangements, the Program could benefit retail
investors. To better understand the Program's potential impact, the
Exchange represents that it ``will produce data throughout the pilot,
which will include statistics about participation, the frequency and
level of price improvement provided by the Program, and any effects on
the broader market structure, and would be reviewed by the Commission
prior to any extension of the Program beyond the proposed one-year
pilot term, or permanent approval of the Program.'' \35\
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\31\ The Commission recently approved similar Retail Liquidity
Programs for NYSE and NYSE MKT. See RLP Approval Order, supra note
17.
\32\ See Securities Exchange Act Release No. 61358 (Jan. 14,
2010), 75 FR 3594, 3600 (Jan. 21, 2010) (``Concept Release on Equity
Market Structure'').
\33\ See id.
\34\ See id.
\35\ See Notice, supra note 3, 77 FR at 53245.
---------------------------------------------------------------------------
The Program proposes to create additional price improvement
opportunities for retail investors by segmenting retail order flow on
the Exchange and requiring liquidity providers that want to interact
with such retail order flow to do so at a price at least $0.001 per
share better than the Protected Best Bid or Offer. As noted above, the
commenter questioned the fairness of treating retail order flow
differently from other order flow on an exchange by offering price
improvement opportunities only to retail orders. The Commission finds
that, while the Program would treat retail order flow differently from
order flow submitted by other market participants, such segmentation
would not be inconsistent with Section 6(b)(5) of the Act, which
requires that the rules of an exchange
[[Page 71656]]
are not designed to permit unfair discrimination.\36\ The Commission
has previously recognized that the markets generally distinguish
between individual retail investors, whose orders are considered
desirable by liquidity providers because such retail investors are
presumed on average to be less informed about short-term price
movements, and professional traders, whose orders are presumed on
average to be more informed.\37\ The Commission has further recognized
that, because of this distinction, liquidity providers are generally
more inclined to offer price improvement to less informed retail orders
than to more informed professional orders.\38\ Absent opportunities for
price improvement, retail investors may encounter wider spreads that
are a consequence of liquidity providers interacting with informed
order flow. By creating additional competition for retail order flow,
the Program is reasonably designed to attract retail order flow to the
exchange environment, while helping to ensure that retail investors
benefit from the better price that liquidity providers are willing to
give their orders.
---------------------------------------------------------------------------
\36\ The comment letter discussed whether the Program's proposed
Retail Liquidity Identifier constitutes a ``quote'' which would be
subject to Rule 610 of Regulation NMS. That rule, known as the
``Fair Access Rule,'' contains a similar prohibition on unfair
discrimination. The Commission finds that the Program is not
unfairly discriminatory under both Section 6(b)(5) of the Act and
Rule 610 of Regulation NMS. Because the Commission has determined
that the Program is not unfairly discriminatory pursuant to Rule
610, it need not determine whether the Retail Liquidity Identifier
is a ``quote'' for purposes of Rule 610.
\37\ See also Concept Release on Equity Market Structure, supra
note 32; Securities Exchange Act Release No. 64781 (June 30, 2011),
76 FR 39953 (July 7, 2011) (approving a program proposed by an
options exchange that would provide price improvement opportunities
to retail orders based, in part, on questions about execution
quality of retail orders under payment for order flow arrangements
in the options markets). The commenter expressed concern that
institutional investors would not be able to submit RMOs. The
Commission notes that institutional investors tend to be more
informed than retail investors. See supra note 29 and accompanying
text.
\38\ See also Securities Exchange Act Release No. 64781 (June
30, 2011), 76 FR 39953 (July 7, 2011) (noting that ``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,'' and that such losses
are often borne by uninformed retail investors through wider spreads
(citing H.R. Stoll, ``The supply of dealer services in securities
markets,'' Journal of Finance 33 (1978), at 1133-51; L. Glosten & 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 T. Copeland & D. Galai,
``Information effects on the bid-ask spread,'' Journal of Finance 38
(1983), at 1457-69)).
---------------------------------------------------------------------------
The commenter also expressed concern that the Program could create
a two-tiered market and questioned the fairness of preventing
institutional investors from submitting Retail Orders, and thus
receiving price improvement on their orders.\39\ The Commission notes
that the Program might create a desirable opportunity for institutional
investors to interact with retail order flow that they are not able to
reach currently. Today, institutional investors often do not have the
chance to interact with marketable retail orders that are executed
pursuant to internalization arrangements. Thus, by submitting RPI
Orders, institutional investors may be able to reduce their possible
adverse selection costs by interacting with retail order flow.
---------------------------------------------------------------------------
\39\ See supra note 29 and accompanying text.
---------------------------------------------------------------------------
When the Commission is engaged in rulemaking or the review of a
rule filed by a self-regulatory organization, and is required to
consider or determine whether an action is necessary or appropriate in
the public interest, the Commission shall also consider, in addition to
the protection of investors, whether the action will promote
efficiency, competition, and capital formation.\40\ As discussed above,
the Commission believes this Program will promote competition for
retail order flow by allowing Exchange members to submit RPI Orders to
interact with Retail Orders. Such competition may promote efficiency by
facilitating the price discovery process. Moreover, the Commission does
not believe that the Program will have a significant effect on market
structure, or will create any new inefficiencies in current market
structure. Finally, to the extent the Program is successful in
attracting retail order flow, it may generate additional investor
interest in trading securities, thereby promoting capital formation.
---------------------------------------------------------------------------
\40\ See 15 U.S.C. 78c(f).
---------------------------------------------------------------------------
The Commission also believes that the Program is sufficiently
tailored to provide the benefits of potential price improvement only to
bona fide retail order flow originating from natural persons.\41\ The
Commission finds that the Program provides an objective process by
which a member organization could become a RMO, and for appropriate
oversight by the Exchange to monitor for continued compliance with the
terms of these provisions. The Exchange has limited the definition of
Retail Order to an agency order that originates from a natural person
and not a trading algorithm or any other computerized methodology.
Furthermore, a Retail Order must be submitted by a RMO that is approved
by the Exchange. In addition, RMOs would be required to maintain
written policies and procedures to help ensure that they designate as
Retail Orders only those orders which qualify under the Program. If a
member's application to become a RMO is denied by the Exchange, that
member may appeal the determination or re-apply. The Commission
believes that these standards should help ensure that only retail order
flow is submitted into the Program and thereby promote just and
equitable principles of trade and protect investors and the public
interest, while also providing an objective process through which
members may become RMOs.
---------------------------------------------------------------------------
\41\ In addition, the Commission believes that the Program's
provisions concerning the approval and potential disqualification of
RMOs are not inconsistent with the Act. See RLP Approval Order,
supra note 17, 77 FR at 40680 & n.77.
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In addition, the Commission finds that the Program's proposed
dissemination of a Retail Liquidity Identifier would increase the
amount of pricing information available to the marketplace and is
consistent with the Act. The identifier would be disseminated through
the consolidated public market data stream to advertise the presence of
a RPI Order with which Retail Orders could interact. The identifier
would reflect the symbol for a particular security and the side of the
RPI Order interest, but it would not include the price or size of such
interest. The identifier would alert market participants to the
existence of a RPI Order and should provide market participants with
more information about the availability of price improvement
opportunities for retail orders than is currently available.
The commenter questioned whether the Retail Liquidity Identifier is
a ``quotation''. \42\ As we note above, because the Commission has
determined that the Program is not unfairly discriminatory pursuant to
Rule 610, it need not determine whether the Retail Liquidity Identifier
\43\ is a ``quote'' for purposes of Rule 610. Furthermore, the
Commission notes that the staff granted the no-action requests of the
New York Stock Exchange LLC and NYSE MKT concerning Rule 602 of
Regulation NMS with respect to the Retail Liquidity Identifier.\44\
---------------------------------------------------------------------------
\42\ ``Quotation'' means a bid or an offer. 17 CFR 242.601(62).
\43\ The Commission notes that the Retail Liquidity Identifier
proposed by the Exchange is identical to that used by NYSE and NYSE
MKT.
\44\ In that letter, the staff recognized the representations
made by NYSE and NYSE MKT that the Retail Liquidity Identifier does
not meet the definition of ``bid'' or ``offer'' in Rule 600(b)(8) of
Regulation NMS because it does not communicate a specific price. See
Letter from David Shillman, Associate Director, Division of Trading
and Markets, to Janet McGinness, Senior Vice President-Legal and
Corporate Secretary, Office of the General Counsel, NYSE Euronext,
dated July 3, 2012.
A ``bid'' or ``offer'' means the bid price or the offer price
communicated by a member of a national securities exchange or member
of a national securities association to any broker or dealer, or to
any customer, at which it is willing to buy or sell one or more
round lots of an NMS security, as either principal or agent, but
shall not include indications of interest. 17 CFR 242.601(8).
The Exchange similarly requested that the staff of the
Commission not recommend enforcement action to the Commission
against the Exchange under the Quote Rule relating to the kind of
information disseminated through Retail Liquidity Identifier. See
No-Action Letter, supra note 13. The staff has determined to grant
the Exchange's No-Action request pursuant to a letter which is also
being issued today. See Letter from David Shillman, Associate
Director, Division of Trading and Markets, to Eric Swanson, Senior
Vice President and General Counsel, BATS, dated November 27, 2012.
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[[Page 71657]]
The commenter also raised concerns about the additional burdens
broker-dealers would face in evaluating the information contained in
the identifiers to determine their routing obligations. The Commission
believes that the Program will not create any best execution challenges
that are not already present in today's markets. A broker's best
execution obligations are determined by a number of facts and
circumstances, including: (1) The character of the market for the
security (e.g., price, volatility, relative liquidity, and pressure on
available communications): (2) the size and type of transaction; (3)
the number of markets checked; (4) accessibility of the quotation; and
(5) the terms and conditions of the order which result in the
transaction.\45\ A broker would consider the Program when conducting
this analysis. Given the benefits of adding this information to the
marketplace, the Commission believes that the Retail Liquidity
Identifier is an appropriate part of the Program.
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\45\ See FINRA Rule 5310.
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The Exchange believes that the proposed distinctions between its
Program and the approved programs for NYSE and NYSE MKT will both
enhance competition amongst market participants and encourage
competition amongst exchange venues.\46\ Specifically, the Exchange
believes that: allowing all Exchange Users to enter RPI Orders, as
opposed to adopting a special category of retail liquidity provider,
will result in a higher level of competition and maximize price
improvement to incoming Retail Orders; the Program will provide the
maximum price improvement available to incoming Retail Orders because
they will always interact with available contra-side RPI Orders and any
other price-improving contra-side interest; and the Program will
provide all of the price improvement available to incoming Retail
Orders by allowing executions at multiple price levels, as opposed to a
single clearing price level.\47\ The Commission finds that the Program
is reasonably designed to enhance competition amongst market
participants and encourage competition amongst exchange venues. The
Commission also finds that the distinctions between the Exchange's
Program and the approved NYSE and NYSE MKT programs are reasonably
designed to enhance the Program's price-improvement benefits to retail
investors and, therefore, are consistent with the Act.
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\46\ See Notice, supra note 3, 77 FR at 52346.
\47\ See Notice, supra note 3, 77 at 53245-46.
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The Commission notes that it is approving the Program on a pilot
basis. Approving the Program on a pilot basis will allow the Exchange
and market participants to gain valuable practical experience with the
Program during the pilot period. This experience should allow the
Exchange and the Commission to determine whether modifications to the
Program are necessary or appropriate prior to any Commission decision
to approve the Program on a permanent basis. The Exchange also has
agreed to provide the Commission with a significant amount of data that
should assist the Commission in its evaluation of the Program.
Specifically, the Exchange has represented that it ``will produce data
throughout the pilot, which will include statistics about
participation, the frequency and level of price improvement provided by
the Program, and any effects on the broader market structure.'' \48\
The Commission expects that the Exchange will monitor the scope and
operation of the Program and study the data produced during that time
with respect to such issues, and will propose any modifications to the
Program that may be necessary or appropriate.
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\48\ See supra note 37 and accompanying text.
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The Commission also welcomes comments, and empirical evidence, on
the Program during the pilot period to further assist the Commission in
its evaluation of the Program. The Commission notes that any permanent
approval of the Program would require a proposed rule change by the
Exchange, and such rule change will provide an opportunity for public
comment prior to further Commission action.
V. Exemption From the Sub-Penny Rule
Pursuant to its authority under Rule 612(c) of Regulation NMS,\49\
the Commission hereby grants the Exchange a limited exemption from the
Sub-Penny Rule to operate the Program.\50\ For the reasons discussed
below, the Commission determines that such action is necessary or
appropriate in the public interest, and is consistent with the
protection of investors. The exemption shall operate for a period of 12
months, coterminous with the effectiveness of the proposed rule change
approved today.
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\49\ 17 CFR 242.612(c).
\50\ The commenter opined that if the Commission believes that
the protections afforded by sub-penny rule are no longer necessary,
the Commission should address that change in policy through a formal
rulemaking rather than individual exemptions. See supra note 30. For
the reasons expressed in this section, the Commission believes that
granting an exemption from Rule 612 for purposes of the BYX RLP as
proposed is appropriate.
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When the Commission adopted the Sub-Penny Rule in 2005, it
identified a variety of problems caused by sub-pennies that the Sub-
Penny Rule was designed to address:
If investors' limit orders lose execution priority for a
nominal amount, investors may over time decline to use them, thus
depriving the markets of liquidity.
When market participants can gain execution priority for a
nominal amount, important customer protection rules such as exchange
priority rules and the Manning Rule could be undermined.
Flickering quotations that can result from widespread sub-
penny pricing could make it more difficult for broker-dealers to
satisfy their best execution obligations and other regulatory
responsibilities.
Widespread sub-penny quoting could decrease market depth
and lead to higher transaction costs.
Decreasing depth at the inside could cause institutions to
rely more on execution alternatives away from the exchanges,
potentially increasing fragmentation in the securities markets.\51\
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\51\ See Securities Exchange Act Release No. 51808 (June 9,
2005), 70 FR 37496, 37551-52 (June 29, 2005).
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At the same time, the Commission ``acknowledge[d] the possibility
that the balance of costs and benefits could shift in a limited number
of cases or as the markets continue to evolve.'' \52\ Therefore, the
Commission also adopted Rule 612(c), which provides that the Commission
may grant exemptions from the Sub-Penny Rule, either unconditionally or
on specified terms and conditions, if it determined that such an
exemption is necessary or appropriate in the public interest, and is
[[Page 71658]]
consistent with the protection of investors.
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\52\ Id. at 37553.
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The Commission believes that the Exchange's proposal raises such a
case. As described above, under the current market structure, few
marketable retail orders in equity securities are routed to exchanges.
The vast majority of marketable retail orders are internalized by OTC
market makers, who typically pay retail brokers for their order flow.
Retail investors can benefit from such arrangements to the extent that
OTC market makers offer them price improvement over the NBBO. Price
improvement is typically offered in sub-penny amounts.\53\ An
internalizing broker-dealer can offer sub-penny executions, provided
that such executions do not result from impermissible sub-penny orders
or quotations. Accordingly, OTC market makers typically select a sub-
penny price for a trade without quoting at that exact amount or
accepting orders from retail customers seeking that exact price.
Exchanges--and exchange member firms that submit orders and quotations
to exchanges--cannot compete for marketable retail order flow on the
same basis, because it would be impractical for exchange electronic
systems to generate sub-penny executions without exchange liquidity
providers or retail brokerage firms having first submitted sub-penny
orders or quotations, which the Sub-Penny Rule expressly prohibits.
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\53\ When adopting the Sub-Penny Rule, the Commission considered
certain comments that asked the Commission to prohibit broker-
dealers from offering sub-penny price improvement to their
customers, but declined to do so. The Commission stated that
``trading in sub-penny increments does not raise the same concerns
as sub-penny quoting'' and that ``sub-penny executions due to price
improvement are generally beneficial to retail investors.'' Id. at
37556.
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The limited exemption granted today should promote competition
between exchanges and OTC market makers in a manner that is reasonably
designed to minimize the problems that the Commission identified when
adopting the Sub-Penny Rule. Under the Program, sub-penny prices will
not be disseminated through the consolidated quotation data stream,
which should avoid quote flickering and its reduced depth at the inside
quotation. Furthermore, while the Commission remains concerned about
providing enough incentives for market participants to display limit
orders, the Commission does not believe that granting this exemption
(and approving the accompanying proposed rule change) will reduce such
incentives. Market participants that display limit orders currently are
not able to interact with marketable retail order flow because it is
almost entirely routed to internalizing OTC market makers that offer
sub-penny executions. Consequently, enabling the Exchanges to compete
for this retail order flow through the Program should not materially
detract from the current incentives to display limit orders, while
potentially resulting in greater order interaction and price
improvement for marketable retail orders. To the extent that the
Program may raise Manning and best execution issues for broker-dealers,
these issues are already presented by the existing practices of OTC
market makers.
The exemption being granted today is limited to a one-year pilot.
The Exchange has stated that ``sub-penny trading and pricing could
potentially result in undesirable market behavior,'' and, therefore, it
will ``monitor the Program in an effort to identify and address any
such behavior.'' \54\ Furthermore, the Exchange has represented that it
``will produce data throughout the pilot, which will include statistics
about participation, the frequency and level of price improvement
provided by the Program, and any effects on the broader market
structure.'' \55\ The Commission expects to review the data and
observations of the Exchange before determining whether and, if so, how
to extend the exemption from the Sub-Penny Rule.\56\
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\54\ See Request for Sub-Penny Rule Exemption, supra note 10, at
3, n.7.
\55\ See supra note 37 and accompanying text.
\56\ In particular, the Commission expects the Exchange to
observe how maker/taker transaction charges, whether imposed by the
Exchange or by other markets, might impact the use of the Program.
Market distortions could arise where the size of a transaction
rebate, whether for providing or taking liquidity, is greater than
the size of the minimum increment permitted by the Program ($0.001
per share).
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VI. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\57\ that the proposed rule change (SR-BYX-2012-019), as modified
by Amendment No. 2, be and hereby is, approved on a one-year pilot
basis.
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\57\ 15 U.S.C. 78s(b)(2).
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It is also hereby ordered that, pursuant to Rule 612(c) of
Regulation NMS, the Exchange is given a limited exemption from Rule 612
of Regulation NMS allowing it to accept and rank orders priced equal to
or greater than $1.00 per share in increments of $0.001, in the manner
described in the proposed rule change above, on a one-year pilot basis
coterminous with the effectiveness of the proposed rule change.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\58\
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\58\ 17 CFR 200.30-3(a)(12); 17 CFR 200.30-3(a)(83).
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Kevin O'Neill,
Deputy Secretary.
[FR Doc. 2012-29078 Filed 11-30-12; 8:45 am]
BILLING CODE 8011-01-P
