Transaction Fee Pilot for NMS Stocks, 13008-13078 [2018-05545]
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Federal Register / Vol. 83, No. 58 / Monday, March 26, 2018 / Proposed Rules
SECURITIES AND EXCHANGE
COMMISSION
17 CFR Parts 200 and 242
[Release No. 34–82873; File No. S7–05–18]
RIN 3235–AM04
Transaction Fee Pilot for NMS Stocks
Securities and Exchange
Commission.
ACTION: Proposed rule.
AGENCY:
The Securities and Exchange
Commission (‘‘Commission’’ or ‘‘SEC’’)
is proposing to conduct a Transaction
Fee Pilot for National Market System
(‘‘NMS’’) stocks to study the effects that
transaction-based fees and rebates may
have on, and the effects that changes to
those fees and rebates may have on,
order routing behavior, execution
quality, and market quality more
generally. The data generated by the
proposed pilot should help inform the
Commission, as well as market
participants and the public, about any
such effects and thereby facilitate a
data-driven evaluation of the need for
regulatory action in this area.
DATES: Comments should be received on
or before May 25, 2018.
ADDRESSES: Comments may be
submitted by any of the following
methods:
SUMMARY:
Electronic Comments
• Use the Commission’s internet
comment form (https://www.sec.gov/
rules/proposed.shtml); or
• Send an email to rule-comments@
sec.gov. Please include File Number S7–
05–18 on the subject line.
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Paper Comments
• Send paper comments to Brent J.
Fields, Secretary, Securities and
Exchange Commission, 100 F Street NE,
Washington, DC 20549–1090.
All submissions should refer to File
Number S7–05–18. This file number
should be included on the subject line
if email is used. To help the
Commission process and review your
comments more efficiently, please use
only one method. The Commission will
post all comments on the Commission’s
website (https://www.sec.gov/rules/
proposed.shtml). Comments are also
available for website viewing and
printing in the Commission’s Public
Reference Room, 100 F Street NE,
Washington, DC 20549–1090 on official
business days between the hours of
10:00 a.m. and 3:00 p.m. All comments
received will be posted without change.
Persons submitting comments are
cautioned that we do not redact or edit
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personal identifying information from
comment submissions. You should
submit only information that you wish
to make available publicly.
Studies, memoranda, or other
substantive items may be added by the
Commission or staff to the comment file
during this rulemaking. A notification of
the inclusion in the comment file of any
materials will be made available on the
Commission’s website. To ensure direct
electronic receipt of such notifications,
sign up through the ‘‘Stay Connected’’
option at www.sec.gov to receive
notifications by email.
FOR FURTHER INFORMATION CONTACT:
Richard Holley III, Assistant Director;
Johnna Dumler, Special Counsel; Erika
Berg, Special Counsel; or Benjamin
Bernstein, Attorney-Advisor, each with
the Division of Trading and Markets,
Securities and Exchange Commission,
100 F Street NE, Washington, DC 20549,
or at (202) 551–5777.
SUPPLEMENTARY INFORMATION: The
Commission is proposing to adopt Rule
610T to establish a Transaction Fee
Pilot.
Table of Contents
I. Overview
II. Transaction Fees
A. Background
B. Calls for a Pilot
C. Comments on the EMSAC
Recommendation
III. Discussion of the Proposed Pilot
A. Applicable Trading Centers
B. Securities
C. Proposed Pilot Design
1. Test Group 1
2. Test Group 2
3. Test Group 3
4. Control Group
D. Duration
E. Data
1. Pilot Securities Exchange Lists and Pilot
Securities Change Lists
2. Exchange Transaction Fee Summary
3. Order Routing Data
F. Implementation Period
IV. Paperwork Reduction Act
A. Summary of Collection of Information
1. Pilot Securities Exchange Lists and Pilot
Securities Change Lists
2. Exchange Transaction Fee Summary
3. Order Routing Data
B. Proposed Use of Information
C. Respondents
D. Total Initial and Annual Reporting and
Recordkeeping Burdens
1. Pilot Securities Exchange Lists and Pilot
Securities Change Lists
2. Exchange Transaction Fee Summary
3. Order Routing Data
E. Collection of Information is Mandatory
F. Confidentiality of Responses to
Collection of Information
G. Retention Period for Recordkeeping
Requirements
H. Request for Comments
V. Economic Analysis
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A. Background on Transaction-Based Fees
and Potential Conflicts of Interest
1. Overview of Transaction-Based Fees
2. Potential Conflicts of Interest
B. Baseline
1. Current Information Baseline
2. Current Market Environment
C. Analysis of Benefits and Costs of
Proposed Transaction Fee Pilot
1. Benefits of Proposed Transaction Fee
Pilot
2. Costs of Proposed Transaction Fee Pilot
D. Impact on Efficiency, Competition, and
Capital Formation
1. Efficiency
2. Competition
3. Capital Formation
E. Alternatives
1. Expand Proposed Transaction Fee Pilot
To Include ATSs
2. Trade-At Test Group
3. No Overlap With Tick Size Pilot
4. Adjustments to the Proposed
Transaction Fee Pilot Structure
F. Request for Comment
VI. Consideration of Impact on the Economy
VII. Regulatory Flexibility Analysis
VIII. Statutory Authority and Text of the
Proposed Rule
I. Overview
As an integral part of its oversight of
the U.S. equities markets, where
liquidity is dispersed across a large
number of trading centers that are
linked through technology and
regulation into a national market
system, the Commission assesses market
developments, including changes in
technology and business practices, as it
seeks to ensure that the current
regulatory framework continues to
effectively and efficiently promote fair
and orderly markets, investor
protection, and capital formation. From
a regulatory perspective, today’s equity
market structure has been shaped by,
among other things, Regulation NMS,
adopted in 2005, which established the
regulatory framework within which the
markets transitioned from a primarily
manual to a primarily automated trading
environment.1 Among other things,
Regulation NMS put in place order
protection requirements to govern
intermarket trading in an electronically
linked world of dispersed markets, and
supplemented those requirements with
rules addressing fair and efficient access
to quotations and limits on fees charged
to access newly protected quotations.2
Subsequent to the adoption of
Regulation NMS, market practices,
aided by technological innovation,
including advancements in data
1 See Securities Exchange Act Release No. 51808
(June 9, 2005), 70 FR 37496, 37543–46 (June 29,
2005) (‘‘NMS Adopting Release’’).
2 See id.
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management and analysis, and
competition, have continued to evolve.
Since the adoption of Regulation
NMS, the Commission and its staff have
undertaken a number of reviews of
market structure and market events.3 In
addition, the Commission has focused
on initiatives to preserve the operational
integrity of markets and market
participants 4 and pursued a number of
initiatives to enhance regulatory
oversight of the markets, improve the
information available to market
participants about execution activity
and the operation of Alternative Trading
Systems (‘‘ATSs’’), and explored options
to improve how equity market structure
works for small companies.5
3 See, e.g., Securities Exchange Act Release No.
61358 (January 14, 2010), 75 FR 3594, 3600 and
3603 (January 21, 2010) (‘‘Concept Release’’)
(evaluating broadly the performance of market
structure since Regulation NMS, particularly for
long-term investors and for businesses seeking to
raise capital, and soliciting comment on whether
regulatory initiatives to improve market structure
are needed). See also Findings Regarding the
Market Events of May 6, 2010 (September 30, 2012),
available at https://www.sec.gov/news/studies/
2010/marketevents-report.pdf (a report of the staffs
of the Commission and the Commodity Futures
Trading Commission to the Joint Advisory
Committee on Emerging Regulatory Issues on the
events of May 6, 2010 (the ‘‘Flash Crash’’), which
analyzed the extraordinary volatility experienced
on that day and market participant behavior in
response thereto). In response to lessons learned
during the Flash Crash, the Commission and the
self-regulatory organizations (‘‘SROs’’) focused on a
number of critical market structure initiatives,
including single stock circuit breakers for select
NMS stocks and the Limit Up-Limit Down Plan
successor thereto, which now serves as the primary
volatility moderator in the U.S. equity markets. See,
e.g., Securities Exchange Act Release Nos. 62252
(June 10, 2010), 75 FR 34186 (June 16, 2010) (File
Nos. SR–BATS–2010–014; SR–EDGA–2010–01; SR–
EDGX–2010–01; SR–BX–2010–037; SR–ISE–2010–
48; SR–NYSE–2010–39; SR–NYSEAmex–2010–46;
SR–NYSEArca–2010–41; SR–NASDAQ–2010–061;
SR–CHX–2010–10; SR–NSX–2010–05; SR–CBOE–
2010–047) (order approving rule changes to provide
for trading pauses in individual stocks when the
price moves ten percent or more in the preceding
five minute period); 62251 (June 10, 2010), 75 FR
34183 (June 16, 2010) (File No. SR–FINRA–2010–
025) (order approving a rule to permit a halt trading
otherwise than on an exchange where a primary
listing market has issued a trading pause due to
extraordinary market conditions); and 67091 (May
31, 2012), 77 FR 33498 (June 6, 2012) (File No. 4–
631) (order approving, on a pilot basis, the national
market system plan to address extraordinary market
volatility).
4 See Securities Exchange Act Release Nos. 63241
(November 3, 2010), 75 FR 69792 (November 15,
2010) (File No. S7–03–10) (Market Access Rule) and
73639 (November 19, 2014), 79 FR 72252
(December 5, 2014) (File No. S7–01–13) (Regulation
Systems Compliance and Integrity).
5 See Securities Exchange Act Release Nos. 79318
(November 15, 2016), 81 FR 84696 (November 23,
2016) (File No. 4–698) (order approving the
National Market System Plan Governing the
Consolidated Audit Trail); 78309 (July 13, 2016), 81
FR 49431 (July 27, 2016) (File No. S7–14–16)
(proposed amendments to Rule 606 of Regulation
NMS that would require broker-dealers to disclose
additional data to their customers on their routing
and execution of institutional orders); 76474
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In addition, the Equity Market
Structure Advisory Committee
(‘‘EMSAC’’) provided the Commission
with diverse perspectives on the
structure and operations of the U.S.
equities markets, as well as advice and
recommendations on matters related to
equity market structure.6 In particular,
the EMSAC’s recommendations helped
to shape the proposal contained
herein—namely, a pilot program to
produce data on the effect of equity
exchange transaction fees and rebates,
and changes to those fees and rebates,
on order routing behavior, execution
quality, and market quality. Informed by
EMSAC’s recommendation, the
Commission believes that an
appropriately constructed pilot should
provide a valuable source of data to
facilitate an informed data-driven
discussion about potential alternative
approaches to prevailing fee structures.
The discussion below references
various types of ‘‘trading centers,’’
which is a collective term that refers
broadly to the venues that trade NMS
stocks.7 For purposes of this release, the
term ‘‘trading center’’ includes national
securities exchanges that are registered
with the Commission and that trade
NMS stocks (referred to herein as
‘‘equities exchanges’’ or ‘‘exchanges’’),
as well as other types of ‘‘non-exchange
venues’’ that trade NMS stocks,
(November 18, 2015), 80 FR 80997 (December 28,
2015) (File No. S7–23–15) (proposed rule
concerning operational transparency and regulatory
oversight of ATSs); and 74892 (May 6, 2015), 80 FR
27514, 27517–18 (May 13, 2015) (File No. 4–657)
(order approving the NMS Plan to Implement a Tick
Size Pilot Program) (‘‘Tick Size Pilot Approval
Order’’).
6 The EMSAC was a Federal Advisory Committee
established as a broad-based group of experts
charged with providing the Commission
recommendations on a range of complex market
structure issues. See Securities Exchange Act
Release No. 74092 (January 20, 2015), 80 FR 3673
(January 23, 2015) (File No. 265–29). See also
Equity Market Structure Advisory Committee—
Subcommittees, available at https://www.sec.gov/
spotlight/equity-market-structure/equity-marketstructure-advisory-committee-subcommittees.htm.
The EMSAC and its four subcommittees discussed
a variety of equity market structure issues,
including Regulation NMS, trading venue
regulation, market quality, and customer issues.
One of the EMSAC’s subcommittees focused
exclusively on Regulation NMS, especially Rule
610(c) (access fees) and Rule 611 (order protection),
and considered whether parts of Regulation NMS
should be updated in light of the evolution of
technology, markets, and market participants. As
part of its ongoing review of market structure, the
Commission is considering the EMSAC’s
recommendations as it assesses potential changes to
Regulation NMS.
7 See 17 CFR 242.600(b)(78) (defining ‘‘trading
center’’ as ‘‘a national securities exchange or
national securities association that operates an SRO
trading facility, an alternative trading system, an
exchange market maker, an OTC market maker, or
any other broker or dealer that executes orders
internally by trading as principal or crossing orders
as agent.’’).
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13009
including ATSs and broker-dealers that
internalize orders by matching them offexchange with reference to the national
best bid and offer.8 As discussed below,
the proposed Pilot would apply only to
equities exchanges.
II. Transaction Fees
A. Background
Exchanges and other trading centers
aggregate orders to buy and sell
securities from market participants and
have historically charged their members
and users fees when they match an
order to buy against an order to sell, at
which point an execution occurs. As
competition among trading centers
intensified in the late 1990s, ATSs, and
then exchanges, began to offer rebates to
attract order flow.9 The predominant
model that has emerged in the U.S.
equities markets is the ‘‘maker-taker’’
fee model, in which, on the one hand,
a trading center pays its broker-dealer
participants a per share rebate to
provide (i.e., ‘‘make’’) liquidity in
securities and, on the other hand, the
trading center assesses them a fee to
remove (i.e., ‘‘take’’) liquidity.10 The
trading center earns as revenue the
difference between the fee paid by the
‘‘taker’’ of liquidity and the rebate paid
to the provider or ‘‘maker’’ of liquidity.
In a variation on this theme, some other
trading centers have adopted a ‘‘takermaker’’ pricing model (also called an
inverted model), in which they charge
8 See 17 CFR 242.600(b)(42) (defining ‘‘national
best bid and national best offer’’).
9 See, e.g., Memorandum on Maker-Taker Fees on
Equities Exchanges from the Commission’s Division
of Trading and Markets to the Market Structure
Advisory Committee (October 20, 2015), available
at https://www.sec.gov/spotlight/emsac/memomaker-taker-fees-on-equities-exchanges.pdf
(outlining the development of the maker-taker fee
model in the U.S. and summarizing the current
public debate about its impact on equity market
structure) (‘‘Staff Maker-Taker Memo’’). The memo
traces the development of transaction fees and
summarizes the potential benefits and limitations of
maker-taker pricing by presenting market
participants’ divergent views.
10 See id. New fees that an exchange seeks to
impose on its members or persons using its
facilities are effective on the day that the exchange
files them with the Commission, and neither
advance notice nor Commission action is required
before an exchange may implement a fee change.
See 15 U.S.C. 78s(b)(3)(A)(ii). Though Form 19b–4
fee filings are not subject to Commission approval,
the Commission may, within 60 days after an
exchange filed its fee change with the Commission,
summarily suspend the new fee and institute
proceedings to determine whether to disapprove it.
See 15 U.S.C. 78s(b)(3)(C). Exchange fees are subject
to the statutory standards set forth in Section 6 of
the Securities Exchange Act of 1934 (‘‘Exchange
Act’’), which require, among other things, that an
exchange’s fees be an ‘‘equitable allocation’’ of
‘‘reasonable’’ fees and that they not be ‘‘designed to
permit unfair discrimination.’’ See 15 U.S.C.
78f(b)(4)–(5).
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the provider of liquidity and pay a
rebate to the taker of liquidity.11
The Commission periodically has
addressed the ‘‘access fees’’ charged by
trading centers to access their quotes.12
In 2005, the Commission again spoke to
this issue by adopting Rule 610(c) under
Regulation NMS, which prohibits
trading centers from imposing, or
permitting to be imposed, any fees for
the execution of an order against a
‘‘protected quotation’’ 13 that exceed or
accumulate to more than $0.0030 per
share.14 The $0.0030 per share cap
11 See, e.g., Cboe BYX U.S. Equities Exchange Fee
Schedule (as of March 2018), available at https://
markets.cboe.com/us/equities/membership/fee_
schedule/byx/.
12 For example, in the mid-1990s, the
Commission allowed an electronic communication
network (‘‘ECN’’) to facilitate specialist and market
maker quotation obligations by communicating to
the public quotation system the best price and size
of orders entered into the ECN by specialists or
market makers as long as the ECN met certain
conditions and noted that ECNs may impose fees
for access to its system that are ‘‘similar to the
communications and systems charges imposed by
various markets, if not structured to discourage
access by non-subscriber broker-dealers.’’ Securities
Exchange Act Release No. 37619A (September 6,
1996), 61 FR 48290, 48314 n.272 (September 12,
1996) (File No. S7–30–95). See also Securities
Exchange Act Release No. 40760 (December 8,
1998), 63 FR 70844, 70871 (December 22, 1998)
(File No. S7–12–98). Commission staff subsequently
issued a series of no-action letters with respect to
access fees charged by ECNs to non-subscribers.
These letters permitted fees in amounts equal to
those that they charge a ‘‘substantial proportion’’ of
their active broker-dealer subscribers, but no more
than $0.009 per share. See Securities Exchange Act
Release No. 49325 (February 26, 2004), 69 FR
11126, 11156 (March 9, 2004) (File No. S7–10–04)
(‘‘NMS Proposing Release’’) (discussing the noaction relief and the inability of ECNs to charge fees
that have the effect of creating barriers to access for
non-subscribers).
13 Rule 600(b)(58) of Regulation NMS defines a
‘‘protected quotation’’ as a ‘‘protected bid or a
protected offer.’’ 17 CFR 242.600(b)(58). Rule
600(b)(57) of Regulation NMS, in turn, defines a
‘‘protected bid or protected offer’’ as a quotation in
an NMS stock that is: (i) Displayed by an
‘‘automated trading center,’’ (ii) disseminated
pursuant to an effective national market system
plan, and (iii) an ‘‘automated quotation’’ that is the
best bid or best offer of a national securities
exchange or national securities association. 17 CFR
242.600(b)(57). See also 17 CFR 242.600(b)(3)
(defining ‘‘automated quotation’’).
14 See 17 CFR 242.610(c). See also NMS Adopting
Release, supra note 1, at 37543–46. In the
Regulation NMS Proposing Release, the
Commission initially proposed to cap the access
fees that any individual market participant could
charge for equities at $0.0010 per share, with a total
accumulated access fee limit of $0.0020 per share
in any transaction. See NMS Proposing Release,
supra note 12, at 11157–59. In its proposal, the
Commission expressed concern that access fees
added significant non-transparent costs to
transactions, potentially encouraged locked
markets, and created an unequal playing field as
non-ECN broker-dealers were not permitted to
charge access fees in addition to their posted
quotations. See id. However, the Commission
ultimately adopted an access fee cap of $0.0030, in
order to simplify the initial proposal (see NMS
Adopting Release, supra note 1, at 37502) and for
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largely codified the prevailing fee level
set through competition among the
various trading centers.15 The cap on
access fees established by Rule 610(c)
sought in part to prevent high access
fees in excess of the cap from
undermining Regulation NMS’s price
protection and linkage requirements,
while preserving the business model
used by trading centers dependent upon
revenue from fees.16
For maker-taker exchanges, the
amount of the taker fee is bounded by
the cap imposed by Rule 610(c) on the
fees the exchange can charge to access
its best bid/offer for NMS stocks.17 This
cap applies to the fees assessed on an
incoming order that executes against a
resting order or quote, but does not
directly limit rebates paid. The Rule
610(c) cap on fees also typically
indirectly limits the amount of the
rebates that an exchange offers to less
than $0.0030 per share in order to
maintain net positive transaction
revenues.18 For taker-maker exchanges,
the amount of the maker fee charged to
the provider of liquidity is not bounded
by the Rule 610(c) cap, but such fees
typically are no more than $0.0030, and
the taker of liquidity earns a rebate.19
the reasons outlined infra at notes 15–16 and
accompanying text. See 17 CFR 242.610(c). See also
NMS Adopting Release, supra note 1, at 37545.
15 See NMS Adopting Release, supra note 1, at
37545 (stating that ‘‘the $0.003 fee limitation is
consistent with current business practices, as very
few trading centers currently charge fees that
exceed this amount’’).
16 See id. at 37596 (‘‘In the absence of a fee
limitation, the adoption of the Order Protection
Rule and private linkages could significantly boost
the viability of the outlier business model. Outlier
markets might well try to take advantage of
intermarket price protection by acting essentially as
a toll booth between price levels. The high fee
market likely will be the last market to which
orders would be routed, but prices could not move
to the next level until someone routed an order to
take out the displayed price at the outlier market.
Therefore, the outlier market might see little
downside to charging exceptionally high fees, such
as $0.009, even if it is last in priority.’’). See also
17 CFR 242.610(c). Maker-taker fees also are subject
to the proposed rule change process for fees under
the Exchange Act. See 15 U.S.C. 78s(b)(3)(A) and 17
CFR 240.19b–4(f)(2).
17 See 17 CFR 242.610(c).
18 See, e.g., Staff Maker-Taker Memo, supra note
9, at 3. For example, a maker-taker equities
exchange may charge a member $0.0030 to remove
liquidity and pay a rebate of $0.0025 to the member
that adds liquidity. See, e.g., Cboe BZX U.S.
Equities Exchange Fee Schedule (as of March 2018),
available at https://markets.cboe.com/us/equities/
membership/fee_schedule/bzx/. The revenue
earned by a maker-taker exchange on transactions
equals the difference between the fee charged and
the rebate paid.
19 See, e.g., Cboe BYX U.S. Equities Exchange Fee
Schedule (as of March 2018), available at https://
markets.cboe.com/us/equities/membership/fee_
schedule/byx/ (where, for securities above $1.00,
the fee for adding liquidity is $0.0019 and the
rebate for removing liquidity is $0.0005). The make
fee on a taker-maker exchange is not bounded by
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As discussed below, the maker-taker
and taker-maker fee models adopted by
exchanges have attracted considerable
attention.20 In recent years, a variety of
concerns have been expressed about the
maker-taker fee model, in particular the
rebates they pay to attract orders. For
example, some have questioned whether
the prevailing fee structure has created
a conflict of interest for broker-dealers,
who must pursue the best execution of
their customers’ orders while facing
potentially conflicting economic
incentives to avoid fees or earn
rebates—both of which typically are not
passed through the broker-dealer to its
customers—from the trading centers to
which they direct those orders for
execution.21 One academic study of
selected market data suggested that
some broker-dealers route nonmarketable orders to the trading center
offering the highest rebate, and do so in
a manner that the authors contended
might not be consistent with the brokerdealers’ duty of best execution.22 Others
have expressed concern that makertaker access fees may (a) undermine
market transparency since displayed
prices do not account for exchange
transaction fees or rebates and therefore
do not reflect the net economic costs of
a trade; (b) serve as a way to effectively
quote in sub-penny increments on a net
basis when the effect of a maker-taker
exchange’s sub-penny rebate is taken
into account even though the minimum
quoting increment is expressed in full
pennies; (c) introduce unnecessary
market complexity through the
proliferation of new exchange order
types (and new exchanges) designed
solely to take advantage of pricing
models; and (d) drive orders to nonexchange trading centers as market
participants seek to avoid the higher
Rule 610(c) because such fee is not a charge to
access the market’s best bid/offer for NMS stocks.
20 See infra notes 21–28 and accompanying text.
See also U.S. Dep’t of the Treasury, A Financial
System that Creates Economic Opportunity: Capital
Markets 62–63 (2017).
21 See, e.g., Stanislav Dolgopolov, ‘‘The MakerTaker Pricing Model and its Impact on the
Securities Market Structure: A Can of Worms for
Securities Fraud?,’’ 8 Va. L. & Bus. Rev. 231, 270
(2014), available at https://papers.ssrn.com/sol3/
papers.cfm?abstract_id=2399821.
22 Robert H. Battalio, Shane A. Corwin, and
Robert H. Jennings, ‘‘Can Brokers Have It All? On
the Relation Between Make-Take Fees and Limit
Order Execution Quality,’’ Journal of Finance 71,
2193–2237 (2016), available at https://online
library.wiley.com/doi/10.1111/jofi.12422/full
(‘‘Battalio Equity Market Study’’). A non-marketable
order is an order with a limit price that prevents
its immediate execution at current market prices.
See also infra note 229 (discussing non-marketable
orders).
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fees that exchanges charge to subsidize
the rebates they offer.23
By contrast, others have indicated that
the maker-taker model may have
positive effects by enabling exchanges to
compete with non-exchange trading
centers and narrowing quoted spreads
by subsidizing posted prices.24 In
particular, maker-taker fees may narrow
displayed spreads in some securities
insofar as the liquidity rebate effectively
subsidizes the prices of displayed
liquidity.25 In turn, that displayed
liquidity may establish the national best
bid and offer, which is often used as the
benchmark for marketable order flow,
including retail order flow, that is
executed off-exchange by either
23 See, e.g., Curt Bradbury, Market Structure Task
Force Chair, Board of Directors, SIFMA, and
Kenneth E. Bentsen Jr., President and Chief
Executive Officer, SIFMA, Opinion, ‘‘How to
Improve Market Structure,’’ N.Y. Times (July 14,
2014), available at https://dealbook.nytimes.com/
2014/07/14/how-to-improve-market-structure/?_
r=0; Larry Harris, ‘‘Maker-Taker Pricing Effects on
Market Quotations,’’ at 24–25 (November 14, 2013),
available at https://bschool.huji.ac.il/.upload/
hujibusiness/Maker-taker.pdf (‘‘Harris’’);
Dolgopolov, supra note 21; Letter from Richard
Steiner, Global Equities Liaison to Regulatory &
Government Affairs, RBC Capital Markets, to
Elizabeth Murphy, Secretary, Commission, at 4
(November 22, 2013) (‘‘RBC Capital Markets Letter
I’’), available at https://www.sec.gov/;comments/s702-10/s70210-411.pdf.
24 See, e.g., Michael Brolley & Katya Malinova,
‘‘Informed Trading and Maker-Taker Fees in a Low
Latency Limit Order Market,’’ at 2 (October 24,
2013), available at https://papers.ssrn.com/sol3/
papers.cfm?abstract_id=2178102 (‘‘If a maker rebate
is introduced in competitive markets, the bid-ask
spread will decline by (twice) the maker rebate.’’)
(‘‘Brolley and Malinova’’); Shawn O’Donoghue,
‘‘The Effect of Maker-Taker Fees on Investor Order
Choice and Execution Quality in U.S. Stock
Markets’’ (January 23, 2015), available at https://
papers.ssrn.com/sol3/papers.cfm?abstract_
id=2607302 (‘‘O’Donoghue’’); and Jean-Edouard
Colliard & Thierry Foucault, ‘‘Trading Fees and
Efficiency in Limit Order Markets,’’ Oxford
University Press, at n.13 (September 1, 2012),
available at https://thierryfoucault.com/
publications/research-papers/ (arguing that makertaker rebates may help equities exchanges compete
with off-exchange payment for order flow
arrangements, in which wholesale broker-dealers
purchase retail order flow for trading off-exchange).
25 See, e.g., Letter from Richie Prager, Managing
Director, Head of Trading and Liquidity Strategies,
BlackRock, Inc., to Mary Jo White, Chair, SEC, at
2 (September 12, 2014), available at: https://
www.sec.gov/comments/s7-02-10/s70210-419.pdf
(‘‘Some participants have called for elimination of
rebates and maker-taker pricing in its entirety in
conjunction with access fees, but BlackRock
believes that incentives for providing liquidity
positively impact market structure. Incentives
promote price discovery in public markets, increase
available liquidity and tighten spreads. Rebates
compensate liquidity providers for exposing orders
to adverse selection and information leakage.’’). See
also Harris, supra note 23, at 1–2 (noting that while
economic theory suggests that maker-taker pricing
should have narrowed average bid-ask spreads,
intervening factors, such as the growth in electronic
trading, make it difficult to ‘‘entirely attribute[ ]’’
the observed reduction in bid-ask spreads to makertaker pricing; in addition, spreads cannot decrease
for stocks that already trade at penny-wide spreads).
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matching or improving upon those
prices.26 Accordingly, retail orders may
benefit indirectly from the subsidy
provided by maker-taker exchanges.
Some have urged the Commission to
gather data to assess the potential
impact of transaction fees and rebates in
the U.S. markets.27 Most recently, as
discussed below, the EMSAC
recommended that the Commission
conduct a pilot to study the impact of
transaction fees on market quality and
order routing behavior.28 Informed by
that recommendation, the views of those
submitting comment letters on the
EMSAC’s proposal, and the information
and research described herein, the
Commission is proposing that a pilot
program be conducted that would
produce data on the effects of equity
exchange transaction fees and rebates,
and possible effects of changes in those
fees and rebates, on order routing
behavior, execution quality, and market
quality.
B. Calls for a Pilot
The concept of a pilot program to
gather data to study the effects of the
maker-taker model on market quality
and order routing behavior has attracted
increasing attention in recent years.29
Nasdaq experimented with changes to
its transaction fees when it lowered
access fees and rebates in 14 stocks over
a four-month period in 2015.30 Through
its experiment, Nasdaq observed that
‘‘[l]iquidity providers [were] the
primary responders to the fee changes
during the experiment,’’ whereas there
were ‘‘no significant changes in the
nature of liquidity taking during the
26 See
Concept Release, supra note 3, at 3600.
infra note 29 and accompanying text.
Limited experiments on a single market with a
limited subset of securities, like the test performed
by The Nasdaq Stock Market LLC (‘‘Nasdaq’’)
discussed below, where order flow can quickly
move to other exchanges that are not taking part in
the experiment, do not offer the same insights as a
comprehensive market-wide study on transaction
fees. See infra notes 30–34 and accompanying text.
28 See Recommendation for an Access Fee Pilot
(July 8, 2016), available at https://www.sec.gov/
spotlight/emsac/recommendation-access-feepilot.pdf (‘‘EMSAC Pilot Recommendation’’); see
also supra note 38 and accompanying text.
29 See, e.g., Letter from Micah Hauptman,
Financial Services Counsel, Consumer Federation
of America, to Brent J. Fields, Secretary,
Commission, at 2 (December 22, 2014), available at
https://www.sec.gov/comments/4-657/4657-64.pdf
(recommending an access fee pilot as an alternative
to a tick size pilot); and RBC Capital Markets Letter
I, supra note 23, at 3.
30 See Securities Exchange Act Release No. 73967
(December 30, 2014), 80 FR 594 (January 6, 2015)
(SR–NASDAQ–2014–128) (‘‘Nasdaq Pilot’’)
(lowering the access fee to remove liquidity from
$0.0030 to $0.0005 and reducing the credit paid to
display liquidity to $0.0004 (such credits otherwise
ranged from $0.0015 to $0.00305)).
27 See
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pilot.’’ 31 While liquidity providers
could readily route orders to other
trading centers offering higher maker
rebates, Nasdaq offered a number of
possible explanations for why liquidity
takers did not appear to respond to its
experiment, including the fact that order
routing decisions were primarily driven
by best execution parameters not by
exchange fees.32 For these reasons,
Nasdaq itself observed that ‘‘the results
for Nasdaq would not necessarily be
duplicated industry-wide if access fees
and rebates were reduced across the
board.’’ 33 In other words, Nasdaq’s
experiment involved a small sample of
stocks on a single market for a short
duration, all of which make it difficult
to draw inferences about what would
happen if all exchanges participated in
the same experiment simultaneously.
The Commission preliminarily believes,
therefore, that a pilot is necessary to
gather data to facilitate analysis of the
31 See Nasdaq Access Fee Experiment May 2015
Report, at 1, available at https://
www.nasdaqomx.com/digitalAssets/98/98718_
accessfeereporttwo.pdf (‘‘Nasdaq May Report’’).
Nasdaq noted that one of the aims of its experiment
was to ‘‘examine the importance of liquidity
provider rebates to participant firms’ posting
behavior on Nasdaq.’’ Id. Nasdaq’s experiment
showed what it characterized as statistically
significant effects on the Nasdaq Stock Market. For
example, Nasdaq observed the following initial
impact on its market share: ‘‘In aggregate, Nasdaq’s
equally-weighted market share in the experiment
stocks declined by 2.9 percentage points from
January to February. This compares to a decline of
0.9 percentage points in Nasdaq market share in the
control stocks. The change observed in the
experiment stocks is statistically significant using
the diff-in-diff measure.’’ See Nasdaq Access Fee
Experiment March 2015 Report, at 1, available at
https://images.qnasdaqomx.com/Web/
NASDAQOMX/%7Be737af7a-07e8-4119-859c096b306fc6f2%7D_Fee_Cap_Report_3-6-15v3.pdf
(‘‘Nasdaq March Report’’). It also observed the
following impact on its displayed liquidity:
‘‘Nasdaq’s time at the NBBO in the experiment
stocks declined 4.9 percentage points from 93.0%
in January to 88.1% February (Figure 2). This
compares to a decline of 0.3 percentage points in
the control stocks. The difference between the
experiment and control stocks is statistically
significant.’’ See id. at 2.
32 See, e.g., Nasdaq May Report, supra note 31, at
3. Other possible explanations offered by Nasdaq
include, for example, the fact that the number of
stocks in its experiment was too low to justify
broker-dealers recoding their liquidity taking
algorithms in response to the experiment, the
possibility that liquidity taking activity for some
firms may not consider access fees, or that some
liquidity taking algorithms may be based on
displayed size. See id. (‘‘. . . a fifth conjecture is
that the economic incentives for taking liquidity
from sources other than Nasdaq are not materially
affected by the reduction in Nasdaq’s access fees’’).
33 Nasdaq May Report, supra note 31, at 1. See
also EMSAC Pilot Recommendation, supra note 28,
at 3 (‘‘Limited experiments, such as the recent
Nasdaq pilot, have shown that individual market
experiments do not yield conclusive results about
the potential impact of market-wide policy reform
on access fees.’’).
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impact of fees and rebates on the
equities exchanges broadly.34
More recently, the EMSAC’s
Regulation NMS Subcommittee
(‘‘Subcommittee’’) 35 prepared an
outline for a potential access fee pilot,
and the EMSAC discussed that outline,
and the topic of access fees in general,
at its April 2016 meeting.36 Following
that meeting, the Subcommittee revised
its recommendation and prepared a
formal recommendation for
consideration by the EMSAC.37 The
EMSAC considered that revised
34 See, e.g., Nasdaq May Report, supra note 31, at
1 (noting that ‘‘. . . the results for Nasdaq would
not necessarily be duplicated industry-wide if
access fees and rebates were reduced across the
board.’’). See also EMSAC Pilot Recommendation,
supra note 28, at 3 (‘‘Limited experiments, such as
the recent Nasdaq pilot, have shown that individual
market experiments do not yield conclusive results
about the potential impact of market-wide policy
reform on access fees.’’); Nasdaq March Report,
supra note 31, at 3 (‘‘Some commentators on the
access fee experiment have indicated that a
voluntary change in the access fee by one exchange
in fourteen stocks does not tell you what would
happen if there were a mandatory change in the
regulatory maximum access fee across all exchanges
in a considerable number of stocks of NMS stocks.
We do not disagree with that point. Nasdaq
believed in launching the experiment that fourteen
stocks were enough to induce behavioral changes
with statistically and economically measurable
changes. The results from February have proven
that belief was correct.’’); and Letter from Theodore
R. Lazo, Managing Director and Associate General
Counsel, SIFMA, to Brent J. Fields, Secretary,
Commission (January 30, 2015), at 2, available at
https://www.sec.gov/comments/sr-nasdaq-2014-128/
nasdaq2014128-1.pdf (‘‘In particular, the proposal’s
limited scope and application cannot act as a
substitute for a market-wide access fee reduction
that would change the dynamics of access fees and
rebates across the entire market. For the proposal
to accurately measure the structural impact of
reduced access fees, the proposal should be carried
out across all exchanges and with a larger sampling
of symbols.’’). See also Section V.B.1.b.i infra for
additional discussion of the Nasdaq study.
35 The Subcommittee first convened in November
2015, and began by focusing on maker-taker access
fees. In a series of meetings over the following
months, the Subcommittee assembled an outline of
proposed terms for an access fee pilot. It identified
general goals and prepared a recommendation for
the consideration of the full EMSAC for the scope
of a potential pilot, including stock selection,
pricing buckets, and duration, and it also
considered the potential inclusion of non-exchange
markets, taker-maker exchanges, and a trade-at
component. Minutes of those meetings and other
information are available at https://www.sec.gov/
spotlight/equity-market-structure/equity-marketstructure-advisory-committee-subcommittees.htm.
36 See Framework for a Potential Access Fee Pilot
(April 19, 2016), available at https://www.sec.gov/
spotlight/emsac/emsac-regulation-nmssubcommittee-recommendation-041916.pdf. At its
April 2016 meeting, EMSAC discussed the topic of
maker-taker fees and heard from a number of
outside experts. See EMSAC Transcript, April 26,
2016, available at https://www.sec.gov/spotlight/
emsac/emsac-042616-transcript.txt.
37 See Regulation NMS Subcommittee
Recommendation for an Access Fee Pilot (June 10,
2016), available at https://www.sec.gov/spotlight/
emsac/emsac-regulation-nms-recommendation61016.pdf (‘‘June Recommendation’’).
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proposal and recommended that the
Commission pursue an access fee
pilot.38 The EMSAC’s recommendation
stated:
The intent of the proposed pilot is to better
understand, within the context of our current
market structure, the effect of access fees on
liquidity provision, liquidity taking and
order routing with the ultimate goal of
improving market quality. The Committee
does not believe that there are any certain or
predetermined outcomes from the pilot, and
the net effect of many counterbalancing
factors are not believed to be significantly
beneficial or detrimental to any single group.
Ultimately, the findings from the pilot are
purely intended to inform the broader debate
on how to improve market quality for issuers,
investors and market participants.39
The EMSAC’s pilot recommendation
featured four buckets of common stocks
and Exchange-Traded Funds (‘‘ETFs’’) 40
with a market capitalization of at least
$3 billion: A control bucket and three
test buckets with successively lower
access fee caps of $0.0020, $0.0010, and
$0.0002.41 Consistent with the scope of
Rule 610(c) of Regulation NMS, the
EMSAC recommendation did not
include an outright prohibition on
rebates or include taker-maker
exchanges in the pilot.42 The EMSAC
recommended a two-year term for a
pilot and outlined a number of metrics
that could be assessed in connection
with the pilot.43
38 The EMSAC considered the Subcommittee’s
June Recommendation and adopted it, by a vote of
15–1, with slight modifications that preserved the
basic structure of the June Recommendation but
incorporated additional detail, for example, settling
on a two-year term and recommending 100
securities in each test bucket. See EMSAC Pilot
Recommendation, supra note 28. See also EMSAC
Transcript, July 8, 2016, available at https://
www.sec.gov/spotlight/emsac/emsac-070816transcript.txt. The EMSAC member who voted
against the EMSAC Pilot Recommendation noted
his concern that ‘‘capping access fees is going to
discourage liquidity provision and increase
spreads’’ before voting against the EMSAC Pilot
Recommendation. See id. at 22:24–23:6.
39 EMSAC Pilot Recommendation, supra note 28,
at 1.
40 See infra note 96 (discussing ETFs).
41 See EMSAC Pilot Recommendation, supra note
28, at 2. The EMSAC noted that it ‘‘intentionally
selected $.0002 as the rate in Bucket 4 in order to
create a bucket where any rebate should result in
a de minimis economic incentive.’’ Id. at 4.
42 In addition, consistent with the framework of
Rule 610(c), the EMSAC’s proposed fee caps would
apply to protected quotations and not depth of book
quotations, and would have no direct application to
ATSs. See id. at 2.
43 See id. at 2. The recommendation did not
include a ‘‘trade-at’’ provision that would restrict
price matching of protected quotations, but
mentioned an option to include ATSs in the pilot.
See id. at 5 (noting that if trade-at were included,
‘‘the likely shift of flows as a result of trade-at
would both make the pilot more complex and
impact the effective measurement of the access fee
change’’). The EMSAC also noted that ‘‘[t]he tick
pilot will yield some trade-at results that can be
further studied; thus duplication is not warranted.’’
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C. Comments on the EMSAC
Recommendation
Following the establishment of the
EMSAC, the Commission received a
number of comment letters regarding
the impact of access fees and rebates in
the equities markets.44 Several
See id. See also Tick Size Pilot Approval Order,
supra note 5, at 27517–18 (discussing a trade-at
prohibition that, subject to certain exceptions,
prevents a trading center that was not quoting from
price matching protected quotations and permits a
trading center that was quoting at a protected
quotation to execute orders at that level, but only
up to the amount of its displayed size).
44 Letter from Haim Bodek, Managing Principal,
and Stanislav Dolgopolov, Regulatory Consultant,
Decimus Capital Markets, LLC, to Brent J. Fields,
Secretary, Commission (April 25, 2016), available at
https://www.sec.gov/comments/265-29/2652963.pdf (‘‘Decimus Capital Markets Letter’’); Letter
from Elizabeth King, NYSE, to Brent J. Fields,
Secretary, Commission (May 13, 2016), available at
https://www.sec.gov/comments/265-29/2652966.pdf (‘‘NYSE Letter’’); Letter from Joan C. Conley,
Senior Vice President and Corporate Secretary,
Nasdaq, to Brent J. Fields, Secretary, Commission
(May 24, 2016), available at https://www.sec.gov/
comments/265-29/26529-71.pdf (‘‘Nasdaq Letter’’);
Letter from Richard Steiner, RBC Capital Markets,
to The Honorable Mary Jo White, Chair,
Commission (May 24, 2016), available at https://
www.sec.gov/comments/265-29/26529-70.pdf
(‘‘RBC Capital Markets Letter II’’); Letter from
Security Traders Association to SEC EMSAC (June
15, 2016), available at https://www.sec.gov/
comments/265-29/26529-74.pdf (‘‘Security Traders
Association Letter’’); Letter from Kermit Kubitz to
SEC EMSAC (July 5, 2016), available at https://
www.sec.gov/comments/265-29/26529-73.htm
(‘‘Kubitz Letter’’); Letters from J A to Chair White,
Commissioners, and SEC EMSAC (May 23, 2016, &
September 13, 2016), available at https://
www.sec.gov/comments/265-29/26529-68.htm &
https://www.sec.gov/comments/265-29/2652985.htm (‘‘J A Letters’’); Letter from Richard Steiner,
Electronic Trading Strategist, RBC Capital Markets,
to Mary Jo White, Chair, Commission (September
23, 2016), available at https://www.sec.gov/
comments/265-29/26529-86.pdf (‘‘RBC Capital
Markets Letter III’’); Letter from Tyler Gellasch,
Executive Director, Healthy Markets Association, to
Brent J. Fields, Secretary, Commission (December
23, 2016), available at https://www.sec.gov/
comments/265-29/26529-1441899-130023.pdf
(‘‘Healthy Markets Letter I’’); Letter from Theodore
R. Lazo, Managing Director & Associate General
Counsel, SIFMA, to Brent J. Fields, Secretary,
Commission (March 29, 2017), available at https://
www.sec.gov/comments/265-29/26529-1674696149276.pdf (‘‘SIFMA Letter’’); Letter from Tyler
Gellasch, Executive Director, Healthy Markets
Association, to Brent J. Fields, Secretary,
Commission (April 3, 2017), available at https://
www.sec.gov/comments/265-29/26529-1681516149500.pdf (‘‘Healthy Markets Letter II’’); Letter
from Tyler Gellasch, Executive Director, Healthy
Markets Association, to Hon. W. Jay Clayton,
Chairman, Commission (June 13, 2017), available at
https://www.sec.gov/comments/265-29/265291801830-153704.pdf (‘‘Healthy Markets Letter III’’);
Letter from Chris Concannon, President and Chief
Operating Officer, Cboe, Thomas Wittman, CEO,
The Nasdaq Stock Market LLC, and Thomas W.
Farley, President, NYSE, to Hon. Jay Clayton,
Chairman, Commission (October 13, 2017),
available at https://www.sec.gov/comments/265-29/
26529-2641078-161300.pdf (‘‘Joint Exchange
Letter’’); Letter from Brad Katsuyama, Chief
Executive Officer, and John Ramsay, Chief Market
Policy Officer, Investors Exchange LLC, to Hon. Jay
Clayton, Chairman, Commission (November 15,
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commenters voiced support for a pilot
in general or for the various proposals
considered by the Subcommittee and
the EMSAC that culminated in the
EMSAC Pilot Recommendation. One
commenter, for example, expressed
support for an access fee pilot and
characterized the Subcommittee’s
recommendation as ‘‘an excellent
roadmap’’ for such a pilot.45 Other
commenters that support an access fee
pilot remarked that the maker-taker
pricing model contributes to opaque,
non-transparent markets, increases
market complexity and fragmentation,
and generates conflicts of interest that
may impede best execution of orders,
and they urged the Commission to act
promptly on a pilot that could produce
useful data on these issues.46
2017), available at https://www.sec.gov/comments/
265-29/26529-2691444-161491.pdf (‘‘IEX Letter’’);
Email from Tim Quast, President, ModernNetworks
IR LLC, to Hon. Jay Clayton, Chairman, Commission
(December 5, 2017), available at https://
www.sec.gov/comments/265-29/26529-2777697161622.pdf.
45 See Decimus Capital Markets Letter, supra note
44, at 2.
46 See, e.g., Letter from Ari Burstein, Associate
General Counsel, Investment Company Institute, to
Brent Fields, Secretary, Commission (May 11,
2015), available at https://www.sec.gov/comments/
265-29/26529-10.pdf (recommending that the
Commission establish a pilot program that would
prohibit rebates and reduce access fees)
(‘‘Investment Company Institute Letter I’’); Letter
from Managed Funds Association to SEC EMSAC
(September 29, 2015), available at https://
www.sec.gov/comments/265-29/26529-28.pdf
(urging ‘‘a disciplined, data-driven study’’ and
calling for analysis of access fees’ effects on market
liquidity, order routing, execution transparency,
transaction costs, and competition); Letter from
David W. Blass, General Counsel, Investment
Company Institute, to SEC EMSAC (January 20,
2016), available at https://www.sec.gov/comments/
265-29/26529-48.pdf (urging the Commission to
establish a phased pilot program for highly liquid
stocks that would reduce access fees and prohibit
rebates) (‘‘Investment Company Letter II’’); Letter
from the Trading Issues Committee, Canadian
Security Traders Association, Inc., to Brent Fields,
Secretary, Commission (April 6, 2016), available at
https://www.sec.gov/comments/265-29/2652961.pdf (proposing a cross-border study on the effect
of rebates on market quality in conjunction with the
Canadian Securities Administrators); J A Letters,
supra note 44 (retail investor supporting proposed
pilot but suggesting test of payment for order flow
and inclusion of ‘‘trade-at’’ provision); Security
Traders Association Letter, supra note 44
(supporting a pilot of limited number of securities
with varying access fee caps and ‘‘no other
variables’’); RBC Capital Markets Letter III, supra
note 44 (concluding that an access fee pilot based
on the EMSAC recommendation would be ‘‘a
positive step’’ and further suggesting a no-rebate
bucket and the inclusion of taker-maker exchanges
and ATSs); Healthy Markets Letter I, supra note 44
(applauding many aspects of the EMSAC
recommendation, but suggesting that it include all
trading venues and a ‘‘trade-at’’ provision); SIFMA
Letter, supra note 44 (proposing, as one alternative,
that the Commission adopt the EMSAC
recommendation); IEX Letter, supra note 44
(supporting the concept of a fee pilot conducted by
the SEC, but recommending that the pilot include
a no-rebate bucket and apply to inverted
exchanges).
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Some of these same commenters
suggested modifications to the ideas
ultimately embodied in the EMSAC
Pilot Recommendation. For example,
one commenter suggested including a
wider range of securities with lower
market capitalizations, instead of
focusing only on the highly liquid
securities proposed by the EMSAC.47
Several other commenters argued that
any pilot should either ban rebates
altogether or include a ‘‘no-rebate’’ test
bucket—an approach that the EMSAC
considered, but did not ultimately
recommend.48 Finally, a number of
commenters advocated for applying a
pilot to taker-maker exchanges as well
as ATSs.49
47 See Decimus Capital Markets Letter, supra note
44, at 11. But cf. Investment Company Institute
Letter II, supra note 46, at 6–7 (asserting that pilot
securities should be highly liquid stocks, as
measured by average daily trading volume); Joint
Exchange Letter, supra note 44, at 5 (expressing
concern that liquidity in less active stocks could be
negatively impacted by a pilot, but acknowledging
that, ‘‘if less active stocks are omitted, it is difficult
to envision the securities that should be selected
. . .’’). See also infra Section III.B (discussing the
securities to be included in the proposed pilot,
which incorporates a broader range of securities
than the EMSAC recommendation, including NMS
stocks with market capitalizations below $3
billion).
48 See Investment Company Institute Letter II,
supra note 46, at 7 (recommending that the
Commission establish a phased pilot program for
highly liquid stocks that would reduce access fees
and prohibit rebates); RBC Capital Markets Letter
III, supra note 44, at 3 (advocating for the inclusion
of a ‘‘no-rebate’’ bucket in the pilot); Healthy
Markets Letter II, supra note 44, at 6 n.15
(suggesting that the Commission establish a pilot
that eliminates rebates); SIFMA Letter, supra note
44, at 9–10 (suggesting, as an alternative to an
access fee pilot, that the Commission eliminate
rebates); IEX Letter, supra note 44, at 3–4 (stating
that restrictions on access fees may not help the
Commission to evaluate alternatives to the current
exchange pricing system, which is driven primarily
by rebates, and advocating for the inclusion of a
‘‘no-rebate’’ bucket in the pilot). See also Nasdaq
Letter, supra note 44, at 3 (asserting that any pilot
should apply to both fees and rebates). But cf. NYSE
Letter, supra note 44, at 3–4 (arguing that
elimination of rebates, without any other offsetting
incentives, may reduce market-maker incentives to
provide liquidity). See also infra Section III.C
(discussing the design of the proposed pilot, which
includes a ‘‘no-rebate’’ bucket).
49 See RBC Capital Markets Letter III, supra note
44, at 4 (suggesting that the pilot should be applied
to taker-maker exchanges and ATSs); Healthy
Markets Letter I, supra note 44, at 3–4 (taking the
view that ‘‘all relevant exchanges’’ and ATSs
should be included in the pilot). See also Nasdaq
Letter, supra note 44, at 3 (recommending that the
Commission establish a pilot that applies to all
trading centers, including ATSs); Joint Exchange
Letter, supra note 44, at 5 (recommending that the
pilot apply to trading in all off-exchange venues);
IEX Letter, supra note 44, at 4 (suggesting that the
access fee pilot should include taker-maker
exchanges). See also infra Section III.A (discussing
the Commission’s decision to include taker-maker
exchanges, but not ATSs, in the proposed pilot).
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In a joint letter, three exchanges
recommended several other changes 50 if
the Commission proceeds with a pilot
based on the EMSAC’s
recommendation.51 These commenters
suggested that such a pilot should,
among other things: (1) Study ‘‘all forms
of remuneration,’’ in part by adding
measures specifically to study ATS and
broker-dealer remuneration and to show
how the savings realized by brokerdealers from lowered exchange
transaction fees are ‘‘returned to
customers,’’ 52 (2) measure costs to
issuers and shareholders and allow
issuers to have a voice in whether they
are included in a pilot,53 (3) preannounce the measures for
benchmarking and tracking the impact
of a pilot,54 and (4) ‘‘measure gross
shifts in trading from exchange to offexchange venues and among offexchange venues.’’ 55
Other commenters expressed concern
regarding the impact of a pilot.56 For
example, the New York Stock Exchange
LLC (‘‘NYSE’’) believed that, while the
pilot’s lowered fee caps in the three test
groups would reduce the direct costs
paid by broker-dealers to access
displayed exchange quotations, it also
would effectively limit the rebates paid
50 See notes 47 and 49 supra, and note 62 infra,
for a discussion of other changes recommended by
these three exchanges.
51 See Joint Exchange Letter, supra note 44, at
4–5.
52 But cf. IEX Letter, supra note 44, at 2 (‘‘The
idea that a substantial conflict of interest cannot be
addressed unless all other conflicts are addressed
simultaneously is not viable.’’).
53 See Section III.B infra (discussing the
Commission’s decision to include a broader range
of securities than the EMSAC recommendation,
including NMS stocks with market capitalizations
below $3 billion). See also Sections V.C.2.b and
V.D.3 infra (discussing the potential costs to small
and mid-capitalization issuers).
54 See Section III.E infra (discussing the measures
that the Commission intends to use to benchmark
and track the impact of the proposed Pilot).
55 See Joint Exchange Letter, supra note 44, at
4–5. See also Section III.E.3 infra (discussing the
order routing data that the Commission intends to
use to measure shifts in trading); Section V.E.1 infra
(noting that the Commission can use existing data
sources to track shifts in trading between equities
exchanges and ATSs).
56 See, e.g., Letter from David M. Weisberger,
Managing Director and Global Head, RegOne
Solutions, a Markit company, to Brent Fields,
Secretary, Commission (October 9, 2015), available
at https://www.sec.gov/comments/265-29/2652930.pdf (raising various questions about proposals to
modify access fees, including risks that such
proposals could hurt retail investors and lower
available liquidity); Letter from John I. Sanders &
Benjamin Leighton, Wake Forest School of Law
Community Law and Business Clinic (October 20,
2015), at 6–7, available at https://www.sec.gov/
comments/265-29/26529-33.pdf (opining that a shift
away from maker-taker pricing could affect
liquidity and suggesting that the Commission
instead focus on utilizing market manipulation
rules, limiting order types, and regulating
colocation).
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by exchanges to attract liquidity, which
could ‘‘reduce the competitiveness of
exchanges relative to dark pools. . .
.’’ 57 NYSE further argued that the
Subcommittee’s concept for a pilot was
‘‘designed to test investors’ and listed
companies’ tolerance for worsening
market quality’’ since market making
and market quality ‘‘are largely driven
by incentives and corresponding
obligations.’’ 58 NYSE recommended an
alternative initiative that would lower
access fee caps, prohibit maker-taker
pricing models, and institute a ‘‘tradeat’’ rule.59
Nasdaq suggested the Commission
pursue an alternative pilot that caps
both fees and rebates, as it believed that
more meaningful data would result by
removing price from market
participants’ routing decisions.60
Nasdaq also argued that the pilot should
apply to all trading centers.61 Finally,
Nasdaq thought that a two-year term for
a pilot would be too long, observing that
its own transaction fee experiment
suggested that the impact on liquidity
provision was evident quickly.62
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57 NYSE
Letter, supra note 44, at 3. NYSE was
critical of the potential application of access fee
caps to non-displayed liquidity, an idea considered
but not recommended by the EMSAC, because it
believed that such caps on exchanges would
advantage ATSs. Id. at 5–6.; but cf. RBC Capital
Markets Letter III, supra note 44, at 4 (asserting that
the pilot program should cover non-displayed
orders on exchanges to ensure complete and
accurate data). See also infra Section III.C
(discussing the design of the proposed pilot).
58 See NYSE Letter, supra note 44, at 3.
59 See id. at 6. Some commenters seemed to agree
with NYSE that a ‘‘trade-at’’ rule should be
included in the pilot. See Nasdaq Letter, supra note
44, at 2. Others opposed inclusion of a ‘‘trade-at’’
rule. See RBC Capital Markets Letter III, supra note
44 (stating that a ‘‘trade-at’’ rule would be
duplicative, given the inclusion of such a
component in the Tick Size Pilot, and opining that
a ‘‘trade-at’’ rule could obscure data showing the
impact of pricing); Healthy Markets Letter I, supra
note 44, at 4 (noting that inclusion of a ‘‘trade-at’’
rule would increase the pilot’s complexity and
decrease its utility, but opining that all trading
venues should be included in the pilot if a ‘‘tradeat’’ rule is excluded). See also infra Section III.C
(discussing the design of the proposed pilot).
60 See Nasdaq Letter, supra note 44, at 3. See also
infra Section III.C.3 (discussing the Pilot’s inclusion
of a ‘‘no-rebate’’ bucket).
61 See Nasdaq Letter, supra note 44, at 3. See also
infra Section III.A (discussing the Commission’s
decision to expand on the EMSAC Pilot
Recommendation to apply the Pilot to all equities
exchanges, but not to ATSs).
62 See Nasdaq Letter, supra note 44, at 3; Joint
Exchange Letter, supra note 44, at 5 (recommending
that the proposed pilot last no more than one year
and that the Commission develop criteria for
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One commenter, the Chicago Board
Options Exchange, Incorporated, now
known as Cboe Exchange, Inc. (‘‘Cboe’’),
recommended against doing a pilot, and
instead suggested abolishing the equity
fee cap and requiring ATSs to file fee
changes with the Commission.63
Similarly, Nasdaq, NYSE, and Cboe
jointly suggested that the Commission
should forgo conducting a pilot that
only touches on one aspect of
Regulation NMS and instead
recommended a broader review of the
impact of remuneration on routing and
trading.64 Alternatively, Nasdaq, NYSE,
and Cboe recommended that, if the
Commission seeks to conduct an access
fee pilot, it should first (1) articulate a
strong and clear duty of best execution
to ameliorate the conflict of interest
between a broker and its customer, (2)
require improved disclosures regarding
execution quality and routing practices
to deter potential conflicts, and (3)
adopt its proposed amendments to
Regulation ATS 65 to enhance the
operational transparency of ATSs.66
evaluating the possibility of the pilot’s early
termination). See also, e.g., Nasdaq May Report,
supra note 31, at 1 (summarizing some of Nasdaq’s
explanations regarding the results of its transaction
fee experiment); and infra Section III.D (discussing
the Commission’s decision to limit the two-year
term recommended by EMSAC with an automatic
sunset at the end of the first year).
63 See Letter from Edward T. Tilly, CEO, Cboe, to
SEC EMSAC (January 28, 2016), available at https://
www.sec.gov/comments/265-29/26529-51.pdf. Cboe
opined that ‘‘broad and arbitrary price controls’’ are
a ‘‘drastic measure’’ that conflicts with ‘‘the very
concept of a market-based system.’’ Id. at 9–10. As
another alternative, one commenter proposed that
the Commission require venues to include ‘‘all-in’’
costs in their visible quotes. See Letter from
Michael J. Friedman, General Counsel, Trillium, to
Brent J. Fields, Secretary, Commission (May 14,
2015), available at https://www.sec.gov/comments/
265-29/26529-18.pdf.
64 See Joint Exchange Letter, supra note 44, at 2
and 6. Investors Exchange LLC (‘‘IEX’’), disagreed
with this suggestion and pointed out that the
Commission ‘‘has been engaged in a holistic review
of market structure at least since the issuance of its
Equity Market Structure Concept Release in 2010,’’
which ‘‘has led to consideration of the Fee Pilot.’’
See IEX Letter, supra note 44, at 3. IEX further
opined that maker-taker pricing need not be
addressed simultaneously with all other market
structure issues, given ‘‘the amount of fees and
rebates involved (over $2.5 billion in 2016), the
inefficiencies that result from hundreds of pricing
tiers, and the proven negative consequences to
investors that result from routing orders to high
rebate exchanges.’’ Id. at 2–3.
65 Securities Exchange Act Release No. 40760
(December 8, 1998), 63 FR 70844 (December 22,
1998).
66 See Joint Exchange Letter, supra note 44, at 2–
4. But cf. IEX Letter, supra note 44, at 3
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Investors’ Exchange LLC (‘‘IEX’’)
responded to the comments jointly
submitted by Nasdaq, NYSE, and Cboe
by characterizing those exchanges’
arguments as ‘‘part of a familiar
playbook to stave off market reform.’’ 67
While IEX agreed that Nasdaq, NYSE,
and Cboe had identified important areas
for consideration, IEX did not support
delaying action on a transaction fee
pilot 68 and disputed whether the broad
review suggested by Nasdaq, NYSE, and
Cboe was necessary.69 Rather, IEX
strongly supported the idea of a
transaction fee pilot, but recommended
that any such pilot include a ‘‘norebate’’ bucket and apply to inverted
exchanges.70
III. Discussion of the Proposed Pilot
The Commission is proposing to
conduct a Transaction Fee Pilot (the
‘‘Pilot’’ or ‘‘Transaction Fee Pilot’’) for
NMS stocks, as described below. In
formulating this proposal, the
Commission has taken into
consideration the recommendation of
the EMSAC for an access fee pilot, the
views of those submitting comment
letters on the EMSAC’s proposal, and
the information and research described
throughout this release. The
Commission’s proposal, in an effort to
more broadly test the impact of
transaction fees and rebates, differs from
the EMSAC’s recommendation in
several respects, as discussed further
below.71 The Commission notes that the
proposed Pilot is not designed to test
the impact of transaction fees and
rebates on all aspects of equities market
structure, including market
fragmentation and the proliferation of
complex order types, but rather focuses
on order routing behavior, execution
quality, and market quality.
The following chart summarizes the
proposed terms of the Pilot, which are
discussed in more detail below:
(characterizing this recommendation as one with
‘‘no logic other than commercial protectionism in
delaying action on fees and rebates’’).
67 See IEX Letter, supra note 44, at 2.
68 See id. at 3.
69 See id. at 2–3; see also notes 52 and 64 supra.
70 See id. at 1–4; see also notes 48–49 supra.
71 Because the proposed Pilot would apply more
broadly to more types of transaction fees beyond
only fees to access a protected quotation, the
Commission therefore is not characterizing the
proposal as an ‘‘Access Fee Pilot.’’
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72 See 17 CFR 242.610(c) (addressing ‘‘fees for the
execution of an order . . . in an NMS stock,’’ where
‘‘NMS stock’’ is defined as ‘‘any NMS security other
than an option’’ under 17 CFR 242.600(b)(47)).
73 As a result, options exchange fees for the
execution of one options contract typically far
exceed the Rule 610(c) cap of $0.0030. See, e.g.,
NYSE Arca Options Fee Schedule, available at
https://www.nyse.com/publicdocs/nyse/markets/
arca-options/NYSE_Arca_Options_Fee_
Schedule.pdf (including fees, as of September 2017,
of $0.50 for electronic executions that take liquidity
in Penny Pilot Issues for Broker-Dealer orders).
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to options exchanges and then consider
how that cap would impact current
options exchange fee models, which
would introduce considerable
additional complexity.74 For these
reasons, the Commission is not
proposing to include options exchanges
in the proposed Pilot.
However, the scope of the proposed
Pilot would be broader than both the
EMSAC’s recommendation and Rule
610(c), in that it would include all
equities exchanges—including takermaker exchanges. For example, the
proposed Pilot’s fee cap in Test Groups
1 and 2 (detailed below) would apply
the cap to the take fee on a maker-taker
exchange and also would apply the cap
to the maker fee on a taker-maker
exchange.75 The EMSAC did not
recommend including taker-maker
exchanges or ATSs in an access fee pilot
because it endeavored to remain
consistent with the current market
structure, including the Rule 610(c)
74 See also EMSAC Pilot Recommendation, supra
note 28, at 5. None of the comment letters
submitted to the EMSAC advocated for including
options exchanges in an access fee pilot.
75 See supra note 19 (discussing Rule 610(c) and
the taker-maker model). The proposed fee caps in
Test Groups 1 and 2 (detailed below) would not
apply to rebates. For example, the proposed Pilot’s
fee cap in Test Group 2 would not apply the cap
to the maker rebate on a maker-taker exchange, nor
would it apply the cap to the taker rebate on a takermaker exchange.
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access fee cap, which only caps fees for
removing a protected quotation and
does not apply to ATSs.76 A number of
commenters disagreed with the
approach recommended by the
EMSAC.77 These commenters asserted
that a pilot would provide more
meaningful data if applied more
broadly; 78 one commenter explained
that a broader approach would reduce
the possibility of ‘‘gaming,’’ as well as
provide more accurate testing of order
flows.79 Another commenter believed
that liquidity and market quality on
traditional, maker-taker exchanges
would suffer unless taker-maker
exchanges and ATSs were included in
the proposed Pilot.80 Another
76 See EMSAC Pilot Recommendation, supra note
28, at 5.
77 See supra note 49.
78 See, e.g., Nasdaq Letter, supra note 44, at 3; IEX
Letter, supra note 44, at 4 (arguing that inverted
exchanges should be included in a pilot because the
pilot otherwise would test ‘‘only how much
distortive pricing can be transferred to these
venues’’).
79 See RBC Capital Markets Letter III, supra note
44, at 4. But cf. infra notes 86–93 and
accompanying text (acknowledging the potential for
‘‘gaming,’’ but discussing the Commission’s
decision to exclude ATSs from the Pilot).
80 See Nasdaq Letter, supra note 44, at 2. But cf.
infra notes 89–93 and accompanying text (noting
that Nasdaq’s fee experiment results would not
necessarily be duplicated in an industry-wide pilot
and explaining that the Pilot could potentially
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A. Applicable Trading Centers
The proposed Pilot, consistent with
the EMSAC’s recommendation, would
apply solely to the equities exchanges.
The fee cap under Rule 610(c), on which
the proposed Pilot is largely based, does
not apply to options exchanges.72
Specifically, the fee cap under Rule
610(c) applies to NMS stocks on a per
share basis whereas options contracts
are derivatives that represent a number
of shares, typically 100 shares of stock
per options contract for a single-stock
option, and the current fee cap under
Rule 610(c) is not calibrated to account
for that difference.73 Because options
and equities are materially different
types of securities, the current fee cap
applicable to equities exchanges does
not apply, and cannot readily be
applied, to options exchanges. If options
exchanges were to be included in a
pilot, the Commission would first need
to create a new type of fee cap to apply
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commenter believed that a pilot should
include all equities exchanges and
ATSs, but acknowledged that a pilot
based on the current parameters of Rule
610(c) would be difficult to apply to
taker-maker exchanges and ATSs.81
The Commission believes that the
proposed Pilot should be designed to
broadly study the impact of transaction
fees and rebates on order routing
behavior, execution quality, and market
quality. To achieve a broader study, the
Commission preliminarily believes that
including all equities exchanges,
including taker-maker exchanges, in the
proposed Pilot is appropriate. Including
all equities exchanges in the proposed
Pilot will ensure that the Pilot will
collect data on all equities markets that
are registered national securities
exchanges, whose fees are all subject to
the requirements of the Exchange Act
and the rule filing requirements
thereunder, thus treating equally all
similarly situated entities.
However, expanding the proposed
Pilot to non-exchange trading centers,
such as ATSs, whose fees currently are
not subject to Rule 610(c) would have
the effect of imposing, in the terms of a
pilot, an entirely new regulatory regime
on entities whose fees are not currently
subject to the substantive and process
requirements applicable to exchanges,
and that are currently not subject to
access fee caps in any respect. The
Commission, therefore, believes that
doing so would introduce a number of
complexities that it preliminarily does
not believe are warranted for purposes
of this proposed Pilot. In particular,
while equities exchanges charge
transaction-based fees, ATSs, especially
‘‘dark pool’’ ATSs that are part of a large
broker-dealer order handling business,
may not charge separate transactionbased fees for executions in their ATSs,
and instead might use bundled pricing
that does not associate particular orders
with particular fees.82 Consequently,
incorporating ATSs into the proposed
Pilot would be substantially more
complex if the proposed Pilot required
ATSs to radically change their fee
models and renegotiate their pricing
arrangements with their customers in
improve the competitive position of exchanges vis`
a-vis ATSs).
81 See Healthy Markets Letter I, supra note 44, at
4; see also Section III.A infra (discussing the
difficulties of applying the Pilot to ATSs).
82 See, e.g., Letter from William P. Neuberger and
Andrew F. Silverman, Managing Directors and
Global Co-Heads of Morgan Stanley Electronic
Trading, to Brent J. Fields, Secretary, Commission
(May 19, 2016), available at https://www.sec.gov/
comments/s7-23-15/s72315-37.pdf (commenting on
File No. S7–23–15 concerning regulation of NMS
Stock Alternative Trading Systems and noting that
ATS fees may be bundled with brokerage services).
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order to assess fees differently than they
do today solely to accommodate the
proposed Pilot.83
Because the proposed Pilot is
designed to study, among other things,
the potential conflicts of interest faced
by broker-dealers when routing orders
as a result of transaction fees and
rebates, it is necessary to be able to
directly observe the effects of changes in
transaction fees and rebates on their
trading. As discussed above, some have
questioned whether a broker-dealer’s
economic incentive to avoid
transaction-based fees and earn
transaction-based rebates impacts its
order routing decisions in a manner that
creates a misalignment between the
broker-dealer’s economic interests and
its obligation to seek the best execution
for its customer’s order.84 To the extent
ATSs do not charge transaction-based
fees, it is not practicable to include
them in a pilot that is structured to test
the impact of changes in transaction
fees. Accordingly, the Commission
preliminarily believes that excluding
ATSs from the proposed Pilot is
appropriate, and that broadly applying
the Pilot to all equities exchanges,
regardless of their pricing model, will
allow the proposed Pilot to collect data
on the effects of changes in transaction
fees and rebates, which will permit the
study of, among other things, potential
conflicts of interest faced by brokerdealers when routing orders.85
The Commission acknowledges the
concerns raised by Nasdaq about
excluding ATSs from the proposed
Pilot.86 Specifically, Nasdaq noted that
during its fee experiment, when Nasdaq
lowered its rebates, liquidity providers
‘‘immediately moved their quotes to
other exchanges.’’ 87 As a result, Nasdaq
stated that unless ATSs are included in
the pilot ‘‘we are likely to find that
liquidity and market quality on
exchanges will be fundamentally
harmed, ultimately to the detriment of
public investors’’ and ‘‘[i]ssuers
included in the pilot would see a
diminishment of transparent quotes,
widening of quoted spreads, and an
83 See infra Section V.E.1. (noting that the
inclusion of ATSs in the proposed Pilot may not be
practical and is likely to substantially increase the
costs of the proposed Pilot).
84 See supra notes 21–22 and accompanying text.
85 While ATSs would not be subject to the
proposed Pilot, data on ATS market share are
available from FINRA, available at https://
otctransparency.finra.org, which could provide an
indication of whether routing to ATSs increase or
decrease during the proposed Pilot. See infra
Section V.C.1.b. (discussing possible changes in
routing to ATSs during the proposed Pilot).
86 See Nasdaq Letter, supra note 44, at 2.
87 Id.
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inferior overall trading experience.’’ 88
However, as discussed above, unlike for
liquidity adding orders, Nasdaq found
‘‘no significant changes in the nature of
liquidity taking’’ during its fee
experiment.89 The Commission
believes, as discussed above and as
Nasdaq itself observes, that ‘‘the results
for Nasdaq would not necessarily be
duplicated industry-wide if access fees
and rebates were reduced across the
board.’’ 90 For example, the fact that
some market participants ‘‘immediately
moved their quotes to other exchanges’’
may be because other equities
exchanges did not participate in
Nasdaq’s fee experiment and those
market participants who specifically
sought to quote on an equities exchange,
and not an ATS, responded accordingly
by moving some of their activity to
equities exchanges that continued to
offer rebates. The Commission notes
that the proposed Pilot would not
impact the ability of an equities
exchange to maintain a ‘‘protected
quote,’’ an advantage that an ATS does
not enjoy, and to the extent that the
demand associated with liquidity taking
on exchanges remains stable, it could
continue to attract liquidity providers
desiring that protection despite changes
to rebates. Further, the Commission
notes that some have argued that high
equities exchange maker rebates
necessitate high offsetting taker fees,
which may cause some liquidity taking
order flow to migrate to non-exchange
trading centers in search of lower
transaction costs.91 The proposed Pilot’s
lower fee caps in Test Groups 1 and 2,
discussed below, could possibly
improve the competitive position of
`
exchanges vis-a-vis ATSs.92
Accordingly, the Commission
preliminarily believes that it is
appropriate to exclude ATSs from the
proposed Pilot, which also is consistent
88 Id.
89 See
Nasdaq May Report, supra note 31, at 1.
May Report, supra note 31, at 1. See
also EMSAC Pilot Recommendation, supra note 28,
at 3 (‘‘Limited experiments, such as the recent
Nasdaq pilot, have shown that individual market
experiments do not yield conclusive results about
the potential impact of market-wide policy reform
on access fees.’’).
91 See, e.g., BlackRock Inc. Viewpoint, U.S.
Equity Market Structure: An Investor Perspective, at
7 (April 2014), available at https://
www.blackrock.com/corporate/en-us/literature/
whitepaper/viewpoint-us-equity-market-structureapril-2014.pdf (‘‘Reducing the access fee caps is one
solution that would narrow the price disparity and
lessen the impact of cost in routing decisions. This
may also curb the usage of off-exchange venues,
such as dark pools and internalizers, as a major
benefit of these trading platforms is their cost
efficiency relative to exchanges.’’) (‘‘BlackRock
Viewpoint’’).
92 See id.
90 Nasdaq
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with the EMSAC’s recommendation.93
The Commission further notes that the
inclusion of ATSs is discussed as an
alternative in the economic analysis
below.
The Commission requests comment
on the trading centers to be included in
the proposed Pilot. In particular, the
Commission solicits comment on the
following. To the extent possible, please
provide specific data, analyses, or
studies for support.
1. The proposed Pilot would apply to
all equities exchanges. Should the scope
be expanded or reduced? If so, what
should the scope be? What would be the
anticipated impacts of the revised
scope?
2. Should the Commission include
taker-maker equities exchanges in the
proposed Pilot? Why or why not? What
would be the anticipated impact of
excluding taker-maker equities
exchanges from the proposed Pilot?
3. Should the proposed Pilot be
expanded to include ATSs? Why or why
not? What would be the anticipated
impact of including ATSs in the
proposed Pilot? If the proposed Pilot
were expanded to include ATSs, should
all ATSs be included or only certain
ATSs? What, if any, are the potential
competitive impacts of excluding ATSs
from the proposed Pilot? Would
including ATSs in the proposed Pilot
have any likely effect on ATS business
models? To what extent do ATSs charge
fees that are not transaction-based? If
the proposed Pilot includes ATSs, how
should it apply to ATS fees that are not
transaction-based? Also, to apply the
proposed Pilot to ATSs, would the
Commission need to impose other new
requirements on ATSs, such as fee
disclosure requirements? If ATSs were
to be included in the proposed Pilot,
would they be able to collect and report
the proposed data 94 or would changes
be necessary to accommodate ATSs?
4. Should the proposed Pilot include
options exchanges? Why or why not?
What would be the anticipated impact
of including options exchanges in the
proposed Pilot? How would the quality
and extent of the data be impacted by
including or excluding options
exchanges? What, if any, are the
potential impacts, including
competitive impacts, of excluding
93 See EMSAC Pilot Recommendation, supra note
28, at 5 (‘‘. . . the Committee does not believe that
extending the application of Rule 610(c) to ATSs
would be a beneficial part of the pilot given that
(i) such limitation does not apply today, (ii) ATSs
are not afforded a protected quote, and (iii) ATS
transaction fees generally take the form of an
institutional commission.’’).
94 See Section III.E infra for a description of the
proposed data.
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options exchanges from the proposed
Pilot? What, if any, are the potential
competitive impacts of subjecting
options exchanges to fee caps?
B. Securities
The Commission proposes to include
in the Pilot all NMS stocks, which
includes common stocks and ExchangeTraded Products (‘‘ETPs’’), among other
securities,95 with an initial share price
at the time the pre-Pilot Period
commences of at least $2, an unlimited
duration or a duration beyond the end
of the post-Pilot Period, and no
restrictions on market capitalization
(collectively, ‘‘Pilot Securities’’).96 As
discussed below, throughout the
duration of the proposed Pilot,
including the pre- and post-Pilot
Periods, if a Pilot Security in one of the
Test Groups closes below $1, the
security would be removed from the
Test Group and would no longer be
subject to the Pilot pricing restrictions.97
While the EMSAC did not specify a
minimum price threshold, the
Commission is proposing an initial $2
threshold that would apply at the time
of the initial Pilot Securities selection,
as was done for the Tick Size Pilot. On
a continuing basis, the price threshold
would be $1, also as was done for the
Tick Size Pilot. If a Test Group
security’s share price closes below $1 at
95 See 17 CFR 242.600(b)(47) (defining ‘‘NMS
stock’’). The Commission notes that although the
EMSAC recommended limiting the access fee pilot
to common stocks and ETFs, because Rule 610(c)
applies to all NMS stocks, and not just common
stocks and ETPs (including ETFs), the Commission
preliminarily believes it is appropriate to extend the
Pilot to all NMS stocks.
96 The EMSAC recommended including ETFs,
which are open-end fund vehicles or unit
investment trusts that are registered as investment
companies under the Investment Company Act of
1940. The Commission’s proposal uses the broader
term of ETPs, which, in addition to ETFs, also
includes trust or partnership vehicles that are not
registered under the 1940 Act because they do not
invest primarily in securities, as well as ExchangeTraded Notes (‘‘ETNs’’). ETNs are senior debt
instruments that pay a return based on the
performance of a reference asset. Unlike the two
other categories of ETPs, ETNs are not pooled
vehicles, and they do not hold an underlying
portfolio of securities or other assets. See generally
Securities Exchange Act Release No. 75165 (June
12, 2015), 80 FR 34729, 34731 (June 17, 2015)
(Request for Comment on Exchange-Traded
Products). The EMSAC record, including transcripts
of EMSAC meetings, does not contain any
substantive discussion of the distinction between
ETFs and ETPs. However, all such securities are
‘‘NMS stocks’’ subject to Rule 610(c), and the
Commission preliminarily does not believe there is
a meaningful basis to justify excluding any of them
from the proposed Pilot. See 17 CFR 242.600(b)(47)
(defining ‘‘NMS stock’’). See also proposed Rule
610T(b)(1)(ii) (defining ‘‘Pilot Securities’’).
97 See also proposed Rule 610T(b)(3)(ii)(D)
(concerning the Pilot Securities Change List and the
capture of the date on which any Pilot Security
closes below $1).
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the end of a trading day during the
proposed Pilot, it would be dropped
from the Test Group and removed from
the proposed Pilot.98 Under Rule 610(c),
stocks with quotations of less than $1
are subject to a structurally different fee
cap (based on a percentage of the quoted
price) than stocks with quotations of $1
or greater (based on a fixed dollar
amount),99 and equities exchanges
typically also assess fees differently for
stocks priced less than $1 (i.e., based on
a percentage of the price rather than a
fixed fee amount).100 Accordingly, the
$1 minimum continuing price threshold
recognizes those distinctions and avoids
applying the proposed Pilot’s Test
Group fixed dollar fee caps to securities
below $1 for which a fixed dollar cap
would be incompatible with the current
existing percentage-based standards
applicable to those securities.101
The Commission preliminarily
believes that an initial minimum $2 per
share price threshold at the time of the
initial stock selection captures
substantially all NMS stocks while also
providing a cushion so that
substantially all of the securities
selected for each Test Group will remain
part of their respective Test Groups for
the duration of the proposed Pilot and
not be dropped on account of their share
price closing below $1 during the Pilot,
as it is uncommon for securities priced
at $2 or more to fall below $1.102 This
98 See Section III.E.1 infra (discussing the
obligations for primary listing exchanges to
maintain Lists of Pilot Securities that will be
updated as necessary prior to the beginning of
trading on each day the U.S. equities markets are
open for trading to communicate changes to Pilot
Securities). Stocks in the Control Group that close
below $1 would be removed from the Pilot. As
discussed below, exchanges would be required to
record on the Pilot Securities Change Lists the date
that a stock closes below $1.
99 While Rule 610(c) imposes a cap of $0.0030 for
a protected quotation of $1.00 or more, the cap is
0.3% when the protected quotation is less than
$1.00. See 17 CFR 242.610(c).
100 See, e.g., New York Stock Exchange Price List,
available at https://www.nyse.com/publicdocs/
nyse/markets/nyse/NYSE_Price_List.pdf.
101 For example, applying Test Group 2’s $0.0015
cap to a security priced at $0.25, which currently
would be subject to a fee cap of $0.00075 under
Rule 610(c) (i.e., 0.3% of $0.25) would be
inapposite.
102 Based on data computed from Center for
Research on Securities Prices (CRSP), during the
last five years (2012–2016), 94.4% of publicly
traded common stocks and ETPs had a share price
above $2. Of those stocks, only 4.3% dropped
below $1 at any point in that period. In addition,
NYSE and Nasdaq can initiate delisting proceedings
if a security trades below $1 for a certain period of
time. See, e.g., NYSE Listed Company Manual
Section 802.01C; Nasdaq Equity Rule 5450(a)(1).
See also Cboe BYX Rule 14.7(e)(1) (continued
listing requirement of a minimum bid price of $1
per share); NYSE Arca Rule 5.2(c) (maintenance
requirement of a $5 closing bid price or $3 closing
bid price under the alternate listing requirement).
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initial threshold also will increase the
likelihood that the securities in each
Test Group remain the same throughout
the entire proposed Pilot, which will
provide consistency in the Test Groups
and avoid any adverse impact caused by
changes to the composition of the Test
Groups.103
With respect to market capitalization,
the EMSAC recommended limiting the
pilot to large capitalization stocks with
a minimum market capitalization of $3
billion in part to avoid overlap with the
Tick Size Pilot, which commenced on
October 3, 2016, and is scheduled to last
for a two-year period until October 3,
2018.104 The Commission notes that the
Tick Size Pilot may conclude before the
proposed Pilot commences, but if not,
the Commission believes that the strong
support for a pilot in the near term,
reflected in the comments summarized
above, as well as the proposed Pilot’s
design, which, as discussed below,
would protect the integrity of the data
in both pilots, weighs in favor of
proceeding expeditiously and not
waiting for the Tick Size Pilot to first
expire.105
The Commission preliminarily
believes that a more comprehensive
pilot covering all NMS stocks, including
those with market capitalizations below
$3 billion, would produce a more
meaningful dataset to facilitate broader
analysis of the impact of transaction fees
and rebates across the full spectrum of
NMS stocks, including both large
market capitalization companies with
potentially substantial liquidity and
trading activity as well as mid- and
103 Similarly, the requirement that Pilot Securities
have an unlimited duration or a duration beyond
the end of the post-Pilot Period is intended to avoid
selecting stocks that would expire and drop out
during the Pilot, which also should provide
consistency in the Test Groups and avoid adverse
impacts caused by changes to the composition of
the Test Groups.
104 See EMSAC Pilot Recommendation, supra
note 28, at 2. See also EMSAC Transcript, April 26,
2016, supra note 36, at 27:7–15 (reflecting the
Subcommittee’s desire to run the Tick Size Pilot
simultaneously with the Pilot without either
program impacting the other). See also Investor
Alert: Tick Size Pilot Program—What Investors
Need to Know, available at https://www.sec.gov/
oiea/investor-alerts-bulletins/ia_ticksize.html
(summarizing the Tick Size Pilot).
105 See, e.g., Healthy Markets Letter I, supra note
44, at 5 (noting that ‘‘market participants, experts,
and policymakers have been clamoring for the
Commission to adopt a study to address order
routing incentives for years’’); RBC Capital Markets
Letter III, supra note 44, at 1 (‘‘[T]he sooner that a
pilot can be approved and commenced, the sooner
the Commission will have the benefit of the pilot’s
data, and the sooner it can implement needed
reforms.’’); IEX Letter, supra note 44, at 4 (‘‘The
EMSAC recommendation was issued more than one
year ago, and no one believes that concerns over
maker-taker pricing have become less relevant since
then. We believe that the time to proceed with the
pilot is long past due.’’).
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small capitalization companies with
potentially less trading activity. A
broader dataset will, in turn, permit the
Commission and researchers to perform
more in-depth analyses among different
segments of the securities market, which
may be more informative than a
narrower pilot for evaluations of the
various theories for how transaction fees
and rebates may impact routing
behavior, execution quality, and market
quality.
For example, some have suggested
that transaction rebates are distortive
and unnecessary for liquid large
capitalization companies because, to the
extent that those securities already trade
at spreads no wider than the minimum
trading increment, the rebate cannot
serve to narrow the quoted spread
further and the high fee that offsets the
rebate undermines price transparency
because a quote at the same displayed
price on different equities exchanges
(with different levels of fees) less closely
reflects the actual net price to trade at
any one exchange.106 The limitation or
removal of rebates for liquid large
capitalization stocks therefore may be
less likely to lead to deterioration in
market quality in those securities.107 On
the other hand, some have argued that
the beneficial aspects of rebates,
including their potential to contribute to
narrowing quoted spreads, may
outweigh their potential for these
distortions in mid- and small
capitalization securities, which can face
persistent challenges in attracting
liquidity.108 Accordingly, transaction
rebates may facilitate the provision of
beneficial liquidity for mid- and small
capitalization securities, and may
outweigh any negative distortive impact
106 See, e.g., James Angel, Lawrence Harris &
Chester Spatt, ‘‘Equity Trading in the 21st Century,’’
Quarterly Journal of Finance 1, (2011), available at
https://doi.org/10.1142/S2010139211000067
(noting that ‘‘[t]he obfuscation makes it more
difficult for traders to recognize the true costs of
their trading.’’) (‘‘Angel, Harris, and Spatt’’); Joe
Ratterman, Chief Executive Officer, & Chris
Concannon, President, BATS, ‘‘Open Letter to U.S.
Securities Industry Participants Re: Market
Structure Reform Discussion,’’ at 1 (January 6,
2015), available at https://cdn.batstrading.com/
resources/newsletters/OpenLetter010615.pdf
(‘‘BATS Open Letter’’) (arguing that ‘‘[a] substantial
reduction in access fees, and their corresponding
rebates, would help remove conflicts or a
perception of conflicts with respect to those highly
liquid securities that no longer require liquidity
incentives.’’).
107 See, e.g., BlackRock Viewpoint, supra note 91,
at 7 (‘‘The value of liquidity and therefore the need
for incentives and rebates is not the same across all
stocks. Regulators should review whether highly
liquid stocks require any rebates at all.’’).
108 See, e.g., BATS Open Letter, supra note 106,
at 3 (‘‘. . . BATS does not believe that highly liquid
securities require as great a rebate as less liquid
securities. . . . ’’).
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on broker-dealer incentives, market
complexity, or price transparency.109
To study these possible effects, the
Commission believes it is important to
gather data on the impact of fees and
rebates on stocks of all market
capitalizations. While it is possible that
some observations from a pilot focused
on large capitalization stocks also could
be relevant to mid- and small
capitalization stocks, it is likely that
other observations could be inapposite,
and without including smaller stocks in
a pilot, the Commission and researchers
would lack data to study the impact on
them.
Implementing without undue delay a
broad pilot that includes stocks of all
market capitalizations could potentially
cause the Pilot to overlap with the Tick
Size Pilot. Although such an overlap
may be unlikely, the proposed Pilot has
been designed so that, if necessary, it
could proceed simultaneously with the
Tick Size Pilot without distorting the
effects of either pilot.110 Specifically, as
discussed further below, in the event of
an overlap each Test Group would be
comprised of two subgroups, one of
which contains securities included in
the Tick Size Pilot, and one of which
does not, enabling the Commission and
researchers to identify and control for
any possible effects of an overlap.111
The Commission therefore believes that
this proposed Pilot design would
protect the integrity of the data in both
the proposed Pilot and the Tick Size
Pilot, to the extent that the pilots
overlap.112 Staging one transaction fee
pilot for large capitalization stocks in
109 See
id.
Section III.C infra for additional
explanation regarding how the Pilot would control
for the potential overlap with the Tick Size Pilot.
Notably, if the two pilots overlap and the Tick Size
Pilot ends before the proposed Pilot (if adopted)
ends, the Transaction Fee Pilot’s proposed Test
Groups would not change. Alternatively, if the two
pilots would not overlap at all because the Tick
Size Pilot ends before the proposed Pilot (if
adopted) commences, then the overlap design
discussed below would not be necessary. See
Section III.C (noting that each Test Group would
remain constant for the duration of the proposed
Pilot with only limited exceptions).
111 The proposed overlap structure, which can be
seen in Test Groups 1(a), 2(a), and 3(a) reflected in
the table below titled ‘‘Proposed Pilot Design of the
Transaction Fee Pilot for NMS Stocks,’’ is
specifically designed to enable comparison between
subgroups within a particular Test Group, as well
as across Test Groups, to identify any differences
between those securities that overlap with the Tick
Size Pilot and those that do not.
112 In addition, conducting both pilots
simultaneously would increase the amount of data
collected while both pilots are active, which may
increase the statistical power of tests of the
marginal impact of transaction fees or rebates or of
different tick sizes. Statistical power refers to the
ability for statistical tests to identify differences
across samples when those differences are indeed
significant.
110 See
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the near term (i.e., that does not overlap
with the Tick Size Pilot’s $3 billion
market capitalization threshold) and
conducting a separate, subsequent
transaction fee pilot for mid- and small
capitalization stocks following the
conclusion of the Tick Size Pilot also
would achieve that objective. However,
the Commission preliminarily believes
that it is preferable to proceed
expeditiously with a broad transaction
fee pilot because the data to be collected
from the proposed Pilot, and the
analyses that will follow, will help
inform the Commission and the public
on the potential impact of transaction
fees and rebates across all segments of
NMS stocks.
Further, the Commission
preliminarily does not believe that
including smaller capitalization stocks
in the proposed Pilot should
disproportionately harm those issuers,
even though it may result in the
reduction or elimination of transactionbased rebate incentives 113 that would
otherwise be used to attract posted
liquidity in those stocks on maker-taker
exchanges, as discussed above.114 While
the proposed Pilot would reduce or
eliminate rebate incentives to transact in
those securities on an exchange for
certain Test Groups, the proposed Pilot
would not impact the ability of an
exchange to maintain a ‘‘protected
quote,’’ which may offset the reduced
rebate incentive and continue to serve
as an incentive to attract liquidity
providers.115 In addition, the proposed
Pilot would reduce exchange
transaction fees for certain Test Groups,
as discussed below, thereby making it
less expensive—and consequently more
attractive—to transact in those securities
on an exchange, which also may offset
the reduced rebate incentive and attract
liquidity providers. Accordingly,
including in the proposed Pilot smaller
capitalization companies that are part of
the Tick Size Pilot will allow the
Commission to collect data in the near
term on the impact of transaction fees
and rebates on NMS stocks, including
smaller capitalization stocks, which
may trade differently than large
113 See supra notes 108–109 and accompanying
text for an explanation of the beneficial aspects of
rebates for mid- and small capitalization securities.
See also Section V.C.2.f infra for a discussion of the
potential impact of subjecting small-capitalization
securities to both the Tick Size Pilot and the
proposed Pilot.
114 See, e.g., EMSAC Pilot Recommendation,
supra note 28, at 1 (noting that there may not be
‘‘any certain or predetermined outcomes from the
pilot, and the net effect of many counterbalancing
factors are not believed to be significantly beneficial
or detrimental to any single group.’’).
115 The Commission has a variety of mechanisms
to address issues that may arise under the Pilot. See
15 U.S.C. 78mm.
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capitalization stocks and thus may be
affected differently by changes to
transaction fees and rebates.
The Commission requests comment
on the securities to be included in the
proposed Pilot. In particular, the
Commission solicits comment on the
following. To the extent possible, please
provide specific data, analyses, or
studies for support.
5. Is the proposed sample size of
securities for the proposed Pilot
reasonable? If not, what other selection
criteria should be used? What changes
should the Commission consider to
inclusion or exclusion from the sample
set? Should the Commission include a
narrower or broader universe of
securities? In particular, should only
common stocks and ETPs be included in
the proposed Pilot and should other
types of NMS stocks, like rights and
warrants, be excluded from the Pilot?
Why or why not? Is the proposed
selection method for the Pilot
reasonable?
6. Is the inclusion of ETPs
appropriate? Does the proposed Pilot
design account for relevant distinctions
between ETPs and other stocks? Should
the proposed Pilot exclude ETPs that are
not ETFs?
7. If the Commission excludes ETPs
from the proposed Pilot, what would be
the effects on the quality and extent of
data? How would this impact the study?
8. Should other types of securities be
included, such as options? Should
certain securities be excluded? Why or
why not?
9. If the timing of the proposed Pilot
appears likely to coincide with the Tick
Size Pilot, would it be reasonable to
proceed simultaneously with the
proposed Pilot? Why or why not? To the
extent that there is no overlap between
the proposed Pilot and the Tick Size
Pilot, the Commission would not retain
the overlap design. Do commenters
agree with this approach?
10. Is the initial $2 per share
threshold reasonable? Why or why not?
Is there another level at which this
threshold should be set?
11. Is the $1 per share minimum
continuing price threshold reasonable?
Why or why not? Is there another level
at which this threshold should be set?
12. Should the Commission require a
minimum market capitalization? If so,
what should be the threshold? What
would be the impacts of this revised
market capitalization threshold?
13. Should the Commission require a
minimum trading volume for NMS
stocks in the proposed Pilot?
14. What are the likely effects of the
proposed Pilot on issuers and capital
formation? In particular, are different
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types of issuers likely to be affected in
different ways by the proposed Pilot,
and, if so, how?
15. Should issuers be allowed to opt
out of the proposed Pilot or would
allowing issuers to opt out adversely
affect the proposed Pilot? If so, how?
What would be the impact on the extent
and quality of the data? For example,
could it reduce the representativeness of
the results obtained from the Pilot,
particularly if those issuers that opt out
are predominantly one type of issuer
(e.g., small or mid-capitalization
issuers)? If issuers were allowed to opt
out, should only certain types of issuers
be allowed to opt out, e.g., smallcapitalization stocks or stocks with low
levels of liquidity? How should the
Commission consider the benefits and
costs on the overall Pilot? How should
the costs to issuers and shareholders be
measured?
C. Proposed Pilot Design
Pursuant to proposed Rule 610T(b)(1),
the Commission would designate by
notice the initial List of Pilot Securities.
That list would place each NMS stock
that meets the initial criteria to be a
Pilot Security into one of the three
proposed Test Groups or into the
Control Group. Each of the three Test
Groups would be selected through
stratified sampling by market
capitalization, share price, and
liquidity.116 The composition of each
Test Group would remain constant for
the duration of the proposed Pilot,
except that the exchanges would update
this information, as described below, to
reflect changes to the composition of the
groups caused by mergers, delistings, or
removal from a Test Group due to the
share price of a stock closing below $1.
Each Test Group would contain 1,000
NMS stocks, with the remainder of
eligible NMS stocks to be included in
the Control Group. If the proposed
Transaction Fee Pilot is adopted and
commences before the end of the Tick
Size Pilot, the selection of the common
stocks for the Transaction Fee Pilot Test
Groups would take into consideration
the common stocks in the Tick Size
Pilot.117 If the two pilots would not
116 Stratified sampling refers to selecting stocks
for each Test Group and the Control Group
according to predefined criteria. As proposed, the
predefined criteria would result in each Test Group
and the Control Group containing a group of stocks
that, as a group, reflect a similar distribution of
market capitalization, share price, and liquidity. For
example, when stratifying stocks on the basis of
liquidity, each Test Group and the Control Group
would have a similar distribution of high, moderate,
and low liquidity securities.
117 Specifically, if the two pilots would overlap,
then each of the proposed Transaction Fee Pilot’s
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overlap at all because the Tick Size Pilot
ends before the proposed Pilot (if
adopted) commences, then the overlap
design of dividing each group into two
subgroups would not be necessary and
each Test Group would simply contain
1,000 NMS stocks without subgroups.
The Commission preliminarily
believes that this design would be
representative of the size of the overall
population of NMS stocks and would
provide sufficient statistical power to
identify differences among the Test
sradovich on DSK3GMQ082PROD with PROPOSALS2
three Test Groups would be divided into two
subgroups—one that overlaps with the Tick Size
Pilot and one that does not overlap. The subgroups
that overlap with the Tick Size Pilot would each
contain 270 NMS stocks (45 stocks would be
selected from each of the three Tick Size Pilot test
groups (45 stocks × 3 Tick Size Pilot groups = 135
total), with the remaining 135 stocks coming from
the Tick Size Pilot’s control group, for a total of 270
common stocks). The subgroups that do not overlap
with the Tick Size Pilot would each contain 730
NMS stocks: 150 large-capitalization common
stocks, 100 small- and mid-capitalization stocks
that do not overlap with the Tick Size Pilot, 260
ETPs, and 220 other NMS stocks. For purposes of
the proposed Pilot, large-capitalization common
stocks would be common stocks with market
capitalizations above $3 billion and conversely,
small- and mid-capitalization common stocks
would be those with market capitalizations of $3
billion or less. See Section III.B supra for discussion
regarding including securities with market
capitalizations above, as well as below, $3 billion
in the proposed Pilot. See also proposed Rule
610T(b)(2)(ii)(D) (containing fields for certain types
of NMS stocks that would be included in the
proposed Pilot). The Commission would select
stocks from the pool of securities eligible for the
Tick Size Pilot in the same manner as it selects the
stocks that would not overlap with the Tick Size
Pilot.
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Groups with respect to common stocks
and ETPs.118 This selection
methodology for the Pilot Securities is
intended to help ensure that the
proposed Transaction Fee Pilot Test
Groups would be similar in composition
to each other and to the Control Group,
as well as to the composition of the Tick
Size Pilot test groups. This proposed
design would reduce the likelihood that
the proposed Transaction Fee Pilot
would cause data issues for the study of
the Tick Size Pilot and vice versa.119
While the EMSAC limited its
recommendation by proposing test
groups modeled on the current
regulatory structure reflected in Rule
610(c), the Commission instead has
preliminarily determined to more
broadly study the impact of all
transaction fees on order routing
behavior, execution quality, and market
quality.120 Including all equities
118 See supra note 112 (defining ‘‘statistical
power’’). The Commission preliminarily believes
that any reduction in the number of NMS stocks in
any particular group could provide less statistical
power and thereby affect the conclusions of the
Pilot.
119 See Section V.C.1.a.i.A infra. The proposed
design ensures that similar proportions of stocks
impacted by the Tick Size Pilot would be included
in each Test Group of the Transaction Fee Pilot,
such that any Tick Size Pilot effects would be
uniform across the proposed Pilot. Researchers
would therefore be able to control for those effects
and minimize any data distortion.
120 The Commission notes that one of the goals of
Rule 610(c) was to support the integrity of the price
protection requirement established by Rule 611 of
Regulation NMS. See NMS Adopting Release, supra
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exchanges in the proposed Pilot, even
those with taker-maker fee models,
would ensure that the Pilot will collect
data on all equities markets that are
registered national securities exchanges,
whose fees are all subject to the
requirements of the Exchange Act and
the rule filing requirements thereunder,
thus treating equally all similarly
situated entities.
In addition, as is the case currently
under Rule 610(c), the proposed Pilot
would permit equities exchanges to
charge varied transaction fees for Pilot
Securities within each Test Group, so
long as such fees comply with the
conditions (including the applicable
cap) set for that group. The Commission
believes that this would allow equities
exchanges to continue to compete for
order flow by adjusting their access fees
within the bounds of the proposed Pilot.
The Commission is proposing to
apply the following pricing restrictions
to Test Groups 1, 2, and 3, and the
Control Group would remain subject to
the current access fee cap in Rule
610(c):
note 1, at 37503 (‘‘Finally and most importantly, the
fee limitation of Rule 610 is necessary to support
the integrity of the price protection requirement
established by the adopted Order Protection Rule.
In the absence of a fee limitation, some ‘outlier’
trading centers might take advantage of the
requirement to protect displayed quotations by
charging exorbitant fees to those required to access
the outlier’s quotations. Rule 610’s fee limitation
precludes the initiation of this business practice,
which would compromise the fairness and
efficiency of the NMS.’’).
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For Pilot Securities in Test Group 1,
equities exchanges could neither
impose, nor permit to be imposed, any
fee or fees for the display of, or
execution against, the displayed best bid
or offer of such market in NMS stocks
that exceeds or accumulates to more
than $0.0015 per share. The cap in Test
Group 1 would apply to transaction fees
assessed on the remover (taker) of
liquidity as well as transaction fees
assessed on the provider (maker) of
liquidity.121
121 In other words, the fee cap in Test Group 1
would apply the cap to the take fee charged to the
taker on a maker-taker exchange and also would
apply the cap to the make fee charged to the maker
on a taker-maker exchange.
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The EMSAC recommended three test
groups, with fee caps of $0.0020,
$0.0010, and $0.0002, respectively. The
Commission also is proposing three test
groups, two with fee caps of $0.0015
and $0.0005, and one that prohibits
rebates and Linked Pricing. The
Commission preliminarily believes that
it is appropriate to test an intermediate
reduction in the fee cap. However,
because the proposed Pilot includes a
no-rebate bucket, the Commission
preliminary believes it is preferable to
test a cap, set at half of the current
$0.0030 cap, rather than two
intermediate caps as EMSAC
recommended. This approach will allow
the proposed Pilot to test more
pronounced changes to the status quo
without increasing the total number of
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Test Groups. Accordingly, as discussed
below, in addition to the $0.0015 test
group, the proposed Pilot also includes
a test group of $0.0005 (as proposed
Test Group 2) as well as a no-rebate
bucket (which EMSAC did not
recommend).122 The Commission
preliminarily believes that having a total
of three Test Groups would allow the
proposed Pilot to test several different
scenarios while avoiding
overcomplicating the Pilot and would
represent a pilot design with which the
exchanges are familiar because it aligns
122 See infra Section III.C.2 (discussing proposed
Test Group 2) and Section III.C.3 (discussing
proposed Test Group 3).
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with the Tick Size Pilot’s three test
groups.123
Finally, the EMSAC’s proposed first
group would have applied its cap only
to fees assessed for removing liquidity,
which is consistent with the application
of Rule 610(c)’s fee cap.124 As discussed
above, the Commission instead is
proposing to apply Test Group 1’s cap
to fees assessed for removing or posting
liquidity. In other words, as discussed
above, the proposed cap in Test Group
1 would apply to maker-taker pricing as
well as taker-maker pricing, which some
comments submitted in response to the
EMSAC’s recommendation supported.
The Commission preliminarily believes
that applying the cap in Test Group 1 to
any fees assessed—including to fees for
providing liquidity in a taker-maker
pricing model—would help achieve the
purpose of the proposed Pilot by
applying the test conditions broadly to
all equities exchange transaction fees
and not just fees for accessing a
protected quotation.
2. Test Group 2
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For Pilot Securities in Test Group 2,
equities exchanges could neither
impose, nor permit to be imposed, any
fee or fees for the display of, or
execution against, the displayed best bid
or offer of such market that exceed or
accumulate to more than $0.0005 per
share. The cap in Test Group 2 would
apply to transaction fees assessed on the
remover (taker) of liquidity as well as
transaction fees assessed on the
provider (maker) of liquidity.125
The level of the Commission’s
proposed cap for Test Group 2 is
intended to introduce a materially lower
cap than Test Group 1 to further reduce
the potential distortion created by
current levels of rebates, while
continuing to permit, for the
preponderance of exchange transaction
volume, the ability of an exchange to
maintain its net profit on a
transaction.126 Specifically, Test Group
123 Maintaining three test groups for the proposed
Pilot would allow it to align closely with the Tick
Size Pilot’s three test groups, with which the
exchanges are familiar. In addition, the proposed
Test Groups have been designed to account for
overlap between the two pilots and control for the
potential that such overlap could possibly affect the
results of the Pilot. See supra Section III.B.
124 See supra note 76 and accompanying text
(noting that the Rule 610(c) access fee cap only caps
fees for removing a protected quotation).
125 In other words, the fee cap in Test Group 2
would apply the cap to the take fee charged to the
taker on a maker-taker equities exchange and also
would apply the cap to the make fee charged to the
maker on a taker-maker equities exchange.
126 For example, if an exchange’s base fee to take
liquidity is $0.0030 and its base rebate to provide
liquidity is $0.0020, the exchange would earn
$0.0010 (net capture rate). The proposed cap for
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2 would prohibit exchanges from
charging more than $0.0005 on one side
of a transaction, which means an
exchange would only have that amount
(or less) to fund the rebate it pays to the
other side of the transaction, unless it
uses other sources of revenue to
subsidize the rebate. Therefore, the
Commission expects that Test Group 2’s
$0.0005 cap would significantly reduce,
if not eliminate, the likelihood that an
exchange would choose to offer rebates
at their current levels for Pilot Securities
in this group, while nevertheless
retaining the ability of exchanges to
compete by offering rebates if they so
choose.127 Accordingly, Test Group 2 is
designed to test the impact of materially
lower rebates and fees, where the
potentially distortive effects of rebates,
and the fees used to fund those rebates,
is greatly reduced and thereby gather
data on the impact of that reduction on
order routing decisions, execution
quality, and market quality.
3. Test Group 3
For Pilot Securities in Test Group 3,
equities exchanges generally would be
prohibited from offering rebates, either
for removing or posting liquidity, and,
as discussed further below, from
offering a discount or incentive on
transaction fee pricing applicable to
removing (providing) liquidity that is
linked to providing (removing)
liquidity. In addition, for the reason
discussed below, Test Group 3 would be
unique in that the prohibition on rebates
would apply not only to displayed topof-book 128 liquidity, but also would
Test Group 2 would allow such an exchange to
maintain its current net capture rate on such
transaction if it charged both sides $0.0005, though
charging both sides of a transaction for Test Group
2 securities would result in a change to the
exchange’s fee model to a ‘‘traditional’’ pricing
structure for those securities. As of December 2017,
Nasdaq’s base take fee was $0.0030 and its base
rebate was $0.0020; NYSE’s base take fee was
$0.0030 and its base rebate was $0.0014; NYSE
Arca’s base take fee was $0.0030 and its base rebate
was $0.0020; and CboeBZX’s base take fee was
$0.0030 and its base rebate was $0.0020. See,
respectively, https://nasdaqtrader.com/
Trader.aspx?id=PriceListTrading2 (Nasdaq), https://
www.nyse.com/markets/nyse/trading-info/fees
(NYSE), https://www.nyse.com/publicdocs/nyse/
markets/nyse-arca/NYSE_Arca_Marketplace_
Fees.pdf (NYSE Arca), and https://
markets.cboe.com/us/equities/membership/fee_
schedule/bzx/ (CboeBZX).
127 For example, a maker-taker equities exchange
might choose to offer a $0.0004 rebate and charge
a fee of $0.0005 for stocks in Test Group 2. In this
way, exchanges could continue to compete with
one another by offering rebates. Compared to
current levels of rebates, which may approach the
level of the current $0.0030 cap, a rebate of $0.0004,
by comparison, would be materially lower.
128 ‘‘Top-of-book’’ means the aggregated best bid
and best offer resting on an exchange; in other
words, aggregate interest that represents the highest
bid (to buy) and the lowest offer (to sell). See 17
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apply to depth-of-book 129 and
undisplayed liquidity.130 In contrast,
Test Groups 1 and 2, like the Rule
610(c) fee cap, only cap fees for the
execution of an order against a
‘‘protected quotation,’’ which is defined
as an exchange’s displayed top-of-book
quote.131 While rebates would be
prohibited in Test Group 3, transaction
fees for securities in Test Group 3 would
remain subject to the current $0.0030
access fee cap in Rule 610(c) for
accessing a protected quotation.132
While the EMSAC considered
recommending a zero-rebate bucket, its
recommendation ultimately did not
contain such a component.133 Several
commenters argued, however, that a
pilot should either ban rebates
altogether or include a ‘‘no-rebate’’ test
bucket.134 In light of the current debate
surrounding transaction fees and the
particular attention paid to the potential
conflict of interest presented by the
payment of transaction-based rebates,
the Commission believes that the
proposed Pilot would be substantially
more informative with a no-rebate
bucket than a pilot without one, because
the no-rebate bucket would allow the
proposed Pilot to gather data to test the
effects of an outright prohibition on
transaction-based rebates. Specifically,
if rebates create a conflict of interest for
broker-dealers when they decide where
to route an order to post or take
liquidity, and if those conflicts have an
effect on order routing behavior,
execution quality, or market quality,
then only a complete prohibition on
rebates will allow the Commission to
study directly these conflicts and their
effects by observing what would happen
in the absence of rebates. While Test
Group 2’s low cap should reduce the
CFR 242.600(b)(7) (defining ‘‘best bid’’ and ‘‘best
offer’’).
129 ‘‘Depth-of-book’’ refers to all resting bids and
offers other than the best bid and best offer; in other
words, all orders to buy at all price levels less
aggressive than the highest priced bid (to buy) or
all offers to sell at all price levels less aggressive
than the lowest priced offer (to sell). See 17 CFR
242.600(b)(8) (defining ‘‘bid’’ and ‘‘offer’’).
130 ‘‘Undisplayed’’ refers to resting orders that are
‘‘hidden’’ and not displayed publicly in the
consolidated market data. See 17 CFR
242.600(b)(13) (defining ‘‘consolidated display’’ and
(b)(60) (defining ‘‘published bid and published
offer’’). See also infra notes 136–139 and
accompanying text.
131 See 17 CFR 242.600(b)(58) (defining
‘‘protected quotation’’).
132 In other words, Test Group 3 would prohibit
rebates for both posting and taking liquidity, but
would remain subject to Rule 610(c), which caps
fees for taking liquidity. Test Group 3 would not
cap fees for posting liquidity.
133 See EMSAC Pilot Recommendation, supra
note 28, at 4. The EMSAC acknowledged that
‘‘[c]apping inducements is not an existing
component of our market structure.’’ Id.
134 See supra note 48.
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likelihood that a market will offer a
material rebate because the cap would
limit the market’s ability to offset the
rebate by charging a slightly higher fee
to the other side of the transaction, the
possibility exists that rebates would
nevertheless continue to be offered in
Test Group 2. The Commission
preliminarily believes that to gather data
to study potential conflicts of interest
presented by the payment of rebates and
the effects they may have on order
routing behavior, execution quality, and
market quality, it is necessary for the
proposed Pilot to establish a test group
that entirely prohibits the payment of
transaction-based rebates—which some
believe drive distortions of those
items.135 At the same time, Test Group
3 would not further restrict the ability
of equities exchanges to charge for
transaction services. By prohibiting all
rebates, but not lowering the existing
Rule 610(c) fee cap for Pilot Securities
in Test Group 3, equities exchanges
would no longer need to charge
transaction fees at levels priced to offset
the rebates they pay, while at the same
time they would retain the ability to
charge transaction fees as high as the
current $0.0030 cap. Accordingly, Test
Group 3 is intended to test, within the
current regulatory structure, natural
equilibrium pricing for transaction fees
in an environment where all rebates are
prohibited and exchanges do not need
to charge offsetting transaction fees on
the contra-side to subsidize those
rebates.
As proposed, Test Group 3 would
prohibit payment of transaction-based
rebates broadly for both posting and
removing liquidity. In this respect, the
Commission notes that Rule 610(c)’s
access fee caps do not currently apply
to non-displayed liquidity and depth-ofbook quotes, and exchange fee
schedules typically do not impose
differing fees based on those
parameters.136 The EMSAC noted a
135 See, e.g., supra notes 21 (discussing the
potential distortions caused by the conflicts of
interest faced by broker-dealers in light of
conflicting economic incentives to earn rebates,
which typically are not passed through by the
broker-dealer to its customers, from the trading
centers to which they direct orders for execution);
23 (discussing potential distortions of unnecessary
market complexity through the proliferation of
exchange order types and new exchanges, the
incentive to trade off-exchange to avoid high fees,
and the indirect ability to quote in sub-penny
increments on a net basis); and 106 (discussing
potential distortions caused by the high fees that
offset rebates, which can undermine price
transparency because a quote at the same displayed
price on different exchanges (with different fees)
does not reflect the actual net price to trade on any
one trading center).
136 Three equities exchanges do impose differing
fees for certain orders based on whether the order
is displayed or non-displayed, including: (1) IEX,
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theoretical possibility that lower access
fee caps could create an incentive for
SROs to begin charging more to access
non-displayed interest or depth-of-book
quotes. However, such differing fees
would lead to uncertainty for market
participants that remove liquidity as
they would not be able to control with
absolute certainty whether they interact
with such interest.137 The Commission
preliminarily believes that the prospect
of market participant objections to the
uncertainty regarding what they would
expect to pay to remove liquidity would
make this outcome highly unlikely.
However, in Test Group 3, the
possibility of an exchange continuing to
offer rebates for non-displayed and
depth-of-book quotes, while eliminating
them on displayed interest, could have
the potential to distort the Pilot results
to the extent that stocks in Test Group
3 remained subject to the potential
conflicts of interest associated with
rebates on non-displayed and depth-ofbook quotes.138 Accordingly, to avoid
which incentivizes displayed liquidity by charging
a lower transaction fee of $0.0003 for posting or
taking displayed interest and imposes a higher fee
of $0.0009 per share to post or take non-displayed
liquidity; (2) NYSE American, which incentivizes
posting of displayed liquidity and imposes a
standard fee of $0.0002 per share to remove
liquidity or post non-displayed liquidity, though it
does offer rebates to eDMMs; and (3) Cboe EDGA,
which encourages non-displayed liquidity by not
charging transaction fees for posting non-displayed
liquidity and charging a low fee to take nondisplayed interest, but imposes its standard fee on
posting or removing displayed liquidity. See
Investors Exchange Fee Schedule, available at
https://iextrading.com/trading/fees/; NYSE
American Fee Schedule, available at https://
www.nyse.com/publicdocs/nyse/markets/nyseamerican/NYSE_America_Equities_Price_List.pdf;
and Cboe EDGA Exchange Fee Schedule, available
at https://markets.cboe.com/us/equities/
membership/fee_schedule/edga/. While these
exchanges impose differing fees depending on the
displayed nature of interest, none pay rebates
uniquely for non-displayed orders or depth-of-book
interest, and therefore would not be impacted by
the application of Test Group 3’s prohibition on the
payment of rebates to all interest, including nondisplayed liquidity and depth-of-book quotes.
137 For example, a liquidity taker’s order could
interact with displayed or non-displayed liquidity
(or both). If fees differed between them, market
participants would face uncertainty when making
routing decisions over what transaction fees they
would incur.
138 For example, a market participant seeking to
take liquidity may have an incentive to route to a
taker-maker market that offered rebates for
executing against non-displayed interest if the
market participant expected to trade both with the
full amount of displayed interest and also with nondisplayed interest (and thus collect a rebate from
interacting with the latter). Alternatively, a liquidity
provider could have an incentive to route to a
maker-taker market that offered rebates on nondisplayed interest if the participant was able to use
certain order types to ensure that its order remained
non-displayed and executed only as ‘‘poster’’ to
earn a rebate. For example, the provider could use
a post-only order instruction to ensure that it never
takes liquidity (and thus gets assessed a fee) and
combine that with an instruction to prevent the
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13023
any potential distortion from a
narrowly-tailored ‘‘no rebate’’ bucket
that was subject to exceptions and
permitted rebates to continue to be
offered on certain interest, the
Commission preliminarily believes it is
necessary to outright prohibit payment
of any and all rebates in Test Group 3,
including non-displayed liquidity and
depth-of-book interest. Doing so will
permit the Commission to gather data
on a ‘‘no rebate’’ environment, thereby
allowing the Commission to observe
directly the impact of rebates on order
routing behavior, execution quality, and
market quality by observing an
environment where transaction-based
rebates are not offered and comparing
that to the control group where rebates
continue to be offered. In turn, this data
may inform the Commission about the
extent to which rebates offered by
equities markets are compatible with
broker-dealers executing their
customers’ orders in the best market.139
Finally, in addition to prohibiting
rebates, Test Group 3 also would
prohibit exchanges from offering a
discount or incentive on transaction fee
pricing applicable to removing
(providing) liquidity on the exchange
that is linked to providing (removing)
liquidity on the exchange (‘‘Linked
Pricing’’). For example, for Pilot
Securities in Test Group 3, an exchange
would be prohibited from adopting any
discounts on transaction fees to remove
(i.e., ‘‘take’’) liquidity where that
discount is determined based on the
broker-dealer’s posted (i.e., ‘‘make’’)
volume on the exchange, which would
result in the broker-dealer paying a
lower take fee in return for providing a
certain level of liquidity on the
exchange. However, as discussed further
below, exchanges would not be
prohibited from adopting new rules to
provide non-rebate Linked Pricing to
their registered market makers if the
non-rebate discount or incentive is in
consideration for meeting market
quality metrics specified in an exchange
rule.
Prohibiting Linked Pricing for Test
Group 3 is designed to support the
objectives of that Test Group.
Specifically, in Test Group 3, the
Commission is seeking to obtain
information about what would happen
in the absence of the incentive created
by offering rebates and the potential
conflicts of interest they can present,
including what would happen to fee
order from becoming displayed. In either of these
two examples, the market could continue to offer
an incentive to earn a rebate on, or by interacting
with, non-displayed liquidity, which could distort
the results of the proposed Pilot.
139 See 15 U.S.C. 78k–1(a)(1)(C)(iv).
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levels if they no longer subsidize those
rebates. For example, if ‘‘taker’’
transaction fees no longer are used to
fund ‘‘maker’’ rebates, an exchange’s
taker fee would no longer be subject to
that potential distortion and could be
set at an equilibrium level in response
to competition, which could put
downward pressure on ‘‘taker’’
transaction fees. Accordingly, Test
Group 3 is designed to gather data on
the impact of creating an environment
where fee levels are not potentially
distorted by rebates and rebates do not
influence routing.
In support of creating such an
environment for Test Group 3,
exchanges also would be prohibited
from introducing new Linked Pricing
models that could possibly perpetuate
similar potential distortions that makertaker and taker-maker pricing models
may impose on transaction fees. For
example, if an exchange adopts Linked
Pricing for Test Group 3 securities, it
might offer a discounted transaction fee
to remove liquidity only to those market
participants that post a certain volume
on the exchange. In effect, offering
Linked Pricing to market participants in
Test Group 3 without first requiring
them to meet market quality metrics
designed to benefit the overall market
could continue to potentially distort
transaction fee pricing if the fees are set
at a level above their natural
equilibrium, within the current
regulatory structure, in order to
subsidize the Linked Pricing incentive,
and also could perpetuate the potential
conflicts of interest associated with
rebates and order routing.
If, instead of paying rebates,
exchanges seek to provide a discount or
incentive on transaction fee pricing
applicable to removing (providing)
liquidity that is linked to providing
(removing) liquidity, then equilibrium
pricing may not be achieved to the
extent that transaction fees are linked in
this way. In turn, perpetuating this
potential distortion could cloud the
Pilot data for Test Group 3 if the Linked
Pricing incentive interferes with the
proposed Pilot’s ability to isolate and
analyze the impacts—on both the maker
rebate (fee) and the taker fee (rebate)—
of eliminating rebates in Test Group 3.
Accordingly, the Commission
preliminarily believes that prohibiting
exchanges from offering not only rebates
but also Linked Pricing in Test Group 3
is appropriate to maintain the integrity
of Test Group 3 and would facilitate
analysis of securities in Test Group 3
consistent with its objective to test the
impact of eliminating rebates and the
potential distortions that rebates may
cause.
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While rebates and Linked Pricing
would be prohibited broadly for Test
Group 3, the Commission proposes to
permit an exchange to adopt new rules
to provide non-rebate Linked Pricing to
its registered market makers during the
proposed Pilot in consideration for
meeting market quality metrics.140
Exchanges have an interest in offering
incentives to attract broker-dealers to
become registered market makers on the
exchange and commit to meet market
making standards specified in exchange
rules so that the exchange can, in turn,
use the liquidity provided by its
registered market makers to attract
buyers and sellers to the exchange. The
Commission preliminarily believes that
permitting exchanges to adopt new rules
to offer Linked Pricing to market makers
for Test Group 3 securities preserves the
ability of an exchange to attract market
makers through non-rebate incentives
and thereby helps maintain the baseline
framework for registered market makers
against which the effects of the
proposed Pilot would be assessed.
4. Control Group
NMS stocks selected as Pilot
Securities that are not placed in one of
the three proposed Test Groups would
be placed in the Control Group, which
would be approximately the same size
as each of the other three Test Groups
combined and have a similar
composition.141 Transaction fees for
Pilot Securities in the Control Group
would remain subject to the current
Rule 610(c) access fee cap. Consistent
with Rule 610(c), the Control Group
would only cap fees for taking
(removing) a protected quotation; it
would not apply to fees for posting
liquidity or otherwise cap or prohibit
rebates. The Commission preliminarily
believes that having a control group is
vital to test the effects of lower
transaction fees in the proposed Test
140 To adopt Linked Pricing for Pilot Securities in
Test Group 3 during the proposed Pilot, an
exchange would need to propose new market
making standards in a proposed rule change filing
submitted pursuant to Section 19(b)(2) of the
Exchange Act, and also would need to propose the
fee incentive it would provide for meeting those
standards. For example, an exchange may establish
a specified minimum quote size combined with a
requirement to be at the national best bid and offer
for a designated percentage of the day. In return for
meeting those continuous quoting requirements, the
exchange might offer its registered market makers
a fee discount to remove liquidity.
141 NMS stocks (including ETPs) placed in the
Control Group must meet the same selection criteria
as those NMS stocks placed in Test Groups 1, 2, and
3 (e.g., the NMS stock must have a share price of
at least $2 at the time of selection, must maintain
a share price of at least $1 per share to remain in
the proposed Pilot, and must have an unlimited
duration or a duration beyond the end of the postPilot Period).
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Groups and that a control group with
the current access fee cap would
provide an appropriate baseline for
analyzing the effect of the proposed
Pilot.
In sum, the Commission preliminarily
believes that the proposed size and
composition of each of the three Test
Groups is appropriate to ensure
representativeness of the samples as
well as sufficient statistical power
across the Control and three Test
Groups and therefore will produce a
robust sample size for analysis that
would allow the Commission and the
public to reliably examine, compare,
and assess the effects of differing
transaction fees and rebates to inform
future regulatory initiatives in this area.
Further, the Commission preliminarily
believes that the proposed Pilot design
is appropriately tailored to account for
potential overlap with the Tick Size
Pilot.
The Commission requests comment
on the design of the proposed Pilot. In
particular, the Commission solicits
comment on the following. To the
extent possible, please provide specific
data, analyses, or studies for support.
16. Is the proposed Pilot reasonably
designed to evaluate the effect of
transaction fees on order routing
behavior, execution quality, and market
quality? Why or why not? Should the
Commission implement an alternative
design, and if so, what should it be?
What would be the impacts of the
alternative design?
17. Are the $0.0015 and $0.0005 fee
cap levels reasonable? Should the
Commission use different caps, for
example $0.0002 or $0.0009 for Test
Group 2? Should the Commission use
the caps suggested by EMSAC (i.e.,
$0.0020, $0.0010, and $0.0002)?
18. Rather than cap fees for Test
Groups 1 and 2, should the pilot instead
focus those Test Groups on rebate
restrictions? If so, what restrictions and
caps should the Commission impose?
19. Are the proposed restrictions in
Test Group 3 on rebates and Linked
Pricing reasonable? Why or why not? Is
the proposed language in Rule 610T(a)
clear? For example, is the phrase
‘‘impose, or permit to be imposed’’
sufficiently clear? If not, what
alternative language should the
Commission use?
20. If volume or liquidity changed for
the Pilot Securities in Test Group 3,
how, if at all, would such changes
impact institutional traders? What
volume or liquidity would be impactful?
What would be the impact? For
example, if fewer liquidity providers
post orders in Test Group 3 Pilot
Securities because there is no rebate for
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them to earn, would institutional traders
be more likely to obtain queue priority?
Why or why not?
21. If the Pilot data reveals an impact
on quoted prices in Test Group 3 where,
in the absence of rebates, spreads widen
for a certain segment of stocks and ETPs
(e.g., those that are moderately liquid),
but not others (e.g., those that are highly
liquid or those that are highly illiquid),
how should the Commission evaluate
that impact?
22. Is maintaining the current fee cap
of $0.0030 reasonable for Test Group 3,
or should the Commission not subject
Test Group 3 to the current fee cap in
Rule 610(c)? Why or why not? Should
the Commission cap fees for Test Group
3 using a different amount?
23. For securities in Test Group 3,
where rebates would not be permitted,
will competition and market forces
produce a market equilibrium that
constrains exchange access fees to levels
at or below today’s current pricing?
What do commenters consider to be a
reasonable level for exchange
transaction fees? If equilibrium
transaction fee pricing is achieved,
would such forces obviate the need for
a fee cap at all? Or would a cap on
exchange access fees continue to be
necessary to constrain exchange pricing
as long as Rule 611 of Regulation NMS
imposes order protection requirements
applicable to exchanges with protected
quotations?
24. Should one or more of the Test
Groups eliminate protected quotation
status, and thus the order protection
requirements of Regulation NMS, for
certain securities? Would doing so
provide helpful insights into order
routing? Why or why not?
25. If analysis of the proposed Pilot
data were to suggest that rebates offered
by maker-taker exchanges do not affect
quoted spreads or contribute to market
quality or execution quality for the most
actively traded NMS stocks, do
commenters believe that the minimum
trading increment for those most
actively traded stocks should be
reduced, for example, to a half-penny?
Why?
26. Would there be a sufficient
number of stocks and ETPs in each Test
Group? Why or why not? Or would
fewer stocks and ETPs in each Test
Group be capable of providing
statistically significant data? If so, how
many stocks and ETPs should be
included in each Test Group? How
would the quality and extent of the data
be affected?
27. Should the proposed Pilot overlap
with the Tick Size Pilot? If so, does the
proposed Pilot design adequately
account for potential overlap with the
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Tick Size Pilot? Why or why not? What
are the potential impacts of such
overlap for equities exchanges, issuers,
and other market participants? How
could the Commission better design the
proposed Pilot to deal with any overlap
between the two pilots?
28. Should Test Group 3’s prohibition
on rebates and Linked Pricing apply to
depth-of-book and undisplayed
liquidity? Why or why not? Should the
fee caps in the other Test Groups also
apply to depth-of-book and undisplayed
liquidity? Why or why not?
29. Should the proposed Pilot include
a ‘‘trade-at’’ provision that would
restrict price matching of protected
quotations? Why or why not? How
would a ‘‘trade-at’’ component affect the
data generated by the proposed Pilot?
Should the Commission consider an
alternative methodology to evaluate
‘‘trade at’’?
30. Is the proposed Pilot design
subject to any particular limitations
with respect to achieving the objectives
of the Pilot? Of what kind? How could
the proposed Pilot design be improved
to prevent such limitations?
31. Should an equities exchange be
able to offer rebates in Test Group 1 or
2 in excess of the fees it charges to the
contra-side of an execution? For
example, should the proposed Pilot
prohibit equities exchanges from
offering rebates in excess of $0.0015 in
Test Group 1 or $0.0005 in Test Group
2? Why or why not?
32. Would increasing transparency for
customers into broker-dealer business
models and/or trading practices
(including, for example, transparency
regarding broker-dealer revenue
streams, order routing practices, or other
matters) be a more effective way of
addressing potential broker-dealer
conflicts of interest arising from access
fees and rebates?
D. Duration
The Commission is proposing a twoyear term for the proposed Pilot, with an
automatic sunset at the end of the first
year unless, prior to that time, the
Commission publishes a notice
determining that the Pilot shall continue
for up to another year. In addition, as
discussed below, the Commission is
proposing a six-month pre-Pilot Period
as well as a six-month post-Pilot Period.
The Commission preliminarily believes
this approach will give the Commission
flexibility and help ensure its ability to
gather sufficient data to reliably analyze
the Pilot’s impact on order routing
behavior, execution quality, and market
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13025
quality.142 The Commission believes
that providers and takers of liquidity
need time to gain experience with the
different Test Groups, and the proposed
Pilot needs to be long enough to make
it economically worthwhile for market
participants to adapt their behavior.143
The proposed Pilot should continue to
collect data over a sufficiently long
period of time that is capable of
providing a sample that would have
adequate statistical power. The
Commission would need to observe
developments during the proposed Pilot
to determine whether to sunset it.
The EMSAC recommended a two-year
duration for a pilot, and the
Commission’s rule incorporates the
possibility of a two-year pilot. The
Commission believes that a two-year
duration, with automatic possible
sunset at the end of the first year is
preferable because it would provide
flexibility as the data from the Pilot
develops. To suspend the automatic
sunset, under proposed Rule 610T(c),
the Commission would publish, no later
than thirty days prior to the sunset date,
a notice on its website and in the
Federal Register. The Commission
could suspend the sunset, for example,
if it believed that additional time would
help ensure that market developments
are fully reflected in the data with
sufficient statistical power for analysis.
The Commission also, for example,
could suspend the sunset if the
Commission believed that a potentially
disruptive event experienced during the
first one-year period counsels in favor of
conducting the proposed Pilot for its
full two-year term. Alternatively, the
Commission could leave the sunset in
142 See EMSAC Pilot Recommendation, supra
note 28, at 2. The EMSAC recommended an initial
three-month phase-in period involving 10 stocks,
after which each Test Group would be expanded to
include the remaining securities in each group. See
id. at 2. While a phase-in period would allow
markets and market participants to implement the
required fee changes in a staged manner and
provide an opportunity to address unforeseen
implementation issues, the Commission believes
that markets and market participants are
accustomed to dealing with transaction fee changes
and therefore should be readily capable of
accommodating the terms of the proposed Pilot
with the advance notice provided by the
Commission’s rulemaking process. Further, though
exchanges would be required to collect and report
certain data, as described below, the proposed Pilot
would not require equities exchanges to make any
changes to any of their trading systems, and
therefore the Commission preliminarily believes a
phased implementation schedule would not be
necessary to test changes to outward facing systems.
143 See, e.g., EMSAC Transcript, July 8, 2016,
available at https://www.sec.gov/spotlight/emsac/
emsac-070816-transcript.txt (comments of Joe
Mecane noting that ‘‘[a]fter further discussion, we
thought two years was the right time frame, because
the behavioral changes that we think that will result
from the pilot program will take . . . some time to
filter through the marketplace.’’).
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place by not publishing a notice if the
one-year period was sufficient to fully
reflect market developments and the
data collected provides adequate
statistical power to analyze those
developments.
While the Commission considered
proposing a shorter period, such as that
recommended by Nasdaq,144 a shorter
duration for the Pilot than the proposal
(i.e., less than one year) may allow
short-term or seasonal events to unduly
impact the Pilot data. For example, if
the proposed Pilot were only six months
long, the Pilot may or may not produce
a sufficiently broad set of data capable
of permitting analysis into potential
conflicts of interest associated with
transaction-based fees and rebates and
the effects that changes to those fees and
rebates have on order routing behavior,
execution quality, and market quality.
Further, as noted above, Commission
is proposing a six-month pre-Pilot
Period as well as a six-month post-Pilot
Period. The pre-Pilot Period is intended
to gather current data to help establish
a baseline against which to assess the
effects of the proposed Pilot. The postPilot Period is intended to help assess
any post-Pilot effects following the
conclusion of the proposed Pilot. For
both the pre- and post-Pilot Periods, the
Commission is proposing to require the
equities exchanges to publicly post on
their websites the same data they would
be required to publicly post for the
proposed Pilot.
Finally, as noted above, Nasdaq,
NYSE, and Cboe have recommended
that the Commission, instead of
proceeding with a proposal for a
transaction fee pilot, first take final
action on two of the Commission’s
proposed rulemakings (disclosure of
order handling information and
regulation of NMS stock Alternative
Trading Systems) and issue additional
guidance on broker-dealers’ duty of best
execution.145 IEX criticized those
recommendations as delaying tactics
motivated by ‘‘commercial
protectionism’’ from exchanges whose
business models are ‘‘completely reliant
on the payment of rebates.’’ 146 The
Commission believes that proceeding
with a pilot in the near term would be
appropriate as it would complement the
Commission’s other market structure
initiatives and would gather data to
inform the Commission and the public
on the impact of equities transaction
144 See
145 See
Nasdaq Letter, supra note 44, at 3.
Joint Exchange Letter, supra note 44, at 2–
146 See
IEX Letter, supra note 44, at 2–3.
4.
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fees and whether additional regulatory
action is needed or appropriate.
The Commission requests comment
on the proposed duration for the
proposed Pilot, including the pre- and
post-Pilot Periods. In particular, the
Commission solicits comment on the
following. To the extent possible, please
provide specific data, analyses, or
studies for support.
33. Is the proposed duration long
enough for the proposed Pilot to
generate data to analyze the impact of
transaction fees? If not, what time
period should be selected? Is a different
time period preferable?
34. Is the provision for an automatic
sunset at the end of the first year unless,
prior to that time, the Commission
publishes a notice determining that the
Pilot shall continue for up to another
year, reasonable? What factors or
conditions would support continuing
the proposed Pilot beyond one year?
35. The EMSAC recommended an
initial three-month phase-in period
involving a limited number of stocks,
after which each test group would be
expanded to include the remaining
securities in each group. As proposed,
the Pilot would not include a phase-in
period. Would such a period be useful?
Why or why not?
36. Are the proposed pre-Pilot and
post-Pilot terms sufficient? Should the
Commission select different lengths, or
gather different data during those
periods? Specifically, instead of a 6
month pre- and post-Pilot Period,
should the Commission adopt a 3, 4, or
5 month pre-Pilot and post-Pilot Period?
Which, if any, of those is the shortest
period that would provide sufficient
statistical power for analysis,
particularly with respect to ETPs? If the
Commission requires at least 6 months
of pre-Pilot Period data, to what extent
could the exchanges access and use
historical data to populate the required
pre-Pilot data described in Section E
below? For example, could exchanges
access 3 months of historical data such
that the pre-Pilot Period could be
structured as a 3 month pre-Pilot Period
combined with 3 months of historical
data immediately preceding that period,
for a total of 6 months of cumulative
pre-Pilot data? How much time would
be necessary for the exchanges to
compile 6 months of historical data?
37. Do commenters believe that the
Commission should, before taking
action on the proposed Pilot, first take
final action on the Commission’s
proposed rulemakings concerning
disclosure of order handling
information and regulation of NMS
stock Alternative Trading Systems, and/
or issue new guidance on broker-
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dealers’ duty of best execution, or do
commenters agree that proceeding with
the proposed Pilot in the near term
would complement the Commission’s
other market structure initiatives?
E. Data
The Commission preliminarily
believes that the following data should
be collected and made publicly
available as described below in order to
facilitate the Commission’s ability to
assess the impact of the proposed Pilot
and, as discussed below, promote
transparency about the Pilot Securities
as well as basic information about
equities exchange fees and changes to
those fees during the Pilot.147
1. Pilot Securities Exchange Lists and
Pilot Securities Change Lists
As discussed above, proposed Rule
610T(b)(1) would require the
Commission to publish on its website a
notice containing the initial List of Pilot
Securities,148 which would identify the
securities in the proposed Pilot and
assign each of them to a designated Test
Group (or the Control Group). While
proposed Rule 610T does not impose a
deadline by which this notice must be
published, the Commission
preliminarily expects that it would
publish this notice approximately one
month prior to the start of the Pilot
Period.
To account for corporate changes
during the proposed Pilot that affect the
Pilot Securities, such as name changes,
mergers, or dissolutions, proposed
paragraph (b) of Rule 610T provides a
process to update and publicly
disseminate information about changes
to the List of Pilot Securities. As
discussed and defined further below,
the Commission is proposing to require
each equities primary listing
exchange 149 to publicly post on its
147 The data and information that is to be made
publicly available would be records of the equities
exchanges and accordingly, would be subject to the
recordkeeping requirements of Rule 17a–1 under
the Exchange Act. See 17 CFR 240.17a–1.
148 Proposed Rule 610T(b)(1)(ii) would define
‘‘Pilot Securities’’ for purposes of Rule 610T as the
NMS stocks designated by the Commission on the
initial List of Pilot Securities pursuant to paragraph
(b)(1)(i) of Rule 610T and any successors to such
NMS stocks. At the time of selection by the
Commission, an NMS stock would be included in
the Pilot only if it has an unlimited duration or a
duration beyond the end of the post-Pilot Period
and a minimum initial share price of at least $2. If
the share price of a Pilot Security in one of the Test
Groups closes below $1 at the end of a trading day,
it would be removed from the Test Group and
would no longer be subject to the pricing
restrictions set forth in (a)(1)–(3) of proposed Rule
610T.
149 Proposed Rule 610T(b)(1)(iii) would define
‘‘primary listing exchange’’ for purposes of Rule
610T as a national securities exchange on which an
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website downloadable files containing a
list of its primary listed securities
included in the proposed Pilot as well
as an updated cumulative list of all
changes to any Pilot Security for which
it serves as the primary listing
market.150 An exchange would have to
include this information on its website
as downloadable files that are freely and
persistently available and easily
accessible by the general public.151 In
addition, the information must be
presented in a manner that facilitates
access by machines without
encumbrance by user name, password,
or other access constraints 152 and the
files and information therein could not
be subject to any usage restrictions, such
as restrictions on access, retrieval,
distribution, and reuse. Requiring the
exchanges to make this information
freely and publicly available with
completely unencumbered access would
facilitate the ability of any person to use
the information to conduct and make
public research and analyses consistent
with the purposes of this Pilot.
The Commission believes that it is
important to maintain an updated list of
Pilot Securities so that market
participants can know with certainty
throughout the duration of the proposed
Pilot the Test Group and/or Control
Group assignments for all Pilot
Securities, thereby avoiding any
confusion over how the proposed Pilot
affects the stocks in which market
participants trade. Further, it is
important to maintain detailed
information on historical changes to
Pilot Securities and their associated Test
Groups and/or Control Group in order to
NMS stock is listed. If an NMS stock is listed on
more than one national securities exchange,
proposed Rule 610T(b)(1)(iii) provides that the
national securities exchange upon which the NMS
stock has been listed the longest shall be the
primary listing exchange.
150 The Commission notes that the primary listing
exchanges maintain public web pages containing
similar lists with respect to the Tick Size Pilot. The
lists for NYSE and NYSE American listed stocks are
available on the NYSE website, available at https://
www.nyse.com/tick-pilot. The lists for Nasdaq listed
stocks are available on the Nasdaq website,
available at https://www.nasdaqtrader.com/
Trader.aspx?id=TickPilot.
151 ‘‘Persistently available’’ means that through
the end of the required five-year post-Pilot retention
period, all data from the Pilot would need to be
continually available on each exchange’s website.
‘‘Accessible’’ means that the Pilot data posted by
each exchange must be able to be indexed by third
party query applications and easily found on each
exchange’s website.
152 Common access constraints may include:
‘‘CAPTCHA’’ (i.e., ‘‘Completely Automated Public
Turing Test to Tell Computer and Humans Apart’’)
constraints, which commonly provide a challengeresponse test to determine whether or not the user
is human and block access to the information by
machines; user name and password access
requirements; user registration requirements; and
limitations on downloads.
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ensure that market participants,
researchers, and the Commission have
ready access to definitive information
on the Pilot Securities, which will assist
the Commission and researchers in
analyzing pilot data and assessing and
accounting for changes to any Pilot
Securities during the duration of the
Pilot, including the post-Pilot Period.
The Commission believes that the
primary listing exchanges, as defined in
proposed Rule 610T(b)(1)(iii), are in the
best position to provide this information
because they oversee their listed issuers
and have rules in place that require
listed issuers to report corporate change
information to them.153 Accordingly,
the primary listing exchanges are made
aware of changes relevant to the
proposed Pilot for the securities listed
on their markets, and therefore are in
the best position to disseminate this
information by making it publicly
available on their websites.
a. Pilot Securities Exchange Lists
As discussed further below, prior to
the beginning of trading on the first day
of the Pilot Period, proposed Rule
610T(b)(2)(i) would require each
national securities exchange that is a
primary listing exchange for equities to
publicly post on its website
downloadable files containing a list, in
pipe-delimited ASCII format,154 of all
securities included in the proposed
Pilot for which the equities exchange
serves as the primary listing exchange
(the ‘‘Pilot Securities Exchange List’’).
Proposed Rule 610T(b)(2)(ii) specifies
153 See NYSE Listed Company Manual Rule
204.18 (Name Change) (requiring listed issuers to
provide notice to NYSE of intended name changes
20 days in advance of the date set for mailing the
shareholders’ proxy materials dealing with the
matter); Nasdaq Listing Rule 5250(e)(3)(A) (Record
Keeping Change) (requiring listed issuers to provide
notice to Nasdaq of name changes no later than 10
days after the change); NYSE Arca Listed Company
Manual Rule 5.3–E(i)(1)(i)(D) (Financial Reports
and Related Notices) (requiring listed issuers to
notify the Exchange of changes in company name);
Cboe BZX Exchange, Inc. Rule 14.6(e)(3)(A) (Record
Keeping Change) (requiring listed issuers to provide
notice to the Exchange of name changes no later
than 10 days after the change); NYSE American
Company Guide Sec. 930 (Change of Name)
(requiring listed issuers to provide advance notice
to the Exchange of intended name changes); IEX
Rule 14.207(e)(3)(A) (Record Keeping Change)
(requiring listed issuers to provide notice to the
Exchange of name changes no later than 10 days
after the change).
154 The Commission understands that the equities
exchanges and market participants have experience
utilizing this common file format and will be able
to create and make use of lists of Pilot Securities
in pipe-delimited ASCII format (also referred to as
a ‘‘text’’ file) without difficulty. In particular, the
exchanges use this format in the Tick Size Pilot. See
Tick Size Pilot Data Collection Securities Files,
available at https://www.finra.org/industry/oats/ticksize-pilot-data-collection-securities-files (noting that
‘‘[t]he Pilot Securities files are pipe-delimited .txt
files.’’).
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the required fields for the Pilot
Securities Exchange Lists, which are:
Ticker symbol, security name, primary
listing exchange, security type (common
stock, ETP, preferred stock, warrant,
closed-end fund, structured product,
ADR, or other), Test Group (1, 2, 3 or
Control Group), as well as the date the
entry was last updated. The
Commission preliminarily believes that
this list would contain the essential
identifying information necessary to
inform market participants and the
public about the securities included in
the proposed Pilot, and the security type
field would permit the Commission and
researchers to easily identify subsets of
NMS stocks so they can be analyzed
separately.
Each primary listing exchange would
be responsible for keeping current its
Pilot Securities Exchange List to reflect
any changes. Specifically, proposed
Rule 610T(b)(2)(i) would require the
primary listing exchanges to maintain
and update their Pilot Security
Exchange List, as necessary, prior to the
beginning of trading on each business
day that the U.S. equities markets are
open for trading (also referred to herein
as a ‘‘trading day’’). If a change occurs
that alters any of the fields required by
Rule 610T(b)(2)(ii), such as ticker
symbol, security name, or Test Group,
the primary listing exchange for that
Pilot Security must update its Pilot
Securities Exchange List prior to the
beginning of trading on the first trading
day for which such change is effective.
The primary listing exchanges would be
required to continue to update the Pilot
Securities Exchange Lists, as necessary,
through to the conclusion of the postPilot Period.
b. Pilot Securities Change Lists
In addition, proposed Rule
610T(b)(3)(i) would require each
equities primary listing exchange to
maintain and publicly post on its
website downloadable files containing a
list, in pipe-delimited ASCII format, of
each separate change applicable to any
Pilot Securities for which that primary
listing exchange serves or, during the
course of the Pilot, has served as the
primary listing exchange (the ‘‘Pilot
Securities Change List’’). Proposed Rule
610T(b)(3)(ii) specifies the required
fields for the Pilot Securities Change
List, which, in addition to the fields
required for the Pilot Securities
Exchange List, are: New ticker symbol
(if applicable); new security name (if
applicable); deleted date (if applicable);
date the security closed below $1 (if
applicable); effective date of the change;
and reason for change. The list would be
updated by the primary listing exchange
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to include all changes since the
inception of the Pilot, for the Pilot
Securities listed on the exchange.
Examples of changes that would appear
on this list include name changes, ticker
symbol changes, mergers, delistings, or
removal from a Test Group due to the
share price of a stock closing below $1.
Each primary listing exchange would be
required to update and post its Pilot
Securities Change List prior to the
beginning of trading on each trading day
the U.S. equities markets are open for
trading and keep it current through the
end of the post-Pilot Period. The Pilot
Securities Change List is designed to
serve as a cumulative list that provides
ready access to all changes to Pilot
Securities listed on a particular equities
exchange that have occurred subsequent
to a primary listing exchange posting its
initial Pilot Securities Exchange List on
its website.
The Commission believes that market
participants and the public would
benefit from having access to accurate
and up-to-date information on the Pilot
Securities and their classification in a
particular Test Group or Control Group
during the Pilot. As it is possible that
changes to some of the Pilot Securities
may occur over the course of the
proposed Pilot, information about those
changes could be useful to brokerdealers and other market participants
when making routing and execution
decisions. Accordingly, the Commission
believes it is important for there to be
ready access to relevant updates that
impact the Pilot Securities Exchange
Lists. Because the primary listing
exchanges currently track corporate
actions that affect their listed issuers,
the Commission believes they are best
positioned to disseminate information
about those changes as they apply to the
securities listed on their markets by
making it publicly available on their
respective websites.
Further, having access to an updated,
cumulative list reflecting all changes to
the Pilot Securities will assist the
Commission and researchers in
analyzing the Pilot data. In particular,
ready public access to the record of
changes to Pilot Securities and any
changes to the applicable Test Groups
(or Control Group) that will be reflected
in the Pilot Securities Change Lists
would provide transparency to the
public that the Commission and
researchers could use when assessing
Pilot data, and also could be useful to
market participants, including brokerdealers that route customer orders, to
assess and review changes to the lists of
Pilot Securities over time.
The primary listing exchanges would
be required, pursuant to Proposed Rule
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610T(b), to keep the lists publicly
posted on their websites beginning with
the Pilot Period through the post-Pilot
Period, as defined in Proposed Rule
610T(c), and for five years after the end
of the post-Pilot Period.155 The lists
must be easily accessible and freely and
persistently available in downloadable
form and shall not be subject to any
restrictions, including, but not limited
to, access or usage restrictions.156 The
Commission preliminarily believes that
continued public availability of this
information (particularly the Pilot
Securities Change Lists) during the Pilot
and for several years thereafter would be
useful for market participants and the
public, including academic researchers,
because it would permit changes to the
Pilot Securities to be easily tracked for
comparison and analysis of the impact
of those changes. Accordingly, the
Commission expects that researchers
would be interested in tracking changes
to Pilot Securities over the course of the
proposed Pilot, and that there likely
would be continued interest in the Pilot
Securities Exchange Lists and Pilot
Securities Change Lists for some time
following the conclusion of the
proposed Pilot as researchers analyze
the Pilot data and conduct their own
independent assessments. Accordingly,
the Commission believes that the public
would benefit from the primary listing
exchanges maintaining the lists they
prepare pursuant to Proposed Rule
610T(b) on their public websites for a
period of not less than five years
following the conclusion of the postPilot Period because it would provide
for ready access by the public to
perform analyses which are likely to
occur for several years following the
conclusion of the proposed Pilot.
The Commission requests comment
on the initial List of Pilot Securities, the
Pilot Securities Exchange List, and the
Pilot Securities Change List, including
the contents thereof and method of
publication of that information. In
particular, the Commission solicits
comment on the following. To the
extent possible, please provide specific
data, analyses, or studies for support.
38. Should the Commission determine
the initial Pilot Securities and specify
the Test Group (or Control Group)
assignments at a specified minimum
period of time prior to the start of the
Pilot Period? Is one month sufficient, or
155 While both the Pilot Securities Exchange Lists
and the Pilot Securities Change Lists would be
required to be publicly posted for five years after
the end of the post-Pilot Period, the primary listing
exchanges would not be required to continue to
update such lists following the conclusion of the
post-Pilot Period.
156 See proposed Rule 610T(b)(4).
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should the notice be published closer to
the start of the Pilot, such as two weeks
prior? For comparison, the Commission
selected securities for the Regulation
SHO Pilot approximately ten months
before the start of the Regulation SHO
Pilot and the SROs assigned stocks to
test groups one month before the start of
the Tick Size Pilot. Does the experience
with either of those pilots provide any
insight into when the Commission
should determine the initial Pilot
Securities for the proposed Pilot? Or is
it necessary for the Commission to
select the Pilot Securities and assign
them to groups prior to the pre-Pilot
Period? Please explain. What, if any,
operational or implementation
complexities did market participants
experience in relation to the timing of
the assignment of securities in the
previous pilots?
39. Do the procedures specified in
Proposed Rule 610T(b) offer an
appropriate framework for maintaining
the list of securities for the proposed
Transaction Fee Pilot? If not, what other
arrangement should the Commission
implement? If yes, do any adjustments
need to be made to accommodate the
proposed Pilot?
40. Is a pipe-delimited ASCII format
the appropriate file format for
maintaining the Pilot Securities
Exchange Lists and Pilot Securities
Change Lists? If not, what other format
is more appropriate? Why is such
alternate format preferred over a pipedelimited ASCII format?
41. How long should the rule require
that exchanges maintain historical
versions of the lists on their public
websites for public availability? Is five
years appropriate, or should they be
maintained on public websites for more
or less time?
42. Should the Commission require,
in order to make the data more
accessible and usable from the
exchanges’ websites, more automated
access to the data? For example, should
the Commission require an exchange to
make the data publicly available on its
website via RSS Feeds 157 and/or
APIs? 158 If so, which would be more
preferable and why? What would be the
benefits? What costs would be
associated with such functionality?
43. Are the requirements for posting
the required information on a public
157 RSS Feeds (Really Simple Syndication) are a
type of web feed which allows users to access
updates to online content in a standardized,
computer-readable format.
158 API (Application Programming Interface) is a
set of clearly defined methods of communication
between various software components which can
make it easier to develop a computer program by
providing all the building blocks, which are then
put together by programmers.
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website, including the prohibition on
access and usage restrictions,
appropriate to ensure that the public
and the Commission will have
unfettered access to and be able to use
effectively, without encumbrance, the
information? Should the Commission
impose any other requirements for
posting the information? How would
usage restrictions impact the ability to
analyze the data?
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2. Exchange Transaction Fee Summary
To facilitate analysis of the Pilot data,
including the effect that transactionbased fees and rebates have on order
routing behavior, execution quality, and
market quality, the Commission
preliminarily believes that it is
necessary for the exchanges to post
publicly standardized select data on
transaction fees and rebates, including
changes to fees and rebates for NMS
stocks in each Test Group and the
Control Group, as well as average and
median realized fees measured
monthly.159 While the proposed Pilot
would cap access fees differently in Test
Groups 1 and 2, exchanges would have
the freedom to set fees at any level
below those caps. The Exchange
Transaction Fee Summary should
facilitate comparison of each exchange’s
basic fee structure across all equities
exchanges and help identify, in
summary fashion, changes to those fees.
Because changes to transaction fees
and rebates currently are described
using Form 19b–4 in individual
proposed rule change filings that can be
fairly complex, the Commission believes
that compiling a dataset of fees and fee
changes from Form 19b–4 fee filings
alone for use in studying the proposed
Pilot would be cumbersome and labor
intensive for researchers and may
discourage research. Further, the
Commission recognizes that exchanges
may use unique terminology to describe
their fees, which could make
comparison of fees across exchanges
difficult for a researcher, so the proposal
provides for standardized terms to ease
comparison across exchanges. The
Commission is proposing that
exchanges publicly post on their
websites in a downloadable file
information on their fees (including
rebates) and fee changes during the
proposed Pilot (including for the prePilot and post-Pilot Periods) using an
eXtensible Markup Language (XML)
schema to be published on the
159 Some fee changes would not be affected by the
proposed Pilot. For example, fixed membership
fees, regulatory fees, and connectivity fees that are
not assessed by transaction would not fall within
the scope of the proposed Pilot.
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Commission’s website.160 Similar to the
Pilot Securities lists, discussed above,
exchanges would be required to
publicly post downloadable files
containing the Exchange Transaction
Fee Summary, which would require
exchanges to post that information on a
website that is freely and persistently
available and easily accessible by the
general public. Further, exchanges
would be required to present the
information in a manner that facilitates
access by machines without
encumbrance, and the files and
information therein could not be subject
to any usage restrictions such as
restrictions on access, retrieval,
distribution, and reuse.
The Commission preliminarily
believes that the unencumbered
availability of this data using the
proposed XML schema would enhance
data quality and facilitate analysis on
the correlation between changes in
transaction fees and changes in order
routing behavior, execution quality, and
market quality.161 There are other
alternatives to the Commission
proposed XML schema such as CSV and
JSON formats. The CSV format provides
the most compact file size among the
alternatives; however, it also is the least
flexible as it cannot convey the same
complexity as XML or JSON or directly
incorporate validation rules thereby
potentially resulting in lower data
quality. The JSON format provides a file
size similar to XML and can convey
complex data structures; however, XML
is more widely supported by software
packages and applications that are likely
to be used by researchers and the
public. Therefore, the use of JSON
would likely impact reuse and analysis
of the data provided by the proposed
Pilot.
Accordingly, for the duration of the
proposed Pilot, including the pre- and
post-Pilot Periods, proposed Rule
610T(e) would require each national
securities exchange that trades NMS
stocks to compile and post publicly a
dataset using an XML schema to be
published on the Commission’s website
160 See proposed Rule 610T(e). The Commission’s
schema is a set of custom XML tags and XML
restrictions designed by the Commission to reflect
the proposed disclosures in Rule 610T(e). This
requirement does not impact a national securities
exchange’s obligation pursuant to Section 19(b) of
the Exchange Act and Rule 19b–4 thereunder
concerning filing a notice of proposed rule change
to effectuate a change in transaction fees and
updating the schedule of fees posted on the
exchange’s website to reflect such changes. See
supra note 10 (discussing the procedural and
substantive requirements applicable to Form 19b–
4 fee filings).
161 See supra Section V.E.4 (discussing the
proposed XML format and the limits of using ASCII
format for the Exchange Transaction Fee Summary).
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13029
that contains specified information on
its fees and fee changes that affect each
Test Group and the Control Group.162
Proposed Rule 610T(e) would require
the equities exchanges to post on their
websites an initial Exchange
Transaction Fee Summary before the
start of trading on the first day of the
pre-Pilot Period and would require the
information to be updated through the
close of trading on the last day of the
post-Pilot Period. During the Pilot,
including the pre- and post-Pilot
Periods, proposed Rule 610T(e) would
require the equities exchanges to update
the Exchange Transaction Fee Summary
on a monthly basis within 10 business
days of the first day of each calendar
month to reflect data collected for the
prior month.163
Proposed Rule 610T(e) specifies the
information to be provided in the
Exchange Transaction Fee Summary.
Specifically, the proposed summary of
information relating to fees and fee
changes would identify the selfregulatory organization by name (‘‘SRO
Name’’) so that the Commission and
researchers would be able to link each
exchange to its reported fees.
Further, the proposed summary
would identify the applicable Pilot Test
Group (i.e., 1, 2, 3, or Control), and it
would identify the ‘‘Base’’ take fee
(rebate), the ‘‘Base’’ make rebate (fee),
the ‘‘Top Tier’’ take fee (rebate), and the
‘‘Top Tier’’ make rebate (fee), as
applicable.164 For purposes of the
Exchange Transaction Fee Summaries,
‘‘Base’’ fee/rebate refers to the standard
amount assessed or rebate offered before
any applicable discounts, tiers, caps, or
other incentives are applied. Further,
‘‘Top Tier’’ fee/rebate refers to the fee
assessed or rebate offered after all
applicable discounts, tiers, caps, or
other incentives are applied. The
Commission preliminarily believes that
the Base and Top Tier information
would be useful to the Commission and
researchers as an approximation of the
fee and rebate information that brokerdealers incorporate into their routing
decisions, which will be useful in
interpreting the Pilot data. For example,
the information can be used to help
identify and track changes in fees and
rebates and the timing of those changes,
which can be compared to changes in
162 Because the Pilot Securities would be subject
to a continuing minimum share price of $1, the
proposed dataset would only contain information
on fees applicable to transactions in securities with
a per share price $1 or more.
163 Using the month of December 2018 as an
example, on or before January 16, 2019, an
exchange would be required to post the required
information based on data it collected during the
previous month of December.
164 See proposed Rule 610T(e).
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order routing behavior, execution
quality, and market quality.
In addition, proposed Rule 610T(e)
would require exchanges to calculate
the ‘‘average’’ and ‘‘median’’ per share
fees and rebates, which the exchange
would compute as the monthly realized
average or median per-share fee paid or
rebate received by participants on the
exchange during the prior calendar
month.165 The summary would require
average and median per share fees and
rebates to be reported separately for
each participant category (discussed
below), Test Group, displayed/nondisplayed, and top/depth of book. The
Commission believes the inclusion of
average and median figures is helpful as
the Base and Top Tier figures are
general values and not all broker-dealers
would pay or receive those amounts.
While Base and Top Tier would be
useful to facilitate comparison across
exchanges, the addition of average and
median figures will provide additional
insight into the typical fees paid or
rebates received by broker-dealers at
each exchange. In turn, this information
would be useful to the Commission and
researchers analyzing how fees and
rebates affect order routing decisions.
While the average realized fee or rebate
paid/earned by market participants on
an exchange can be skewed by
extremely large or small values, the
median figures would not be affected by
such values because median figures
reflect the midpoint of values with an
equal probability of falling above or
below that amount. The Commission
preliminarily believes that both the
average and median realized fee/rebate
figures would be helpful to the
Commission and researchers in
analyzing Pilot data and the
Commission and researchers could
incorporate both figures into their
analyses, in addition to the Base and
Top Tier data, discussed above. For
example, a researcher could examine
average realized per share fees and
rebates when exploring order routing
decisions with respect to particular
exchanges across broker-dealers.
Likewise, a researcher could consider
median realized per share fees and
rebates when examining the routing
decisions of an individual broker-dealer
faced with a choice of multiple
165 Using the month of December 2018 as an
example, on or before January 16, 2019, an
exchange would be required to post, among other
data, the Base and Top Tier fees and rebates in
effect on December 1, any changes to the Base or
Top Tier fees and rebates during the month of
December, and the average and median per-share
fees paid or rebates received by participants on the
exchange for the month of December.
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competing exchanges each with
different fees and rebates.
Further, the proposed summary of
information would require equities
exchanges to report ‘‘record type’’ and
‘‘participant type.’’ Specifically, ‘‘record
type’’ would be an indicator variable to
enable the Commission and researchers
to quickly identify whether the fee being
reported is an average/median figure, or
whether it is the Base or Top Tier fee.
Knowing whether a particular fee or
rebate is either the Base/Top Tier or
average/median would help the
Commission and researchers avoid
confusion and provide important clarity
in the dataset to facilitate use of the
information. The ‘‘participant type’’ also
would be an indicator variable and
would require exchanges to separately
report fees applicable to registered
market makers or other market
participants. To the extent that an
exchange maintains different fees and
rebates (e.g., different Base or Top Tier
fees or rebates) for market makers
compared to other market participants,
this indicator variable would allow the
Commission and researchers to
separately analyze market makers from
other participants, which could be
valuable when considering the effects of
fees and rebates on execution quality
and market quality as they impact the
incentives on market makers to provide
liquidity on specific exchanges. In
addition, proposed Rule 610T(e) would
require the equities exchanges to
identify whether the fees and rebates
reported in the summary apply to
displayed or non-displayed liquidity or
both displayed and non-displayed
liquidity and whether they apply to the
top or depth of book or to both top and
depth of book.166 These indicator
variables will help the Commission and
researchers identify whether the fees/
rebates reported in the dataset differ
between displayed and non-displayed
orders or between top and depth of
book. If an exchange does differentiate
between those conditions in the
assessment of fees or provision or
rebates, then it would so indicate.
Inclusion of this information in the
summary of information will allow the
Commission and researchers to observe
differences at exchanges in fees/rebates
to provide or remove liquidity, which
could be used to evaluate order routing,
execution quality, and market quality.
Finally, proposed Rule 610T(e)(7) and
(8) would require the equities exchanges
to identify the effective date for each fee
(rebate) reported and, when applicable,
the end date after which the fee (rebate)
was no longer in effect.167 In addition,
equities exchanges would report a
separate indicator variable to identify
when they change fees other than on the
first trading day of a calendar month.168
Specifically, this variable would
distinguish whether the average and
median values reported in the dataset
represent the pre-change average/
median or post-change average/median.
For example, if an exchange changes its
fees on the 15th of a month, then the
average and median fees reported before
the 15th would be marked to distinguish
them from the average and median fees
reported on and after the 15th of the
month. This indicator variable would be
necessary to allow the Commission and
researchers to line up the time of
reported fee information with observed
order routing and execution and market
quality information in the Pilot data.
As proposed, each equities exchange
would be required to post publicly on
its website an initial Exchange
Transaction Fee Summary containing
the information prescribed in Rule
610T(e) using an XML schema to be
published on the Commission’s website
prior to the start of trading on the first
day of the pre-Pilot Period. Pursuant to
proposed Rule 610T(e), each equities
exchange thereafter would be required
to publicly post an updated dataset
within 10 business days of the first day
of each calendar month and would
continue to do so until the end of the
post-Pilot Period.
The Commission recognizes that
including only the Base fee (rebate), Top
Tier fee (rebate), average fee (rebate),
and median fee (rebate) ignores
significant variation in exchange fee
schedules. However, including more
granular information on specific
individual fees and rebates would
complicate the data, could be difficult to
standardize across exchanges, and could
potentially make the Pilot more
expensive than proposed. Further, the
Commission preliminarily believes that
the proposed data fields provide
sufficient information to assess the
range of fees and the variation across
exchanges in fees and facilitate analysis
of the Pilot data, which otherwise
would be challenging to summarize
independently and accurately in light of
the considerable complexity of
exchange fee schedules noted above.
Reporting the fee information separately
for registered market makers, as a group,
and other market participants, as a
group, will allow the Commission to
separate out the class of market makers
to see how changes to fees and rebates
167 See
166 See
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proposed Rule 610T(e)(10).
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impact the fulfillment of their
responsibility to provide liquidity. The
Commission believes each exchange
should summarize this information
because each exchange is best able to
understand its own fees and unique fee
terminology.
The Commission requests comment
on the proposed Exchange Transaction
Fee Summary proposed in connection
with the proposed Pilot. In particular,
the Commission solicits comment on
the following. To the extent possible,
please provide specific data, analyses,
or studies for support.
44. Is the proposed Exchange
Transaction Fee Summary useful to
permit comparisons to be made across
exchanges? If not, what type of
information should be captured?
45. Is having an Exchange Transaction
Fee Summary that uses the same XML
schema useful when examining the Pilot
data? Should the proposed Pilot use an
alternative schema? If so, how should
the schema change and what would be
the impacts of such changes?
46. Are the data elements included in
the Commission’s proposed schema
reasonable? Should any changes be
made and what would be the impacts of
such changes?
47. What information in the Exchange
Transaction Fee Summary is most
useful? What additional information in
the Exchange Transaction Fee Summary
would be helpful? Is any information in
the proposed Exchange Transaction Fee
Summary not useful and, if so, should
it be removed? Please explain. If so,
should alternative information be
selected instead?
48. Are both ‘‘average’’ and ‘‘median’’
fees useful metrics, or should other
measures be selected and what would
be the impacts of those alternatives?
49. The proposal would require
separate reporting for registered market
makers, as a group, and other market
participants, as a group. Should further
groups be identified? Would customers
or professionals be appropriate groups
on which to collect fee data?
50. Are monthly updates to the
Exchange Transaction Fee Summary
appropriate, or should the Commission
require the exchanges to post this
information more or less frequently and
why?
51. Should the Commission require
exchanges to report in the Exchange
Transaction Fee Summary additional
information on proposed rule change
filings that change transaction fees
reported in the Exchange Transaction
Fee Summary? If so, what information
should be reported? Would the file
number of the exchange’s proposed rule
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change be sufficient, or should links be
captured that reference the filing?
52. Should the Commission require
the exchanges to specially identify any
filing submitted to the Commission that
establishes or changes a fee, rebate, or
other charge imposed by the Exchange?
What form should this identification
take? Should the title of the filing
require a special identifier? Should the
exchanges be required to post a
consolidated list of such filings on a
publicly available website?
53. Should the Commission require
submission of the Exchange Transaction
Fee Summaries through EDGAR instead
of requiring exchanges to post that
information on each individual equities
exchange’s website? If so, how would
this affect the exchange filers and how
would it affect users of the Exchange
Transaction Fee Summaries?
3. Order Routing Data
To provide public data to facilitate an
examination of the impact of the
proposed Pilot on order routing
behavior, execution quality, and market
quality, the Commission proposes in
Rule 610T(d) to require throughout the
duration of the Pilot, as well as during
the pre-Pilot Period and the post-Pilot
Period, that each national securities
exchange that trades NMS stocks
prepare a downloadable file containing
sets of order routing data in accordance
with the specifications proposed in Rule
610T(d), for the prior month.169 The
data would be in pipe-delimited ASCII
format, and be publicly posted on each
exchange’s website no later than the last
day of the following month. As
proposed for the lists of Pilot Securities
and the Exchange Transaction Fee
Summary, exchanges would be required
to publicly post downloadable files
containing this order routing
information. Exchanges would be
required to post this information on a
website that is freely and persistently
available and easily accessible by the
general public. In addition, exchanges
would be required to present this
information in a manner that facilitates
access by machines without
encumbrance by user name, password,
or access constraints and the files and
information therein could not be subject
to any usage restrictions, such as
restrictions on retrieval, distribution,
and reuse. Requiring the exchanges to
post and maintain this order routing
information with free and completely
unencumbered access would facilitate
169 For example, by September 30th, an exchange
would be required to post the required information
containing order routing data for August.
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13031
research and analyses consistent with
the purposes of this Pilot.
For the pre-Pilot Period, order routing
datasets would include each NMS stock.
For the Pilot Period and post-Pilot
Period, order routing datasets would
include each Pilot Security. As
discussed below, the order routing data
must contain aggregated and
anonymized broker-dealer order routing
information.170 Also as discussed
below, the required datasets would
contain order routing information for
liquidity-providing orders and liquiditytaking orders that is aggregated by day,
by security, by exchange, and by brokerdealer on an anonymous basis.171 If the
equities exchanges are reporting to the
Consolidated Audit Trail (‘‘CAT’’) at the
time the proposed Pilot commences,
they would be able to compile the
required order routing data by utilizing
the data they collect pursuant to the
national market system plan (‘‘CAT
NMS Plan’’).172
As described in paragraph (d) to
proposed Rule 610T, the Commission is
proposing that each equities exchange
would be required to post publicly two
datasets on their websites in pipedelimited ASCII format. One dataset
would include daily volume statistics of
liquidity-providing orders by security
and by anonymized broker-dealer,
separating held and not-held orders.
The second dataset would include daily
volume statistics of liquidity-taking
orders by security and by anonymized
broker-dealer, separating held and notheld orders. The specific fields for each
dataset as set forth in paragraph (d) to
proposed Rule 610T are: Code
identifying the equities exchange; eightdigit code identifying the date of the
calendar day of trading; ticker symbol;
unique, anonymized broker-dealer
identification code; order type code;
order size codes; number of orders
received; cumulative number of shares
of orders received; cumulative number
of shares of orders cancelled prior to
execution; cumulative number of shares
of orders executed at receiving market
center; and cumulative number of
shares of orders routed to another
170 See supra note 154 describing the reasons for
requiring data to be provided in pipe-delimited
ASCII format. Aggregated order routing data would
consist of the cumulative (total) number of orders
or shares of orders received, cancelled, executed, or
routed to another trading center by order type and
order size, accumulated by day, by security, by
anonymized broker-dealer, and by exchange, as
detailed in proposed Rule 610T(d).
171 See proposed Rule 610T(d).
172 See Securities Exchange Act Release No.
79318 (November 15, 2016), 81 FR 84696
(November 23, 2016) (Joint Industry Plan; Order
Approving the National Market System Plan
Governing the Consolidated Audit Trail) and CAT
NMS Plan Sections 6.3–6.4.
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execution venue. In addition, the
liquidity-providing orders dataset also
would require a field specifying the
cumulative number of shares executed
within certain specified time periods
after order receipt by the exchange.
The Commission preliminarily
believes that the publicly-available
order routing data should provide
researchers and the Commission with
data necessary to serve the
Commission’s regulatory purposes in
studying the potential conflicts of
interest associated with transactionbased fees and rebates and the effects
that changes to those fees and rebates
have on order routing behavior,
execution quality, and market quality.
In particular, the order routing data
would contain information about the
exchanges to which broker-dealers route
orders, which will permit a closer
examination of how broker-dealers may
change their order routing behavior in
response to changes in fees and rebates
at each exchange. Because brokerdealers may respond differently to
differing levels of fees and rebates and
the inherent conflicts of interest fees
and rebates present when making
routing decisions, the Commission
preliminarily believes that data at the
broker-dealer level would facilitate
statistical analysis of those differences
and the conflicts of interest associated
with them. The order routing data also
would provide valuable information on
order type, order size, time to execution,
and information on order execution,
cancellation, and reroutes, all of which
should facilitate analysis into routing
behavior in response to differing levels
of fees and rebates. In addition, this
same information would also facilitate
an analysis of the effects that changes to
transaction-based fees and rebates may
have on execution and market quality
by permitting a close examination of
matters such as liquidity concentration
and competition for order flow among
equities exchanges in different fee and
rebate environments.
Further, proposed Rule 610T(d)
would require during the course of the
Pilot, as well as during the pre-Pilot
Period and the post-Pilot Period, each
national securities exchange that trades
NMS stocks to publicly post on its
website downloadable files in pipedelimited ASCII format no later than the
last day of each month, sets of order
routing data in accordance with the
specifications in proposed Rule 610T(d),
for the prior month. The Commission is
proposing to require the equities
exchanges to collect and make available
pre-Pilot and post-Pilot data, which
would provide necessary benchmark
information against which the
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Commission could assess the impact of
the Pilot, and the impact of the Pilot on
potential conflicts of interest associated
with transaction-based fees and rebates
and the effects that changes to those fees
and rebates have on order routing
behavior, execution quality, and market
quality.
In preparing the datasets, the equities
exchanges would be required to
anonymize information relating to the
identity of individual broker-dealers
before making the order routing datasets
publicly available. In order to track and
aggregate the activity of particular
broker-dealers across multiple
exchanges, the Commission
preliminarily believes it is important for
each equities exchange to utilize the
same anonymized code to identify a
broker-dealer.
Using a single code to identify each
unique broker-dealer will allow the
Commission and researchers to easily
combine the separate exchange data
files and sort them by unique brokerdealers, therein allowing the
Commission and researchers to identify
aggregate activity at the broker-dealer
level across all equities exchanges. In
turn, the ability to combine and sort all
exchange data by anonymized codes
representing individual broker-dealers
would be useful for capturing and
analyzing individual broker-dealer order
routing decisions.
In order to facilitate the
anonymization of the identities of
broker-dealers, representatives of the
Commission would provide to the
equities exchanges, on a confidential
basis, a Broker-Dealer Anonymization
Key. The Broker-Dealer Anonymization
Key would provide the anonymization
code for every broker-dealer whose
order routing data would be included in
the order routing datasets. The
Commission preliminarily believes that
it would be most efficient to create the
Broker-Dealer Anonymization Key by
assigning a unique, anonymized
identification code to each central
registration depository identifier
(‘‘CRD’’), which are identifiers of
registered broker-dealers known and
regularly used by both the Commission
and the equities exchanges.173 To
protect the identities of broker-dealers,
the Broker-Dealer Anonymization Key
would only be accessible to
representatives of the Commission and
the equities exchanges.
Because proposed Rule 610T would
state that the identities of broker-dealers
contained in the Order Routing Datasets,
and the Broker-Dealer Anonymization
173 CRD numbers are captured in the
Commission’s EDGAR system.
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Key, are regulatory information,
exchanges would not be permitted to
access or use that information for any
commercial or non-regulatory purpose.
The Commission considers the
identities of broker-dealers in the
proposed Order Routing Data, as well as
the Broker-Dealer Anonymization Key,
to be regulatory information produced
for the specific and exclusive purpose of
conducting the Pilot, which ultimately
will inform the Commission’s (as well
as exchanges’ and the public’s)
regulatory consideration of the impact
of transaction fees on equities market
structure. The Commission believes it
would be inconsistent with an
exchange’s rules to use the BrokerDealer Anonymization Key and the
Order Routing Data to benefit its
business operations.174 Accordingly,
Rule 610T would expressly prohibit
exchanges from accessing or using the
Pilot’s order routing data for commercial
or non-regulatory purposes for reasons
including, but not limited to, setting
transaction fees, marketing, business
development, and customer outreach.175
The Commission believes that the
public availability of the order routing
datasets would be useful to allow
market participants, researchers, and
others to conduct independent analyses
of the proposed Pilot and its impacts. To
the extent these analyses reveal useful
information about the potential conflicts
of interest associated with transactionbased fees and rebates and the effects
that changes to those fees and rebates
have on order routing behavior,
174 Section 19(g)(1) of the Act requires, in part,
that every self-regulatory organization comply with
its own rules. See 15 U.S.C. 78s(g)(1). Corporate
governance documents for equities exchange
holding companies contain rules that restrict the
use of information related to an equities exchange’s
self-regulatory function and do not permit use or
disclosure of such information for commercial
purposes. See By-laws of Nasdaq, Inc., Article XII,
Section 12.1(b), available at https://
nasdaq.cchwallstreet.com/NASDAQTools/Platform
Viewer.asp?selectednode=chp_1_1_3_6&manual=
%2Fnasdaq%2Fmain%2Fnasdaq-corporg%2F;
Eighth Amended Bylaws of Intercontinental
Exchange Inc., Article VIII, Section 8.1, available at
https://ir.theice.com/governance/governance-andcharter-documents; Cboe Global Markets, Inc. and
Subsidiaries Code of Business Conduct and Ethics,
available at https://ir.cboe.com/∼/media/Files/C/
CBOE-IR-V2/corporate-governance/code-ofbusiness-conduct-and-ethics-27-oct-2017adopted.pdf; Bylaws of IEX Group, Inc., Article VII,
Section 35, available at https://iextrading.com/
docs/governance/IEXG%20Bylaws.pdf; Bylaws of
CHX Holdings, Inc., Article III, Section 2, available
at https://www.chx.com/chx-holdings/bylaws/.
175 For example, proposed Rule 610T would
prohibit an exchange’s non-regulatory personnel
from having access to the Broker-Dealer
Anonymization Key or using that information to
decipher the order routing data posted by
competing exchanges to learn the identities of those
exchanges’ biggest customers and then solicit those
customers for itself.
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execution quality, and market quality,
the Commission believes it would use
the resulting analyses for its own
regulatory purposes to further inform
itself and the public on whether further
regulatory action in this area is
appropriate.
The Commission requests comment
on the order routing-related data to be
included in the proposed Pilot. In
particular, the Commission solicits
comment on the following. To the
extent possible, please provide specific
data, analyses, or studies for support.
54. What data are necessary to
facilitate analysis of the potential
conflicts of interest associated with
transaction-based fees and rebates and
the effects that changes to those fees and
rebates have on order routing behavior,
execution quality, and market quality?
Are there any specific measures that
commenters believe would facilitate
that analysis? For example, do
commenters agree with the Joint
Exchange Letter’s recommendation to
study the impact on broker-dealers and
their customers of savings realized from
lowered exchange transaction fees? 176 If
so, what data would facilitate that
analysis?
55. If the CAT repository was
operational, as specified in the CAT
NMS Plan, would the Commission have
sufficient data to evaluate order routing
behavior without this Pilot? Does the
lack of the CAT affect the costs
necessary for this proposed Pilot, and if
so how?
56. Should the Commission require
the order routing datasets to separate
out held and not-held orders? Why or
why not? Are there certain shared
characteristics regarding the handling of
not-held orders, such as a greater
likelihood to be directed to particular
exchanges, that would be beneficial to
assess? Please explain.
57. Should the Commission also
require exchanges to separately report
non-anonymized datasets to the
Commission? If so, what additional data
would be useful?
58. Will anonymizing the proposed
data sufficiently protect confidential
information? Are any further safeguards
necessary? Why or why not? Are there
other groupings that would be
preferable, like aggregation units? If not,
what benefits or limitations would there
be in analyzing the data if the entirety
of a broker-dealer’s order routing
activity is aggregated?
59. Should the Commission use CRD
numbers to create the Broker-Dealer
Anonymization Key? If not, why not?
Are there other accessible identifying
176 See
Joint Exchange Letter, supra note 44, at 4.
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markers that the Commission should
use to create the Broker-Dealer
Anonymization Key?
60. Would the equities exchanges be
able to work with representatives of the
Commission to validate the BrokerDealer Anonymization Key? What
additional information, if any, would be
helpful for constructing the BrokerDealer Anonymization Key?
61. Should the Commission require
the data to be aggregated at a broader
level, such as by groups of similar
market participants? Why or why not? Is
there a need to aggregate the activity of
any market participants to protect their
identity? For example, should the
identity of large market participants be
aggregated? What unique risks are posed
for market participants whose trading
constitutes a material portion of overall
volume? Why would anonymization of
a particular broker-dealer not be
sufficient for purposes of concealing the
broker-dealer’s identity? What impact
would aggregating order routing data at
a broader level have on the ability for
the Commission and researchers to
assess the impact of the proposed Pilot
on order routing behavior, execution
quality, and market quality?
62. Should the Commission collect
pre-Pilot and post-Pilot data? For how
long of a period should it collect such
data? Is six months sufficient for each
period? Should it collect such data for
a shorter period, like three or four
months, or a longer period? Should the
lengths of the pre-Pilot and post-Pilot
Periods be equal, or could the
Commission instead collect pre-Pilot
data for three months and post-Pilot
data for six months and still have
adequate statistical power to evaluate
the results of the Pilot?
63. Should the Commission require
the equities exchanges to both report the
datasets to the Commission and make
them publicly available on their
websites? Is it sufficient to require the
equities exchanges to make the datasets
publicly available on their websites? To
what extent would that reduce the
burdens associated with complying with
this provision?
F. Implementation Period
The Commission proposes to notify
the public through a notice of the start
and end dates of the pre-Pilot, Pilot, and
post-Pilot Periods, including any
suspension of the one-year sunset of the
Pilot Period.177 The start date of the prePilot Period would be one month from
the date the Commission issues the
notice, and the end date of the pre-Pilot
177 See proposed Rule 610T(c). The notice would
be posted on the Commission’s website.
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Period would be six months from the
pre-Pilot Period’s start date.
Accordingly, the Pilot, which is to start
at the conclusion of the pre-Pilot Period,
would begin seven months from the
date the Commission issues the notice.
The post-Pilot Period would start at the
conclusion of the Pilot and would end
six months from the post-Pilot Period’s
start date.
The Commission recognizes that the
proposed Pilot will require the equities
exchanges to make certain changes to
their fees to conform to the proposed
terms of the Pilot and will require
market participants to adjust their order
routing systems in response to those
changes. However, because equities
exchanges frequently adjust their
transaction fees and rebates with little,
if any, advance notice to the public
through immediately effective Form
19b–4 fee filings, the Commission
preliminarily believes that brokerdealers currently are well situated to
promptly accommodate any changes
required to implement and comply with
the proposed Pilot.178 Such adjustments
may be more time-consuming than
usual for broker-dealers and other
market participants insofar as additional
programming may be needed to account
for the different fee and rebate levels
across three Test Groups and one
Control Group of proposed Pilot.179
Nevertheless, the Commission
preliminarily believes that brokerdealers and other market participants
will have time and notice before the
onset of the proposed Pilot, including
the proposed six-month pre-Pilot
Period, to begin to make updates to their
trading strategies and execution
algorithms, including planning for the
prohibition on rebates and Linked
Pricing in Test Group 3 and the fact that
different stocks will be subject to
different fee caps during the proposed
Pilot. Thereafter, when the initial List of
Pilot Securities is released and the
exchanges submit their fee filings,
broker-dealers could input those data
points into their trading systems in the
same manner they do today when
exchanges change their fees.
In addition, for the duration of the
proposed Pilot and during the pre- and
post-Pilot Periods, each equities
exchange would be required, pursuant
178 SROs are required to file with the Commission
copies of any proposed rule or any proposed rule
change. 15 U.S.C. 78s(b)(1). Any proposed rule
change establishing or changing a due, fee, or other
charge imposed by the self-regulatory organization
takes effect upon filing with the Commission. 15
U.S.C. 78s(b)(3)(A)(ii).
179 See Section V.C.2.b. infra for a discussion of
the costs that broker-dealers and other market
participants may face in complying with the Pilot.
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to proposed Rule 610T(d), to post
publicly on its website specified
datasets of order routing data aggregated
by date, ticker symbol, national
securities exchange, and broker-dealer.
Separately, the equities exchanges also
would be required to make changes to
accommodate the requirements of
proposed Rule 610T(b) concerning
publication of information about the
Pilot Securities and proposed Rule
610T(e) concerning reports of data on
their fees and fee changes.
To provide time for the equities
exchanges to make these changes, the
Commission proposes that the start date
of the pre-Pilot Period would be one
month from the date it issues the notice
pursuant to proposed Rule 610T(c).
Accordingly, the start date of the Pilot
Period, which would begin at the
conclusion of the pre-Pilot Period,
would be no earlier than seven months
from the date of the Commission’s
notice issued pursuant to proposed Rule
610T(c). The Commission preliminarily
believes that this process should
provide sufficient advance notice to the
equities exchanges to allow them time
to put in place mechanisms to comply
with the proposed requirements of Rule
610T and sufficient advance notice to
broker-dealers and other market
participants to allow them time to put
in place any necessary changes to their
order routing programming.180
The Commission requests comment
on the proposed implementation period
for the proposed Pilot. Specifically, the
Commission solicits comment on the
following. To the extent possible, please
provide specific data, analyses, or
studies for support.
64. Is a one month period following
the Commission’s notice prior to the
start of the pre-Pilot Period sufficient
time to allow the equities exchanges to
prepare for the pre-Pilot Period
requirements? Why or why not?
65. Is a minimum seven month period
following the Commission’s notice
sufficient time to allow affected entities
to establish and test mechanisms to
comply with the proposed
requirements? Why or why not? Should
there be an alternate implementation
period, such as twelve months? If so,
what would be preferable and why?
66. What technological or systems
changes are necessary to effectuate the
proposed Pilot? How would any such
changes differ from changes required to
accommodate routine changes in
exchange fee schedules?
IV. Paperwork Reduction Act
Certain provisions of the proposed
rule contain ‘‘collection of information
requirements’’ within the meaning of
the Paperwork Reduction Act of 1995
(‘‘PRA’’).181 The Commission is
submitting these collections of
information to the Office of
Management and Budget (‘‘OMB’’) for
review in accordance with 44 U.S.C.
3507(d) and 5 CFR 1320.11.182 An
agency may not conduct or sponsor, and
a person is not required to respond to,
a collection of information unless the
agency displays a currently valid
control number.183 The title of the new
collection of information is
‘‘Transaction Fee Pilot Data.’’
A. Summary of Collection of
Information
1. Pilot Securities Exchange Lists and
Pilot Securities Change Lists
As discussed above, the Commission
would publish by notice the initial List
of Pilot Securities, which would
identify the securities in the proposed
Pilot and assign each of them to a
designated Test Group (or the Control
Group).
Prior to the start of trading on the first
day of the Pilot Period, proposed Rule
610T(b)(2)(i) would require each
national securities equities exchange
that is a primary listing exchange for
NMS stocks to publicly post on its
website a Pilot Securities Exchange List,
in pipe-delimited ASCII format, of all
Pilot Securities for which it serves as
the primary listing exchange. Proposed
Rule 610T(b)(2)(i) also would require
each primary listing exchange to
maintain and update this list as
necessary prior to the beginning of each
trading day. In addition, proposed Rule
610T(b)(3)(i) would require that prior to
the beginning of trading each trading
day, a primary listing exchange would
be required to publicly post on its
website a Pilot Securities Change List,
in pipe-delimited ASCII format, that
cumulatively lists each separate change
to Pilot Securities for which it serves or
has served as the primary listing
exchange. A proposed set of
specifications for both lists is set forth
in paragraph (b) of the proposed Rule.
The two lists are intended to make
available information about updates to
the List of Pilot Securities as well as
detailed information on changes to Pilot
Securities and their associated Test
Groups. Proposed Rule 610T(b) would
require both the Pilot Securities
181 44
U.S.C. 3501 et seq.
U.S.C. 3507; 5 CFR 1320.11.
183 5 CFR 1320.11(l).
182 44
180 See
id.
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Exchange List and the Pilot Securities
Change List to be made publicly
available on equities exchange websites
and remain posted for the duration of
the proposed Pilot, including the postPilot Period, as well as for five years
thereafter. Because the primary listing
exchanges oversee their listed issuers
and have rules in place that require
listed issuers to report corporate change
information to them, the primary listing
exchanges are in the best position to
make this information publicly
available.
Further, the Commission believes that
market participants and the public
would benefit from having access to
accurate and up-to-date information on
the Pilot Securities and their respective
test groups during the proposed Pilot. In
addition, access to cumulative detailed
information about changes to the Pilot
Securities will assist the Commission in
analyzing order routing data and will
provide information to the public that
researchers could use when assessing
Pilot data.
2. Exchange Transaction Fee Summary
As discussed above, the Commission
preliminarily believes that it is
necessary for the exchanges to post
publicly standardized and simplified
data on the equities exchanges’
transaction fees and rebates, and the
effective date for any change thereto,
individually for each Test Group and
the Control Group.184 This information
is intended to facilitate analysis of the
Pilot’s order routing data, including the
effect that transaction-based fees and
rebates have on order routing behavior,
execution quality, and market quality.
In particular, while the proposed Pilot
would cap access fees differently in Test
Groups 1 and 2, exchanges would have
the freedom to set fees at any level
below those caps. Changes to equities
exchange transaction fees and rebates
currently are described in individual
proposed rule change filings, so
compiling a summary of information
relating to fees and fee changes from
Form 19b–4 fee filings for use in
studying the proposed Pilot would be
cumbersome and labor intensive for
researchers and could discourage
research and analysis of the Pilot data.
Further, because equities exchanges
may use unique terminology to describe
their fees, the Commission preliminarily
believes the equities exchanges are in
the best position to provide this
information and ensure that information
184 Some fee changes would not impact or relate
to the proposed Pilot. For example, fixed
membership fees, regulatory fees, and connectivity
fees that are not assessed by transaction would not
fall within the scope of the proposed Pilot.
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relating to their fees and rebates and
changes thereto is correctly reflected
using a common XML schema to
facilitate comparison. In addition, only
equities exchanges have access to
information necessary to compute
monthly realized average and median
transaction fees, which would be
required fields.
Proposed Rule 610T(e) specifies the
proposed fields to be required,
including information on Base fees and
rebates, Top Tier fees and rebates, and
monthly realized average and median
fees paid or rebates given, each reported
separately for registered market makers
and other participants.185 In addition,
proposed Rule 610T(e) would require
equities exchanges to identify the
effective date for each fee (rebate)
change reported and, when applicable,
the end date after which the fee (rebate)
was no longer in effect. It also would
require equities exchanges to specify
fees and rebates that apply to each Pilot
Test Group (or the Control Group), and
to what type of participant (market
maker or other market participant) they
apply. Further, equities exchanges
would be required to indicate whether
any of the reported fees or rebates are
applied differently depending on
whether the interest is non-displayed or
ranked in the depth-of-book. Finally, as
proposed in Rule 610T(e), the equities
exchanges would prepare this
information and make it publicly
available on their websites.
This Exchange Transaction Fee
Summary would be intended to
facilitate comparison of exchanges’
basic fee structures and help identify, in
summary fashion, changes to those fees
(rebates).
Rule 610T(e) would require each
national securities exchange that trades
NMS stocks to publicly post this
information before the beginning of
trading on the first day of the pre-Pilot
Period, and update it on a monthly basis
thereafter through the close of trading
on the last day of the post-Pilot Period.
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3. Order Routing Data
Proposed Rule 610T(d) would require
each national securities exchange that
trades NMS stocks to prepare, in pipedelimited ASCII format, and publicly
post on its website, no later than the last
day of each month, specified order
185 Including only the Base fee (rebate), average
fee (rebate), median fee (rebate), and the Top Tier
fee (rebate) ignores significant variation in exchange
fee schedules. However, additional information
would complicate the data and could be difficult to
standardize across exchanges. Further, the
Commission preliminarily believes that the
proposed data fields provide sufficient information
to assess the range of fees and the variation across
exchanges in fees.
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routing data containing aggregated and
anonymized broker-dealer order routing
information for the prior month in
accordance with the specifications set
forth in proposed Rule 610T(d). Such
data would be collected throughout the
duration of the proposed Pilot, as well
as during the pre-Pilot Period and the
post-Pilot Period. For the pre-Pilot
Period, order routing datasets would
include each NMS stock. For the Pilot
Period and post-Pilot Period, order
routing datasets would include each
Pilot Security. As noted above, if the
equities exchanges are reporting to the
CAT at the time the proposed Pilot
commences, the Commission
preliminarily believes that they would
be able to compile the required order
routing data by using the data reported
to the central repository. Publicly
posting the datasets would provide the
Commission, market participants,
academic scholars, and the public with
order routing data necessary to serve the
Commission’s regulatory purposes in
studying the potential conflicts of
interest associated with transactionbased fees and rebates and the effects
that changes to those fees and rebates
have on order routing behavior,
execution quality, and market quality.
In particular, the proposed order routing
datasets would contain aggregated order
routing data on liquidity-providing and
liquidity-taking orders by security, by
day, by exchange, and by anonymized
broker-dealer, separating held and notheld orders, which should facilitate
analysis into order routing behavior in
response to differing levels of fees and
rebates under the proposed Pilot.
Further, in order to construct a dataset
that both provides benchmark statistics
for the pre-Pilot Period and also
captures data to show changes after the
end of the proposed Pilot, equities
exchanges would provide the required
data for dates starting six months prior
to the Pilot Period through six months
after the end of the Pilot Period. As
proposed, the exchanges would publicly
post the order routing datasets on their
websites in pipe-delimited ASCII
format, which would provide ready
access to the data to facilitate analyses
of the impact of the proposed Pilot.
B. Proposed Use of Information
The data collected during the
proposed Pilot would allow the
Commission, market participants,
academic scholars, and the public to
study the potential conflicts of interest
associated with transaction-based fees
and rebates and the effects that changes
to those fees and rebates have on order
routing behavior, execution quality, and
market quality. In turn, this information
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13035
should facilitate a data-driven
evaluation of future policy choices.
By publishing and maintaining a Pilot
Securities Exchange List and a Pilot
Securities Change List, each primary
listing exchange would help ensure that
the Commission, market participants,
academic scholars, and the public have
up-to-date information on corporate
changes to listed issuers that impact the
list of Pilot Securities, as well as
changes to the composition of any of the
proposed test groups. For example, if a
stock undergoes a name change, ticker
symbol change, corporate merger, or
goes out of business, the primary listing
exchanges would help disseminate
information necessary to keep current
the Pilot Securities Exchange List and
the Test Groups into which the Pilot
Securities are placed by the proposed
Pilot.
The proposed Exchange Transaction
Fee Summary containing information on
fees and fee changes that affect each
Test Group and the Control Group
should help facilitate more efficient
analysis of the effect that transactionbased fees and rebates, and changes to
transaction-based fees and rebates, have
on order routing behavior, execution
quality, and market quality by
facilitating comparison across equities
exchanges of each exchange’s basic fee
structure and identifying, in summary
fashion, changes to those fees. The
Commission preliminarily believes that
the public availability of this data
would facilitate this analysis of order
routing data by the Commission, as well
as by market participants, academic
scholars, and the public.
The proposed collection of order
routing data would provide to the
Commission and others necessary
information on broker-dealer order
routing behavior in response to changes
in fees and rebates at each exchange, as
well as information on order type, order
size, time to execution, and information
on order execution, cancellation, and
reroutes, all of which should facilitate
analysis of routing behavior in response
to differing levels of fees and rebates
and the impact of fee changes on
execution quality and market quality. In
addition, the collection of data for a prePilot Period would provide an
important benchmark against which to
evaluate the order routing data collected
during the proposed Pilot, and the
collection of post-Pilot data would
allow analysis of changes to order
routing behavior when the proposed
Pilot ends. Together, the information on
changes and updates to the universe of
Pilot Securities, the Exchange
Transaction Fee Summary, and the
order routing datasets is intended to
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allow the Commission and others ready
access to information to assess whether
and in what ways changes to fees and
rebates affect market participant
behavior and impact the conflicts of
interest faced by market participants. In
addition to analysis by the Commission,
market participants, academic scholars,
and the public would be able to use this
data for their own studies.
C. Respondents
The respondents to this collection of
information would be the equities
exchanges, which are registered national
securities exchanges that trade NMS
stocks. Specifically, Rule 610T(b),
which covers the Pilot Securities
Exchange Lists and Pilot Securities
Change Lists, would apply to the five
primary listing exchanges for NMS
stocks. Rule 610T(d), which requires
datasets on order routing, would apply
to all thirteen equities exchanges that
are currently registered with the
Commission. Rule 610T(e), which
requires datasets on fees (rebates) and
fee (rebate) changes, would apply to all
thirteen equities exchanges currently
registered with the Commission.
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D. Total Initial and Annual Reporting
and Recordkeeping Burdens
1. Pilot Securities Exchange Lists and
Pilot Securities Change Lists
After the Commission designates the
initial List of Pilot Securities and prior
to the start of trading on the first day of
the Pilot Period, proposed Rule
610T(b)(2) would require each primary
listing exchange to compile in pipedelimited ASCII format, publicly post
on its website, and update as necessary,
a list of the Pilot Securities for which
the equities exchange serves as the
primary listing exchange (i.e., the ‘‘Pilot
Securities Exchange List’’), as well as a
list of certain changes to any Pilot
Security for which it serves or has
served as the primary listing market
(i.e., the ‘‘Pilot Securities Change List’’).
Specifically, upon publication of the
initial List of Pilot Securities by the
Commission, the primary listing
exchanges would be required to
determine which Pilot Securities are
listed on their market and compile and
publicly post downloadable files
containing a list of those securities,
including all data fields specified in
proposed Rule 610T(b)(2)(i) on their
websites in pipe-delimited ASCII
format. The Commission preliminarily
estimates that each primary listing
exchange would incur, on average, a
one-time burden of approximately 8
burden hours per primary listing
exchange to compile and publicly post
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their initial Pilot Securities Exchange
List.186 Accordingly, the Commission
preliminarily believes that the aggregate
one-time burden associated with the
initial Pilot Securities Exchange Lists
would be 40 burden hours.187
After posting its initial Pilot
Securities Exchange List, each equities
exchange would be required to keep
current that list to reflect any changes,
and to prepare and publicly post on its
website until the end of the post-Pilot
Period the Pilot Securities Change List
prior to the beginning of trading each
trading day. The Commission
preliminarily believes that each primary
listing exchange has existing systems to
monitor the names of listed companies
and process any changes due to mergers,
name changes, or other corporate
actions, or transfer of a security that
closed below $1 per share from a Test
Group to the Control Group.188
Moreover, the Commission
preliminarily believes these systems are
currently being used to maintain the
lists of pilot securities for the Tick Size
Pilot, which, as noted above, employs a
similar test-group structure and applies
to many of the same securities, so the
primary listing exchanges already have
a process in place to update lists of pilot
securities.189 However, each primary
listing exchange would have to adapt
these systems as necessary for the
proposed Transaction Fee Pilot, notably
the fact that the proposed Transaction
Fee Pilot would apply to a larger
number of securities than does the Tick
Size Pilot. Accordingly, the Commission
preliminarily estimates that each
primary listing market would incur a
one-time burden of approximately 12
burden hours of internal legal,
compliance, and information technology
operations to develop appropriate
systems to track and compile changes
relevant to Pilot Securities listed on
their market for an aggregate one-time
burden of approximately 60 burden
hours.190 The Commission preliminarily
estimates that, once the primary listing
exchanges have established these
systems, on average, each primary
186 The Commission bases this estimate on a fulltime Compliance Manager and Programmer Analyst
each spending approximately 4 hours, for a
combined total of approximately 8 hours, to
compile and publicly post to an exchange’s website
a downloadable file containing the initial Pilot
Securities Exchange List.
187 8 burden hours per primary listing exchange
× 5 primary listing exchanges = 40 burden hours.
188 See supra note 153 and accompanying text.
189 See supra note 150 and accompanying text.
190 The Commission derived the total estimated
burdens from the following estimates: (Attorney at
4 hours) + (Compliance Manager at 4 hours) +
(Programmer Analyst at 4 hours) = 12 burden hours.
12 burden hours per primary listing exchange × 5
primary listing exchanges = 60 burden hours.
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listing exchange would incur 126
burden hours annually to compile any
changes related to Pilot Securities, such
as name changes or mergers, and to
publicly post the updated Pilot
Securities Exchange Lists and Pilot
Securities Change Lists on their
websites prior to the start of each
trading day.191 Accordingly, the
Commission preliminarily estimates an
average, aggregate annual burden of 630
burden hours to update and publicly
post the lists of Pilot Securities.192
2. Exchange Transaction Fee Summary
Proposed Rule 610T(e) would require
each national securities exchange that
trades NMS stocks to maintain and
publicly post on their websites
downloadable files, using an XML
schema to be published on the
Commission’s website, data concerning
changes in transaction fees (rebates),
and the effective date for each fee
(rebate) change, for securities subject to
the proposed Pilot. The Exchange
Transaction Fee Summary would be
required to be posted on the equities
exchanges’ websites before the start of
trading on the first day of the pre-Pilot
Period through the close of trading on
the last day of the post-Pilot Period.
Proposed Rule 610T(e) would require
equities exchanges to update this
summary of information within ten
business days following the beginning
of each calendar month. Proposed Rule
610T(e) specifies the proposed fields to
be required, including, among other
things, information on Base fees and
rebates, average and median per share
fees paid or rebates given, and Top Tier
fees and rebates, each reported
separately for registered market makers
and other participants. In addition,
proposed Rule 610T(e) would require
equities exchanges to specify whether
the fees (rebates) reported in the
summary apply to displayed or nondisplayed orders or between top and
depth of book. Finally, the proposed
rule would require equities exchanges to
identify the effective date for each fee
(rebate) change reported, including,
when applicable, an indicator to flag
instances where an equities exchange
has changed fees other than on the first
trading day of a calendar month and the
end date after which the fee (rebate) was
no longer in effect. It also would require
exchanges to specify fees that apply to
191 The Commission bases this estimate on a fulltime Compliance Manager and Programmer Analyst
together spending approximately 30 minutes per
trading day updating and posting the required lists
(approximately 252 trading days × 30 minutes per
trading day = 7,560 minutes (126 hours)).
192 126 burden hours per primary listing exchange
× 5 primary listing exchanges = 630 burden hours.
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each Pilot Test Group (or the Control
Group), and to what type of interest the
fees apply.193
The Commission is proposing to
require that each equities exchange
publicly post on its websites the
Exchange Transaction Fee Summary
each month, using an XML schema
published on the Commission’s website.
The Commission preliminarily believes
that all the data necessary to complete
the summary are currently maintained
by the equities exchanges. However, the
equities exchanges would be required to
compute the monthly realized average
and median per share fees and rebates,
using fee and volume information that
the equities exchanges maintain. The
Commission preliminarily estimates
that each equities exchange would incur
a one-time burden of approximately 80
burden hours of internal legal,
compliance, information technology,
and business operations to develop
appropriate systems for tracking fee
changes, computing the monthly
averages, and formatting the data and
posting it on its website in accordance
with the proposed rule.194 Therefore,
the Commission preliminarily estimates
that the average one-time initial
aggregate burden for all equities
exchanges necessary for the
development and implementation of the
systems needed to capture the
transaction fee information and post it
193 In addition, the Commission anticipates that
each equities exchange would submit one Form
19b–4 fee filing to implement the proposed Pilot
and one Form 19b–4 fee filing at the conclusion of
the proposed Pilot to remove the required pricing
restrictions. Each equities exchange might also
choose to submit additional Form 19b–4 fee filings
during the proposed Pilot. While such filings may
impose certain costs on the equities exchanges,
those burdens are already accounted for in the
comprehensive Paperwork Reduction Act
Information Collection submission for Form 19b–4.
See OMB Control No. 3235–0045 (August 19, 2016),
81 FR 57946 (August 24, 2016) (Request to OMB for
Extension of Rule 19b–4 and Form 19b–4 PRA). The
Commission does not expect the baseline number
of Form 19b–4 fee filings to increase as a result of
the proposed Pilot, nor does it believe that the
incremental costs outlined in Section V.C.2.a
exceed those costs used to arrive at the average
costs and/or burdens reflected in the Form 19b–4
PRA submission.
194 The Commission preliminarily estimates that
an equities exchange would assign responsibilities
for review and potential modification of its systems
and technology to an Attorney, a Compliance
Manager, a Programmer Analyst and a Senior
Business Analyst. The Commission estimates the
burden of reviewing and potentially modifying its
systems and technology to be as follows: (Attorney
at 20 hours) + (Compliance Manager at 20 hours)
+ (Programmer Analyst at 20 hours) + (Business
Analyst at 20 hours) = 80 burden hours per equities
exchange. See Securities Exchange Act Release No.
76624 (Dec. 11, 2015), 80 FR 79757, 79771 fn. 93
(Dec. 23, 2015) (SBS Taxonomy Proposing Release)
(estimating the types of employees that would
retain responsibility for modifying technology
systems).
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on their websites in the specified format
in compliance with proposed Rule
610T(e) would be 1,040 hours.195
Once an equities exchange has
established the appropriate systems
required for compiling, formatting, and
publicly posting the Exchange
Transaction Fee Summary in the
specified format, the Commission
preliminarily believes that it would be
necessary for each equities exchange to
monitor its systems to ensure its
technology is up to date and reporting
the required data in accordance with
proposed Rule 610T(e). The
Commission preliminarily estimates
that, on average, an equities exchange
would incur an ongoing burden of
approximately 40 burden hours per year
to monitor and, if necessary, update its
systems used for compiling, formatting
and publicly posting the Exchange
Transaction Fee Summaries in
accordance with the proposed Rule.196
Therefore, the Commission
preliminarily estimates that the average
aggregate, ongoing, annual burden for
all equities exchanges to monitor their
systems would be 520 hours.197
Under the proposed rule, the equities
exchanges would be required to format,
calculate certain figures and post their
initial Exchange Transaction Fee
Summary at the outset of the pre-Pilot
Period. As this would be the first time
an equities exchange would be required
to produce and post on their website
such a summary, the Commission
preliminarily estimates that it would
require approximately 4 burden hours
for each equities exchange to complete
the initial Exchange Transaction Fee
Summary and perform the necessary
calculations.198 In addition, each
equities exchange would be required to
make its summary publicly available on
its website using an XML schema to be
published on the Commission’s website.
As discussed below, the Commission
preliminarily believes that the equities
exchanges have experience applying the
XML format to market data.199 However,
the Commission preliminarily believes
that initially each equities exchange
would incur a burden specific to the
initial Exchange Transaction Fee
Summary to ensure that it has properly
implemented the XML schema.
Therefore, the Commission
preliminarily estimates that each
equities exchange would incur a burden
of 2 burden hours related to post the
initial Exchange Transaction Fee
Summary publicly on its website using
the XML schema to be published on the
Commission’s website.200 Accordingly,
the Commission preliminarily estimates
that equities exchanges would incur, in
aggregate, an initial burden of 52 hours
to complete their initial Exchange
Transaction Fee Summary 201 and an
initial burden of 26 hours to post that
dataset publicly on their websites using
an XML schema to be published on the
Commission’s website, for a total
aggregate, initial burden of 78 burden
hours.202
In addition, each equities exchange
would be required to update the
Exchange Transaction Fee Summary on
a monthly basis to account for changes
from the prior month, if any, and to
report monthly realized average median
fee and rebate information. The
Commission preliminarily believes that
such updates would require fewer
burden hours, as the equities exchanges
would have experience calculating
necessary data and formatting the
reports as required by the proposed
Rule. Accordingly, the Commission
preliminarily estimates that it would
require approximately 2 burden hours
each month, or 24 burden hours on an
annualized basis, for each equities
exchange to update.203 This estimate
contemplates the impact of publicly
posting the summary using the XML
schema to be published on the
Commission’s website. Accordingly, the
Commission preliminarily estimates
that equities exchanges would incur, an
aggregate, annual burden of 312 burden
hours to publicly post on their websites
195 80 burden hours per equities exchange × 13
equities exchanges = 1,040 burden hours.
196 Total estimated burdens which reflect the
Commission’s preliminary view that annual
ongoing burdens would be approximately half the
burdens of initially ensuring it has the appropriate
systems to capture the required information in the
required format: (Attorney at 10 hours) +
(Compliance Manager at 10 hours) + (Programmer
Analyst at 10 hours) + (Senior Business Analyst at
10 hours) = 40 burden hours.
197 40 burden hours per equities exchange × 13
equities exchanges = 520 burden hours.
198 The Commission derived the total estimated
burden from the following estimates: (Compliance
Manager at 2 hours) + (Senior Business Analyst at
2 hours) = 4 burden hours per equities exchange.
199 See infra notes 364–366 and accompanying
text.
200 The Commission derived the total estimated
burden from the following estimates, which reflect
the Commission’s preliminary belief that the
equities exchanges have experience posting
information in an XML format on publicly-available
websites: (Compliance Manager at 1 hour) +
(Programmer Analyst at 1 hour) = 2 burden hours
per equities exchange.
201 4 burden hours per equities exchange × 13
equities exchanges = 52 burden hours.
202 2 burden hours per equities exchange × 13
equities exchanges = 26 burden hours.
203 The Commission derived the total estimated
burden from the following estimates: (Compliance
Manager at 1 hour) + (Programmer Analyst at 1
hour) = 2 burden hours per equities exchange per
month. 2 burden hours per equities exchange per
month × 12 months per year = 24 burden hours per
equities exchange per year.
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the Exchange Transaction Fee
Summaries.204
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3. Order Routing Data
Proposed Rule 610T(d) would require
each national securities exchange that
trades NMS stocks to prepare, in pipedelimited ASCII format, and publicly
post on its website, no later than the last
day of each month, specified data
containing aggregated and anonymized
broker-dealer order routing information
for the prior month in accordance with
the specifications set forth in proposed
Rule 610T(d). Such data would be
collected throughout the duration of the
Pilot, as well as during the six-month
pre-Pilot Period and the six-month postPilot Period. For the pre-Pilot Period,
order routing datasets would include
each NMS stock. For the Pilot Period
and post-Pilot Period, order routing
datasets would include each Pilot
Security. In preparing the order routing
datasets, the equities exchanges would
be required to anonymize information
relating to the identity of individual
broker-dealers before making the
datasets publicly available. This
anonymization would be achieved
through the use of an anonymization
key developed by the Commission,
using CRDs.205
The Commission preliminarily
estimates that, on average, there would
be no paperwork burden to the equities
exchanges to capture the required order
routing data, as the Commission expects
that the equities exchanges would
collect the required data to create the
order routing datasets through existing
systems and technology already in place
for the collection and reporting of data
pursuant to the CAT NMS Plan.
Furthermore, the Commission notes that
the equities exchanges currently
generate similar monthly datasets
pursuant to Rule 605 of Regulation
NMS.206 Accordingly, the Commission
preliminarily believes that the equities
exchanges would be able to leverage
existing systems and technology utilized
for Rule 605 reporting purposes to
create the proposed monthly order
routing datasets. The Commission
preliminarily believes, however, that the
equities exchanges would incur an
initial one-time burden of 80 burden
hours per equities exchange to ensure
that its systems and technology are able
to accommodate the proposed
requirements to aggregate, anonymize,
and publicly post the order routing
204 2 burden hours per equities exchange × 13
equities exchanges × 12 monthly updates = 312
burden hours per year.
205 See supra Section III.E.3.
206 See 17 CFR 242.605.
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information.207 Accordingly, the
Commission preliminarily estimates
that the aggregate one-time initial
burden for ensuring its systems and
technology are able to aggregate,
anonymize, and post the required order
routing data in compliance with
proposed Rule 610T(d) would be 1,040
burden hours.208
Once an equities exchange has
determined that it maintains the
appropriate systems and technology
required for aggregation, anonymization,
and posting of the required information,
the Commission preliminarily believes
that it would be necessary for each
equities exchange to undertake ongoing
efforts to ensure that their systems and
technology are up to date so that the
equities exchange may remain in
compliance with the proposed Rule.
These efforts could include personnel
time to monitor the posting of the
required data and the maintenance of
the systems necessary to post the
required data. The Commission
preliminarily estimates that, on average,
it would take an equities exchange
approximately 40 burden hours per year
to ensure that the systems and
technology are up to date so as to
facilitate compliance with the proposed
Rule.209 Therefore, the Commission
preliminarily estimates that the
aggregate annual burden to maintain the
systems necessary to aggregate,
anonymize, and post the required order
routing information to be approximately
520 burden hours per year.210
In addition, each equities exchange
would incur an ongoing burden
associated with creating and formatting
the order routing datasets to be publicly
posted each month. The equities
exchanges have experience with
creating similar datasets in accordance
207 The Commission preliminarily estimates that
an equities exchange will assign responsibilities for
review and potential modification of its systems
and technology to an Attorney, a Compliance
Manager, a Programmer Analyst and a Senior
Business Analyst. The Commission estimates the
burden of reviewing and potentially modifying its
systems and technology to be as follows: (Attorney
at 20 hours) + (Compliance Manager at 20 hours)
+ (Programmer Analyst at 20 hours) + (Senior
Business Analyst at 20 hours) = 80 burden hours
per equities exchange. See supra note 194.
208 80 burden hours per equities exchange × 13
equities exchanges = 1,040 burden hours.
209 The Commission derived the total estimated
burdens from the following estimates, which reflect
the Commission’s preliminary view that annual
ongoing burdens would be approximately half the
burdens of initially ensuring it has the appropriate
systems to capture the required information in the
required format: (Attorney at 10 hours) +
(Compliance Analyst at 10 hours) + (Programmer
Analyst at 10 hours) + (Business Analyst at 10
hours) = 40 burden hours per equities exchange.
210 40 burden hours per equities exchange × 13
equities exchanges = 520 burden hours.
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with their obligations under Rule 605 of
Regulation NMS. The Commission
preliminarily believes that each equities
exchange would incur burdens similar
to those associated with preparing Rule
605 reports.211 Accordingly, the
Commission preliminarily believes that
each equities exchange would incur a
burden of six burden hours per month,
or 72 burden hours per year, to prepare
and publicly post on its website the
order routing datasets.212 Therefore, the
aggregate, annual burden to publicly
post on their websites order routing
datasets in accordance with proposed
Rule 610T(d) would be approximately
936 burden hours.213
E. Collection of Information Is
Mandatory
Each collection of information
discussed above would be a mandatory
collection of information.
F. Confidentiality of Responses to
Collection of Information
The Pilot Securities Exchange List,
Pilot Securities Change List, Order
Routing Datasets, and the Exchange
Transaction Fee Summary would not be
confidential. Rather, each would be
publicly posted by the exchanges. With
respect to the Order Routing Datasets,
the equities exchanges would
anonymize the data they collect under
Proposed Rule 610T(d) before publicly
posting it on their respective websites.
G. Retention Period for Recordkeeping
Requirements
National securities exchanges would
be required to retain records and
information pursuant to Rule 17a–1
under the Exchange Act.214
H. Request for Comments
Pursuant to 44 U.S.C. 3506(c)(2)(B),
the Commission solicits comments to:
67. Evaluate whether the proposed
collections of information are necessary
for the proper performance of the
functions of the agency, including
whether the information shall have
practical utility;
68. Evaluate the accuracy of our
estimates of the burden of the proposed
collection of information;
69. Determine whether there are ways
to enhance the quality, utility, and
211 See FR Doc. 2016–08552, 81 FR 22143 (April
14, 2016) (‘‘Request to OMB for Extension of Rule
605 of Regulation NMS’’).
212 Compliance Manager at 3 hours + Programmer
Analyst at 3 hours = 6 burden hours per month, per
equities exchange. 6 burden hours per month × 12
months = 72 burden hours per year, per equities
exchange.
213 72 burden hours per year × 13 equities
exchanges = 936 burden hours.
214 17 CFR 240.17a–1. See also supra note 147.
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clarity of the information to be
collected; and
70. Evaluate whether there are ways
to minimize the burden of collection of
information on those who are to
respond, including through the use of
automated collection techniques or
other forms of information technology.
Persons submitting comments on the
collection of information requirements
should direct them to the Office of
Management and Budget, Attention:
Desk Officer for the Securities and
Exchange Commission, Office of
Information and Regulatory Affairs,
Washington, DC 20503, and should also
send a copy of their comments to
Secretary, Securities and Exchange
Commission, 100 F Street NE,
Washington, DC 20549–1090, with
reference to File Number S7–05–18.
Requests for materials submitted to
OMB by the Commission with regard to
this collection of information should be
in writing, with reference to File
Number S7–05–18 and be submitted to
the Securities and Exchange
Commission, Office of FOIA/PA
Services, 100 F Street NE, Washington,
DC 20549–2736. As OMB is required to
make a decision concerning the
collection of information between 30
and 60 days after publication, a
comment to OMB is best assured of
having its full effect if OMB receives it
within 30 days of publication.
V. Economic Analysis
As explained above, the proposed
Transaction Fee Pilot is designed to
produce information on the effect of
transaction-based fees on order routing
decisions by broker-dealers, as well as
execution and market quality.215 In
recent years, a number of academics and
market participants have expressed
concern that the structure of
transaction-based fee pricing may lead
to potential conflicts of interest between
broker-dealers and their customers
when brokers-dealers route customer
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215 Execution
quality generally refers to how
favorably customer orders are executed. Execution
quality measures are similar to liquidity measures
and tend to include transaction costs, the speed of
execution, the probability that the trade will be
executed, and the price impact of the trade. See
NMS Adopting Release, supra note 1, at 37513–15,
37537–38. Market quality encompasses execution
quality but also relates more generally to how well
the markets function. Market quality measures
include liquidity, price discovery, and volatility in
prices. See, e.g., Henrik Bessembinder, ‘‘Trade
Execution Costs and Market Quality after
Decimalization,’’ Journal of Financial and
Quantitative Analysis 38, 747–777 (2003) available
at https://doi.org/10.2307/4126742; Maureen
O’Hara and Mao Ye, ‘‘Is Market Fragmentation
Harming Market Quality?’’, Journal of Financial
Economics 100, 459–474 (2011) available at https://
www.sciencedirect.com/science/article/pii/
S0304405X11000390.
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orders to trading centers offering large
rebates so that the broker-dealer can
capture the rebates, even when these
venues do not offer high execution
quality.216 However, as discussed in
more detail below, the Commission
cannot determine from existing
empirical evidence the impact, if any, of
transaction-based fees on order routing
decisions by broker-dealers.
Specifically, determining whether a
causal relationship between exchanges’
choice of transaction-based fees and
broker-dealers’ routing decisions is
complicated because transaction-based
fees and order routing decisions could
be jointly determined and order routing
decisions could influence fees just as
fees could influence order routing
decisions. Currently available data do
not permit researchers to isolate these
factors and thus identify the existence
or direction of such a causal
relationship, which in turn impedes
researchers’ ability to determine the
extent to which conflicts may exist.217
Moreover, the identification of potential
causal relations between fees and order
routing decisions becomes increasingly
complex as exchanges modify their
fees.218
Because of the existing lack of
empirical evidence regarding these
potential conflicts of interest, additional
information would assist the
Commission in making regulatory
decisions about whether and how to
address transaction-based fees and
rebates. To remedy the insufficiency of
existing empirical evidence, the
Commission is proposing a Transaction
Fee Pilot, which would provide the
Commission and the public with data
currently unavailable to study fees and
rebates that exchanges assess to brokerdealers and observe the effects of
potential conflicts of interest that could
arise between broker-dealers and their
customers in connection with these fees.
Specifically, the Commission expects
216 See, e.g., Angel, Harris and Spatt, supra note
106; Battalio Equity Market Study, supra note 22;
Harris, supra note 23.
217 As proposed, the Transaction Fee Pilot would
require the exchanges to make data available to the
Commission and the public. Raw data provided by
the Transaction Fee Pilot are likely to be used by
a subset of academic and regulatory researchers
(hereafter ‘‘researchers’’) to develop analyses and
discussion about the effects of transaction-based
fees and rebates on order routing decisions, which
could provide valuable information to the public
and to the Commission.
218 Over the last five years, U.S. equities
exchanges, on average, have made 34 revisions, or
approximately 6.7 revisions per year, to their
transaction-based fees and rebates. In contrast to
these changes, which are at the discretion of the
exchanges and subject to Commission review, the
proposed Transaction Fee Pilot would impose a
change to access fees and rebates outside of the
exchanges’ control. See Section V.B.2.b infra.
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13039
that these data are likely to shed light
on the extent, if any, to which brokerdealers route orders in ways that benefit
the broker-dealer but may not be
optimal for customers. The data
obtained from the proposed Transaction
Fee Pilot would inform any possible
future regulatory action that addresses
these potential conflicts of interest to
the ultimate benefit of investors. In
addition, the proposed Transaction Fee
Pilot data would also provide
information about other potential
economic effects of reducing access fee
caps or prohibiting rebates or Linked
Pricing. For example, the proposed
Transaction Fee Pilot could offer
information on whether prohibiting
rebates or Linked Pricing alters brokerdealer behavior in a manner that affects
market quality. Specifically, the
proposed Pilot may provide information
on how rebates affect quoted spreads,
particularly for small and mid-cap
securities, as well as how changes to
fees affect order flow among trading
centers.219
The proposed Transaction Fee Pilot
would permit the study of whether
conflicts of interest exist by (1)
providing an exogenous shock to
transaction-based fees and rebates, and
(2) enabling the collection of
representative results of data across a
broad range of securities.220 An
exogenous shock is an unpredictable or
unexpected event that is outside of the
economy or the system (i.e., not under
the control or influence of those being
studied) but can induce endogenous
(i.e., within the system) responses. In
the context of this proposed rule, the
exogenous shock would take the form of
either a reduction of the maximum
permissible access fees or a prohibition
on rebates or Linked Pricing paid by all
U.S. equities exchanges. This shock
would allow the Commission and others
to explore how exogenous changes to
fees and rebates could lead to changes
in the ways in which broker-dealers
route customer orders for a broad
sample of NMS securities. Specifically,
the reduction in fees or elimination of
rebates or Linked Pricing, as required in
specific test groups of the proposed
Pilot, may reduce the magnitude of a
potential conflict of interest between
broker-dealers and their clients caused
by transaction-based fees and rebates. A
219 See Section V.C.1.a.ii infra, for further
discussion of the benefits of studying other
economic effects of transaction fees and rebates.
220 See Section V.B.1 infra, for discussion of
existing studies related to these topics and their
limitations. See also Section II.B supra, for details
of the Nasdaq study, which examined a change in
the access fees and rebates charged by Nasdaq for
14 stocks over a four-month period.
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reduction in this potential conflict of
interest would, in turn, be reflected in
measurable changes to broker-dealer
order routing decisions.
As discussed in Section III.C, the
proposed Pilot would span a two-year
period, with an automatic sunset at the
end of the first year unless, prior to that
date, the Commission publishes a notice
determining that the proposed Pilot
shall continue for up to another year,221
and would apply to both maker-taker
and taker-maker exchanges. All NMS
stocks (including ETPs) that have prices
of at least $2.00 at the time of selection
would be included in the proposed Pilot
and would be segmented into three test
groups and one control group. Each test
group would contain a mix of stocks
and ETPs, stratified based on variables
such as market capitalization, share
price, and liquidity.222 Under the
requirements of the proposed Pilot, the
exchanges could not charge any access
fee or, where applicable, provide rebates
or Linked Pricing, in excess of the
limitations indicated by the proposed
Pilot. Stocks and ETPs in Test Groups
1 and 2 would be restricted to maximum
fees of $0.0015 and $0.0005 (with no
restrictions on rebates), respectively,
while Test Group 3 would eliminate the
exchanges’ ability to provide rebates to
liquidity providers on maker-taker
exchanges and liquidity takers on takermaker exchanges for both displayed and
non-displayed liquidity and would
prohibit Linked Pricing. Both the
Control Group and Test Group 3 would
maintain the current access fee cap of
$0.0030 required by Rule 610(c) of
Regulation NMS. By construction, Test
Group 3 is designed to observe the effect
of the absence of rebates or Linked
Pricing on conflicts of interest and the
equilibrium fee level and how that fee
level would affect order routing
decisions, execution quality, and market
quality. Further, exchanges would
continue to be permitted to have varying
fees within each test group, and would
be permitted to change their fees at their
discretion, subject to Commission
review, during the proposed Pilot for
securities within each test group, so
long as they comply with the conditions
of the applicable test group.
In the absence of the proposed Pilot,
the Commission preliminarily believes
it is unlikely that exchanges would
collectively undertake a similar pilot
and voluntarily coordinate the
exogenous shock to fees and rebates
across a broad set of securities, broker-
dealers, and exchanges that would be
required to appropriately analyze the
effects of changes to fees and rebates.223
By imposing the same modifications to
fees and rebates on all U.S. equities
exchanges, the proposed Pilot would
allow the Commission and the public to
obtain data that would permit them to
examine how changes to fees and
rebates affect order routing decisions of
broker-dealers. Accordingly, the
Commission believes that the proposed
Pilot would enable the collection of
valuable data for both the Commission
and the public that would otherwise be
unavailable.
The Commission is mindful of the
costs imposed by, and the benefits
obtained from, our rules. Whenever the
Commission engages in rulemaking and
is required to consider or determine
whether an action is necessary or
appropriate in the public interest,
Section 3(f) of the Exchange Act
requires the Commission to consider
whether the action would promote
efficiency, competition, and capital
formation, in addition to the protection
of investors.224 Further, when making
rules under the Exchange Act, Section
23(a)(2) of the Exchange Act requires the
Commission to consider the impact
such rules would have on
competition.225 Section 23(a)(2) of the
Exchange Act also prohibits the
Commission from adopting any rule that
would impose a burden on competition
not necessary or appropriate in
furtherance of the purposes of the
Exchange Act.226 The Commission
preliminarily believes that many of the
likely impacts of this proposal on
efficiency, competition, and capital
formation would be temporary in nature
and would affect markets only for the
duration of the proposed Pilot. The
following analysis considers in detail
the economic effects that may result
from the Transaction Fee Pilot proposed
in this release.
Where possible, the Commission has
quantified the likely economic effects of
the proposed Transaction Fee Pilot;
however, as explained further below,
the Commission is unable to quantify all
of the economic effects because it lacks
the information necessary to provide
reasonable estimates. In some cases,
quantification depends heavily on
factors outside of the control of the
Commission, which make it difficult to
predict how market participants would
act under the conditions of the proposed
Pilot. For example, because of the
221 See
223 See
222 See
224 See
Section III.D infra.
supra note 116. The Commission would
detail the specifications of the stratification by
notice.
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Section V.B.1.b.i infra.
15 U.S.C. 77b(b) and 15 U.S.C. 78c(f).
225 See 15 U.S.C. 78w(a)(2).
226 Id.
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flexibility that market participants have
with respect to the choice of trading
center for execution of transactions and
because those choices can be influenced
by factors outside of the scope of this
pilot, such as volume discounts, the
Commission cannot quantify, ahead of
the proposed Pilot, the economic impact
of any changes in order routing
decisions by broker-dealers that may
result from the proposed Pilot.
Nevertheless, as described more fully
below, the Commission provides both a
qualitative assessment of the potential
effects and a quantified estimate of the
potential aggregate initial and aggregate
ongoing costs, where feasible. The
Commission encourages commenters to
provide data and information to help
quantify the costs, benefits, and the
potential impacts of the proposed rule
on efficiency, competition, and capital
formation.
A. Background on Transaction-Based
Fees and Potential Conflicts of Interest
This section provides a review of
transaction-based fee models, including
a discussion of the history and
mechanics of transaction-based pricing.
This section also presents an overview
of the recent concerns about potential
conflicts of interest between brokerdealers and their customers attributed to
access fees and rebates assessed by
exchanges.
1. Overview of Transaction-Based Fees
Maker-taker pricing models originated
on electronic communications networks
(ECNs) in the late 1990s as ECNs
attempted to attract order flow and draw
liquidity from traditional exchanges by
offering rebates to market participants
that posted liquidity to their
platforms.227 Shortly thereafter,
exchanges followed suit and adopted
maker-taker pricing models as market
share migrated from traditional
exchanges to ECNs. Today, nearly all
U.S. equities exchanges have some form
of transaction-based pricing models.228
Generally, transaction-based pricing
models charge fees or remit rebates to
members depending on whether their
executed orders ‘‘make’’ or ‘‘take’’
liquidity from the market. An order that
makes liquidity provides share volume
(or depth) on a trading center at various
execution prices, whereas an order that
227 In 1997, Island ECN was the first electronic
trading platform to offer rebates to attract limit
orders to its platform.
228 As of March 2018, EDGA and IEX do not
operate as a maker-taker or taker-maker market,
although both charge flat fees. The remaining 11
exchanges are either maker-taker (nine) or takermaker (two) exchanges. The baseline discusses
these exchanges in more detail.
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takes liquidity removes the volume (or
depth) resting on the trading center
provided by the make orders. Orders
that make, or provide, liquidity are nonmarketable limit orders, which are limit
orders that are submitted to an exchange
or other trading center that cannot be
filled immediately when they arrive
because no market participant is willing
to trade at the price of the order (i.e., the
limit price).229 For example, if a
customer places an order to sell 100
shares of a security at $9.00 per share
when the prevailing market bid price is
$8.75, that customer is placing a nonmarketable limit sell order that indicates
her willingness to provide 100 shares of
liquidity to the market at a price of
$9.00. In contrast, orders that take, or
remove, liquidity, are marketable orders.
A marketable order, in turn, can be
either a market order, which is an order
to buy or sell a security to be executed
immediately at current market prices,230
or a marketable limit order, which is
either a limit buy order with a price at
or above the lowest offer price in the
market or a limit sell order with a price
at or below the highest bid in the
market. For example, if a customer
places an order to sell 100 shares of a
security at $8.50 per share when the
prevailing market bid price is $8.75 at
a depth of more than 100 shares, that
customer is placing a marketable limit
sell order, and would take 100 shares of
liquidity at a price of $8.75.
In maker-taker models, an exchange
charges an access fee to broker-dealers
that take liquidity using marketable
orders and remits a rebate to brokerdealers that make liquidity by placing
standing non-marketable limit orders
that subsequently interact with
marketable orders. In a taker-maker
market, the exchange charges an access
fee to broker-dealers that provide
liquidity by placing non-marketable
limit orders and pays a rebate to market
participants that take liquidity using
marketable orders. In 2005, the
Commission adopted Rule 610(c) of
Regulation NMS,231 which limited the
maximum access fee that could be
charged by maker-taker exchanges to
$0.0030 per share. The adoption of the
fee limit was designed to ensure the
fairness and accuracy of the displayed
quotations by establishing an upper
bound on the cost of accessing such
229 A limit order is an order to buy or sell a
security at a specified price or better. As the price
of the non-marketable order gets further from the
bid or offer price, the greater the likelihood that the
non-marketable order must rest until better priced
orders execute.
230 As long as there are willing sellers and buyers,
market orders are filled.
231 See NMS Adopting Release, supra note 1.
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quotations,232 while also precluding
certain trading centers from raising their
fees substantially to market participants
required to access their quotations by
the Order Protection Rule,233 and
preventing certain trading centers from
taking advantage of intermarket price
protection by acting as toll booths
between price levels.234
2. Potential Conflicts of Interest
Academics, market participants,
regulators, and legislators recently have
expressed concern about how
transaction-based fees have affected
order routing decisions by brokerdealers and the execution quality
obtained by customers.235 This concern
has centered on the potential for
conflicts of interest between brokerdealers and their customers that may
distort best execution practices.
Broker-dealers are required to use
reasonable diligence to execute
customer orders according to best
execution standards, which require
broker-dealers ‘‘to execute customers’
trades at the most favorable terms
reasonably available under the
circumstances . . .’’ 236 When seeking
best execution for their orders, brokerdealers often consider opportunities to
obtain prices better than those currently
quoted. In order to comply with best
execution standards, broker-dealers
evaluate their aggregate customer orders
and periodically assess which
competing trading center offers the most
favorable terms of execution.237 The
quoted prices that are used by brokerdealers to meet their best execution
232 See
id. at 37543–46.
NMS Adopting Release, supra note 1, at
37504–38. The Order Protection Rule is designed to
ensure that investors receive a consistent price
quotation for NMS stocks across all exchanges
where a security is traded and that investors receive
the best possible execution price for marketable
orders.
234 See id. at 37584. See also Harris, supra note
23 (suggesting that large access fees were a response
to some trading venues paying large rebates to
market participants as a means of attracting order
flow to those venues in the early days of makertaker exchanges).
235 See Staff Maker-Taker Memo, supra note 99.
See also Angel, Harris, and Spatt, supra note 106;
Jeffrey Bacidore, Hernan Otero, and Alak Vasa,
‘‘Does Smart Routing Matter?’’, Working Paper,
Investment Technology Group, Inc. (2010),
available at: https://papers.ssrn.com/sol3/
papers.cfm?abstract_id=1681449 (‘‘Bacidore, Otero,
and Vasa’’); Battalio Equity Market Study, supra
note 22; Harris, supra note 23. In addition to
potential conflicts of interest, several of these
studies have also indicated that transaction-based
pricing models have led to reduced price
transparency for investors and increased market
fragmentation and complexity. These are discussed
in greater detail in Section V.C.1.b, infra.
236 See NMS Adopting Release, supra note 1, at
37537–38. See also supra note 215.
237 See NMS Adopting Release, supra note 1, at
37537–38.
233 See
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13041
standards do not reflect any access fees
assessed or rebates offered by the
exchanges.238
Even while complying with best
execution requirements, broker-dealers
may route non-marketable limit orders
to trading centers that offer the best
quoted prices but that also offer high
rebates for those orders, which the
broker-dealers may then retain, rather
than pass through to customers.239 The
availability of high rebates, however,
may influence how broker-dealers route
customer orders to the detriment of
customers, even if orders are still routed
to an exchange posting the best quoted
prices.240 One study, for example,
shows lower execution quality, in terms
of reduced probability of execution or
increased time to execution, for nonmarketable limit orders on exchanges
that pay high rebates.241 Thus, brokerdealers may route orders to exchanges
that have the best quoted prices but are
suboptimal for customers in other ways
238 See,
e.g., Angel, Harris, and Spatt, supra note
106.
239 The potential conflicts of interest are more
likely when broker-dealers retain the rebates,
because such broker-dealers have greater incentive
to maximize those rebates potentially at the expense
of customer execution quality. The Battalio Equity
Market Study, for example, found that a sample of
retail broker-dealers appear to route orders to
venues that offer large rebates, thereby maximizing
order flow payments. However, as noted in the
Battalio Equity Market Study, routing orders to
venues with large rebates did not result in superior
execution quality for non-marketable limit orders.
See Battalio Equity Market Study, supra note 22.
See also David Cimon, ‘‘Broker Routing Decisions
in Limit Order Markets,’’ Working paper, Bank of
Canada, (2017) available at https://
papers.ssrn.com/sol3/papers.cfm?abstract_
id=2789804. Cimon provides a theoretical model of
conflicts of interest in broker-dealer markets, where
broker-dealers route marketable orders to venues
with low access fees to reduce the access fees paid
by the broker-dealer, increasing the volume of
uninformed orders and lowering the risk of adverse
selection for non-marketable limit orders posted to
that venue.
240 The duty of best execution requires brokerdealers to execute customer trades at the most
favorable terms reasonably available under the
circumstances. See NMS Adopting Release, supra
note 1, at 37537–38. The duty of best execution is
not inconsistent with the automated routing of
orders; however, broker-dealers must periodically
assess the quality of competing markets to ensure
that order flow is directed to markets providing the
most beneficial terms for their customer orders.
241 See, Battalio Equity Market Study, supra note
22, which finds some evidence that execution
quality is related to the transaction-based fees. For
instance, in their analysis of a single order-routing
system, for a sample of matched limit orders placed
on high fee and low fee venues, high fee venues
have a fill rate of approximately 73%, while low fee
venues have a fill rate of approximately 99% (Table
V). Further, in a multiple regression analysis (Table
VI), the study shows that the probability of filling
an order is decreasing as the take fee increases,
while the time to execution increases. The
limitations of the Battalio Equity Market Study are
discussed below in Section V.B.1.b, infra.
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because orders are either less likely or
take longer to execute.
Maker-taker exchanges with high
rebates tend to have high access fees,
which increase the cost to brokerdealers to execute marketable orders.
These high access fees may lead brokerdealers to route marketable orders to
exchanges with lower access fees, even
though there may be a significant
number of standing non-marketable
limit orders on exchanges with higher
access fees.242 As the broker-dealers
route marketable orders to exchanges
with lower access fees, execution
quality for the non-marketable limit
orders is likely to deteriorate because
the non-marketable limit orders are
likely to have lower probability of
execution and longer times to execution
for orders that do execute. High rebates
may also limit the ability of an exchange
to generate a liquidity externality
because these high rebates could draw
order flow to exchanges with low
execution quality, despite the
availability of higher execution quality
on other trading centers.243 This
behavior may fragment order flow. In
contrast, if exchanges did not provide
high rebates, broker-dealers may be
more likely to route orders to exchanges
that quote the best price and have the
best overall execution quality,244
permitting order flow to consolidate on
those venues.
In general, customer orders routed to
exchanges that remit high rebates are
also more likely to face adverse
selection when executed.245 Adverse
selection occurs when one party to a
transaction has less information about
the value of an asset than the other party
to the transaction, resulting in the
possibility that the less informed party
only transacts when it is
disadvantageous to do so. In the context
242 See,
Angel, Harris, and Spatt, supra note 106.
liquidity externality occurs when a given
trading center becomes the preferred trading
destination for both marketable and non-marketable
orders.
244 See Battalio Equity Market Study, supra note
22, at 2232 (‘‘[O]ur results suggest that . . . routing
decisions based primarily on rebates/fees are
inconsistent with best execution. For limit order
traders, there are significant opportunity costs [with
respect to execution quality] with routing all
nonmarketable limit orders to a single venue
offering the highest liquidity rebates.’’).
245 See, Angel, Harris, and Spatt, supra note 106.
See also Peter Hoffman, ‘‘Adverse Selection, Market
Access and Inter-market Competition,’’ Journal of
Banking & Finance 65, 108–119 (2016), available at
https://www.sciencedirect.com/science/article/pii/
S0378426615002976; Sviatoslav Rosov, ‘‘HFT, Price
Improvement, Adverse Selection: An Expensive
Way to Get Tighter Spreads?’’, CFA Institute (2014)
available at https://blogs.cfainstitute.org/market
integrity/2014/12/18/hft-price-improvementadverse-selection-an-expensive-way-to-get-tighterspreads/ (‘‘Rosov’’).
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243 A
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of order execution, adverse selection is
likely to occur because some fraction of
market participants is likely to possess
more precise information about the
value of a security.246 Order flow from
these ‘‘informed traders’’ is generally
routed to exchanges. In order for the
exchanges to draw sufficient liquidity to
satisfy the orders placed by informed
traders, they may offer high rebates to
broker-dealers to attract non-marketable
limit orders, which are likely to be
placed by uninformed traders, to satisfy
the demands of informed traders’ order
flow.247 Under such circumstances,
these non-marketable limit orders face
an adverse selection problem because
they execute against marketable orders
that likely were placed by informed
traders.248 As adverse selection
increases at high rebate/high fee
exchanges, informed traders will always
execute orders to the detriment of
uninformed traders (retail customers),
i.e., the orders will more likely be
executed at disadvantageous prices for
the uniformed traders relative to
customer orders routed to low rebate/
low fee exchanges, where the likelihood
of facing an informed trader is less.249
246 Some market participants may know more
about the value of a security because some
investors, such as some professional traders, could
just be better at processing public information. See,
e.g., Michael Brennan and Avanidhar
Subrahmanyam, ‘‘Market Microstructure and Asset
Pricing: On the Compensation for Illiquidity in
Stock Returns,’’ Journal of Financial Economics 41,
441–464 (1996), available at https://www.science
direct.com/science/article/pii/0304405X9500870K;
David Easley and Maureen O’Hara, ‘‘Information
and the Cost of Capital,’’ Journal of Finance 59,
1553–1583 (2004), available at https://online
library.wiley.com/doi/10.1111/j.15406261.2004.00672.x/pdf.
247 Exchanges do not have sufficient liquidity
from retail marketable orders because they are
generally internalized or routed to wholesalers to
avoid access fees. Several studies indicate that
internalizers are unlikely to accept marketable
orders from market participants that are likely to be
informed. See Angel, Harris, and Spatt, supra note
216; Rosov, supra note 245.
248 See, e.g., Dolgopolov, supra note 21. For
example, if an investor had a non-marketable limit
buy order at $10, when the current market price
was $10.25, that standing limit order to buy at $10
is likely to only get executed when prices are
declining.
249 See Katya Malinova and Andreas Park,
‘‘Subsidizing Liquidity; the Impact of Make/Take
Fees on Market Quality,’’ Journal of Finance 70,
509–536 (2015), available at https://online
library.wiley.com/doi/10.1111/j.15406261.2004.00672.x/pdf (examining the introduction
of maker rebates on the Toronto Stock Exchange);
Yiping Lin, Peter Swan, and Frederick H. deB.
Harris, ‘‘Maker-Taker Fees, Liquidity Competition,
and High Frequency Trading,’’ Working Paper,
University of New South Wales (2017) (examining
the Nasdaq pilot, described above in Section II.B).
In analyses of markets where exchanges conducted
pilots altering the access fees and rebates paid on
subsets of stocks, results indicate that markets with
lower access fees (and rebates) had reduced adverse
selection costs. Venues with lower access fees could
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In these situations, the broker-dealers
thus face a potential conflict of interest
when they receive high rebates from the
exchanges seeking to attract liquidity
while their customers bear costs of the
disadvantageous prices resulting from
the adverse selection.
Given the competitive nature of the
broker-dealer industry,250 the
Commission considered whether
competition could alleviate potential
conflicts of interest between investors
and broker-dealers, as investors choose
between broker-dealers that offer to
place orders on their behalf. To the
extent that investors are able to identify
broker-dealers that do not act on
potential conflicts of interest, investors
could discourage broker-dealers from
acting on such conflicts of interest. The
Commission preliminarily believes,
however, that competition between
broker-dealers may not resolve this
issue because of a combination of three
reasons: Asymmetric information,
switching costs and a lack of collective
action.
First, asymmetric information
between broker-dealers and their
customers limits the ability of customers
to identify broker-dealers that do not act
on potential conflicts of interest. For
example, customers do not generally
have access to information about brokerdealers’ individual sources of
revenue.251 As discussed below in more
detail, although disclosures required
pursuant to Rule 606 provide
information about material conflicts of
interest related to payment for order
flow, these disclosures do not provide
information on the effect of transactionbased fees on order routing decisions.
Moreover, while under Rule 606, a
customer may request information about
the venues to which her orders were
routed in the prior six months, a
customer cannot necessarily use this
information to compare how these
orders would have been treated by other
broker-dealers. Further, these
draw increased order flow from both informed and
uninformed traders. If the proportion of informed
traders is unlikely to change due to fees and rebates
changes, as overall order flow increases due to
lower access fees, then the likeihood of transacting
with an informed trader declines, thereby reducing
the adverse selection costs to traders.
250 See Section V.B.2.a infra.
251 While consolidated revenues may be available
from Form 10–K filings for broker-dealers that are
public reporting companies, broker-dealers do not
report revenues attributable to specific sources,
such as rebates from a particular exchange or
payments for order flow from a particular venue.
For instance, revenues derived from commissions
and fees are often just reported in aggregate as
‘‘Commissions and Fees.’’ Therefore, even though
aggregate revenues for some broker-dealers are
publicly available, customers do not have access to
the information on individual sources of revenue
that could reveal potential conflicts of interest.
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disclosures do not provide customers
with information about the payment and
collection of transaction-based fees and
rebates by broker-dealers.
Second, even if investors had
sufficient information to conclude they
would be better served by a different
broker-dealer, investors may face costs
in switching broker-dealers.252 If these
switching costs are high relative to the
costs that investors anticipate may arise
from potential conflicts of interest,
investors may not switch broker-dealers
even if it appears that their brokerdealer may have acted on conflicts of
interest.
The presence of switching costs also
may exacerbate a collective action
problem among investors.253 While
investors could provide incentives to
broker-dealers to eliminate potential
conflicts of interest by threatening to
move accounts away from brokerdealers known to act on conflicts of
interest, switching costs may undermine
the credibility of such a threat. This is
because, although each customer
individually bears a cost to switch
accounts, the benefits of a successful
threat, while conditional on a sufficient
number of customers agreeing to switch,
are available to all customers whether
they would switch or not. If the
switching costs are high relative to the
proportion of customer defections
necessary to threaten a broker-dealer,
customers are unlikely to generate
enough of a threat to alter brokerdealers’ behavior.
sradovich on DSK3GMQ082PROD with PROPOSALS2
B. Baseline
We compare the economic effects of
the proposed rule, including benefits,
costs, and effects on efficiency,
competition, and capital formation, to a
baseline that consists of the existing
regulatory framework and market
structure. As explained above, by
temporarily altering the fee and rebate
structure for certain NMS stocks
(including ETPs), the proposed Pilot is
designed to produce information on
order routing behavior that would not
otherwise be available. The baseline
discusses the existing set of information,
as well as the exchanges’ current
practices with respect to fees and
rebates and the regulations governing
those fees and rebates.
252 These switching costs may be monetary, but
may also have a time and effort component.
253 Collective action occurs when a number of
individuals or entities work together to achieve a
common objective, such as investors acting to
reduce the potential conflicts of interest in order
routing decisions by broker-dealers.
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1. Current Information Baseline
While the studies cited above discuss
the potential issues for investors
associated with transaction-based fee
models,254 limited empirical evidence
exists to date about the extent that
potential conflicts of interest arise from
maker-taker and taker-maker pricing
models and how transaction-based fees
affect the integrity and structure of the
U.S. equity markets. Below, we discuss
the existing information currently
available to the Commission or the
public that concerns the relationship
between transaction-based fees and
order routing decisions and describe the
limitations of this information for use in
policy discussions regarding
transaction-based fees and potential
conflicts of interest.
a. Existing Information
The existing empirical studies
available regarding the relation between
transaction-based fees, order routing
decisions, and execution quality
consists of two studies: One academic
study and a study conducted by
Nasdaq.255 According to the Battalio
Equity Market Study, broker-dealers
appear to trade execution quality of
customer orders, as measured by the
likelihood of and time to execution (and
not price), for the rebates obtained by
providing liquidity to maker-taker
venues.256 By routing orders to
exchanges that pay high rebates, brokerdealers may engage in rebate capture at
the expense of client execution.257
Using data obtained from mandatory
Rule 606 disclosures over a two-month
254 See
supra note 216.
a number of studies theoretically
suggest that the transaction-based pricing structure
coupled with discretion by broker-dealers over
order routing decisions could lead to potential
conflicts of interest with their customers, only the
Battalio Equity Market Study provides empirical
evidence on the effect of fees and rebates on order
routing. Battalio Equity Market Study, supra note
22. As discussed more thoroughly below in Section
V.B.1.b, the Battalio Equity Market Study, while
enlightening, has a number of limitations that
inhibit the ability to draw causal inferences from it
about potential conflicts of interest. See, e.g., Angel,
Harris, and Spatt, supra notes 106 and 216;
Dolgopolov, supra note 21; Harris, supra note 23.
256 The Battalio Equity Market Study’s abstract of
the paper states: ‘‘We identify retail brokers that
seemingly route orders to maximize order flow
payments by selling market orders and sending
limit order to venues paying large liquidity
rebates. . . . [W]e document a negative relation
between limit order execution quality and rebate/
fee level. This finding suggests that order routing
designed to maximize liquidity rebates does not
maximize limit order execution quality. . . .’’ See
Battalio Equity Market Study, supra note 22, at
2193.
257 See Battalio Equity Market Study, supra note
22. See also Section V.A.2 supra, for an overview
of the potential conflicts of interest that emerge.
255 Although
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window,258 the Battalio Equity Market
Study also identified that four of the ten
broker-dealers included in the analysis
route limit orders exclusively to market
makers or to exchanges that offered the
largest liquidity rebates (and charging
the highest access fees).259 A number of
tests in the Battalio Equity Market Study
also show that low-fee venues provide
better execution quality for limit orders,
as measured by the likelihood of an
order fill, the speed of execution, and
higher average realized spreads, relative
to high-fee venues, suggesting that order
routing decisions to high rebate venues
are likely to be suboptimal from a
customer’s perspective, and may be
indicative of potential conflicts of
interest.
Separately, and as discussed in
Section II.B,260 Nasdaq independently
conducted a study, whereby it lowered
access fees and rebates for a sample of
14 stocks over a period of four months
in 2015, providing an exogenous shock
to the transaction-based pricing model
on the exchange. The Nasdaq
experiment lowered both the access fees
charged and the liquidity rebates paid
on the securities included in their
study.261 Nasdaq’s analysis indicated
that Nasdaq’s reduction in access fees
and liquidity rebates reduced Nasdaq’s
market share and Nasdaq’s incidence of
providing the NBBO, suggesting that
Nasdaq experienced a decline in some
measures of market quality as a result of
the changes to access fees and
rebates.262 Further, Nasdaq found that
258 Rule 606 requires broker-dealers to provide
quarterly reports that provide an overview of their
routing practices. See Securities Exchange Act
Release No. 51808 (November 27, 2000), 65 FR
75414, (December 1, 2000) (‘‘Disclosure or Order
Execution and Routing Practices’’). Rule 606
disclosures require broker-dealers to disclose
material aspects of their relationships with certain
trading venues, including a description of payment
for order flow. The reports, however, do not require
broker-dealers to disclose the amounts of payment
for order flow, or the rebates received or access fees
paid.
259 See Battalio Equity Market Study, supra note
22. The Battalio Equity Market Study, however,
does not specify whether the limit orders are
marketable or non-marketable limit orders, as Rule
606 disclosures do not segment these orders.
260 See supra notes 31 and 32 and corresponding
text.
261 The Nasdaq study lowered access fees to
$0.0005 and rebates to $0.0004 simultaneously for
a set of 14 securities, half of which identified
Nasdaq as the primary listing exchange, the other
half which identified the NYSE as the primary
listing exchange. The Nasdaq released two reports
(see supra note 31) examining the changes to a
number of metrics related to market quality.
262 Although the 14 stocks experienced a decline
in market share on Nasdaq and their incidence of
time at the NBBO, there was no statistically
significant change in the level of liquidity taking,
variance ratio, realized spread, return
autocorrelation, effective spread, relative effective
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there was a shift in the composition of
the top five liquidity providers for the
securities that occurred as a result of the
experiment.263
Two studies have examined
exogenous shifts between maker-taker
and payment for order flow pricing
models on U.S. options exchanges.264
These studies found that the movement
from a payment for order flow model to
a maker-taker model led to a decrease in
execution costs for option classes
affected by the shift, improved quoted
spreads, and altered broker-dealer order
routing behavior to account for the
fees.265 However, the change to a
payment for order flow model from a
maker-taker model yielded better
execution quality, but a reduction in the
number of orders and order volume.266
A number of existing data sources
could be used independently or in
combination to relate transaction-based
fees to order routing and execution
quality. For instance, in the Battalio
Equity Market Study and the Nasdaq
Study discussed above, researchers
employed some combination of Rule
606 data, proprietary broker-dealer data,
the Trade and Quote (TAQ) database,267
and proprietary exchange data. In
spread, quoted spread, relative quoted spread,
displayed dollar depth at the NBBO, or time
between either quote updates or price changes in
the NBBO. See Nasdaq May Report, supra note 31.
263 The top five liquidity providers prior to the
start of the pilot significantly reduced their
liquidity provision from 44.5% of the liquidity
provided pre-pilot to 28.7% in the pilot period.
However, the top five liquidity providers from the
pilot period had a significant increase in their
liquidity provision from 29.7% pre-pilot to 41.5%
in the pilot period. See Nasdaq May Report, supra
note 31.
264 See Amber Anand, Jian Hua, and Tim
McCormick, ‘‘Make-Take Structure and Market
Quality: Evidence from the U.S. Options Markets,’’
Management Science 62, 3217–3290 (2016),
available at: https://pubsonline.informs.org/doi/
abs/10.1287/mnsc.2015.2274 (‘‘Anand, Hua, and
McCormick’’); Robert Battalio, Todd Griffith, and
Robert Van Ness, ‘‘Make-Take Fees versus Order
Flow Inducements: Evidence from the NASDAQ
OMX PHLX Exchange,’’ Working Paper, University
of Notre Dame (2017), available at: https://
www1.villanova.edu/content/dam/villanova/VSB/
assets/marc/marc2017/SSRN-id2870000.pdf
(‘‘Battalio, Griffith, and Van Ness’’). Anand, Hua,
and McCormick explores the transition from a
payment for order flow model to a maker-taker
model on NYSE ARCA, while Battalio, Griffith, and
Van Ness examines the shift on NASDAQ OMX
PHLX (‘‘PHLX’’) from a maker-taker model to a
payment for order flow model.
265 See Anand, Hua, and McCormick, supra note
264.
266 See Battalio, Griffith, and Van Ness, supra
note 264.
267 The Battalio Equity Market Study, supra note
22, relies on Rule 606 disclosures to identify order
routing for a small sample of broker-dealers,
proprietary broker-dealer data from a single smartorder routing system to capture limit order
execution quality for this broker-dealer’s orders,
and the TAQ data to measure execution quality as
a function of each venue’s taker fee or rebate.
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addition, while not employed in
previous studies, CAT data, Rule 605
data, and exchanges’ Form 19b–4 fee
filings and fee schedules available from
each exchange’s website, could provide
insights into the relation between
transaction-based fees, order routing,
and execution quality.
Rule 606 requires broker-dealers to
make publicly available quarterly
reports that provide an overview of their
routing practices for non-directed retail
orders in NMS securities. As a further
requirement of Rule 606, broker-dealers
must disclose the identities of the ten
venues to which the largest number of
orders were routed for execution. Rule
606 disclosures additionally require
broker-dealers to disclose material
aspects of their relationships with
trading venues to which they route
orders, including a description of
payment for order flow and any profit
sharing relationships, which, like
rebates, could lead to potential conflicts
of interest for broker-dealers when
routing orders.268 Researchers and other
analysts interested in order routing data
can download these forms quarterly
directly from broker-dealer websites.
Proprietary data from broker-dealers
or exchanges could also provide
information about order routing and
execution quality. Broker-dealer data
include information on the orders
received and routed by that brokerdealer, including where the brokerdealer routed orders, whether the orders
execute, and the price, size, and time of
execution. Exchange data include
information on the order received by an
exchange, including which members
routed orders to the exchange, whether
the orders execute, and the price, size,
and time of execution. As these data
include commercially sensitive
information, they are not broadly
available.
Once the CAT Phase 1 becomes
operational,269 the Commission and
SROs will have information on all
exchange routing and exchange
executions for all NMS securities. In
CAT Phase 1, exchanges would record
and report order events on every order
they receive for NMS securities. Order
268 Conflicts of interest for broker-dealers
potentially could arise from a number of sources,
including affiliations with trading venues, receipt of
payment for order flow, receipt of payment from
profit-sharing relationships, and rebates. Rule 606,
however, requires only descriptions of any
arrangements for payment for order flow, but does
not require broker-dealers to provide information
on the net amount of payment for order flow,
payment received from profit-sharing relationships,
or disclosure of access fees paid or rebates received.
See Disclosure of Order Execution and Routing
Practice, supra note 258, at 75425–28.
269 See supra note 172.
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events include order receipt, order
routes, order modifications, order
cancelations, and order executions.
Rule 605 data provides information
about execution quality by market
center, including exchanges, ATSs, and
broker-dealers that execute orders, by
requiring standardized reports of
statistical information regarding order
execution, and was designed to improve
the public disclosure of order execution
practices by exchanges.270 These data
are available monthly from market
center websites or data vendors, and
provide information on execution
quality statistics such as transaction
costs, execution speed, and fill rates
reported separately for marketable and
non-marketable orders.
Beyond Rule 605 data, researchers
could also use the TAQ database as a
means of measuring order execution
quality. The TAQ database is publicly
available (for a fee) from the NYSE and
provides access to all trades and quotes
for NMS securities, from which
researchers and other analysts can
estimate trade-based measures of
execution quality.
Finally, researchers and other analysts
can manually create datasets of
exchange fees and rebates from the
information that exchanges provide on
their websites and release in their
Notice of Filing of Proposed Rule
Changes, which would capture
information contained in exchanges’
Form 19b–4 fee filings. The Form 19b–
4 fee filings record changes to the
existing exchange fee schedules with
the Commission. At any point that an
exchange chooses to make a change to
any aspect of its access fees and rebates,
the exchange must provide notice to the
Commission that it is filing a proposed
rule change to amend its existing fee
and rebate schedule. Exchanges may file
their revisions to fees and rebates for
immediate effectiveness upon
submitting the Form 19b–4 fee filings
with the Commission.
b. Limitations of Existing Information
Existing studies and available data
sources are limited in ways that are
likely to reduce the strength of
conclusions that relate to the impact of
transaction-based fees and rebates on
order routing decisions and the
existence or magnitude of potential
conflicts of interest between brokerdealers and their customers. The
limitations of existing studies fall
primarily into two categories: (1) The
results of the studies may not be
representative, and (2) the results of the
270 See Disclosure of Order Execution and
Routing Practice, supra note 258, at 75417–25.
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studies cannot make a causal
connection needed to inform on
potential conflicts of interest. This
section discusses those limitations as
well as separately discussing the
limitations associated with existing
sources of data mentioned above.
sradovich on DSK3GMQ082PROD with PROPOSALS2
i. Representative Results
The results of both the Battalio Equity
Market Study and the Nasdaq study may
not be representative of the potential
impacts of broad changes in access fees
or rebates. Drawing market-wide
inferences from the limited samples in
these studies could be problematic
because the results are predicated on
information obtained from a single
broker-dealer or trading venue. First, the
Battalio Equity Market Study uses order
level data from a single broker-dealer to
determine the relation between makertaker fees and limit order execution
quality. Analysis based on observation
of a single broker-dealer may not
provide representative results because
the relation between transaction-based
fees and potential conflicts of interest
may not be generalizable to other
broker-dealers. For example, over 400
broker-dealers maintain membership
with at least one U.S. equities
exchange.271 If the single broker-dealer
examined in the Battalio Equity Market
Study has significantly different order
routing behavior than the average
broker-dealer that routes orders to
exchanges, the information obtained
from examining the relation between
transaction-based fees and order routing
decisions of that broker-dealer would
not be representative of the entire
market and therefore would provide an
incomplete representation of potential
conflicts of interest.
The Battalio Equity Market Study also
relies on a sample of Rule 606 order
routing decisions obtained directly from
the reporting entities’ websites from a
limited sample of ten well-known
national retail brokers from a single
quarterly reporting cycle (October and
November 2012). As discussed above,
over 400 broker-dealers are members of
at least one national securities
exchange. The ten retail brokers
analyzed in the Battalio Equity Market
Study make up approximately 2.1% of
the broker-dealers with exchange
memberships, and less than 0.3% of
broker-dealers overall. Although these
are well-known retail brokers, due to the
lack of representativeness of the sample
(e.g., the majority of the broker-dealers
271 Estimates based on data from Form 1 of the
X–17A–5 filings. As of December 31, 2016, 3,972
broker-dealers that filed form X–17A–5. See Section
V.B.2.a infra.
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represented in the Battalio Equity
Market Study are online broker-dealers),
these broker-dealers may be more (or
less) likely than the average brokerdealer to route customer orders in ways
that benefit themselves at the expense of
their customers. The findings in the
Battalio Equity Market Study, therefore,
may not be representative of a broader
sample of broker-dealers. Moreover, the
Commission is unable to determine if
the Battalio Equity Market Study’s
analyses of the Rule 606 disclosure data
has statistical power because the
authors did not provide any statistical
analyses beyond the percentage of
market or limit orders routed to a
particular exchange.
Similarly, the results of the Nasdaq
study may not be representative of the
broader market, as the Nasdaq study
affected only a very small sample of
common stocks and focused on order
routing to a single exchange. As
discussed in Section II.B, Nasdaq
selected 14 stocks to be part of the
analysis, which represent only 0.3% of
all NMS stocks. The sample is unlikely
to be representative of the universe of
NMS securities for two reasons: (1) The
sample included a small number of
stocks (and no ETPs),272 and (2) less
than one-third of these stocks were
small or mid-capitalization at the time
of the analysis, although most had
market capitalizations close to $3 billion
immediately prior to the study.273
Further, the analysis only focused on
the effects of changes to transactionbased fees for a single exchange:
Nasdaq. As the other equities exchanges
did not have similar changes to
transaction-based fees and rebates, any
inferences drawn from the Nasdaq study
may not be valid under different
circumstances in which all equities
exchanges were subject to consistent
revisions to transaction-based fees.
In the spirit of the Nasdaq study,
exchanges could coordinate voluntarily
to simultaneously implement a pilot
similar to the Nasdaq pilot on all
exchanges over a broader sample of
stocks, to produce more representative
results. The Commission preliminarily
believes, however, that exchanges
would not be likely to coordinate
changes to access fees and rebates for
the purpose of studying potential
conflicts of interest between brokerdealers and their customers because of
competitive incentives, such as
272 Only common stocks were included in the
Nasdaq study, while the proposed Pilot will include
NMS stocks, which includes common stocks as well
as ETPs.
273 Market capitalizations are computed from
CRSP shares outstanding and stock price, as of
December 31, 2014.
PO 00000
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13045
inducements to draw order flow away
from competitors.274
Researchers could conduct studies
with data sources currently available
that provide more representative results
than those provided in existing studies.
However, the Commission preliminarily
believes that data limitations discussed
in greater detail below could make such
studies difficult. Moreover, the results
of such studies would unlikely be able
to establish a causal connection between
transaction-based fees and order routing
decisions by broker-dealers needed to
inform policy decisions on potential
conflicts of interest. The importance of
causal inference is discussed in the next
section.
ii. Causality
In addition to limitations in how
representative results may be, existing
studies are also of limited use for policy
decisions because they cannot test for
causal relationships between transaction
fees and order routing decisions.
Because transaction-based fees and
order routing decisions could be jointly
determined, researchers cannot readily
disentangle the direction of causality,
and therefore cannot determine the
extent that potential conflicts exist. The
identification of causal relations
between fees and order routing
decisions becomes increasingly complex
because exchanges have some discretion
to modify their fees.275 In practice,
researchers attempt to identify and
measure causal relations in two ways:
(1) Exogenous shocks, which have been
discussed above, and (2) econometric
techniques, such as an instrumental
variables approach.276
Although the Nasdaq study
implements an exogenous shock, which
could have permitted causal inference
regarding the relationships between
transaction fees, order routing, and
market quality, that study did not
analyze the impact of potential conflicts
of interest on order routing decisions.
Further, even if the Nasdaq study had
analyzed a causal relationship between
transaction-based fee and rebates and
potential conflicts of interest, the
274 With respect to the Nasdaq study, the purpose
of revising access fees and rebates was to determine
how these changes affected market share and
Nasdaq’s fraction of time at the NBBO.
275 Over the last five years, the exchanges, on
average, have made 34 revisions, or approximately
6.7 revisions per year, to their transaction-based
fees and rebates. See Section V.B.2.b infra.
276 The method of instrumental variables is used
to estimate causal relationships when controlled
experiments or exogenous shocks are not feasible.
An ‘‘instrument’’ changes the explanatory variable
but has no independent effect on the dependent
variable, allowing a researcher to uncover the
causal effect of the explanatory variables on the
dependent variable of interest.
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limited representativeness of the Nasdaq
sample, would limit the generality of
the study.
With respect to the transition between
forms of pricing models that occurred
on the option exchanges, discussed
above, the key limitation is the
comparison of maker-taker pricing
models with payment for order flow
pricing models. Studies that explore
these regime shifts between maker-taker
to payment for order flow models are
not comparing situations in which one
regime could theoretically have lower
conflicts of interest than the other.277
Each of these types of models is likely
to create potential conflicts of interest
that could affect how broker-dealers
route their customer orders,278 although
evidence does not suggest that one form
of pricing model is more or less prone
to conflicts than another. Moreover, the
change from one form of pricing model
to another could introduce new
conflicts of interest that did not
previously exist. Therefore, the
Commission preliminarily believes that
exchange-driven transitions between
maker-taker and payment for order flow
pricing models are not likely to provide
information about potential conflicts of
interest driven by the maker-taker and
taker-maker models or to inform the
Commission about future regulatory
decisions regarding transaction-based
fees.
The Battalio Equity Market Study
attempts to test for causal relationships
between liquidity rebates and order
routing decisions of broker-dealers
using an instrumental variables
approach. However, in the absence of an
exogenous shock to access fee caps or
rebates outside the control of exchanges,
the authors are unable to definitively
determine the causes of broker-dealers’
order routing decisions through the use
of econometric techniques.
Consequently, the authors are unable to
disentangle whether fees and rebates
drive broker-dealer order routing
decisions or order routing decisions
determine fees and rebates chosen by
exchanges.
Although exchanges revise their fee
schedules frequently, the Commission
preliminarily does not believe that
sradovich on DSK3GMQ082PROD with PROPOSALS2
277 See
supra note 264.
Robert Battalio, Andriy Shkilko, and
Robert Van Ness, ‘‘To Pay or Be Paid? The Impact
of Taker Fees and Order Flow Inducements on
Trading Costs in U.S. Options Markets,’’ Journal of
Financial and Quantitative Analysis 51, 1637–1662
(2016), available at: https://www.cambridge.org/
core/services/aop-cambridge-core/content/view/
0782CE3E9679C29BB910A66192D27201/S00221
09016000582a.pdf/div-class-title-to-pay-or-be-paidthe-impact-of-taker-fees-and-order-flowinducements-on-trading-costs-in-u-s-optionsmarkets-div.pdf.
278 See
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studying order routing and execution
quality around these fee changes alone
can establish causality because fee
changes are at the discretion of
exchanges and could be caused by
changes to order routing behavior. In the
absence of an event outside of the
control of the exchanges (e.g., an
exogenous shock to either fees or
rebates), identifying the direction of
causality between changes in fees and
order routing behavior is nearly
impossible. Thus, any discretionary
actions by exchanges to revise their fee
schedules independently of other
exchanges is unlikely to yield
information that would be valuable to
the Commission for informing any
future policy decisions about potential
conflicts of interest between brokerdealers and their customers.
iii. Existing Data Sources
As noted above, several data sources
provide information on order routing
and execution quality. While
researchers theoretically could use these
data sources to produce representative
results regarding the relation between
transaction-based fees, order routing,
and execution quality, the Commission
preliminarily believes that data
limitations, would make these studies
difficult to produce.
As discussed previously, Rule 606
disclosures provide information on
order routing. Rule 606 disclosures are
currently the only data publicly
available to researchers and others on
order routing by broker-dealers;
however, limitations in the Rule 606
data reduce the ability of researchers to
use the data to produce representative
results. The data are cumbersome to
collect on a broad scale, as researchers
would generally need to access each
broker-dealer’s web page to manually
download the data. The Rule 606 data
are also only available at a quarterly
frequency, and broker dealers are not
required to maintain historical data,
which hampers the ability to efficiently
produce research on multiple quarters
of data, and could lead to short sample
periods that may provide relatively
limited power for statistical tests.279
Notably, there currently is no central
repository of these data, so any
collection of this information by
researchers would be a lengthy and
labor-intensive process. For example, a
researcher that has not already
downloaded a time series of Rule 606
reports would need to download one
quarter at a time, waiting three months
for each quarter’s data to create a time
series; assembling a single year’s worth
279 See
PO 00000
supra note 118.
Frm 00040
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of data would require nine to twelve
months. Such delays could significantly
increase the opportunity costs of
undertaking such studies and decrease
the likelihood of new research on the
relation between transaction-based fees
and order routing decisions. Moreover,
these limitations also could prevent
other researchers and other analysts
from verifying or replicating analyses if
researchers did not concurrently collect
the Rule 606 reports across the same
periods of observation.
In addition, the quarterly frequency of
the Rule 606 reports by broker-dealers is
different from the frequency of changes
in fee schedules by exchanges (e.g., as
presented in Table 2, over a recent fiveyear measurement period, the average
exchange updated its fees schedule
approximately 6.7 times per year).280
Further, while the Rule 606 data
provides order routing at the brokerdealer level, such information is not
granular enough to thoroughly study
potential conflicts of interest.
The value of Rule 606 disclosures for
identifying possible conflicts of interest
resulting from transaction-based fees
would be limited for a number of
additional reasons, even if the
Commission were to require a historical
time series of these disclosures for all
broker-dealers.
First, each broker-dealer discloses
data for only its top ten order routing
venues. Second, because broker-dealers
disclose data at a quarterly frequency, a
five-year sample of Rule 606 data for a
single broker-dealer, would include
only 20 observations, limiting statistical
power. Third, although Rule 606 reports
also provide some disclosure about
potential broker-dealer conflicts of
interest, they do not include any
disclosure of access fees assessed or
rebates offered by exchanges to the
broker-dealers. Fourth, Rule 606 data do
not distinguish between marketable and
non-marketable limit orders. Finally,
Rule 606 currently covers only retail
orders. If institutional orders also are
subject to potential conflicts of interest,
studying Rule 606 data alone would not
inform on such conflicts of interest.
To produce representative results
using proprietary broker-dealer or
exchange data would require obtaining
these data from a sufficient number of
diverse broker-dealers and exchanges.
However, proprietary data from brokerdealers or exchanges are generally not
available to the public. While some
researchers have obtained such data
280 Not every fee schedule revision pertains to
access fees or rebates. To focus only on these
revisions, each Form 19b–4 fee filing was evaluated
to determine that revisions to fees or rebates were
pertinent to this baseline.
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from a single broker-dealer or exchange,
and some broker-dealers and exchanges
employ their own researchers, the
Commission preliminarily believes that
it would be difficult for researchers to
obtain such data from a sufficient
number of broker-dealers or exchanges
in order to produce representative
results.
Regardless of whether researchers
would obtain data from Rule 606
disclosures or directly from exchanges,
much of the data currently available is
either unstructured or in a nonstandardized format. For instance, many
broker-dealers provide PDF files of Rule
606 disclosures, while exchanges use
bespoke terminology to classify their
fees and rebates, which likely limits the
value of these data for researchers
examining the effect of fees and rebates
on order routing decisions. This lack of
standardization across platforms could
make it difficult for researchers to
aggregate data and construct
representative samples for comparison
and analyses.
While Rule 605 and TAQ data are
available to researchers and may
provide information about execution
quality, they too have a number of
limitations. For example, Rule 605 data
provides execution quality information
for both marketable and non-marketable
orders; however, the methodologies for
estimating measures of the speed of
execution of non-marketable orders are
outdated.281 For instance, Rule 605
measures realized spreads based on
quotations five minutes after the time of
order execution and recent research
suggests using quotations that more
closely follow a trade, because any
temporary price impact of a trade goes
away within seconds, not minutes, of
the trade.282 Like Rule 606 data, Rule
605 data also covers smaller retail-sized
orders only, and the data are only
available at the monthly frequency.
Instead, researchers and the
Commission could rely on TAQ data, a
publicly available dataset provided by
the NYSE to subscribers, in order to
capture some measures of execution
quality. However, the TAQ data has
limited information on limit order
execution quality that would be
valuable to the Commission and others.
To incorporate transaction-based fee
information into analyses, researchers
would need to manually collect and
compile the information from
281 See
Concept Release, supra note 3.
e.g., Jennifer Conrad and Sunil Wahal,
‘‘The Term Structure of Liquidity Provision,’’
Working Paper, University of North Carolina—
Chapel Hill (2017), available at: https://
papers.ssrn.com/sol3/papers.cfm?abstract_
id=2837111.
282 See,
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exchanges’ websites and their Form
19b–4 fee filings, which notify the
Commission of changes to those fee
schedules. Although the current fee
schedules are posted on exchange
websites, in order to identify changes to
those fees, researchers would need to
search the Commission’s website for
such Form 19b–4 fee filings to identify
when exchanges change their fees and
to gather information about those fees,
as exchanges do not file their fees on a
routine basis, but rather only when
making changes. Such information
would be cumbersome to compile.
Additionally, because of the complexity
of exchange fee structures and the lack
of standardization of these structures
across exchanges, identifying
comparable fees across exchanges is
unwieldy. For example, identifying the
base or top-tier fees across exchanges
could be difficult for researchers. As
shown in Table 2 below, the average
exchange has 24 different access fee
categories and 21 different rebate
categories. Further, exchanges do not
disclose per share average or median
fees charged and rebates earned on any
report or filing, so such information is
unavailable to the public. To add to the
impediments to fee data aggregation and
comparison, Form 19b–4 fee filings are
available only as PDF files
downloadable from the Commission’s
website, thereby increasing the costs of
aggregation across exchanges over time
by researchers.
Even if limitations to data availability
and aggregation were overcome and
researchers could construct a
representative sample of fee and routing
data, researchers would still face
obstacles in understanding the
relationship between transaction-based
fees and rebates and routing decisions.
Without an exogenous shock to fees and
rebates to infer the causal relation
between these transaction-based fees
and order routing decisions, researchers
would not be able to analyze whether
the order routing decisions observed are
driven by fees and rebates or vice
versa.283
2. Current Market Environment
This section provides an overview of
the market for trading services, and of
the exchanges and ATSs that could be
affected as a result of revisions to the
transaction-based fee structure required
by the proposed Pilot. Where
information is currently available to the
Commission, a description of the
current practices of exchanges along
dimensions that are relevant to the
proposed Pilot (e.g., summary
283 See
PO 00000
information on their current fee
schedule or the frequency of fee
revisions) are included.
a. Market for Trading Services
The market for trading services,
which is served by exchanges, ATSs,
and other liquidity providers
(internalizers and others),284 relies on
competition to supply investors with
execution services at efficient prices.
These trading venues, which compete to
match traders with counterparties,
provide a platform for price negotiation
and dissemination of trading
information. The market for trading
services in NMS securities consists of 13
national equity market exchanges and
34 ATSs. Other off-exchange venues
include internalizers and wholesalers,
which execute a substantial volume of
retail order flow. The remainder of this
section discusses the current
competitive landscape for exchanges
and ATSs relevant to our economic
analysis of the proposed Pilot.
Since the adoption of Regulation NMS
in 2005, the market for trading services
has become more fragmented and
competitive. As of July 18, 2017, 13
national equity market exchanges
operate in the U.S., as shown in Table
1. Of these exchanges, nine are makertaker exchanges and two are taker-maker
pricing exchanges; the EDGA and IEX
operate as flat-fee exchanges.285 Since
Regulation NMS was adopted in 2005,
the market for trading services has
become significantly more competitive
as measured by the decline in market
share of individual exchanges,
discussed in more detail below. The
number of U.S. equities exchanges has
increased by over 60%, as the number
of exchanges increased from eight
exchanges in 2005 to 13 exchanges
operating today, as shown in Table 1.286
284 See
supra note 247.
charges a flat fee of $0.0009 for trades
against non-displayed liquidity on both sides of the
market, and charges $0.0003 for trade execution
against displayed liquidity. See https://
iextrading.com/trading/fees. As of March 2018,
EDGA is no longer operating as a taker-maker
market, but is also operating as a flat-fee venue. See
https://markets.cboe.com/us/equities/.
286 Although 13 U.S. equities exchanges currently
operate as of March 2018, the majority of these
exchanges are part of exchange families. For
instance, NYSE, NYSE Arca, NYSE American, and
NYSE National, are all part of the NYSE Group,
which is wholly owned by the Intercontinental
Exchange (ICE), while Nasdaq, Phlx, and BX, are
owned by Nasdaq. BATS, BATS–Y, EDGA, and
EDGX, which all operated as ATSs in 2005, are all
subsidiaries of Cboe Global Market, Inc. Although
many exchanges belong to exchange groups, the
Commission preliminarily believes that each of
these exchanges operates independently of the
other exchanges owned by the same parent
company. IEX became a registered exchange in
285 IEX
Section V.B.1.b.ii supra.
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Several studies have suggested that
transaction-based fee pricing partially
drove the increase in the number of U.S.
equities exchanges since 2005.287
Execution services are a lucrative
business, which encourages new trading
centers to enter the market in the hopes
of capturing rents associated with order
execution.288 As discussed above,
liquidity externalities, where the more
liquid venues attract more interest and
therefore more liquidity, could result in
a single venue (or very limited number
of venues) being the preferred trading
location for any given stock because all
traders could optimally route orders to
the venue with the highest liquidity for
a given stock.289 If rebates offered by
exchanges are large enough, they
provide incentives for market
participants to route orders to those
venues, in order to capture the rebates.
Rebates offered by exchanges, therefore,
may ‘‘break’’ the liquidityexternality.
TABLE 1—U.S. NATIONAL EQUITIES EXCHANGES AS OF JULY 2017
Exchange
Market fee type
Exchange
in 2005?
Market
Share 290
(%)
Cboe BZX—https://markets.cboe.com ..........................................................
Cboe BYX—https://markets.cboe.com ..........................................................
Cboe EDGA 291—https://markets.cboe.com ..................................................
Cboe EDGX—https://markets.cboe.com .......................................................
BX 292—www.nasdaqtrader.com ....................................................................
Phlx (PSX)—www.nasdaqtrader.com ............................................................
Nasdaq—www.nasdaqtrader.com .................................................................
NYSE Arca—https://www.nyse.com/markets ................................................
NYSE American 293—https://www.nyse.com/markets ...................................
NYSE—https://www.nyse.com/markets .........................................................
NYSE National 294—https://www.nyse.com/markets .....................................
CHX—www.chx.com ......................................................................................
IEX—www.iextrading.com .............................................................................
Maker-Taker ......................................
Taker-Maker ......................................
Taker-Maker ......................................
Maker-Taker ......................................
Taker-Maker ......................................
Maker-Taker ......................................
Maker-Taker ......................................
Maker-Taker ......................................
Maker-Taker ......................................
Maker-Taker ......................................
Maker-Taker ......................................
Maker-Taker ......................................
............................................................
..................
..................
..................
..................
✓
✓
✓
✓
✓
✓
✓
✓
..................
5.95
4.80
1.64
6.38
3.02
0.76
14.51
9.03
0.34
13.90
........................
0.42
2.14
sradovich on DSK3GMQ082PROD with PROPOSALS2
Table 1 also highlights that market
share of trading volume among
exchanges is not very concentrated.
Although NYSE and Nasdaq have the
largest overall total volume market
shares of approximately 14% each
among the exchanges, as of July 2017,
these two exchanges collectively
account for less than 30% of the total
market share of trading volume for NMS
securities, indicating that the market for
trading services has become
decentralized, and has become more so
over time. For instance, between 2004
and 2013, the market share of NYSElisted stocks on the NYSE declined from
approximately 80% to 20%, while
market share on other exchanges and
off-exchange trading centers has
increased.295 This decentralization
provides market participants with a
choice among venues when they route
orders, and may also encourage
exchanges to attract order flow. For
instance, transaction-based fees
represent one means by which national
securities exchanges may compete for
order flow, and exchanges may adopt
business models that focus on attracting
order flow by offering large rebates or
charging competitive fees. Exchanges
may compete for order flow on other
dimensions as well, by offering better
execution quality and innovations in
order types and other trading
mechanisms.
In addition to competing with other
U.S. equities exchanges, exchanges also
compete for order flow from offexchange trading centers, including
ATSs, internalizers, and others. Brokerdealers may opt to route order flow offexchange, as they may be able to avoid
access fees paid to exchanges for doing
so. Off-exchange trading makes up a
substantial fraction of total volume, as
approximately 37% of all transaction
reports are routed using the NYSE and
Nasdaq Trade Reporting Facilities as of
July 2017.296 Of that off-exchange NMS
share volume, approximately 13% was
attributable to ATSs, of which 34 traded
NMS securities as of July 2017.297 The
remaining 24% of off-exchange share
volume is routed to other off-exchange
trading centers, such as internalizers.298
In aggregate, broker-dealers and other
market participants have a large and
varied set of options as to where they
route orders, whether to exchanges or to
2016. Further, NSX (NYSE National) existed as an
exchange in 2005, but halted operations in 2016. It
was acquired by NYSE/ICE in January 2017, which
indicated at the time of the acquisition that it will
operate the exchange as NYSE National. See ‘‘NYSE
Finalizes Acquisition of National Stock Exchange,’’
Press Release, Intercontinental Exchange (January
31, 2017), available at: https://ir.theice.com/press/
press-releases/all-categories/2017/01-31-2017232800326. Researchers can adequately control for
exchanges that are subsidiaries of the same parent
when conducting analyses of the effect of changes
in transaction-based fees on order routes.
287 See, e.g., Angel, Harris, and Spatt, supra notes
106 and 216; Harris, supra note 23.
288 See id.
289 Liquidity externalities are discussed in more
detail in Section V.A.2, supra.
290 Shares are computed based on share volume.
Market shares for the exchanges reported do not
add up to 100%, since approximately 37% of share
volume trades off-exchange on over-the-counter
venues.
291 As of March 2018, EDGA is no longer
operating as a taker-maker exchange and is now
operating as a flat-fee venue; however, it was
operating as one as of July 2017 when the data for
this table was obtained.
292 In 2005, BX existed as the Boston Stock
Exchange.
293 As of July 2017, NYSE American is no longer
a purely maker-taker market as only certain types
of market participants (electronic Designated
Market Makers) are eligible for rebates. See NYSE
American Equities Price List, available at: https://
www.nyse.com/publicdocs/nyse/markets/nyseamerican/NYSE_America_Equities_Price_List.pdf.
294 NYSE acquired NSX in January 2017, and the
exchange is now known as NYSE National.
Although not currently operational, the
Commission has assumed for the purposes of this
analysis that it will be operational during the Pilot.
295 See Angel, Harris, and Spatt, supra note 216,
Figures 2.17 and 2.18. Although less evident than
for NYSE-listed securities, the effect is similar for
the Nasdaq market.
296 Data on off-exchange market share are
available from the BATS Global Market web page,
available at https://markets.cboe.com/us/equities/
market_share/
297 The estimates of ATSs that trade NMS stocks
and ATS trade volume share was developed using
weekly summaries of trade volume collected from
ATSs pursuant to FINRA Rule 4552. See also
Securities Exchange Act Release No. 76474
(November 18, 2015), 80 FR 80998, 81109
(December 28, 2015) (Regulation of NMS Stock
Alternative Trading Systems). The estimates in this
release were calculated in the same manner as in
the cited release. See also ‘‘OTC (ATS & Non-ATS)
Transparency,’’ FINRA, available at: https://
www.finra.org/Industry/Compliance/Market
Transparency/ATS/.
298 Total market share is collected from the BATS
Global Market web page, available at: https://
markets.cboe.com/us/equities/market_share/. ATS
weekly market share is collected from FINRA,
available at: https://otctransparency.finra.org.
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off-exchange trading centers. Moreover,
empirical evidence suggests that
traditional exchanges, such as NYSE
and Nasdaq, are losing market share to
off-exchange trading centers and newer
exchanges,299 which may provide
different incentives to broker-dealers in
order to attract this order flow,
including access fees and rebates. We
discuss the current environment for
transaction-based fees in the next
section.
The proposed Pilot is also likely to
affect competition among broker-dealers
that route institutional and retail orders.
These broker-dealers compete in a
segment of the market for broker-dealer
services. The market for broker-dealer
services is highly competitive, with
most business concentrated among a
small set of large broker-dealers and
thousands of small broker-dealers
competing in niche or regional segments
of the market.300 Large broker-dealers
typically enjoy economies of scale over
small broker-dealers and compete with
each other to service the smaller brokerdealers, who are both their competitors
and their customers.301 As of December
31, 2016, approximately 4,000 brokerdealers filed Form X–17a-5. These firms
varied in size, with median assets of
approximately $725,000, average assets
of nearly $1 billion, and total assets
across all broker-dealers of
approximately $3.9 trillion. The twenty
largest broker-dealers held
approximately 75% of the assets of
broker-dealers overall, with total assets
of $2.93 trillion, indicating the high
degree of concentration in the industry.
Of the 3,972 broker-dealers that filed
Form X–17a–5, 430 are members of U.S.
equities exchanges. Broker-dealers that
are members of equities exchanges had,
on average, higher total assets than other
broker-dealers, with median assets of
$21 million, average assets of $8.6
billion, and total assets across all
broker-dealers that are members of
exchanges of $3.6 trillion.
b. Transaction-Based Fees and Rebates
Exchanges are required to disclose
their current fee schedules, which
include transaction-based fees and
rebates, connectivity fees, membership
fees, among others.302 When exchanges
update their fees, they are required to
file Form 19b–4 with the Commission,
which if filed pursuant to Section
19(b)(3)(A) makes fee changes effective
upon filing.303 Although these fee
schedules and Form 19b–4 fee filings
contain information about fees beyond
transaction-based fees and rebates, in
this baseline, the discussion is limited
13049
to only transaction-based fees and
rebates and any changes thereto.
Table 2 reports the range of minimum
and maximum access fees and rebates,
as well as the number of categories for
each (in parentheses below the fee
ranges), by exchange, for the most
recently available fee schedule.304 On
average, U.S. exchanges have 24 access
fee categories and 21 rebate categories
associated with these fee schedules. For
the maker-taker exchanges, access fees
are capped at $0.0030, but are as little
as zero in some fee categories for some
exchanges; taker-maker exchanges,
because they are not restricted in the
amount they can charge to nonmarketable limit orders, have fees that
range as high as $0.0033. Seven
exchanges have some categories of
rebates that exceed the maximum access
fees charged by exchanges.
Table 2 also provides the number of
fee revisions for the exchanges as
reported in their Form 19b–4 fee filings
to the Commission in the last five years
(July 16, 2012–July 18, 2017).
Exchanges, on average, have changed
their fee schedules 34 times in the last
five years,305 indicating that the average
exchange revises its transaction-based
fee schedules about seven times per year
(approximately every 7.4 weeks).
TABLE 2—SUMMARY OF TRANSACTION-BASED FEE SCHEDULES FOR U.S. NATIONAL EQUITIES EXCHANGES AS OF JULY
2017
Number of
revisions
(5 years)
Exchange
Cboe BZX .......................................................................
Cboe BYX .......................................................................
Cboe EDGA ....................................................................
Cboe EDGX ....................................................................
BX ...................................................................................
Phlx (PSX) ......................................................................
Nasdaq ............................................................................
NYSE Arca ......................................................................
NYSE American ..............................................................
NYSE ..............................................................................
NYSE National 306 ...........................................................
CHX .................................................................................
IEX ..................................................................................
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Forseveral of the exchange families,
information about revenues and costs
attributed to transaction-based fees and
299 See
Angel, Harris, and Spatt, supra note 216.
Securities Exchange Act Release No.
63241 (November 3, 2010), 75 FR 69791, 69822
(November 15, 2010) (‘‘Risk Management Controls
for Brokers or Dealers with Market Access’’).
301 See id.
302 See 17 CFR 240.19b–4(m)(1), which requires
each SRO to post and maintain a current and
complete version of its rules, including those
300 See
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40
45
47
64
31
26
59
51
9
38
19
8
1
Date of last
fee schedule
available
7/15/2017
7/15/2017
7/15/2017
7/15/2017
7/13/2017
7/15/2017
7/20/2017
7/3/2017
7/24/2017
7/1/2017
9/20/2016
5/3/2017
8/19/2016
Access fees
(# of categories)
$0.0000–$0.0030 (31) ...
$0.0000–$0.0033 (36) ...
$0.0000–$0.0032 (48) ...
$0.0000–$0.0030 (37) ...
$0.0005–$0.0030 (10) ...
$0.0026–$0.0030 (5) .....
$0.0030 (2) ....................
$0.0006–$0.0030 (68) ...
$0.0003–$0.0030 (34) ...
$0.0003–$0.0030 (14) ...
$0.0003–$0.0030 (2) .....
$0.0030 (1) ....................
$0.0009 ..........................
Rebates
(# of categories)
$0.0010–$0.0032
$0.0010–$0.0025
$0.0011–$0.0027
$0.0011–$0.0034
$0.0000–$0.0025
$0.0023–$0.0031
$0.0000–$0.0034
$0.0002–$0.0033
$0.0000–$0.0045
$0.0000–$0.0045
$0.0000 (1)
$0.0020 (1)
¥$0.0009
(16)
(12)
(10)
(19)
(8)
(7)
(36)
(61)
(41)
(40)
rebates is available in aggregate from
Form 10–K filings. Using the statements
of income from Form 10–K filings for
2016 capturing the net (of rebates)
transactions-based revenues, the Nasdaq
exchanges (Nasdaq, BX, and PSX)
related to transaction-based fees and rebates, on its
website.
303 As discussed in Section V.B.1.b.iii supra, fee
information, such as that included in exchange fee
schedules or Form 19b–4 fee filings, does not have
standardization or formatting requirements.
304 The access fee and rebate ranges in Table 2 are
collected from recent fee schedules (as of July 18,
2017) available from each individual exchange’s
website (listed in Table 1). Table 2 provides the
date from which these fee schedules were reported.
The ranges in fees are the minimum and maximum
fees and rebates reported by each exchange.
305 The median number of revisions to fee and
rebate schedules by exchanges is 38 over the fiveyear period.
306 NYSE acquired NSX in January 2017, and the
exchange is now known as NYSE National. As of
March 2018, the exchange currently has not
submitted new fee schedules nor has it reported any
trading volume in recent months.
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earned $564 million.307 Based on the
same measure the NYSE-affiliated
exchanges (NYSE, NYSE Arca, NYSE
American, and NYSE National) earned
$223 million in transaction-based fees
net of rebates,308 while the BATS Global
Markets (now, Cboe BZX, Cboe BYX,
Cboe EDGA, and Cboe EGDX), for the
nine months ended September 30, 2016,
earned $177 million in transactionbased fees net of rebates.309 Neither
CHX nor IEX or their affiliates are
publicly traded, meaning that these
exchanges do not file an annual Form
10–K with the Commission. As a result,
public information regarding the
revenues or profits associated with
transaction-based fees does not exist for
these exchanges.
Information on the net transactionsbased revenues for each individual
exchange, as opposed to the amounts
reported for exchange groups in Form
10–K filings, is not currently publicly
available, making it difficult to analyze
the fees and rebates for an individual
exchange. To estimate the net
transactions-based revenues for each
individual exchange, Table 3 reports the
maximum and median net transaction-
based fees based on each exchange’s
most recently reported fee schedule and
the share volume of each exchange for
June 16, 2017 through July 18, 2017.310
As evidenced by the significant
differences between the sum of net of
rebate revenues for entities reporting to
the same exchange group obtained from
Table 3 and the total net of rebate
revenues for each exchange family
reported on the Form 10–K or 10–Q
filings, this approach does not yield
reliable results, highlighting the
limitations on the data currently
available to researchers.
TABLE 3—ESTIMATES OF ANNUALIZED PER-EXCHANGE NET TRANSACTION-BASED FEE REVENUES FROM TRANSACTIONBASED FEES AND MONTHLY EXCHANGE SHARE VOLUME
[for June 16, 2017–July 18, 2017]
[in millions]
Exchanges
Share
volume 311
Annualized
midpoint
difference
Per share
profit
(median)
Annualized
maximum
difference
Per share
profit
(maximum)
Cboe BZX ............................................................................
Cboe BYX ............................................................................
Cboe EDGA .........................................................................
Cboe EDGX .........................................................................
BX ........................................................................................
Phlx (PSX) ...........................................................................
Nasdaq .................................................................................
NYSE Arca ...........................................................................
NYSE American ...................................................................
NYSE ...................................................................................
NYSE National .....................................................................
CHX ......................................................................................
IEX .......................................................................................
8,677
7,003
2,388
9,310
4,411
1,115
21,171
13,175
494
20,277
........................
609
3,117
($62.5)
(8.4)
(8.6)
(83.8)
24.5
1.3
330.3
7.9
(3.6)
(146)
........................
7.3
N/A
($0.0006)
(0.0001)
(0.0003)
(0.0008)
0.0005
0.0001
0.0013
0.0001
(0.0006)
(0.0006)
........................
0.0010
$0.0000
$208.2
193.3
60.2
212.3
158.8
9.4
762.2
442.7
17.8
730
........................
7.3
N/A
$0.0020
0.0023
0.0021
0.0019
0.0030
0.0007
0.0030
0.0028
0.0030
0.0030
........................
0.0010
0.0000
C. Analysis of Benefits and Costs of
Proposed Transaction Fee Pilot
1. Benefits of Proposed Transaction Fee
Pilot
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The Commission expects that the
benefits of the proposed Transaction Fee
Pilot would fall into two categories:
More informed policy decisions,
including more information about
potential conflicts of interest between
broker-dealers and their customers
(primary benefits) and more information
on other issues important to the
Commission (ancillary benefits), as well
as other benefits that may accrue to
market participants for the duration of
the proposed Pilot. In this section we
307 See the Nasdaq 2016 Form 10–K filings,
available at: https://www.sec.gov/Archives/edgar/
data/1120193/000112019317000003/ndaq1231
201610-k.htm. Net transaction-based revenues for
equity securities were approximately 25% of total
operating margin.
308 See the Intercontinental Exchange 2016 Form
10–K filings, available at: https://otp.investis.com/
clients/us/intercontinental_exchange_group2/SEC/
sec-show.aspx?Type=html&FilingId=11827791
&Cik=0001571949. For the Intercontinental
Exchange, net transaction-based revenues were
approximately 10% of operating income for 2016.
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i. Benefits of Studying Potential
Conflicts of Interest
The Commission preliminarily
believes that the proposed Transaction
Fee Pilot would lead to a more thorough
understanding of issues related to
potential conflicts of interest arising
from transaction-based pricing models,
which would ultimately inform the
Commission’s policy decisions. This
increased understanding would derive
from design elements of the proposed
Transaction Fee Pilot that address the
limitations of currently available
information described in the baseline:
Lack of representative results, inability
to identify causality, and insufficient
publicly available data. The data
obtained will improve the quality of
research and analysis by the
Commission and others, which will
provide additional data about the effect
of transaction-based fees on order
routing decisions of broker-dealers in
ways that reflect potential conflicts of
interest with their clients. The
Commission believes that these
additional data, which would be
unavailable in the absence of the
proposed Pilot, would help the
309 See the Bats Global Markets Form 10–Q filings
(September 30, 2016), available at: https://
www.snl.com/Cache/36600023.pdf. Cboe
announced its intent to acquire BATS Global
Markets in September 2016, and the acquisition
became effective on March 1, 2017. For the ninemonth ending September 30, 2016, the net
transaction-based revenues were 62% of BATS
operating profits over the same time period.
310 The share volume is obtained from the Cboe
website, available at https://markets.cboe.com/us/
equities/market_share/. To compute the maximum
profit attainable, staff took the difference between
the highest possible access fee and the lowest
possible rebate and multiplied it by the monthly
share volume. For a midpoint profit, the median of
the access fees less the median of the rebates is
computed and multiplied it by share volume. In
order to make the results comparable to those
reported above from Form 10–K filings, the monthly
profits are annualized by multiplying each monthly
profit amount by 12.
311 Monthly share volume obtained from Cboe for
June 16, 2017 through July 18, 2017, available at
https://markets.cboe.com/us/equities/market_share/.
discuss each of the categories of benefits
as well as potential limitations to those
benefits.
a. Benefits of More Informed Policy
Decisions
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Commission make more informed and
effective future policy decisions to the
ultimate benefit of investors.
To obtain the additional data to
understand the relationship between
fees and rebates and order routing
decisions, the proposed Transaction Fee
Pilot would simultaneously create
several different fee environments, each
of which restricts transaction-based fees
differently, and would make available
data that allows researchers to compare
order routing, execution quality, and
market quality in these fee
environments to the current fee
environment. The study of these
comparisons would inform the
Commission and the public about any
possible conflicts of interest that arise as
a result of transaction-based fees. The
Commission preliminarily believes that
the different fee environments created
by the proposed Pilot, even though
implemented temporarily and over
representative subsamples NMS
securities, would produce effects on
order routing decisions by brokerdealers that are identical or similar to
those that would arise under a similar
permanent change to our regulatory
environment. Therefore, the
Commission preliminarily believes that
the information obtained from the Pilot
will help inform our consideration of
any future proposals.
As noted, three distinct features of the
proposed Pilot’s design would facilitate
analyses of the relationship, if any,
between fees and potential conflicts of
interest. Specifically, the proposed Pilot
is designed to provide (1) representative
results; (2) sufficient information to
determine causality; and (3) more direct
access to data that is currently
unavailable or requires lengthy and
labor-intensive effort to compile and
process. The following sections discuss
in detail each of these aspects of the
proposed Pilot and how they could
improve upon the information currently
available.
A. Representative Results
In the context of the proposed
Transaction Fee Pilot,
representativeness of results means that
the impact of the proposed Pilot’s terms
on a Test Group during the Pilot Period
is likely to be consistent with the impact
of the results on the Test Group if the
Pilot’s terms were permanent (as
opposed to temporary).
Representativeness is desirable for
researchers and policy makers because
it ensures that inferences drawn from
the results of analysis of Pilot data are
likely to be similar to those that would
emerge if the terms were permanent. As
discussed in the baseline, current
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analyses are limited in their ability to
broadly inform policy choices by some
combination of the following: Order
routing data from a single broker-dealer,
a small sample of securities, a single
exchange, or a short sample period. By
contrast, the Commission preliminarily
believes that the proposed Pilot, as
designed, would produce more
representative results. Specifically, as
discussed in detail below, the proposed
Pilot would cover a large stratified
sample of nearly all NMS stocks
(including ETPs), both maker-taker and
taker-maker exchanges, and access fee
caps as well as a prohibition on rebates
or Linked Pricing, and would have a
two-year duration with an automatic
sunset at the end of the first year unless
the Commission determines, at its
discretion, that the proposed Pilot shall
continue for up to another year.312 The
proposed Pilot also would capture and
make available to the public for research
and analysis, a comprehensive database
of the order routing decisions of all
broker-dealers that route orders to U.S.
equities exchanges. As detailed in the
baseline, it would be infeasible for
researchers to compile current data
sources across all broker-dealers.
The Commission preliminarily
believes that the proposed Pilot would
produce representative results,
presenting a significant improvement on
existing studies, because the proposed
Pilot applies to a large stratified sample
of NMS stocks (including ETPs) with
prices of at least $2.00 per share at the
date of the Pilot Securities selection,
and with no restrictions on market
capitalization. In particular, the
Commission recognizes that any
possible conflicts of interest related to
transaction-based fees could vary across
securities such that the results of a pilot
focused only on large capitalization
stocks may not provide information
relevant to small capitalization stocks or
ETPs.313 Including nearly all NMS
securities allows the results to inform
policy choices across any subset of these
securities. The stratification of the
stocks selected for each test group is
designed to ensure that each test group
and the control group have a similar
composition, facilitating a comparison
across groups, which further supports
the representativeness of results. If, for
instance, the test groups and control
group had a different composition,
312 As designed, the proposed Pilot will only
exclude NMS securities that have prices below
$2.00 per share as of the date of pilot selection. As
detailed above, the data would also be produced for
a six-month pre-Pilot Period and a six-month postPilot Period.
313 See, e.g., Battalio Equity Market Study, supra
note 22.
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13051
researchers might not be able to
distinguish whether differences across
test groups and the control group stem
from different fee environments or
different sample composition, rendering
the results less representative. In
addition, the Commission preliminarily
believes that the sample sizes in the test
groups are sufficient to provide the
statistical power necessary to identify
differences across the samples.
Representativeness of results of the
Pilot would also be promoted by the
choice of the Pilot Security selection
date. The proposed rule would allow
the Commission to select the Pilot
Securities at any point in time up to
Pilot start date. As noted in Section
III.E.1, the Commission anticipates that
it would assign and designate by notice
each Pilot Security to one Test Group or
the Control Group approximately one
month prior to the start of the Pilot. By
assigning securities close to the start of
the Pilot, each Test Group and the
Control Group are likely to be more
comparable during the Pilot. Because
stratification criteria (e.g., market
capitalization and liquidity) vary
naturally over time, the closer the
assignments occurs to the proposed
Pilot effective date, the more
comparable the Test Groups would be
during the proposed Pilot. Selection of
securities close to the start of the
proposed Pilot would also be more
likely to include the intended universe
of securities, by capturing securities that
enter the market between the possible
adoption of the rule and the start of the
proposed Pilot, while avoiding
securities that exit during this period.
Further, to the extent that market
participants would change their
behavior in anticipation of the proposed
Pilot, setting the selection period close
to the proposed Pilot effective date
could reduce the effect of such behavior
on pre-Pilot data.
The results of the proposed Pilot
would be further representative because
the proposed Pilot applies to all U.S.
equities exchanges regardless of fee
structure. Broker-dealers potentially
face transaction-fee related conflicts of
interest regardless of whether those fees
are on maker-taker exchanges or takermaker exchanges. Further, a pilot that
addresses only a single fee structure
would not produce results relevant for
policy choices that also would apply to
another fee structure.
Applying the proposed Pilot to all
exchanges also improves upon the
existing analysis of the limited fee
experiment conducted by Nasdaq,
which only covered a single exchange,
as explained in Section V.B.1. While the
results from that study are suggestive
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that broker-dealers routed customer
orders to other exchanges that did not
change their transaction-based fees,
reasons other than potential conflicts of
interest could have impacted the
changes in order routing decisions. The
Commission believes that the proposed
Pilot would achieve representativeness
by requiring transaction-fee changes for
all U.S. equities exchanges, which
would allow researchers to identify how
these revisions affect order routing
decisions across exchanges. Further, the
proposed Pilot would require that
changes to fees or rebates would be
applied at the security level, which
means that for any given security, the
limitation on access fees or rebates
would be ubiquitous across all
exchanges.
In addition, the proposed Pilot
achieves representativeness by imposing
access fee caps and a prohibition on
rebates or Linked Pricing. The existing
literature suggests that the potential
conflicts of interest arising from access
fees could induce behavior that would
be different from the behavior induced
from conflicts arising from rebates or
Linked Pricing. Therefore, the inclusion
of caps on both access fees and rebates
or Linked Pricing allows for a more
comprehensive analysis of any possible
conflicts of interest than could be
achieved by focusing solely on access
fees or rebates. For example, Test Group
2 limits access fees to $0.0005, which
could feasibly limit rebates paid on
displayed liquidity, while Test Group 3
strictly prohibits rebates or Linked
Pricing across the entire depth of book
for displayed and non-displayed
liquidity. On the surface, it appears that
Test Groups 2 and 3 both could
eliminate rebates paid to broker-dealers;
however, these categories are not equal
in their ability to reduce rebates.314
Test Group 3 would completely
prohibit rebates or Linked Pricing,
which could provide information on
how exchanges compete for order flow
when rebates are not an option for
exchanges, and could provide insight
into the equilibrium level of access fees
in the absence of rebates or Linked
Pricing.315 Prohibiting exchanges from
314 The Commission preliminarily believes that
applying the top of book and depth of book
restriction to Test Group 3, but not in Test Group
2, is not an area of significant difference between
the two test groups. Section III.C.3, supra, provides
discussion for why Test Groups 1 and 2 do not have
requirements to access fees for non-displayed or
depth-of-book liquidity.
315 Equilibrium refers to conditions of a system in
which all competing influences are balanced. For
instance, with respect to the Test Group 3, this
could be the level of access fee charged by
exchanges from which no exchange has any
incentive to increase or decrease that fee. This
would be the equilibrium access fee.
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offering rebates or Linked Pricing in
Test Group 3 is necessary to maintain
the economic integrity of Test Group 3
and to provide information about Test
Group 3 consistent with its objective to
test the impact of eliminating rebates on
the natural equilibrium level of fees,
within the current regulatory structure,
and the potential conflicts of interest
that rebates may cause.316 Although
Rule 610(c) of Regulation NMS caps the
maximum access fee for exchanges at
$0.0030, in the absence of rebates or
Linked Pricing, competition among
exchanges could drive the average
access fee to an amount substantially
below $0.0030.317 In other words, Test
Group 3 would allow competition
among exchanges, in the absence of
rebates or Linked Pricing, to determine
the level of access fees from which
exchanges have no incentive to move
away.
The Commission further preliminarily
believes that the duration of the
proposed Pilot would produce
sufficiently representative results. If
broker-dealers incorporate transaction
fees and rebates into their order routing
decisions, a two-year duration for the
proposed Pilot, with an automatic
sunset at the end of the first year, unless
the Commission publishes a notice
determining that the proposed Pilot
shall continue for up to a second year,
would likely make it economically
worthwhile for broker-dealers to change
their routing behavior during the Pilot
by making it costly to avoid the
proposed Pilot. Specifically, as
discussed below, the Commission
recognizes that broker-dealers would
incur costs to incorporate new fee
schedules that are consistent with the
proposed Pilot’s requirements into their
order routing decisions. Broker-dealers
could ignore the Pilot to avoid these
costs. If enough broker-dealers ignore
the Pilot, the Pilot might not produce
results that provide the Commission and
the public a sense of the likely impact
316 If Linked Pricing were not prohibited, market
participants could potentially circumvent the
prohibition on rebates through Linked Pricing
mechanisms. Therefore, including prohibitions on
rebates or Linked Pricing could provide information
to the Commission and the public about potential
conflicts of interest associated with rebates or
substitutes for rebates, such as Linked Pricing, as
well as the equilibrium fee that emerges in the
absence of rebates or Linked Pricing.
317 In addition to removing rebates or Linked
Pricing in Test Group 3, the Commission could also
temporarily suspend limitations on access fee caps
imposed by Rule 610(c) of Regulation NMS.
However, implementing multiple changes within a
single test group may prevent researchers and
others from clearly determining the effect of the
prohibition of rebates on order routing decisions of
broker-dealers from the effect resulting from the
removal of access fee caps.
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of permanent changes to fee caps or
rebates. However, to the extent that
broker-dealers incorporate transactionbased fees and rebates into their order
routing decisions, ignoring the proposed
Pilot would also be costly for brokerdealers, and these costs increase with
the duration of the Pilot. The
Commission preliminarily believes that
the proposed Pilot duration, even with
a one-year sunset, is long enough to
produce representative results because,
as discussed below in Section V.C.2.b,
broker-dealers that incorporate
transaction-based fees and rebates into
their routing decisions would find it
economically worthwhile to adapt their
behavior in response to the Pilot.
Further, the provision for an
automatic sunset facilitates
representative results because it
provides the Commission with
flexibility as the data from the proposed
Pilot develops. For example, the
Commission could suspend the sunset
if, for example, it believed that
additional time would help ensure that
market developments are fully reflected
in the data with sufficient statistical
power for analysis, recognizing that
such market developments are
uncertain. Therefore, the sunset
provides flexibility to the Commission
to observe developments during the
proposed Pilot to determine whether to
allow the sunset to occur.
The Commission preliminarily
believes that the inclusion of a broad
sample of NMS securities, including
small and mid-capitalization stocks,
ensures representative results from the
proposed Pilot. Although previous
studies, as discussed above, suggest that
any possible conflicts of interest are
likely to be the greatest for smallcapitalization securities,318 the
Commission believes that it is important
to the design of the proposed
Transaction Fee Pilot to include these
small and mid-capitalization stocks
(including ETPs).
As a result, small and midcapitalization securities could be subject
to both the Transaction Fee Pilot and
the Tick Size Pilot for some period of
time. However, the Commission
preliminarily believes that any overlap
between the pilots is unlikely. If the
pilots do overlap, the proposed Pilot
selection process facilitates the overlap
with the Tick Size Pilot while
maintaining representative results. In
particular, the selection process for the
proposed Pilot would result in similar
proportions of stocks impacted by the
proposed Transaction Fee Pilot in each
318 See Battalio Equity Market Study, supra note
22; Harris, supra note 23.
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Tick Size Pilot test and control groups.
Specifically, each of the proposed
Transaction Fee Pilot’s three test groups
would be divided into two subgroups—
one that overlaps with the Tick Size
Pilot and one that does not overlap.319
Assuming each pilot test group affects
the other pilot’s test and control groups
similarly, this design safeguards the
results of each pilot by ensuring that
Tick Size Pilot effects are uniform
across the proposed Transaction Fee
Pilot and vice versa, such that
researchers are able to control for effects
of the Tick Size Pilot on the proposed
Transaction Fee Pilot and vice versa.
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B. Causality
In addition to providing
representative results, the Commission
expects the proposed Transaction Fee
Pilot to achieve the benefits identified
above because it would, among other
things, provide insight into the degree to
which transaction-based fees result in
potential conflicts of interest that alter
broker-dealer routing decisions to the
detriment of investors. Such causal
information is necessary when
considering policy choices aimed at
reducing any possible distortions
related to potential conflicts of interest.
As detailed in the baseline, exogenous
shocks are a means by which
researchers may establish the existence
of a causal relationship between
changes to transaction-based fees and
changes to order routing decisions of
broker-dealers and infer whether these
decisions are related to possible
conflicts of interest.320 This proposed
Pilot facilitates the establishment of
causality through an exogenous shock
that simultaneously creates several
distinct fee environments, each of
which restricts transaction-based fees or
rebates differently, enabling
synchronized comparisons to the
current environment.
The Commission preliminarily
believes that the proposed Pilot is able
to facilitate the examination of causality
because the proposed Pilot would
produce a single exogenous shock that
differentially impacts either fees or
319 Each test group would contain 270 common
stocks that overlap with the Tick Size Pilot, with
45 stocks selected from each of the three Tick Size
Pilot test groups (45 stocks × 3 Tick Size Pilot
groups = 135 total) with the remaining 135 stocks
coming from the Tick Size Pilot’s control group. See
supra note 117 and accompanying text.
320 As discussed in the baseline, establishing
causality can be accomplished through either
exogenous shocks or econometric methods, such as
instrumental variable analysis. As noted above, the
Battalio Equity Market Study, supra note 22, which
employed an instrumental variables approach, was
unable to definitely establish causal relations
between transaction-based fees and rebates and
order routing decisions.
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rebates on both maker-taker and takermaker exchanges. Although exchanges
adjust their fee schedules frequently,
which could affect the order routing
decisions of broker-dealers, researchers
have, to date, been unable to determine
whether these discretionary changes to
fees cause order routing decisions or
whether order routing decisions cause
the changes in fees. With the exception
of the Nasdaq study, which lacks
representative results, prior analyses
lacked an exogenous shock to fees, thus
any conclusions about causality that are
drawn from these studies may not
provide reliable information about
possible conflicts of interest.321
Exogenous shocks, such as those in the
proposed Transaction Fee Pilot provide
researchers a clear means of analyzing
the direction of causality.322
As discussed above, the proposed
Pilot would produce a single exogenous
shock that differentially affects multiple
test groups. The simultaneity of the
exogenous shocks across test groups
also facilitates examination of causality.
If some market-wide event were to
result in deviations in order routing
behavior during the proposed
Transaction Fee Pilot, the event would
likely affect stocks in each test group as
well as the control group. Researchers
can easily control for the impact of the
market-wide event, because the impact
of the market-wide event would likely
affect test groups and the control group
similarly, and therefore, would be
unlikely to appear in the comparisons of
the test groups to the control group. By
contrast, if the exogenous shocks were
not simultaneous, the market-wide
event may impact only one test group,
complicating the comparisons of that
test group to the baseline period or to
the other test groups.
The design of the proposed Pilot
further enhances researchers’ ability to
identify causal relationships. The
Commission preliminarily believes that
publishing daily updates to the List of
Pilot Securities facilitates the
identification of causal relations
between transaction-based fees and
order routing decisions. By requiring
daily updates to the List of Pilot
Securities, the proposed Pilot would
provide broker-dealers with the
321 Although the Nasdaq study provides an
exogenous shock to both access fees and rebates
simultaneously for a subset of securities, the value
of the results are impeded by (1) the small sample
size of the study and (2) the limit of the shock to
a single exchange, as broker-dealers could just route
order flow to a different exchange. See supra note
31.
322 Other econometric techniques, such as
instrumental variables methodology, are used only
when an exogenous shock (or other controlled
experiment) cannot be established.
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information they need to track the exact
securities in each test group in real-time
and when securities exit the Pilot. This
information may be crucial for brokerdealers that choose to adjust their
routing behavior during the pilot. If
broker-dealers are unable to track which
securities are in which test groups, the
Pilot results could provide misleading
causal information.
C. Expansion of Publicly Available Data
The Commission also expects the
Transaction Fee Pilot to attain the
benefits identified above because it
would provide access to data that would
either not be available to the public or
that would require lengthy and laborintensive collection. Having a
representative source of data available
to the public is critical for the
production of research and analyses
about the effect of transaction-based fees
on broker-dealer order routing
decisions. If more research and analyses
become available, that research is more
likely to provide increased depth and
perspective on potential conflicts of
interest to the Commission. Making the
data available to the public also
provides transparency and allows others
to replicate, validate, and confirm the
information that the Commission
considers in connection with policy
choices.
The Commission preliminarily
believes that the proposed data
requirements improve upon existing
data, as is discussed in more detail
below; thus, any inferences drawn from
existing data sources prior to the
proposed pilot would likely have
limited value in providing information
about the effect of transaction-based fees
on order routing decisions. The Pilot’s
characteristics would enable
representative results and a means to
examine the exogenous shocks to
transaction-based fees. The public
availability of the Pilot data would
facilitate study of whether the
exogenous shocks to transaction-based
fees affect order routing and are related
to potential conflicts of interest between
broker-dealers and their customers. The
proposed Pilot would make information
on order routing decisions available on
a more granular level and would reduce
the cumbersome nature of data
collection associated with existing order
routing data and fee data.
The Transaction Fee Pilot would
enable the public to gain access to order
routing data not currently available to
them and would provide access to fee
data in a simplified and standardized
form, which would improve the quality
of the analyses produced as a result of
the Pilot. Although order routing data
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and fee schedules are publicly available
through a combination of Rule 606
disclosures and exchange websites,
respectively, the Transaction Fee Pilot
would resolve a number of limitations
associated with using currently
available data to study the effect of
transaction-based fees on potential
conflicts of interest. Further, the
proposed Pilot would make available
broker-dealer order routing data for all
exchange-member broker-dealers for the
Pilot duration, which substantially
expands the data that would be
available to researchers in the absence
of the Pilot.
The Transaction Fee Pilot would
make available to the public new data
on order routing decisions anonymized
and aggregated by day, by security, by
broker-dealer, and by exchange. This
data would facilitate the analyses of
aggregated daily order-routing decisions
for a comprehensive sample of brokerdealers, which are likely to provide
representative results of how changes in
transaction fees and rebates affect these
decisions. Even if the Commission were
to require a historical time series of a
complete set of broker-dealer Rule 606
disclosures to be made publicly
available, the limitations presented in
Section V.B.1 would still exist, namely
data frequency, which likely would
limit any statistical power associated
with analyses of the data, nondisclosure of potential conflicts of
interest related to transaction-based
fees, and the focus on retail orders.
The order routing data obtained as a
result of the proposed Pilot would
instead provide superior information to
that currently available. Data would be
available for a representative sample of
NMS securities, across all brokerdealers, and exchanges, at the daily
frequency, which would provide
sufficient data for analyses, while
solving the issue of statistical power.
Relative to the data that some studies
acquire from broker-dealers and
exchanges,323 the order routing data
released during the Transaction Fee
Pilot would also allow researchers to
observe a time series of data across
broker-dealers and exchanges. The
reduction in the start-up costs of
examining order routing data, where
start-up costs could include handcollection of data over long time series,
would likely encourage more research
that would utilize data from the
Transaction Fee Pilot. Further, more
granular order routing data (e.g., daily
order routing statistics by anonymized
broker-dealer) would facilitate more
323 See,
e.g., Battalio Equity Market Study, supra
note 22.
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targeted analysis. Together, these effects
would facilitate higher quality research
on issues such as potential conflicts of
interest, which would improve the
quality of the information available to
the Commission for policy decisions.
An additional requirement of the
proposed Pilot is that the exchanges
would be required to provide a
standardized dataset of fees, the
Exchange Transaction Fee Summary.
Although researchers could identify
some of the effects of changes to
transaction-based fees and rebates on
order routing decisions directly from
knowing which securities are in a given
test group, these data could improve the
quality of tests of the Pilot by allowing
researchers to incorporate information
on how exchanges vary cross-sectionally
in their fee and rebate structures, even
within the various test groups. In
particular, this information would allow
researchers to create proxies for which
exchanges are likely to be more or less
expensive for marketable or marketable
limit orders. For instance, within Test
Group 1, the maximum allowable access
fee is $0.0015; however, each exchange
may have different base and top-tier
fees. Thus, only knowing that a security
is in Test Group 1 would be incomplete
information about how orders might be
routed by broker-dealers to different
exchanges, and the Exchange
Transaction Fee Summary would
provide that information. Moreover, the
Exchange Transaction Fee Summary
would provide researchers with
historical (realized) average and median
per share fees and rebates to provide an
ex post analysis of how actual fees
affected order routing decisions from
the prior period, which is not available
from any data source today. This
information provides another avenue for
researchers to identify exchanges that
are more expensive or less expensive
using actual past fees instead of a fee
schedule that varies widely across
participants.
Exchanges would construct Exchange
Transaction Fee Summaries according
to an XML schema to be published on
the Commission’s website, and
exchanges would update this
information monthly.324 These data
would be standardized and consistently
formatted, which would ease the use of
these data for researchers, as each
exchange would have to report the base,
top-tier, average, and median fees, as
detailed above in Section III.E.2. Each
month, exchanges would be required to
report realized average and median per
324 The standardized fee data, as would be
required by the proposed Pilot, is discussed in
Section III.E.2, supra.
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share fees, as well as any ‘‘spot’’
revisions to fees associated with Form
19b-4 fee filings to the Commission.
These fee data would be publicly posted
on each exchange’s website.325
The Exchange Transaction Fee
Summary released during the Pilot
would: (1) Ease aggregation across
exchanges, which affords researchers an
opportunity to obtain representative
results; (2) replicate across studies,
which would provide validation of
findings; and (3) reduce burdens
associated with fee data collection,
which could encourage more research
on the impact of fees and rebates on
routing behavior. Because each
exchange would be required to provide
its Exchange Transaction Fee Summary
using the Commission’s XML schema,
data on fees and rebates would be
produced in a structured and
standardized format, allowing
researchers to easily aggregate and
compile the data across all of the U.S.
equities exchanges. The format of the
data would facilitate the ability of a
researcher to obtain representativeness
in her results, which could enhance
current views on possible conflicts of
interest related to transaction-based
fees.
Moreover, because all researchers
would have access to the same set of
data on transaction-based fees and
rebates, they would be able to replicate,
validate, and confirm the analyses of
one another, which would be difficult to
do with existing data sources. Unlike
currently available fee data,
downloadable files containing the
Exchange Transaction Fee Summary
would be publicly posted on each
exchange’s website and would provide
researchers with consistent measures of
various categories of fees and rebates,
described in Section III.E.2, thereby
reducing costs to researchers to collect
and analyze the data provided. Thus,
the Commission preliminarily believes
that a standardized reporting of
summary data on fees by the exchanges
would facilitate analysis of the effect of
transaction-based fees on order routing
decisions by broker-dealers.
The proposed rule would require that
the Exchange Transaction Fee Summary
be structured using an XML schema to
be published on the Commission’s
325 Proposed Rule 610(T) requires each exchange
to publicly post on its website downloadable files
containing the Exchange Transaction Fee Summary
and update them on a monthly basis. Similarly,
each exchange would be required to publicly post
on its website downloadable files containing daily
aggregated and anonymized order routing statistics,
updated monthly. Each exchange would also be
required to provide daily on its website
downloadable files containing the List of Pilot
Securities and the Pilot Securities Change List.
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website. Data that are structured in a
standard format can result in lower
costs to analysts and higher quality data.
An additional key benefit of structured
data is increased usability. If, for
instance, the Exchange Transaction Fee
Summary were not standardized across
the exchanges, researchers would have
to manually rekey the data, a timeconsuming process which has the
potential to introduce a variety of errors,
such as inadvertently keying in the
wrong data or interpreting the filings
inconsistently, thereby reducing
comparability. With the data in the
reports structured in XML, researchers
could immediately download the
information directly into databases and
use various software packages for
viewing, manipulation, aggregation,
comparison, and analysis. This would
enhance their ability to conduct largescale analysis and immediate
comparison of the fee structures of
exchanges. The Commission
preliminarily believes that requiring
these reports to be made available in an
XML format would provide flexibility to
researchers and would facilitate
statistical and comparative analyses
across exchanges, test groups, and date
ranges.
Moreover, as an open standard, XML
is widely available to the public at no
cost. As an open standard, XML is
maintained by an industry consensusbased organization, rather than the
Commission, and undergoes constant
review. As updates to XML or industry
practice develop, the Commission’s
XML schema may also have to be
updated to reflect the updates in
technology. In those cases, the
supported version of the XML schema
would be published on the
Commission’s website and the outdated
version of the schema would be
removed in order to maintain data
quality and consistency with the XML
standard.
The Commission’s proposed XML
schema would also incorporate certain
validations to help ensure data quality.
Validations are restrictions placed on
the formatting for each data element so
that comparable data are presented
comparably. Complete and
appropriately formatted data enhances
data users’ abilities to normalize and
aggregate the data for review and
analysis. The validations incorporated
into the schema would be effective for
checking data completeness and
appropriate formatting, and would help
the exchanges ensure that the data they
post adheres to the Commission’s XML
schema in completeness and
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formatting.326 Accordingly, the
Exchange Transaction Fee Summary
reports made available by exchanges in
XML format pursuant to the proposed
rule would have to be validated against
the most recent XML schema published
on the Commission’s website.
ii. Benefits of Studying Other Economic
Effects
In addition to potential conflicts of
interest, a number of studies have
expressed other concerns related to
transaction-based fees. For example,
studies predict that transaction-based
fee pricing has led to increased market
fragmentation and complexity.327 As an
ancillary benefit to the Transaction Fee
Pilot, the Commission and the public
possibly could obtain data to facilitate
analyses and research relating to the
effects of fees and rebates on market
fragmentation and market complexity in
addition to those designed to study the
potential conflicts of interest. These
analyses are likely to be informative to
the Commission as it evaluates future
policy decisions.
Through the use of the order routing
data from the Transaction Fee Pilot,
researchers would be able to study order
flow among different venues, which
could provide insights into whether
changes in transaction-based fees affect
the current baseline of competition
between exchanges and off-exchange
trading centers, even in the absence of
potential conflicts of interest. Existing
literature suggests that transaction-based
pricing has contributed to an increase in
the number of venues competing for
order flow over time.328 By offering
rebates or Linked Pricing, start-up
maker-taker and taker-maker trading
centers have been able to attract order
326 These validations, however, will not test for
the underlying accuracy of the data.
327 See, e.g., Thierry Foucault, Ohad Kadan, and
Eugene Kandel, ‘‘Limit Order Book as a Market for
Liquidity,’’ Review of Financial Studies 18, 1171–
1217 (2005), available at: https://
academic.oup.com/rfs/article/18/4/1171/1595760
(‘‘Foucault et al. (2005)’’); Marios Panayides,
Barbara Rindi, and Ingrid Werner, ‘‘Trading Fees
and Intermarket Competition,’’ Working Paper,
University of Pittsburgh (2017) available at: https://
papers.ssrn.com/sol3/papers.cfm?abstract_
id=2910438 (‘‘Panayides et al. (2017)’’). Panayides
et al. (2017) builds on the theoretical model of
Foucault et al. (2005) and finds a decline in market
quality and fraction of order flow to an exchange
as its relative rebate declines or the take fee
increases.
328 As discussed in the baseline, the number of
exchanges has increased since 2005, and market
share has become less concentrated over the same
time period. These exchanges are not fully
independent; the majority of the U.S. equities
exchanges belong to three exchange groups. The
Commission preliminarily believes that any
analyses of the effects of transaction-based fees on
order routing decisions can appropriately control
for exchange groups.
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flow from exchanges such as NYSE and
Nasdaq, thereby reducing liquidity
externalities, or concentration of order
flow to a preferred venue, and leading
to increased fragmentation of the market
for trading services. By altering the
access fee and rebate structures for
exchanges, researchers may be able to
identify whether these changes lead to
more (or less) concentration of liquidity
and how they affect competition for
order flow among exchanges, which
could lead to less (or more) market
fragmentation. The effect of transactionbased fees on market fragmentation
could not be examined in the absence of
the Pilot.
By design, the Transaction Fee Pilot
would alter access fees and rebates in
some test groups, also providing
researchers with information on how
these revisions affect the quoted spreads
(e.g., whether the spreads widen or
narrow). The width of the quoted spread
is considered to be an indicator of a
stock’s liquidity, with narrower spreads
generally indicating more liquid
securities. The proposed Pilot could
provide information on whether fees
and rebates affect the liquidity of
securities, as measured by the quoted
spreads, across different test groups.
Existing studies suggest that quoted
spreads appear to decline as liquidity
rebates increase; 329 thus, rebates appear
to decrease the cost of trading (and
narrow the NBBO), thereby potentially
improving investor and market
welfare.330 For some marketable orders,
the net spread (the quoted spread plus
the cost of access fees) is wider than the
quoted spread, thereby potentially
reducing transparency because quoted
spreads (for at least some orders) are
different from the net spread, yet most
retail customers are unaware of the
difference.331 Without transparency of
the fees and rebates assessed to traders,
the true costs of trading may be
concealed, thereby creating a distortion
between the quoted spread and the net
cost of trading. Additional distortions
between the quoted spread and the net
costs for customers arise because orders
are priced on different schedules in
329 See Angel, Harris, and Spatt, supra notes 106
and 216; Brolley and Malinova, supra note 24;
Harris, supra note 23; O’Donoghue, supra note 24.
330 See Brolley and Malinova, supra note 24.
Academic studies suggest that the majority of retail
orders are executed off-exchange at prices based on
the NBBO, thereby providing retail investors with
better prices in the presence of rebates. If, however,
large rebates provide incentives for broker-dealers
to route retail orders to these exchanges instead of
to off-exchange venues, retail customers may not be
fully aware of the total cost associated with their
orders. See e.g., Angel, Harris, and Spatt, supra
notes 106 and 216.
331 See Harris, supra note 23.
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different markets.332 Even if several
trading centers match the NBBO, the
magnitude of the access fees and
liquidity rebates could significantly
affect the net price paid by
customers.333
iii. Potential Limitations on the Benefits
The Commission recognizes that
pilots are unpredictable and as such
considered whether possible limitations
associated with pilots generally, as well
as certain issues presented by the design
of this pilot in particular, would limit
the benefits of the Transaction Fee Pilot.
The Commission preliminarily believes
that the limitations of pilots, some of
which may affect the Transaction Fee
Pilot as discussed below, should not
impede its success. This section
discusses, in greater detail below, issues
associated with pilots in general and the
potential concerns with resultant
research and analyses, as well as
overlap with the Tick Size Pilot.
Pilots may face limitations related to
the unpredictable nature of market
conditions and confounding events.
Even if a pilot lasted several years, not
all of the market conditions of interest
could be experienced. Depending on the
requirements of pilots, such limitations
might reduce the usefulness of the
information obtained.334 The
Commission preliminarily believes,
however, that the value of the
information obtained from the proposed
Transaction Fee Pilot is not dependent
upon having variation in market
conditions over time, and that the
duration of the proposed Pilot would
provide sufficient information for future
analyses.
In addition, pilots also face the
limitation that market participants,
knowing that a pilot is underway, may
not act as they would in a permanent
regime.335 In the context of this pilot,
332 See
333 See
Angel, Harris, and Spatt, supra notes 106.
Battalio Equity Market Study, supra note
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22.
334 For instance, a pilot could be designed where
the information obtained from the proposed Pilot
would only be valuable if certain market
conditions, such as high market volatility or a
recessionary period occurred. If, however, markets
experience low volatility or are in an expansionary
period, the proposed Pilot may either not be
sufficiently long enough to capture the events that
it requires to be useful or would have to be
extended to ensure that those market conditions
could occur.
335 For example, one study provided evidence
suggesting that trading behavior may not have
completely adjusted to the Regulation SHO pilot.
See, Ekkehart Boehmer, Charles Jones, and Xiaoyun
Zhang, ‘‘Unshackling Short Sellers: The Repeal of
the Uptick Rule,’’ Working Paper, Columbia
University (2008), available at: https://
www0.gsb.columbia.edu/faculty/cjones/Uptick
RepealDec11.pdf. Despite this effect, the study
found evidence consistent with the evidence
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broker-dealers could choose to retain
their current order-routing decisions for
the duration of the proposed Pilot,
which could be costly to such brokerdealers.336 Broker-dealers, when
deciding whether to adjust any order
routing behavior that currently depends
on fees and rebates, would likely trade
off the costs of retaining strategies that
are no longer profitable because of the
restrictions imposed by the proposed
Pilot against the costs of adjusting the
algorithms for their smart order routing
systems, as explained below Section
V.C.2. The costs of ‘‘waiting out’’ the
pilot increase with the duration of the
pilot, whereas the costs of adjusting the
algorithms of the smart order routers do
not. Alternatively, broker-dealers could
substantially change their business
model in order to avoid the Pilot.337
Either of these outcomes could lead to
results that would not represent the
effects of a permanent rule change. The
Commission preliminarily believes that
it is unlikely that broker-dealers would
maintain existing order routing
decisions or alter their business models
to avoid the Pilot. In particular, the
Commission preliminarily believes that
the proposed Pilot duration is likely to
make it economically worthwhile for
broker-dealers to adjust their order
routing behavior, as the total costs of
changes to order routing systems are
estimated to be on average
approximately $42,900 per brokerdealer, if the Pilot were to automatically
sunset at the end of the first year.338
gathered from the Regulation SHO pilot. See
Securities Exchange Act Release No. 50103 (July 28,
2004), 69 FR 48008 (August 6, 2004) (‘‘Regulation
SHO’’).
336 If broker-dealers have smart order routing
systems that use algorithms that maximize rebate
capture, as suggested in the Battalio Equity Market
Study, supra note 22, then for at least some subset
of securities, broker-dealers would not be able to
pursue rebates from those exchanges, so it would
be suboptimal for broker-dealers to not reconsider
their order routing choices. If broker-dealers,
however, already have order routing decisions that
are optimal from a customer’s perspective (i.e.,
based on execution quality) and are not driven by
potential conflicts of interest (i.e., maximizing
rebates), then for at least some broker-dealers, their
order routing decisions may be unchanged,
particularly if execution quality does not migrate
between exchanges as a result of the
implementation of the proposed Pilot.
337 It could be costly for broker-dealers to
completely alter their business models because they
may not find it worthwhile to do so for a temporary
pilot. Further, if a broker-dealer has discretionary
control over a customer’s account, the broker-dealer
could alter their business model by overweighting
stocks in the control group and underweighting
stocks in Test Group 3, if the objective of the
broker-dealer is to continue to capture rebates.
338 The costs for broker-dealers to update their
order routing systems are detailed in Section
V.C.2.f. If the proposed Pilot were extended for up
to an additional year, the total costs to brokerdealers would be approximately $67,000 per brokerdealer.
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Further, although the proposed Pilot
could automatically sunset at the end of
the first year, the Commission retains
the flexibility to suspend the sunset to
continue the proposed Pilot for up to an
additional year, at its discretion, if the
Commission believes that it needs
additional data for any reason.
In order to facilitate analysis of data
during the Pilot Period, the Commission
believes that it is important to collect
sufficient data during a pre-Pilot Period.
The pre-Pilot data can then be compared
with the data that would be produced
during the Pilot Period, which would
permit analysis of any changes to order
routing behavior, execution quality, and
market quality between the two for the
Pilot Securities in each of the Test
Groups. To make this comparison
informative, the length of the pre-Pilot
Period needs to be long enough to
obtain sufficient statistical power to
permit analysis of the stocks and ETP
Pilot Securities. In turn, sufficient
statistical power in tests that compare
the pre-Pilot data to the Pilot data
would allow the Commission and others
to more easily use the information
obtained from the Pilot to inform future
regulatory consideration of exchange
transaction fees and their impact on the
markets.339 The Commission
preliminarily believes that at least six
months of pre-Pilot data may be
required to obtain the necessary
statistical power to permit analysis of
the Pilot Securities during the Pilot,
particularly ETPs.340 Without sufficient
statistical power, researchers cannot use
statistical techniques to distinguish
between a pilot that has no effect and
pilot data that do not provide enough
power to detect an effect. In such
situations, in order to have sufficient
data to obtain statistical power,
researchers would have to wait until the
conclusion of the post-Pilot period to
gather additional data, likely delaying
the initial results of the proposed Pilot
and the Commission’s consideration
thereof.
Furthermore, a short pre-Pilot Period
introduces additional risk that analysis
of certain Pilot data may be
uninformative. Even if researchers were
to wait until the conclusion of the postPilot period to begin analysis, they may
not be able to identify the effects of the
Pilot because data obtained from the
post-Pilot period could be confounded
by information about the Pilot. For
example, if exchanges alter their fee
structures in the post-Pilot period as a
result of the Pilot (rather than revert
back to their fee models in effect prior
339 See
340 See
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to the Pilot), data from the post-Pilot
period likely would be unable to
supplement or substitute for data
obtained from a shorter pre-Pilot Period,
underscoring the importance of a longer
pre-Pilot Period. Thus, the value of any
analyses obtained from the Pilot may be
limited, thereby reducing the
information obtained from such
analyses for any potential regulatory
recommendations.
The Commission preliminarily does
not believe that the benefits of the
proposed Transaction Fee Pilot would
be limited by the potential overlap with
the Tick Size Pilot. For at least some
portion of the proposed Transaction Fee
Pilot’s pre-period or Pilot Period, a
sample of small and mid-capitalization
stocks could simultaneously be subject
to two pilots.341 Two potential issues
associated with the overlap between the
pilots could lead to incorrect inferences
in any analyses of the data produced by
the proposed Pilot.342 First, researchers
would have to create additional control
groups to account for the overlap with
the Tick Size Pilot, which potentially
increases the costs for researchers to
study the proposed Transaction Fee
Pilot. Second, the interaction between
the test groups arising from the overlap
may not be consistent across test
groups.343 However, the Commission
preliminarily believes that researchers
could appropriately control for such
interaction in their analyses of either
pilot.
The Commission recognizes that the
data obtained from the Transaction Fee
Pilot would not be straightforward to
study. Specifically, the changes in fees
or rebates imposed by the proposed
Pilot may change transaction costs in a
way that results in changes to order
routing decisions by broker-dealers,
even absent potential conflicts of
341 Sections V.C.2.b and V.D.3, infra, discuss
more thoroughly the implications for small and
mid-capitalization issuers.
342 In addition to these two issues, there may not
be sufficient statistical power to jointly test the
impact of being in test groups of both pilots. Given
the limited number of securities that would, for
example, be part of Test Group 1 of the Transaction
Fee Pilot and Test Group 1 of the Tick Size Pilot
(45 stocks), a substantial number of time series
observations would likely be necessary to achieve
statistical power. Depending on when the
Transaction Fee Pilot becomes effective, there may
only be limited overlap between the two pilots, if
any. However, understanding the joint impact is not
the reason for overlapping the pilots.
343 The stratification approach that would be used
to construct the test groups assumes that the impact
of changes to fees and rebates would be the same
across all Tick Size Pilot test groups, and that
representativeness would be maintained. If the
impacts are different, then a researcher might not
be able to control for all of the interactions,
potentially undermining the reliability of the
results.
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interest. Studying how order routing
changes during the proposed Pilot,
without jointly studying why it changes,
would not be sufficient to understand
any possible conflicts of interest.
Researchers can carefully select and
apply sophisticated econometric
techniques to distinguish the proportion
of changes in order routing decisions
resulting from execution quality
considerations from those resulting from
potential conflicts of interest.
Nonetheless, this complication could
reduce the number and/or quality of
studies of the proposed Transaction Fee
Pilot.
b. Other Benefits of the Proposed
Transaction Fee Pilot
Other benefits may emerge that would
affect markets and market participants
for the duration of the proposed Pilot,
such as reduced conflicts of interest for
some test groups or lower all-in costs of
trading. As discussed in further detail
below, the Commission preliminarily
believes that other likely benefits of this
proposal would be temporary in nature
and affect markets and market
participants only for the duration of the
proposed Pilot.
The potential conflicts of interest
discussed above could be mitigated
during the duration of the proposed
Pilot for investors in at least some
subset of securities. For instance, in Test
Group 2 where access fees are lowered
or Test Group 3 where rebates or Linked
Pricing are prohibited, broker-dealers
may alter their order routing behavior
because the incentives to capture
rebates or Linked Pricing are lessened or
removed from this subset of securities.
The Commission notes, as discussed in
the baseline section, that it lacks
sufficient evidence of these potential
conflicts of interest to ascertain the
harm to investors from the conflicts;
instead, the proposal itself would be a
mechanism for ascertaining the
magnitude of any such benefits.
Therefore, the Commission at this time
is uncertain of the magnitude of these
benefits.
For at least some subsets of securities
where rebates are likely to be reduced
to de minimis levels or eliminated
entirely for the duration of the proposed
Pilot, broker-dealers could increase the
routing of customer orders to offexchange trading centers, such as ATSs.
When broker-dealers can no longer
capture rebates or Linked Pricing for
some subsets of securities, they could
change their order routing to offexchange trading centers, because this
would allow these broker-dealers to
avoid access fees for marketable orders.
Off-exchange trading centers are
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13057
required to match the prevailing NBBO,
and the Commission understands that
most ATSs do not charge access fees or
pay rebates and could temporarily
reduce the all-in costs of trading for
orders routed off-exchange.344
As an additional temporary benefit
resulting from the proposed Pilot, lower
access fees or eliminated rebates or
Linked Pricing in some test groups
could drive down the cost of routing
orders to exchanges, which could draw
order flow away from ATSs and back to
exchanges, potentially resulting in an
improvement in exchange execution
quality. A reduction in access fees in
proposed Transaction Fee Pilot test
groups could induce broker-dealers to
route more marketable orders to makertaker exchanges. As marketable orders
increase on maker-taker exchanges,
under the assumption that brokerdealers route orders in their customer’s
best interest, non-marketable orders
could also be routed to the same
exchanges, because the likelihood of
execution and possibly the speed of
execution improve for non-marketable
orders with an increase in marketable
orders. Thus, as a by-product of the
proposed Pilot, exchanges temporarily
may see improvements in their overall
execution quality and may see an
increase in routing of order flow by
broker-dealers even in the absence of
large rebates. This could benefit
investors as they may temporarily
obtain better execution quality or price
improvement for some securities that
they would not otherwise obtain in the
absence of the proposed Pilot.
The exogenous shock to fees and
rebates also could temporarily affect the
transparency of quoted spreads. Several
studies suggest that access fees and
rebates, while narrowing the quoted
spread, increase the net cost of trading
but in a way that is not transparent to
investors.345 Reductions to access fees
and rebates could increase the
transparency of the all-in costs of
trading for investors. Although the
proposed Pilot is not designed to
provide investors with full transparency
of the net costs of trading, for at least
344 In addition to the potentially lower all-in costs
of trading for orders routed off-exchange, ATSs also
reduce the likelihood of price impact associated
with large trades, as those investors trading blocks
of shares could potentially reduce the price impact
of their trades by crossing orders off-exchange,
which could reduce the likelihood that other
market participants find out about the order ahead
of the execution. See Jennifer Conrad, Kevin
Johnson, and Sunil Wahal, ‘‘Institutional Trading
and Alternative Trading Systems,’’ Journal of
Financial Economics 70, 99–114, (2003) available at
https://www.sciencedirect.com/science/article/pii/
S0304405X03001430.
345 See Angel, Harris, and Spatt, supra notes 106
and 216.
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some test groups, where rebates are
likely to be reduced to de minimis levels
or prohibited outright, investors may
obtain partial transparency on how
rebates affect quoted spreads and
possibly the all-in costs of trading. This
effect could be particularly important
for small and mid-capitalization
securities, where price transparency
may be low and which are likely to
experience an increase in spreads, and
could subsequently reduce liquidity for
these securities as a result of the
exogenous shocks to fees and rebates.
Therefore, for the duration of the
proposed Pilot, an unintended benefit to
investors in these securities is that
prices may be more transparent as the
all-in costs of trading are closer to the
true economic net cost as reflected in
the displayed quotes.
The Commission preliminarily
believes that another temporary benefit
of the proposal would be that the
proposed Transaction Fee Pilot could
prevent some traders from indirectly
quoting in sub-pennies.346 Rebates have
the practical effect of reducing the
minimum tick size by the size of the
rebate, and in effect allow trading
centers to offer quotations superior to
the existing quote. Several studies
suggested that the use of fees and
rebates to effectively undercut
quotations by sub-pennies is
particularly severe in taker-maker
markets.347 The proposed Transaction
Fee Pilot would, in some test groups,
reduce or eliminate rebates, which
could stem this indirect reduction of
tick sizes, and could provide the
Commission and the public with
information currently unavailable about
the frequency of this issue.
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2. Costs of Proposed Transaction Fee
Pilot
This section describes the compliance
costs associated with the proposed
Transaction Fee Pilot, followed by the
additional temporary costs that could
affect issuers, investors, broker-dealers,
346 Rule 612 of Regulation NMS prohibits traders
from submitting sub-penny quotations on securities
trading at prices over $1.00. The purpose of the subpenny quotation prohibition was two-fold: (1) To
prevent high frequency traders from front-running
standing non-marketable limit orders and (2) to
reduce the complexity of trading systems. See NMS
Adopting Release, supra note 1, at 37550–57.
347 See, e.g., Angel, Harris, and Spatt, supra note
216; Harris, supra note 23. One study noted that as
a result of the Tick Size Pilot test group with the
trade-at provision, taker-maker markets have seen a
significant increase in market share, in part due to
this quotation issue. See Carole Comerton-Forde,
Vincent Gregoire, and Zhuo Zhong, ‘‘Inverted Fee
Venues and Market Quality,’’ Working Paper,
University of Melbourne (2017), available at:
https://papers.ssrn.com/sol3/papers.cfm?abstract_
id=2939012.
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exchanges, and other market
participants resulting from the proposed
Pilot.
a. Exchange Compliance Costs of the
Proposed Transaction Fee Pilot
The proposed Pilot would impose
costs on exchanges to comply with the
Pilot’s requirements to collect, calculate,
and publicly post data required by the
Pilot on their websites, as well as to
implement the required fee changes. An
overview of the requirements of the
proposed Pilot are presented in this
section, and are discussed in more
detail below. Specifically, exchanges
that serve as the primary listing market
would be required to publicly post on
their websites downloadable files
containing the Pilot Securities Exchange
List, derived from the initial List of Pilot
Securities published on the
Commission’s website by notice, as well
as maintain and update the Pilot
Securities Exchange List as necessary
prior to the beginning of trading on each
trading day. Separately, prior to the
beginning of trading on each trading day
and throughout the duration of the
proposed Pilot, each primary listing
exchange shall publicly post on its
website a downloadable file containing
a Pilot Securities Change List, which
lists each separate change applicable to
any Pilot Security (i.e., name changes,
mergers, or other corporate events) for
which the exchange serves or has served
as the primary listing exchange.348
The proposed Pilot would also require
that each exchange provide a monthly
standardized Exchange Transaction Fee
Summary, detailed in Section III.E.2,
which includes information on the
initial list of fees and rebates associated
with each test group and the control
group, as well as changes to those fees
and rebates corresponding with Form
19b–4 fee filings made to the
Commission. In addition to the base and
top-tier fees and rebates required in the
Exchange Transaction Fee Summary,
exchanges would also be required to
calculate and publicly post on their
websites the realized monthly average
and median per share fees and rebates
as part of the Exchange Transaction Fee
Summary.
As discussed in more detail in Section
III.E.3, equities exchanges would
prepare and publicly post on their
websites, order routing data, updated on
a monthly basis, containing aggregated
and anonymized broker-dealer order
348 As discussed in Section III.E.1, supra, the
Commission would publish by notice the initial List
of Pilot Securities, which would identify the
securities in the proposed Pilot and assign each of
them to a designated test group (or the control
group).
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routing information. The required
datasets, detailed in proposed Rule
610T(d), would contain order routing
information for liquidity-providing
orders and liquidity-taking orders
aggregated by day, by security, by
broker-dealer, and by exchange on an
anonymous basis. The Commission
expects that the equities exchanges
would compile the required order
routing data by utilizing the data they
collect pursuant to the CAT.349 As
discussed below, each exchange would
need to aggregate at the daily level the
order routing statistics detailed in
proposed Rule 610T(d) and would need
to anonymize that data at the brokerdealer level, using the anonymization
key provided by representatives of the
Commission at the outset of the
proposed Pilot. These data, in pipedelimited ASCII format, would be
publicly posted to each exchange’s
website, no later than the last day of
each month for the prior month.
Although the proposed rule requires
that exchanges release order routing
data at the anonymized broker-dealer
level, market participants or researchers
theoretically could reverse engineer
proprietary trading strategies of other
market participants, which could have
implications for the profitability of
those strategies going forward if they
were revealed or mimicked by other
participants. The Commission is
sensitive to the potential proprietary
nature of the order routing data but
preliminarily believes that releasing the
order routing data would not affect
market participants because the
likelihood of being able to reverse
engineer broker-dealers’ order-level
strategies is low because the data would
be aggregated by security and day and
would anonymize the broker-dealers.
The proposal requires the order routing
data to be anonymized at the brokerdealer level to limit the degree to which
it reveals proprietary information. The
order routing data are also aggregated by
day, and released with a delay, to limit
revealing individual strategies in the
event someone was able to reverse
engineer broker-dealer identities. The
Commission provides estimates of the
costs associated with complying with
the proposed Transaction Fee Pilot’s
reporting requirements, discussed in
detail below.
349 See Section III.E.3 supra, which provides a
more detailed discussion of the use of the CAT for
the collection of order routing data.
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b. Updating the Pilot Securities
Exchange List and Pilot Securities
Change List
As described above, the exchanges
would maintain and make public prior
to the start of each trading day the Pilot
Securities Exchange List of the
securities included in each test or
control group on its website, in
accordance with Rule 610T(b), making
relevant adjustments for ticker symbol
changes and corporate actions (i.e.,
mergers or name changes). Further, each
exchange would publicly post on its
website the updated Pilot Securities
Change List prior to the start of each
trading day, which would list,
separately, changes to applicable Pilot
Securities. Additional details of what
would be included in each list are
provided in Section III.E.1.
From time to time, exchanges update
issuers’ ticker symbols for various
reasons, such as a merger or a corporate
reorganization and notify their members
when such changes become effective.
Given that every exchange has practices
in place to update its members about the
listed securities and has also adjusted
its normal processes to account for the
Tick Size Pilot, the Commission
preliminarily believes that the costs
associated with providing required data
for the proposed Transaction Fee Pilot
would not place undue cost burdens
upon the exchanges. The processes used
by exchanges to update the list of pilot
securities for the Tick Size Pilot could
be used to also track the proposed
Transaction Fee Pilot securities, as well
as any changes to those securities as
detailed above in Section III.E.1.
Upon the initial publication of the
List of Pilot Securities by notice by the
Commission, the primary listing
exchanges 350 would need to determine
which securities are listed on their
market, compile, and publicly post on
their websites downloadable files in
pipe-delimited ASCII format a list of
those securities. The Commission
preliminarily estimates that the costs
associated with the initial compilation
of the Pilot Securities Exchange List
would cost $2,060 per exchange, or
$10,300, in aggregate.351
350 The five primary listing exchanges are NYSE,
Nasdaq, NYSE American, NYSE ARCA, and BATS.
351 This estimate is based on the following:
[(Compliance Manager (4 hours) × $298) +
(Programmer Analyst (4 hours) × $232)] = $2,060
per exchange, or $2,060 × 5 primary listing
exchanges = $10,300 in aggregate. The burden hours
are obtained from Section IV.J.1, supra. The
Commission estimates the wage rate associated with
these burden hours based on salary information for
the securities industry compiled by the Securities
Industry and Financial Markets Association
(SIFMA). The estimated wage figure for attorneys,
for example, is based on published rates for
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The Commission understands that
each primary listing exchange has
existing systems to monitor and
maintain the Pilot Securities Exchange
List and the Pilot Securities Change List
as a result of certain corporate
actions.352 While these systems can be
used to collect the data required to be
made public for the Pilot Securities
Exchange List and the Pilot Securities
Change List, the Commission further
understands that these systems would
have to be adapted to conform to the
requirements of the proposed Pilot. The
Commission estimates that it would cost
each primary listing exchange
approximately $3,720 to develop
appropriate systems for the proposed
Transaction Fee Pilot, or $18,600 in
aggregate across the five U.S. primary
listing exchanges.353 Once these systems
are established, the Commission
estimates that it would cost each
exchange $86,300 for the entire duration
of the proposed Pilot, including up to
the one-month pre-Pilot Period, a twoyear Pilot duration, and the six-month
post-Pilot Period, or $431,500 across the
five primarily listing exchanges,354 to
attorneys, modified to account for a 1,800-hour
work-year and multiplied by 5.35 to account for
bonuses, firm size, employee benefits, and
overhead, yielding an effective hourly rate for 2013
of $380 for attorneys. See Securities Industry and
Financial Markets Association, Management &
Professional Earnings in the Securities Industry—
2013, available at: https://www.sifma.org/resources/
research/management-and-professional-earningsin-the-securities-industry-2013/. These estimates are
adjusted for inflation based on Bureau of Labor
Statistics data on CPI–U between January 2013
(230.280) and January 2017 (242.839). Therefore,
the 2017 inflation-adjusted effective hourly wage
rates for attorneys are estimated at $401 ($380 ×
242.839/230.280). The Commission discusses other
costs of compliance with the proposed rule below.
352 See supra note 150. As discussed above,
primary listing exchanges have experience in
producing and maintaining similar lists on their
websites with respect to the Tick Size Pilot, which
should be adaptable to meet the requirements of the
proposed Transaction Fee Pilot.
353 This estimate is based on the following:
[(Attorney (4 hours) × $401) + (Compliance Manager
(4 hours) × $298) + (Programmer Analyst (4 hours)
× $232)] ≈ $3,720 per exchange, or $3,720 × 5
exchanges ≈ $18,600 in aggregate. The burden hours
are obtained from Section IV.J.1, supra.
354 If the proposed Pilot were to automatically
sunset at the end of the first year, the total number
of days that the exchanges would need to provide
the Pilot Securities Exchange List and the Pilot
Securities Change Lists would be up to 651
business days (up to 21 business days for the onemonth pre-Pilot Period, 504 business days for the
two-year Pilot horizon (252 business days per year
× 2 years), and 126 business days for the six-month
post-Pilot Period). The total number of days in the
pre-Pilot Period would be no more than 21 trading
days, but could be as short as zero days depending
on when the exchanges begin to publish the Lists.
The cost estimate for providing these lists for the
entire period is based on the following:
[(Compliance Manager (0.25 hour × 651 trading
days) × $298) + (Programmer Analyst (0.25 hour ×
651 trading days) × $232)] ≈ $86,300, or $86,300 ×
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13059
publicly post on each exchange’s
website the Pilot Securities Exchange
List and Pilot Securities Change List
prior to the start of each trading day in
pipe-delimited ASCII format. If the
Commission determined that the
proposed Pilot shall be automatically
sunset at the end of the first year, the
Commission estimates that the costs to
each exchange would be $52,900 for the
one-month pre-Pilot Period, a one-year
Pilot duration, and the six-month postPilot Period, or $264,500 across the five
primarily listing exchanges.355
c. Producing the Exchange Transaction
Fee Summary in XML Format
In addition to the Pilot Securities
Exchange List provided by the primarily
listing exchanges, all U.S. equities
exchanges would also need to publicly
post on their websites the Exchange
Transaction Fee Summary,
downloadable files containing the initial
set of fees at the outset of the proposed
Transaction Fee Pilot as well as monthly
updates to include both changes to fees
and rebates reported in Form 19b-4 fee
filings and realized average and median
per share fees and rebates, as discussed
in Section III.E.2. The Exchange
Transaction Fee Summary would need
to be updated promptly in response to
any changes to its dataset following the
beginning of each calendar month from
the pre-Pilot Period through the postPilot Period. The exchanges would be
required to provide information on any
transaction-based fee changes, according
to Rule 610T(e), that they make during
the proposed Pilot, including the
effective dates of fee revisions. The
proposed rule also requires that each
exchange calculates the realized
monthly average and median per share
fees and rebates, as discussed in more
detail in Section III.E.2.
A requirement at the outset of the
proposed Pilot is that exchanges would
need to report their base and top-tier
5 exchanges ≈ $431,500, in aggregate. The burden
hours are obtained from Section IV.J.1, supra.
355 If the proposed Pilot were to automatically
sunset at the end of the first year, the total number
of days that the exchanges would need to provide
the Pilot Securities Exchange List and the Pilot
Securities Change Lists would be up to 399
business days (up to 21 business days for the onemonth pre-Pilot Period, 252 business days for the
one-year Pilot horizon, and 126 business days for
the six-month post-Pilot Period). The total number
of days in the pre-Pilot Period would be no more
than 21 trading days, but could be as short as zero
days depending on when the exchanges begin to
publish the Lists. The cost estimate for providing
these Lists for the entire period is based on the
following: [(Compliance Manager (0.25 hour × 399
trading days) × $298) + (Programmer Analyst (0.25
hour × 399 trading days) × $232)] ≈ $52,900, or
$52,900 × 5 exchanges ≈ $264,500, in aggregate. The
burden hours are obtained from Section IV.J.1,
supra.
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fees and rebates, which the Commission
estimates would cost each exchange
$1,130, or $14,700, in aggregate across
the 13 U.S. equities exchanges.356 The
reported base and top-tier fees and
rebates would be mandatory elements of
the Exchange Transaction Fee
Summary. Concurrent with the
submission of the Form 19b–4 fee filings
to the Commission at the outset of the
proposed Transaction Fee Pilot, the
exchanges would also be required to
publicly post on their websites
downloadable files containing the initial
Exchange Transaction Fee Summary,
using an XML schema to be published
on the Commission’s website. The
Commission estimates that it would cost
exchanges $530 each to post this
summary dataset to their websites, or
$6,900 in aggregate across the 13 U.S.
equities exchanges, using an XML
schema to be published on the
Commission’s website.357
The proposed rule would also require
that exchanges compute the monthly
average and median realized per share
fees and rebates, as detailed in Section
III.E.2. These data would provide the
Commission and the public aggregated
data on the actual per share levels of
fees and rebates assessed in the prior
month, which the Commission believes
is critical for estimating the effects of
fees and rebates on order routing
decisions. The Commission
preliminarily believes that the costs
associated with computing these
summary data on fees and rebates are
likely to be larger than the costs
associated with updating the Exchange
Transaction Fee Summary, discussed in
detail below, and would likely require
new systems by the exchanges to track
the average and median fees.
The Commission estimates that each
exchange would have a one-time cost of
$24,000, or $312,000 in aggregate across
the 13 U.S. equities exchanges,
associated with the development and
implementation of systems tracking
realized monthly average and median
per share fees pursuant to the proposed
rule.358 The Commission further
356 The estimate is based on the following:
[(Compliance Manager (2 hours) × $298) + (Senior
Business Analyst (2 hours) × $265)] ≈ $1,130, or
$1,130 × 13 equities exchanges ≈ $14,700 in
aggregate. The burden hours are obtained from
Section IV.J.1, supra.
357 This estimate is based on the following:
[(Compliance Manager (1 hours) × $298) +
(Programmer Analyst (1 hours) × $232)] = $530 per
exchange, or $530 × 13 U.S. equities exchanges ≈
$6,900 in aggregate. The burden hours are obtained
from Section IV.J.1, supra.
358 This estimate is based on the following, which
reflects the Commission’s experience with and
burden estimates for SRO systems changes:
[(Attorney (20 hours) × $401) + (Compliance
Manager (20 hours) × $298) + (Programmer Analyst
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anticipates that it would cost an
additional $12,000 annually, or
$156,000, in aggregate, per year, to
ensure that the system technology is up
to date and remains in compliance with
the proposed rule.359
Moreover, as discussed above,
exchanges would be required to produce
monthly updates to the Exchange
Transaction Fee Summary to capture
realized average and median per share
fees as well as any revisions to fee
schedules made by the exchanges,
which would be reflected in changes to
base or top-tier fees and rebates,
detailed in Section III.E.2. The
Commission estimates that each month
it would cost each exchange $530 to
update the dataset of summary fees to
reflect the updates to historical realized
average and median per share fees and
changes to the base and top-tier fees.
This would require each exchange to
make a total of 36 updates to the
Exchange Transaction Fee Summary
from the pre-Pilot Period through the
post-Pilot Period, if the Commission
determined that the proposed Pilot
should continue for up to a second year
and not automatically sunset at the end
of the first year.360 Each exchange
would have total costs of updates to the
Exchange Transaction Fee Summary of
approximately $19,100 per exchange, or
$248,300 among the 13 exchanges over
the pilot duration, including pre- and
post-periods.361 If the proposed Pilot
were to automatically sunset at the end
of the first year, without the
Commission determining that an
(20 hours) × $232) + (Senior Business Analyst (20
hours) × $265] ≈ $24,000 per exchange, or $24,000
× 13 exchanges ≈ $312,000 in aggregate. The burden
hours are obtained from Section IV.J.1, supra.
359 This estimate is based on the following, which
reflects the Commission’s experience with and
burden estimates for SRO systems changes:
[(Attorney (10 hours) × $401) + (Compliance
Manager (10 hours) × $298) + (Programmer Analyst
(10 hours) × $232) + (Senior Business Analyst (10
hours) × $265] ≈ $12,000 per exchange, or $12,000
× 13 exchanges ≈ $156,000 in aggregate. The burden
hours are obtained from Section IV.J.1, supra.
360 This estimate of updates to the Exchange
Transaction Fee Summary is the aggregation of
updates from the pre-Pilot Period (6), the two-year
pilot period if the Commission determines that an
extension of up to an additional year was needed
(24), and the post-pilot period (6), for a total
number of 36 updates.
361 This estimate is based on the following:
[(Compliance Manager (1 hours) × $298) +
(Programmer Analyst (1 hours) × $232)] = $530 per
exchange, or $530 × 36 fee changes per exchange
≈ $19,100. The 36 fee changes for the exchange
encompass six updates during the six-month prePilot Period, 24 updates during the two-year Pilot
Period, assuming that the Commission determines
that the additional year is required, and six updates
during the six-month post-Pilot Period. In aggregate,
updates to the Exchange Transaction Fee Summary
are estimated to cost $19,100 × 13 U.S. equities
exchanges ≈ $248,300. The burden hours are
obtained from Section IV.J.1, supra.
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extension for up to an additional year
was needed, this would decrease the
total number of updates to the Exchange
Transaction Fee Summary to 24.362
Under an automatic sunset at the end of
the first year, each exchange would have
total costs of updates to the Exchange
Transaction Fee Summary of
approximately $12,700 per exchange, or
$165,100 among the 13 exchanges over
the pilot duration, including pre- and
post-periods.363 As detailed above, the
Commission preliminarily estimates
that the costs associated with the
monthly updates to the Exchange
Transaction Fee Summary would be a
small fraction of the costs associated
with the initial allocation of fees
required at the outset of the proposed
Pilot.
As discussed in Section III, the
proposal would require that the
Exchange Transaction Fee Summary be
published on the exchanges’ websites
using an XML schema to be published
on the Commission’s website. The
Commission understands that there are
varying costs associated with varying
degrees of structuring. The Commission
preliminarily believes that most of the
exchanges already have experience
applying the XML format to market
data. For example, the exchanges and
market participants regularly use the
FIX protocol 364 and FpML 365 to
exchange information on highly
structured financial instruments and
related market data.366
362 This estimate of updates to the Exchange
Transaction Fee Summary is the aggregation of
updates from the pre-Pilot Period (6), the one-year
pilot period with an automatic sunset at the end of
the first year (12), and the post-pilot period (6), for
a total number of 24 updates.
363 This estimate is based on the following:
[(Compliance Manager (1 hours) × $298) +
(Programmer Analyst (1 hours) × $232)] = $530 per
exchange, or $530 × 24 fee changes per exchange
≈ $12,700. The 24 fee changes for the exchange
encompass six updates during the six-month prePilot Period, 12 updates during the one-year Pilot
Period, assuming that the Commission determines
that the additional year is not required and the Pilot
is automatically sunset at the end of the first year,
and six updates during the six-month post-Pilot
Period. In aggregate, updates to the Exchange
Transaction Fee Summary are estimated to cost
$12,700 × 13 U.S. equities exchanges ≈ $165,100.
The burden hours are obtained from Section IV.J.1,
supra.
364 The Financial Information eXchange (FIX)
protocol is an electronic communications protocol
that provides a non-proprietary, free and open XML
standard for international real-time exchange of
information related to the securities transactions
and markets. See https://www.fixtrading.org/.
365 FpML (Financial products Markup Language)
is an open source XML standard for electronic
dealing and processing of OTC derivatives. It
establishes the industry protocol for sharing
information on, and dealing in, financial derivatives
and structured products. See https://www.fpml.
org/.
366 Most of the exchanges have at least some
portion of their data available through XML
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The Commission anticipates that
implementation of the proposed Pilot’s
XML schema would draw upon
exchange resources and experiences
previously used to implement other
supply chain information standards,
like those discussed above, that were
developed by industry consensus-based
organizations. Costs generally associated
with the implementation may include
those for: Identifying the data required
by the proposed Pilot within the
exchange source systems; mapping the
relevant fields in the exchanges’ data
source systems to the Commission’s
proposed XML schema; implementing,
testing and executing the validation
rules; and developing the website
posting processes as required by the
proposed rule. The initial costs to
exchanges of complying with the
Commission’s proposed XML schema in
order to publicly post the Exchange
Transaction Fee Summary in this format
would be $500 per exchange, or $6,500
in aggregate across the 13 exchanges.367
For all updates to the Exchange
Transaction Fee Summary, the
Commission estimates that any burden
associated with making those available
using the XML schema is included in
the costs of the updates discussed
above.
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d. Producing the Order Routing Data
The proposed rule also would require
as part of the proposed Transaction Fee
Pilot that exchanges would prepare, in
pipe-delimited ASCII format, and
publicly post on their websites, order
routing data, updated monthly,
containing aggregated and anonymized
broker-dealer order routing information.
As discussed in proposed Rule 610T(d)
formats. For instance, the NYSE Group of exchanges
provides daily closing prices, among other data, in
XML, Excel, and pipe-delimited ASCII, while the
Nasdaq exchanges (Nasdaq, BX, and PHLX) and
Cboe exchanges (Cboe BZX, Cboe BYX, Cboe EDGA,
and Cboe EDGX), provide daily share volume data,
among other data, in XML. Information on the use
of XML by exchanges is available at www.nyse.com,
www.nasdaqomx.com, www.cboe.com, for the
NYSE, Nasdaq, and Cboe exchange groups,
respectively, and was obtained from a staff review
of information on publicly available exchange
websites. The Commission was unable to obtain
information from CHX or IEX on their use of XML
from information available on their publicly
available websites.
367 This estimate is based on the following, which
reflects the Commission’s experience with and
burden estimates for systems changes to map to an
XML schema: [(Programmer Analyst (1 hours) ×
$232) + (Senior Business Analyst (1 hours) × $265]
≈ $500 per exchange, or $500 × 13 exchanges ≈
$6,500 in aggregate. See Securities Exchange Act
Release No. 78309 (July 13, 2016), 81 FR 49431,
49475 (July 27, 2016) (‘‘Disclosure of Order
Handling Information’’). The estimate is lower than
that for proposed Rule 606 disclosures because the
costs for those disclosures encompassed many
additional requirements beyond the mapping to an
XML schema.
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and in Section III.E.3, the datasets
would contain separate order routing
data for liquidity-providing and
liquidity-taking orders aggregated by
day, by security, by anonymized brokerdealer, and by exchange, each month.
The Commission preliminarily
believes that as long as the CAT Phase
1 data are available at the
implementation of the proposed
Transaction Fee Pilot, the exchanges
would be able to use that data to
construct the order routing data
required by the proposed rule. In
particular, the CAT Data will include
records for every order received by an
exchange that indicate the member
routing the order to the exchange and
details regarding the type of security.
The CAT Data will also include other
information necessary to create the
order routing data such as order type
information, special handling
instructions, and execution information.
In the event that the CAT Phase 1 data
were not available, the exchanges would
have to use existing systems to collect
the required order routing data.368
Regardless of which system exchanges
use for the order routing data, the
Commission anticipates they would
incur costs in producing the
downloadable files containing
aggregated and anonymized monthly
order routing data to be posted publicly
on the exchanges’ websites. The
proposal would require that the
exchanges adhere to using the common
broker-dealer anonymization key
provided by a representative of the
Commission in order to track and
analyze the activity of a given brokerdealer across multiple exchanges. As
discussed in Section III.E.3, the
Commission would construct a brokerdealer anonymization code, which
would be an anonymized code common
to a broker-dealer across all exchanges
using CRD information.
The exchanges would also be required
to make public the aggregated,
anonymized order routing data
described in Section III.E.3. The
proposal requires that the exchanges
would make public each month a
dataset of aggregated, anonymized data
368 The Commission acknowledged the use of
CAT for future pilots in its Approval Order of the
CAT NMS Plan. See note 172 supra. The
Commission is aware that much of the data
produced by the CAT are highly sensitive and if not
properly anonymized and aggregated could reveal
personally identifiable information (PII) at the
investor level or proprietary trading strategies at the
broker-dealer level. Accordingly, the exchanges
would only make public as part of the Transaction
Fee Pilot order routing data that are aggregated on
a daily basis and anonymized of broker-dealers to
minimize the potential for revelation or reverse
engineering of proprietary order routing decisions.
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on order routing statistics, detailed in
proposed Rule 610T(d), by day, by
issuer, and by broker-dealer. The
Commission estimates that each
exchange would have a one-time cost of
$24,000, or $312,000 in aggregate across
the 13 exchanges, associated with the
development and implementation of
systems needed to aggregate and
anonymize the order routing
information, as well as store the data, in
the pipe-delimited ASCII format
specified by the proposed rule and as
detailed in proposed Rule 610T(d).369
The Commission anticipates that it
would cost each exchange an additional
$12,000 per year, or $156,000 in
aggregate per year, to ensure that the
system and storage technology is up to
date and remains in compliance with
the proposed rule.370
The proposed rule would require that
exchanges produce monthly updates of
the order routing data, and make them
publicly available on their websites in
pipe-delimited ASCII format by the end
of the month, as detailed in Section
III.E.3 and proposed Rule 610T(d). The
Commission estimates that the
publication and updates of the order
routing dataset would cost $1,600 each
month. This would require each
exchange to make a total of 24 updates
to the order routing data from the prePilot Period through the post-Pilot
Period, if the proposed Pilot were to
automatically sunset at the end of the
first year. Each exchange would have
recurring costs of updates to the order
routing data of approximately $57,600
per exchange, or $748,800 among the 13
exchanges over the entire duration of
the Pilot, and the pre-Pilot and postPilot periods.371 If the Commission were
369 This estimate is based on the following, which
reflects the Commission’s experience with and
burden estimates for SRO systems changes:
[(Attorney (20 hours) × $401) + (Compliance
Manager (20 hours) × $298) + (Programmer Analyst
(20 hours) × $232) + (Senior Business Analyst (20
hours) × $265] ≈ $24,000 per exchange, or $24,000
× 13 exchanges ≈ $312,000 in aggregate. The burden
hours are obtained from Section IV.J.1, supra.
370 This estimate is based on the following, which
reflects the Commission’s experience with and
burden estimates for SRO systems changes:
[(Attorney (10 hours) × $401) + (Compliance
Manager (10 hours) × $298) + (Programmer Analyst
(10 hours) × $232) + (Senior Business Analyst (10
hours) × $265] ≈ $12,000 per exchange, or $11,960
× 13 exchanges ≈ $156,000 in aggregate. The burden
hours are obtained from Section IV.J.1, supra.
371 This estimate is based on the following:
[(Compliance Manager (3 hours) × $298) +
(Programmer Analyst (3 hours) × $232)] ≈ $1,600
per exchange, or $1,600 × 36 fee changes per
exchange ≈ $57,600. The burden hours are obtained
from Section IV.J.1, supra. The 36 updates to the
order routing data for each exchange encompass six
updates during the six-month pre-Pilot Period, 24
updates during the two-year Pilot Period, assuming
that the Commission determines at the end of the
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to allow the proposed Pilot to
automatically sunset at the end of the
first year, this would decrease the total
number of monthly updates to the order
routing data by 12 to 24.372 Under the
automatic sunset, each exchange would
have recurring costs of updates to the
order routing data of approximately
$38,400 per exchange, or $499,200
among the 13 exchanges over a one-year
Pilot, and the pre-Pilot and post-Pilot
periods.373
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e. Fee-Related Costs to Exchanges
At the outset of the proposed Pilot,
each equities exchange would need to
provide to the Commission a
comprehensive Form 19b–4 fee filing
reflecting all of the applicable fees and
rebates relevant to each of the three
Pilot Test Groups, as well as the Control
Group—to reflect the temporary changes
to transaction-based fees and rebates as
a result of the proposed Pilot. The
Commission anticipates considerable
costs associated with and time devoted
by each exchange to optimally assign
fees and rebates across Test Groups,
within the parameters allowed by the
proposed Pilot, including any
incentives, tiers, caps, and discounts
available. The Commission estimates
that it would cost $48,400 per-exchange
for the initial Form 19b–4 fee filing or
$629,200 in aggregate.374 The
Commission further anticipates that
exchanges would bear similar costs
first year that it shall continue the proposed Pilot
for up to an additional year, and six updates during
the six-month post-pilot period. In aggregate,
updates to the order routing data are estimated to
cost $57,600 × 13 U.S. equities exchanges ≈
$748,800.
372 This estimate of updates to the order routing
data is the aggregation of updates from the pre-Pilot
Period (6), the one-year Pilot Period assuming that
the Commission allows the Pilot to automatically
sunset at the end of the first year (12), and the postPilot Period (6), for a total number of 24 updates.
373 This estimate is based on the following:
[(Compliance Manager (3 hours) × $298) +
(Programmer Analyst (3 hours) × $232)] ≈ $1,600
per exchange, or $1,600 × 24 fee changes per
exchange ≈ $38,400. The burden hours are obtained
from Section IV.J.1, supra. The 24 updates to the
order routing data for each exchange encompass six
updates during the six-month pre-Pilot Period, 12
updates during the first year of the Pilot Period,
assuming that the Commission determines at the
end of the first year that it shall automatically
sunset the proposed Pilot, and six updates during
the six-month post-pilot period. In aggregate,
updates to the order routing data are estimated to
cost $38,400 × 13 U.S. equities exchanges ≈
$499,200.
374 The estimate is based on the following:
[(Attorney (40 hours) × $401) + (Compliance
Attorney (40 hours) × $352) + (Assistant General
Counsel (25 hours) × $449) + (Director of
Compliance (15 hours) × $470)] ≈ $48,400, or
$48,400 × 13 equities exchanges ≈ $629,200 in
aggregate. See OMB Control No. 3235–0045 (August
19, 2016), 81 FR 57946 (August 24, 2016) (‘‘Request
to OMB for Extension of Rule 19b–4 and Form
19b–4 Filings’’).
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upon the completion of the proposed
Pilot to prepare Form 19b–4 fee filings
for the Commission.
In addition to the initial production of
the Form 19b–4 fee filing at the outset
of the proposed Pilot, exchanges may
also choose to make periodic updates to
their fee and rebate schedules, and
provide Form 19b–4 fee filings to notify
the Commission and the public of those
updates. As noted in the baseline, the
average exchange makes approximately
seven changes to its fee schedules per
year. While recognizing the possibility
that as a result of the proposed Pilot,
exchanges may revise their fee
schedules more or less often during the
proposed Pilot, the Commission has no
basis to expect an increase in the
number of Form 19b–4 fee filings other
than at the beginning or end of the
proposed Pilot and has no basis to
expect a decrease.
The Commission also recognizes that
as an outcome of the proposed Pilot, the
complexity of the Form 19b–4 fee filings
could increase, thereby increasing the
overall costs for exchanges to revise
their fee and rebate schedules.375 As
discussed above, the proposed Pilot
would require exchanges to design
multiple new fee structures for each of
the test groups, which would then
translate into additional information in
each Form 19b–4 fee filing submitted
during the proposed Pilot. These costs
are likely to increase because the
exchanges could take considerably more
time to design and describe fee
structures in each filing than they do
designing fee structures today. As
discussed above in the baseline, the
average fee schedules of exchanges are
complex, with many different categories
of fees or rebates assessed to NMS
stocks (including ETPs). Assuming the
frequency remains constant, then the
proposed Pilot could increase the
incremental costs incurred by exchanges
to file the expected Form 19b–4 fee
filings during the proposed Pilot.376 The
375 The Commission preliminarily believes that
the inclusion of Linked Pricing prohibitions for Test
Group 3 should not increase the complexity of
Form 19b–4 filings for exchanges because many
exchanges already report non-cash incentives, such
as tiered pricing or volume discounts, as part of
their standard filings. Further, the Commission does
not believe that exchanges currently use Linked
Pricing mechanisms and instead most rely on
rebates.
376 Maintaining the current average frequency of
7 19b–4 filings per year would mean that the
average exchange would file a total of 14 19b–4
filings during the two-year pilot (7 filings × 2 year
duration). If the Commission were to allow the
proposed Pilot to automatically sunset at the end
of the first year, then the total number of 19b–4
filings could decrease by 7 filings. Annually, across
all 13 exchanges, the Commission preliminarily
estimates that there will be 91 19b–4 filings (7
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additional costs would only be relevant
for Form 19b–4 fee filings that occur
during the proposed Pilot Period, and
would not apply to Form 19b–4 fee
filings in the pre-Pilot or post-Pilot
Periods, as the Commission does not
believe that there will be any
incremental costs associated with
increased complexity of these filings
during these periods. The Commission
estimates that each exchange would
bear an incremental cost of $10,600 per
Form 19b–4 fee filing to account for the
increased complexity associated with
the requirements of the proposed Pilot,
or $1,930,000 for the anticipated 182
Form 19b–4 fee filings for fee and rebate
revisions across the 13 U.S. equities
exchanges during the two-year pilot
duration.377 If the proposed Pilot were
to automatically sunset at the end of the
first year, the Commission estimates that
exchanges would bear costs of
approximately $965,000 for the
anticipated 91 Form 19b–4 filings for fee
and rebate revisions across the 13 U.S.
equities exchanges during the first year
of the Pilot duration.
f. Other Costs Associated With the
Proposed Transaction Fee Pilot
As discussed in further detail below,
the Commission preliminarily believes
that many of the other likely costs of
this proposal would be temporary in
nature and affect markets only for the
duration of the proposed Pilot. For
instance, more complicated fee
structures could also increase an
exchange’s processing costs of tracking
and calculating monthly invoices for its
members during the proposed Pilot;
however, the Commission does not have
any information on the costs to
exchanges for tracking and calculating
monthly member invoices and therefore
cannot provide estimates of quantified
costs. The following section includes
discussion of implementation costs for
broker-dealers, the temporary effect on
filings × 13 exchanges). If the Commission
determines that the proposed Pilot shall continue
for a second year, in aggregate, the 13 exchanges
could file a total of 182 19b–4 filings (91 × two-year
Pilot duration).
377 The estimate is based on the following:
[(Attorney (8 hours) × $401) + (Compliance
Attorney (8 hours) × $352) + (Assistant General
Counsel (6 hours) × $449) + (Director of Compliance
(4 hours) × $470)] ≈ $10,600, or $10,600 × 182 fee
changes in aggregate across 13 exchanges over the
two-year pilot duration ≈ $1,930,000 in aggregate,
assuming that the Commission determines that the
proposed Pilot shall continue for up to an
additional year. If the proposed Pilot were to
automatically sunset after the first year, the
Commission preliminarily believes that the costs
associated with 91 19b–4 filings (13 exchanges × 7
filings) would be approximately $965,000 ($10,600
× 91 filings). See Request to OMB for Extension of
Rule 19b–4 and Form 19b–4 Filings, supra note
374.
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brokerage commissions, the effects to
exchanges of liquidity externalities and
complexity, and costs associated with
the overlap with the Tick Size Pilot.
In addition to the compliance costs
for exchanges associated with the
implementation of the proposed Pilot,
exchanges also may experience a change
to their revenues associated with
transaction-based fees and rebates. As
discussed in the baseline, the exchange
groups NYSE Group, Nasdaq, and BATS
Global Markets, had net transaction-fee
revenue of $223 million, $564 million,
and $177 million, respectively, in 2016
as obtained from their Form 10–K or
Form 10–Q filings. As discussed in
more detail below, the margin between
fees and rebates ranges from $0.0001 to
$0.0005.378 If the margin were $0.0005,
exchanges could have no reduction in
their overall net revenues (fees less
rebates). If, instead, the margin is less
than $0.0005, then exchanges could
experience a decline in revenues
attributable to securities in Test Group
2, if they continue to provide a nominal
rebate to broker-dealers as an
inducement to route orders to that
exchange. Moreover, because Test
Group 3 would prohibit rebates or
Linked Pricing without changing the fee
cap, exchanges would have incentives
to charge higher fees than a competitive
equilibrium would suggest, subsidizing
any shortfall in revenues arising from
Test Group 2. Competitive pressures
arising from other market participants,
including ATSs, could affect the success
of any attempted revenue subsidization
by exchanges through increased fees.
As noted above, the Commission
preliminarily estimates that the only test
group that could result in reduced
revenues for exchanges is Test Group 2.
Below, the Commission estimates a
possible range of effects to the monthly
revenues in aggregate across exchanges
depending on the magnitude of the
rebate that they could pay. Given that
fees and rebates are interconnected, the
Commission preliminarily assumes that
as fees are reduced as a requirement of
the proposed Pilot, exchanges will
similarly reduce rebates paid; therefore,
the Commission preliminarily believes
that exchanges are unlikely to pay
rebates in excess of the maximum fee
permitted in a given test group. The
maximum per share revenue for Test
Group 2 would then be $0.0005, with a
minimum of $0.0000, depending on
whether the exchange paid no rebate or
a rebate of $0.0005, respectively, which
would leave the exchange net revenue
neutral before operating costs under the
second scenario. Assuming that the
378 See
Section V.D.2 infra.
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share volume in Test Group 2 would be
one-sixth of the total share volume
across all securities,379 using data from
Table 3 in the baseline, Test Group 2
would have share volume of
approximately 15.3 billion each
month.380 Under the scenario where
exchanges paid no rebates in Test Group
2, the Commission preliminarily
anticipates no change in revenue,
assuming that the margin between fee
revenue and rebate cost of $0.0005.381 If,
instead, exchanges paid rebates of
$0.0005, where the net capture would
be zero for Test Group 2, this would
lead to a monthly aggregate shortfall in
revenues across all exchanges of
$7,650,000.382 At the exchange level,
Nasdaq, which has the largest monthly
volume percentage (23%), would have a
monthly shortfall of $1,760,000.383 If
exchanges are likely to have similar
share volume each month, then the
annual average shortfall across all
exchanges would be $91.8 million.
Compared to the margin between fee
revenue and the cost of rebates for the
publicly traded exchanges, detailed in
the baseline, the annual revenue
shortfall would be approximately
9.5%.384 If the net capture on exchanges
379 As designed, the proposed Pilot would
allocate an equal number of securities to the three
test groups and the control group (i.e., the test
groups combined would have 50% of the NMS
securities and the control group would have 50%).
Each test group would have one-third of the
combined test group allocation, thereby, in total
leaving each test group with one-sixth of the
securities included in the proposed Pilot. Assuming
that the allocation of share volume would be similar
due to the stratification of the sample discussed
above, each test group would have one-sixth of total
share volume each month.
380 Table 3 in the baseline shows aggregate
exchange share volume for July 2017 was 91.7
billion shares, of which one-sixth would be 15.3
billion shares. Further, the Commission
preliminarily estimates that these volume figures
would be similar across all months, assuming no
seasonality in share volume.
381 In addition, an exchange could have no
change in net margin if its current margin is
between $0.0005 and $0.0010 and the exchange
charged for both taking and making liquidity.
However, the effect of charging both sides on net
revenues is unknown because charging both sides
could change the nature of the exchange’s order
flow.
382 If Test Group 2 has monthly share volume of
15.3 billion shares, then the revenue shortfall is
estimated to be 15.3 billion × $0.0005 ≈ $7,650,000.
383 As shown in Table 3, Nasdaq’s July 2017
shares are 21.2 billion. Nasdaq’s overall share is
21.2/91.7 ≈ 23%. The Commission estimates the
monthly revenue shortfall for Nasdaq to be 0.23 ×
$7,650,000 ≈ $1,760,000.
384 In aggregate, the NYSE Group, Nasdaq, and
BATS Global Markets earned a margin between fee
revenues and costs of rebates of approximately $960
million in 2016. If the revenue shortfall was $92
million, then the percentage shortfall would be $92
million/$960 million ≈ 9.5%. However, this is
likely to be too high since BATS Global Markets
only reported financial statements for the first nine
months of 2016. In the nine-months ending
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is less than $0.0005, on average, then
exchanges could either maintain their
current margin between fees and rebates
(e.g., if the net capture is $0.0003, then
exchanges could reduce rebates to
$0.0002) or could increase the margin
by reducing rebates even further (e.g.,
reduce rebates to $0.0001, and increase
net capture to $0.0004).
Although the costs of compliance
with the proposed Pilot primarily affect
the exchanges, broker-dealers and other
market participants are also likely to
have implementation costs as a result of
the proposed Pilot, if they decide to
alter their behavior in response to the
Pilot. For instance, many broker-dealers
have smart-order routing systems that
use algorithms to route orders based on
certain criteria, such as fill rates, time to
execution, or highest rebates.385 In
response to the proposed Pilot, market
participants that use smart-order routers
could have a one-time cost at the onset
(and the conclusion) of the Pilot to
adjust their algorithms to reflect the
shocks to transaction-based fees. In the
absence of smart-order routers, market
participants could still need to adjust
the execution determinations to take
advantage of the changes implemented
during the proposed Pilot. The
Commission preliminarily believes that
the costs associated with updating the
execution algorithms by broker-dealers
are likely to be more costly than the
periodic adjustments that broker-dealers
may make to incorporate changes to fee
schedules implemented by exchanges
because they are likely to require more
complex programming that segments
stocks into different fee regimes, rather
than just altering codes or inputs.
The Commission preliminarily
believes that broker-dealers that are
members of exchanges already have in
place order routing systems, whether
smart order routers or algorithmic
trading programs that route orders to
exchanges for which they are members.
Therefore, the Commission does not
expect that broker-dealers would need
to bear start-up costs associated with
implementing new order routing
systems as a result of the proposed Pilot,
September 2016, BATS earned a margin between
fee revenues and costs of rebates of approximately
$177 million. Assuming that BATS earned revenues
at a constant rate throughout the year, then the 12month margin would have been $236 million ($177
million/9 months = $x million/12 months, x = $236
million). In that case, the aggregate margin would
have increased from $960 million to $1.023 billion,
which would have reduced the percentage shortfall
from approximately 9.5% to 9.0% ($92 million/
$1.023 billion).
385 See Bacidore, Otero, and Vasa, supra note 235,
which found that smart-order routers designed to
maximize rebates delivered worse execution quality
to their clients.
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and would only need to make
modifications to the existing code to
capture changes in fees and rebates
associated with each test group of
securities. The Commission estimates
that the costs to broker-dealers that are
members of exchanges to make the
initial adjustment to their order routing
systems at the outset of the proposed
Pilot would be $8,700 per broker-dealer,
or $3,741,000 in aggregate across the
430 broker-dealers that are currently
members of equities exchanges.386 The
Commission further estimates that
broker-dealers would bear a similar cost
to alter their order routing systems at
the conclusion of the proposed Pilot.
As a result of the proposed Pilot, the
Commission expects that broker-dealers
would make adjustments to their order
routing systems associated with changes
to fees or rebates submitted by
exchanges through Form 19b–4 fee
filings to the Commission. As discussed
in the baseline, exchanges, on average,
make changes to fees or rebates
approximately seven times per year;
therefore, broker-dealers are likely to
have experience in adjusting the order
routing systems to reflect these routine
changes to fees and rebates. Although
broker-dealers have experience with
revisions to exchange fee and rebate
schedules, due to the added complexity
of having to adjust and update multiple
modules within their order routing
systems, broker-dealers are likely to face
higher costs per adjustment as a result
of the proposed Pilot. The Commission
preliminarily believes that the peradjustment costs associated with these
changes are likely to be a small fraction
of the costs associated with the initial
costs of updating the routing systems to
reflect the required fee and rebate
revisions at the outset of the proposed
Pilot. The Commission estimates that
the additional costs to broker-dealers
that are members of exchanges to make
periodic adjustments to their order
routing systems to reflect changes in
fees and rebates would be $265 per
adjustment, or $114,000 in aggregate
across the 430 broker-dealers that are
members of U.S. equities exchanges.387
386 This estimate is based on the following, which
reflects the Commission’s experiences with and
burden estimates for broker-dealer systems changes:
[(Attorney (5 hours) × $401) + (Compliance Manager
(10 hours) × $298) + (Programmer Analyst (10
hours) × $232) + (Senior Business Analyst (5 hours)
× $265)] ≈ $8,700 per broker-dealer that is a member
of at least one exchange. As of December 31, 2016,
430 unique broker-dealers were members of
exchanges (Form X–17a–5). The aggregate costs of
updating order routing systems to reflect the
proposed Transaction Fee Pilot requirements would
cost $8,700 × 430 ≈ $3,741,000.
387 This estimate is based on the following, which
reflects the Commission’s experiences with and
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As shown above, the Commission
preliminarily expects that exchanges, if
submitting changes to fees and rebates
at the same rate as they have in the last
five years, would submit 182 total
revisions to fees and rebates over the
pilot duration, if the Pilot were to
automatically sunset at the end of the
first year. Therefore, the aggregate costs
of updating order routing systems
would be $48,200 per broker-dealer, or
$20,726,000 in total across all brokerdealers.388 If the Pilot were to
automatically sunset at the end of the
first year, the aggregate costs of updating
order routing systems would be $24,100
per broker-dealer, or $10,363,000 in
total across all broker-dealers. The
Commission notes, however, that these
estimates may be overstated, as not all
broker-dealers are members of all
exchanges, which would reduce the
total number of changes to the orderrouting systems that they would
implement. Therefore, the Commission
preliminarily believes that the costs to
broker-dealers of adjusting their order
routing systems as a results of the
proposed Pilot are nominal, and each
broker-dealer would spend on average
approximately $67,000 to update their
systems over the entire proposed Pilot
Period.389 If the Commission
determined that the proposed Pilot shall
automatically sunset at the end of the
first year, then the costs associated with
these updates would be approximately
$42,900 per broker-dealer. Moreover, as
noted above, this estimate assumes that
burden estimates for broker-dealer systems changes:
[(Compliance Manager (0.5 hours) × $298) +
(Programmer Analyst (0.5 hours) × $232)] = $265
per broker-dealer that is a member of at least one
exchange. The aggregate costs updating order
routing systems to reflect the periodic fee and
rebate revisions would cost $265 × 430 ≈ $114,000.
388 If 182 total fee and rebate changes were to
occur over the duration of the proposed Pilot (13
equities exchanges × 7 revisions per year × 2 years
= 182), each broker-dealer would bear costs of
updating its order routing systems of $265 × 182 ≈
$48,200, or $20,726,000 ($48,200 × 430) in aggregate
across all broker-dealers over the first year of the
proposed Pilot. The Commission estimates that
costs would be approximately $10,363,000 ($265 ×
13 exchanges × 7 updates × 430 broker-dealers) if
the Commission determined that proposed Pilot
automatically sunset at the end of the first year.
389 These costs reflect the costs of approximately
$9,000 at the outset of the proposed Pilot to update
the order routing system to reflect the changes to
the fee structure for securities in the test groups,
approximately $49,000 to reflect the incremental
costs of the estimated 182 revisions to fee schedules
during the proposed Pilot ($530 per revisions × 7
revisions per year × 2 years × 13 exchanges), and
$9,000 at the conclusion of the proposed Pilot to
unwind changes to the order routing systems, for
a total of $67,000 per broker-dealer. If the proposed
Pilot were to automatically sunset at the end of one
year, then these costs would be approximately
$42,900 ($530 × 7 revisions × 13 exchanges) per
broker-dealer. See supra note 338 and the
accompanying text.
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broker-dealers are members of all 13
U.S. equities exchanges, whereas many
are members of only a subset of
exchanges, which would further reduce
the costs of updating their order routing
systems.
Exchanges and broker-dealers could
also bear an increased cost of
complexity associated with the
exogenous shocks to the fees and rebates
as required by the various test groups.
As of July 2017, exchanges have 24 fee
categories and 21 rebate categories, on
average. If exchanges maintain the same
level of complexity in their fee
schedules during the proposed Pilot, up
to a four-fold increase in the number of
fee and rebate categories could occur,
which would increase complexity for
the exchanges, and would also increase
complexity for broker-dealers who
incorporate fees into their order routing
decisions. Although the proposal would
require exchanges to report a fee dataset
as well as any changes to those fees, the
exchanges may not simplify their actual
fee schedules. For the duration of the
proposed Pilot, however, the exchanges
could resort to simplified fee schedules
relative to the current baseline to reduce
the costs of complying with the
proposed Pilot.
Beyond the implementation and
compliance costs for exchanges and
broker-dealers associated with the
proposed Transaction Fee Pilot, a
number of temporary costs could be
borne by investors as a result of the
Pilot. The changes to the transactionbased fee structure could lead to
temporary, suboptimal outcomes for
market participants, such as short-lived
increases in brokerage commissions. It
has been shown in several studies that
brokerage commissions today are at
historically low levels.390 Brokerage
clients seeking simplicity in their
overall cost structure may have a
preference for low commissions and
increased services provided by brokerdealers, and in turn, may allow brokerdealers to capture rebates (and bear the
costs of access fees), either through
explicit contracts or implicit
agreements.391 As a result, the proposed
Pilot could lead to higher overall
commissions as rebates obtained by
broker-dealers fall, thereby temporarily
reducing the overall welfare of retail
brokerage clients as a result of increased
commissions.392
390 See Angel, Harris, and Spatt, supra notes 106
and 216.
391 See supra note 37. See also O’Donoghue,
supra note 24.
392 The Commission acknowledges differing
effects on brokerage commissions could occur as a
result of the proposed Pilot depending on whether
the client is a retail customer versus an institutional
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For instance, the elimination of
rebates or Linked Pricing in Test Group
3 could result in a transfer from brokerdealers to exchanges. Assuming, as
discussed above,393 the margin between
fees and rebates is $0.0002 per share,
with access fees of $0.0030 per share
and rebates of $0.0028 per share, Test
Group 3 could result in a transfer of
$0.0028 from broker-dealers to the
exchanges, particularly because
exchanges would be prohibited from
offering Linked Pricing mechanisms that
could act as substitutes for cash
rebates.394 Following this example, and
using the same estimation procedure to
calculate costs to exchanges attributable
to the reduction in fees in Test Group
2, the estimates of the potential
increased revenue to exchanges are as
follows. Assuming that the share
volume in Test Group 3 would be onesixth of the total share volume across all
securities,395 using data from Table 3 in
the baseline, Test Group 3 would have
share volume of approximately 15.3
billion each month.396 If the margin
between fee revenue and rebate cost is
$0.0002, as discussed above, then under
the assumption that exchanges reduce
fees to $0.0002 in Test Group 3, the
Commission preliminarily anticipates
no change in revenue for exchanges, and
no transfer from broker-dealers. If,
instead, exchanges charged fees of
$0.0030 while prohibited from paying
rebates or Linked Pricing in Test Group
customer. For instance, some brokerage accounts
charge per-transaction commissions to retail clients
(e.g., Fidelity charges $4.95 per trade,
www.fidelity.com, while TD Ameritrade charges
$6.95 per trade, www.tdameritrade.com).
Institutional commissions, on the other hand, are
highly negotiated and may be based on something
other than a per trade or per share basis, such as
a flat fee for use of a broker’s order routing
algorithm; however, data on the structure or
magnitude of institutional commissions is not
publicly available.
393 See supra note 28.
394 Although the Commission preliminarily
believes that competition among exchanges would
drive access fees down for Test Group 3 as a result
of the elimination of rebates, exchanges could
charge access fees as high as the current cap of
$0.0030.
395 As designed, the Pilot would allocate an equal
number of securities to the three test groups and the
control group (i.e., the test groups combined would
have 50% of the NMS securities and the control
group would have 50%). Each test group would
have one-third of the combined test group
allocation, thereby, in total leaving each test group
with one-sixth of the securities included in the
pilot. Assuming that the allocation of share volume
would be similar due to the stratification of the
sample discussed above, each test group would
have one-sixth of total share volume each month.
396 Table 3 in the baseline shows aggregate
exchange share volume for July 2017 was 91.7
billion shares, of which one-sixth would be 15.3
billion shares. Further, the Commission
preliminarily estimates that these volume figures
would be similar across all months, assuming no
seasonality in share volume.
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3, the Commission preliminarily
estimates a monthly aggregate increase
in revenues across all exchanges of
$42,840,000.397 If exchanges are likely
to have similar share volume each
month, then the estimated annual
average increase in revenues across all
exchanges would be $514.1 million.
This transfer of rebates from the brokerdealers to exchanges could feasibly
increase exchange revenue by
approximately 53.6%.398 Moreover,
these costs could likely fall to investors
in the form of higher commissions or
fees charged to cover the decrease in
broker-dealer revenue due to losses in
rebates for securities in Test Group 3.
The Commission further
acknowledges that if brokerage
commissions were to increase as a result
of the proposed Pilot, broker-dealers
could continue to charge higher
commissions even after the conclusion
of the proposed Pilot. However, due to
competition among broker-dealers,
including the proliferation of low-cost
online broker-dealers, the Commission
preliminarily believes that brokerdealers would be unlikely to
significantly increase brokerage
commissions as a result of the proposed
Pilot.399
As a result of the proposed Pilot,
effective bid-ask spreads could
temporarily widen for securities in
certain test groups due to the
elimination or reduction of rebates.
According to one study, transactionbased rebates could serve to artificially
lower the NBBO, which could lower the
trading costs to investors.400 This
reasoning suggests that wider effective
bid-ask spreads could temporarily
increase transactions costs for
397 If Test Group 3 has monthly share volume of
15.3 billion shares, and the margin would increase
by $0.0028 ($0.0030 ¥ $0.0002), the revenue
increase per month is estimated to be 15.3 billion
× $0.0028 ≈ $42,840,000.
398 In aggregate, the NYSE Group, Nasdaq, and
BATS Global Markets earned a margin between fee
revenues and costs of rebates of approximately $960
million in 2016. If the estimated margin increased
by $514.1 million, then the percentage increase in
this margin would be $514.1 million/$960 million
≈ 53.6%. However, this is likely to be too high since
BATS Global Markets only reported financial
statements for the first nine months of 2016. In the
nine-months ending September 2016, BATS earned
a margin between fee revenues and costs of rebates
of approximately $177 million. Assuming that
BATS earned revenues at a constant rate throughout
the year, then the 12-month margin would have
been $236 million ($177 million/9 months = $×
million/12 months, × = $236 million). In that case,
the aggregate margin would have increased from
$960 million to $1.023 billion, which would have
reduced the percentage increase from
approximately 53.6% to 50.3% ($514.1 million/
$1.023 billion).
399 See Section V.B.2.a supra, which discusses the
competitive environment for broker-dealer services.
400 See Angel, Harris, and Spatt, supra note 106.
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internalized order flow or orders routed
to ATSs that execute based on the
NBBO, which would predominantly
impact retail investors, as well as for
orders executing on exchanges.
However, any potential degradation of
the effective bid-ask spread due to lower
or reduced rebates could be mitigated by
lower access fees.
The reduction or elimination of
rebates could also particularly affect
smaller exchanges due to the liquidity
externality. As liquidity tends to
consolidate for reasons discussed in
Section V.A.2, the restrictions on
rebates as a result of the proposed Pilot
could harm smaller exchanges that
perhaps compete by paying large rebates
rather than by producing better prices or
execution quality. In the short run, this
could lead to lost revenue for these
exchanges, and potentially could have
longer-term effects if smaller exchanges
consolidate or exit as a result of the
proposed Pilot. As discussed above,
using available data, the Commission
estimates that aggregate revenue
shortfalls for exchanges are likely to
range between zero and $92 million
annually.401
Markets may also temporarily become
even more complex as a result of the
proposed Pilot. Exchanges could
promote additional order types and may
even initiate new types of markets as a
result of the proposed Pilot, which
would only serve to further fragment
markets and add to their complexity, the
costs of which could be borne by
investors. The Commission
preliminarily believes, however, that a
new exchange registered in response to
the Pilot would be unlikely to become
operational before the conclusion of the
proposed Pilot.
Simultaneously subjecting a subset of
NMS securities to both the Tick Size
Pilot and the proposed Transaction Fee
Pilot could increase potential costs to
issuers, particularly for smallcapitalization issuers, to the extent that
any overlap between the pilots could
occur. Small issuers that could be
subject to both pilots are most likely to
face adverse liquidity environments,
and therefore, are most likely to have
ramifications to their liquidity, such as
larger spreads, as a result of the
simultaneity of the pilots. Longer term,
if the temporary impacts on liquidity
acutely affect some firms, it could affect
capital formation for these securities
and could lead to the potential exit of
these issuers from the capital markets,
through acquisition or delisting, as these
401 See Section V.C.2.a supra, for the estimates of
revenue shortfalls that could occur as a result of the
proposed Pilot.
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preliminarily believes that any of the
direct effects of this proposal on
efficiency, competition and capital
formation would likely be temporary in
nature and affect markets only for the
duration of the proposed Pilot. The
Commission preliminarily believes that
the information obtained as a result of
the proposed Transaction Fee Pilot
could improve regulatory efficiency,
because analyses of this data are likely
to provide a more representative view of
the effect of transaction-based fees on
order routing decisions than would be
available to the Commission in the
absence of the proposed Pilot. Further,
the proposed Pilot may have a number
of temporary effects on price efficiency,
the competitive dynamics between
exchanges and off-exchange trading
venues in the market for trading
services, and on capital formation,
particularly for small issuers.
As discussed above, a primary benefit
of the proposed Pilot is that it would
produce data that will be relevant for
the Commission’s consideration of the
economic effects of transaction-based
fees. The data obtained from the
proposed Transaction Fee Pilot would
provide information not currently
available to the Commission about the
role of transaction-based fees in the
market for trading services and how that
affects competition between exchanges
and with off-exchange trading centers.
D. Impact on Efficiency, Competition,
and Capital Formation
Exchange Act Section 3(f) requires the
Commission when engaging in
rulemaking to consider or determine
whether an action is necessary or
appropriate in the public interest, and to
consider, in addition to the protection of
investors, whether the action will
promote efficiency, competition, and
capital formation.405 As discussed in
further detail below, the Commission
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small issuers are least likely to be able
to ride out negative liquidity shocks.
Instead, the proposed Pilot could lead
some issuers to delay entering the
capital markets for the duration of the
proposed Pilot.402
Separately, the implementation costs
to exchanges associated with running
two pilots on subsets of the same
securities could have significant costs
related to the complexity of multiple
pilots, to the extent that the pilots could
overlap. Although the exchanges
already have operational experience
with implementing the Tick Size Pilot,
the costs of implementation provided
above could be underestimated because
of the complexity of tracking the same
issuers within multiple pilots. For
instance, the Commission preliminarily
estimates that it will cost $3,720 per
exchange to construct its initial Pilot
Securities Exchange List, and $33,400
annually to update this list daily.
Because exchanges may have to identify
securities that are in both the
Transaction Fee Pilot and the Tick Size
Pilot for some period of time, the costs
of producing the Pilot Securities
Exchange List could exceed these
values.403 The Commission, therefore,
preliminarily believes that any excess
costs are likely to be proportional to the
duration of the overlap between the
Tick Size Pilot and the proposed
Transaction Fee Pilot.404
1. Efficiency
The proposed Transaction Fee Pilot
would provide the Commission with an
opportunity to empirically examine the
effects of an exogenous shock to
transaction fees and rebates order
routing behavior, execution quality and
market quality. Insofar as the data
produced by the proposed Pilot permits
the Commission and the public to
evaluate and comment upon the
potential impacts of alternative policy
options, the proposal may promote
regulatory efficiency. In the absence of
the proposed Pilot, the Commission
would have to rely on currentlyavailable data to inform future policy
decisions related to transaction-based
fees and data limitations may impair the
efficiency of policy decisions based on
this information.
The temporary efficiency impacts the
Commission expects during the
proposed Pilot depend on how the
proposed Pilot fee and rebate
restrictions proposed for the three test
groups balance the interests of different
groups of market participants. For
example, if during the Pilot, the lower
fee caps and no-rebate restriction
induced by the proposed Pilot cause
broker-dealers to be more likely to route
402 If rebates are associated with increased
liquidity, particularly for small issuers, then
prohibitions on rebates or Linked Pricing could
adversely affect those firms. However, the
Commission preliminarily believes that exempting
registered market makers from the prohibition on
non-rebate incentives could lessen the impact to
liquidity for small issuers.
403 See supra note 353.
404 If such overlap occurred, and was limited to
the pre-Pilot data collection period for the proposed
Transaction Fee Pilot, the additional costs related
to implementation, complexity, and uncertainty
could be minimal because the two pilots would not
operate simultaneously. As discussed in Section
V.C.1.a.i.A, supra, the Commission preliminarily
believes that any overlap could be minimal. See
also supra note 342 for a discussion of the potential
statistical power of testing the joint effects of the
two pilots simultaneously. The Commission is
cognizant that a longer overlap could be costly to
market participants.
405 See 15 U.S.C. 78c(f).
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customer orders to trading centers with
better pricing, higher speed of
execution, or higher probability of
execution, rather than to trading centers
with the largest rebates, the proposed
Pilot may temporarily improve the
efficiency of capital allocation by
lowering execution costs. Efficiency of
capital allocation could be reduced if, as
a response to the loss in revenue from
rebates, broker-dealers increase
commissions or fees charged to
customers. Higher commissions or fees
could reduce customers’ willingness to
trade or could lead to a lower injection
of capital into the markets by investors
because a larger fraction of each
investable dollar would go to
compensate broker-dealers for the lost
revenue. However, because rebates are
generally accompanied by higher access
fees, the overall costs to broker-dealers
to route orders to exchanges could
decline for some test groups, which
could lead to a decrease in commissions
or fees and temporarily increase the
efficiency of capital allocation.
For the duration of the proposed
Transaction Fee Pilot, lower access fees
could improve liquidity of stocks and
ETPs in some test groups, by reducing
the costs to execute marketable orders.
As marketable orders become less
costly, these orders are likely to be
routed to exchanges with lower access
fees, improving execution quality and
possibly creating a liquidity externality,
whereby lower access fee venues will
become the preferred trading center for
marketable and non-marketable
orders.406 An increase in liquidity could
improve informational efficiency by
allowing securities prices to adjust more
quickly to changes in fundamentals.
As a result of the proposed Pilot, price
efficiency might also improve; quoted
spreads also may more closely reflect
the net cost of trading and could
temporarily increase price transparency
for securities in certain test groups.
Currently, broker-dealers do not relay
information about amounts of fees paid
or rebates received on trades to their
customers, thereby limiting the
transparency of the total costs incurred
to execute a trade. The proposed Pilot
would not mandate disclosure by the
exchanges or the broker-dealers of
order-level transaction-based fees; and
therefore, will not resolve the
limitations to transparency of the total
fees paid and rebates received by
broker-dealers discussed above. As fees
decline or rebates are removed in some
406 As discussed in detail above, improvements in
execution quality could present as better prices for
execution, higher probability of execution, and
faster time to execution. See supra note 215.
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test groups, however, the deviation in
the net cost of trading from the quoted
spread could shrink, thereby at least
partially improving price transparency
for the duration of the proposed Pilot,
and temporarily improving pricing
efficiency and price discovery.
Therefore, as an additional benefit of the
proposed Pilot, the Commission could
also examine the temporary effect of
revisions to access fees and rebates on
quoted spreads, to better inform future
policy recommendations of the effects of
transaction-based fees on price
efficiency.407
Other aspects of the proposed Pilot
temporarily may impair efficiency. The
proposed Pilot is intended to reduce
(and in some cases eliminate) rebates or
Linked Pricing for a substantial portion
of NMS stocks (including ETPs);
however, the loss of rebates or Linked
Pricing in Test Group 3 could have a
differential effect between large and
small capitalization securities.408 If
exchanges use rebates as a mechanism
to provide broker-dealers with
incentives to post non-marketable
orders to exchanges, in the absence of
rebates, broker-dealers instead may have
incentives to post these orders to offexchange trading centers, such as ATSs.
This may lead to a temporary widening
of the NBBO, which could lead to a
temporary reduction of liquidity that
could be particularly severe for small or
mid-cap securities. Thus, the overall
informational efficiency of prices, as a
result of widening spreads, could
temporarily decline with the
implementation of the proposed Pilot.
Furthermore, even if broker-dealers
do not use ATSs and internalization
more intensively, the proposed Pilot
may temporarily impair the efficiency of
transactions in certain Test Groups,
through the impact of Pilot-induced fee
and rebate changes on the NBBO. As
discussed earlier, one potentially
distortive effect of transaction-based
fees on maker-taker trading centers is
that they provide incentives for market
participants to post more aggressive
limit orders (e.g., limit orders close to
the current market price) because they
anticipate receiving rebates if their
orders are executed. To the extent that
reductions in rebates result in a wider
bid-ask spread in certain stocks and
ETPs during the proposed Pilot Period,
this may increase transaction costs for
internalized order flow or orders routed
to ATSs that execute based on the
NBBO and for orders executing on
exchanges.409 For example, if an ATS
407 See
Section V.C.2.b supra.
supra note 402.
409 See Angel, Harris, and Spatt, supra note 106.
408 See
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offers to execute buy orders at the
average of the national best offer and
midpoint, rather than at the wider
quoted spread, the ATS would execute
these orders at higher prices than those
available on exchanges. Notably, the
impact of less aggressive limit orders is
less likely to affect marketable orders on
maker-taker trading centers, because
lower taker fees could mitigate the
impact of a wider quoted spread on total
transaction costs for liquidity takers.
Finally, the Commission
acknowledges that the fee caps and
prohibition on rebates or Linked Pricing
imposed on the test groups during the
proposed Pilot further constrain the
exchanges’ abilities to strategically
choose fee and rebate schedules and for
some NMS stocks may restrict the fees
and rebates further beyond the current
levels, which could be efficient from the
exchanges’ perspective, incorporating
their beliefs about the trade-off between
revenues and costs associated with
these transaction-based fees. The
proposal could temporarily result in
more or less efficient fee and rebate
schedules because the exchanges might
not be able to optimize their pricing
structure for some test groups of
securities. While the Commission does
not currently have information to
determine the current level of efficiency
of fees and rebates, the information that
the Commission and the public receive
from the proposed Pilot could enable
the analysis of market impacts
stemming from changes to fees,
potentially permitting the Commission
to assess alternative requirements for
transaction-based fees that may be more
efficient.
2. Competition
While the Commission preliminarily
believes that most of the impacts of the
proposed Pilot on the market for trading
services would be limited to the
duration of the proposed Pilot, some
effects may last beyond the end of the
proposed Pilot. Certain exchanges could
be harmed if a reduction in rebates
results in consolidation of orders at
other exchanges. This could occur if the
proposed Pilot attenuates the potentially
distortive impact of transaction-based
fees and causes broker-dealers to route
orders to trading centers they perceive
as more liquid. To the extent that
increased order flow in a security
directed to a particular venue
encourages broker-dealers to route more
orders for that security to the venue, a
liquidity externality may develop,
making the venue the preferred routing
destination for all orders. Although
these effects would likely last only for
the duration of the proposed Pilot,
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13067
depending on the extent of the liquidity
externalities, smaller exchanges could
experience long-lasting competitive
effects. The proposed Transaction Fee
Pilot could also temporarily discourage
entry of new exchanges that might
otherwise emerge to take advantage of
the maker-taker and taker-maker pricing
models.410 Under such circumstances,
while the consolidation of liquidity may
benefit market participants, it may also
make it difficult for trading centers with
low volumes in particular securities to
compete with trading centers that
represent liquidity centers in these
securities. This could lead to
consolidation or exit by small exchanges
as a result of the proposed Pilot,
although the Commission preliminarily
believes that either of those events is
unlikely because the anticipated
revenue shortfall, as discussed above,
would be for a limited duration and
would not be significant enough to
cause this result.
The proposed Transaction Fee Pilot
may also temporarily alter competition
among exchanges that use transactionbased fee pricing models. Exchanges
that pay fees and remit rebates
frequently revise their fee schedules in
order to remain competitive and to
attract order flow. The impact of the
proposal on competition depends on the
extent to which the fee caps and
prohibition on rebates or Linked Pricing
restrict exchanges’ transaction-based fee
strategies. On one hand, the proposed
Pilot, while changing either access fees
or rebates on certain subsets of
securities, could leave the margins that
exchanges obtain from transaction-based
pricing models unchanged and could
preserve the current state of competition
among exchanges in the market for
those securities. Several earlier studies
suggest that the average difference
between the access fees and rebates is
approximately $0.0005; however, the
EMSAC NMS Subcommittee observed
that the current typical margin per share
is $0.0002,411 and a recent report from
2017 suggests that the spread between
fees and rebates is approximately
$0.0001.412 For instance, for stocks in
410 Academic studies suggest a number of new
exchanges emerged specifically to take advantage of
maker-taker and taker-maker pricing models. See,
e.g., Angel, Harris, and Spatt, supra note 106.
411 See supra note 28.
412 See, e.g., Laura Cardella, Jia Hao, and Ivalina
Kalcheva, ‘‘Make and Take Fees in the U.S. Equity
Market,’’ Working Paper, University of Arizona
(2015), available at: https://www.rhsmith.umd.edu/
files/Documents/Centers/CFP/research/cardella_
hao_kalcheva.pdf (‘‘Cardella, et al. study’’); Harris,
supra note 23. Each of these papers indicates the
difference between fees and rebates is
approximately $0.0005 per share; the Cardella et al.
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Test Group 1, which limits access fees
to no greater than $0.0015, it may be
possible for exchanges to modify fee
structures in a way that leaves margins
unchanged and does not impact
competition between exchanges.
However, this may not be true for all
test groups, and some exchanges may be
unable to maintain current average
margins per share for stocks in Test
Group 2.413 These exchanges may
choose to compete less intensively for
order flow in this test group, instead
focusing on stocks and ETPs in other
test groups. Some of the shortfall in the
competition for order flow for this
subset of securities could be filled by
off-exchange trading centers.
Alternatively, exchanges may revise
pricing strategies for stocks in other
groups, choosing to implicitly subsidize
rebates for stocks in some test groups
using fees from stocks in other test
groups. This may increase competition
for order flow in some test groups while
reducing it in others. In the presence of
tighter restrictions on transaction-based
fees during the proposed Pilot Period,
exchanges could compete in other ways
to attract trading volume (e.g., discounts
on connectivity fees or increased
volume discounts), although the
Commission believes that for some test
groups the ability to offer meaningful
volume discounts would be limited.414
The proposed Transaction Fee Pilot
may not only affect competition
between exchanges, but also could affect
broker-dealers’ decisions to route orders
to off-exchange trading centers for the
duration of the proposed Pilot, affecting
how exchanges compete with other
execution venues in the market for
trading services. Lower rebates during
the proposed Pilot Period may prompt
broker-dealers to internalize a higher
proportion of order flow or route a
higher proportion of order flow to
wholesalers and ATSs. This could alter
the current competitive dynamics
among trading centers in favor of nonstudy, however, uses data from 2008 to 2010. A
recent discussion indicates that the difference
between fees and rebates is $0.0001. See, e.g., ‘‘How
to Align Broker and Customer Interests to Make
Exchanges More Competitive,’’ Trillium
Management, LLC (June 28, 2017), available at:
https://www.trlm.com/align-broker-customerinterests-make-exchanges-competitive/.
413 As discussed in Section III.C.2, if the margin
between fees and rebates exceeds $0.0005,
exchanges theoretically could assess fees to both the
make and take sides of the market; however, the
Commission preliminarily believes that exchanges
are unlikely to do so.
414 For NMS stocks included in Test Group 3,
order flow incentives would be substantially
reduced, particularly any new inducements that
provide a discount or incentive on one side of the
market that is linked to activity on the opposite side
of the market.
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exchange trading centers. Lower access
fees, on the other hand, could attract
marketable order flow from the ATSs
and back to the exchanges, which could
tilt the competitive equilibrium in favor
of the national securities exchanges.
The proposed Pilot could also
temporarily affect the competition for
order flow for ATSs and could
subsequently alter their market share.
As discussed in the baseline, the market
share of trading volume on ATSs is
approximately 13%. If the prohibition of
rebates or Linked Pricing in Test Group
3 leads to increased order flow
migrating to off-exchange trading
centers, this may increase the fraction of
transaction volume to ATSs or other offexchange venues traditionally captured
by exchanges. The reduction in access
fees in some of the test groups, however,
could lead to exchanges attracting more
order flow away from ATSs and other
off-exchange trading centers. Similarly,
if the equilibrium access fee in Test
Group 3 is below $0.0030 in the absence
of rebates, exchanges may be able to
draw order flow from off-exchange
trading centers.
The Commission recognizes that the
potential temporary competitive
impacts stemming from the proposed
Pilot would generally depend on the
exposure of each trading center to each
test group and the control group of NMS
stocks, because the constraints on fees
and rebates apply differently to each
group. For instance, if a high portion of
an exchange’s volume was derived from
stocks in Test Group 2, it may be at a
particular competitive disadvantage
relative to an exchange that served
markets across all groups, because a
substantial reduction in the fee cap
applicable to Test Group 2 would apply
to a higher proportion of its trading
volume. However, the Commission
preliminarily believes that, given its aim
of producing representative groups of
stocks and ETPs for the purposes of the
proposed Pilot, trading centers are not
likely to be substantially more exposed
to NMS stocks in any one group.
3. Capital Formation
The Commission preliminarily does
not expect the proposed Pilot to have a
substantial permanent impact on capital
formation because the proposed Pilot is
limited in duration, though many of the
implementation costs associated with
the proposed Pilot would require
exchanges to expend resources related
to maintaining the List of Pilot
Securities and any changes to that lists,
as well as the maintenance of the
Exchange Transaction Fee Summary
and the order routing data, they may
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have otherwise invested elsewhere or
distributed to shareholders.415
As discussed above,416 the
Commission recognizes that the overall
temporary impact of the proposed
Transaction Fee Pilot on liquidity and
total transaction costs could be positive
or negative. As a result, the impact of
the proposed Pilot on capital formation
is uncertain. On one hand, the proposed
Pilot could temporarily reduce total
transaction costs for many market
participants by consolidating liquidity
and improving execution quality. To the
extent that such cost reductions are
realized, they may, for instance, permit
market participants to more efficiently
deploy financial resources by reducing
the cost of hedging financial risks. As a
result, the proposed Pilot may
marginally and temporarily promote
capital formation. Improvements in both
liquidity and price efficiency could
make capital markets more attractive, at
least for the duration of the proposed
Pilot. The temporary reduction in
rebates to certain test groups as a result
of the implementation of the proposed
Pilot could widen quoted spreads,
thereby potentially leading to worse
execution prices and subsequently
reducing liquidity for the duration of
the proposed Pilot.417 This would have
similar indirect impacts on capital
formation but in the opposite direction,
by increasing the cost of hedging
financial risks.
The proposed Pilot may also affect
capital formation through its impact on
discretionary accounts. A number of
broker-dealers have discretionary
agreements with their clients, wherein
the broker can transact in the client’s
account without the client’s consent.
For the duration of the proposed
Transaction Fee Pilot, some brokerdealers may alter the composition of
their clients’ portfolios to trade and hold
greater proportions of the accounts in
high-rebate NMS stocks (including
ETPs) in the Control Group and Test
Group 1. Such revisions to portfolio
415 The costs associated with implementation and
compliance with the proposed Transaction Fee
Pilot are discussed in more detail above (Section
V.C.2.a, supra).
416 Section V.C.1.a.ii, supra, provides a
discussion of price transparency, which could
improve liquidity and total transaction costs, while
the liquidity externality is discussed in Section
V.A.2, supra.
417 See, George Chacko, Jakub Jurek, and Erik
Stafford, ‘‘The Price of Immediacy,’’ Journal of
Finance 63, 1253–1290 (2008), available at: https://
onlinelibrary.wiley.com/doi/10.1111/j.15406261.2008.01357.x/full (‘‘Chacko et al.’’). According
to Chacko et al., liquidity has three important
dimensions: Price, quantity, and immediacy. A
market for a security is considered ‘‘liquid’’ if an
investor can quickly execute a significant quantity
at a price at or near fundamental value.
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composition as a result of the proposed
Pilot are not necessarily efficient from
an investor’s perspective and could
have a detrimental impact on capital
formation insofar as they increase the
riskiness of client portfolios or decrease
client portfolios’ expected returns.418
This behavior would temporarily distort
the market for high-rebate stocks and
ETPs, creating a higher demand for
these securities and potentially leading
to an inefficient allocation of capital
based on signals that are unrelated to
firm fundamentals.
As discussed above, the proposed
Pilot could lead to a temporary
reduction of liquidity that could be
particularly severe for small or midcapitalization securities.419 In addition
to reducing the informational efficiency
of prices, if the effects of the proposed
Pilot are severe enough, longer term, it
could affect capital formation for these
securities. If the temporary impacts on
liquidity acutely impact some firms, it
could lead to either the potential exit of
these issuers from the capital markets,
through acquisition or delisting, as these
small issuers are those least likely to
ride out negative liquidity shocks.
Further, the proposed Pilot could lead
to a delay by some issuers to enter the
capital markets during the proposed
Pilot’s duration.
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E. Alternatives
Below, the Commission discusses a
number of alternatives to the proposed
Transaction Fee Pilot. As explained
above, the proposed Pilot is designed to
collect data on how changes to fees and
rebates affect order routing behavior and
execution, which could inform the
Commission and the public as to any
possible conflicts of interest between
broker-dealers and their customers. The
Commission considers four sets of
alternatives: (1) Expansion of the
proposed Pilot to include ATSs; (2)
inclusion of a trade-at provision; (3)
prohibition of overlap with the Tick
Size Pilot; and (4) adjustments to the
basic pilot structure (e.g., the inclusion
of a zero access fee test group). Where
appropriate, suggestions attributable to
the EMSAC recommendation have been
418 Allocative efficiency in the context of
investment choice is optimized when there are no
restrictions on the set of investment opportunities
available to an investor. See, e.g., Niels Christian
Nielsen, ‘‘The Investment Decision of the Firm
under Uncertainty and the Allocative Efficiency of
Capital Markets,’’ Journal of Finance 31, 587–602
(1976), available at: https://www.jstor.org/stable/
2326628. If the proposed Pilot potentially leads
some broker-dealers to alter the investment
opportunity set to avoid securities that do not pay
rebates, then allocative efficiency for those
investors would likely be impaired since the
opportunity set is restricted.
419 See supra note 402.
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identified within the scope of the
alternatives presented below.420
1. Expand Proposed Transaction Fee
Pilot To Include ATSs
As proposed, the Transaction Fee
Pilot would not require ATSs to comply
with the requirements on the limits to
access fees or rebates imposed by the
Pilot. One alternative would be the
inclusion of ATSs in the proposed
Transaction Fee Pilot proposal.
Including ATSs in the proposed
Transaction Fee Pilot would increase
availability of data for an important
segment of trading activity in the NMS
securities, would cover a larger portion
of the order routing inducements,421
and could enhance the information
regarding possible conflicts of interest
available to the Commission. ATSs
capture a large fraction of transaction
volume for NMS stocks (approximately
13% as of July 2017), indicating that
they are important competitors to
exchanges and other off-exchange
trading centers.422 Some studies have
noted that transaction-based fees and
rebates have likely caused some order
flow to migrate from exchanges to offexchange trading centers, such as ATSs,
in order to avoid high access fees levied
by some exchanges.423
An alternative that includes ATSs
would be broader than the proposed
Pilot and would also include more
inducements, besides fees and rebates,
that broker-dealers might receive for
routing orders to particular trading
centers, including ATSs.424 The
Commission has limited information
about how ATS fee structures might
induce broker-dealers to route orders to
ATSs thereby creating potential
conflicts of interest between brokerdealers and their clients. If it included
trading centers beyond exchanges, the
proposed Pilot would provide
information to the Commission and the
public about a more complete set of
order routing decisions by brokerdealers because it would increase the
representativeness of the results
obtained, and may provide a deeper
understanding of how exogenous shocks
to fees and rebates affect order routing
decisions. Further, because transactionbased fees and rebates are one possible
method that exchanges and ATSs use as
inducements for order flow, a pilot that
420 See
supra note 37.
supra note 268.
422 See supra note 298.
423 See Angel, Harris, and Spatt, supra note 216.
424 As discussed above, the proposed rule only
prohibits new inducements that provide a discount
or incentive on one side of the market that is linked
to activity on the opposite side of the market for
Test Group 3.
13069
was inclusive of these other
inducements would further expand our
understanding of what drives order
routing decisions and might raise
possible conflicts of interest.
The Commission preliminarily
believes that the inclusion of ATSs and
other inducements for order flow into
the proposed Transaction Fee Pilot is
likely to substantially increase the costs
relative to the current proposal and may
not be practical. Because broker-dealers
that operate ATSs could bundle fees for
ATS usage with other broker-dealer fees,
the proposal might not practically be
able to impose an access fee cap or
prohibition on rebates on ATS fees.
Further, the Commission currently does
not require that ATSs provide periodic
public disclosures on their fees, as it
does with national securities exchanges,
and these fees do not need to be filed
with or approved by the Commission.
Unlike exchanges, which must report
their fees schedules publicly on their
websites, and must file Form 19b–4
with the Commission to effect any
changes to those fee schedules, ATSs
currently have no reporting
requirements for their fees. The costs to
ATSs of participating in the Pilot would
be higher relative to the costs to the
exchanges in two ways: (1) The Pilot
would require ATSs to report
information that is currently not
required by regulation for the purpose of
the proposed Pilot, and (2) the Pilot
would impose significant start-up costs
on the ATSs to set up systems to report
these fees. Thus, including ATSs in an
alternative version of the proposed Pilot
would likely increase both the costs and
the complexity of the proposed Pilot
because it would likely require a shift in
the disclosure regime for these trading
centers.
Even in the absence of including
ATSs in the proposed Pilot, the
Commission would be able to obtain
information on the proportion of trades
going to ATSs from several sources.
First, several transaction datasets,
including trade reporting facility (TRF)
data and TAQ data, provide information
on off-exchange trades, including ATS
trades. Further, FINRA produces
periodic (weekly) data on the total
shares of NMS securities executed by
individual ATSs.425 Thus, the
Commission would obtain information
from the proposed Pilot to identify
whether exogenous shocks to
421 See
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425 Combining the FINRA volume data executed
by ATSs for a given security, with other data, such
as TAQ, which would provide total share volume
for a given security, a researcher would be able to
estimate the fraction of ATS trading as a percentage
of total trading in NMS securities over the same
time period.
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transaction-based fees on exchanges
have an effect on order routing
decisions, including whether brokerdealers alter their routing of order to
ATSs during the proposed Pilot. The
inclusion of ATSs into the requirements
of the proposed Pilot, however, would
likely significantly add to the proposed
Pilot’s complexity and cost a significant
amount of money to implement.
2. Trade-At Test Group
The proposed Transaction Fee Pilot
could include a ‘‘trade-at’’ provision in
conjunction with the changes to the fees
and rebates currently proposed in the
Pilot.426 The trade-at provision would
require that orders be routed to a market
with the best displayed price or are
executed at a materially improved price.
A trade-at provision could increase
incentives to display prices, as offexchange trading centers would no
longer be able to match the best price
offered elsewhere, but instead would
have to provide significant price
improvement or start displaying their
quotes at the NBBO. Including the tradeat provision as a component of the
proposed Transaction Fee Pilot could
potentially increase the level of
displayed liquidity across all venues,
because off-exchange trading centers,
such as ATSs, would have increased
incentives to display prices, and could
have effects on the order routing
decisions of broker-dealers. Orders
routed to exchanges that are not posting
the best prices could be indicative of
potential conflicts of interest between
broker-dealers and their customers.
Including a trade-at subgroup could
provide supplemental information to
the Commission about how a
combination of trade-at provisions
coupled with revisions to transactionbased fees affect broker-dealer order
routing decisions.
From an implementation perspective,
including a trade-at provision would
result in a pilot that is more complex
than the proposed Pilot. As proposed,
the Pilot has three test groups for
different exogenous shocks to fees or
rebates; adding a trade-at provision
would double the number of test groups,
thereby increasing the costs of
implementation for exchanges. Such an
addition would also likely increase the
difficulty of analyses. The Tick Size
Pilot includes a trade-at group because
exchanges were concerned that, in the
426 Because
a ‘‘trade-at’’ provision is already a
requirement of the Tick Size Pilot, to the extent that
there is overlap between the two pilots and
sufficient statistical power, the Commission may be
able to obtain valuable information from that pilot
without the need to include a trade-at provision in
the proposed Transaction Fee Pilot.
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current market environment, a larger
tick size could induce order flow to go
off-exchange.427 However, unlike the
Tick Size Pilot, the Commission
preliminarily believes that as a result of
the proposed Transaction Fee Pilot,
marketable order flow would be less
likely to flow to off-exchange trading
centers, because as access fees for some
test groups would decline, order flow
could be drawn back to exchanges. The
Commission, therefore, preliminary
believes that the inclusion of the tradeat provision would not likely provide
much additional information to address
the potential conflicts of interest
between broker-dealers and their
customers beyond that afforded by the
proposal.
3. No Overlap With Tick Size Pilot
As proposed, the Transaction Fee
Pilot could overlap with the Tick Size
Pilot for some portion of the proposed
Pilot duration, although the length of
that overlap is uncertain, and the
Commission preliminarily believes that
any anticipated overlap would be
minimal and would depend on when
the proposed Transaction Fee Pilot
would become effective, if adopted.
Alternatively, the Commission could
consider two separate alternatives that
both address the elimination of the
overlap of the proposed Transaction Fee
Pilot with the Tick Size Pilot: (1)
Limiting the sample to securities with
market capitalizations of at least $3
billion or (2) delaying the
implementation of the Pilot until the
Tick Size Pilot is concluded.
The first potential alternative is
similar to that recommended by
EMSAC, whereby the pilot would
include only securities with market
capitalizations in excess of $3 billion, in
order to avoid the simultaneity of the
Tick Size Pilot and the proposed
Transaction Fee Pilot for a subset of
securities. The advantage to this
approach is that the proposed
Transaction Fee Pilot could start
without consideration for the Tick Size
Pilot duration, and could reduce
implementation and complexity
burdens for exchanges and brokerdealers because no subset of securities
would be subject to the two pilots
simultaneously. However, this approach
of only examining the effects of changes
on transaction-based fees for securities
with market capitalizations of at least $3
billion would significantly reduce the
overall sample representativeness
desired by the proposed Pilot, which
would limit the usefulness of any data
427 See Tick Size Pilot Approval Order, supra
note 5, at 27538–42.
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obtained from such a pilot. The
Commission preliminarily believes that
removing these smaller issuers, for
which the potential conflicts of interest
could likely be the largest,428 from the
proposed Transaction Fee Pilot would
limit the value of the information
received, and would be less useful to
the Commission for informing future
policy recommendations related to these
conflicts, as discussed in more detail in
Section V.C.1.a.i.A.
Alternatively, the Commission could
delay full implementation of the
proposed Transaction Fee Pilot until six
months after the Tick Size pilot
concludes, to the extent that such
overlap between the pilots exists. By
implementing each pilot sequentially,
the Commission would obtain distinct
information generated by each pilot, and
would reduce the potential costs
incurred by exchanges and brokerdealers in implementing simultaneous
pilots, as well as the temporary other
costs borne by small issuers and other
market participants, discussed in detail
in Section V.C.2.b. On the other hand,
running sequential pilots could delay
the benefits of the information the
Commission anticipates realizing from
the pilot.
The Commission preliminarily
believes that the alternative to delay
implementing the proposed Transaction
Fee Pilot to avoid any overlap (to the
extent that such an overlap would
otherwise occur) with the Tick Size
Pilot would provide minimal cost
savings relative to the proposal. As
discussed in Section V.C.2.b, the
Commission anticipates that the costs
associated with overlapping the
proposed Transaction Fee Pilot with the
Tick Size Pilot could be small. Further,
as discussed above, the Commission
preliminarily believes the Pilot’s design
would prevent any overlap, to the extent
that overlap between the proposed
Transaction Fee Pilot and the Tick Size
Pilot occurs, from compromising the
Pilot results.
4. Adjustments to the Proposed
Transaction Fee Pilot Structure
The alternatives described above
provide significant revisions to the
approach or the representativeness of
the proposed Transaction Fee Pilot. This
section discusses a number of
alternatives that detail other
428 See Battalio Equity Market Study, supra note
22; Harris, supra note 23. The negative relationship
between access fees and execution quality (realized
spreads) increases for low-priced securities,
suggesting that low-priced or small capitalization
stocks are more likely to have potential conflicts of
interest related to transaction-based fees than large
capitalization stocks.
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adjustments to the basic structure of the
Pilot as proposed. These include an
alternative time frame for the Pilot
duration or the pre- and post-Pilot
Periods, a zero access fee test group,
alternative access fee caps, and the
inclusion of non-displayed liquidity or
depth-of-book provisions in Test Groups
1 and 2.
As currently proposed, the
Transaction Fee Pilot would be
implemented for two years with an
automatic sunset at the end of the first
year, unless the Commission publishes
a notice determining that the proposed
Pilot shall continue for up to another
year. Alternatively, the Commission
could recommend an earlier or later
Pilot sunset or a longer or shorter Pilot
duration. An earlier Pilot sunset would
shorten the anticipated proposed Pilot
duration, reducing the time period
during which potential negative
temporary effects resulting from the
proposed Pilot could occur. However, if
the anticipated duration of the proposed
Pilot were sufficiently short, some
broker-dealers could either choose to
not alter their current order routing
behavior and wait out the length of the
Pilot, which would limit the usefulness
of the information obtained by the
Pilot.429 A shorter anticipated duration
also could reduce the usefulness of the
information and the benefits provided
by the proposed Pilot, if it reduced the
statistical power of any analyses,
because it would make it more difficult
for researchers to detect whether an
effect actually exists.430
Conversely, as the anticipated Pilot
duration increases so too would the
costs for exchanges, as this would
extend the duration of the changes to
their revenue models and the costs of
compliance with the proposed Pilot
requirements. However, increasing the
duration beyond two years is unlikely to
provide any significant increases in the
benefits identified above. As discussed
in Section V.C.1.a.i, the Commission
preliminarily believes that the proposed
Pilot duration, even with a one-year
sunset would make it economically
worthwhile for broker-dealers to alter
their order-routing decisions, because it
would likely be costly for broker-dealers
429 See Section V.C.1.a.iii, which discusses the
potential limitations associated with pilots,
including a discussion that some market
participants could choose to not alter their behavior
if the proposed Pilot had a short duration.
430 The Commission staff estimates that it would
require a minimum Pilot duration of six months to
achieve sufficient statistical power to detect
whether an effect is actually present; therefore, any
Pilot duration shorter than six months would have
limited benefits for detecting the effect of
transaction-based fees and rebates on order routing
decisions, execution quality, and market quality.
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to sit out the full duration of the
proposed Pilot or retain pre-Pilot order
routing decisions for its duration.
Further, a longer Pilot duration would
increase the costs associated with a
longer time period in which temporary
negative externalities arising from the
proposed Pilot would exist. These
externalities could have longer-term
implications on efficiency, competition,
and capital formation, and could reduce
overall levels of investor protection.
The Commission could alternatively
propose a pilot with a fixed two-year
duration. A two-year pilot without the
possibility of an automatic sunset at the
end of the first year would have the
same maximum costs as a pilot with a
sunset, but would not have the potential
to reduce costs in the event that the
sunset occurs. The alternative would
also not provide the Commission with
the flexibility to efficiently end the
proposed Pilot early once the Pilot
produced sufficient data to obtain
representative results. On the other
hand, broker-dealers could perceive
higher expected costs of not adapting to
the Pilot under the alternative because
they could expect the sunset to reduce
the anticipated duration of the Pilot.
However, the Commission preliminarily
believes that broker-dealers that base
their order routing decisions on
transaction-based fees and rebates will
incur sufficient costs from not enacting
changes to their order routing decisions
in response to the Pilot with an
expected one-year sunset such that they
are not likely to sit out the Pilot Period;
therefore, a mandatory two-year pilot
would not likely provide any additional
behavioral change that would not
already be obtainable from the proposed
Pilot.
As currently proposed, the Pilot
requires a six-month pre-Pilot Period
and a six-month post-Pilot Period,
which would allow the Commission and
the public to compare order routing
decisions in the same stocks both with
and without the proposed Pilot
restrictions as well as across stocks in
different test groups. Alternatively, the
Commission could propose shorter prePilot and post-Pilot Periods. Shorter preand post-Pilot Periods would reduce
costs to exchanges of having to provide
the Exchange Transaction Fee Summary
and order routing data. These reduced
costs come at the trade-off of shorter
horizons for data collection that could
lead to reduced statistical power and
reduce the ability of the proposed Pilot
to produce representative results.431
431 The Commission staff estimates the pilot
would need to produce approximately six months
of data to detect changes unique to ETPs, and
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If the proposed Pilot included a zero
access fee test group, this would
effectively serve to temporarily remove
a source of revenue for exchanges
entirely from a subset of securities. This
approach could produce additional
information, such as how order routing
behavior and execution quality changes
in the absence of transaction-based fees
(and likely rebates), that could be useful
to the Commission to facilitate future
policy decisions regarding the
transaction-based pricing structures of
exchanges. However, any new revenue
model created during the proposed Pilot
could provide additional incentives for
broker-dealers to route order flow from
customers in a manner that could make
possible conflicts of interest more or
less pervasive, complicating analysis of
the pilot. If a zero access fee test group
were included, exchanges would be
unable to charge access fees to market
participants that take liquidity from
maker-taker markets or make liquidity
on taker-maker exchanges. The
inclusion of a zero access fee test group
would thus completely eliminate the
transaction-based fee model for a subset
of securities, which could force
exchanges to create entirely new
revenue models for securities in this test
group. Although inclusion of a zero
access fee test group could potentially
provide expanded information to the
Commission and the public about
possible conflicts of interest, the
Commission notes that these would
come at the cost of lost revenue to
exchanges for eliminating transactionbased fees entirely or costs associated
with the creation of new revenue
models only for the duration of the
Pilot.
The Pilot, as currently proposed,
would have three test groups: (1) One
that caps access fees at $0.0015; (2) one
that caps access fees at $0.0005; and (3)
one that prohibits rebates or Linked
Pricing for displayed and non-displayed
liquidity and along the entire depth of
the limit order book. Alternatively, the
Commission could have proposed other
test groups with different caps on access
fees. For example, the Commission
could have proposed only caps to access
fees, similar to those in the EMSAC
between 60 and 69 days of data to detect changes
unique to small and large NMS stocks, respectively.
The methodology employed provided power tests
on the distributions of average daily dollar volume
data for ETPs and small and large capitalization
NMS common stocks obtained from the CRSP U.S.
Stock Database. The power tests determined the
number of days of data that would be required to
detect a 10% change in the daily volume of various
subgroups of securities.
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recommendation,432 or could have
increased the number of test groups.
Only studying exogenous shocks to
access fees would have limited the
amount and type of information
available to the Commission, given that
the theoretical literature suggests that
potential conflicts of interest are linked
to rebates more than to access fees. Any
alternative would likely replace the zero
rebate test group with another access fee
cap group. Thus, without a test group
that specifically focuses on the removal
of rebates and the corresponding impact
on conflicts of interest, the Commission
and the public would have a set of
information of lower value than it
would otherwise. An alternative to
increase the number of test groups could
produce more gradation in the caps to
access fees, this alternative would likely
increase the complexity of the proposed
Pilot, and would increase the
implementations costs to account for the
additional test groups. These costs
would be borne with little incremental
benefit to the quality of information
produced from these additional test
groups, because these additional groups
would only provide minor variations in
access fees from those already proposed.
As the Pilot is currently proposed,
only Test Group 3, which eliminates
rebates or Linked Pricing, would restrict
fees or rebates or Linked Pricing in nondisplayed liquidity and depth-of-book.
As discussed in Section III.C.3, under
the proposed Pilot, perverse incentives
to move liquidity away from the
displayed liquidity or the top-of-book
could be created if rebates are not
eliminated along the entire book and for
displayed and non-displayed liquidity.
As an alternative to the current Pilot
proposal, the Transaction Fee Pilot
could also revise access fees in Test
Groups 1 and 2 to cover both nondisplayed liquidity and the depth-ofbook. Unlike the problem associated
with moving away from displayed
liquidity that could emerge if rebates or
Linked Pricing were not removed from
the entire depth of the limit order book,
the Commission does not believe that
under the proposed Pilot incentives
would emerge for exchanges to charge
more to access non-displayed interest or
depth-of-book quotes. Such differing
fees across displayed and non-displayed
liquidity as well as the depth of the
limit order book would lead to
increased uncertainty for market
participants that take liquidity, as they
would not be able to control whether
432 The maximum access fee caps under the
EMSAC recommendation would be $0.0020 (Test
Group 1), $0.0010 (Test Group 2), and $0.0002 (Test
Group 3).
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their executions are with displayed or
non-displayed liquidity. If the fees
differed between displayed and nondisplayed liquidity, broker-dealers
would face cost uncertainty when
making routing decisions over what
access fees they would incur. From the
exchanges’ perspective, having differing
fees for posting or interacting with
displayed and non-displayed liquidity
would be burdensome to track and more
costly to administer and, to the extent
the uncertainty it creates dissuades
market participants from routing to their
market, could ultimately cause them to
lose order flow. Accordingly, the
Commission preliminarily believes that
it is unnecessary to mandate
transaction-based fee caps for the nondisplayed liquidity.
Under the current proposal, Test
Group 3 would prohibit rebates or
Linked Pricing on NMS stocks
(including ETPs). Alternatively, the
Commission could instead prohibit only
rebates, without any extension to other
similar inducements that an exchange
might use to attract order flow. The
Commission, however, believes that an
alternative that excludes like
inducements from Test Group 3 would
provide opportunities for exchanges to
work around the rebate prohibition,
which would likely reduce the
effectiveness of the information received
about NMS stocks (including ETPs) in
Test Group 3.
The Commission alternatively could
propose a limitation on Linked Pricing
across all Test Groups, not just Test
Group 3. Given that Test Groups 1 and
2 would undergo a reduction in fees due
to the lower caps in each of those
groups, which likely would lead to a
corresponding reduction in rebates,
exchanges may choose to alter other like
incentives, which would allow them to
supplement the incentive they provide
for activity in securities in Test Groups
1 and 2, and could distort the
information obtained from the Pilot.
However, from the exchanges’
perspective, enhancing like
inducements would further erode
margins related to transaction activity.
Therefore, the Commission
preliminarily believes that it is
unnecessary to prohibit like
inducements for Test Groups 1 and 2.
As currently proposed, the
Transaction Fee Pilot does not require
the exchanges to produce much
additional information on order
execution quality statistics. As an
alternative, the Commission could
require that the exchanges produce
daily Rule 605 data similar to that
required in Appendix B.1 of the Tick
Size Pilot Plan. Providing daily order
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execution quality statistics are
important for the Tick Size Pilot,
because order size is influenced by tick
size, and is an important determinant of
execution quality. As a result, tradebased measures of the effect of the Tick
Size Pilot might not yield the same
results as order-based measures of the
Tick Size Pilot, such as that in data
required in Appendix B.1 of the Tick
Size Pilot Plan. However, the proposed
Transaction Fee Pilot might not alter
order sizes nearly as dramatically as in
the Tick Size Pilot, or might not alter
them at all. Therefore, the Commission
preliminarily does not expect that
results of the proposed Transaction Fee
Pilot using trade-based execution
quality measures to differ from results
using order-based execution quality
measures. Even though exchanges have
systems in place to capture some
elements of daily data as required by the
Tick Size Pilot, including this data
could be costly for the exchanges to
provide with limited benefit for the
proposed Transaction Fee Pilot. As
currently proposed, the Transaction Fee
Pilot would provide daily information
on shares submitted, executed, and
cancelled to an exchange, and would
provide some limit order execution
quality information, such as time to
execution and likelihood of execution,
that are not currently available from
other existing data sources.433
As the Pilot is currently proposed,
downloadable files containing the
Exchange Transaction Fee Summary
would need to be publicly posted on
each exchange’s website using an XML
schema to be published on the
Commission’s website. Alternatively,
similar to the List of Pilot Securities, the
Exchange Transaction Fee Summary
could be reported in pipe-delimited
ASCII format. However, the pipedelimited ASCII format does not
support validations. As discussed
earlier, validations help ensure that
comparable data are formatted
consistently and reported completely.
Validations also help the exchanges to
test whether the data are complete and
formatted correctly before posting the
data. Because the pipe-delimited ASCII
format does not support validations,
exchanges have to manually review data
completeness and correct formatting. In
the case that an exchange was to post
incorrectly formatted or incomplete
data, the exchange would have to incur
the burden of reviewing the data again
to identify the problem and reposting
433 For example, existing studies often
incorporate execution quality statistics estimated
from TAQ data. See, e.g., Battalio Equity Market
Study, supra note 22.
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the data. Validations help ensure that
any inconsistencies in data
completeness or formatting can be
automatically tested for and identified
before posting. And because some fields
in the data may be manually entered
(i.e., the Exchange Transaction Fee
Summary), having validations would
help ensure the quality of this data.
Requiring a format that incorporates
validations would also best enhance
data users’ abilities to normalize,
aggregate, compare, and analyze the
Exchange Transaction Fee Summary
data because the data is assured to be
complete and consistently formatted.
Therefore, the Commission does not
believe that the Exchange Transaction
Fee Summary should be reported in
pipe-delimited ASCII format as that
would limit both the data’s accessibility
and ease of use.
F. Request for Comment
The Commission seeks commenters’
views and suggestions on all aspects of
its economic analysis of the proposed
rule. In particular, the Commission asks
commenters to consider the following
questions:
71. Is the proposed Pilot, in the form
of a temporary Commission rule,
necessary to achieve the objectives of
this Pilot? Are there other approaches
that would achieve these objectives?
Has the Commission appropriately
evaluated the benefits and costs of
conducting successive (or potentially
simultaneous) pilots?
72. Is there existing data that could
yield the same information, with respect
to sample representativeness and
causality, on the relation between
transaction-based fees and rebates on
order routing behavior, execution
quality and market quality that could be
obtained by the Commission in place of
the proposed Transaction Fee Pilot?
Please explain in detail.
73. Is there additional data that the
Commission should gather from the
proposed Pilot? Please be specific as to
what this data would be and how it
could inform the Commission about
possible conflicts of interest related to
access fees and rebates.
74. Do you believe the Commission’s
assessment of the baseline for economic
analysis is reasonable? Why or why not?
Please explain in detail.
75. Do you believe that the proposing
release accurately describes the baseline
and how those current practices could
change under the proposed Pilot? Why
or why not? Please explain in detail.
76. Do you believe that the
Commission has accurately described
how market participants would be
affected by the proposed Transaction
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Fee Pilot? Why or why not? Please
explain in detail.
77. Do you believe that the
Commission has accurately described
the benefits of the information that
would be received from the proposed
Transaction Fee Pilot? Why or why not?
Please explain in detail.
78. Is the Commission’s analysis of
the costs and benefits of the proposed
Transaction Fee Pilot accurate and
complete? Why or why not? Please
explain in detail.
79. Do you believe that there are costs
or benefits that would accrue to
investors likely as a result of the
proposed Pilot? If so, please explain in
detail.
80. Do you believe that there are
additional costs that may arise from the
proposed Transaction Fee Pilot? If so,
do you believe there are methods by
which the Commission could reduce the
costs imposed by the proposed Pilot
while still achieving its goals? Please
explain in detail.
81. Do you believe that the order
routing data could facilitate the reverse
engineering of proprietary order routing
strategies despite the daily aggregation
and anonymization of the data at the
broker-dealer level? Why or why not? If
so, do you believe that there are
alternative, safer methods of providing
the order routing data that would still
allow the Pilot to achieve its goals?
Please explain in detail.
82. Do you believe that there are
additional benefits or costs that could be
quantified or otherwise monetized?
Why or why not? If so, please identify
the categories, and if possible, provide
specific estimates or data.
a. Given that the Tick Size Pilot
requires exchanges to compile a daily
list of pilot securities and to identify
changes to those pilot securities due to
name changes, mergers, and other
corporate events, are the costs estimated
for compliance with reporting of the
daily pilot list for the proposed
Transaction Fee Pilot reasonable?
b. Given that exchanges submit Form
19b–4 fee filings to the Commission
regularly, are the costs estimated for
Form 19b–4 fee filings associated with
the commencement of the proposed
Pilot or for periodic revisions to
transaction-based fees and rebates
reasonable?
c. As exchanges frequently update
their transaction-based fees and rebates,
can market participants provide
estimates of the costs associated with
updating order routing systems as a
result of fee changes?
83. Are there any effects on efficiency,
competition, and capital formation that
are not identified or are misidentified in
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the above analysis? Please be specific
and provide data and analysis to
support your views.
84. Do you believe that the
Commission has accurately described
how the competitive landscape for the
market for trading services for NMS
securities would be temporarily affected
by the proposed Transaction Fee Pilot?
Why or why not? Please explain in
detail. Does the release discuss all
relevant forms of competition and
whether the proposal could alter them?
If not, which additional forms of
competition could the proposed Pilot
impact and how? Please explain in
detail.
85. Are there alternative approaches
to reporting fee data in XML format that
would facilitate ease of use? What are
the likely costs of compliance of the
proposed requirements? Please explain
in detail.
86. Would any alternative approaches
outlined above better achieve the
objectives articulated by the
Commission? Which approach and
why? What would be the costs and
benefits of these approaches? Please
explain in detail.
87. Would the inclusion of ATSs in
the proposed Transaction Fee Pilot
better achieve the objectives articulated
by the Commission? What would be the
costs and benefits of including these
venues? Please explain in detail.
88. What should be the appropriate
length of the pre-Pilot Period and postPilot Period in terms of achieving
sufficient statistical power?
89. What other economic effects are
likely to be associated with the
proposed Transaction Fee Pilot?
VI. Consideration of Impact on the
Economy
For purposes of the Small Business
Regulatory Enforcement Fairness Act of
1996 (‘‘SBREFA’’),434 the Commission
requests comment on the potential effect
of the proposed rule on the United
States economy on an annual basis. The
Commission also requests comment on
any potential increases in costs or prices
for consumers or individual industries,
and any potential effect on competition,
investment, or innovation. Commenters
are requested to provide empirical data
and other factual support for their views
to the extent possible.
VII. Regulatory Flexibility Analysis
The Regulatory Flexibility Act
(‘‘RFA’’) 435 requires Federal agencies, in
434 Public Law 104–121, Title II, 110 Stat. 857
(1996) (codified in various sections of 5 U.S.C., 15
U.S.C. and as a note to 5 U.S.C. 601).
435 5 U.S.C. 601 et seq.
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promulgating rules, to consider the
impact of those rules on small entities.
Section 603(a) 436 of the Administrative
Procedure Act,437 as amended by the
RFA, generally requires the Commission
to undertake a regulatory flexibility
analysis of all proposed rules, or
proposed rule amendments, to
determine the impact of such
rulemaking on ‘‘small entities.’’ 438
Section 605(b) of the RFA states that
this requirement shall not apply ‘‘to any
proposed or final rule if the head of the
agency certifies that the rule will not, if
promulgated, have a significant
economic impact on a substantial
number of small entities ’’ 439
The proposed rule would apply to
national securities exchanges registered
with the Commission under Section 6 of
the Exchange Act.440 With regard to a
national securities exchange, the
Commission’s definition of a small
entity is an exchange that has been
exempt from the reporting requirements
of Rule 601 of Regulation NMS, and is
not affiliated with any person (other
than a natural person) that is not a small
business or small organization.441 None
of the national securities exchanges
registered under Section 6 of the
Exchange Act that would be subject to
the proposed Pilot are ‘‘small entities’’
for purposes of the RFA. In particular,
none of the equities exchanges are
exempt from Rule 601 of Regulation
NMS.
As discussed above, the proposed rule
will not apply to any ‘‘small entities.’’
Therefore, for the purposes of the RFA,
the Commission certifies that the
proposed rule would not have a
significant economic impact on a
substantial number of small entities.
The Commission requests comment
regarding this certification. In
particular, the Commission solicits
comment on the following:
90. Do commenters agree with the
Commission’s certification? If not,
please describe the nature of any impact
on small entities and provide empirical
data to illustrate the extent of the
impact.
436 5
U.S.C. 603(a).
U.S.C. 551 et seq.
438 The Commission has adopted definitions for
the term ‘‘small entity’’ for purposes of Commission
rulemaking in accordance with the RFA. Those
definitions, as relevant to this proposed rulemaking,
are set forth in Rule 0–10, 17 CFR 240.0–10. See
Securities Exchange Act Release No. 18451 (January
28, 1982), 47 FR 5215 (February 4, 1982) (File No.
AS–305).
439 5 U.S.C. 605(b).
440 See supra Sections IV (Paperwork Reduction
Act) and V (Economic Analysis) (discussing, among
other things, the current market environment and
compliance obligations for national securities
exchanges).
441 See 17 CFR 240.0–10(e).
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437 5
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VIII. Statutory Authority and Text of
the Proposed Rule
Pursuant to the Exchange Act, and
particularly Sections 3(b), 5, 6, 11A, 15,
17, and 23(a) thereof, 15 U.S.C. 78c, 78e,
78f, 78k–1, 78o, 78q, and 78w(a), the
Commission proposes to amend Title 17
of the Code of Federal Regulations in
the manner set forth below.
List of Subjects
17 CFR Part 200
Administrative practice and
procedure, Authority delegations
(Government agencies), Organization
and functions (Government agencies).
17 CFR Part 242
Brokers, Reporting and recordkeeping
requirements, Securities.
For the reasons set out in the
preamble, the Commission is proposing
to amend Title 17, Chapter II of the
Code of Federal Regulations as follows:
PART 200—ORGANIZATION;
CONDUCT AND ETHICS; AND
INFORMATION AND REQUESTS
1. The authority citation for part 200
continues to read in part as follows:
■
Authority: 15 U.S.C. 77c, 77o, 77s, 77z–
3, 77sss, 78d, 78d–1, 78d–2, 78o–4, 78w,
78ll(d), 78mm, 80a–37, 80b–11, 7202, and
7211 et seq., unless otherwise noted.
2. Amend Section 200.30–3 by adding
paragraph (a)(84) to read as follows:
■
§ 200.30–3 Delegation of Authority to
Director of Division of Trading and Markets.
*
*
*
*
*
(a) * * *
(84) To issue notices pursuant to Rule
610T(b)(1)(i) and (c) (17 CFR
242.610T(b)(1)(i) and (c)).
*
*
*
*
*
PART 242—REGULATIONS M, SHO,
ATS, AC, NMS AND SBSR AND
CUSTOMER MARGIN REQUIREMENTS
FOR SECURITY FUTURES
3. The authority citation for part 242
continues to read as follows:
■
Authority: 15 U.S.C. 77g, 77q(a), 77s(a),
78b, 78c, 78g(c)(2), 78i(a), 78j, 78k–1(c), 78l,
78m, 78n, 78o(b), 78o(c), 78o(g), 78q(a),
78q(b), 78q(h), 78w(a), 78dd–1, 78mm, 80a–
23, 80a–29, and 80a–37.
4. Add Section 242.610T to read as
follows:
■
§ 242. 610T
Equity transaction fee pilot.
(a) Pilot Pricing Restrictions.
Notwithstanding Rule 610(c), on a pilot
basis for the period specified in
paragraph (c) of this section, in
connection with a transaction in an
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NMS stock, a national securities
exchange may not:
(1) For Test Group 1, impose, or
permit to be imposed, any fee or fees for
the display of, or execution against, the
displayed best bid or offer of such
market that exceed or accumulate to
more than $0.0015 per share;
(2) For Test Group 2, impose, or
permit to be imposed, any fee or fees for
the display of, or execution against, the
displayed best bid or offer of such
market that exceed or accumulate to
more than $0.0005 per share;
(3) For Test Group 3, provide to any
person, or permit to be provided to any
person, a rebate or other remuneration
in connection with an execution, or
offer, or permit to be offered, any linked
pricing that provides a discount or
incentive on transaction fees applicable
to removing (providing) liquidity that is
linked to providing (removing)
liquidity, except to the extent the
exchange has a rule to provide nonrebate linked pricing to its registered
market makers in consideration for
meeting market quality metrics; and
(4) For the Control Group, impose, or
permit to be imposed, any fee or fees in
contravention of the limits specified in
17 CFR 242.610(c).
(b) Pilot Securities.
(1) Initial List of Pilot Securities.
(i) The Commission shall designate by
notice the initial List of Pilot Securities,
and shall assign each Pilot Security to
one Test Group or the Control Group.
(ii) For purposes of Rule 610T, ‘‘Pilot
Securities’’ means the NMS stocks
designated by the Commission on the
initial List of Pilot Securities pursuant
to paragraph (b)(1)(i) and any successors
to such NMS stocks. At the time of
selection by the Commission, an NMS
stock must have a minimum initial
share price of at least $2 to be included
in the Pilot and must have an unlimited
duration or a duration beyond the end
of the post-Pilot Period. If the share
price of a Pilot Security in one of the
Test Groups or the Control Group closes
below $1 at the end of a trading day, it
shall be removed from the Test Group
or the Control Group and will no longer
be subject to the pricing restrictions set
forth in (a)(1)–(3) of this section.
(iii) For purposes of Rule 610T,
‘‘primary listing exchange’’ means the
national securities exchange on which
the NMS stock is listed. If an NMS stock
is listed on more than one national
securities exchange, the national
securities exchange upon which the
NMS stock has been listed the longest
shall be the primary listing exchange.
(2) Pilot Securities Exchange Lists.
(i) After the Commission selects the
initial List of Pilot Securities and prior
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to the beginning of trading on the first
day of the Pilot Period each primary
listing exchange shall publicly post on
its website downloadable files
containing a list, in pipe-delimited
ASCII format, of the Pilot Securities for
which the exchange serves as the
primary listing exchange. Each primary
listing exchange shall maintain and
update this list as necessary prior to the
beginning of trading on each business
day that the U.S. equities markets are
open for trading through the end of the
post-Pilot Period.
(ii) The Pilot Securities Exchange
Lists shall contain the following fields:
(A) Ticker Symbol;
(B) Security Name;
(C) Primary Listing Exchange;
(D) Security Type:
(1) Common Stock;
(2) ETP;
(3) Preferred Stock;
(4) Warrant;
(5) Closed-End Fund;
(6) Structured Product;
(7) ADR;
(8) Other;
(E) Test Group:
(1) Control Group;
(2) Test Group 1;
(3) Test Group 2;
(4) Test Group 3;
(F) Date the Entry Was Last Updated.
(3) Pilot Securities Change Lists.
(i) Prior to the beginning of trading on
each trading day the U.S. equities
markets are open for trading throughout
the duration of the Pilot, including the
post-Pilot Period, each primary listing
exchange shall publicly post on its
website downloadable files containing a
Pilot Securities Change List, in pipedelimited ASCII format, that lists each
separate change applicable to any Pilot
Securities for which it serves or has
served as the primary listing exchange.
The Pilot Securities Change List will
provide a cumulative list of all changes
to the Pilot Securities that the primary
listing exchange has made to the Pilot
Securities Exchange List published
pursuant to (b)(2).
(ii) In addition to the fields required
for the Pilot Securities Exchange List,
the Pilot Securities Change Lists shall
contain the following fields:
(A) New Ticker Symbol (if
applicable);
(B) New Security Name (if
applicable);
(C) Deleted Date (if applicable);
(D) Date Security Closed Below $1 (if
applicable);
(E) Effective Date of Change; and
(F) Reason for the Change.
(4) Posting Requirement. All
information publicly posted in
downloadable files pursuant to
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610T(b)(2) and (3) shall be and remain
freely and persistently available and
easily accessible by the general public
on the primary listing exchange’s
website for a period of not less than five
years from the conclusion of the postPilot Period. In addition, the
information shall be presented in a
manner that facilitates access by
machines without encumbrance, and
shall not be subject to any restrictions,
including restrictions on access,
retrieval, distribution and reuse.
(c) Pilot Duration.
(1) The Pilot shall include a sixmonth ‘‘pre-Pilot Period;’’
(2) A two-year ‘‘Pilot Period’’ with an
automatic sunset at the end of the first
year unless, no later than thirty days
prior to that time, the Commission
publishes a notice that the Pilot shall
continue for up to another year; and
(3) A six-month ‘‘post-Pilot Period.’’
(4) The Commission shall designate
by notice the commencement and
termination dates of the pre-Pilot
Period, Pilot Period, and post-Pilot
Period, including any suspension of the
one-year sunset of the Pilot Period.
(d) Order Routing Datasets.
Throughout the duration of the Pilot,
including the pre-Pilot Period and postPilot Period, each national securities
exchange that trades NMS stocks shall
publicly post on its website
downloadable files, in pipe-delimited
ASCII format, no later than the last day
of each month, containing sets of order
routing data, for the prior month, in
accordance with the specifications
below. For the pre-Pilot Period, order
routing datasets shall include each NMS
stock. For the Pilot Period and post-Pilot
Period, order routing datasets shall
include each Pilot Security. All
information publicly posted pursuant to
this paragraph (d) shall be and remain
freely and persistently available and
easily accessible by the general public
on the national securities exchange’s
website for a period of not less than five
years from the conclusion of the postPilot Period. In addition, the
information shall be presented in a
manner that facilitates access by
machines without encumbrance, and
shall not be subject to any restrictions,
including restrictions on access,
retrieval, distribution, and reuse. Each
national securities exchange shall treat
the identities of broker-dealers
contained in the Order Routing Datasets,
including the broker-dealer
anonymization key, as regulatory
information and shall not access or use
that information for any commercial or
non-regulatory purpose.
(1) Dataset of daily volume statistics
include the following specifications of
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liquidity-providing orders by security
and separating held and not-held orders
in pipe-delimited ASCII format with
field names as the first record and a
consistent naming convention that
indicates the exchange and date of the
file:
(i) Code identifying the submitting
exchange.
(ii) Eight-digit code identifying the
date of the calendar day of trading in the
format ‘‘yyyymmdd.’’
(iii) Symbol assigned to an NMS stock
(including ETPs) under the national
market system plan to which the
consolidated best bid and offer for such
a security are disseminated.
(iv) Unique, anonymized brokerdealer identification code.
(v) Order type code
(A) Inside-the-quote orders;
(B) At-the-quote limit orders; and
(C) Near-the-quote limit orders.
(vi) Order size codes
(A) <100 share bucket;
(B) 100–499 share bucket;
(C) 500–1,999 share bucket;
(D) 2,000–4,999 share bucket;
(E) 5,000–9,999 share bucket; and
(F) > 10,000 share bucket.
(vii) Number of orders received.
(viii) Cumulative number of shares of
orders received.
(ix) Cumulative number of shares of
orders cancelled prior to execution.
(x) Cumulative number of shares of
orders executed at receiving market
center.
(xi) Cumulative number of shares of
orders routed to another execution
venue.
(xii) Cumulative number of shares of
orders executed within
(A) 0 to <100 microseconds of order
receipt;
(B) 100 microseconds to <100
milliseconds of order receipt;
(C) 100 milliseconds to <1 second of
order receipt;
(D) 1 second to <30 seconds of order
receipt;
(E) 30 seconds to <60 seconds of order
receipt;
(F) 60 seconds to <5 minutes of order
receipt;
(G) 5 minutes to <30 minutes of order
receipt; and
(H) >30 minutes of order receipt.
(2) Dataset of daily volume statistics
include the following specifications of
liquidity-taking orders by security and
separating held and not-held orders in
pipe-delimited ASCII format with field
names as the first record and a
consistent naming convention that
indicates the exchange and date of the
file:
(i) Code identifying the submitting
exchange.
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(ii) Eight-digit code identifying the
date of the calendar day of trading in the
format ‘‘yyyymmdd.’’
(iii) Symbol assigned to an NMS stock
(including ETPs) under the national
market system plan to which the
consolidated best bid and offer for such
a security are disseminated.
(iv) Unique, anonymized brokerdealer identification code.
(v) Order type code
(A) Market orders; and
(B) Marketable limit orders.
(vi) Order size codes
(A) <100 share bucket;
(B) 100–499 share bucket;
(C) 500–1,999 share bucket;
(D) 2,000–4,999 share bucket;
(E) 5,000–9,999 share bucket; and
(F) >10,000 share bucket.
(vii) Number of orders received.
(viii) Cumulative number of shares of
orders received.
(ix) Cumulative number of shares of
orders cancelled prior to execution.
(x) Cumulative number of shares of
orders executed at receiving market
center.
(xi) Cumulative number of shares of
orders routed to another execution
venue.
(e) Exchange Transaction Fee
Summary. Throughout the duration of
the Pilot, including the pre-Pilot Period
and post-Pilot Period, each national
securities exchange that trades NMS
stocks shall publicly post on its website
downloadable files containing
information relating to transaction fees
and rebates and changes thereto
(applicable to securities having a price
greater than $1). Each national securities
exchange shall post its initial Exchange
Transaction Fee Summary prior to the
start of trading on the first day of the
pre-Pilot Period and update its
Exchange Transaction Fee Summary on
a monthly basis within 10 business days
of the first day of each calendar month,
to reflect data collected for the prior
month. The information prescribed by
this section shall be made available
using the most recent version of the
XML schema published on the
Commission’s website. All information
publicly posted pursuant to this
paragraph (e) shall be and remain freely
and persistently available and easily
accessible on the national securities
exchange’s website for a period of not
less than five years from the conclusion
of the post-Pilot Period. In addition, the
information shall be presented in a
manner that facilitates access by
machines without encumbrance, and
shall not be subject to any restrictions,
including restrictions on access,
retrieval, distribution, and reuse. The
Exchange Transaction Fee Summary
shall contain the following fields:
(1) SRO Name;
(2) Record Type Indicator:
(i) Reported Fee is the Monthly
Average;
(ii) Reported Fee is the Median;
(iii) Reported Fee is the Spot Monthly;
(3) Participant Type:
(i) Registered Market Maker;
(ii) All Others;
(4) Test Group:
(i) Control Group;
(ii) Test Group 1;
(iii) Test Group 2;
(iv) Test Group 3;
(5) Applicability to Displayed and
Non-Displayed Interest:
(i) Displayed only;
(ii) Non-displayed only;
(iii) Both displayed and nondisplayed;
(6) Applicability to Top and Depth of
Book Interest:
(i) Top of book only;
(ii) Depth of book only;
(iii) Both top and depth of book;
(7) Effective Date of Fee or Rebate;
(8) End Date of Currently Reported
Fee or Rebate (if applicable);
(9) Month and Year of the monthly
realized reported average and median
per share fees;
(10) Pre/Post Fee Changes Indicator (if
applicable) denoting implementation of
a new fee or rebate on a day other than
the first day of the month;
(11) Base and Top Tier Fee or Rebate:
(i) Take (to remove):
(A) Base Fee/Rebate reflecting the
standard amount assessed or rebated
before any applicable discounts, tiers,
caps, or other incentives are applied;
(B) Top Tier Fee/Rebate reflecting the
amount assessed or rebated after any
applicable discounts, tiers, caps, or
other incentives are applied;
(ii) Make (to provide):
(A) Base Fee/Rebate reflecting the
standard amount assessed or rebated
before any applicable discounts, tiers,
caps, or other incentives are applied;
(B) Top Tier Fee/Rebate reflecting the
amount assessed or rebated after any
applicable discounts, tiers, caps, or
other incentives are applied;
(12) Average Take Fee (Rebate)/
Average Make Rebate (Fee), by
Participant Type, Test Group,
Displayed/Non-Displayed, and Top/
Depth of Book; and
(13) Median Take Fee (Rebate)/
Median Make Fee (Rebate), by
Participant Type, Test Group,
Displayed/Non-Displayed, and Top/
Depth of Book.
The following will not appear in the
Code of Federal Regulations.
Exhibit 1: Data Definitions for the
Exchange Transaction Fee Summary
The table below represents the data
model for the reporting requirements of
an Exchange Transaction Fee Summary.
This data model reflects the disclosures
required by proposed 17 CFR
242.610T(e) and the logical
representation of those disclosures to a
corresponding XML element. The
Commission’s proposed XML schema is
the formal electronic representation of
this data model.
• Concept—the information content
as described in proposed 17 CFR
242.610T(e) items 1 through 12.
• Element—a name for the XML
element.
• Type—the XML data type, either a
list of possible values or a general type
such as ‘‘number’’.
• Spot, Monthly—How the element
appears in a record of that type.
Æ R—Required. The XML file is not
valid unless this element is present.
Æ NA—Not applicable. The element
may appear in the record but its value
is not to be used.
Æ O—Optional. The XML file is valid
without that element; whether it
appears for a particular SRO, record
type, test group, etc., depends on the
actual fee being described. XML
validation by itself cannot determine
this.
• When Absent—If the element is
absent, its value is interpreted as if it
had been present with the value shown.
• Definition—Text to be included in
the XML definition file (‘‘schema’’).
Concept
Element
Type
Spot
Monthly
When
absent
Definition
SRO ................................
sro ...................................
Non-empty Text ..............
R
R
............
Record Type ...................
rt .....................................
S or M .............................
R
R
............
A required unique code to identify each SRO in
the Transaction Fee Pilot.
A required record type indicator. M, if the fee type
reported is the monthly realized fee (average or
median fee); S, if the fee type reported is a spot
fee schedule (base or top tier fee).
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Element
Type
Spot
Monthly
When
absent
Definition
Participant Type ..............
ptcpt ................................
MM, Other or Blank ........
O
O
Blank
Test Group ......................
grp ..................................
1, 2, 3, or C ....................
R
R
............
Displayed ........................
disp .................................
D, N, or B .......................
R
R
............
Top/Depth .......................
topOrDepth .....................
T, D, or B ........................
R
R
............
Start Date ........................
start .................................
YYYY–MM–DD ...............
R
O
............
End Date .........................
end ..................................
YYYY–MM–DD or Blank
O
O
Blank
Month and Year ..............
YearMonth ......................
YYYY–MM ......................
NA
R
............
Pre/Post ..........................
preOrPost .......................
1, 2, or Blank ..................
O
O
Blank
Base Taker Fee ..............
baseTakeFee ..................
Number ...........................
R
NA
............
Top Tier Taker Fee .........
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Concept
topTierTakeFee ..............
Number ...........................
R
NA
............
Average Taker Fee .........
avgTakeFee ....................
Number ...........................
NA
R
............
MM, if the fees are for market makers, or else
Other. Required for spot records if the exchange
charged market makers and others different
base and top tier fees. Required for monthly fee
records if the exchange charged different average or median fees or pays different average or
median fees. Otherwise blank or absent.
A required indicator that identifies the test or control group during the Pilot and post-Pilot Period.
1, 2, 3—Test Groups 1, 2, 3; C—Control group.
D—Displayed, N—Not displayed, B—Both. For
spot fee type records, if the fees are the same
between displayed and non-displayed liquidity,
then the exchange may report both in a single
‘‘B’’ record. For monthly records, this should be
segmented into the average and median fee per
share for displayed liquidity, and the average
and median fee for non-displayed liquidity unless
there are no differences between the average
and median fees for displayed and non-displayed liquidity, in which case the exchange can
report the average and median fee in a single
‘‘B’’ record.
T—Fees for top-of-book liquidity; D—Fees for
depth-of-book liquidity; B—Both. For spot
records, if the fees are the same between topof-book and depth-of-book liquidity, then the exchange may report both fees in a single ‘‘B’’
record. For monthly records, if there are no differences between the fees for top-of-book and
depth-of-book liquidity, then the exchange may
include only the average and median fees in a
single ‘‘B’’ record.
The start date element must be present for a spot
fee record, and the end element cannot appear
alone. The effective date for any fee changes.
This should correspond to the effective date referenced in the Form 19b–4 fee filings submitted
to the Commission. This is needed in a monthly
record only if fees changed on a day other than
the first of the month; otherwise blank or absent.
The last date that a given fee is viable prior to any
fee changes. This column will be blank unless a
mid-month change to fees is made. This should
correspond to the last date that a given fee is
applicable prior to the effective date of the new
fee reflected in Form 19b–4 fee filings submitted
to the Commission to capture any revisions to
transaction-based fees and rebates. This is
needed in a monthly record only if fees changed
on a day other than the first of the month.
The year and month of the monthly realized reported average and median per share fees.
An indicator variable needed only if the exchange
changed fees on a day other than the first day
of the month. Blank—there were no fee changes
other than on the first day of the month. 1—The
average and median are the pre-change average and median for the part of the month prior
to the change. 2—The average and median are
the post-change average and median for the
part of the month after the change.
The Base Taker Fee is the standard per share fee
assessed or rebate offered before any applicable discounts, tiers, caps, or other incentives are
applied. Fees have a positive sign; rebates have
a negative sign.
The Top Tier Taker Fee is the per share fee assessed or rebate offered after all applicable discounts, tiers, caps, or other incentives are applied. Fees have a positive sign; rebates have a
negative sign.
The monthly average realized Taker fee assessed
or rebate offered per share by category (i.e., test
group, participant type, displayed vs. non-displayed, and top-of-book vs. depth-of-book). Fees
have a positive sign; rebates have a negative
sign.
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Concept
Element
Type
Spot
Monthly
When
absent
Definition
Median Taker Fee ..........
medianTakeFee ..............
Number ...........................
NA
R
............
Base Maker Fee .............
baseMakeFee .................
Number ...........................
R
NA
............
Top Tier Maker Fee ........
topTierMakeFee .............
Number ...........................
R
NA
............
Average Maker Fee ........
avgMakeFee ...................
Number ...........................
NA
R
............
Median Maker Fee ..........
medianMakeFee .............
Number ...........................
NA
R
............
The monthly median realized Taker fee assessed
or rebate offered per share by category (i.e., test
group, participant type, displayed vs. non-displayed, and top-of-book vs. depth-of-book),
across broker-dealers. Fees have a positive
sign; rebates have a negative sign.
The Base Maker Fee is the standard per share fee
assessed or rebate offered before any applicable discounts, tiers, caps, or other incentives are
applied. Fees have a positive sign; rebates have
a negative sign.
The Top Tier Maker Fee is the per share fee assessed or rebate offered all applicable discounts, tiers, caps, or other incentives are applied per share. Fees have a positive sign; rebates have a negative sign.
The monthly average realized Maker fee assessed
or rebate offered per share by category (i.e., test
group, participant type, displayed vs. non-displayed, and top-of-book vs. depth-of-book). Fees
have a positive sign; rebates have a negative
sign.
The monthly median realized Maker fee assessed
or rebate offered per share by category (i.e., test
group, participant type, displayed vs. non-displayed, or top-of-book vs. depth-of-book), across
broker-dealers. Fees have a positive sign; rebates have a negative sign.
By the Commission.
Dated: March 14, 2018.
Brent J. Fields,
Secretary.
[FR Doc. 2018–05545 Filed 3–23–18; 8:45 am]
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]]>Agencies
[Federal Register Volume 83, Number 58 (Monday, March 26, 2018)]
[Proposed Rules]
[Pages 13008-13078]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-05545]
[[Page 13007]]
Vol. 83
Monday,
No. 58
March 26, 2018
Part II
Securities and Exchange Commission
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17 CFR Parts 200 and 242
Transaction Fee Pilot for NMS Stocks; Proposed Rule
Federal Register / Vol. 83 , No. 58 / Monday, March 26, 2018 /
Proposed Rules
[[Page 13008]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 200 and 242
[Release No. 34-82873; File No. S7-05-18]
RIN 3235-AM04
Transaction Fee Pilot for NMS Stocks
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
-----------------------------------------------------------------------
SUMMARY: The Securities and Exchange Commission (``Commission'' or
``SEC'') is proposing to conduct a Transaction Fee Pilot for National
Market System (``NMS'') stocks to study the effects that transaction-
based fees and rebates may have on, and the effects that changes to
those fees and rebates may have on, order routing behavior, execution
quality, and market quality more generally. The data generated by the
proposed pilot should help inform the Commission, as well as market
participants and the public, about any such effects and thereby
facilitate a data-driven evaluation of the need for regulatory action
in this area.
DATES: Comments should be received on or before May 25, 2018.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (https://www.sec.gov/rules/proposed.shtml); or
Send an email to [email protected]. Please include
File Number S7-05-18 on the subject line.
Paper Comments
Send paper comments to Brent J. Fields, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.
All submissions should refer to File Number S7-05-18. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method. The Commission will post all comments on the
Commission's website (https://www.sec.gov/rules/proposed.shtml).
Comments are also available for website viewing and printing in the
Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549-1090 on official business days between the hours of 10:00 a.m.
and 3:00 p.m. All comments received will be posted without change.
Persons submitting comments are cautioned that we do not redact or edit
personal identifying information from comment submissions. You should
submit only information that you wish to make available publicly.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any materials will
be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at www.sec.gov to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Richard Holley III, Assistant
Director; Johnna Dumler, Special Counsel; Erika Berg, Special Counsel;
or Benjamin Bernstein, Attorney-Advisor, each with the Division of
Trading and Markets, Securities and Exchange Commission, 100 F Street
NE, Washington, DC 20549, or at (202) 551-5777.
SUPPLEMENTARY INFORMATION: The Commission is proposing to adopt Rule
610T to establish a Transaction Fee Pilot.
Table of Contents
I. Overview
II. Transaction Fees
A. Background
B. Calls for a Pilot
C. Comments on the EMSAC Recommendation
III. Discussion of the Proposed Pilot
A. Applicable Trading Centers
B. Securities
C. Proposed Pilot Design
1. Test Group 1
2. Test Group 2
3. Test Group 3
4. Control Group
D. Duration
E. Data
1. Pilot Securities Exchange Lists and Pilot Securities Change
Lists
2. Exchange Transaction Fee Summary
3. Order Routing Data
F. Implementation Period
IV. Paperwork Reduction Act
A. Summary of Collection of Information
1. Pilot Securities Exchange Lists and Pilot Securities Change
Lists
2. Exchange Transaction Fee Summary
3. Order Routing Data
B. Proposed Use of Information
C. Respondents
D. Total Initial and Annual Reporting and Recordkeeping Burdens
1. Pilot Securities Exchange Lists and Pilot Securities Change
Lists
2. Exchange Transaction Fee Summary
3. Order Routing Data
E. Collection of Information is Mandatory
F. Confidentiality of Responses to Collection of Information
G. Retention Period for Recordkeeping Requirements
H. Request for Comments
V. Economic Analysis
A. Background on Transaction-Based Fees and Potential Conflicts
of Interest
1. Overview of Transaction-Based Fees
2. Potential Conflicts of Interest
B. Baseline
1. Current Information Baseline
2. Current Market Environment
C. Analysis of Benefits and Costs of Proposed Transaction Fee
Pilot
1. Benefits of Proposed Transaction Fee Pilot
2. Costs of Proposed Transaction Fee Pilot
D. Impact on Efficiency, Competition, and Capital Formation
1. Efficiency
2. Competition
3. Capital Formation
E. Alternatives
1. Expand Proposed Transaction Fee Pilot To Include ATSs
2. Trade-At Test Group
3. No Overlap With Tick Size Pilot
4. Adjustments to the Proposed Transaction Fee Pilot Structure
F. Request for Comment
VI. Consideration of Impact on the Economy
VII. Regulatory Flexibility Analysis
VIII. Statutory Authority and Text of the Proposed Rule
I. Overview
As an integral part of its oversight of the U.S. equities markets,
where liquidity is dispersed across a large number of trading centers
that are linked through technology and regulation into a national
market system, the Commission assesses market developments, including
changes in technology and business practices, as it seeks to ensure
that the current regulatory framework continues to effectively and
efficiently promote fair and orderly markets, investor protection, and
capital formation. From a regulatory perspective, today's equity market
structure has been shaped by, among other things, Regulation NMS,
adopted in 2005, which established the regulatory framework within
which the markets transitioned from a primarily manual to a primarily
automated trading environment.\1\ Among other things, Regulation NMS
put in place order protection requirements to govern intermarket
trading in an electronically linked world of dispersed markets, and
supplemented those requirements with rules addressing fair and
efficient access to quotations and limits on fees charged to access
newly protected quotations.\2\ Subsequent to the adoption of Regulation
NMS, market practices, aided by technological innovation, including
advancements in data
[[Page 13009]]
management and analysis, and competition, have continued to evolve.
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\1\ See Securities Exchange Act Release No. 51808 (June 9,
2005), 70 FR 37496, 37543-46 (June 29, 2005) (``NMS Adopting
Release'').
\2\ See id.
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Since the adoption of Regulation NMS, the Commission and its staff
have undertaken a number of reviews of market structure and market
events.\3\ In addition, the Commission has focused on initiatives to
preserve the operational integrity of markets and market participants
\4\ and pursued a number of initiatives to enhance regulatory oversight
of the markets, improve the information available to market
participants about execution activity and the operation of Alternative
Trading Systems (``ATSs''), and explored options to improve how equity
market structure works for small companies.\5\
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\3\ See, e.g., Securities Exchange Act Release No. 61358
(January 14, 2010), 75 FR 3594, 3600 and 3603 (January 21, 2010)
(``Concept Release'') (evaluating broadly the performance of market
structure since Regulation NMS, particularly for long-term investors
and for businesses seeking to raise capital, and soliciting comment
on whether regulatory initiatives to improve market structure are
needed). See also Findings Regarding the Market Events of May 6,
2010 (September 30, 2012), available at https://www.sec.gov/news/studies/2010/marketevents-report.pdf (a report of the staffs of the
Commission and the Commodity Futures Trading Commission to the Joint
Advisory Committee on Emerging Regulatory Issues on the events of
May 6, 2010 (the ``Flash Crash''), which analyzed the extraordinary
volatility experienced on that day and market participant behavior
in response thereto). In response to lessons learned during the
Flash Crash, the Commission and the self-regulatory organizations
(``SROs'') focused on a number of critical market structure
initiatives, including single stock circuit breakers for select NMS
stocks and the Limit Up-Limit Down Plan successor thereto, which now
serves as the primary volatility moderator in the U.S. equity
markets. See, e.g., Securities Exchange Act Release Nos. 62252 (June
10, 2010), 75 FR 34186 (June 16, 2010) (File Nos. SR-BATS-2010-014;
SR-EDGA-2010-01; SR-EDGX-2010-01; SR-BX-2010-037; SR-ISE-2010-48;
SR-NYSE-2010-39; SR-NYSEAmex-2010-46; SR-NYSEArca-2010-41; SR-
NASDAQ-2010-061; SR-CHX-2010-10; SR-NSX-2010-05; SR-CBOE-2010-047)
(order approving rule changes to provide for trading pauses in
individual stocks when the price moves ten percent or more in the
preceding five minute period); 62251 (June 10, 2010), 75 FR 34183
(June 16, 2010) (File No. SR-FINRA-2010-025) (order approving a rule
to permit a halt trading otherwise than on an exchange where a
primary listing market has issued a trading pause due to
extraordinary market conditions); and 67091 (May 31, 2012), 77 FR
33498 (June 6, 2012) (File No. 4-631) (order approving, on a pilot
basis, the national market system plan to address extraordinary
market volatility).
\4\ See Securities Exchange Act Release Nos. 63241 (November 3,
2010), 75 FR 69792 (November 15, 2010) (File No. S7-03-10) (Market
Access Rule) and 73639 (November 19, 2014), 79 FR 72252 (December 5,
2014) (File No. S7-01-13) (Regulation Systems Compliance and
Integrity).
\5\ See Securities Exchange Act Release Nos. 79318 (November 15,
2016), 81 FR 84696 (November 23, 2016) (File No. 4-698) (order
approving the National Market System Plan Governing the Consolidated
Audit Trail); 78309 (July 13, 2016), 81 FR 49431 (July 27, 2016)
(File No. S7-14-16) (proposed amendments to Rule 606 of Regulation
NMS that would require broker-dealers to disclose additional data to
their customers on their routing and execution of institutional
orders); 76474 (November 18, 2015), 80 FR 80997 (December 28, 2015)
(File No. S7-23-15) (proposed rule concerning operational
transparency and regulatory oversight of ATSs); and 74892 (May 6,
2015), 80 FR 27514, 27517-18 (May 13, 2015) (File No. 4-657) (order
approving the NMS Plan to Implement a Tick Size Pilot Program)
(``Tick Size Pilot Approval Order'').
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In addition, the Equity Market Structure Advisory Committee
(``EMSAC'') provided the Commission with diverse perspectives on the
structure and operations of the U.S. equities markets, as well as
advice and recommendations on matters related to equity market
structure.\6\ In particular, the EMSAC's recommendations helped to
shape the proposal contained herein--namely, a pilot program to produce
data on the effect of equity exchange transaction fees and rebates, and
changes to those fees and rebates, on order routing behavior, execution
quality, and market quality. Informed by EMSAC's recommendation, the
Commission believes that an appropriately constructed pilot should
provide a valuable source of data to facilitate an informed data-driven
discussion about potential alternative approaches to prevailing fee
structures.
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\6\ The EMSAC was a Federal Advisory Committee established as a
broad-based group of experts charged with providing the Commission
recommendations on a range of complex market structure issues. See
Securities Exchange Act Release No. 74092 (January 20, 2015), 80 FR
3673 (January 23, 2015) (File No. 265-29). See also Equity Market
Structure Advisory Committee--Subcommittees, available at https://www.sec.gov/spotlight/equity-market-structure/equity-market-structure-advisory-committee-subcommittees.htm. The EMSAC and its
four subcommittees discussed a variety of equity market structure
issues, including Regulation NMS, trading venue regulation, market
quality, and customer issues. One of the EMSAC's subcommittees
focused exclusively on Regulation NMS, especially Rule 610(c)
(access fees) and Rule 611 (order protection), and considered
whether parts of Regulation NMS should be updated in light of the
evolution of technology, markets, and market participants. As part
of its ongoing review of market structure, the Commission is
considering the EMSAC's recommendations as it assesses potential
changes to Regulation NMS.
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The discussion below references various types of ``trading
centers,'' which is a collective term that refers broadly to the venues
that trade NMS stocks.\7\ For purposes of this release, the term
``trading center'' includes national securities exchanges that are
registered with the Commission and that trade NMS stocks (referred to
herein as ``equities exchanges'' or ``exchanges''), as well as other
types of ``non-exchange venues'' that trade NMS stocks, including ATSs
and broker-dealers that internalize orders by matching them off-
exchange with reference to the national best bid and offer.\8\ As
discussed below, the proposed Pilot would apply only to equities
exchanges.
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\7\ See 17 CFR 242.600(b)(78) (defining ``trading center'' as
``a national securities exchange or national securities association
that operates an SRO trading facility, an alternative trading
system, an exchange market maker, an OTC market maker, or any other
broker or dealer that executes orders internally by trading as
principal or crossing orders as agent.'').
\8\ See 17 CFR 242.600(b)(42) (defining ``national best bid and
national best offer'').
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II. Transaction Fees
A. Background
Exchanges and other trading centers aggregate orders to buy and
sell securities from market participants and have historically charged
their members and users fees when they match an order to buy against an
order to sell, at which point an execution occurs. As competition among
trading centers intensified in the late 1990s, ATSs, and then
exchanges, began to offer rebates to attract order flow.\9\ The
predominant model that has emerged in the U.S. equities markets is the
``maker-taker'' fee model, in which, on the one hand, a trading center
pays its broker-dealer participants a per share rebate to provide
(i.e., ``make'') liquidity in securities and, on the other hand, the
trading center assesses them a fee to remove (i.e., ``take'')
liquidity.\10\ The trading center earns as revenue the difference
between the fee paid by the ``taker'' of liquidity and the rebate paid
to the provider or ``maker'' of liquidity. In a variation on this
theme, some other trading centers have adopted a ``taker-maker''
pricing model (also called an inverted model), in which they charge
[[Page 13010]]
the provider of liquidity and pay a rebate to the taker of
liquidity.\11\
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\9\ See, e.g., Memorandum on Maker-Taker Fees on Equities
Exchanges from the Commission's Division of Trading and Markets to
the Market Structure Advisory Committee (October 20, 2015),
available at https://www.sec.gov/spotlight/emsac/memo-maker-taker-fees-on-equities-exchanges.pdf (outlining the development of the
maker-taker fee model in the U.S. and summarizing the current public
debate about its impact on equity market structure) (``Staff Maker-
Taker Memo''). The memo traces the development of transaction fees
and summarizes the potential benefits and limitations of maker-taker
pricing by presenting market participants' divergent views.
\10\ See id. New fees that an exchange seeks to impose on its
members or persons using its facilities are effective on the day
that the exchange files them with the Commission, and neither
advance notice nor Commission action is required before an exchange
may implement a fee change. See 15 U.S.C. 78s(b)(3)(A)(ii). Though
Form 19b-4 fee filings are not subject to Commission approval, the
Commission may, within 60 days after an exchange filed its fee
change with the Commission, summarily suspend the new fee and
institute proceedings to determine whether to disapprove it. See 15
U.S.C. 78s(b)(3)(C). Exchange fees are subject to the statutory
standards set forth in Section 6 of the Securities Exchange Act of
1934 (``Exchange Act''), which require, among other things, that an
exchange's fees be an ``equitable allocation'' of ``reasonable''
fees and that they not be ``designed to permit unfair
discrimination.'' See 15 U.S.C. 78f(b)(4)-(5).
\11\ See, e.g., Cboe BYX U.S. Equities Exchange Fee Schedule (as
of March 2018), available at https://markets.cboe.com/us/equities/membership/fee_schedule/byx/.
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The Commission periodically has addressed the ``access fees''
charged by trading centers to access their quotes.\12\ In 2005, the
Commission again spoke to this issue by adopting Rule 610(c) under
Regulation NMS, which prohibits trading centers from imposing, or
permitting to be imposed, any fees for the execution of an order
against a ``protected quotation'' \13\ that exceed or accumulate to
more than $0.0030 per share.\14\ The $0.0030 per share cap largely
codified the prevailing fee level set through competition among the
various trading centers.\15\ The cap on access fees established by Rule
610(c) sought in part to prevent high access fees in excess of the cap
from undermining Regulation NMS's price protection and linkage
requirements, while preserving the business model used by trading
centers dependent upon revenue from fees.\16\
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\12\ For example, in the mid-1990s, the Commission allowed an
electronic communication network (``ECN'') to facilitate specialist
and market maker quotation obligations by communicating to the
public quotation system the best price and size of orders entered
into the ECN by specialists or market makers as long as the ECN met
certain conditions and noted that ECNs may impose fees for access to
its system that are ``similar to the communications and systems
charges imposed by various markets, if not structured to discourage
access by non-subscriber broker-dealers.'' Securities Exchange Act
Release No. 37619A (September 6, 1996), 61 FR 48290, 48314 n.272
(September 12, 1996) (File No. S7-30-95). See also Securities
Exchange Act Release No. 40760 (December 8, 1998), 63 FR 70844,
70871 (December 22, 1998) (File No. S7-12-98). Commission staff
subsequently issued a series of no-action letters with respect to
access fees charged by ECNs to non-subscribers. These letters
permitted fees in amounts equal to those that they charge a
``substantial proportion'' of their active broker-dealer
subscribers, but no more than $0.009 per share. See Securities
Exchange Act Release No. 49325 (February 26, 2004), 69 FR 11126,
11156 (March 9, 2004) (File No. S7-10-04) (``NMS Proposing
Release'') (discussing the no-action relief and the inability of
ECNs to charge fees that have the effect of creating barriers to
access for non-subscribers).
\13\ Rule 600(b)(58) of Regulation NMS defines a ``protected
quotation'' as a ``protected bid or a protected offer.'' 17 CFR
242.600(b)(58). Rule 600(b)(57) of Regulation NMS, in turn, defines
a ``protected bid or protected offer'' as a quotation in an NMS
stock that is: (i) Displayed by an ``automated trading center,''
(ii) disseminated pursuant to an effective national market system
plan, and (iii) an ``automated quotation'' that is the best bid or
best offer of a national securities exchange or national securities
association. 17 CFR 242.600(b)(57). See also 17 CFR 242.600(b)(3)
(defining ``automated quotation'').
\14\ See 17 CFR 242.610(c). See also NMS Adopting Release, supra
note 1, at 37543-46. In the Regulation NMS Proposing Release, the
Commission initially proposed to cap the access fees that any
individual market participant could charge for equities at $0.0010
per share, with a total accumulated access fee limit of $0.0020 per
share in any transaction. See NMS Proposing Release, supra note 12,
at 11157-59. In its proposal, the Commission expressed concern that
access fees added significant non-transparent costs to transactions,
potentially encouraged locked markets, and created an unequal
playing field as non-ECN broker-dealers were not permitted to charge
access fees in addition to their posted quotations. See id. However,
the Commission ultimately adopted an access fee cap of $0.0030, in
order to simplify the initial proposal (see NMS Adopting Release,
supra note 1, at 37502) and for the reasons outlined infra at notes
15-16 and accompanying text. See 17 CFR 242.610(c). See also NMS
Adopting Release, supra note 1, at 37545.
\15\ See NMS Adopting Release, supra note 1, at 37545 (stating
that ``the $0.003 fee limitation is consistent with current business
practices, as very few trading centers currently charge fees that
exceed this amount'').
\16\ See id. at 37596 (``In the absence of a fee limitation, the
adoption of the Order Protection Rule and private linkages could
significantly boost the viability of the outlier business model.
Outlier markets might well try to take advantage of intermarket
price protection by acting essentially as a toll booth between price
levels. The high fee market likely will be the last market to which
orders would be routed, but prices could not move to the next level
until someone routed an order to take out the displayed price at the
outlier market. Therefore, the outlier market might see little
downside to charging exceptionally high fees, such as $0.009, even
if it is last in priority.''). See also 17 CFR 242.610(c). Maker-
taker fees also are subject to the proposed rule change process for
fees under the Exchange Act. See 15 U.S.C. 78s(b)(3)(A) and 17 CFR
240.19b-4(f)(2).
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For maker-taker exchanges, the amount of the taker fee is bounded
by the cap imposed by Rule 610(c) on the fees the exchange can charge
to access its best bid/offer for NMS stocks.\17\ This cap applies to
the fees assessed on an incoming order that executes against a resting
order or quote, but does not directly limit rebates paid. The Rule
610(c) cap on fees also typically indirectly limits the amount of the
rebates that an exchange offers to less than $0.0030 per share in order
to maintain net positive transaction revenues.\18\ For taker-maker
exchanges, the amount of the maker fee charged to the provider of
liquidity is not bounded by the Rule 610(c) cap, but such fees
typically are no more than $0.0030, and the taker of liquidity earns a
rebate.\19\
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\17\ See 17 CFR 242.610(c).
\18\ See, e.g., Staff Maker-Taker Memo, supra note 9, at 3. For
example, a maker-taker equities exchange may charge a member $0.0030
to remove liquidity and pay a rebate of $0.0025 to the member that
adds liquidity. See, e.g., Cboe BZX U.S. Equities Exchange Fee
Schedule (as of March 2018), available at https://markets.cboe.com/us/equities/membership/fee_schedule/bzx/. The revenue earned by a
maker-taker exchange on transactions equals the difference between
the fee charged and the rebate paid.
\19\ See, e.g., Cboe BYX U.S. Equities Exchange Fee Schedule (as
of March 2018), available at https://markets.cboe.com/us/equities/membership/fee_schedule/byx/ (where, for securities above $1.00, the
fee for adding liquidity is $0.0019 and the rebate for removing
liquidity is $0.0005). The make fee on a taker-maker exchange is not
bounded by Rule 610(c) because such fee is not a charge to access
the market's best bid/offer for NMS stocks.
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As discussed below, the maker-taker and taker-maker fee models
adopted by exchanges have attracted considerable attention.\20\ In
recent years, a variety of concerns have been expressed about the
maker-taker fee model, in particular the rebates they pay to attract
orders. For example, some have questioned whether the prevailing fee
structure has created a conflict of interest for broker-dealers, who
must pursue the best execution of their customers' orders while facing
potentially conflicting economic incentives to avoid fees or earn
rebates--both of which typically are not passed through the broker-
dealer to its customers--from the trading centers to which they direct
those orders for execution.\21\ One academic study of selected market
data suggested that some broker-dealers route non-marketable orders to
the trading center offering the highest rebate, and do so in a manner
that the authors contended might not be consistent with the broker-
dealers' duty of best execution.\22\ Others have expressed concern that
maker-taker access fees may (a) undermine market transparency since
displayed prices do not account for exchange transaction fees or
rebates and therefore do not reflect the net economic costs of a trade;
(b) serve as a way to effectively quote in sub-penny increments on a
net basis when the effect of a maker-taker exchange's sub-penny rebate
is taken into account even though the minimum quoting increment is
expressed in full pennies; (c) introduce unnecessary market complexity
through the proliferation of new exchange order types (and new
exchanges) designed solely to take advantage of pricing models; and (d)
drive orders to non-exchange trading centers as market participants
seek to avoid the higher
[[Page 13011]]
fees that exchanges charge to subsidize the rebates they offer.\23\
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\20\ See infra notes 21-28 and accompanying text. See also U.S.
Dep't of the Treasury, A Financial System that Creates Economic
Opportunity: Capital Markets 62-63 (2017).
\21\ See, e.g., Stanislav Dolgopolov, ``The Maker-Taker Pricing
Model and its Impact on the Securities Market Structure: A Can of
Worms for Securities Fraud?,'' 8 Va. L. & Bus. Rev. 231, 270 (2014),
available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2399821.
\22\ Robert H. Battalio, Shane A. Corwin, and Robert H.
Jennings, ``Can Brokers Have It All? On the Relation Between Make-
Take Fees and Limit Order Execution Quality,'' Journal of Finance
71, 2193-2237 (2016), available at https://onlinelibrary.wiley.com/doi/10.1111/jofi.12422/full (``Battalio Equity Market Study''). A
non-marketable order is an order with a limit price that prevents
its immediate execution at current market prices. See also infra
note 229 (discussing non-marketable orders).
\23\ See, e.g., Curt Bradbury, Market Structure Task Force
Chair, Board of Directors, SIFMA, and Kenneth E. Bentsen Jr.,
President and Chief Executive Officer, SIFMA, Opinion, ``How to
Improve Market Structure,'' N.Y. Times (July 14, 2014), available at
https://dealbook.nytimes.com/2014/07/14/how-to-improve-market-structure/?_r=0; Larry Harris, ``Maker-Taker Pricing Effects on
Market Quotations,'' at 24-25 (November 14, 2013), available at
https://bschool.huji.ac.il/.upload/hujibusiness/Maker-taker.pdf
(``Harris''); Dolgopolov, supra note 21; Letter from Richard
Steiner, Global Equities Liaison to Regulatory & Government Affairs,
RBC Capital Markets, to Elizabeth Murphy, Secretary, Commission, at
4 (November 22, 2013) (``RBC Capital Markets Letter I''), available
at https://www.sec.gov/;comments/s7-02-10/s70210-411.pdf.
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By contrast, others have indicated that the maker-taker model may
have positive effects by enabling exchanges to compete with non-
exchange trading centers and narrowing quoted spreads by subsidizing
posted prices.\24\ In particular, maker-taker fees may narrow displayed
spreads in some securities insofar as the liquidity rebate effectively
subsidizes the prices of displayed liquidity.\25\ In turn, that
displayed liquidity may establish the national best bid and offer,
which is often used as the benchmark for marketable order flow,
including retail order flow, that is executed off-exchange by either
matching or improving upon those prices.\26\ Accordingly, retail orders
may benefit indirectly from the subsidy provided by maker-taker
exchanges.
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\24\ See, e.g., Michael Brolley & Katya Malinova, ``Informed
Trading and Maker-Taker Fees in a Low Latency Limit Order Market,''
at 2 (October 24, 2013), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2178102 (``If a maker rebate is introduced in
competitive markets, the bid-ask spread will decline by (twice) the
maker rebate.'') (``Brolley and Malinova''); Shawn O'Donoghue, ``The
Effect of Maker-Taker Fees on Investor Order Choice and Execution
Quality in U.S. Stock Markets'' (January 23, 2015), available at
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2607302
(``O'Donoghue''); and Jean-Edouard Colliard & Thierry Foucault,
``Trading Fees and Efficiency in Limit Order Markets,'' Oxford
University Press, at n.13 (September 1, 2012), available at https://thierryfoucault.com/publications/research-papers/ (arguing that
maker-taker rebates may help equities exchanges compete with off-
exchange payment for order flow arrangements, in which wholesale
broker-dealers purchase retail order flow for trading off-exchange).
\25\ See, e.g., Letter from Richie Prager, Managing Director,
Head of Trading and Liquidity Strategies, BlackRock, Inc., to Mary
Jo White, Chair, SEC, at 2 (September 12, 2014), available at:
https://www.sec.gov/comments/s7-02-10/s70210-419.pdf (``Some
participants have called for elimination of rebates and maker-taker
pricing in its entirety in conjunction with access fees, but
BlackRock believes that incentives for providing liquidity
positively impact market structure. Incentives promote price
discovery in public markets, increase available liquidity and
tighten spreads. Rebates compensate liquidity providers for exposing
orders to adverse selection and information leakage.''). See also
Harris, supra note 23, at 1-2 (noting that while economic theory
suggests that maker-taker pricing should have narrowed average bid-
ask spreads, intervening factors, such as the growth in electronic
trading, make it difficult to ``entirely attribute[ ]'' the observed
reduction in bid-ask spreads to maker-taker pricing; in addition,
spreads cannot decrease for stocks that already trade at penny-wide
spreads).
\26\ See Concept Release, supra note 3, at 3600.
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Some have urged the Commission to gather data to assess the
potential impact of transaction fees and rebates in the U.S.
markets.\27\ Most recently, as discussed below, the EMSAC recommended
that the Commission conduct a pilot to study the impact of transaction
fees on market quality and order routing behavior.\28\ Informed by that
recommendation, the views of those submitting comment letters on the
EMSAC's proposal, and the information and research described herein,
the Commission is proposing that a pilot program be conducted that
would produce data on the effects of equity exchange transaction fees
and rebates, and possible effects of changes in those fees and rebates,
on order routing behavior, execution quality, and market quality.
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\27\ See infra note 29 and accompanying text. Limited
experiments on a single market with a limited subset of securities,
like the test performed by The Nasdaq Stock Market LLC (``Nasdaq'')
discussed below, where order flow can quickly move to other
exchanges that are not taking part in the experiment, do not offer
the same insights as a comprehensive market-wide study on
transaction fees. See infra notes 30-34 and accompanying text.
\28\ See Recommendation for an Access Fee Pilot (July 8, 2016),
available at https://www.sec.gov/spotlight/emsac/recommendation-access-fee-pilot.pdf (``EMSAC Pilot Recommendation''); see also
supra note 38 and accompanying text.
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B. Calls for a Pilot
The concept of a pilot program to gather data to study the effects
of the maker-taker model on market quality and order routing behavior
has attracted increasing attention in recent years.\29\ Nasdaq
experimented with changes to its transaction fees when it lowered
access fees and rebates in 14 stocks over a four-month period in
2015.\30\ Through its experiment, Nasdaq observed that ``[l]iquidity
providers [were] the primary responders to the fee changes during the
experiment,'' whereas there were ``no significant changes in the nature
of liquidity taking during the pilot.'' \31\ While liquidity providers
could readily route orders to other trading centers offering higher
maker rebates, Nasdaq offered a number of possible explanations for why
liquidity takers did not appear to respond to its experiment, including
the fact that order routing decisions were primarily driven by best
execution parameters not by exchange fees.\32\ For these reasons,
Nasdaq itself observed that ``the results for Nasdaq would not
necessarily be duplicated industry-wide if access fees and rebates were
reduced across the board.'' \33\ In other words, Nasdaq's experiment
involved a small sample of stocks on a single market for a short
duration, all of which make it difficult to draw inferences about what
would happen if all exchanges participated in the same experiment
simultaneously. The Commission preliminarily believes, therefore, that
a pilot is necessary to gather data to facilitate analysis of the
[[Page 13012]]
impact of fees and rebates on the equities exchanges broadly.\34\
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\29\ See, e.g., Letter from Micah Hauptman, Financial Services
Counsel, Consumer Federation of America, to Brent J. Fields,
Secretary, Commission, at 2 (December 22, 2014), available at
https://www.sec.gov/comments/4-657/4657-64.pdf (recommending an
access fee pilot as an alternative to a tick size pilot); and RBC
Capital Markets Letter I, supra note 23, at 3.
\30\ See Securities Exchange Act Release No. 73967 (December 30,
2014), 80 FR 594 (January 6, 2015) (SR-NASDAQ-2014-128) (``Nasdaq
Pilot'') (lowering the access fee to remove liquidity from $0.0030
to $0.0005 and reducing the credit paid to display liquidity to
$0.0004 (such credits otherwise ranged from $0.0015 to $0.00305)).
\31\ See Nasdaq Access Fee Experiment May 2015 Report, at 1,
available at https://www.nasdaqomx.com/digitalAssets/98/98718_accessfeereporttwo.pdf (``Nasdaq May Report''). Nasdaq noted
that one of the aims of its experiment was to ``examine the
importance of liquidity provider rebates to participant firms'
posting behavior on Nasdaq.'' Id. Nasdaq's experiment showed what it
characterized as statistically significant effects on the Nasdaq
Stock Market. For example, Nasdaq observed the following initial
impact on its market share: ``In aggregate, Nasdaq's equally-
weighted market share in the experiment stocks declined by 2.9
percentage points from January to February. This compares to a
decline of 0.9 percentage points in Nasdaq market share in the
control stocks. The change observed in the experiment stocks is
statistically significant using the diff-in-diff measure.'' See
Nasdaq Access Fee Experiment March 2015 Report, at 1, available at
https://images.qnasdaqomx.com/Web/NASDAQOMX/%7Be737af7a-07e8-4119-859c-096b306fc6f2%7D_Fee_Cap_Report_3-6-15v3.pdf (``Nasdaq March
Report''). It also observed the following impact on its displayed
liquidity: ``Nasdaq's time at the NBBO in the experiment stocks
declined 4.9 percentage points from 93.0% in January to 88.1%
February (Figure 2). This compares to a decline of 0.3 percentage
points in the control stocks. The difference between the experiment
and control stocks is statistically significant.'' See id. at 2.
\32\ See, e.g., Nasdaq May Report, supra note 31, at 3. Other
possible explanations offered by Nasdaq include, for example, the
fact that the number of stocks in its experiment was too low to
justify broker-dealers recoding their liquidity taking algorithms in
response to the experiment, the possibility that liquidity taking
activity for some firms may not consider access fees, or that some
liquidity taking algorithms may be based on displayed size. See id.
(``. . . a fifth conjecture is that the economic incentives for
taking liquidity from sources other than Nasdaq are not materially
affected by the reduction in Nasdaq's access fees'').
\33\ Nasdaq May Report, supra note 31, at 1. See also EMSAC
Pilot Recommendation, supra note 28, at 3 (``Limited experiments,
such as the recent Nasdaq pilot, have shown that individual market
experiments do not yield conclusive results about the potential
impact of market-wide policy reform on access fees.'').
\34\ See, e.g., Nasdaq May Report, supra note 31, at 1 (noting
that ``. . . the results for Nasdaq would not necessarily be
duplicated industry-wide if access fees and rebates were reduced
across the board.''). See also EMSAC Pilot Recommendation, supra
note 28, at 3 (``Limited experiments, such as the recent Nasdaq
pilot, have shown that individual market experiments do not yield
conclusive results about the potential impact of market-wide policy
reform on access fees.''); Nasdaq March Report, supra note 31, at 3
(``Some commentators on the access fee experiment have indicated
that a voluntary change in the access fee by one exchange in
fourteen stocks does not tell you what would happen if there were a
mandatory change in the regulatory maximum access fee across all
exchanges in a considerable number of stocks of NMS stocks. We do
not disagree with that point. Nasdaq believed in launching the
experiment that fourteen stocks were enough to induce behavioral
changes with statistically and economically measurable changes. The
results from February have proven that belief was correct.''); and
Letter from Theodore R. Lazo, Managing Director and Associate
General Counsel, SIFMA, to Brent J. Fields, Secretary, Commission
(January 30, 2015), at 2, available at https://www.sec.gov/comments/sr-nasdaq-2014-128/nasdaq2014128-1.pdf (``In particular, the
proposal's limited scope and application cannot act as a substitute
for a market-wide access fee reduction that would change the
dynamics of access fees and rebates across the entire market. For
the proposal to accurately measure the structural impact of reduced
access fees, the proposal should be carried out across all exchanges
and with a larger sampling of symbols.''). See also Section
V.B.1.b.i infra for additional discussion of the Nasdaq study.
---------------------------------------------------------------------------
More recently, the EMSAC's Regulation NMS Subcommittee
(``Subcommittee'') \35\ prepared an outline for a potential access fee
pilot, and the EMSAC discussed that outline, and the topic of access
fees in general, at its April 2016 meeting.\36\ Following that meeting,
the Subcommittee revised its recommendation and prepared a formal
recommendation for consideration by the EMSAC.\37\ The EMSAC considered
that revised proposal and recommended that the Commission pursue an
access fee pilot.\38\ The EMSAC's recommendation stated:
---------------------------------------------------------------------------
\35\ The Subcommittee first convened in November 2015, and began
by focusing on maker-taker access fees. In a series of meetings over
the following months, the Subcommittee assembled an outline of
proposed terms for an access fee pilot. It identified general goals
and prepared a recommendation for the consideration of the full
EMSAC for the scope of a potential pilot, including stock selection,
pricing buckets, and duration, and it also considered the potential
inclusion of non-exchange markets, taker-maker exchanges, and a
trade-at component. Minutes of those meetings and other information
are available at https://www.sec.gov/spotlight/equity-market-structure/equity-market-structure-advisory-committee-subcommittees.htm.
\36\ See Framework for a Potential Access Fee Pilot (April 19,
2016), available at https://www.sec.gov/spotlight/emsac/emsac-regulation-nms-subcommittee-recommendation-041916.pdf. At its April
2016 meeting, EMSAC discussed the topic of maker-taker fees and
heard from a number of outside experts. See EMSAC Transcript, April
26, 2016, available at https://www.sec.gov/spotlight/emsac/emsac-042616-transcript.txt.
\37\ See Regulation NMS Subcommittee Recommendation for an
Access Fee Pilot (June 10, 2016), available at https://www.sec.gov/spotlight/emsac/emsac-regulation-nms-recommendation-61016.pdf
(``June Recommendation'').
\38\ The EMSAC considered the Subcommittee's June Recommendation
and adopted it, by a vote of 15-1, with slight modifications that
preserved the basic structure of the June Recommendation but
incorporated additional detail, for example, settling on a two-year
term and recommending 100 securities in each test bucket. See EMSAC
Pilot Recommendation, supra note 28. See also EMSAC Transcript, July
8, 2016, available at https://www.sec.gov/spotlight/emsac/emsac-070816-transcript.txt. The EMSAC member who voted against the EMSAC
Pilot Recommendation noted his concern that ``capping access fees is
going to discourage liquidity provision and increase spreads''
before voting against the EMSAC Pilot Recommendation. See id. at
22:24-23:6.
The intent of the proposed pilot is to better understand, within
the context of our current market structure, the effect of access
fees on liquidity provision, liquidity taking and order routing with
the ultimate goal of improving market quality. The Committee does
not believe that there are any certain or predetermined outcomes
from the pilot, and the net effect of many counterbalancing factors
are not believed to be significantly beneficial or detrimental to
any single group. Ultimately, the findings from the pilot are purely
intended to inform the broader debate on how to improve market
quality for issuers, investors and market participants.\39\
---------------------------------------------------------------------------
\39\ EMSAC Pilot Recommendation, supra note 28, at 1.
The EMSAC's pilot recommendation featured four buckets of common
stocks and Exchange-Traded Funds (``ETFs'') \40\ with a market
capitalization of at least $3 billion: A control bucket and three test
buckets with successively lower access fee caps of $0.0020, $0.0010,
and $0.0002.\41\ Consistent with the scope of Rule 610(c) of Regulation
NMS, the EMSAC recommendation did not include an outright prohibition
on rebates or include taker-maker exchanges in the pilot.\42\ The EMSAC
recommended a two-year term for a pilot and outlined a number of
metrics that could be assessed in connection with the pilot.\43\
---------------------------------------------------------------------------
\40\ See infra note 96 (discussing ETFs).
\41\ See EMSAC Pilot Recommendation, supra note 28, at 2. The
EMSAC noted that it ``intentionally selected $.0002 as the rate in
Bucket 4 in order to create a bucket where any rebate should result
in a de minimis economic incentive.'' Id. at 4.
\42\ In addition, consistent with the framework of Rule 610(c),
the EMSAC's proposed fee caps would apply to protected quotations
and not depth of book quotations, and would have no direct
application to ATSs. See id. at 2.
\43\ See id. at 2. The recommendation did not include a ``trade-
at'' provision that would restrict price matching of protected
quotations, but mentioned an option to include ATSs in the pilot.
See id. at 5 (noting that if trade-at were included, ``the likely
shift of flows as a result of trade-at would both make the pilot
more complex and impact the effective measurement of the access fee
change''). The EMSAC also noted that ``[t]he tick pilot will yield
some trade-at results that can be further studied; thus duplication
is not warranted.'' See id. See also Tick Size Pilot Approval Order,
supra note 5, at 27517-18 (discussing a trade-at prohibition that,
subject to certain exceptions, prevents a trading center that was
not quoting from price matching protected quotations and permits a
trading center that was quoting at a protected quotation to execute
orders at that level, but only up to the amount of its displayed
size).
---------------------------------------------------------------------------
C. Comments on the EMSAC Recommendation
Following the establishment of the EMSAC, the Commission received a
number of comment letters regarding the impact of access fees and
rebates in the equities markets.\44\ Several
[[Page 13013]]
commenters voiced support for a pilot in general or for the various
proposals considered by the Subcommittee and the EMSAC that culminated
in the EMSAC Pilot Recommendation. One commenter, for example,
expressed support for an access fee pilot and characterized the
Subcommittee's recommendation as ``an excellent roadmap'' for such a
pilot.\45\ Other commenters that support an access fee pilot remarked
that the maker-taker pricing model contributes to opaque, non-
transparent markets, increases market complexity and fragmentation, and
generates conflicts of interest that may impede best execution of
orders, and they urged the Commission to act promptly on a pilot that
could produce useful data on these issues.\46\
---------------------------------------------------------------------------
\44\ Letter from Haim Bodek, Managing Principal, and Stanislav
Dolgopolov, Regulatory Consultant, Decimus Capital Markets, LLC, to
Brent J. Fields, Secretary, Commission (April 25, 2016), available
at https://www.sec.gov/comments/265-29/26529-63.pdf (``Decimus
Capital Markets Letter''); Letter from Elizabeth King, NYSE, to
Brent J. Fields, Secretary, Commission (May 13, 2016), available at
https://www.sec.gov/comments/265-29/26529-66.pdf (``NYSE Letter'');
Letter from Joan C. Conley, Senior Vice President and Corporate
Secretary, Nasdaq, to Brent J. Fields, Secretary, Commission (May
24, 2016), available at https://www.sec.gov/comments/265-29/26529-71.pdf (``Nasdaq Letter''); Letter from Richard Steiner, RBC Capital
Markets, to The Honorable Mary Jo White, Chair, Commission (May 24,
2016), available at https://www.sec.gov/comments/265-29/26529-70.pdf
(``RBC Capital Markets Letter II''); Letter from Security Traders
Association to SEC EMSAC (June 15, 2016), available at https://www.sec.gov/comments/265-29/26529-74.pdf (``Security Traders
Association Letter''); Letter from Kermit Kubitz to SEC EMSAC (July
5, 2016), available at https://www.sec.gov/comments/265-29/26529-73.htm (``Kubitz Letter''); Letters from J A to Chair White,
Commissioners, and SEC EMSAC (May 23, 2016, & September 13, 2016),
available at https://www.sec.gov/comments/265-29/26529-68.htm &
https://www.sec.gov/comments/265-29/26529-85.htm (``J A Letters'');
Letter from Richard Steiner, Electronic Trading Strategist, RBC
Capital Markets, to Mary Jo White, Chair, Commission (September 23,
2016), available at https://www.sec.gov/comments/265-29/26529-86.pdf
(``RBC Capital Markets Letter III''); Letter from Tyler Gellasch,
Executive Director, Healthy Markets Association, to Brent J. Fields,
Secretary, Commission (December 23, 2016), available at https://www.sec.gov/comments/265-29/26529-1441899-130023.pdf (``Healthy
Markets Letter I''); Letter from Theodore R. Lazo, Managing Director
& Associate General Counsel, SIFMA, to Brent J. Fields, Secretary,
Commission (March 29, 2017), available at https://www.sec.gov/comments/265-29/26529-1674696-149276.pdf (``SIFMA Letter''); Letter
from Tyler Gellasch, Executive Director, Healthy Markets
Association, to Brent J. Fields, Secretary, Commission (April 3,
2017), available at https://www.sec.gov/comments/265-29/26529-1681516-149500.pdf (``Healthy Markets Letter II''); Letter from
Tyler Gellasch, Executive Director, Healthy Markets Association, to
Hon. W. Jay Clayton, Chairman, Commission (June 13, 2017), available
at https://www.sec.gov/comments/265-29/26529-1801830-153704.pdf
(``Healthy Markets Letter III''); Letter from Chris Concannon,
President and Chief Operating Officer, Cboe, Thomas Wittman, CEO,
The Nasdaq Stock Market LLC, and Thomas W. Farley, President, NYSE,
to Hon. Jay Clayton, Chairman, Commission (October 13, 2017),
available at https://www.sec.gov/comments/265-29/26529-2641078-161300.pdf (``Joint Exchange Letter''); Letter from Brad Katsuyama,
Chief Executive Officer, and John Ramsay, Chief Market Policy
Officer, Investors Exchange LLC, to Hon. Jay Clayton, Chairman,
Commission (November 15, 2017), available at https://www.sec.gov/comments/265-29/26529-2691444-161491.pdf (``IEX Letter''); Email
from Tim Quast, President, ModernNetworks IR LLC, to Hon. Jay
Clayton, Chairman, Commission (December 5, 2017), available at
https://www.sec.gov/comments/265-29/26529-2777697-161622.pdf.
\45\ See Decimus Capital Markets Letter, supra note 44, at 2.
\46\ See, e.g., Letter from Ari Burstein, Associate General
Counsel, Investment Company Institute, to Brent Fields, Secretary,
Commission (May 11, 2015), available at https://www.sec.gov/comments/265-29/26529-10.pdf (recommending that the Commission
establish a pilot program that would prohibit rebates and reduce
access fees) (``Investment Company Institute Letter I''); Letter
from Managed Funds Association to SEC EMSAC (September 29, 2015),
available at https://www.sec.gov/comments/265-29/26529-28.pdf
(urging ``a disciplined, data-driven study'' and calling for
analysis of access fees' effects on market liquidity, order routing,
execution transparency, transaction costs, and competition); Letter
from David W. Blass, General Counsel, Investment Company Institute,
to SEC EMSAC (January 20, 2016), available at https://www.sec.gov/comments/265-29/26529-48.pdf (urging the Commission to establish a
phased pilot program for highly liquid stocks that would reduce
access fees and prohibit rebates) (``Investment Company Letter
II''); Letter from the Trading Issues Committee, Canadian Security
Traders Association, Inc., to Brent Fields, Secretary, Commission
(April 6, 2016), available at https://www.sec.gov/comments/265-29/26529-61.pdf (proposing a cross-border study on the effect of
rebates on market quality in conjunction with the Canadian
Securities Administrators); J A Letters, supra note 44 (retail
investor supporting proposed pilot but suggesting test of payment
for order flow and inclusion of ``trade-at'' provision); Security
Traders Association Letter, supra note 44 (supporting a pilot of
limited number of securities with varying access fee caps and ``no
other variables''); RBC Capital Markets Letter III, supra note 44
(concluding that an access fee pilot based on the EMSAC
recommendation would be ``a positive step'' and further suggesting a
no-rebate bucket and the inclusion of taker-maker exchanges and
ATSs); Healthy Markets Letter I, supra note 44 (applauding many
aspects of the EMSAC recommendation, but suggesting that it include
all trading venues and a ``trade-at'' provision); SIFMA Letter,
supra note 44 (proposing, as one alternative, that the Commission
adopt the EMSAC recommendation); IEX Letter, supra note 44
(supporting the concept of a fee pilot conducted by the SEC, but
recommending that the pilot include a no-rebate bucket and apply to
inverted exchanges).
---------------------------------------------------------------------------
Some of these same commenters suggested modifications to the ideas
ultimately embodied in the EMSAC Pilot Recommendation. For example, one
commenter suggested including a wider range of securities with lower
market capitalizations, instead of focusing only on the highly liquid
securities proposed by the EMSAC.\47\ Several other commenters argued
that any pilot should either ban rebates altogether or include a ``no-
rebate'' test bucket--an approach that the EMSAC considered, but did
not ultimately recommend.\48\ Finally, a number of commenters advocated
for applying a pilot to taker-maker exchanges as well as ATSs.\49\
---------------------------------------------------------------------------
\47\ See Decimus Capital Markets Letter, supra note 44, at 11.
But cf. Investment Company Institute Letter II, supra note 46, at 6-
7 (asserting that pilot securities should be highly liquid stocks,
as measured by average daily trading volume); Joint Exchange Letter,
supra note 44, at 5 (expressing concern that liquidity in less
active stocks could be negatively impacted by a pilot, but
acknowledging that, ``if less active stocks are omitted, it is
difficult to envision the securities that should be selected . .
.''). See also infra Section III.B (discussing the securities to be
included in the proposed pilot, which incorporates a broader range
of securities than the EMSAC recommendation, including NMS stocks
with market capitalizations below $3 billion).
\48\ See Investment Company Institute Letter II, supra note 46,
at 7 (recommending that the Commission establish a phased pilot
program for highly liquid stocks that would reduce access fees and
prohibit rebates); RBC Capital Markets Letter III, supra note 44, at
3 (advocating for the inclusion of a ``no-rebate'' bucket in the
pilot); Healthy Markets Letter II, supra note 44, at 6 n.15
(suggesting that the Commission establish a pilot that eliminates
rebates); SIFMA Letter, supra note 44, at 9-10 (suggesting, as an
alternative to an access fee pilot, that the Commission eliminate
rebates); IEX Letter, supra note 44, at 3-4 (stating that
restrictions on access fees may not help the Commission to evaluate
alternatives to the current exchange pricing system, which is driven
primarily by rebates, and advocating for the inclusion of a ``no-
rebate'' bucket in the pilot). See also Nasdaq Letter, supra note
44, at 3 (asserting that any pilot should apply to both fees and
rebates). But cf. NYSE Letter, supra note 44, at 3-4 (arguing that
elimination of rebates, without any other offsetting incentives, may
reduce market-maker incentives to provide liquidity). See also infra
Section III.C (discussing the design of the proposed pilot, which
includes a ``no-rebate'' bucket).
\49\ See RBC Capital Markets Letter III, supra note 44, at 4
(suggesting that the pilot should be applied to taker-maker
exchanges and ATSs); Healthy Markets Letter I, supra note 44, at 3-4
(taking the view that ``all relevant exchanges'' and ATSs should be
included in the pilot). See also Nasdaq Letter, supra note 44, at 3
(recommending that the Commission establish a pilot that applies to
all trading centers, including ATSs); Joint Exchange Letter, supra
note 44, at 5 (recommending that the pilot apply to trading in all
off-exchange venues); IEX Letter, supra note 44, at 4 (suggesting
that the access fee pilot should include taker-maker exchanges). See
also infra Section III.A (discussing the Commission's decision to
include taker-maker exchanges, but not ATSs, in the proposed pilot).
---------------------------------------------------------------------------
In a joint letter, three exchanges recommended several other
changes \50\ if the Commission proceeds with a pilot based on the
EMSAC's recommendation.\51\ These commenters suggested that such a
pilot should, among other things: (1) Study ``all forms of
remuneration,'' in part by adding measures specifically to study ATS
and broker-dealer remuneration and to show how the savings realized by
broker-dealers from lowered exchange transaction fees are ``returned to
customers,'' \52\ (2) measure costs to issuers and shareholders and
allow issuers to have a voice in whether they are included in a
pilot,\53\ (3) pre-announce the measures for benchmarking and tracking
the impact of a pilot,\54\ and (4) ``measure gross shifts in trading
from exchange to off-exchange venues and among off-exchange venues.''
\55\
---------------------------------------------------------------------------
\50\ See notes 47 and 49 supra, and note 62 infra, for a
discussion of other changes recommended by these three exchanges.
\51\ See Joint Exchange Letter, supra note 44, at 4-5.
\52\ But cf. IEX Letter, supra note 44, at 2 (``The idea that a
substantial conflict of interest cannot be addressed unless all
other conflicts are addressed simultaneously is not viable.'').
\53\ See Section III.B infra (discussing the Commission's
decision to include a broader range of securities than the EMSAC
recommendation, including NMS stocks with market capitalizations
below $3 billion). See also Sections V.C.2.b and V.D.3 infra
(discussing the potential costs to small and mid-capitalization
issuers).
\54\ See Section III.E infra (discussing the measures that the
Commission intends to use to benchmark and track the impact of the
proposed Pilot).
\55\ See Joint Exchange Letter, supra note 44, at 4-5. See also
Section III.E.3 infra (discussing the order routing data that the
Commission intends to use to measure shifts in trading); Section
V.E.1 infra (noting that the Commission can use existing data
sources to track shifts in trading between equities exchanges and
ATSs).
---------------------------------------------------------------------------
Other commenters expressed concern regarding the impact of a
pilot.\56\ For example, the New York Stock Exchange LLC (``NYSE'')
believed that, while the pilot's lowered fee caps in the three test
groups would reduce the direct costs paid by broker-dealers to access
displayed exchange quotations, it also would effectively limit the
rebates paid
[[Page 13014]]
by exchanges to attract liquidity, which could ``reduce the
competitiveness of exchanges relative to dark pools. . . .'' \57\ NYSE
further argued that the Subcommittee's concept for a pilot was
``designed to test investors' and listed companies' tolerance for
worsening market quality'' since market making and market quality ``are
largely driven by incentives and corresponding obligations.'' \58\ NYSE
recommended an alternative initiative that would lower access fee caps,
prohibit maker-taker pricing models, and institute a ``trade-at''
rule.\59\
---------------------------------------------------------------------------
\56\ See, e.g., Letter from David M. Weisberger, Managing
Director and Global Head, RegOne Solutions, a Markit company, to
Brent Fields, Secretary, Commission (October 9, 2015), available at
https://www.sec.gov/comments/265-29/26529-30.pdf (raising various
questions about proposals to modify access fees, including risks
that such proposals could hurt retail investors and lower available
liquidity); Letter from John I. Sanders & Benjamin Leighton, Wake
Forest School of Law Community Law and Business Clinic (October 20,
2015), at 6-7, available at https://www.sec.gov/comments/265-29/26529-33.pdf (opining that a shift away from maker-taker pricing
could affect liquidity and suggesting that the Commission instead
focus on utilizing market manipulation rules, limiting order types,
and regulating colocation).
\57\ NYSE Letter, supra note 44, at 3. NYSE was critical of the
potential application of access fee caps to non-displayed liquidity,
an idea considered but not recommended by the EMSAC, because it
believed that such caps on exchanges would advantage ATSs. Id. at 5-
6.; but cf. RBC Capital Markets Letter III, supra note 44, at 4
(asserting that the pilot program should cover non-displayed orders
on exchanges to ensure complete and accurate data). See also infra
Section III.C (discussing the design of the proposed pilot).
\58\ See NYSE Letter, supra note 44, at 3.
\59\ See id. at 6. Some commenters seemed to agree with NYSE
that a ``trade-at'' rule should be included in the pilot. See Nasdaq
Letter, supra note 44, at 2. Others opposed inclusion of a ``trade-
at'' rule. See RBC Capital Markets Letter III, supra note 44
(stating that a ``trade-at'' rule would be duplicative, given the
inclusion of such a component in the Tick Size Pilot, and opining
that a ``trade-at'' rule could obscure data showing the impact of
pricing); Healthy Markets Letter I, supra note 44, at 4 (noting that
inclusion of a ``trade-at'' rule would increase the pilot's
complexity and decrease its utility, but opining that all trading
venues should be included in the pilot if a ``trade-at'' rule is
excluded). See also infra Section III.C (discussing the design of
the proposed pilot).
---------------------------------------------------------------------------
Nasdaq suggested the Commission pursue an alternative pilot that
caps both fees and rebates, as it believed that more meaningful data
would result by removing price from market participants' routing
decisions.\60\ Nasdaq also argued that the pilot should apply to all
trading centers.\61\ Finally, Nasdaq thought that a two-year term for a
pilot would be too long, observing that its own transaction fee
experiment suggested that the impact on liquidity provision was evident
quickly.\62\
---------------------------------------------------------------------------
\60\ See Nasdaq Letter, supra note 44, at 3. See also infra
Section III.C.3 (discussing the Pilot's inclusion of a ``no-rebate''
bucket).
\61\ See Nasdaq Letter, supra note 44, at 3. See also infra
Section III.A (discussing the Commission's decision to expand on the
EMSAC Pilot Recommendation to apply the Pilot to all equities
exchanges, but not to ATSs).
\62\ See Nasdaq Letter, supra note 44, at 3; Joint Exchange
Letter, supra note 44, at 5 (recommending that the proposed pilot
last no more than one year and that the Commission develop criteria
for evaluating the possibility of the pilot's early termination).
See also, e.g., Nasdaq May Report, supra note 31, at 1 (summarizing
some of Nasdaq's explanations regarding the results of its
transaction fee experiment); and infra Section III.D (discussing the
Commission's decision to limit the two-year term recommended by
EMSAC with an automatic sunset at the end of the first year).
---------------------------------------------------------------------------
One commenter, the Chicago Board Options Exchange, Incorporated,
now known as Cboe Exchange, Inc. (``Cboe''), recommended against doing
a pilot, and instead suggested abolishing the equity fee cap and
requiring ATSs to file fee changes with the Commission.\63\ Similarly,
Nasdaq, NYSE, and Cboe jointly suggested that the Commission should
forgo conducting a pilot that only touches on one aspect of Regulation
NMS and instead recommended a broader review of the impact of
remuneration on routing and trading.\64\ Alternatively, Nasdaq, NYSE,
and Cboe recommended that, if the Commission seeks to conduct an access
fee pilot, it should first (1) articulate a strong and clear duty of
best execution to ameliorate the conflict of interest between a broker
and its customer, (2) require improved disclosures regarding execution
quality and routing practices to deter potential conflicts, and (3)
adopt its proposed amendments to Regulation ATS \65\ to enhance the
operational transparency of ATSs.\66\
---------------------------------------------------------------------------
\63\ See Letter from Edward T. Tilly, CEO, Cboe, to SEC EMSAC
(January 28, 2016), available at https://www.sec.gov/comments/265-29/26529-51.pdf. Cboe opined that ``broad and arbitrary price
controls'' are a ``drastic measure'' that conflicts with ``the very
concept of a market-based system.'' Id. at 9-10. As another
alternative, one commenter proposed that the Commission require
venues to include ``all-in'' costs in their visible quotes. See
Letter from Michael J. Friedman, General Counsel, Trillium, to Brent
J. Fields, Secretary, Commission (May 14, 2015), available at
https://www.sec.gov/comments/265-29/26529-18.pdf.
\64\ See Joint Exchange Letter, supra note 44, at 2 and 6.
Investors Exchange LLC (``IEX''), disagreed with this suggestion and
pointed out that the Commission ``has been engaged in a holistic
review of market structure at least since the issuance of its Equity
Market Structure Concept Release in 2010,'' which ``has led to
consideration of the Fee Pilot.'' See IEX Letter, supra note 44, at
3. IEX further opined that maker-taker pricing need not be addressed
simultaneously with all other market structure issues, given ``the
amount of fees and rebates involved (over $2.5 billion in 2016), the
inefficiencies that result from hundreds of pricing tiers, and the
proven negative consequences to investors that result from routing
orders to high rebate exchanges.'' Id. at 2-3.
\65\ Securities Exchange Act Release No. 40760 (December 8,
1998), 63 FR 70844 (December 22, 1998).
\66\ See Joint Exchange Letter, supra note 44, at 2-4. But cf.
IEX Letter, supra note 44, at 3 (characterizing this recommendation
as one with ``no logic other than commercial protectionism in
delaying action on fees and rebates'').
---------------------------------------------------------------------------
Investors' Exchange LLC (``IEX'') responded to the comments jointly
submitted by Nasdaq, NYSE, and Cboe by characterizing those exchanges'
arguments as ``part of a familiar playbook to stave off market
reform.'' \67\ While IEX agreed that Nasdaq, NYSE, and Cboe had
identified important areas for consideration, IEX did not support
delaying action on a transaction fee pilot \68\ and disputed whether
the broad review suggested by Nasdaq, NYSE, and Cboe was necessary.\69\
Rather, IEX strongly supported the idea of a transaction fee pilot, but
recommended that any such pilot include a ``no-rebate'' bucket and
apply to inverted exchanges.\70\
---------------------------------------------------------------------------
\67\ See IEX Letter, supra note 44, at 2.
\68\ See id. at 3.
\69\ See id. at 2-3; see also notes 52 and 64 supra.
\70\ See id. at 1-4; see also notes 48-49 supra.
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III. Discussion of the Proposed Pilot
The Commission is proposing to conduct a Transaction Fee Pilot (the
``Pilot'' or ``Transaction Fee Pilot'') for NMS stocks, as described
below. In formulating this proposal, the Commission has taken into
consideration the recommendation of the EMSAC for an access fee pilot,
the views of those submitting comment letters on the EMSAC's proposal,
and the information and research described throughout this release. The
Commission's proposal, in an effort to more broadly test the impact of
transaction fees and rebates, differs from the EMSAC's recommendation
in several respects, as discussed further below.\71\ The Commission
notes that the proposed Pilot is not designed to test the impact of
transaction fees and rebates on all aspects of equities market
structure, including market fragmentation and the proliferation of
complex order types, but rather focuses on order routing behavior,
execution quality, and market quality.
---------------------------------------------------------------------------
\71\ Because the proposed Pilot would apply more broadly to more
types of transaction fees beyond only fees to access a protected
quotation, the Commission therefore is not characterizing the
proposal as an ``Access Fee Pilot.''
---------------------------------------------------------------------------
The following chart summarizes the proposed terms of the Pilot,
which are discussed in more detail below:
[[Page 13015]]
[GRAPHIC] [TIFF OMITTED] TP26MR18.000
A. Applicable Trading Centers
The proposed Pilot, consistent with the EMSAC's recommendation,
would apply solely to the equities exchanges. The fee cap under Rule
610(c), on which the proposed Pilot is largely based, does not apply to
options exchanges.\72\ Specifically, the fee cap under Rule 610(c)
applies to NMS stocks on a per share basis whereas options contracts
are derivatives that represent a number of shares, typically 100 shares
of stock per options contract for a single-stock option, and the
current fee cap under Rule 610(c) is not calibrated to account for that
difference.\73\ Because options and equities are materially different
types of securities, the current fee cap applicable to equities
exchanges does not apply, and cannot readily be applied, to options
exchanges. If options exchanges were to be included in a pilot, the
Commission would first need to create a new type of fee cap to apply to
options exchanges and then consider how that cap would impact current
options exchange fee models, which would introduce considerable
additional complexity.\74\ For these reasons, the Commission is not
proposing to include options exchanges in the proposed Pilot.
---------------------------------------------------------------------------
\72\ See 17 CFR 242.610(c) (addressing ``fees for the execution
of an order . . . in an NMS stock,'' where ``NMS stock'' is defined
as ``any NMS security other than an option'' under 17 CFR
242.600(b)(47)).
\73\ As a result, options exchange fees for the execution of one
options contract typically far exceed the Rule 610(c) cap of
$0.0030. See, e.g., NYSE Arca Options Fee Schedule, available at
https://www.nyse.com/publicdocs/nyse/markets/arca-options/NYSE_Arca_Options_Fee_Schedule.pdf (including fees, as of September
2017, of $0.50 for electronic executions that take liquidity in
Penny Pilot Issues for Broker-Dealer orders).
\74\ See also EMSAC Pilot Recommendation, supra note 28, at 5.
None of the comment letters submitted to the EMSAC advocated for
including options exchanges in an access fee pilot.
---------------------------------------------------------------------------
However, the scope of the proposed Pilot would be broader than both
the EMSAC's recommendation and Rule 610(c), in that it would include
all equities exchanges--including taker-maker exchanges. For example,
the proposed Pilot's fee cap in Test Groups 1 and 2 (detailed below)
would apply the cap to the take fee on a maker-taker exchange and also
would apply the cap to the maker fee on a taker-maker exchange.\75\ The
EMSAC did not recommend including taker-maker exchanges or ATSs in an
access fee pilot because it endeavored to remain consistent with the
current market structure, including the Rule 610(c) access fee cap,
which only caps fees for removing a protected quotation and does not
apply to ATSs.\76\ A number of commenters disagreed with the approach
recommended by the EMSAC.\77\ These commenters asserted that a pilot
would provide more meaningful data if applied more broadly; \78\ one
commenter explained that a broader approach would reduce the
possibility of ``gaming,'' as well as provide more accurate testing of
order flows.\79\ Another commenter believed that liquidity and market
quality on traditional, maker-taker exchanges would suffer unless
taker-maker exchanges and ATSs were included in the proposed Pilot.\80\
Another
[[Page 13016]]
commenter believed that a pilot should include all equities exchanges
and ATSs, but acknowledged that a pilot based on the current parameters
of Rule 610(c) would be difficult to apply to taker-maker exchanges and
ATSs.\81\
---------------------------------------------------------------------------
\75\ See supra note 19 (discussing Rule 610(c) and the taker-
maker model). The proposed fee caps in Test Groups 1 and 2 (detailed
below) would not apply to rebates. For example, the proposed Pilot's
fee cap in Test Group 2 would not apply the cap to the maker rebate
on a maker-taker exchange, nor would it apply the cap to the taker
rebate on a taker-maker exchange.
\76\ See EMSAC Pilot Recommendation, supra note 28, at 5.
\77\ See supra note 49.
\78\ See, e.g., Nasdaq Letter, supra note 44, at 3; IEX Letter,
supra note 44, at 4 (arguing that inverted exchanges should be
included in a pilot because the pilot otherwise would test ``only
how much distortive pricing can be transferred to these venues'').
\79\ See RBC Capital Markets Letter III, supra note 44, at 4.
But cf. infra notes 86-93 and accompanying text (acknowledging the
potential for ``gaming,'' but discussing the Commission's decision
to exclude ATSs from the Pilot).
\80\ See Nasdaq Letter, supra note 44, at 2. But cf. infra notes
89-93 and accompanying text (noting that Nasdaq's fee experiment
results would not necessarily be duplicated in an industry-wide
pilot and explaining that the Pilot could potentially improve the
competitive position of exchanges vis-[agrave]-vis ATSs).
\81\ See Healthy Markets Letter I, supra note 44, at 4; see also
Section III.A infra (discussing the difficulties of applying the
Pilot to ATSs).
---------------------------------------------------------------------------
The Commission believes that the proposed Pilot should be designed
to broadly study the impact of transaction fees and rebates on order
routing behavior, execution quality, and market quality. To achieve a
broader study, the Commission preliminarily believes that including all
equities exchanges, including taker-maker exchanges, in the proposed
Pilot is appropriate. Including all equities exchanges in the proposed
Pilot will ensure that the Pilot will collect data on all equities
markets that are registered national securities exchanges, whose fees
are all subject to the requirements of the Exchange Act and the rule
filing requirements thereunder, thus treating equally all similarly
situated entities.
However, expanding the proposed Pilot to non-exchange trading
centers, such as ATSs, whose fees currently are not subject to Rule
610(c) would have the effect of imposing, in the terms of a pilot, an
entirely new regulatory regime on entities whose fees are not currently
subject to the substantive and process requirements applicable to
exchanges, and that are currently not subject to access fee caps in any
respect. The Commission, therefore, believes that doing so would
introduce a number of complexities that it preliminarily does not
believe are warranted for purposes of this proposed Pilot. In
particular, while equities exchanges charge transaction-based fees,
ATSs, especially ``dark pool'' ATSs that are part of a large broker-
dealer order handling business, may not charge separate transaction-
based fees for executions in their ATSs, and instead might use bundled
pricing that does not associate particular orders with particular
fees.\82\ Consequently, incorporating ATSs into the proposed Pilot
would be substantially more complex if the proposed Pilot required ATSs
to radically change their fee models and renegotiate their pricing
arrangements with their customers in order to assess fees differently
than they do today solely to accommodate the proposed Pilot.\83\
---------------------------------------------------------------------------
\82\ See, e.g., Letter from William P. Neuberger and Andrew F.
Silverman, Managing Directors and Global Co-Heads of Morgan Stanley
Electronic Trading, to Brent J. Fields, Secretary, Commission (May
19, 2016), available at https://www.sec.gov/comments/s7-23-15/s72315-37.pdf (commenting on File No. S7-23-15 concerning regulation
of NMS Stock Alternative Trading Systems and noting that ATS fees
may be bundled with brokerage services).
\83\ See infra Section V.E.1. (noting that the inclusion of ATSs
in the proposed Pilot may not be practical and is likely to
substantially increase the costs of the proposed Pilot).
---------------------------------------------------------------------------
Because the proposed Pilot is designed to study, among other
things, the potential conflicts of interest faced by broker-dealers
when routing orders as a result of transaction fees and rebates, it is
necessary to be able to directly observe the effects of changes in
transaction fees and rebates on their trading. As discussed above, some
have questioned whether a broker-dealer's economic incentive to avoid
transaction-based fees and earn transaction-based rebates impacts its
order routing decisions in a manner that creates a misalignment between
the broker-dealer's economic interests and its obligation to seek the
best execution for its customer's order.\84\ To the extent ATSs do not
charge transaction-based fees, it is not practicable to include them in
a pilot that is structured to test the impact of changes in transaction
fees. Accordingly, the Commission preliminarily believes that excluding
ATSs from the proposed Pilot is appropriate, and that broadly applying
the Pilot to all equities exchanges, regardless of their pricing model,
will allow the proposed Pilot to collect data on the effects of changes
in transaction fees and rebates, which will permit the study of, among
other things, potential conflicts of interest faced by broker-dealers
when routing orders.\85\
---------------------------------------------------------------------------
\84\ See supra notes 21-22 and accompanying text.
\85\ While ATSs would not be subject to the proposed Pilot, data
on ATS market share are available from FINRA, available at https://otctransparency.finra.org, which could provide an indication of
whether routing to ATSs increase or decrease during the proposed
Pilot. See infra Section V.C.1.b. (discussing possible changes in
routing to ATSs during the proposed Pilot).
---------------------------------------------------------------------------
The Commission acknowledges the concerns raised by Nasdaq about
excluding ATSs from the proposed Pilot.\86\ Specifically, Nasdaq noted
that during its fee experiment, when Nasdaq lowered its rebates,
liquidity providers ``immediately moved their quotes to other
exchanges.'' \87\ As a result, Nasdaq stated that unless ATSs are
included in the pilot ``we are likely to find that liquidity and market
quality on exchanges will be fundamentally harmed, ultimately to the
detriment of public investors'' and ``[i]ssuers included in the pilot
would see a diminishment of transparent quotes, widening of quoted
spreads, and an inferior overall trading experience.'' \88\ However, as
discussed above, unlike for liquidity adding orders, Nasdaq found ``no
significant changes in the nature of liquidity taking'' during its fee
experiment.\89\ The Commission believes, as discussed above and as
Nasdaq itself observes, that ``the results for Nasdaq would not
necessarily be duplicated industry-wide if access fees and rebates were
reduced across the board.'' \90\ For example, the fact that some market
participants ``immediately moved their quotes to other exchanges'' may
be because other equities exchanges did not participate in Nasdaq's fee
experiment and those market participants who specifically sought to
quote on an equities exchange, and not an ATS, responded accordingly by
moving some of their activity to equities exchanges that continued to
offer rebates. The Commission notes that the proposed Pilot would not
impact the ability of an equities exchange to maintain a ``protected
quote,'' an advantage that an ATS does not enjoy, and to the extent
that the demand associated with liquidity taking on exchanges remains
stable, it could continue to attract liquidity providers desiring that
protection despite changes to rebates. Further, the Commission notes
that some have argued that high equities exchange maker rebates
necessitate high offsetting taker fees, which may cause some liquidity
taking order flow to migrate to non-exchange trading centers in search
of lower transaction costs.\91\ The proposed Pilot's lower fee caps in
Test Groups 1 and 2, discussed below, could possibly improve the
competitive position of exchanges vis-[agrave]-vis ATSs.\92\
---------------------------------------------------------------------------
\86\ See Nasdaq Letter, supra note 44, at 2.
\87\ Id.
\88\ Id.
\89\ See Nasdaq May Report, supra note 31, at 1.
\90\ Nasdaq May Report, supra note 31, at 1. See also EMSAC
Pilot Recommendation, supra note 28, at 3 (``Limited experiments,
such as the recent Nasdaq pilot, have shown that individual market
experiments do not yield conclusive results about the potential
impact of market-wide policy reform on access fees.'').
\91\ See, e.g., BlackRock Inc. Viewpoint, U.S. Equity Market
Structure: An Investor Perspective, at 7 (April 2014), available at
https://www.blackrock.com/corporate/en-us/literature/whitepaper/viewpoint-us-equity-market-structure-april-2014.pdf (``Reducing the
access fee caps is one solution that would narrow the price
disparity and lessen the impact of cost in routing decisions. This
may also curb the usage of off-exchange venues, such as dark pools
and internalizers, as a major benefit of these trading platforms is
their cost efficiency relative to exchanges.'') (``BlackRock
Viewpoint'').
\92\ See id.
---------------------------------------------------------------------------
Accordingly, the Commission preliminarily believes that it is
appropriate to exclude ATSs from the proposed Pilot, which also is
consistent
[[Page 13017]]
with the EMSAC's recommendation.\93\ The Commission further notes that
the inclusion of ATSs is discussed as an alternative in the economic
analysis below.
---------------------------------------------------------------------------
\93\ See EMSAC Pilot Recommendation, supra note 28, at 5 (``. .
. the Committee does not believe that extending the application of
Rule 610(c) to ATSs would be a beneficial part of the pilot given
that (i) such limitation does not apply today, (ii) ATSs are not
afforded a protected quote, and (iii) ATS transaction fees generally
take the form of an institutional commission.'').
---------------------------------------------------------------------------
The Commission requests comment on the trading centers to be
included in the proposed Pilot. In particular, the Commission solicits
comment on the following. To the extent possible, please provide
specific data, analyses, or studies for support.
1. The proposed Pilot would apply to all equities exchanges. Should
the scope be expanded or reduced? If so, what should the scope be? What
would be the anticipated impacts of the revised scope?
2. Should the Commission include taker-maker equities exchanges in
the proposed Pilot? Why or why not? What would be the anticipated
impact of excluding taker-maker equities exchanges from the proposed
Pilot?
3. Should the proposed Pilot be expanded to include ATSs? Why or
why not? What would be the anticipated impact of including ATSs in the
proposed Pilot? If the proposed Pilot were expanded to include ATSs,
should all ATSs be included or only certain ATSs? What, if any, are the
potential competitive impacts of excluding ATSs from the proposed
Pilot? Would including ATSs in the proposed Pilot have any likely
effect on ATS business models? To what extent do ATSs charge fees that
are not transaction-based? If the proposed Pilot includes ATSs, how
should it apply to ATS fees that are not transaction-based? Also, to
apply the proposed Pilot to ATSs, would the Commission need to impose
other new requirements on ATSs, such as fee disclosure requirements? If
ATSs were to be included in the proposed Pilot, would they be able to
collect and report the proposed data \94\ or would changes be necessary
to accommodate ATSs?
---------------------------------------------------------------------------
\94\ See Section III.E infra for a description of the proposed
data.
---------------------------------------------------------------------------
4. Should the proposed Pilot include options exchanges? Why or why
not? What would be the anticipated impact of including options
exchanges in the proposed Pilot? How would the quality and extent of
the data be impacted by including or excluding options exchanges? What,
if any, are the potential impacts, including competitive impacts, of
excluding options exchanges from the proposed Pilot? What, if any, are
the potential competitive impacts of subjecting options exchanges to
fee caps?
B. Securities
The Commission proposes to include in the Pilot all NMS stocks,
which includes common stocks and Exchange-Traded Products (``ETPs''),
among other securities,\95\ with an initial share price at the time the
pre-Pilot Period commences of at least $2, an unlimited duration or a
duration beyond the end of the post-Pilot Period, and no restrictions
on market capitalization (collectively, ``Pilot Securities'').\96\ As
discussed below, throughout the duration of the proposed Pilot,
including the pre- and post-Pilot Periods, if a Pilot Security in one
of the Test Groups closes below $1, the security would be removed from
the Test Group and would no longer be subject to the Pilot pricing
restrictions.\97\
---------------------------------------------------------------------------
\95\ See 17 CFR 242.600(b)(47) (defining ``NMS stock''). The
Commission notes that although the EMSAC recommended limiting the
access fee pilot to common stocks and ETFs, because Rule 610(c)
applies to all NMS stocks, and not just common stocks and ETPs
(including ETFs), the Commission preliminarily believes it is
appropriate to extend the Pilot to all NMS stocks.
\96\ The EMSAC recommended including ETFs, which are open-end
fund vehicles or unit investment trusts that are registered as
investment companies under the Investment Company Act of 1940. The
Commission's proposal uses the broader term of ETPs, which, in
addition to ETFs, also includes trust or partnership vehicles that
are not registered under the 1940 Act because they do not invest
primarily in securities, as well as Exchange-Traded Notes
(``ETNs''). ETNs are senior debt instruments that pay a return based
on the performance of a reference asset. Unlike the two other
categories of ETPs, ETNs are not pooled vehicles, and they do not
hold an underlying portfolio of securities or other assets. See
generally Securities Exchange Act Release No. 75165 (June 12, 2015),
80 FR 34729, 34731 (June 17, 2015) (Request for Comment on Exchange-
Traded Products). The EMSAC record, including transcripts of EMSAC
meetings, does not contain any substantive discussion of the
distinction between ETFs and ETPs. However, all such securities are
``NMS stocks'' subject to Rule 610(c), and the Commission
preliminarily does not believe there is a meaningful basis to
justify excluding any of them from the proposed Pilot. See 17 CFR
242.600(b)(47) (defining ``NMS stock''). See also proposed Rule
610T(b)(1)(ii) (defining ``Pilot Securities'').
\97\ See also proposed Rule 610T(b)(3)(ii)(D) (concerning the
Pilot Securities Change List and the capture of the date on which
any Pilot Security closes below $1).
---------------------------------------------------------------------------
While the EMSAC did not specify a minimum price threshold, the
Commission is proposing an initial $2 threshold that would apply at the
time of the initial Pilot Securities selection, as was done for the
Tick Size Pilot. On a continuing basis, the price threshold would be
$1, also as was done for the Tick Size Pilot. If a Test Group
security's share price closes below $1 at the end of a trading day
during the proposed Pilot, it would be dropped from the Test Group and
removed from the proposed Pilot.\98\ Under Rule 610(c), stocks with
quotations of less than $1 are subject to a structurally different fee
cap (based on a percentage of the quoted price) than stocks with
quotations of $1 or greater (based on a fixed dollar amount),\99\ and
equities exchanges typically also assess fees differently for stocks
priced less than $1 (i.e., based on a percentage of the price rather
than a fixed fee amount).\100\ Accordingly, the $1 minimum continuing
price threshold recognizes those distinctions and avoids applying the
proposed Pilot's Test Group fixed dollar fee caps to securities below
$1 for which a fixed dollar cap would be incompatible with the current
existing percentage-based standards applicable to those
securities.\101\
---------------------------------------------------------------------------
\98\ See Section III.E.1 infra (discussing the obligations for
primary listing exchanges to maintain Lists of Pilot Securities that
will be updated as necessary prior to the beginning of trading on
each day the U.S. equities markets are open for trading to
communicate changes to Pilot Securities). Stocks in the Control
Group that close below $1 would be removed from the Pilot. As
discussed below, exchanges would be required to record on the Pilot
Securities Change Lists the date that a stock closes below $1.
\99\ While Rule 610(c) imposes a cap of $0.0030 for a protected
quotation of $1.00 or more, the cap is 0.3% when the protected
quotation is less than $1.00. See 17 CFR 242.610(c).
\100\ See, e.g., New York Stock Exchange Price List, available
at https://www.nyse.com/publicdocs/nyse/markets/nyse/NYSE_Price_List.pdf.
\101\ For example, applying Test Group 2's $0.0015 cap to a
security priced at $0.25, which currently would be subject to a fee
cap of $0.00075 under Rule 610(c) (i.e., 0.3% of $0.25) would be
inapposite.
---------------------------------------------------------------------------
The Commission preliminarily believes that an initial minimum $2
per share price threshold at the time of the initial stock selection
captures substantially all NMS stocks while also providing a cushion so
that substantially all of the securities selected for each Test Group
will remain part of their respective Test Groups for the duration of
the proposed Pilot and not be dropped on account of their share price
closing below $1 during the Pilot, as it is uncommon for securities
priced at $2 or more to fall below $1.\102\ This
[[Page 13018]]
initial threshold also will increase the likelihood that the securities
in each Test Group remain the same throughout the entire proposed
Pilot, which will provide consistency in the Test Groups and avoid any
adverse impact caused by changes to the composition of the Test
Groups.\103\
---------------------------------------------------------------------------
\102\ Based on data computed from Center for Research on
Securities Prices (CRSP), during the last five years (2012-2016),
94.4% of publicly traded common stocks and ETPs had a share price
above $2. Of those stocks, only 4.3% dropped below $1 at any point
in that period. In addition, NYSE and Nasdaq can initiate delisting
proceedings if a security trades below $1 for a certain period of
time. See, e.g., NYSE Listed Company Manual Section 802.01C; Nasdaq
Equity Rule 5450(a)(1). See also Cboe BYX Rule 14.7(e)(1) (continued
listing requirement of a minimum bid price of $1 per share); NYSE
Arca Rule 5.2(c) (maintenance requirement of a $5 closing bid price
or $3 closing bid price under the alternate listing requirement).
\103\ Similarly, the requirement that Pilot Securities have an
unlimited duration or a duration beyond the end of the post-Pilot
Period is intended to avoid selecting stocks that would expire and
drop out during the Pilot, which also should provide consistency in
the Test Groups and avoid adverse impacts caused by changes to the
composition of the Test Groups.
---------------------------------------------------------------------------
With respect to market capitalization, the EMSAC recommended
limiting the pilot to large capitalization stocks with a minimum market
capitalization of $3 billion in part to avoid overlap with the Tick
Size Pilot, which commenced on October 3, 2016, and is scheduled to
last for a two-year period until October 3, 2018.\104\ The Commission
notes that the Tick Size Pilot may conclude before the proposed Pilot
commences, but if not, the Commission believes that the strong support
for a pilot in the near term, reflected in the comments summarized
above, as well as the proposed Pilot's design, which, as discussed
below, would protect the integrity of the data in both pilots, weighs
in favor of proceeding expeditiously and not waiting for the Tick Size
Pilot to first expire.\105\
---------------------------------------------------------------------------
\104\ See EMSAC Pilot Recommendation, supra note 28, at 2. See
also EMSAC Transcript, April 26, 2016, supra note 36, at 27:7-15
(reflecting the Subcommittee's desire to run the Tick Size Pilot
simultaneously with the Pilot without either program impacting the
other). See also Investor Alert: Tick Size Pilot Program--What
Investors Need to Know, available at https://www.sec.gov/oiea/investor-alerts-bulletins/ia_ticksize.html (summarizing the Tick
Size Pilot).
\105\ See, e.g., Healthy Markets Letter I, supra note 44, at 5
(noting that ``market participants, experts, and policymakers have
been clamoring for the Commission to adopt a study to address order
routing incentives for years''); RBC Capital Markets Letter III,
supra note 44, at 1 (``[T]he sooner that a pilot can be approved and
commenced, the sooner the Commission will have the benefit of the
pilot's data, and the sooner it can implement needed reforms.'');
IEX Letter, supra note 44, at 4 (``The EMSAC recommendation was
issued more than one year ago, and no one believes that concerns
over maker-taker pricing have become less relevant since then. We
believe that the time to proceed with the pilot is long past
due.'').
---------------------------------------------------------------------------
The Commission preliminarily believes that a more comprehensive
pilot covering all NMS stocks, including those with market
capitalizations below $3 billion, would produce a more meaningful
dataset to facilitate broader analysis of the impact of transaction
fees and rebates across the full spectrum of NMS stocks, including both
large market capitalization companies with potentially substantial
liquidity and trading activity as well as mid- and small capitalization
companies with potentially less trading activity. A broader dataset
will, in turn, permit the Commission and researchers to perform more
in-depth analyses among different segments of the securities market,
which may be more informative than a narrower pilot for evaluations of
the various theories for how transaction fees and rebates may impact
routing behavior, execution quality, and market quality.
For example, some have suggested that transaction rebates are
distortive and unnecessary for liquid large capitalization companies
because, to the extent that those securities already trade at spreads
no wider than the minimum trading increment, the rebate cannot serve to
narrow the quoted spread further and the high fee that offsets the
rebate undermines price transparency because a quote at the same
displayed price on different equities exchanges (with different levels
of fees) less closely reflects the actual net price to trade at any one
exchange.\106\ The limitation or removal of rebates for liquid large
capitalization stocks therefore may be less likely to lead to
deterioration in market quality in those securities.\107\ On the other
hand, some have argued that the beneficial aspects of rebates,
including their potential to contribute to narrowing quoted spreads,
may outweigh their potential for these distortions in mid- and small
capitalization securities, which can face persistent challenges in
attracting liquidity.\108\ Accordingly, transaction rebates may
facilitate the provision of beneficial liquidity for mid- and small
capitalization securities, and may outweigh any negative distortive
impact on broker-dealer incentives, market complexity, or price
transparency.\109\
---------------------------------------------------------------------------
\106\ See, e.g., James Angel, Lawrence Harris & Chester Spatt,
``Equity Trading in the 21st Century,'' Quarterly Journal of Finance
1, (2011), available at https://doi.org/10.1142/S2010139211000067
(noting that ``[t]he obfuscation makes it more difficult for traders
to recognize the true costs of their trading.'') (``Angel, Harris,
and Spatt''); Joe Ratterman, Chief Executive Officer, & Chris
Concannon, President, BATS, ``Open Letter to U.S. Securities
Industry Participants Re: Market Structure Reform Discussion,'' at 1
(January 6, 2015), available at https://cdn.batstrading.com/resources/newsletters/OpenLetter010615.pdf (``BATS Open Letter'')
(arguing that ``[a] substantial reduction in access fees, and their
corresponding rebates, would help remove conflicts or a perception
of conflicts with respect to those highly liquid securities that no
longer require liquidity incentives.'').
\107\ See, e.g., BlackRock Viewpoint, supra note 91, at 7 (``The
value of liquidity and therefore the need for incentives and rebates
is not the same across all stocks. Regulators should review whether
highly liquid stocks require any rebates at all.'').
\108\ See, e.g., BATS Open Letter, supra note 106, at 3 (``. . .
BATS does not believe that highly liquid securities require as great
a rebate as less liquid securities. . . . '').
\109\ See id.
---------------------------------------------------------------------------
To study these possible effects, the Commission believes it is
important to gather data on the impact of fees and rebates on stocks of
all market capitalizations. While it is possible that some observations
from a pilot focused on large capitalization stocks also could be
relevant to mid- and small capitalization stocks, it is likely that
other observations could be inapposite, and without including smaller
stocks in a pilot, the Commission and researchers would lack data to
study the impact on them.
Implementing without undue delay a broad pilot that includes stocks
of all market capitalizations could potentially cause the Pilot to
overlap with the Tick Size Pilot. Although such an overlap may be
unlikely, the proposed Pilot has been designed so that, if necessary,
it could proceed simultaneously with the Tick Size Pilot without
distorting the effects of either pilot.\110\ Specifically, as discussed
further below, in the event of an overlap each Test Group would be
comprised of two subgroups, one of which contains securities included
in the Tick Size Pilot, and one of which does not, enabling the
Commission and researchers to identify and control for any possible
effects of an overlap.\111\ The Commission therefore believes that this
proposed Pilot design would protect the integrity of the data in both
the proposed Pilot and the Tick Size Pilot, to the extent that the
pilots overlap.\112\ Staging one transaction fee pilot for large
capitalization stocks in
[[Page 13019]]
the near term (i.e., that does not overlap with the Tick Size Pilot's
$3 billion market capitalization threshold) and conducting a separate,
subsequent transaction fee pilot for mid- and small capitalization
stocks following the conclusion of the Tick Size Pilot also would
achieve that objective. However, the Commission preliminarily believes
that it is preferable to proceed expeditiously with a broad transaction
fee pilot because the data to be collected from the proposed Pilot, and
the analyses that will follow, will help inform the Commission and the
public on the potential impact of transaction fees and rebates across
all segments of NMS stocks.
---------------------------------------------------------------------------
\110\ See Section III.C infra for additional explanation
regarding how the Pilot would control for the potential overlap with
the Tick Size Pilot. Notably, if the two pilots overlap and the Tick
Size Pilot ends before the proposed Pilot (if adopted) ends, the
Transaction Fee Pilot's proposed Test Groups would not change.
Alternatively, if the two pilots would not overlap at all because
the Tick Size Pilot ends before the proposed Pilot (if adopted)
commences, then the overlap design discussed below would not be
necessary. See Section III.C (noting that each Test Group would
remain constant for the duration of the proposed Pilot with only
limited exceptions).
\111\ The proposed overlap structure, which can be seen in Test
Groups 1(a), 2(a), and 3(a) reflected in the table below titled
``Proposed Pilot Design of the Transaction Fee Pilot for NMS
Stocks,'' is specifically designed to enable comparison between
subgroups within a particular Test Group, as well as across Test
Groups, to identify any differences between those securities that
overlap with the Tick Size Pilot and those that do not.
\112\ In addition, conducting both pilots simultaneously would
increase the amount of data collected while both pilots are active,
which may increase the statistical power of tests of the marginal
impact of transaction fees or rebates or of different tick sizes.
Statistical power refers to the ability for statistical tests to
identify differences across samples when those differences are
indeed significant.
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Further, the Commission preliminarily does not believe that
including smaller capitalization stocks in the proposed Pilot should
disproportionately harm those issuers, even though it may result in the
reduction or elimination of transaction-based rebate incentives \113\
that would otherwise be used to attract posted liquidity in those
stocks on maker-taker exchanges, as discussed above.\114\ While the
proposed Pilot would reduce or eliminate rebate incentives to transact
in those securities on an exchange for certain Test Groups, the
proposed Pilot would not impact the ability of an exchange to maintain
a ``protected quote,'' which may offset the reduced rebate incentive
and continue to serve as an incentive to attract liquidity
providers.\115\ In addition, the proposed Pilot would reduce exchange
transaction fees for certain Test Groups, as discussed below, thereby
making it less expensive--and consequently more attractive--to transact
in those securities on an exchange, which also may offset the reduced
rebate incentive and attract liquidity providers. Accordingly,
including in the proposed Pilot smaller capitalization companies that
are part of the Tick Size Pilot will allow the Commission to collect
data in the near term on the impact of transaction fees and rebates on
NMS stocks, including smaller capitalization stocks, which may trade
differently than large capitalization stocks and thus may be affected
differently by changes to transaction fees and rebates.
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\113\ See supra notes 108-109 and accompanying text for an
explanation of the beneficial aspects of rebates for mid- and small
capitalization securities. See also Section V.C.2.f infra for a
discussion of the potential impact of subjecting small-
capitalization securities to both the Tick Size Pilot and the
proposed Pilot.
\114\ See, e.g., EMSAC Pilot Recommendation, supra note 28, at 1
(noting that there may not be ``any certain or predetermined
outcomes from the pilot, and the net effect of many counterbalancing
factors are not believed to be significantly beneficial or
detrimental to any single group.'').
\115\ The Commission has a variety of mechanisms to address
issues that may arise under the Pilot. See 15 U.S.C. 78mm.
---------------------------------------------------------------------------
The Commission requests comment on the securities to be included in
the proposed Pilot. In particular, the Commission solicits comment on
the following. To the extent possible, please provide specific data,
analyses, or studies for support.
5. Is the proposed sample size of securities for the proposed Pilot
reasonable? If not, what other selection criteria should be used? What
changes should the Commission consider to inclusion or exclusion from
the sample set? Should the Commission include a narrower or broader
universe of securities? In particular, should only common stocks and
ETPs be included in the proposed Pilot and should other types of NMS
stocks, like rights and warrants, be excluded from the Pilot? Why or
why not? Is the proposed selection method for the Pilot reasonable?
6. Is the inclusion of ETPs appropriate? Does the proposed Pilot
design account for relevant distinctions between ETPs and other stocks?
Should the proposed Pilot exclude ETPs that are not ETFs?
7. If the Commission excludes ETPs from the proposed Pilot, what
would be the effects on the quality and extent of data? How would this
impact the study?
8. Should other types of securities be included, such as options?
Should certain securities be excluded? Why or why not?
9. If the timing of the proposed Pilot appears likely to coincide
with the Tick Size Pilot, would it be reasonable to proceed
simultaneously with the proposed Pilot? Why or why not? To the extent
that there is no overlap between the proposed Pilot and the Tick Size
Pilot, the Commission would not retain the overlap design. Do
commenters agree with this approach?
10. Is the initial $2 per share threshold reasonable? Why or why
not? Is there another level at which this threshold should be set?
11. Is the $1 per share minimum continuing price threshold
reasonable? Why or why not? Is there another level at which this
threshold should be set?
12. Should the Commission require a minimum market capitalization?
If so, what should be the threshold? What would be the impacts of this
revised market capitalization threshold?
13. Should the Commission require a minimum trading volume for NMS
stocks in the proposed Pilot?
14. What are the likely effects of the proposed Pilot on issuers
and capital formation? In particular, are different types of issuers
likely to be affected in different ways by the proposed Pilot, and, if
so, how?
15. Should issuers be allowed to opt out of the proposed Pilot or
would allowing issuers to opt out adversely affect the proposed Pilot?
If so, how? What would be the impact on the extent and quality of the
data? For example, could it reduce the representativeness of the
results obtained from the Pilot, particularly if those issuers that opt
out are predominantly one type of issuer (e.g., small or mid-
capitalization issuers)? If issuers were allowed to opt out, should
only certain types of issuers be allowed to opt out, e.g., small-
capitalization stocks or stocks with low levels of liquidity? How
should the Commission consider the benefits and costs on the overall
Pilot? How should the costs to issuers and shareholders be measured?
C. Proposed Pilot Design
Pursuant to proposed Rule 610T(b)(1), the Commission would
designate by notice the initial List of Pilot Securities. That list
would place each NMS stock that meets the initial criteria to be a
Pilot Security into one of the three proposed Test Groups or into the
Control Group. Each of the three Test Groups would be selected through
stratified sampling by market capitalization, share price, and
liquidity.\116\ The composition of each Test Group would remain
constant for the duration of the proposed Pilot, except that the
exchanges would update this information, as described below, to reflect
changes to the composition of the groups caused by mergers, delistings,
or removal from a Test Group due to the share price of a stock closing
below $1.
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\116\ Stratified sampling refers to selecting stocks for each
Test Group and the Control Group according to predefined criteria.
As proposed, the predefined criteria would result in each Test Group
and the Control Group containing a group of stocks that, as a group,
reflect a similar distribution of market capitalization, share
price, and liquidity. For example, when stratifying stocks on the
basis of liquidity, each Test Group and the Control Group would have
a similar distribution of high, moderate, and low liquidity
securities.
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Each Test Group would contain 1,000 NMS stocks, with the remainder
of eligible NMS stocks to be included in the Control Group. If the
proposed Transaction Fee Pilot is adopted and commences before the end
of the Tick Size Pilot, the selection of the common stocks for the
Transaction Fee Pilot Test Groups would take into consideration the
common stocks in the Tick Size Pilot.\117\ If the two pilots would not
[[Page 13020]]
overlap at all because the Tick Size Pilot ends before the proposed
Pilot (if adopted) commences, then the overlap design of dividing each
group into two subgroups would not be necessary and each Test Group
would simply contain 1,000 NMS stocks without subgroups.
---------------------------------------------------------------------------
\117\ Specifically, if the two pilots would overlap, then each
of the proposed Transaction Fee Pilot's three Test Groups would be
divided into two subgroups--one that overlaps with the Tick Size
Pilot and one that does not overlap. The subgroups that overlap with
the Tick Size Pilot would each contain 270 NMS stocks (45 stocks
would be selected from each of the three Tick Size Pilot test groups
(45 stocks x 3 Tick Size Pilot groups = 135 total), with the
remaining 135 stocks coming from the Tick Size Pilot's control
group, for a total of 270 common stocks). The subgroups that do not
overlap with the Tick Size Pilot would each contain 730 NMS stocks:
150 large-capitalization common stocks, 100 small- and mid-
capitalization stocks that do not overlap with the Tick Size Pilot,
260 ETPs, and 220 other NMS stocks. For purposes of the proposed
Pilot, large-capitalization common stocks would be common stocks
with market capitalizations above $3 billion and conversely, small-
and mid-capitalization common stocks would be those with market
capitalizations of $3 billion or less. See Section III.B supra for
discussion regarding including securities with market
capitalizations above, as well as below, $3 billion in the proposed
Pilot. See also proposed Rule 610T(b)(2)(ii)(D) (containing fields
for certain types of NMS stocks that would be included in the
proposed Pilot). The Commission would select stocks from the pool of
securities eligible for the Tick Size Pilot in the same manner as it
selects the stocks that would not overlap with the Tick Size Pilot.
---------------------------------------------------------------------------
The Commission preliminarily believes that this design would be
representative of the size of the overall population of NMS stocks and
would provide sufficient statistical power to identify differences
among the Test Groups with respect to common stocks and ETPs.\118\ This
selection methodology for the Pilot Securities is intended to help
ensure that the proposed Transaction Fee Pilot Test Groups would be
similar in composition to each other and to the Control Group, as well
as to the composition of the Tick Size Pilot test groups. This proposed
design would reduce the likelihood that the proposed Transaction Fee
Pilot would cause data issues for the study of the Tick Size Pilot and
vice versa.\119\
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\118\ See supra note 112 (defining ``statistical power''). The
Commission preliminarily believes that any reduction in the number
of NMS stocks in any particular group could provide less statistical
power and thereby affect the conclusions of the Pilot.
\119\ See Section V.C.1.a.i.A infra. The proposed design ensures
that similar proportions of stocks impacted by the Tick Size Pilot
would be included in each Test Group of the Transaction Fee Pilot,
such that any Tick Size Pilot effects would be uniform across the
proposed Pilot. Researchers would therefore be able to control for
those effects and minimize any data distortion.
---------------------------------------------------------------------------
While the EMSAC limited its recommendation by proposing test groups
modeled on the current regulatory structure reflected in Rule 610(c),
the Commission instead has preliminarily determined to more broadly
study the impact of all transaction fees on order routing behavior,
execution quality, and market quality.\120\ Including all equities
exchanges in the proposed Pilot, even those with taker-maker fee
models, would ensure that the Pilot will collect data on all equities
markets that are registered national securities exchanges, whose fees
are all subject to the requirements of the Exchange Act and the rule
filing requirements thereunder, thus treating equally all similarly
situated entities.
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\120\ The Commission notes that one of the goals of Rule 610(c)
was to support the integrity of the price protection requirement
established by Rule 611 of Regulation NMS. See NMS Adopting Release,
supra note 1, at 37503 (``Finally and most importantly, the fee
limitation of Rule 610 is necessary to support the integrity of the
price protection requirement established by the adopted Order
Protection Rule. In the absence of a fee limitation, some `outlier'
trading centers might take advantage of the requirement to protect
displayed quotations by charging exorbitant fees to those required
to access the outlier's quotations. Rule 610's fee limitation
precludes the initiation of this business practice, which would
compromise the fairness and efficiency of the NMS.'').
---------------------------------------------------------------------------
In addition, as is the case currently under Rule 610(c), the
proposed Pilot would permit equities exchanges to charge varied
transaction fees for Pilot Securities within each Test Group, so long
as such fees comply with the conditions (including the applicable cap)
set for that group. The Commission believes that this would allow
equities exchanges to continue to compete for order flow by adjusting
their access fees within the bounds of the proposed Pilot.
The Commission is proposing to apply the following pricing
restrictions to Test Groups 1, 2, and 3, and the Control Group would
remain subject to the current access fee cap in Rule 610(c):
[[Page 13021]]
[GRAPHIC] [TIFF OMITTED] TP26MR18.001
1. Test Group 1
For Pilot Securities in Test Group 1, equities exchanges could
neither impose, nor permit to be imposed, any fee or fees for the
display of, or execution against, the displayed best bid or offer of
such market in NMS stocks that exceeds or accumulates to more than
$0.0015 per share. The cap in Test Group 1 would apply to transaction
fees assessed on the remover (taker) of liquidity as well as
transaction fees assessed on the provider (maker) of liquidity.\121\
---------------------------------------------------------------------------
\121\ In other words, the fee cap in Test Group 1 would apply
the cap to the take fee charged to the taker on a maker-taker
exchange and also would apply the cap to the make fee charged to the
maker on a taker-maker exchange.
---------------------------------------------------------------------------
The EMSAC recommended three test groups, with fee caps of $0.0020,
$0.0010, and $0.0002, respectively. The Commission also is proposing
three test groups, two with fee caps of $0.0015 and $0.0005, and one
that prohibits rebates and Linked Pricing. The Commission preliminarily
believes that it is appropriate to test an intermediate reduction in
the fee cap. However, because the proposed Pilot includes a no-rebate
bucket, the Commission preliminary believes it is preferable to test a
cap, set at half of the current $0.0030 cap, rather than two
intermediate caps as EMSAC recommended. This approach will allow the
proposed Pilot to test more pronounced changes to the status quo
without increasing the total number of Test Groups. Accordingly, as
discussed below, in addition to the $0.0015 test group, the proposed
Pilot also includes a test group of $0.0005 (as proposed Test Group 2)
as well as a no-rebate bucket (which EMSAC did not recommend).\122\ The
Commission preliminarily believes that having a total of three Test
Groups would allow the proposed Pilot to test several different
scenarios while avoiding overcomplicating the Pilot and would represent
a pilot design with which the exchanges are familiar because it aligns
[[Page 13022]]
with the Tick Size Pilot's three test groups.\123\
---------------------------------------------------------------------------
\122\ See infra Section III.C.2 (discussing proposed Test Group
2) and Section III.C.3 (discussing proposed Test Group 3).
\123\ Maintaining three test groups for the proposed Pilot would
allow it to align closely with the Tick Size Pilot's three test
groups, with which the exchanges are familiar. In addition, the
proposed Test Groups have been designed to account for overlap
between the two pilots and control for the potential that such
overlap could possibly affect the results of the Pilot. See supra
Section III.B.
---------------------------------------------------------------------------
Finally, the EMSAC's proposed first group would have applied its
cap only to fees assessed for removing liquidity, which is consistent
with the application of Rule 610(c)'s fee cap.\124\ As discussed above,
the Commission instead is proposing to apply Test Group 1's cap to fees
assessed for removing or posting liquidity. In other words, as
discussed above, the proposed cap in Test Group 1 would apply to maker-
taker pricing as well as taker-maker pricing, which some comments
submitted in response to the EMSAC's recommendation supported. The
Commission preliminarily believes that applying the cap in Test Group 1
to any fees assessed--including to fees for providing liquidity in a
taker-maker pricing model--would help achieve the purpose of the
proposed Pilot by applying the test conditions broadly to all equities
exchange transaction fees and not just fees for accessing a protected
quotation.
---------------------------------------------------------------------------
\124\ See supra note 76 and accompanying text (noting that the
Rule 610(c) access fee cap only caps fees for removing a protected
quotation).
---------------------------------------------------------------------------
2. Test Group 2
For Pilot Securities in Test Group 2, equities exchanges could
neither impose, nor permit to be imposed, any fee or fees for the
display of, or execution against, the displayed best bid or offer of
such market that exceed or accumulate to more than $0.0005 per share.
The cap in Test Group 2 would apply to transaction fees assessed on the
remover (taker) of liquidity as well as transaction fees assessed on
the provider (maker) of liquidity.\125\
---------------------------------------------------------------------------
\125\ In other words, the fee cap in Test Group 2 would apply
the cap to the take fee charged to the taker on a maker-taker
equities exchange and also would apply the cap to the make fee
charged to the maker on a taker-maker equities exchange.
---------------------------------------------------------------------------
The level of the Commission's proposed cap for Test Group 2 is
intended to introduce a materially lower cap than Test Group 1 to
further reduce the potential distortion created by current levels of
rebates, while continuing to permit, for the preponderance of exchange
transaction volume, the ability of an exchange to maintain its net
profit on a transaction.\126\ Specifically, Test Group 2 would prohibit
exchanges from charging more than $0.0005 on one side of a transaction,
which means an exchange would only have that amount (or less) to fund
the rebate it pays to the other side of the transaction, unless it uses
other sources of revenue to subsidize the rebate. Therefore, the
Commission expects that Test Group 2's $0.0005 cap would significantly
reduce, if not eliminate, the likelihood that an exchange would choose
to offer rebates at their current levels for Pilot Securities in this
group, while nevertheless retaining the ability of exchanges to compete
by offering rebates if they so choose.\127\ Accordingly, Test Group 2
is designed to test the impact of materially lower rebates and fees,
where the potentially distortive effects of rebates, and the fees used
to fund those rebates, is greatly reduced and thereby gather data on
the impact of that reduction on order routing decisions, execution
quality, and market quality.
---------------------------------------------------------------------------
\126\ For example, if an exchange's base fee to take liquidity
is $0.0030 and its base rebate to provide liquidity is $0.0020, the
exchange would earn $0.0010 (net capture rate). The proposed cap for
Test Group 2 would allow such an exchange to maintain its current
net capture rate on such transaction if it charged both sides
$0.0005, though charging both sides of a transaction for Test Group
2 securities would result in a change to the exchange's fee model to
a ``traditional'' pricing structure for those securities. As of
December 2017, Nasdaq's base take fee was $0.0030 and its base
rebate was $0.0020; NYSE's base take fee was $0.0030 and its base
rebate was $0.0014; NYSE Arca's base take fee was $0.0030 and its
base rebate was $0.0020; and CboeBZX's base take fee was $0.0030 and
its base rebate was $0.0020. See, respectively, https://nasdaqtrader.com/Trader.aspx?id=PriceListTrading2 (Nasdaq), https://www.nyse.com/markets/nyse/trading-info/fees (NYSE), https://www.nyse.com/publicdocs/nyse/markets/nyse-arca/NYSE_Arca_Marketplace_Fees.pdf (NYSE Arca), and https://markets.cboe.com/us/equities/membership/fee_schedule/bzx/ (CboeBZX).
\127\ For example, a maker-taker equities exchange might choose
to offer a $0.0004 rebate and charge a fee of $0.0005 for stocks in
Test Group 2. In this way, exchanges could continue to compete with
one another by offering rebates. Compared to current levels of
rebates, which may approach the level of the current $0.0030 cap, a
rebate of $0.0004, by comparison, would be materially lower.
---------------------------------------------------------------------------
3. Test Group 3
For Pilot Securities in Test Group 3, equities exchanges generally
would be prohibited from offering rebates, either for removing or
posting liquidity, and, as discussed further below, from offering a
discount or incentive on transaction fee pricing applicable to removing
(providing) liquidity that is linked to providing (removing) liquidity.
In addition, for the reason discussed below, Test Group 3 would be
unique in that the prohibition on rebates would apply not only to
displayed top-of-book \128\ liquidity, but also would apply to depth-
of-book \129\ and undisplayed liquidity.\130\ In contrast, Test Groups
1 and 2, like the Rule 610(c) fee cap, only cap fees for the execution
of an order against a ``protected quotation,'' which is defined as an
exchange's displayed top-of-book quote.\131\ While rebates would be
prohibited in Test Group 3, transaction fees for securities in Test
Group 3 would remain subject to the current $0.0030 access fee cap in
Rule 610(c) for accessing a protected quotation.\132\
---------------------------------------------------------------------------
\128\ ``Top-of-book'' means the aggregated best bid and best
offer resting on an exchange; in other words, aggregate interest
that represents the highest bid (to buy) and the lowest offer (to
sell). See 17 CFR 242.600(b)(7) (defining ``best bid'' and ``best
offer'').
\129\ ``Depth-of-book'' refers to all resting bids and offers
other than the best bid and best offer; in other words, all orders
to buy at all price levels less aggressive than the highest priced
bid (to buy) or all offers to sell at all price levels less
aggressive than the lowest priced offer (to sell). See 17 CFR
242.600(b)(8) (defining ``bid'' and ``offer'').
\130\ ``Undisplayed'' refers to resting orders that are
``hidden'' and not displayed publicly in the consolidated market
data. See 17 CFR 242.600(b)(13) (defining ``consolidated display''
and (b)(60) (defining ``published bid and published offer''). See
also infra notes 136-139 and accompanying text.
\131\ See 17 CFR 242.600(b)(58) (defining ``protected
quotation'').
\132\ In other words, Test Group 3 would prohibit rebates for
both posting and taking liquidity, but would remain subject to Rule
610(c), which caps fees for taking liquidity. Test Group 3 would not
cap fees for posting liquidity.
---------------------------------------------------------------------------
While the EMSAC considered recommending a zero-rebate bucket, its
recommendation ultimately did not contain such a component.\133\
Several commenters argued, however, that a pilot should either ban
rebates altogether or include a ``no-rebate'' test bucket.\134\ In
light of the current debate surrounding transaction fees and the
particular attention paid to the potential conflict of interest
presented by the payment of transaction-based rebates, the Commission
believes that the proposed Pilot would be substantially more
informative with a no-rebate bucket than a pilot without one, because
the no-rebate bucket would allow the proposed Pilot to gather data to
test the effects of an outright prohibition on transaction-based
rebates. Specifically, if rebates create a conflict of interest for
broker-dealers when they decide where to route an order to post or take
liquidity, and if those conflicts have an effect on order routing
behavior, execution quality, or market quality, then only a complete
prohibition on rebates will allow the Commission to study directly
these conflicts and their effects by observing what would happen in the
absence of rebates. While Test Group 2's low cap should reduce the
[[Page 13023]]
likelihood that a market will offer a material rebate because the cap
would limit the market's ability to offset the rebate by charging a
slightly higher fee to the other side of the transaction, the
possibility exists that rebates would nevertheless continue to be
offered in Test Group 2. The Commission preliminarily believes that to
gather data to study potential conflicts of interest presented by the
payment of rebates and the effects they may have on order routing
behavior, execution quality, and market quality, it is necessary for
the proposed Pilot to establish a test group that entirely prohibits
the payment of transaction-based rebates--which some believe drive
distortions of those items.\135\ At the same time, Test Group 3 would
not further restrict the ability of equities exchanges to charge for
transaction services. By prohibiting all rebates, but not lowering the
existing Rule 610(c) fee cap for Pilot Securities in Test Group 3,
equities exchanges would no longer need to charge transaction fees at
levels priced to offset the rebates they pay, while at the same time
they would retain the ability to charge transaction fees as high as the
current $0.0030 cap. Accordingly, Test Group 3 is intended to test,
within the current regulatory structure, natural equilibrium pricing
for transaction fees in an environment where all rebates are prohibited
and exchanges do not need to charge offsetting transaction fees on the
contra-side to subsidize those rebates.
---------------------------------------------------------------------------
\133\ See EMSAC Pilot Recommendation, supra note 28, at 4. The
EMSAC acknowledged that ``[c]apping inducements is not an existing
component of our market structure.'' Id.
\134\ See supra note 48.
\135\ See, e.g., supra notes 21 (discussing the potential
distortions caused by the conflicts of interest faced by broker-
dealers in light of conflicting economic incentives to earn rebates,
which typically are not passed through by the broker-dealer to its
customers, from the trading centers to which they direct orders for
execution); 23 (discussing potential distortions of unnecessary
market complexity through the proliferation of exchange order types
and new exchanges, the incentive to trade off-exchange to avoid high
fees, and the indirect ability to quote in sub-penny increments on a
net basis); and 106 (discussing potential distortions caused by the
high fees that offset rebates, which can undermine price
transparency because a quote at the same displayed price on
different exchanges (with different fees) does not reflect the
actual net price to trade on any one trading center).
---------------------------------------------------------------------------
As proposed, Test Group 3 would prohibit payment of transaction-
based rebates broadly for both posting and removing liquidity. In this
respect, the Commission notes that Rule 610(c)'s access fee caps do not
currently apply to non-displayed liquidity and depth-of-book quotes,
and exchange fee schedules typically do not impose differing fees based
on those parameters.\136\ The EMSAC noted a theoretical possibility
that lower access fee caps could create an incentive for SROs to begin
charging more to access non-displayed interest or depth-of-book quotes.
However, such differing fees would lead to uncertainty for market
participants that remove liquidity as they would not be able to control
with absolute certainty whether they interact with such interest.\137\
The Commission preliminarily believes that the prospect of market
participant objections to the uncertainty regarding what they would
expect to pay to remove liquidity would make this outcome highly
unlikely.
---------------------------------------------------------------------------
\136\ Three equities exchanges do impose differing fees for
certain orders based on whether the order is displayed or non-
displayed, including: (1) IEX, which incentivizes displayed
liquidity by charging a lower transaction fee of $0.0003 for posting
or taking displayed interest and imposes a higher fee of $0.0009 per
share to post or take non-displayed liquidity; (2) NYSE American,
which incentivizes posting of displayed liquidity and imposes a
standard fee of $0.0002 per share to remove liquidity or post non-
displayed liquidity, though it does offer rebates to eDMMs; and (3)
Cboe EDGA, which encourages non-displayed liquidity by not charging
transaction fees for posting non-displayed liquidity and charging a
low fee to take non-displayed interest, but imposes its standard fee
on posting or removing displayed liquidity. See Investors Exchange
Fee Schedule, available at https://iextrading.com/trading/fees/;
NYSE American Fee Schedule, available at https://www.nyse.com/publicdocs/nyse/markets/nyse-american/NYSE_America_Equities_Price_List.pdf; and Cboe EDGA Exchange Fee
Schedule, available at https://markets.cboe.com/us/equities/membership/fee_schedule/edga/. While these exchanges impose
differing fees depending on the displayed nature of interest, none
pay rebates uniquely for non-displayed orders or depth-of-book
interest, and therefore would not be impacted by the application of
Test Group 3's prohibition on the payment of rebates to all
interest, including non-displayed liquidity and depth-of-book
quotes.
\137\ For example, a liquidity taker's order could interact with
displayed or non-displayed liquidity (or both). If fees differed
between them, market participants would face uncertainty when making
routing decisions over what transaction fees they would incur.
---------------------------------------------------------------------------
However, in Test Group 3, the possibility of an exchange continuing
to offer rebates for non-displayed and depth-of-book quotes, while
eliminating them on displayed interest, could have the potential to
distort the Pilot results to the extent that stocks in Test Group 3
remained subject to the potential conflicts of interest associated with
rebates on non-displayed and depth-of-book quotes.\138\ Accordingly, to
avoid any potential distortion from a narrowly-tailored ``no rebate''
bucket that was subject to exceptions and permitted rebates to continue
to be offered on certain interest, the Commission preliminarily
believes it is necessary to outright prohibit payment of any and all
rebates in Test Group 3, including non-displayed liquidity and depth-
of-book interest. Doing so will permit the Commission to gather data on
a ``no rebate'' environment, thereby allowing the Commission to observe
directly the impact of rebates on order routing behavior, execution
quality, and market quality by observing an environment where
transaction-based rebates are not offered and comparing that to the
control group where rebates continue to be offered. In turn, this data
may inform the Commission about the extent to which rebates offered by
equities markets are compatible with broker-dealers executing their
customers' orders in the best market.\139\
---------------------------------------------------------------------------
\138\ For example, a market participant seeking to take
liquidity may have an incentive to route to a taker-maker market
that offered rebates for executing against non-displayed interest if
the market participant expected to trade both with the full amount
of displayed interest and also with non-displayed interest (and thus
collect a rebate from interacting with the latter). Alternatively, a
liquidity provider could have an incentive to route to a maker-taker
market that offered rebates on non-displayed interest if the
participant was able to use certain order types to ensure that its
order remained non-displayed and executed only as ``poster'' to earn
a rebate. For example, the provider could use a post-only order
instruction to ensure that it never takes liquidity (and thus gets
assessed a fee) and combine that with an instruction to prevent the
order from becoming displayed. In either of these two examples, the
market could continue to offer an incentive to earn a rebate on, or
by interacting with, non-displayed liquidity, which could distort
the results of the proposed Pilot.
\139\ See 15 U.S.C. 78k-1(a)(1)(C)(iv).
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Finally, in addition to prohibiting rebates, Test Group 3 also
would prohibit exchanges from offering a discount or incentive on
transaction fee pricing applicable to removing (providing) liquidity on
the exchange that is linked to providing (removing) liquidity on the
exchange (``Linked Pricing''). For example, for Pilot Securities in
Test Group 3, an exchange would be prohibited from adopting any
discounts on transaction fees to remove (i.e., ``take'') liquidity
where that discount is determined based on the broker-dealer's posted
(i.e., ``make'') volume on the exchange, which would result in the
broker-dealer paying a lower take fee in return for providing a certain
level of liquidity on the exchange. However, as discussed further
below, exchanges would not be prohibited from adopting new rules to
provide non-rebate Linked Pricing to their registered market makers if
the non-rebate discount or incentive is in consideration for meeting
market quality metrics specified in an exchange rule.
Prohibiting Linked Pricing for Test Group 3 is designed to support
the objectives of that Test Group. Specifically, in Test Group 3, the
Commission is seeking to obtain information about what would happen in
the absence of the incentive created by offering rebates and the
potential conflicts of interest they can present, including what would
happen to fee
[[Page 13024]]
levels if they no longer subsidize those rebates. For example, if
``taker'' transaction fees no longer are used to fund ``maker''
rebates, an exchange's taker fee would no longer be subject to that
potential distortion and could be set at an equilibrium level in
response to competition, which could put downward pressure on ``taker''
transaction fees. Accordingly, Test Group 3 is designed to gather data
on the impact of creating an environment where fee levels are not
potentially distorted by rebates and rebates do not influence routing.
In support of creating such an environment for Test Group 3,
exchanges also would be prohibited from introducing new Linked Pricing
models that could possibly perpetuate similar potential distortions
that maker-taker and taker-maker pricing models may impose on
transaction fees. For example, if an exchange adopts Linked Pricing for
Test Group 3 securities, it might offer a discounted transaction fee to
remove liquidity only to those market participants that post a certain
volume on the exchange. In effect, offering Linked Pricing to market
participants in Test Group 3 without first requiring them to meet
market quality metrics designed to benefit the overall market could
continue to potentially distort transaction fee pricing if the fees are
set at a level above their natural equilibrium, within the current
regulatory structure, in order to subsidize the Linked Pricing
incentive, and also could perpetuate the potential conflicts of
interest associated with rebates and order routing.
If, instead of paying rebates, exchanges seek to provide a discount
or incentive on transaction fee pricing applicable to removing
(providing) liquidity that is linked to providing (removing) liquidity,
then equilibrium pricing may not be achieved to the extent that
transaction fees are linked in this way. In turn, perpetuating this
potential distortion could cloud the Pilot data for Test Group 3 if the
Linked Pricing incentive interferes with the proposed Pilot's ability
to isolate and analyze the impacts--on both the maker rebate (fee) and
the taker fee (rebate)--of eliminating rebates in Test Group 3.
Accordingly, the Commission preliminarily believes that prohibiting
exchanges from offering not only rebates but also Linked Pricing in
Test Group 3 is appropriate to maintain the integrity of Test Group 3
and would facilitate analysis of securities in Test Group 3 consistent
with its objective to test the impact of eliminating rebates and the
potential distortions that rebates may cause.
While rebates and Linked Pricing would be prohibited broadly for
Test Group 3, the Commission proposes to permit an exchange to adopt
new rules to provide non-rebate Linked Pricing to its registered market
makers during the proposed Pilot in consideration for meeting market
quality metrics.\140\ Exchanges have an interest in offering incentives
to attract broker-dealers to become registered market makers on the
exchange and commit to meet market making standards specified in
exchange rules so that the exchange can, in turn, use the liquidity
provided by its registered market makers to attract buyers and sellers
to the exchange. The Commission preliminarily believes that permitting
exchanges to adopt new rules to offer Linked Pricing to market makers
for Test Group 3 securities preserves the ability of an exchange to
attract market makers through non-rebate incentives and thereby helps
maintain the baseline framework for registered market makers against
which the effects of the proposed Pilot would be assessed.
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\140\ To adopt Linked Pricing for Pilot Securities in Test Group
3 during the proposed Pilot, an exchange would need to propose new
market making standards in a proposed rule change filing submitted
pursuant to Section 19(b)(2) of the Exchange Act, and also would
need to propose the fee incentive it would provide for meeting those
standards. For example, an exchange may establish a specified
minimum quote size combined with a requirement to be at the national
best bid and offer for a designated percentage of the day. In return
for meeting those continuous quoting requirements, the exchange
might offer its registered market makers a fee discount to remove
liquidity.
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4. Control Group
NMS stocks selected as Pilot Securities that are not placed in one
of the three proposed Test Groups would be placed in the Control Group,
which would be approximately the same size as each of the other three
Test Groups combined and have a similar composition.\141\ Transaction
fees for Pilot Securities in the Control Group would remain subject to
the current Rule 610(c) access fee cap. Consistent with Rule 610(c),
the Control Group would only cap fees for taking (removing) a protected
quotation; it would not apply to fees for posting liquidity or
otherwise cap or prohibit rebates. The Commission preliminarily
believes that having a control group is vital to test the effects of
lower transaction fees in the proposed Test Groups and that a control
group with the current access fee cap would provide an appropriate
baseline for analyzing the effect of the proposed Pilot.
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\141\ NMS stocks (including ETPs) placed in the Control Group
must meet the same selection criteria as those NMS stocks placed in
Test Groups 1, 2, and 3 (e.g., the NMS stock must have a share price
of at least $2 at the time of selection, must maintain a share price
of at least $1 per share to remain in the proposed Pilot, and must
have an unlimited duration or a duration beyond the end of the post-
Pilot Period).
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In sum, the Commission preliminarily believes that the proposed
size and composition of each of the three Test Groups is appropriate to
ensure representativeness of the samples as well as sufficient
statistical power across the Control and three Test Groups and
therefore will produce a robust sample size for analysis that would
allow the Commission and the public to reliably examine, compare, and
assess the effects of differing transaction fees and rebates to inform
future regulatory initiatives in this area. Further, the Commission
preliminarily believes that the proposed Pilot design is appropriately
tailored to account for potential overlap with the Tick Size Pilot.
The Commission requests comment on the design of the proposed
Pilot. In particular, the Commission solicits comment on the following.
To the extent possible, please provide specific data, analyses, or
studies for support.
16. Is the proposed Pilot reasonably designed to evaluate the
effect of transaction fees on order routing behavior, execution
quality, and market quality? Why or why not? Should the Commission
implement an alternative design, and if so, what should it be? What
would be the impacts of the alternative design?
17. Are the $0.0015 and $0.0005 fee cap levels reasonable? Should
the Commission use different caps, for example $0.0002 or $0.0009 for
Test Group 2? Should the Commission use the caps suggested by EMSAC
(i.e., $0.0020, $0.0010, and $0.0002)?
18. Rather than cap fees for Test Groups 1 and 2, should the pilot
instead focus those Test Groups on rebate restrictions? If so, what
restrictions and caps should the Commission impose?
19. Are the proposed restrictions in Test Group 3 on rebates and
Linked Pricing reasonable? Why or why not? Is the proposed language in
Rule 610T(a) clear? For example, is the phrase ``impose, or permit to
be imposed'' sufficiently clear? If not, what alternative language
should the Commission use?
20. If volume or liquidity changed for the Pilot Securities in Test
Group 3, how, if at all, would such changes impact institutional
traders? What volume or liquidity would be impactful? What would be the
impact? For example, if fewer liquidity providers post orders in Test
Group 3 Pilot Securities because there is no rebate for
[[Page 13025]]
them to earn, would institutional traders be more likely to obtain
queue priority? Why or why not?
21. If the Pilot data reveals an impact on quoted prices in Test
Group 3 where, in the absence of rebates, spreads widen for a certain
segment of stocks and ETPs (e.g., those that are moderately liquid),
but not others (e.g., those that are highly liquid or those that are
highly illiquid), how should the Commission evaluate that impact?
22. Is maintaining the current fee cap of $0.0030 reasonable for
Test Group 3, or should the Commission not subject Test Group 3 to the
current fee cap in Rule 610(c)? Why or why not? Should the Commission
cap fees for Test Group 3 using a different amount?
23. For securities in Test Group 3, where rebates would not be
permitted, will competition and market forces produce a market
equilibrium that constrains exchange access fees to levels at or below
today's current pricing? What do commenters consider to be a reasonable
level for exchange transaction fees? If equilibrium transaction fee
pricing is achieved, would such forces obviate the need for a fee cap
at all? Or would a cap on exchange access fees continue to be necessary
to constrain exchange pricing as long as Rule 611 of Regulation NMS
imposes order protection requirements applicable to exchanges with
protected quotations?
24. Should one or more of the Test Groups eliminate protected
quotation status, and thus the order protection requirements of
Regulation NMS, for certain securities? Would doing so provide helpful
insights into order routing? Why or why not?
25. If analysis of the proposed Pilot data were to suggest that
rebates offered by maker-taker exchanges do not affect quoted spreads
or contribute to market quality or execution quality for the most
actively traded NMS stocks, do commenters believe that the minimum
trading increment for those most actively traded stocks should be
reduced, for example, to a half-penny? Why?
26. Would there be a sufficient number of stocks and ETPs in each
Test Group? Why or why not? Or would fewer stocks and ETPs in each Test
Group be capable of providing statistically significant data? If so,
how many stocks and ETPs should be included in each Test Group? How
would the quality and extent of the data be affected?
27. Should the proposed Pilot overlap with the Tick Size Pilot? If
so, does the proposed Pilot design adequately account for potential
overlap with the Tick Size Pilot? Why or why not? What are the
potential impacts of such overlap for equities exchanges, issuers, and
other market participants? How could the Commission better design the
proposed Pilot to deal with any overlap between the two pilots?
28. Should Test Group 3's prohibition on rebates and Linked Pricing
apply to depth-of-book and undisplayed liquidity? Why or why not?
Should the fee caps in the other Test Groups also apply to depth-of-
book and undisplayed liquidity? Why or why not?
29. Should the proposed Pilot include a ``trade-at'' provision that
would restrict price matching of protected quotations? Why or why not?
How would a ``trade-at'' component affect the data generated by the
proposed Pilot? Should the Commission consider an alternative
methodology to evaluate ``trade at''?
30. Is the proposed Pilot design subject to any particular
limitations with respect to achieving the objectives of the Pilot? Of
what kind? How could the proposed Pilot design be improved to prevent
such limitations?
31. Should an equities exchange be able to offer rebates in Test
Group 1 or 2 in excess of the fees it charges to the contra-side of an
execution? For example, should the proposed Pilot prohibit equities
exchanges from offering rebates in excess of $0.0015 in Test Group 1 or
$0.0005 in Test Group 2? Why or why not?
32. Would increasing transparency for customers into broker-dealer
business models and/or trading practices (including, for example,
transparency regarding broker-dealer revenue streams, order routing
practices, or other matters) be a more effective way of addressing
potential broker-dealer conflicts of interest arising from access fees
and rebates?
D. Duration
The Commission is proposing a two-year term for the proposed Pilot,
with an automatic sunset at the end of the first year unless, prior to
that time, the Commission publishes a notice determining that the Pilot
shall continue for up to another year. In addition, as discussed below,
the Commission is proposing a six-month pre-Pilot Period as well as a
six-month post-Pilot Period. The Commission preliminarily believes this
approach will give the Commission flexibility and help ensure its
ability to gather sufficient data to reliably analyze the Pilot's
impact on order routing behavior, execution quality, and market
quality.\142\ The Commission believes that providers and takers of
liquidity need time to gain experience with the different Test Groups,
and the proposed Pilot needs to be long enough to make it economically
worthwhile for market participants to adapt their behavior.\143\ The
proposed Pilot should continue to collect data over a sufficiently long
period of time that is capable of providing a sample that would have
adequate statistical power. The Commission would need to observe
developments during the proposed Pilot to determine whether to sunset
it.
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\142\ See EMSAC Pilot Recommendation, supra note 28, at 2. The
EMSAC recommended an initial three-month phase-in period involving
10 stocks, after which each Test Group would be expanded to include
the remaining securities in each group. See id. at 2. While a phase-
in period would allow markets and market participants to implement
the required fee changes in a staged manner and provide an
opportunity to address unforeseen implementation issues, the
Commission believes that markets and market participants are
accustomed to dealing with transaction fee changes and therefore
should be readily capable of accommodating the terms of the proposed
Pilot with the advance notice provided by the Commission's
rulemaking process. Further, though exchanges would be required to
collect and report certain data, as described below, the proposed
Pilot would not require equities exchanges to make any changes to
any of their trading systems, and therefore the Commission
preliminarily believes a phased implementation schedule would not be
necessary to test changes to outward facing systems.
\143\ See, e.g., EMSAC Transcript, July 8, 2016, available at
https://www.sec.gov/spotlight/emsac/emsac-070816-transcript.txt
(comments of Joe Mecane noting that ``[a]fter further discussion, we
thought two years was the right time frame, because the behavioral
changes that we think that will result from the pilot program will
take . . . some time to filter through the marketplace.'').
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The EMSAC recommended a two-year duration for a pilot, and the
Commission's rule incorporates the possibility of a two-year pilot. The
Commission believes that a two-year duration, with automatic possible
sunset at the end of the first year is preferable because it would
provide flexibility as the data from the Pilot develops. To suspend the
automatic sunset, under proposed Rule 610T(c), the Commission would
publish, no later than thirty days prior to the sunset date, a notice
on its website and in the Federal Register. The Commission could
suspend the sunset, for example, if it believed that additional time
would help ensure that market developments are fully reflected in the
data with sufficient statistical power for analysis. The Commission
also, for example, could suspend the sunset if the Commission believed
that a potentially disruptive event experienced during the first one-
year period counsels in favor of conducting the proposed Pilot for its
full two-year term. Alternatively, the Commission could leave the
sunset in
[[Page 13026]]
place by not publishing a notice if the one-year period was sufficient
to fully reflect market developments and the data collected provides
adequate statistical power to analyze those developments.
While the Commission considered proposing a shorter period, such as
that recommended by Nasdaq,\144\ a shorter duration for the Pilot than
the proposal (i.e., less than one year) may allow short-term or
seasonal events to unduly impact the Pilot data. For example, if the
proposed Pilot were only six months long, the Pilot may or may not
produce a sufficiently broad set of data capable of permitting analysis
into potential conflicts of interest associated with transaction-based
fees and rebates and the effects that changes to those fees and rebates
have on order routing behavior, execution quality, and market quality.
---------------------------------------------------------------------------
\144\ See Nasdaq Letter, supra note 44, at 3.
---------------------------------------------------------------------------
Further, as noted above, Commission is proposing a six-month pre-
Pilot Period as well as a six-month post-Pilot Period. The pre-Pilot
Period is intended to gather current data to help establish a baseline
against which to assess the effects of the proposed Pilot. The post-
Pilot Period is intended to help assess any post-Pilot effects
following the conclusion of the proposed Pilot. For both the pre- and
post-Pilot Periods, the Commission is proposing to require the equities
exchanges to publicly post on their websites the same data they would
be required to publicly post for the proposed Pilot.
Finally, as noted above, Nasdaq, NYSE, and Cboe have recommended
that the Commission, instead of proceeding with a proposal for a
transaction fee pilot, first take final action on two of the
Commission's proposed rulemakings (disclosure of order handling
information and regulation of NMS stock Alternative Trading Systems)
and issue additional guidance on broker-dealers' duty of best
execution.\145\ IEX criticized those recommendations as delaying
tactics motivated by ``commercial protectionism'' from exchanges whose
business models are ``completely reliant on the payment of rebates.''
\146\ The Commission believes that proceeding with a pilot in the near
term would be appropriate as it would complement the Commission's other
market structure initiatives and would gather data to inform the
Commission and the public on the impact of equities transaction fees
and whether additional regulatory action is needed or appropriate.
---------------------------------------------------------------------------
\145\ See Joint Exchange Letter, supra note 44, at 2-4.
\146\ See IEX Letter, supra note 44, at 2-3.
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The Commission requests comment on the proposed duration for the
proposed Pilot, including the pre- and post-Pilot Periods. In
particular, the Commission solicits comment on the following. To the
extent possible, please provide specific data, analyses, or studies for
support.
33. Is the proposed duration long enough for the proposed Pilot to
generate data to analyze the impact of transaction fees? If not, what
time period should be selected? Is a different time period preferable?
34. Is the provision for an automatic sunset at the end of the
first year unless, prior to that time, the Commission publishes a
notice determining that the Pilot shall continue for up to another
year, reasonable? What factors or conditions would support continuing
the proposed Pilot beyond one year?
35. The EMSAC recommended an initial three-month phase-in period
involving a limited number of stocks, after which each test group would
be expanded to include the remaining securities in each group. As
proposed, the Pilot would not include a phase-in period. Would such a
period be useful? Why or why not?
36. Are the proposed pre-Pilot and post-Pilot terms sufficient?
Should the Commission select different lengths, or gather different
data during those periods? Specifically, instead of a 6 month pre- and
post-Pilot Period, should the Commission adopt a 3, 4, or 5 month pre-
Pilot and post-Pilot Period? Which, if any, of those is the shortest
period that would provide sufficient statistical power for analysis,
particularly with respect to ETPs? If the Commission requires at least
6 months of pre-Pilot Period data, to what extent could the exchanges
access and use historical data to populate the required pre-Pilot data
described in Section E below? For example, could exchanges access 3
months of historical data such that the pre-Pilot Period could be
structured as a 3 month pre-Pilot Period combined with 3 months of
historical data immediately preceding that period, for a total of 6
months of cumulative pre-Pilot data? How much time would be necessary
for the exchanges to compile 6 months of historical data?
37. Do commenters believe that the Commission should, before taking
action on the proposed Pilot, first take final action on the
Commission's proposed rulemakings concerning disclosure of order
handling information and regulation of NMS stock Alternative Trading
Systems, and/or issue new guidance on broker-dealers' duty of best
execution, or do commenters agree that proceeding with the proposed
Pilot in the near term would complement the Commission's other market
structure initiatives?
E. Data
The Commission preliminarily believes that the following data
should be collected and made publicly available as described below in
order to facilitate the Commission's ability to assess the impact of
the proposed Pilot and, as discussed below, promote transparency about
the Pilot Securities as well as basic information about equities
exchange fees and changes to those fees during the Pilot.\147\
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\147\ The data and information that is to be made publicly
available would be records of the equities exchanges and
accordingly, would be subject to the recordkeeping requirements of
Rule 17a-1 under the Exchange Act. See 17 CFR 240.17a-1.
---------------------------------------------------------------------------
1. Pilot Securities Exchange Lists and Pilot Securities Change Lists
As discussed above, proposed Rule 610T(b)(1) would require the
Commission to publish on its website a notice containing the initial
List of Pilot Securities,\148\ which would identify the securities in
the proposed Pilot and assign each of them to a designated Test Group
(or the Control Group). While proposed Rule 610T does not impose a
deadline by which this notice must be published, the Commission
preliminarily expects that it would publish this notice approximately
one month prior to the start of the Pilot Period.
---------------------------------------------------------------------------
\148\ Proposed Rule 610T(b)(1)(ii) would define ``Pilot
Securities'' for purposes of Rule 610T as the NMS stocks designated
by the Commission on the initial List of Pilot Securities pursuant
to paragraph (b)(1)(i) of Rule 610T and any successors to such NMS
stocks. At the time of selection by the Commission, an NMS stock
would be included in the Pilot only if it has an unlimited duration
or a duration beyond the end of the post-Pilot Period and a minimum
initial share price of at least $2. If the share price of a Pilot
Security in one of the Test Groups closes below $1 at the end of a
trading day, it would be removed from the Test Group and would no
longer be subject to the pricing restrictions set forth in (a)(1)-
(3) of proposed Rule 610T.
---------------------------------------------------------------------------
To account for corporate changes during the proposed Pilot that
affect the Pilot Securities, such as name changes, mergers, or
dissolutions, proposed paragraph (b) of Rule 610T provides a process to
update and publicly disseminate information about changes to the List
of Pilot Securities. As discussed and defined further below, the
Commission is proposing to require each equities primary listing
exchange \149\ to publicly post on its
[[Page 13027]]
website downloadable files containing a list of its primary listed
securities included in the proposed Pilot as well as an updated
cumulative list of all changes to any Pilot Security for which it
serves as the primary listing market.\150\ An exchange would have to
include this information on its website as downloadable files that are
freely and persistently available and easily accessible by the general
public.\151\ In addition, the information must be presented in a manner
that facilitates access by machines without encumbrance by user name,
password, or other access constraints \152\ and the files and
information therein could not be subject to any usage restrictions,
such as restrictions on access, retrieval, distribution, and reuse.
Requiring the exchanges to make this information freely and publicly
available with completely unencumbered access would facilitate the
ability of any person to use the information to conduct and make public
research and analyses consistent with the purposes of this Pilot.
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\149\ Proposed Rule 610T(b)(1)(iii) would define ``primary
listing exchange'' for purposes of Rule 610T as a national
securities exchange on which an NMS stock is listed. If an NMS stock
is listed on more than one national securities exchange, proposed
Rule 610T(b)(1)(iii) provides that the national securities exchange
upon which the NMS stock has been listed the longest shall be the
primary listing exchange.
\150\ The Commission notes that the primary listing exchanges
maintain public web pages containing similar lists with respect to
the Tick Size Pilot. The lists for NYSE and NYSE American listed
stocks are available on the NYSE website, available at https://www.nyse.com/tick-pilot. The lists for Nasdaq listed stocks are
available on the Nasdaq website, available at https://www.nasdaqtrader.com/Trader.aspx?id=TickPilot.
\151\ ``Persistently available'' means that through the end of
the required five-year post-Pilot retention period, all data from
the Pilot would need to be continually available on each exchange's
website. ``Accessible'' means that the Pilot data posted by each
exchange must be able to be indexed by third party query
applications and easily found on each exchange's website.
\152\ Common access constraints may include: ``CAPTCHA'' (i.e.,
``Completely Automated Public Turing Test to Tell Computer and
Humans Apart'') constraints, which commonly provide a challenge-
response test to determine whether or not the user is human and
block access to the information by machines; user name and password
access requirements; user registration requirements; and limitations
on downloads.
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The Commission believes that it is important to maintain an updated
list of Pilot Securities so that market participants can know with
certainty throughout the duration of the proposed Pilot the Test Group
and/or Control Group assignments for all Pilot Securities, thereby
avoiding any confusion over how the proposed Pilot affects the stocks
in which market participants trade. Further, it is important to
maintain detailed information on historical changes to Pilot Securities
and their associated Test Groups and/or Control Group in order to
ensure that market participants, researchers, and the Commission have
ready access to definitive information on the Pilot Securities, which
will assist the Commission and researchers in analyzing pilot data and
assessing and accounting for changes to any Pilot Securities during the
duration of the Pilot, including the post-Pilot Period. The Commission
believes that the primary listing exchanges, as defined in proposed
Rule 610T(b)(1)(iii), are in the best position to provide this
information because they oversee their listed issuers and have rules in
place that require listed issuers to report corporate change
information to them.\153\ Accordingly, the primary listing exchanges
are made aware of changes relevant to the proposed Pilot for the
securities listed on their markets, and therefore are in the best
position to disseminate this information by making it publicly
available on their websites.
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\153\ See NYSE Listed Company Manual Rule 204.18 (Name Change)
(requiring listed issuers to provide notice to NYSE of intended name
changes 20 days in advance of the date set for mailing the
shareholders' proxy materials dealing with the matter); Nasdaq
Listing Rule 5250(e)(3)(A) (Record Keeping Change) (requiring listed
issuers to provide notice to Nasdaq of name changes no later than 10
days after the change); NYSE Arca Listed Company Manual Rule 5.3-
E(i)(1)(i)(D) (Financial Reports and Related Notices) (requiring
listed issuers to notify the Exchange of changes in company name);
Cboe BZX Exchange, Inc. Rule 14.6(e)(3)(A) (Record Keeping Change)
(requiring listed issuers to provide notice to the Exchange of name
changes no later than 10 days after the change); NYSE American
Company Guide Sec. 930 (Change of Name) (requiring listed issuers to
provide advance notice to the Exchange of intended name changes);
IEX Rule 14.207(e)(3)(A) (Record Keeping Change) (requiring listed
issuers to provide notice to the Exchange of name changes no later
than 10 days after the change).
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a. Pilot Securities Exchange Lists
As discussed further below, prior to the beginning of trading on
the first day of the Pilot Period, proposed Rule 610T(b)(2)(i) would
require each national securities exchange that is a primary listing
exchange for equities to publicly post on its website downloadable
files containing a list, in pipe-delimited ASCII format,\154\ of all
securities included in the proposed Pilot for which the equities
exchange serves as the primary listing exchange (the ``Pilot Securities
Exchange List''). Proposed Rule 610T(b)(2)(ii) specifies the required
fields for the Pilot Securities Exchange Lists, which are: Ticker
symbol, security name, primary listing exchange, security type (common
stock, ETP, preferred stock, warrant, closed-end fund, structured
product, ADR, or other), Test Group (1, 2, 3 or Control Group), as well
as the date the entry was last updated. The Commission preliminarily
believes that this list would contain the essential identifying
information necessary to inform market participants and the public
about the securities included in the proposed Pilot, and the security
type field would permit the Commission and researchers to easily
identify subsets of NMS stocks so they can be analyzed separately.
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\154\ The Commission understands that the equities exchanges and
market participants have experience utilizing this common file
format and will be able to create and make use of lists of Pilot
Securities in pipe-delimited ASCII format (also referred to as a
``text'' file) without difficulty. In particular, the exchanges use
this format in the Tick Size Pilot. See Tick Size Pilot Data
Collection Securities Files, available at https://www.finra.org/industry/oats/tick-size-pilot-data-collection-securities-files
(noting that ``[t]he Pilot Securities files are pipe-delimited .txt
files.'').
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Each primary listing exchange would be responsible for keeping
current its Pilot Securities Exchange List to reflect any changes.
Specifically, proposed Rule 610T(b)(2)(i) would require the primary
listing exchanges to maintain and update their Pilot Security Exchange
List, as necessary, prior to the beginning of trading on each business
day that the U.S. equities markets are open for trading (also referred
to herein as a ``trading day''). If a change occurs that alters any of
the fields required by Rule 610T(b)(2)(ii), such as ticker symbol,
security name, or Test Group, the primary listing exchange for that
Pilot Security must update its Pilot Securities Exchange List prior to
the beginning of trading on the first trading day for which such change
is effective. The primary listing exchanges would be required to
continue to update the Pilot Securities Exchange Lists, as necessary,
through to the conclusion of the post-Pilot Period.
b. Pilot Securities Change Lists
In addition, proposed Rule 610T(b)(3)(i) would require each
equities primary listing exchange to maintain and publicly post on its
website downloadable files containing a list, in pipe-delimited ASCII
format, of each separate change applicable to any Pilot Securities for
which that primary listing exchange serves or, during the course of the
Pilot, has served as the primary listing exchange (the ``Pilot
Securities Change List''). Proposed Rule 610T(b)(3)(ii) specifies the
required fields for the Pilot Securities Change List, which, in
addition to the fields required for the Pilot Securities Exchange List,
are: New ticker symbol (if applicable); new security name (if
applicable); deleted date (if applicable); date the security closed
below $1 (if applicable); effective date of the change; and reason for
change. The list would be updated by the primary listing exchange
[[Page 13028]]
to include all changes since the inception of the Pilot, for the Pilot
Securities listed on the exchange. Examples of changes that would
appear on this list include name changes, ticker symbol changes,
mergers, delistings, or removal from a Test Group due to the share
price of a stock closing below $1. Each primary listing exchange would
be required to update and post its Pilot Securities Change List prior
to the beginning of trading on each trading day the U.S. equities
markets are open for trading and keep it current through the end of the
post-Pilot Period. The Pilot Securities Change List is designed to
serve as a cumulative list that provides ready access to all changes to
Pilot Securities listed on a particular equities exchange that have
occurred subsequent to a primary listing exchange posting its initial
Pilot Securities Exchange List on its website.
The Commission believes that market participants and the public
would benefit from having access to accurate and up-to-date information
on the Pilot Securities and their classification in a particular Test
Group or Control Group during the Pilot. As it is possible that changes
to some of the Pilot Securities may occur over the course of the
proposed Pilot, information about those changes could be useful to
broker-dealers and other market participants when making routing and
execution decisions. Accordingly, the Commission believes it is
important for there to be ready access to relevant updates that impact
the Pilot Securities Exchange Lists. Because the primary listing
exchanges currently track corporate actions that affect their listed
issuers, the Commission believes they are best positioned to
disseminate information about those changes as they apply to the
securities listed on their markets by making it publicly available on
their respective websites.
Further, having access to an updated, cumulative list reflecting
all changes to the Pilot Securities will assist the Commission and
researchers in analyzing the Pilot data. In particular, ready public
access to the record of changes to Pilot Securities and any changes to
the applicable Test Groups (or Control Group) that will be reflected in
the Pilot Securities Change Lists would provide transparency to the
public that the Commission and researchers could use when assessing
Pilot data, and also could be useful to market participants, including
broker-dealers that route customer orders, to assess and review changes
to the lists of Pilot Securities over time.
The primary listing exchanges would be required, pursuant to
Proposed Rule 610T(b), to keep the lists publicly posted on their
websites beginning with the Pilot Period through the post-Pilot Period,
as defined in Proposed Rule 610T(c), and for five years after the end
of the post-Pilot Period.\155\ The lists must be easily accessible and
freely and persistently available in downloadable form and shall not be
subject to any restrictions, including, but not limited to, access or
usage restrictions.\156\ The Commission preliminarily believes that
continued public availability of this information (particularly the
Pilot Securities Change Lists) during the Pilot and for several years
thereafter would be useful for market participants and the public,
including academic researchers, because it would permit changes to the
Pilot Securities to be easily tracked for comparison and analysis of
the impact of those changes. Accordingly, the Commission expects that
researchers would be interested in tracking changes to Pilot Securities
over the course of the proposed Pilot, and that there likely would be
continued interest in the Pilot Securities Exchange Lists and Pilot
Securities Change Lists for some time following the conclusion of the
proposed Pilot as researchers analyze the Pilot data and conduct their
own independent assessments. Accordingly, the Commission believes that
the public would benefit from the primary listing exchanges maintaining
the lists they prepare pursuant to Proposed Rule 610T(b) on their
public websites for a period of not less than five years following the
conclusion of the post-Pilot Period because it would provide for ready
access by the public to perform analyses which are likely to occur for
several years following the conclusion of the proposed Pilot.
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\155\ While both the Pilot Securities Exchange Lists and the
Pilot Securities Change Lists would be required to be publicly
posted for five years after the end of the post-Pilot Period, the
primary listing exchanges would not be required to continue to
update such lists following the conclusion of the post-Pilot Period.
\156\ See proposed Rule 610T(b)(4).
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The Commission requests comment on the initial List of Pilot
Securities, the Pilot Securities Exchange List, and the Pilot
Securities Change List, including the contents thereof and method of
publication of that information. In particular, the Commission solicits
comment on the following. To the extent possible, please provide
specific data, analyses, or studies for support.
38. Should the Commission determine the initial Pilot Securities
and specify the Test Group (or Control Group) assignments at a
specified minimum period of time prior to the start of the Pilot
Period? Is one month sufficient, or should the notice be published
closer to the start of the Pilot, such as two weeks prior? For
comparison, the Commission selected securities for the Regulation SHO
Pilot approximately ten months before the start of the Regulation SHO
Pilot and the SROs assigned stocks to test groups one month before the
start of the Tick Size Pilot. Does the experience with either of those
pilots provide any insight into when the Commission should determine
the initial Pilot Securities for the proposed Pilot? Or is it necessary
for the Commission to select the Pilot Securities and assign them to
groups prior to the pre-Pilot Period? Please explain. What, if any,
operational or implementation complexities did market participants
experience in relation to the timing of the assignment of securities in
the previous pilots?
39. Do the procedures specified in Proposed Rule 610T(b) offer an
appropriate framework for maintaining the list of securities for the
proposed Transaction Fee Pilot? If not, what other arrangement should
the Commission implement? If yes, do any adjustments need to be made to
accommodate the proposed Pilot?
40. Is a pipe-delimited ASCII format the appropriate file format
for maintaining the Pilot Securities Exchange Lists and Pilot
Securities Change Lists? If not, what other format is more appropriate?
Why is such alternate format preferred over a pipe-delimited ASCII
format?
41. How long should the rule require that exchanges maintain
historical versions of the lists on their public websites for public
availability? Is five years appropriate, or should they be maintained
on public websites for more or less time?
42. Should the Commission require, in order to make the data more
accessible and usable from the exchanges' websites, more automated
access to the data? For example, should the Commission require an
exchange to make the data publicly available on its website via RSS
Feeds \157\ and/or APIs? \158\ If so, which would be more preferable
and why? What would be the benefits? What costs would be associated
with such functionality?
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\157\ RSS Feeds (Really Simple Syndication) are a type of web
feed which allows users to access updates to online content in a
standardized, computer-readable format.
\158\ API (Application Programming Interface) is a set of
clearly defined methods of communication between various software
components which can make it easier to develop a computer program by
providing all the building blocks, which are then put together by
programmers.
---------------------------------------------------------------------------
43. Are the requirements for posting the required information on a
public
[[Page 13029]]
website, including the prohibition on access and usage restrictions,
appropriate to ensure that the public and the Commission will have
unfettered access to and be able to use effectively, without
encumbrance, the information? Should the Commission impose any other
requirements for posting the information? How would usage restrictions
impact the ability to analyze the data?
2. Exchange Transaction Fee Summary
To facilitate analysis of the Pilot data, including the effect that
transaction-based fees and rebates have on order routing behavior,
execution quality, and market quality, the Commission preliminarily
believes that it is necessary for the exchanges to post publicly
standardized select data on transaction fees and rebates, including
changes to fees and rebates for NMS stocks in each Test Group and the
Control Group, as well as average and median realized fees measured
monthly.\159\ While the proposed Pilot would cap access fees
differently in Test Groups 1 and 2, exchanges would have the freedom to
set fees at any level below those caps. The Exchange Transaction Fee
Summary should facilitate comparison of each exchange's basic fee
structure across all equities exchanges and help identify, in summary
fashion, changes to those fees.
---------------------------------------------------------------------------
\159\ Some fee changes would not be affected by the proposed
Pilot. For example, fixed membership fees, regulatory fees, and
connectivity fees that are not assessed by transaction would not
fall within the scope of the proposed Pilot.
---------------------------------------------------------------------------
Because changes to transaction fees and rebates currently are
described using Form 19b-4 in individual proposed rule change filings
that can be fairly complex, the Commission believes that compiling a
dataset of fees and fee changes from Form 19b-4 fee filings alone for
use in studying the proposed Pilot would be cumbersome and labor
intensive for researchers and may discourage research. Further, the
Commission recognizes that exchanges may use unique terminology to
describe their fees, which could make comparison of fees across
exchanges difficult for a researcher, so the proposal provides for
standardized terms to ease comparison across exchanges. The Commission
is proposing that exchanges publicly post on their websites in a
downloadable file information on their fees (including rebates) and fee
changes during the proposed Pilot (including for the pre-Pilot and
post-Pilot Periods) using an eXtensible Markup Language (XML) schema to
be published on the Commission's website.\160\ Similar to the Pilot
Securities lists, discussed above, exchanges would be required to
publicly post downloadable files containing the Exchange Transaction
Fee Summary, which would require exchanges to post that information on
a website that is freely and persistently available and easily
accessible by the general public. Further, exchanges would be required
to present the information in a manner that facilitates access by
machines without encumbrance, and the files and information therein
could not be subject to any usage restrictions such as restrictions on
access, retrieval, distribution, and reuse.
---------------------------------------------------------------------------
\160\ See proposed Rule 610T(e). The Commission's schema is a
set of custom XML tags and XML restrictions designed by the
Commission to reflect the proposed disclosures in Rule 610T(e). This
requirement does not impact a national securities exchange's
obligation pursuant to Section 19(b) of the Exchange Act and Rule
19b-4 thereunder concerning filing a notice of proposed rule change
to effectuate a change in transaction fees and updating the schedule
of fees posted on the exchange's website to reflect such changes.
See supra note 10 (discussing the procedural and substantive
requirements applicable to Form 19b-4 fee filings).
---------------------------------------------------------------------------
The Commission preliminarily believes that the unencumbered
availability of this data using the proposed XML schema would enhance
data quality and facilitate analysis on the correlation between changes
in transaction fees and changes in order routing behavior, execution
quality, and market quality.\161\ There are other alternatives to the
Commission proposed XML schema such as CSV and JSON formats. The CSV
format provides the most compact file size among the alternatives;
however, it also is the least flexible as it cannot convey the same
complexity as XML or JSON or directly incorporate validation rules
thereby potentially resulting in lower data quality. The JSON format
provides a file size similar to XML and can convey complex data
structures; however, XML is more widely supported by software packages
and applications that are likely to be used by researchers and the
public. Therefore, the use of JSON would likely impact reuse and
analysis of the data provided by the proposed Pilot.
---------------------------------------------------------------------------
\161\ See supra Section V.E.4 (discussing the proposed XML
format and the limits of using ASCII format for the Exchange
Transaction Fee Summary).
---------------------------------------------------------------------------
Accordingly, for the duration of the proposed Pilot, including the
pre- and post-Pilot Periods, proposed Rule 610T(e) would require each
national securities exchange that trades NMS stocks to compile and post
publicly a dataset using an XML schema to be published on the
Commission's website that contains specified information on its fees
and fee changes that affect each Test Group and the Control Group.\162\
Proposed Rule 610T(e) would require the equities exchanges to post on
their websites an initial Exchange Transaction Fee Summary before the
start of trading on the first day of the pre-Pilot Period and would
require the information to be updated through the close of trading on
the last day of the post-Pilot Period. During the Pilot, including the
pre- and post-Pilot Periods, proposed Rule 610T(e) would require the
equities exchanges to update the Exchange Transaction Fee Summary on a
monthly basis within 10 business days of the first day of each calendar
month to reflect data collected for the prior month.\163\
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\162\ Because the Pilot Securities would be subject to a
continuing minimum share price of $1, the proposed dataset would
only contain information on fees applicable to transactions in
securities with a per share price $1 or more.
\163\ Using the month of December 2018 as an example, on or
before January 16, 2019, an exchange would be required to post the
required information based on data it collected during the previous
month of December.
---------------------------------------------------------------------------
Proposed Rule 610T(e) specifies the information to be provided in
the Exchange Transaction Fee Summary. Specifically, the proposed
summary of information relating to fees and fee changes would identify
the self-regulatory organization by name (``SRO Name'') so that the
Commission and researchers would be able to link each exchange to its
reported fees.
Further, the proposed summary would identify the applicable Pilot
Test Group (i.e., 1, 2, 3, or Control), and it would identify the
``Base'' take fee (rebate), the ``Base'' make rebate (fee), the ``Top
Tier'' take fee (rebate), and the ``Top Tier'' make rebate (fee), as
applicable.\164\ For purposes of the Exchange Transaction Fee
Summaries, ``Base'' fee/rebate refers to the standard amount assessed
or rebate offered before any applicable discounts, tiers, caps, or
other incentives are applied. Further, ``Top Tier'' fee/rebate refers
to the fee assessed or rebate offered after all applicable discounts,
tiers, caps, or other incentives are applied. The Commission
preliminarily believes that the Base and Top Tier information would be
useful to the Commission and researchers as an approximation of the fee
and rebate information that broker-dealers incorporate into their
routing decisions, which will be useful in interpreting the Pilot data.
For example, the information can be used to help identify and track
changes in fees and rebates and the timing of those changes, which can
be compared to changes in
[[Page 13030]]
order routing behavior, execution quality, and market quality.
---------------------------------------------------------------------------
\164\ See proposed Rule 610T(e).
---------------------------------------------------------------------------
In addition, proposed Rule 610T(e) would require exchanges to
calculate the ``average'' and ``median'' per share fees and rebates,
which the exchange would compute as the monthly realized average or
median per-share fee paid or rebate received by participants on the
exchange during the prior calendar month.\165\ The summary would
require average and median per share fees and rebates to be reported
separately for each participant category (discussed below), Test Group,
displayed/non-displayed, and top/depth of book. The Commission believes
the inclusion of average and median figures is helpful as the Base and
Top Tier figures are general values and not all broker-dealers would
pay or receive those amounts. While Base and Top Tier would be useful
to facilitate comparison across exchanges, the addition of average and
median figures will provide additional insight into the typical fees
paid or rebates received by broker-dealers at each exchange. In turn,
this information would be useful to the Commission and researchers
analyzing how fees and rebates affect order routing decisions. While
the average realized fee or rebate paid/earned by market participants
on an exchange can be skewed by extremely large or small values, the
median figures would not be affected by such values because median
figures reflect the midpoint of values with an equal probability of
falling above or below that amount. The Commission preliminarily
believes that both the average and median realized fee/rebate figures
would be helpful to the Commission and researchers in analyzing Pilot
data and the Commission and researchers could incorporate both figures
into their analyses, in addition to the Base and Top Tier data,
discussed above. For example, a researcher could examine average
realized per share fees and rebates when exploring order routing
decisions with respect to particular exchanges across broker-dealers.
Likewise, a researcher could consider median realized per share fees
and rebates when examining the routing decisions of an individual
broker-dealer faced with a choice of multiple competing exchanges each
with different fees and rebates.
---------------------------------------------------------------------------
\165\ Using the month of December 2018 as an example, on or
before January 16, 2019, an exchange would be required to post,
among other data, the Base and Top Tier fees and rebates in effect
on December 1, any changes to the Base or Top Tier fees and rebates
during the month of December, and the average and median per-share
fees paid or rebates received by participants on the exchange for
the month of December.
---------------------------------------------------------------------------
Further, the proposed summary of information would require equities
exchanges to report ``record type'' and ``participant type.''
Specifically, ``record type'' would be an indicator variable to enable
the Commission and researchers to quickly identify whether the fee
being reported is an average/median figure, or whether it is the Base
or Top Tier fee. Knowing whether a particular fee or rebate is either
the Base/Top Tier or average/median would help the Commission and
researchers avoid confusion and provide important clarity in the
dataset to facilitate use of the information. The ``participant type''
also would be an indicator variable and would require exchanges to
separately report fees applicable to registered market makers or other
market participants. To the extent that an exchange maintains different
fees and rebates (e.g., different Base or Top Tier fees or rebates) for
market makers compared to other market participants, this indicator
variable would allow the Commission and researchers to separately
analyze market makers from other participants, which could be valuable
when considering the effects of fees and rebates on execution quality
and market quality as they impact the incentives on market makers to
provide liquidity on specific exchanges. In addition, proposed Rule
610T(e) would require the equities exchanges to identify whether the
fees and rebates reported in the summary apply to displayed or non-
displayed liquidity or both displayed and non-displayed liquidity and
whether they apply to the top or depth of book or to both top and depth
of book.\166\ These indicator variables will help the Commission and
researchers identify whether the fees/rebates reported in the dataset
differ between displayed and non-displayed orders or between top and
depth of book. If an exchange does differentiate between those
conditions in the assessment of fees or provision or rebates, then it
would so indicate. Inclusion of this information in the summary of
information will allow the Commission and researchers to observe
differences at exchanges in fees/rebates to provide or remove
liquidity, which could be used to evaluate order routing, execution
quality, and market quality.
---------------------------------------------------------------------------
\166\ See proposed Rule 610T(e)(5) and (6).
---------------------------------------------------------------------------
Finally, proposed Rule 610T(e)(7) and (8) would require the
equities exchanges to identify the effective date for each fee (rebate)
reported and, when applicable, the end date after which the fee
(rebate) was no longer in effect.\167\ In addition, equities exchanges
would report a separate indicator variable to identify when they change
fees other than on the first trading day of a calendar month.\168\
Specifically, this variable would distinguish whether the average and
median values reported in the dataset represent the pre-change average/
median or post-change average/median. For example, if an exchange
changes its fees on the 15th of a month, then the average and median
fees reported before the 15th would be marked to distinguish them from
the average and median fees reported on and after the 15th of the
month. This indicator variable would be necessary to allow the
Commission and researchers to line up the time of reported fee
information with observed order routing and execution and market
quality information in the Pilot data.
---------------------------------------------------------------------------
\167\ See proposed Rule 610T(e).
\168\ See proposed Rule 610T(e)(10).
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As proposed, each equities exchange would be required to post
publicly on its website an initial Exchange Transaction Fee Summary
containing the information prescribed in Rule 610T(e) using an XML
schema to be published on the Commission's website prior to the start
of trading on the first day of the pre-Pilot Period. Pursuant to
proposed Rule 610T(e), each equities exchange thereafter would be
required to publicly post an updated dataset within 10 business days of
the first day of each calendar month and would continue to do so until
the end of the post-Pilot Period.
The Commission recognizes that including only the Base fee
(rebate), Top Tier fee (rebate), average fee (rebate), and median fee
(rebate) ignores significant variation in exchange fee schedules.
However, including more granular information on specific individual
fees and rebates would complicate the data, could be difficult to
standardize across exchanges, and could potentially make the Pilot more
expensive than proposed. Further, the Commission preliminarily believes
that the proposed data fields provide sufficient information to assess
the range of fees and the variation across exchanges in fees and
facilitate analysis of the Pilot data, which otherwise would be
challenging to summarize independently and accurately in light of the
considerable complexity of exchange fee schedules noted above.
Reporting the fee information separately for registered market makers,
as a group, and other market participants, as a group, will allow the
Commission to separate out the class of market makers to see how
changes to fees and rebates
[[Page 13031]]
impact the fulfillment of their responsibility to provide liquidity.
The Commission believes each exchange should summarize this information
because each exchange is best able to understand its own fees and
unique fee terminology.
The Commission requests comment on the proposed Exchange
Transaction Fee Summary proposed in connection with the proposed Pilot.
In particular, the Commission solicits comment on the following. To the
extent possible, please provide specific data, analyses, or studies for
support.
44. Is the proposed Exchange Transaction Fee Summary useful to
permit comparisons to be made across exchanges? If not, what type of
information should be captured?
45. Is having an Exchange Transaction Fee Summary that uses the
same XML schema useful when examining the Pilot data? Should the
proposed Pilot use an alternative schema? If so, how should the schema
change and what would be the impacts of such changes?
46. Are the data elements included in the Commission's proposed
schema reasonable? Should any changes be made and what would be the
impacts of such changes?
47. What information in the Exchange Transaction Fee Summary is
most useful? What additional information in the Exchange Transaction
Fee Summary would be helpful? Is any information in the proposed
Exchange Transaction Fee Summary not useful and, if so, should it be
removed? Please explain. If so, should alternative information be
selected instead?
48. Are both ``average'' and ``median'' fees useful metrics, or
should other measures be selected and what would be the impacts of
those alternatives?
49. The proposal would require separate reporting for registered
market makers, as a group, and other market participants, as a group.
Should further groups be identified? Would customers or professionals
be appropriate groups on which to collect fee data?
50. Are monthly updates to the Exchange Transaction Fee Summary
appropriate, or should the Commission require the exchanges to post
this information more or less frequently and why?
51. Should the Commission require exchanges to report in the
Exchange Transaction Fee Summary additional information on proposed
rule change filings that change transaction fees reported in the
Exchange Transaction Fee Summary? If so, what information should be
reported? Would the file number of the exchange's proposed rule change
be sufficient, or should links be captured that reference the filing?
52. Should the Commission require the exchanges to specially
identify any filing submitted to the Commission that establishes or
changes a fee, rebate, or other charge imposed by the Exchange? What
form should this identification take? Should the title of the filing
require a special identifier? Should the exchanges be required to post
a consolidated list of such filings on a publicly available website?
53. Should the Commission require submission of the Exchange
Transaction Fee Summaries through EDGAR instead of requiring exchanges
to post that information on each individual equities exchange's
website? If so, how would this affect the exchange filers and how would
it affect users of the Exchange Transaction Fee Summaries?
3. Order Routing Data
To provide public data to facilitate an examination of the impact
of the proposed Pilot on order routing behavior, execution quality, and
market quality, the Commission proposes in Rule 610T(d) to require
throughout the duration of the Pilot, as well as during the pre-Pilot
Period and the post-Pilot Period, that each national securities
exchange that trades NMS stocks prepare a downloadable file containing
sets of order routing data in accordance with the specifications
proposed in Rule 610T(d), for the prior month.\169\ The data would be
in pipe-delimited ASCII format, and be publicly posted on each
exchange's website no later than the last day of the following month.
As proposed for the lists of Pilot Securities and the Exchange
Transaction Fee Summary, exchanges would be required to publicly post
downloadable files containing this order routing information. Exchanges
would be required to post this information on a website that is freely
and persistently available and easily accessible by the general public.
In addition, exchanges would be required to present this information in
a manner that facilitates access by machines without encumbrance by
user name, password, or access constraints and the files and
information therein could not be subject to any usage restrictions,
such as restrictions on retrieval, distribution, and reuse. Requiring
the exchanges to post and maintain this order routing information with
free and completely unencumbered access would facilitate research and
analyses consistent with the purposes of this Pilot.
---------------------------------------------------------------------------
\169\ For example, by September 30th, an exchange would be
required to post the required information containing order routing
data for August.
---------------------------------------------------------------------------
For the pre-Pilot Period, order routing datasets would include each
NMS stock. For the Pilot Period and post-Pilot Period, order routing
datasets would include each Pilot Security. As discussed below, the
order routing data must contain aggregated and anonymized broker-dealer
order routing information.\170\ Also as discussed below, the required
datasets would contain order routing information for liquidity-
providing orders and liquidity-taking orders that is aggregated by day,
by security, by exchange, and by broker-dealer on an anonymous
basis.\171\ If the equities exchanges are reporting to the Consolidated
Audit Trail (``CAT'') at the time the proposed Pilot commences, they
would be able to compile the required order routing data by utilizing
the data they collect pursuant to the national market system plan
(``CAT NMS Plan'').\172\
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\170\ See supra note 154 describing the reasons for requiring
data to be provided in pipe-delimited ASCII format. Aggregated order
routing data would consist of the cumulative (total) number of
orders or shares of orders received, cancelled, executed, or routed
to another trading center by order type and order size, accumulated
by day, by security, by anonymized broker-dealer, and by exchange,
as detailed in proposed Rule 610T(d).
\171\ See proposed Rule 610T(d).
\172\ See Securities Exchange Act Release No. 79318 (November
15, 2016), 81 FR 84696 (November 23, 2016) (Joint Industry Plan;
Order Approving the National Market System Plan Governing the
Consolidated Audit Trail) and CAT NMS Plan Sections 6.3-6.4.
---------------------------------------------------------------------------
As described in paragraph (d) to proposed Rule 610T, the Commission
is proposing that each equities exchange would be required to post
publicly two datasets on their websites in pipe-delimited ASCII format.
One dataset would include daily volume statistics of liquidity-
providing orders by security and by anonymized broker-dealer,
separating held and not-held orders. The second dataset would include
daily volume statistics of liquidity-taking orders by security and by
anonymized broker-dealer, separating held and not-held orders. The
specific fields for each dataset as set forth in paragraph (d) to
proposed Rule 610T are: Code identifying the equities exchange; eight-
digit code identifying the date of the calendar day of trading; ticker
symbol; unique, anonymized broker-dealer identification code; order
type code; order size codes; number of orders received; cumulative
number of shares of orders received; cumulative number of shares of
orders cancelled prior to execution; cumulative number of shares of
orders executed at receiving market center; and cumulative number of
shares of orders routed to another
[[Page 13032]]
execution venue. In addition, the liquidity-providing orders dataset
also would require a field specifying the cumulative number of shares
executed within certain specified time periods after order receipt by
the exchange.
The Commission preliminarily believes that the publicly-available
order routing data should provide researchers and the Commission with
data necessary to serve the Commission's regulatory purposes in
studying the potential conflicts of interest associated with
transaction-based fees and rebates and the effects that changes to
those fees and rebates have on order routing behavior, execution
quality, and market quality. In particular, the order routing data
would contain information about the exchanges to which broker-dealers
route orders, which will permit a closer examination of how broker-
dealers may change their order routing behavior in response to changes
in fees and rebates at each exchange. Because broker-dealers may
respond differently to differing levels of fees and rebates and the
inherent conflicts of interest fees and rebates present when making
routing decisions, the Commission preliminarily believes that data at
the broker-dealer level would facilitate statistical analysis of those
differences and the conflicts of interest associated with them. The
order routing data also would provide valuable information on order
type, order size, time to execution, and information on order
execution, cancellation, and reroutes, all of which should facilitate
analysis into routing behavior in response to differing levels of fees
and rebates. In addition, this same information would also facilitate
an analysis of the effects that changes to transaction-based fees and
rebates may have on execution and market quality by permitting a close
examination of matters such as liquidity concentration and competition
for order flow among equities exchanges in different fee and rebate
environments.
Further, proposed Rule 610T(d) would require during the course of
the Pilot, as well as during the pre-Pilot Period and the post-Pilot
Period, each national securities exchange that trades NMS stocks to
publicly post on its website downloadable files in pipe-delimited ASCII
format no later than the last day of each month, sets of order routing
data in accordance with the specifications in proposed Rule 610T(d),
for the prior month. The Commission is proposing to require the
equities exchanges to collect and make available pre-Pilot and post-
Pilot data, which would provide necessary benchmark information against
which the Commission could assess the impact of the Pilot, and the
impact of the Pilot on potential conflicts of interest associated with
transaction-based fees and rebates and the effects that changes to
those fees and rebates have on order routing behavior, execution
quality, and market quality.
In preparing the datasets, the equities exchanges would be required
to anonymize information relating to the identity of individual broker-
dealers before making the order routing datasets publicly available. In
order to track and aggregate the activity of particular broker-dealers
across multiple exchanges, the Commission preliminarily believes it is
important for each equities exchange to utilize the same anonymized
code to identify a broker-dealer.
Using a single code to identify each unique broker-dealer will
allow the Commission and researchers to easily combine the separate
exchange data files and sort them by unique broker-dealers, therein
allowing the Commission and researchers to identify aggregate activity
at the broker-dealer level across all equities exchanges. In turn, the
ability to combine and sort all exchange data by anonymized codes
representing individual broker-dealers would be useful for capturing
and analyzing individual broker-dealer order routing decisions.
In order to facilitate the anonymization of the identities of
broker-dealers, representatives of the Commission would provide to the
equities exchanges, on a confidential basis, a Broker-Dealer
Anonymization Key. The Broker-Dealer Anonymization Key would provide
the anonymization code for every broker-dealer whose order routing data
would be included in the order routing datasets. The Commission
preliminarily believes that it would be most efficient to create the
Broker-Dealer Anonymization Key by assigning a unique, anonymized
identification code to each central registration depository identifier
(``CRD''), which are identifiers of registered broker-dealers known and
regularly used by both the Commission and the equities exchanges.\173\
To protect the identities of broker-dealers, the Broker-Dealer
Anonymization Key would only be accessible to representatives of the
Commission and the equities exchanges.
---------------------------------------------------------------------------
\173\ CRD numbers are captured in the Commission's EDGAR system.
---------------------------------------------------------------------------
Because proposed Rule 610T would state that the identities of
broker-dealers contained in the Order Routing Datasets, and the Broker-
Dealer Anonymization Key, are regulatory information, exchanges would
not be permitted to access or use that information for any commercial
or non-regulatory purpose. The Commission considers the identities of
broker-dealers in the proposed Order Routing Data, as well as the
Broker-Dealer Anonymization Key, to be regulatory information produced
for the specific and exclusive purpose of conducting the Pilot, which
ultimately will inform the Commission's (as well as exchanges' and the
public's) regulatory consideration of the impact of transaction fees on
equities market structure. The Commission believes it would be
inconsistent with an exchange's rules to use the Broker-Dealer
Anonymization Key and the Order Routing Data to benefit its business
operations.\174\ Accordingly, Rule 610T would expressly prohibit
exchanges from accessing or using the Pilot's order routing data for
commercial or non-regulatory purposes for reasons including, but not
limited to, setting transaction fees, marketing, business development,
and customer outreach.\175\
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\174\ Section 19(g)(1) of the Act requires, in part, that every
self-regulatory organization comply with its own rules. See 15
U.S.C. 78s(g)(1). Corporate governance documents for equities
exchange holding companies contain rules that restrict the use of
information related to an equities exchange's self-regulatory
function and do not permit use or disclosure of such information for
commercial purposes. See By-laws of Nasdaq, Inc., Article XII,
Section 12.1(b), available at https://nasdaq.cchwallstreet.com/NASDAQTools/PlatformViewer.asp?selectednode=chp_1_1_3_6&manual=%2Fnasdaq%2Fmain%2Fnasdaq-corporg%2F; Eighth Amended Bylaws of Intercontinental
Exchange Inc., Article VIII, Section 8.1, available at https://ir.theice.com/governance/governance-and-charter-documents; Cboe
Global Markets, Inc. and Subsidiaries Code of Business Conduct and
Ethics, available at https://ir.cboe.com/~/media/Files/C/CBOE-IR-V2/
corporate-governance/code-of-business-conduct-and-ethics-27-oct-
2017-adopted.pdf; Bylaws of IEX Group, Inc., Article VII, Section
35, available at https://iextrading.com/docs/governance/IEXG%20Bylaws.pdf; Bylaws of CHX Holdings, Inc., Article III,
Section 2, available at https://www.chx.com/chx-holdings/bylaws/.
\175\ For example, proposed Rule 610T would prohibit an
exchange's non-regulatory personnel from having access to the
Broker-Dealer Anonymization Key or using that information to
decipher the order routing data posted by competing exchanges to
learn the identities of those exchanges' biggest customers and then
solicit those customers for itself.
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The Commission believes that the public availability of the order
routing datasets would be useful to allow market participants,
researchers, and others to conduct independent analyses of the proposed
Pilot and its impacts. To the extent these analyses reveal useful
information about the potential conflicts of interest associated with
transaction-based fees and rebates and the effects that changes to
those fees and rebates have on order routing behavior,
[[Page 13033]]
execution quality, and market quality, the Commission believes it would
use the resulting analyses for its own regulatory purposes to further
inform itself and the public on whether further regulatory action in
this area is appropriate.
The Commission requests comment on the order routing-related data
to be included in the proposed Pilot. In particular, the Commission
solicits comment on the following. To the extent possible, please
provide specific data, analyses, or studies for support.
54. What data are necessary to facilitate analysis of the potential
conflicts of interest associated with transaction-based fees and
rebates and the effects that changes to those fees and rebates have on
order routing behavior, execution quality, and market quality? Are
there any specific measures that commenters believe would facilitate
that analysis? For example, do commenters agree with the Joint Exchange
Letter's recommendation to study the impact on broker-dealers and their
customers of savings realized from lowered exchange transaction fees?
\176\ If so, what data would facilitate that analysis?
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\176\ See Joint Exchange Letter, supra note 44, at 4.
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55. If the CAT repository was operational, as specified in the CAT
NMS Plan, would the Commission have sufficient data to evaluate order
routing behavior without this Pilot? Does the lack of the CAT affect
the costs necessary for this proposed Pilot, and if so how?
56. Should the Commission require the order routing datasets to
separate out held and not-held orders? Why or why not? Are there
certain shared characteristics regarding the handling of not-held
orders, such as a greater likelihood to be directed to particular
exchanges, that would be beneficial to assess? Please explain.
57. Should the Commission also require exchanges to separately
report non-anonymized datasets to the Commission? If so, what
additional data would be useful?
58. Will anonymizing the proposed data sufficiently protect
confidential information? Are any further safeguards necessary? Why or
why not? Are there other groupings that would be preferable, like
aggregation units? If not, what benefits or limitations would there be
in analyzing the data if the entirety of a broker-dealer's order
routing activity is aggregated?
59. Should the Commission use CRD numbers to create the Broker-
Dealer Anonymization Key? If not, why not? Are there other accessible
identifying markers that the Commission should use to create the
Broker-Dealer Anonymization Key?
60. Would the equities exchanges be able to work with
representatives of the Commission to validate the Broker-Dealer
Anonymization Key? What additional information, if any, would be
helpful for constructing the Broker-Dealer Anonymization Key?
61. Should the Commission require the data to be aggregated at a
broader level, such as by groups of similar market participants? Why or
why not? Is there a need to aggregate the activity of any market
participants to protect their identity? For example, should the
identity of large market participants be aggregated? What unique risks
are posed for market participants whose trading constitutes a material
portion of overall volume? Why would anonymization of a particular
broker-dealer not be sufficient for purposes of concealing the broker-
dealer's identity? What impact would aggregating order routing data at
a broader level have on the ability for the Commission and researchers
to assess the impact of the proposed Pilot on order routing behavior,
execution quality, and market quality?
62. Should the Commission collect pre-Pilot and post-Pilot data?
For how long of a period should it collect such data? Is six months
sufficient for each period? Should it collect such data for a shorter
period, like three or four months, or a longer period? Should the
lengths of the pre-Pilot and post-Pilot Periods be equal, or could the
Commission instead collect pre-Pilot data for three months and post-
Pilot data for six months and still have adequate statistical power to
evaluate the results of the Pilot?
63. Should the Commission require the equities exchanges to both
report the datasets to the Commission and make them publicly available
on their websites? Is it sufficient to require the equities exchanges
to make the datasets publicly available on their websites? To what
extent would that reduce the burdens associated with complying with
this provision?
F. Implementation Period
The Commission proposes to notify the public through a notice of
the start and end dates of the pre-Pilot, Pilot, and post-Pilot
Periods, including any suspension of the one-year sunset of the Pilot
Period.\177\ The start date of the pre-Pilot Period would be one month
from the date the Commission issues the notice, and the end date of the
pre-Pilot Period would be six months from the pre-Pilot Period's start
date. Accordingly, the Pilot, which is to start at the conclusion of
the pre-Pilot Period, would begin seven months from the date the
Commission issues the notice. The post-Pilot Period would start at the
conclusion of the Pilot and would end six months from the post-Pilot
Period's start date.
---------------------------------------------------------------------------
\177\ See proposed Rule 610T(c). The notice would be posted on
the Commission's website.
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The Commission recognizes that the proposed Pilot will require the
equities exchanges to make certain changes to their fees to conform to
the proposed terms of the Pilot and will require market participants to
adjust their order routing systems in response to those changes.
However, because equities exchanges frequently adjust their transaction
fees and rebates with little, if any, advance notice to the public
through immediately effective Form 19b-4 fee filings, the Commission
preliminarily believes that broker-dealers currently are well situated
to promptly accommodate any changes required to implement and comply
with the proposed Pilot.\178\ Such adjustments may be more time-
consuming than usual for broker-dealers and other market participants
insofar as additional programming may be needed to account for the
different fee and rebate levels across three Test Groups and one
Control Group of proposed Pilot.\179\ Nevertheless, the Commission
preliminarily believes that broker-dealers and other market
participants will have time and notice before the onset of the proposed
Pilot, including the proposed six-month pre-Pilot Period, to begin to
make updates to their trading strategies and execution algorithms,
including planning for the prohibition on rebates and Linked Pricing in
Test Group 3 and the fact that different stocks will be subject to
different fee caps during the proposed Pilot. Thereafter, when the
initial List of Pilot Securities is released and the exchanges submit
their fee filings, broker-dealers could input those data points into
their trading systems in the same manner they do today when exchanges
change their fees.
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\178\ SROs are required to file with the Commission copies of
any proposed rule or any proposed rule change. 15 U.S.C. 78s(b)(1).
Any proposed rule change establishing or changing a due, fee, or
other charge imposed by the self-regulatory organization takes
effect upon filing with the Commission. 15 U.S.C. 78s(b)(3)(A)(ii).
\179\ See Section V.C.2.b. infra for a discussion of the costs
that broker-dealers and other market participants may face in
complying with the Pilot.
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In addition, for the duration of the proposed Pilot and during the
pre- and post-Pilot Periods, each equities exchange would be required,
pursuant
[[Page 13034]]
to proposed Rule 610T(d), to post publicly on its website specified
datasets of order routing data aggregated by date, ticker symbol,
national securities exchange, and broker-dealer. Separately, the
equities exchanges also would be required to make changes to
accommodate the requirements of proposed Rule 610T(b) concerning
publication of information about the Pilot Securities and proposed Rule
610T(e) concerning reports of data on their fees and fee changes.
To provide time for the equities exchanges to make these changes,
the Commission proposes that the start date of the pre-Pilot Period
would be one month from the date it issues the notice pursuant to
proposed Rule 610T(c). Accordingly, the start date of the Pilot Period,
which would begin at the conclusion of the pre-Pilot Period, would be
no earlier than seven months from the date of the Commission's notice
issued pursuant to proposed Rule 610T(c). The Commission preliminarily
believes that this process should provide sufficient advance notice to
the equities exchanges to allow them time to put in place mechanisms to
comply with the proposed requirements of Rule 610T and sufficient
advance notice to broker-dealers and other market participants to allow
them time to put in place any necessary changes to their order routing
programming.\180\
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\180\ See id.
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The Commission requests comment on the proposed implementation
period for the proposed Pilot. Specifically, the Commission solicits
comment on the following. To the extent possible, please provide
specific data, analyses, or studies for support.
64. Is a one month period following the Commission's notice prior
to the start of the pre-Pilot Period sufficient time to allow the
equities exchanges to prepare for the pre-Pilot Period requirements?
Why or why not?
65. Is a minimum seven month period following the Commission's
notice sufficient time to allow affected entities to establish and test
mechanisms to comply with the proposed requirements? Why or why not?
Should there be an alternate implementation period, such as twelve
months? If so, what would be preferable and why?
66. What technological or systems changes are necessary to
effectuate the proposed Pilot? How would any such changes differ from
changes required to accommodate routine changes in exchange fee
schedules?
IV. Paperwork Reduction Act
Certain provisions of the proposed rule contain ``collection of
information requirements'' within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').\181\ The Commission is submitting
these collections of information to the Office of Management and Budget
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR
1320.11.\182\ An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless the agency
displays a currently valid control number.\183\ The title of the new
collection of information is ``Transaction Fee Pilot Data.''
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\181\ 44 U.S.C. 3501 et seq.
\182\ 44 U.S.C. 3507; 5 CFR 1320.11.
\183\ 5 CFR 1320.11(l).
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A. Summary of Collection of Information
1. Pilot Securities Exchange Lists and Pilot Securities Change Lists
As discussed above, the Commission would publish by notice the
initial List of Pilot Securities, which would identify the securities
in the proposed Pilot and assign each of them to a designated Test
Group (or the Control Group).
Prior to the start of trading on the first day of the Pilot Period,
proposed Rule 610T(b)(2)(i) would require each national securities
equities exchange that is a primary listing exchange for NMS stocks to
publicly post on its website a Pilot Securities Exchange List, in pipe-
delimited ASCII format, of all Pilot Securities for which it serves as
the primary listing exchange. Proposed Rule 610T(b)(2)(i) also would
require each primary listing exchange to maintain and update this list
as necessary prior to the beginning of each trading day. In addition,
proposed Rule 610T(b)(3)(i) would require that prior to the beginning
of trading each trading day, a primary listing exchange would be
required to publicly post on its website a Pilot Securities Change
List, in pipe-delimited ASCII format, that cumulatively lists each
separate change to Pilot Securities for which it serves or has served
as the primary listing exchange. A proposed set of specifications for
both lists is set forth in paragraph (b) of the proposed Rule.
The two lists are intended to make available information about
updates to the List of Pilot Securities as well as detailed information
on changes to Pilot Securities and their associated Test Groups.
Proposed Rule 610T(b) would require both the Pilot Securities Exchange
List and the Pilot Securities Change List to be made publicly available
on equities exchange websites and remain posted for the duration of the
proposed Pilot, including the post-Pilot Period, as well as for five
years thereafter. Because the primary listing exchanges oversee their
listed issuers and have rules in place that require listed issuers to
report corporate change information to them, the primary listing
exchanges are in the best position to make this information publicly
available.
Further, the Commission believes that market participants and the
public would benefit from having access to accurate and up-to-date
information on the Pilot Securities and their respective test groups
during the proposed Pilot. In addition, access to cumulative detailed
information about changes to the Pilot Securities will assist the
Commission in analyzing order routing data and will provide information
to the public that researchers could use when assessing Pilot data.
2. Exchange Transaction Fee Summary
As discussed above, the Commission preliminarily believes that it
is necessary for the exchanges to post publicly standardized and
simplified data on the equities exchanges' transaction fees and
rebates, and the effective date for any change thereto, individually
for each Test Group and the Control Group.\184\ This information is
intended to facilitate analysis of the Pilot's order routing data,
including the effect that transaction-based fees and rebates have on
order routing behavior, execution quality, and market quality.
---------------------------------------------------------------------------
\184\ Some fee changes would not impact or relate to the
proposed Pilot. For example, fixed membership fees, regulatory fees,
and connectivity fees that are not assessed by transaction would not
fall within the scope of the proposed Pilot.
---------------------------------------------------------------------------
In particular, while the proposed Pilot would cap access fees
differently in Test Groups 1 and 2, exchanges would have the freedom to
set fees at any level below those caps. Changes to equities exchange
transaction fees and rebates currently are described in individual
proposed rule change filings, so compiling a summary of information
relating to fees and fee changes from Form 19b-4 fee filings for use in
studying the proposed Pilot would be cumbersome and labor intensive for
researchers and could discourage research and analysis of the Pilot
data. Further, because equities exchanges may use unique terminology to
describe their fees, the Commission preliminarily believes the equities
exchanges are in the best position to provide this information and
ensure that information
[[Page 13035]]
relating to their fees and rebates and changes thereto is correctly
reflected using a common XML schema to facilitate comparison. In
addition, only equities exchanges have access to information necessary
to compute monthly realized average and median transaction fees, which
would be required fields.
Proposed Rule 610T(e) specifies the proposed fields to be required,
including information on Base fees and rebates, Top Tier fees and
rebates, and monthly realized average and median fees paid or rebates
given, each reported separately for registered market makers and other
participants.\185\ In addition, proposed Rule 610T(e) would require
equities exchanges to identify the effective date for each fee (rebate)
change reported and, when applicable, the end date after which the fee
(rebate) was no longer in effect. It also would require equities
exchanges to specify fees and rebates that apply to each Pilot Test
Group (or the Control Group), and to what type of participant (market
maker or other market participant) they apply. Further, equities
exchanges would be required to indicate whether any of the reported
fees or rebates are applied differently depending on whether the
interest is non-displayed or ranked in the depth-of-book. Finally, as
proposed in Rule 610T(e), the equities exchanges would prepare this
information and make it publicly available on their websites.
---------------------------------------------------------------------------
\185\ Including only the Base fee (rebate), average fee
(rebate), median fee (rebate), and the Top Tier fee (rebate) ignores
significant variation in exchange fee schedules. However, additional
information would complicate the data and could be difficult to
standardize across exchanges. Further, the Commission preliminarily
believes that the proposed data fields provide sufficient
information to assess the range of fees and the variation across
exchanges in fees.
---------------------------------------------------------------------------
This Exchange Transaction Fee Summary would be intended to
facilitate comparison of exchanges' basic fee structures and help
identify, in summary fashion, changes to those fees (rebates).
Rule 610T(e) would require each national securities exchange that
trades NMS stocks to publicly post this information before the
beginning of trading on the first day of the pre-Pilot Period, and
update it on a monthly basis thereafter through the close of trading on
the last day of the post-Pilot Period.
3. Order Routing Data
Proposed Rule 610T(d) would require each national securities
exchange that trades NMS stocks to prepare, in pipe-delimited ASCII
format, and publicly post on its website, no later than the last day of
each month, specified order routing data containing aggregated and
anonymized broker-dealer order routing information for the prior month
in accordance with the specifications set forth in proposed Rule
610T(d). Such data would be collected throughout the duration of the
proposed Pilot, as well as during the pre-Pilot Period and the post-
Pilot Period. For the pre-Pilot Period, order routing datasets would
include each NMS stock. For the Pilot Period and post-Pilot Period,
order routing datasets would include each Pilot Security. As noted
above, if the equities exchanges are reporting to the CAT at the time
the proposed Pilot commences, the Commission preliminarily believes
that they would be able to compile the required order routing data by
using the data reported to the central repository. Publicly posting the
datasets would provide the Commission, market participants, academic
scholars, and the public with order routing data necessary to serve the
Commission's regulatory purposes in studying the potential conflicts of
interest associated with transaction-based fees and rebates and the
effects that changes to those fees and rebates have on order routing
behavior, execution quality, and market quality. In particular, the
proposed order routing datasets would contain aggregated order routing
data on liquidity-providing and liquidity-taking orders by security, by
day, by exchange, and by anonymized broker-dealer, separating held and
not-held orders, which should facilitate analysis into order routing
behavior in response to differing levels of fees and rebates under the
proposed Pilot. Further, in order to construct a dataset that both
provides benchmark statistics for the pre-Pilot Period and also
captures data to show changes after the end of the proposed Pilot,
equities exchanges would provide the required data for dates starting
six months prior to the Pilot Period through six months after the end
of the Pilot Period. As proposed, the exchanges would publicly post the
order routing datasets on their websites in pipe-delimited ASCII
format, which would provide ready access to the data to facilitate
analyses of the impact of the proposed Pilot.
B. Proposed Use of Information
The data collected during the proposed Pilot would allow the
Commission, market participants, academic scholars, and the public to
study the potential conflicts of interest associated with transaction-
based fees and rebates and the effects that changes to those fees and
rebates have on order routing behavior, execution quality, and market
quality. In turn, this information should facilitate a data-driven
evaluation of future policy choices.
By publishing and maintaining a Pilot Securities Exchange List and
a Pilot Securities Change List, each primary listing exchange would
help ensure that the Commission, market participants, academic
scholars, and the public have up-to-date information on corporate
changes to listed issuers that impact the list of Pilot Securities, as
well as changes to the composition of any of the proposed test groups.
For example, if a stock undergoes a name change, ticker symbol change,
corporate merger, or goes out of business, the primary listing
exchanges would help disseminate information necessary to keep current
the Pilot Securities Exchange List and the Test Groups into which the
Pilot Securities are placed by the proposed Pilot.
The proposed Exchange Transaction Fee Summary containing
information on fees and fee changes that affect each Test Group and the
Control Group should help facilitate more efficient analysis of the
effect that transaction-based fees and rebates, and changes to
transaction-based fees and rebates, have on order routing behavior,
execution quality, and market quality by facilitating comparison across
equities exchanges of each exchange's basic fee structure and
identifying, in summary fashion, changes to those fees. The Commission
preliminarily believes that the public availability of this data would
facilitate this analysis of order routing data by the Commission, as
well as by market participants, academic scholars, and the public.
The proposed collection of order routing data would provide to the
Commission and others necessary information on broker-dealer order
routing behavior in response to changes in fees and rebates at each
exchange, as well as information on order type, order size, time to
execution, and information on order execution, cancellation, and
reroutes, all of which should facilitate analysis of routing behavior
in response to differing levels of fees and rebates and the impact of
fee changes on execution quality and market quality. In addition, the
collection of data for a pre-Pilot Period would provide an important
benchmark against which to evaluate the order routing data collected
during the proposed Pilot, and the collection of post-Pilot data would
allow analysis of changes to order routing behavior when the proposed
Pilot ends. Together, the information on changes and updates to the
universe of Pilot Securities, the Exchange Transaction Fee Summary, and
the order routing datasets is intended to
[[Page 13036]]
allow the Commission and others ready access to information to assess
whether and in what ways changes to fees and rebates affect market
participant behavior and impact the conflicts of interest faced by
market participants. In addition to analysis by the Commission, market
participants, academic scholars, and the public would be able to use
this data for their own studies.
C. Respondents
The respondents to this collection of information would be the
equities exchanges, which are registered national securities exchanges
that trade NMS stocks. Specifically, Rule 610T(b), which covers the
Pilot Securities Exchange Lists and Pilot Securities Change Lists,
would apply to the five primary listing exchanges for NMS stocks. Rule
610T(d), which requires datasets on order routing, would apply to all
thirteen equities exchanges that are currently registered with the
Commission. Rule 610T(e), which requires datasets on fees (rebates) and
fee (rebate) changes, would apply to all thirteen equities exchanges
currently registered with the Commission.
D. Total Initial and Annual Reporting and Recordkeeping Burdens
1. Pilot Securities Exchange Lists and Pilot Securities Change Lists
After the Commission designates the initial List of Pilot
Securities and prior to the start of trading on the first day of the
Pilot Period, proposed Rule 610T(b)(2) would require each primary
listing exchange to compile in pipe-delimited ASCII format, publicly
post on its website, and update as necessary, a list of the Pilot
Securities for which the equities exchange serves as the primary
listing exchange (i.e., the ``Pilot Securities Exchange List''), as
well as a list of certain changes to any Pilot Security for which it
serves or has served as the primary listing market (i.e., the ``Pilot
Securities Change List''). Specifically, upon publication of the
initial List of Pilot Securities by the Commission, the primary listing
exchanges would be required to determine which Pilot Securities are
listed on their market and compile and publicly post downloadable files
containing a list of those securities, including all data fields
specified in proposed Rule 610T(b)(2)(i) on their websites in pipe-
delimited ASCII format. The Commission preliminarily estimates that
each primary listing exchange would incur, on average, a one-time
burden of approximately 8 burden hours per primary listing exchange to
compile and publicly post their initial Pilot Securities Exchange
List.\186\ Accordingly, the Commission preliminarily believes that the
aggregate one-time burden associated with the initial Pilot Securities
Exchange Lists would be 40 burden hours.\187\
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\186\ The Commission bases this estimate on a full-time
Compliance Manager and Programmer Analyst each spending
approximately 4 hours, for a combined total of approximately 8
hours, to compile and publicly post to an exchange's website a
downloadable file containing the initial Pilot Securities Exchange
List.
\187\ 8 burden hours per primary listing exchange x 5 primary
listing exchanges = 40 burden hours.
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After posting its initial Pilot Securities Exchange List, each
equities exchange would be required to keep current that list to
reflect any changes, and to prepare and publicly post on its website
until the end of the post-Pilot Period the Pilot Securities Change List
prior to the beginning of trading each trading day. The Commission
preliminarily believes that each primary listing exchange has existing
systems to monitor the names of listed companies and process any
changes due to mergers, name changes, or other corporate actions, or
transfer of a security that closed below $1 per share from a Test Group
to the Control Group.\188\ Moreover, the Commission preliminarily
believes these systems are currently being used to maintain the lists
of pilot securities for the Tick Size Pilot, which, as noted above,
employs a similar test-group structure and applies to many of the same
securities, so the primary listing exchanges already have a process in
place to update lists of pilot securities.\189\ However, each primary
listing exchange would have to adapt these systems as necessary for the
proposed Transaction Fee Pilot, notably the fact that the proposed
Transaction Fee Pilot would apply to a larger number of securities than
does the Tick Size Pilot. Accordingly, the Commission preliminarily
estimates that each primary listing market would incur a one-time
burden of approximately 12 burden hours of internal legal, compliance,
and information technology operations to develop appropriate systems to
track and compile changes relevant to Pilot Securities listed on their
market for an aggregate one-time burden of approximately 60 burden
hours.\190\ The Commission preliminarily estimates that, once the
primary listing exchanges have established these systems, on average,
each primary listing exchange would incur 126 burden hours annually to
compile any changes related to Pilot Securities, such as name changes
or mergers, and to publicly post the updated Pilot Securities Exchange
Lists and Pilot Securities Change Lists on their websites prior to the
start of each trading day.\191\ Accordingly, the Commission
preliminarily estimates an average, aggregate annual burden of 630
burden hours to update and publicly post the lists of Pilot
Securities.\192\
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\188\ See supra note 153 and accompanying text.
\189\ See supra note 150 and accompanying text.
\190\ The Commission derived the total estimated burdens from
the following estimates: (Attorney at 4 hours) + (Compliance Manager
at 4 hours) + (Programmer Analyst at 4 hours) = 12 burden hours. 12
burden hours per primary listing exchange x 5 primary listing
exchanges = 60 burden hours.
\191\ The Commission bases this estimate on a full-time
Compliance Manager and Programmer Analyst together spending
approximately 30 minutes per trading day updating and posting the
required lists (approximately 252 trading days x 30 minutes per
trading day = 7,560 minutes (126 hours)).
\192\ 126 burden hours per primary listing exchange x 5 primary
listing exchanges = 630 burden hours.
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2. Exchange Transaction Fee Summary
Proposed Rule 610T(e) would require each national securities
exchange that trades NMS stocks to maintain and publicly post on their
websites downloadable files, using an XML schema to be published on the
Commission's website, data concerning changes in transaction fees
(rebates), and the effective date for each fee (rebate) change, for
securities subject to the proposed Pilot. The Exchange Transaction Fee
Summary would be required to be posted on the equities exchanges'
websites before the start of trading on the first day of the pre-Pilot
Period through the close of trading on the last day of the post-Pilot
Period. Proposed Rule 610T(e) would require equities exchanges to
update this summary of information within ten business days following
the beginning of each calendar month. Proposed Rule 610T(e) specifies
the proposed fields to be required, including, among other things,
information on Base fees and rebates, average and median per share fees
paid or rebates given, and Top Tier fees and rebates, each reported
separately for registered market makers and other participants. In
addition, proposed Rule 610T(e) would require equities exchanges to
specify whether the fees (rebates) reported in the summary apply to
displayed or non-displayed orders or between top and depth of book.
Finally, the proposed rule would require equities exchanges to identify
the effective date for each fee (rebate) change reported, including,
when applicable, an indicator to flag instances where an equities
exchange has changed fees other than on the first trading day of a
calendar month and the end date after which the fee (rebate) was no
longer in effect. It also would require exchanges to specify fees that
apply to
[[Page 13037]]
each Pilot Test Group (or the Control Group), and to what type of
interest the fees apply.\193\
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\193\ In addition, the Commission anticipates that each equities
exchange would submit one Form 19b-4 fee filing to implement the
proposed Pilot and one Form 19b-4 fee filing at the conclusion of
the proposed Pilot to remove the required pricing restrictions. Each
equities exchange might also choose to submit additional Form 19b-4
fee filings during the proposed Pilot. While such filings may impose
certain costs on the equities exchanges, those burdens are already
accounted for in the comprehensive Paperwork Reduction Act
Information Collection submission for Form 19b-4. See OMB Control
No. 3235-0045 (August 19, 2016), 81 FR 57946 (August 24, 2016)
(Request to OMB for Extension of Rule 19b-4 and Form 19b-4 PRA). The
Commission does not expect the baseline number of Form 19b-4 fee
filings to increase as a result of the proposed Pilot, nor does it
believe that the incremental costs outlined in Section V.C.2.a
exceed those costs used to arrive at the average costs and/or
burdens reflected in the Form 19b-4 PRA submission.
---------------------------------------------------------------------------
The Commission is proposing to require that each equities exchange
publicly post on its websites the Exchange Transaction Fee Summary each
month, using an XML schema published on the Commission's website. The
Commission preliminarily believes that all the data necessary to
complete the summary are currently maintained by the equities
exchanges. However, the equities exchanges would be required to compute
the monthly realized average and median per share fees and rebates,
using fee and volume information that the equities exchanges maintain.
The Commission preliminarily estimates that each equities exchange
would incur a one-time burden of approximately 80 burden hours of
internal legal, compliance, information technology, and business
operations to develop appropriate systems for tracking fee changes,
computing the monthly averages, and formatting the data and posting it
on its website in accordance with the proposed rule.\194\ Therefore,
the Commission preliminarily estimates that the average one-time
initial aggregate burden for all equities exchanges necessary for the
development and implementation of the systems needed to capture the
transaction fee information and post it on their websites in the
specified format in compliance with proposed Rule 610T(e) would be
1,040 hours.\195\
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\194\ The Commission preliminarily estimates that an equities
exchange would assign responsibilities for review and potential
modification of its systems and technology to an Attorney, a
Compliance Manager, a Programmer Analyst and a Senior Business
Analyst. The Commission estimates the burden of reviewing and
potentially modifying its systems and technology to be as follows:
(Attorney at 20 hours) + (Compliance Manager at 20 hours) +
(Programmer Analyst at 20 hours) + (Business Analyst at 20 hours) =
80 burden hours per equities exchange. See Securities Exchange Act
Release No. 76624 (Dec. 11, 2015), 80 FR 79757, 79771 fn. 93 (Dec.
23, 2015) (SBS Taxonomy Proposing Release) (estimating the types of
employees that would retain responsibility for modifying technology
systems).
\195\ 80 burden hours per equities exchange x 13 equities
exchanges = 1,040 burden hours.
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Once an equities exchange has established the appropriate systems
required for compiling, formatting, and publicly posting the Exchange
Transaction Fee Summary in the specified format, the Commission
preliminarily believes that it would be necessary for each equities
exchange to monitor its systems to ensure its technology is up to date
and reporting the required data in accordance with proposed Rule
610T(e). The Commission preliminarily estimates that, on average, an
equities exchange would incur an ongoing burden of approximately 40
burden hours per year to monitor and, if necessary, update its systems
used for compiling, formatting and publicly posting the Exchange
Transaction Fee Summaries in accordance with the proposed Rule.\196\
Therefore, the Commission preliminarily estimates that the average
aggregate, ongoing, annual burden for all equities exchanges to monitor
their systems would be 520 hours.\197\
---------------------------------------------------------------------------
\196\ Total estimated burdens which reflect the Commission's
preliminary view that annual ongoing burdens would be approximately
half the burdens of initially ensuring it has the appropriate
systems to capture the required information in the required format:
(Attorney at 10 hours) + (Compliance Manager at 10 hours) +
(Programmer Analyst at 10 hours) + (Senior Business Analyst at 10
hours) = 40 burden hours.
\197\ 40 burden hours per equities exchange x 13 equities
exchanges = 520 burden hours.
---------------------------------------------------------------------------
Under the proposed rule, the equities exchanges would be required
to format, calculate certain figures and post their initial Exchange
Transaction Fee Summary at the outset of the pre-Pilot Period. As this
would be the first time an equities exchange would be required to
produce and post on their website such a summary, the Commission
preliminarily estimates that it would require approximately 4 burden
hours for each equities exchange to complete the initial Exchange
Transaction Fee Summary and perform the necessary calculations.\198\ In
addition, each equities exchange would be required to make its summary
publicly available on its website using an XML schema to be published
on the Commission's website. As discussed below, the Commission
preliminarily believes that the equities exchanges have experience
applying the XML format to market data.\199\ However, the Commission
preliminarily believes that initially each equities exchange would
incur a burden specific to the initial Exchange Transaction Fee Summary
to ensure that it has properly implemented the XML schema. Therefore,
the Commission preliminarily estimates that each equities exchange
would incur a burden of 2 burden hours related to post the initial
Exchange Transaction Fee Summary publicly on its website using the XML
schema to be published on the Commission's website.\200\ Accordingly,
the Commission preliminarily estimates that equities exchanges would
incur, in aggregate, an initial burden of 52 hours to complete their
initial Exchange Transaction Fee Summary \201\ and an initial burden of
26 hours to post that dataset publicly on their websites using an XML
schema to be published on the Commission's website, for a total
aggregate, initial burden of 78 burden hours.\202\
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\198\ The Commission derived the total estimated burden from the
following estimates: (Compliance Manager at 2 hours) + (Senior
Business Analyst at 2 hours) = 4 burden hours per equities exchange.
\199\ See infra notes 364-366 and accompanying text.
\200\ The Commission derived the total estimated burden from the
following estimates, which reflect the Commission's preliminary
belief that the equities exchanges have experience posting
information in an XML format on publicly-available websites:
(Compliance Manager at 1 hour) + (Programmer Analyst at 1 hour) = 2
burden hours per equities exchange.
\201\ 4 burden hours per equities exchange x 13 equities
exchanges = 52 burden hours.
\202\ 2 burden hours per equities exchange x 13 equities
exchanges = 26 burden hours.
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In addition, each equities exchange would be required to update the
Exchange Transaction Fee Summary on a monthly basis to account for
changes from the prior month, if any, and to report monthly realized
average median fee and rebate information. The Commission preliminarily
believes that such updates would require fewer burden hours, as the
equities exchanges would have experience calculating necessary data and
formatting the reports as required by the proposed Rule. Accordingly,
the Commission preliminarily estimates that it would require
approximately 2 burden hours each month, or 24 burden hours on an
annualized basis, for each equities exchange to update.\203\ This
estimate contemplates the impact of publicly posting the summary using
the XML schema to be published on the Commission's website.
Accordingly, the Commission preliminarily estimates that equities
exchanges would incur, an aggregate, annual burden of 312 burden hours
to publicly post on their websites
[[Page 13038]]
the Exchange Transaction Fee Summaries.\204\
---------------------------------------------------------------------------
\203\ The Commission derived the total estimated burden from the
following estimates: (Compliance Manager at 1 hour) + (Programmer
Analyst at 1 hour) = 2 burden hours per equities exchange per month.
2 burden hours per equities exchange per month x 12 months per year
= 24 burden hours per equities exchange per year.
\204\ 2 burden hours per equities exchange x 13 equities
exchanges x 12 monthly updates = 312 burden hours per year.
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3. Order Routing Data
Proposed Rule 610T(d) would require each national securities
exchange that trades NMS stocks to prepare, in pipe-delimited ASCII
format, and publicly post on its website, no later than the last day of
each month, specified data containing aggregated and anonymized broker-
dealer order routing information for the prior month in accordance with
the specifications set forth in proposed Rule 610T(d). Such data would
be collected throughout the duration of the Pilot, as well as during
the six-month pre-Pilot Period and the six-month post-Pilot Period. For
the pre-Pilot Period, order routing datasets would include each NMS
stock. For the Pilot Period and post-Pilot Period, order routing
datasets would include each Pilot Security. In preparing the order
routing datasets, the equities exchanges would be required to anonymize
information relating to the identity of individual broker-dealers
before making the datasets publicly available. This anonymization would
be achieved through the use of an anonymization key developed by the
Commission, using CRDs.\205\
---------------------------------------------------------------------------
\205\ See supra Section III.E.3.
---------------------------------------------------------------------------
The Commission preliminarily estimates that, on average, there
would be no paperwork burden to the equities exchanges to capture the
required order routing data, as the Commission expects that the
equities exchanges would collect the required data to create the order
routing datasets through existing systems and technology already in
place for the collection and reporting of data pursuant to the CAT NMS
Plan. Furthermore, the Commission notes that the equities exchanges
currently generate similar monthly datasets pursuant to Rule 605 of
Regulation NMS.\206\ Accordingly, the Commission preliminarily believes
that the equities exchanges would be able to leverage existing systems
and technology utilized for Rule 605 reporting purposes to create the
proposed monthly order routing datasets. The Commission preliminarily
believes, however, that the equities exchanges would incur an initial
one-time burden of 80 burden hours per equities exchange to ensure that
its systems and technology are able to accommodate the proposed
requirements to aggregate, anonymize, and publicly post the order
routing information.\207\ Accordingly, the Commission preliminarily
estimates that the aggregate one-time initial burden for ensuring its
systems and technology are able to aggregate, anonymize, and post the
required order routing data in compliance with proposed Rule 610T(d)
would be 1,040 burden hours.\208\
---------------------------------------------------------------------------
\206\ See 17 CFR 242.605.
\207\ The Commission preliminarily estimates that an equities
exchange will assign responsibilities for review and potential
modification of its systems and technology to an Attorney, a
Compliance Manager, a Programmer Analyst and a Senior Business
Analyst. The Commission estimates the burden of reviewing and
potentially modifying its systems and technology to be as follows:
(Attorney at 20 hours) + (Compliance Manager at 20 hours) +
(Programmer Analyst at 20 hours) + (Senior Business Analyst at 20
hours) = 80 burden hours per equities exchange. See supra note 194.
\208\ 80 burden hours per equities exchange x 13 equities
exchanges = 1,040 burden hours.
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Once an equities exchange has determined that it maintains the
appropriate systems and technology required for aggregation,
anonymization, and posting of the required information, the Commission
preliminarily believes that it would be necessary for each equities
exchange to undertake ongoing efforts to ensure that their systems and
technology are up to date so that the equities exchange may remain in
compliance with the proposed Rule. These efforts could include
personnel time to monitor the posting of the required data and the
maintenance of the systems necessary to post the required data. The
Commission preliminarily estimates that, on average, it would take an
equities exchange approximately 40 burden hours per year to ensure that
the systems and technology are up to date so as to facilitate
compliance with the proposed Rule.\209\ Therefore, the Commission
preliminarily estimates that the aggregate annual burden to maintain
the systems necessary to aggregate, anonymize, and post the required
order routing information to be approximately 520 burden hours per
year.\210\
---------------------------------------------------------------------------
\209\ The Commission derived the total estimated burdens from
the following estimates, which reflect the Commission's preliminary
view that annual ongoing burdens would be approximately half the
burdens of initially ensuring it has the appropriate systems to
capture the required information in the required format: (Attorney
at 10 hours) + (Compliance Analyst at 10 hours) + (Programmer
Analyst at 10 hours) + (Business Analyst at 10 hours) = 40 burden
hours per equities exchange.
\210\ 40 burden hours per equities exchange x 13 equities
exchanges = 520 burden hours.
---------------------------------------------------------------------------
In addition, each equities exchange would incur an ongoing burden
associated with creating and formatting the order routing datasets to
be publicly posted each month. The equities exchanges have experience
with creating similar datasets in accordance with their obligations
under Rule 605 of Regulation NMS. The Commission preliminarily believes
that each equities exchange would incur burdens similar to those
associated with preparing Rule 605 reports.\211\ Accordingly, the
Commission preliminarily believes that each equities exchange would
incur a burden of six burden hours per month, or 72 burden hours per
year, to prepare and publicly post on its website the order routing
datasets.\212\ Therefore, the aggregate, annual burden to publicly post
on their websites order routing datasets in accordance with proposed
Rule 610T(d) would be approximately 936 burden hours.\213\
---------------------------------------------------------------------------
\211\ See FR Doc. 2016-08552, 81 FR 22143 (April 14, 2016)
(``Request to OMB for Extension of Rule 605 of Regulation NMS'').
\212\ Compliance Manager at 3 hours + Programmer Analyst at 3
hours = 6 burden hours per month, per equities exchange. 6 burden
hours per month x 12 months = 72 burden hours per year, per equities
exchange.
\213\ 72 burden hours per year x 13 equities exchanges = 936
burden hours.
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E. Collection of Information Is Mandatory
Each collection of information discussed above would be a mandatory
collection of information.
F. Confidentiality of Responses to Collection of Information
The Pilot Securities Exchange List, Pilot Securities Change List,
Order Routing Datasets, and the Exchange Transaction Fee Summary would
not be confidential. Rather, each would be publicly posted by the
exchanges. With respect to the Order Routing Datasets, the equities
exchanges would anonymize the data they collect under Proposed Rule
610T(d) before publicly posting it on their respective websites.
G. Retention Period for Recordkeeping Requirements
National securities exchanges would be required to retain records
and information pursuant to Rule 17a-1 under the Exchange Act.\214\
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\214\ 17 CFR 240.17a-1. See also supra note 147.
---------------------------------------------------------------------------
H. Request for Comments
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits
comments to:
67. Evaluate whether the proposed collections of information are
necessary for the proper performance of the functions of the agency,
including whether the information shall have practical utility;
68. Evaluate the accuracy of our estimates of the burden of the
proposed collection of information;
69. Determine whether there are ways to enhance the quality,
utility, and
[[Page 13039]]
clarity of the information to be collected; and
70. Evaluate whether there are ways to minimize the burden of
collection of information on those who are to respond, including
through the use of automated collection techniques or other forms of
information technology.
Persons submitting comments on the collection of information
requirements should direct them to the Office of Management and Budget,
Attention: Desk Officer for the Securities and Exchange Commission,
Office of Information and Regulatory Affairs, Washington, DC 20503, and
should also send a copy of their comments to Secretary, Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549-1090, with
reference to File Number S7-05-18. Requests for materials submitted to
OMB by the Commission with regard to this collection of information
should be in writing, with reference to File Number S7-05-18 and be
submitted to the Securities and Exchange Commission, Office of FOIA/PA
Services, 100 F Street NE, Washington, DC 20549-2736. As OMB is
required to make a decision concerning the collection of information
between 30 and 60 days after publication, a comment to OMB is best
assured of having its full effect if OMB receives it within 30 days of
publication.
V. Economic Analysis
As explained above, the proposed Transaction Fee Pilot is designed
to produce information on the effect of transaction-based fees on order
routing decisions by broker-dealers, as well as execution and market
quality.\215\ In recent years, a number of academics and market
participants have expressed concern that the structure of transaction-
based fee pricing may lead to potential conflicts of interest between
broker-dealers and their customers when brokers-dealers route customer
orders to trading centers offering large rebates so that the broker-
dealer can capture the rebates, even when these venues do not offer
high execution quality.\216\ However, as discussed in more detail
below, the Commission cannot determine from existing empirical evidence
the impact, if any, of transaction-based fees on order routing
decisions by broker-dealers. Specifically, determining whether a causal
relationship between exchanges' choice of transaction-based fees and
broker-dealers' routing decisions is complicated because transaction-
based fees and order routing decisions could be jointly determined and
order routing decisions could influence fees just as fees could
influence order routing decisions. Currently available data do not
permit researchers to isolate these factors and thus identify the
existence or direction of such a causal relationship, which in turn
impedes researchers' ability to determine the extent to which conflicts
may exist.\217\ Moreover, the identification of potential causal
relations between fees and order routing decisions becomes increasingly
complex as exchanges modify their fees.\218\
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\215\ Execution quality generally refers to how favorably
customer orders are executed. Execution quality measures are similar
to liquidity measures and tend to include transaction costs, the
speed of execution, the probability that the trade will be executed,
and the price impact of the trade. See NMS Adopting Release, supra
note 1, at 37513-15, 37537-38. Market quality encompasses execution
quality but also relates more generally to how well the markets
function. Market quality measures include liquidity, price
discovery, and volatility in prices. See, e.g., Henrik Bessembinder,
``Trade Execution Costs and Market Quality after Decimalization,''
Journal of Financial and Quantitative Analysis 38, 747-777 (2003)
available at https://doi.org/10.2307/4126742; Maureen O'Hara and Mao
Ye, ``Is Market Fragmentation Harming Market Quality?'', Journal of
Financial Economics 100, 459-474 (2011) available at https://www.sciencedirect.com/science/article/pii/S0304405X11000390.
\216\ See, e.g., Angel, Harris and Spatt, supra note 106;
Battalio Equity Market Study, supra note 22; Harris, supra note 23.
\217\ As proposed, the Transaction Fee Pilot would require the
exchanges to make data available to the Commission and the public.
Raw data provided by the Transaction Fee Pilot are likely to be used
by a subset of academic and regulatory researchers (hereafter
``researchers'') to develop analyses and discussion about the
effects of transaction-based fees and rebates on order routing
decisions, which could provide valuable information to the public
and to the Commission.
\218\ Over the last five years, U.S. equities exchanges, on
average, have made 34 revisions, or approximately 6.7 revisions per
year, to their transaction-based fees and rebates. In contrast to
these changes, which are at the discretion of the exchanges and
subject to Commission review, the proposed Transaction Fee Pilot
would impose a change to access fees and rebates outside of the
exchanges' control. See Section V.B.2.b infra.
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Because of the existing lack of empirical evidence regarding these
potential conflicts of interest, additional information would assist
the Commission in making regulatory decisions about whether and how to
address transaction-based fees and rebates. To remedy the insufficiency
of existing empirical evidence, the Commission is proposing a
Transaction Fee Pilot, which would provide the Commission and the
public with data currently unavailable to study fees and rebates that
exchanges assess to broker-dealers and observe the effects of potential
conflicts of interest that could arise between broker-dealers and their
customers in connection with these fees. Specifically, the Commission
expects that these data are likely to shed light on the extent, if any,
to which broker-dealers route orders in ways that benefit the broker-
dealer but may not be optimal for customers. The data obtained from the
proposed Transaction Fee Pilot would inform any possible future
regulatory action that addresses these potential conflicts of interest
to the ultimate benefit of investors. In addition, the proposed
Transaction Fee Pilot data would also provide information about other
potential economic effects of reducing access fee caps or prohibiting
rebates or Linked Pricing. For example, the proposed Transaction Fee
Pilot could offer information on whether prohibiting rebates or Linked
Pricing alters broker-dealer behavior in a manner that affects market
quality. Specifically, the proposed Pilot may provide information on
how rebates affect quoted spreads, particularly for small and mid-cap
securities, as well as how changes to fees affect order flow among
trading centers.\219\
---------------------------------------------------------------------------
\219\ See Section V.C.1.a.ii infra, for further discussion of
the benefits of studying other economic effects of transaction fees
and rebates.
---------------------------------------------------------------------------
The proposed Transaction Fee Pilot would permit the study of
whether conflicts of interest exist by (1) providing an exogenous shock
to transaction-based fees and rebates, and (2) enabling the collection
of representative results of data across a broad range of
securities.\220\ An exogenous shock is an unpredictable or unexpected
event that is outside of the economy or the system (i.e., not under the
control or influence of those being studied) but can induce endogenous
(i.e., within the system) responses. In the context of this proposed
rule, the exogenous shock would take the form of either a reduction of
the maximum permissible access fees or a prohibition on rebates or
Linked Pricing paid by all U.S. equities exchanges. This shock would
allow the Commission and others to explore how exogenous changes to
fees and rebates could lead to changes in the ways in which broker-
dealers route customer orders for a broad sample of NMS securities.
Specifically, the reduction in fees or elimination of rebates or Linked
Pricing, as required in specific test groups of the proposed Pilot, may
reduce the magnitude of a potential conflict of interest between
broker-dealers and their clients caused by transaction-based fees and
rebates. A
[[Page 13040]]
reduction in this potential conflict of interest would, in turn, be
reflected in measurable changes to broker-dealer order routing
decisions.
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\220\ See Section V.B.1 infra, for discussion of existing
studies related to these topics and their limitations. See also
Section II.B supra, for details of the Nasdaq study, which examined
a change in the access fees and rebates charged by Nasdaq for 14
stocks over a four-month period.
---------------------------------------------------------------------------
As discussed in Section III.C, the proposed Pilot would span a two-
year period, with an automatic sunset at the end of the first year
unless, prior to that date, the Commission publishes a notice
determining that the proposed Pilot shall continue for up to another
year,\221\ and would apply to both maker-taker and taker-maker
exchanges. All NMS stocks (including ETPs) that have prices of at least
$2.00 at the time of selection would be included in the proposed Pilot
and would be segmented into three test groups and one control group.
Each test group would contain a mix of stocks and ETPs, stratified
based on variables such as market capitalization, share price, and
liquidity.\222\ Under the requirements of the proposed Pilot, the
exchanges could not charge any access fee or, where applicable, provide
rebates or Linked Pricing, in excess of the limitations indicated by
the proposed Pilot. Stocks and ETPs in Test Groups 1 and 2 would be
restricted to maximum fees of $0.0015 and $0.0005 (with no restrictions
on rebates), respectively, while Test Group 3 would eliminate the
exchanges' ability to provide rebates to liquidity providers on maker-
taker exchanges and liquidity takers on taker-maker exchanges for both
displayed and non-displayed liquidity and would prohibit Linked
Pricing. Both the Control Group and Test Group 3 would maintain the
current access fee cap of $0.0030 required by Rule 610(c) of Regulation
NMS. By construction, Test Group 3 is designed to observe the effect of
the absence of rebates or Linked Pricing on conflicts of interest and
the equilibrium fee level and how that fee level would affect order
routing decisions, execution quality, and market quality. Further,
exchanges would continue to be permitted to have varying fees within
each test group, and would be permitted to change their fees at their
discretion, subject to Commission review, during the proposed Pilot for
securities within each test group, so long as they comply with the
conditions of the applicable test group.
---------------------------------------------------------------------------
\221\ See Section III.D infra.
\222\ See supra note 116. The Commission would detail the
specifications of the stratification by notice.
---------------------------------------------------------------------------
In the absence of the proposed Pilot, the Commission preliminarily
believes it is unlikely that exchanges would collectively undertake a
similar pilot and voluntarily coordinate the exogenous shock to fees
and rebates across a broad set of securities, broker-dealers, and
exchanges that would be required to appropriately analyze the effects
of changes to fees and rebates.\223\ By imposing the same modifications
to fees and rebates on all U.S. equities exchanges, the proposed Pilot
would allow the Commission and the public to obtain data that would
permit them to examine how changes to fees and rebates affect order
routing decisions of broker-dealers. Accordingly, the Commission
believes that the proposed Pilot would enable the collection of
valuable data for both the Commission and the public that would
otherwise be unavailable.
---------------------------------------------------------------------------
\223\ See Section V.B.1.b.i infra.
---------------------------------------------------------------------------
The Commission is mindful of the costs imposed by, and the benefits
obtained from, our rules. Whenever the Commission engages in rulemaking
and is required to consider or determine whether an action is necessary
or appropriate in the public interest, Section 3(f) of the Exchange Act
requires the Commission to consider whether the action would promote
efficiency, competition, and capital formation, in addition to the
protection of investors.\224\ Further, when making rules under the
Exchange Act, Section 23(a)(2) of the Exchange Act requires the
Commission to consider the impact such rules would have on
competition.\225\ Section 23(a)(2) of the Exchange Act also prohibits
the Commission from adopting any rule that would impose a burden on
competition not necessary or appropriate in furtherance of the purposes
of the Exchange Act.\226\ The Commission preliminarily believes that
many of the likely impacts of this proposal on efficiency, competition,
and capital formation would be temporary in nature and would affect
markets only for the duration of the proposed Pilot. The following
analysis considers in detail the economic effects that may result from
the Transaction Fee Pilot proposed in this release.
---------------------------------------------------------------------------
\224\ See 15 U.S.C. 77b(b) and 15 U.S.C. 78c(f).
\225\ See 15 U.S.C. 78w(a)(2).
\226\ Id.
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Where possible, the Commission has quantified the likely economic
effects of the proposed Transaction Fee Pilot; however, as explained
further below, the Commission is unable to quantify all of the economic
effects because it lacks the information necessary to provide
reasonable estimates. In some cases, quantification depends heavily on
factors outside of the control of the Commission, which make it
difficult to predict how market participants would act under the
conditions of the proposed Pilot. For example, because of the
flexibility that market participants have with respect to the choice of
trading center for execution of transactions and because those choices
can be influenced by factors outside of the scope of this pilot, such
as volume discounts, the Commission cannot quantify, ahead of the
proposed Pilot, the economic impact of any changes in order routing
decisions by broker-dealers that may result from the proposed Pilot.
Nevertheless, as described more fully below, the Commission provides
both a qualitative assessment of the potential effects and a quantified
estimate of the potential aggregate initial and aggregate ongoing
costs, where feasible. The Commission encourages commenters to provide
data and information to help quantify the costs, benefits, and the
potential impacts of the proposed rule on efficiency, competition, and
capital formation.
A. Background on Transaction-Based Fees and Potential Conflicts of
Interest
This section provides a review of transaction-based fee models,
including a discussion of the history and mechanics of transaction-
based pricing. This section also presents an overview of the recent
concerns about potential conflicts of interest between broker-dealers
and their customers attributed to access fees and rebates assessed by
exchanges.
1. Overview of Transaction-Based Fees
Maker-taker pricing models originated on electronic communications
networks (ECNs) in the late 1990s as ECNs attempted to attract order
flow and draw liquidity from traditional exchanges by offering rebates
to market participants that posted liquidity to their platforms.\227\
Shortly thereafter, exchanges followed suit and adopted maker-taker
pricing models as market share migrated from traditional exchanges to
ECNs. Today, nearly all U.S. equities exchanges have some form of
transaction-based pricing models.\228\
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\227\ In 1997, Island ECN was the first electronic trading
platform to offer rebates to attract limit orders to its platform.
\228\ As of March 2018, EDGA and IEX do not operate as a maker-
taker or taker-maker market, although both charge flat fees. The
remaining 11 exchanges are either maker-taker (nine) or taker-maker
(two) exchanges. The baseline discusses these exchanges in more
detail.
---------------------------------------------------------------------------
Generally, transaction-based pricing models charge fees or remit
rebates to members depending on whether their executed orders ``make''
or ``take'' liquidity from the market. An order that makes liquidity
provides share volume (or depth) on a trading center at various
execution prices, whereas an order that
[[Page 13041]]
takes liquidity removes the volume (or depth) resting on the trading
center provided by the make orders. Orders that make, or provide,
liquidity are non-marketable limit orders, which are limit orders that
are submitted to an exchange or other trading center that cannot be
filled immediately when they arrive because no market participant is
willing to trade at the price of the order (i.e., the limit
price).\229\ For example, if a customer places an order to sell 100
shares of a security at $9.00 per share when the prevailing market bid
price is $8.75, that customer is placing a non-marketable limit sell
order that indicates her willingness to provide 100 shares of liquidity
to the market at a price of $9.00. In contrast, orders that take, or
remove, liquidity, are marketable orders. A marketable order, in turn,
can be either a market order, which is an order to buy or sell a
security to be executed immediately at current market prices,\230\ or a
marketable limit order, which is either a limit buy order with a price
at or above the lowest offer price in the market or a limit sell order
with a price at or below the highest bid in the market. For example, if
a customer places an order to sell 100 shares of a security at $8.50
per share when the prevailing market bid price is $8.75 at a depth of
more than 100 shares, that customer is placing a marketable limit sell
order, and would take 100 shares of liquidity at a price of $8.75.
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\229\ A limit order is an order to buy or sell a security at a
specified price or better. As the price of the non-marketable order
gets further from the bid or offer price, the greater the likelihood
that the non-marketable order must rest until better priced orders
execute.
\230\ As long as there are willing sellers and buyers, market
orders are filled.
---------------------------------------------------------------------------
In maker-taker models, an exchange charges an access fee to broker-
dealers that take liquidity using marketable orders and remits a rebate
to broker-dealers that make liquidity by placing standing non-
marketable limit orders that subsequently interact with marketable
orders. In a taker-maker market, the exchange charges an access fee to
broker-dealers that provide liquidity by placing non-marketable limit
orders and pays a rebate to market participants that take liquidity
using marketable orders. In 2005, the Commission adopted Rule 610(c) of
Regulation NMS,\231\ which limited the maximum access fee that could be
charged by maker-taker exchanges to $0.0030 per share. The adoption of
the fee limit was designed to ensure the fairness and accuracy of the
displayed quotations by establishing an upper bound on the cost of
accessing such quotations,\232\ while also precluding certain trading
centers from raising their fees substantially to market participants
required to access their quotations by the Order Protection Rule,\233\
and preventing certain trading centers from taking advantage of
intermarket price protection by acting as toll booths between price
levels.\234\
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\231\ See NMS Adopting Release, supra note 1.
\232\ See id. at 37543-46.
\233\ See NMS Adopting Release, supra note 1, at 37504-38. The
Order Protection Rule is designed to ensure that investors receive a
consistent price quotation for NMS stocks across all exchanges where
a security is traded and that investors receive the best possible
execution price for marketable orders.
\234\ See id. at 37584. See also Harris, supra note 23
(suggesting that large access fees were a response to some trading
venues paying large rebates to market participants as a means of
attracting order flow to those venues in the early days of maker-
taker exchanges).
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2. Potential Conflicts of Interest
Academics, market participants, regulators, and legislators
recently have expressed concern about how transaction-based fees have
affected order routing decisions by broker-dealers and the execution
quality obtained by customers.\235\ This concern has centered on the
potential for conflicts of interest between broker-dealers and their
customers that may distort best execution practices.
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\235\ See Staff Maker-Taker Memo, supra note 99. See also Angel,
Harris, and Spatt, supra note 106; Jeffrey Bacidore, Hernan Otero,
and Alak Vasa, ``Does Smart Routing Matter?'', Working Paper,
Investment Technology Group, Inc. (2010), available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1681449 (``Bacidore,
Otero, and Vasa''); Battalio Equity Market Study, supra note 22;
Harris, supra note 23. In addition to potential conflicts of
interest, several of these studies have also indicated that
transaction-based pricing models have led to reduced price
transparency for investors and increased market fragmentation and
complexity. These are discussed in greater detail in Section
V.C.1.b, infra.
---------------------------------------------------------------------------
Broker-dealers are required to use reasonable diligence to execute
customer orders according to best execution standards, which require
broker-dealers ``to execute customers' trades at the most favorable
terms reasonably available under the circumstances . . .'' \236\ When
seeking best execution for their orders, broker-dealers often consider
opportunities to obtain prices better than those currently quoted. In
order to comply with best execution standards, broker-dealers evaluate
their aggregate customer orders and periodically assess which competing
trading center offers the most favorable terms of execution.\237\ The
quoted prices that are used by broker-dealers to meet their best
execution standards do not reflect any access fees assessed or rebates
offered by the exchanges.\238\
---------------------------------------------------------------------------
\236\ See NMS Adopting Release, supra note 1, at 37537-38. See
also supra note 215.
\237\ See NMS Adopting Release, supra note 1, at 37537-38.
\238\ See, e.g., Angel, Harris, and Spatt, supra note 106.
---------------------------------------------------------------------------
Even while complying with best execution requirements, broker-
dealers may route non-marketable limit orders to trading centers that
offer the best quoted prices but that also offer high rebates for those
orders, which the broker-dealers may then retain, rather than pass
through to customers.\239\ The availability of high rebates, however,
may influence how broker-dealers route customer orders to the detriment
of customers, even if orders are still routed to an exchange posting
the best quoted prices.\240\ One study, for example, shows lower
execution quality, in terms of reduced probability of execution or
increased time to execution, for non-marketable limit orders on
exchanges that pay high rebates.\241\ Thus, broker-dealers may route
orders to exchanges that have the best quoted prices but are suboptimal
for customers in other ways
[[Page 13042]]
because orders are either less likely or take longer to execute.
---------------------------------------------------------------------------
\239\ The potential conflicts of interest are more likely when
broker-dealers retain the rebates, because such broker-dealers have
greater incentive to maximize those rebates potentially at the
expense of customer execution quality. The Battalio Equity Market
Study, for example, found that a sample of retail broker-dealers
appear to route orders to venues that offer large rebates, thereby
maximizing order flow payments. However, as noted in the Battalio
Equity Market Study, routing orders to venues with large rebates did
not result in superior execution quality for non-marketable limit
orders. See Battalio Equity Market Study, supra note 22. See also
David Cimon, ``Broker Routing Decisions in Limit Order Markets,''
Working paper, Bank of Canada, (2017) available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2789804. Cimon provides
a theoretical model of conflicts of interest in broker-dealer
markets, where broker-dealers route marketable orders to venues with
low access fees to reduce the access fees paid by the broker-dealer,
increasing the volume of uninformed orders and lowering the risk of
adverse selection for non-marketable limit orders posted to that
venue.
\240\ The duty of best execution requires broker-dealers to
execute customer trades at the most favorable terms reasonably
available under the circumstances. See NMS Adopting Release, supra
note 1, at 37537-38. The duty of best execution is not inconsistent
with the automated routing of orders; however, broker-dealers must
periodically assess the quality of competing markets to ensure that
order flow is directed to markets providing the most beneficial
terms for their customer orders.
\241\ See, Battalio Equity Market Study, supra note 22, which
finds some evidence that execution quality is related to the
transaction-based fees. For instance, in their analysis of a single
order-routing system, for a sample of matched limit orders placed on
high fee and low fee venues, high fee venues have a fill rate of
approximately 73%, while low fee venues have a fill rate of
approximately 99% (Table V). Further, in a multiple regression
analysis (Table VI), the study shows that the probability of filling
an order is decreasing as the take fee increases, while the time to
execution increases. The limitations of the Battalio Equity Market
Study are discussed below in Section V.B.1.b, infra.
---------------------------------------------------------------------------
Maker-taker exchanges with high rebates tend to have high access
fees, which increase the cost to broker-dealers to execute marketable
orders. These high access fees may lead broker-dealers to route
marketable orders to exchanges with lower access fees, even though
there may be a significant number of standing non-marketable limit
orders on exchanges with higher access fees.\242\ As the broker-dealers
route marketable orders to exchanges with lower access fees, execution
quality for the non-marketable limit orders is likely to deteriorate
because the non-marketable limit orders are likely to have lower
probability of execution and longer times to execution for orders that
do execute. High rebates may also limit the ability of an exchange to
generate a liquidity externality because these high rebates could draw
order flow to exchanges with low execution quality, despite the
availability of higher execution quality on other trading centers.\243\
This behavior may fragment order flow. In contrast, if exchanges did
not provide high rebates, broker-dealers may be more likely to route
orders to exchanges that quote the best price and have the best overall
execution quality,\244\ permitting order flow to consolidate on those
venues.
---------------------------------------------------------------------------
\242\ See, Angel, Harris, and Spatt, supra note 106.
\243\ A liquidity externality occurs when a given trading center
becomes the preferred trading destination for both marketable and
non-marketable orders.
\244\ See Battalio Equity Market Study, supra note 22, at 2232
(``[O]ur results suggest that . . . routing decisions based
primarily on rebates/fees are inconsistent with best execution. For
limit order traders, there are significant opportunity costs [with
respect to execution quality] with routing all nonmarketable limit
orders to a single venue offering the highest liquidity rebates.'').
---------------------------------------------------------------------------
In general, customer orders routed to exchanges that remit high
rebates are also more likely to face adverse selection when
executed.\245\ Adverse selection occurs when one party to a transaction
has less information about the value of an asset than the other party
to the transaction, resulting in the possibility that the less informed
party only transacts when it is disadvantageous to do so. In the
context of order execution, adverse selection is likely to occur
because some fraction of market participants is likely to possess more
precise information about the value of a security.\246\ Order flow from
these ``informed traders'' is generally routed to exchanges. In order
for the exchanges to draw sufficient liquidity to satisfy the orders
placed by informed traders, they may offer high rebates to broker-
dealers to attract non-marketable limit orders, which are likely to be
placed by uninformed traders, to satisfy the demands of informed
traders' order flow.\247\ Under such circumstances, these non-
marketable limit orders face an adverse selection problem because they
execute against marketable orders that likely were placed by informed
traders.\248\ As adverse selection increases at high rebate/high fee
exchanges, informed traders will always execute orders to the detriment
of uninformed traders (retail customers), i.e., the orders will more
likely be executed at disadvantageous prices for the uniformed traders
relative to customer orders routed to low rebate/low fee exchanges,
where the likelihood of facing an informed trader is less.\249\ In
these situations, the broker-dealers thus face a potential conflict of
interest when they receive high rebates from the exchanges seeking to
attract liquidity while their customers bear costs of the
disadvantageous prices resulting from the adverse selection.
---------------------------------------------------------------------------
\245\ See, Angel, Harris, and Spatt, supra note 106. See also
Peter Hoffman, ``Adverse Selection, Market Access and Inter-market
Competition,'' Journal of Banking & Finance 65, 108-119 (2016),
available at https://www.sciencedirect.com/science/article/pii/S0378426615002976; Sviatoslav Rosov, ``HFT, Price Improvement,
Adverse Selection: An Expensive Way to Get Tighter Spreads?'', CFA
Institute (2014) available at https://blogs.cfainstitute.org/marketintegrity/2014/12/18/hft-price-improvement-adverse-selection-an-expensive-way-to-get-tighter-spreads/ (``Rosov'').
\246\ Some market participants may know more about the value of
a security because some investors, such as some professional
traders, could just be better at processing public information. See,
e.g., Michael Brennan and Avanidhar Subrahmanyam, ``Market
Microstructure and Asset Pricing: On the Compensation for
Illiquidity in Stock Returns,'' Journal of Financial Economics 41,
441-464 (1996), available at https://www.sciencedirect.com/science/article/pii/0304405X9500870K; David Easley and Maureen O'Hara,
``Information and the Cost of Capital,'' Journal of Finance 59,
1553-1583 (2004), available at https://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.2004.00672.x/pdf.
\247\ Exchanges do not have sufficient liquidity from retail
marketable orders because they are generally internalized or routed
to wholesalers to avoid access fees. Several studies indicate that
internalizers are unlikely to accept marketable orders from market
participants that are likely to be informed. See Angel, Harris, and
Spatt, supra note 216; Rosov, supra note 245.
\248\ See, e.g., Dolgopolov, supra note 21. For example, if an
investor had a non-marketable limit buy order at $10, when the
current market price was $10.25, that standing limit order to buy at
$10 is likely to only get executed when prices are declining.
\249\ See Katya Malinova and Andreas Park, ``Subsidizing
Liquidity; the Impact of Make/Take Fees on Market Quality,'' Journal
of Finance 70, 509-536 (2015), available at https://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.2004.00672.x/pdf
(examining the introduction of maker rebates on the Toronto Stock
Exchange); Yiping Lin, Peter Swan, and Frederick H. deB. Harris,
``Maker-Taker Fees, Liquidity Competition, and High Frequency
Trading,'' Working Paper, University of New South Wales (2017)
(examining the Nasdaq pilot, described above in Section II.B). In
analyses of markets where exchanges conducted pilots altering the
access fees and rebates paid on subsets of stocks, results indicate
that markets with lower access fees (and rebates) had reduced
adverse selection costs. Venues with lower access fees could draw
increased order flow from both informed and uninformed traders. If
the proportion of informed traders is unlikely to change due to fees
and rebates changes, as overall order flow increases due to lower
access fees, then the likeihood of transacting with an informed
trader declines, thereby reducing the adverse selection costs to
traders.
---------------------------------------------------------------------------
Given the competitive nature of the broker-dealer industry,\250\
the Commission considered whether competition could alleviate potential
conflicts of interest between investors and broker-dealers, as
investors choose between broker-dealers that offer to place orders on
their behalf. To the extent that investors are able to identify broker-
dealers that do not act on potential conflicts of interest, investors
could discourage broker-dealers from acting on such conflicts of
interest. The Commission preliminarily believes, however, that
competition between broker-dealers may not resolve this issue because
of a combination of three reasons: Asymmetric information, switching
costs and a lack of collective action.
---------------------------------------------------------------------------
\250\ See Section V.B.2.a infra.
---------------------------------------------------------------------------
First, asymmetric information between broker-dealers and their
customers limits the ability of customers to identify broker-dealers
that do not act on potential conflicts of interest. For example,
customers do not generally have access to information about broker-
dealers' individual sources of revenue.\251\ As discussed below in more
detail, although disclosures required pursuant to Rule 606 provide
information about material conflicts of interest related to payment for
order flow, these disclosures do not provide information on the effect
of transaction-based fees on order routing decisions. Moreover, while
under Rule 606, a customer may request information about the venues to
which her orders were routed in the prior six months, a customer cannot
necessarily use this information to compare how these orders would have
been treated by other broker-dealers. Further, these
[[Page 13043]]
disclosures do not provide customers with information about the payment
and collection of transaction-based fees and rebates by broker-dealers.
---------------------------------------------------------------------------
\251\ While consolidated revenues may be available from Form 10-
K filings for broker-dealers that are public reporting companies,
broker-dealers do not report revenues attributable to specific
sources, such as rebates from a particular exchange or payments for
order flow from a particular venue. For instance, revenues derived
from commissions and fees are often just reported in aggregate as
``Commissions and Fees.'' Therefore, even though aggregate revenues
for some broker-dealers are publicly available, customers do not
have access to the information on individual sources of revenue that
could reveal potential conflicts of interest.
---------------------------------------------------------------------------
Second, even if investors had sufficient information to conclude
they would be better served by a different broker-dealer, investors may
face costs in switching broker-dealers.\252\ If these switching costs
are high relative to the costs that investors anticipate may arise from
potential conflicts of interest, investors may not switch broker-
dealers even if it appears that their broker-dealer may have acted on
conflicts of interest.
---------------------------------------------------------------------------
\252\ These switching costs may be monetary, but may also have a
time and effort component.
---------------------------------------------------------------------------
The presence of switching costs also may exacerbate a collective
action problem among investors.\253\ While investors could provide
incentives to broker-dealers to eliminate potential conflicts of
interest by threatening to move accounts away from broker-dealers known
to act on conflicts of interest, switching costs may undermine the
credibility of such a threat. This is because, although each customer
individually bears a cost to switch accounts, the benefits of a
successful threat, while conditional on a sufficient number of
customers agreeing to switch, are available to all customers whether
they would switch or not. If the switching costs are high relative to
the proportion of customer defections necessary to threaten a broker-
dealer, customers are unlikely to generate enough of a threat to alter
broker-dealers' behavior.
---------------------------------------------------------------------------
\253\ Collective action occurs when a number of individuals or
entities work together to achieve a common objective, such as
investors acting to reduce the potential conflicts of interest in
order routing decisions by broker-dealers.
---------------------------------------------------------------------------
B. Baseline
We compare the economic effects of the proposed rule, including
benefits, costs, and effects on efficiency, competition, and capital
formation, to a baseline that consists of the existing regulatory
framework and market structure. As explained above, by temporarily
altering the fee and rebate structure for certain NMS stocks (including
ETPs), the proposed Pilot is designed to produce information on order
routing behavior that would not otherwise be available. The baseline
discusses the existing set of information, as well as the exchanges'
current practices with respect to fees and rebates and the regulations
governing those fees and rebates.
1. Current Information Baseline
While the studies cited above discuss the potential issues for
investors associated with transaction-based fee models,\254\ limited
empirical evidence exists to date about the extent that potential
conflicts of interest arise from maker-taker and taker-maker pricing
models and how transaction-based fees affect the integrity and
structure of the U.S. equity markets. Below, we discuss the existing
information currently available to the Commission or the public that
concerns the relationship between transaction-based fees and order
routing decisions and describe the limitations of this information for
use in policy discussions regarding transaction-based fees and
potential conflicts of interest.
---------------------------------------------------------------------------
\254\ See supra note 216.
---------------------------------------------------------------------------
a. Existing Information
The existing empirical studies available regarding the relation
between transaction-based fees, order routing decisions, and execution
quality consists of two studies: One academic study and a study
conducted by Nasdaq.\255\ According to the Battalio Equity Market
Study, broker-dealers appear to trade execution quality of customer
orders, as measured by the likelihood of and time to execution (and not
price), for the rebates obtained by providing liquidity to maker-taker
venues.\256\ By routing orders to exchanges that pay high rebates,
broker-dealers may engage in rebate capture at the expense of client
execution.\257\ Using data obtained from mandatory Rule 606 disclosures
over a two-month window,\258\ the Battalio Equity Market Study also
identified that four of the ten broker-dealers included in the analysis
route limit orders exclusively to market makers or to exchanges that
offered the largest liquidity rebates (and charging the highest access
fees).\259\ A number of tests in the Battalio Equity Market Study also
show that low-fee venues provide better execution quality for limit
orders, as measured by the likelihood of an order fill, the speed of
execution, and higher average realized spreads, relative to high-fee
venues, suggesting that order routing decisions to high rebate venues
are likely to be suboptimal from a customer's perspective, and may be
indicative of potential conflicts of interest.
---------------------------------------------------------------------------
\255\ Although a number of studies theoretically suggest that
the transaction-based pricing structure coupled with discretion by
broker-dealers over order routing decisions could lead to potential
conflicts of interest with their customers, only the Battalio Equity
Market Study provides empirical evidence on the effect of fees and
rebates on order routing. Battalio Equity Market Study, supra note
22. As discussed more thoroughly below in Section V.B.1.b, the
Battalio Equity Market Study, while enlightening, has a number of
limitations that inhibit the ability to draw causal inferences from
it about potential conflicts of interest. See, e.g., Angel, Harris,
and Spatt, supra notes 106 and 216; Dolgopolov, supra note 21;
Harris, supra note 23.
\256\ The Battalio Equity Market Study's abstract of the paper
states: ``We identify retail brokers that seemingly route orders to
maximize order flow payments by selling market orders and sending
limit order to venues paying large liquidity rebates. . . . [W]e
document a negative relation between limit order execution quality
and rebate/fee level. This finding suggests that order routing
designed to maximize liquidity rebates does not maximize limit order
execution quality. . . .'' See Battalio Equity Market Study, supra
note 22, at 2193.
\257\ See Battalio Equity Market Study, supra note 22. See also
Section V.A.2 supra, for an overview of the potential conflicts of
interest that emerge.
\258\ Rule 606 requires broker-dealers to provide quarterly
reports that provide an overview of their routing practices. See
Securities Exchange Act Release No. 51808 (November 27, 2000), 65 FR
75414, (December 1, 2000) (``Disclosure or Order Execution and
Routing Practices''). Rule 606 disclosures require broker-dealers to
disclose material aspects of their relationships with certain
trading venues, including a description of payment for order flow.
The reports, however, do not require broker-dealers to disclose the
amounts of payment for order flow, or the rebates received or access
fees paid.
\259\ See Battalio Equity Market Study, supra note 22. The
Battalio Equity Market Study, however, does not specify whether the
limit orders are marketable or non-marketable limit orders, as Rule
606 disclosures do not segment these orders.
---------------------------------------------------------------------------
Separately, and as discussed in Section II.B,\260\ Nasdaq
independently conducted a study, whereby it lowered access fees and
rebates for a sample of 14 stocks over a period of four months in 2015,
providing an exogenous shock to the transaction-based pricing model on
the exchange. The Nasdaq experiment lowered both the access fees
charged and the liquidity rebates paid on the securities included in
their study.\261\ Nasdaq's analysis indicated that Nasdaq's reduction
in access fees and liquidity rebates reduced Nasdaq's market share and
Nasdaq's incidence of providing the NBBO, suggesting that Nasdaq
experienced a decline in some measures of market quality as a result of
the changes to access fees and rebates.\262\ Further, Nasdaq found that
[[Page 13044]]
there was a shift in the composition of the top five liquidity
providers for the securities that occurred as a result of the
experiment.\263\
---------------------------------------------------------------------------
\260\ See supra notes 31 and 32 and corresponding text.
\261\ The Nasdaq study lowered access fees to $0.0005 and
rebates to $0.0004 simultaneously for a set of 14 securities, half
of which identified Nasdaq as the primary listing exchange, the
other half which identified the NYSE as the primary listing
exchange. The Nasdaq released two reports (see supra note 31)
examining the changes to a number of metrics related to market
quality.
\262\ Although the 14 stocks experienced a decline in market
share on Nasdaq and their incidence of time at the NBBO, there was
no statistically significant change in the level of liquidity
taking, variance ratio, realized spread, return autocorrelation,
effective spread, relative effective spread, quoted spread, relative
quoted spread, displayed dollar depth at the NBBO, or time between
either quote updates or price changes in the NBBO. See Nasdaq May
Report, supra note 31.
\263\ The top five liquidity providers prior to the start of the
pilot significantly reduced their liquidity provision from 44.5% of
the liquidity provided pre-pilot to 28.7% in the pilot period.
However, the top five liquidity providers from the pilot period had
a significant increase in their liquidity provision from 29.7% pre-
pilot to 41.5% in the pilot period. See Nasdaq May Report, supra
note 31.
---------------------------------------------------------------------------
Two studies have examined exogenous shifts between maker-taker and
payment for order flow pricing models on U.S. options exchanges.\264\
These studies found that the movement from a payment for order flow
model to a maker-taker model led to a decrease in execution costs for
option classes affected by the shift, improved quoted spreads, and
altered broker-dealer order routing behavior to account for the
fees.\265\ However, the change to a payment for order flow model from a
maker-taker model yielded better execution quality, but a reduction in
the number of orders and order volume.\266\
---------------------------------------------------------------------------
\264\ See Amber Anand, Jian Hua, and Tim McCormick, ``Make-Take
Structure and Market Quality: Evidence from the U.S. Options
Markets,'' Management Science 62, 3217-3290 (2016), available at:
https://pubsonline.informs.org/doi/abs/10.1287/mnsc.2015.2274
(``Anand, Hua, and McCormick''); Robert Battalio, Todd Griffith, and
Robert Van Ness, ``Make-Take Fees versus Order Flow Inducements:
Evidence from the NASDAQ OMX PHLX Exchange,'' Working Paper,
University of Notre Dame (2017), available at: https://www1.villanova.edu/content/dam/villanova/VSB/assets/marc/marc2017/SSRN-id2870000.pdf (``Battalio, Griffith, and Van Ness''). Anand,
Hua, and McCormick explores the transition from a payment for order
flow model to a maker-taker model on NYSE ARCA, while Battalio,
Griffith, and Van Ness examines the shift on NASDAQ OMX PHLX
(``PHLX'') from a maker-taker model to a payment for order flow
model.
\265\ See Anand, Hua, and McCormick, supra note 264.
\266\ See Battalio, Griffith, and Van Ness, supra note 264.
---------------------------------------------------------------------------
A number of existing data sources could be used independently or in
combination to relate transaction-based fees to order routing and
execution quality. For instance, in the Battalio Equity Market Study
and the Nasdaq Study discussed above, researchers employed some
combination of Rule 606 data, proprietary broker-dealer data, the Trade
and Quote (TAQ) database,\267\ and proprietary exchange data. In
addition, while not employed in previous studies, CAT data, Rule 605
data, and exchanges' Form 19b-4 fee filings and fee schedules available
from each exchange's website, could provide insights into the relation
between transaction-based fees, order routing, and execution quality.
---------------------------------------------------------------------------
\267\ The Battalio Equity Market Study, supra note 22, relies on
Rule 606 disclosures to identify order routing for a small sample of
broker-dealers, proprietary broker-dealer data from a single smart-
order routing system to capture limit order execution quality for
this broker-dealer's orders, and the TAQ data to measure execution
quality as a function of each venue's taker fee or rebate.
---------------------------------------------------------------------------
Rule 606 requires broker-dealers to make publicly available
quarterly reports that provide an overview of their routing practices
for non-directed retail orders in NMS securities. As a further
requirement of Rule 606, broker-dealers must disclose the identities of
the ten venues to which the largest number of orders were routed for
execution. Rule 606 disclosures additionally require broker-dealers to
disclose material aspects of their relationships with trading venues to
which they route orders, including a description of payment for order
flow and any profit sharing relationships, which, like rebates, could
lead to potential conflicts of interest for broker-dealers when routing
orders.\268\ Researchers and other analysts interested in order routing
data can download these forms quarterly directly from broker-dealer
websites.
---------------------------------------------------------------------------
\268\ Conflicts of interest for broker-dealers potentially could
arise from a number of sources, including affiliations with trading
venues, receipt of payment for order flow, receipt of payment from
profit-sharing relationships, and rebates. Rule 606, however,
requires only descriptions of any arrangements for payment for order
flow, but does not require broker-dealers to provide information on
the net amount of payment for order flow, payment received from
profit-sharing relationships, or disclosure of access fees paid or
rebates received. See Disclosure of Order Execution and Routing
Practice, supra note 258, at 75425-28.
---------------------------------------------------------------------------
Proprietary data from broker-dealers or exchanges could also
provide information about order routing and execution quality. Broker-
dealer data include information on the orders received and routed by
that broker-dealer, including where the broker-dealer routed orders,
whether the orders execute, and the price, size, and time of execution.
Exchange data include information on the order received by an exchange,
including which members routed orders to the exchange, whether the
orders execute, and the price, size, and time of execution. As these
data include commercially sensitive information, they are not broadly
available.
Once the CAT Phase 1 becomes operational,\269\ the Commission and
SROs will have information on all exchange routing and exchange
executions for all NMS securities. In CAT Phase 1, exchanges would
record and report order events on every order they receive for NMS
securities. Order events include order receipt, order routes, order
modifications, order cancelations, and order executions.
---------------------------------------------------------------------------
\269\ See supra note 172.
---------------------------------------------------------------------------
Rule 605 data provides information about execution quality by
market center, including exchanges, ATSs, and broker-dealers that
execute orders, by requiring standardized reports of statistical
information regarding order execution, and was designed to improve the
public disclosure of order execution practices by exchanges.\270\ These
data are available monthly from market center websites or data vendors,
and provide information on execution quality statistics such as
transaction costs, execution speed, and fill rates reported separately
for marketable and non-marketable orders.
---------------------------------------------------------------------------
\270\ See Disclosure of Order Execution and Routing Practice,
supra note 258, at 75417-25.
---------------------------------------------------------------------------
Beyond Rule 605 data, researchers could also use the TAQ database
as a means of measuring order execution quality. The TAQ database is
publicly available (for a fee) from the NYSE and provides access to all
trades and quotes for NMS securities, from which researchers and other
analysts can estimate trade-based measures of execution quality.
Finally, researchers and other analysts can manually create
datasets of exchange fees and rebates from the information that
exchanges provide on their websites and release in their Notice of
Filing of Proposed Rule Changes, which would capture information
contained in exchanges' Form 19b-4 fee filings. The Form 19b-4 fee
filings record changes to the existing exchange fee schedules with the
Commission. At any point that an exchange chooses to make a change to
any aspect of its access fees and rebates, the exchange must provide
notice to the Commission that it is filing a proposed rule change to
amend its existing fee and rebate schedule. Exchanges may file their
revisions to fees and rebates for immediate effectiveness upon
submitting the Form 19b-4 fee filings with the Commission.
b. Limitations of Existing Information
Existing studies and available data sources are limited in ways
that are likely to reduce the strength of conclusions that relate to
the impact of transaction-based fees and rebates on order routing
decisions and the existence or magnitude of potential conflicts of
interest between broker-dealers and their customers. The limitations of
existing studies fall primarily into two categories: (1) The results of
the studies may not be representative, and (2) the results of the
[[Page 13045]]
studies cannot make a causal connection needed to inform on potential
conflicts of interest. This section discusses those limitations as well
as separately discussing the limitations associated with existing
sources of data mentioned above.
i. Representative Results
The results of both the Battalio Equity Market Study and the Nasdaq
study may not be representative of the potential impacts of broad
changes in access fees or rebates. Drawing market-wide inferences from
the limited samples in these studies could be problematic because the
results are predicated on information obtained from a single broker-
dealer or trading venue. First, the Battalio Equity Market Study uses
order level data from a single broker-dealer to determine the relation
between maker-taker fees and limit order execution quality. Analysis
based on observation of a single broker-dealer may not provide
representative results because the relation between transaction-based
fees and potential conflicts of interest may not be generalizable to
other broker-dealers. For example, over 400 broker-dealers maintain
membership with at least one U.S. equities exchange.\271\ If the single
broker-dealer examined in the Battalio Equity Market Study has
significantly different order routing behavior than the average broker-
dealer that routes orders to exchanges, the information obtained from
examining the relation between transaction-based fees and order routing
decisions of that broker-dealer would not be representative of the
entire market and therefore would provide an incomplete representation
of potential conflicts of interest.
---------------------------------------------------------------------------
\271\ Estimates based on data from Form 1 of the X-17A-5
filings. As of December 31, 2016, 3,972 broker-dealers that filed
form X-17A-5. See Section V.B.2.a infra.
---------------------------------------------------------------------------
The Battalio Equity Market Study also relies on a sample of Rule
606 order routing decisions obtained directly from the reporting
entities' websites from a limited sample of ten well-known national
retail brokers from a single quarterly reporting cycle (October and
November 2012). As discussed above, over 400 broker-dealers are members
of at least one national securities exchange. The ten retail brokers
analyzed in the Battalio Equity Market Study make up approximately 2.1%
of the broker-dealers with exchange memberships, and less than 0.3% of
broker-dealers overall. Although these are well-known retail brokers,
due to the lack of representativeness of the sample (e.g., the majority
of the broker-dealers represented in the Battalio Equity Market Study
are online broker-dealers), these broker-dealers may be more (or less)
likely than the average broker-dealer to route customer orders in ways
that benefit themselves at the expense of their customers. The findings
in the Battalio Equity Market Study, therefore, may not be
representative of a broader sample of broker-dealers. Moreover, the
Commission is unable to determine if the Battalio Equity Market Study's
analyses of the Rule 606 disclosure data has statistical power because
the authors did not provide any statistical analyses beyond the
percentage of market or limit orders routed to a particular exchange.
Similarly, the results of the Nasdaq study may not be
representative of the broader market, as the Nasdaq study affected only
a very small sample of common stocks and focused on order routing to a
single exchange. As discussed in Section II.B, Nasdaq selected 14
stocks to be part of the analysis, which represent only 0.3% of all NMS
stocks. The sample is unlikely to be representative of the universe of
NMS securities for two reasons: (1) The sample included a small number
of stocks (and no ETPs),\272\ and (2) less than one-third of these
stocks were small or mid-capitalization at the time of the analysis,
although most had market capitalizations close to $3 billion
immediately prior to the study.\273\ Further, the analysis only focused
on the effects of changes to transaction-based fees for a single
exchange: Nasdaq. As the other equities exchanges did not have similar
changes to transaction-based fees and rebates, any inferences drawn
from the Nasdaq study may not be valid under different circumstances in
which all equities exchanges were subject to consistent revisions to
transaction-based fees.
---------------------------------------------------------------------------
\272\ Only common stocks were included in the Nasdaq study,
while the proposed Pilot will include NMS stocks, which includes
common stocks as well as ETPs.
\273\ Market capitalizations are computed from CRSP shares
outstanding and stock price, as of December 31, 2014.
---------------------------------------------------------------------------
In the spirit of the Nasdaq study, exchanges could coordinate
voluntarily to simultaneously implement a pilot similar to the Nasdaq
pilot on all exchanges over a broader sample of stocks, to produce more
representative results. The Commission preliminarily believes, however,
that exchanges would not be likely to coordinate changes to access fees
and rebates for the purpose of studying potential conflicts of interest
between broker-dealers and their customers because of competitive
incentives, such as inducements to draw order flow away from
competitors.\274\
---------------------------------------------------------------------------
\274\ With respect to the Nasdaq study, the purpose of revising
access fees and rebates was to determine how these changes affected
market share and Nasdaq's fraction of time at the NBBO.
---------------------------------------------------------------------------
Researchers could conduct studies with data sources currently
available that provide more representative results than those provided
in existing studies. However, the Commission preliminarily believes
that data limitations discussed in greater detail below could make such
studies difficult. Moreover, the results of such studies would unlikely
be able to establish a causal connection between transaction-based fees
and order routing decisions by broker-dealers needed to inform policy
decisions on potential conflicts of interest. The importance of causal
inference is discussed in the next section.
ii. Causality
In addition to limitations in how representative results may be,
existing studies are also of limited use for policy decisions because
they cannot test for causal relationships between transaction fees and
order routing decisions. Because transaction-based fees and order
routing decisions could be jointly determined, researchers cannot
readily disentangle the direction of causality, and therefore cannot
determine the extent that potential conflicts exist. The identification
of causal relations between fees and order routing decisions becomes
increasingly complex because exchanges have some discretion to modify
their fees.\275\ In practice, researchers attempt to identify and
measure causal relations in two ways: (1) Exogenous shocks, which have
been discussed above, and (2) econometric techniques, such as an
instrumental variables approach.\276\
---------------------------------------------------------------------------
\275\ Over the last five years, the exchanges, on average, have
made 34 revisions, or approximately 6.7 revisions per year, to their
transaction-based fees and rebates. See Section V.B.2.b infra.
\276\ The method of instrumental variables is used to estimate
causal relationships when controlled experiments or exogenous shocks
are not feasible. An ``instrument'' changes the explanatory variable
but has no independent effect on the dependent variable, allowing a
researcher to uncover the causal effect of the explanatory variables
on the dependent variable of interest.
---------------------------------------------------------------------------
Although the Nasdaq study implements an exogenous shock, which
could have permitted causal inference regarding the relationships
between transaction fees, order routing, and market quality, that study
did not analyze the impact of potential conflicts of interest on order
routing decisions. Further, even if the Nasdaq study had analyzed a
causal relationship between transaction-based fee and rebates and
potential conflicts of interest, the
[[Page 13046]]
limited representativeness of the Nasdaq sample, would limit the
generality of the study.
With respect to the transition between forms of pricing models that
occurred on the option exchanges, discussed above, the key limitation
is the comparison of maker-taker pricing models with payment for order
flow pricing models. Studies that explore these regime shifts between
maker-taker to payment for order flow models are not comparing
situations in which one regime could theoretically have lower conflicts
of interest than the other.\277\ Each of these types of models is
likely to create potential conflicts of interest that could affect how
broker-dealers route their customer orders,\278\ although evidence does
not suggest that one form of pricing model is more or less prone to
conflicts than another. Moreover, the change from one form of pricing
model to another could introduce new conflicts of interest that did not
previously exist. Therefore, the Commission preliminarily believes that
exchange-driven transitions between maker-taker and payment for order
flow pricing models are not likely to provide information about
potential conflicts of interest driven by the maker-taker and taker-
maker models or to inform the Commission about future regulatory
decisions regarding transaction-based fees.
---------------------------------------------------------------------------
\277\ See supra note 264.
\278\ See Robert Battalio, Andriy Shkilko, and Robert Van Ness,
``To Pay or Be Paid? The Impact of Taker Fees and Order Flow
Inducements on Trading Costs in U.S. Options Markets,'' Journal of
Financial and Quantitative Analysis 51, 1637-1662 (2016), available
at: https://www.cambridge.org/core/services/aop-cambridge-core/content/view/0782CE3E9679C29BB910A66192D27201/S0022109016000582a.pdf/div-class-title-to-pay-or-be-paid-the-impact-of-taker-fees-and-order-flow-inducements-on-trading-costs-in-u-s-options-markets-div.pdf.
---------------------------------------------------------------------------
The Battalio Equity Market Study attempts to test for causal
relationships between liquidity rebates and order routing decisions of
broker-dealers using an instrumental variables approach. However, in
the absence of an exogenous shock to access fee caps or rebates outside
the control of exchanges, the authors are unable to definitively
determine the causes of broker-dealers' order routing decisions through
the use of econometric techniques. Consequently, the authors are unable
to disentangle whether fees and rebates drive broker-dealer order
routing decisions or order routing decisions determine fees and rebates
chosen by exchanges.
Although exchanges revise their fee schedules frequently, the
Commission preliminarily does not believe that studying order routing
and execution quality around these fee changes alone can establish
causality because fee changes are at the discretion of exchanges and
could be caused by changes to order routing behavior. In the absence of
an event outside of the control of the exchanges (e.g., an exogenous
shock to either fees or rebates), identifying the direction of
causality between changes in fees and order routing behavior is nearly
impossible. Thus, any discretionary actions by exchanges to revise
their fee schedules independently of other exchanges is unlikely to
yield information that would be valuable to the Commission for
informing any future policy decisions about potential conflicts of
interest between broker-dealers and their customers.
iii. Existing Data Sources
As noted above, several data sources provide information on order
routing and execution quality. While researchers theoretically could
use these data sources to produce representative results regarding the
relation between transaction-based fees, order routing, and execution
quality, the Commission preliminarily believes that data limitations,
would make these studies difficult to produce.
As discussed previously, Rule 606 disclosures provide information
on order routing. Rule 606 disclosures are currently the only data
publicly available to researchers and others on order routing by
broker-dealers; however, limitations in the Rule 606 data reduce the
ability of researchers to use the data to produce representative
results. The data are cumbersome to collect on a broad scale, as
researchers would generally need to access each broker-dealer's web
page to manually download the data. The Rule 606 data are also only
available at a quarterly frequency, and broker dealers are not required
to maintain historical data, which hampers the ability to efficiently
produce research on multiple quarters of data, and could lead to short
sample periods that may provide relatively limited power for
statistical tests.\279\ Notably, there currently is no central
repository of these data, so any collection of this information by
researchers would be a lengthy and labor-intensive process. For
example, a researcher that has not already downloaded a time series of
Rule 606 reports would need to download one quarter at a time, waiting
three months for each quarter's data to create a time series;
assembling a single year's worth of data would require nine to twelve
months. Such delays could significantly increase the opportunity costs
of undertaking such studies and decrease the likelihood of new research
on the relation between transaction-based fees and order routing
decisions. Moreover, these limitations also could prevent other
researchers and other analysts from verifying or replicating analyses
if researchers did not concurrently collect the Rule 606 reports across
the same periods of observation.
---------------------------------------------------------------------------
\279\ See supra note 118.
---------------------------------------------------------------------------
In addition, the quarterly frequency of the Rule 606 reports by
broker-dealers is different from the frequency of changes in fee
schedules by exchanges (e.g., as presented in Table 2, over a recent
five-year measurement period, the average exchange updated its fees
schedule approximately 6.7 times per year).\280\ Further, while the
Rule 606 data provides order routing at the broker-dealer level, such
information is not granular enough to thoroughly study potential
conflicts of interest.
---------------------------------------------------------------------------
\280\ Not every fee schedule revision pertains to access fees or
rebates. To focus only on these revisions, each Form 19b-4 fee
filing was evaluated to determine that revisions to fees or rebates
were pertinent to this baseline.
---------------------------------------------------------------------------
The value of Rule 606 disclosures for identifying possible
conflicts of interest resulting from transaction-based fees would be
limited for a number of additional reasons, even if the Commission were
to require a historical time series of these disclosures for all
broker-dealers.
First, each broker-dealer discloses data for only its top ten order
routing venues. Second, because broker-dealers disclose data at a
quarterly frequency, a five-year sample of Rule 606 data for a single
broker-dealer, would include only 20 observations, limiting statistical
power. Third, although Rule 606 reports also provide some disclosure
about potential broker-dealer conflicts of interest, they do not
include any disclosure of access fees assessed or rebates offered by
exchanges to the broker-dealers. Fourth, Rule 606 data do not
distinguish between marketable and non-marketable limit orders.
Finally, Rule 606 currently covers only retail orders. If institutional
orders also are subject to potential conflicts of interest, studying
Rule 606 data alone would not inform on such conflicts of interest.
To produce representative results using proprietary broker-dealer
or exchange data would require obtaining these data from a sufficient
number of diverse broker-dealers and exchanges. However, proprietary
data from broker-dealers or exchanges are generally not available to
the public. While some researchers have obtained such data
[[Page 13047]]
from a single broker-dealer or exchange, and some broker-dealers and
exchanges employ their own researchers, the Commission preliminarily
believes that it would be difficult for researchers to obtain such data
from a sufficient number of broker-dealers or exchanges in order to
produce representative results.
Regardless of whether researchers would obtain data from Rule 606
disclosures or directly from exchanges, much of the data currently
available is either unstructured or in a non-standardized format. For
instance, many broker-dealers provide PDF files of Rule 606
disclosures, while exchanges use bespoke terminology to classify their
fees and rebates, which likely limits the value of these data for
researchers examining the effect of fees and rebates on order routing
decisions. This lack of standardization across platforms could make it
difficult for researchers to aggregate data and construct
representative samples for comparison and analyses.
While Rule 605 and TAQ data are available to researchers and may
provide information about execution quality, they too have a number of
limitations. For example, Rule 605 data provides execution quality
information for both marketable and non-marketable orders; however, the
methodologies for estimating measures of the speed of execution of non-
marketable orders are outdated.\281\ For instance, Rule 605 measures
realized spreads based on quotations five minutes after the time of
order execution and recent research suggests using quotations that more
closely follow a trade, because any temporary price impact of a trade
goes away within seconds, not minutes, of the trade.\282\ Like Rule 606
data, Rule 605 data also covers smaller retail-sized orders only, and
the data are only available at the monthly frequency. Instead,
researchers and the Commission could rely on TAQ data, a publicly
available dataset provided by the NYSE to subscribers, in order to
capture some measures of execution quality. However, the TAQ data has
limited information on limit order execution quality that would be
valuable to the Commission and others.
---------------------------------------------------------------------------
\281\ See Concept Release, supra note 3.
\282\ See, e.g., Jennifer Conrad and Sunil Wahal, ``The Term
Structure of Liquidity Provision,'' Working Paper, University of
North Carolina--Chapel Hill (2017), available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2837111.
---------------------------------------------------------------------------
To incorporate transaction-based fee information into analyses,
researchers would need to manually collect and compile the information
from exchanges' websites and their Form 19b-4 fee filings, which notify
the Commission of changes to those fee schedules. Although the current
fee schedules are posted on exchange websites, in order to identify
changes to those fees, researchers would need to search the
Commission's website for such Form 19b-4 fee filings to identify when
exchanges change their fees and to gather information about those fees,
as exchanges do not file their fees on a routine basis, but rather only
when making changes. Such information would be cumbersome to compile.
Additionally, because of the complexity of exchange fee structures and
the lack of standardization of these structures across exchanges,
identifying comparable fees across exchanges is unwieldy. For example,
identifying the base or top-tier fees across exchanges could be
difficult for researchers. As shown in Table 2 below, the average
exchange has 24 different access fee categories and 21 different rebate
categories. Further, exchanges do not disclose per share average or
median fees charged and rebates earned on any report or filing, so such
information is unavailable to the public. To add to the impediments to
fee data aggregation and comparison, Form 19b-4 fee filings are
available only as PDF files downloadable from the Commission's website,
thereby increasing the costs of aggregation across exchanges over time
by researchers.
Even if limitations to data availability and aggregation were
overcome and researchers could construct a representative sample of fee
and routing data, researchers would still face obstacles in
understanding the relationship between transaction-based fees and
rebates and routing decisions. Without an exogenous shock to fees and
rebates to infer the causal relation between these transaction-based
fees and order routing decisions, researchers would not be able to
analyze whether the order routing decisions observed are driven by fees
and rebates or vice versa.\283\
---------------------------------------------------------------------------
\283\ See Section V.B.1.b.ii supra.
---------------------------------------------------------------------------
2. Current Market Environment
This section provides an overview of the market for trading
services, and of the exchanges and ATSs that could be affected as a
result of revisions to the transaction-based fee structure required by
the proposed Pilot. Where information is currently available to the
Commission, a description of the current practices of exchanges along
dimensions that are relevant to the proposed Pilot (e.g., summary
information on their current fee schedule or the frequency of fee
revisions) are included.
a. Market for Trading Services
The market for trading services, which is served by exchanges,
ATSs, and other liquidity providers (internalizers and others),\284\
relies on competition to supply investors with execution services at
efficient prices. These trading venues, which compete to match traders
with counterparties, provide a platform for price negotiation and
dissemination of trading information. The market for trading services
in NMS securities consists of 13 national equity market exchanges and
34 ATSs. Other off-exchange venues include internalizers and
wholesalers, which execute a substantial volume of retail order flow.
The remainder of this section discusses the current competitive
landscape for exchanges and ATSs relevant to our economic analysis of
the proposed Pilot.
---------------------------------------------------------------------------
\284\ See supra note 247.
---------------------------------------------------------------------------
Since the adoption of Regulation NMS in 2005, the market for
trading services has become more fragmented and competitive. As of July
18, 2017, 13 national equity market exchanges operate in the U.S., as
shown in Table 1. Of these exchanges, nine are maker-taker exchanges
and two are taker-maker pricing exchanges; the EDGA and IEX operate as
flat-fee exchanges.\285\ Since Regulation NMS was adopted in 2005, the
market for trading services has become significantly more competitive
as measured by the decline in market share of individual exchanges,
discussed in more detail below. The number of U.S. equities exchanges
has increased by over 60%, as the number of exchanges increased from
eight exchanges in 2005 to 13 exchanges operating today, as shown in
Table 1.\286\
[[Page 13048]]
Several studies have suggested that transaction-based fee pricing
partially drove the increase in the number of U.S. equities exchanges
since 2005.\287\
---------------------------------------------------------------------------
\285\ IEX charges a flat fee of $0.0009 for trades against non-
displayed liquidity on both sides of the market, and charges $0.0003
for trade execution against displayed liquidity. See https://iextrading.com/trading/fees. As of March 2018, EDGA is no longer
operating as a taker-maker market, but is also operating as a flat-
fee venue. See https://markets.cboe.com/us/equities/.
\286\ Although 13 U.S. equities exchanges currently operate as
of March 2018, the majority of these exchanges are part of exchange
families. For instance, NYSE, NYSE Arca, NYSE American, and NYSE
National, are all part of the NYSE Group, which is wholly owned by
the Intercontinental Exchange (ICE), while Nasdaq, Phlx, and BX, are
owned by Nasdaq. BATS, BATS-Y, EDGA, and EDGX, which all operated as
ATSs in 2005, are all subsidiaries of Cboe Global Market, Inc.
Although many exchanges belong to exchange groups, the Commission
preliminarily believes that each of these exchanges operates
independently of the other exchanges owned by the same parent
company. IEX became a registered exchange in 2016. Further, NSX
(NYSE National) existed as an exchange in 2005, but halted
operations in 2016. It was acquired by NYSE/ICE in January 2017,
which indicated at the time of the acquisition that it will operate
the exchange as NYSE National. See ``NYSE Finalizes Acquisition of
National Stock Exchange,'' Press Release, Intercontinental Exchange
(January 31, 2017), available at: https://ir.theice.com/press/press-releases/all-categories/2017/01-31-2017-232800326. Researchers can
adequately control for exchanges that are subsidiaries of the same
parent when conducting analyses of the effect of changes in
transaction-based fees on order routes.
\287\ See, e.g., Angel, Harris, and Spatt, supra notes 106 and
216; Harris, supra note 23.
---------------------------------------------------------------------------
Execution services are a lucrative business, which encourages new
trading centers to enter the market in the hopes of capturing rents
associated with order execution.\288\ As discussed above, liquidity
externalities, where the more liquid venues attract more interest and
therefore more liquidity, could result in a single venue (or very
limited number of venues) being the preferred trading location for any
given stock because all traders could optimally route orders to the
venue with the highest liquidity for a given stock.\289\ If rebates
offered by exchanges are large enough, they provide incentives for
market participants to route orders to those venues, in order to
capture the rebates. Rebates offered by exchanges, therefore, may
``break'' the liquidity externality.
---------------------------------------------------------------------------
\288\ See id.
\289\ Liquidity externalities are discussed in more detail in
Section V.A.2, supra.
\290\ Shares are computed based on share volume. Market shares
for the exchanges reported do not add up to 100%, since
approximately 37% of share volume trades off-exchange on over-the-
counter venues.
\291\ As of March 2018, EDGA is no longer operating as a taker-
maker exchange and is now operating as a flat-fee venue; however, it
was operating as one as of July 2017 when the data for this table
was obtained.
\292\ In 2005, BX existed as the Boston Stock Exchange.
\293\ As of July 2017, NYSE American is no longer a purely
maker-taker market as only certain types of market participants
(electronic Designated Market Makers) are eligible for rebates. See
NYSE American Equities Price List, available at: https://www.nyse.com/publicdocs/nyse/markets/nyse-american/NYSE_America_Equities_Price_List.pdf.
\294\ NYSE acquired NSX in January 2017, and the exchange is now
known as NYSE National. Although not currently operational, the
Commission has assumed for the purposes of this analysis that it
will be operational during the Pilot.
Table 1--U.S. National Equities Exchanges as of July 2017
----------------------------------------------------------------------------------------------------------------
Exchange in Market Share
Exchange Market fee type 2005? \290\ (%)
----------------------------------------------------------------------------------------------------------------
Cboe BZX--https://markets.cboe.com............. Maker-Taker....................... ........... 5.95
Cboe BYX--https://markets.cboe.com............. Taker-Maker....................... ........... 4.80
Cboe EDGA \291\--https://markets.cboe.com...... Taker-Maker....................... ........... 1.64
Cboe EDGX--https://markets.cboe.com............ Maker-Taker....................... ........... 6.38
BX \292\--www.nasdaqtrader.com................. Taker-Maker....................... [check] 3.02
Phlx (PSX)--www.nasdaqtrader.com............... Maker-Taker....................... [check] 0.76
Nasdaq--www.nasdaqtrader.com................... Maker-Taker....................... [check] 14.51
NYSE Arca--https://www.nyse.com/markets........ Maker-Taker....................... [check] 9.03
NYSE American \293\--https://www.nyse.com/ Maker-Taker....................... [check] 0.34
markets.
NYSE--https://www.nyse.com/markets............. Maker-Taker....................... [check] 13.90
NYSE National \294\--https://www.nyse.com/ Maker-Taker....................... [check] ..............
markets.
CHX--www.chx.com............................... Maker-Taker....................... [check] 0.42
IEX--www.iextrading.com........................ .................................. ........... 2.14
----------------------------------------------------------------------------------------------------------------
Table 1 also highlights that market share of trading volume among
exchanges is not very concentrated. Although NYSE and Nasdaq have the
largest overall total volume market shares of approximately 14% each
among the exchanges, as of July 2017, these two exchanges collectively
account for less than 30% of the total market share of trading volume
for NMS securities, indicating that the market for trading services has
become decentralized, and has become more so over time. For instance,
between 2004 and 2013, the market share of NYSE-listed stocks on the
NYSE declined from approximately 80% to 20%, while market share on
other exchanges and off-exchange trading centers has increased.\295\
This decentralization provides market participants with a choice among
venues when they route orders, and may also encourage exchanges to
attract order flow. For instance, transaction-based fees represent one
means by which national securities exchanges may compete for order
flow, and exchanges may adopt business models that focus on attracting
order flow by offering large rebates or charging competitive fees.
Exchanges may compete for order flow on other dimensions as well, by
offering better execution quality and innovations in order types and
other trading mechanisms.
---------------------------------------------------------------------------
\295\ See Angel, Harris, and Spatt, supra note 216, Figures 2.17
and 2.18. Although less evident than for NYSE-listed securities, the
effect is similar for the Nasdaq market.
---------------------------------------------------------------------------
In addition to competing with other U.S. equities exchanges,
exchanges also compete for order flow from off-exchange trading
centers, including ATSs, internalizers, and others. Broker-dealers may
opt to route order flow off-exchange, as they may be able to avoid
access fees paid to exchanges for doing so. Off-exchange trading makes
up a substantial fraction of total volume, as approximately 37% of all
transaction reports are routed using the NYSE and Nasdaq Trade
Reporting Facilities as of July 2017.\296\ Of that off-exchange NMS
share volume, approximately 13% was attributable to ATSs, of which 34
traded NMS securities as of July 2017.\297\ The remaining 24% of off-
exchange share volume is routed to other off-exchange trading centers,
such as internalizers.\298\ In aggregate, broker-dealers and other
market participants have a large and varied set of options as to where
they route orders, whether to exchanges or to
[[Page 13049]]
off-exchange trading centers. Moreover, empirical evidence suggests
that traditional exchanges, such as NYSE and Nasdaq, are losing market
share to off-exchange trading centers and newer exchanges,\299\ which
may provide different incentives to broker-dealers in order to attract
this order flow, including access fees and rebates. We discuss the
current environment for transaction-based fees in the next section.
---------------------------------------------------------------------------
\296\ Data on off-exchange market share are available from the
BATS Global Market web page, available at https://markets.cboe.com/us/equities/market_share/
\297\ The estimates of ATSs that trade NMS stocks and ATS trade
volume share was developed using weekly summaries of trade volume
collected from ATSs pursuant to FINRA Rule 4552. See also Securities
Exchange Act Release No. 76474 (November 18, 2015), 80 FR 80998,
81109 (December 28, 2015) (Regulation of NMS Stock Alternative
Trading Systems). The estimates in this release were calculated in
the same manner as in the cited release. See also ``OTC (ATS & Non-
ATS) Transparency,'' FINRA, available at: https://www.finra.org/Industry/Compliance/MarketTransparency/ATS/.
\298\ Total market share is collected from the BATS Global
Market web page, available at: https://markets.cboe.com/us/equities/market_share/. ATS weekly market share is collected from FINRA,
available at: https://otctransparency.finra.org.
\299\ See Angel, Harris, and Spatt, supra note 216.
---------------------------------------------------------------------------
The proposed Pilot is also likely to affect competition among
broker-dealers that route institutional and retail orders. These
broker-dealers compete in a segment of the market for broker-dealer
services. The market for broker-dealer services is highly competitive,
with most business concentrated among a small set of large broker-
dealers and thousands of small broker-dealers competing in niche or
regional segments of the market.\300\ Large broker-dealers typically
enjoy economies of scale over small broker-dealers and compete with
each other to service the smaller broker-dealers, who are both their
competitors and their customers.\301\ As of December 31, 2016,
approximately 4,000 broker-dealers filed Form X-17a-5. These firms
varied in size, with median assets of approximately $725,000, average
assets of nearly $1 billion, and total assets across all broker-dealers
of approximately $3.9 trillion. The twenty largest broker-dealers held
approximately 75% of the assets of broker-dealers overall, with total
assets of $2.93 trillion, indicating the high degree of concentration
in the industry. Of the 3,972 broker-dealers that filed Form X-17a-5,
430 are members of U.S. equities exchanges. Broker-dealers that are
members of equities exchanges had, on average, higher total assets than
other broker-dealers, with median assets of $21 million, average assets
of $8.6 billion, and total assets across all broker-dealers that are
members of exchanges of $3.6 trillion.
---------------------------------------------------------------------------
\300\ See Securities Exchange Act Release No. 63241 (November 3,
2010), 75 FR 69791, 69822 (November 15, 2010) (``Risk Management
Controls for Brokers or Dealers with Market Access'').
\301\ See id.
---------------------------------------------------------------------------
b. Transaction-Based Fees and Rebates
Exchanges are required to disclose their current fee schedules,
which include transaction-based fees and rebates, connectivity fees,
membership fees, among others.\302\ When exchanges update their fees,
they are required to file Form 19b-4 with the Commission, which if
filed pursuant to Section 19(b)(3)(A) makes fee changes effective upon
filing.\303\ Although these fee schedules and Form 19b-4 fee filings
contain information about fees beyond transaction-based fees and
rebates, in this baseline, the discussion is limited to only
transaction-based fees and rebates and any changes thereto.
---------------------------------------------------------------------------
\302\ See 17 CFR 240.19b-4(m)(1), which requires each SRO to
post and maintain a current and complete version of its rules,
including those related to transaction-based fees and rebates, on
its website.
\303\ As discussed in Section V.B.1.b.iii supra, fee
information, such as that included in exchange fee schedules or Form
19b-4 fee filings, does not have standardization or formatting
requirements.
---------------------------------------------------------------------------
Table 2 reports the range of minimum and maximum access fees and
rebates, as well as the number of categories for each (in parentheses
below the fee ranges), by exchange, for the most recently available fee
schedule.\304\ On average, U.S. exchanges have 24 access fee categories
and 21 rebate categories associated with these fee schedules. For the
maker-taker exchanges, access fees are capped at $0.0030, but are as
little as zero in some fee categories for some exchanges; taker-maker
exchanges, because they are not restricted in the amount they can
charge to non-marketable limit orders, have fees that range as high as
$0.0033. Seven exchanges have some categories of rebates that exceed
the maximum access fees charged by exchanges.
---------------------------------------------------------------------------
\304\ The access fee and rebate ranges in Table 2 are collected
from recent fee schedules (as of July 18, 2017) available from each
individual exchange's website (listed in Table 1). Table 2 provides
the date from which these fee schedules were reported. The ranges in
fees are the minimum and maximum fees and rebates reported by each
exchange.
---------------------------------------------------------------------------
Table 2 also provides the number of fee revisions for the exchanges
as reported in their Form 19b-4 fee filings to the Commission in the
last five years (July 16, 2012-July 18, 2017). Exchanges, on average,
have changed their fee schedules 34 times in the last five years,\305\
indicating that the average exchange revises its transaction-based fee
schedules about seven times per year (approximately every 7.4 weeks).
---------------------------------------------------------------------------
\305\ The median number of revisions to fee and rebate schedules
by exchanges is 38 over the five-year period.
Table 2--Summary of Transaction-Based Fee Schedules for U.S. National Equities Exchanges as of July 2017
--------------------------------------------------------------------------------------------------------------------------------------------------------
Number of Date of last
Exchange revisions (5 fee schedule Access fees (# of categories) Rebates (# of categories)
years) available
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cboe BZX.............................. 40 7/15/2017 $0.0000-$0.0030 (31)................... $0.0010-$0.0032 (16)
Cboe BYX.............................. 45 7/15/2017 $0.0000-$0.0033 (36)................... $0.0010-$0.0025 (12)
Cboe EDGA............................. 47 7/15/2017 $0.0000-$0.0032 (48)................... $0.0011-$0.0027 (10)
Cboe EDGX............................. 64 7/15/2017 $0.0000-$0.0030 (37)................... $0.0011-$0.0034 (19)
BX.................................... 31 7/13/2017 $0.0005-$0.0030 (10)................... $0.0000-$0.0025 (8)
Phlx (PSX)............................ 26 7/15/2017 $0.0026-$0.0030 (5).................... $0.0023-$0.0031 (7)
Nasdaq................................ 59 7/20/2017 $0.0030 (2)............................ $0.0000-$0.0034 (36)
NYSE Arca............................. 51 7/3/2017 $0.0006-$0.0030 (68)................... $0.0002-$0.0033 (61)
NYSE American......................... 9 7/24/2017 $0.0003-$0.0030 (34)................... $0.0000-$0.0045 (41)
NYSE.................................. 38 7/1/2017 $0.0003-$0.0030 (14)................... $0.0000-$0.0045 (40)
NYSE National \306\................... 19 9/20/2016 $0.0003-$0.0030 (2).................... $0.0000 (1)
CHX................................... 8 5/3/2017 $0.0030 (1)............................ $0.0020 (1)
IEX................................... 1 8/19/2016 $0.0009................................ -$0.0009
--------------------------------------------------------------------------------------------------------------------------------------------------------
For several of the exchange families, information about revenues
and costs attributed to transaction-based fees and rebates is available
in aggregate from Form 10-K filings. Using the statements of income
from Form 10-K filings for 2016 capturing the net (of rebates)
transactions-based revenues, the Nasdaq exchanges (Nasdaq, BX, and PSX)
[[Page 13050]]
earned $564 million.\307\ Based on the same measure the NYSE-affiliated
exchanges (NYSE, NYSE Arca, NYSE American, and NYSE National) earned
$223 million in transaction-based fees net of rebates,\308\ while the
BATS Global Markets (now, Cboe BZX, Cboe BYX, Cboe EDGA, and Cboe
EGDX), for the nine months ended September 30, 2016, earned $177
million in transaction-based fees net of rebates.\309\ Neither CHX nor
IEX or their affiliates are publicly traded, meaning that these
exchanges do not file an annual Form 10-K with the Commission. As a
result, public information regarding the revenues or profits associated
with transaction-based fees does not exist for these exchanges.
---------------------------------------------------------------------------
\306\ NYSE acquired NSX in January 2017, and the exchange is now
known as NYSE National. As of March 2018, the exchange currently has
not submitted new fee schedules nor has it reported any trading
volume in recent months.
\307\ See the Nasdaq 2016 Form 10-K filings, available at:
https://www.sec.gov/Archives/edgar/data/1120193/000112019317000003/ndaq1231201610-k.htm. Net transaction-based revenues for equity
securities were approximately 25% of total operating margin.
\308\ See the Intercontinental Exchange 2016 Form 10-K filings,
available at: https://otp.investis.com/clients/us/intercontinental_exchange_group2/SEC/sec-show.aspx?Type=html&FilingId=11827791&Cik=0001571949. For the
Intercontinental Exchange, net transaction-based revenues were
approximately 10% of operating income for 2016.
\309\ See the Bats Global Markets Form 10-Q filings (September
30, 2016), available at: https://www.snl.com/Cache/36600023.pdf. Cboe
announced its intent to acquire BATS Global Markets in September
2016, and the acquisition became effective on March 1, 2017. For the
nine-month ending September 30, 2016, the net transaction-based
revenues were 62% of BATS operating profits over the same time
period.
---------------------------------------------------------------------------
Information on the net transactions-based revenues for each
individual exchange, as opposed to the amounts reported for exchange
groups in Form 10-K filings, is not currently publicly available,
making it difficult to analyze the fees and rebates for an individual
exchange. To estimate the net transactions-based revenues for each
individual exchange, Table 3 reports the maximum and median net
transaction-based fees based on each exchange's most recently reported
fee schedule and the share volume of each exchange for June 16, 2017
through July 18, 2017.\310\ As evidenced by the significant differences
between the sum of net of rebate revenues for entities reporting to the
same exchange group obtained from Table 3 and the total net of rebate
revenues for each exchange family reported on the Form 10-K or 10-Q
filings, this approach does not yield reliable results, highlighting
the limitations on the data currently available to researchers.
---------------------------------------------------------------------------
\310\ The share volume is obtained from the Cboe website,
available at https://markets.cboe.com/us/equities/market_share/. To
compute the maximum profit attainable, staff took the difference
between the highest possible access fee and the lowest possible
rebate and multiplied it by the monthly share volume. For a midpoint
profit, the median of the access fees less the median of the rebates
is computed and multiplied it by share volume. In order to make the
results comparable to those reported above from Form 10-K filings,
the monthly profits are annualized by multiplying each monthly
profit amount by 12.
Table 3--Estimates of Annualized Per-Exchange Net Transaction-Based Fee Revenues From Transaction-Based Fees and
Monthly Exchange Share Volume
[for June 16, 2017-July 18, 2017]
[in millions]
----------------------------------------------------------------------------------------------------------------
Annualized Per share Annualized Per share
Exchanges Share volume midpoint profit maximum profit
\311\ difference (median) difference (maximum)
----------------------------------------------------------------------------------------------------------------
Cboe BZX........................ 8,677 ($62.5) ($0.0006) $208.2 $0.0020
Cboe BYX........................ 7,003 (8.4) (0.0001) 193.3 0.0023
Cboe EDGA....................... 2,388 (8.6) (0.0003) 60.2 0.0021
Cboe EDGX....................... 9,310 (83.8) (0.0008) 212.3 0.0019
BX.............................. 4,411 24.5 0.0005 158.8 0.0030
Phlx (PSX)...................... 1,115 1.3 0.0001 9.4 0.0007
Nasdaq.......................... 21,171 330.3 0.0013 762.2 0.0030
NYSE Arca....................... 13,175 7.9 0.0001 442.7 0.0028
NYSE American................... 494 (3.6) (0.0006) 17.8 0.0030
NYSE............................ 20,277 (146) (0.0006) 730 0.0030
NYSE National................... .............. .............. .............. .............. ..............
CHX............................. 609 7.3 0.0010 7.3 0.0010
IEX............................. 3,117 N/A $0.0000 N/A 0.0000
----------------------------------------------------------------------------------------------------------------
C. Analysis of Benefits and Costs of Proposed Transaction Fee Pilot
---------------------------------------------------------------------------
\311\ Monthly share volume obtained from Cboe for June 16, 2017
through July 18, 2017, available at https://markets.cboe.com/us/equities/market_share/.
---------------------------------------------------------------------------
1. Benefits of Proposed Transaction Fee Pilot
The Commission expects that the benefits of the proposed
Transaction Fee Pilot would fall into two categories: More informed
policy decisions, including more information about potential conflicts
of interest between broker-dealers and their customers (primary
benefits) and more information on other issues important to the
Commission (ancillary benefits), as well as other benefits that may
accrue to market participants for the duration of the proposed Pilot.
In this section we discuss each of the categories of benefits as well
as potential limitations to those benefits.
a. Benefits of More Informed Policy Decisions
i. Benefits of Studying Potential Conflicts of Interest
The Commission preliminarily believes that the proposed Transaction
Fee Pilot would lead to a more thorough understanding of issues related
to potential conflicts of interest arising from transaction-based
pricing models, which would ultimately inform the Commission's policy
decisions. This increased understanding would derive from design
elements of the proposed Transaction Fee Pilot that address the
limitations of currently available information described in the
baseline: Lack of representative results, inability to identify
causality, and insufficient publicly available data. The data obtained
will improve the quality of research and analysis by the Commission and
others, which will provide additional data about the effect of
transaction-based fees on order routing decisions of broker-dealers in
ways that reflect potential conflicts of interest with their clients.
The Commission believes that these additional data, which would be
unavailable in the absence of the proposed Pilot, would help the
[[Page 13051]]
Commission make more informed and effective future policy decisions to
the ultimate benefit of investors.
To obtain the additional data to understand the relationship
between fees and rebates and order routing decisions, the proposed
Transaction Fee Pilot would simultaneously create several different fee
environments, each of which restricts transaction-based fees
differently, and would make available data that allows researchers to
compare order routing, execution quality, and market quality in these
fee environments to the current fee environment. The study of these
comparisons would inform the Commission and the public about any
possible conflicts of interest that arise as a result of transaction-
based fees. The Commission preliminarily believes that the different
fee environments created by the proposed Pilot, even though implemented
temporarily and over representative subsamples NMS securities, would
produce effects on order routing decisions by broker-dealers that are
identical or similar to those that would arise under a similar
permanent change to our regulatory environment. Therefore, the
Commission preliminarily believes that the information obtained from
the Pilot will help inform our consideration of any future proposals.
As noted, three distinct features of the proposed Pilot's design
would facilitate analyses of the relationship, if any, between fees and
potential conflicts of interest. Specifically, the proposed Pilot is
designed to provide (1) representative results; (2) sufficient
information to determine causality; and (3) more direct access to data
that is currently unavailable or requires lengthy and labor-intensive
effort to compile and process. The following sections discuss in detail
each of these aspects of the proposed Pilot and how they could improve
upon the information currently available.
A. Representative Results
In the context of the proposed Transaction Fee Pilot,
representativeness of results means that the impact of the proposed
Pilot's terms on a Test Group during the Pilot Period is likely to be
consistent with the impact of the results on the Test Group if the
Pilot's terms were permanent (as opposed to temporary).
Representativeness is desirable for researchers and policy makers
because it ensures that inferences drawn from the results of analysis
of Pilot data are likely to be similar to those that would emerge if
the terms were permanent. As discussed in the baseline, current
analyses are limited in their ability to broadly inform policy choices
by some combination of the following: Order routing data from a single
broker-dealer, a small sample of securities, a single exchange, or a
short sample period. By contrast, the Commission preliminarily believes
that the proposed Pilot, as designed, would produce more representative
results. Specifically, as discussed in detail below, the proposed Pilot
would cover a large stratified sample of nearly all NMS stocks
(including ETPs), both maker-taker and taker-maker exchanges, and
access fee caps as well as a prohibition on rebates or Linked Pricing,
and would have a two-year duration with an automatic sunset at the end
of the first year unless the Commission determines, at its discretion,
that the proposed Pilot shall continue for up to another year.\312\ The
proposed Pilot also would capture and make available to the public for
research and analysis, a comprehensive database of the order routing
decisions of all broker-dealers that route orders to U.S. equities
exchanges. As detailed in the baseline, it would be infeasible for
researchers to compile current data sources across all broker-dealers.
---------------------------------------------------------------------------
\312\ As designed, the proposed Pilot will only exclude NMS
securities that have prices below $2.00 per share as of the date of
pilot selection. As detailed above, the data would also be produced
for a six-month pre-Pilot Period and a six-month post-Pilot Period.
---------------------------------------------------------------------------
The Commission preliminarily believes that the proposed Pilot would
produce representative results, presenting a significant improvement on
existing studies, because the proposed Pilot applies to a large
stratified sample of NMS stocks (including ETPs) with prices of at
least $2.00 per share at the date of the Pilot Securities selection,
and with no restrictions on market capitalization. In particular, the
Commission recognizes that any possible conflicts of interest related
to transaction-based fees could vary across securities such that the
results of a pilot focused only on large capitalization stocks may not
provide information relevant to small capitalization stocks or
ETPs.\313\ Including nearly all NMS securities allows the results to
inform policy choices across any subset of these securities. The
stratification of the stocks selected for each test group is designed
to ensure that each test group and the control group have a similar
composition, facilitating a comparison across groups, which further
supports the representativeness of results. If, for instance, the test
groups and control group had a different composition, researchers might
not be able to distinguish whether differences across test groups and
the control group stem from different fee environments or different
sample composition, rendering the results less representative. In
addition, the Commission preliminarily believes that the sample sizes
in the test groups are sufficient to provide the statistical power
necessary to identify differences across the samples.
---------------------------------------------------------------------------
\313\ See, e.g., Battalio Equity Market Study, supra note 22.
---------------------------------------------------------------------------
Representativeness of results of the Pilot would also be promoted
by the choice of the Pilot Security selection date. The proposed rule
would allow the Commission to select the Pilot Securities at any point
in time up to Pilot start date. As noted in Section III.E.1, the
Commission anticipates that it would assign and designate by notice
each Pilot Security to one Test Group or the Control Group
approximately one month prior to the start of the Pilot. By assigning
securities close to the start of the Pilot, each Test Group and the
Control Group are likely to be more comparable during the Pilot.
Because stratification criteria (e.g., market capitalization and
liquidity) vary naturally over time, the closer the assignments occurs
to the proposed Pilot effective date, the more comparable the Test
Groups would be during the proposed Pilot. Selection of securities
close to the start of the proposed Pilot would also be more likely to
include the intended universe of securities, by capturing securities
that enter the market between the possible adoption of the rule and the
start of the proposed Pilot, while avoiding securities that exit during
this period. Further, to the extent that market participants would
change their behavior in anticipation of the proposed Pilot, setting
the selection period close to the proposed Pilot effective date could
reduce the effect of such behavior on pre-Pilot data.
The results of the proposed Pilot would be further representative
because the proposed Pilot applies to all U.S. equities exchanges
regardless of fee structure. Broker-dealers potentially face
transaction-fee related conflicts of interest regardless of whether
those fees are on maker-taker exchanges or taker-maker exchanges.
Further, a pilot that addresses only a single fee structure would not
produce results relevant for policy choices that also would apply to
another fee structure.
Applying the proposed Pilot to all exchanges also improves upon the
existing analysis of the limited fee experiment conducted by Nasdaq,
which only covered a single exchange, as explained in Section V.B.1.
While the results from that study are suggestive
[[Page 13052]]
that broker-dealers routed customer orders to other exchanges that did
not change their transaction-based fees, reasons other than potential
conflicts of interest could have impacted the changes in order routing
decisions. The Commission believes that the proposed Pilot would
achieve representativeness by requiring transaction-fee changes for all
U.S. equities exchanges, which would allow researchers to identify how
these revisions affect order routing decisions across exchanges.
Further, the proposed Pilot would require that changes to fees or
rebates would be applied at the security level, which means that for
any given security, the limitation on access fees or rebates would be
ubiquitous across all exchanges.
In addition, the proposed Pilot achieves representativeness by
imposing access fee caps and a prohibition on rebates or Linked
Pricing. The existing literature suggests that the potential conflicts
of interest arising from access fees could induce behavior that would
be different from the behavior induced from conflicts arising from
rebates or Linked Pricing. Therefore, the inclusion of caps on both
access fees and rebates or Linked Pricing allows for a more
comprehensive analysis of any possible conflicts of interest than could
be achieved by focusing solely on access fees or rebates. For example,
Test Group 2 limits access fees to $0.0005, which could feasibly limit
rebates paid on displayed liquidity, while Test Group 3 strictly
prohibits rebates or Linked Pricing across the entire depth of book for
displayed and non-displayed liquidity. On the surface, it appears that
Test Groups 2 and 3 both could eliminate rebates paid to broker-
dealers; however, these categories are not equal in their ability to
reduce rebates.\314\
---------------------------------------------------------------------------
\314\ The Commission preliminarily believes that applying the
top of book and depth of book restriction to Test Group 3, but not
in Test Group 2, is not an area of significant difference between
the two test groups. Section III.C.3, supra, provides discussion for
why Test Groups 1 and 2 do not have requirements to access fees for
non-displayed or depth-of-book liquidity.
---------------------------------------------------------------------------
Test Group 3 would completely prohibit rebates or Linked Pricing,
which could provide information on how exchanges compete for order flow
when rebates are not an option for exchanges, and could provide insight
into the equilibrium level of access fees in the absence of rebates or
Linked Pricing.\315\ Prohibiting exchanges from offering rebates or
Linked Pricing in Test Group 3 is necessary to maintain the economic
integrity of Test Group 3 and to provide information about Test Group 3
consistent with its objective to test the impact of eliminating rebates
on the natural equilibrium level of fees, within the current regulatory
structure, and the potential conflicts of interest that rebates may
cause.\316\ Although Rule 610(c) of Regulation NMS caps the maximum
access fee for exchanges at $0.0030, in the absence of rebates or
Linked Pricing, competition among exchanges could drive the average
access fee to an amount substantially below $0.0030.\317\ In other
words, Test Group 3 would allow competition among exchanges, in the
absence of rebates or Linked Pricing, to determine the level of access
fees from which exchanges have no incentive to move away.
---------------------------------------------------------------------------
\315\ Equilibrium refers to conditions of a system in which all
competing influences are balanced. For instance, with respect to the
Test Group 3, this could be the level of access fee charged by
exchanges from which no exchange has any incentive to increase or
decrease that fee. This would be the equilibrium access fee.
\316\ If Linked Pricing were not prohibited, market participants
could potentially circumvent the prohibition on rebates through
Linked Pricing mechanisms. Therefore, including prohibitions on
rebates or Linked Pricing could provide information to the
Commission and the public about potential conflicts of interest
associated with rebates or substitutes for rebates, such as Linked
Pricing, as well as the equilibrium fee that emerges in the absence
of rebates or Linked Pricing.
\317\ In addition to removing rebates or Linked Pricing in Test
Group 3, the Commission could also temporarily suspend limitations
on access fee caps imposed by Rule 610(c) of Regulation NMS.
However, implementing multiple changes within a single test group
may prevent researchers and others from clearly determining the
effect of the prohibition of rebates on order routing decisions of
broker-dealers from the effect resulting from the removal of access
fee caps.
---------------------------------------------------------------------------
The Commission further preliminarily believes that the duration of
the proposed Pilot would produce sufficiently representative results.
If broker-dealers incorporate transaction fees and rebates into their
order routing decisions, a two-year duration for the proposed Pilot,
with an automatic sunset at the end of the first year, unless the
Commission publishes a notice determining that the proposed Pilot shall
continue for up to a second year, would likely make it economically
worthwhile for broker-dealers to change their routing behavior during
the Pilot by making it costly to avoid the proposed Pilot.
Specifically, as discussed below, the Commission recognizes that
broker-dealers would incur costs to incorporate new fee schedules that
are consistent with the proposed Pilot's requirements into their order
routing decisions. Broker-dealers could ignore the Pilot to avoid these
costs. If enough broker-dealers ignore the Pilot, the Pilot might not
produce results that provide the Commission and the public a sense of
the likely impact of permanent changes to fee caps or rebates. However,
to the extent that broker-dealers incorporate transaction-based fees
and rebates into their order routing decisions, ignoring the proposed
Pilot would also be costly for broker-dealers, and these costs increase
with the duration of the Pilot. The Commission preliminarily believes
that the proposed Pilot duration, even with a one-year sunset, is long
enough to produce representative results because, as discussed below in
Section V.C.2.b, broker-dealers that incorporate transaction-based fees
and rebates into their routing decisions would find it economically
worthwhile to adapt their behavior in response to the Pilot.
Further, the provision for an automatic sunset facilitates
representative results because it provides the Commission with
flexibility as the data from the proposed Pilot develops. For example,
the Commission could suspend the sunset if, for example, it believed
that additional time would help ensure that market developments are
fully reflected in the data with sufficient statistical power for
analysis, recognizing that such market developments are uncertain.
Therefore, the sunset provides flexibility to the Commission to observe
developments during the proposed Pilot to determine whether to allow
the sunset to occur.
The Commission preliminarily believes that the inclusion of a broad
sample of NMS securities, including small and mid-capitalization
stocks, ensures representative results from the proposed Pilot.
Although previous studies, as discussed above, suggest that any
possible conflicts of interest are likely to be the greatest for small-
capitalization securities,\318\ the Commission believes that it is
important to the design of the proposed Transaction Fee Pilot to
include these small and mid-capitalization stocks (including ETPs).
---------------------------------------------------------------------------
\318\ See Battalio Equity Market Study, supra note 22; Harris,
supra note 23.
---------------------------------------------------------------------------
As a result, small and mid-capitalization securities could be
subject to both the Transaction Fee Pilot and the Tick Size Pilot for
some period of time. However, the Commission preliminarily believes
that any overlap between the pilots is unlikely. If the pilots do
overlap, the proposed Pilot selection process facilitates the overlap
with the Tick Size Pilot while maintaining representative results. In
particular, the selection process for the proposed Pilot would result
in similar proportions of stocks impacted by the proposed Transaction
Fee Pilot in each
[[Page 13053]]
Tick Size Pilot test and control groups. Specifically, each of the
proposed Transaction Fee Pilot's three test groups would be divided
into two subgroups--one that overlaps with the Tick Size Pilot and one
that does not overlap.\319\ Assuming each pilot test group affects the
other pilot's test and control groups similarly, this design safeguards
the results of each pilot by ensuring that Tick Size Pilot effects are
uniform across the proposed Transaction Fee Pilot and vice versa, such
that researchers are able to control for effects of the Tick Size Pilot
on the proposed Transaction Fee Pilot and vice versa.
---------------------------------------------------------------------------
\319\ Each test group would contain 270 common stocks that
overlap with the Tick Size Pilot, with 45 stocks selected from each
of the three Tick Size Pilot test groups (45 stocks x 3 Tick Size
Pilot groups = 135 total) with the remaining 135 stocks coming from
the Tick Size Pilot's control group. See supra note 117 and
accompanying text.
---------------------------------------------------------------------------
B. Causality
In addition to providing representative results, the Commission
expects the proposed Transaction Fee Pilot to achieve the benefits
identified above because it would, among other things, provide insight
into the degree to which transaction-based fees result in potential
conflicts of interest that alter broker-dealer routing decisions to the
detriment of investors. Such causal information is necessary when
considering policy choices aimed at reducing any possible distortions
related to potential conflicts of interest. As detailed in the
baseline, exogenous shocks are a means by which researchers may
establish the existence of a causal relationship between changes to
transaction-based fees and changes to order routing decisions of
broker-dealers and infer whether these decisions are related to
possible conflicts of interest.\320\ This proposed Pilot facilitates
the establishment of causality through an exogenous shock that
simultaneously creates several distinct fee environments, each of which
restricts transaction-based fees or rebates differently, enabling
synchronized comparisons to the current environment.
---------------------------------------------------------------------------
\320\ As discussed in the baseline, establishing causality can
be accomplished through either exogenous shocks or econometric
methods, such as instrumental variable analysis. As noted above, the
Battalio Equity Market Study, supra note 22, which employed an
instrumental variables approach, was unable to definitely establish
causal relations between transaction-based fees and rebates and
order routing decisions.
---------------------------------------------------------------------------
The Commission preliminarily believes that the proposed Pilot is
able to facilitate the examination of causality because the proposed
Pilot would produce a single exogenous shock that differentially
impacts either fees or rebates on both maker-taker and taker-maker
exchanges. Although exchanges adjust their fee schedules frequently,
which could affect the order routing decisions of broker-dealers,
researchers have, to date, been unable to determine whether these
discretionary changes to fees cause order routing decisions or whether
order routing decisions cause the changes in fees. With the exception
of the Nasdaq study, which lacks representative results, prior analyses
lacked an exogenous shock to fees, thus any conclusions about causality
that are drawn from these studies may not provide reliable information
about possible conflicts of interest.\321\ Exogenous shocks, such as
those in the proposed Transaction Fee Pilot provide researchers a clear
means of analyzing the direction of causality.\322\
---------------------------------------------------------------------------
\321\ Although the Nasdaq study provides an exogenous shock to
both access fees and rebates simultaneously for a subset of
securities, the value of the results are impeded by (1) the small
sample size of the study and (2) the limit of the shock to a single
exchange, as broker-dealers could just route order flow to a
different exchange. See supra note 31.
\322\ Other econometric techniques, such as instrumental
variables methodology, are used only when an exogenous shock (or
other controlled experiment) cannot be established.
---------------------------------------------------------------------------
As discussed above, the proposed Pilot would produce a single
exogenous shock that differentially affects multiple test groups. The
simultaneity of the exogenous shocks across test groups also
facilitates examination of causality. If some market-wide event were to
result in deviations in order routing behavior during the proposed
Transaction Fee Pilot, the event would likely affect stocks in each
test group as well as the control group. Researchers can easily control
for the impact of the market-wide event, because the impact of the
market-wide event would likely affect test groups and the control group
similarly, and therefore, would be unlikely to appear in the
comparisons of the test groups to the control group. By contrast, if
the exogenous shocks were not simultaneous, the market-wide event may
impact only one test group, complicating the comparisons of that test
group to the baseline period or to the other test groups.
The design of the proposed Pilot further enhances researchers'
ability to identify causal relationships. The Commission preliminarily
believes that publishing daily updates to the List of Pilot Securities
facilitates the identification of causal relations between transaction-
based fees and order routing decisions. By requiring daily updates to
the List of Pilot Securities, the proposed Pilot would provide broker-
dealers with the information they need to track the exact securities in
each test group in real-time and when securities exit the Pilot. This
information may be crucial for broker-dealers that choose to adjust
their routing behavior during the pilot. If broker-dealers are unable
to track which securities are in which test groups, the Pilot results
could provide misleading causal information.
C. Expansion of Publicly Available Data
The Commission also expects the Transaction Fee Pilot to attain the
benefits identified above because it would provide access to data that
would either not be available to the public or that would require
lengthy and labor-intensive collection. Having a representative source
of data available to the public is critical for the production of
research and analyses about the effect of transaction-based fees on
broker-dealer order routing decisions. If more research and analyses
become available, that research is more likely to provide increased
depth and perspective on potential conflicts of interest to the
Commission. Making the data available to the public also provides
transparency and allows others to replicate, validate, and confirm the
information that the Commission considers in connection with policy
choices.
The Commission preliminarily believes that the proposed data
requirements improve upon existing data, as is discussed in more detail
below; thus, any inferences drawn from existing data sources prior to
the proposed pilot would likely have limited value in providing
information about the effect of transaction-based fees on order routing
decisions. The Pilot's characteristics would enable representative
results and a means to examine the exogenous shocks to transaction-
based fees. The public availability of the Pilot data would facilitate
study of whether the exogenous shocks to transaction-based fees affect
order routing and are related to potential conflicts of interest
between broker-dealers and their customers. The proposed Pilot would
make information on order routing decisions available on a more
granular level and would reduce the cumbersome nature of data
collection associated with existing order routing data and fee data.
The Transaction Fee Pilot would enable the public to gain access to
order routing data not currently available to them and would provide
access to fee data in a simplified and standardized form, which would
improve the quality of the analyses produced as a result of the Pilot.
Although order routing data
[[Page 13054]]
and fee schedules are publicly available through a combination of Rule
606 disclosures and exchange websites, respectively, the Transaction
Fee Pilot would resolve a number of limitations associated with using
currently available data to study the effect of transaction-based fees
on potential conflicts of interest. Further, the proposed Pilot would
make available broker-dealer order routing data for all exchange-member
broker-dealers for the Pilot duration, which substantially expands the
data that would be available to researchers in the absence of the
Pilot.
The Transaction Fee Pilot would make available to the public new
data on order routing decisions anonymized and aggregated by day, by
security, by broker-dealer, and by exchange. This data would facilitate
the analyses of aggregated daily order-routing decisions for a
comprehensive sample of broker-dealers, which are likely to provide
representative results of how changes in transaction fees and rebates
affect these decisions. Even if the Commission were to require a
historical time series of a complete set of broker-dealer Rule 606
disclosures to be made publicly available, the limitations presented in
Section V.B.1 would still exist, namely data frequency, which likely
would limit any statistical power associated with analyses of the data,
non-disclosure of potential conflicts of interest related to
transaction-based fees, and the focus on retail orders.
The order routing data obtained as a result of the proposed Pilot
would instead provide superior information to that currently available.
Data would be available for a representative sample of NMS securities,
across all broker-dealers, and exchanges, at the daily frequency, which
would provide sufficient data for analyses, while solving the issue of
statistical power. Relative to the data that some studies acquire from
broker-dealers and exchanges,\323\ the order routing data released
during the Transaction Fee Pilot would also allow researchers to
observe a time series of data across broker-dealers and exchanges. The
reduction in the start-up costs of examining order routing data, where
start-up costs could include hand-collection of data over long time
series, would likely encourage more research that would utilize data
from the Transaction Fee Pilot. Further, more granular order routing
data (e.g., daily order routing statistics by anonymized broker-dealer)
would facilitate more targeted analysis. Together, these effects would
facilitate higher quality research on issues such as potential
conflicts of interest, which would improve the quality of the
information available to the Commission for policy decisions.
---------------------------------------------------------------------------
\323\ See, e.g., Battalio Equity Market Study, supra note 22.
---------------------------------------------------------------------------
An additional requirement of the proposed Pilot is that the
exchanges would be required to provide a standardized dataset of fees,
the Exchange Transaction Fee Summary. Although researchers could
identify some of the effects of changes to transaction-based fees and
rebates on order routing decisions directly from knowing which
securities are in a given test group, these data could improve the
quality of tests of the Pilot by allowing researchers to incorporate
information on how exchanges vary cross-sectionally in their fee and
rebate structures, even within the various test groups. In particular,
this information would allow researchers to create proxies for which
exchanges are likely to be more or less expensive for marketable or
marketable limit orders. For instance, within Test Group 1, the maximum
allowable access fee is $0.0015; however, each exchange may have
different base and top-tier fees. Thus, only knowing that a security is
in Test Group 1 would be incomplete information about how orders might
be routed by broker-dealers to different exchanges, and the Exchange
Transaction Fee Summary would provide that information. Moreover, the
Exchange Transaction Fee Summary would provide researchers with
historical (realized) average and median per share fees and rebates to
provide an ex post analysis of how actual fees affected order routing
decisions from the prior period, which is not available from any data
source today. This information provides another avenue for researchers
to identify exchanges that are more expensive or less expensive using
actual past fees instead of a fee schedule that varies widely across
participants.
Exchanges would construct Exchange Transaction Fee Summaries
according to an XML schema to be published on the Commission's website,
and exchanges would update this information monthly.\324\ These data
would be standardized and consistently formatted, which would ease the
use of these data for researchers, as each exchange would have to
report the base, top-tier, average, and median fees, as detailed above
in Section III.E.2. Each month, exchanges would be required to report
realized average and median per share fees, as well as any ``spot''
revisions to fees associated with Form 19b-4 fee filings to the
Commission. These fee data would be publicly posted on each exchange's
website.\325\
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\324\ The standardized fee data, as would be required by the
proposed Pilot, is discussed in Section III.E.2, supra.
\325\ Proposed Rule 610(T) requires each exchange to publicly
post on its website downloadable files containing the Exchange
Transaction Fee Summary and update them on a monthly basis.
Similarly, each exchange would be required to publicly post on its
website downloadable files containing daily aggregated and
anonymized order routing statistics, updated monthly. Each exchange
would also be required to provide daily on its website downloadable
files containing the List of Pilot Securities and the Pilot
Securities Change List.
---------------------------------------------------------------------------
The Exchange Transaction Fee Summary released during the Pilot
would: (1) Ease aggregation across exchanges, which affords researchers
an opportunity to obtain representative results; (2) replicate across
studies, which would provide validation of findings; and (3) reduce
burdens associated with fee data collection, which could encourage more
research on the impact of fees and rebates on routing behavior. Because
each exchange would be required to provide its Exchange Transaction Fee
Summary using the Commission's XML schema, data on fees and rebates
would be produced in a structured and standardized format, allowing
researchers to easily aggregate and compile the data across all of the
U.S. equities exchanges. The format of the data would facilitate the
ability of a researcher to obtain representativeness in her results,
which could enhance current views on possible conflicts of interest
related to transaction-based fees.
Moreover, because all researchers would have access to the same set
of data on transaction-based fees and rebates, they would be able to
replicate, validate, and confirm the analyses of one another, which
would be difficult to do with existing data sources. Unlike currently
available fee data, downloadable files containing the Exchange
Transaction Fee Summary would be publicly posted on each exchange's
website and would provide researchers with consistent measures of
various categories of fees and rebates, described in Section III.E.2,
thereby reducing costs to researchers to collect and analyze the data
provided. Thus, the Commission preliminarily believes that a
standardized reporting of summary data on fees by the exchanges would
facilitate analysis of the effect of transaction-based fees on order
routing decisions by broker-dealers.
The proposed rule would require that the Exchange Transaction Fee
Summary be structured using an XML schema to be published on the
Commission's
[[Page 13055]]
website. Data that are structured in a standard format can result in
lower costs to analysts and higher quality data. An additional key
benefit of structured data is increased usability. If, for instance,
the Exchange Transaction Fee Summary were not standardized across the
exchanges, researchers would have to manually rekey the data, a time-
consuming process which has the potential to introduce a variety of
errors, such as inadvertently keying in the wrong data or interpreting
the filings inconsistently, thereby reducing comparability. With the
data in the reports structured in XML, researchers could immediately
download the information directly into databases and use various
software packages for viewing, manipulation, aggregation, comparison,
and analysis. This would enhance their ability to conduct large-scale
analysis and immediate comparison of the fee structures of exchanges.
The Commission preliminarily believes that requiring these reports to
be made available in an XML format would provide flexibility to
researchers and would facilitate statistical and comparative analyses
across exchanges, test groups, and date ranges.
Moreover, as an open standard, XML is widely available to the
public at no cost. As an open standard, XML is maintained by an
industry consensus-based organization, rather than the Commission, and
undergoes constant review. As updates to XML or industry practice
develop, the Commission's XML schema may also have to be updated to
reflect the updates in technology. In those cases, the supported
version of the XML schema would be published on the Commission's
website and the outdated version of the schema would be removed in
order to maintain data quality and consistency with the XML standard.
The Commission's proposed XML schema would also incorporate certain
validations to help ensure data quality. Validations are restrictions
placed on the formatting for each data element so that comparable data
are presented comparably. Complete and appropriately formatted data
enhances data users' abilities to normalize and aggregate the data for
review and analysis. The validations incorporated into the schema would
be effective for checking data completeness and appropriate formatting,
and would help the exchanges ensure that the data they post adheres to
the Commission's XML schema in completeness and formatting.\326\
Accordingly, the Exchange Transaction Fee Summary reports made
available by exchanges in XML format pursuant to the proposed rule
would have to be validated against the most recent XML schema published
on the Commission's website.
---------------------------------------------------------------------------
\326\ These validations, however, will not test for the
underlying accuracy of the data.
---------------------------------------------------------------------------
ii. Benefits of Studying Other Economic Effects
In addition to potential conflicts of interest, a number of studies
have expressed other concerns related to transaction-based fees. For
example, studies predict that transaction-based fee pricing has led to
increased market fragmentation and complexity.\327\ As an ancillary
benefit to the Transaction Fee Pilot, the Commission and the public
possibly could obtain data to facilitate analyses and research relating
to the effects of fees and rebates on market fragmentation and market
complexity in addition to those designed to study the potential
conflicts of interest. These analyses are likely to be informative to
the Commission as it evaluates future policy decisions.
---------------------------------------------------------------------------
\327\ See, e.g., Thierry Foucault, Ohad Kadan, and Eugene
Kandel, ``Limit Order Book as a Market for Liquidity,'' Review of
Financial Studies 18, 1171-1217 (2005), available at: https://academic.oup.com/rfs/article/18/4/1171/1595760 (``Foucault et al.
(2005)''); Marios Panayides, Barbara Rindi, and Ingrid Werner,
``Trading Fees and Intermarket Competition,'' Working Paper,
University of Pittsburgh (2017) available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2910438 (``Panayides et
al. (2017)''). Panayides et al. (2017) builds on the theoretical
model of Foucault et al. (2005) and finds a decline in market
quality and fraction of order flow to an exchange as its relative
rebate declines or the take fee increases.
---------------------------------------------------------------------------
Through the use of the order routing data from the Transaction Fee
Pilot, researchers would be able to study order flow among different
venues, which could provide insights into whether changes in
transaction-based fees affect the current baseline of competition
between exchanges and off-exchange trading centers, even in the absence
of potential conflicts of interest. Existing literature suggests that
transaction-based pricing has contributed to an increase in the number
of venues competing for order flow over time.\328\ By offering rebates
or Linked Pricing, start-up maker-taker and taker-maker trading centers
have been able to attract order flow from exchanges such as NYSE and
Nasdaq, thereby reducing liquidity externalities, or concentration of
order flow to a preferred venue, and leading to increased fragmentation
of the market for trading services. By altering the access fee and
rebate structures for exchanges, researchers may be able to identify
whether these changes lead to more (or less) concentration of liquidity
and how they affect competition for order flow among exchanges, which
could lead to less (or more) market fragmentation. The effect of
transaction-based fees on market fragmentation could not be examined in
the absence of the Pilot.
---------------------------------------------------------------------------
\328\ As discussed in the baseline, the number of exchanges has
increased since 2005, and market share has become less concentrated
over the same time period. These exchanges are not fully
independent; the majority of the U.S. equities exchanges belong to
three exchange groups. The Commission preliminarily believes that
any analyses of the effects of transaction-based fees on order
routing decisions can appropriately control for exchange groups.
---------------------------------------------------------------------------
By design, the Transaction Fee Pilot would alter access fees and
rebates in some test groups, also providing researchers with
information on how these revisions affect the quoted spreads (e.g.,
whether the spreads widen or narrow). The width of the quoted spread is
considered to be an indicator of a stock's liquidity, with narrower
spreads generally indicating more liquid securities. The proposed Pilot
could provide information on whether fees and rebates affect the
liquidity of securities, as measured by the quoted spreads, across
different test groups. Existing studies suggest that quoted spreads
appear to decline as liquidity rebates increase; \329\ thus, rebates
appear to decrease the cost of trading (and narrow the NBBO), thereby
potentially improving investor and market welfare.\330\ For some
marketable orders, the net spread (the quoted spread plus the cost of
access fees) is wider than the quoted spread, thereby potentially
reducing transparency because quoted spreads (for at least some orders)
are different from the net spread, yet most retail customers are
unaware of the difference.\331\ Without transparency of the fees and
rebates assessed to traders, the true costs of trading may be
concealed, thereby creating a distortion between the quoted spread and
the net cost of trading. Additional distortions between the quoted
spread and the net costs for customers arise because orders are priced
on different schedules in
[[Page 13056]]
different markets.\332\ Even if several trading centers match the NBBO,
the magnitude of the access fees and liquidity rebates could
significantly affect the net price paid by customers.\333\
---------------------------------------------------------------------------
\329\ See Angel, Harris, and Spatt, supra notes 106 and 216;
Brolley and Malinova, supra note 24; Harris, supra note 23;
O'Donoghue, supra note 24.
\330\ See Brolley and Malinova, supra note 24. Academic studies
suggest that the majority of retail orders are executed off-exchange
at prices based on the NBBO, thereby providing retail investors with
better prices in the presence of rebates. If, however, large rebates
provide incentives for broker-dealers to route retail orders to
these exchanges instead of to off-exchange venues, retail customers
may not be fully aware of the total cost associated with their
orders. See e.g., Angel, Harris, and Spatt, supra notes 106 and 216.
\331\ See Harris, supra note 23.
\332\ See Angel, Harris, and Spatt, supra notes 106.
\333\ See Battalio Equity Market Study, supra note 22.
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iii. Potential Limitations on the Benefits
The Commission recognizes that pilots are unpredictable and as such
considered whether possible limitations associated with pilots
generally, as well as certain issues presented by the design of this
pilot in particular, would limit the benefits of the Transaction Fee
Pilot. The Commission preliminarily believes that the limitations of
pilots, some of which may affect the Transaction Fee Pilot as discussed
below, should not impede its success. This section discusses, in
greater detail below, issues associated with pilots in general and the
potential concerns with resultant research and analyses, as well as
overlap with the Tick Size Pilot.
Pilots may face limitations related to the unpredictable nature of
market conditions and confounding events. Even if a pilot lasted
several years, not all of the market conditions of interest could be
experienced. Depending on the requirements of pilots, such limitations
might reduce the usefulness of the information obtained.\334\ The
Commission preliminarily believes, however, that the value of the
information obtained from the proposed Transaction Fee Pilot is not
dependent upon having variation in market conditions over time, and
that the duration of the proposed Pilot would provide sufficient
information for future analyses.
---------------------------------------------------------------------------
\334\ For instance, a pilot could be designed where the
information obtained from the proposed Pilot would only be valuable
if certain market conditions, such as high market volatility or a
recessionary period occurred. If, however, markets experience low
volatility or are in an expansionary period, the proposed Pilot may
either not be sufficiently long enough to capture the events that it
requires to be useful or would have to be extended to ensure that
those market conditions could occur.
---------------------------------------------------------------------------
In addition, pilots also face the limitation that market
participants, knowing that a pilot is underway, may not act as they
would in a permanent regime.\335\ In the context of this pilot, broker-
dealers could choose to retain their current order-routing decisions
for the duration of the proposed Pilot, which could be costly to such
broker-dealers.\336\ Broker-dealers, when deciding whether to adjust
any order routing behavior that currently depends on fees and rebates,
would likely trade off the costs of retaining strategies that are no
longer profitable because of the restrictions imposed by the proposed
Pilot against the costs of adjusting the algorithms for their smart
order routing systems, as explained below Section V.C.2. The costs of
``waiting out'' the pilot increase with the duration of the pilot,
whereas the costs of adjusting the algorithms of the smart order
routers do not. Alternatively, broker-dealers could substantially
change their business model in order to avoid the Pilot.\337\ Either of
these outcomes could lead to results that would not represent the
effects of a permanent rule change. The Commission preliminarily
believes that it is unlikely that broker-dealers would maintain
existing order routing decisions or alter their business models to
avoid the Pilot. In particular, the Commission preliminarily believes
that the proposed Pilot duration is likely to make it economically
worthwhile for broker-dealers to adjust their order routing behavior,
as the total costs of changes to order routing systems are estimated to
be on average approximately $42,900 per broker-dealer, if the Pilot
were to automatically sunset at the end of the first year.\338\
Further, although the proposed Pilot could automatically sunset at the
end of the first year, the Commission retains the flexibility to
suspend the sunset to continue the proposed Pilot for up to an
additional year, at its discretion, if the Commission believes that it
needs additional data for any reason.
---------------------------------------------------------------------------
\335\ For example, one study provided evidence suggesting that
trading behavior may not have completely adjusted to the Regulation
SHO pilot. See, Ekkehart Boehmer, Charles Jones, and Xiaoyun Zhang,
``Unshackling Short Sellers: The Repeal of the Uptick Rule,''
Working Paper, Columbia University (2008), available at: https://www0.gsb.columbia.edu/faculty/cjones/UptickRepealDec11.pdf. Despite
this effect, the study found evidence consistent with the evidence
gathered from the Regulation SHO pilot. See Securities Exchange Act
Release No. 50103 (July 28, 2004), 69 FR 48008 (August 6, 2004)
(``Regulation SHO'').
\336\ If broker-dealers have smart order routing systems that
use algorithms that maximize rebate capture, as suggested in the
Battalio Equity Market Study, supra note 22, then for at least some
subset of securities, broker-dealers would not be able to pursue
rebates from those exchanges, so it would be suboptimal for broker-
dealers to not reconsider their order routing choices. If broker-
dealers, however, already have order routing decisions that are
optimal from a customer's perspective (i.e., based on execution
quality) and are not driven by potential conflicts of interest
(i.e., maximizing rebates), then for at least some broker-dealers,
their order routing decisions may be unchanged, particularly if
execution quality does not migrate between exchanges as a result of
the implementation of the proposed Pilot.
\337\ It could be costly for broker-dealers to completely alter
their business models because they may not find it worthwhile to do
so for a temporary pilot. Further, if a broker-dealer has
discretionary control over a customer's account, the broker-dealer
could alter their business model by overweighting stocks in the
control group and underweighting stocks in Test Group 3, if the
objective of the broker-dealer is to continue to capture rebates.
\338\ The costs for broker-dealers to update their order routing
systems are detailed in Section V.C.2.f. If the proposed Pilot were
extended for up to an additional year, the total costs to broker-
dealers would be approximately $67,000 per broker-dealer.
---------------------------------------------------------------------------
In order to facilitate analysis of data during the Pilot Period,
the Commission believes that it is important to collect sufficient data
during a pre-Pilot Period. The pre-Pilot data can then be compared with
the data that would be produced during the Pilot Period, which would
permit analysis of any changes to order routing behavior, execution
quality, and market quality between the two for the Pilot Securities in
each of the Test Groups. To make this comparison informative, the
length of the pre-Pilot Period needs to be long enough to obtain
sufficient statistical power to permit analysis of the stocks and ETP
Pilot Securities. In turn, sufficient statistical power in tests that
compare the pre-Pilot data to the Pilot data would allow the Commission
and others to more easily use the information obtained from the Pilot
to inform future regulatory consideration of exchange transaction fees
and their impact on the markets.\339\ The Commission preliminarily
believes that at least six months of pre-Pilot data may be required to
obtain the necessary statistical power to permit analysis of the Pilot
Securities during the Pilot, particularly ETPs.\340\ Without sufficient
statistical power, researchers cannot use statistical techniques to
distinguish between a pilot that has no effect and pilot data that do
not provide enough power to detect an effect. In such situations, in
order to have sufficient data to obtain statistical power, researchers
would have to wait until the conclusion of the post-Pilot period to
gather additional data, likely delaying the initial results of the
proposed Pilot and the Commission's consideration thereof.
---------------------------------------------------------------------------
\339\ See supra note 118.
\340\ See supra note 430.
---------------------------------------------------------------------------
Furthermore, a short pre-Pilot Period introduces additional risk
that analysis of certain Pilot data may be uninformative. Even if
researchers were to wait until the conclusion of the post-Pilot period
to begin analysis, they may not be able to identify the effects of the
Pilot because data obtained from the post-Pilot period could be
confounded by information about the Pilot. For example, if exchanges
alter their fee structures in the post-Pilot period as a result of the
Pilot (rather than revert back to their fee models in effect prior
[[Page 13057]]
to the Pilot), data from the post-Pilot period likely would be unable
to supplement or substitute for data obtained from a shorter pre-Pilot
Period, underscoring the importance of a longer pre-Pilot Period. Thus,
the value of any analyses obtained from the Pilot may be limited,
thereby reducing the information obtained from such analyses for any
potential regulatory recommendations.
The Commission preliminarily does not believe that the benefits of
the proposed Transaction Fee Pilot would be limited by the potential
overlap with the Tick Size Pilot. For at least some portion of the
proposed Transaction Fee Pilot's pre-period or Pilot Period, a sample
of small and mid-capitalization stocks could simultaneously be subject
to two pilots.\341\ Two potential issues associated with the overlap
between the pilots could lead to incorrect inferences in any analyses
of the data produced by the proposed Pilot.\342\ First, researchers
would have to create additional control groups to account for the
overlap with the Tick Size Pilot, which potentially increases the costs
for researchers to study the proposed Transaction Fee Pilot. Second,
the interaction between the test groups arising from the overlap may
not be consistent across test groups.\343\ However, the Commission
preliminarily believes that researchers could appropriately control for
such interaction in their analyses of either pilot.
---------------------------------------------------------------------------
\341\ Sections V.C.2.b and V.D.3, infra, discuss more thoroughly
the implications for small and mid-capitalization issuers.
\342\ In addition to these two issues, there may not be
sufficient statistical power to jointly test the impact of being in
test groups of both pilots. Given the limited number of securities
that would, for example, be part of Test Group 1 of the Transaction
Fee Pilot and Test Group 1 of the Tick Size Pilot (45 stocks), a
substantial number of time series observations would likely be
necessary to achieve statistical power. Depending on when the
Transaction Fee Pilot becomes effective, there may only be limited
overlap between the two pilots, if any. However, understanding the
joint impact is not the reason for overlapping the pilots.
\343\ The stratification approach that would be used to
construct the test groups assumes that the impact of changes to fees
and rebates would be the same across all Tick Size Pilot test
groups, and that representativeness would be maintained. If the
impacts are different, then a researcher might not be able to
control for all of the interactions, potentially undermining the
reliability of the results.
---------------------------------------------------------------------------
The Commission recognizes that the data obtained from the
Transaction Fee Pilot would not be straightforward to study.
Specifically, the changes in fees or rebates imposed by the proposed
Pilot may change transaction costs in a way that results in changes to
order routing decisions by broker-dealers, even absent potential
conflicts of interest. Studying how order routing changes during the
proposed Pilot, without jointly studying why it changes, would not be
sufficient to understand any possible conflicts of interest.
Researchers can carefully select and apply sophisticated econometric
techniques to distinguish the proportion of changes in order routing
decisions resulting from execution quality considerations from those
resulting from potential conflicts of interest. Nonetheless, this
complication could reduce the number and/or quality of studies of the
proposed Transaction Fee Pilot.
b. Other Benefits of the Proposed Transaction Fee Pilot
Other benefits may emerge that would affect markets and market
participants for the duration of the proposed Pilot, such as reduced
conflicts of interest for some test groups or lower all-in costs of
trading. As discussed in further detail below, the Commission
preliminarily believes that other likely benefits of this proposal
would be temporary in nature and affect markets and market participants
only for the duration of the proposed Pilot.
The potential conflicts of interest discussed above could be
mitigated during the duration of the proposed Pilot for investors in at
least some subset of securities. For instance, in Test Group 2 where
access fees are lowered or Test Group 3 where rebates or Linked Pricing
are prohibited, broker-dealers may alter their order routing behavior
because the incentives to capture rebates or Linked Pricing are
lessened or removed from this subset of securities. The Commission
notes, as discussed in the baseline section, that it lacks sufficient
evidence of these potential conflicts of interest to ascertain the harm
to investors from the conflicts; instead, the proposal itself would be
a mechanism for ascertaining the magnitude of any such benefits.
Therefore, the Commission at this time is uncertain of the magnitude of
these benefits.
For at least some subsets of securities where rebates are likely to
be reduced to de minimis levels or eliminated entirely for the duration
of the proposed Pilot, broker-dealers could increase the routing of
customer orders to off-exchange trading centers, such as ATSs. When
broker-dealers can no longer capture rebates or Linked Pricing for some
subsets of securities, they could change their order routing to off-
exchange trading centers, because this would allow these broker-dealers
to avoid access fees for marketable orders. Off-exchange trading
centers are required to match the prevailing NBBO, and the Commission
understands that most ATSs do not charge access fees or pay rebates and
could temporarily reduce the all-in costs of trading for orders routed
off-exchange.\344\
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\344\ In addition to the potentially lower all-in costs of
trading for orders routed off-exchange, ATSs also reduce the
likelihood of price impact associated with large trades, as those
investors trading blocks of shares could potentially reduce the
price impact of their trades by crossing orders off-exchange, which
could reduce the likelihood that other market participants find out
about the order ahead of the execution. See Jennifer Conrad, Kevin
Johnson, and Sunil Wahal, ``Institutional Trading and Alternative
Trading Systems,'' Journal of Financial Economics 70, 99-114, (2003)
available at https://www.sciencedirect.com/science/article/pii/S0304405X03001430.
---------------------------------------------------------------------------
As an additional temporary benefit resulting from the proposed
Pilot, lower access fees or eliminated rebates or Linked Pricing in
some test groups could drive down the cost of routing orders to
exchanges, which could draw order flow away from ATSs and back to
exchanges, potentially resulting in an improvement in exchange
execution quality. A reduction in access fees in proposed Transaction
Fee Pilot test groups could induce broker-dealers to route more
marketable orders to maker-taker exchanges. As marketable orders
increase on maker-taker exchanges, under the assumption that broker-
dealers route orders in their customer's best interest, non-marketable
orders could also be routed to the same exchanges, because the
likelihood of execution and possibly the speed of execution improve for
non-marketable orders with an increase in marketable orders. Thus, as a
by-product of the proposed Pilot, exchanges temporarily may see
improvements in their overall execution quality and may see an increase
in routing of order flow by broker-dealers even in the absence of large
rebates. This could benefit investors as they may temporarily obtain
better execution quality or price improvement for some securities that
they would not otherwise obtain in the absence of the proposed Pilot.
The exogenous shock to fees and rebates also could temporarily
affect the transparency of quoted spreads. Several studies suggest that
access fees and rebates, while narrowing the quoted spread, increase
the net cost of trading but in a way that is not transparent to
investors.\345\ Reductions to access fees and rebates could increase
the transparency of the all-in costs of trading for investors. Although
the proposed Pilot is not designed to provide investors with full
transparency of the net costs of trading, for at least
[[Page 13058]]
some test groups, where rebates are likely to be reduced to de minimis
levels or prohibited outright, investors may obtain partial
transparency on how rebates affect quoted spreads and possibly the all-
in costs of trading. This effect could be particularly important for
small and mid-capitalization securities, where price transparency may
be low and which are likely to experience an increase in spreads, and
could subsequently reduce liquidity for these securities as a result of
the exogenous shocks to fees and rebates. Therefore, for the duration
of the proposed Pilot, an unintended benefit to investors in these
securities is that prices may be more transparent as the all-in costs
of trading are closer to the true economic net cost as reflected in the
displayed quotes.
---------------------------------------------------------------------------
\345\ See Angel, Harris, and Spatt, supra notes 106 and 216.
---------------------------------------------------------------------------
The Commission preliminarily believes that another temporary
benefit of the proposal would be that the proposed Transaction Fee
Pilot could prevent some traders from indirectly quoting in sub-
pennies.\346\ Rebates have the practical effect of reducing the minimum
tick size by the size of the rebate, and in effect allow trading
centers to offer quotations superior to the existing quote. Several
studies suggested that the use of fees and rebates to effectively
undercut quotations by sub-pennies is particularly severe in taker-
maker markets.\347\ The proposed Transaction Fee Pilot would, in some
test groups, reduce or eliminate rebates, which could stem this
indirect reduction of tick sizes, and could provide the Commission and
the public with information currently unavailable about the frequency
of this issue.
---------------------------------------------------------------------------
\346\ Rule 612 of Regulation NMS prohibits traders from
submitting sub-penny quotations on securities trading at prices over
$1.00. The purpose of the sub-penny quotation prohibition was two-
fold: (1) To prevent high frequency traders from front-running
standing non-marketable limit orders and (2) to reduce the
complexity of trading systems. See NMS Adopting Release, supra note
1, at 37550-57.
\347\ See, e.g., Angel, Harris, and Spatt, supra note 216;
Harris, supra note 23. One study noted that as a result of the Tick
Size Pilot test group with the trade-at provision, taker-maker
markets have seen a significant increase in market share, in part
due to this quotation issue. See Carole Comerton-Forde, Vincent
Gregoire, and Zhuo Zhong, ``Inverted Fee Venues and Market
Quality,'' Working Paper, University of Melbourne (2017), available
at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2939012.
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2. Costs of Proposed Transaction Fee Pilot
This section describes the compliance costs associated with the
proposed Transaction Fee Pilot, followed by the additional temporary
costs that could affect issuers, investors, broker-dealers, exchanges,
and other market participants resulting from the proposed Pilot.
a. Exchange Compliance Costs of the Proposed Transaction Fee Pilot
The proposed Pilot would impose costs on exchanges to comply with
the Pilot's requirements to collect, calculate, and publicly post data
required by the Pilot on their websites, as well as to implement the
required fee changes. An overview of the requirements of the proposed
Pilot are presented in this section, and are discussed in more detail
below. Specifically, exchanges that serve as the primary listing market
would be required to publicly post on their websites downloadable files
containing the Pilot Securities Exchange List, derived from the initial
List of Pilot Securities published on the Commission's website by
notice, as well as maintain and update the Pilot Securities Exchange
List as necessary prior to the beginning of trading on each trading
day. Separately, prior to the beginning of trading on each trading day
and throughout the duration of the proposed Pilot, each primary listing
exchange shall publicly post on its website a downloadable file
containing a Pilot Securities Change List, which lists each separate
change applicable to any Pilot Security (i.e., name changes, mergers,
or other corporate events) for which the exchange serves or has served
as the primary listing exchange.\348\
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\348\ As discussed in Section III.E.1, supra, the Commission
would publish by notice the initial List of Pilot Securities, which
would identify the securities in the proposed Pilot and assign each
of them to a designated test group (or the control group).
---------------------------------------------------------------------------
The proposed Pilot would also require that each exchange provide a
monthly standardized Exchange Transaction Fee Summary, detailed in
Section III.E.2, which includes information on the initial list of fees
and rebates associated with each test group and the control group, as
well as changes to those fees and rebates corresponding with Form 19b-4
fee filings made to the Commission. In addition to the base and top-
tier fees and rebates required in the Exchange Transaction Fee Summary,
exchanges would also be required to calculate and publicly post on
their websites the realized monthly average and median per share fees
and rebates as part of the Exchange Transaction Fee Summary.
As discussed in more detail in Section III.E.3, equities exchanges
would prepare and publicly post on their websites, order routing data,
updated on a monthly basis, containing aggregated and anonymized
broker-dealer order routing information. The required datasets,
detailed in proposed Rule 610T(d), would contain order routing
information for liquidity-providing orders and liquidity-taking orders
aggregated by day, by security, by broker-dealer, and by exchange on an
anonymous basis. The Commission expects that the equities exchanges
would compile the required order routing data by utilizing the data
they collect pursuant to the CAT.\349\ As discussed below, each
exchange would need to aggregate at the daily level the order routing
statistics detailed in proposed Rule 610T(d) and would need to
anonymize that data at the broker-dealer level, using the anonymization
key provided by representatives of the Commission at the outset of the
proposed Pilot. These data, in pipe-delimited ASCII format, would be
publicly posted to each exchange's website, no later than the last day
of each month for the prior month.
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\349\ See Section III.E.3 supra, which provides a more detailed
discussion of the use of the CAT for the collection of order routing
data.
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Although the proposed rule requires that exchanges release order
routing data at the anonymized broker-dealer level, market participants
or researchers theoretically could reverse engineer proprietary trading
strategies of other market participants, which could have implications
for the profitability of those strategies going forward if they were
revealed or mimicked by other participants. The Commission is sensitive
to the potential proprietary nature of the order routing data but
preliminarily believes that releasing the order routing data would not
affect market participants because the likelihood of being able to
reverse engineer broker-dealers' order-level strategies is low because
the data would be aggregated by security and day and would anonymize
the broker-dealers. The proposal requires the order routing data to be
anonymized at the broker-dealer level to limit the degree to which it
reveals proprietary information. The order routing data are also
aggregated by day, and released with a delay, to limit revealing
individual strategies in the event someone was able to reverse engineer
broker-dealer identities. The Commission provides estimates of the
costs associated with complying with the proposed Transaction Fee
Pilot's reporting requirements, discussed in detail below.
[[Page 13059]]
b. Updating the Pilot Securities Exchange List and Pilot Securities
Change List
As described above, the exchanges would maintain and make public
prior to the start of each trading day the Pilot Securities Exchange
List of the securities included in each test or control group on its
website, in accordance with Rule 610T(b), making relevant adjustments
for ticker symbol changes and corporate actions (i.e., mergers or name
changes). Further, each exchange would publicly post on its website the
updated Pilot Securities Change List prior to the start of each trading
day, which would list, separately, changes to applicable Pilot
Securities. Additional details of what would be included in each list
are provided in Section III.E.1.
From time to time, exchanges update issuers' ticker symbols for
various reasons, such as a merger or a corporate reorganization and
notify their members when such changes become effective. Given that
every exchange has practices in place to update its members about the
listed securities and has also adjusted its normal processes to account
for the Tick Size Pilot, the Commission preliminarily believes that the
costs associated with providing required data for the proposed
Transaction Fee Pilot would not place undue cost burdens upon the
exchanges. The processes used by exchanges to update the list of pilot
securities for the Tick Size Pilot could be used to also track the
proposed Transaction Fee Pilot securities, as well as any changes to
those securities as detailed above in Section III.E.1.
Upon the initial publication of the List of Pilot Securities by
notice by the Commission, the primary listing exchanges \350\ would
need to determine which securities are listed on their market, compile,
and publicly post on their websites downloadable files in pipe-
delimited ASCII format a list of those securities. The Commission
preliminarily estimates that the costs associated with the initial
compilation of the Pilot Securities Exchange List would cost $2,060 per
exchange, or $10,300, in aggregate.\351\
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\350\ The five primary listing exchanges are NYSE, Nasdaq, NYSE
American, NYSE ARCA, and BATS.
\351\ This estimate is based on the following: [(Compliance
Manager (4 hours) x $298) + (Programmer Analyst (4 hours) x $232)] =
$2,060 per exchange, or $2,060 x 5 primary listing exchanges =
$10,300 in aggregate. The burden hours are obtained from Section
IV.J.1, supra. The Commission estimates the wage rate associated
with these burden hours based on salary information for the
securities industry compiled by the Securities Industry and
Financial Markets Association (SIFMA). The estimated wage figure for
attorneys, for example, is based on published rates for attorneys,
modified to account for a 1,800-hour work-year and multiplied by
5.35 to account for bonuses, firm size, employee benefits, and
overhead, yielding an effective hourly rate for 2013 of $380 for
attorneys. See Securities Industry and Financial Markets
Association, Management & Professional Earnings in the Securities
Industry--2013, available at: https://www.sifma.org/resources/research/management-and-professional-earnings-in-the-securities-industry-2013/. These estimates are adjusted for inflation based on
Bureau of Labor Statistics data on CPI-U between January 2013
(230.280) and January 2017 (242.839). Therefore, the 2017 inflation-
adjusted effective hourly wage rates for attorneys are estimated at
$401 ($380 x 242.839/230.280). The Commission discusses other costs
of compliance with the proposed rule below.
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The Commission understands that each primary listing exchange has
existing systems to monitor and maintain the Pilot Securities Exchange
List and the Pilot Securities Change List as a result of certain
corporate actions.\352\ While these systems can be used to collect the
data required to be made public for the Pilot Securities Exchange List
and the Pilot Securities Change List, the Commission further
understands that these systems would have to be adapted to conform to
the requirements of the proposed Pilot. The Commission estimates that
it would cost each primary listing exchange approximately $3,720 to
develop appropriate systems for the proposed Transaction Fee Pilot, or
$18,600 in aggregate across the five U.S. primary listing
exchanges.\353\ Once these systems are established, the Commission
estimates that it would cost each exchange $86,300 for the entire
duration of the proposed Pilot, including up to the one-month pre-Pilot
Period, a two-year Pilot duration, and the six-month post-Pilot Period,
or $431,500 across the five primarily listing exchanges,\354\ to
publicly post on each exchange's website the Pilot Securities Exchange
List and Pilot Securities Change List prior to the start of each
trading day in pipe-delimited ASCII format. If the Commission
determined that the proposed Pilot shall be automatically sunset at the
end of the first year, the Commission estimates that the costs to each
exchange would be $52,900 for the one-month pre-Pilot Period, a one-
year Pilot duration, and the six-month post-Pilot Period, or $264,500
across the five primarily listing exchanges.\355\
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\352\ See supra note 150. As discussed above, primary listing
exchanges have experience in producing and maintaining similar lists
on their websites with respect to the Tick Size Pilot, which should
be adaptable to meet the requirements of the proposed Transaction
Fee Pilot.
\353\ This estimate is based on the following: [(Attorney (4
hours) x $401) + (Compliance Manager (4 hours) x $298) + (Programmer
Analyst (4 hours) x $232)] [ap] $3,720 per exchange, or $3,720 x 5
exchanges [ap] $18,600 in aggregate. The burden hours are obtained
from Section IV.J.1, supra.
\354\ If the proposed Pilot were to automatically sunset at the
end of the first year, the total number of days that the exchanges
would need to provide the Pilot Securities Exchange List and the
Pilot Securities Change Lists would be up to 651 business days (up
to 21 business days for the one-month pre-Pilot Period, 504 business
days for the two-year Pilot horizon (252 business days per year x 2
years), and 126 business days for the six-month post-Pilot Period).
The total number of days in the pre-Pilot Period would be no more
than 21 trading days, but could be as short as zero days depending
on when the exchanges begin to publish the Lists. The cost estimate
for providing these lists for the entire period is based on the
following: [(Compliance Manager (0.25 hour x 651 trading days) x
$298) + (Programmer Analyst (0.25 hour x 651 trading days) x $232)]
[ap] $86,300, or $86,300 x 5 exchanges [ap] $431,500, in aggregate.
The burden hours are obtained from Section IV.J.1, supra.
\355\ If the proposed Pilot were to automatically sunset at the
end of the first year, the total number of days that the exchanges
would need to provide the Pilot Securities Exchange List and the
Pilot Securities Change Lists would be up to 399 business days (up
to 21 business days for the one-month pre-Pilot Period, 252 business
days for the one-year Pilot horizon, and 126 business days for the
six-month post-Pilot Period). The total number of days in the pre-
Pilot Period would be no more than 21 trading days, but could be as
short as zero days depending on when the exchanges begin to publish
the Lists. The cost estimate for providing these Lists for the
entire period is based on the following: [(Compliance Manager (0.25
hour x 399 trading days) x $298) + (Programmer Analyst (0.25 hour x
399 trading days) x $232)] [ap] $52,900, or $52,900 x 5 exchanges
[ap] $264,500, in aggregate. The burden hours are obtained from
Section IV.J.1, supra.
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c. Producing the Exchange Transaction Fee Summary in XML Format
In addition to the Pilot Securities Exchange List provided by the
primarily listing exchanges, all U.S. equities exchanges would also
need to publicly post on their websites the Exchange Transaction Fee
Summary, downloadable files containing the initial set of fees at the
outset of the proposed Transaction Fee Pilot as well as monthly updates
to include both changes to fees and rebates reported in Form 19b-4 fee
filings and realized average and median per share fees and rebates, as
discussed in Section III.E.2. The Exchange Transaction Fee Summary
would need to be updated promptly in response to any changes to its
dataset following the beginning of each calendar month from the pre-
Pilot Period through the post-Pilot Period. The exchanges would be
required to provide information on any transaction-based fee changes,
according to Rule 610T(e), that they make during the proposed Pilot,
including the effective dates of fee revisions. The proposed rule also
requires that each exchange calculates the realized monthly average and
median per share fees and rebates, as discussed in more detail in
Section III.E.2.
A requirement at the outset of the proposed Pilot is that exchanges
would need to report their base and top-tier
[[Page 13060]]
fees and rebates, which the Commission estimates would cost each
exchange $1,130, or $14,700, in aggregate across the 13 U.S. equities
exchanges.\356\ The reported base and top-tier fees and rebates would
be mandatory elements of the Exchange Transaction Fee Summary.
Concurrent with the submission of the Form 19b-4 fee filings to the
Commission at the outset of the proposed Transaction Fee Pilot, the
exchanges would also be required to publicly post on their websites
downloadable files containing the initial Exchange Transaction Fee
Summary, using an XML schema to be published on the Commission's
website. The Commission estimates that it would cost exchanges $530
each to post this summary dataset to their websites, or $6,900 in
aggregate across the 13 U.S. equities exchanges, using an XML schema to
be published on the Commission's website.\357\
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\356\ The estimate is based on the following: [(Compliance
Manager (2 hours) x $298) + (Senior Business Analyst (2 hours) x
$265)] [ap] $1,130, or $1,130 x 13 equities exchanges [ap] $14,700
in aggregate. The burden hours are obtained from Section IV.J.1,
supra.
\357\ This estimate is based on the following: [(Compliance
Manager (1 hours) x $298) + (Programmer Analyst (1 hours) x $232)] =
$530 per exchange, or $530 x 13 U.S. equities exchanges [ap] $6,900
in aggregate. The burden hours are obtained from Section IV.J.1,
supra.
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The proposed rule would also require that exchanges compute the
monthly average and median realized per share fees and rebates, as
detailed in Section III.E.2. These data would provide the Commission
and the public aggregated data on the actual per share levels of fees
and rebates assessed in the prior month, which the Commission believes
is critical for estimating the effects of fees and rebates on order
routing decisions. The Commission preliminarily believes that the costs
associated with computing these summary data on fees and rebates are
likely to be larger than the costs associated with updating the
Exchange Transaction Fee Summary, discussed in detail below, and would
likely require new systems by the exchanges to track the average and
median fees.
The Commission estimates that each exchange would have a one-time
cost of $24,000, or $312,000 in aggregate across the 13 U.S. equities
exchanges, associated with the development and implementation of
systems tracking realized monthly average and median per share fees
pursuant to the proposed rule.\358\ The Commission further anticipates
that it would cost an additional $12,000 annually, or $156,000, in
aggregate, per year, to ensure that the system technology is up to date
and remains in compliance with the proposed rule.\359\
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\358\ This estimate is based on the following, which reflects
the Commission's experience with and burden estimates for SRO
systems changes: [(Attorney (20 hours) x $401) + (Compliance Manager
(20 hours) x $298) + (Programmer Analyst (20 hours) x $232) +
(Senior Business Analyst (20 hours) x $265] [ap] $24,000 per
exchange, or $24,000 x 13 exchanges [ap] $312,000 in aggregate. The
burden hours are obtained from Section IV.J.1, supra.
\359\ This estimate is based on the following, which reflects
the Commission's experience with and burden estimates for SRO
systems changes: [(Attorney (10 hours) x $401) + (Compliance Manager
(10 hours) x $298) + (Programmer Analyst (10 hours) x $232) +
(Senior Business Analyst (10 hours) x $265] [ap] $12,000 per
exchange, or $12,000 x 13 exchanges [ap] $156,000 in aggregate. The
burden hours are obtained from Section IV.J.1, supra.
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Moreover, as discussed above, exchanges would be required to
produce monthly updates to the Exchange Transaction Fee Summary to
capture realized average and median per share fees as well as any
revisions to fee schedules made by the exchanges, which would be
reflected in changes to base or top-tier fees and rebates, detailed in
Section III.E.2. The Commission estimates that each month it would cost
each exchange $530 to update the dataset of summary fees to reflect the
updates to historical realized average and median per share fees and
changes to the base and top-tier fees. This would require each exchange
to make a total of 36 updates to the Exchange Transaction Fee Summary
from the pre-Pilot Period through the post-Pilot Period, if the
Commission determined that the proposed Pilot should continue for up to
a second year and not automatically sunset at the end of the first
year.\360\ Each exchange would have total costs of updates to the
Exchange Transaction Fee Summary of approximately $19,100 per exchange,
or $248,300 among the 13 exchanges over the pilot duration, including
pre- and post-periods.\361\ If the proposed Pilot were to automatically
sunset at the end of the first year, without the Commission determining
that an extension for up to an additional year was needed, this would
decrease the total number of updates to the Exchange Transaction Fee
Summary to 24.\362\ Under an automatic sunset at the end of the first
year, each exchange would have total costs of updates to the Exchange
Transaction Fee Summary of approximately $12,700 per exchange, or
$165,100 among the 13 exchanges over the pilot duration, including pre-
and post-periods.\363\ As detailed above, the Commission preliminarily
estimates that the costs associated with the monthly updates to the
Exchange Transaction Fee Summary would be a small fraction of the costs
associated with the initial allocation of fees required at the outset
of the proposed Pilot.
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\360\ This estimate of updates to the Exchange Transaction Fee
Summary is the aggregation of updates from the pre-Pilot Period (6),
the two-year pilot period if the Commission determines that an
extension of up to an additional year was needed (24), and the post-
pilot period (6), for a total number of 36 updates.
\361\ This estimate is based on the following: [(Compliance
Manager (1 hours) x $298) + (Programmer Analyst (1 hours) x $232)] =
$530 per exchange, or $530 x 36 fee changes per exchange [ap]
$19,100. The 36 fee changes for the exchange encompass six updates
during the six-month pre-Pilot Period, 24 updates during the two-
year Pilot Period, assuming that the Commission determines that the
additional year is required, and six updates during the six-month
post-Pilot Period. In aggregate, updates to the Exchange Transaction
Fee Summary are estimated to cost $19,100 x 13 U.S. equities
exchanges [ap] $248,300. The burden hours are obtained from Section
IV.J.1, supra.
\362\ This estimate of updates to the Exchange Transaction Fee
Summary is the aggregation of updates from the pre-Pilot Period (6),
the one-year pilot period with an automatic sunset at the end of the
first year (12), and the post-pilot period (6), for a total number
of 24 updates.
\363\ This estimate is based on the following: [(Compliance
Manager (1 hours) x $298) + (Programmer Analyst (1 hours) x $232)] =
$530 per exchange, or $530 x 24 fee changes per exchange [ap]
$12,700. The 24 fee changes for the exchange encompass six updates
during the six-month pre-Pilot Period, 12 updates during the one-
year Pilot Period, assuming that the Commission determines that the
additional year is not required and the Pilot is automatically
sunset at the end of the first year, and six updates during the six-
month post-Pilot Period. In aggregate, updates to the Exchange
Transaction Fee Summary are estimated to cost $12,700 x 13 U.S.
equities exchanges [ap] $165,100. The burden hours are obtained from
Section IV.J.1, supra.
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As discussed in Section III, the proposal would require that the
Exchange Transaction Fee Summary be published on the exchanges'
websites using an XML schema to be published on the Commission's
website. The Commission understands that there are varying costs
associated with varying degrees of structuring. The Commission
preliminarily believes that most of the exchanges already have
experience applying the XML format to market data. For example, the
exchanges and market participants regularly use the FIX protocol \364\
and FpML \365\ to exchange information on highly structured financial
instruments and related market data.\366\
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\364\ The Financial Information eXchange (FIX) protocol is an
electronic communications protocol that provides a non-proprietary,
free and open XML standard for international real-time exchange of
information related to the securities transactions and markets. See
https://www.fixtrading.org/.
\365\ FpML (Financial products Markup Language) is an open
source XML standard for electronic dealing and processing of OTC
derivatives. It establishes the industry protocol for sharing
information on, and dealing in, financial derivatives and structured
products. See https://www.fpml.org/ org/.
\366\ Most of the exchanges have at least some portion of their
data available through XML formats. For instance, the NYSE Group of
exchanges provides daily closing prices, among other data, in XML,
Excel, and pipe-delimited ASCII, while the Nasdaq exchanges (Nasdaq,
BX, and PHLX) and Cboe exchanges (Cboe BZX, Cboe BYX, Cboe EDGA, and
Cboe EDGX), provide daily share volume data, among other data, in
XML. Information on the use of XML by exchanges is available at
www.nyse.com, www.nasdaqomx.com, www.cboe.com, for the NYSE, Nasdaq,
and Cboe exchange groups, respectively, and was obtained from a
staff review of information on publicly available exchange websites.
The Commission was unable to obtain information from CHX or IEX on
their use of XML from information available on their publicly
available websites.
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[[Page 13061]]
The Commission anticipates that implementation of the proposed
Pilot's XML schema would draw upon exchange resources and experiences
previously used to implement other supply chain information standards,
like those discussed above, that were developed by industry consensus-
based organizations. Costs generally associated with the implementation
may include those for: Identifying the data required by the proposed
Pilot within the exchange source systems; mapping the relevant fields
in the exchanges' data source systems to the Commission's proposed XML
schema; implementing, testing and executing the validation rules; and
developing the website posting processes as required by the proposed
rule. The initial costs to exchanges of complying with the Commission's
proposed XML schema in order to publicly post the Exchange Transaction
Fee Summary in this format would be $500 per exchange, or $6,500 in
aggregate across the 13 exchanges.\367\ For all updates to the Exchange
Transaction Fee Summary, the Commission estimates that any burden
associated with making those available using the XML schema is included
in the costs of the updates discussed above.
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\367\ This estimate is based on the following, which reflects
the Commission's experience with and burden estimates for systems
changes to map to an XML schema: [(Programmer Analyst (1 hours) x
$232) + (Senior Business Analyst (1 hours) x $265] [ap] $500 per
exchange, or $500 x 13 exchanges [ap] $6,500 in aggregate. See
Securities Exchange Act Release No. 78309 (July 13, 2016), 81 FR
49431, 49475 (July 27, 2016) (``Disclosure of Order Handling
Information''). The estimate is lower than that for proposed Rule
606 disclosures because the costs for those disclosures encompassed
many additional requirements beyond the mapping to an XML schema.
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d. Producing the Order Routing Data
The proposed rule also would require as part of the proposed
Transaction Fee Pilot that exchanges would prepare, in pipe-delimited
ASCII format, and publicly post on their websites, order routing data,
updated monthly, containing aggregated and anonymized broker-dealer
order routing information. As discussed in proposed Rule 610T(d) and in
Section III.E.3, the datasets would contain separate order routing data
for liquidity-providing and liquidity-taking orders aggregated by day,
by security, by anonymized broker-dealer, and by exchange, each month.
The Commission preliminarily believes that as long as the CAT Phase
1 data are available at the implementation of the proposed Transaction
Fee Pilot, the exchanges would be able to use that data to construct
the order routing data required by the proposed rule. In particular,
the CAT Data will include records for every order received by an
exchange that indicate the member routing the order to the exchange and
details regarding the type of security. The CAT Data will also include
other information necessary to create the order routing data such as
order type information, special handling instructions, and execution
information. In the event that the CAT Phase 1 data were not available,
the exchanges would have to use existing systems to collect the
required order routing data.\368\ Regardless of which system exchanges
use for the order routing data, the Commission anticipates they would
incur costs in producing the downloadable files containing aggregated
and anonymized monthly order routing data to be posted publicly on the
exchanges' websites. The proposal would require that the exchanges
adhere to using the common broker-dealer anonymization key provided by
a representative of the Commission in order to track and analyze the
activity of a given broker-dealer across multiple exchanges. As
discussed in Section III.E.3, the Commission would construct a broker-
dealer anonymization code, which would be an anonymized code common to
a broker-dealer across all exchanges using CRD information.
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\368\ The Commission acknowledged the use of CAT for future
pilots in its Approval Order of the CAT NMS Plan. See note 172
supra. The Commission is aware that much of the data produced by the
CAT are highly sensitive and if not properly anonymized and
aggregated could reveal personally identifiable information (PII) at
the investor level or proprietary trading strategies at the broker-
dealer level. Accordingly, the exchanges would only make public as
part of the Transaction Fee Pilot order routing data that are
aggregated on a daily basis and anonymized of broker-dealers to
minimize the potential for revelation or reverse engineering of
proprietary order routing decisions.
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The exchanges would also be required to make public the aggregated,
anonymized order routing data described in Section III.E.3. The
proposal requires that the exchanges would make public each month a
dataset of aggregated, anonymized data on order routing statistics,
detailed in proposed Rule 610T(d), by day, by issuer, and by broker-
dealer. The Commission estimates that each exchange would have a one-
time cost of $24,000, or $312,000 in aggregate across the 13 exchanges,
associated with the development and implementation of systems needed to
aggregate and anonymize the order routing information, as well as store
the data, in the pipe-delimited ASCII format specified by the proposed
rule and as detailed in proposed Rule 610T(d).\369\ The Commission
anticipates that it would cost each exchange an additional $12,000 per
year, or $156,000 in aggregate per year, to ensure that the system and
storage technology is up to date and remains in compliance with the
proposed rule.\370\
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\369\ This estimate is based on the following, which reflects
the Commission's experience with and burden estimates for SRO
systems changes: [(Attorney (20 hours) x $401) + (Compliance Manager
(20 hours) x $298) + (Programmer Analyst (20 hours) x $232) +
(Senior Business Analyst (20 hours) x $265] [ap] $24,000 per
exchange, or $24,000 x 13 exchanges [ap] $312,000 in aggregate. The
burden hours are obtained from Section IV.J.1, supra.
\370\ This estimate is based on the following, which reflects
the Commission's experience with and burden estimates for SRO
systems changes: [(Attorney (10 hours) x $401) + (Compliance Manager
(10 hours) x $298) + (Programmer Analyst (10 hours) x $232) +
(Senior Business Analyst (10 hours) x $265] [ap] $12,000 per
exchange, or $11,960 x 13 exchanges [ap] $156,000 in aggregate. The
burden hours are obtained from Section IV.J.1, supra.
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The proposed rule would require that exchanges produce monthly
updates of the order routing data, and make them publicly available on
their websites in pipe-delimited ASCII format by the end of the month,
as detailed in Section III.E.3 and proposed Rule 610T(d). The
Commission estimates that the publication and updates of the order
routing dataset would cost $1,600 each month. This would require each
exchange to make a total of 24 updates to the order routing data from
the pre-Pilot Period through the post-Pilot Period, if the proposed
Pilot were to automatically sunset at the end of the first year. Each
exchange would have recurring costs of updates to the order routing
data of approximately $57,600 per exchange, or $748,800 among the 13
exchanges over the entire duration of the Pilot, and the pre-Pilot and
post-Pilot periods.\371\ If the Commission were
[[Page 13062]]
to allow the proposed Pilot to automatically sunset at the end of the
first year, this would decrease the total number of monthly updates to
the order routing data by 12 to 24.\372\ Under the automatic sunset,
each exchange would have recurring costs of updates to the order
routing data of approximately $38,400 per exchange, or $499,200 among
the 13 exchanges over a one-year Pilot, and the pre-Pilot and post-
Pilot periods.\373\
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\371\ This estimate is based on the following: [(Compliance
Manager (3 hours) x $298) + (Programmer Analyst (3 hours) x $232)]
[ap] $1,600 per exchange, or $1,600 x 36 fee changes per exchange
[ap] $57,600. The burden hours are obtained from Section IV.J.1,
supra. The 36 updates to the order routing data for each exchange
encompass six updates during the six-month pre-Pilot Period, 24
updates during the two-year Pilot Period, assuming that the
Commission determines at the end of the first year that it shall
continue the proposed Pilot for up to an additional year, and six
updates during the six-month post-pilot period. In aggregate,
updates to the order routing data are estimated to cost $57,600 x 13
U.S. equities exchanges [ap] $748,800.
\372\ This estimate of updates to the order routing data is the
aggregation of updates from the pre-Pilot Period (6), the one-year
Pilot Period assuming that the Commission allows the Pilot to
automatically sunset at the end of the first year (12), and the
post-Pilot Period (6), for a total number of 24 updates.
\373\ This estimate is based on the following: [(Compliance
Manager (3 hours) x $298) + (Programmer Analyst (3 hours) x $232)]
[ap] $1,600 per exchange, or $1,600 x 24 fee changes per exchange
[ap] $38,400. The burden hours are obtained from Section IV.J.1,
supra. The 24 updates to the order routing data for each exchange
encompass six updates during the six-month pre-Pilot Period, 12
updates during the first year of the Pilot Period, assuming that the
Commission determines at the end of the first year that it shall
automatically sunset the proposed Pilot, and six updates during the
six-month post-pilot period. In aggregate, updates to the order
routing data are estimated to cost $38,400 x 13 U.S. equities
exchanges [ap] $499,200.
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e. Fee-Related Costs to Exchanges
At the outset of the proposed Pilot, each equities exchange would
need to provide to the Commission a comprehensive Form 19b-4 fee filing
reflecting all of the applicable fees and rebates relevant to each of
the three Pilot Test Groups, as well as the Control Group--to reflect
the temporary changes to transaction-based fees and rebates as a result
of the proposed Pilot. The Commission anticipates considerable costs
associated with and time devoted by each exchange to optimally assign
fees and rebates across Test Groups, within the parameters allowed by
the proposed Pilot, including any incentives, tiers, caps, and
discounts available. The Commission estimates that it would cost
$48,400 per-exchange for the initial Form 19b-4 fee filing or $629,200
in aggregate.\374\ The Commission further anticipates that exchanges
would bear similar costs upon the completion of the proposed Pilot to
prepare Form 19b-4 fee filings for the Commission.
---------------------------------------------------------------------------
\374\ The estimate is based on the following: [(Attorney (40
hours) x $401) + (Compliance Attorney (40 hours) x $352) +
(Assistant General Counsel (25 hours) x $449) + (Director of
Compliance (15 hours) x $470)] [ap] $48,400, or $48,400 x 13
equities exchanges [ap] $629,200 in aggregate. See OMB Control No.
3235-0045 (August 19, 2016), 81 FR 57946 (August 24, 2016)
(``Request to OMB for Extension of Rule 19b-4 and Form 19b-4
Filings'').
---------------------------------------------------------------------------
In addition to the initial production of the Form 19b-4 fee filing
at the outset of the proposed Pilot, exchanges may also choose to make
periodic updates to their fee and rebate schedules, and provide Form
19b-4 fee filings to notify the Commission and the public of those
updates. As noted in the baseline, the average exchange makes
approximately seven changes to its fee schedules per year. While
recognizing the possibility that as a result of the proposed Pilot,
exchanges may revise their fee schedules more or less often during the
proposed Pilot, the Commission has no basis to expect an increase in
the number of Form 19b-4 fee filings other than at the beginning or end
of the proposed Pilot and has no basis to expect a decrease.
The Commission also recognizes that as an outcome of the proposed
Pilot, the complexity of the Form 19b-4 fee filings could increase,
thereby increasing the overall costs for exchanges to revise their fee
and rebate schedules.\375\ As discussed above, the proposed Pilot would
require exchanges to design multiple new fee structures for each of the
test groups, which would then translate into additional information in
each Form 19b-4 fee filing submitted during the proposed Pilot. These
costs are likely to increase because the exchanges could take
considerably more time to design and describe fee structures in each
filing than they do designing fee structures today. As discussed above
in the baseline, the average fee schedules of exchanges are complex,
with many different categories of fees or rebates assessed to NMS
stocks (including ETPs). Assuming the frequency remains constant, then
the proposed Pilot could increase the incremental costs incurred by
exchanges to file the expected Form 19b-4 fee filings during the
proposed Pilot.\376\ The additional costs would only be relevant for
Form 19b-4 fee filings that occur during the proposed Pilot Period, and
would not apply to Form 19b-4 fee filings in the pre-Pilot or post-
Pilot Periods, as the Commission does not believe that there will be
any incremental costs associated with increased complexity of these
filings during these periods. The Commission estimates that each
exchange would bear an incremental cost of $10,600 per Form 19b-4 fee
filing to account for the increased complexity associated with the
requirements of the proposed Pilot, or $1,930,000 for the anticipated
182 Form 19b-4 fee filings for fee and rebate revisions across the 13
U.S. equities exchanges during the two-year pilot duration.\377\ If the
proposed Pilot were to automatically sunset at the end of the first
year, the Commission estimates that exchanges would bear costs of
approximately $965,000 for the anticipated 91 Form 19b-4 filings for
fee and rebate revisions across the 13 U.S. equities exchanges during
the first year of the Pilot duration.
---------------------------------------------------------------------------
\375\ The Commission preliminarily believes that the inclusion
of Linked Pricing prohibitions for Test Group 3 should not increase
the complexity of Form 19b-4 filings for exchanges because many
exchanges already report non-cash incentives, such as tiered pricing
or volume discounts, as part of their standard filings. Further, the
Commission does not believe that exchanges currently use Linked
Pricing mechanisms and instead most rely on rebates.
\376\ Maintaining the current average frequency of 7 19b-4
filings per year would mean that the average exchange would file a
total of 14 19b-4 filings during the two-year pilot (7 filings x 2
year duration). If the Commission were to allow the proposed Pilot
to automatically sunset at the end of the first year, then the total
number of 19b-4 filings could decrease by 7 filings. Annually,
across all 13 exchanges, the Commission preliminarily estimates that
there will be 91 19b-4 filings (7 filings x 13 exchanges). If the
Commission determines that the proposed Pilot shall continue for a
second year, in aggregate, the 13 exchanges could file a total of
182 19b-4 filings (91 x two-year Pilot duration).
\377\ The estimate is based on the following: [(Attorney (8
hours) x $401) + (Compliance Attorney (8 hours) x $352) + (Assistant
General Counsel (6 hours) x $449) + (Director of Compliance (4
hours) x $470)] [ap] $10,600, or $10,600 x 182 fee changes in
aggregate across 13 exchanges over the two-year pilot duration [ap]
$1,930,000 in aggregate, assuming that the Commission determines
that the proposed Pilot shall continue for up to an additional year.
If the proposed Pilot were to automatically sunset after the first
year, the Commission preliminarily believes that the costs
associated with 91 19b-4 filings (13 exchanges x 7 filings) would be
approximately $965,000 ($10,600 x 91 filings). See Request to OMB
for Extension of Rule 19b-4 and Form 19b-4 Filings, supra note 374.
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f. Other Costs Associated With the Proposed Transaction Fee Pilot
As discussed in further detail below, the Commission preliminarily
believes that many of the other likely costs of this proposal would be
temporary in nature and affect markets only for the duration of the
proposed Pilot. For instance, more complicated fee structures could
also increase an exchange's processing costs of tracking and
calculating monthly invoices for its members during the proposed Pilot;
however, the Commission does not have any information on the costs to
exchanges for tracking and calculating monthly member invoices and
therefore cannot provide estimates of quantified costs. The following
section includes discussion of implementation costs for broker-dealers,
the temporary effect on
[[Page 13063]]
brokerage commissions, the effects to exchanges of liquidity
externalities and complexity, and costs associated with the overlap
with the Tick Size Pilot.
In addition to the compliance costs for exchanges associated with
the implementation of the proposed Pilot, exchanges also may experience
a change to their revenues associated with transaction-based fees and
rebates. As discussed in the baseline, the exchange groups NYSE Group,
Nasdaq, and BATS Global Markets, had net transaction-fee revenue of
$223 million, $564 million, and $177 million, respectively, in 2016 as
obtained from their Form 10-K or Form 10-Q filings. As discussed in
more detail below, the margin between fees and rebates ranges from
$0.0001 to $0.0005.\378\ If the margin were $0.0005, exchanges could
have no reduction in their overall net revenues (fees less rebates).
If, instead, the margin is less than $0.0005, then exchanges could
experience a decline in revenues attributable to securities in Test
Group 2, if they continue to provide a nominal rebate to broker-dealers
as an inducement to route orders to that exchange. Moreover, because
Test Group 3 would prohibit rebates or Linked Pricing without changing
the fee cap, exchanges would have incentives to charge higher fees than
a competitive equilibrium would suggest, subsidizing any shortfall in
revenues arising from Test Group 2. Competitive pressures arising from
other market participants, including ATSs, could affect the success of
any attempted revenue subsidization by exchanges through increased
fees.
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\378\ See Section V.D.2 infra.
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As noted above, the Commission preliminarily estimates that the
only test group that could result in reduced revenues for exchanges is
Test Group 2. Below, the Commission estimates a possible range of
effects to the monthly revenues in aggregate across exchanges depending
on the magnitude of the rebate that they could pay. Given that fees and
rebates are interconnected, the Commission preliminarily assumes that
as fees are reduced as a requirement of the proposed Pilot, exchanges
will similarly reduce rebates paid; therefore, the Commission
preliminarily believes that exchanges are unlikely to pay rebates in
excess of the maximum fee permitted in a given test group. The maximum
per share revenue for Test Group 2 would then be $0.0005, with a
minimum of $0.0000, depending on whether the exchange paid no rebate or
a rebate of $0.0005, respectively, which would leave the exchange net
revenue neutral before operating costs under the second scenario.
Assuming that the share volume in Test Group 2 would be one-sixth of
the total share volume across all securities,\379\ using data from
Table 3 in the baseline, Test Group 2 would have share volume of
approximately 15.3 billion each month.\380\ Under the scenario where
exchanges paid no rebates in Test Group 2, the Commission preliminarily
anticipates no change in revenue, assuming that the margin between fee
revenue and rebate cost of $0.0005.\381\ If, instead, exchanges paid
rebates of $0.0005, where the net capture would be zero for Test Group
2, this would lead to a monthly aggregate shortfall in revenues across
all exchanges of $7,650,000.\382\ At the exchange level, Nasdaq, which
has the largest monthly volume percentage (23%), would have a monthly
shortfall of $1,760,000.\383\ If exchanges are likely to have similar
share volume each month, then the annual average shortfall across all
exchanges would be $91.8 million. Compared to the margin between fee
revenue and the cost of rebates for the publicly traded exchanges,
detailed in the baseline, the annual revenue shortfall would be
approximately 9.5%.\384\ If the net capture on exchanges is less than
$0.0005, on average, then exchanges could either maintain their current
margin between fees and rebates (e.g., if the net capture is $0.0003,
then exchanges could reduce rebates to $0.0002) or could increase the
margin by reducing rebates even further (e.g., reduce rebates to
$0.0001, and increase net capture to $0.0004).
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\379\ As designed, the proposed Pilot would allocate an equal
number of securities to the three test groups and the control group
(i.e., the test groups combined would have 50% of the NMS securities
and the control group would have 50%). Each test group would have
one-third of the combined test group allocation, thereby, in total
leaving each test group with one-sixth of the securities included in
the proposed Pilot. Assuming that the allocation of share volume
would be similar due to the stratification of the sample discussed
above, each test group would have one-sixth of total share volume
each month.
\380\ Table 3 in the baseline shows aggregate exchange share
volume for July 2017 was 91.7 billion shares, of which one-sixth
would be 15.3 billion shares. Further, the Commission preliminarily
estimates that these volume figures would be similar across all
months, assuming no seasonality in share volume.
\381\ In addition, an exchange could have no change in net
margin if its current margin is between $0.0005 and $0.0010 and the
exchange charged for both taking and making liquidity. However, the
effect of charging both sides on net revenues is unknown because
charging both sides could change the nature of the exchange's order
flow.
\382\ If Test Group 2 has monthly share volume of 15.3 billion
shares, then the revenue shortfall is estimated to be 15.3 billion x
$0.0005 [ap] $7,650,000.
\383\ As shown in Table 3, Nasdaq's July 2017 shares are 21.2
billion. Nasdaq's overall share is 21.2/91.7 [ap] 23%. The
Commission estimates the monthly revenue shortfall for Nasdaq to be
0.23 x $7,650,000 [ap] $1,760,000.
\384\ In aggregate, the NYSE Group, Nasdaq, and BATS Global
Markets earned a margin between fee revenues and costs of rebates of
approximately $960 million in 2016. If the revenue shortfall was $92
million, then the percentage shortfall would be $92 million/$960
million [ap] 9.5%. However, this is likely to be too high since BATS
Global Markets only reported financial statements for the first nine
months of 2016. In the nine-months ending September 2016, BATS
earned a margin between fee revenues and costs of rebates of
approximately $177 million. Assuming that BATS earned revenues at a
constant rate throughout the year, then the 12-month margin would
have been $236 million ($177 million/9 months = $x million/12
months, x = $236 million). In that case, the aggregate margin would
have increased from $960 million to $1.023 billion, which would have
reduced the percentage shortfall from approximately 9.5% to 9.0%
($92 million/$1.023 billion).
---------------------------------------------------------------------------
Although the costs of compliance with the proposed Pilot primarily
affect the exchanges, broker-dealers and other market participants are
also likely to have implementation costs as a result of the proposed
Pilot, if they decide to alter their behavior in response to the Pilot.
For instance, many broker-dealers have smart-order routing systems that
use algorithms to route orders based on certain criteria, such as fill
rates, time to execution, or highest rebates.\385\ In response to the
proposed Pilot, market participants that use smart-order routers could
have a one-time cost at the onset (and the conclusion) of the Pilot to
adjust their algorithms to reflect the shocks to transaction-based
fees. In the absence of smart-order routers, market participants could
still need to adjust the execution determinations to take advantage of
the changes implemented during the proposed Pilot. The Commission
preliminarily believes that the costs associated with updating the
execution algorithms by broker-dealers are likely to be more costly
than the periodic adjustments that broker-dealers may make to
incorporate changes to fee schedules implemented by exchanges because
they are likely to require more complex programming that segments
stocks into different fee regimes, rather than just altering codes or
inputs.
---------------------------------------------------------------------------
\385\ See Bacidore, Otero, and Vasa, supra note 235, which found
that smart-order routers designed to maximize rebates delivered
worse execution quality to their clients.
---------------------------------------------------------------------------
The Commission preliminarily believes that broker-dealers that are
members of exchanges already have in place order routing systems,
whether smart order routers or algorithmic trading programs that route
orders to exchanges for which they are members. Therefore, the
Commission does not expect that broker-dealers would need to bear
start-up costs associated with implementing new order routing systems
as a result of the proposed Pilot,
[[Page 13064]]
and would only need to make modifications to the existing code to
capture changes in fees and rebates associated with each test group of
securities. The Commission estimates that the costs to broker-dealers
that are members of exchanges to make the initial adjustment to their
order routing systems at the outset of the proposed Pilot would be
$8,700 per broker-dealer, or $3,741,000 in aggregate across the 430
broker-dealers that are currently members of equities exchanges.\386\
The Commission further estimates that broker-dealers would bear a
similar cost to alter their order routing systems at the conclusion of
the proposed Pilot.
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\386\ This estimate is based on the following, which reflects
the Commission's experiences with and burden estimates for broker-
dealer systems changes: [(Attorney (5 hours) x $401) + (Compliance
Manager (10 hours) x $298) + (Programmer Analyst (10 hours) x $232)
+ (Senior Business Analyst (5 hours) x $265)] [ap] $8,700 per
broker-dealer that is a member of at least one exchange. As of
December 31, 2016, 430 unique broker-dealers were members of
exchanges (Form X-17a-5). The aggregate costs of updating order
routing systems to reflect the proposed Transaction Fee Pilot
requirements would cost $8,700 x 430 [ap] $3,741,000.
---------------------------------------------------------------------------
As a result of the proposed Pilot, the Commission expects that
broker-dealers would make adjustments to their order routing systems
associated with changes to fees or rebates submitted by exchanges
through Form 19b-4 fee filings to the Commission. As discussed in the
baseline, exchanges, on average, make changes to fees or rebates
approximately seven times per year; therefore, broker-dealers are
likely to have experience in adjusting the order routing systems to
reflect these routine changes to fees and rebates. Although broker-
dealers have experience with revisions to exchange fee and rebate
schedules, due to the added complexity of having to adjust and update
multiple modules within their order routing systems, broker-dealers are
likely to face higher costs per adjustment as a result of the proposed
Pilot. The Commission preliminarily believes that the per-adjustment
costs associated with these changes are likely to be a small fraction
of the costs associated with the initial costs of updating the routing
systems to reflect the required fee and rebate revisions at the outset
of the proposed Pilot. The Commission estimates that the additional
costs to broker-dealers that are members of exchanges to make periodic
adjustments to their order routing systems to reflect changes in fees
and rebates would be $265 per adjustment, or $114,000 in aggregate
across the 430 broker-dealers that are members of U.S. equities
exchanges.\387\ As shown above, the Commission preliminarily expects
that exchanges, if submitting changes to fees and rebates at the same
rate as they have in the last five years, would submit 182 total
revisions to fees and rebates over the pilot duration, if the Pilot
were to automatically sunset at the end of the first year. Therefore,
the aggregate costs of updating order routing systems would be $48,200
per broker-dealer, or $20,726,000 in total across all broker-
dealers.\388\ If the Pilot were to automatically sunset at the end of
the first year, the aggregate costs of updating order routing systems
would be $24,100 per broker-dealer, or $10,363,000 in total across all
broker-dealers. The Commission notes, however, that these estimates may
be overstated, as not all broker-dealers are members of all exchanges,
which would reduce the total number of changes to the order-routing
systems that they would implement. Therefore, the Commission
preliminarily believes that the costs to broker-dealers of adjusting
their order routing systems as a results of the proposed Pilot are
nominal, and each broker-dealer would spend on average approximately
$67,000 to update their systems over the entire proposed Pilot
Period.\389\ If the Commission determined that the proposed Pilot shall
automatically sunset at the end of the first year, then the costs
associated with these updates would be approximately $42,900 per
broker-dealer. Moreover, as noted above, this estimate assumes that
broker-dealers are members of all 13 U.S. equities exchanges, whereas
many are members of only a subset of exchanges, which would further
reduce the costs of updating their order routing systems.
---------------------------------------------------------------------------
\387\ This estimate is based on the following, which reflects
the Commission's experiences with and burden estimates for broker-
dealer systems changes: [(Compliance Manager (0.5 hours) x $298) +
(Programmer Analyst (0.5 hours) x $232)] = $265 per broker-dealer
that is a member of at least one exchange. The aggregate costs
updating order routing systems to reflect the periodic fee and
rebate revisions would cost $265 x 430 [ap] $114,000.
\388\ If 182 total fee and rebate changes were to occur over the
duration of the proposed Pilot (13 equities exchanges x 7 revisions
per year x 2 years = 182), each broker-dealer would bear costs of
updating its order routing systems of $265 x 182 [ap] $48,200, or
$20,726,000 ($48,200 x 430) in aggregate across all broker-dealers
over the first year of the proposed Pilot. The Commission estimates
that costs would be approximately $10,363,000 ($265 x 13 exchanges x
7 updates x 430 broker-dealers) if the Commission determined that
proposed Pilot automatically sunset at the end of the first year.
\389\ These costs reflect the costs of approximately $9,000 at
the outset of the proposed Pilot to update the order routing system
to reflect the changes to the fee structure for securities in the
test groups, approximately $49,000 to reflect the incremental costs
of the estimated 182 revisions to fee schedules during the proposed
Pilot ($530 per revisions x 7 revisions per year x 2 years x 13
exchanges), and $9,000 at the conclusion of the proposed Pilot to
unwind changes to the order routing systems, for a total of $67,000
per broker-dealer. If the proposed Pilot were to automatically
sunset at the end of one year, then these costs would be
approximately $42,900 ($530 x 7 revisions x 13 exchanges) per
broker-dealer. See supra note 338 and the accompanying text.
---------------------------------------------------------------------------
Exchanges and broker-dealers could also bear an increased cost of
complexity associated with the exogenous shocks to the fees and rebates
as required by the various test groups. As of July 2017, exchanges have
24 fee categories and 21 rebate categories, on average. If exchanges
maintain the same level of complexity in their fee schedules during the
proposed Pilot, up to a four-fold increase in the number of fee and
rebate categories could occur, which would increase complexity for the
exchanges, and would also increase complexity for broker-dealers who
incorporate fees into their order routing decisions. Although the
proposal would require exchanges to report a fee dataset as well as any
changes to those fees, the exchanges may not simplify their actual fee
schedules. For the duration of the proposed Pilot, however, the
exchanges could resort to simplified fee schedules relative to the
current baseline to reduce the costs of complying with the proposed
Pilot.
Beyond the implementation and compliance costs for exchanges and
broker-dealers associated with the proposed Transaction Fee Pilot, a
number of temporary costs could be borne by investors as a result of
the Pilot. The changes to the transaction-based fee structure could
lead to temporary, suboptimal outcomes for market participants, such as
short-lived increases in brokerage commissions. It has been shown in
several studies that brokerage commissions today are at historically
low levels.\390\ Brokerage clients seeking simplicity in their overall
cost structure may have a preference for low commissions and increased
services provided by broker-dealers, and in turn, may allow broker-
dealers to capture rebates (and bear the costs of access fees), either
through explicit contracts or implicit agreements.\391\ As a result,
the proposed Pilot could lead to higher overall commissions as rebates
obtained by broker-dealers fall, thereby temporarily reducing the
overall welfare of retail brokerage clients as a result of increased
commissions.\392\
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\390\ See Angel, Harris, and Spatt, supra notes 106 and 216.
\391\ See supra note 37. See also O'Donoghue, supra note 24.
\392\ The Commission acknowledges differing effects on brokerage
commissions could occur as a result of the proposed Pilot depending
on whether the client is a retail customer versus an institutional
customer. For instance, some brokerage accounts charge per-
transaction commissions to retail clients (e.g., Fidelity charges
$4.95 per trade, www.fidelity.com, while TD Ameritrade charges $6.95
per trade, www.tdameritrade.com). Institutional commissions, on the
other hand, are highly negotiated and may be based on something
other than a per trade or per share basis, such as a flat fee for
use of a broker's order routing algorithm; however, data on the
structure or magnitude of institutional commissions is not publicly
available.
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[[Page 13065]]
For instance, the elimination of rebates or Linked Pricing in Test
Group 3 could result in a transfer from broker-dealers to exchanges.
Assuming, as discussed above,\393\ the margin between fees and rebates
is $0.0002 per share, with access fees of $0.0030 per share and rebates
of $0.0028 per share, Test Group 3 could result in a transfer of
$0.0028 from broker-dealers to the exchanges, particularly because
exchanges would be prohibited from offering Linked Pricing mechanisms
that could act as substitutes for cash rebates.\394\ Following this
example, and using the same estimation procedure to calculate costs to
exchanges attributable to the reduction in fees in Test Group 2, the
estimates of the potential increased revenue to exchanges are as
follows. Assuming that the share volume in Test Group 3 would be one-
sixth of the total share volume across all securities,\395\ using data
from Table 3 in the baseline, Test Group 3 would have share volume of
approximately 15.3 billion each month.\396\ If the margin between fee
revenue and rebate cost is $0.0002, as discussed above, then under the
assumption that exchanges reduce fees to $0.0002 in Test Group 3, the
Commission preliminarily anticipates no change in revenue for
exchanges, and no transfer from broker-dealers. If, instead, exchanges
charged fees of $0.0030 while prohibited from paying rebates or Linked
Pricing in Test Group 3, the Commission preliminarily estimates a
monthly aggregate increase in revenues across all exchanges of
$42,840,000.\397\ If exchanges are likely to have similar share volume
each month, then the estimated annual average increase in revenues
across all exchanges would be $514.1 million.
---------------------------------------------------------------------------
\393\ See supra note 28.
\394\ Although the Commission preliminarily believes that
competition among exchanges would drive access fees down for Test
Group 3 as a result of the elimination of rebates, exchanges could
charge access fees as high as the current cap of $0.0030.
\395\ As designed, the Pilot would allocate an equal number of
securities to the three test groups and the control group (i.e., the
test groups combined would have 50% of the NMS securities and the
control group would have 50%). Each test group would have one-third
of the combined test group allocation, thereby, in total leaving
each test group with one-sixth of the securities included in the
pilot. Assuming that the allocation of share volume would be similar
due to the stratification of the sample discussed above, each test
group would have one-sixth of total share volume each month.
\396\ Table 3 in the baseline shows aggregate exchange share
volume for July 2017 was 91.7 billion shares, of which one-sixth
would be 15.3 billion shares. Further, the Commission preliminarily
estimates that these volume figures would be similar across all
months, assuming no seasonality in share volume.
\397\ If Test Group 3 has monthly share volume of 15.3 billion
shares, and the margin would increase by $0.0028 ($0.0030 -
$0.0002), the revenue increase per month is estimated to be 15.3
billion x $0.0028 [ap] $42,840,000.
---------------------------------------------------------------------------
This transfer of rebates from the broker-dealers to exchanges could
feasibly increase exchange revenue by approximately 53.6%.\398\
Moreover, these costs could likely fall to investors in the form of
higher commissions or fees charged to cover the decrease in broker-
dealer revenue due to losses in rebates for securities in Test Group 3.
---------------------------------------------------------------------------
\398\ In aggregate, the NYSE Group, Nasdaq, and BATS Global
Markets earned a margin between fee revenues and costs of rebates of
approximately $960 million in 2016. If the estimated margin
increased by $514.1 million, then the percentage increase in this
margin would be $514.1 million/$960 million [ap] 53.6%. However,
this is likely to be too high since BATS Global Markets only
reported financial statements for the first nine months of 2016. In
the nine-months ending September 2016, BATS earned a margin between
fee revenues and costs of rebates of approximately $177 million.
Assuming that BATS earned revenues at a constant rate throughout the
year, then the 12-month margin would have been $236 million ($177
million/9 months = $x million/12 months, x = $236 million). In that
case, the aggregate margin would have increased from $960 million to
$1.023 billion, which would have reduced the percentage increase
from approximately 53.6% to 50.3% ($514.1 million/$1.023 billion).
---------------------------------------------------------------------------
The Commission further acknowledges that if brokerage commissions
were to increase as a result of the proposed Pilot, broker-dealers
could continue to charge higher commissions even after the conclusion
of the proposed Pilot. However, due to competition among broker-
dealers, including the proliferation of low-cost online broker-dealers,
the Commission preliminarily believes that broker-dealers would be
unlikely to significantly increase brokerage commissions as a result of
the proposed Pilot.\399\
---------------------------------------------------------------------------
\399\ See Section V.B.2.a supra, which discusses the competitive
environment for broker-dealer services.
---------------------------------------------------------------------------
As a result of the proposed Pilot, effective bid-ask spreads could
temporarily widen for securities in certain test groups due to the
elimination or reduction of rebates. According to one study,
transaction-based rebates could serve to artificially lower the NBBO,
which could lower the trading costs to investors.\400\ This reasoning
suggests that wider effective bid-ask spreads could temporarily
increase transactions costs for internalized order flow or orders
routed to ATSs that execute based on the NBBO, which would
predominantly impact retail investors, as well as for orders executing
on exchanges. However, any potential degradation of the effective bid-
ask spread due to lower or reduced rebates could be mitigated by lower
access fees.
---------------------------------------------------------------------------
\400\ See Angel, Harris, and Spatt, supra note 106.
---------------------------------------------------------------------------
The reduction or elimination of rebates could also particularly
affect smaller exchanges due to the liquidity externality. As liquidity
tends to consolidate for reasons discussed in Section V.A.2, the
restrictions on rebates as a result of the proposed Pilot could harm
smaller exchanges that perhaps compete by paying large rebates rather
than by producing better prices or execution quality. In the short run,
this could lead to lost revenue for these exchanges, and potentially
could have longer-term effects if smaller exchanges consolidate or exit
as a result of the proposed Pilot. As discussed above, using available
data, the Commission estimates that aggregate revenue shortfalls for
exchanges are likely to range between zero and $92 million
annually.\401\
---------------------------------------------------------------------------
\401\ See Section V.C.2.a supra, for the estimates of revenue
shortfalls that could occur as a result of the proposed Pilot.
---------------------------------------------------------------------------
Markets may also temporarily become even more complex as a result
of the proposed Pilot. Exchanges could promote additional order types
and may even initiate new types of markets as a result of the proposed
Pilot, which would only serve to further fragment markets and add to
their complexity, the costs of which could be borne by investors. The
Commission preliminarily believes, however, that a new exchange
registered in response to the Pilot would be unlikely to become
operational before the conclusion of the proposed Pilot.
Simultaneously subjecting a subset of NMS securities to both the
Tick Size Pilot and the proposed Transaction Fee Pilot could increase
potential costs to issuers, particularly for small-capitalization
issuers, to the extent that any overlap between the pilots could occur.
Small issuers that could be subject to both pilots are most likely to
face adverse liquidity environments, and therefore, are most likely to
have ramifications to their liquidity, such as larger spreads, as a
result of the simultaneity of the pilots. Longer term, if the temporary
impacts on liquidity acutely affect some firms, it could affect capital
formation for these securities and could lead to the potential exit of
these issuers from the capital markets, through acquisition or
delisting, as these
[[Page 13066]]
small issuers are least likely to be able to ride out negative
liquidity shocks. Instead, the proposed Pilot could lead some issuers
to delay entering the capital markets for the duration of the proposed
Pilot.\402\
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\402\ If rebates are associated with increased liquidity,
particularly for small issuers, then prohibitions on rebates or
Linked Pricing could adversely affect those firms. However, the
Commission preliminarily believes that exempting registered market
makers from the prohibition on non-rebate incentives could lessen
the impact to liquidity for small issuers.
---------------------------------------------------------------------------
Separately, the implementation costs to exchanges associated with
running two pilots on subsets of the same securities could have
significant costs related to the complexity of multiple pilots, to the
extent that the pilots could overlap. Although the exchanges already
have operational experience with implementing the Tick Size Pilot, the
costs of implementation provided above could be underestimated because
of the complexity of tracking the same issuers within multiple pilots.
For instance, the Commission preliminarily estimates that it will cost
$3,720 per exchange to construct its initial Pilot Securities Exchange
List, and $33,400 annually to update this list daily. Because exchanges
may have to identify securities that are in both the Transaction Fee
Pilot and the Tick Size Pilot for some period of time, the costs of
producing the Pilot Securities Exchange List could exceed these
values.\403\ The Commission, therefore, preliminarily believes that any
excess costs are likely to be proportional to the duration of the
overlap between the Tick Size Pilot and the proposed Transaction Fee
Pilot.\404\
---------------------------------------------------------------------------
\403\ See supra note 353.
\404\ If such overlap occurred, and was limited to the pre-Pilot
data collection period for the proposed Transaction Fee Pilot, the
additional costs related to implementation, complexity, and
uncertainty could be minimal because the two pilots would not
operate simultaneously. As discussed in Section V.C.1.a.i.A, supra,
the Commission preliminarily believes that any overlap could be
minimal. See also supra note 342 for a discussion of the potential
statistical power of testing the joint effects of the two pilots
simultaneously. The Commission is cognizant that a longer overlap
could be costly to market participants.
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D. Impact on Efficiency, Competition, and Capital Formation
Exchange Act Section 3(f) requires the Commission when engaging in
rulemaking to consider or determine whether an action is necessary or
appropriate in the public interest, and to consider, in addition to the
protection of investors, whether the action will promote efficiency,
competition, and capital formation.\405\ As discussed in further detail
below, the Commission preliminarily believes that any of the direct
effects of this proposal on efficiency, competition and capital
formation would likely be temporary in nature and affect markets only
for the duration of the proposed Pilot. The Commission preliminarily
believes that the information obtained as a result of the proposed
Transaction Fee Pilot could improve regulatory efficiency, because
analyses of this data are likely to provide a more representative view
of the effect of transaction-based fees on order routing decisions than
would be available to the Commission in the absence of the proposed
Pilot. Further, the proposed Pilot may have a number of temporary
effects on price efficiency, the competitive dynamics between exchanges
and off-exchange trading venues in the market for trading services, and
on capital formation, particularly for small issuers.
---------------------------------------------------------------------------
\405\ See 15 U.S.C. 78c(f).
---------------------------------------------------------------------------
As discussed above, a primary benefit of the proposed Pilot is that
it would produce data that will be relevant for the Commission's
consideration of the economic effects of transaction-based fees. The
data obtained from the proposed Transaction Fee Pilot would provide
information not currently available to the Commission about the role of
transaction-based fees in the market for trading services and how that
affects competition between exchanges and with off-exchange trading
centers.
1. Efficiency
The proposed Transaction Fee Pilot would provide the Commission
with an opportunity to empirically examine the effects of an exogenous
shock to transaction fees and rebates order routing behavior, execution
quality and market quality. Insofar as the data produced by the
proposed Pilot permits the Commission and the public to evaluate and
comment upon the potential impacts of alternative policy options, the
proposal may promote regulatory efficiency. In the absence of the
proposed Pilot, the Commission would have to rely on currently-
available data to inform future policy decisions related to
transaction-based fees and data limitations may impair the efficiency
of policy decisions based on this information.
The temporary efficiency impacts the Commission expects during the
proposed Pilot depend on how the proposed Pilot fee and rebate
restrictions proposed for the three test groups balance the interests
of different groups of market participants. For example, if during the
Pilot, the lower fee caps and no-rebate restriction induced by the
proposed Pilot cause broker-dealers to be more likely to route customer
orders to trading centers with better pricing, higher speed of
execution, or higher probability of execution, rather than to trading
centers with the largest rebates, the proposed Pilot may temporarily
improve the efficiency of capital allocation by lowering execution
costs. Efficiency of capital allocation could be reduced if, as a
response to the loss in revenue from rebates, broker-dealers increase
commissions or fees charged to customers. Higher commissions or fees
could reduce customers' willingness to trade or could lead to a lower
injection of capital into the markets by investors because a larger
fraction of each investable dollar would go to compensate broker-
dealers for the lost revenue. However, because rebates are generally
accompanied by higher access fees, the overall costs to broker-dealers
to route orders to exchanges could decline for some test groups, which
could lead to a decrease in commissions or fees and temporarily
increase the efficiency of capital allocation.
For the duration of the proposed Transaction Fee Pilot, lower
access fees could improve liquidity of stocks and ETPs in some test
groups, by reducing the costs to execute marketable orders. As
marketable orders become less costly, these orders are likely to be
routed to exchanges with lower access fees, improving execution quality
and possibly creating a liquidity externality, whereby lower access fee
venues will become the preferred trading center for marketable and non-
marketable orders.\406\ An increase in liquidity could improve
informational efficiency by allowing securities prices to adjust more
quickly to changes in fundamentals.
---------------------------------------------------------------------------
\406\ As discussed in detail above, improvements in execution
quality could present as better prices for execution, higher
probability of execution, and faster time to execution. See supra
note 215.
---------------------------------------------------------------------------
As a result of the proposed Pilot, price efficiency might also
improve; quoted spreads also may more closely reflect the net cost of
trading and could temporarily increase price transparency for
securities in certain test groups. Currently, broker-dealers do not
relay information about amounts of fees paid or rebates received on
trades to their customers, thereby limiting the transparency of the
total costs incurred to execute a trade. The proposed Pilot would not
mandate disclosure by the exchanges or the broker-dealers of order-
level transaction-based fees; and therefore, will not resolve the
limitations to transparency of the total fees paid and rebates received
by broker-dealers discussed above. As fees decline or rebates are
removed in some
[[Page 13067]]
test groups, however, the deviation in the net cost of trading from the
quoted spread could shrink, thereby at least partially improving price
transparency for the duration of the proposed Pilot, and temporarily
improving pricing efficiency and price discovery. Therefore, as an
additional benefit of the proposed Pilot, the Commission could also
examine the temporary effect of revisions to access fees and rebates on
quoted spreads, to better inform future policy recommendations of the
effects of transaction-based fees on price efficiency.\407\
---------------------------------------------------------------------------
\407\ See Section V.C.2.b supra.
---------------------------------------------------------------------------
Other aspects of the proposed Pilot temporarily may impair
efficiency. The proposed Pilot is intended to reduce (and in some cases
eliminate) rebates or Linked Pricing for a substantial portion of NMS
stocks (including ETPs); however, the loss of rebates or Linked Pricing
in Test Group 3 could have a differential effect between large and
small capitalization securities.\408\ If exchanges use rebates as a
mechanism to provide broker-dealers with incentives to post non-
marketable orders to exchanges, in the absence of rebates, broker-
dealers instead may have incentives to post these orders to off-
exchange trading centers, such as ATSs. This may lead to a temporary
widening of the NBBO, which could lead to a temporary reduction of
liquidity that could be particularly severe for small or mid-cap
securities. Thus, the overall informational efficiency of prices, as a
result of widening spreads, could temporarily decline with the
implementation of the proposed Pilot.
---------------------------------------------------------------------------
\408\ See supra note 402.
---------------------------------------------------------------------------
Furthermore, even if broker-dealers do not use ATSs and
internalization more intensively, the proposed Pilot may temporarily
impair the efficiency of transactions in certain Test Groups, through
the impact of Pilot-induced fee and rebate changes on the NBBO. As
discussed earlier, one potentially distortive effect of transaction-
based fees on maker-taker trading centers is that they provide
incentives for market participants to post more aggressive limit orders
(e.g., limit orders close to the current market price) because they
anticipate receiving rebates if their orders are executed. To the
extent that reductions in rebates result in a wider bid-ask spread in
certain stocks and ETPs during the proposed Pilot Period, this may
increase transaction costs for internalized order flow or orders routed
to ATSs that execute based on the NBBO and for orders executing on
exchanges.\409\ For example, if an ATS offers to execute buy orders at
the average of the national best offer and midpoint, rather than at the
wider quoted spread, the ATS would execute these orders at higher
prices than those available on exchanges. Notably, the impact of less
aggressive limit orders is less likely to affect marketable orders on
maker-taker trading centers, because lower taker fees could mitigate
the impact of a wider quoted spread on total transaction costs for
liquidity takers.
---------------------------------------------------------------------------
\409\ See Angel, Harris, and Spatt, supra note 106.
---------------------------------------------------------------------------
Finally, the Commission acknowledges that the fee caps and
prohibition on rebates or Linked Pricing imposed on the test groups
during the proposed Pilot further constrain the exchanges' abilities to
strategically choose fee and rebate schedules and for some NMS stocks
may restrict the fees and rebates further beyond the current levels,
which could be efficient from the exchanges' perspective, incorporating
their beliefs about the trade-off between revenues and costs associated
with these transaction-based fees. The proposal could temporarily
result in more or less efficient fee and rebate schedules because the
exchanges might not be able to optimize their pricing structure for
some test groups of securities. While the Commission does not currently
have information to determine the current level of efficiency of fees
and rebates, the information that the Commission and the public receive
from the proposed Pilot could enable the analysis of market impacts
stemming from changes to fees, potentially permitting the Commission to
assess alternative requirements for transaction-based fees that may be
more efficient.
2. Competition
While the Commission preliminarily believes that most of the
impacts of the proposed Pilot on the market for trading services would
be limited to the duration of the proposed Pilot, some effects may last
beyond the end of the proposed Pilot. Certain exchanges could be harmed
if a reduction in rebates results in consolidation of orders at other
exchanges. This could occur if the proposed Pilot attenuates the
potentially distortive impact of transaction-based fees and causes
broker-dealers to route orders to trading centers they perceive as more
liquid. To the extent that increased order flow in a security directed
to a particular venue encourages broker-dealers to route more orders
for that security to the venue, a liquidity externality may develop,
making the venue the preferred routing destination for all orders.
Although these effects would likely last only for the duration of the
proposed Pilot, depending on the extent of the liquidity externalities,
smaller exchanges could experience long-lasting competitive effects.
The proposed Transaction Fee Pilot could also temporarily discourage
entry of new exchanges that might otherwise emerge to take advantage of
the maker-taker and taker-maker pricing models.\410\ Under such
circumstances, while the consolidation of liquidity may benefit market
participants, it may also make it difficult for trading centers with
low volumes in particular securities to compete with trading centers
that represent liquidity centers in these securities. This could lead
to consolidation or exit by small exchanges as a result of the proposed
Pilot, although the Commission preliminarily believes that either of
those events is unlikely because the anticipated revenue shortfall, as
discussed above, would be for a limited duration and would not be
significant enough to cause this result.
---------------------------------------------------------------------------
\410\ Academic studies suggest a number of new exchanges emerged
specifically to take advantage of maker-taker and taker-maker
pricing models. See, e.g., Angel, Harris, and Spatt, supra note 106.
---------------------------------------------------------------------------
The proposed Transaction Fee Pilot may also temporarily alter
competition among exchanges that use transaction-based fee pricing
models. Exchanges that pay fees and remit rebates frequently revise
their fee schedules in order to remain competitive and to attract order
flow. The impact of the proposal on competition depends on the extent
to which the fee caps and prohibition on rebates or Linked Pricing
restrict exchanges' transaction-based fee strategies. On one hand, the
proposed Pilot, while changing either access fees or rebates on certain
subsets of securities, could leave the margins that exchanges obtain
from transaction-based pricing models unchanged and could preserve the
current state of competition among exchanges in the market for those
securities. Several earlier studies suggest that the average difference
between the access fees and rebates is approximately $0.0005; however,
the EMSAC NMS Subcommittee observed that the current typical margin per
share is $0.0002,\411\ and a recent report from 2017 suggests that the
spread between fees and rebates is approximately $0.0001.\412\ For
instance, for stocks in
[[Page 13068]]
Test Group 1, which limits access fees to no greater than $0.0015, it
may be possible for exchanges to modify fee structures in a way that
leaves margins unchanged and does not impact competition between
exchanges. However, this may not be true for all test groups, and some
exchanges may be unable to maintain current average margins per share
for stocks in Test Group 2.\413\ These exchanges may choose to compete
less intensively for order flow in this test group, instead focusing on
stocks and ETPs in other test groups. Some of the shortfall in the
competition for order flow for this subset of securities could be
filled by off-exchange trading centers. Alternatively, exchanges may
revise pricing strategies for stocks in other groups, choosing to
implicitly subsidize rebates for stocks in some test groups using fees
from stocks in other test groups. This may increase competition for
order flow in some test groups while reducing it in others. In the
presence of tighter restrictions on transaction-based fees during the
proposed Pilot Period, exchanges could compete in other ways to attract
trading volume (e.g., discounts on connectivity fees or increased
volume discounts), although the Commission believes that for some test
groups the ability to offer meaningful volume discounts would be
limited.\414\
---------------------------------------------------------------------------
\411\ See supra note 28.
\412\ See, e.g., Laura Cardella, Jia Hao, and Ivalina Kalcheva,
``Make and Take Fees in the U.S. Equity Market,'' Working Paper,
University of Arizona (2015), available at: https://www.rhsmith.umd.edu/files/Documents/Centers/CFP/research/cardella_hao_kalcheva.pdf (``Cardella, et al. study''); Harris,
supra note 23. Each of these papers indicates the difference between
fees and rebates is approximately $0.0005 per share; the Cardella et
al. study, however, uses data from 2008 to 2010. A recent discussion
indicates that the difference between fees and rebates is $0.0001.
See, e.g., ``How to Align Broker and Customer Interests to Make
Exchanges More Competitive,'' Trillium Management, LLC (June 28,
2017), available at: https://www.trlm.com/align-broker-customer-interests-make-exchanges-competitive/.
\413\ As discussed in Section III.C.2, if the margin between
fees and rebates exceeds $0.0005, exchanges theoretically could
assess fees to both the make and take sides of the market; however,
the Commission preliminarily believes that exchanges are unlikely to
do so.
\414\ For NMS stocks included in Test Group 3, order flow
incentives would be substantially reduced, particularly any new
inducements that provide a discount or incentive on one side of the
market that is linked to activity on the opposite side of the
market.
---------------------------------------------------------------------------
The proposed Transaction Fee Pilot may not only affect competition
between exchanges, but also could affect broker-dealers' decisions to
route orders to off-exchange trading centers for the duration of the
proposed Pilot, affecting how exchanges compete with other execution
venues in the market for trading services. Lower rebates during the
proposed Pilot Period may prompt broker-dealers to internalize a higher
proportion of order flow or route a higher proportion of order flow to
wholesalers and ATSs. This could alter the current competitive dynamics
among trading centers in favor of non-exchange trading centers. Lower
access fees, on the other hand, could attract marketable order flow
from the ATSs and back to the exchanges, which could tilt the
competitive equilibrium in favor of the national securities exchanges.
The proposed Pilot could also temporarily affect the competition
for order flow for ATSs and could subsequently alter their market
share. As discussed in the baseline, the market share of trading volume
on ATSs is approximately 13%. If the prohibition of rebates or Linked
Pricing in Test Group 3 leads to increased order flow migrating to off-
exchange trading centers, this may increase the fraction of transaction
volume to ATSs or other off-exchange venues traditionally captured by
exchanges. The reduction in access fees in some of the test groups,
however, could lead to exchanges attracting more order flow away from
ATSs and other off-exchange trading centers. Similarly, if the
equilibrium access fee in Test Group 3 is below $0.0030 in the absence
of rebates, exchanges may be able to draw order flow from off-exchange
trading centers.
The Commission recognizes that the potential temporary competitive
impacts stemming from the proposed Pilot would generally depend on the
exposure of each trading center to each test group and the control
group of NMS stocks, because the constraints on fees and rebates apply
differently to each group. For instance, if a high portion of an
exchange's volume was derived from stocks in Test Group 2, it may be at
a particular competitive disadvantage relative to an exchange that
served markets across all groups, because a substantial reduction in
the fee cap applicable to Test Group 2 would apply to a higher
proportion of its trading volume. However, the Commission preliminarily
believes that, given its aim of producing representative groups of
stocks and ETPs for the purposes of the proposed Pilot, trading centers
are not likely to be substantially more exposed to NMS stocks in any
one group.
3. Capital Formation
The Commission preliminarily does not expect the proposed Pilot to
have a substantial permanent impact on capital formation because the
proposed Pilot is limited in duration, though many of the
implementation costs associated with the proposed Pilot would require
exchanges to expend resources related to maintaining the List of Pilot
Securities and any changes to that lists, as well as the maintenance of
the Exchange Transaction Fee Summary and the order routing data, they
may have otherwise invested elsewhere or distributed to
shareholders.\415\
---------------------------------------------------------------------------
\415\ The costs associated with implementation and compliance
with the proposed Transaction Fee Pilot are discussed in more detail
above (Section V.C.2.a, supra).
---------------------------------------------------------------------------
As discussed above,\416\ the Commission recognizes that the overall
temporary impact of the proposed Transaction Fee Pilot on liquidity and
total transaction costs could be positive or negative. As a result, the
impact of the proposed Pilot on capital formation is uncertain. On one
hand, the proposed Pilot could temporarily reduce total transaction
costs for many market participants by consolidating liquidity and
improving execution quality. To the extent that such cost reductions
are realized, they may, for instance, permit market participants to
more efficiently deploy financial resources by reducing the cost of
hedging financial risks. As a result, the proposed Pilot may marginally
and temporarily promote capital formation. Improvements in both
liquidity and price efficiency could make capital markets more
attractive, at least for the duration of the proposed Pilot. The
temporary reduction in rebates to certain test groups as a result of
the implementation of the proposed Pilot could widen quoted spreads,
thereby potentially leading to worse execution prices and subsequently
reducing liquidity for the duration of the proposed Pilot.\417\ This
would have similar indirect impacts on capital formation but in the
opposite direction, by increasing the cost of hedging financial risks.
---------------------------------------------------------------------------
\416\ Section V.C.1.a.ii, supra, provides a discussion of price
transparency, which could improve liquidity and total transaction
costs, while the liquidity externality is discussed in Section
V.A.2, supra.
\417\ See, George Chacko, Jakub Jurek, and Erik Stafford, ``The
Price of Immediacy,'' Journal of Finance 63, 1253-1290 (2008),
available at: https://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.2008.01357.x/full (``Chacko et al.''). According to Chacko et
al., liquidity has three important dimensions: Price, quantity, and
immediacy. A market for a security is considered ``liquid'' if an
investor can quickly execute a significant quantity at a price at or
near fundamental value.
---------------------------------------------------------------------------
The proposed Pilot may also affect capital formation through its
impact on discretionary accounts. A number of broker-dealers have
discretionary agreements with their clients, wherein the broker can
transact in the client's account without the client's consent. For the
duration of the proposed Transaction Fee Pilot, some broker-dealers may
alter the composition of their clients' portfolios to trade and hold
greater proportions of the accounts in high-rebate NMS stocks
(including ETPs) in the Control Group and Test Group 1. Such revisions
to portfolio
[[Page 13069]]
composition as a result of the proposed Pilot are not necessarily
efficient from an investor's perspective and could have a detrimental
impact on capital formation insofar as they increase the riskiness of
client portfolios or decrease client portfolios' expected returns.\418\
This behavior would temporarily distort the market for high-rebate
stocks and ETPs, creating a higher demand for these securities and
potentially leading to an inefficient allocation of capital based on
signals that are unrelated to firm fundamentals.
---------------------------------------------------------------------------
\418\ Allocative efficiency in the context of investment choice
is optimized when there are no restrictions on the set of investment
opportunities available to an investor. See, e.g., Niels Christian
Nielsen, ``The Investment Decision of the Firm under Uncertainty and
the Allocative Efficiency of Capital Markets,'' Journal of Finance
31, 587-602 (1976), available at: https://www.jstor.org/stable/2326628. If the proposed Pilot potentially leads some broker-dealers
to alter the investment opportunity set to avoid securities that do
not pay rebates, then allocative efficiency for those investors
would likely be impaired since the opportunity set is restricted.
---------------------------------------------------------------------------
As discussed above, the proposed Pilot could lead to a temporary
reduction of liquidity that could be particularly severe for small or
mid-capitalization securities.\419\ In addition to reducing the
informational efficiency of prices, if the effects of the proposed
Pilot are severe enough, longer term, it could affect capital formation
for these securities. If the temporary impacts on liquidity acutely
impact some firms, it could lead to either the potential exit of these
issuers from the capital markets, through acquisition or delisting, as
these small issuers are those least likely to ride out negative
liquidity shocks. Further, the proposed Pilot could lead to a delay by
some issuers to enter the capital markets during the proposed Pilot's
duration.
---------------------------------------------------------------------------
\419\ See supra note 402.
---------------------------------------------------------------------------
E. Alternatives
Below, the Commission discusses a number of alternatives to the
proposed Transaction Fee Pilot. As explained above, the proposed Pilot
is designed to collect data on how changes to fees and rebates affect
order routing behavior and execution, which could inform the Commission
and the public as to any possible conflicts of interest between broker-
dealers and their customers. The Commission considers four sets of
alternatives: (1) Expansion of the proposed Pilot to include ATSs; (2)
inclusion of a trade-at provision; (3) prohibition of overlap with the
Tick Size Pilot; and (4) adjustments to the basic pilot structure
(e.g., the inclusion of a zero access fee test group). Where
appropriate, suggestions attributable to the EMSAC recommendation have
been identified within the scope of the alternatives presented
below.\420\
---------------------------------------------------------------------------
\420\ See supra note 37.
---------------------------------------------------------------------------
1. Expand Proposed Transaction Fee Pilot To Include ATSs
As proposed, the Transaction Fee Pilot would not require ATSs to
comply with the requirements on the limits to access fees or rebates
imposed by the Pilot. One alternative would be the inclusion of ATSs in
the proposed Transaction Fee Pilot proposal. Including ATSs in the
proposed Transaction Fee Pilot would increase availability of data for
an important segment of trading activity in the NMS securities, would
cover a larger portion of the order routing inducements,\421\ and could
enhance the information regarding possible conflicts of interest
available to the Commission. ATSs capture a large fraction of
transaction volume for NMS stocks (approximately 13% as of July 2017),
indicating that they are important competitors to exchanges and other
off-exchange trading centers.\422\ Some studies have noted that
transaction-based fees and rebates have likely caused some order flow
to migrate from exchanges to off-exchange trading centers, such as
ATSs, in order to avoid high access fees levied by some exchanges.\423\
---------------------------------------------------------------------------
\421\ See supra note 268.
\422\ See supra note 298.
\423\ See Angel, Harris, and Spatt, supra note 216.
---------------------------------------------------------------------------
An alternative that includes ATSs would be broader than the
proposed Pilot and would also include more inducements, besides fees
and rebates, that broker-dealers might receive for routing orders to
particular trading centers, including ATSs.\424\ The Commission has
limited information about how ATS fee structures might induce broker-
dealers to route orders to ATSs thereby creating potential conflicts of
interest between broker-dealers and their clients. If it included
trading centers beyond exchanges, the proposed Pilot would provide
information to the Commission and the public about a more complete set
of order routing decisions by broker-dealers because it would increase
the representativeness of the results obtained, and may provide a
deeper understanding of how exogenous shocks to fees and rebates affect
order routing decisions. Further, because transaction-based fees and
rebates are one possible method that exchanges and ATSs use as
inducements for order flow, a pilot that was inclusive of these other
inducements would further expand our understanding of what drives order
routing decisions and might raise possible conflicts of interest.
---------------------------------------------------------------------------
\424\ As discussed above, the proposed rule only prohibits new
inducements that provide a discount or incentive on one side of the
market that is linked to activity on the opposite side of the market
for Test Group 3.
---------------------------------------------------------------------------
The Commission preliminarily believes that the inclusion of ATSs
and other inducements for order flow into the proposed Transaction Fee
Pilot is likely to substantially increase the costs relative to the
current proposal and may not be practical. Because broker-dealers that
operate ATSs could bundle fees for ATS usage with other broker-dealer
fees, the proposal might not practically be able to impose an access
fee cap or prohibition on rebates on ATS fees. Further, the Commission
currently does not require that ATSs provide periodic public
disclosures on their fees, as it does with national securities
exchanges, and these fees do not need to be filed with or approved by
the Commission. Unlike exchanges, which must report their fees
schedules publicly on their websites, and must file Form 19b-4 with the
Commission to effect any changes to those fee schedules, ATSs currently
have no reporting requirements for their fees. The costs to ATSs of
participating in the Pilot would be higher relative to the costs to the
exchanges in two ways: (1) The Pilot would require ATSs to report
information that is currently not required by regulation for the
purpose of the proposed Pilot, and (2) the Pilot would impose
significant start-up costs on the ATSs to set up systems to report
these fees. Thus, including ATSs in an alternative version of the
proposed Pilot would likely increase both the costs and the complexity
of the proposed Pilot because it would likely require a shift in the
disclosure regime for these trading centers.
Even in the absence of including ATSs in the proposed Pilot, the
Commission would be able to obtain information on the proportion of
trades going to ATSs from several sources. First, several transaction
datasets, including trade reporting facility (TRF) data and TAQ data,
provide information on off-exchange trades, including ATS trades.
Further, FINRA produces periodic (weekly) data on the total shares of
NMS securities executed by individual ATSs.\425\ Thus, the Commission
would obtain information from the proposed Pilot to identify whether
exogenous shocks to
[[Page 13070]]
transaction-based fees on exchanges have an effect on order routing
decisions, including whether broker-dealers alter their routing of
order to ATSs during the proposed Pilot. The inclusion of ATSs into the
requirements of the proposed Pilot, however, would likely significantly
add to the proposed Pilot's complexity and cost a significant amount of
money to implement.
---------------------------------------------------------------------------
\425\ Combining the FINRA volume data executed by ATSs for a
given security, with other data, such as TAQ, which would provide
total share volume for a given security, a researcher would be able
to estimate the fraction of ATS trading as a percentage of total
trading in NMS securities over the same time period.
---------------------------------------------------------------------------
2. Trade-At Test Group
The proposed Transaction Fee Pilot could include a ``trade-at''
provision in conjunction with the changes to the fees and rebates
currently proposed in the Pilot.\426\ The trade-at provision would
require that orders be routed to a market with the best displayed price
or are executed at a materially improved price. A trade-at provision
could increase incentives to display prices, as off-exchange trading
centers would no longer be able to match the best price offered
elsewhere, but instead would have to provide significant price
improvement or start displaying their quotes at the NBBO. Including the
trade-at provision as a component of the proposed Transaction Fee Pilot
could potentially increase the level of displayed liquidity across all
venues, because off-exchange trading centers, such as ATSs, would have
increased incentives to display prices, and could have effects on the
order routing decisions of broker-dealers. Orders routed to exchanges
that are not posting the best prices could be indicative of potential
conflicts of interest between broker-dealers and their customers.
Including a trade-at subgroup could provide supplemental information to
the Commission about how a combination of trade-at provisions coupled
with revisions to transaction-based fees affect broker-dealer order
routing decisions.
---------------------------------------------------------------------------
\426\ Because a ``trade-at'' provision is already a requirement
of the Tick Size Pilot, to the extent that there is overlap between
the two pilots and sufficient statistical power, the Commission may
be able to obtain valuable information from that pilot without the
need to include a trade-at provision in the proposed Transaction Fee
Pilot.
---------------------------------------------------------------------------
From an implementation perspective, including a trade-at provision
would result in a pilot that is more complex than the proposed Pilot.
As proposed, the Pilot has three test groups for different exogenous
shocks to fees or rebates; adding a trade-at provision would double the
number of test groups, thereby increasing the costs of implementation
for exchanges. Such an addition would also likely increase the
difficulty of analyses. The Tick Size Pilot includes a trade-at group
because exchanges were concerned that, in the current market
environment, a larger tick size could induce order flow to go off-
exchange.\427\ However, unlike the Tick Size Pilot, the Commission
preliminarily believes that as a result of the proposed Transaction Fee
Pilot, marketable order flow would be less likely to flow to off-
exchange trading centers, because as access fees for some test groups
would decline, order flow could be drawn back to exchanges. The
Commission, therefore, preliminary believes that the inclusion of the
trade-at provision would not likely provide much additional information
to address the potential conflicts of interest between broker-dealers
and their customers beyond that afforded by the proposal.
---------------------------------------------------------------------------
\427\ See Tick Size Pilot Approval Order, supra note 5, at
27538-42.
---------------------------------------------------------------------------
3. No Overlap With Tick Size Pilot
As proposed, the Transaction Fee Pilot could overlap with the Tick
Size Pilot for some portion of the proposed Pilot duration, although
the length of that overlap is uncertain, and the Commission
preliminarily believes that any anticipated overlap would be minimal
and would depend on when the proposed Transaction Fee Pilot would
become effective, if adopted. Alternatively, the Commission could
consider two separate alternatives that both address the elimination of
the overlap of the proposed Transaction Fee Pilot with the Tick Size
Pilot: (1) Limiting the sample to securities with market
capitalizations of at least $3 billion or (2) delaying the
implementation of the Pilot until the Tick Size Pilot is concluded.
The first potential alternative is similar to that recommended by
EMSAC, whereby the pilot would include only securities with market
capitalizations in excess of $3 billion, in order to avoid the
simultaneity of the Tick Size Pilot and the proposed Transaction Fee
Pilot for a subset of securities. The advantage to this approach is
that the proposed Transaction Fee Pilot could start without
consideration for the Tick Size Pilot duration, and could reduce
implementation and complexity burdens for exchanges and broker-dealers
because no subset of securities would be subject to the two pilots
simultaneously. However, this approach of only examining the effects of
changes on transaction-based fees for securities with market
capitalizations of at least $3 billion would significantly reduce the
overall sample representativeness desired by the proposed Pilot, which
would limit the usefulness of any data obtained from such a pilot. The
Commission preliminarily believes that removing these smaller issuers,
for which the potential conflicts of interest could likely be the
largest,\428\ from the proposed Transaction Fee Pilot would limit the
value of the information received, and would be less useful to the
Commission for informing future policy recommendations related to these
conflicts, as discussed in more detail in Section V.C.1.a.i.A.
---------------------------------------------------------------------------
\428\ See Battalio Equity Market Study, supra note 22; Harris,
supra note 23. The negative relationship between access fees and
execution quality (realized spreads) increases for low-priced
securities, suggesting that low-priced or small capitalization
stocks are more likely to have potential conflicts of interest
related to transaction-based fees than large capitalization stocks.
---------------------------------------------------------------------------
Alternatively, the Commission could delay full implementation of
the proposed Transaction Fee Pilot until six months after the Tick Size
pilot concludes, to the extent that such overlap between the pilots
exists. By implementing each pilot sequentially, the Commission would
obtain distinct information generated by each pilot, and would reduce
the potential costs incurred by exchanges and broker-dealers in
implementing simultaneous pilots, as well as the temporary other costs
borne by small issuers and other market participants, discussed in
detail in Section V.C.2.b. On the other hand, running sequential pilots
could delay the benefits of the information the Commission anticipates
realizing from the pilot.
The Commission preliminarily believes that the alternative to delay
implementing the proposed Transaction Fee Pilot to avoid any overlap
(to the extent that such an overlap would otherwise occur) with the
Tick Size Pilot would provide minimal cost savings relative to the
proposal. As discussed in Section V.C.2.b, the Commission anticipates
that the costs associated with overlapping the proposed Transaction Fee
Pilot with the Tick Size Pilot could be small. Further, as discussed
above, the Commission preliminarily believes the Pilot's design would
prevent any overlap, to the extent that overlap between the proposed
Transaction Fee Pilot and the Tick Size Pilot occurs, from compromising
the Pilot results.
4. Adjustments to the Proposed Transaction Fee Pilot Structure
The alternatives described above provide significant revisions to
the approach or the representativeness of the proposed Transaction Fee
Pilot. This section discusses a number of alternatives that detail
other
[[Page 13071]]
adjustments to the basic structure of the Pilot as proposed. These
include an alternative time frame for the Pilot duration or the pre-
and post-Pilot Periods, a zero access fee test group, alternative
access fee caps, and the inclusion of non-displayed liquidity or depth-
of-book provisions in Test Groups 1 and 2.
As currently proposed, the Transaction Fee Pilot would be
implemented for two years with an automatic sunset at the end of the
first year, unless the Commission publishes a notice determining that
the proposed Pilot shall continue for up to another year.
Alternatively, the Commission could recommend an earlier or later Pilot
sunset or a longer or shorter Pilot duration. An earlier Pilot sunset
would shorten the anticipated proposed Pilot duration, reducing the
time period during which potential negative temporary effects resulting
from the proposed Pilot could occur. However, if the anticipated
duration of the proposed Pilot were sufficiently short, some broker-
dealers could either choose to not alter their current order routing
behavior and wait out the length of the Pilot, which would limit the
usefulness of the information obtained by the Pilot.\429\ A shorter
anticipated duration also could reduce the usefulness of the
information and the benefits provided by the proposed Pilot, if it
reduced the statistical power of any analyses, because it would make it
more difficult for researchers to detect whether an effect actually
exists.\430\
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\429\ See Section V.C.1.a.iii, which discusses the potential
limitations associated with pilots, including a discussion that some
market participants could choose to not alter their behavior if the
proposed Pilot had a short duration.
\430\ The Commission staff estimates that it would require a
minimum Pilot duration of six months to achieve sufficient
statistical power to detect whether an effect is actually present;
therefore, any Pilot duration shorter than six months would have
limited benefits for detecting the effect of transaction-based fees
and rebates on order routing decisions, execution quality, and
market quality.
---------------------------------------------------------------------------
Conversely, as the anticipated Pilot duration increases so too
would the costs for exchanges, as this would extend the duration of the
changes to their revenue models and the costs of compliance with the
proposed Pilot requirements. However, increasing the duration beyond
two years is unlikely to provide any significant increases in the
benefits identified above. As discussed in Section V.C.1.a.i, the
Commission preliminarily believes that the proposed Pilot duration,
even with a one-year sunset would make it economically worthwhile for
broker-dealers to alter their order-routing decisions, because it would
likely be costly for broker-dealers to sit out the full duration of the
proposed Pilot or retain pre-Pilot order routing decisions for its
duration. Further, a longer Pilot duration would increase the costs
associated with a longer time period in which temporary negative
externalities arising from the proposed Pilot would exist. These
externalities could have longer-term implications on efficiency,
competition, and capital formation, and could reduce overall levels of
investor protection.
The Commission could alternatively propose a pilot with a fixed
two-year duration. A two-year pilot without the possibility of an
automatic sunset at the end of the first year would have the same
maximum costs as a pilot with a sunset, but would not have the
potential to reduce costs in the event that the sunset occurs. The
alternative would also not provide the Commission with the flexibility
to efficiently end the proposed Pilot early once the Pilot produced
sufficient data to obtain representative results. On the other hand,
broker-dealers could perceive higher expected costs of not adapting to
the Pilot under the alternative because they could expect the sunset to
reduce the anticipated duration of the Pilot. However, the Commission
preliminarily believes that broker-dealers that base their order
routing decisions on transaction-based fees and rebates will incur
sufficient costs from not enacting changes to their order routing
decisions in response to the Pilot with an expected one-year sunset
such that they are not likely to sit out the Pilot Period; therefore, a
mandatory two-year pilot would not likely provide any additional
behavioral change that would not already be obtainable from the
proposed Pilot.
As currently proposed, the Pilot requires a six-month pre-Pilot
Period and a six-month post-Pilot Period, which would allow the
Commission and the public to compare order routing decisions in the
same stocks both with and without the proposed Pilot restrictions as
well as across stocks in different test groups. Alternatively, the
Commission could propose shorter pre-Pilot and post-Pilot Periods.
Shorter pre- and post-Pilot Periods would reduce costs to exchanges of
having to provide the Exchange Transaction Fee Summary and order
routing data. These reduced costs come at the trade-off of shorter
horizons for data collection that could lead to reduced statistical
power and reduce the ability of the proposed Pilot to produce
representative results.\431\
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\431\ The Commission staff estimates the pilot would need to
produce approximately six months of data to detect changes unique to
ETPs, and between 60 and 69 days of data to detect changes unique to
small and large NMS stocks, respectively. The methodology employed
provided power tests on the distributions of average daily dollar
volume data for ETPs and small and large capitalization NMS common
stocks obtained from the CRSP U.S. Stock Database. The power tests
determined the number of days of data that would be required to
detect a 10% change in the daily volume of various subgroups of
securities.
---------------------------------------------------------------------------
If the proposed Pilot included a zero access fee test group, this
would effectively serve to temporarily remove a source of revenue for
exchanges entirely from a subset of securities. This approach could
produce additional information, such as how order routing behavior and
execution quality changes in the absence of transaction-based fees (and
likely rebates), that could be useful to the Commission to facilitate
future policy decisions regarding the transaction-based pricing
structures of exchanges. However, any new revenue model created during
the proposed Pilot could provide additional incentives for broker-
dealers to route order flow from customers in a manner that could make
possible conflicts of interest more or less pervasive, complicating
analysis of the pilot. If a zero access fee test group were included,
exchanges would be unable to charge access fees to market participants
that take liquidity from maker-taker markets or make liquidity on
taker-maker exchanges. The inclusion of a zero access fee test group
would thus completely eliminate the transaction-based fee model for a
subset of securities, which could force exchanges to create entirely
new revenue models for securities in this test group. Although
inclusion of a zero access fee test group could potentially provide
expanded information to the Commission and the public about possible
conflicts of interest, the Commission notes that these would come at
the cost of lost revenue to exchanges for eliminating transaction-based
fees entirely or costs associated with the creation of new revenue
models only for the duration of the Pilot.
The Pilot, as currently proposed, would have three test groups: (1)
One that caps access fees at $0.0015; (2) one that caps access fees at
$0.0005; and (3) one that prohibits rebates or Linked Pricing for
displayed and non-displayed liquidity and along the entire depth of the
limit order book. Alternatively, the Commission could have proposed
other test groups with different caps on access fees. For example, the
Commission could have proposed only caps to access fees, similar to
those in the EMSAC
[[Page 13072]]
recommendation,\432\ or could have increased the number of test groups.
Only studying exogenous shocks to access fees would have limited the
amount and type of information available to the Commission, given that
the theoretical literature suggests that potential conflicts of
interest are linked to rebates more than to access fees. Any
alternative would likely replace the zero rebate test group with
another access fee cap group. Thus, without a test group that
specifically focuses on the removal of rebates and the corresponding
impact on conflicts of interest, the Commission and the public would
have a set of information of lower value than it would otherwise. An
alternative to increase the number of test groups could produce more
gradation in the caps to access fees, this alternative would likely
increase the complexity of the proposed Pilot, and would increase the
implementations costs to account for the additional test groups. These
costs would be borne with little incremental benefit to the quality of
information produced from these additional test groups, because these
additional groups would only provide minor variations in access fees
from those already proposed.
---------------------------------------------------------------------------
\432\ The maximum access fee caps under the EMSAC recommendation
would be $0.0020 (Test Group 1), $0.0010 (Test Group 2), and $0.0002
(Test Group 3).
---------------------------------------------------------------------------
As the Pilot is currently proposed, only Test Group 3, which
eliminates rebates or Linked Pricing, would restrict fees or rebates or
Linked Pricing in non-displayed liquidity and depth-of-book. As
discussed in Section III.C.3, under the proposed Pilot, perverse
incentives to move liquidity away from the displayed liquidity or the
top-of-book could be created if rebates are not eliminated along the
entire book and for displayed and non-displayed liquidity. As an
alternative to the current Pilot proposal, the Transaction Fee Pilot
could also revise access fees in Test Groups 1 and 2 to cover both non-
displayed liquidity and the depth-of-book. Unlike the problem
associated with moving away from displayed liquidity that could emerge
if rebates or Linked Pricing were not removed from the entire depth of
the limit order book, the Commission does not believe that under the
proposed Pilot incentives would emerge for exchanges to charge more to
access non-displayed interest or depth-of-book quotes. Such differing
fees across displayed and non-displayed liquidity as well as the depth
of the limit order book would lead to increased uncertainty for market
participants that take liquidity, as they would not be able to control
whether their executions are with displayed or non-displayed liquidity.
If the fees differed between displayed and non-displayed liquidity,
broker-dealers would face cost uncertainty when making routing
decisions over what access fees they would incur. From the exchanges'
perspective, having differing fees for posting or interacting with
displayed and non-displayed liquidity would be burdensome to track and
more costly to administer and, to the extent the uncertainty it creates
dissuades market participants from routing to their market, could
ultimately cause them to lose order flow. Accordingly, the Commission
preliminarily believes that it is unnecessary to mandate transaction-
based fee caps for the non-displayed liquidity.
Under the current proposal, Test Group 3 would prohibit rebates or
Linked Pricing on NMS stocks (including ETPs). Alternatively, the
Commission could instead prohibit only rebates, without any extension
to other similar inducements that an exchange might use to attract
order flow. The Commission, however, believes that an alternative that
excludes like inducements from Test Group 3 would provide opportunities
for exchanges to work around the rebate prohibition, which would likely
reduce the effectiveness of the information received about NMS stocks
(including ETPs) in Test Group 3.
The Commission alternatively could propose a limitation on Linked
Pricing across all Test Groups, not just Test Group 3. Given that Test
Groups 1 and 2 would undergo a reduction in fees due to the lower caps
in each of those groups, which likely would lead to a corresponding
reduction in rebates, exchanges may choose to alter other like
incentives, which would allow them to supplement the incentive they
provide for activity in securities in Test Groups 1 and 2, and could
distort the information obtained from the Pilot. However, from the
exchanges' perspective, enhancing like inducements would further erode
margins related to transaction activity. Therefore, the Commission
preliminarily believes that it is unnecessary to prohibit like
inducements for Test Groups 1 and 2.
As currently proposed, the Transaction Fee Pilot does not require
the exchanges to produce much additional information on order execution
quality statistics. As an alternative, the Commission could require
that the exchanges produce daily Rule 605 data similar to that required
in Appendix B.1 of the Tick Size Pilot Plan. Providing daily order
execution quality statistics are important for the Tick Size Pilot,
because order size is influenced by tick size, and is an important
determinant of execution quality. As a result, trade-based measures of
the effect of the Tick Size Pilot might not yield the same results as
order-based measures of the Tick Size Pilot, such as that in data
required in Appendix B.1 of the Tick Size Pilot Plan. However, the
proposed Transaction Fee Pilot might not alter order sizes nearly as
dramatically as in the Tick Size Pilot, or might not alter them at all.
Therefore, the Commission preliminarily does not expect that results of
the proposed Transaction Fee Pilot using trade-based execution quality
measures to differ from results using order-based execution quality
measures. Even though exchanges have systems in place to capture some
elements of daily data as required by the Tick Size Pilot, including
this data could be costly for the exchanges to provide with limited
benefit for the proposed Transaction Fee Pilot. As currently proposed,
the Transaction Fee Pilot would provide daily information on shares
submitted, executed, and cancelled to an exchange, and would provide
some limit order execution quality information, such as time to
execution and likelihood of execution, that are not currently available
from other existing data sources.\433\
---------------------------------------------------------------------------
\433\ For example, existing studies often incorporate execution
quality statistics estimated from TAQ data. See, e.g., Battalio
Equity Market Study, supra note 22.
---------------------------------------------------------------------------
As the Pilot is currently proposed, downloadable files containing
the Exchange Transaction Fee Summary would need to be publicly posted
on each exchange's website using an XML schema to be published on the
Commission's website. Alternatively, similar to the List of Pilot
Securities, the Exchange Transaction Fee Summary could be reported in
pipe-delimited ASCII format. However, the pipe-delimited ASCII format
does not support validations. As discussed earlier, validations help
ensure that comparable data are formatted consistently and reported
completely. Validations also help the exchanges to test whether the
data are complete and formatted correctly before posting the data.
Because the pipe-delimited ASCII format does not support validations,
exchanges have to manually review data completeness and correct
formatting. In the case that an exchange was to post incorrectly
formatted or incomplete data, the exchange would have to incur the
burden of reviewing the data again to identify the problem and
reposting
[[Page 13073]]
the data. Validations help ensure that any inconsistencies in data
completeness or formatting can be automatically tested for and
identified before posting. And because some fields in the data may be
manually entered (i.e., the Exchange Transaction Fee Summary), having
validations would help ensure the quality of this data. Requiring a
format that incorporates validations would also best enhance data
users' abilities to normalize, aggregate, compare, and analyze the
Exchange Transaction Fee Summary data because the data is assured to be
complete and consistently formatted. Therefore, the Commission does not
believe that the Exchange Transaction Fee Summary should be reported in
pipe-delimited ASCII format as that would limit both the data's
accessibility and ease of use.
F. Request for Comment
The Commission seeks commenters' views and suggestions on all
aspects of its economic analysis of the proposed rule. In particular,
the Commission asks commenters to consider the following questions:
71. Is the proposed Pilot, in the form of a temporary Commission
rule, necessary to achieve the objectives of this Pilot? Are there
other approaches that would achieve these objectives? Has the
Commission appropriately evaluated the benefits and costs of conducting
successive (or potentially simultaneous) pilots?
72. Is there existing data that could yield the same information,
with respect to sample representativeness and causality, on the
relation between transaction-based fees and rebates on order routing
behavior, execution quality and market quality that could be obtained
by the Commission in place of the proposed Transaction Fee Pilot?
Please explain in detail.
73. Is there additional data that the Commission should gather from
the proposed Pilot? Please be specific as to what this data would be
and how it could inform the Commission about possible conflicts of
interest related to access fees and rebates.
74. Do you believe the Commission's assessment of the baseline for
economic analysis is reasonable? Why or why not? Please explain in
detail.
75. Do you believe that the proposing release accurately describes
the baseline and how those current practices could change under the
proposed Pilot? Why or why not? Please explain in detail.
76. Do you believe that the Commission has accurately described how
market participants would be affected by the proposed Transaction Fee
Pilot? Why or why not? Please explain in detail.
77. Do you believe that the Commission has accurately described the
benefits of the information that would be received from the proposed
Transaction Fee Pilot? Why or why not? Please explain in detail.
78. Is the Commission's analysis of the costs and benefits of the
proposed Transaction Fee Pilot accurate and complete? Why or why not?
Please explain in detail.
79. Do you believe that there are costs or benefits that would
accrue to investors likely as a result of the proposed Pilot? If so,
please explain in detail.
80. Do you believe that there are additional costs that may arise
from the proposed Transaction Fee Pilot? If so, do you believe there
are methods by which the Commission could reduce the costs imposed by
the proposed Pilot while still achieving its goals? Please explain in
detail.
81. Do you believe that the order routing data could facilitate the
reverse engineering of proprietary order routing strategies despite the
daily aggregation and anonymization of the data at the broker-dealer
level? Why or why not? If so, do you believe that there are
alternative, safer methods of providing the order routing data that
would still allow the Pilot to achieve its goals? Please explain in
detail.
82. Do you believe that there are additional benefits or costs that
could be quantified or otherwise monetized? Why or why not? If so,
please identify the categories, and if possible, provide specific
estimates or data.
a. Given that the Tick Size Pilot requires exchanges to compile a
daily list of pilot securities and to identify changes to those pilot
securities due to name changes, mergers, and other corporate events,
are the costs estimated for compliance with reporting of the daily
pilot list for the proposed Transaction Fee Pilot reasonable?
b. Given that exchanges submit Form 19b-4 fee filings to the
Commission regularly, are the costs estimated for Form 19b-4 fee
filings associated with the commencement of the proposed Pilot or for
periodic revisions to transaction-based fees and rebates reasonable?
c. As exchanges frequently update their transaction-based fees and
rebates, can market participants provide estimates of the costs
associated with updating order routing systems as a result of fee
changes?
83. Are there any effects on efficiency, competition, and capital
formation that are not identified or are misidentified in the above
analysis? Please be specific and provide data and analysis to support
your views.
84. Do you believe that the Commission has accurately described how
the competitive landscape for the market for trading services for NMS
securities would be temporarily affected by the proposed Transaction
Fee Pilot? Why or why not? Please explain in detail. Does the release
discuss all relevant forms of competition and whether the proposal
could alter them? If not, which additional forms of competition could
the proposed Pilot impact and how? Please explain in detail.
85. Are there alternative approaches to reporting fee data in XML
format that would facilitate ease of use? What are the likely costs of
compliance of the proposed requirements? Please explain in detail.
86. Would any alternative approaches outlined above better achieve
the objectives articulated by the Commission? Which approach and why?
What would be the costs and benefits of these approaches? Please
explain in detail.
87. Would the inclusion of ATSs in the proposed Transaction Fee
Pilot better achieve the objectives articulated by the Commission? What
would be the costs and benefits of including these venues? Please
explain in detail.
88. What should be the appropriate length of the pre-Pilot Period
and post-Pilot Period in terms of achieving sufficient statistical
power?
89. What other economic effects are likely to be associated with
the proposed Transaction Fee Pilot?
VI. Consideration of Impact on the Economy
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996 (``SBREFA''),\434\ the Commission requests comment on the
potential effect of the proposed rule on the United States economy on
an annual basis. The Commission also requests comment on any potential
increases in costs or prices for consumers or individual industries,
and any potential effect on competition, investment, or innovation.
Commenters are requested to provide empirical data and other factual
support for their views to the extent possible.
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\434\ Public Law 104-121, Title II, 110 Stat. 857 (1996)
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note
to 5 U.S.C. 601).
---------------------------------------------------------------------------
VII. Regulatory Flexibility Analysis
The Regulatory Flexibility Act (``RFA'') \435\ requires Federal
agencies, in
[[Page 13074]]
promulgating rules, to consider the impact of those rules on small
entities. Section 603(a) \436\ of the Administrative Procedure
Act,\437\ as amended by the RFA, generally requires the Commission to
undertake a regulatory flexibility analysis of all proposed rules, or
proposed rule amendments, to determine the impact of such rulemaking on
``small entities.'' \438\ Section 605(b) of the RFA states that this
requirement shall not apply ``to any proposed or final rule if the head
of the agency certifies that the rule will not, if promulgated, have a
significant economic impact on a substantial number of small entities
'' \439\
---------------------------------------------------------------------------
\435\ 5 U.S.C. 601 et seq.
\436\ 5 U.S.C. 603(a).
\437\ 5 U.S.C. 551 et seq.
\438\ The Commission has adopted definitions for the term
``small entity'' for purposes of Commission rulemaking in accordance
with the RFA. Those definitions, as relevant to this proposed
rulemaking, are set forth in Rule 0-10, 17 CFR 240.0-10. See
Securities Exchange Act Release No. 18451 (January 28, 1982), 47 FR
5215 (February 4, 1982) (File No. AS-305).
\439\ 5 U.S.C. 605(b).
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The proposed rule would apply to national securities exchanges
registered with the Commission under Section 6 of the Exchange
Act.\440\ With regard to a national securities exchange, the
Commission's definition of a small entity is an exchange that has been
exempt from the reporting requirements of Rule 601 of Regulation NMS,
and is not affiliated with any person (other than a natural person)
that is not a small business or small organization.\441\ None of the
national securities exchanges registered under Section 6 of the
Exchange Act that would be subject to the proposed Pilot are ``small
entities'' for purposes of the RFA. In particular, none of the equities
exchanges are exempt from Rule 601 of Regulation NMS.
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\440\ See supra Sections IV (Paperwork Reduction Act) and V
(Economic Analysis) (discussing, among other things, the current
market environment and compliance obligations for national
securities exchanges).
\441\ See 17 CFR 240.0-10(e).
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As discussed above, the proposed rule will not apply to any ``small
entities.'' Therefore, for the purposes of the RFA, the Commission
certifies that the proposed rule would not have a significant economic
impact on a substantial number of small entities.
The Commission requests comment regarding this certification. In
particular, the Commission solicits comment on the following:
90. Do commenters agree with the Commission's certification? If
not, please describe the nature of any impact on small entities and
provide empirical data to illustrate the extent of the impact.
VIII. Statutory Authority and Text of the Proposed Rule
Pursuant to the Exchange Act, and particularly Sections 3(b), 5, 6,
11A, 15, 17, and 23(a) thereof, 15 U.S.C. 78c, 78e, 78f, 78k-1, 78o,
78q, and 78w(a), the Commission proposes to amend Title 17 of the Code
of Federal Regulations in the manner set forth below.
List of Subjects
17 CFR Part 200
Administrative practice and procedure, Authority delegations
(Government agencies), Organization and functions (Government
agencies).
17 CFR Part 242
Brokers, Reporting and recordkeeping requirements, Securities.
For the reasons set out in the preamble, the Commission is
proposing to amend Title 17, Chapter II of the Code of Federal
Regulations as follows:
PART 200--ORGANIZATION; CONDUCT AND ETHICS; AND INFORMATION AND
REQUESTS
0
1. The authority citation for part 200 continues to read in part as
follows:
Authority: 15 U.S.C. 77c, 77o, 77s, 77z-3, 77sss, 78d, 78d-1,
78d-2, 78o-4, 78w, 78ll(d), 78mm, 80a-37, 80b-11, 7202, and 7211 et
seq., unless otherwise noted.
0
2. Amend Section 200.30-3 by adding paragraph (a)(84) to read as
follows:
Sec. 200.30-3 Delegation of Authority to Director of Division of
Trading and Markets.
* * * * *
(a) * * *
(84) To issue notices pursuant to Rule 610T(b)(1)(i) and (c) (17
CFR 242.610T(b)(1)(i) and (c)).
* * * * *
PART 242--REGULATIONS M, SHO, ATS, AC, NMS AND SBSR AND CUSTOMER
MARGIN REQUIREMENTS FOR SECURITY FUTURES
0
3. The authority citation for part 242 continues to read as follows:
Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2),
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g),
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and
80a-37.
0
4. Add Section 242.610T to read as follows:
Sec. 242. 610T Equity transaction fee pilot.
(a) Pilot Pricing Restrictions. Notwithstanding Rule 610(c), on a
pilot basis for the period specified in paragraph (c) of this section,
in connection with a transaction in an NMS stock, a national securities
exchange may not:
(1) For Test Group 1, impose, or permit to be imposed, any fee or
fees for the display of, or execution against, the displayed best bid
or offer of such market that exceed or accumulate to more than $0.0015
per share;
(2) For Test Group 2, impose, or permit to be imposed, any fee or
fees for the display of, or execution against, the displayed best bid
or offer of such market that exceed or accumulate to more than $0.0005
per share;
(3) For Test Group 3, provide to any person, or permit to be
provided to any person, a rebate or other remuneration in connection
with an execution, or offer, or permit to be offered, any linked
pricing that provides a discount or incentive on transaction fees
applicable to removing (providing) liquidity that is linked to
providing (removing) liquidity, except to the extent the exchange has a
rule to provide non-rebate linked pricing to its registered market
makers in consideration for meeting market quality metrics; and
(4) For the Control Group, impose, or permit to be imposed, any fee
or fees in contravention of the limits specified in 17 CFR 242.610(c).
(b) Pilot Securities.
(1) Initial List of Pilot Securities.
(i) The Commission shall designate by notice the initial List of
Pilot Securities, and shall assign each Pilot Security to one Test
Group or the Control Group.
(ii) For purposes of Rule 610T, ``Pilot Securities'' means the NMS
stocks designated by the Commission on the initial List of Pilot
Securities pursuant to paragraph (b)(1)(i) and any successors to such
NMS stocks. At the time of selection by the Commission, an NMS stock
must have a minimum initial share price of at least $2 to be included
in the Pilot and must have an unlimited duration or a duration beyond
the end of the post-Pilot Period. If the share price of a Pilot
Security in one of the Test Groups or the Control Group closes below $1
at the end of a trading day, it shall be removed from the Test Group or
the Control Group and will no longer be subject to the pricing
restrictions set forth in (a)(1)-(3) of this section.
(iii) For purposes of Rule 610T, ``primary listing exchange'' means
the national securities exchange on which the NMS stock is listed. If
an NMS stock is listed on more than one national securities exchange,
the national securities exchange upon which the NMS stock has been
listed the longest shall be the primary listing exchange.
(2) Pilot Securities Exchange Lists.
(i) After the Commission selects the initial List of Pilot
Securities and prior
[[Page 13075]]
to the beginning of trading on the first day of the Pilot Period each
primary listing exchange shall publicly post on its website
downloadable files containing a list, in pipe-delimited ASCII format,
of the Pilot Securities for which the exchange serves as the primary
listing exchange. Each primary listing exchange shall maintain and
update this list as necessary prior to the beginning of trading on each
business day that the U.S. equities markets are open for trading
through the end of the post-Pilot Period.
(ii) The Pilot Securities Exchange Lists shall contain the
following fields:
(A) Ticker Symbol;
(B) Security Name;
(C) Primary Listing Exchange;
(D) Security Type:
(1) Common Stock;
(2) ETP;
(3) Preferred Stock;
(4) Warrant;
(5) Closed-End Fund;
(6) Structured Product;
(7) ADR;
(8) Other;
(E) Test Group:
(1) Control Group;
(2) Test Group 1;
(3) Test Group 2;
(4) Test Group 3;
(F) Date the Entry Was Last Updated.
(3) Pilot Securities Change Lists.
(i) Prior to the beginning of trading on each trading day the U.S.
equities markets are open for trading throughout the duration of the
Pilot, including the post-Pilot Period, each primary listing exchange
shall publicly post on its website downloadable files containing a
Pilot Securities Change List, in pipe-delimited ASCII format, that
lists each separate change applicable to any Pilot Securities for which
it serves or has served as the primary listing exchange. The Pilot
Securities Change List will provide a cumulative list of all changes to
the Pilot Securities that the primary listing exchange has made to the
Pilot Securities Exchange List published pursuant to (b)(2).
(ii) In addition to the fields required for the Pilot Securities
Exchange List, the Pilot Securities Change Lists shall contain the
following fields:
(A) New Ticker Symbol (if applicable);
(B) New Security Name (if applicable);
(C) Deleted Date (if applicable);
(D) Date Security Closed Below $1 (if applicable);
(E) Effective Date of Change; and
(F) Reason for the Change.
(4) Posting Requirement. All information publicly posted in
downloadable files pursuant to 610T(b)(2) and (3) shall be and remain
freely and persistently available and easily accessible by the general
public on the primary listing exchange's website for a period of not
less than five years from the conclusion of the post-Pilot Period. In
addition, the information shall be presented in a manner that
facilitates access by machines without encumbrance, and shall not be
subject to any restrictions, including restrictions on access,
retrieval, distribution and reuse.
(c) Pilot Duration.
(1) The Pilot shall include a six-month ``pre-Pilot Period;''
(2) A two-year ``Pilot Period'' with an automatic sunset at the end
of the first year unless, no later than thirty days prior to that time,
the Commission publishes a notice that the Pilot shall continue for up
to another year; and
(3) A six-month ``post-Pilot Period.''
(4) The Commission shall designate by notice the commencement and
termination dates of the pre-Pilot Period, Pilot Period, and post-Pilot
Period, including any suspension of the one-year sunset of the Pilot
Period.
(d) Order Routing Datasets. Throughout the duration of the Pilot,
including the pre-Pilot Period and post-Pilot Period, each national
securities exchange that trades NMS stocks shall publicly post on its
website downloadable files, in pipe-delimited ASCII format, no later
than the last day of each month, containing sets of order routing data,
for the prior month, in accordance with the specifications below. For
the pre-Pilot Period, order routing datasets shall include each NMS
stock. For the Pilot Period and post-Pilot Period, order routing
datasets shall include each Pilot Security. All information publicly
posted pursuant to this paragraph (d) shall be and remain freely and
persistently available and easily accessible by the general public on
the national securities exchange's website for a period of not less
than five years from the conclusion of the post-Pilot Period. In
addition, the information shall be presented in a manner that
facilitates access by machines without encumbrance, and shall not be
subject to any restrictions, including restrictions on access,
retrieval, distribution, and reuse. Each national securities exchange
shall treat the identities of broker-dealers contained in the Order
Routing Datasets, including the broker-dealer anonymization key, as
regulatory information and shall not access or use that information for
any commercial or non-regulatory purpose.
(1) Dataset of daily volume statistics include the following
specifications of liquidity-providing orders by security and separating
held and not-held orders in pipe-delimited ASCII format with field
names as the first record and a consistent naming convention that
indicates the exchange and date of the file:
(i) Code identifying the submitting exchange.
(ii) Eight-digit code identifying the date of the calendar day of
trading in the format ``yyyymmdd.''
(iii) Symbol assigned to an NMS stock (including ETPs) under the
national market system plan to which the consolidated best bid and
offer for such a security are disseminated.
(iv) Unique, anonymized broker-dealer identification code.
(v) Order type code
(A) Inside-the-quote orders;
(B) At-the-quote limit orders; and
(C) Near-the-quote limit orders.
(vi) Order size codes
(A) <100 share bucket;
(B) 100-499 share bucket;
(C) 500-1,999 share bucket;
(D) 2,000-4,999 share bucket;
(E) 5,000-9,999 share bucket; and
(F) > 10,000 share bucket.
(vii) Number of orders received.
(viii) Cumulative number of shares of orders received.
(ix) Cumulative number of shares of orders cancelled prior to
execution.
(x) Cumulative number of shares of orders executed at receiving
market center.
(xi) Cumulative number of shares of orders routed to another
execution venue.
(xii) Cumulative number of shares of orders executed within
(A) 0 to <100 microseconds of order receipt;
(B) 100 microseconds to <100 milliseconds of order receipt;
(C) 100 milliseconds to <1 second of order receipt;
(D) 1 second to <30 seconds of order receipt;
(E) 30 seconds to <60 seconds of order receipt;
(F) 60 seconds to <5 minutes of order receipt;
(G) 5 minutes to <30 minutes of order receipt; and
(H) >30 minutes of order receipt.
(2) Dataset of daily volume statistics include the following
specifications of liquidity-taking orders by security and separating
held and not-held orders in pipe-delimited ASCII format with field
names as the first record and a consistent naming convention that
indicates the exchange and date of the file:
(i) Code identifying the submitting exchange.
[[Page 13076]]
(ii) Eight-digit code identifying the date of the calendar day of
trading in the format ``yyyymmdd.''
(iii) Symbol assigned to an NMS stock (including ETPs) under the
national market system plan to which the consolidated best bid and
offer for such a security are disseminated.
(iv) Unique, anonymized broker-dealer identification code.
(v) Order type code
(A) Market orders; and
(B) Marketable limit orders.
(vi) Order size codes
(A) <100 share bucket;
(B) 100-499 share bucket;
(C) 500-1,999 share bucket;
(D) 2,000-4,999 share bucket;
(E) 5,000-9,999 share bucket; and
(F) >10,000 share bucket.
(vii) Number of orders received.
(viii) Cumulative number of shares of orders received.
(ix) Cumulative number of shares of orders cancelled prior to
execution.
(x) Cumulative number of shares of orders executed at receiving
market center.
(xi) Cumulative number of shares of orders routed to another
execution venue.
(e) Exchange Transaction Fee Summary. Throughout the duration of
the Pilot, including the pre-Pilot Period and post-Pilot Period, each
national securities exchange that trades NMS stocks shall publicly post
on its website downloadable files containing information relating to
transaction fees and rebates and changes thereto (applicable to
securities having a price greater than $1). Each national securities
exchange shall post its initial Exchange Transaction Fee Summary prior
to the start of trading on the first day of the pre-Pilot Period and
update its Exchange Transaction Fee Summary on a monthly basis within
10 business days of the first day of each calendar month, to reflect
data collected for the prior month. The information prescribed by this
section shall be made available using the most recent version of the
XML schema published on the Commission's website. All information
publicly posted pursuant to this paragraph (e) shall be and remain
freely and persistently available and easily accessible on the national
securities exchange's website for a period of not less than five years
from the conclusion of the post-Pilot Period. In addition, the
information shall be presented in a manner that facilitates access by
machines without encumbrance, and shall not be subject to any
restrictions, including restrictions on access, retrieval,
distribution, and reuse. The Exchange Transaction Fee Summary shall
contain the following fields:
(1) SRO Name;
(2) Record Type Indicator:
(i) Reported Fee is the Monthly Average;
(ii) Reported Fee is the Median;
(iii) Reported Fee is the Spot Monthly;
(3) Participant Type:
(i) Registered Market Maker;
(ii) All Others;
(4) Test Group:
(i) Control Group;
(ii) Test Group 1;
(iii) Test Group 2;
(iv) Test Group 3;
(5) Applicability to Displayed and Non-Displayed Interest:
(i) Displayed only;
(ii) Non-displayed only;
(iii) Both displayed and non-displayed;
(6) Applicability to Top and Depth of Book Interest:
(i) Top of book only;
(ii) Depth of book only;
(iii) Both top and depth of book;
(7) Effective Date of Fee or Rebate;
(8) End Date of Currently Reported Fee or Rebate (if applicable);
(9) Month and Year of the monthly realized reported average and
median per share fees;
(10) Pre/Post Fee Changes Indicator (if applicable) denoting
implementation of a new fee or rebate on a day other than the first day
of the month;
(11) Base and Top Tier Fee or Rebate:
(i) Take (to remove):
(A) Base Fee/Rebate reflecting the standard amount assessed or
rebated before any applicable discounts, tiers, caps, or other
incentives are applied;
(B) Top Tier Fee/Rebate reflecting the amount assessed or rebated
after any applicable discounts, tiers, caps, or other incentives are
applied;
(ii) Make (to provide):
(A) Base Fee/Rebate reflecting the standard amount assessed or
rebated before any applicable discounts, tiers, caps, or other
incentives are applied;
(B) Top Tier Fee/Rebate reflecting the amount assessed or rebated
after any applicable discounts, tiers, caps, or other incentives are
applied;
(12) Average Take Fee (Rebate)/Average Make Rebate (Fee), by
Participant Type, Test Group, Displayed/Non-Displayed, and Top/Depth of
Book; and
(13) Median Take Fee (Rebate)/Median Make Fee (Rebate), by
Participant Type, Test Group, Displayed/Non-Displayed, and Top/Depth of
Book.
The following will not appear in the Code of Federal Regulations.
Exhibit 1: Data Definitions for the Exchange Transaction Fee Summary
The table below represents the data model for the reporting
requirements of an Exchange Transaction Fee Summary. This data model
reflects the disclosures required by proposed 17 CFR 242.610T(e) and
the logical representation of those disclosures to a corresponding XML
element. The Commission's proposed XML schema is the formal electronic
representation of this data model.
Concept--the information content as described in proposed
17 CFR 242.610T(e) items 1 through 12.
Element--a name for the XML element.
Type--the XML data type, either a list of possible values
or a general type such as ``number''.
Spot, Monthly--How the element appears in a record of that
type.
[cir] R--Required. The XML file is not valid unless this element is
present.
[cir] NA--Not applicable. The element may appear in the record but
its value is not to be used.
[cir] O--Optional. The XML file is valid without that element;
whether it appears for a particular SRO, record type, test group, etc.,
depends on the actual fee being described. XML validation by itself
cannot determine this.
When Absent--If the element is absent, its value is
interpreted as if it had been present with the value shown.
Definition--Text to be included in the XML definition file
(``schema'').
--------------------------------------------------------------------------------------------------------------------------------------------------------
When
Concept Element Type Spot Monthly absent Definition
--------------------------------------------------------------------------------------------------------------------------------------------------------
SRO............................ sro........................... Non-empty Text................ R R ........ A required unique code
to identify each SRO in
the Transaction Fee
Pilot.
Record Type.................... rt............................ S or M........................ R R ........ A required record type
indicator. M, if the
fee type reported is
the monthly realized
fee (average or median
fee); S, if the fee
type reported is a spot
fee schedule (base or
top tier fee).
[[Page 13077]]
Participant Type............... ptcpt......................... MM, Other or Blank............ O O Blank MM, if the fees are for
market makers, or else
Other. Required for
spot records if the
exchange charged market
makers and others
different base and top
tier fees. Required for
monthly fee records if
the exchange charged
different average or
median fees or pays
different average or
median fees. Otherwise
blank or absent.
Test Group..................... grp........................... 1, 2, 3, or C................. R R ........ A required indicator
that identifies the
test or control group
during the Pilot and
post-Pilot Period. 1,
2, 3--Test Groups 1, 2,
3; C--Control group.
Displayed...................... disp.......................... D, N, or B.................... R R ........ D--Displayed, N--Not
displayed, B--Both. For
spot fee type records,
if the fees are the
same between displayed
and non-displayed
liquidity, then the
exchange may report
both in a single ``B''
record. For monthly
records, this should be
segmented into the
average and median fee
per share for displayed
liquidity, and the
average and median fee
for non-displayed
liquidity unless there
are no differences
between the average and
median fees for
displayed and non-
displayed liquidity, in
which case the exchange
can report the average
and median fee in a
single ``B'' record.
Top/Depth...................... topOrDepth.................... T, D, or B.................... R R ........ T--Fees for top-of-book
liquidity; D--Fees for
depth-of-book
liquidity; B--Both. For
spot records, if the
fees are the same
between top-of-book and
depth-of-book
liquidity, then the
exchange may report
both fees in a single
``B'' record. For
monthly records, if
there are no
differences between the
fees for top-of-book
and depth-of-book
liquidity, then the
exchange may include
only the average and
median fees in a single
``B'' record.
Start Date..................... start......................... YYYY-MM-DD.................... R O ........ The start date element
must be present for a
spot fee record, and
the end element cannot
appear alone. The
effective date for any
fee changes. This
should correspond to
the effective date
referenced in the Form
19b-4 fee filings
submitted to the
Commission. This is
needed in a monthly
record only if fees
changed on a day other
than the first of the
month; otherwise blank
or absent.
End Date....................... end........................... YYYY-MM-DD or Blank........... O O Blank The last date that a
given fee is viable
prior to any fee
changes. This column
will be blank unless a
mid-month change to
fees is made. This
should correspond to
the last date that a
given fee is applicable
prior to the effective
date of the new fee
reflected in Form 19b-4
fee filings submitted
to the Commission to
capture any revisions
to transaction-based
fees and rebates. This
is needed in a monthly
record only if fees
changed on a day other
than the first of the
month.
Month and Year................. YearMonth..................... YYYY-MM....................... NA R ........ The year and month of
the monthly realized
reported average and
median per share fees.
Pre/Post....................... preOrPost..................... 1, 2, or Blank................ O O Blank An indicator variable
needed only if the
exchange changed fees
on a day other than the
first day of the month.
Blank--there were no
fee changes other than
on the first day of the
month. 1--The average
and median are the pre-
change average and
median for the part of
the month prior to the
change. 2--The average
and median are the post-
change average and
median for the part of
the month after the
change.
Base Taker Fee................. baseTakeFee................... Number........................ R NA ........ The Base Taker Fee is
the standard per share
fee assessed or rebate
offered before any
applicable discounts,
tiers, caps, or other
incentives are applied.
Fees have a positive
sign; rebates have a
negative sign.
Top Tier Taker Fee............. topTierTakeFee................ Number........................ R NA ........ The Top Tier Taker Fee
is the per share fee
assessed or rebate
offered after all
applicable discounts,
tiers, caps, or other
incentives are applied.
Fees have a positive
sign; rebates have a
negative sign.
Average Taker Fee.............. avgTakeFee.................... Number........................ NA R ........ The monthly average
realized Taker fee
assessed or rebate
offered per share by
category (i.e., test
group, participant
type, displayed vs. non-
displayed, and top-of-
book vs. depth-of-
book). Fees have a
positive sign; rebates
have a negative sign.
[[Page 13078]]
Median Taker Fee............... medianTakeFee................. Number........................ NA R ........ The monthly median
realized Taker fee
assessed or rebate
offered per share by
category (i.e., test
group, participant
type, displayed vs. non-
displayed, and top-of-
book vs. depth-of-
book), across broker-
dealers. Fees have a
positive sign; rebates
have a negative sign.
Base Maker Fee................. baseMakeFee................... Number........................ R NA ........ The Base Maker Fee is
the standard per share
fee assessed or rebate
offered before any
applicable discounts,
tiers, caps, or other
incentives are applied.
Fees have a positive
sign; rebates have a
negative sign.
Top Tier Maker Fee............. topTierMakeFee................ Number........................ R NA ........ The Top Tier Maker Fee
is the per share fee
assessed or rebate
offered all applicable
discounts, tiers, caps,
or other incentives are
applied per share. Fees
have a positive sign;
rebates have a negative
sign.
Average Maker Fee.............. avgMakeFee.................... Number........................ NA R ........ The monthly average
realized Maker fee
assessed or rebate
offered per share by
category (i.e., test
group, participant
type, displayed vs. non-
displayed, and top-of-
book vs. depth-of-
book). Fees have a
positive sign; rebates
have a negative sign.
Median Maker Fee............... medianMakeFee................. Number........................ NA R ........ The monthly median
realized Maker fee
assessed or rebate
offered per share by
category (i.e., test
group, participant
type, displayed vs. non-
displayed, or top-of-
book vs. depth-of-
book), across broker-
dealers. Fees have a
positive sign; rebates
have a negative sign.
--------------------------------------------------------------------------------------------------------------------------------------------------------
By the Commission.
Dated: March 14, 2018.
Brent J. Fields,
Secretary.
[FR Doc. 2018-05545 Filed 3-23-18; 8:45 am]
BILLING CODE 8011-01-P
