Transaction Fee Pilot for NMS Stocks, 5202-5306 [2018-27982]

Download as PDF 5202 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 200 and 242 [Release No. 34–84875; File No. S7–05–18] RIN 3235–0761 Transaction Fee Pilot for NMS Stocks Securities and Exchange Commission. ACTION: Final rule. AGENCY: The Securities and Exchange Commission (‘‘Commission’’ or ‘‘SEC’’) is adopting a new rule of Regulation National Market System (‘‘Regulation NMS’’) under the Securities and Exchange Act of 1934 (‘‘Exchange Act’’) to conduct a Transaction Fee Pilot (‘‘Pilot’’) for National Market System (‘‘NMS’’) stocks to study the effects that exchange transaction fee-and-rebate pricing models may have on order routing behavior, execution quality, and market quality. We expect the data generated by the pilot, combined with data from existing sources, will facilitate an empirical evaluation of whether the existing exchange transaction-based fee and rebate structure is operating effectively to further statutory goals. DATES: Effective date: April 22, 2019 through December 29, 2023. Compliance date: As designated by Notice pursuant to 17 CFR 242.610T(c)(2). SUMMARY: FOR FURTHER INFORMATION CONTACT: Richard Holley III, Assistant Director; Johnna Dumler, Special Counsel; Erika Berg, Special Counsel; or Benjamin Bernstein, Special Counsel, 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 adopting new 17 CFR 242.610T (Rule 610T) to conduct a Transaction Fee Pilot for NMS stocks. Table of Contents I. Executive Summary of Rule 610T II. Discussion of Rule 610T A. Focus on Exchange Pricing Models and the Distortions They Can Cause 1. Exchange Fee Models and Regulatory Framework 2. Impact of Exchange Fee Models 3. Focus on Exchange Fee Models 4. Non-Exchange Trading Centers 5. Options Exchanges B. Securities 1. The Share Price Threshold of Pilot Securities 2. The Duration of Pilot Securities 3. Selecting Pilot Securities From All NMS Stocks VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 4. The Ability of Issuers to Opt Out of the Pilot C. Pilot Design 1. Need for a Pilot 2. Pilot Design 3. No Overlap With Tick Size Pilot 4. Stratified Selection of Pilot Securities 5. Number of NMS Stocks Included in Each Test Group 6. Reduction to the Pilot Size 7. Fee Cap Test Groups 8. Control Group 9. Alternative Designs 10. Metrics To Assess the Pilot D. Timing and Duration 1. Disclosure Initiatives and the Pilot 2. Automatic Sunset at Year One 3. Pre- and Post-Pilot Periods 4. Early Termination 5. Inclusion of a Phase-In Period E. Data 1. Pilot Securities Exchange Lists and Pilot Securities Change Lists 2. Exchange Transaction Fee Summary 3. Order Routing Data F. Implementation G. The Commission’s Authority To Conduct the Pilot III. Paperwork Reduction Act A. Summary of Collection of Information 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 Summaries 3. Order Routing Datasets E. Collection of Information Is Mandatory F. Confidentiality of Responses to Collection of Information G. Retention Period for Recordkeeping Requirements IV. Economic Analysis A. Background and Market Failures 1. Market Failure at the Broker-Dealer Level 2. Market Failure at the Exchange Level B. Baseline 1. Current Information Baseline 2. Current Market Environment C. Analysis of Benefits and Costs of Transaction Fee Pilot 1. Benefits of Transaction Fee Pilot 2. Costs of the Pilot D. Impact on Efficiency, Competition, and Capital Formation 1. Efficiency 2. Competition 3. Capital Formation E. Alternatives 1. Propose Rulemaking Without Conducting a Pilot 2. Expand Transaction Fee Pilot To Include Non-Exchange Trading Centers 3. Trade-At Test Group 4. Alternative Pilot 5. Adjustments to the Transaction Fee Pilot Structure V. Regulatory Flexibility Analysis VI. Statutory Authority and Text of the Rule Amendments I. Executive Summary of Rule 610T Congress directed the Commission, through Section 11A of the Exchange PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 Act, to facilitate the establishment of a national market system and use its broad authority to carry out the objectives of Section 11A, including, among others, to assure the economically efficient execution of securities transactions.1 In furtherance of these goals, and as part of its oversight of registered national securities exchanges, the Commission periodically undertakes reviews of various aspects of market structure and current regulations to evaluate whether, in light of changes in technology and business practices, the current regulatory framework continues to fairly, effectively, and efficiently promote fair and orderly markets, serve the public interest and the protection of investors, and promote capital formation. As discussed below, one aspect of the current regulatory framework focuses on the current pricing and fee structure for transactions in securities. As the Commission discussed in its Pilot proposal, the predominant transaction pricing structure that developed among equities exchanges to attract order flow is the ‘‘maker-taker’’ fee model.2 Specifically, out of thirteen equities exchanges, seven utilize the ‘‘makertaker’’ fee model, in which they pay a rebate to a provider of liquidity and charge a fee to a taker of liquidity. Among the remaining exchanges, four utilize a ‘‘taker-maker’’ pricing model (also called an inverted model) where they charge a fee to a provider of liquidity and pay a rebate to a taker of liquidity,3 and two have a ‘‘flat fee’’ model.4 In recent years this area has 1 15 U.S.C. 78k–1(a)(1)(C)(i). See also supra Section II.G (discussing the Commission’s authority to conduct the Pilot). 2 See Securities Exchange Act Release No. 82873 (March 14, 2018), 83 FR 13008 (March 26, 2018) (‘‘Proposing Release’’ or ‘‘Proposal’’). 3 See Cboe BYX U.S. Equities Exchange Fee Schedule (as of December 2018), available at https://markets.cboe.com/us/equities/membership/ fee_schedule/byx/; Cboe EDGA U.S. Equities Exchange Fee Schedule (as of December 2018), available at https://markets.cboe.com/us/equities/ membership/fee_schedule/edga/; Nasdaq BX Fee Schedule (as of December 2018), available at https://www.nasdaqtrader.com/Trader.aspx?id=bx_ pricing; NYSE National Schedule of Fees and Rebates (as of December 2018), available at https:// www.nyse.com/publicdocs/nyse/regulation/nyse/ NYSE_National_Schedule_of_Fees.pdf. EDGA adopted a taker-maker fee schedule in July 2018. See Securities Exchange Act Release No. 83643 (July 16, 2018), 83 FR 34643 (July 20, 2018) (SR– CboeEDGA–2018–012). 4 See Investors Exchange Fee Schedule (as of December 2018), available at https:// iextrading.com/trading/fees/; NYSE American Equities Trading Fees and Price List (as of December 2018), available at https:// www.nyse.com/publicdocs/nyse/markets/nyseamerican/NYSE_America_Equities_Price_List.pdf. NYSE American offers rebates to eDMMs in their assigned NYSE American-listed securities. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations attracted considerable attention and generated significant debate, focusing on the effects, both positive and negative, that exchange transactionbased pricing models may have on market quality and execution quality, with some commenters advocating action by the Commission. The Commission is uniquely situated and vested with the responsibility under Section 11A of the Exchange Act to examine the impact that this aspect of our market structure has on our national market system. And, in light of the questions raised about the impact of these fee models and the amount of attention garnered, we believe this is an area ripe for Commission review. But, the Commission currently lacks the data necessary to meaningfully analyze the impact that exchange transaction feeand-rebate pricing models have on order routing behavior, market and execution quality, and our market structure generally. To address this information gap, the Commission has designed the Pilot to produce data that will facilitate a more thorough understanding of the potential issues associated with exchange transaction-based pricing models. In particular, the Commission has designed the Pilot to gather data on the effect both current regulatory fee caps and rebates have on market quality and execution quality. The data 5203 gathered will assist the Commission in determining whether any changes in the current regulatory framework are appropriate and enable the Commission to make more informed and effective policy decisions. This, in turn, enables the Commission to carry out the objectives of the national market system and oversee the national securities exchanges. As discussed fully in the proposing release, the Commission proposed a pilot to test the effect of exchange transaction fees and rebates.5 The following chart summarizes the terms of the Pilot as adopted, which are discussed in more detail below: TRANSACTION FEE PILOT FOR NMS STOCKS Duration ................. Applicable trading centers. Pilot securities ....... Pilot design ........... 2 years with an automatic sunset at 1 year unless, no later than 30 days prior to that time, the Commission publishes a notice that the pilot shall continue for up to 1 additional year; plus a 6-month pre-Pilot Period and 6-month post-Pilot Period. Equities exchanges (including maker-taker & taker-maker) but not ATSs or other non-exchange trading centers. NMS stocks with average daily trading volumes ≥30,000 shares with a share price ≥$2 per share that do not close below $1 per share during the Pilot and that have an unlimited duration or a duration beyond the end of the post-Pilot Period. Group Number of NMS stocks Fee cap Rebates permitted? Test Group 1 ..... 730 ........................ Test Group 2 ..... 730 (plus appended Canadian interlisted stocks). $0.0010 fee cap for removing and providing displayed liquidity (no cap on rebates). The 17 CFR 242.610(c) (Rule 610(c)) $0.0030 cap continues to apply to fees for removing displayed liquidity. Control Group .... Pilot Securities not in Test Groups 1 or 2. The Rule 610(c) cap continues to apply to fees for removing displayed liquidity (no cap on rebates). Yes. No. Rebates and Linked Pricing Prohibited for removing and providing displayed and undisplayed liquidity (except for specified market maker activity). Yes. Pilot data ............... 1. Pilot Securities Exchange Lists and Pilot Securities Change Lists. 2. Exchange Transaction Fee Summary. 3. Order Routing Datasets. II. Discussion of Rule 610T the Commission is adopting Rule 610T with certain modifications from that in the proposal. In response to its proposal to conduct a Transaction Fee Pilot in NMS stocks (the ‘‘Pilot’’), the Commission received a number of comment letters from a diverse group of commenters, including exchanges, investment managers, broker-dealers, and other market participants, as well as academics, listed issuers, analytics firms, market observers, and industry associations.6 As discussed below, after review and consideration of the comments received, 5 See Proposing Release, supra note 2. Proposal was developed, in part, by reference to a recommendation for an access fee pilot submitted to the Commission by the Equity Market Structure Advisory Committee (the ‘‘EMSAC’’). See Proposing Release, supra note 2, at 13009, 13012–14. 6 The VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 A. Focus on Exchange Pricing Models and the Effects They Can Cause 1. Exchange Fee Models and Regulatory Framework Regardless of the fee model, all fees of a registered national securities exchange ‘‘exchange’’) are subject to the standards and process requirements set forth in the federal securities laws.7 In 7 Under the Exchange Act, exchange fee changes 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). The Commission may, within 60 days after an exchange filed its fee change PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 particular, Section 6 of the Exchange Act requires, among other things, that the rules of an exchange provide for the ‘‘equitable allocation’’ of ‘‘reasonable’’ fees and that they not be ‘‘designed to permit unfair discrimination.’’ 8 Section 11A of the Exchange Act directs the Commission to use its authority to facilitate the establishment of a national market system for securities that assures economically efficient execution of securities transactions, fair competition, availability of information with respect 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). 8 See 15 U.S.C. 78f(b)(4)–(5). E:\FR\FM\20FER2.SGM 20FER2 5204 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations to quotations for and transactions in securities, and the practicability of brokers executing investors’ orders in the best market.9 In addition, Rule 610(c) of Regulation NMS imposes upon exchanges a fee cap of $0.0030 per share for the execution of an order against its ‘‘protected quotation.’’ 10 In 2005, when it adopted the fee limitation in Rule 610(c), the Commission noted, in part: The adopted fee limitation set forth in Rule 610(c) of Regulation NMS is designed to preclude individual trading centers from raising their fees substantially in an attempt to take improper advantage of strengthened protection against trade-throughs and the adoption of a private linkage regime. In particular, the fee limitation is necessary to address ‘outlier’ trading centers that otherwise might charge high fees to other market participants required to access their quotations by the Order Protection Rule. It also precludes a trading center from charging high fees selectively to competitors, practices that have occurred in the market for Nasdaq stocks. 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.11 In light of the considerable debate surrounding exchange fee models that pay rebates, which is well documented in the comment letters submitted on the proposed Pilot, and the passage of time since the Commission first adopted the Rule 610(c) fee cap as part of Regulation NMS in 2005, the Commission now seeks to gather data to facilitate an empirical assessment of the effect of exchange transaction fees and rebates broadly—including the impact and continued appropriateness of the Rule 610(c) fee cap 12—by testing the effects of changes to exchange fees and rebates 9 See 15 U.S.C. 78k–1(a)(1). CFR 242.610(c); Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496, 37543–46 (June 29, 2005) (‘‘NMS Adopting Release’’). See also 17 CFR 242.600(b)(58) (defining ‘‘protected quotation’’); 17 CFR 242.600(b)(57) (defining ‘‘protected bid or protected offer’’); 17 CFR 242.600(b)(3) (defining ‘‘automated quotation’’). 11 NMS Adopting Release, supra note 10, at 37545. 12 At the time of its adoption in 2005, the fee cap codified the then-prevailing fee level set through competition among the various trading centers. See NMS Adopting Release, supra note 10, 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’’). 10 17 VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 on the markets and market participant behavior. 2. Impact of Exchange Fee Models In response to the Proposing Release, the Commission received a number of comment letters criticizing existing feeand-rebate pricing models, but also a number of comment letters expressing support for those same pricing regimes.13 Many commenters focused on one potential distortion—whether current pricing models ‘‘present broker-dealers with a potential conflict of interest,’’ because their ‘‘duty to pursue best execution could be compromised when their trading venue decision is driven by the economic incentive to minimize access fees paid and maximize rebates received.’’ 14 As another commenter explained, ‘‘a broker is incentivized to route an order to the venue that pays it the most (or costs the least), instead of the venue that has the highest likelihood of offering the best execution for its customers, such as the one that offers a higher probability of execution or meaningful price improvement.’’ 15 As evidence of the potential harm that can result from the conflicts presented by exchange rebates, one commenter noted that institutional investors ‘‘that specifically instruct brokers to remove rebate-driven trading behaviors from their algorithms achieve significantly lower trading costs that result in higher returns to their investors.’’ 16 One commenter attributed this harm to the tendency of rebates to ‘‘affect the length of the order queue of passive limit orders on the major maker-taker exchanges, while high take fees on these 13 The potential distortions mentioned by the commenters (and discussed in this section) include, among others: (1) Conflicts of interest faced by routing broker-dealers; (2) excess intermediation and potential adverse selection; (3) market fragmentation; (4) exchange fee avoidance; (5) complexity; (6) transparency; and (7) elevated fees to subsidize rebates. 14 Capital Group Letter, at 2. See also, e.g., ICI Letter I, at 2; Vanguard Letter, at 2; Invesco Letter, at 2; CFA Letter, at 2; Oppenheimer Letter, at 2; Spatt Letter, at 4; AJO Letter, at 1; Larry Harris Letter, at 3. 15 Healthy Markets Letter I, at 5. See also, e.g., Copeland Letter, at 1; Wellington Letter, at 1; Norges Letter, at 2. 16 Babelfish Letter, at 1–3 (also referencing a Clearpool Group study that found that a ‘‘fee sensitive VWAP algorithm executed during volatile times incurred seven times as much cost as a fee agnostic algorithm’’). See also T. Rowe Price Letter, at 2 (stating that ‘‘[r]etail orders . . . are generally placed on the exchange that offers the highest rebate to the broker, but show[s] lower execution quality in terms of reduced probability of execution’’); Capital Group Letter, at 2 (‘‘Our internal trade analysis suggests that execution quality may be negatively impacted when brokerdealers’ routing decisions are made to minimize access fees.’’). PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 markets make them less attractive for marketable orders that cross the spread.’’ The commenter argued that the ‘‘net result of this perverse pricing dynamic is a lower likelihood of execution and a higher likelihood of adverse selection for orders in the maker-taker queues,’’ because orders at the ‘‘middle or back of the queue . . . are less likely to trade at their desired price, and when they do trade, the overall market price as reflected by the [National Best Bid and Offer (‘‘NBBO’’)] is more likely to move against them, than when trading on venues that do not pay rebates.’’ 17 A number of commenters discussed other potential effects of exchange pricing models. Some commenters believed that transaction fees and rebates contribute to market fragmentation 18 because they encourage investors to ‘‘turn to inverted markets to improve queue priority’’ 19 or to ‘‘route orders to non-exchange trading centers to avoid the higher access fees that exchanges charge to subsidize the rebates they offer.’’ 20 Likewise, one commenter thought that ‘‘transaction fees and rebates contribute to market complexity through the proliferation of new order types . . . designed to exploit different transaction pricing models.’’ 21 Other commenters believed that ‘‘[t]ransaction fees and rebates . . . undermine market transparency because the prices displayed by exchanges—and provided on trade reports—do not include fee or rebate information and therefore do not fully reflect net trade prices.’’ 22 Finally, some commenters 17 IEX Letter I, at 6, A–1–A–2; IEX Letter II, at 7; IEX Letter IV (appending research to support these views). See also, e.g., Babelfish Letter, at 2 (stating that a ‘‘frequently realized scenario is that flow sent solely to a high rebate destination waits in queue, often winds up canceled because price moves away, and then receives an inferior price upon the eventual execution’’); Larry Harris Letter, at 1, 3; Brandes Letter, at 1–2. But see Grasso Letter, at 3 (‘‘waiting for a rebate[ ] may be fine’’ if ‘‘you have low confidence about future prices for a large order and don’t mind if the order trades slowly while you accumulate shares’’). 18 See, e.g., ICI Letter I, at 2. 19 Credit Suisse Commentary, at 2. See also, e.g., Larry Harris Letter, at 3 (noting that ‘‘orders standing at inverted exchanges usually execute before orders standing at the same price at makertaker exchanges’’). 20 Capital Group Letter, at 2. See also, e.g., IEX Letter I, at 3 (‘‘Excessive take fees . . . have been criticized as leading to the migration of some order flow to less-regulated non-exchange venues in search of reduced transaction costs, resulting in increased market fragmentation and market complexity.’’). 21 ICI Letter I, at 2. See also, e.g., Vanguard Letter, at 2 (indicating that the ‘‘desire to maximize rebate revenue and avoid fees created order complexity within the equity markets as traders sought profitable trading strategies’’). 22 ICI Letter I, at 2. See also, e.g., Goldman Sachs Letter, at 3; Invesco Letter, at 2; State Street Letter, E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations asserted that current pricing models unfairly subsidize rebates 23 or benefit sophisticated market participants like market-makers and proprietary traders at the expense of other market participants.24 Other commenters expressed support for current exchange pricing models. For example, one commenter believed that maker-taker pricing ‘‘provides important benefits to issuers and investors,’’ because exchanges ‘‘use rebates as a tool to promote displayed liquidity and price discovery, which results in competitive bid-ask spreads, saving transaction costs that investors may otherwise incur.’’ 25 Another commenter argued that rebates can promote displayed liquidity by providing ‘‘a payment in exchange for posters of liquidity giving up several valuable options,’’ including ‘‘the power to decide the time of the trade’’ and the ability to conceal trading intentions until the point of execution.26 Building on this idea, one commenter characterized ‘‘[a]ccess fee caps and related rebates’’ as features that ‘‘enable exchanges to compete with nonexchange trading venues by essentially subsidizing the posted prices . . . and narrow[ing] the NBBO, making it slightly more expensive to either match or improve upon those prices offexchange.’’ 27 at 2; Wellington Letter, at 1; Oppenheimer Letter, at 2; Capital Group Letter, at 3. 23 See, e.g., Clearpool Letter, at 3 (stating that ‘‘exchanges chase order flow and provide rebates and other pricing incentives to the largest trading firms at the expense of smaller market participants who cannot take advantage of such rebates and, in effect, end up subsidizing the trading of larger firms’’); IEX Letter I, at 3 (stating that transaction fees are ‘‘used in effect to subsidize the payment of rebates,’’ which ‘‘results in a substantial penalty on investors and other participants who . . . have a need for immediate liquidity’’). 24 See, e.g., T. Rowe Price Letter, at 2 (stating that rebates lead to ‘‘excessive intermediation . . . benefiting short-term intermediaries at the expense of long-term investors’’); ModernIR Letter, at 3 (stating that rebates ‘‘promote[ ] arbitrage, and pricesetting as its own end,’’ leading to a ‘‘paucity of real orders’’); Larry Harris Letter, at 1, 5–6 (stating that current pricing models facilitate ‘‘the execution of various parasitic trading strategies by proprietary traders to the detriment of public investors’’); Capital Group Letter, at 3. 25 State Street Letter, at 2. See also, e.g., Virtu Letter, at 3; Fidelity Letter, at 3; Nasdaq Letter I, at 9; Cboe Letter I, at 15–16. See also Nasdaq Letter III, at Exhibit A (providing graphs using data from September 2018 on average quoted spread across exchanges in S&P 500 stocks and time at the best quote across those stocks). But cf. Larry Harris Letter, at 6–9 (acknowledging that ‘‘quoted spreads are narrower under maker-taker pricing,’’ but opining that ‘‘the narrower quoted spreads do not benefit the public’’). 26 Magma Letter, at 3. See also, e.g., NYSE Letter IV, at 2 (arguing that ‘‘pricing incentives enhance the quality and reliability of display markets’’); FIA Letter, at 4. 27 FIA Letter, at 3–4. See also NYSE Letter I, at 6 (stating that rebates ‘‘allow liquidity providers to VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 As commenters fundamentally disagreed about the effect of exchange transaction fee models and whether they have a positive or a negative impact on the U.S. equities markets, commenters also held conflicting views regarding whether and how the Commission should conduct the Pilot. 3. Focus on Exchange Fee Models Recognizing the unique regulatory framework applicable to exchange fees, and the disagreement over the impact of exchange fees and rebates on the markets and market participants, the Commission focused its proposed Pilot on studying the effect of exchange transaction fees and rebates on order routing behavior, execution quality, and market quality. Accordingly, the Commission proposed to include within the Pilot all equities exchanges regardless of fee model. A large number of commenters supported applying the Pilot to all equities exchanges.28 For example, one commenter believed that the Pilot ‘‘should include all equities exchanges . . . because rebates of any kind provide inducements to trade and distort markets.’’ 29 A different commenter thought that including taker-maker exchanges was ‘‘both logical and feasible, given that all equities exchanges assess fees that are subject to the Exchange Act and its rule filing requirements.’’ 30 Other commenters ‘‘agree[d] with the Commission’s assessment that the Pilot should apply to all equity exchanges . . . thus treating all similarly situated exchanges equally,’’ because this would be ‘‘critically important in determining what impact the reduction of access fees or the elimination of rebates will have on order routing practices.’’ 31 Some other commenters, however, opposed including taker-maker exchanges in the quote narrower spreads by providing another source of revenue’’); Grasso Letter, at 4 (‘‘the main outcome of exchange pricing seems to be that it forces exchanges to compete for customers,’’ because it ‘‘keeps their margins tight and gives them incentives to improve the quality of their offerings’’). 28 See, e.g., Joint Asset Managers Letter, at 2; Brandes Letter, at 2; Themis Trading Letter I, at 3; AJO Letter, at 1–2; OMERS Letter, at 2; Copeland Letter, at 2; Virtu Letter, at 6; Nuveen Letter, at 2; BlackRock Letter, at 1; RBC Letter I, at 3; Vanguard Letter, at 2; CFA Letter, at 4; Wellington Letter, at 2; Joint Pension Plan Letter, at 2; Oppenheimer Letter, at 2; Clearpool Letter, at 5 n.8; TD Ameritrade Letter, at 4; Capital Group Letter, at 3; Healthy Markets Letter I, at 10; Morgan Stanley Letter, at 3 n.5; AGF Letter, at 1. 29 AJO Letter, at 1–2. 30 See RBC Letter I, at 3–4. 31 Capital Group Letter, at 3. See also, e.g., Clearpool Letter, at 5 n.8; Oppenheimer Letter, at 2; Brandes Letter, at 2; Copeland Letter, at 2. PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 5205 Pilot, noting that Rule 610(c) does not apply to taker-maker exchanges.32 After considering the comments on this issue, the Commission continues to believe that focusing the Pilot on equities exchanges regardless of fee model is appropriate because it treats alike similarly situated entities that all are subject to the same regulatory framework and thereby will allow the Commission to evaluate the effect of exchange fee-and-rebate pricing models and the continued appropriateness of the Rule 610(c) fee cap. Further, it would be incongruous to study rebates and fees offered by one type of equities exchange (maker-taker), but not another type of equities exchange (taker-maker) where the fees of both types of entities are subject to the same legal requirements and can introduce the same types of distortions that the Pilot seeks to study. 4. Non-Exchange Trading Centers As proposed, the Pilot would exclude non-exchange trading centers such as alternative trading systems (‘‘ATSs’’).33 Several commenters opined on this aspect of the proposal. A number of commenters agreed with the Commission’s proposal to exclude nonexchange trading centers from the Pilot.34 Some of those commenters noted that exchanges are subject to various fee-related regulatory provisions that are entirely inapplicable to nonexchange trading centers. For example, one commenter noted that nonexchange trading centers are not currently subject to any access fee caps, and including such trading venues in the Pilot ‘‘would have the unintended and harmful effect of unnecessarily changing ATS business models . . . .’’ 35 In addition, several commenters emphasized the fundamental ways in which the fee structures employed by 32 See, e.g., Cboe Letter I, at 28. Proposing Release, supra note 2, at 13014. As discussed in the Proposing Release, the term ‘‘trading center’’ as used there and throughout this release is a collective term that refers broadly to the venues that trade NMS stocks. See id. at 13009 n.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. 34 See, e.g., Brandes Letter, at 2; AJO Letter, at 2; MFA Letter, at 2; BIDS Letter, at 1–2; BlackRock Letter, at 1; SIFMA Letter, at 5; Virtu Letter, at 6; Fidelity Letter, at 10; Citi Letter, at 2; Clearpool Letter, at 4–5; Luminex Letter, at 1; Morgan Stanley Letter, at 3 n.5. 35 Virtu Letter, at 6. See also, e.g., SIFMA Letter, at 5; Clearpool Letter, at 5. 33 See E:\FR\FM\20FER2.SGM 20FER2 5206 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations non-exchange trading centers are different from the fee models utilized by the equities exchanges and, as a result, concluded that excluding non-exchange trading centers was appropriate.36 For example, one such commenter explained that ‘‘inducements (low fees, no fees, rebates) offered by ATSs and other off-exchange venues are not universal across all broker-dealers or market participants. Instead, the fees paid (or not paid) by market participants to ATSs and other off-exchange venues are negotiated between each market participant and the trading venue,’’ such that ‘‘the number of fee permutations and inconsistencies across brokers for any single ATS could be substantial.’’ 37 Still other commenters believed that excluding non-exchange trading centers from the Pilot was appropriate because ‘‘ATSs are not protected venues, and thus free market competition among them constrains their pricing power.’’ 38 One commenter supported excluding ATSs because ‘‘there is nothing to be gained by including venues that don’t have the same underlying issues that exchanges present with their rebate and ‘maker-taker’ pricing models.’’ 39 On the other hand, other commenters expressed concerns with omitting nonexchange venues from the Pilot.40 One concern was that by excluding nonexchange venues, the Pilot data would be incomplete. For example, one commenter believed that excluding nonexchange venues ‘‘could create an imperfect picture of the overall impact of the transaction fees put in place under the Pilot program’’ and could compromise the value and utility of the data collected during the Pilot. 41 Another commenter argued that by excluding non-exchange venues, the 36 See, e.g., Morgan Stanley Letter, at 3 n.5 (stating that ‘‘many broker-dealer[ ] operators of ATSs generally charge clients an overall commission rate (rather than an access fee) for a bundle of services, including access to their ATSs’’); BIDS Letter, at 1–2, AJO Letter, at 2; Healthy Markets Letter I, at 10. 37 AJO Letter, at 2. 38 Citi Letter, at 2. See also, e.g., Fidelity Letter, at 10 (stating that ‘‘ATS’ fee structures are already subject to competitive market forces and have more complex pricing models than exchanges[,] making their participation in the Proposed Pilot less useful’’); SIFMA Letter, at 5 (opining that ‘‘competitive forces already push access fees [at ATSs] to an appropriate level . . . lower than the access fees charged by exchanges,’’ because ATS access fees ‘‘are included in the total cost consideration of trading’’). 39 Luminex Letter, at 1. 40 See, e.g., Nasdaq Letter I, at 2, 5–7; Cboe Letter I, at 12–13; MFS Letter, at 2; RBC Letter I, at 4; ASA Letter, at 3; ViableMkts Letter, at 2; Angel Letter II, at 2. 41 See Wellington Letter, at 2 (acknowledging, however, that it is ‘‘impractical for the Commission to include off-exchange venues’’). See also, e.g., RBC Letter I, at 4; ProAssurance Letter, at 2. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 Pilot will not return ‘‘meaningful data upon which to make informed analysis and conclusions’’ because it would ‘‘ignore off-exchange trading representing approximately 39 percent of total U.S. equities market trading.’’ 42 This commenter further believed that the Pilot would be unable to properly assess the potential conflicts of interest because it will not know ‘‘the baseline for remuneration occurring offexchange, or know what impact the Proposal has on that baseline[.]’’ 43 One commenter objected to excluding ATSs ‘‘based on the fact that the proposed Pilot is a ‘new regulatory regime’ for ATSs . . . .’’ 44 While one commenter recognized the complexity involved with subjecting non-exchange trading centers to the access fee cap under Rule 610(c), it argued that such complexity did not provide a sufficient basis to treat exchanges and non-exchange trading centers disparately.45 A few commenters recommended excluding ATSs, but requiring them to submit the required order routing data.46 The Commission believes that excluding non-exchange venues from the Pilot should not negatively impact the Pilot’s data or impact its results. As noted above, the Pilot is designed, among other things, to assess the effects of exchange fee models. Because exchange fee models are materially different both in their structure and regulatory treatment, the potential effects that may be associated with exchange fee models are not applicable in the same manner to ATSs. Similarly, the question of whether rebates narrow the quoted spread is inapplicable to ATSs, which do not publicly display an automated quotation. Further, ATS activity is not being overlooked as increases or decreases in ATS volume during the Pilot will be reflected in other existing data sources. Accordingly, Commission researchers (hereinafter ‘‘researchers’’) will be able to assess market-wide changes in order flow during the Pilot. Further, even if non-exchange venues provided order routing data pursuant to the Pilot, researchers would be unable to meaningfully correlate changes in an ATS’s order flow with the fees of that ATS because those fees are bespoke, typically bundled, and are not as transparent as exchange fees.47 42 Nasdaq Letter I, at 2, 5–7. See also, e.g., NYSE Letter I, at 2. 43 See Nasdaq Letter I, at 7. 44 See, e.g., Cboe Letter I, at 13. 45 See NYSE Letter I, at 7–8. 46 See, e.g., Better Markets Letter, at 8. 47 As noted by several commenters, equities exchanges and non-exchange trading centers currently employ different fee models. While PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 Exchange fees are not only fully transparent in published fee schedules, but exchange fee changes must be filed with the Commission and thus they have a precise effective date attached to each filing. This level of transparency for exchange fees and rebates, which is not present for ATSs,48 is an important component facilitating researchers’ ability to draw causal connections with the Pilot’s results. While obtaining order routing data from ATSs might provide interesting insight into their business, it could not be meaningfully correlated with ATS fees and fee changes and is not necessary to study the Pilot’s results. Rather, existing sources of data on ATS activity, including data published by the Financial Industry Regulatory Authority (‘‘FINRA’’), will permit researchers to observe changes in ATS activity during the Pilot. Among commenters critical of excluding non-exchange venues, some believed it could raise competitive issues to apply the Pilot’s pricing limitations to the equities exchanges, but not impose the same pricing limitations on non-exchange trading centers that trade the same equities securities.49 One exchange commenter found it ‘‘inexplicabl[e]’’ that the Pilot ‘‘focuses only on exchanges and entirely ignores off-exchange venues, which are the venues that are most likely to benefit from a pilot that pointedly decreases the incentive (i.e., rebates) to post protected quotes on-exchange.’’ 50 Several commenters suggested that the exclusion of non-exchange trading centers from the Pilot could ‘‘create incentives for market participants to move more order flow to off-exchange platforms,’’ thereby putting the national securities exchanges at a competitive disadvantage as compared to offexchange trading centers.51 However, a equities exchanges charge transaction-based fees, non-exchange trading centers may not charge separate transaction-based fees, but instead may use bundled pricing such that a particular order is not necessarily associated with a particular fee. See, e.g., Morgan Stanley Letter, at 3 n.5 (stating that ‘‘many broker-dealer[ ] operators of ATSs generally charge clients an overall commission rate (rather than an access fee) for a bundle of services, including access to their ATSs’’); BIDS Letter, at 1– 2, AJO Letter, at 2. See also Proposing Release, supra note 2, at 13016. The Commission is not aware of any ATSs that currently pay transactionbased rebates. 48 See supra notes 310–312 and accompanying text (discussing recent amendments to Regulation ATS and their relevance to the proposed Pilot). 49 See, e.g., ASA Letter, at 3; Cboe Letter I, at 12, 26–27; Nasdaq Letter I, at 5–7; NYSE Letter I, at 3– 8. 50 See Cboe Letter I, at 12. See also Nasdaq Letter I, at 6; NYSE Letter I, at 3–5; NYSE Letter II, at 12. 51 See, e.g., Wellington Letter, at 2; Oppenheimer Letter, at 3; Angel Letter II, at 2; Nasdaq Letter I, at 6–7; Cboe Letter I, at 12; NYSE Letter I, at 3–5; Curtiss-Wright Letter, at 1; ASA Letter, at 3. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations commenter suggested the opposite could happen and that the Pilot might actually ‘‘encourage more order flow to gravitate to the exchanges’’ because the Pilot would reduce the access fee cap on the equities exchanges thereby making it less expensive to transact on an exchange.52 The Commission does not believe that the Pilot necessarily will put the equities exchanges at a competitive disadvantage or disproportionally harm them when competing with nonexchange trading centers for investors’ orders. Currently, only exchanges are subject to the Rule 610(c) fee cap, and Test Group 1 is designed to test a lower cap. The Commission does not believe that exchanges charging lower fees will necessarily make them less competitive with other venues for natural order flow, for example order flow that removes liquidity. Rather, it is possible that lower fees in Test Group 1 across all exchanges may actually improve their competitive position in attracting that order flow,53 particularly with respect to fee sensitive routing algorithms because, all else being equal, fee sensitive algorithms generally seek to minimize trading costs and would likely rank exchanges more favorably in their routing tables when exchanges reduce their fees to remove liquidity. In addition to testing a lower fee cap level, the Pilot also will test a prohibition on rebates and ‘‘Linked Pricing,’’ which, as discussed further below, is defined as a discount or incentive on transaction fee pricing applicable to removing (or providing) liquidity that is linked to providing (or removing) liquidity.54 The intent of this is to gather data to assess, among other things, the effect of exchange rebates. Potential distortions, which may be caused or exacerbated by exchange rebates, may themselves be placing exchanges at a competitive disadvantage, in which case the elimination of rebates could improve the competitive position of exchanges, for example if taker fees are set at levels independent of the need to subsidize maker rebates. Once again, data is needed to empirically assess this issue, and the Commission believes that the Pilot is the best way to obtain that data.55 Further, while exchanges may compete with non-exchange trading 52 See, e.g., Citi Letter, at 2; Decimus Letter, at 5– 6. 53 See, e.g., Citi Letter, at 2; Decimus Letter, at 5– 6. See also, infra Section IV.D ‘‘Impact on Efficiency, Competition and Capital Formation’’ and note 782 infra and accompanying text. 54 See Rule 610T(a)(2). 55 See infra Section IV.A.2. and C.1.a.i. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 centers for order flow, exchange fees and the fees of non-exchange trading centers are treated very differently under the federal securities laws. Indeed, one of the distinguishing features of registered national securities exchanges is that—unlike non-exchange trading centers—their fees are subject to the principles-based standards set forth in the Exchange Act, as well as the rule filing requirements thereunder. In particular, the federal securities laws require the entirety of each and every fee, due, and charge assessed by an exchange to be transparent and publicly posted for all to see, and must be an equitable allocation of reasonable dues, fees and other charges and not be unfairly discriminatory.56 On the other hand, similar requirements do not apply to the fees of non-exchange trading centers that do not provide public transparency into their full itemized fee schedules and typically are individually negotiated on a customer-by-customer basis.57 By including all equities exchanges regardless of fee model, and excluding other types of trading centers, the Pilot is designed to include all trading centers whose fees are subject to the principles-based standards set forth in the Exchange Act as well as the rule filing requirements thereunder.58 Thus, the Pilot will produce data to empirically evaluate 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 Commission believes that subjecting non-exchange trading centers to the Pilot would go beyond the scope of the current regulatory framework that applies only to exchanges and would not further the Commission’s evaluation of the impact of the existing regulatory regime, including, but not limited to, the Regulation NMS fee cap, which applies exclusively to exchange fees and rebates. In effect, the Pilot will help the 56 See 15 U.S.C. 78f(b)(4)–(5). exchange fee changes are published for public comment and required to be publicly posted on the internet, whereas fees of non-exchange trading centers are typically bespoke. Fee changes of non-exchange trading centers are not subject to the provisions of the federal securities laws requiring that fees be an ‘‘equitable allocation’’ of ‘‘reasonable’’ fees and not ‘‘unfairly discriminatory.’’ 58 See 15 U.S.C. 78f(b)(4)–(5) (requiring, 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.’’). In addition, only exchange fees are subject to the rule filing requirements under Section 19(b) of the Exchange Act and 17 CFR 240.19b–4 (Rule 19b–4) thereunder. See also Proposing Release, supra note 2, at 13016. 57 All PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 5207 Commission carry out its statutory responsibility to assess the effect of exchange fees and rebates, which do not apply to non-exchange trading centers.59 5. Options Exchanges Finally, the Commission proposed to exclude options exchanges from the Pilot, because options and equities are materially different types of securities. In addition, the access fee cap under Rule 610(c) does not currently apply to the options exchanges.60 Several commenters agreed with the Commission’s exclusion of the options exchanges.61 No commenters suggested that the Commission include options markets in the Pilot. For the reasons noted above and discussed in the Proposing Release, the Commission is not including options markets within the scope of the Pilot.62 B. Securities As proposed, all NMS stocks 63 that meet specified initial and continuing minimum standards would be eligible for inclusion in the Pilot (collectively, ‘‘Pilot Securities’’).64 The Commission received a number of comments regarding the scope of Pilot Securities to be included in the Pilot. 1. The Share Price Threshold of Pilot Securities The Commission proposed that an NMS stock must have a minimum initial share price of $2 at the time the prePilot Period commences to be included in the Pilot and that any Pilot Securities that close below $1 at the end of a trading day during the proposed Pilot would be removed from the Pilot.65 59 While exchange fees are filed with the Commission on Form 19b–4 and the Commission publishes notice of them for public comment and has an opportunity to summarily suspend them within 60 days, the Commission’s non-action on a fee filing within that period does not constitute an endorsement or approval of an exchange fee. Issues with fees and how they impact market participants and market structure may or may not be obvious at first and adverse effects may take time to manifest as the market adjusts to a new fee. The Commission, and the exchanges as self-regulatory organizations, must enforce their rules and the federal securities laws with the goal of protecting investors and the public interest. 60 See Proposing Release, supra note 2, at 13015. 61 See, e.g., MFA Letter, at 2; SIFMA Letter, at 5; Fidelity Letter, at 10. 62 See Proposing Release, supra note 2, at 13015. 63 See 17 CFR 242.600(b)(47) (defining ‘‘NMS stock’’). 64 See Proposing Release, supra note 2, at 13017. See also Proposed Rule 610T(b)(1)(ii). 65 See Proposing Release, supra note 2, at 13017; Proposed Rule 610T(b)(1)(ii). The Commission notes that the proposed language in Rule 610T(b)(1)(ii) has been modified slightly. As proposed, Rule 610T(b)(1)(ii) contained the phrase E:\FR\FM\20FER2.SGM Continued 20FER2 5208 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations One commenter opposed the $2 initial minimum share price threshold as overly restrictive.66 Other commenters, however, agreed that the securities in the Pilot should have an initial minimum $2 per share price threshold at the time of the initial stock selection, because this threshold ‘‘will capture virtually all NMS stocks while minimizing the risk that securities will drop out of the Pilot . . . .’’ 67 One of these commenters believed the proposed thresholds would ‘‘help ensure consistency among the Test Groups and limit the risk of data anomalies due to changes in the composition of those groups.’’ 68 Another commenter noted that the choice of ‘‘$2 and $1 thresholds . . . follows the reasonable parameters established during [the] . . . Tick Size Pilot’’ and asserted that the ‘‘determination to pull out securities that close at under $1 during the pilot seems appropriate, especially given the fundamentally different fee structures applicable to stocks with prices less than $1.00.’’ 69 The Commission continues to believe that the proposed share price thresholds for Pilot Securities are appropriate. The Commission notes that no commenters opposed the proposed $1 minimum continuing price threshold, which will exclude such stocks from the Pilot because stocks with quotations of less than $1 are subject to different regulatory and fee treatment.70 The Commission continues to believe that an initial $2 share price threshold will best balance the need to include a broad set of NMS stocks in the Pilot with the desire to ensure that substantially all of the securities selected at the outset of the Pilot remain part of their respective Test Groups throughout the duration of the Pilot, including during the pre- and post-Pilot periods. The Commission does not believe that the $2 threshold is overly restrictive because, as discussed ‘‘minimum initial share price of at least $2 . . . .’’ As adopted, the clause ‘‘minimum initial share price of $2’’ is being substituted for the phrase ‘‘minimum initial share price of at least $2’’ to delete redundant text. In addition, as proposed, Rule 610T(b)(1)(ii) explained that a Pilot Security that closes below $1 would 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). . . .’’ As adopted, this language is being modified slightly to make it more concise. Accordingly, as adopted, this language provides that if the share price of a Pilot Security closes below $1 at the end of a trading day ‘‘it will be removed from the Pilot.’’ 66 See Angel Letter I, at 2. 67 RBC Letter I, at 5. See also, e.g., Better Markets Letter, at 6; Healthy Markets Letter I, at 11–12. 68 RBC Letter I, at 5. 69 Healthy Markets Letter I, at 12. 70 See Proposing Release, supra note 2, at 13017. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 in the Proposal, it is uncommon for securities priced at $2 or more to fall below $1.71 Lowering the initial stock selection threshold below $2 could increase the likelihood that securities selected for the Pilot get dropped from the Pilot if their share price closed below $1 during the Pilot. Such a result would change the composition of the Test Groups during the Pilot, which might adversely impact the quality of the data produced by the Pilot. For these reasons and the reasons discussed in the Proposing Release, the Commission adopts as proposed the share price thresholds set forth in Rule 610T(b)(1)(ii). 2. The Duration of Pilot Securities The Commission proposed that, in order to be included in the Pilot, an NMS stock must have an unlimited duration or a duration beyond the end of the post-Pilot period in order to be included in the Pilot.72 No comments were received regarding this condition. For the reasons outlined in the Proposing Release, the Commission adopts this aspect of the Pilot as proposed.73 3. Selecting Pilot Securities From All NMS Stocks The Commission proposed to select Pilot Securities from among the entire universe of NMS stocks, subject to the minimum share price threshold and duration requirements. As proposed, the Pilot would include a broad and diverse cross-section of securities, including, for example, stocks of all market capitalizations as well as ETPs. The Commission received comments on the universe of Pilot Securities that generally fell into four categories: (1) The inclusion of stocks with market capitalizations below $3 billion, (2) the inclusion of ETPs, (3) the inclusion of Canadian interlisted stocks, and (4) the inclusion of NMS stocks other than stocks of operating companies and ETPs. Each of these points is discussed below. a. Market Capitalization and Liquidity The Commission proposed to select Pilot Securities from among NMS stocks of all market capitalizations.74 A few 71 See id. at 13017 n.102 (noting that only 4.3% of publicly traded common stocks and ETPs with a share price above $2 during 2012–2016 dropped below $1 in that period). 72 See Proposing Release, supra note 2, at 13017; Proposed Rule 610T(b)(1)(ii). 73 See Proposing Release, supra note 2, at 13018 n.103. 74 See id. at 13018. The EMSAC’s recommendation was to limit a pilot to stocks above $3 billion in market capitalization in order to avoid overlap with the Tick Size Pilot. See id. The PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 commenters recommended that the Pilot exclude securities with smaller market capitalizations and/or thinly-traded securities. One commenter suggested that the ‘‘majority of securities within the Test Groups should be more liquid’’ and that thinly-traded securities, if included, ‘‘should be a minority of all securities in the Test Groups.’’ 75 Similarly, one exchange commenter stated that the Pilot ‘‘should exclude less active stocks as the liquidity in such stocks will likely be severely and negatively impacted by this Pilot.’’ 76 This commenter asserted that ‘‘[l]ess active stocks are highly dependent on professional liquidity providers to post liquidity’’ and speculated that ‘‘[d]ecreasing incentives for liquidity providers to post liquidity in less active stocks will have a pronounced impact on liquidity . . . manifest[ing] in significantly wider spreads and significantly less depth in these securities.’’ 77 Noting that ‘‘many industry participants appear to advocate for increased incentives for liquidity provision in thinly-traded stocks,’’ the commenter did not believe that the Pilot’s goals were ‘‘worth the risk to liquidity and capital formation that the Commission itself identifie[d.]’’ 78 Another commenter was similarly concerned that the Pilot would ‘‘have a significant impact on small to medium issuers since exchanges will not be able to provide incentives to market makers to support trading in those companies’ securities.’’ 79 This commenter stated that ‘‘[l]iquidity rebates can be critical for such securities to motivate market makers to support the stock with aggressive and actionable quotations.’’ 80 Further, the commenter opined that the Pilot would ‘‘risk damaging companies’ ability to efficiently raise capital,’’ which it believed would ‘‘particularly harm small and medium sized companies, for which the current market structure is already not Commission notes, however, that the Tick Size Pilot ended on September 28, 2018 and the Pilot Period for the Transaction Fee Pilot will not start before the post-pilot period for the Tick Size Pilot ends on April 2, 2019. See Section II.C.3. infra. 75 RBC Letter I, at 6. See also, e.g., Harris Letter, at 1; T. Rowe Price Letter, at 4. 76 Cboe Letter I, at 28. 77 Id. See also, e.g., Morgan Stanley Letter, at 4; Leaf Letter, at 1. 78 Cboe Letter I, at 19. See also, e.g., Proposing Release, supra note 2, at 13069. 79 Nasdaq Letter I, at 8–9. 80 Id. at 3, 9 (alleging that the Pilot was ‘‘arbitrary and capricious and not in accordance with law,’’ because it gave ‘‘short shrift’’ to these concerns). See also Virtu Letter, at 7 (expressing concern that the Pilot would ‘‘harm investors in . . . less liquid ETPs, which will be faced with less liquidity and wider spreads when they seek to sell their holdings’’). E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations optimized.’’ 81 The commenter further argued that ‘‘incentives (rebates) are important to creating two-sided markets across all stocks, especially thinly traded stocks.’’ 82 Many other commenters supported including a broad scope of Pilot Securities. For example, a group of twenty-one asset managers submitting a joint letter stated that ‘‘[a]s many NMS stocks as possible should be in scope, including those with market capitalizations below $3bln,’’ in order to create a ‘‘meaningful’’ dataset.83 Another commenter agreed that the Pilot ‘‘should encompass the broadest universe of securities, as is feasible, in order to maximize the sample size and provide the most robust dataset possible,’’ further arguing that ‘‘[o]mitting securities of a specific market cap seems arbitrary, would provide an incomplete view of the overall market, and runs the risk of excluding meaningful data and biasing the study.’’ 84 Building on these arguments, other commenters believed it was important to specifically ‘‘test the argument that rebates are required to promote liquidity provision in illiquid stocks.’’ 85 One commenter noted that this debate ‘‘has raged for years,’’ which is ‘‘the point of the pilot: To provide market participants and the Commission with the data needed to make those analyses.’’ 86 Another commenter similarly asserted that the Pilot should include a broad set of NMS stocks to ‘‘help settle academic debates on the relative impact of rebates on liquid vs. less-liquid stocks and other supposedly beneficial aspects of rebates.’’ 87 5. Notably, some of these commenters directly challenged the argument, set forth by a number of other commenters, that thinly-traded or smallercapitalization NMS stocks would be harmed by the Pilot’s pricing restrictions. One commenter explained that, ‘‘for less liquid stocks, spreads tend to be wider, and as a result rebates become less relevant as a matter of simple mathematics.’’ 88 To illustrate the point, the commenter referred to a ‘‘stock that typically trades at a five-cent quoted spread,’’ noting that a ‘‘typical .0025 per share rebate would equal onetwentieth of the quoted spread, so in these instances a market maker’s revenue from capturing the spread would far outweigh the contribution of the rebate’’ 89 (emphasis in original). Another commenter also questioned the ‘‘significance of liquidity rebates for making markets in less liquid/smallercap stocks,’’ because it believed this ‘‘marginal incentive to provide liquidity . . . is likely to be weak in the smallercap space typically characterized by wide bid-ask spreads . . . .’’ 90 To support this argument, the commenter referred to ‘‘an empirical study of changes in maker-taker arrangements on two European trading venues owned by BATS,’’ now owned by Cboe Global Markets, which suggested that ‘‘ ‘an elimination of the make fee and a reduced take fee cap would result in worse market quality for large capitalization stocks but better market quality for small capitalization stocks’ ’’ (emphasis in original).91 For this reason, the commenter asserted that the ‘‘link articulated by the opponents of the proposed pilot is at best uncertain and that the pilot may in fact result in improved liquidity for smaller-cap 82 Nasdaq Letter III, at 1. The commenter provided a chart showing how the exchanges compare to each other with respect to maintaining a two-sided quote at least 50% of the day. In the chart, some of the exchanges with a higher percent of two-sided markets more than 50% of the day have taker-maker pricing, in which they incentivize the removal of liquidity and charge fees to the provider of liquidity. Id. at Exhibit A. But cf. NYSE Letter II, at 9–10 (arguing that rebates are necessary to promote display of liquidity). 83 Joint Asset Managers Letter, at 2. See also, e.g., Spatt Letter, at 1–2 (stating that the Pilot was a ‘‘very significant improvement over the EMSAC proposal’’ and that one of the ‘‘major improvements’’ was ‘‘the inclusion of lower market value stocks’’); Healthy Markets Letter I, at 11–12; Wellington Letter, at 2; MFA Letter, at 2; Nuveen Letter, at 2; Lipson Letter, at 1; BlackRock Letter, at 1; Vanguard Letter, at 2; CFA Letter, at 4; CIEBA Letter, at 2; Joint Pension Plan Letter, at 2; Oppenheimer Letter, at 2. 84 AJO Letter, at 2. 85 Babelfish Letter, at 3. 86 Healthy Markets Letter I, at 13. 87 Better Markets Letter, at 6. See also, e.g., Vanguard Letter, at 2 (‘‘By including all NMS stocks, the SEC will receive data to analyze the impacts of transaction fees on market quality across various types of securities.’’); TD Ameritrade Letter, at 6–7 n.11 (‘‘including securities of small, mid and large cap companies . . . will include some data on the impact that varying transaction fees will have [on] thinly traded securities’’). 88 IEX Letter II, at 7. See also Credit Suisse Commentary, at 1, 3 (stating that the Pilot ‘‘is likely to affect stocks differently depending on their liquidity profile,’’ but expecting stocks ‘‘with wider spreads’’ in Test Groups 2 and 3 ‘‘to continue to behave similarly given that their liquidity may be less driven by rebate-incentivized trading strategies to begin with’’). But cf. NYSE Letter II, at 11 (asserting that it was ‘‘untrue’’ that ‘‘spreads for less-liquid securities are not sensitive to rebate levels’’ and referring to chart showing that NYSE American-listed securities, ‘‘which are generally less-liquid securities’’ spent less average time at the NBBO compared to maker-taker venues). 89 IEX Letter II, at 7. 90 Decimus Letter, at 4–5 (citing Marios Panayides et al., Trading Fees and Intermarket Competition 26 (Charles A. Dice Ctr. for Research in Fin. Econ., Ohio State Univ., Working Paper No. 2017–3, 2017, available at, https://ssrn.com/abstract=2910438). 91 Id. at 5. 81 Nasdaq Letter I, at 2. See also ASA Letter, at VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 5209 stocks’’ (emphasis in original).92 The commenter therefore contended that it was ‘‘imperative to include a set of smaller-cap stocks in the pilot, as the opponents’ claims on the existence of unambiguous harm to liquidity appear to be exaggerated and driven by preconceived notions.’’ 93 The Commission believes that the many commenters have, through their analysis and ultimate disagreement on this issue, emphasized the need for the Pilot to test the effect of transaction fees and rebates on NMS stocks of all market capitalizations. It is unclear whether or not changes to fees and rebates would harm smaller capitalization or thinlytraded NMS stocks.94 As some commenters have noted, it also is possible that the Pilot may have little effect on smaller-capitalization or thinly-traded NMS stocks or that the Pilot may even improve the liquidity of such stocks.95 The Commission also notes that a pilot focused solely on large capitalization stocks may not produce sufficient data to investigate how changes to transaction fees and rebates will affect liquidity or capital formation across the market. Because including smaller-capitalization NMS stocks in the Pilot will produce a more meaningful dataset to support a broad investigation into the effect of transaction fees and rebates on the full spectrum of NMS stocks and among different segments of the securities market, the Commission adopts this aspect of the rule as proposed. As discussed further below, notwithstanding the decision to include all NMS stocks regardless of market capitalization, the Commission believes it is appropriate to exclude certain thinly-traded securities (e.g., securities that trade fewer than 30,000 shares per day), in part because rebates at that level of trading would be low enough to be unlikely to impact order routing behavior and researchers would be unlikely to get sufficient statistical power to analyze them in isolation at those volume levels.96 92 Id. 93 Id. 94 See, e.g., Proposing Release, supra note 2, at 13065–66, and 13069. 95 See, e.g., notes 88–92 supra and accompanying text. 96 See supra Section II.C.6 (discussing the exclusion of securities that trade fewer than 30,000 shares per day on average from Test Groups 1 and 2). See also supra notes 88–92 and accompanying text. Accordingly, the Commission notes that many thinly-traded securities will be excluded from the Pilot, which should assuage commenters’ concerns regarding the impact of the Pilot on less liquid or thinly-traded securities. E:\FR\FM\20FER2.SGM 20FER2 5210 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations b. The Inclusion of ETPs The Commission proposed to select Pilot Securities from among all NMS stocks, including ETPs. A number of commenters supported including ETPs in the Pilot. Several commenters noted, for example, that including ETPs ‘‘would produce a more inclusive analysis of rebates and fees across all segments of NMS stocks.’’ 97 One such commenter believed that ‘‘the benefits from collecting data that informs longterm market structure improvements will outweigh any potential temporary disadvantage.’’ 98 On the other hand, a number of commenters expressed concern with including ETPs in the Pilot. For example, one commenter stated that ‘‘[m]any ETP issuers are . . . strongly opposed to the inclusion of ETPs in the Pilot’’ and suggested that the Commission had not ‘‘sufficiently explained why it is appropriate to include ETPs in any Pilot.’’ 99 This commenter noted that ‘‘exchanges have implemented numerous incentive structures designed to promote liquidity and narrow spreads in ETPs’’ that could be disrupted by the Pilot, ‘‘negatively impact[ing] liquidity and spreads in ETPs to the detriment of both new and existing investors.’’ 100 Similarly, another commenter expected the Pilot to ‘‘result in spreads widening for ETPs holding pilot stocks, even if ETPs are not included in the pilot, given that fair value calculations rely on underlying constituent pricing,’’ and therefore cautioned that ‘‘any negative effects of the pilot on transaction costs could be intensified for ETP investors.’’ 101 A few commenters ‘‘believe[d] that the goals of the pilot can be achieved without having to include ETPs in the pilot,’’ because ‘‘[t]he effects of the pilot on stocks will be sufficient to draw conclusions about potential changes to access fee rules.’’ 102 The Commission continues to believe that it is important to include ETPs in the Pilot, because excluding them would hamper the Commission’s ability to gather key data that could be used to inform future regulatory action in this area. The Commission does not believe it will be able to draw meaningful conclusions about the impact of changes to transaction fees and rebates on ETPs by observing the effects of the Pilot on other securities, in part because ETPs 97 BlackRock Letter, at 1. See also, e.g., Fidelity Letter, at 9. 98 Vanguard Letter, at 2. 99 Cboe Letter I, at 17–18. 100 Id. 101 State Street Letter, at 3. 102 See, e.g., id. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 have a unique create-and-redeem process that does not apply to other NMS stocks.103 Nevertheless, ETPs are subject to the same rules and fees that apply to all NMS stocks. To the extent that the Pilot results may inform future policymaking, Pilot data that includes all types of NMS stocks that would be impacted, including ETPs, will be more useful. Further, some commenters expressed concern regarding the potential for competitive effects among certain ETP issuers. As one commenter noted, ‘‘if two ETPs with similar underliers or that track the same index are placed in the two different [T]est [G]roups, the Pilot would inevitably determine winners and losers.’’ 104 Another commenter explained that ‘‘ETPs with similar investment strategies are more substitutable than stocks of operating companies,’’ such that ‘‘market quality metrics likely play a greater role in driving flows to ETPs.’’ 105 For that reason, ‘‘[i]f competing ETPs are in different test groups—and market quality varies among the test groups,’’ the commenter believed that ‘‘investors might migrate toward products in the test groups with better market quality,’’ thereby ‘‘tilt[ing] the playing field in favor of ETPs that happen to be assigned—at random—to test groups that perform better at the expense of other products.’’ 106 While a few commenters discussed which treatment group would be most problematic,107 many of the commenters took no position on the direction of the presumed competitive impact and did not speculate about how (or whether) 103 See, e.g., Securities Exchange Act Release No. 75165 (June 12, 2015), 80 FR 34729, 34732 (June 17, 2015) (Request for Comment on Exchange-Traded Products) (discussing the create-and-redeem process for ETPs); Transcript of the Division of Trading and Markets’ Roundtable on Market Structure for Thinly-Traded Securities (April 23, 2018), available at https://www.sec.gov/spotlight/ equity-market-structure-roundtables/thinly-tradedsecurities-rountable-042318-transcript.txt (Panel Three discussing ETPs). In particular, large volumes in ETPs can be transacted directly with the ETP issuer in creation units, making the trading center volume in ETPs less relevant to institutional traders that transact in large size orders. 104 Morgan Stanley Letter, at 3–4. See also Nasdaq Letter I, at 8–9 (stating that the Pilot was ‘‘arbitrary and capricious and not in accordance with law,’’ in part because the Commission had ‘‘fail[ed] to consider’’ the competitive effects of placing ‘‘ETPs tracking similar indexes . . . in different test groups’’); Cboe Letter I, at 17. 105 ICI Letter I, at 4 n.8. 106 Id. at 4. See also, e.g., NYSE Letter I, at 7; Nasdaq Letter I, at 8. 107 See, e.g., Credit Suisse Commentary, at 6 (stating that the Pilot could ‘‘unintentionally advantage ETFs in the lower fee group’’). But cf. Nasdaq Letter I, at 8 (stating that ETPs ‘‘in the lower rebate groups would find themselves at a competitive disadvantage to their competitors and may lose market share during the pilot as a result’’). PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 inclusion in specific Pilot Groups would help or harm ETPs.108 To address the potential competitive harm, a few of these commenters recommended that the Commission exclude ETPs from the Pilot altogether,109 while most recommended that the Commission select ETPs in a manner that may avoid any potential competitive effects among similar ETPs, by: (1) Rotating all of the Pilot Securities through the various treatment groups,110 (2) rotating only ETPs through the various treatment groups,111 or (3) placing in the same Test Group ETPs tracking similar indexes or holding similar investments.112 Other commenters criticized these proposed alternatives for selecting ETPs. One commenter, for example, questioned ‘‘whether any of the proposed remedies would address these concerns effectively or fairly.’’ 113 Another commenter expressed concern that the suggestions to place ‘‘similar’’ ETPs in the same Test Group might be too complex to implement, as determining whether ETPs are ‘‘similar’’ to one another for purposes of Pilot rotation can be extremely nuanced.114 This commenter explained that an ‘‘effective classification should take into account an ETP’s underlying index, portfolio constituents and asset class to provide an appropriate ‘apples to apples’ analysis,’’ in addition to ‘‘factors such as assets under management, spread size and daily trading volume,’’ which the commenter believed ‘‘would 108 See, e.g., SIFMA Letter, at 4–5; Invesco Letter, at 2–3; Morgan Stanley Letter, at 3–4. 109 See, e.g., Cboe Letter I, at 28; Invesco Letter, at 2–3; State Street Letter, at 3; STA Letter, at 4. 110 See, e.g., ICI Letter I, at 4–5, 5 n.10 (suggesting that the Commission rotate securities every three to six months); Oppenheimer Letter, at 3; Angel Letter II, at 3 (suggesting a quarterly rotation). These commenters did not believe that rotation would ‘‘adversely affect the validity of pilot data’’ or ‘‘impose more than a de minimis implementation burden or other costs on market participants.’’ ICI Letter I, at 4. See also Angel Letter II, at 3. These commenters suggested that ‘‘[a]nalysis of individual security characteristics before and after a rotation to a new group[ ] could yield relevant and important results.’’ Oppenheimer Letter, at 3. See also Angel Letter II, at 3. 111 See, e.g., SIFMA Letter, at 5; State Street Letter, at 4; Healthy Markets Letter II, at 8. 112 SIFMA Letter, at 4. See also, e.g., Nuveen Letter, at 2; BlackRock Letter, at 2; FIA Letter, at 4; Fidelity Letter, at 9; State Street Letter, at 4; STANY Letter, at 4; Healthy Markets Letter II, at 8. But cf. Angel Letter II, at 3 (stating that ‘‘similar ETFs are probably the best natural controls for each other, as their underlying portfolios are virtually identical,’’ such that ‘‘similar ETFs should definitely be in different treatment groups to increase the power of the pilot’’). 113 Schwab Letter, at 3. 114 Invesco Letter I, at 2–3. See also, e.g., Healthy Markets Letter II, at 8 (noting that it may be ‘‘difficult to clearly and consistently define ‘similar’ ETPs’’). E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations introduce unnecessary complexity into the Proposal.’’ 115 The Commission recognizes the concern that securities placed in one treatment group could be impacted differently than similar securities placed in a different treatment group. While that effect could occur for any security (e.g., stocks of different operating companies in the same industry), it could potentially be more prominent for ETPs that may be substantially similar. Nevertheless, the Commission notes that similar ETPs are not necessarily identical and many other factors influence investor demand and trading, including expense ratios, trading commissions, and existing holdings. The Commission has carefully considered the three alternatives suggested by the commenters 116 and declines to adopt them. Rotating either (1) all Pilot Securities or (2) only ETPs would increase complexity and could increase the costs of the Pilot as the Commission, exchanges, and market participants would need to manage a pilot whose securities change treatment groups every several months. In particular, a rotation design would be considerably more complex than the proposed design by, for example, adding more treatment subgroups and requiring frequent rotation of those subgroups. Given the choice between a simple Pilot design with a short duration, on one hand, and a considerably more complex design with a longer duration, on the other hand, the Commission prefers to adopt this aspect of the rule as proposed. Compared to the alternative designs suggested by some commenters, the proposal results in a short narrowly drawn pilot with fewer complexities and burdens, which is an outcome supported by many commenters.117 The Commission also considered the suggestion to group ETPs with similar underlying holdings into the same treatment group. While this suggestion involves slightly less ongoing complexity than rotating securities during the Pilot, the Commission declines to adopt this suggestion because it introduces its own complexity in that categorizing ETPs according to their underlying holdings (and potentially other characteristics) involves the exercise of subjective 115 Invesco Letter, at 2–3. Commission also considered comments providing suggestions relevant to the implementation of these three alternatives. As discussed above, the Commission is not adopting the alternatives. 117 See Section II.D.2 (discussing the duration of the Pilot) and Section II.C.5. through 6. (discussing the number of stocks to be included in the Pilot) infra. 116 The VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 judgment. In addition, grouping similar ETPs can negatively impact the representativeness of the different treatment groups, particularly if all of the similar ETPs are similar in volume, price, and market capitalization. The Commission believes it may learn more from a study that compares how different pricing regimes affect similarly-situated ETPs, whereas keeping similar ETPs in the same treatment groups could reduce the quality and usefulness of Pilot’s results by inhibiting the ability of researchers to compare treatment groups. While the potential exists that similar ETPs in different Pilot treatment groups might trade differently during the Pilot, it is not certain—and commenters held divergent views concerning—whether and to what extent the Pilot would be a contributing factor. Whether the absence of rebates or lower fees help or hurt trading in similar ETPs is far from certain, and whether investors would base trading decisions on those distinctions is unclear. Excluding ETPs to avoid speculative harm would, however, decidedly reduce the utility of the Pilot’s results to inform future policy making. Therefore, the Commission has determined not to adopt a requirement to rotate securities or to group like ETPs. For these reasons, the Commission adopts the rule as proposed to include ETPs in the Pilot. c. The Inclusion of Canadian Interlisted Stocks In the Proposal, the Commission requested comment on the selection criteria and whether the Commission should consider inclusion or exclusion of certain stocks from the Pilot sample set.118 In response, several commenters discussed the inclusion of Canadian interlisted stocks in the Pilot and recommended that the Commission coordinate with Canadian securities regulators to avoid altering the trading dynamics between Canada and the U.S. in those securities.119 For example, one 118 See Proposing Release, supra note 2, at 13019 (Questions #5 and 8). See also id. at 13013 n.46 (noting the receipt of a letter from the Canadian Security Traders Association proposing a crossborder study on the effect of rebates on market quality in conjunction with the Canadian Securities Administrators). 119 See, e.g., Fidelity Letter, at 8; OMERS Letter, at 1; FIA Letter, at 4; Healthy Markets Letter I, at 35; STA Letter, at 5. Canadian interlisted stocks are stocks of Canada-based companies that are primarily listed on a Canadian exchange (generally the Toronto Stock Exchange), but that choose to also dually-list on a U.S. exchange. See https:// www.tsx.com/trading/toronto-stock-exchange/feeschedule/ni-23-101 (for a quarterly list of approximately 187 interlisted securities published by the Toronto Stock Exchange featuring stocks that are listed on the Toronto Stock Exchange or the TSX Venture Exchange). PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 5211 commenter was ‘‘concerned that the inclusion of Canadian interlisted stocks in either one of the reduced access fee or no rebate test groups may materially impact order flow by encouraging transactions to move away from U.S. exchanges and on to Canadian exchanges.’’ 120 Other commenters suggested that the Commission coordinate with the Canadian Securities Administrators to avoid ‘‘dramatic differences in the trading economics on inter-listed stocks between Canadian and U.S. markets.’’ 121 The Commission also received a comment letter from the academics retained by the Canadian Securities Administrators (‘‘CSA’’) to assist with planning, conducting, and analyzing a Canadian transaction fee pilot (‘‘Canadian Pilot’’).122 According to the CSA researchers, the Canadian Pilot likely will propose that, for approximately 180 interlisted stocks, 90 of them would be included in a norebate test group with the remaining 90 placed in a control group.123 In their letter, the CSA researchers requested that the Commission’s Pilot treat interlisted stocks similarly to their Canadian Pilot proposal—i.e., that both pilots place the same 90 interlisted stocks into their respective no-rebate group and place the other 90 stocks into their respective control group.124 By doing so, the CSA researchers believe that both pilots will avoid confounding the analysis for each respective pilot with respect to interlisted stocks because differences in fees and rebates otherwise could incentivize shifts in cross-border routing.125 The Commission agrees with the CSA researchers and believes that it is appropriate to coordinate with the CSA on a transaction fee pilot in order to avoid the potential for distortionary effects between U.S. and Canadian markets if rebates in the ‘‘no-rebate’’ interlisted stocks continue to be allowed on one country’s exchanges but not the other. Accordingly, in the event that the CSA proceeds with the Canadian Pilot concurrently with the Commission’s Pilot, the Commission will append to the no-rebate Test Group the same Canadian interlisted stocks that the CSA selects for its no-rebate treatment group, and the remaining interlisted stocks will 120 FIA Letter, at 4. See also Fidelity Letter, at 8. e.g., STA Letter, at 5. 122 See CSA Letter. The preliminary details of the pilot contemplated by the CSA, as reflected in the CSA Letter, were not publicly available prior to the Proposing Release. 123 Id. at 1. 124 Id. at 2. 125 Id. at 1–2. 121 See, E:\FR\FM\20FER2.SGM 20FER2 5212 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations be placed into the Control Group.126 Placing the same interlisted stocks into the Pilot’s no-rebate test group that the Canadian Pilot places into its no-rebate test group will avoid the potential to alter the trading dynamics between Canadian exchanges and U.S. exchanges in those stocks that otherwise could result if not all exchanges were subject to the same conditions, which should support the integrity of the no-rebate test groups in both pilots.127 Coordination also will avoid the potential for the Commission’s Pilot to interfere with the ability of Canadian securities regulators to conduct a pilot of their own on Canadian-listed stocks which could be adversely impacted in the absence of coordination.128 The Commission appreciates the interest expressed by the CSA researchers in coordinating on a pilot with respect to interlisted stocks, and looks forward to cooperating with the CSA on this important data-gathering initiative in a manner that benefits both nations’ securities markets. d. The Inclusion of Other Types of NMS Stocks A few commenters addressed the inclusion of other types of NMS stocks, such as American Depositary Receipts (‘‘ADRs’’), rights, and warrants. One commenter supported the proposed broad scope of Pilot Securities and believed that ‘‘analysis of . . . ADRs could provide additional insight into the effect rebates and fees have on liquidity, spreads and the overall trade experience.’’ 129 Another commenter objected to the Commission’s proposal to include rights and warrants in the Pilot, but did not explain the basis for 126 In the event that the Canadian pilot does not go forward or does not commence simultaneously with the Commission’s Pilot, interlisted stocks will be placed at the Pilot’s outset into the Control Group. Placing interlisted stocks in the Control Group will preserve the status quo for interlisted stocks and avoid altering the trading dynamics in them between U.S. and Canadian exchanges, which will avoid adversely impacting Test Groups 1 and 2 with respect to those stocks. If the Canadian pilot does go forward, but the interlisted stocks that will be included in its no-rebate test group are not known by the Commission at the time the Commission issues the initial List of Pilot Securities, the Commission may separately issue a subsequent list identifying the interlisted stocks that will be appended to Test Group 2 or the Control Group for the remainder of the Pilot. 127 See, e.g., Proposing Release, supra note 2, at 13024 (discussing the design of proposed Test Group 3 and the prohibition in Linked Pricing to support the integrity of a no-rebate test group). See also CSA Letter, at 1 (expressing concern that ‘‘the results of the Canadian Pilot may be statistically and economically inconclusive’’ without coordination with the Pilot). 128 See CSA Letter, at 1. 129 Oppenheimer Letter, at 3. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 discussions renders the ‘Opt Out’ option absolutely essential.’’ 134 Another commenter suggested that the Commission could address such concerns by ‘‘conven[ing] a summit for issuers and perhaps [creating] a series of webcasts . . . to explain the purpose of the test,’’ as well as by ‘‘form[ing] an Issuer Advisory Committee that can weigh data and let companies opt into or out of a test.’’ 135 The Commission’s proposal was subject to a full notice-and-comment rulemaking process during which the Commission received a large number of comments from the public, including issuers and their listing exchanges. While the EMSAC recommendation was one of many inputs that informed the Commission’s development of the Pilot, the Commission’s Pilot differs substantially from EMSAC’s recommendation as numerous commenters have recognized.136 Accordingly, the Commission believes that issuers, as well as other market participants, have had ample opportunity to participate in the consideration of the Commission’s proposal for the Pilot. 4. The Ability of Issuers To Opt Out of Other commenters supported opt out the Pilot based on specific concerns surrounding the potential impact of the Pilot. A The Commission solicited comment as to whether issuers should be allowed number of these commenters were listed company issuers that expressed concern to request that their securities not be about how the Pilot would affect trading included in one of the Pilot’s Test Groups (i.e., ‘‘opt out’’) and the potential in their securities.137 Commenters impact that such an approach might 134 Issuer Network Letter I, at 2, 7 (emphasis have on the extent and quality of the omitted). 132 data collected by the Pilot. 135 ModernIR Email, at 1. See also Issuer Network Several commenters argued that Letter I, at 7 (suggesting that the Commission issuers should be permitted to opt out ‘‘[p]lace the Access Fee Pilot on hold for 90 days while [it] gathers a Blue Ribbon Panel . . . of a of participation in the Pilot based on dozen or so NYSE and Nasdaq listed company process concerns. For example, one financial executives so that we might conduct a commenter’s ‘‘largest concern [was] that comprehensive review’’ of the Pilot (emphasis the genesis of the proposal . . . omitted)). 136 The EMSAC held meetings open to the public, deliberately excluded issuer representation’’ by ‘‘excluding the NYSE which were publicly webcast, as it was developing its recommendations. To promote awareness of and Nasdaq from participation on the those meetings, the Commission issued press 133 [EMSAC].’’ This commenter asserted releases to announce those meetings, which included the agenda for those meetings. See, e.g., that the ‘‘exclusion . . . from SEC Press Release 2015–216 (announcing the participation in the pre-proposal its objection.130 As noted above, however, most commenters expressed general support for a Pilot that includes all NMS stocks.131 The Commission continues to believe that it is appropriate to select Pilot Securities from among the overall universe of NMS stocks. Accordingly, the Commission will include all types of NMS stocks in the Pilot, subject to the selection criteria described below. The Commission believes this is appropriate because exchange fees and rebates apply to all NMS stocks, as does the fee cap under Rule 610(c). Aligning the scope of the Pilot with the scope of equities fees and the equities fee cap will best facilitate analysis of the impact of changes to transaction fees and rebates on different segments of the securities market. Excluding from its scope any categories of NMS stocks would deprive the Commission of data to inform future regulatory action regarding this segment of the market. For those reasons, the Commission adopts this aspect of the Pilot as proposed, subject to the selection methodology described below in Section II.C. 130 TD Ameritrade Letter, at 4. 131 See, e.g., Vanguard Letter, at 2; Joint Pension Plan Letter, at 2; Oppenheimer Letter, at 2. 132 See Proposing Release, supra note 2, at 13019. 133 Issuer Network Letter I, at 2 (emphasis omitted) and Issuer Network Letter II. See also Cboe Letter I, at 14–15 (criticizing the Pilot as ‘‘based on recommendations made by a committee that, however well-meaning, was flawed in its construction’’ because it lacked ‘‘exchange or issuer representation’’); Home Depot Letter, at 2 (stating that the EMSAC ‘‘did not include any input from issuers or issuer advocates . . . like NYSE and Nasdaq’’ and that it was ‘‘difficult’’ for ‘‘issuers . . . to understand how this Pilot could be implemented without input from the issuers . . . it will directly impact’’); ModernIR Email, at 1 (stating that a ‘‘study . . . crafted without input or choice for issuers . . . would be an inexcusable travesty’’). PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 agenda for an October 27, 2015 EMSAC meeting, highlighting the discussion of fees and rebates, and soliciting comments from the public thereon), available at https://www.sec.gov/news/pressrelease/ 2015-216.html. The Commission also published meeting minutes and transcripts of the full EMSAC meetings. Finally, the Commission provided a mechanism for the public to submit comments to the EMSAC for its consideration, and a number of people did submit comments. See https:// www.sec.gov/comments/265-29/265-29.shtml (comment file for File No. 265–29). 137 See, e.g., P&G Letter, at 1; McDermott Letter, at 1; Level Brands Letter, at 1; ACCO Letter, at 1; NorthWestern Letter, at 1–2; Ethan Allen Letter, at 1; Unitil Letter, at 1; Johnson Letter, at 2; Sensient Letter, at 2; Hawaii Letter, at 1; Cott Letter, at 1; Leaf Letter, at 1–2; First Majestic Letter, at 1; SIFCO Letter, at 2; Weingarten Letter, at 1; Ennis Letter, at 2; Trex Letter, at 1; Genesis Letter, at 1; Tredegar Letter, at 1; Energizer Letter, at 1; ProAssurance E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations supporting opt out emphasized the importance of giving issuers the ability to avoid potential costs and uncertainty resulting from the Pilot.138 For example, one commenter believed that the Pilot could ‘‘caus[e] spreads to widen in securities selected for the test groups,’’ such that ‘‘companies conducting a repurchase program or secondary offering would incur higher costs,’’ and the Commission received a number of comment letters from listed issuers specifically referencing that point and echoing the same concerns.139 This commenter further argued that ‘‘the Proposal would also harm the ability of issuers whose securities are subject to access fee caps to compete’’ with issuers not subject to the Pilot’s exchange fee restrictions.140 Many other commenters opposed opt out.141 Some of these commenters dismissed the concerns described above regarding the potential costs on issuers whose stock is included in the Pilot.142 For example, one commenter disagreed with the notion that ‘‘rebates are needed to incentivize market makers to quote tight spreads’’ in the stocks of certain issuers who had submitted comment letters.143 This commenter explained that the ‘‘fifth of a cent rebate is not incentivizing a tight bid-ask spread in these issuers’ stocks,’’ because that rebate represents an insignificant portion of their average spread.144 Another commenter disagreed with the Letter, at 1; Home Depot Letter, at 1; SMP Letter, at 2; Halliburton Letter, at 1; Era Letter, at 2; Natural Grocers Letter, at 2; Newpark Letter, at 2; KnightSwift Letter, at 2; Farmer Mac Letter, at 1; BancorpSouth Letter, at 1–2; Haverty Letter, at 1; Ampco-Pittsburgh Letter, at 2; Anixter Letter, at 2; Avangrid Letter, at 2; NHC Letter, at 1; HP Letter, at 2; Curtiss-Wright Letter, at 2; Murphy Letter, at 1. 138 See, e.g., Cboe Letter I, at 29; ASA Letter, at 4–5. 139 See Addendum to Healthy Markets Letter II, at 11 (attaching an email from NYSE to its listed companies). See also note 137 supra. 140 See NYSE Letter I, at 4. In its letter, the commenter mentioned analysis it performed on NYSE-listed issuer secondary offerings in 2017 that suggested that issuers ‘‘with average spreads under 20 basis points paid an average discount to market price of 2.6%’’ and that ‘‘companies with spreads above 20 basis points had to discount their offerings nearly twice as much, to 4.9%.’’ NYSE Letter I, at 14 n.51. It is unclear, however, whether wider spreads cause larger offering discounts or whether they are simply correlated with them. For example, smaller companies that are less well capitalized may have a wider spread compared to a larger, better capitalized company, which could result in spreads being correlated with a company’s cost of capital (i.e., wider spreads could be a reflection of a company’s relative credit risk and cost of capital, not a driver of it). 141 See, e.g., Joint Asset Managers Letter, at 2; Citi Letter, at 5; AJO Letter, at 2; Lipson Letter, at 1. 142 See supra notes 138–140 and accompanying text. 143 Themis Trading Letter II, at 3. 144 Id. at 2–3. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 suggestion that the Pilot would have a negative impact on issuers, arguing that such position ‘‘directly contradicts the public support by investors for the Pilot.’’ 145 This commenter opined that the ‘‘fundamental forces of supply and demand that affect . . . the relative attractiveness of individual public company stocks will be in no way impaired if . . . exchanges are precluded from paying a rebate, or required to accept a lower access fee.’’ 146 Other commenters asserted that opt out would ‘‘adversely affect the quality of the data and the credibility of the Pilot,’’ which could weaken the findings that could be drawn from it.147 One commenter explained that opt out ‘‘would undercut the ability of economists to draw sharp inferences based upon performance differences between the treated and control stocks’’ and that the ‘‘non-random character of ‘opt outs’ ’’ could ‘‘disproportionately reflect firms that were especially responsive to feedback from the listing exchange or could disproportionately reflect less liquid stocks, which would be especially important for the access fee pilot.’’ 148 One listed issuer, which is a large investment manager, ‘‘welcome[d] the opportunity for [its] stock to be included in the Pilot, with the ultimate goal of improving the overall market to be one where prices can be set by long-term investors without distortion from speculative market participants.’’ 149 This issuer did not ‘‘expect that a reduction or outright removal of rebates will have any significant or harmful effects on the quality of prices displayed in the public lit market, interfere with genuine liquidity and price formation, 145 IEX Letter II, at 3. See also, e.g., Joint Pension Plan Letter, at 2 (stating that the ‘‘asset manager/ asset owner community is heavily supportive of such a pilot,’’ which should ‘‘provide the necessary confidence to all public companies to be included’’); ICI Letter II, at 2 (‘‘market structure is not a primary consideration guiding the investment decisions of long-term investors’’); Joint Asset Managers Letter, at 2; Healthy Markets Letter II, at 2. But cf. NYSE Letter II, at 4 (stating that ‘‘many buy-side institutions’’ supporting the Pilot ‘‘are willing to experiment with real-world public companies and end investors to ‘get the data,’ even if the expected impact of limiting or eliminating rebates will be a deterioration of the public quote’’). 146 IEX Letter II, at 3–4. 147 RBC Letter I, at 6. See also, e.g., LATEC Letter, at 2; Joint Pension Plan Letter, at 2; MFS Letter, at 3; Clearpool Letter, at 8. 148 Spatt Letter, at 3. See also, e.g., Healthy Markets Letter I, at 12; CII Letter, at 4. 149 T. Rowe Price Letter, at 4. The issuer explained that its stock, ‘‘on average, trades about 1.5 million shares daily, with an average displayed size of 200 shares and a spread of nearly $0.07,’’ with ‘‘40% of [its] average daily volume occur[ring] as displayed on exchange volume.’’ Id. at 4–5. PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 5213 or negatively impact [its] stock’s trading volume, spread or displayed size.’’ 150 Finally, two commenters further argued that opt out would be inconsistent with the existing market structure. One of these commenters observed that ‘‘[i]ssuers currently have no say over exchanges’ policies’’ and that ‘‘exchanges that modify their access fees dozens of times a year do not survey issuers or permit them to opt-out of these fee changes or creation of order types.’’ 151 The other commenter opined that opt out ‘‘may set an unfortunate precedent that would allow an issuer to pick and choose among those aspects of the National Market System that it likes while rejecting other aspects that it may find less attractive to it, but [which] are necessary to the smooth functioning of [the] United States public equity markets.’’ 152 After careful consideration, the Commission does not believe that issuers should be permitted to opt out of participation in the Pilot. While the Commission understands issuers’ concerns, allowing issuers to opt out could undermine the representativeness of the Pilot’s treatment groups and potentially bias the Pilot’s results, depending on the number and characteristics of issuers that opt out. In turn, researchers would be less able to rely on the data to perform analyses and draw specific conclusions about the impact of the Pilot, thereby limiting the usefulness of the Pilot’s data to the Commission and future regulatory initiatives.153 Although some commenters believe that issuers may incur potential costs or endure competitive harms depending on which of the Pilot’s treatment groups their stock is in, other commenters have argued that such effects are unlikely to manifest. The Commission does not believe it is appropriate to implement an opt out provision that could frustrate the collection of useful and representative data based solely on concerns expressed by some commenters regarding uncertain harms. It is precisely because of this uncertainty that the Commission believes it is necessary to conduct the Pilot to study these contested issues through an objective empirical review of exchange transaction fees and rebates. For those reasons, the Commission 150 Id. at 5. Markets Letter, at 7. 152 MFS Letter, at 3. 153 See, e.g., Short Sale Position and Transaction Reporting, Study by the Staff of the Division of Economic and Risk Analysis, June 5, 2014, at 66– 67 (discussing selection bias in the context of an ‘‘opt in’’ voluntary pilot design). 151 Better E:\FR\FM\20FER2.SGM 20FER2 5214 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations adopts this aspect of the Pilot as proposed. C. Pilot Design 1. Need for a Pilot As a threshold issue, commenters disagreed about whether the Commission should conduct any kind of pilot study of transaction fees and rebates. One commenter, for example, characterized the proposed Pilot as ‘‘a solution in search of problem’’ and claimed that the Commission ‘‘has provided no evidence that existing fee practices are harming investors or interfering with fair competition.’’ 154 Another commenter believed that the Pilot was unnecessary, but for the opposite reason—namely, that there is ample evidence of the negative effects of exchange rebate pricing models, such that the Commission should instead take immediate action to ban them.155 Most commenters, however, thought a Commission-led pilot was necessary and supported the Commission’s proposal to conduct one.156 These supportive commenters observed that ‘‘market participants have heavily debated the effects that transactionbased fees, particularly access fees, and rebates may have on the equity markets’’ and ‘‘commend[ed] the SEC for advancing this discussion through a time-limited, empirical study.’’ 157 Some of those commenters thought a Commission-led pilot was necessary because competitive pressures among exchanges may serve as a barrier to market-led reforms in this area.158 The Commission agrees with the commenters that stated that the Pilot is necessary because, as reflected in the comments discussed above,159 there is strong disagreement about the impact of exchange fee-and-rebate pricing models but a lack of data to study the issue. The Commission believes it is important to further investigate these impacts.160 2. Pilot Design For each NMS stock that meets the initial criteria to be a Pilot Security, discussed above, the Commission proposed to assign it to one of three Test Groups, with 1,000 NMS stocks each, or the Control Group.161 The composition of each Test Group would remain constant for the duration of the Pilot, except, 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 $1.162 The Commission received a number of comments on the proposed Pilot design, discussed below, focusing mainly on the number of securities included in each Test Group. After consideration of all the comments received and for the reasons discussed below, the Commission is adopting two Test Groups that each contain 730 NMS stocks, functionally combining proposed Test Groups 1 and 2 into a new Test Group 1 with a blended fee cap of $0.0010. Accordingly, for the duration of the Pilot, the following pricing restrictions will apply to Test Groups 1 and 2, while the Control Group will remain subject to the current access fee cap in Rule 610(c): Proposed Adopted 730 NMS stocks. $0.0010 fee cap for removing & providing displayed liquidity. Not adopted. No Rebate Test Group .......... 1,000 NMS stocks .......................................................... $0.0015 fee cap for removing & providing displayed liquidity. 1,000 NMS stocks .......................................................... $0.0005 fee cap for removing & providing displayed liquidity. 1,000 NMS stocks .......................................................... Control Group ........................ Rebates and Linked Pricing Prohibited for removing & providing displayed & undisplayed liquidity (except for specified market maker activity). Rule 610(c) cap applies ................................................. Pilot Securities not in a Test Group ............................... Fee Cap Test Group 1 .......... Fee Cap Test Group 2 .......... 154 Cboe Letter I, at 5. See also, e.g., Virtu Letter, at 1–2; Nasdaq Letter I, at 12–13. But cf. MFA Letter, at 2 (stating that ‘‘regulators should periodically assess market practices and regulations to ensure that U.S. equity markets continue to remain efficient, liquid, fair, resilient and transparent for all market participants’’). 155 See Larry Harris Letter, at 9–10. 156 See, e.g., Decimus Letter, at 4 (stating that the Pilot ‘‘would be valuable in generating concrete information and more preferable to back-of-theenvelope calculations based on questionable assumptions’’); Wellington Letter, at 1 (stating that the Commission could only ‘‘draw[ ] definitive conclusions on the impact of existing pricing models . . . through an actual implementation’’ of the Pilot); Verret Letter I, at 4 (stating that the Commission ‘‘appears to have considered adoption of a mandatory rule to reshape market structure, and determined instead to take the more deliberative and less costly approach of an initial pilot program to generate more data from which it can determine a path forward on market structure reform’’); IAC Recommendation, at 2; MFA Letter, VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 730 NMS stocks (plus appended Canadian interlisted stocks). No change. No change. No change. at 2; ICI Letter I, at 1–2; RBC Letter I, at 2; Joint Asset Managers Letter, at 2; Clark-Joseph Letter, at 1; Babelfish Letter, at 3; State Street Letter, at 2; Themis Trading Letter II, at 3; IEX Letter I, at 2–3. 157 Fidelity Letter, at 2. See also, e.g., Brandes Letter, at 1 (expressing support for the Pilot and the ‘‘Commission’s effort to shed light into a subject of heated debate among market participants’’); Barnard Letter, at 1 (stating that the Pilot was ‘‘important, as historically there are many views on this topic, but a paucity of credible data from which to draw conclusions’’); Angel Letter II, at 1 (stating that ‘‘various commenters have wildly differing perspectives on what will happen under the pilot,’’ which is ‘‘strong evidence as to why the pilot is necessary’’). 158 See, e.g., T. Rowe Price Letter, at 3; Clearpool Letter, at 2. The Commission notes that Nasdaq conducted an independent access fee experiment in 2015, but the limited nature of that experiment makes it difficult to draw conclusions from the data gathered by Nasdaq. See Proposing Release, supra note 2, at 13011–12. See also, e.g., IEX Letter III, PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 at 6 (‘‘Nasdaq’s experiment and its outcomes aren’t a perfect proxy for what is likely to happen in the Transaction Fee Pilot. That experiment was done unilaterally and only in highly-liquid securities.’’); Larry Harris Letter, at 9 (noting that Nasdaq’s ‘‘experimental fee reduction did not occur at all trading venues that traded the subject securities,’’ demonstrating that ‘‘regulatory action is necessary to establish a common pricing standard because market forces alone will not do it’’). 159 See Section II.A.2 for a discussion of these comments. 160 See also Section II.A.2 for a discussion of these impacts. 161 See Proposing Release, supra note 2, at 13019. The Commission notes that the proposed language in Rule 610T(b)(2)(ii)(E) has been modified slightly. As proposed, Rule 610T(b)(2)(ii)(E) was labeled as ‘‘Test Group.’’ As adopted, the label ‘‘Pilot Group’’ is being substituted for the phrase ‘‘Test Group’’ to provide additional clarity. 162 See id. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations 3. No Overlap With Tick Size Pilot While the Commission’s proposed Pilot design took into consideration the possibility that the Pilot could have been adopted before the end of the Tick Size Pilot Program, the Commission also noted that the overlap design would not be necessary if that were not the case.163 A few commenters opined on the potential overlap between the proposed Pilot and the Tick Size Pilot, disagreeing on whether overlap would be appropriate.164 However, because the Tick Size Pilot ended on September 28, 2018, there no longer is any need for the Transaction Fee Pilot to control for potential data distortions that could have otherwise resulted from the simultaneous operation of the two pilot programs. Accordingly, the Commission is not adopting the proposed Tick Size Pilot overlap design. Relatedly, some commenters discussed whether there should be a delay between the end of the Tick Size Pilot and the start of the proposed Transaction Fee Pilot, with commenters disagreeing on that point. For example, one commenter thought a delay would be appropriate to allow markets to normalize before conducting a subsequent pilot 165 while another commenter thought markets would revert to their baseline state extremely quickly after the Tick Size Pilot ends.166 The Tick Size Pilot concluded, but post-pilot data continues to be collected until April 2, 2019. However, the Transaction Fee Pilot is subject to a onemonth implementation period followed by a six-month pre-Pilot Period. Accordingly, the core of the Transaction Fee Pilot will not commence until after the post-pilot period for the Tick Size Pilot ends. By then, the Commission believes that the markets will have had sufficient time to normalize and any overlap between the Transaction Fee Pilot’s pre-Pilot Period and the Tick Size Pilot’s post-pilot period will be minimal. In both cases, the respective pre- and post-pilot periods are collecting benchmark data on the status quo. As such, the overlap between them should not compromise either dataset. Finally, two commenters recommended that the Commission 163 See Proposing Release, supra note 2, at 13019– 13020 n.117, 13020 (describing the proposed composition of the Tick Size Pilot overlap subgroups). In the Proposal, the Commission specifically solicited comment on whether the Pilot should overlap with the Tick Size Pilot. See id. at 13025. 164 Cf., e.g., Clark-Joseph Letter, at 2 (noting that overlap ‘‘certainly would not be a serious impediment’’); SIFMA Letter, at 3 (arguing against an overlap). 165 See Cboe Letter I, at 30. 166 See Healthy Markets Letter I, at 14. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 analyze the Tick Size Pilot data prior to proceeding with the Transaction Fee Pilot.167 While preliminary results from the Tick Size Pilot have been made public, the two pilots are sufficiently dissimilar that the Commission sees no reason for delay. The Tick Size Pilot tested a wider minimum increment (from one cent to five cents) for smallercapitalization stocks, whereas the Transaction Fee Pilot will test a lower rate for the Rule 610(c) fee cap and a prohibition on exchange rebates (which typically are less than one-third of a penny) for stocks of all market capitalizations. Accordingly, findings from the Tick Size Pilot are not relevant to the design of the Transaction Fee Pilot. 4. Stratified Selection of Pilot Securities The Commission proposed to select the stocks to be included in each of the Test Groups and the Control Group through stratified sampling in a manner that permits comparisons between each Test Group and the Control Group.168 One commenter expressed support for the proposed approach to stratification and noted that it was ‘‘fundamental to the ability to undertake causal inference in this setting . . . .’’ 169 In contrast, a number of public company commenters expressed concern that stratified sampling could result in their stocks being placed in a different Test Group from other similar stocks in their ‘‘peer group,’’ which could complicate comparisons of their stock’s performance against peer-group metrics.170 As discussed above, those commenters supported allowing companies to ‘‘opt out’’ of the Pilot, which could impact the stratification.171 Further, as discussed above, some commenters recommended that the Commission select ETPs for the Pilot in a manner that may avoid any potential competitive effects among similar ETPs, either by: (1) Rotating all of the Pilot Securities through the various treatment groups, (2) rotating only ETPs through the various treatment groups, or (3) grouping ETPs with similar underlying holdings into the same treatment group.172 While the Commission understands the concerns of these commenters, as discussed above in Section II.B, allowing issuers to opt out of the Pilot could undermine the representativeness of the Pilot’s treatment groups and bias Cboe Letter I, at 29; Nasdaq Letter I, at 4. Proposing Release, supra note 2, at 13019. 169 See Spatt Letter, at 3. 170 See, e.g., Mastercard Letter, at 2; Avangrid Letter, at 2; Energizer Letter, at 1. 171 See supra Section III.C.4. 172 See supra Section III.C.3.b. 5215 the Pilot’s results. Further, also as discussed above in Section II.B, rotating ETPs would require the Commission to implement a more complex and lengthy design in order to maintain sufficient statistical power, both of which would increase the costs and complexity of the Pilot—a result viewed unfavorably by most commenters. Finally, grouping similar ETPs also could negatively impact the stratification of the different treatment groups, particularly if all of the similar ETPs are similar in volume, price, and market capitalization. In turn, this could reduce the quality and usefulness of Pilot’s results by inhibiting the ability of researchers to compare treatment groups. In order to ensure that the Pilot Securities are selected in a way that permits researchers to investigate causal connections, it is imperative to stratify the Test Groups so that researchers can study the effects of changes in fees and rebates within each Test Group, between Test Groups, and between a Test Group and the Control Group. In permitting this type of analysis, the Pilot should be better able to inform future policy considerations to improve the operation of the national market system to the benefit of investors and issuers alike. Accordingly, the Commission is adopting the stratified sampling construct as proposed. 5. Number of NMS Stocks Included in Each Test Group The Commission proposed to include 1,000 Pilot Securities in each Test Group (i.e., 3,000 total across three Test Groups) with the remainder to be included in the Control Group in order to be representative of the overall population of NMS stocks and provide sufficient statistical power to identify differences between the Test Groups with respect to common stocks and ETPs.173 Several commenters supported including 1,000 stocks in each Test Group, believing that including 1,000 stocks in each Test Group would facilitate analysis of transaction fees and rebates on a broad cross section of different types of NMS stocks and generate statistically significant conclusions.174 Many commenters, however, thought that the Pilot should include fewer 167 See 168 See PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 173 See Proposing Release, supra note 2, at 13019– 20. 174 See Brandes Letter, at 2; Themis Trading Letter I, at 3; Oppenheimer Letter, at 2; Spatt Letter, at 2; IEX Letter I, at 5; Verret Letter I, at 4; AGF Letter, at 2; MFA Letter, at 3. E:\FR\FM\20FER2.SGM 20FER2 5216 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations securities in each Test Group.175 Several of these commenters believed the Pilot could obtain statistically significant data even with fewer stocks in each Test Group.176 Other commenters urged the Commission to reduce the number of securities included in the Test Groups in order to reduce costs associated with the Pilot.177 Several commenters argued that the Pilot was effectively a large scale change to the current equity market structure and that it would be more appropriate for a pilot program to apply to a smaller percentage of the universe of NMS stocks.178 Further to this point, several commenters believed that a large Pilot may be difficult to unwind, with one commenter stating that an immediate return to current transaction fee and rebate dynamics for stocks included in the Test Groups ‘‘could prove to be more disruptive to market participants and overall market quality than the actual implementation of the Pilot.’’ 179 Some commenters also believed the Pilot would negatively impact trading in the stocks placed in certain Test Groups, such as by adversely impacting spreads, and accordingly recommended including fewer stocks so as to limit potential negative consequences.180 Of the commenters that advocated for reducing the number of Pilot Securities in each Test Group, some suggested alternative amounts to be included. Several commenters recommended including 100 stocks in each Test Group.181 A few others suggested that each Test Group include 500 stocks.182 One commenter recommended ‘‘a more tailored Pilot that includes the 225 most heavily traded names, 225 mid-cap stocks, 225 small caps and 225 ETFs would provide 175 See Magma Letter, at 3; FIA Letter, at 4; SIFMA Letter, at 4; Schwab Letter, at 2; Fidelity Letter, at 8–9; Citadel Letter, at 2; State Street Letter, at 3; Citi Letter, at 5; Clearpool Letter, at 7; TD Ameritrade Letter, at 1; STA Letter, at 3–4; STANY Letter, at 3; Nasdaq Letter I, at 10; Cboe Letter I, at 27; T. Rowe Price Letter, at 4; Mastercard Letter, at 2; NorthWestern Letter, at 1; Energizer Letter, at 1; Era Letter, at 1; Knight-Swift Letter, at 2; ASA Letter, at 4–5. 176 See Magma Letter, at 3; Schwab Letter, at 2; Fidelity Letter, at 8–9; Clearpool Letter, at 7; STA Letter, at 3–4; Cboe Letter I, at 27. 177 See SIFMA Letter, at 4; Schwab Letter, at 2; Citadel Letter, at 6; Citi Letter, at 5. 178 See Magma Letter, at 3; FIA Letter, at 4; Citi Letter, at 5; Clearpool Letter, at 7; Nasdaq Letter I, at 10. 179 See Citadel Letter, at 6. See also SIFMA Letter, at 4; Citi Letter, at 5. 180 See STA Letter, at 3; STANY Letter, at 3; State Street Letter, at 3; TD Ameritrade Letter, at 1, 3; Mastercard Letter, at 2. 181 See FIA Letter, at 4; Schwab Letter, at 2; State Street Letter, at 3; STANY Letter, at 3; Era Letter, at 1; Cboe Letter I, at 27. 182 See SIFMA Letter, at 4; Citi Letter, at 5; STA Letter, at 3. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 statistically significant data without burdening a material portion of the market.’’ 183 The Commission has carefully considered the concerns expressed by commenters regarding the size of the Pilot’s Test Groups.184 As previously discussed, the Commission cannot know in advance the full effects of the Pilot, whether they be positive or negative. Indeed, commenters expressed a variety of contradicting viewpoints and estimations about the potential impacts of the Pilot on the execution quality and market quality of NMS stocks that would be included in the Test Groups.185 Given this uncertainty, it is crucial that the Pilot be able to produce results that are capable of facilitating an empirical review of the effect of the prevailing fee structures on the equities markets. To achieve this purpose, the Pilot needs to generate a sufficient number of observations over its one-year duration to obtain sufficient statistical power to identify differences among the Test Groups with respect to common stocks and ETPs, thereby permitting researchers to investigate causal connections using economic analysis capable of finding statistical significance. Statistical power refers to the ability for statistical tests to identify differences across samples when those differences are indeed significant and broadly is derived from the number of observations during a study. In other words, statistical power can be present when observing a limited number of subjects over a long period of time or a large number of subjects over a shorter period of time. Because the Commission desires a shorter duration for the Pilot, it therefore needs to have sufficient observable data points over the shorter pilot duration. Accordingly, if the Pilot does not contain enough securities, it may be incapable of producing statistically sound results and will not allow researchers to analyze differences in securities. With statistical power and a sufficiently large sample size, researchers can conduct analysis of what impact (1) reductions in fees and (2) reductions in or prohibitions on rebates might have, if any, on stocks depending on their trading volume or market capitalization. A pilot design that would not provide this meaningful data about the impact that billions of dollars of exchange fees and rebates may have on the markets and market 183 See 184 See T. Rowe Price Letter, at 4. supra notes 175–183 and accompanying text. 185 See, e.g., supra notes 75–93 and accompanying text. PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 structure, would not achieve the Commission’s goal of conducting a pilot capable of facilitating an objective empirical view to advance that debate. To achieve these aims, using econometric methods designed to allow researchers to detect a 10% change with a standard confidence level of 95%, the Commission has determined that 730 securities in each Test Group are needed to enable the Pilot to produce statistically meaningful results capable of informing the Commission’s future policymaking efforts. The Commission believes that a 10% change in behavior represents an economically meaningful change that will facilitate analysis of the Pilot’s results, and therefore is an appropriate standard for the Pilot.186 The determination to include 730 securities in each Test Group accounted for the need to obtain statistically significant results among stocks of various liquidity profiles as well as ETPs. While the number of NMS stocks that will be included in each Test Group will be larger than what was recommended by some commenters, the Commission believes that a smaller number of stocks may not have sufficient statistical power given the Pilot’s proposed duration.187 Furthermore, in response to comments questioning why the Pilot included more securities than did the Tick Size Pilot, the Commission notes that the Tick Size Pilot featured 400 corporate stocks for each of its Test Groups.188 Importantly, the Tick Size Pilot did not contain ETPs or large-cap stocks. In comparison, the Transaction Fee Pilot will contain ETPs and largecap stocks. Accordingly, in light of the significantly higher number of securities eligible for inclusion, the Transaction Fee Pilot needs to include considerably more Pilot Securities than did the Tick Size Pilot, while continuing to achieve the same statistical power for each of those groups of securities. Moreover, while several commenters either implicitly or explicitly referenced the EMSAC recommendation to include 100 stocks in each Test Group, EMSAC’s recommendation differs substantially from the Commission’s proposal. Notably, the EMSAC recommendation was limited to common stocks with a 186 A confidence level of 95% is a standard accepted confidence level in statistical analyses. See, e.g., William H. Greene, Econometric Analysis 1033 (Appendix C.6) (6th ed. 2007) (discussing standard confidence levels in academic research). 187 See also note 695 infra. 188 See, e.g., Citadel Letter, at 6; TD Ameritrade Letter, at 2; Cboe Letter I, at 27. See also Securities Exchange Act Release No. 74892 (May 6, 2015), 80 FR 27514, 27517 (May 13, 2015) (File No. 4–657) (order approving the National Market System Plan to Implement a Tick Size Pilot Program). E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations market capitalization above $3 billion and did not include ETPs, mid- and small-cap stocks, or other types of NMS stocks. In order for the Pilot to permit a broader empirical review of the impact of transaction fees and rebates on order routing, execution quality, and market quality, it is critical that the sample size be representative of the population of NMS stocks for which exchange transaction fees and rebates are economically meaningful. The Pilot must contain enough securities to achieve the statistical power necessary to permit closer analysis of the Pilot’s results in order to identify differences in order routing behavior, market quality, and execution quality among subgroups of NMS stocks (e.g., ETPs, or tiers of common stock). 6. Reduction to the Pilot Size To respond to commenters’ concerns with the size of the Pilot, including a recommendation from the SEC’s Investor Advisory Committee, the Commission has determined to eliminate one Test Group and reduce the number of stocks in each Test Group to 730. In order to materially reduce the size of the Pilot without sacrificing statistical power, the Commission has determined to: (1) Only place Pilot Securities in a Test Group if, at the time of selection, they trade 30,000 shares or more per day on average and (2) eliminate a Test Group. With respect to securities that trade fewer than 30,000 shares per day, assuming, at an extreme, that such security trades 100% of its volume on a maker-taker exchange paying a $0.0030 rebate, then it would generate $100 in rebates per day. In addition, for thinly-traded stocks with wider spreads, the rebate would be less impactful as it would represent a smaller percentage of the quoted spread. This amount of rebates would be economically insignificant and would be unlikely to impact order routing behaviors of broker-dealers. In addition, this level of trade volume makes it unlikely to produce sufficient statistical power to analyze the securities in isolation because the variability in their quoting and trading characteristics renders it unlikely the Pilot would generate a sufficient number of observations given the Pilot’s proposed duration. In addition, for commenters that believe that thinly-traded stocks need rebates to narrow their quoted spreads, excluding these securities from the Pilot will allow exchanges to continue to apply their current fee schedules to them, which will provide another point of reference to analyze when comparing these VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 securities to those with slightly higher trading volumes. Finally, the Commission believes that eliminating one Test Group and functionally combining proposed Test Group 1 and Test Group 2 into a new Test Group with a $0.0010 cap will result in decreasing the number of NMS stocks included in a Test Group in the Pilot by one-third, which is integral in reducing the overall size of the Pilot by more than one-half. The Commission believes this material reduction directly responds to commenters’ concerns, while still providing the Pilot with a meaningful group in which to test a reduced fee cap and a prohibition on rebates and Linked Pricing. Accordingly, the Commission believes that the Pilot’s design of 730 NMS stocks per Test Group strikes an appropriate balance by reducing the number of stocks in each Test Group and thus mitigating the concerns of commenters about potential detrimental impacts that could be caused by the proposed larger size of the Pilot,189 without undermining the ability to obtain useful data to study the impact of changes to transaction fees and rebates on order routing behavior, execution quality, and market quality for a broad spectrum of stocks. It also is large enough to accommodate drop offs among Pilot Securities (e.g., due to mergers, bankruptcies, or stocks closing below $1).190 7. Fee Cap Test Groups The Commission proposed that 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.191 The level proposed for Test Group 2 was $0.0005 per share.192 After careful consideration of the comments received, which are discussed below, the Commission is eliminating Test Group 2 and adopting a revised Test Group 1 with a $0.0010 cap. a. Fee Cap Level Commenters disagreed about the appropriateness or justification for the proposed fee cap levels.193 For example, 189 See supra notes 175–180 and accompanying text. 190 See Proposing Release, supra note 2, at n. 102. Proposed Rule 610T(a)(1). See also Proposing Release, supra note 2, at 13021–22. 192 See Proposed Rule 610T(a)(2). See also Proposing Release, supra note 2, at 13022. 193 See Cboe Letter I, at 16 (stating that the Proposing Release ‘‘does nothing to justify how the 191 See PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 5217 one commenter stated that ‘‘exchanges currently compete on fees by offering a range of access fees and rebates within the confines of the current $0.0030 access fee cap’’ but the fee caps in Test Groups 1 and 2 ‘‘will reduce the exchanges’ ability to compete on fees by 50% in Test Group 1’’ and ‘‘83% in Test Group 2’’ which could be ‘‘to the detriment of investors and the public interest.’’ 194 In contrast, regarding proposed Test Group 1, another commenter stated that ‘‘[a]t 15 mils, there is still room for significant fee differentiation and rebates remain sizeable.’’ 195 With respect to Test Group 2, one commenter stated that ‘‘[i]f the ultimate intent of the proposal is to determine whether or not reducing access fees will have an effect on how brokers route their customers’ orders, then we fully support the notion of Test Group 2 to see if the incentive to avoid access fees is eliminated with a 5 cents per 100 share cap.’’ 196 Another commenter further stated that ‘‘to the extent that rebates have been traditionally funded by exchanges by the fees collected,’’ then Test Group 2 ‘‘may lead to rebate reductions’’ and obtaining data on this point is ‘‘part of the reason why a study is needed.’’ 197 Finally, the Investor Advisory Committee recommended that the Commission structure the Pilot’s Test Groups ‘‘as simply as possible,’’ and was not persuaded that, in addition to having the no-rebate Test Group, having two additional Test Groups with separate fee caps ‘‘will generate enough additional information to justify the additional effort.’’ 198 Accordingly, the Investor Advisory Committee recommended that the Commission consider having, in addition to the norebate Test Group, only one Test Group with a fee cap and suggested a cap of $0.0010.199 The Commission appreciates the recommendation of the Investor Advisory Committee and agrees with it. As noted above and further discussed below, eliminating Test Group 2 will decrease the size of the Pilot by one$0.0015 and $0.0005 fee cap levels are appropriate’’ and that lowering the current fee cap ‘‘without meaningful discussion or justification is concerning and inappropriate’’); Morgan Stanley Letter, at 1. But cf. Healthy Markets Letter I, at 15–16 (stating that the fee caps for Test Groups 1 and 2 ‘‘appear to be well-justified’’). 194 See Cboe Letter I, at 16–17. 195 See Credit Suisse Commentary, at 3. 196 See T. Rowe Price Letter, at 2. 197 See Healthy Markets Letter I, at 15–16. 198 IAC Recommendation, at 1. 199 See id. For other commenters suggesting a $0.0010 fee cap, see Goldman Sachs Letter and NYSE Letter III. E:\FR\FM\20FER2.SGM 20FER2 5218 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations third. New Test Group 1 will have a cap of $0.0010, which adopts the Investor Advisory Committee’s recommendation and represents a blended average of the two fee caps the Commission originally proposed. The Commission believes that new Test Group 1 retains the equities exchanges’ ability to compete through differing fees and rebates, as a fee cap of $0.0010 provides exchanges with an opportunity to utilize various fee and rebate structures to compete for order flow. As some commenters noted, the current access fee cap was set thirteen years ago and may represent an outsized portion of transaction costs in light of the technological efficiencies achieved by the equities markets in the last decade.200 As revised, new Test Group 1 will facilitate an analysis of the extent to which exchanges reduce rebates from their current levels as a result of a materially reduced cap on the fees used to subsidize those rebates, and the impact of a reduced fee and rebate level on order routing behavior, execution quality, and market quality. In addition, by materially reducing the fee cap, the Commission believes that new Test Group 1 will provide useful data on the extent to which current exchange fee levels (bounded by the current access fee cap) serve as a disincentive to take liquidity on an exchange. Obtaining useful information to better understand the potential impact of a significantly reduced access fee cap will ultimately be beneficial to investors and the public interest, as it may help illuminate the extent to which the current fees and rebates effect the market and the extent to which those effects have a detrimental impact on investor transaction costs. b. Applicability to Depth-of-Book and Non-Displayed Liquidity As proposed, Test Groups 1 and 2 were designed to isolate and test a reduction in the Rule 610(c) fee cap, with all else remaining unchanged. In the Proposing Release, the Commission asked whether commenters thought the fee caps in Test Groups 1 and 2 also should apply to depth-of-book and undisplayed liquidity.201 One commenter recommended that it should.202 In the Proposing Release, the Commission stated that it preliminarily believed it was unnecessary for the fee cap Test Groups to apply to depth-of200 See Citi Letter, at 1–2; Goldman Sachs Letter, at 2. 201 See 202 See Proposing Release, supra note 2, at 13025. Clearpool Letter, at 3 n.6. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 book and undisplayed liquidity because it would be highly unlikely for an exchange to begin charging more to access non-displayed interest or depthof-book quotes (compared to displayed interest), as it would lead to uncertainty for market participants that remove liquidity because they typically would not be able to know in advance or control with absolute certainty whether they interact with non-displayed interest or depth-of-book quotes.203 The Commission continues to believe it would be unlikely that either makertaker or taker-maker exchanges would begin charging differing fees in such a manner.204 Furthermore, the Commission notes that the Rule 610(c) access fee cap does not currently apply to non-displayed interest or depth-ofbook quotes. Introducing a new variable into the fee cap Test Groups would make it more difficult to isolate the effects of a particular change and uncover causal connections. Accordingly, for the reasons noted above and discussed in the Proposing Release, the Commission is not adopting this suggestion.205 c. Prohibiting Rebates and Linked Pricing in Test Groups 1 and 2 In Test Groups 1 and 2 the Commission did not propose to cap the level of rebates, prohibit rebates, or prohibit Linked Pricing, the latter two of which it proposed to do in the no-rebate Test Group as discussed below.206 In response, several commenters advocated for applying restrictions on rebates to the fee cap Test Groups, primarily in reaction to the potential for exchanges to subsidize their rebates at or near current levels from sources other than transaction fee revenue.207 For example, one commenter stated that ‘‘[t]here is already ample evidence to suggest that some exchanges currently use revenues from other sources to subsidize their order routing incentives, including rebates,’’ such that the proposed fee caps may have no impact on the level of rebates paid for Pilot Securities in the 203 See Proposing Release, supra note 2, at 13023 n.136–37 and accompanying text. 204 In the Proposing Release, the Commission acknowledged that there were three exchanges that charged different fees for displayed and nondisplayed liquidity. See id. Currently, there are two, IEX and NYSE American. The Commission notes that the differences in fees are minimal and because a small portion of exchanges have chosen to adopt this fee structure to date, it is unlikely a significant portion will choose to do so. 205 See Proposing Release, supra note 2, at 13022– 23. 206 See Section II.C.6.d. infra. See also Proposing Release, supra note 2, at 13021–24. 207 See CFA Letter, at 6; Clearpool Letter, at 2– 3; Healthy Markets Letter I at 27–29. PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 fee cap Test Groups.208 This commenter therefore suggested that the fee cap Test Groups include two subgroups, one as proposed, and a second that would prohibit rebates and Linked Pricing (and also apply to depth-of-book and nondisplayed liquidity).209 The Commission has carefully considered these comments and has determined not to adopt these additional restrictions. While adding more variables or more Test Groups to the Pilot could produce informative results, it would directly complicate the Pilot’s design thus raising the Pilot’s costs and burdens. For example, if the Commission were to add subgroups to new Test Group 1 to prohibit rebates, it likely would have to expand the number of stocks included in the treatment groups or expand the duration of the Pilot in order to achieve statistical power.210 It also would further complicate exchange fee schedules and could lead to more variability in exchange fees if exchanges customized their pricing differently for each Test Group and subgroup. Rather, the Pilot’s design represents a comparatively simple construct that is easier to implement and manage and yet should still facilitate the Commission’s ability to analyze the impact of fees and rebates on order routing behavior, execution quality, and market quality. Achieving these goals, while minimizing complexity and burdens, will also assist the Commission as it considers potential future policy initiatives informed by the results of the Pilot. In addition, the fee cap Test Groups were specifically selected to provide the exchanges with the continued ability to offer rebates, should they so choose, albeit at lower levels, without impacting an exchange’s ability to maintain its net profit on a per transaction basis. The Commission declines to prohibit rebates in new Test Group 1 as doing so would go beyond the construct and application of the Rule 610(c) fee cap by introducing additional variables, and thus would distinctly alter the status quo in that Test Group, thereby complicating the analysis in that treatment group. Lastly, the Commission continues to believe that it is unlikely that exchanges will offer rebates at their current levels for Pilot Securities in new Test Group 1 because exchanges will need to charge lower offsetting transaction fees in that group in order to maintain a profitable 208 See Healthy Markets Letter I, at 28. id. at 16. 210 See supra Section II.C.5 discussing the need to generate a sufficient number of observations over the Pilot’s duration to permit researchers to investigate causal connections using economic analysis capable of finding statistical significance. 209 See E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations pricing model. However, the Commission also recognizes, as did commenters, that it is possible that the exchanges may choose to subsidize rebates in Test Group 1 from other sources of revenue, which could result in rebates exceeding the fee cap in that group. Whether and to what extent that would occur in practice would be an important result in new Test Group 1, and so the Commission believes the Pilot should be structured so as not to preclude that possible result. The Commission will closely monitor the fees charged by the exchanges for nontransaction services during the Pilot and will consider the Pilot’s impact on such fees. d. No-Rebate Test Group The Commission proposed that for Pilot Securities in Test Group 3, equities exchanges generally would be prohibited from offering rebates, either for removing or posting liquidity, and from offering Linked Pricing, which, as discussed further below, is defined as a discount or incentive on transaction fee pricing applicable to removing (or providing) liquidity that is linked to providing (or removing) liquidity.211 In addition, Test Group 3 would be unique in that its restrictions would apply not only to displayed top-of-book 212 liquidity, but also would apply to depth-of-book 213 and undisplayed liquidity.214 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. After careful consideration of the comments received on Test Group 3, discussed below, the Commission is adopting Rule 610T(a)(3) as proposed, though it is being renamed as ‘‘Test Group 2’’ since the Commission has reduced the number of Test Groups from three to two. 211 See Proposed Rule 610T(a)(3); Proposing Release, supra note 2, at 13022–24. 212 ‘‘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’’). 213 ‘‘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’’). 214 ‘‘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’’). VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 e. Prohibiting Rebates While there was significant disagreement among commenters on this aspect of the Pilot, most commenters supported a ‘‘no rebate’’ group as they believed it was critical to fully examine the effect that transaction fees and rebates have on order routing behavior, execution quality, and market quality.215 In contrast, several commenters opposed prohibiting equities exchanges from paying rebates. Specifically, three of the four exchange commenters asserted that it would inhibit the ability of exchanges to compete with offexchange trading venues.216 In addition, these three commenters, together with other commenters, expressed concerns that prohibiting exchanges from paying rebates to liquidity providers would widen the quoted bid-ask spread on exchanges, which could raise costs on investors.217 Several of these commenters believed that eliminating rebates for ‘‘less-liquid’’ or ‘‘small and medium sized companies’’ would disproportionately impact the quoted spreads for such stocks as they believed that rebates are a more significant incentive to provide liquidity for less actively traded securities.218 Other commenters also expressed concerns that spreads would widen for ETPs, specifically less liquid ETPs, if rebates were prohibited or significantly reduced.219 The Commission is aware of the potential for adversely impacting 215 See, e.g., Joint Asset Managers Letter, at 1; Clark-Joseph Letter, at 2; Brandes Letter, at 1; CII Letter, at 3; Themis Trading Letter I, at 3; AJO Letter, at 3; OMERS Letter, at 2; Copeland Letter, at 2; ICI Letter I, at 3; Nuveen Letter, at 2; SIFMA Letter, at 3–4; Better Markets Letter, at 2, 5; RBC Letter I, at 3; Vanguard Letter, at 2–3; Fidelity Letter, at 9; Invesco Letter, at 2; CFA Letter, at 4; MFS Letter, at 2; Wellington Letter, at 2; Joint Pension Plan Letter, at 2; Citi Letter, at 2; Oppenheimer Letter, at 2; Clearpool Letter, at 2; Spatt Letter, at 2; Capital Group Letter, at 3; Healthy Markets Letter I, at 17; IEX Letter I, at 5; Verret Letter I, at 4; Norges Letter, at 2; AGF Letter, at 1; Decimus Letter, at 3; JPMorgan Letter, at 3. 216 See Cboe Letter I, at 7, 15–16; NYSE Letter I, at 3–6; Nasdaq Letter I, at 7–8. See also, e.g., Mastercard Letter, at 1–2; Capital Group Letter, at 3; Magma Letter, at 2; FIA Letter, at 4. 217 See, e.g., Cboe Letter I, at 7; Nasdaq Letter I, at 9; NYSE Letter I, at 6; Magma Letter, at 2; State Street Letter, at 3; Morgan Stanley Letter, at 4; Cboe Letter II, at 4–7. See also Nasdaq Letter III, at Exhibit A (providing graphs using data from September 2018 on average quoted spread across exchanges in S&P 500 stocks and time at the best quote across those stocks). But cf. Larry Harris Letter, at 6–9 (acknowledging that ‘‘quoted spreads are narrower under maker-taker pricing,’’ but opining that ‘‘the narrower quoted spreads do not benefit the public’’). 218 See, e.g., Nasdaq Letter I, at 9; NYSE Letter II, at 11; RBC Letter I, at 5; Nasdaq Letter III. 219 See, e.g., Virtu Letter, at 7; Schwab Letter, at 3; State Street Letter, at 2. PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 5219 smaller capitalization securities, however, the Commission does not agree with the commenters that believe that the Pilot necessarily will result in such harm, or if there are adverse effects in the trading of all or some portion of smaller capitalization securities, that the net effect across securities will be negative. Rather, the Commission agrees with the many commenters who believed that it is unclear what the ultimate net impact of a no-rebate Test Group will be on quoted spreads and trading costs for NMS stocks of different market capitalizations and trading characteristics.220 The purpose of the Pilot is to generate results that can offer data-driven insight on these questions as a basis for possible future policy making in this area. As discussed elsewhere, the revised Pilot has excluded securities that trade fewer than 30,000 shares per day, as they are less likely to provide actionable data. This lack of empirical clarity is reflected in the divergent views of commenters who offered conflicting predictions of the outcome of a norebate Test Group. For example, one commenter questioned whether rebates were necessary to attract displayed liquidity, opining that ‘‘[p]ublic data shows that inverted and flat-fee exchanges often have quotes on both sides of the NBBO, which shows that market participants are willing to pay these exchanges to post quotes at the NBBO based on their intrinsic desire to trade and not just in response to an exchange rebate’’ 221 (emphasis in original). In response, one exchange commenter suggested that Cboe EDGA Exchange, which does not pay rebates, has wider spreads for displayed liquidity as compared to Cboe EDGX Exchange, which does pay rebates for posting liquidity.222 A different commenter did not ‘‘anticipate a material widening for the most liquid names (where rebates aren’t necessary to incentivize liquidity providers) or the most illiquid names (where rebates aren’t sizable enough to incentivize liquidity providers),’’ and instead anticipated ‘‘a likely outcome of increased spreads for the middle tier of 220 See, e.g., Decimus Letter, at 5 (observing that ‘‘claims on the existence of unambiguous harm to liquidity appear to be exaggerated and driven by preconceived notions’’). See also Section IV infra (discussing the uncertainty of the Pilot’s outcomes). 221 IEX Letter II, at 7. 222 See NYSE Letter II, at 2. One commenter questioned NYSE’s analysis in this regard, noting that in general EDGA’s volume is limited to ‘‘the most liquid names.’’ This commenter stated that NYSE ‘‘distorts the real likely impact of the [P]ilot’’ by including spreads on less liquid securities. See Mulson Letter II, at 2. E:\FR\FM\20FER2.SGM 20FER2 5220 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations securities, where rebates have perhaps kept spreads artificially narrow.’’ 223 Another commenter believed that quoted prices are ‘‘almost always set by natural investors’’ and therefore, ‘‘[r]emoving rebates will not disrupt the desire of natural investors to post liquidity and tighten spreads.’’ 224 In response, one commenter was ‘‘skeptical’’ about this and stated that ‘‘it is not realistic for the buy-side to be continuously active on both sides of the market across all stocks impacted by the Transaction Fee Pilot.’’ 225 That said, another commenter, which also is a listed issuer, stated that it did not ‘‘expect that a reduction or outright removal of rebates will have any significant or harmful effects on the quality of prices displayed in the public lit market, interfere with genuine liquidity and price formation, or negatively impact [its] stock’s trading volume, spread or displayed size.’’ 226 The Commission believes that the significant disagreement among commenters on the potential impacts of prohibiting rebates demonstrates the need to include a no-rebate bucket in the Pilot. For example, it is unclear what effect—if any—the payment of a rebate has on a stock that trades over 10 million shares per day with an average natural quoted spread width constrained by the minimum trading increment of $0.01. Likewise, it is unclear what effect—if any—the payment of a rebate has on a stock that trades less than 100,000 shares per day with an average quoted spread of $0.10 or more. In either case, the absence of rebates may have little or no effect on quotes or competition for natural order flow in such securities. Data is needed to empirically evaluate commenters’ diverging views of the effect of rebates. The Pilot is designed to produce this and other data. By prohibiting rebates in one Test Group the Pilot should produce results that facilitate a direct study of the effect of rebates, including on fees, order routing, execution quality, and market quality.227 The Commission believes that the no-rebate Test Group will provide useful information on trading in the absence of rebates that will facilitate a data-driven approach to better understand the role and effect of rebates in our current market structure. The results generated by this Test Group will 223 Citi Letter, at 3–4. See also Credit Suisse Commentary, at 3. 224 See Mulson Letter I, at 1. See also IEX Letter II, at 6. 225 NYSE Letter II, at 11. 226 See T. Rowe Price Letter, at 5. 227 See Proposing Release, supra note 2, at 13022– 23. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 allow researchers to study the relationship between rebates and quoted spreads for stocks of varying liquidity profiles and market capitalizations. It also will allow market participants to directly test with their own order flow whether, in the absence of rebates in the most actively traded stocks, they are better able to compete for queue priority and thereby capture the quoted spread when posting liquidity.228 Therefore, the Commission continues to believe that the Pilot will be substantially more informative with a no-rebate bucket and the value of generating that information to inform the Commission’s consideration of the effect of exchange transaction fee models justifies proceeding with the Pilot to better inform both sides of the rebate debate with data to test their hypotheses. In summary, the Commission has carefully considered commenters’ suggested alternatives and whether to include the no-rebate feature in the Pilot, and in light of the important regulatory purpose the Pilot is designed to achieve, the Commission has determined that, for the reasons discussed throughout, it is important to have a Test Group that specifically focuses on the removal of rebates and the corresponding impact on conflicts of interest, execution quality, and market quality. Finally, one commenter asserted that banning rebates ‘‘presents [a] misapplication of Rule 610(c)’’ because the Commission has never before banned rebates.229 While neither Rule 610(c), nor any other Commission rule, currently prohibits a national securities exchange from paying a rebate to provide or remove liquidity, the Commission does not believe that the no-rebate Test Group misapplies Rule 610(c), or any other rule. The no-rebate Test Group is not based on or related to Rule 610(c). Rule 610(c) caps fees for removing a protected quotation, whereas the no-rebate Test Group does not further limit fees and instead prohibits rebates, among other things. Indeed, the Rule 610(c) fee cap continues to apply—unchanged and in its entirety—to the no-rebate Test Group. The data generated by the Pilot will help empirically assess, in light of changing market conditions, whether the existing transaction-based fee and rebate structure continues to further the 228 See, e.g., T. Rowe Price Letter, at 2; Brandes Letter, at 1–2; Babelfish Letter, at 2. 229 See Cboe Letter I, at 12–13. See also Section II.G (responding to comments regarding the Commission’s legal authority to conduct the Pilot). PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 statutory goals.230 Importantly, while exchanges would retain the ability to charge transaction fees as high as the current $0.0030 cap in the no-rebate Test Group, they would no longer need to charge transaction fees at levels priced to offset the rebates they formerly paid. Accordingly, the no-rebate Test Group is intended to test, within the current Regulation NMS regulatory structure, natural equilibrium pricing for transaction fees. f. Application to Depth-of-Book and Non-Displayed Liquidity Several commenters supported applying the prohibition on rebates in the no-rebate Test Group to depth-ofbook and non-displayed liquidity as they believed it would avoid the risk that the Pilot’s results could be subject to distortions if exchanges continue to offer rebates for depth-of-book and nondisplayed liquidity.231 In contrast, two exchange commenters opposed this aspect of the proposal. One characterized this aspect of the proposal as an ‘‘unjustified pricing restriction[ ]’’ that was part of a ‘‘new regulatory scheme . . . .’’ 232 The other argued that ‘‘[t]he Proposal lacks internal coherence’’ in that it excludes ATSs ‘‘because they do not have protected quotes, but then includ[es] unlit exchange orders that also are unprotected.’’ 233 For the reasons stated in the Proposing Release, the Commission continues to believe that allowing exchanges to continue to offer rebates in the no-rebate Test Group for depth-ofbook and non-displayed orders could substantially distort the Pilot results.234 The no-rebate Test Group is designed to test the absence of exchange transaction rebates. It would weaken the Pilot’s results to prohibit rebates on displayed orders but allow them on non-displayed orders, as the Pilot would not be able to collect data on what would happen in the absence of rebates. Only by prohibiting the payment of all rebates in one Test Group will the Commission be able to gather data on a pure ‘‘no rebate’’ environment, thereby facilitating a direct observation of the impact of rebates on order routing behavior, execution quality, and market quality 230 For example, if take fees are set at levels to subsidize maker rebates, and if those rebates have little or no impact on quoted spreads of certain NMS stocks, then the take fees on trades in those stocks may constitute a tax on takers of liquidity without a corresponding benefit to the market. 231 See, e.g., Clark-Joseph Letter, at 2; Clearpool Letter, at 3 n.6; Healthy Markets Letter I, at 18; IEX Letter I, at 7. 232 NYSE Letter I, at 12. 233 Nasdaq Letter I, at 6. 234 See Proposing Release, supra note 2, at 13023. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations when compared to the other Test Group and Control Group. As noted above, the Commission received a significant number of comments in support of directly studying the effects of prohibiting rebates.235 In order to avoid the potential distortion from a too-narrowlytailored Test Group that focuses only on one type of rebate but ignores another, the Commission believes that prohibiting rebates on all exchange volume—including depth-of-book and non-displayed liquidity—is necessary to generate the most useful Pilot results on the effect of exchange transaction rebates broadly. In addition, the Commission believes that the no-rebate Test Group’s application to depth-of-book and nondisplayed orders is consistent with the Commission’s decision to exclude ATSs, which do not have protected quotes.236 As discussed above, ATSs are excluded from the Pilot based on a number of reasons, including the materially different treatment of exchange fees under the current federal securities laws and their lack of a protected quotation. With respect to the no-rebate Test Group, it would be incoherent for the Commission to purport to test a prohibition on exchange transaction-based rebates but do so only for some rebates (i.e., on displayed interest) while ignoring the potential for exchanges to pay rebates on non-displayed liquidity and depthof-book interest.237 The possibility that an exchange could offer rebates for nondisplayed and depth-of-book quotes, while eliminating them on displayed interest, could present a loophole with the potential to undermine the design of the no-rebate Test Group and distort the Pilot results for the no-rebate Test Group, rendering the results of the Pilot’s ‘‘no-rebate’’ Test Group incapable of speaking to the impact of rebates. g. Maintaining Rule 610(c) Access Fee Cap Two commenters recommended that, unlike Rule 610(c), the no-rebate Test Group go beyond Rule 610(c) to also prohibit exchanges from charging fees in excess of $0.0030 to provide displayed liquidity.238 As noted in the Proposing Release, the no-rebate Test Group is designed specifically to test, within the 235 See supra note 215. supra note 233. 237 Price-time priority (where orders are prioritized for execution based on ranking by price and, when two orders are at the same price, by time of entry), generally does provide the ability for an incoming order to bypass non-displayed liquidity. 238 See Healthy Markets Letter I, at 18; CFA Letter, at 6–7. 236 Cf. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 current regulatory structure, natural equilibrium pricing for transaction fees in an environment where exchange transaction-based rebates are prohibited.239 While this would theoretically allow an exchange to charge fees in excess of $0.0030 to provide liquidity, the Commission notes that several exchanges stated that one of the perceived benefits in providing rebates to liquidity providers is that it facilitates narrower spreads and therefore believes it is unlikely exchanges would charge such higher fees during the Pilot.240 One commenter expressed concerns that the no-rebate Test Group would ‘‘provide exchanges with the flexibility to propose a variety of new fee structures for liquidity-taking orders,’’ which could create new conflicts for brokers routing customer orders.241 Accordingly, this commenter believed that the no-rebate Test Group should instead impose a fee cap of $0.0002, where the expectation would be that rebates would be lowered to a de minimis amount and the Pilot would be more symmetrical and thereby more effective in analyzing broker order routing practices.242 The Commission continues to believe that in light of the current debate surrounding the potential conflict of interest posed by the payment of rebates and potential effects they may have on the markets, including the many comments received in response to the Proposal, the Pilot will be substantially more informative with a no-rebate bucket than a bucket that dramatically lowers the fee cap assuming that rebates would follow. While reducing the fee cap to $0.0002 would reduce the likelihood that an exchange would offer rebates at current levels (assuming the exchange desired to fund transaction-based rebates only through transaction-based fees), exchanges would retain the ability to pay rebates and could subsidize them from other sources of revenue leading to rebates that greatly exceed $0.0002. In contrast, only a complete prohibition on rebates will permit researchers to observe directly the impact of rebates on order routing behavior, execution quality, and market quality, and compare this Test Group to the Control Group and the other Test Group where rebates can continue to be offered. Further, imposing a fee cap of $0.0002 instead of prohibiting rebates would not allow Test Group 2 to test, within the 239 See 240 See Proposing Release, supra note 2, at 13023. supra notes 217–218 and accompanying text. 241 See 242 See PO 00000 Citadel Letter, at 5. id. Frm 00021 Fmt 4701 Sfmt 4700 5221 current Regulation NMS regulatory structure, natural equilibrium pricing for transaction fees, particularly if the cap is below where the natural equilibrium price would otherwise be found. Two commenters expressed concern that because exchanges can continue to charge access fees of up to $0.0030 per share in the no-rebate Test Group, they may fail to engage in competition on fees.243 In contrast, another commenter believed that, in the no-rebate Test Group, ‘‘the fee for removing liquidity could still move closer to zero in order for exchanges to incentivize takers in the absence of rebates.’’ 244 The Commission believes that observing price competition in the absence of any distortive effects caused by rebates is an important aspect of the Pilot. Accordingly, the no-rebate Test Group is intended to test, within our current regulatory structure, whether competitive market forces are sufficient to produce natural equilibrium pricing for transaction fees in the absence of rebates. h. Prohibiting Linked Pricing In connection with prohibiting rebates, the no-rebate Test Group also would prohibit Linked Pricing, such that 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.245 Some commenters that addressed the prohibition on Linked Pricing were supportive of the proposal and generally believed that the prohibition would preserve the integrity of the Pilot and facilitate an environment where exchanges are able to set transaction fees at a natural equilibrium level.246 In contrast, two exchange commenters opposed the prohibition.247 Specifically, one commenter characterized this aspect of the proposal, in conjunction with the prohibition on rebates, as an ‘‘unjustified pricing restriction’’ that is ‘‘unrelated to Regulation NMS’s Access 243 See Fidelity Letter, at 9; Citadel Letter, at 5. Suisse Commentary, at 4. 245 See Proposing Release, supra note 2, at 13023. The Commission notes that most exchanges also utilize tiering in their pricing models in which they offer lower fees or larger credits in return for additional volume. See, e.g., Spatt Letter, at 4; RBC Letter II, at 4. 246 See, e.g., Capital Group Letter, at 3; IEX Letter I, at 7. 247 See NYSE Letter I, at 12; Cboe Letter I, at 10. 244 Credit E:\FR\FM\20FER2.SGM 20FER2 5222 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations Fee Cap.’’ 248 As discussed above, the no-rebate Test Group, including the Linked Pricing prohibition, is not based exclusively on the Rule 610(c) fee cap. The Commission continues to believe that prohibiting Linked Pricing supports the objective of the no-rebate Test Group, which is to gather data on the impact of creating an environment where fee levels are not potentially distorted by the rebates they subsidize and rebates do not influence routing, particularly for customer orders.249 In the absence of a Linked Pricing prohibition, exchanges could use make (take) volume to subsidize take (make) activity, which could perpetuate the cross-subsidization of fees. For example, if an exchange adopts Linked Pricing for the no-rebate Test Group securities, it might offer a discounted transaction fee to remove liquidity only to those market participants that post a certain volume on the exchange. Perpetuating this potential distortion could cloud the Pilot results for the no-rebate Test Group if the Linked Pricing incentive interferes with the Pilot’s ability to isolate and analyze the impacts on fees and routing that the no-rebate Test Group is designed to study. Two commenters recommended that the Commission also prohibit an exchange from offering any inducement, including discounts on non-transaction fees, such as those for market data, colocation, or connectivity ports, which are linked to trading volumes in the norebate Test Group.250 The Commission is not expanding the application of the Linked Pricing prohibition in the manner suggested by these commenters. The Pilot, and the no-rebate Test Group specifically, is designed to test the extent to which transaction fees and rebates create conflicts of interest that influence order routing or introduce distortions that impede execution quality and market quality. The Pilot is not designed to eliminate or control for all potential inducements to transact on a particular market and the Commission believes that expanding the Pilot to a wider array of variables could inhibit the Pilot’s ability to isolate the impacts of exchange transaction-based rebates and the effects they may have.251 Further, two commenters requested the Commission to clarify that the 248 NYSE 249 See Letter I, at 12. Proposing Release, supra note 2, at 13023– 24. 250 See RBC Letter I, at 3; MFS Letter, at 2–3. is the case for any fee or fee change an exchange adopts, if an exchange were to propose such a fee change it would need to analyze in its Form 19b-4 filing how its fee change constitutes an ‘‘equitable allocation’’ of ‘‘reasonable’’ fees and how it is not ‘‘unfairly discriminatory.’’ See 15 U.S.C. 78s(b)(3)(A)(ii). 251 As VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 Linked Pricing prohibition applies across Test Groups such that exchanges may not tie rebates or transaction fee discounts in another Test Group to volume in the no-rebate Test Group.252 As previously stated in the Proposal, the no-rebate Test Group 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 proposing the Linked Pricing prohibition, the Commission recognized that a Linked Pricing arrangement could potentially distort transaction fee pricing if fees continue to be set at a subsidy level above their natural equilibrium, and it also could perpetuate the potential conflicts of interest associated with rebates and order routing. Any Linked Pricing incentives offered by exchanges that are linked, or otherwise related to, posting or removing liquidity in Pilot Securities included in the no-rebate Test Group would contradict the Commission’s intent for the no-rebate Test Group and frustrate the ability of the Pilot to generate useful data in that group. Accordingly, the Linked Pricing prohibition in Test Group 2 prohibits exchanges from offering any discounts or incentives on transaction fees that are linked to activity, whether it be posting or removing activity, in any securities included in Test Group 2, as well as prohibits exchanges from offering Linked Pricing arrangements in Test Group 2 securities that are based on, or include, activity in any Pilot Securities. In addition, one commenter ‘‘suggest[ed] that the linked pricing prohibition should extend to auction fees or any other transaction fees charged by the exchange,’’ as ‘‘[c]losing auction fees, especially, are a significant source of listing market revenue, and . . . discounts on these fees could likewise lead to the distortions described by the Commission (or even to increases in auction fees to other participants to fund the targeted discounts).’’ 253 Because Rule 610T(a)(3) prohibits exchanges from providing a discount or incentive on transaction fees applicable to removing (providing) liquidity that is linked to providing (removing) liquidity, and auction fees are ‘‘transaction fees,’’ the Linked Pricing prohibition applies to auction fees. Exchanges will not be permitted to consider make (take) volume during intraday trading when calculating auction fees, as such an arrangement would perpetuate potential distortions associated with fee-and-rebate pricing 252 See 253 IEX PO 00000 IEX Letter I, at 7–8; Norges Letter, at 2. Letter I, at 7. Frm 00022 Fmt 4701 Sfmt 4700 models including the crosssubsidization of fees. i. Linked Pricing Market Maker Exception The Commission proposed an exception to the Linked Pricing prohibition to permit an exchange to adopt new rules to provide non-rebate Linked Pricing to its registered market makers during the Pilot in consideration for the market maker meeting rulesbased market quality metrics.254 The Commission explained that to qualify for this limited exception, an exchange would need to propose market making standards in a 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.255 Several commenters requested further clarification about the market maker exception to the prohibition on Linked Pricing. Specifically, one commenter recommended that the Commission provide additional detail about the types of market quality metrics upon which access to Linked Pricing is contingent.256 Other commenters believed that it is important that any such standards adopted by exchanges be sufficiently stringent to prevent market participants from availing themselves of Linked Pricing in a manner that would jeopardize the ability of the no-rebate Test Group to provide valuable data on the impact of the absence of rebates (or a rebate-like incentive) on order routing behavior, execution quality, and market quality or that would permit market participants to unfairly exploit this aspect of the Pilot.257 The Commission continues to believe that permitting exchanges to adopt rules to offer Linked Pricing to their registered market makers for securities in the no-rebate Test Group preserves the ability of an exchange to attract market makers through non-rebate incentives and thereby helps maintain the baseline framework in which exchanges can provide incentives to their registered market makers.258 Commenters highlighted the importance of ensuring that any new rules that exchanges propose to provide Linked Pricing to registered market makers in the no-rebate Test Group be designed so as to not inhibit the Pilot’s ability to 254 See Proposing Release, supra note 2, at 13024. id. at 13024 n.140. 256 See Clark-Joseph Letter, at 2–3. 257 See, e.g., Brandes Letter, at 2; Themis Trading Letter I, at 3; CFA Letter, at 7; Clearpool Letter, at 4; Healthy Markets Letter I, at 33; Decimus Letter, at 6 n.22. 258 See Proposing Release, supra note 2, at 13024. 255 See E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations generate useful data on the impact of rebates on order routing behavior, execution quality, and market quality. The Commission agrees that if they are not narrowly tailored, these non-rebate incentive programs could continue to potentially distort transaction fee pricing, particularly if the exchange’s fees are set at a subsidy level above the natural equilibrium within the current regulatory structure to subsidize these market maker incentives. Rather, the market maker exception to Linked Pricing is intended to permit an exchange to impose rules for its registered market makers in ways that would improve its market in a meaningful way, such that it could use the enhanced liquidity provided by its registered market makers to improve its displayed quotation and thereby attract buyers and sellers to the exchange.259 The non-rebate incentives would only apply to trading activity by a registered market maker in its capacity as a market maker (i.e., acting as principal), and would not apply to any customer activity or activity from other trading desks or business units affiliated with the market maker (and possibly using the same MPID), be it agency, principal or riskless principal trading, traded by or through such market maker. Accordingly, only a registered market maker’s principal trading activity in its capacity as a registered market maker in the no-rebate Test Group would be able to satisfy any market quality metrics, and the only trades that would be eligible to receive the non-rebate incentive pricing would be a registered market maker’s principal trades in its capacity as a registered market maker in the no-rebate Test Group securities. 8. Control Group The Commission proposed that Pilot Securities that are not placed in one of the Test Groups would be placed in the Control Group.260 One commenter addressed the Control Group and supported the Commission’s proposed approach.261 The Commission continues to believe that a control group is vital to test the effects of fee changes in the 259 See id. While it will be up to each individual exchange to design market quality metrics for offering non-rebate Linked Pricing to their registered market makers, such metrics could include, for example: (1) Requirements to trade to stabilize the market; (2) requirements on consecutive price changes and price continuity; (3) material time quoting on both sides of the NBBO; (4) materially enhanced quoted depth on both sides of the NBBO; (5) frequency of setting an improved BBO on the exchange; (6) frequency of setting an improved NBBO; and (7) compliance with narrow maximum quote widths. 260 See Proposing Release, supra note 2, at 13024. 261 See Healthy Markets Letter I, at 19. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 Test Groups, as a control group subject to the current access fee cap would provide an appropriate baseline for analyzing the effects of the Pilot against the status quo.262 For these reasons and the reasons discussed in the Proposing Release, the Commission is adopting the Control Group as proposed, which will be subject to the current Rule 610(c) access fee cap.263 9. Alternative Designs a. Include a Trade-At Requirement In the Proposing Release, the Commission asked whether the Pilot should include a ‘‘trade-at’’ provision that would restrict price matching of protected quotations.264 Several commenters supported including a trade-at requirement because they believed doing so would increase the amount of liquidity available on exchanges and thereby further price discovery.265 In contrast, other commenters opposed including a trade-at requirement as they believed doing so would increase the Pilot’s complexity; impact the ability of the data to assess the impact of transaction fees and rebates on order routing, execution quality, and market quality; be inconsistent with, or unnecessary for, a study of the issues pertinent to the Pilot; and be anti-competitive.266 In addition, two commenters noted that a trade-at requirement would not be necessary because the reduction in the fee cap ultimately could result in more volume being executed on exchanges.267 The Commission believes that adding a trade-at requirement would unnecessarily complicate the Pilot in a manner that would increase costs on market participants and potentially impact the ability of the Pilot to isolate the effects of changes in exchange transaction fees and rebates. 262 See id. 17 CFR 242.610(c). Consistent with Rule 610(c), the Control Group will only cap fees for taking (removing) a protected quotation; it will not apply to fees for posting liquidity or otherwise cap or prohibit rebates. See also Proposing Release, supra note 2, at 13024. 264 See Proposing Release, supra note 2, at 13025. A ‘‘trade at’’ provision would require that orders be routed to a market with the best displayed price or be executed at a materially improved price. 265 See e.g., Adorney Letter, at 1; Birch Bay Letter, at 1. In addition, in clarifying its position on rebates in equity market structure, NYSE stated that it could support a prohibition on rebates if ‘‘done in a measured manner that creates an offsetting incentive to display liquidity, such as a ‘Trade At’ provision[ ]’’ which the Pilot does not provide. NYSE Letter II, at 5. 266 See, e.g., MFA Letter, at 3; ICI Letter I, at 3; BlackRock Letter, at 2; FIA Letter, at 5; SIFMA Letter, at 4; Fidelity Letter, at 10; Citadel Letter, at 6–7; Citi Letter, at 3. 267 See SIFMA Letter, at 4; Citi Letter, at 3. 263 See PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 5223 Accordingly, the Commission is not including a trade-at requirement in the Pilot. If the Pilot were to also assess the impact of a trade-at requirement, it would need to increase the number of Test Groups, thereby increasing the number of securities included in the Pilot, to be able to isolate the effects of a trade-at requirement separately from the effects of changes in exchange transaction fees and rebates. The Commission believes any potential benefits from analyzing the impact of a trade-at requirement do not justify the additional costs that expanding the Pilot would impose. Rather than introduce another variable into the Pilot, the Commission believes that the Pilot should remain focused on permitting an analysis, in the context of our current market structure, of the effect of exchange transaction fees and rebates. Further, the Commission notes that the Tick Size Pilot featured a trade-at test group, so as that pilot’s post-pilot period concludes, the Commission will have access to current data to analyze the impact of a trade-at prohibition in the context of that pilot.268 b. No Fee Cap Test Group Several commenters advocated for including a Test Group that does not cap transaction fees, believing that it is important to test whether competition alone can constrain pricing and result in a natural equilibrium transaction fee.269 One commenter noted that currently fees tend to ‘‘cluster’’ at the access fee cap imposed by Rule 610(c) and as such recommended including an additional Test Group that does not cap fees.270 When it adopted Rule 610(c), the Commission explained that the access fee cap is necessary to, among other things, inhibit the ability of exchanges to take advantage of the Order Protection Rule by acting as a ‘‘toll booth’’ between price levels and ensure that quotations are fair and useful by limiting the ability of high fees to distort the price of displayed limit orders.271 The Commission believes that the norebate Test Group will permit analysis of the impact of competitive forces on fees in the absence of current practices 268 See also infra Section IV.E (discussing trade- at). 269 See, e.g., Clark-Joseph Letter, at 2; Nasdaq Letter I, at 13; Cboe Letter I, at 27–28. 270 See Barnard Letter, at 1. Another commenter recommended including a Test Group that did not cap fees because it believed that the current structure encourages exchanges to charge fees for data feeds and technology services, which the commenter suggests are higher than they otherwise would be if transaction fees were not capped. See Modern IR Letter, at 3. 271 NMS Adopting Release, supra note 10, at 37545. E:\FR\FM\20FER2.SGM 20FER2 5224 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations that use fees to subsidize those rebates. Specifically, to the extent exchanges will no longer need to charge access fees up to $0.0030 to subsidize rebates in that Test Group, the Commission believes that competitive forces among the exchanges may result in fees approaching a new equilibrium level, within the current regulatory structure, for stocks in the no-rebate Test Group.272 The Commission notes that the order protection requirements of 17 CFR 242.611 (Rule 611) will continue to apply to all of the Pilot Securities including those in the no-rebate Test Group. As such, the basis for imposing a fee cap (summarized above) remains intact during the Pilot and the Commission believes that applying the current fee cap to the no-rebate Test Group will guard against the possibility, albeit highly unlikely, that an outlier exchange could seek to charge exorbitant fees for the no-rebate Test Group stocks that would be inconsistent with the rationale behind the Rule 610(c) fee cap.273 c. Basis Point Pricing Two commenters recommended that, because stock prices have increased (i.e., a number of high profile stocks currently trade above $100 per share), using basis point pricing may be a better reference point than using the current access fee cap because the current access fee cap can impact stocks differently based on their price.274 Specifically, one of these commenters proposed that ‘‘Test Group 1 contain the same constraints as Test Group 3 but with an access fee limitation expressed in basis points.’’ 275 However, the Commission believes that doing so would increase the Pilot’s complexity and could interfere with the Pilot’s ability to provide useful data to assess the impact of the current exchange fee models on order routing behavior, execution quality, and market quality because exchange transaction fees and rebates are currently not assessed in 272 See, e.g., Goldman Sachs Letter, at 2 (characterizing $0.0030 as an ‘‘outdated benchmark’’ that ‘‘is too high and far from representative of true prices in the marketplace’’). 273 The Commission notes that the Proposal included a question regarding whether a fee cap would continue to be necessary to constrain exchange pricing if equilibrium pricing is achieved and the Commission expects that some market participants may analyze the Pilot results for answers to this question. See Proposing Release, supra note 2, at 13025. 274 See Clearpool Letter, at 3; Cboe Letter II, at 8– 9. Another commenter also stated that it thought it was ‘‘a worthwhile exercise to explore the possibility of a move to basis points. . . . ’’ See Citi Letter, at 6. 275 See Clearpool Letter, at 3. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 basis points and thus this would introduce a new variable into the Test Group as it could raise or lower the fees depending on a stock’s share price, which can vary over time. The more variables that are introduced, the more difficult it could be to isolate the effects of a particular change and uncover causal connections. Accordingly, the Commission is not adopting a requirement that one of the Test Groups include an access fee cap expressed in basis points. d. Higher Fee Caps and Fees Based on Tick Size Four commenters addressed a question in the Proposing Release about including a Test Group that would allow for access fees higher than the current cap under Rule 610(c).276 One of these commenters specifically recommended reducing access fees to $0.0005 per share for the most liquid securities, while imposing gradually higher access fees for stocks of lower liquidity, up to a cap of potentially $0.0050 for the least liquid securities.277 Another commenter recommended including an additional Test Group with an access fee cap of $0.0040, believing this would provide data to test whether an increase in the fee cap reduces bidask spreads in light of the many comments contending that spreads will increase in conjunction with lower rebates connected to a reduced access fee cap.278 In addition, one commenter suggested that if tick sizes were set based on the characteristics of an individual stock, the transaction fee cap could then be a particular percentage of the tick size.279 Such an approach could result in an access fee cap above $0.0030 per share for certain securities. The Commission has carefully considered these suggestions. As discussed above, other commenters have noted that the current access fee cap was set thirteen years ago when markets and technology were markedly different.280 Indeed, a few commenters argued it was outdated and too high.281 Accordingly, the Commission does not believe that raising the access fee cap to levels that are above what trading centers were charging thirteen years ago necessarily is consistent with the technological efficiencies that have been realized in the intervening years. While 276 See Nasdaq Letter I, at 13; TD Ameritrade Letter, at 6; Angel Letter II, at 2; Cboe Letter II, at 8. 277 See TD Ameritrade Letter, at 6. 278 See Angel Letter II, at 2. See also Cboe Letter II, at 8. 279 See Morgan Stanley Letter, at 3. 280 See supra note 200 and accompanying text. 281 See id. PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 market-based solutions and even regulatory responses to enhance the investor experience with trading in thinly-traded securities are worthy of attention, and were the subject of a recent Division of Trading and Markets staff roundtable, the Commission does not believe that the Pilot should introduce the potential for higher rebates—and the further exacerbated distortions that would likely accompany them—when it is attempting to study the effect of the current exchange fee models and fee and rebate levels.282 Accordingly, the Commission is not adopting a higher fee cap in any of the Pilot’s Test Groups. e. Order Protection Rule The Commission solicited comment on whether it would be appropriate to suspend the Rule 611 order protection requirements in one or more Test Groups.283 In response, three commenters opposed eliminating the order protection requirements within the Pilot because doing so would increase the cost and complexity of the Pilot, and also could complicate analysis of the Pilot’s results to the extent it clouded the focus on transaction fees and rebates.284 In contrast, one commenter recommended eliminating the order protection requirements for securities in the no-rebate Test Group.285 This commenter stated that prohibiting rebates is insufficient to ‘‘remove the perceived or real conflicts on broker routing or materially address’’ various negative effects that the commenter believed Rule 611 has had on the equities markets.286 After considering the comments received, the Commission believes that the Pilot should not introduce additional variables by, in this case, removing the Rule 611 protected quotation status for automated quotations in any particular Test Group. In order to add a new variable to the Pilot, the Commission would need to include additional Test Groups and increase the number of securities in order to be able to isolate separately the effects of each variable that is included 282 See Transcript of the Division of Trading and Markets’ Roundtable on Market Structure for Thinly-Traded Securities (April 23, 2018), available at https://www.sec.gov/spotlight/equity-marketstructure-roundtables/thinly-traded-securitiesrountable-042318-transcript.txt. 283 See Proposing Release, supra note 2, at 13025. 284 See SIFMA Letter, at 4; JPMorgan Letter, at 3; Schwab Letter, at 3 (also stating that eliminating Rule 611 for certain Pilot Securities ‘‘would significantly negatively impact retail order flow and the quality of trade execution’’). 285 See T. Rowe Price Letter, at 2–4. 286 See id. at 4. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations in the Pilot or else it would create an asymmetric Pilot that would make it more difficult to evaluate the data and establish causal inferences regarding the impacts of changes to exchange transaction fees and rebates. As discussed above, most commenters were critical of the Pilot’s proposed size. The Commission desires to have a narrowly tailored pilot focused on generating useful data on the impact of exchange fees and rebates on order routing behavior, execution quality, and market quality. Adding another variable to the Pilot would increase the Pilot’s complexity as well as costs of the Pilot. f. Other Ideas for Additional Test Groups and Related Questions In addition to the above questions, the Commission asked a number of other questions in the Proposing Release to solicit commenters’ opinions on equities market structure issues and whether the Pilot should be used as a vehicle to further investigate other related areas. The Commission received a few comments on these points. For example, in response to a question about whether commenters believe the minimum trading increment should be reduced for the most actively traded NMS stocks if the Pilot’s data suggests that rebates do not significantly improve market quality or execution quality for these securities, one commenter stated it ‘‘would strongly support inclusion of a halfpenny spread bucket, or consideration of a separate small-tick pilot for highly liquid stocks.’’ 287 Another commenter recommended that the Pilot test a prohibition on ‘‘tiered pricing,’’ whereby exchanges offer lower per share fees or greater per share rebates to market participants that transact in greater volumes, believing that absent such a prohibition, exchanges would continue to offer these incentives, which would serve ‘‘to potentially work around the prohibition on offering rebates.’’ 288 Further, one commenter suggested adding a new Test Group ‘‘to test an anti-fragmentation policy,’’ in which ‘‘the order that sets the SIP NBBO receives the execution in all circumstances (e.g., bypassing hidden orders). ’’289 The Commission appreciates all of these recommendations. After considering these comments, as well as other comments opposed to including more NMS stocks in the Pilot, the Commission believes that the Pilot 287 Pragma Letter, at 4. See also Proposing Release, supra note 2, at 13025. 288 See Clearpool Letter, at 3–4. 289 See Birch Bay Letter, at 2. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 should not introduce additional variables. In order to add a new variable to the Pilot, the Commission would need to include additional Test Groups and materially increase the number of securities (or materially increase the Pilot’s duration) to be able to isolate separately the effects of each variable that is included in the Pilot. Otherwise, adding variables would create an asymmetric Pilot that would make it more difficult to evaluate the data and establish causal inferences regarding the impacts of changes to exchange transaction fees and rebates. As discussed above, most commenters were critical of the Pilot’s proposed size and the Commission similarly desires to have a narrowly tailored pilot focused on generating useful data on the impact of exchange fees and rebates on order routing behavior, execution quality, and market quality. Adding another variable to the Pilot would increase the Pilot’s size, complexity, and costs. g. Gradual Reduction of Current Fee Cap Across All Stocks One commenter suggested that, rather than conducting the Pilot, the Commission should instead consider imposing a ‘‘gradual reduction of the current fee cap across all stocks periodically.’’ 290 The commenter stated that this approach would facilitate data collection and an opportunity ‘‘to observe order routing behavior changes, while applying the same economics to all stocks uniformly.’’ 291 Furthermore, the commenter stated that if a control group was necessary in this scenario ‘‘for comparison purposes’’ it would recommend placing 50% of stocks in the control group and the other 50% in the Test Group subject to the gradual reductions in access fees.292 The Commission has considered this alternative but believes that the Pilot is a preferable approach because it will permit researchers to conduct differences-in-differences analysis over a much shorter time frame. By establishing stratified treatment groups and simultaneously testing different changes in the same variable, the Pilot will reduce the impact of events (economic, natural, political, etc.) across time and thereby is more conducive to an apples-to-apples comparison of the various treatment groups to one another. Pursuing a simultaneous and linear gradual reduction, such as that proposed by the commenter, could require greatly extending the Pilot’s duration depending on the number of 290 Morgan Stanley Letter, at 2. fee cap levels to be tested. More importantly, this proposed alternative would not provide the Commission with the opportunity to directly observe the impact of rebates on order routing behavior, execution quality, and market quality because it would not necessarily include a prohibition on rebates and therefore having a no-rebate bucket will be substantially more informative. Lastly, as the Commission believes that a Control Group is necessary to ensure the usefulness of the Pilot’s data, pursuing the proposed structure would impact more NMS stocks than the Pilot (as 50% of stocks would be included in the Test Group and 50% in the control group). h. $0.0010 Access Fee One commenter recommended that rather than pursuing the Pilot, the Commission should instead amend Rule 610(c) to reduce the access fee cap to $0.0010 and also ‘‘conduct an abbreviated study of the effects of eliminating rebates similar to the criteria of Pilot Test Group Three.’’ 293 This commenter stated that ‘‘there is broad recognition’’ that the access fee cap should be reduced and the Pilot will ‘‘be lengthy, complex and costly’’ but ‘‘will not yield a different conclusion.’’ 294 The commenter stated that reducing the access fee cap to $0.0010 would be calibrated with present-day trading and execution costs, would better ensure displayed prices reflect the actual economic costs of an execution, and would allow exchanges to continue maintain their current net capture rates, while also choosing to offer rebates to incentivize liquidity provision if they chose to do so.295 The Commission believes that its revised Pilot design responds to this commenter’s core recommendation, though the Commission is instituting a $0.0010 fee cap as part of the Pilot and not as an amendment to Rule 610(c). The Commission continues to believe that a Pilot is necessary to provide data to objectively evaluate the effect of exchange fees and rebates. Ultimately, the Pilot will enable a data-driven analysis of the impact of transaction fees and rebates on order routing behavior, execution quality, and market quality, which will serve as a valuable precursor to the Commission’s consideration of future policy making in this area. 10. Metrics To Assess the Pilot A number of commenters recommended that the Commission 293 See 291 Id. 294 Id. 292 Id. 295 Id. PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 5225 E:\FR\FM\20FER2.SGM Goldman Sachs Letter, at 1–4. at 1. 20FER2 5226 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations more clearly articulate what it believes would constitute a ‘‘successful’’ Pilot and how it will judge whether the Pilot achieves that measure of success.296 Several of these commenters suggested specific metrics or criteria they thought the Commission should analyze when evaluating the impact of the Pilot, many of which were measurement criteria suggested by EMSAC.297 One commenter suggested that the Commission provide guidance about how its staff will be evaluating the metrics used to determine whether to recommend market structure changes to the Commission following the Pilot.298 In addition, two commenters suggested the Commission designate an independent third party to conduct an analysis of the Pilot data upon the Pilot’s completion.299 Another commenter stated that the ‘‘industry should be afforded the opportunity to comment’’ on the metrics and criteria used to evaluate the Pilot.300 In response to these comments, the Commission emphasizes that its staff will likely not be the sole entity analyzing data related to the Pilot. As was the case for the recent Tick Size Pilot, the Commission believes that market participants will publish their own analyses of the Pilot using data that is uniquely available to them and the metrics that they believe are most useful or relevant, and encourages market participants to do so.301 To the extent that interested parties prepare their own analyses, they may submit them to tradingandmarkets@sec.gov with the words ‘‘Transaction Fee Pilot Analysis’’ in the subject line, and the Commission 296 See, e.g., State Street Letter, at 2; Fidelity Letter, at 3–4; Capital Group Letter, at 4; ICI Letter I, at 5; OMERS Letter, at 2; MFS Letter, at 2; Virtu Letter, at 8; FIA Letter, at 2; SIFMA Letter, at 2– 3, 5; TD Ameritrade Letter, at 2; STANY Letter, at 3; Morgan Stanley Letter, at 3; Cboe Letter I, at 29; Nasdaq Letter I, at 7; NYSE Letter, at 2; Pragma Letter, at 2; ModernNetworks Letter; Healthy Markets Letter I, at 35. 297 See, e.g., State Street Letter, at 2–3; Fidelity Letter, at 8; Vanguard Letter, at 3; ICI Letter I, at 5; T. Rowe Price Letter, at 4; MFS Letter, at 2; BlackRock Letter, at 2–3; SIFMA Letter, at 5–6; Morgan Stanley Letter, at 3; Spatt Letter, at 5; Cboe Letter I, at 29; IEX Letter I, at 2; Pragma Letter, at 2–3. 298 See SIFMA Letter, at 3. Another commenter requested that the Commission clarify the role it expects the Division of Economic and Risk Analysis to play in analyzing the Pilot’s data and provide an anticipated timeline for the issuance of a report on the Pilot data. See IEX Letter I, at 2. 299 See Fidelity Letter, at 3, 8; MFS Letter, at 2. 300 See Virtu Letter, at 8. 301 For example, institutional firms could study their ability to capture the spread when passively posting, and how that is impacted within the Pilot’s treatment groups. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 will post those reports on its public website.302 The Commission encourages market participants to make public any analysis they perform on their own trading activity, such as non-proprietary transaction cost analysis (‘‘TCA’’), so that it may be publicly reviewed and used to help inform the public dialogue concerning the effect of exchange fees and rebates.303 To the extent that independent analyses are made public, they can contribute to the Commission’s consideration of any future regulatory action in this area. Given the valuable input of independent analysis, the Commission believes that the success or failure of the Pilot will be determined by whether it produces an exogenous shock that generates measurable responses capable of providing insight into the effects of fees and rebates on the markets and market participant behavior.304 In the absence of a Commission Pilot that effects change across all equities exchanges in a coordinated manner, researchers would be unable to collect meaningful, comparative data to test the effects of such changes and perform those analyses.305 Success or failure of the Pilot is thus independent of the outcome of the Pilot. 302 The Commission encourages market participants to disclose what sources of data they used for their analyses and describe the methodology they used, and to make those reports publicly and freely available. 303 For example, the Pilot’s order routing datasets will collect aggregated data, not individual orderby-order level data, and reflects the ‘‘child’’ orders that are processed by an exchange. Thus, the order routing dataset will not capture the entire lifecycle of a ‘‘parent’’ order from its inception through to execution. Accordingly, the Pilot’s order routing datasets will not by themselves permit analyses on an order-by-order basis, and will therefore be unable to assess the execution quality of orders at the ‘‘parent’’ level. If market participants and other interested parties conduct parent order-level analyses and make their findings public, then the Commission would be able to consider them as it assesses the Pilot’s ultimate impact on order routing behavior, execution quality, and market quality. See, e.g., T. Rowe Price Letter, at 4 (recommending that the Commission view analyses of the Pilot conducted by registered investment advisers as a ‘‘key input’’). 304 As noted in the Proposal, the Pilot is designed to produce an exogenous shock that simultaneously creates distinct fee environments, each of which restricts transaction-based fees or rebates differently, enabling synchronized comparisons to the current environment for purposes of inferring the existence of causal relationships. See Proposing Release, supra note 2, at 13047 and 53. An exogenous shock to a system occurs when an element of the system is changed from without the system. (i.e., the change or shock is not under the control or influence of those within the system) but can induce endogenous (i.e., within the system) responses. In the Pilot’s context, the exogenous shock takes the form of a reduction of the maximum permissible transaction fees and a prohibition on rebates and Linked Pricing on all U.S. equities exchanges. See infra Section IV. 305 See infra Section IV.B.1. PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 For example, a Pilot that shows, with statistical significance, that rebates narrow the quoted spread in thinlytraded stocks would be equally ‘‘successful’’ as a Pilot that shows that rebates do not narrow the spread in such stocks. In this sense, the ‘‘success’’ of the Pilot is that it created the conditions that permit measurement and analysis of that issue in a manner that helps resolve speculative assumptions among the commenters about the impact of fees and rebates. Furthermore, it is worth noting that the data collected pursuant to Rule 610T is only part of what researchers will need to conduct analysis of the impact of exchange fees and rebates on the markets. For example, the Pilot’s order routing datasets contain data to help assess order routing and certain aspects of execution quality, but will not contain any data on exchange quotations, which is available from existing sources. Consequently, researchers will need to use existing data sources to assess the impact of the Pilot on exchange quoting activity and market quality. As such, to the extent that the Pilot data produces null results, for example the Pilot’s order routing datasets do not show any change in liquidity during the Pilot, the Commission believes that independent analysis from market participants, looking at order-level data, may nevertheless detect an impact. Even if the Pilot produces a null result for some metrics, and third-party analysis is not publicly available or does not find an impact, the Commission nevertheless believes the Pilot would still be useful to inform future policymaking that is intended to benefit investors.306 In response to commenters’ requests for additional insight into the types of questions that the Commission hopes the Pilot will be able to answer, the Commission believes that the order routing datasets, as well as other data that is already readily accessible to researchers, should facilitate analysis of the impact of the Pilot through a broad spectrum of metrics. In particular, the Commission will consider, and encourages others to consider, the following questions in contemplating the impact of changes to fees and rebates across the exchanges. These questions include, but are not limited to: 306 For example, a result that shows no impact on liquidity for a Test Group may still be relevant to the Commission’s consideration of the effects of transaction fee-and-rebate pricing models on order routing behavior, execution quality, and market quality and whether the existing exchange transaction-based fee and rebate structure continues to further the statutory goals. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations 1. To what extent do access fees and rebates impact routing decisions for liquidity-taking orders? Are orders to take liquidity more likely to be routed to an exchange (compared to an off-exchange venue or ATS) in a lower access fee environment than they are currently? To what extent are impacts or changes in routing decisions driven by potential conflicts of interest created by transaction fees and rebates rather than other factors such as fill rates and execution quality? 2. To what extent do access fees and rebates impact routing decisions for liquidity-supplying orders? Are orders to provide liquidity less likely to be routed to an exchange (compared to an off-exchange venue or ATS) in a lower rebate environment than they are currently? To what extent do impacts or changes in order routing appear to be driven by potential conflicts of interest caused by rebates rather than other factors such as execution quality (e.g., fill-rates, time to fill, capturing the quoted spread, adverse selection, or reversion)? 3. What impact does a reduction or elimination in rebates have on the NBBO, including spread width and the depth of interest displayed at the NBBO? To what extent does a potential decrease in depth of interest at the NBBO result in lower fill rates or smaller fill sizes for investor orders? Are natural investors better able to obtain queue priority in exchange order books, and are they more frequently able to capture the quoted spread when posting passively (e.g., buy on the bid and sell on the offer)? 4. Are there common characteristics for securities (e.g., average daily trading volume, price, or market capitalization) where a reduction or elimination of rebates begins to impact quoted spread? If so, what are those common characteristics and at what level do reduced rebates begin to have an impact on quoted spread? To what extent does a change in quoted spread affect transaction costs for investor orders? If quoted spread widens in a security, to what extent is the potential spread cost offset by the reduction in the transaction fees paid, or a change in the ability to capture the quoted spread? 5. Are there common characteristics for securities where a reduction or elimination of rebates does not impact quoted spread? If so, what are those common characteristics (e.g., average daily trading volume, price, or market capitalization)? 6. Are there common characteristics for securities (e.g., average daily trading volume, price, or market capitalization) where a reduction or elimination of rebates begins to impact effective spread? 7. How can we best understand the effects of rebates provided on inverted venues (where rebates are paid to takers of liquidity)? 8. What impact do lower access fees and rebates have on the amount of displayed and non-displayed liquidity on exchanges? 9. In the absence of rebates, do competition and market forces operate to produce a market equilibrium (within the current regulatory structure) that constrains transaction fees to levels at or below today’s current access fee cap? What do such market forces, and any resultant equilibrium pricing, VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 tell us about the need to impose a cap on access fees? Does the Pilot provide any data that suggests, in the absence of rebates, an access fee cap would still be necessary as long as Rule 611 of Regulation NMS continues to impose order protection requirements on exchanges with protected quotes? 10. What is the impact of a lower fee cap on trading volumes on each exchange? What is the impact of a lower fee cap on other measures of liquidity on each exchange? How should we understand the difference between volume and liquidity? 11. What is the impact of lower rebates on the ability of smaller exchanges to attract liquidity-supplying orders? By providing a mechanism that is uniquely capable of facilitating an empirical review of these and similar questions, the Pilot is an essential tool that can further the understanding of an important component of equities market structure. While other market structure issues also might benefit from a pilot, exchange transaction fees currently are a prime focus for empirical study, as evidenced by, among other things, the EMSAC’s recommendation to the Commission and the number and nature of comments the Commission received on its proposal. Ultimately, the Commission desires to use the Pilot’s results to help assess whether (and, if so, in which types of NMS stocks) rebates have a positive impact on execution and market quality, or whether they have no or little effect or a negative effect. D. Timing and Duration 1. Disclosure Initiatives and the Pilot While a number of commenters urged the Commission to proceed expeditiously with its proposed pilot,307 other commenters believed the Commission should pursue different market structure initiatives before conducting the Pilot 308 or in lieu of the Pilot.309 The Commission has adopted two of the market structure initiatives 307 See, e.g., IEX Letter I, at 1; Joint Pension Plan Letter, at 2; Better Markets Letter, at 3; Brandes Letter, at 2; Clearpool Letter, at 7. 308 See, e.g., RBC Letter I, at 4; T. Rowe Price Letter, at 4; Citi Letter, at 2. 309 See, e.g., Nasdaq Letter I, at 1, 3 (‘‘[A] transaction fee experiment is inappropriate at this time because there are alternatives and prerequisites the Commission must further evaluate.’’); NYSE Letter I, at 17–19 (stating that the Commission should consider ‘‘less costly and more effective alternatives’’ to the Pilot); Cboe Letter I, at 12, 22, 27 (recommending that the Commission undertake a ‘‘holistic examination of the entire equities market framework’’ including consideration of ‘‘possible changes to the Order Protection Rule [and] the Minimum Tick Increment Rule,’’ ‘‘[s]trengthening and [a]rticulating the Duty of Best Execution,’’ providing ‘‘greater broker-dealer transparency,’’ and adopting amendments to Regulation ATS). PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 5227 identified by commenters—namely, proposals to enhance the operational transparency of ATSs and to enhance disclosure of order routing behavior.310 While some commenters believed that the information and data from those new rules would complement the Pilot and ‘‘improve understanding of pilot data,’’ 311 others believed the new rules would instead allow the Commission to determine ‘‘whether a problem exists without risking the potential negative impact of a pilot’’ 312 or thought that potential conflicts of interest in order routing behavior would be better addressed through increased transparency and disclosure than by the Pilot.313 The Commission disagrees. Comments urging the Commission to pursue disclosure-based initiatives focused only on one narrow aspect of 310 See, e.g., Nasdaq Letter I, at 1, 3; NYSE Letter, at 17–18; Cboe Letter I, at 12, 22, 27, Fidelity Letter, at 4. See also Securities Exchange Act Release Nos. 83663 (July 18, 2018), 83 FR 38768 (August 7, 2018) (‘‘Regulation ATS–N’’) and 34528 (November 2, 2018), 83 FR 58338 (November 19, 2018) (‘‘Amendments to Order Handling Disclosure’’). 311 ICI Letter I, at 5–6, 6 n.12; ICI Letter II, at 3. See also, e.g., RBC Letter I, at 4; Citi Letter, at 2; Citadel Letter, at 3, 7 (stating that ‘‘it is important to first finalize and implement . . . Rule 606 enhancements before implementing the Pilot’’ to ‘‘safeguard the integrity of the Pilot by ensuring that any changes to broker-dealer order routing practices that result from the increased transparency mandated by amended Rule 606 are isolated from any similar changes that result from the design of the Pilot’’); Spatt Letter, at 4 (stating that the ‘‘the enhanced disclosures proposed would strengthen the potential causal inference that the response to [the Pilot] would allow’’). Some commenters questioned whether the Pilot should proceed, because they believed that the adoption of Regulation ATS–N and the Amendments to Order Handling Disclosure will ‘‘impact the very potential conflicts of interest the Commission aims to study . . . .’’ Nasdaq Letter II, at 2–4; see also NYSE Letter IV, at 2–3. As noted in this section, the scope of the Pilot is broader than just conflicts of interest. Therefore, those initiatives, or the impact they may have on order routing behavior, would not provide sufficient data to evaluate the effects of transaction fees and rebates on market quality and execution quality. See infra Section IV.B.1. 312 Nasdaq Letter I, at 1–2, 4; Nasdaq Letter II, at 2–4 (suggesting that the adoption of these regulations ‘‘further reduce[d] the already weak need for the [Pilot]’’). See also, e.g., STANY Letter, at 2; ASA Letter, at 5–6; Era Letter, at 1. But cf. Verret Letter I, at 4 (stating that the ‘‘collection of data from broker-dealers’’ or the use of ‘‘existing data contained in [OATS]’’ were not ‘‘feasible alternatives,’’ because a ‘‘randomized trial is far superior for the purpose of generating robust statistical analysis to inform subsequent rulemaking’’); Proposing Release, supra note 2, at 13046–47 (outlining the limitations of existing data sources). 313 See, e.g., STANY Letter, at 2; FIA Letter, at 3; Grasso Letter, at 2. But cf. ICI Letter II, at 3 (noting that disclosure-based rulemakings ‘‘will not directly reduce the potential for exchange transaction pricing models to create conflicts of interest for broker dealers, nor will they provide data that would allow an institutional investor to measure the impact of fee avoidance on routing decisions’’); Luminex Letter, at 1; Spatt Letter, at 4; IEX Letter II, at 9. E:\FR\FM\20FER2.SGM 20FER2 5228 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations the Pilot—studying the conflicts of interest between brokers and their customers that are presented when exchanges pay rebates. However, such an approach does not adequately advance the Pilot’s broader purpose— obtaining a better understanding of all potential impacts from fees and rebates, and how fees and rebates may affect stocks differently depending on their liquidity. Similarly, some commenters recommended that, either before conducting the Pilot or in lieu of the Pilot, the Commission should pursue other market initiatives such as enhancing broker-dealers’ duty of best execution 314 or undertaking a ‘‘broader review of equity market structure,’’ including the consideration of possible changes to the Order Protection Rule or the Minimum Tick Increment Rule.315 Other commenters disagreed and did not believe that the Commission should delay the Pilot in order to pursue other market structure initiatives.316 For example, a few commenters advocated proceeding with the Pilot because the Pilot may help to inform future policy changes in these other areas.317 Other commenters characterized the ‘‘holistic reform’’ advocated by other commenters as ‘‘an elusive goal’’ 318 in light of market participants’ competing interests—one that has been used to ‘‘slow down market structure reform for the past decade.’’ 319 The Commission believes that there is no need to delay proceeding with the Pilot in order to pursue other potential equity market structure initiatives. The Pilot seeks to resolve several equity market structure questions that have been debated for several years. Similarly, the Commission does not believe that it needs to complete the Pilot before proceeding to consider other equity market structure initiatives. Other initiatives may implicate equity market structure questions that are narrower or broader than, or independent of, exchange fee models, such as considering innovative approaches to thinly-traded securities. 314 See, e.g., Nasdaq Letter I, at 3–4; Fidelity Letter, at 6; Cboe Letter I, at 21–22. 315 See Cboe Letter I, at 12; FIA Letter, at 3; Nasdaq Letter I, at 4. 316 See, e.g., IEX Letter II, at 9; Better Markets Letter, at 3; Brandes Letter, at 2; AJO Letter, at 2; OMERS Letter, at 3; Clearpool Letter, at 7. Some of these commenters suggested that the Pilot should proceed in conjunction with action on other market structure initiatives. See, e.g., SIFMA Letter, at 1; Pragma Letter, at 3–4. 317 See, e.g., Verrett Letter I, at 5; Better Markets Letter, at 3. 318 Brandes Letter, at 2. 319 Themis Trading Letter I, at 6. See also ICI Letter I, at 3. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 The Commission expects that it will continue to evaluate the need for other changes to equity market structure during the Pilot. 2. Automatic Sunset at Year One The Commission proposed that the Pilot have a duration of one year with a maximum period of two years. Specifically, the proposed Pilot duration featured an automatic sunset at the end of the first year unless, prior to that time, the Commission publishes a notice that the Pilot shall continue for up to one additional year.320 After careful consideration of the comments received, the Commission is adopting Rule 610T(c) as proposed. Many commenters supported the proposed duration of the Pilot.321 For example, one commenter asserted that ‘‘each pricing experiment needs to be in place for a sufficient length of time to enable the firms to adjust their routing logic.’’ 322 Others agreed that the proposed duration would reduce the ‘‘desire to ‘wait out’ the Pilot’’ and would avoid ‘‘the incentive to alter behavior in order to distort the Pilot’s results . . . .’’ 323 Several commenters supported the automatic sunset provision after one-year.324 A few commenters, however, thought the proposed duration was too short and 320 See Proposing Release, supra note 2, at 13025. The Commission notes that the proposed language in Rule 610T(c)(a)(ii) has been modified slightly. As proposed, Rule 610T(c)(1)(ii) contained the phrase ‘‘shall continue for up to another year.’’ As adopted, the phrase ‘‘shall continue for up to one additional year’’ is being substituted for the phrase ‘‘shall continue for up to another year’’ to simplify the rule text without substantively changing the requirement. 321 See, e.g., SIFMA Letter, at 3; AGF Letter, at 2; Wellington Letter, at 2. See also RBC Letter I, at 6 (stating ‘‘a pilot of at least one year and no more than two years will ensure that ample data is collected over time, that the restrictions of the various Pilot Test Groups cannot be evaded by delay, and that the Pilot does not exist for a period of time beyond which its data would be cumulative or of marginal significance relative to data produced earlier in the Pilot period’’). 322 See Citi Letter, at 5 (stating that ‘‘[c]ostsensitive firms may be able to more quickly adapt to new pricing, while liquidity-based routers may need time to collect a new sample set to adjust their routing logic,’’ such that ‘‘data in the weeks closer to the conclusion of the Pilot may more accurately reflect the state of the market and what the implications would be if implemented long-term’’). One commenter, however, did not believe that certain ‘‘broker-dealers, proprietary traders, and algorithm vendors’’ would ‘‘incorporate the new fees into their routing systems on a timely basis, if ever,’’ because according to this commenter, ‘‘[c]hanges are costly and may prove to be ultimately unnecessary if pricing reverts following the termination of the pilot study.’’ Larry Harris Letter, at 11. 323 Joint Asset Managers Letter, at 2. See also Joint Pension Plan Letter, at 2; Brandes Letter, at 2. 324 See, e.g., SIFMA Letter, at 3; CFA Letter, at 6; Fidelity Letter, at 9; IEX Letter I, at 4. PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 that a minimum two-year pilot would be necessary.325 Some other commenters believed that the necessary data could be obtained within a shorter time frame. Among commenters advocating for a shorter Pilot Period, the recommended duration varied and ranged from those who felt there would be an ‘‘immediate and measurable impact upon implementation’’ 326 to those who felt the appropriate time frame should be modified to an absolute maximum of one year.327 One commenter questioned whether a ‘‘1–2 year pilot that changes fees on 3,000 names’’ was ‘‘really a ‘pilot’ or in fact a de facto imposition of a significant reduction of transaction fees[.]’’ 328 Several commenters expressed their view that the proposed length of the Pilot would ‘‘exacerbate[ ] the negative impact upon the affected issuers.’’ 329 One commenter took issue with the proposed length of the Pilot by challenging what it believed to be conflicting statements of the Commission in its original Proposal. According to the commenter, the Commission asserted, on the one hand, that the ‘‘market quickly reacts to changes in (and elimination of) pricing changes, but on the other hand, claims that the market does not react unless the changes are in effect for at least a year.’’ 330 The Commission believes both of those statements are correct and do not conflict. While many market participants will react promptly to pricing changes, particularly those with cost-based routing algorithms, others may need additional time to fine tune liquidity-based routing algorithms as order flow changes in response to fee changes.331 More importantly, however, the Pilot needs to be long enough to discourage any market participant inclined to resist adapting its behavior to the fee changes.332 A few commenters opposed the oneyear sunset provision, but for a variety of different reasons. For example, one commenter thought a full two-year pilot was necessary, another thought the Commission separately has the authority to revise or terminate the Pilot early and does not need a sunset 325 See, e.g., Babelfish Letter, at 3; Healthy Markets Letter I, at 19. 326 See TD Ameritrade, at 5; see also, e.g., NorthWestern Letter, at 1. 327 See, e.g., FIA Letter, at 4; STANY Letter, at 3– 4. 328 Magma Letter, at 3. See also, e.g., Apache Letter, at 1; Unitil Letter, at 2. 329 See, e.g., Ethan Allen Letter, at 1; ProAssurance Letter, at 2; Knight-Swift Letter, at 2. 330 NYSE Letter I, at 16. 331 See, e.g., Citi Letter, at 5; Babelfish Letter, at 3. 332 See Proposing Release, supra note 2, at 13071. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations provision, and a third was critical of the lack of metrics that would accompany the automatic sunset.333 After careful consideration of the comments received, the Commission is adopting the Pilot’s duration as proposed. The Commission believes that the Pilot’s duration will provide an appropriate balance between providing certainty about the maximum duration for the Pilot while also allowing flexibility to conduct a Pilot for more than one year if necessary to collect representative data. Further, the Pilot’s duration should be long enough to make it economically worthwhile for market participants to adapt their behavior and not ‘‘wait out’’ the Pilot. In addition, in light of the number of Pilot Securities selected, which were selected to ensure sufficient statistical power to allow for meaningful analysis, the Pilot’s duration will allow for the collection of a robust and representative data set over a sufficiently long period of time,. The Commission considered a shorter time period for the Pilot, but is concerned that short-term or seasonal events could unduly impact the Pilot results and therefore data collected over a shorter duration may not yield a sufficiently representative dataset that would be capable of permitting analysis into the impact of 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. For example, a shorter pilot period could be impacted by seasonal idiosyncrasies, macroeconomic factors, or even weather events. Further, the Commission recognizes that some market participants, for example, broker-dealers whose liquidity-focused routing strategies are based on, and continually updated based on, several weeks’ worth of data, will need time to fine tune their revised routing strategies. While some market participants may adjust quickly, others, like proprietary trading market participants, may wait to see how other market participants react before refining their own routing strategies.334 In other words, it could take a few months before some market participants finish calibrating their routing strategies to the fees and rebates that the exchanges adopt consistent with the Pilot’s requirements and adjust them as trading dynamics settle in response to those changes. The exchanges also could take a number of weeks to settle on new fee models as they see how other exchanges modify their fee models to comply with 333 See Babelfish Letter, at 3; Healthy Markets Letter I, at 19; Cboe Letter I, at 19. 334 See, e.g., Citi Letter, at 5. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 5229 the Pilot’s requirements and then respond accordingly, which could further delay the time it takes for brokerdealers to adjust their routing and trading algorithms. Accounting for all of this, the Commission intends that the proposed duration of the Pilot be long enough to encourage wide participation by all market participants (and discourage ‘‘waiting out’’ the Pilot) and thereby help ensure that the Pilot produces results that are more reliable, robust, and useful. The Commission also considered extending the Pilot period to two-years as suggested by several commenters, and as was recommended by the EMSAC, but continues to believe that the inclusion of the automatic sunset provision at the end of the first year is preferable because it will provide flexibility in the event that the Commission believes additional time is necessary to ensure the collection of a robust dataset with adequate statistical power for analysis, but will allow the Pilot to automatically end after one-year in the event that sufficient data is collected by that point with sufficient statistical power to allow for meaningful analysis. ability of the Pilot to obtain useful data. The Commission believes that sixmonth pre- and post-Pilot Periods are necessary to establish a baseline against which to compare the data collected during the Pilot Period and any postPilot effects following the conclusion of the proposed Pilot. Although the Commission appreciates the desire of market participants to expedite the Pilot while constraining costs, the Commission considers six months to be necessary to provide the targeted statistical power for obtaining baseline data. As discussed above, statistical power largely is a function of the number of observations over a specified period of time. In order to shorten the pre- and post-Pilot Periods (e.g., to three months instead of six months) while maintaining the same statistical power, the Commission would need to increase the number of securities in the Pilot by at least 120 securities. As discussed above and consistent with the comments it received, the Commission desires to limit, not increase, the number of securities included in the Pilot. Accordingly, the Commission is not adopting a shorter duration for the pre- and post-Pilot Periods. 3. Pre- and Post-Pilot Periods The Commission proposed a sixmonth pre-Pilot Period as well as a sixmonth post-Pilot Period.335 During those periods, the Commission proposed to require the equities exchanges to collect and make available the order routing datasets and Exchange Transaction Fee Summaries in order to provide necessary benchmark information against which researchers could assess the impact of the Pilot.336 Two commenters supported the proposed six-month pre-Pilot and postPilot data collection periods.337 In contrast, two commenters suggested adopting three-month long pre-Pilot and post-Pilot Periods.338 The Commission desires to implement the Pilot in a manner that imposes the least amount of costs on the exchanges without compromising the 4. Early Termination Proposed Rule 610T did not contain a specific provision regarding early termination of the Pilot. Several commenters recommended that the Commission develop specific criteria for evaluating the possibility that the Pilot may need to be terminated early.339 Some recommended that the Pilot specifically include a ‘‘kill switch’’ to effectuate an early termination.340 Several commenters supported the need for the Commission to address unanticipated negative consequences quickly,341 but one commenter cautioned that the Commission would need to act in a measured manner because the industry would need time to unwind the Pilot.342 One commenter suggested that the Commission might want to terminate the Pilot early if (1) it produced a ‘‘robust statistical sample set earlier than a year, such that [the Commission could] end the Pilot and proceed to adopt permanent rule changes’’ and (2) ‘‘if there is unintended impact from the Pilot that warrants a 335 See Proposing Release, supra note 2, at 13025– 26. See also Proposed Rule 610T(c). 336 Proposed Rule 610T(d) and (e). See also Proposing Release, supra note 2, at 13029, 13032. Primary listing exchanges will also be required to prepare and publicly post updated Pilot Securities Exchange Lists and Pilot Securities Change Lists for the duration of the Pilot Period and through the post-Pilot Period. Id. at 13027–28. The pre-Pilot data is intended to establish a baseline against which to assess the effects of the Pilot, while the post-Pilot Period is intended to help assess any post-Pilot effects following the conclusion of the Pilot. 337 See FIF Letter, at 7, 9; Healthy Markets Letter I, at 19. 338 See IEX Letter I, at 4; FIA Letter, at 4. PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 339 See e.g., SIFMA Letter, at 3; Issuer Network Letter I, at 4; State Street Letter, at 4; Cboe Letter I, at 28. 340 See Citi Letter, at 4; TD Ameritrade Letter, at 1, 5; Morgan Stanley Letter, at 4; Cboe Letter I, at 28–29; Vanguard Letter, at 3; STANY Letter, at 4; Angel Letter II, at 3. 341 See Schwab Letter, at 2; Cboe Letter I, at 29. 342 See TD Ameritrade Letter, at 5. See also Morgan Stanley Letter, at 4; SIFMA Letter, at 3. E:\FR\FM\20FER2.SGM 20FER2 5230 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations stoppage.’’ 343 Other commenters emphasized the need for the Commission to closely monitor the impact of the Pilot on retail investors in particular.344 For example, one commenter argued that if the Pilot data suggests ‘‘clear harm to the retail investor in . . . relevant execution quality metrics’’ like ‘‘quoted spread, depth of liquidity, intraday stock volatility, and opportunities for price improvement on impacted securities,’’ then the Pilot ‘‘should be immediately suspended.’’ 345 Another commenter urged the Commission to closely monitor the Pilot’s effect on thinlytraded stocks and establish ‘‘predetermined means for discontinuing the Pilot in the event that the reviewed data shows undue harm to market or execution quality.’’ 346 However, one commenter noted that the Commission is not obligated to ‘‘cease the [P]ilot if the costs to liquidity prove significant.’’ 347 The Commission acknowledges the concerns raised by commenters regarding the potential for unintended and unanticipated consequences to the equities markets that the Pilot may have. The Commission intends to carefully monitor for any such effects during the Pilot Period. However, the Commission does not believe that it is necessary to add a ‘‘kill switch’’ to Rule 610T because the Commission already has broad exemptive authority that obviates the need for a separate kill switch. For example, if at any time the Commission believes that the protection of investors may be compromised by the Pilot, the Commission has broad authority under Section 36 of the Exchange Act to modify or terminate the Pilot early.348 5. Inclusion of a Phase-In Period The Commission did not propose a phase-in period for the Pilot. Three commenters recommended a phase-in period without elaborating on its 343 See Vanguard Letter, at 3. See also Angel Letter II, at 3 (noting that the Pilot could be suspended quickly if ‘‘there is abundant evidence one way or the other about the results,’’ such as ‘‘a dramatic increase in market quality for one particular treatment group,’’ in which case ‘‘that particular group’s treatment could become the new rule,’’ or ‘‘if the pilot produces fast and unequivocal results showing harm to one particular treatment group, that treatment should be halted’’). 344 See Schwab Letter, at 2; Citi Letter, at 4. 345 See Schwab Letter, at 2. 346 See STANY Letter, at 4. 347 Verret Letter I, at 5. 348 See 15 U.S.C. 78mm (setting forth the Commission’s authority, by rule, regulation or order, to conditionally or unconditionally exempt persons, transactions or securities (or classes thereof) from any Exchange Act provision, rule or regulation if such exemption is necessary or appropriate in the public interest and is consistent with the protection of investors). VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 purpose, though they referenced the EMSAC’s recommendation for an initial three-month phase-in period involving 10 stocks.349 A different commenter did not believe that the EMSAC’s threemonth phase-in period was necessary.350 The Commission has considered these comments and believes a phase-in approach is not necessary and unnecessarily would add to the length of the Pilot. Although such an approach would allow the 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 continues to believe that, because exchange fees can become immediately effective upon their filing with the Commission, the markets and market participants are accustomed to dealing with frequent exchange fee changes in which fees can change on all stocks at once, or only for a subset of stocks or a subset of trading mechanisms. Accordingly, exchanges and market participants should be capable of accommodating the terms of the proposed Pilot with the advance notice contemplated by the Pilot. Further, although exchanges would be required to collect and report certain data, the proposed Pilot would not necessitate changes to exchange trading systems, and therefore, the Commission continues to believe a phased implementation schedule is not necessary to test the types of changes contemplated by the Pilot. E. Data The Commission proposed that certain data be collected and made publicly available in order to facilitate the Commission’s and researchers’ ability to assess the impact of the Pilot, as well as to promote transparency about the Pilot Securities and to provide basic information about equities exchange fees and changes to those fees during the Pilot.351 The Commission is adopting the Pilot Securities Lists, the Exchange Transaction Fee Summary, and the order routing datasets subject to the modifications described below. 1. Pilot Securities Exchange Lists and Pilot Securities Change Lists As proposed, the Commission would publish, approximately one month 349 See State Street Letter, at 4; TD Ameritrade Letter, at 4; STANY Letter, at 3. See also 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’’). 350 See AJO Letter, at 2. 351 See Proposing Release, supra note 2, at 13026. PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 before the start of the Pilot Period, the initial List of Pilot Securities, which identifies the securities in the Pilot and their designated Test Group (or the Control Group).352 Thereafter, each primary listing exchange 353 would publish a freely and publicly available daily Pilot Securities Exchange List of the Pilot Securities that are primarily listed on its exchange and also publish a Pilot Securities Change List of the cumulative changes to that list, and keep both lists available on their websites for five years.354 The Commission received one comment that was supportive of the proposed requirements for disseminating and updating the Pilot Securities lists, including the pipedelimited ASCII file format and the five year retention period.355 This commenter also had ‘‘no objections to the proposed posting requirements, providing there is adequate data security and controlled access.’’ 356 The Commission is not adopting any new requirements for data security with respect to the Pilot Securities lists because that data is not private or otherwise sensitive in nature and because the exchanges already are subject to Regulation SCI governing access to their systems that support trading.357 For the reasons stated in the Proposing Release, the Commission is adopting as proposed the requirements in Rule 610T(b) for the primary listing exchanges to publicly post on their websites downloadable files containing the Pilot Securities Exchange Lists and the Pilot Securities Change Lists.358 The Commission is adding one additional 352 See Proposed Rule 610T(b)(1). See also Proposing Release, supra note 2, at 13026. When the Commission publishes this list, the pre-Pilot Period will have been in place for approximately five months. 353 See Proposed Rule 610T(b)(1)(iii) (defining ‘‘primary listing exchange’’ for purposes of Rule 610T). 354 See Proposing Release, supra note 2, at 13027– 28. The Commission notes that the proposed language in Rule 610T(b)(3)(i) has been modified slightly. As proposed, Rule 610T(b)(3)(i) contained the phrase ‘‘throughout the duration of the Pilot, including the post-Pilot Period.’’ As adopted, the phrase ‘‘throughout the end of the post-Pilot Period’’ is being substituted for the phrase ‘‘throughout the duration of the Pilot, including the post-Pilot Period’’ to simplify the rule text without substantively changing the applicability of the posting requirement. 355 See FIF Letter, at 5. 356 Id. 357 See 17 CFR 242.1001(a)(1). SCI systems include all computer, network, electronic, technical, automated or similar systems of, or operated by or on behalf of, an SCI entity that directly support activities such as trading and order routing, among other things. 17 CFR 242.1000. 358 See Proposing Release, supra note 2, 13026– 28. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations field, ‘‘stratum code,’’ to both lists.359 As discussed in the Proposal and above, the Commission will stratify Pilot Securities as it assigns them to the Test Groups and Control Group to ensure that each group has a similar composition, which facilitates comparison across groups.360 As it does so, the Commission will assign a stratum code to each Pilot Security that identifies that security’s liquidity strata. The code is a static value and, as such, will remain constant throughout the Pilot. The Commission will include this stratum code on the initial List of Pilot Securities that it disseminates. To link each Pilot Security and its stratum code, the Commission is requiring the primary listing exchanges to include this data element on each Pilot Securities Exchange List and Pilot Securities Change List. Including this field on each list will clearly identify each Pilot Security’s liquidity stratum, thereby allowing researchers to control for the fact that within some liquidity strata, the ratio of Test Group stocks to Control Group stocks is lower than it is for others, which should facilitate analysis of the Pilot’s data. 2. Exchange Transaction Fee Summary As proposed, each exchange that trades NMS stocks would be required to compile, update monthly, and make freely and publicly available a dataset using an XML schema published on the Commission’s website that contains specified information on its fees and fee changes during the Pilot.361 In particular, each exchange would identify, among other things, 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, as well as the Pilot Group (i.e., 1, 2, or Control) that applies to the 359 The Commission is also modifying the name of the field specified in proposed Rule 610T(b)(2)(ii)(E). The Commission proposed the field be named ‘‘Test Group.’’ As adopted, the field will be named ‘‘Pilot Group’’ to provide additional clarity. 360 See Proposing Release, supra note 2, 13019, 13051. 361 The Commission notes that the proposed language in Rule 610T(e) has been modified slightly. As proposed, Rule 610T(e) contained the phrase ‘‘each national securities exchange that trades NMS stocks. . . .’’ As adopted, the clause ‘‘that facilitates trading in NMS stocks’’ is being substituted for the phrase ‘‘that trades NMS stocks’’ to clarify that exchanges facilitate trading by their members in NMS stocks. In addition, the Commission notes that, as proposed, Rule 610T(e) contained a parenthetical which explained that data requirements set forth in subsection (e) were ‘‘applicable to securities having a price greater than $1.’’ As adopted, that parenthetical has been modified slightly to clarify that the requirements of subsection (e) apply to ‘‘securities having a price equal to or greater than $1.’’ VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 fee being reported.362 Exchanges also would 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, reported separately for each participant category (registered market makers or other market participants), Test Group, displayed/non-displayed, and top/depth of book.363 In the Proposing Release, the Commission asked several questions about the Exchange Transaction Fee Summary including questions about the proposed form, content, and posting requirements. Commenters supported requiring the equities exchanges to publicly post the Exchange Transaction Fee Summary as well as the proposed fields included in the summaries.364 Among those questions included in the Proposing Release, the Commission specifically asked commenters to suggest types of information that should be captured on the Exchange Transaction Fee Summary that would be useful to make comparisons across exchanges, and a few commenters offered specific suggestions.365 Specifically, two commenters requested that the Exchange Transaction Fee Summary include the number of pricing tiers used by the exchanges, the number of firms that were in each tier, and information on transaction costs in each tier.366 Similarly, another commenter suggested that the Exchange Transaction Fee Summary provide context on the Base and Top Tier fees by including the number of member firms, by participant type, that qualified for the Base and Top Tier fees and rebates reported on the Exchange Transaction Fee Summary.367 While the Commission appreciates these suggestions, it believes that adding more granular details about specific pricing tiers, which can vary greatly by exchange, would overcomplicate the fee summaries such that it would be difficult to standardize the information, thereby rendering the data less useful to researchers when comparing exchanges for purposes of the Pilot.368 Further, with respect to the number of members 362 See Proposed Rule 610T(e). See also Proposing Release, supra note 2, at 13029–30. 363 See Proposing Release, supra note 2, at 13030. See also Rule 610T(e). 364 See, e.g., SIFMA Letter, at 6; Better Markets Letter, at 7; Spatt Letter, at 4–5; and IEX Letter I, at 9. 365 See Proposing Release, supra note 2, at 13031. 366 See CFA Letter, at 5; Healthy Markets Letter I, at 22. 367 See IEX Letter I, at 9. 368 See Proposing Release, supra note 2, at 13030. PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 5231 qualifying for the Base and Top Tier fees and rebates, the Commission believes that the information that exchanges will report on average and median realized fees and rebates should be sufficient for purposes of analyzing the Pilot’s results, including any changes in order routing. We believe that the disclosure of the number of members qualifying for the Base and Top Tier fees and rebates would also require other disclosures (including, e.g., such member’s trade volume at each tier) in order to provide context to the information. Providing all of these additional data points would increase the costs and complexity of the Pilot. The Commission however, does not believe that the incremental benefit of this information justifies additional costs and complexities. Accordingly, the Commission will not be requiring the exchanges to include additional information on their pricing tiers. As part of its request for comment in the Proposal on what additional information would be helpful to include in the Exchange Transaction Fee Summary, the Commission specifically asked whether other measures beyond average and median fees should be selected.369 In response, one commenter recommended that in addition to requiring the average and median per share fees and rebates, the Commission also require the ‘‘mode’’ per share fee and rebate (i.e., the most frequently paid fee and rebate by each exchange’s members), because the commenter believed it would ‘‘enable a more accurate comparison of the fees and rebates most often applied by each exchange.’’ 370 The Commission appreciates this suggestion, but continues to believe that for purposes of this Pilot, the proposed information on mean and median realized fees and rebates will be sufficient for purposes of analyzing the results of the Pilot, including any changes in order routing. Lastly, a few commenters requested that the Exchange Transaction Fee Summary information be hosted at a central location rather than posted on the exchanges’ individual websites.371 While the Commission recognizes that it could be more convenient if the information were made available in one central location, because the data must be made available unencumbered and in a standardized XML schema format, the Commission believes that any person would readily be able to obtain and combine the summaries posted by each equities exchange with minimal effort. 369 See Proposing Release, supra note 2, at 13031. RBC Letter I, at 5. 371 See Better Markets Letter, at 7; CFA Letter, at 5; Healthy Markets Letter I, at 23. 370 See E:\FR\FM\20FER2.SGM 20FER2 5232 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations Because of this, the Commission is not adopting a requirement on exchanges to consolidate this material and make it available in a central location. 3. Order Routing Data To facilitate an examination of the impact of the Pilot on order routing behavior, execution quality, and market quality, the Commission proposed to require throughout the Pilot (including during the pre-Pilot Period and the postPilot Period) that each equities exchange prepare and publicly post a monthly downloadable file containing sets of anonymized order routing data in accordance with the specifications proposed in Rule 610T(d).372 Specifically, Rule 610T(d) would require exchanges to provide the order routing information in two datasets— one for liquidity-providing orders and one for liquidity-taking orders, both aggregated by day, security, and brokerdealer.373 The Commission further proposed that equities exchanges would be required to anonymize the identity of individual broker-dealers before making the order routing datasets publicly available, using an anonymization key provided by the Commission.374 A number of commenters supported the proposed requirements regarding the order routing datasets, expressing the belief that these requirements would provide researchers with useful data that would facilitate an analysis of the impact of transaction fees and rebates on order routing, execution quality, and market quality.375 Several commenters believed the data would enable the Commission to make data-driven decisions on potential future equity market structure policy initiatives.376 Others specifically supported the website posting requirement to make the data freely and publicly available.377 372 See Proposing Release, supra note 2, at 13031. Rule 610T(d)(1)–(2). The Commission notes that the proposed language in Rule 610T(d) has been modified slightly. As proposed, Rule 610T(d) contained the phrase ‘‘each national securities exchange that trades NMS stocks. . . .’’ As adopted, the clause ‘‘that facilitates trading in NMS stocks’’ is being substituted for the phrase ‘‘that trades NMS stocks’’ to clarify that exchanges facilitate trading by their members in NMS stocks. 374 See Proposing Release, supra note 2, at 13032. 375 See, e.g., Barnard Letter, at 1; CII Letter, at 2– 3; Better Markets Letter, at 7; Invesco Letter, at 1– 2; Wellington Letter, at 1; CFA Letter, at 5; Clearpool Letter, at 6; ICI Letter I, at 5; RBC Letter I, at 5; Joint Pension Plan Letter, at 2; Oppenheimer Letter, at 2; IEX Letter I, at 10; Capital Group Letter, at 4; Healthy Markets Letter I, at 24; Angel Letter, at 1; Verret Letter I, at 1, 7; Spatt Letter, at 3. 376 See, e.g., Clark-Joseph Letter, at 1; Nuveen Letter, at 2; NYSTRS Letter, at 1; RBC Letter I, at 2; Invesco Letter, at 2; CFA Letter, at 1; State Street Letter, at 2; AJO Letter, at 1; Vanguard Letter, at 2. 377 See, e.g., AJO Letter, at 3–4; ICI Letter I, at 5; CFA Letter, at 5. 373 Proposed VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 In addition, other comments addressed matters such as: Separating held and not-held orders in the datasets, separating principal from agency orders in the datasets, and not collecting ‘‘parent order’’ routing information.378 Other commenters expressed concern that not collecting similar data from non-exchange venues would decrease the utility of the data and provide the Commission with an incomplete picture of the Pilot’s impact.379 Other commenters were critical of the proposed order routing data requirements because they believed, despite the anonymization and aggregation requirements, that publicly available data could be reverse engineered to reveal commerciallysensitive information about individual broker-dealers.380 These concerns are discussed further, below. a. Held and Not-Held Orders The Commission proposed to require exchanges to separate out held and notheld orders in the order routing datasets and requested comment on whether orders should be separated out in that manner and whether there are certain shared characteristics of such orders that would be beneficial to assess when analyzing the Pilot data.381 In response, several commenters stated that exchanges currently do not capture whether orders are held or not held.382 Two commenters added that capturing that information would impose additional costs on market participants who would need to update their systems to include this information in the order messages they send to exchanges, as well as impose additional costs on exchanges to capture and report whether an order is held or not held.383 The Commission has considered these comments and has determined not to require the exchanges to separate held and not-held orders in the order routing datasets. In proposing to require capture of held and not-held orders, the Commission sought to include a data field that is readily available to and currently captured by exchanges and that would provide insight into the capacity in which a broker-dealer is handling orders. In turn, that information could be useful to assess the broker-dealer’s routing of those orders. For example, orders that are ‘‘held to the market’’ may be routed 378 See infra notes 382, 386, and 395–397. 379 See supra notes 41–46. 380 See infra note 404. 381 See Proposing Release, supra note 2, at 13031, 13033. 382 See FIA Letter, at 3 fn. 8; FIF Letter, at 6; Citadel Letter, at 3 fn. 5; IEX Letter I, at 10. 383 See FIA Letter, at 3 fn. 8; IEX Letter I, at 10. PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 differently than orders that are ‘‘not held’’ and for which the broker-dealer exercises more discretion in their execution. By separating out these orders, researchers would have access to an additional metric that potentially could be helpful in analyzing the Pilot data and parsing the results. As commenters have indicated, however, broker-dealers do not transmit this information to exchanges and exchanges thus do not capture it. The Commission does not wish to impose new data collection requirements with respect to this Pilot data field, and therefore is not adopting this element. However, as detailed below, the Commission is adopting a new requirement for exchanges to instead separate out orders based on their order capacity (e.g., principal, riskless principal, and agency), which information currently is transmitted to exchanges by broker-dealers.384 b. Principal Order Flow and Order Capacity In response to the Commission’s question in the Proposing Release about what data are necessary to facilitate an analysis of the potential conflicts of interest associated with transaction fees and rebates,385 several commenters requested that the order routing datasets exclude orders marked as principal or riskless principal because the potential conflicts of interest posed by exchange transaction fees and rebates pose a potential harm primarily when brokerdealers are routing orders for customers in an agency capacity and may be unduly influenced by exchange fees and rebates to the detriment of obtaining the best execution for the customer’s order.386 To the extent a broker-dealer is routing its own proprietary order and is unduly influenced by exchange fees and rebates, then, at worst, it would only be harming itself. In other words, as noted by one commenter, ‘‘a broker may route principal orders to maximize rebates and minimize access fees which would not be considered a conflict of interest.’’387 Without separating out orders by their order capacity, one commenter argued that the order routing datasets could generate ‘‘misleading results’’ because the trades of various market participants could be aggregated at the same broker 384 See, e.g., FIX Tag 528 (Order Capacity) under FIX 4.4 and Fix Tag 47 (Rule80A) under TIF 4.2, available at https://btobits.com/fixopaedia/ index.html. 385 See Proposing Release, supra note 2, at 13033. 386 See FIA Letter, at 3; SIFMA Letter, at 8; Citadel Letter, at 3; Citi Letter, at 5–6. 387 SIFMA Letter, at 8. See also Cboe Letter I, at 3 fn. 8. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations due to ‘‘direct market access arrangements,’’ and these orders would be indistinguishable from customer orders routed by that broker.388 In this way, agency orders (which are subject to conflicts of interest concerns that are relevant to the Pilot) could be mixed in with principal orders (which are not subject to conflicts of interest concerns that are relevant to the Pilot) and the inability to distinguish them could cloud the results. Accordingly, one commenter recommended separating principal and agency orders in the order routing datasets, while continuing to include both types of order flow.389 The commenter believed that specifically identifying the extent to which orders are principal orders or agency orders ‘‘would further facilitate the analysis of order flow and a better understanding of the efficacy of the [P]ilot.’’ 390 After careful consideration of these comments, the Commission has determined to require exchanges to separate out orders by order capacity (e.g., principal, riskless principal, and agency). Requiring exchanges to separately aggregate orders according to their order capacity will allow researchers to more precisely parse the data as recommended by several commenters, particularly when analyzing the potential conflicts of interest in broker-dealer routing presented by exchange fee-and-rebate pricing models. For example, researchers will be able to separate out and exclude principal orders when studying conflicts of interest, as conflicts of interest do not present the potential for harmful impact with respect to such orders as they do for agency orders where the broker-dealer is routing for others. In addition, researchers will be able to include orders of any order capacity when studying other questions, such as intermediation, queue length, and time to execution, as such issues are relevant to orders of any capacity. Further, the Commission believes that principal orders should be included in the order routing datasets, as the Pilot is designed to assess more than just conflicts of interest between brokers and their customers in order routing. It also is designed to observe the impact of exogenous shocks to transaction fees and rebates on execution quality and market quality broadly. Accordingly, the Pilot will provide the opportunity to obtain useful data on matters such as 388 See 389 See FIA Letter, at 3 fn. 9. Clearpool Letter, at 6. 390 Id. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 intermediation, queue length, and time to execution; the impact of fees and rebates on liquidity adding and liquidity removing activity; the relationship between payment of rebates on making activity (or taking activity on an inverted exchange) and fee levels for taking activity (or making activity on an inverted exchange); and the impact of fees and rebates on order routing behavior generally. Consideration of these issues directly implicates principal order flow and, as such, the Commission believes it is critical for the aggregated volume statistics included in the order routing datasets to include principal orders. c. Order Designation In response to questions in the Proposing Release on specific measures and data that would facilitate an analysis of the effects that changes to transaction fees and rebates have on order routing behavior, execution quality, and market quality, several commenters recommended that the Commission analyze the impacts of fees and rebates on various aspects of the execution quality of investors’ limit orders.391 Further, on the impact that prohibiting rebates may have on quoted spreads and displayed liquidity, commenters also disagreed about the willingness and ability for investors, other than those that are motivated by rebate capture, to post liquidity in order to capture the quoted spread.392 In addition, in attempting to utilize transaction data to analyze the impact of reduced or eliminated rebates, one commenter recommended that the dataset exclude orders that presently are not eligible for rebates, such as those designated for participation in opening and closing auctions.393 While analyzing the impact of reduced or eliminated rebates is one potential analysis for which the Pilot’s data may be useful, the Pilot’s purpose is broader in scope. As such, the Commission continues to believe that it is appropriate for the order routing datasets to capture all liquidityproviding and liquidity-taking orders. However, in response to the commenters’ recommendations discussed above and in an effort to ensure that the order routing data be as useful as possible and facilitate an analysis of the impacts of the Pilot, the 391 See, e.g., Fidelity Letter, at 8; ICI Letter I, at 5; SIFMA Letter, at 5–6; IEX Letter I, at 2. See also Proposing Release, supra note 2, at 13033. 392 See supra notes 224–225 and accompanying text. 393 See Mulson Letter I. PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 5233 Commission has determined to further refine the order routing dataset by requiring exchanges to report separately the volume statistics by ‘‘order designation,’’ which will require exchanges to separate out post-only orders as well as auction orders. Separating the volume statistics in this manner will allow isolation of the cumulative number of post-only orders, which are limit orders that include instructions to never remove liquidity, and may be more reflective of a rebatesensitive market participant. With the data further refined in this manner, the Commission believes the data will be more useful in analyzing the impacts of the Pilot both in comparing the pre-Pilot data to the Pilot data and in comparing the data across the Test Groups and Control Group during the Pilot. In particular, the further refinement will facilitate assessment of the impact of the Pilot on the willingness of investors to passively post orders and their ability to obtain queue priority (i.e., represent the best price in the exchange’s limit order book) and capture the quoted spread when doing so (i.e., buy on the bid and sell on the offer).394 Furthermore, with respect to auction orders, which are orders specifically designated for execution in either an opening or closing auction, instead of separating out auction orders, exchanges may instead elect to simply exclude them from the order routing datasets, as an alternative means of complying with the order designation requirement. The Commission has determined to allow the exchanges to choose between these two approaches so that they may choose the option that is the least burdensome. If exchanges choose to include auction order data in the order routing datasets, they will need to comply with the requirement by separating orders by order designation, so that these orders may be separately identified and accounted for in any analyses of the Pilot’s data. The ability to isolate auction orders recognizes the uniqueness of the auction process and will facilitate separation of that data in order to study the Pilot’s impact on trading during the regular market session without potentially biasing the results by including auction activity, for which different trading rules, order types, and fees apply. 394 See E:\FR\FM\20FER2.SGM supra Section II.C.10. 20FER2 5234 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations d. Broker Routing Data Several commenters addressed the utility of obtaining order routing data from broker-dealers that route customer orders in assessing the potential conflicts of interest related to transaction fees and rebates.395 Several of these commenters explained that obtaining data from broker-dealers (in addition to or in place of obtaining such data from exchanges) would facilitate an analysis of the impact of transaction fees and rebates on order routing behavior and potential conflicts of interest from the perspective of customers, as the brokers would have information that can be used to assess the execution quality of a ‘‘parent order’’ and would provide information on the broader universe of potential routing destinations, including non-exchange trading venues.396 One commenter added that investors needed to conduct their own analyses of their orders to understand the impact of the Pilot on their brokers.397 The Commission is not requiring data collection from broker-dealers or nonexchange trading venues. The order routing datasets will include aggregated data from exchanges (as opposed to individual order level data from brokerdealers) representing the sum totals of the ‘‘child’’ orders that are processed by an exchange. While the Pilot will not capture the entire lifecycle of a ‘‘parent’’ order from its inception, the Commission believes that its approach will minimize the implementation costs on market participants while ensuring that the Commission and researchers have useful data on child orders to observe the impacts of introducing exogenous shocks to exchange transaction fees and rebates. The order routing data provided by the exchanges represents the information that would be directly correlated to these exogenous shocks. Data that is available elsewhere 398 will provide the ability to understand any observed changes in order flows or market share to nonexchange venues during the Pilot. Further, the Commission agrees with the commenters that noted that market participants need to conduct their own analyses of their own order flow. If market participants conduct their own analyses, including parent order-level 395 See, e.g., Healthy Markets Letter I, at 24–25; Pragma Letter, at 3; NYSE Letter I, at 9–10; NYSE Letter II, at 12–13; Viable Mkts Letter, at 2; Babelfish Letter, at 3. 396 See e.g., Healthy Markets Letter I, at 24–25; Pragma Letter, at 3; NYSE Letter I, at 9–10; NYSE Letter II, at 12; Viable Mkts Letter, at 2. 397 See Babelfish Letter, at 3. 398 See FINRA OTC Transparency Data, available at https://otctransparency.finra.org/. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 analyses, and wish to provide that information to the Commission and the public, the Commission would be able to consider the information in assessing the Pilot’s ultimate impact on order routing behavior, execution quality, and market quality. The Commission encourages market participants to conduct analyses and make the results of their analyses public. The Commission also encourages any interested party that prepares an analysis of the Pilot to submit it to the Commission for posting on the Commission’s website.399 e. Directed Orders Two commenters recommended that the order routing datasets identify whether orders are directed or nondirected.400 One of these commenters believed that directed orders do not feature ‘‘the same level of discretion and conflicts of interest that are the primary focus of the’’ Pilot.401 After careful consideration of these comments the Commission has determined not to require the order routing datasets to identify directed orders. The Commission recognizes that researchers may be interested in isolating orders directed by customers to specific exchanges because these orders may not be subject to the same potential conflicts of interest that may be present when a broker chooses where to route a customer order. However, separating out directed orders in the datasets (which report aggregated data and not order-byorder data) would require exchanges and broker-dealers to incur additional costs in preparing the Pilot’s order routing data. Further, the Pilot is designed to assess more than just conflicts of interest between brokers and their customers in order routing, and separate identification of directed and non-directed orders is not germane to the other questions the Pilot is designed to explore. Accordingly, the Commission believes that the additional implementation costs that adding such a requirement would impose are not justified by any benefits that may accrue from identifying, on an aggregated basis, directed orders in the order routing data. f. Utilizing the Consolidated Audit Trail Two commenters recommended that, instead of requiring separate order routing datasets, the Commission instead use data that the equities exchanges will report to the 399 See supra note 302 and accompanying text. Healthy Markets Letter I, at 23–24; Clearpool Letter, at 6. 401 Healthy Markets Letter I, at 23. 400 See PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 Consolidated Audit Trail (‘‘CAT’’).402 In the Proposing Release, the Commission stated that if the equities exchanges are reporting to the CAT at the time the Pilot commences, they would be able to compile the order routing datasets by utilizing the data they collect pursuant to the CAT national market system plan.403 However, there have been delays in the development and building of the CAT, and the reporting required by the first phase of the CAT NMS Plan has been delayed. Although the exchanges and FINRA have recently begun to report certain data to the CAT central repository, they continue to work to fully implement the first phase of the CAT NMS Plan, including linkages between reported events and regulators’ query functionality. The Commission believes that it is important to proceed with the Pilot and not delay the Pilot until the exchanges have begun full reporting to the CAT and the CAT operates in a manner that would facilitate the data analysis contemplated by the Pilot. g. Anonymization and Public Availability Several commenters expressed concerns about having the exchanges publicly post the order routing datasets, despite the requirement that the exchanges anonymize the identities of broker-dealers before making the datasets publicly available. These commenters believed that the order routing data could potentially be ‘‘reversed engineered’’ such that market participants might be able to ascertain the identities of individual brokerdealers in some circumstances.404 In contrast, one commenter acknowledged that ensuring confidentiality is ‘‘critical’’ and was ‘‘pleased to see that the SEC has recognized this in proposing anonymizing certain of the proposed data to protect confidential information.’’ 405 Of the commenters concerned about the potential for reverse engineering, one of these commenters provided an example of how the information could 402 See Citadel Letter, at 3; TD Ameritrade Letter, at 6. In response to the Commission’s solicitation of comment in the Proposing Release on whether the CAT repository, if it were operational, would provide sufficient data to evaluate the Pilot, one commenter stated that it believed the data reported from the CAT would provide the necessary information with respect to order routing data. See FIF Letter, at 2. 403 See Proposing Release, supra note 2, at 13031 n. 172 and accompanying text. 404 See, e.g., FIA Letter, at 3; Virtu Letter, at 7– 8; SIFMA Letter, at 6; FIF Letter, at 2; Citadel Letter, at 4; Citi Letter, at 6; TD Ameritrade Letter, at 5; STANY Letter, at 5; IEX Letter I, at 10; Credit Suisse Commentary, at 6; Morgan Stanley Letter, at 4. 405 See Clearpool Letter, at 6–7. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations be reverse engineered if ‘‘a market participant could direct a large order in a particular symbol to a specific brokerdealer, and then identify the presence of that order’’ in the order routing datasets.406 This commenter added that market participants may also be able to compare the order routing datasets with reports published pursuant to 17 CFR 242.605 (Rule 605 of Regulation NMS) to determine the identity of brokerdealers.407 Once a broker-dealer’s identity is likely known, this commenter believed that competitors could use the order routing datasets to discern that broker’s ‘‘(a) market share and activity in a given security, (b) overall routing practices, and (c) relative aggressiveness or passiveness in specific securities.’’ 408 This commenter also believed that strategies used by institutional investors that are customers of broker-dealers ‘‘may also be susceptible to reverseengineering.’’ 409 Another commenter added that it believed ‘‘market participants and others will be able to identify certain broker-dealers routing strategies by comparing the Pilot data to publicly available 17 CFR 242.606 (Rule 606) disclosures, or by other means,’’ although it did not specify those other means.410 Several of the commenters that expressed concern about the public availability of the order routing data, despite the proposed anonymization requirements, recommended approaches to address their concerns. Some of these commenters stated that the Commission should receive order routing data at the broker-dealer level, but that the public should only have access to data that is further aggregated, such that the data would include statistics for firms of similar types or business models, or simply aggregate all orders received by the exchange.411 However, in contrast, two commenters noted that the order routing data aggregated by broker would be important to analyses undertaken by researchers and therefore should be made more broadly available.412 Two other commenters suggested that if the order routing data aggregated by broker would be helpful for researchers, the Commission should provide that data to researchers only if they sign a non406 Citadel 407 See 413 See Letter, at 4. 408 Id. 409 Id. 410 See TD Ameritrade Letter, at 5. e.g., Citadel Letter, at 4; Credit Suisse Commentary, at 6; IEX Letter I, at 10; Morgan Stanley Letter, at 4; STANY Letter, at 5; SIFMA Letter, at 6–7; TD Ameritrade Letter, at 5; FIF Letter, at 7. 412 See Lipson Letter, at 1; Spatt Letter, at 3. 411 See, 18:36 Feb 19, 2019 Citadel Letter, at 5; Citi Letter, at 6. SIFMA Letter, at 7; STANY Letter, at 5; Fidelity Letter, at 11. 415 Several commenters expressed concerns that the equities exchanges would have access to the Broker Dealer Anonymization Key. See, e.g., Virtu Letter, at 8; SIFMA Letter, at 7; FIF Letter, at 2; STANY Letter, at 5; IEX Letter I, at 10; Morgan Stanley Letter, at 4. As adopted, the exchanges would not have access to the Broker Dealer Anonymization Key, which addresses the commenters’ concerns. 414 See id. VerDate Sep<11>2014 disclosure agreement.413 In addition, three commenters recommended that if order routing datasets are to be made publicly available on exchange websites, they should be subject to a 120 day delay instead of a 30 day delay.414 The Commission appreciates commenters’ concerns about the need to safeguard the confidentiality of the order routing datasets. The Commission agrees that if market participants were able to identify specific broker-dealers in the datasets, there is the potential that the data could be reverse engineered to reveal proprietary information about trading attributable to specific broker-dealers. The Commission has revised its approach to eliminate the public availability of the order routing datasets to help address these concerns, while still furthering the goals of the Pilot. More specifically, to address commenters’ concerns with the public availability of the data and the exchanges’ role in preparing it for dissemination, the Commission is not adopting the requirement for the exchanges to anonymize 415 and publicly post the order routing data. The Commission, however, believes it is important for the Commission itself to have access to the order routing dataset, so the Commission can consider the effects of rebates and transaction-based fees on order routing behavior, execution quality, and market quality. Accordingly, given the potential for reverse engineering, the Exchanges will be required to provide order routing data directly to the Commission. While the Commission anticipated benefits from market participants, researchers, and others in conducting independent analysis of the Pilot and its impacts, the Commission has carefully balanced the concerns about possible reverse engineering of the order routing data against these benefits. The Commission believes that it can assess the effects of the transaction-fee and rebate models on order routing behavior and thereby achieve this goal of the Pilot without requiring public disclosure of order routing data attributable to a specific broker-dealer. The Commission is not adopting the requirement for exchanges to make public in an anonymized form the order Jkt 247001 PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 5235 routing data, but the exchanges will instead identify individual brokerdealers by MPID or CRD number in the order routing data they send to the Commission. The Commission recognizes that order routing data attributable to a specific broker-dealer is particularly sensitive and is non-public information.416 The Commission, however, intends to make public analyses, results, and studies using the order routing data. In determining whether and how to make public this or any other information, the Commission will be sensitive to the concerns articulated by commenters and will consider steps such as aggregating or anonymizing order routing data. Specifically, the Commission is adopting a requirement for each exchange to prepare and transmit directly to the Commission, in pipedelimited ASCII format, no later than the last day of each month, a file containing sets of order routing data.417 While the Commission is not requiring the exchanges to anonymize the data and thus will no longer provide exchanges with the Broker-Dealer Anonymization Key, the Commission is requiring each exchange to provide its order routing data by broker-dealers’ CRD number and MPIDs in order to provide aggregated broker-dealer level data to the Commission to facilitate its analysis of the data.418 The Commission believes that the suggested alternative to further aggregate the datasets, for example, to combine the data of several firms together or combine all firms together, would seriously compromise the ability of researchers to investigate the potential conflicts of interest in routing because researchers would not be able to see an individual broker-dealer’s orders across all exchanges and thereby would not be able to assess how any particular broker-dealer may have been influenced by fees and rebates at 416 The Commission will deem broker-dealer identifying order routing data as being subject to a confidential treatment request under 17 CFR 200.83 without the need to submit a request. The Freedom of Information Act provides at least two potentially pertinent exemptions under which the Commission has authority to withhold certain information. See 5 U.S.C. 552(b)(4) and (8). 417 See Proposing Release, supra note 2, at 13033 (asking whether commenters think exchanges should be required to report the datasets directly to the Commission). Further, in its Proposal, the Commission noted that it considers the order routing data to be ‘‘regulatory’’ information and proposed to prohibit exchanges from accessing or using the information for commercial purposes. See id. at 13032. The Commission is adopting as proposed the prohibition on exchange personnel accessing the data for commercial purposes, as exchanges will have access to the information. 418 See id. at 13032. See also Rule 610T(d)(1)(iv) and (d)(2)(iv). E:\FR\FM\20FER2.SGM 20FER2 5236 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations different exchanges.419 Because brokerdealer level data already is consolidated (i.e., the data would not separate out individual customer activity), adding another level of consolidation by grouping broker-dealers together would cloud insight into the potential conflicts of interest question, rendering the data potentially useless for the purpose of studying conflicts of interest. Accordingly, the Commission continues to believe that it needs access to the order routing data in its proposed form, without further aggregation of the data.420 F. Implementation The Commission proposed to publish a notice setting forth the start and end dates of the pre-Pilot, Pilot, and postPilot Periods.421 If applicable, the Commission also would publish a notice if it determines to suspend the one-year sunset of the Pilot Period.422 As discussed in the Proposing Release, 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. Thus, 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 commence at the conclusion of the Pilot and would end six months from the post-Pilot Period’s start date. The Commission proposed to publish the initial notice setting forth the start date for each of the Pilot’s three periods, and do so with a one-month minimum advance notice in order to allow the equities exchanges to finalize their preparations for the Pilot’s pre-Pilot Period, as well as provide at least a seven-month advance notice to market participants of the start date on which 419 See, e.g., CFA Letter, at 5 (believing that ‘‘breaking the data out at the broker-dea[le]r level will permit a closer examination of how different broker-dealers may change their order routing behavior in response to changes in fees and rebates at each exchange.’’); Lipson Letter, at 1; Spatt Letter, at 3; Better Markets Letter, at 7; Healthy Markets Letter I, at 24 fn. 87. 420 The Commission notes that the proposed language in Rule 610T(d)(1)(vi)(F), (d)(1)(xii)(H), and (d)(2)(vi)(F) has been modified slightly. As proposed, Rule 610T(d)(1)(vi)(F) and Rule 610T(d)(2)(vi)(F) both noted that the order size code at the largest share bucket was ‘‘> 10,000.’’ As adopted, the largest share bucket order size code will be reflected as ‘‘≥ 10,000 share bucket.’’ In addition, as proposed, Rule 610T(d)(1)(xii)(H) set forth a time frame of ‘‘> 30 minutes of order receipt.’’ As adopted, that time frame will be clarified to state that the time frame is ‘‘≥30 minutes of order receipt.’’ 421 See Proposing Release, supra note 2, at 13033. 422 See id. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 the Pilot’s conditions would go into effect.423 One commenter agreed that a onemonth period between the Commission’s notice and the start of the pre-Pilot Period would be ‘‘sufficient provid[ed] there are no changes to the Pilot securities lists and assigned test/ control groups.’’ 424 This commenter also agreed that the proposed sevenmonth period following the Commission’s notice would be ‘‘sufficient to prepare for the Pilot.’’ 425 However, this commenter requested that ‘‘any technical specification materials required to support implementation of the Pilot be reviewed with the industry and finalized in an expeditious manner, six months prior to the launch of the pre-Pilot data gathering phase,’’ which the commenter believed would ‘‘allow[ ] necessary time for industry firms to properly scope necessary development work and assign respective resources.’’ 426 Another commenter, however, did not believe that a one month period prior to the start of the pre-Pilot period would be sufficient for the industry to prepare and instead estimated that ‘‘the implementation of the pre-Pilot processing alone [would] take between three to four months.’’ 427 As discussed and addressed above, a few commenters recommended that the Pilot begin with a limited phase-in period with a small number of securities.428 After careful consideration of the comments received, the Commission continues to believe that the proposed implementation approach should provide adequate notice and time for those impacted by the Pilot to prepare for its requirements. The Pilot will begin with a six-month pre-Pilot period during which exchanges will not need to revise their fees to comply with the Pilot. At the conclusion of the pre-Pilot Period, exchanges will be required to revise any of their fees, which will apply to the Pilot Securities, that currently exceed the terms of the Pilot’s Test Groups. While the Exchange Act allows exchanges to file their fees for immediate effectiveness, exchanges may choose to preview their Pilot-related fee changes to their membership to provide them with additional time to adjust their order routing systems in response to those changes.429 The Commission 423 See id. at 13033–34. FIF Letter, at 7–8. 425 See id. at 8. 426 See FIF Letter, at 8. 427 See Cboe Letter I, at 21. 428 See supra notes 349–350 and accompanying text. 429 Although broker-dealers will need to account for different fee and rebate levels across two Test 424 See PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 does not anticipate that technical specification materials will be required to support implementation of the Pilot by broker-dealers because the Pilot solely concerns exchange fees which exchanges commonly adjust with little or no advance notice though immediately effective fee filings with the Commission. Therefore, brokerdealers currently are accustomed to accommodating the types of fee changes that would be required to comply with the requirements of the Pilot. Further, the Commission believes that publishing the start date for each of the Pilot’s three periods in advance, with at least one month’s advance notice, will provide the exchanges with time to prepare the three types of data required by the Pilot. First, because the Commission will determine the initial List of Pilot Securities, the exchanges will only need to perform the ministerial task of separating out their listed issuers and creating the Pilot Securities Exchange Lists and Pilot Securities Change Lists. Second, the Exchange Transaction Fee Summaries will require each exchange to summarize its own fees, for which it is solely responsible, in the specified XML format. For the initial Exchange Transaction Fee Summary, which would be posted prior to the start of trading on the first day of the pre-Pilot Period, exchanges would not need to include information that is calculated on a look-back basis, because the lookback period for that report would predate the pre-Pilot Period. Accordingly, preparation of the initial Exchange Transaction Fee Summary report should be streamlined.430 Finally, the order routing datasets, because they also are prepared on a look-back basis, will not need to be prepared until the end of the second month of the pre-Pilot Period (as it will contain data for the first month of the pre-Pilot period).431 Accordingly, the Commission continues to believe that the proposed time frames set forth in Rule 610T(c)(4) are sufficient to allow the equities exchanges and market participants to prepare for the requirements of the pre-Pilot Period, the Pilot Period, and the post-Pilot Period. Groups and the Control Group if exchanges maintain different fee and rebate levels across the treatment groups, they will have seven months before the start of the Pilot Period to update their execution algorithms, including to accommodate the prohibition on rebates and Linked Pricing in the no-rebate Test Group. 430 The fields in the Exchange Transaction Fee Summary that are calculated based on a look-back period to the prior month are: Rule 610T(e)(9) (month and year of the average and median figures); (12) average take/make; and (13) median take/make. 431 See Proposed Rule 610T(d). E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations No comments were received regarding the required notice to suspend the automatic sunset provision. Accordingly, the Commission adopts this aspect of the Pilot for the reasons outlined in the Proposing Release. G. The Commission’s Authority To Conduct the Pilot The Commission is adopting the Pilot in furtherance of its statutory responsibilities. In 1975, Congress directed the Commission, through enactment of Section 11A of the Exchange Act, to use its authority under the Exchange Act to facilitate the establishment of a national market system to link together the multiple individual markets that trade securities. Congress intended the Commission to take advantage of opportunities created by new data processing and communications technologies to preserve and strengthen the securities markets. Congress also directed the Commission to exercise this authority ‘‘to carry out’’ certain ‘‘objectives,’’ which include assuring: ‘‘economically efficient execution of securities transactions’’; ‘‘fair competition among brokers and dealers, among exchange markets, and between exchange markets and markets other than exchange markets’’; the ‘‘availability . . . of information with respect to quotations for and transactions in securities’’; and ’’ an opportunity . . . for investors’ orders to be executed without the participation of a dealer.’’ 432 In addition, the Exchange Act elsewhere requires that the rules of national securities exchanges (i) ‘‘provide for the equitable allocation of reasonable dues, fees, and other charges among its members and issuers and other persons using its facilities,’’ (ii) not be designed to ‘‘permit unfair discrimination between customers, issuers, brokers, or dealers,’’ and (iii) not ‘‘impose any burden on competition not necessary or appropriate in furtherance of the purposes of [the Act].’’ 433 432 15 U.S.C. 78k–1(a)(1)(C), (a)(2); see also id. sec. 78k–1(c)(1) (stating that self-regulatory organizations shall not make use of the mails or any means or instrumentality of interstate commerce to collect, process, distribute, publish, or prepare for distribution or publication any information with respect to quotations to assist, participate in, or coordinate the distribution or publication of such information, or to effect any transaction in, or to induce or attempt to induce the purchase or sale of, any such security in contravention of such rules and regulations as the Commission shall prescribe to ‘‘assure the . . . fairness and usefulness of the form and content of such information’’). 433 15 U.S.C. 78f(b)(4), (b)(5), (b)(8). The Commission also has authority to adopt the Pilot pursuant to Exchange Act Sections 17(a) [15 U.S.C. 78q(a)] (requiring each exchange to make and keep’’ for prescribed periods such records, furnish such VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 Through these provisions Congress conferred on the Commission ‘‘broad authority to oversee the SROs’ ‘. . . operation . . .’ of the national market system.’’ 434 And it is pursuant to this authority that the Commission originally adopted Rule 610(c). The Pilot reflects the Commission’s efforts to evaluate, in light of changing market conditions, whether the existing transaction-based fee and rebate structure continues to further the statutory goals. In that sense, the Pilot follows as an appropriate progression from Rule 610, and it represents an important step in the Commission’s continuing obligation to implement Congress’s objectives for the national market system. The Commission disagrees with the suggestion by one commenter that the Pilot is inconsistent with Exchange Act Section 19(b)(3)(A), which sets out part of the process by which proposed rule changes by self-regulatory organizations may become effective.435 Contrary to the commenter’s suggestion, nothing in Section 19 interferes with the Commission’s authority described elsewhere in the Exchange Act. Indeed, Section 19 itself makes clear that the Commission retains ultimate authority over the rules of registered exchanges, providing that ‘‘[n]o proposed rule change [by a self-regulatory organization] shall take effect unless approved by the Commission or otherwise permitted in accordance with [Section 19(b)]’’ 436 and making clear that the Commission retains authority to suspend and institute proceedings to approve or disapprove even those exchange rules that are permitted to take effect upon filing with the Commission.437 Moreover, Section 19 explicitly permits the Commission to summarily implement or suspend any such proposed rule changes if, in the Commission’s view, doing so would serve the public interest, protect investors, or assist in maintaining fair and orderly markets.438 And it makes clear that the Commission retains copies thereof, and make and disseminate such reports as the Commission, by rule, ‘‘prescribes as necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of [the Act]’’), and 23(a) [15 U.S.C. 78w(a)] (granting the Commission the power to make such rules and regulations as may be ‘‘necessary or appropriate to implement the provisions of this chapter’’ for which the Commission is responsible or for the execution of the functions vested in the Commission by the Act). 434 City of Providence, Rhode Island v. BATS Global Mkts., Inc., 878 F.3d 36, 41 (2d Cir. 2017). 435 See Cboe Letter I, at 10–11. See 15 U.S.C. 78s(b)(3)(A). 436 15 U.S.C. 78s(b)(1). 437 Id. Sec. 78s(b)(3). 438 Id. Sec. 78s(b)(3)(B), (C). PO 00000 Frm 00037 Fmt 4701 Sfmt 4700 5237 authority to amend exchanges’ rules on its own initiative.439 Commenters also disagreed about whether the Pilot complied with the Commission’s statutory obligations under the Administrative Procedure Act 440 (‘‘APA’’) and whether the Pilot is consistent with the Exchange Act.441 For example, working from the premise that the APA requires the Commission to ‘‘ ‘examine[ ] the relevant data and articulate[ ] a satisfactory explanation for its action including a rational connection between the facts found and the choices made,’ ’’ 442 one commenter believed that the Commission ‘‘lacks the administrative record,’’ ‘‘evidence’’ and ‘‘analysis’’ that would be ‘‘needed to justify such drastic government intrusion into free markets.’’ 443 Another commenter, however, disputed that notion and observed that the Commission had developed the Pilot, in part, by relying on ‘‘empirical literature’’ that ‘‘is directly on point and speaks to the potential distortionary effects that the pilot program is designed to study’’ and that ‘‘certainly provides strong empirical support for further analysis by way of data generated through a pilot study.’’ 444 The responding commenter also found it significant that the Commission was ‘‘presently in the midst of a formal notice and comment process . . . which was informed by years of discussion at, and a proposal from, the [EMSAC]’’ and that the Commission ‘‘had chosen to act via a pilot program rather than a proposal for a long-term rule.’’ 445 The commenter therefore believed the 439 Id. Sec. 78s(c). U.S.C. 500, et seq. 441 A few commenters suggested that the Pilot ‘‘would not withstand judicial scrutiny’’ because certain aspects of the Pilot were ‘‘arbitrary and capricious and not in accordance with law.’’ See, e.g., Nasdaq Letter I, at 3. Specifically, these commenters challenged the sufficiency of the Commission’s economic analysis, the exclusion of non-exchange trading centers from the Pilot, the inclusion of ETPs in the Pilot, the ability of the Pilot to provide the Commission with usable data, and the Commission’s decision to pursue a Pilot instead of other market structure initiatives. See, e.g., Nasdaq Letter I, at 1–4, 8–9, 11; Cboe Letter I, at 12; NYSE Letter, at 2–3, 7. These specific concerns are addressed in Section IV (discussing the Commission’s economic analysis), Section II.A.4 (discussing the exclusion of non-exchange trading centers from the Pilot), Section II.B.3 (discussing the inclusion of ETPs in the Pilot), Section II.E (discussing the ability of the Pilot to provide the Commission with usable data), notes 307–319 supra (discussing the Commission’s decision to pursue a Pilot in conjunction with other market structure initiatives). 442 Nasdaq Letter I, at 11 (quoting Motor Vehicle Mfrs. Ass’n of U.S., Inc. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983)). 443 Id. at 11–12. 444 Verret Letter I, at 5–6. 445 Id. at 6. 440 5 E:\FR\FM\20FER2.SGM 20FER2 5238 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations Commission had fulfilled its statutory obligations in ‘‘determin[ing] that, given existing evidence suggesting the distortive effect of practices in the market tied to rebates or access fees, a pilot program will provide sufficient information to inform potential future rulemaking.’’ 446 The Commission agrees and notes that it has carefully examined available data on this issue, engaged in a lengthy and deliberative process, and taken into account the recommendations of two independent advisory bodies (EMSAC and the Investor Advisory Committee). The Commission developed the Pilot through a thorough review of the empirical literature, which was cited and discussed in the Proposing Release, as well as submitted as comments in response to this proposal.447 Moreover, as discussed in the Proposal, the EMSAC conducted a thorough process to consider, and ultimately formally recommend, that a pilot be conducted.448 The EMSAC reflected a broad and diverse set of perspectives. In addition, EMSAC heard testimony from experts during its open meetings (which included as panelists senior executives from exchanges) regarding exchange fee models, the appropriateness of a transaction fee pilot, and the shape that such a pilot should take.449 In addition to EMSAC, the independent Investor Advisory Committee also submitted a recommendation in support of the Pilot.450 After considering all of the available information, the Commission has identified a fundamental disagreement among exchanges, market participants, academics, and industry experts regarding the impact of such fees and rebates on the markets.451 This disagreement is further exacerbated by the lack of data to evaluate these competing claims. The Commission believes that the Pilot is necessary to study the impact of exchange fees and rebates to determine whether a regulatory response is needed to mitigate the potential distortions that current exchange pricing models introduce to order routing behavior, market quality, and execution quality. Some commenters argued that the Pilot’s imposition of new fee caps 446 Id. at 5. e.g., Swan Letter; IEX Letter I; NYSE 447 See, Letter I. 448 See Proposing Release, supra note 2, at 13009 n.6, 13012–14. 449 See id. at 13009–14. 450 See IAC Recommendation. 451 See, e.g., Section II.A.2. supra for a discussion of comments regarding the impact of current pricing models on market quality, execution quality, and order routing. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 constituted ‘‘impermissible government rate-making.’’ 452 For example, one exchange commenter stated that ‘‘[g]overnment-imposed price controls’’ ‘‘reduce choices for market participants,’’ ‘‘distort competition between over-the-counter venues and exchanges,’’ and are ‘‘costly to administer and lacking in an incentive to be efficient,’’ such that ‘‘they are only indicated where they overcome severe market imperfection such as monopoly ownership of a critical resource.’’ 453 As discussed above, another commenter asserted that the Exchange Act ‘‘plainly contemplates that exchanges, rather than the SEC, will make an initial determination as to the price of a particular product or service,’’ and indicating that ‘‘fee setting is the province of each exchange, subject to the competitive forces that naturally control fees’’ and ‘‘subject to oversight only in particular situations.’’ 454 Commenters expanded on this argument by stating that the Commission had not sufficiently ‘‘evaluate[d] whether there is any evidence that the Commission’s objectives in adopting the cap on access fees . . . are not being met.’’ 455 One 452 Nasdaq Letter I, at 2. See also Cboe Letter I, at 1. 453 Nasdaq Letter I, at 5, 11–12. See also Cboe Letter I, at 11; Mexco Letter, at 1. One commenter agreed that ‘‘price controls on access fees indicate something is broken in market structure,’’ but observed that ‘‘there has been no serious economic analysis, let alone a cost-benefit analysis, of what the optimal fee cap (if any) should be’’ and that the Pilot would ‘‘provide solid evidence that can be used to determine the optimal fee cap.’’ Angel Letter I, at 1–2; Angel Letter II, at 2. 454 Cboe Letter I, at 10 (citing 15 U.S.C. 78s(b)(3)(A)(ii), which provides that ‘‘a proposed rule change shall take effect upon filing with the Commission if designated by the self-regulatory organization as. . . establishing or changing a due, fee, or other charge imposed by the self-regulatory organization on any person, whether or not the person is a member of the self-regulatory organization’’). This commenter also noted that ‘‘every single exchange transaction fee in place today was filed with, and processed by, the Commission’’ and that any fees that were inconsistent with the Exchange Act ‘‘could have been suspended or abrogated by the Commission if that were deemed necessary.’’ Id. at 6. 455 NYSE Letter I, at 11. This commenter identified the relevant ‘‘objectives’’ of Rule 610(c) as preventing the exchanges from ‘‘undermining Regulation NMS’s price protection and linkage requirements.’’ Id. Another commenter similarly characterized the ‘‘justification for the fee cap under Rule 610(c)’’ as ‘‘the existence of sustained market power created by the requirement of best execution and the prohibition against trading through,’’ which would permit exchanges to ‘‘charge high access fees thereby undermining Regulation NMS’s price protection and linkage requirements.’’ This commenter believed that the Commission had wrongfully assumed ‘‘that the market power presumably wielded by equities exchanges is so great that they may charge excessive fees now and in the future’’ unless ‘‘artificial government price constraints’’ are imposed. Nasdaq Letter I, at 12–13, PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 commenter, for example, found it ‘‘concerning that the fee caps in the proposed Pilot do absolutely nothing to further the justification of the original cap and, unlike the original access fee cap, are set at levels that completely undercut existing rates.’’ 456 Exchange commenters further contended that the Pilot imposes ‘‘completely new limitations on exchanges’ business’’ that were ‘‘unrelated to Regulation NMS’s Access Fee Cap,’’ because the Pilot would ‘‘expand[ ] the cap on fees that exchanges may charge for execution not only against a protected quote, but for execution against any quote on an exchange, including depth-of-book and non-displayed orders,’’ as well as ‘‘limit . . . the rebates that an exchange pays’’ and ‘‘pricing that is linked to providing or removing liquidity on an exchange.’’ 457 The Pilot has two Test Groups, one of which does not cap fees at all, but rather leaves in place the current Rule 610(c) fee cap and simply prohibits exchanges from paying rebates or offering Linked Pricing. The other Test Group does impose a lower fee cap for a small portion of NMS stocks (730 out of over 8,000 NMS stocks) for a limited period of time, but is doing so to study the effects of exchange fee-and-rebate pricing models and to gather data to assess the impact on the markets and market participants of a revised and lowered cap compared to the current cap. Further, the Commission selected an amount for that cap that was recommended by commenters, including the Investor Advisory Committee. As explained above, the existing fee cap was designed, in part, to prevent trading centers from charging unreasonably high fees to market participants required to honor their quotations by the Order Protection Rule.458 Because ‘‘[a]ccess fees tend to be highest when markets use them to fund substantial rebates to liquidity providers, rather than merely to compensate for agency services,’’ the Commission was concerned that ‘‘the published quotations of [outlier] 12 n.38. The third commenter stated that the ‘‘original fee cap rationale’’ was to ‘‘address predatory outlier pricing.’’ Cboe Letter I, at 14. 456 Cboe Letter I, at 14. 457 NYSE Letter I, at 12. See also Cboe Letter I, at 10 (stating that it was a ‘‘conflict[ ] with the purposes of the Exchange Act and [a] depart[ure] from Commission precedent’’ to ‘‘cap fees for transactions that do not implicate intermarket price protection’’ and ‘‘ban[ ] linked pricing,’’ which has been ‘‘utilized by exchanges with SEC consent for years’’). 458 See Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496, 37545 (June 29, 2005) (File No. S7–10–04). E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations markets would not reliably indicate the true price that is actually available to investors or that would be realized by liquidity providers.’’ 459 The Commission explained that the fee cap helped assure the fairness and usefulness of quotation information; limit the extent to which the true price for those who access quotations can vary from the displayed price; permit broker-dealers to route orders in a manner consistent with the operation of a national market system; and protect limit orders and promote best-priced quotations.460 Accordingly, the Commission imposed a $0.0030 fee cap, which it believed reflected a competitive rate that was consistent with current business practices at the time (i.e., in 2005).461 In establishing the Rule 610(c) fee cap, the Commission did not, however, cede its responsibility to ensure that markets continue to function in a fair, transparent, and efficient manner; nor did it state that the $0.0030 fee cap could not be revisited if market conditions changed. The Pilot is designed to determine, among other things, whether such a change has occurred. Despite assertions by one commenter that ‘‘powerful competitive forces are clearly present that discourage exchanges from exercising unabated pricing power,’’ 462 a $0.0030 fee is still consistently charged by many exchanges, raising concerns among other commenters that the fee cap is stuck at a non-competitive and, perhaps, an artificially high rate.463 Several commenters have also indicated that current pricing models have resulted in the kind of distortive pricing that Rule 610(c) was designed to prevent.464 459 Id. 460 Id. 461 Id. 462 Nasdaq Letter I, at 13. e.g., BlackRock Letter, at 1 (‘‘[T]he existing access fee cap is outdated and permits market forces to drive fees and rebates to excessive levels relative to the current magnitude of commissions and bid-ask spreads.’’); Goldman Sachs Letter, at 2 (identifying a ‘‘well-developed, general consensus amongst market participants that a $0.0030 per share Fee Cap is an outdated benchmark for execution costs in today’s trading environment . . . and far from representative of true prices in the marketplace’’); Citi Letter, at 1– 2 (stating that ‘‘today’s 30-mil cap on access fees that the exchanges can charge to access liquidity on their venues represents a more significant percentage of the economics of each trade’’). 464 See, e.g., ICI Letter I, at 2 (‘‘Transaction fees and rebates also undermine market transparency because the prices displayed by exchanges—and provided on trade reports—do not include fee or rebate information and therefore do not fully reflect net trade prices.’’); Goldman Sachs Letter, at 3 (stating that ‘‘displayed prices do not reflect the actual economic costs because exchange fees and rebates are not reflected in those prices’’); Oppenheimer Letter, at 2 (‘‘[T]o the extent that 463 See, VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 Testing lower fee levels, and a no-rebate fee regime,465 will help the Commission to determine whether further regulatory action is needed to achieve the objectives of Rule 610(c) as well as the Commission’s statutory mandate to oversee the equities markets. The Commission’s position is echoed by other commenters that found the ‘‘suggest[ion] that the Commission lacks the authority to implement the Pilot, or that testing a rebate ban or alternative access fee caps would constitute an impermissible form of price control . . . meritless’’ 466 or ‘‘entirely inaccurate.’’ 467 One commenter, for example, noted that the Exchange Act ‘‘provides very broad authority for the Commission to regulate all aspects of exchange operation, including fee schedules . . . .’’ 468 This commenter further observed that ‘‘it makes no sense to attack the Commission’s proposal as an impermissible form of ‘rate setting’ when the markets have been operating with exchange fee limits for more than 10 years.’’ 469 Moreover, this commenter asserted that ‘‘exchange criticisms’’ regarding ‘‘price control[s]’’ are ‘‘contradicted by their acceptance of th[e] existing price regulation’’ in Rule 610(c), which ‘‘may better serve their interests than the alternative caps and rebate prohibition included in the Pilot.’’ 470 transaction fees and rebates obfuscate the actual price bid or offered for a security, the ‘maker-taker’ pricing model has the potential to undermine price transparency . . . .’’). 465 In response to commenters who complained that the Pilot’s fee cap Test Group applies to fees to provide liquidity, instead of being limited to fees to remove liquidity as is the case for Rule 610(c), and therefore it is ‘‘unrelated’’ to the existing fee regime and the Rule 610(c) construct, the Commission notes that when it adopted the Rule 610(c) fee cap it expressly noted that it would ‘‘monitor the operation of these rules to assess whether in practice . . . broader coverage of the rule is necessary.’’ See NMS Adopting Release, supra note 10, at 37546. 466 IEX Letter I, at 6. 467 Verret Letter I, at 2. See also IAC Recommendation, at 1 (‘‘[T]he purpose of the Pilot is not to consider imposing price controls, but instead to consider requiring fees (of whatever size) to be structured so as to minimize complexity and agency costs.’’). 468 IEX Letter I, at 6–7 (‘‘The fact that the SEC has not previously chosen to use its authority to prohibit rebates, or test their elimination through a pilot, does not mean it lacks authority. . . .’’); see also Verret Letter I, at 3. 469 IEX Letter II, at 9. See also Verret Letter I, at 2 (stating that ‘‘one might properly describe the Reg NMS regime as itself a decade-long experiment in price controls’’). 470 IEX Letter I, at 7; IEX Letter II, at 9 (‘‘NYSE seems to be saying, ‘We are fine with the current fee regulation, because we have been able to operate very profitably under it, but it would be illegal to even test different fee restrictions unless you impose them on ATSs.’’). See also, e.g., Verret Letter I, at 2 (‘‘Exchanges appear comfortable when price controls on the liquidity taking side benefit PO 00000 Frm 00039 Fmt 4701 Sfmt 4700 5239 A few other commenters believed that the Commission had not sufficiently identified or discussed the statutory authority to conduct the Pilot.471 One commenter stated that the Proposing Release did not contain an ‘‘explanation as to how those specific statutory sections [cited by the Commission], either individually or collectively, provide the Commission with the authority to carry out the Proposal’s broad rate-setting requirements’’ or a ‘‘discussion of the Commission’s statutory authority at all . . . .’’ 472 This commenter asserted that the Commission ‘‘cannot simply skip this analysis or assume it has unrestricted authority to conduct pilots on the basis that the Proposal is intended to be temporary.’’ 473 The Commission notes that it followed its standard practice in the Proposing Release to identify the statutory authority under which it promulgated its Proposal. The Commission has complied with its statutory obligations in promulgating the Pilot and has clear statutory authority to adopt the Pilot, which the Commission believes furthers the purposes of the Exchange Act.474 III. Paperwork Reduction Act Certain provisions that the Commission is adopting today contain ‘‘collection of information requirements’’ within the meaning of the Paperwork Reduction Act of 1995 (‘‘PRA’’).475 The Commission published their business models, but challenge the Commission’s authority to implement what they describe as price controls when their own business models are negatively impacted.’’); Larry Harris Letter, at 6 (noting that ‘‘exchange holding companies have a strong interest in maintaining the current system’’ and that the ‘‘SEC may reasonably consider these interests when evaluating comments submitted by the exchanges); Themis Trading Letter II, at 3 (stating that the Commission should not be ‘‘distracted. . . by conflicted stock exchanges desperately fearful that their business models might come crashing down’’). 471 See, e.g., Cboe Letter I, at 9. 472 NYSE Letter I, at 12. 473 Id. See also Cboe Letter I, at 11. For example, the commenter noted that the Commission had ‘‘provided no analysis or discussion demonstrating its reasoned decision-making of how the specific fee structures to be mandated in the Proposal would be equitably allocated or reasonable’’ under Section 6 of the Exchange Act. NYSE Letter I, at 12. See also 15 U.S.C. 78f(b)(4) (requiring the rules of an exchange to ‘‘provide for the equitable allocation of reasonable dues, fees, and other charges among its members and issuers and other persons using its facilities’’). 474 If any of the provisions of these amendments, or the application thereof to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application. 475 44 U.S.C. 3501 et seq. E:\FR\FM\20FER2.SGM 20FER2 5240 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations a notice requesting comment on the collection of information requirements in the Proposing Release 476 and submitted relevant information to the Office of Management and Budget (‘‘OMB’’) for review in accordance with the PRA and its implementing regulations.477 The title of the new collection of information for Rule 610T is ‘‘Transaction Fee Pilot Data.’’ Compliance with these collections of information requirements is mandatory. 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. We have applied for an OMB Control Number for this collection of information. The Commission requested comment on the collection of information requirements in the Proposing Release. The Commission received two comment letters on the estimates for the collection of information requirements included in the Proposing Release, which are discussed below.478 A. Summary of Collection of Information The Pilot requires the equities exchanges to prepare four sets of data that constitute a collection of information within the meaning of the PRA. First, pursuant to Rule 610T(b), the primary listing exchanges will be required to prepare and publicly post two sets of data on the Pilot Securities listed on their markets—the Pilot Securities Exchange Lists and the Pilot Securities Change Lists.479 In addition, pursuant to Rule 610T(d), all equities exchanges will be required to provide to the Commission monthly order routing datasets.480 Lastly, pursuant to Rule 610T(e), all equities exchanges will be required to prepare and publicly post the Exchange Transaction Fee Summaries, which are monthly summaries of information concerning fees assessed and rebates paid to market participants transacting on the exchange.481 B. Proposed Use of Information The data collected during the Pilot, including the Pilot Securities Exchange Lists, Pilot Securities Change Lists, Exchange Transaction Fee Summaries, and order routing datasets, will allow researchers and market participants to have ready access to information that will facilitate the study of the impact of an exogenous shock to transaction fees and rebates on order routing behavior, execution quality, and market quality. In turn, this information should facilitate a data-driven evaluation of future policy choices. In addition, 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, researchers, 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 Test Groups during the Pilot. C. Respondents The respondents to this collection of information will 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, will apply to the six primary listing exchanges for NMS stocks. Rule 610T(d), which requires datasets on order routing, will 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, will apply to all thirteen equities exchanges currently registered with the Commission. D. Total Initial and Annual Reporting and Recordkeeping Burdens The burdens associated with the Pilot are described fully below, but the below table briefly summarizes the relevant burdens set forth in the Proposing Release and in this release. Annual burdens (hours/ exchange) Category Release Pilot Securities Exchange Lists ...................................................... Proposing Release ...................................... Adopting Release ........................................ Proposing Release ...................................... Adopting Release ........................................ Proposing Release ...................................... Adopting Release ........................................ Proposing Release ...................................... Adopting Release ........................................ Pilot Securities Change Lists ......................................................... Exchange Transaction Fee Summaries ......................................... Order Routing Datasets ................................................................. 1. Pilot Securities Exchange Lists and Pilot Securities Change Lists 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 Rule 610T(b)(2)(i) on their 476 See Proposing Release, supra note 2, at 13038– 39. 480 See supra Section II.E.3. supra Section II.E.0. 482 See Proposing Release, supra note 2, at 13036. The Commission based this estimate on a full-time Compliance Manager and Programmer Analyst each spending approximately 4 hours, for a combined 481 See 477 44 U.S.C. 3507; 5 CFR 1320.11. NYSE Letter I, at 15; Cboe Letter I, at 21. 479 See supra Section II.E.0. 478 See VerDate Sep<11>2014 websites in pipe-delimited ASCII format. The Commission preliminarily estimated 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 its initial Pilot Securities Exchange List.482 One commenter stated that it ‘‘anticipates it could take as many as 44 hours’’ to compile the initial Pilot 18:36 Feb 19, 2019 Jkt 247001 PO 00000 Frm 00040 Fmt 4701 Sfmt 4700 One-time burdens (hours/ exchange) N/A N/A 126 126 64 64 112 124 8 44 12 12 86 86 80 80 Securities Exchange List.483 The commenter stated that its estimates of the costs associated with the Pilot are based on its ‘‘prior experience implementing the Tick Size Pilot, and other similar initiatives . . . .’’ 484 In light of this comment, the Commission is increasing its estimate. While, unlike for the Tick Size Pilot, the Commission will prepare the Initial List of Pilot Securities and assign them to their 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. See id. at 13036 n.186. 483 See NYSE Letter I, at 15. 484 See id. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations respective treatment groups, and therefore the exchanges will only need to separate out their listed securities into a separate list, the Commission nevertheless will increase its estimate as the commenter suggested. Accordingly, the Commission estimates that each primary listing exchange would incur, on average, a one-time burden of approximately 44 burden hours per primary listing exchange to compile and publicly post their initial Pilot Securities Exchange List.485 Accordingly, the Commission believes that the aggregate one-time burden associated with the initial Pilot Securities Exchange Lists would be 264 burden hours.486 After posting its initial Pilot Securities Exchange List, each equities exchange will be required to keep current that list to reflect any changes, and to also prepare and publicly post on its website until the end of the postPilot Period the Pilot Securities Change List prior to the beginning of trading each trading day. The Commission preliminarily estimated 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 its market.487 The Commission also preliminarily estimated that, once the primary listing exchanges have established these systems, on average, each primary listing exchange would incur 0.5 burden hours daily, or 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 its website prior to the start of each trading day.488 One exchange commenter stated that ‘‘the Commission predicts it that would 485 The Commission continues to believe that this will require the services a full-time Compliance Manager and Programmer Analyst. The Commission estimates that each Compliance Manager and Programmer Analyst will each spend approximately 22 hours, for a combined total of approximately 44 hours, to compile and publicly post to an exchange’s website a downloadable file containing the initial Pilot Securities Exchange List. 486 44 burden hours per primary listing exchange × 6 primary listing exchanges = 264 burden hours. 487 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. See Proposing Release, supra note 2, at 13036. 488 The Commission based 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)). See id. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 take only 12.5 hours to develop and maintain systems to comply’’ with the requirements to update prior to the start of each trading day the Pilot Securities Exchange Lists and Pilot Securities Change Lists.489 Based on ‘‘its prior experience implementing the Tick Size Pilot, and other similar initiatives,’’ this commenter further stated that it believed ‘‘it could take as many as 300.5 hours to develop and maintain those systems.’’ 490 While the commenter did not elaborate on how it computed its estimate or whether it represents an aggregate burden estimate or an annualized estimate, the commenter appears to have misunderstood the burden estimates contained in the Proposing Release because the Commission’s estimate greatly exceeded 12.5 hours. Specifically, the Commission’s preliminary estimates included a one-time burden of 8 hours for primary listing exchanges to compile and publicly post the initial Pilot Securities Exchange List, a one-time burden of 12 hours for primary listing exchanges to develop appropriate systems to track and compile changes to Pilot Securities, and an ongoing burden of 126 hours annually to compile any such changes and publicly post the updated Pilot Securities Exchange Lists and Pilot Securities Change Lists, for an aggregate burden estimate of 335 hours per exchange for the entire Pilot.491 Assuming that the commenter’s estimate of 300.5 hours is meant to be an aggregate burden estimate, the Commission notes that its revised aggregate burden estimate of 371 hours exceeds the commenter’s estimate. The Commission’s estimates are averages that take into account the diverse set of six primary listing exchanges and the expected burdens that they would collectively experience as a result of the Pilot. Moreover, the Commission expects that the primary listing exchanges will be able to leverage their experience and resources from the recent Tick Size Pilot to meet the requirements of the Pilot. As noted above, unlike for the Tick Size Pilot, the Commission will set the initial List of Pilot Securities and the primary listing 489 NYSE Letter I, at 15. See also Cboe Letter I, at 21 (stating that the ‘‘implementation and ongoing costs of the Pilot will be significantly larger in terms of burden hours and expenditures than the Commission estimates,’’ but providing no specific analysis or alternative estimates). 491 See Proposing Release, supra note 2, at 13036. The Commission notes that it has revised its aggregate burden estimate upwards to 371 hours for each exchange to address commenter concerns that the estimated burden associated with compiling and publicly posting the initial Pilot Securities Exchange List was too low. 490 Id. PO 00000 Frm 00041 Fmt 4701 Sfmt 4700 5241 exchanges only need to keep those lists up to date if their listed issuers experience any relevant change. Accordingly, the burdens on the primary listing exchanges with respect to the lists of Pilot Securities should be less than those incurred during the Tick Size Pilot.492 For those reasons, the Commission continues to believe its estimate of the aggregate one-time burden for primary listing exchanges to develop appropriate systems to track and compile changes relevant to Pilot Securities listed on their markets will be approximately 12 burden hours for each primary listing exchange, or 72 total burden hours, and the average, aggregate annual burden to update and publicly post the lists of Pilot Securities will be approximately 126 burdens hours for each primary listing exchange, or 756 total burden hours for all 6 exchanges.493 2. Exchange Transaction Fee Summaries The Commission is requiring 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 believes that all the data necessary to complete the summary are currently maintained by the equities exchanges. However, the equities exchanges will be required to compute the monthly realized average and median per share fees and rebates, each by participant type, that qualified for the Base and Top Tier fees and rebates, using fee and volume information that the equities exchanges maintain. The Commission preliminarily estimated 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.494 One commenter objected generally to the Commission’s burden estimates, but 492 See Proposing Release, supra note 2, at 13027 n.153 and accompanying text; note 740 infra. 493 126 burden hours per primary listing exchange × 6 primary listing exchanges = 756 burden hours. 494 See Proposing Release, supra note 2, at 13037. The Commission preliminarily estimated 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 estimated 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 id. at 13037 n.194. E:\FR\FM\20FER2.SGM 20FER2 5242 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations did not provide its own estimates of specific burden hours or costs.495 The Commission continues to estimate that each equities exchange will incur a onetime 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.496 Accordingly, the 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 Rule 610T(e) will be 1,040 hours.497 The Commission also preliminarily estimated that, on average, an equities exchange would incur an ongoing burden of approximately 40 burden hours per year, approximately half the estimated burden to develop appropriate systems, to monitor and, if necessary, update its systems used for compiling, formatting and publicly posting the Exchange Transaction Fee Summaries.498 One commenter objected generally to the Commission’s burden estimates, but did not specifically explain whether or how this burden estimate was incorrect.499 The Commission continues to estimate that the annual ongoing burdens associated with monitoring and, if necessary, updating these systems would be approximately half the burdens of initially developing the systems. Accordingly, the Commission continues to estimate that an equities exchange will 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 495 Cboe Letter I, at 21 (stating that the ‘‘implementation and ongoing costs of the Pilot will be significantly larger in terms of burden hours and expenditures than the Commission estimates,’’ but providing no specific analysis or alternative estimates). But cf. Better Markets Letter, at 2 (‘‘All of the data-fields are thoughtfully proposed, and the cost of producing them is minimal and certainly acceptable given the enormity of the benefits.’’ The commenter did not provide specific burden hour or cost estimates.). 496 (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. 497 80 burden hours per equities exchange × 13 equities exchanges = 1,040 burden hours. 498 See Proposing Release, supra note 2, at 13037. (Attorney at 10 hours) + (Compliance Manager at 10 hours) + (Programmer Analyst at 10 hours) + (Senior Business Analyst at 10 hours) = 40 burden hours. 499 See note 495 supra. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 Transaction Fee Summaries.500 The average aggregate, ongoing, annual burden for all equities exchanges to monitor their systems will be 520 hours.501 The equities exchanges will 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 its website such a summary, the Commission preliminarily estimated 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.502 In addition, each equities exchange will be required to make its summary publicly available on its website using an XML schema to be published on the Commission’s website. As the Commission preliminarily believed that the equities exchanges had experience applying the XML format to market data,503 the Commission estimated that initially each equities exchange would incur a burden of 2 burden hours specific to the initial Exchange Transaction Fee Summary to ensure that it has properly implemented the XML schema.504 One commenter objected generally to the Commission’s burden estimates, but did not specifically explain whether or how this burden estimate was incorrect.505 The Commission continues to estimate that each equities exchange will require approximately 4 burden hours to complete the initial Exchange Transaction Fee Summary,506 for an aggregate, initial burden of 52 hours to complete its initial Exchange 500 (Attorney at 10.5 hours) + (Compliance Manager at 10.5 hours) + (Programmer Analyst at 11 hours) + (Senior Business Analyst at 10.5 hours) = 40 burden hours. 501 40 burden hours per equities exchange × 13 equities exchanges = 520 burden hours. 502 See Proposing Release, supra note 2, at 13037. 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. See id. at 13037 n.198. 503 See id. at 13037 n.199 and accompanying text. 504 See id. at 13037. 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. See id. at fn. 200. 505 See note 495 supra. 506 (Compliance Manager at 2 hours) + (Senior Business Analyst at 2 hours) = 4 burden hours per equities exchange. PO 00000 Frm 00042 Fmt 4701 Sfmt 4700 Transaction Fee Summary.507 The Commission also continues to estimate that each equities exchange will incur an initial burden of approximately 2 burdens hours for an aggregate, initial burden of 26 hours to post that dataset publicly on its website using an XML schema to be published on the Commission’s website. The total aggregate, initial burden to complete the initial Exchange Transaction Fee Summary will therefore be 78 burden hours.508 Each equities exchange will 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 fee and rebate information. The Commission preliminarily believed that such updates would require fewer burden hours than the initial Exchange Transaction Fee Summary, as the equities exchanges would have experience calculating necessary data and formatting the reports as required by the Rule.509 Accordingly, the Commission preliminarily estimated that it would require approximately 2 burden hours each month, or 24 burden hours on an annualized basis, for each equities exchange to update the Exchange Transaction Fee Summary.510 This estimate contemplated the impact of publicly posting the summary using the XML schema to be published on the Commission’s website. One commenter objected generally to the Commission’s burden estimates, but did not specifically explain whether or how this burden estimate was incorrect.511 The Commission continues to estimate that it will require approximately 2 burden hours each month, or 24 burden hours on an annualized basis, for each equities exchange to update the Exchange Transaction Fee Summary.512 As such, the equities exchanges will incur an aggregate, annual burden of 312 burden hours to update and publicly post on 507 4 burden hours per equities exchange × 13 equities exchanges = 52 burden hours. 508 2 burden hours per equities exchange × 13 equities exchanges = 26 burden hours. 509 See Proposing Release, supra note 2, at 13037. 510 See id. 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. See id. at 13037 n.203. 511 See note 495 supra. 512 (Compliance Manager at 1 hours) + (Programmer Analyst at 1 hours) = 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. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations their websites the Exchange Transaction Fee Summaries.513 3. Order Routing Datasets The Commission preliminarily estimated that, on average, there would be no paperwork burden to the equities exchanges to capture the order routing data required pursuant to Rule 610T(d) to be included in the order routing datasets, as the Commission expected that the equities exchanges would collect the required data to create the order routing datasets by leveraging existing systems and technology already in place for the collection and reporting of data.514 The Commission believes this continues to be true with the changes to the order routing datasets, which also involve data elements currently captured by existing systems. The Commission preliminarily believed, however, that the equities exchanges would incur an initial onetime burden of 80 burden hours per equities exchange to ensure that their systems and technology are able to accommodate the proposed requirements to aggregate, anonymize, and publicly post the order routing information.515 While the exchanges will still need to aggregate the data, they no longer will need to anonymize and publicly post it and instead will transmit the information to the Commission. The Commission continues to believe that each equities exchange would incur an initial onetime burden of 80 burden hours to ensure that its systems and technology are able to accommodate the requirements to aggregate and provide to the Commission the order routing information. Accordingly, the Commission estimates that the aggregate one-time initial burden for ensuring an exchange’s systems and technology are able to aggregate and provide to the Commission the required order routing data in compliance with Rule 610T(d) will be 1,040 burden hours.516 513 2 burden hours per equities exchange × 13 equities exchanges × 12 monthly updates = 312 burden hours per year. 514 See Proposing Release, supra note 2, at 13038. 515 See id. The Commission preliminarily estimated 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 estimated 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 id. at 13038 n.207. 516 80 burden hours per equities exchange × 13 equities exchanges = 1,040 burden hours. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 The Commission also preliminarily estimated 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 Rule.517 The Commission continues to estimate 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 Rule. Therefore, the Commission estimates that the aggregate annual burden to maintain the systems necessary to aggregate and provide to the Commission the required order routing information is approximately 520 burden hours per year.518 Each equities exchange would incur an ongoing burden associated with creating and formatting the order routing datasets each month. The Commission noted that the equities exchanges have experience with creating similar datasets in accordance with their obligations under Rule 605 of Regulation NMS.519 The Commission preliminarily believed that each equities exchange would incur burdens similar to those associated with preparing Rule 605 reports.520 Accordingly, the Commission preliminarily believed 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.521 While the order routing datasets will not be publicly posted but will instead be provided to the Commission, the Commission is requiring the equities exchanges to separate out post-only orders and auction-only orders (or exclude auction-only orders if they so choose). The Commission estimates that separating out these orders will require approximately 1 additional burden hour per month. As such, the Commission 517 See Proposing Release, supra note 2, at 13038. The Commission derived the total estimated burdens from the following estimates, which reflected the Commission’s preliminary view that annual ongoing burdens would be approximately half the burdens of initially ensuring an exchange 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. See id. at 13038 n.209. 518 40 burden hours per equities exchange × 13 equities exchanges = 520 burden hours. 519 See Proposing Release, supra note 2, at 13038. 520 See id. See also FR Doc. 2016–08552, 81 FR 22143 (April 14, 2016) (‘‘Request to OMB for Extension of Rule 605 of Regulation NMS’’). 521 Compliance Manager at 3 hours + Programmer Analyst at 4 hours = 7 burden hours per month, per equities exchange. 7 burden hours per month × 12 months = 84 burden hours per year, per equities exchange. PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 5243 estimates that each equities exchange will incur a burden of approximately seven burden hours per month, or 84 burden hours per year, to prepare and provide to the Commission the order routing datasets. Therefore, the aggregate, annual burden to prepare and provide to the Commission order routing datasets in accordance with Rule 610T(d) will be approximately 1,092 burden hours.522 One exchange commenter stated that ‘‘the Commission allocates 160 hours associated with producing order routing data,’’ but estimated that it ‘‘would actually require over 400 hours,’’ based on ‘‘its prior experience implementing the Tick Size Pilot, and other similar initiatives . . . .’’ 523 While the commenter did not elaborate on how it computed its estimate or whether it represents an aggregate burden estimate or an annualized estimate, the commenter appears to have misunderstood the burden estimates contained in the Proposing Release because the Commission’s estimate exceeds the 160 hours cited by the commenter. Specifically, the Commission’s preliminary estimate included a one-time burden of 80 hours and an ongoing burden of 112 hours annually,524 for an aggregate burden estimate of 416 hours per exchange for the entire Pilot.525 Second, the commenter does not explain how it calculated its estimate of ‘‘over 400 hours,’’ break down the costs included in this estimate, or specify whether this number is an aggregate burden estimate or an annualized estimate. Assuming that the commenter’s estimate of over 400 hours is meant to be an aggregate burden estimate, the Commission notes that its revised aggregate burden estimate of 452 hours is substantially similar. The Commission notes that exchanges will no longer be required to publicly post this data, but will instead transmit the datasets directly to the Commission. Moreover, the Commission expects that the exchanges will be able to leverage their experience and 522 84 burden hours per year × 13 equities exchanges = 1,092 burden hours. 523 NYSE Letter I, at 15. See also Cboe Letter I, at 21 (stating that the ‘‘implementation and ongoing costs of the Pilot will be significantly larger in terms of burden hours and expenditures than the Commission estimates,’’ but providing no specific analysis or alternative estimates). 524 The Commission notes that it has revised this estimate upwards to 124 burden hours annually. 525 See Proposing Release, supra note 2, at 13038. The Commission notes that it has revised this estimate upwards to 452 burden hours per exchange for the entire Pilot. E:\FR\FM\20FER2.SGM 20FER2 5244 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations resources from the Tick Size Pilot to meet the requirements of the Pilot.526 For those reasons, the Commission believes its estimate of the one-time burden for exchanges to develop and implement appropriate systems to aggregate the order routing data will be, on average, 80 burden hours for each exchange, and the ongoing annual burden to update these systems and to gather and to transmit the relevant data to the Commission will be, on average, 124 burden hours for each exchange. E. Collection of Information Is Mandatory All of the collections of information pursuant to Rule 610T would be mandatory. F. Confidentiality of Responses to Collection of Information The Commission believes that the broker-dealer specific order routing data should be protected from disclosure subject to the provisions of applicable law.527 The Commission will deem broker-dealer identifying order routing data as being subject to a confidential treatment request under 17 CFR 200.83 without the need to submit a request. The Pilot Securities Exchange List, Pilot Securities Change List, and the Exchange Transaction Fee Summary would not be confidential. Rather, each would be publicly posted by the exchanges. G. Retention Period for Recordkeeping Requirements National securities exchanges would be required to retain records and information pursuant to 17 CFR 240.17a–1 (Rule 17a–1 under the Exchange Act).528 IV. Economic Analysis As discussed above, the Pilot is designed to produce information on the impact of transaction fee-and-rebate pricing models on order routing decisions by broker-dealers, as well as their impact on execution and market quality.529 In recent years, a number of 526 See Section C.2.a.iii. infra. See also, e.g., Better Markets Letter, at 2. 527 See, e.g., 5 U.S.C. 552 et seq.; 15 U.S.C. 78x (governing the public availability of information obtained by the Commission). 528 17 CFR 240.17a–1. 529 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 10, 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 VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 academics and market participants have expressed concern that the structure of exchange transaction-based fee pricing may lead, for example, to potential conflicts of interest between brokerdealers and their customers when brokers-dealers route customer orders to trading centers offering rebates so that the broker-dealer can capture the rebates, even when these venues do not offer high execution quality.530 However, as discussed in more detail below, the Commission cannot determine from existing empirical evidence the impact, if any, of exchange transaction fee models on order routing decisions by broker-dealers or on market and execution quality.531 Specifically, determining whether a causal relationship between exchanges’ transaction fee-and-rebate pricing models and broker-dealers’ behavior is complicated because, for example, such pricing models 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 and any potential negative impacts may manifest.532 volatility in prices. See, e.g., Henrik Bessembinder, Trade Execution Costs and Market Quality after Decimalization, 38 J. Fin. & Quantitative Analysis 747–77 (2003), https://doi.org/10.2307/ 4126742https://doi.org/10.2307/4126742; Maureen O’Hara & Mao Ye, Is Market Fragmentation Harming Market Quality? 100 J. Fin. Econ. 459–74 (2011), https://doi.org/10.1016/ j.jfineco.2011.02.006. 530 See, e.g., James Angel, Lawrence Harris & Chester Spatt, Equity Trading in the 21st Century, 1 Q. J. Fin. (2011), https://doi.org/10.1142/ S2010139211000067 (hereinafter ‘‘Angel, Harris, & Spatt’’); Robert H. Battalio, Shane A. Corwin, & Robert H. Jennings, Can Brokers Have It All? On the Relation Between Make-Take Fees and Limit Order Execution Quality, 71 J. Fin. 2193–237 (2016), https://onlinelibrary.wiley.com/doi/10.1111/ jofi.12422/full (hereinafter ‘‘Battalio Equity Market Study’’); Larry Harris, Maker-Taker Pricing Effects on Market Quotations 24–25 (USC Marshall Sch. Bus., Draft No. 0.91, 2013), https://bschool.huji.ac.il/ .upload/hujibusiness/Maker-taker.pdf (hereinafter ‘‘Harris’’). 531 For commenters concurring with this assessment, see, e.g., Barnard Letter, at 1 (stating the Pilot ‘‘should provide credible analyses of the effects—both positive and negative—of exchange fees and rebates on the quality and efficiency of trading.’’); Better Markets Letter at 2 (stating that the Commission ‘‘lacks sufficient data to outlaw rebates’’ and believed that the Pilot ‘‘should fill this data and knowledge gap.’’). 532 Many commenters expressed support for the Pilot and the utility of the information that may be gained from it. See AJO Letter, at 1, CII Letter, at 3, NYSTRS Letter, at 1, ICI Letter I, at 1–2, MFS Letter, at 1, Nuveen Letter, at 2, Clark-Joseph Letter, at 1, RBC Letter I, at 2, Invesco Letter, at 2, CFA PO 00000 Frm 00044 Fmt 4701 Sfmt 4700 Because of the existing lack of empirical evidence regarding the potential conflicts of interest and potential effects of exchange fee models, additional information would assist the Commission in making future regulatory decisions. To remedy the insufficiency of existing empirical evidence, the Commission is adopting the Pilot to generate data that is otherwise unavailable to study fees and rebates that exchanges assess to broker-dealers and observe the impacts of those fees and rebates on the markets and market participants. Specifically, the Commission expects that the data collected is 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, and the extent to which exchange pricing models create distortions that may have adverse impacts. The data obtained from the Pilot will inform future regulatory initiatives to the ultimate benefit of investors.533 In addition, the Pilot will provide information about other potential economic effects of reducing access fee caps or prohibiting rebates and Linked Pricing. For example, the Pilot could offer information on whether prohibiting rebates and Linked Pricing alters broker-dealer behavior in a manner that affects market quality, such as by impacting quoted spreads across NMS stocks.534 The Pilot is uniquely capable of generating empirical evidence that is currently lacking because it is designed to provide an exogenous shock to transaction fee-and-rebate pricing models across all exchanges simultaneously and facilitate the collection of representative data across a broad range of securities.535 An exogenous shock to a system occurs when an element of the system is changed from without the system. (i.e., the change or shock is not under the control or influence of those within the system) but can induce endogenous (i.e., within the system) responses. In the Pilot’s context, the exogenous shock Letter, at 1, State Street Letter, at 2, Wellington Letter, at 1, Joint Pension Plan Letter, at 2, Oppenheimer Letter, at 2, Angel Letter I, at 1, Vanguard Letter, at 2, Verret Letter I, at 1, T. Rowe Price Letter, at 1. 533 See, e.g., Babelfish Letter, at 3; Clearpool Letter, at 2; T. Rowe Price Letter, at 1, 3, and ClarkJoseph Letter, at 1. 534 See infra Section V.C.1.a.ii, for further discussion of the benefits of studying other economic effects of transaction fees and rebates. 535 See infra Section V., for discussion of existing studies related to these topics and their limitations. See also supra Section II.B (discussing the Nasdaq study, which examined a change in the access fees and rebates charged by Nasdaq for 14 stocks over a four-month period). E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations takes the form of a reduction of the maximum permissible transaction fees and a prohibition on rebates and Linked Pricing on all U.S. equities exchanges. This shock will allow researchers to explore how changes to fees and rebates could lead to changes in broker-dealer order routing and market and execution quality for a broad sample of NMS securities.536 Specifically, the reduction in fees or the elimination of rebates and Linked Pricing, as required in specific Test Groups of the Pilot, may reduce the magnitude or eliminate the potential conflict of interest between brokerdealers and their clients and the potential distortions introduced by exchange transaction-based fees and rebates. These effects would, in turn, be reflected in measurable changes to the order routing and execution quality of stocks in the Pilot’s Test Groups. The terms of the Pilot are discussed in Section II above. Exchanges will continue to be permitted to have varying fees within each Test Group, and will be permitted to change their fees at their discretion, subject to the proposed rule change filing requirements of Section 19 of the Exchange Act, during the Pilot for securities within each Test Group, so long as they comply with the conditions applicable to that Test Group. In the absence of the Pilot, the Commission 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 analyze the effects of changes to fees and rebates.537 By imposing the same modifications to fees and rebates on all U.S. equities exchanges, the Pilot will allow researchers to obtain data that will permit them to examine the impact of changes to fees and rebates on the order routing decisions of brokerdealers. If all exchanges were not subject to the pilot terms, the pilot data would be limited because broker-dealers could redirect their order flow to the non-participating exchanges. Accordingly, the Commission believes that the Pilot will enable the collection of valuable data that would otherwise be unavailable. The Commission is mindful of the costs imposed by, and the benefits obtained from, the rules it promulgates. Whenever the Commission engages in 536 See, e.g., CII Letter, at 3, NYSTRS Letter, at 1, RBC Letter I, at 2, Joint Pension Plan Letter, at 2, Oppenheimer Letter, at 2 537 See, e.g., Clearpool Letter, at 2. As discussed above, Nasdaq conducted its own fee experiment, but other exchanges did not conduct similar experiments simultaneous with Nasdaq. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 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.538 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.539 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.540 A few commenters challenged the sufficiency of the economic analysis contained in the Proposal. For example, one commenter argued the proposal was ‘‘arbitrary and capricious’’ because the Commission failed to consider the economic consequences of its proposal and only partially framed the costs and benefits of the Proposal, ignoring important and significant factors and costs.541 Similarly, another commenter believed that the ‘‘cost-benefit analysis contain[ed] numerous flaws that are inconsistent with the Commission’s obligation to provide a ‘reasoned basis’ for its regulations,’’ namely that the Commission had ‘‘substantially underestimated the costs of the Proposal’’ and ‘‘fail[ed] to identify any countervailing market benefit that justifies imposing . . . harms on . . . exchanges and issuers.’’ 542 Another commenter thought the Commission understated the potential costs of the Pilot while overstating the benefits.543 For example, some commenters noted that they anticipated the Pilot would result in wider spreads, increased transaction costs, and increased broker commissions, all of which would result in added costs to investors.544 Several commenters thought the Commission failed to consider or underestimated the 538 See 539 See 15 U.S.C. 77b(b); 15 U.S.C. 78c(f). 15 U.S.C. 78w(a)(2). 540 Id. 541 See Nasdaq Letter I, at 3, 11. Letter I, at 3, 12. See also, e.g., Level Brands Letter, at 1; Johnson Letter, at 1; Sensient Letter; Tredegar Letter, at 1; Halliburton Letter, at 1. 543 See ASA Letter, at 5. See also T.D. Ameritrade Letter, at 3 (estimating costs of widening spreads to its clients at $24,000,000). 544 NYSE Letter I, at 13. See also TD Ameritrade Letter, at 3 (estimating costs of widening spreads to its clients at $24,000,000 annually) and Energizer Letter, at 1. 542 NYSE PO 00000 Frm 00045 Fmt 4701 Sfmt 4700 5245 implementation costs of the Pilot,545 while other commenters challenged these assertions and instead believed the Pilot would impose minimal costs on exchanges and broker-dealers, particularly in light of the existing processes and technology that currently support immediately effective fee changes from the exchanges.546 Finally, other commenters felt that the economic analysis failed to adequately account for the projected costs to particular categories of market participant.547 Other commenters supported the Commission’s analysis. For example, one commenter argued that ‘‘differing estimates of costs is not a sufficient basis alone to challenge Commission action.’’ 548 This commenter argued that the commenters ‘‘tend to ignore the benefit side of cost-benefit analysis’’ and believed that ‘‘the most significant benefit of the pilot is its potential to inform subsequent rulemaking,’’ such that the ‘‘mere presence of uncertainty in the Commission’s estimates of potential costs and benefits does not by itself open the pilot program to challenge.’’ 549 While acknowledging the potential for ‘‘liquidity effects,’’ this commenter further noted that the Commission ‘‘is merely held to make a reasonable estimate of those costs before adopting a pilot program,’’ not to ‘‘make a perfect estimate’’ or ‘‘cease the pilot if the costs to liquidity prove significant.’’ 550 The economic analysis provided in the Proposing Release thoroughly described the potential economic effects of the Transaction Fee Pilot, including the benefits, costs, and alternatives and 545 See STANY Letter, at 2; Cboe Letter I, at 21; Nasdaq Letter I, at 10; FIA Letter, at 3; Citi Letter, at 5. 546 See, e.g., Vanguard Letter, at 3; Better Markets Letter, at 2; Healthy Markets Letter I, at 34; Angel Letter II, at 3. 547 See, e.g., Cboe Letter, at 7 n.14 and 20 (noting failure to adequately address lost revenue to exchanges); NYSE Letter I, at 3; NYSE Letter I, at 3 and 13 (addressing impact on small businesses and issuers); Apache Letter, at 2 (noting potential negative cost impacts to issuers engaged in secondary offerings or conducting share repurchasing programs); Nasdaq Letter I, at 8 (noting potential added cost to market makers when pricing arbitrage opportunities because of additional complexity in exchange pricing models under the Pilot). 548 Verret Letter I, at 3–4. See also Verret Letter I, at 7 (asserting that ‘‘[a]rguments by the Exchanges concerning the pilot proposal’s failure to quantify costs are irrelevant, in so far as the proposal properly identifies where they might at present be unquantifiable and particularly where those unquantifiable costs relate to the data the pilot is intended to generate.’’). 549 Verret Letter I, at 3–4. See also IEX Letter III, at 8, 10 (arguing that these commenters ignore ‘‘the full range of benefits that investors could realize if rebates were banned entirely’’). 550 Verret Letter I, at 4–5. E:\FR\FM\20FER2.SGM 20FER2 5246 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations the potential effect on efficiency, competition, and capital formation. Like the Proposing Release, where possible, the Commission has quantified below the likely economic effects of the 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 makes it difficult to predict how market participants would act under the conditions of the 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 the Pilot, such as volume discounts, the Commission cannot quantify, ahead of the Pilot, the economic impact of any changes in order routing decisions by brokerdealers that may result from the 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. A. Background and Market Failures The Commission’s Proposal provided a review of transaction-based fee models, including a discussion of the history and mechanics of transactionbased pricing and an overview of the concerns about potential conflicts of interest between broker-dealers and their customers attributed to access fees and rebates assessed by exchanges as well as the potential distortions that exchange fee models can introduce into market structure.551 The Commission considered whether competition within the broker-dealer industry, as well as competition among the equities exchanges, is sufficient to alleviate potential conflicts of interest presented by exchange fees and rebates and also the potential distortions such fee-and-rebate models may introduce. The Commission believes that competition between broker-dealers may not be capable of addressing these potential conflicts and distortions for three reasons: asymmetric information, switching costs, and a lack of collective action, each of which is discussed below. Further, competition between broker-dealers is not readily capable of independently resolving the other potential concerns presented by exchange fee models, such as excessive 551 See Proposing Release, supra note 2. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 intermediation, fragmentation, complexity, and cross-subsidization because those issues are within the exclusive control of the exchanges. The limitations of competition among the equities exchanges is discussed in detail below. 1. Market Failure at the Broker-Dealer Level The Commission considered whether competition could alleviate potential conflicts of interest between investors and broker-dealers, as investors choose broker-dealers to place orders on their behalf.552 To the extent that investors are able to identify broker-dealers that do not act on potential conflicts of interest in a manner inconsistent with the interests of their customers, investors could discourage brokerdealers from acting on such conflicts of interest and avoid doing business with those broker-dealers that do not offer such assurances. However, several commenters opined that competition and deference to market forces alone would not be sufficient to challenge the ‘‘deeply rooted conflicts of interest’’ that they believe are present in today’s market structure.553 For example, one commenter noted that many institutional clients are tied to large broker/dealers because of the multitude of services that their brokers provide, so they cannot simply ‘‘fire their brokers’’ if they are unhappy with their routing decisions.554 Further, the Commission does not believe that competition among broker-dealers alone will be sufficient to address potential conflicts of interest in order routing decisions because of three conditions that are present in today’s markets: 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.555 For example, customers do not generally have access to information about brokerdealers’ individual sources of 552 See Section infra IV.B.2.a. e.g., Better Market Letter at 1 (stating ‘‘[p]ayments by the exchanges that incentivize and induce routing decisions by broker-dealers at the expense of best execution and market quality is one of the most entrenched and insidious market practices today, and requires forceful and independent intervention by the SEC.’’). See also Themis Trading Letter at 4–5; Larry Harris Letter at 9; Clearpool at 2. 554 See Themis Trading Letter I, at 5. 555 See Larry Harris Letter, at 3 (noting that most brokerage customers do not know about potential broker agency problems and so do not know that their brokers may not be representing their orders as best they might). 553 See, PO 00000 Frm 00046 Fmt 4701 Sfmt 4700 revenue.556 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 fee-and-rebate pricing models on order routing decisions. Moreover, while under Rule 606, a customer may request certain information about how her broker routed certain orders on her behalf, a customer cannot necessarily use this information to compare how these orders would have been treated by broker-dealers other than her own. Further while recent amendments to Rule 606 would provide customers with limited information about transaction fees paid and transaction rebates received by the broker, the disclosure would not provide data to enable the customer to assess the impact of exchange transaction fees and rebates on market quality and execution quality. 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.557 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.558 Investors could provide incentives to brokerdealers to eliminate potential conflicts of interest by threatening to move accounts away from broker-dealers known to act on conflicts of interest. The collective action problem arises because, although each customer individually bears a cost to switch accounts, the benefits of a successful threat are available to all customers whether they would switch or not. If the 556 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. 557 These switching costs may be monetary, but may also have a time and effort component. 558 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. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations 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. 2. Market Failure at the Exchange Level Several commenters considered whether existing market forces, including competition among the equities exchanges, are sufficient to address the potential distortions caused by exchange pricing models. Some commenters felt that ‘‘some regulatory solution,’’ like the Pilot, ‘‘may be necessary to force market participants, particularly exchanges, to change the manner in which they conduct business’’ because competitive pressures on exchanges may serve as a barrier to market-led reforms in this area.559 Further, one commenter noted that ‘‘market forces cause the exchanges to choose maker-taker and inverted fee models to the detriment of the public interest’’ and therefore regulatory action is necessary to address market distortions caused by the maker-taker and taker-maker fee models.560 Further, the Commission notes that one market conducted a limited unilateral access fee experiment in 2015 to test the impact of reductions to its fees and rebates on 14 securities traded on its market. 561 Several commenters noted the limited utility of that study given its narrow scope and applicability to one market.562 The fact that no other 559 Clearpool Letter, at 2. See also T. Rowe Price Letter, at 1 (‘‘enthusiastically agree[ing] with the Commission that a pilot is necessary to gather data,’’ in part because ‘‘exchanges have little incentive to reduce the fee cap on their own’’). See also Larry Harris Letter, at 9 (noting that ‘‘regulatory action is necessary to establish a common pricing standard because market forces alone will not do it’’). Larry Harris Letter, at 6 (noting that ‘‘exchange holding companies have a strong interest in maintaining the current system’’ and that the ‘‘SEC may reasonably consider these interests when evaluating comments submitted by the exchanges’’); Themis Trading Letter II, at 3 (stating that the Commission should not be ‘‘distracted . . . by conflicted stock exchanges desperately fearful that their business models might come crashing down’’). 560 See Larry Harris Letter, at 9. See also Themis Trading Letter I, at 5 (noting that several exchanges oppose the pilot because they are motivated by their ‘‘own profit incentives and not what is best for the market’’). 561 See Proposing Release, supra note 2, at 13011– 12. See also Section IV.B.1.a.ii, infra discussing the Nasdaq Experiment in greater detail. 562 See, e.g., Themis Trading Letter I, at 3 (stating that a ‘‘more comprehensive multilateral marketwide approach would be needed to yield usable data that could be used to test how lower access fees, and a lack of rebates, would impact market quality and marketplace behavior’’ (emphasis omitted)); IEX Letter III, at 6 (‘‘Nasdaq’s experiment and its outcomes aren’t a perfect proxy for what is likely to happen in the Transaction Fee Pilot. That experiment was done unilaterally and only in VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 exchange joined in the 2015 access fee experiment, or independently undertook a similar study thereafter, supports the view that it is unlikely that competition among the exchanges alone would compel the exchanges to study, let alone address, potential distortions that may result from their fee and rebate models. B. Baseline We compare the economic effects of the 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 Pilot is designed to produce information on order routing behavior that would not otherwise be available. The baseline, therefore, includes the existing information available to the Commission in the absence of a pilot, which the Commission could use to inform future regulatory action.563 The baseline also sets out the exchanges’ current practices with respect to fees and rebates and the regulations governing those fees and rebates. 1. Current Information Baseline While the theoretical studies referenced in the Proposing Release suggest that transaction-based fee models create potential issues for investors,564 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 exchange transactionbased fees and rebates impact market and execution quality and affect the integrity and structure of the U.S. equity markets.565 Consequently, the relation highly-liquid securities.’’); Larry Harris Letter, at 9 (noting that Nasdaq’s ‘‘experimental fee reduction did not occur at all trading venues that traded the subject securities,’’ demonstrating that ‘‘regulatory action is necessary to establish a common pricing standard because market forces alone will not do it’’). 563 See supra Section IV.E.1 for the discussion of the alternative that the Commission proceed with rulemaking initiatives without first conducting the Pilot. That alternative differs from the baseline presented here because it directly presumes regulatory changes whereas the baseline for the Economic Analysis does not presume regulatory changes resulting from the Pilot. 564 See, e.g., Proposing Release supra note 6 at Section IV.A. and C. 565 Several commenters supported the Pilot as a necessary step to produce data to inform the heavily contested debate surrounding the impact of exchange fees and rebates on order routing, market quality, and execution quality. See, e.g., Barnard Letter, at 1 (‘‘historically there are many views on this topic, but a paucity of credible data from which to draw conclusions’’); Wellington Letter, at 1, and Clark-Joseph Letter, at 1. PO 00000 Frm 00047 Fmt 4701 Sfmt 4700 5247 between transaction-based pricing and conflicts of interest is not well understood.566 Additionally, commenters are divided as to how to interpret existing knowledge. One Commenter stated that we had ‘‘much to learn’’ 567 while other commenters felt that there was sufficient existing knowledge to move directly to rule making without a Pilot.568 Below, we discuss the existing information currently available to the Commission or the public that concerns the relationship between transactionbased fee-and-rebate pricing models and order routing decisions and we describe the limitations of this information for use in policy discussions regarding transaction-based fees and rebates and the potential conflicts of interest and potential distortions that may accompany them. We then discuss the potential to produce additional information regarding the impact of exchange fees and rebates absent the Pilot. While a number of studies attempt to document the relation between transaction-based fees, order routing decisions, and execution quality, these 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. This section details these limitations. a. Limitations of Existing Studies Multiple commenters submitted empirical evidence that they argued was consistent with conflicts of interest. For example, one Commenter cited evidence that trade execution algorithms that are fee sensitive tend to have lower execution quality than algorithms that are not fee sensitive.569 Another Commenter cited existing academic, industry, and government sources suggesting the existence of conflicts of interest, or of the investing public’s perception that there exist conflicts of interest.570 Another commenter suggested evidence existed that routing decisions were not always in the best interest of investors by arguing that adverse selection differs by exchange, and that this difference can be observed using TAQ data.571 Another commenter presented their study arguing that 566 See Nuveen Letter, at 2 e.g., Spatt Letter, at 3 568 See e.g., Larry Harris Letter, at 10 569 See Babelfish Letter, at 2–3 570 See CFA Letter, at 2 571 See Healthy Markets Letter I, at 2, 6 567 See E:\FR\FM\20FER2.SGM 20FER2 5248 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations longer queues lead to increased transaction costs, and connected longer queues with the practice of paying rebates.572 Another Commenter referenced a study suggesting that trading costs vary across exchanges.573 Although the above listed commenters all felt that the evidence did suggest that fees and rebates led to conflicts of interest, other commenters did not come to the same conclusion. One commenter felt that there was ‘‘no evidence that fee practices are harming investors or interfering with fair competition’’ and consequently felt that a Pilot was not justified.574 The studies and analysis presented by Commenters and the studies discussed below have significant limitations with regard to establishing causal links between fees and rebates and order routing decisions. These limitations fall primarily into two categories: (1) The results of the studies may not be representative, and (2) the results of the studies cannot make a causal connection needed to inform on potential conflicts of interest. When a study’s results are representative, the results can be applied across a broadly defined group. Drawing broad inferences from limited samples could be problematic because the results might be specific to specific securities, broker-dealers, or trading venues. In the context of regulatory decision-making, representative results should inform on the potential effects over the scope of the market covered by the decision. When results are not representative of the full scope of a regulatory decision, that regulatory decision may have an unpredictable effect over the part not represented by the results. For example, if the results of a study cover only certain types of issuers, the results may not apply to all types of issuers and therefore, any regulatory changes based on such studies may have unanticipated effects on the types of issuers not included in the study. In addition to limitations in how representative results may be, existing studies cannot test for causal relationships between transaction fees and order routing decisions, even around fee revisions. 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 572 See IEX Letter IV, at 9 AGF Letter, at 1 574 See CBOE Letter I, at 5 See also Nasdaq Letter I, at II–12 573 See VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 between fees and order routing decisions becomes increasingly complex because exchanges frequently modify their fees.575 In practice, researchers attempt to identify and measure causal relations in two ways: (1) Exogenous shocks and (2) econometric techniques, such as an instrumental variables approach.576 The Commission disagrees with one commenter who felt that sufficient data existed to move forward with regulation prohibiting rebates because ‘‘the theory is well-accepted, and no prior evidence contradicts it.’’ 577 In the absence of causal data, regulators can use theory— and their best judgment based on their expertise—to guide their decision making. However, in this case, for the reasons discussed throughout this release, the Commission believes that empirically assessing the various theories, causal impacts, and effects of the transaction fee-and rebate pricing model is appropriate. i. Battalio Equity Market Study 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.578 By routing orders to exchanges that pay high rebates, broker-dealers may engage in rebate capture at the expense of client execution.579 Using data obtained from mandatory Rule 606 disclosures over a two-month window,580 the Battalio 575 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 infra Section IV.B.2.b. 576 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. 577 See Harris Letter, at 10. 578 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 5307, at 2193. 579 See Battalio Equity Market Study, supra note 5307. See also supra Section IV.A.2, for an overview of the potential conflicts of interest that emerge. 580 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) (hereinafter ‘‘Disclosure PO 00000 Frm 00048 Fmt 4701 Sfmt 4700 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 charged the highest access fees). 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 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. Although the Battalio study provides evidence suggestive of conflicts of interest, the study has a number of limitations which render the Commission unable to use this study to robustly determine that rebates cause costly conflicts of interest for brokerdealers. 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.581 Analysis based on observation of a single brokerdealer 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.582 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 reports 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 of Order Execution and Routing Practices’’). See also supra note 310 and accompanying text and infra Section IV.B.1.b.i, ‘‘Rule 606 Data.’’ 581 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. See Battalio Equity Market Study, supra note 530. 582 Estimates based on data from Form 1 of the X–17A–5 filings. As of December 31, 2017, 3,860 broker-dealers that filed form X–17A–5. See infra Section IV.B.2.a. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations November 2012). As discussed above, approximately 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 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. In sum, the absence of an exogenous shock to access fee caps or rebates outside the control of exchanges leaves the authors unable to definitively determine the causes of broker-dealers’ order routing decisions. Consequently, the authors are unable to disentangle whether fees and rebates drive brokerdealer order routing decisions or order routing decisions determine fees and rebates chosen by exchanges. ii. The Nasdaq Experiment Nasdaq independently conducted an experiment, 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.583 Nasdaq produced two reports on the experiment 584 and an academic study 583 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. Nasdaq released two reports see infra note 584 (examining the changes to a number of metrics related to market quality). 584 The first report provided by Nasdaq can be found on their webpage https://qnasdaqomx.com/ AccessFeeExperiment (‘‘Nasdaq’s first report’’, or the ‘‘first Nasdaq report’’). The second report provided by Nasdaq can be found at https:// people.stern.nyu.edu/jhasbrou/SternMicroMtg/ VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 examining the experiment was submitted as a comment.585 Both Nasdaq’s first study report and the Swan study indicate that when Nasdaq lowered fees and rebates they lost market share in the stocks with lower fees and rebates. According to analysis in the Swan study, the market share that Nasdaq lost appeared to migrate to other make-take venues with higher fees and rebates. Additionally, both Nasdaq’s analysis as well as the Swan study find that the experiment led to a decrease in the fraction of time that Nasdaq quoted at the NBBO. The Swan study also estimated a variety of additional tests to measure the impact of the experiment on various aspects of market quality. The results of these tests are mixed. The Swan study found that the Nasdaq experiment improved market quality on Nasdaq in terms of improved fill rates and fill times as well as narrower cumfee effective spreads and cum-fee realized spreads.586 While cum-rebate effective spreads, fill rates and fill times improve on the Nasdaq during the experiment, the Swan study finds that the experiment diminished market quality in terms of quoted spreads and raw realized spreads which both increase during the experiment.587 Additionally, the Swan study shows that some measures of market quality were unchanged by the Nasdaq experiment, namely, the Swan study finds no change in raw effective spread.588 In Nasdaq’s second report on the experiment they examine various market quality measures and find no impact on effective spread, relative effective spread, quoted spread, relative quoted spread, displayed dollar depth at SternMicroMtg2015/Supplemental/ (‘‘Nasdaq’s second report’’, or the ‘‘Second Nasdaq report’’). 585 See Swan Letter which submitted the paper: Yiping Lin, Peter Swan, & Frederick Harris, Why Maker-Taker Fees Improve Exchange Quality: Theory and Natural Experiment Evidence, Working Paper, (2018), https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=3034901 (hereinafter ‘‘Swan study’’); Nasdaq’s Second Report, at 1. 586 Cum fee indicates that the computation of spreads included the fee or rebate charged. It is a measure of the total cost of transacting. 587 The effective spread is the cost to transact and is defined as two times the absolute difference between the price of a trade and the prevailing midpoint at the time of trade. The effective spread can be decomposed into two components, the realized spread and price impact of the trade. The price impact is generally viewed as the portion of the effective spread that compensates market makers for adverse selection losses. The realized spread is the portion of the spread that market makers ‘realize’ after adverse selection costs are taken into account. Raw realized spreads are realized spreads that do not take into account the all-in cost of trading, i.e., they exclude rebates from the calculations 588 Raw effective spreads are effective spreads that do not take into account the all-in cost of trading, i.e., they exclude fees from the calculations. PO 00000 Frm 00049 Fmt 4701 Sfmt 4700 5249 the NBBO, time between quote updates on the consolidated tape, and time between price changes in the NBBO on the consolidated tape. In examining the impact of the experiment on price efficiency, the Swan study finds mixed evidence that prices quoted on Nasdaq become less efficient during the experiment. First, the Swan study finds that global price impact declines during the experiment. Price impact is commonly employed as a measure of the informativeness of trades. The Swan study explains the decline in price impact with a theoretical model which suggests that rebates subsidize market makers for the adverse selection costs that they bearthereby allowing them the ability to bear additional adverse selection which induces informed traders to trade more aggressively in the presence of rebates. Consequently, their model predicts that informed trades will congregate on exchanges with high rebates. Additionally, the Swan study finds using variance ratios that price efficiency declines on Nasdaq during the experiment. However when using autocorrelation of trades as a measure of price efficiency, the tests indicate a decrease in autocorrelation—suggesting more efficient stock prices on Nasdaq.589 Additional analysis on price efficiency comes from Nasdaq’s second report which explores the impact of their experiment on market wide price efficiency and finds no change in price impact, autocorrelation of trades, or variance ratios. The Swan study also empirically examines how the Nasdaq experiment impacted the trading behavior of high frequency traders (‘‘HFTs’’) and nonHFTs and finds that as a result of the experiment HFTs added liquidity less often and took liquidity more often while non-HFTs did the opposite. Nasdaq also examined trading behavior and found that there was a shift in the composition of the top five liquidity providers for the securities that occurred as a result of the experiment. The top five liquidity providers prior to the start of the pilot significantly reduced their liquidity provision from 44.5% of the liquidity provided prepilot 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. 589 The interpretation of the price efficiency results is difficult because it is unclear what price efficiency on one exchange means in the absence of the other exchanges. Usually price efficiency is measured across all exchanges trading a given security. E:\FR\FM\20FER2.SGM 20FER2 5250 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations While Nasdaq believes that the results from their study do not support the need for a pilot,590 the Commission disagrees because the Nasdaq experiment and the subsequent analysis suffers from the following limitations. First, the Nasdaq experiment may not be representative of the broader market. Nasdaq selected 14 stocks to be part of the analysis, which represent 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),591 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.592 The small number of stocks makes interpretation of the results more difficult because a change to such a small number of stocks may not be significant enough for traders to alter their behavior.593 Additionally, the Commission is not able to make inference about the effect of a market wide change to fees and or rebates from the Nasdaq experiment because, as noted by multiple commenters, the effects of the experiment apply to a single exchange: Nasdaq.594 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. 595 Lastly, none of the analysis of the Nasdaq study analyzes 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 fees and rebates and potential conflicts 590 See Nasdaq Letter I, at 10. common stocks were included in the Nasdaq study, while the proposed Pilot will include NMS stocks, which includes common stocks as well as ETPs. 592 Market capitalizations are computed from CRSP shares outstanding and stock price, as of December 31, 2014. See also Themis Trading Letter I, at 2; NorthWestern Letter, at 1 and IEX Letter III, at 6. 593 Nasdaq acknowledges this limitation in their second report analyzing the experiment. See supra note 584 See also Themis Trading Letter I, at 2 and IEX Letter III, at 6 for commenters expressing similar concerns about the representativeness of Nasdaq’s sample. 594 See Swan Letter, at 3; Themis Trading Letter I, at 2; Credit Suisse Commentary, at 2, Larry Harris Letter, at 9, and IEX Letter III, at 6. 595 This point was acknowledged in Nasdaq’s second report. See supra note 584. This point was also brought up by multiple commenters. See Swan Letter, at 3; Credit Suisse Commentary, at 2; and Larry Harris Letter, at 9. 591 Only VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 of interest, the limited representativeness of the Nasdaq sample would limit the generality of the study. iii. Options Market Studies Three studies have examined exogenous shifts between maker-taker and payment for order flow pricing models on U.S. options exchanges.596 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.597 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.598 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. For example, 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. Each of these models is likely to create potential conflicts of interest that could affect how broker-dealers route their customer orders,599 although evidence does not suggest that one form of pricing model is more or less prone 596 See Amber Anand, Jian Hua, & Tim McCormick, Make-Take Structure and Market Quality: Evidence from the U.S. Options Markets, 62 Mgmt. Sci. 3085, 3217–90 (2016), https:// pubsonline.informs.org/doi/abs/10.1287/ mnsc.2015.2274 (hereinafter ‘‘Anand, Hua, & McCormick’’); Robert Battalio, Todd Griffith, & Robert Van Ness, Make-Take Fees versus Order Flow Inducements: Evidence from the NASDAQ OMX PHLX Exchange, 12th Ann. Mid-Atlantic Res. Conf. in Fin. (2017), https://www1.villanova.edu/ content/dam/villanova/VSB/assets/marc/ marc2017/SSRN-id2870000.pdf (hereinafter ‘‘Battalio, Griffith, and Van Ness’’); Robert Battalio, Andriy Shkilko, & 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, 51 J. Fin. & Quantitative Analysis (Oct. 2016) 1637, 1637–62 https://www.cambridge.org/ core/journals/journal-of-financial-and-quantitativeanalysis/article/div-classtitleto-pay-or-be-paid-theimpact-of-taker-fees-and-order-flow-inducementson-trading-costs-in-us-options-marketsdiv/ 0782CE3E9679C29BB910A66192D27201 (hereinafter ‘‘Battalio, Shkilko & Van Ness’’). Anand, Hua, & McCormick explores the transition from a payment for order flow model to a makertaker model on NYSE ARCA, while Battalio, Griffith, and Van Ness as well as Battalio, Shkilko, & Van Ness examine the shift on NASDAQ OMX PHLX (‘‘PHLX’’) from a maker-taker model to a payment for order flow model. 597 Id. 598 Id. 599 See Battalio, Shkilko & Van Ness, supra note 596, at 1637–62. PO 00000 Frm 00050 Fmt 4701 Sfmt 4700 to conflicts than another. Moreover, the change from one form of pricing model to another could introduce new conflicts of interest or impacts on market and execution quality that did not previously exist. Therefore, the Commission believes that exchangedriven transitions between maker-taker and payment for order flow pricing models are not likely to provide information about potential conflicts of interest and impacts on market and execution quality driven by the makertaker and taker-maker models or to inform the Commission about future regulatory decisions regarding transaction-based fee models. Additionally, these studies lack causality. Specifically the decision to invert an exchange from a taker/maker to a maker/taker exchange, which these studies are based on, is an endogenous decision, and therefore these studies lack the ability to make causal inference further hindering the Commission’s ability to draw inference from these studies. b. Limitations of Existing and Anticipated Data Some Commenters suggested that existing data sources could be employed in lieu of a Pilot to study the Commissions objectives.600 Another Commenter argued that enhancing existing data would be sufficient.601 To this end, the Commission considered whether a number of existing data sources could be used independently or in combination to relate transactionbased fees to order routing and execution quality. This section discusses these data sources. For instance, in the Battalio Equity Market Study and the Nasdaq study discussed above, the authors employed some combination of Rule 606 data, proprietary broker-dealer data, the Trade and Quote (TAQ) database,602 and proprietary exchange data. In addition, while not employed in previous studies, CAT data, OATS data, Rule 605 data, Form ATS–N 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, and fees 600 See STANY Letter, at 2; Nasdaq Letter I, at 11– 12; NYSE Letter I, at 17; and Nasdaq Letter III, at 1–2. 601 See Era Letter, at 1. But cf. IEX Letter II, at 9. 602 Battalio Equity Market Study, supra note 530, 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. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations and other arrangements. As noted above, several data sources provide information on order routing and execution quality. While researchers could use these data sources to produce some representative results regarding the relation between transaction-based fees, order routing, and execution quality, the Commission believes that available data has several limitations, which include: Granularity, completeness, periodicity, format, and availability. i. Rule 606 Data Rule 606 requires broker-dealers to make publicly available quarterly reports that provide an overview of their routing practices on certain orders in NMS securities. As amended, brokerdealers must provide information for the ten venues to which the largest number of total non-directed orders were routed for execution and for any venue to which five percent or more of nondirected orders were routed for execution. Rule 606 disclosures also require broker-dealers to disclose in a standardized format material aspects of their relationships with trading venues to which they route orders, including a description of, among other things, the payment for order flow and any profit sharing relationships, which, like rebates, could influence the brokerdealer’s order routing decision and potentially lead to potential conflicts of interest for broker-dealers when routing orders.603 Researchers and other analysts interested in order routing data can download these forms quarterly directly from broker-dealer websites. Some commenters believed that the amendments to the Rule 606 data would render the Pilot unnecessary.604 Indeed, a few commenters suggested that Rule 606 data, perhaps combined with other existing data, would be sufficient to study conflicts of interest among brokerdealers.605 The Commission disagrees that this type of analysis would serve the purposes of the Pilot.606 Such an approach would not adequately advance the Pilot’s broader purpose to study the effects that exchange transaction feeand-rebate pricing models may have on order routing behavior, execution quality, and market quality, in addition to conflicts of interest between brokers and their customers that are presented 603 See Section III.B.3 of Amendments to Order Handling Disclosure, supra note 310. 604 See Cboe letter I, at 26; FIA Letter, at 3; STANY Letter, at 2; Nasdaq Letter I, at 1–2, 4; NYSE Letter I, at 18. 605 See STANY Letter, at 2; Nasdaq Letter I, at 11– 12; ERA Letter, at 1. 606 See also IEX Letter I, at 9. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 when exchanges pay rebates.607 Further, disclosure alone would not provide an exogenous shock that generates measurable responses capable of providing insight into the effects of fees and rebates on the markets and market participant behavior. In addition, the quarterly frequency of the public Rule 606 reports by brokerdealers 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).608 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. Specifically, the 606 data is aggregated at the quarterly level. This frequency will not enable researchers to look at the full picture of how a brokerdealer responds to fees because exchanges on average revise their fee schedules 6.7 times per year. With 13 exchanges this amounts to 87 fee changes per year. Consequently, the fees that exchanges charge in a given quarter relative to the other exchanges will likely change multiple times within a quarter. Consequently, Rule 606 data is limited in how it can be employed to evaluate comprehensively the impact of order flow responding to fees and rebates. 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. First, each brokerdealer 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 brokerdealer, would include only 20 observations, limiting statistical power. In sum, the Commission believes that the amended Rule 606 data will provide useful information to complement the Pilot; however it is insufficient by itself to determine the impact of exchange transaction fees and rebates on brokerdealer order routing decisions, or inform the Commission of the impact of exchange pricing on market and execution quality.609 607 See, e.g., ICI Letter II at 3. every fee schedule revision pertains to transaction 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. 609 Multiple commenters expressed views similar to this and urged the Commission to adopt 606 amendments prior to the adoption of the Pilot. See, e.g., Citadel Letter, at 3; OMERS Letter, at 3; ICI 608 Not PO 00000 Frm 00051 Fmt 4701 Sfmt 4700 5251 ii. CAT Data and OATS Data Once the CAT Phase 1 becomes operational,610 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 cancellations, and order executions. Likewise, the Order Audit Trail Systems (OATS) data could inform on order routing decisions.611 The OATS data tracks customer orders from the receipt of the order through execution or cancellation. Information in the OATS data reflects the terms of the order, including the security, price, shares, account type, handling instructions, and side of the market for which the order was placed; where the order was routed for execution; modifications to the order; and execution information, including the capacity in which the firm acted in the trade. Although the CAT and OATS data could feasibly be used to produce order routing data similar to that required by the Pilot, as indicated by one commenter, without the corresponding ‘‘randomized trial,’’ the use of OATS data alone would be insufficient to determine causality in the effect of fees and rebates on order routing decisions because it would not be possible to determine from the data whether fees respond to changes in order routing decisions or whether order routing decisions respond to changes in fees. Consequently, in the absence of an exogenous shock to fees, CAT and OATS data cannot provide the Commission with robust evidence about how access fees impact order routing decisions.612 iii. Proprietary Broker-Dealer Data Proprietary data from broker-dealers or exchanges could also provide information about order routing decisions. 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 orders received by an exchange, including which members routed orders to the exchange, whether the orders execute, and the price, size, and time of Letter I, at 5–6; Fidelity Letter, at 2; IEX Letter II, at 9. 610 See supra Section II.E.3.vi. 611 See Nasdaq Letter I, at 4. 612 See Verret Letter I, at 4. E:\FR\FM\20FER2.SGM 20FER2 5252 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations execution. Indeed, several commenters stated that if 606 data were not sufficient to answer the Commission’s questions about broker dealer routing decisions, then the Commission could request routing tables and information directly from broker-dealers or request other Transaction Cost Analysis (TCA) data to supplement the 606 data.613 While these data would provide potentially more granular data about order routing, as proprietary datasets, there is no standard format that exchanges or broker-dealers use to aggregate this data, which makes cross broker-dealer or cross exchange comparison difficult. Even if a dataset of proprietary data could be produced from data obtained directly from exchanges or broker-dealers, the data would still lack an exogenous shock to fees which is necessary to determine a causal link between order routing decisions and exchange fees. iv. Rule 605 Data A few commenters suggested that Rule 605 data used in conjunction with other data such as Rule 606 data, could provide information about broker dealer conflicts of interest.614 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.615 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 nonmarketable orders. While Rule 605 data is available to researchers and may provide information about execution quality, it too has 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.616 For instance, Rule 605 measures realized spreads based on quotations five minutes after the time of 613 See Nasdaq Letter I, at 11–12 and FIA Letter, at 3. 614 See STANY Letter, at 2 and Nasdaq Letter I, at 11–12. 615 See Disclosure of Order Execution and Routing Practices, supra note 580, at 75417–25. 616 See Securities Exchange Act Release No. 61358 (January 14, 2010), 75 FR 3594 (January 21, 2010) (hereinafter ‘‘Concept Release’’). VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 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.617 Finally, Rule 605 data is limited in that it covers only held orders and orders of less than 10,000 shares. v. TAQ Data Beyond Rule 605 data, researchers could also use the TAQ database as a means of measuring order execution quality or estimating market share to use as a measure for order routing decisions. The TAQ database is publicly available (for a fee) from NYSE and provides access to all trades and top of the book quotes for NMS securities, from which researchers and other analysts can estimate trade-based measures of execution quality such as effective spreads. While TAQ data are available to academic researchers, TAQ has a number of limitations in its precision in the measurement of order routing and execution quality. An exchange’s market share can differ significantly from its share of orders received because exchanges reroute orders they cannot execute at the best prices and some exchanges reroute more orders than others. In addition, TAQ doesn’t provide information on the brokers or dealers underlying the trades or quotes, so TAQ cannot tell us about the decisions of individual brokers. While TAQ facilitates the estimation of trade and quote-based measures of execution and market quality, it does not facilitate the estimation of order-based measures of execution quality, which are more precise than trade-based measures. In particular, order-based measures allow for the consideration of order size, which can be different and often larger than trade size. Order-based measures also consider the costs of latency whereas trade-based measures do not. Additionally, since TAQ only provides data on trades it does not provide a means of estimating execution quality for limit orders. vi. Information From Exchange 19b–4 Filings Finally, researchers both in and outside of the Commission, who wish to link fees and rebates to various outcomes, can manually create datasets of exchange fees and rebates from the information that exchanges provide on their websites and release in their 617 See, e.g., Jennifer Conrad & Sunil Wahal, The Term Structure of Liquidity Provision (August 8, 2018) (unpublished manuscript) https:// papers.ssrn.com/sol3/papers.cfm?abstract_ id=2837111. PO 00000 Frm 00052 Fmt 4701 Sfmt 4700 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 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. A key limitation to this data, particularly for researchers outside the Commission, is that exchanges use bespoke terminology to classify their fees and rebates. Consequently, identifying comparable fees across exchanges is difficult. 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. Lastly, even if a comprehensive dataset of fee changes were created, it would not be sufficient by itself to study the link between order routing decisions and fees because the dataset can only tell when and how an exchange revised fees, and not why the fee changed or if the fee change affected order routing behavior. In essence the data still lacks the ability to establish a causal connection between fee changes and order routing decisions. vii. Form ATS–N Following implementation in January 2019, the public will have more information on ATS conflicts of interest and fees. In particular, in June 2018, the Commission adopted amendments to 17 CFR 242.300 through 242.303 (Regulation ATS) and 17 CFR 240.3a1– 1 (Rule 3a1–1 under the Exchange Act).618 As part of these amendments, NMS Stock ATSs will be required to 618 See Securities Exchange Act Release Nos. 83663 (July 18, 2018), 83 FR 38768 (August 7, 2018). E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations publicly report on new Form ATS–N information about the manner in which the ATS operates and activities of the broker-dealer operator and its affiliates, as well as potential conflicts of interest within the NMS Stock ATSs. While Form ATS–N will contain high level information on operations and affiliates of the ATS, it will not contain detailed information, such as ATS routing tables. Therefore, it would not contain detailed information on how fees and rebates affect the order routing decisions of the ATS. Form ATS–N also will require ATSs to provide public disclosures about the different types of fees they charge, along with the ranges of those fees and whether they are bundled with any other services. However this information would not be nearly as granular as the exact fee disclosures that would be required by the Pilot. Nor do they provide as much information as the fee disclosures that exchanges are currently required to disclose. These limitations make it difficult to use the ATS–N data to make causal inference about the impact of fees and rebates on order routing decisions. case it would be the order routing decisions that drive the exchange fees. The data alone do not allow researchers to distinguish whether order routing determines fees or whether fees determine order routing. Similarly, existing data, even if it didn’t have the limitations above, would not enable researchers to infer the causal impact of fee-based order routing on order execution quality. If fees and execution quality are linked, then exchanges may change their fees in response to changes in execution quality. For example, raising rebates might attract more liquidity providers and induce additional order flow to the exchange. An exchange that is experiencing low execution quality might raise rebates to address this problem. Under these circumstances, an empirical analysis that lacks an exogenous shock to fees/rebates might erroneously conclude that increased rebates cause a conflict of interest because they are correlated with low execution quality and increased order flow. Such a conclusion might lead the Commission to draw incorrect conclusions. c. The Potential To Study the Causal Link Between Fees, Rebates, and Conflicts of Interest Absent a Pilot Absent a Pilot, the Commission does not believe it would have comprehensive, empirical evidence to study the effects on the market that the Pilot is intended to study. In particular, as indicated above, the Commission does not believe the theoretical evidence on incentives and potential other effects are indicative of brokerdealers actually acting on those incentives. Further, even if the data sources above did not suffer from their limitations, researchers would struggle to identify the causality necessary to robustly link fee and rebate effects on order routing to order execution quality. Indeed, this link requires two steps: First establishing a causal link between fees and rebates and order routing and then between fee-based order routing and order execution quality. Even with perfect data, any study linking fees and rebates to order routing would suffer from an inability to draw conclusions about causality. While such a study might find a correlation between fees/ rebates and order routing decisions, the researchers would be unable to conclude which event was driving which. In particular, since exchanges compete for market share, it is reasonable to expect that exchanges change their fees and rebates in response to changes in order routing decisions by broker dealers. If this is the 2. Current Market Environment This section provides an overview of the competitive landscape that could be affected as a result of revisions to the transaction-based fee structure required by the Pilot. Where information is currently available to the Commission, a description of the current practices of exchanges along dimensions that are relevant to the Pilot (e.g., summary information on their current fee schedule or the frequency of fee revisions) are included. The Commission requested that commenters provide additional information to inform the baseline as part of the proposal. Where available, the baseline has been supplemented to reflect additional baseline information that was received from commenters. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 a. Market for Trading Services The market for trading services, which is served by exchanges, ATSs, and other liquidity providers (internalizers and others), relies on competition to supply investors with execution services at efficient prices. These trading venues, which compete to match traders with counterparties, provide platforms for price negotiation and the dissemination of trading information. The market for trading services in NMS stocks currently consists of 13 national equity market exchanges and 34 operational ATSs. Other off-exchange venues include broker-dealer internalizers and PO 00000 Frm 00053 Fmt 4701 Sfmt 4700 5253 wholesalers, which execute a substantial volume of retail order flow. The remainder of this section discusses the current competitive landscape for exchanges, ATSs, and others relevant to our economic analysis of the Pilot. Since the adoption of Regulation NMS in 2005, the market for trading services has become more fragmented and competitive. Of the 13 exchanges, seven are maker-taker exchanges and four are taker-maker pricing exchanges, as shown in Table 1; the NYSE American and IEX operate as flat-fee exchanges.619 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.620 Several studies have suggested that transaction-based fee pricing partially drove the increase in the number of U.S. equities exchanges since 2005.621 Execution services are a lucrative business, which encourages new trading centers to enter the market in the hopes of capturing rents associated with order 619 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 IEX, Investors Exchange Fee Schedule (August 1, 2018), https:// iextrading.com/trading/fees (last visited September 18, 2018). As of March 2018, EDGA is no longer operating as a taker-maker market, but is also operating as a flat-fee venue. See Cboe, Cboe US Equities (2018) https://markets.cboe.com/us/ equities/ (last visited September 18, 2018). 620 While the number of exchanges was eight, there were other non-exchange trading venues in 2005 (i.e., ECNs), which were displayed markets that utilized a standard price-time-priority market model similar to exchanges. 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. 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 and was re-opened for trading in May 2018. See Intercontinental Exchange, NYSE Finalizes Acquisition of National Stock Exchange, Bus. Wire: News (Jan. 31, 2017, 6:28 p.m.) https:// www.businesswire.com/news/home/ 20170131006474/en/. 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. 621 See, e.g., Angel, Harris, & Spatt, supra note 530; Harris, supra note 530. E:\FR\FM\20FER2.SGM 20FER2 5254 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations execution.622 As discussed in the proposing release, 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.623 But 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, and possibly despite the liquidity profile or execution quality of those venues. Rebates offered by exchanges, therefore, may ‘‘break’’ the liquidity externality. TABLE 1—U.S. NATIONAL EQUITIES EXCHANGES Exchange in 2005? Exchange Market fee type 624 Cboe BZX: https://markets.cboe.com ..................................................... Cboe BYX: https://markets.cboe.com ..................................................... Cboe EDGA: https://markets.cboe.com .................................................. Cboe EDGX: https://markets.cboe.com .................................................. BX: www.nasdaqtrader.com .................................................................... Phlx (PSX): www.nasdaqtrader.com ....................................................... Nasdaq: www.nasdaqtrader.com ............................................................ NYSE Arca: https://www.nyse.com/markets ........................................... NYSE American 626: https://www.nyse.com/markets .............................. NYSE: https://www.nyse.com/markets .................................................... NYSE National 627: 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 ................................... Flat Fee .......................................... Maker-Taker ................................... Taker-Maker ................................... Maker-Taker ................................... Flat-fee ........................................... Total ................................................................................................. ........................................................ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ........................ Market share 625 (%) 6.14 4.86 1.26 5.58 3.00 0.70 15.76 8.87 0.32 12.16 0.64 0.57 6.14 66.00 Table 1 highlights that the market share of trading volume among exchanges is not very concentrated. Although NYSE and Nasdaq have the largest market share of approximately 12% and 16%, respectively, among the exchanges, as of July 2018, these two exchanges collectively account for less than 30% of the total market share of trading volume for NMS stocks, indicating that the market for trading services has become decentralized, and has become more so over time. For instance, between 2004 and 2013, the NYSE’s market share of NYSE-listed stocks declined from approximately 80% to 20%, while market share of other exchanges and off-exchange trading centers has increased.628 This decentralization provides market participants with a choice among venues when they route orders, and may also encourage exchanges to compete to attract order flow. A number of commenters suggested that exchanges compete intensely with each other to attract order flow.629 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 also develop different business models to attract different types of order flow.630 For example, maker-taker venues may offer large rebates to attract liquidity supplying orders.631 They may then rely on this liquidity to attract marketable orders, to which they charge a high transaction fee in order to both offset the cost of the large rebates and to ensure a profitable transaction pricing model. Alternatively, inverted exchanges offer higher rebates to compete to attract marketable orders. Exchanges may also compete for order flow on other dimensions as well, by offering better execution quality, better technology, and innovations in order types and other trading mechanisms.632 In addition to competing with other U.S. equities exchanges, exchanges also compete for order flow with offexchange trading centers, including ATSs, internalizers, and others. One way exchanges compete with offexchange trading venues is through the use of rebates. For example, a number 622 See, e.g., Angel, Harris, & Spatt, supra note 530; Harris, supra note 530. 623 See Proposing Release, supra note 2, at 13042. See also ICI Letter II at 4. 624 See supra notes 3 and 4. 625 Shares are computed based on trading volume in August 2018. Market shares for the exchanges reported do not add up to 100%, because approximately 34% of trading volume is executed off-exchange on over-the-counter venues. These market share figures differ slightly from the ones in footnote 9 of Cboe Letter I, which provided market share for May 2018. While these differences could result from the focus on more recent data, the Commission is not sure if the differences could also be driven by differing methodologies. Nonetheless, the figures in Cboe Letter I are consistent with the conclusions in this release. Also, the off-exchange share differs slightly from the 39% share in Nasdaq Letter I, at 2. Note that the off-exchange share in the Proposing Release was 40%. 626 Since July 2017, NYSE American has not been 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 (July 26, 2018), https:// www.nyse.com/publicdocs/nyse/markets/nyseamerican/NYSE_America_Equities_Price_List.pdf. 627 NYSE acquired NSX in January 2017, and the exchange is now known as NYSE National. The exchange was re-opened for trading in May 2018 as taker-maker exchange. 628 See Angel, Harris, & Spatt, supra note 5307, Figures 2.17 and 2.18. Although less evident than for NYSE-listed securities, the effect is similar for the Nasdaq market. 629 See, e.g., CBOE Letter I, at 2; NASDAQ Letter I, at 11–13. One commenter suggested that in the Proposal, the Commission made the assumption that exchange groups had market power without providing evidence to support the assumption. This commenter also argued that no exchange group controls even 25 percent of market share and that competition is robust between and among equities exchanges. See NASDAQ Letter I, at 12–13. 630 One commenter suggested that in the Proposal, the Commission failed to account for the two-sided nature of exchange platforms when assessing the competitive impact of the Proposal. See NASDAQ Letter II, at 4–5. In the Proposal, the Commission separately discussed the potential impact of the Pilot on the competition for trading volume, see the Proposal, supra note 2, at 13068. The Commission also discussed some ways the Pilot could potentially impact marketable and nonmarketable order flow, see the Proposal, supra note 2, at 13057. Additionally, in Section IV.D.2.a, the Commission separately discusses the potential effects of the Pilot on marketable and nonmarketable order flow. 631 A number of commenters said exchanges use rebates to compete to attract limit orders to supply liquidity. See, e.g. NASDAQ Letter I, at 12; Virtu Letter, at 3; State Street Letter, at 2. 632 One commenter also suggested that exchanges also compete to attract to liquidity using many costly features, including rebates, incentive programs, superior execution systems, regulatory quality, and customer service. See NASDAQ Letter I, at 12. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 PO 00000 Frm 00054 Fmt 4701 Sfmt 4700 E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations of commenters argued that one way exchanges compete with off-exchange trading venues is by using liquidity rebates to attract liquidity and narrow the displayed spread, which makes it more expensive for off-exchange trading venues to either match or improve upon the NBBO.633 Exchange transaction fees may also affect competition between exchanges and off-exchange trading venues. For example, commenters suggested that broker-dealers may opt to route order flow off-exchange in order to avoid higher transaction fees charged by exchanges.634 Off-exchange trading venues may also compete with exchanges to attract order flow by offering more flexibility in how they execute orders. One commenter noted that ‘‘market participants choose to send orders to off-exchange venues for reasons other than avoiding fees,’’ including ‘‘investors anonymity, the ability to trade in more granular tick sizes, the flexibility to segment the treatment of different types of clients, the ability to choose trading counterparties, and the ability to accommodate customer errors.’’ 635 Off-exchange trading makes up a substantial fraction of total volume, as approximately 34% of all transaction reports are routed using the NYSE and Nasdaq Trade Reporting Facilities as of August 2018.636 Of that off-exchange NMS share volume, approximately 14% was attributable to ATSs, of which 34 traded NMS securities as of August 2018.637 The remaining 21% of offexchange share volume is routed to other off-exchange trading centers, such as internalizers.638 In aggregate, broker-dealers and other market participants have a large and varied set of options as to where they 633 See e.g., FIA Letter, at 3–4; NYSE Letter I, at 6; Grasso Letter, at 4. 634 See e.g., IEX Letter I, at 3; Credit Suisse Commentary, at 2. 635 See NYSE Letter I, at 6. 636 Data on off-exchange market share are available from Cboe https://markets.cboe.com/us/ equities/market_share/ (last visited November 8, 2018). 637 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) (hereinafter ‘‘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: Reg. Filing & Reporting (2018), https://www.finra.org/Industry/ Compliance/MarketTransparency/ATS/. 638 Total market share is collected from Cboe https://markets.cboe.com/us/equities/market_share/ (last visited November 8, 2018). ATS weekly market share is collected from FINRA, https:// otctransparency.finra.org (last visited November 8, 2018). VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 route orders, whether to exchanges or to 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,639 which may provide different incentives to broker-dealers in order to attract this order flow, including transaction fees and rebates. We discuss the current levels of transaction-based fees in Section IV.B.2.e below. b. Market for Liquidity Provision Several commenters discussed the importance of liquidity providers to an exchange’s ability to compete in the market for trading services.640 Within the exchange framework, liquidity providers, such as market makers, other proprietary traders, and investors, compete to supply liquidity to liquidity demanders. They compete by posting displayed limit orders on exchanges, or by posting undisplayed limit orders on exchanges or ATSs. Liquidity providers profit by buying at a price lower than the price at which they sell and/or by collecting rebates that are greater than the fees they pay. Hence, an execution is a necessary means of profiting from liquidity provision, whether the liquidity provider seeks to profit from price changes or rebates. Liquidity providers, and traders more generally, seek to manage their trading profits by managing the tradeoff between the price they get in an execution, the certainty of execution, and any adverse selection resulting from the execution.641 When a liquidity supplier more aggressively prices their limit order, they increase the chance that their order will execute, but they trade this off against their order executing at a worse price and increased chance of their order being adversely selected if it does execute. To get an execution, the limit orders need to be at the top of a queue at a given price and venue and placed on a venue able to attract liquidity demanders. Displaying a limit order attracts liquidity demanders to the venue displaying the limit order, and thus improves the probability of execution, but could also increase the risk of being adversely selected, which reduces profits. For example, an algorithm that is skilled at identifying short-term price movements may be programmed to hit displayed limit buy orders at a price following a signal that 639 See Angel, Harris, & Spatt, supra note 530. e.g., Cboe Letter I; NYSE Letter I. 641 See NYSE Letter II at 8 for more concrete factors considered by liquidity providers. 640 See, PO 00000 Frm 00055 Fmt 4701 Sfmt 4700 5255 the price is about to go down. In such a situation, the liquidity provider is unlikely to quickly sell at a price higher than the recent purchase, and therefore, these situations are costly for the liquidity provider. One way to attempt to reduce adverse selection costs is to not display the limit order. When the order is not displayed, the traders with the price signals may not see it and, as a result, would be less likely to pick it off. On the other hand, an undisplayed limit order also risks not getting executed when an execution would be profitable. For example, an undisplayed limit buy order is less likely to execute than a displayed limit buy order just prior to an increase in the price because marketable sell orders that do not anticipate the price increase are likely to route to venues with competitively priced limit buy orders and would not be able to identify which venues have undisplayed limit buy orders. Rebates and fees can also affect where liquidity providers choose to supply liquidity. Maker-taker exchanges, which pay rebates to liquidity suppliers, provide them with extra revenue when trades are executed. This could encourage liquidity suppliers to post at more aggressive prices for some securities, subject to the fact that displayed quotes on stock exchanges must be priced in one-cent increments. However, competition among liquidity suppliers to earn rebates could lead to longer queues in an order book, which could decrease the chance that a liquidity supplier’s order executes unless they are at or near the front of the queue. In contrast, inverted exchanges, which charge liquidity suppliers a fee when they supply liquidity and offer a rebate to takers of liquidity, usually have shorter queue lengths and an economic incentive to take liquidity, which increases the chance that a liquidity supplier’s order executes. c. Market for Broker-Dealer Services The Commission considered the potential for the Pilot 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.642 Large broker-dealers 642 See Securities Exchange Act Release No. 63241 (November 3, 2010), 75 FR 69791, 69822 (November 15, 2010) (hereinafter ‘‘Risk E:\FR\FM\20FER2.SGM Continued 20FER2 5256 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations 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.643 As of December 31, 2017, approximately 3,860 brokerdealers filed Form X–17a–5. These firms vary in size, with median assets of approximately $800,000, average assets of nearly $1 billion, and total assets across all broker-dealers of approximately $4 trillion. The twenty largest broker-dealers held approximately 72% of the assets of broker-dealers overall, with total assets of $2.89 trillion, indicating the high degree of concentration in the industry. Of the 3,860 broker-dealers that filed Form X–17a–5, 397 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 $25.5 million, average assets of $9.2 billion, and total assets across all broker-dealers that are members of exchanges of $3.65 trillion. d. Market for Assets Under Management Many commenters expressed concern about the impact of the Pilot on the market for assets under management, particularly on exchange-traded products (‘‘ETPs’’). Asset management firms compete with each other in a segment of the market for assets under management. They offer different types of investment vehicles, such as mutual funds, close-end funds, and ETPs,644 which compete with each other to attract investor funds. Investor funds in an investment vehicle are pooled together and invested in financial assets, with investors sharing any profits or losses incurred by the investment vehicle according to each investor’s interest in the vehicle. Asset management firms generally earn revenue by charging fees based on the value of the assets they manage on behalf of investors in their investment vehicles.645 Investment vehicles compete with other investment vehicles that follow Management Controls for Brokers or Dealers with Market Access’’). 643 See id. Larger brokers, or those with more order flow, also benefit from the economies of scale that accompany the tiering structure typically provided by exchanges. Accordingly, the brokers with the most liquidity-providing orders may benefit disproportionately from rebates because they generally receive higher rebates within the various tiered pricing models of exchanges. 644 Not all ETPs are pooled investment vehicles. For example, exchange traded notes (‘‘ETNs’’), which are a subset of ETPs, are unsecured, unsubordinated debt securities that trade in the secondary market on exchanges. 645 Investment companies can also earn revenue from other activities such as lending securities. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 similar investment strategies to attract investor funds. They often rely on differences in expense ratios, tracking error, and redemption and trading characteristics when competing to attract investor funds.646 One subset of investment vehicles are ETPs. ETPs differ from other investment vehicles in their trading and redemption characteristics. ETPs are investment vehicles that issue shares that can be bought or sold throughout the day on securities exchanges in the secondary market at a market-determined price. ETPs provide investors with a diverse set of investment options. While the first ETPs held portfolios of securities that replicated the component securities of broad-based domestic stock market indexes, some ETPs now track more specialized indexes, including international equity indexes, fixedincome indexes, or indexes focused on particular industry sectors such as telecommunications or healthcare. Some ETPs seek to track highly customized or bespoke indexes, while others seek to provide a level of leveraged or inverse exposure to an index over a fixed period of time. Investors also have the ability to invest in ETPs that do not track a particular index and are actively managed. A number of commenters noted that ETP issuers face strong competition within similar investment strategies and that small differences in fees and trading characteristics, such as spreads, daily volume, and intraday volatility, may be meaningful to market participants when deciding which ETPs to trade or invest in.647 As of September 2018,648 there were 2,003 ETPs categorized as exchange traded funds (‘‘ETFs’’), 223 ETPs categorized as non-ETF ETPs, and 18 ETPs categorized as ETMFs.649 As of 646 Actively managed investment vehicles also rely on their historical performance when competing to attract investor funds. 647 See, e.g. JPMorgan Letter, at 4; STANY Letter, at 4; Healthy Markets Letter II, at 8; Morgan Stanley Letter, at 3–4. 648 The results are based on data collected from Bloomberg and Morningstar as of September 30, 2018 for US-domiciled ETPs. 649 ETFs operate under exemptive orders that allow them to register as investment companies under the Investment Company Act. See 15 U.S.C. 80a–3(a)(1). Non-ETF ETPs are other ETPs that are not registered under the Investment Company Act. Some are pooled investment vehicles with shares that trade on a securities exchange, but they are not ‘‘investment companies’’ under Investment Company Act because they do not invest primarily in securities. Such ETPs may invest primarily in assets other than securities, such as futures, currencies, or physical commodities (e.g., precious metals). Others are not pooled investment vehicles. For example, ETNs are senior, unsecured, unsubordinated debt securities that are linked to the performance of a market index and trade on PO 00000 Frm 00056 Fmt 4701 Sfmt 4700 this date, ETPs had total net assets of $3.74 trillion. The ten largest ETPs accounted for 28.0% of total ETP net assets and 27.8% of the average dollar trading volume on secondary markets. As the statistics above indicate, ETFs represent the majority of ETPs, they possess characteristics of both mutual funds, which issue redeemable securities, and closed-end funds, which generally issue shares that trade at market-determined prices on a national securities exchange and are not redeemable.650 Similar to mutual funds, ETFs continuously offer their shares for sale. Unlike mutual funds, however, ETFs do not sell or redeem individual shares. Instead, ‘‘authorized participants’’ that have contractual arrangements with the ETF (or its distributor) purchase and redeem ETF shares directly from the ETF in blocks called ‘‘creation units.’’ 651 An authorized participant that purchases a creation unit of ETF shares directly from the ETF deposits with the ETF a ‘‘basket’’ of securities and other assets identified by the ETF that day, and then receives the creation unit of securities exchanges. See fn. 10 and accompanying text in the ETF Proposal, infra note 651, at 37333. ETMFs are exchange traded managed funds. ETMFs also operate under exemptive orders that allow them to register as investment companies under the Investment Company Act, but they have different disclosure requirements than ETFs. See, e.g. Eaton Vance Management, et al., Investment Company Act Rel. Nos. 31333 (Nov. 6, 2014) (notice) and 31361 (Dec. 2, 2014) (order). 650 The Investment Company Act defines ‘‘redeemable security’’ as any security that allows the holder to receive his or her proportionate share of the issuer’s current net assets upon presentation to the issuer. See 15 U.S.C. 80a–2(a)(32). While closed-end fund shares are not redeemable, certain closed-end funds may elect to repurchase their shares at periodic intervals pursuant to rule 23c– 3 under the Investment Company Act (‘‘interval funds’’). Other closed-end funds may repurchase their shares in tender offers pursuant to rule 13e– 4 under the Exchange Act. 651 The Commission’s exemptive orders typically contain a representation by the applicant that an authorized participant will be either: (a) A broker or other participant in the continuous net settlement system of the National Securities Clearing Corporation, a clearing agency registered with the Commission and affiliated with the Depository Trust Company (‘‘DTC’’), or (b) a DTC participant, which has executed a participant agreement with the ETF’s distributor and transfer agent with respect to the creation and redemption of creation units. See, e.g., Emerging Global Advisors, LLC, et al., Investment Company Act Release Nos. 30382 (February 13, 2013), 78 FR 11909 (February 20, 2013) (notice) and 30423 (March 12, 2013) (order) and related application. In June 2018, the Commission proposed a new rule under the Investment Company Act of 1940 that would permit ETFs that satisfy certain conditions to operate without obtaining an exemptive order. In connection with the proposed exemptive rule, the Commission proposed to rescind certain exemptive orders that have been granted to ETFs and their sponsors. See Securities Exchange Act Release No. 10515 (June 28, 2018), 83 FR 37332 (July 31, 2018) (‘‘ETF Proposal’’). E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations ETF shares in return for those assets.652 The basket is generally representative of the ETF’s portfolio 653 and, together with a cash balancing amount, equal in value to the aggregate NAV of the ETF shares in the creation unit.654 After purchasing a creation unit, the authorized participant may hold the individual ETF shares, or sell some or all of them in secondary market transactions. The redemption process is the reverse of the purchase process: The authorized participant redeems a creation unit of ETF shares for a basket of securities and other assets.655 While the Commission currently lacks data on authorized participants, a 2015 surveybased study of fifteen fund sponsors, which together offer two-thirds of all existing ETFs (covering 90% of all ETF assets), finds that the average ETF has 34 authorized participant agreements.656 The study further reports that creation and redemption transactions occurred only on between 10% to 20% of trading days and that only 10% of the daily activity in all ETF shares (by volume) are creations or redemptions.657 Investors can purchase individual ETF shares in the secondary market at prices that may deviate from the ETF’s NAV. As a result, ETF investors may trade shares at prices that do not 652 An ETF may impose fees in connection with the purchase or redemption of creation units that are intended to defray operational processing and brokerage costs to prevent possible shareholder dilution (‘‘transaction fees’’). 653 The basket might not reflect a pro rata slice of an ETF’s portfolio holdings. Subject to the terms of the applicable exemptive relief, an ETF may substitute other securities or cash in the basket for some (or all) of the ETF’s portfolio holdings. Restrictions related to flexibility in baskets have varied over time. See the ETF Proposal, supra note 651, at 37354–58. 654 Non-ETF ETPs also offer creation and redemption processes. Some Non-ETF ETPs that are organized as pooled investment vehicles may offer creation and redemption processes similar to ETFs. Other Non-ETF ETPs may offer creations or redemptions on a less frequent basis. For example, some ETNs may only be redeemed weekly. 655 An authorized participant may act as a principal for its own account when purchasing or redeeming creation units from the ETF. Authorized participants also may act as agent for others, such as market makers, proprietary trading firms, hedge funds or other institutional investors, and receive fees for processing creation units on their behalf. See Abner, D.J. The ETF Handbook: How to Value and Trade Exchange Traded Funds, 2nd ed., Wiley Finance (2016) (‘‘ETF Handbook’’). 656 See, e.g., Antoniewicz, R. & Heinrichs, J. (2014). ‘‘Understanding Exchange-Traded Funds: How ETFs Work.’’ ICI Research Perspective, Vol. 20(5) (available at: https://www.ici.org/pdf/per2005.pdf) (‘‘Antoniewicz’’). 657 NSCC is the sole provider of clearing services for ETF primary market transactions. Whether a creation or redemption order is eligible to be processed through NSCC depends on the eligibility for NSCC processing of the securities in the ETF’s basket. See id. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 necessarily reflect the intrinsic value of the underlying ETF assets.658 As discussed in the ETF Proposal,659 the combination of the creation and redemption process with secondary market trading in ETF shares provides arbitrage opportunities that are designed to help keep the market price of ETF shares at or close to the NAV per share of the ETF.660 For example, if ETF shares are trading on national securities exchanges at a ‘‘discount’’ (a price below the NAV per share of the ETF), an authorized participant can purchase ETF shares in secondary market transactions and, after accumulating enough shares to compose a creation unit, redeem them from the ETF in exchange for the more valuable securities in the ETF’s redemption basket.661 The authorized participant’s purchase of an ETF’s shares on the secondary market, combined with the sale of the ETF’s basket assets, may create upward pressure on the price of the ETF shares, downward pressure on the price of the basket assets, or both, bringing the market price of ETF shares and the value of the ETF’s portfolio holdings closer together.662 Alternatively, if ETF shares are trading at a ‘‘premium’’ (i.e., a price above the NAV per share of the ETF), the transactions in the arbitrage process are reversed and, when arbitrage is working effectively, keep the market price of the ETF’s shares close to its NAV.663 658 It is possible for both the ETF’s NAV per share and its market price to deviate from the intrinsic value of the ETF’s underlying portfolio. In addition, there may be cases in which the ETF’s market price is closer to the intrinsic value of the ETF’s portfolio than its NAV per share. See, e.g., Madhavan, A. & Sobczyk, A. (2016) ‘‘Price Discovery and Liquidity of Exchange-Traded Funds.’’ Journal of Investment Management, Vol 14(2) (available at: https:// www.joim.com/price-dynamics-and-liquidity-ofexchange-traded-funds-2/). 659 See the ETF Proposal, supra note 651, at 37384. 660 ETFs also operate under several conditions designed to facilitate an efficient arbitrage mechanism. For example, ETFs are required to provide some degree of transparency regarding their portfolio holdings by disclosing their holdings prior to the commencement of trading each business day (i.e., portfolio transparency). 661 This redemption would also cause the ETF’s assets under management to decline. 662 As part of this arbitrage process, authorized participants are likely to hedge their intraday risk. For example, when ETF shares are trading at a discount to an estimated intraday NAV per share of the ETF, an authorized participant may short the securities composing the ETF’s redemption basket. After the authorized participant returns a creation unit of ETF shares to the ETF in exchange for the ETF’s baskets, the authorized participant can then use the basket assets to cover its short positions. 663 Market participants also can engage in arbitrage activity without using the creation or redemption processes by buying/shorting shares in the ETF while simultaneously shorting/buying the ETF’s underlying assets. PO 00000 Frm 00057 Fmt 4701 Sfmt 4700 5257 However, authorized participants, other market participants, and arbitrageurs acting in secondary markets may incur costs and be exposed to risk when engaging in arbitrage. The costs include bid-ask spreads and transaction fees associated with the arbitrage trades. In addition, during the time it takes arbitrageurs to execute these trades, they are exposed to the risk that the prices of the basket assets and the ETF shares change. As a consequence, arbitrageurs may decide to wait for any mispricing between the market price of ETF shares and NAV per share to widen until the expected profit from arbitrage is large enough to compensate for any additional costs and risks associated with engaging in the transaction.664 A number of commenters noted that, in order to promote liquidity in thinlytraded ETPs, exchanges offer market makers who meet certain quoting requirements enhanced rebates when supplying liquidity in certain less actively traded ETPs.665 e. 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.666 When exchanges update their fees, they are required to file Form 19b–4 with the Commission; fee changes are permitted to take effect upon filing under Section 19(b)(3)(A) of the Exchange Act.667 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. Table 2 reports the range of minimum and maximum transaction fees and rebates, as well as the number of categories for each (in parentheses below the fee ranges), by exchange, as reported by each exchange on their recent fee schedules.668 On average, 664 As discussed above, authorized participants can also hedge the intraday risk associated with the arbitrage process. See supra note 662. 665 See, e.g., Virtu Letter, at 7; Cboe Letter I, at 17–18. 666 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. 667 As discussed supra Section IV.B.1.b.vi, fee information, such as that included in exchange fee schedules or Form 19b–4 fee filings, does not have standardization or formatting requirements. 668 The transaction fee and rebate ranges in Table 2 are collected from recent fee schedules (as of July 31, 2018) available from each individual exchange’s website (listed in Table 1). Table 2 provides the date from which these fee schedules were reported. E:\FR\FM\20FER2.SGM Continued 20FER2 5258 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations U.S. exchanges have 18 access fee categories and 21 rebate categories associated with these fee schedules.669 For the maker-taker exchanges, access fees do not exceed the Rule 610(c) cap 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.670 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 (August 1, 2013–July 31, 2018). Exchanges, on average, have changed their fee schedules 34 times in the last five years,671 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 2018 Number of revisions (5 years) Date of fee schedule Exchange Fee model Cboe BZX ................................................ Maker-Taker ........... 54 8/16/2018 Cboe BYX ................................................ Taker-Maker ........... 51 8/9/2018 Cboe EDGA ............................................. Taker-Maker ........... 41 8/1/2018 Cboe EDGX ............................................. Maker-Taker ........... 53 8/16/2018 BX ............................................................ Taker-Maker ........... 29 7/20/2018 Phlx (PSX) ............................................... Maker-Taker ........... 24 5/21/2018 Nasdaq ..................................................... Maker-Taker ........... 54 7/25/2018 NYSE Arca ............................................... Maker-Taker ........... 51 8/1/2018 NYSE American ....................................... Flat .......................... 9 7/26/2018 NYSE ....................................................... Maker-Taker ........... 42 8/10/2018 NYSE National 672 .................................... Taker-Maker ........... 11 7/26/2018 CHX .......................................................... Maker-Taker ........... 8 4/26/2018 IEX ........................................................... Flat .......................... 10 8/1/2018 Fees (# of categories) Rebates (# of categories) $0.0000–$0.0033 .... (29) ......................... $0.0000–$0.0033 .... (40) ......................... $0.0000–$0.0032 .... (48) ......................... $0.0000–$0.0032 .... (37) ......................... $0.0005–$0.0030 .... (13) ......................... $0.0028–$0.0030 .... (3) ........................... $0.0000–$0.0030 .... (4) ........................... $0.0005–$0.0035 .... (68) ......................... $0.0002–$0.0030 .... (12) ......................... $0.0003–$0.0030 .... (20) ......................... $0.0003–$0.0025 .... (16) ......................... $0.0007–$0.0040 .... (5) ........................... $0.0009 ................... ($0.0010)–($0.0032) (18) ($0.0005)–($0.0022) (12) ($0.0004)–($0.0027) (14) $0.000–($0.0032) (20) $0.0000–($0.0021) (12) $0.00–($0.0030) (8) $0.0000–($0.00325) (36) ($0.0002)–($0.0035) (65) $0.0000–($0.0045) (4) $0.0000–($0.0045) (41) ($0.0002)–($0.0020) (2) ($0.0009)–($0.0020) (2) $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 2017 capturing the net (of rebates) transactions-based fee revenues, the Nasdaq exchanges (Nasdaq, BX, and PSX) earned $253 million.673 Based on the same measure the NYSE-affiliated exchanges (NYSE, NYSE Arca, NYSE American, and NYSE National) earned $196 million in transaction-based fees net of rebates,674 while the BATS Global Markets (now, Cboe BZX, Cboe BYX, Cboe EDGA, and Cboe EGDX), for the year ended December 31, 2017, earned $153 million in transaction-based fees net of rebates.675 Neither CHX (which became a NYSE-affiliated exchange in 2018) 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 transactionbased fees based on each exchange’s The ranges in fees are the minimum and maximum fees and rebates reported by each exchange. 669 This average does not include the IEX exchange as the fee structure is a flat one. See also, e.g., RBC Letter II (attaching a report titled ‘‘Complexity of Exchange Pricing and Corresponding Challenges to Transparency and Routing’’ in which they identify ‘‘1,023 separate pricing ‘paths’—i.e., separate fees or rebates—across these exchanges.’’). 670 See, e.g., CFA Letter, at 6. 671 The median number of revisions to fee and rebate schedules by exchanges is 41 over the fiveyear period. 672 NYSE acquired NSX in January 2017, and the exchange is now known as NYSE National. As of May 2018, the exchange re-opened for trading and began submitting new fee schedules periodically. 673 See Nasdaq Form 10–K filings (2017), available at https://www.sec.gov/Archives/edgar/ data/1120193/000112019318000003/ ndaq1231201710-k.htm. Transaction-based revenues for equity securities accounted for approximately 59% of total operating income net of rebates and 25% net of rebates and brokerage, clearing, and exchange fees. The Commission has revised the revenue number for Nasdaq for 2017 revenue per the correction provided in the Nasdaq Letter II. 674 See Intercontinental Exchange Form 10–K filings (2017), available at https://www.sec.gov/ Archives/edgar/data/1571949/0001571949 18000003/ice2017123110k.htm. For the Intercontinental Exchange, net cash equity transaction-based revenues were approximately 8.2% of operating income for 2016. 675 See Cboe Form 10–K filings (2017), available at https://www.sec.gov/Archives/edgar/data/ 1374310/000155837018000953/cboe20171231x10k.htm. Cboe’s acquisition of BATS Global Markets became effective on March 1, 2017. For the year ending December 31, 2017, the net transaction-based revenues were 41% of Cboe operating profits. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 PO 00000 Frm 00058 Fmt 4701 Sfmt 4700 E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations most recently reported fee schedule and the share volume of each exchange for July 25, 2018 through August 24, 2018.676 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 5259 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 July 25, 2018–August 24, 2018] [In millions] Share volume (millions) 677 Exchanges Cboe BZX ............................................................................ Cboe BYX ............................................................................ Cboe EDGA ......................................................................... Cboe EDGX ......................................................................... BX ........................................................................................ Phlx (PSX) ........................................................................... Nasdaq ................................................................................. NYSE Arca ........................................................................... NYSE American ................................................................... NYSE ................................................................................... NYSE National ..................................................................... CHX ...................................................................................... IEX ....................................................................................... C. Analysis of Benefits and Costs of Transaction Fee Pilot 1. Benefits of Transaction Fee Pilot The Commission expects that the benefits of the Pilot will fall into two categories: (1) More informed policy decisions, including more information about the economic impact of transaction-based fees and rebates, and (2) other benefits that may accrue to market participants for the duration of the Pilot. In this section we discuss each of the categories of benefits as well as potential limitations to the applicability of information to be drawn from the Pilot. a. Benefits of More Informed Policy Decisions The Commission expects that the primary benefit of the Pilot will be to inform the Commission and public of the economic impact of exchange transaction-based fees and rebates.678 As a result, the Commission will have data 676 The share volume is obtained from Cboe, available at https://markets.cboe.com/us/equities/ market_share/ (last visited September 18, 2018). To compute the maximum profit attainable, staff took the difference between the highest possible transaction fee and the lowest possible rebate and multiplied it by the monthly share volume. For a midpoint profit, the median of the transaction 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. 677 Monthly share volume obtained from Cboe for July 25, 2017 through August 24, 2017, Cboe, U.S. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 Annualized midpoint difference 9,014 7,136 1,853 8,165 4,389 1,035 23,087 13,024 473 17,823 920 830 3,757 ($486.75) 25.69 1.11 (4.90) 36.87 16.15 (34.63) 23.44 (3.69) (128.33) 3.31 8.96 N/A to better inform its regulatory consideration of exchange transactionbased fee-and-rebate pricing models and fee changes, and the potential effects of changes to its regulatory approach concerning the same. In general, more informed regulatory decisions are more likely to result in regulatory approaches that better balance costs and benefits relative to regulatory decisions based on less precise information. In other words, many of the economic benefits derive from subsequent decisions that the Commission can neither predict nor commit to at this time. Indeed, the Commission cannot predict at this time whether the results of the Pilot will suggest any particular policy direction and recognizes that the results could suggest that existing exchange transaction-based fee caps and related rebates may be more beneficial to investors than the policy alternatives examined in the Pilot. Equities Market Volume Summary, available at https://markets.cboe.com/us/equities/market_share/ (last visited September 18, 2018). 678 In contrast, one commenter opined that the primary benefit of the Pilot would be ‘‘the ‘better fills’ that institutional investors will get after the pilot is introduced.’’ Nasdaq Letter III, at 9. This commenter asserted that the Commission had not done a proper cost benefit analysis because its analysis of benefits did not account for the ‘‘opportunity costs’’ inherent in order routing decisions, or other factors which would impact institutional orders. See id. Consequently, the commenter asserted that the Commission overstated the benefit of the Pilot. See id. However, the Commission does not agree that ‘‘better fills’’ will PO 00000 Frm 00059 Fmt 4701 Sfmt 4700 Per share profit (median) ($0.00450) 0.00030 0.00005 (0.00005) 0.00070 0.00130 (0.00013) 0.00015 (0.00065) (0.00060) 0.00030 0.00090 0.00000 Annualized maximum difference $248.78 239.76 62.26 205.77 158.02 37.27 831.14 515.75 17.03 641.63 25.40 30.87 N/A Per share profit (maximum) $0.0023 0.0028 0.0028 0.0021 0.0030 0.0030 0.0030 0.0033 0.0030 0.0030 0.0023 0.0031 0.0000 i. Expected Analysis From the Pilot The Proposing Release discussed the theoretical impact of exchange transaction-based fees and rebates on several potential effects such as conflicts of interest, fragmentation, complexity, liquidity, and off-exchange competition and explained that certain components of the Proposed Pilot would facilitate the study of these effects.679 As noted above, the Commission believes that little empirical evidence currently exists regarding these effects. More specifically, the Pilot will provide information on the direct effects of exchange transaction fee and rebate levels on execution quality and market quality and will facilitate studies of the impact of fees and rebate levels on market participant behavior and competition, including potential conflicts of interest. Sections IV.C.2 and IV.D. discuss many potential economic effects for which this economic analysis be a certain result of the Pilot. Furthermore, the Commission disagrees that it has not adequately analyzed the costs of the Pilot. As noted above, the Commission has quantified the likely economic effects of the Pilot where possible; however, the Commission is unable to quantify all of the economic effects because it lacks the information necessary to provide reasonable estimates. The Commission agrees with the commenter that quantifying benefits using existing data is difficult, thus underscoring the need for a Pilot. A more detailed analysis of the Pilot’s impact on trading costs can be found in Section IV.C.2.b. 679 See Proposing Release, supra note 2, at Section V. E:\FR\FM\20FER2.SGM 20FER2 5260 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations is unable to draw unambiguous conclusions. For example, many commenters disagreed on how reducing exchange fees and rebates affects the competitive landscape between exchanges and off-exchange venues in the market for trading services,680 and the analysis here recognizes that many competitive forces can drive order flow in either direction. The Pilot will provide insight into the impact of transaction fees and rebates on this competitive landscape and can perhaps even shed light into the mechanism behind any observed changes. Further, one commenter argued that this economic analysis ‘‘does not accurately account for the actual level of orders impacted by conflicted broker routing.’’ 681 The Commission believes that it cannot establish the actual level of orders impacted by potentially conflicted broker routing with current data and has designed the Pilot in part to gather more data on the extent to which rebates impact order routing decisions, as explained in the section that follows. The Commission also notes that the Pilot seeks to study the effects of exchange pricing models on market quality and execution quality, which could affect all orders. The Pilot will facilitate the study of order flow among different venues, which could provide insights into whether changes in exchange transaction-based fees and rebates affect, for example, the level of fragmentation. Existing literature suggests that transaction-based pricing has contributed to an increase in the number of venues competing for order flow over time.682 By offering rebates or Linked Pricing, start-up maker-taker and taker-maker exchanges 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.683 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 680 See e.g., Cboe Letter I, at 12; NYSE Letter I, at 9; Nasdaq Letter I, at 2, 5 (suggesting that the Pilot may impact competitive dynamics between exchanges and ATSs). 681 See, e.g., Nasdaq Letter III at 1. 682 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. The majority of the U.S. equities exchanges belong to three exchange groups. The Commission believes that any analyses of the effects of transaction-based fees on order routing decisions can appropriately control for exchange groups. 683 See, e.g., ICI Letter II at 2. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 exchanges, which could lead to less (or more) market fragmentation.684 Test Group 2 will provide insight into the natural equilibrium level of access fees, within the current regulatory structure, in the absence of rebates and Linked Pricing.685 As discussed above, prohibiting exchanges from offering Linked Pricing in Test Group 2 is intended to complement and reinforce the prohibition on rebates.686 Although Rule 610(c) caps the maximum access fee for exchanges at $0.0030, in the absence of rebates and Linked Pricing, competition among exchanges could drive the average access fee to an amount substantially below $0.0030.687 As noted in Section IV.A.2, exchanges have a reduced competitive incentive to reduce fees because doing so would require reducing the rebates that attract order flow to the exchange. Test Group 2 will allow competition among exchanges, in the absence of pressure to offer high rebates or Linked Pricing, to determine the level of access fees, which the Commission and others can observe during the Pilot. Like the other examinations the Pilot can facilitate, the results of an analysis of the equilibrium access fees are not currently predictable with much certainty. The Pilot will facilitate studies of the impact of exchange transaction-based 684 See, e.g., Fidelity Letter, at 9. refers to conditions of a system in which all competing influences are balanced. For instance, with respect to the Test Group 2, this could be the level of transaction fees charged by exchanges from which no exchange has any incentive to increase or decrease that fee outside of a constrained competitive margin. This will be the equilibrium transaction fee. See also, discussion in Section II.C.7.e. An important potential benefit of the Pilot could result if the no rebate Test Group were able to demonstrate a set of conditions wherein regulatory fee caps might not be necessitated in an environment in which natural competitive forces could effectively cap access fees. This would occur if in the no-rebate Test Group the equilibrium fee charged during the Pilot was lower than the fee cap—implying that the fee cap was not binding in this situation. 686 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. 687 See, e.g., Fidelity Letter, at 9; Citadel Letter, at 5. In addition to removing rebates or Linked Pricing in Test Group 2, the Commission could also temporarily suspend limitations on access fee caps imposed by Rule 610(c). Implementing multiple changes within a single test group, however, could 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 if Rule 610(c) restricted access fees during the Pilot. 685 Equilibrium PO 00000 Frm 00060 Fmt 4701 Sfmt 4700 fees and rebates on liquidity by studying metrics such as the quoted spreads.688 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 analysis below is Section IV.C.2.b.iv identifies several reasons that reducing fees and rebates could increase or decrease quoted spreads. The Pilot could provide information on whether exchange fees and rebates affect the liquidity of securities, as measured by the quoted spreads, across different test groups.689 The Commission disagrees with commenters who said that the Pilot was inappropriate because of a one-size-fitsall approach.690 In selecting the number of securities for each Test Group, the Commission staff divided NMS securities into three common stock strata and three ETP strata by liquidity to determine how many stocks each stratum requires to achieve statistical power.691 The staff also separately examined ETPs to determine how many ETPs would be required to achieve statistical power. Having statistical power within each Test Group, and within each Test Group by liquidity strata, helps to ensure that researchers will be able to use Pilot data to inform the Commission regarding the issue of whether different securities should have the same regulatory treatment. ii. How the Pilot Facilitates Study The Pilot will simultaneously create different fee environments, each of which restricts transaction-based fees differently to allow for the comparison of securities that are simultaneously in different regulatory regimes. The study of these comparisons will inform the Commission about economic distortions that may arise as a result of transactionbased fees. Because of the size and length of the Pilot, the Commission believes that the different fee environments over representative subsamples of NMS securities, even though implemented temporarily, will produce effects on market participant behavior that are identical or similar to 688 See, e.g., ICI Letter II at 3 (noting that the Pilot could facilitate the study of how access fees and rebates affect liquidity, including quoted spreads). 689 See. 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, & Spatt, supra note 530. 690 See, e.g., Nasdaq Letter I at 9. 691 See supra Section II.C.5 (discussing statistical power) and infra note 695. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations those that would arise under a similar permanent change. As explained below, three distinct features of the Pilot’s design will facilitate analyses of the relationship, if any, between fees and potential economic distortions. Specifically, the Pilot is designed to provide (1) representative results; (2) more direct access to data that is currently unavailable or requires lengthy and labor-intensive effort to compile and process; and (3) sufficient information to determine causality. The following sections discuss in detail how each of these aspects of the Pilot could facilitate studies of the issues described above. (1) Representative Results In the context of the Pilot, representative results mean that the impact of the 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). Representative results are 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 by some combination of the following: Data from a single brokerdealer, a small sample of securities, a single exchange, or a short sample period. By contrast, the Commission believes that the Pilot, as designed, will produce more representative results. Specifically, as discussed in detail below, the Pilot will cover a large stratified sample of NMS stocks (including ETPs), both maker-taker and taker-maker exchanges, and transaction fee caps as well as a prohibition on rebates and Linked Pricing, and will 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 Pilot shall continue for up to one additional year.692 The Commission believes that the Pilot will produce representative results, presenting a significant improvement on existing studies, because the 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 692 As designed, the Pilot will exclude NMS securities that have prices below $2.00 per share as of the date of pilot selection and NMS securities with average daily volume of less than 30,000 shares. As detailed above, the data will also be produced for a six-month pre-Pilot Period and a sixmonth post-Pilot Period. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 Securities selection, with average daily volume of 30,000 shares or more, and with no restrictions on market capitalization.693 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.694 Including a broad sample of NMS stocks allows the results to inform policy choices across subsets 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 within a given stratum, facilitating a comparison of Test Groups and the Control Group, which further supports the representativeness of results. If, for instance, the Test Groups and Control Group had a different composition within strata, researchers outside the Commission 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 believes that the sample sizes in the Test Groups are sufficient to provide the statistical power necessary to identify differences across the samples, even within strata. The Commission notes that while the adopted Pilot will be able to provide representativeness within strata, changes since the Proposal affect the representativeness of the Test Groups as a whole. In particular, in response to commenters who called for fewer stocks to be included in the Pilot, Commission staff conducted a supplemental analysis of Test Group sizes needed to achieve statistical power.695 In contrast to its 693 See, e.g., Brandes Letter, at 2 (supporting applying the Pilot to the ‘‘widest range of stocks possible’’); Spatt Letter, at 1–2. 694 See, e.g., Battalio Equity Market Study, supra note 5307. 695 The supplemental analysis made several improvements over the analysis used to identify the proposed test group sizes in an attempt to refine the analysis to respond to commenters’ desire for smaller test groups while preserving statistical power. First, the supplemental analysis used more refined methodology that more directly controlled for time series and cross-sectional dependencies. Second, the supplemental analysis considered three quoted spread strata instead of two market capitalization stratum. The market capitalization strata was originally necessary to control for any overlap with the Tick Size Pilot, but quoted spread strata more directly align with the potential economic significance of fees and rebates relative to anticipated transaction costs and the Tick Size Pilot has ended. Third, the supplemental analysis eliminated stocks that trade below 30,000 shares per day. See also supra Section II.C.6. See supra PO 00000 Frm 00061 Fmt 4701 Sfmt 4700 5261 analysis in the Proposal,696 the Commission analyzed the sample sizes in each stratum rather than using the lowest power stratum to determine the ratio of test group stocks to control stocks. As a result, the ratio of test group stocks to control group stocks is lower for some strata. In other words, the Commission was able to reduce the number of securities in test groups by weighting the composition of the test groups relative to the control group more heavily toward securities in certain strata in which more data would be needed to achieve statistical power. While analyses of the Pilot that do not consider the strata may fail to provide representative results, the addition of the stratum identifier to the Exchange Lists will allow researchers in and outside the Commission to consider the strata in their analyses. The Commission believes that the inclusion of a broad sample of NMS stocks, including small and midcapitalization stocks, ensures representative results from the Pilot. Although previous studies, as discussed above, suggest that any possible conflicts of interest are likely to be the greatest for small-capitalization securities,697 the Commission believes that it is important to the design of the Pilot to include these small and midcapitalization stocks (including ETPs). In particular, including these securities in the Pilot will allow the results of the Pilot to inform policy choices across any subset of these securities. Representativeness of results of the Pilot will also be promoted by the choice of the Pilot Security selection date. Rule 610T(b) and (c) contemplate that the Commission will select and announce the Pilot Securities prior to the Pilot start date. As noted in the Proposal, the Commission anticipates that it will 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 Pilot start date, the more comparable the Test Groups will be during the Pilot. Selection of securities close to the start of the Pilot also will be more likely to note 175 (citing commenters that favored smaller test groups). 696 See Proposing Release, supra note 2, at 13019. 697 See, e.g., Battalio Equity Market Study, supra note 5307; Harris, supra note 5307; RBC Letter I, at 5–6. E:\FR\FM\20FER2.SGM 20FER2 5262 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations include the intended universe of securities, by avoiding securities that exit between the adoption of the Rule and the start of the Pilot, while also capturing new securities that enter the market during this period. Further, to the extent that market participants would change their behavior in anticipation of the Pilot, setting the selection period close to the Pilot effective date could reduce the effect of such behavior on pre-Pilot data. The results of the Pilot will be further representative because the 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, and rebates on either the make or take side can both impact market quality and execution quality. 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 Pilot to all exchanges also improves upon the existing analysis of the limited fee experiment conducted by Nasdaq,698 which only covered a single exchange, as explained in Section IV.B.1.a.ii. While the results from that study are suggestive that broker-dealers routed customer orders to other exchanges that did not change their transaction-based fees and rebates, reasons other than potential conflicts of interest could have impacted the changes in order routing decisions. The Commission believes that the Pilot will achieve representativeness by requiring transaction-fee changes for all U.S. equities exchanges, which will allow researchers in and outside the Commission to identify how these revisions affect order routing decisions across exchanges. As discussed above, excluding non-exchange trading centers does not forfeit the representativeness of the results to be obtained from the Pilot, as including them would expand the Pilot to dissimilarly situated trading centers whose fee models and regulatory treatment are incomparable to exchanges. Further, the Pilot will require that changes to fees or rebates are applied at the security level, which means that for any given security, the limitation on access fees or rebates is ubiquitous across all exchanges. In addition, the Pilot achieves representativeness by imposing a fee cap and a prohibition on rebates and Linked Pricing. The existing literature suggests that the potential distortive effects arising from access fees could 698 See, e.g., Larry Harris Letter, at 9. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 induce behavior that would be different from the distortions arising from rebates or Linked Pricing. Therefore, the inclusion of caps on both 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 fees or rebates. The Commission further believes that the duration of the Pilot will produce sufficiently representative results. If broker-dealers incorporate transaction fees and rebates into their order routing decisions, a two-year duration for the Pilot, with an automatic sunset at the end of the first year, unless the Commission publishes a notice determining that the 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 Pilot.699 Specifically, as discussed below, the Commission recognizes that broker-dealers will incur costs to incorporate new fee schedules that are consistent with the Pilot’s requirements into their order routing decisions.700 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 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 Pilot will also impose costs on broker-dealers, and these costs increase with the duration of the Pilot. The Commission believes that the Pilot duration, even with a one-year sunset, is long enough to produce representative results because, as discussed below in Section IV.C.2.b.ii, broker-dealers that incorporate transaction-based fees and rebates into their routing decisions will find it economically worthwhile to adapt their behavior in response to the Pilot. Further, the provision to suspend the automatic sunset facilitates representative results because it provides the Commission with flexibility as the data from the 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 699 See, e.g., Joint Asset Managers Letter, at 2. Other commenters agreed that the Pilot duration will be sufficient but for other reasons. See, e.g., Fidelity Letter at 9 and CFA Letter at 6. 700 See, e.g., Citi Letter, at 5 and Larry Harris Letter, at 11. Also, see infra Section IV.C.2.b.ii for a discussion of the costs broker-dealers could incur during the Pilot. PO 00000 Frm 00062 Fmt 4701 Sfmt 4700 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 Pilot to determine whether to allow the sunset to occur. Some commenters disagreed that one year will be sufficient to achieve a representative sample.701 One commenter said that ‘‘robust data . . . should take two years’’ and that ‘‘technological changes . . . to routing and algorithmic logic for some firms are a hurdle that could require significant time to implement.’’ 702 Another commenter noted the ‘‘complexities of the pilot and the opportunities for significant market evolutions.’’ 703 The Commission notes that it will consider these and other concerns, as noted above, in deciding whether or not to suspend the automatic sunset. The Commission believes that the Pilot will produce representative results despite the Pilot’s treatment of stocks cross-listed on Canadian exchanges during the Pilot and the exclusion of stocks with average daily volume of less than 30,000 shares. A supplemental staff analysis found that the exclusion of the interlisted Canadian stocks from the selection of securities for test group inclusion would not materially impact the representativeness of the remaining sample.704 Second, the exclusion of securities with average trading volume of less than 30,000 shares per day should not materially affect the representativeness of the results because the trading in these stocks generates less than $100 per day in fees or rebates. Additionally, low trading volume stocks tend to have wider spreads rendering a rebate of $.0030 a significantly smaller incentive relative to the size of the spread than it would be for higher volume tighter spread securities. Because of these two factors, the Commission believes fees and rebates are economically much less meaningful inducements to provide liquidity for these stocks. Because of the diminished economic significance of rebates in 701 See, e.g., Babelfish Letter at 3 and Healthy Markets Letter at 19. 702 See Babelfish Letter at 3. 703 See Healthy Markets Letter I at 19. 704 Specifically, the supplemental analysis compared the distributional characteristics of all US listed stocks (including Canadian interlisted stocks) to the distributional characteristics of the subset of US listed stocks that excludes Canadian interlisted stocks to determine whether distributional characteristics of the subset differs statistically significantly from the distributional characteristics of all US listed stocks. The analysis finds that the distribution of the subset that excludes Canadian interlisted securities is statistically similar to the distribution of all US listed stocks. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations these extremely low volume stocks, the Commission believes that there is a lower risk of applying a suboptimal transaction-based fee regulatory regime in these stocks. In other words, because rebates are economically less meaningful for these securities the benefits of the Pilot in informing policy decisions regarding transaction-based fees in these securities are likely low. In addition, the supplemental staff analysis found that excluding these securities increased the potential statistical power of the Pilot. Some commenters suggested that the exclusion of ATSs from the data gathering hinders the representativeness of the data obtained from the Pilot.705 The Commission understands that ATSs often negotiate bespoke agreements with individual subscribers for a bundle of services for which rebates may or may not play a significant role. Even if the Commission obtained detailed information on all of these agreements, it may not be possible to identify the fees or rebates they pay for order flow from the fees for the other bundled services the ATS offers the subscriber in a manner sufficient for inclusion in the Exchange Transaction Fee Data. Also, as discussed in section IV.D.2.a it is uncertain whether the Pilot will lead to exchanges to be in an improved or diminished competitive position with ATSs. Further, without including ATSs in the Pilot, ample public data exists to assess the market share of ATSs relative to exchange market share to observe and measure off-exchange order flow changes. (2) Expansion of Readily Available Data The Commission also expects the Pilot to provide data that would otherwise require lengthy and laborintensive collection. Having a representative source of data is critical for the production of research and analyses about the impact of transaction-based fees on potential distortions. If more data becomes available, that data will assist the Commission in analyzing potential conflicts of interest. The Commission believes that the data produced by the Pilot will improve upon existing data,706 as is discussed in 705 See, e.g., Nasdaq Letter I, at 2, 5 and RBC Letter I, at 4. 706 See Section IV.C.1.a. For commenter statements supporting the usefulness of the data to be obtained from the Pilot See, e.g., Clark-Joseph Letter, at 1, AJO Letter, at 1, CII Letter, at 3, NYSTRS Letter, at 1, Barnard Letter, at 1; ICI Letter I, at 1–2; MFS Letter, at 1; Nuveen Letter, at 2; Better Markets Letter, at 2; RBC Letter I, at 2; Invesco Letter, at 2; CFA Letter, at 1; State Street Letter, at 2; Wellington Letter, at 1; Joint Pension Plan Letter, at 2; Oppenheimer Letter, at 2; Angel VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 more detail below. The ready availability of the Exchange Transaction Fee Summaries will facilitate the study of distortions and the equilibrium level of fees and rebates by reducing the cumbersome nature of collecting fee data. Further, the Pilot will make information on order routing decisions available to the Commission on a more granular level than current readily available data and will improve the feasibility of Commission staff analysis of order routing data during the Pilot.707 The Pilot will enable Commission staff to gain improved access to order routing data and will provide access to fee data in a simplified and standardized form, which will improve the quality of the analyses produced as a result of the Pilot. Although certain order routing data and exchange fee schedules are publicly available through a combination of Rule 606 disclosures and exchange websites, respectively, the Pilot will resolve a number of limitations associated with using currently available data to study the effect of transaction-based fees on potential conflicts of interest and their impact on market quality and execution quality. The order routing data that Commission staff will obtain as a result of the Pilot will provide superior information to that readily available today. Data will be available for a representative sample of NMS stocks, across all broker-dealers, and exchanges, at the daily frequency, which will provide sufficient data for analyses, while providing more statistical power than the Rule 606(a) public reports can provide. Relative to the data that some studies have acquired from brokerdealers and exchanges,708 the order routing data will also allow Commission staff to observe a time series of order routing data across broker-dealers and exchanges. Further, more granular order routing data (e.g., daily order routing statistics that separate principal and agency trading as well as auction, post only, and other orders) than that available publicly will facilitate more targeted analysis. Together, these characteristics of the data will facilitate Letter I, at 1. Some commenters suggest that the data will not be useful because it excludes data from ATSs and doesn’t account for other forms of remuneration that broker dealers receive which may also impact order routing decisions. See NYSE Letter 1 at 1,8–10; ProAssurance Letter, at 2; Cboe Letter I, at 15; Nasdaq Letter I, at 2. 707 The aggregation and availability of the data gathered by the Pilot is one of the primary benefits of the Pilot and provides much of the value of the data collected. See, e.g., NYSE Letter II, at 13; Cboe Letter I, at 3. 708 See, e.g., Battalio Equity Market Study, supra note 530. PO 00000 Frm 00063 Fmt 4701 Sfmt 4700 5263 Commission staff research on issues such as potential conflicts of interest, which will improve the quality of the information available to the Commission for policy decisions. The following discussion illustrates how the data obtained from the Pilot could be used to study the Commission’s objectives.709 The key components in the order routing data that facilitate studies of the impact of transaction-based fees and rebates on order routing and execution quality are daily volume information at the exchange, stock, and broker-dealer level, the separation of liquidity taking and liquidity making orders, the Order Capacity, the Order Designation, the time to execution for liquidity-providing orders, and the ability to estimate fill rates. The routing volume allows Commission researchers to measure how much volume each broker-dealer sends to each exchange each day in individual securities, which can be combined with the Pilot Securities Exchange List and the Exchange Transaction Fee Summary to observe patterns in routing and correlate those patterns with fees and Test or Control Group membership. The exchange level is required to match the order routing data with the fee data; the broker level is required to allow for different routing strategies across broker-dealers; and the daily level in the data facilitates statistical power. The separation of liquidity taking and liquidity making orders allows researchers to match the order routing volume to the potential fee or rebates in the Exchange Transaction Fee Summary. Order Capacity allows Commission researchers to compare order routing and execution quality statistics for Agency Orders to Principal Orders, which are less subject to conflicts of interest concerns than Agency Orders and, thus, provides an added means of obtaining causal identification. Order Designation allows researchers to exclude auction orders and to separately analyze Post Only orders because these orders types are subject to different fee structures (auction orders do not get rebates) or exist for the purpose of capturing rebates (Post Only). Excluding or separately analyzing these orders types provides for cleaner tests that are better able to measure the impacts consistent with the objectives of the Pilot. Finally, the time to execution and ability to estimate fill rates (using orders received, executed, canceled or rerouted) 709 See NYSE Letter II, at 13 suggesting that the proposing release did not provide an illustration for how the data could be used to study the Commission’s objectives. E:\FR\FM\20FER2.SGM 20FER2 5264 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations provides Commission researchers with execution quality information not readily available for liquidity providing or liquidity taking orders.710 An additional requirement of the Pilot is that the exchanges will be required to provide a standardized dataset of fees, the Exchange Transaction Fee Summary, to the public. In particular, this information will allow researchers in and outside the Commission to create proxies for which exchanges are likely to be more or less expensive and which offer the highest rebates. For instance, within Test Group 1, the maximum allowable access fee is $0.0010; however, each exchange may have different base and top-tier fees. Thus, only knowing that a security is in Test Group 1 will be incomplete information about the impact of transaction-based fees and rebates. Moreover, the Exchange Transaction Fee Summary will provide researchers in and outside the Commission with historical (realized) average and median per share fees and rebates to enable an ex post analysis of how actual fees affected past order routing decisions, which is not available from any data source today. Exchanges will construct Exchange Transaction Fee Summaries according to an XML schema to be published on the Commission’s website, and exchanges will update this information monthly.711 These data will be standardized and consistently formatted, which will ease the use of these data for researchers in and outside the Commission, as each exchange will have to report the Base, Top Tier, average and median fees, as detailed above in Section III.E. Each month, exchanges will 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 will be publicly posted on each exchange’s website.712 The Exchange Transaction Fee Summary released during the Pilot will: 710 The Commission recognizes that many tradebased execution quality statistics are readily estimated from publicly available data. See Section IV.E.5.g infra for a discussion of an alternative to require order-based execution quality statistics during the Pilot. 711 The standardized fee data, as would be required by the proposed Pilot, is discussed supra Section III.E.2. 712 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 will be required to publicly post on its website downloadable files containing daily aggregated and anonymized order routing statistics, updated monthly. Each exchange will also be required to provide daily on its website downloadable files containing the List of Pilot Securities and the Pilot Securities Change List. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 (1) Ease aggregation across exchanges, which affords researchers in and outside the Commission an opportunity to obtain representative results; (2) replicate across studies, which will 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. Thus, the Commission believes that a standardized reporting of summary data on fees by the exchanges will facilitate analysis of the effect of transactionbased fees. The rule will require that the Exchange Transaction Fee Summary be structured using an XML schema to be published on the Commission’s website.713 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 in and outside the Commission could immediately download the information directly into databases and use various software packages for viewing, manipulation, aggregation, comparison, and analysis. This will enhance their ability to conduct large-scale analysis and immediate comparison of the fee structures of exchanges. The Commission believes that requiring these reports to be made available in an XML format will provide flexibility to researchers in and outside the Commission and will facilitate statistical and comparative analyses across exchanges, test groups, and date ranges. (3) Causality In addition to providing representative results, the Commission 713 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 will be published on the Commission’s website and the outdated version of the schema will be removed in order to maintain data quality and consistency with the XML standard. The Commission’s XML schema will also incorporate certain validations to help ensure data quality. PO 00000 Frm 00064 Fmt 4701 Sfmt 4700 expects the Pilot to achieve the benefits identified above because it will, among other things, provide insight into the degree to which exchange transactionbased fees and rebates cause economic distortions that either harm or benefit investors. Such causal information is especially useful when considering policy choices aimed at reducing any possible harmful distortions. As detailed in the baseline, exogenous shocks are a means by which researchers may analyze a causal relationship between changes to transaction-based fees and rebates and changes to order routing decisions of broker-dealers.714 This Pilot facilitates the analysis 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 believes that the Pilot is able to facilitate the examination of causality because the Pilot will produce a single exogenous shock that differentially impacts either fees or rebates on both maker-taker and takermaker exchanges. Exogenous shocks, such as those in the Pilot provide researchers with data to analyze the direction of causality.715 For example, a researcher seeking to study the impact of the rebates on transaction costs could estimate a difference-in-differences test that compares transaction costs during the Pilot to the transaction costs before the Pilot and then compare the changes in Test Group securities to the changes in Control Group securities. It also will allow investors who receive 606(b)(3) data from their broker-dealers to directly test with their own 606(b)(3) data whether, in the absence of rebates in the most actively traded stocks, they are better able to compete for queue priority and thereby capture the quoted spread when posting liquidity. More generally, the Pilot will allow researchers, including Commission staff and others, to run difference-in-difference tests on many measures of execution quality and market quality based on publicly available data to examine the causal impact of transaction-based fees and rebates on execution and market quality. As discussed above, the Pilot will produce a single exogenous shock that 714 As discussed in the baseline, analysis of causality can be accomplished through either exogenous shocks or econometric methods, such as instrumental variable analysis. 715 Other econometric techniques, such as instrumental variables methodology, are used when an exogenous shock (or other controlled experiment) cannot be established. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations differentially affects multiple Test Groups at the same time. The simultaneity of the exogenous shock across Test Groups facilitates examinations of causality, particularly in the presence of any confounding effects. For instance, if some marketwide event were to result in deviations in order routing behavior during the Pilot, the event would likely affect stocks in each Test Group as well as the Control Group. The simultaneity allows researchers in and outside the Commission to control for the impact of the market-wide event, because the impact would likely affect the Test Groups and the Control Group similarly. For example, in the difference-indifferences test of transaction costs mentioned above, any market-wide effect would result in changes to fill rates in both the Control Group and Test Group 2. Therefore, the comparison of the changes in Test Group 2 to the changes in the Control Group subtracts the market-wide effect from the total effect, thus isolating the effect of the Pilot. In addition, to facilitate causal analysis of data during the Pilot Period, the Commission believes that it is important to collect sufficient data during a pre-Pilot Period.716 The prePilot data can then be compared with the data that will be produced during the Pilot Period, which will 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 all researchers to more easily use the information obtained from the Pilot to inform future regulatory consideration of exchange transaction fees and rebates and their impact on the markets. The Commission believes that at least six months of prePilot data may be required to obtain the necessary statistical power to permit analysis of the Pilot Securities during the Pilot, particularly ETPs.717 The Commission further believes that the combination of the representative sample, data from the Pilot, and the exogenous shock will facilitate analysis by Commission staff (or institutions who receive 606(b)(3) reports from their broker-dealers) of the degree to which transaction-based fee- and rebate716 See 717 See Healthy Markets Letter I, at 19. supra. Section II.D.3. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 motivated order routing harms order execution quality. In particular, with the exogenous shock, the Order Routing Data, the Exchange Transaction Fee Summaries, and publicly available data, researchers at the Commission can identify both the degree to which transaction fees and rebates impact order routing and, the impact of transaction fee- and rebate-motivated order routing impacts execution quality. Several commenters seemed to state that the Pilot would produce flawed causal results because the Pilot does not include all forms of remuneration.718 While the Commission acknowledges that other forms of remuneration may impact routing decisions, the results will still be informative. Even if some order flow migrates between exchanges and off-exchange venues, Commission staff should still be able to identify the impact of exchange fees and rebates on exchange routing. The Pilot Securities Exchange List and the Pilot Securities Change List further enhance the ability for researchers both inside and outside of the Commission to analyze the effects of transaction-based fees on order routing decisions. By requiring daily updates to the Pilot Securities Change List, the Pilot will 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 will 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. 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 Pilot. This section discusses, in greater detail below, issues associated with pilots in general and the potential concerns with resultant research and analyses. 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 718 See, e.g., Cboe 15–16; NYSE at 9–10; Nasdaq I at 7; RBC Letter I, at 4; ProAssurance at 2. PO 00000 Frm 00065 Fmt 4701 Sfmt 4700 5265 information obtained.719 The Commission believes, however, that the value of the information obtained from the Pilot is not dependent upon having variation in market conditions over time, and that the duration of the Pilot will provide sufficient information to inform policy decisions. 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.720 In the context of this pilot, broker-dealers could choose to retain their current order-routing decisions for the duration of the Pilot, which could be costly to such broker-dealers.721 Brokerdealers, 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 Pilot against the costs of adjusting the algorithms for their smart order routing systems. Alternatively, broker-dealers could substantially change their business model in order to 719 For instance, a pilot could be designed where the information obtained from the 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 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. 720 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, & Xiaoyun Zhang, Unshackling Short Sellers: The Repeal of the Uptick Rule, Colum. U. (2008), https:// www0.gsb.columbia.edu/mygsb/faculty/research/ pubfiles/3231/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 (Aug. 6, 2004) (hereinafter ‘‘Regulation SHO’’). 721 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 530, 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 (e.g., based on execution quality) and are not driven by potential conflicts of interest (e.g., maximizing rebates), then for at least some broker-dealers, their order routing decision process may be unchanged. It is also possible that for broker-dealers with algorithms that dynamically route based upon realtime market metrics, including liquidity metrics, expected fill rates, and current queue length, routing logic may not change, however, routing choices may dynamically adjust based upon changes in those variables that result from altered fee schedules that broker-dealers may implement in conjunction with the Pilot. E:\FR\FM\20FER2.SGM 20FER2 5266 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations avoid the Pilot.722 In addition, the Commission recognizes that the anticipated analysis of order routing data from the Pilot could cause brokerdealers to improve execution quality. This could reflect the ‘‘Hawthorne effect,’’ which refers to the idea that people will often improve their behavior if they believe that they are observed. These outcomes could lead to results that would not represent the effects of a permanent rule change. If that were to occur, a few commenters suggested that this could lead the potential benefits of the Pilot to not justify the costs or risks that the pilot imposes.723 The Commission believes that the Pilot is designed to obtain empirical information about how fees and rebates affect order routing decisions because the size and length of the Pilot render it unlikely that broker-dealers that currently focus their routing on rebates would maintain existing order routing decisions or alter their business models to avoid the Pilot as suggested by some commenters. In particular, the Commission believes that the Pilot duration is likely to make it economically worthwhile for brokerdealers to adjust their order routing behavior. 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, discussed below in Section IV.C.2.b.ii do not. In addition, the potential compromise of the data due to the Hawthorne effect is limited by at least two factors. First, this is not the Commission’s first pilot study. Market participants are relatively accustomed to the Commission collecting data for analysis. Second, the analysis of pre-Pilot data will allow for a baseline observation of unaffected broker-dealer order routing activity. If broker-dealers do not act on conflicts of interest during the baseline period, the Hawthorne effect is irrelevant unless it causes that good baseline behavior.724 If, on the other hand, broker-dealers do act on conflicts of interest during the baseline and the Hawthorne effect results in good behavior during the Pilot, the Pilot should facilitate the measurement of the conflicts. As a result, the Commission believes that the Pilot will produce useful data despite 722 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. 723 See, e.g., FIA Letter, at 3; Citadel Letter, at 4. 724 The Commission does not believe that the Hawthorne effect will cause ‘‘good’’ behavior in the baseline because broker-dealers would need to implement system changes similar to those described in Section IV.B.2.c prior to the pre-Pilot. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 the possible influence of the Hawthorne effect. The Commission recognizes that not all objectives of the Pilot would be straightforward to study. For example, the changes in fees or rebates imposed by the Pilot may change transaction costs in a way that results in changes to order routing decisions by brokerdealers, even absent potential conflicts of interest. Studying how order routing changes during the Pilot, without jointly studying why it changes, would not be sufficient to understand any possible conflicts of interest. Researchers can carefully study the data 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 Pilot. Another limitation on the benefits from the Pilot is that the Pilot will not require that the order routing data be released to the public. As a result, fewer independent analyses of the Pilot’s order routing datasets are likely to be performed, compared to the analysis that might have been obtained if the data were publicly released. However, the Commission believes that sufficient analysis will be produced to yield credible and reliable results without public dissemination of the order routing data. In addition, institutions, including broker dealers, asset managers, and transaction cost analysis (TCA) providers, may produce their own analyses using proprietary data and information. To the extent that interested parties prepare their own analyses, they may submit them to tradingandmarkets@sec.gov with the words ‘‘Transaction Fee Pilot Analysis’’ in the subject line, and the Commission will post those reports on its public website.725 Additionally, only NMS stocks with prices of at least $2 prior to the start of the Pilot are eligible for inclusion in the Pilot. One commenter suggested that NMS stocks with prices between $1 and $2 also be included in the Pilot, as the commenter believed that the impact of fees and rebates are likely to be greatest for these securities.726 The Commission agrees with the commenter who stated that the initial Test and Control Groups in the Pilot would be more representative if they contained securities with prices below $2. 725 As noted above, the Commission encourages market participants to disclose what sources of data they used for their analyses and describe the methodology they used, and to make those reports publicly and freely available. 726 See James Angel Letter I, at 2. PO 00000 Frm 00066 Fmt 4701 Sfmt 4700 However, excluding securities with prices below $2 helps to keep the sample of stocks more stable across the Pilot. This occurs because if a stock’s price falls below $1 it is subject to different regulations, such as a different tick size, and thus would be excluded from the Pilot. By excluding stocks below $2 the Pilot mitigates the risk that the representativeness of the sample may diminish over time as Pilot stocks are removed due to their stock prices falling below $1. The Commission believes that the data obtained from the Pilot will be sufficient to obtain data on the effects to changes in fees and rebates on small, low-priced securities (those with prices close to $2, or any Pilot security that drops below $2 per share, but exceeds $1 per share, after the start of the Pilot). b. Other Benefits of the Transaction Fee Pilot Other benefits may emerge that could affect markets and market participants for the duration of the Pilot, such as potentially reduced conflicts of interest for some Test Groups, lower all-in costs of trading, or improved market quality. The Commission believes that many of the benefits discussed below will be temporary in nature and affect markets and market participants only for the duration of the Pilot. Because the Commission lacks information on the extent to which the impact of exchange fee-and-rebate pricing models affect investors,727 the Commission is unable to quantify many of the temporary benefits of the Pilot discussed below. Some commenters stated their belief that the Pilot would not help investors and issuers.728 As discussed in Sections IV.C.2.b and IV.D.1 the Commission acknowledges that the Pilot could harm execution quality and/or market quality, but the impacts of the Pilot are uncertain. The Pilot could also improve execution quality and/or market quality for the reasons explained in those same sections. For example, as discussed in detail below,729 the Commission is uncertain about whether, or among which securities, the Pilot will result in increases or decreases in quoted spreads and investor transaction costs. A decrease in quoted spreads and/or investor transaction costs during the Pilot in some or all stocks in test groups would benefit investors. Likewise, the Commission is uncertain about how the Pilot will affect price efficiency—the 727 See supra Section IV.A.1 (Market Failure at the Broker Dealer Level) and Section IV.A.2 (Market Failure at the Exchange Level). 728 See, e.g., Nasdaq I, at 1. 729 See infra Section IV.C.2.b.iv E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations Pilot could plausibly improve or degrade price efficiency in certain test group stocks.730 Any improvements would benefit issuers and investors. The Commission believes that another temporary benefit of the rule will be that the Pilot could prevent some traders from indirectly quoting in subpennies.731 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 exchange fees and rebates to effectively undercut quotations by sub-pennies is particularly severe in taker-maker markets.732 The 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 this issue. 2. Costs of the Pilot This section describes the compliance costs associated with the Pilot, followed by the additional costs, some of which are temporary, that could affect issuers, investors, broker-dealers, exchanges, 5267 and other market participants resulting from the Pilot. a. Exchange Compliance Costs of the Pilot The Pilot will impose costs on exchanges to comply with the Pilot’s requirements to collect, calculate, and publicly post data certain required by the Pilot on their websites, transmit the order routing datasets to the Commission, as well as to implement fee changes, if required in order to comply with the Pilot’s restrictions. Table 4 provides a summary of the costs discussed in this section. TABLE 4—SUMMARY OF COMPLIANCE COSTS FOR EXCHANGES Pilot securities exchange list 733 Exchange transaction fee summary 734 Order routing data 735 Listing All All Fee filings 736 Exchange type All Total Listing Non-listing Per exchange Implementation .......................................................................... Periodic: —2-yr Pilot ......................................................................... —1-yr Pilot ......................................................................... Total (implementation + periodic): —2-yr Pilot ......................................................................... —1-yr Pilot ......................................................................... 15,400 26,100 24,000 96,800 162,000 147,000 83,500 50,100 55,000 36,600 103,800 69,200 148,400 74,200 391,000 230,000 307,000 180,000 98,900 65,500 81,000 62,700 127,800 93,200 245,200 171,000 553,000 392,000 454,000 327,000 Total across exchanges Implementation .......................................................................... Periodic: —2-yr Pilot ......................................................................... —1-yr Pilot ......................................................................... Total (implementation + periodic): —2-yr Pilot ......................................................................... —1-yr Pilot ......................................................................... i. Updating the Pilot Securities Exchange List and Pilot Securities ChangeList During the Pilot, the primary listing exchanges will 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. Further, each primary listing exchange will publicly post on its website the updated Pilot Securities Change List prior to the start of each trading day, which will list, separately, changes to applicable Pilot Securities. Additional details of what 730 See infra Section IV.D.1. CFR 242.612 (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 10, at 37550–57. 732 See, e.g., Angel, Harris, & Spatt, supra note 530; Harris, supra note 530. 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 731 17 VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 92,000 339,000 311,000 1,258,000 2,001,000 501,000 301,000 714,000 476,000 1,350,000 900,000 1,929,000 964,000 4,494,000 2,641,000 593,000 393,000 1,054,000 815,000 1,661,000 1,211,000 3,187,000 2,223,000 6,495,000 4,642,000 will be included in each list are provided in Section II.E.1. Upon the initial publication of the List of Pilot Securities by notice by the Commission, the primary listing exchanges 737 will need to determine which of those securities are listed on their market, and then compile a list of those securities and publicly post on their websites that list as a downloadable file in pipe-delimited ASCII format. The Commission initially estimated that the costs associated with the initial compilation of the Pilot Securities Exchange List would cost significant increase in market share, in part due to this quotation issue. See Carole Comerton-Forde, Vincent Gregoire, & Zhuo Zhong, Inverted Fee Venues and Market Quality 1 (August 10, 2018) (unpublished manuscript) (forthcoming J. Fin. Econ.) https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=2939012&download=yes. 733 See infra Section IV.C.2.a i. 734 See infra Section IV.C.2.a ii. 735 See infra Section IV.C.2.a iii. 736 See infra Section IV.C.2.a iv. 737 The primary listing exchanges are NYSE, Nasdaq, NYSE American, NYSE ARCA, BATS and IEX. PO 00000 Frm 00067 Fmt 4701 Sfmt 4700 $2,060 per exchange based on an estimated burden of 8 hours. However, one commenter stated that it ‘‘anticipates it could take as many as 44 hours’’ to compile the initial Pilot Securities Exchange List.738 The commenter stated that its estimates of the costs associated with the Pilot are based on its ‘‘prior experience implementing the Tick Size Pilot.’’ 739 In light of this comment, the Commission is increasing its estimate.740 Accordingly, the Commission estimates that each primary listing exchange would incur, on average, a one-time 738 See NYSE Letter I, at 15. id. 740 The Commission notes that the Tick Size Pilot required the exchanges and FINRA to also select the Pilot securities whereas the Transaction Fee Pilot does not. Therefore, the Transaction Fee Pilot could result in lower costs than the Tick Size Pilot. Nonetheless, the Commission believes it is reasonable to rely on this commenter’s estimate because this commenter has expertise on these costs likely to result in incorporating relatively precise information into the cost estimates. 739 See E:\FR\FM\20FER2.SGM 20FER2 5268 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations burden of approximately 44 burden hours per primary listing exchange to compile and publicly post their initial Pilot Securities Exchange List. Consequently, the Commission now estimates a cost of approximately $11,700 per listing exchange to compile the initial list of securities.741 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.742 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, these systems would have to be adapted to conform to the requirements of the Pilot. The Commission estimates that it would cost each primary listing exchange approximately $3,720 to develop appropriate systems for the Pilot, or about $22,300 in aggregate across the six U.S. primary listing exchanges.743 Once these systems are established, the Commission estimates that it would cost each listing exchange approximately $83,500 for the entire duration of the Pilot, or approximately $501,000 across the six primarily listing exchanges,744 to 741 This estimate is based on the following: [(Compliance Manager (22 hours) × $298) + (Programmer Analyst (22 hours) × $232)] = $11,660 ≈11,700 per exchange, or $11,660 × 6 primary listing exchanges = $69,960 ≈ 70,000 in aggregate. The burden hours are obtained from supra Section III.D.1. 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 [SIFMA], Management & Professional Earnings in the Securities Industry—2013 (October 7, 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 rule below. 742 The Commission notes that the primary listing exchanges maintained public web pages containing similar lists with respect to the recently concluded Tick Size Pilot. The systems to produce lists for the Tick Size pilot should be adaptable to meet the requirements of the Transaction Fee Pilot. 743 This estimate is based on the following: [(Attorney (4 hours) × $401) + (Compliance Manager (4 hours) × $298) + (Programmer Analyst (4 hours) × $232)] = $3,724 per exchange, or $3,724 × 6 exchanges = $22,344 ≈ 22,300 in aggregate. The burden hours are obtained from supra Section III.D.1. 744 If the Pilot were to automatically sunset at the end of the first year, the total number of days that VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 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 Pilot shall automatically sunset at the end of the first year, the Commission estimates that the costs to each exchange would be $50,100 for a one-year Pilot duration and the six-month post-Pilot Period, or approximately $301,000 across the six primarily listing exchanges.745 In sum, the Commission estimates a total cost for each listing exchange of approximately $98,900, or $593,000 in aggregate across exchanges, to comply with the requirement to update and post on its website at the beginning of each trading day the list of its listed securities in each of the Test Groups. This includes an estimated $15,400 in one-time implementation costs and $83,500 in ongoing costs. This estimate is based on one provided by a commenter who, based on their experience with the Tick Size Pilot, estimated that it would take up to 44 hours to compile. 746 Accordingly, the Commission continues to believe its burden estimates are reasonable. iii. 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, which are the exchanges would need to provide the Pilot Securities Exchange List and the Pilot Securities Change Lists would be up to 630 business days (504 business days for the two-year Pilot horizon (252 business days per year × 2 years), and up to 126 business days for the six-month post-Pilot Period). The cost estimate for providing these lists for the entire period is based on the following: [(Compliance Manager (0.25 hour × 630 trading days) × $298) + (Programmer Analyst (0.25 hour × 630 trading days) × $232)] = $83,475 ≈ 83,500, or $83,475 × 6 exchanges = $500,850 ≈ 501,000, in aggregate. The burden hours are obtained from supra Section III.D.1. One commenter provided an estimate of 300.5 burden hours for providing these lists, but the Commission continues to believe its own higher burden estimates are reasonable. See Section III.D.6, supra. 745 If the 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 378 business days (252 business days for the one-year Pilot horizon, and 126 business days for the six-month post-Pilot Period). The cost estimate for providing these Lists for the entire period is based on the following: [(Compliance Manager (0.25 hour × 378 trading days) × $298) + (Programmer Analyst (0.25 hour × 378 trading days) × $232)] = $50,085 ≈ $50,100, or $50,085 × 6 exchanges = $300,510 ≈ $301,000, in aggregate. The burden hours are obtained from supra Section III.D.1. 746 See, e.g., NYSE Letter I, at 15. PO 00000 Frm 00068 Fmt 4701 Sfmt 4700 downloadable files containing the initial set of fees at the outset of the 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 II.E.2. The Exchange Transaction Fee Summary would need to be updated in response to any changes to its fee schedule 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 and rebate changes, according to Rule 610T(e), that they make during the Pilot, including the effective dates of fee revisions. The rule also requires that each exchange calculate numerous statistics relating to their fees as discussed in more detail in Section II.E.2. A requirement at the outset of the Pilot is that exchanges would need to report their base and top-tier fees and rebates, which the Commission estimates would cost each exchange $1,130, or about $14,700, in aggregate across the 13 U.S. equities exchanges.747 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 Transaction Fee Pilot, the exchanges also would 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 will cost exchanges $530 each to post this summary dataset to their websites.748 The rule would also require that exchanges compute the monthly average and median realized per share fees and rebates, as detailed in Section II.E.2. These data will provide the Commission and the public with 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 believes that the costs 747 The estimate is based on the following: (Compliance Manager (2 hours) × $298) + (Senior Business Analyst (2 hours) × $265) = 1,126 ≈ $1,130, or $1,126 × 13 equities exchanges = $14,638 ≈ 14,600 in aggregate. The burden hours are obtained from Section III.D.2, supra. 748 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 = $6,890 ≈ 7,000 in aggregate. The burden hours are obtained from supra Section III.D.2. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations 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 about $24,000, or approximately $311,000 in aggregate across the 13 U.S. equities exchanges, associated with the development and implementation of systems tracking realized monthly average and median share fees pursuant to the rule.749 The Commission further anticipates that it would cost an additional $12,000 annually, or $155,000, in aggregate, per year, to ensure that the system technology is up to date and remains in compliance with the rule.750 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 II.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 Pilot should continue for up to a second year and not automatically sunset at the end of the first year.751 Each exchange would have 749 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] = 23,920 ≈ $24,000 per exchange, or $23,920 × 13 exchanges = $310,960 ≈ 311,000 in aggregate. The burden hours are obtained from supra Section III. D.2. 750 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] = $11,960 ≈ $12,000 per exchange, or $11,960 × 13 exchanges = $155,480 ≈ $155,000 in aggregate. The burden hours are obtained from supra Section III.D.2. 751 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 VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 total costs of updates to the Exchange Transaction Fee Summary of approximately $19,000 per exchange, or $248,000 among the 13 exchanges over the pilot duration, including pre- and post-periods.752 If the 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 24.753 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 $169,000 among the 13 exchanges over the pilot duration, including pre- and post-periods.754 As detailed above, the Commission 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 Pilot. As discussed in Section II, the rule will 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 extension of up to an additional year was needed (24), and the post-pilot period (6), for a total number of 36 updates. 752 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 = $19,080 ≈ $19,000. The 36 fee changes for the exchange encompass six updates during the sixmonth pre-Pilot Period, 24 updates during the twoyear 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 $19,080 × 13 U.S. equities exchanges = $248,040 ≈ $247,000. The burden hours are obtained from supra Section III. D.2. 753 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. 754 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 = $12,720 ≈ $12,700. The 24 fee changes for the exchange encompass six updates during the sixmonth pre-Pilot Period, 12 updates during the oneyear 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 $12,720 × 13 U.S. equities exchanges = $165,360 ≈ $165,000. The burden hours are obtained from supra Section III.D.2. PO 00000 Frm 00069 Fmt 4701 Sfmt 4700 5269 structuring. The Commission 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 755 and FpML 756 to exchange information on highly structured financial instruments and related market data.757 The Commission anticipates that implementation of the 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 Pilot within the exchange source systems; mapping the relevant fields in the exchanges’ data source systems to the Commission’s XML schema; implementing, testing and executing the validation rules; and developing the website posting processes as required by the rule. The initial costs to exchanges of complying with the Commission’s 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.758 For all updates to 755 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 Fix Trading Community, available at https://www.fixtrading.org/. 756 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 Financial products Markup Language [FpML], available at https:// www.fpml.org/. 757 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 for the NYSE, www.nyse.com, Nasdaq, www.nasdaqomx.com, and Cboe, www.cboe.com, 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. 758 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] = $497 ≈ $500 per exchange, or $500 × 13 exchanges = $6,461 ≈ $6,500 in aggregate. See Securities E:\FR\FM\20FER2.SGM Continued 20FER2 5270 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations 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. In sum, the Commission estimates the total cost of the pilot associated with producing the exchange transaction fee summary in XML format to be approximately $81,000 per exchange if the Pilot runs for 2 years and $62,700 per exchange if the Pilot sunsets at the end of the first year. These costs comprise of approximately $26,100 in one time implementation costs and $55,000 in ongoing costs if the Pilot runs for two years, or $36,600 if the Pilot sunsets at the end of the first year. These costs aggregate to approximately $1,054,000 in total costs across all exchanges if the Pilot runs for the entire two years, and $815,000 if the Pilot sunsets at the conclusion of the first year. iv. Producing the Order Routing Data The rule also will require as part of the Pilot that exchanges prepare, in pipe-delimited ASCII format, and transmit to the Commission, order routing data, updated monthly, containing aggregated broker-dealer order routing information. As discussed in Rule 610T(d) and in Section II.E.3, the datasets would contain separate order routing data for liquidityproviding and liquidity-taking orders aggregated by day, by security, by broker-dealer, and by exchange. The Commission believes that as long as the CAT Phase 1 data are available at the implementation of the Pilot, the exchanges would be able to use that data to construct the order routing data required by the 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. Regardless of which system exchanges use for the order routing data, the Commission anticipates they would 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. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 incur costs in producing the downloadable files containing aggregated monthly order routing data to be transmitted to the Commission. The Commission estimates that each exchange would have a one-time cost of approximately $23,900, or approximately $311,000 in aggregate across the 13 exchanges, associated with the development and implementation of systems needed to aggregate the order routing information, as well as store the data, in the pipe-delimited ASCII format specified by the rule and as detailed in Rule 610T(d).759 The Commission anticipates that it will cost each exchange an additional $12,000 per year, or approximately $156,000 in aggregate per year, to ensure that the system and storage technology is up to date and remains in compliance with the rule.760 The rule will require that exchanges produce monthly updates of the order routing data, and transmit them to the Commission in pipe-delimited ASCII format by the end of the month, as detailed in Section II.E.3 and Rule 610T(d). The Commission estimates that the transmittal and updates of the order routing datasets would cost $1,888 each month. This will require each exchange to make a total of 36 updates to the order routing data from the pre-Pilot Period through the post-Pilot Period (if the core Pilot lasts for a full two years). Each exchange would have recurring costs of updates to the order routing data of approximately $68,000 per exchange, or $884,000 among the 13 exchanges over the entire duration of the Pilot, and the pre-Pilot and postPilot periods.761 If the Commission were 759 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] = $23,920 ≈ $23,900 per exchange, or $23,920 × 13 exchanges = $310,960 ≈ $311,000 in aggregate. The burden hours are obtained from supra Section III.D.3. 760 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] = $11,960 ≈ $12,000 per exchange, or $11,960 × 13 exchanges = $155,480 ≈ $156,000 in aggregate. The burden hours are obtained from supra Section III.D.3. 761 This estimate is based on the following: [(Compliance Manager (4 hours) × $298) + (Programmer Analyst (3 hours) × $232)] = $1,888 per exchange, or $1,888 × 36 fee changes per exchange = $67,968 ≈ $68,000. The burden hours are obtained from supra Section III.D.3. The 36 updates to the order routing data for each exchange encompass six updates during the six-month prePilot Period, 24 updates during the two-year Pilot Period, assuming that the Commission determines PO 00000 Frm 00070 Fmt 4701 Sfmt 4700 to allow the 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 24.762 Under the automatic sunset, each exchange would have recurring costs of updates to the order routing data of approximately $45,300 per exchange, or $589,000 among the 13 exchanges over a one-year Pilot, and the pre-Pilot and post-Pilot periods.763 One commenter stated that the Commission underestimated the number of burden hours required to produce the order routing data required by the Pilot.764 This commenter indicated that the Commission allocated 160 burden hours to compile and produce the order routing data, while the commenter estimates that it would take approximately 400 burden hours.765 Over the entire Pilot duration, including the six-month pre and postPilot periods, the Commission estimates that exchanges would have initial systems burden hours of 80 hours, an additional annual burden of 40 hours to update and maintain those systems, plus 84 burden hours per year to produce and publicly post order routing data monthly.766 In sum the Commission estimates the costs of producing the order routing data to include a one-time cost of approximately $23,900 per exchange to set up the data gathering process, $12,000 per year to maintain the data gathering systems, and $1,888 per 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 $67,968 × 13 U.S. equities exchanges = $883,584 ≈ $884,000. 762 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. 763 This estimate is based on the following: [(Compliance Manager (4 hours) × $298) + (Programmer Analyst (3 hours) × $232)] ≈ $1,888 per exchange, or $1,888 × 24 fee changes per exchange = $45,312 ≈ $45,300. The burden hours are obtained from supra Section III.D.3. The 24 updates to the order routing data for each exchange encompass six updates during the six-month prePilot 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 $45,312 × 13 U.S. equities exchanges = $589,056 ≈ $589,000. 764 See NYSE Letter I, at 15. 765 However, it is unclear exactly how the commenter aggregated the data in the Proposing Release to arrive at 160 hours because they did not provide details of their calculation. 766 See Proposing Release, supra note 2, at 13061. Discussion of comments on these estimates is presented in Section III.D.3 supra. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations month to publish the data. Specifically, the Commission estimates initial onetime implementation costs of approximately $23,900 and ongoing costs of approximately $103,800 per exchange if the Pilot lasts two years or $69,200 if the Pilot lasts one year. These costs total approximately $127,800 per exchange if the Pilot lasts two years— or approximately $1,661,000 in aggregate. These costs decline to approximately $93,200 per exchange— or $1,211,000 in aggregate—if the Pilot sunsets after one year. v. Fee-Related Costs to Exchanges When exchanges alter their fees they are required to submit a Form 19b–4 filing with the Commission. Consequently, the Commission expects most exchanges to file two 19b–4 Forms that they would not have otherwise done. Additionally, the Commission expects that the pilot may increase the complexity of these filings. This section provides estimates for the costs associated with the submission of 19b– 4 Forms by the exchanges during the Pilot. At the outset of the Pilot, each equities exchange if their fees do not at that time comply with the Pilot’s pricing restrictions, would need to file with the Commission a comprehensive Form 19b–4 fee filing reflecting all of the applicable fees and rebates applicable to each of the Pilot Groups, as well as the Control Group—to reflect the temporary changes to transaction-based fees and rebates as a result of the Pilot. The Commission anticipates that exchanges will incur costs associated with and devote time to optimally assign fees and rebates across Test Groups, within the parameters allowed by the 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 $629,100 in aggregate.767 The Commission further anticipates that exchanges would bear similar costs upon the completion of the Pilot to prepare Form 19b–4 fee filings for filing with the Commission to reflect changes in fees at the conclusion of the Pilot, should they wish to change their fees or revert to their former pricing models after the Pilot concludes. 767 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)] = $48,395 ≈ $48,400, or $48,395 × 13 equities exchanges = $629,135 ≈ $629,100 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). VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 In addition to the initial production of the Form 19b–4 fee filing at the outset of the Pilot, exchanges may also choose to make periodic updates to their fee and rebate schedules, and file Form 19b–4 fee filings to effectuate those changes and thereby 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 Pilot, exchanges may revise their fee schedules more or less often during the 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 Pilot and has no basis to expect a decrease. The Commission also recognizes that as an outcome of the Pilot, the complexity of the Form 19b–4 fee filings could increase if exchanges seek to impose different fees within Test Groups 1, Test Group 2, and the Control Group, thereby increasing the overall costs for exchanges to revise their fee and rebate schedules.768 As discussed above, the Pilot may require exchanges to design new fee structures to comply with the Pilot’s Test Groups, which would then translate into additional information in each Form 19b–4 fee filing submitted during the Pilot. These costs are likely to increase because the exchanges could take 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. Assuming the frequency remains constant, then the Pilot could increase the incremental costs incurred by exchanges to file the expected Form 19b–4 fee filings during the Pilot.769 The additional costs would 768 The Commission believes that the inclusion of Linked Pricing prohibitions for Test Group 2 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 many exchanges currently use Linked Pricing mechanisms and instead most rely on rebates. 769 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 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 estimates that there will be 91 19b–4 filings (7 filings × 13 exchanges). If the Commission determines that the 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). PO 00000 Frm 00071 Fmt 4701 Sfmt 4700 5271 only be relevant for Form 19b–4 fee filings that occur during the Pilot Period, and would not apply to Form 19b–4 fee filings in the pre-Pilot or postPilot 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 Pilot, or approximately $1,929,000 for the anticipated 182 Form 19b–4 fee filings for fee and rebate revisions across the 13 U.S. equities exchanges during the twoyear pilot duration.770 If the Pilot were to automatically sunset at the end of the first year, the Commission estimates that exchanges would bear costs of approximately $964,000 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. In sum, the Commission expects the pilot to impose on each exchange a onetime cost of $48,400 at the beginning and end of the pilot for the additional 19b–4 filings required by the pilot, as well as an ongoing cost of approximately $10,600 per additional 19b–4 filing to account for increased complexity in 19b–4 filings caused by the Pilot. If we assume that exchanges continue to file 19b–4 filings at an average rate of 7 per year and if the pilot lasts for 2 years, these incremental costs sum to approximately $148,400 per exchange—which declines to $74,200 if the pilot ends after the first year. Combining the cost of the two additional 19b–4 filings with the cost of potential increased complexity provides an estimated cost of the pilot associated with 19b–4 filings of approximately $245,200 per exchange—or $3,187,000 in aggregate—if the pilot lasts two years, or $171,000 per exchange—or $2,223,000 in aggregate—if the pilot expires after the first year. 770 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)] =$10,598 ≈ $10,600, or $10,598 × 182 fee changes in aggregate across 13 exchanges over the two-year pilot duration = $1,928,836 ≈ $1,929,000 in aggregate, assuming that the Commission determines that the Pilot shall continue for up to an additional year. If the Pilot were to automatically sunset after the first year, the Commission believes that the costs associated with 91 19b–4 filings (13 exchanges × 7 filings) would be approximately $964,000 ( ∼$10,598 × 91 filings). See Request to OMB for Extension of Rule 19b–4 and Form 19b–4 Filings, supra note 767. E:\FR\FM\20FER2.SGM 20FER2 5272 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations vi. Other Costs to Exchanges The Pilot may result in more complicated fee structures that could also increase an exchange’s processing costs of tracking and calculating monthly invoices for its members during the 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 and no commenters provided such information. b. Other Costs Associated With the Pilot This section considers additional costs that may occur as a result of the Pilot. Specifically, this section discusses how the Pilot may impact exchanges’ fee revenue, broker-dealer compliance costs, brokerage commissions, liquidity, and issuers. i. Loss of Exchanges’ Fee Revenue The Commission analyzed whether exchanges could experience a change to their fee revenues associated with transaction-based fees and rebates for either of two reasons: A decline in the margin between fees and rebates,771 or a decline in overall trading volume on an exchange as a result of the Pilot.772 In the Proposing Release the Commission stated its belief that only stocks in the test group with a cap of $0.0005 (former Test Group 2) would experience narrower margins and estimated that these narrower margins could result in exchanges incurring revenue losses of up to $7,650,000 per month.773 With the removal of the former Test Group 2 the Commission now believes that the Pilot may not have a significant effect on Exchange revenue, at least not because of narrower margins between fees and rebates. For stocks in Test Group 1 (the Test Group with a fee cap of $0.0010) the Commission does not believe that the Pilot will result in narrower margins earned by the exchanges because the fee cap in this group is double the current typical average net capture (i.e., margin) that exchanges earn which is approximately $0.0005.774 771 On a given trade, an exchange earns the margin between fees and rebates. For example, if an exchange charges a take fee of $.0030 per share and offers a make rebate of $.0025 per share then the margin captured by the exchange is $.0005 per share traded. 772 A number of commenters expressed concern that the Pilot would lead to decreased exchange revenue largely through decreased trading volume. See, e.g., Cboe Letter I, at 7; NYSE Letter I, at 3 and 15–16. 773 See Proposing Release, supra note 2, at 13063. 774 See Proposing Release supra 1 at 13067. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 Consequently, the exchanges can maintain current margins by reducing the rebate offered at the same level as fees charged are reduced.775 For stocks in Test Group 2, the Commission also does not believe that the Pilot is likely to shrink margins. For these stocks the fee cap remains at $0.0030, while exchanges are prohibited from paying rebates and offering Linked Pricing. Consequently, the prohibition of rebates for securities in this Test Group would conceivably allow the exchanges to reduce fees to as low as $0.00025—if charged to both parties in a transaction—without reducing the exchange’s average net capture per trade. While less likely given competitive dynamics, if the exchanges wanted to increase their net capture, it is possible under the pilot terms for total net capture in group one to be as high as $0.002 (if both side were charged the maximum of $0.001), and in group two to be $0.003, both of which are far in excess of the average net capture that exchanges receive today. For these reasons, the Commission now expects the effects of the Pilot on exchange revenue through impacting per-trade margins to be minimal. In addition, the Commission believes that the impact of the Pilot on exchange revenues through changes in trading volume are difficult to determine in advance, but recognizes that the magnitude of such changes could be significant and some potential lost revenue could be in a transfer to investors or among exchanges. The Commission considered whether individual exchanges could experience a decline in trading volume for four reasons, as multiple commenters suggested: If exchanges lose volume to off-exchange venues, if volume declines because of increased transaction costs, if the Pilot reduces excessive intermediation, or if volume shifts among exchanges. The Commission recognizes that the Pilot presents a risk that the Pilot could result in less fee revenue for exchanges due to lower trading volumes. However, the Commission believes that decreased trading volume, while one possible 775 This was the case in Canada when in January 2017 the Canadian Securities Administrators (CSA) approved the lowering of the fee cap for noninterlisted Canadian stocks from $0.0030 to $0.0017. In response to this regulation, the Toronto Stock Exchange retained its $0.0004 margin per trade for continuous trading—high priced securities ($1.00 and over) by lowering both fees and rebates by $0.0008. Fees for taking liquidity on noninterlisted securities reduced from $0.0023 to $0.0015 whereas rebates provided to liquidity providers declined from $0.0019 to $0.0011. Fees and rebates for inter-listed securities remained unchanged. See https://www.tsx.com/resource/en/ 1501. PO 00000 Frm 00072 Fmt 4701 Sfmt 4700 outcome of the Pilot, is not the only reasonable outcome, and that the ex ante effect of the Pilot on trading volume is difficult to determine. First, several commenters stated that reducing or eliminating the ability for exchanges to pay rebates may cause exchanges to become less competitive relative to off-exchange venues like ATSs, which would not be so constrained. The analysis in Section IV.D.2.a identifies significant uncertainty in the potential for exchanges to be less competitive relative to off-exchange venues such as ATSs, and identifies conditions in which they could actually be more competitive.776 Consequently, the Commission cannot determine in advance of the Pilot whether exchanges will lose volume to off-exchange venues. Second, total trading volume, and consequently exchange revenue, could decline if the Pilot increases transaction costs. A number of issuers expressed the concern via comment letters that the Pilot would lead to lower levels of trading volume because of their experience with the Tick Size Pilot.777 However, not all issuers felt that the Pilot would result in lower trading volumes. One issuer ‘‘welcome[d] the opportunity for [its] stock to be included in the Pilot’’ and did not ‘‘expect that a reduction or outright removal of rebates will have any significant or harmful effects on . . . [its] stock’s trading volume.’’ 778 On the other hand, if the Pilot decreases the cost of trading on the exchanges, then the Pilot could increase trading volumes on the exchanges. This view was expressed by one commenter who stated their belief ‘‘the Pilot will reduce the costs of trading on exchanges, which may increase trading volumes on the exchanges.’’ 779 Lower costs of trading, caused by the reduction in fees, might increase trading volume on exchanges for at least two reasons. First, lower trading costs may induce trades that would otherwise not have occurred by allowing investors the ability to trade on smaller increments of information. Lower trading costs may also induce the participation of new traders, such as short-term traders for whom transaction costs are of greatest concern, to transact in a given stock 776 See Section IV.D.2.a. See also Section IV.C.2.b.iv 777 See, e.g., Leaf Letter, at 1–2; Ennis Letter, at 2. 778 T. Rowe Price Letter, at 4–5. 779 See, e.g., TD Ameritrade Letter, at 7. Other commenters also either expressed their belief that the Pilot would not reduce trading volumes (see, e.g., IEX Letter II, at 8; T. Rowe Price Letter, at 5) or expressed uncertainty about the outcome of the Pilot on trading volume (see, e.g. Credit Suisse Commentary, at 5). E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations who would not otherwise participate. Consequently, if the Pilot leads to decreased trading costs, then trading volumes in those stocks may increase— increasing exchange revenue. In Section IV.C.2.b.iv below, the Commission discusses its belief that the effect of the Pilot on liquidity and transaction costs is not clear and could either increase or decrease. Given this uncertainty in the impact on liquidity, the Commission cannot determine in advance whether the Pilot will result in a reduction in liquidity that would reduce trading volume. Third, the Pilot may decrease trading volume, and thus exchange revenues, if it results in a reduction in intermediation by market makers for two reasons, but this would be a transfer to investors. The first reason is that market makers from time to time will use marketable orders to balance inventory. If these market makers decline to participate due to reduced rebate incentives, then their marketable orders will not arrive—diminishing trading volume. The second reason decreased intermediation may lead to lower volumes is that non-market makers might begin to execute their trades via non-marketable orders. Nonmarket makers may submit marketable orders because of an inability to achieve high fill rates with non-marketable limit orders due to significant competition from market makers. The reduction in intermediation may result in situations where two traders with offsetting trades, who would have generated two separate trades with market makers as the counterparty instead execute their trade with each other resulting in one trade. This could occur, for example, if the Pilot reduces queue lengths for investors as discussed in Section IV.C.2.b.iv.(2) below. While this effect would result in a loss in revenue to exchanges that would collect margin on a smaller number of trades, it would be a net gain for investors because executions on a smaller proportion of marketable orders would mean that the investors pay less in transaction fees and would more often capture, or earn, the spread where previously they would have paid the spread to transact. Fourth, even if overall trading volume does not decline or shift to off-exchange venues during the Pilot, individual exchanges may experience a decline in trading volume if the Pilot leads to a change in market share among the lit exchanges. This mechanism is discussed in Section IV.D.2.a. This section also highlights the difficulties in determining the expected redistribution of market share among the existing exchanges due to potentially VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 countervailing economic effects. To this point, one commenter noted that the loss in revenue estimated above relied on ‘‘exchanges’ existing market share percentages’’ which ‘‘assumes that exchanges would remain equally competitive for order flow.’’ 780 The Commission agrees that the Pilot may impact the level and distribution of trading volume on lit exchanges but notes that such a redistribution would be a transfer among exchanges rather than an economic cost. The Commission acknowledges that the reduction or elimination of rebates may particularly affect smaller exchanges due to the liquidity externality, especially if their primary competitive differentiation is based upon a modified fee model. As discussed in the Proposing Release liquidity tends to consolidate.781 Thus, the restrictions on rebates resulting from the Pilot could harm smaller exchanges that may be competing 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. It could also have longer-term effects if smaller exchanges consolidate or exit as a result of the Pilot. However, the Commission does not believe that consolidation or exit is likely during the pilot because only about a quarter of NMS stocks will be included in test groups. The Pilot could also impact exchanges’ fee revenue after the conclusion of the Pilot if as a result of the Pilot broker-dealers permanently alter their order routing decisions after the Pilot is completed. One commenter argued that this may be the case and suggested that the Commission’s claim that the Pilot’s effect on broker-dealers’ routing decisions would be temporary ‘‘[was] contradicted by the Commission’s own finding that brokerdealers would not change their behavior unless the Transaction Fee Pilot lasts for at least one year.’’ 782 To this point, given the competitive nature of financial markets, the Commission does not expect that it would take most brokerdealers up to one year to alter their behavior. Indeed, this commenter supports this belief by stating that exchange and non-exchange trading centers vigorously compete for trading volume, and that market participants are sensitive to revisions in transactionbased pricing models.783 Given this competition, the Commission believes market participants will likely adjust Letter I, at 17. Proposing Release, supra note 2, at 13042. 782 See NYSE Letter I, at 15–16. 783 See State Street Letter, at 2. 5273 their behavior quickly both upon the implementation and conclusion of the Pilot, and that the Pilot duration will incentivize broker-dealers not to ‘‘wait out’’ the Pilot who could be otherwise inclined to do so if the duration were not sufficiently long.784 If the Pilot results in a decline in fee revenue for exchanges, then this could lead to other costs borne by investors as a result. Exchanges could promote additional order types and may even initiate new types of markets as a result of the Pilot, which would only serve to further fragment markets and add to their complexity, the costs of which could be borne by investors.785 In particular, the Commission recognizes the remote possibility that an exchange holding company could attempt to optimize its overall performance during the Pilot by further diversifying with other exchange models. The Commission believes, however, that a new equity exchange registered in direct response to the Pilot would be unlikely to become operational before the conclusion of the Pilot. In addition, the Commission believes that it is unlikely that exchanges will promote additional order types as a result of the Pilot. In sum, the Commission believes that the costs to the exchanges due to narrower margins earned per trade are likely to be minimal—if any—due to the removal of the proposed Test Group with the fee cap of $0.0005. However, the Commission does expect that there could be a change in trading volume or a redistribution of market share among exchanges as market participants reoptimize their order routing systems as a result of the Pilot. However, due to the reasons discussed in this section, the Commission cannot determine in advance of the Pilot whether these market share/trading volume changes will increase or decrease exchange revenue. Consequently, the Commission acknowledges that the Pilot may lead to lower trading volume/market share for exchanges, which would impose a cost in terms of lost transaction fee revenue, but is unable to quantify the expected magnitude of this potential cost and no commenter provided an estimate of the amount of the lost transaction fee revenue. While the Commission cannot determine in advance of the Pilot its impact both in terms of direction and magnitude, the Commission has attempted to estimate the costs should volume decline. Using data from Table 3 in section IV.B.2.e the Commission 780 NYSE 781 See PO 00000 Frm 00073 Fmt 4701 Sfmt 4700 784 See 785 See Section IV.C.1.a.iii, supra. Section III.A. See also, e.g., Fidelity Letter, at 8. E:\FR\FM\20FER2.SGM 20FER2 5274 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations estimates an annualized upper bound on the profit earned from transaction fees for each exchange. Aggregated across all exchanges this number equals approximately $3 billion per year. However, only about 1/4th of NMS securities will be in a test group subject to the Pilot, so the Commission estimates the Pilot could affect the approximately $750 million per year across all exchanges, depending on how much volume changes. Consequently, if the Pilot were to cause a 10% reduction in trading volume on exchanges then this change could reduce fee revenue on the exchanges by approximately $150 million over two years or $75 million if the Commission were to allow the Pilot to automatically sunset at the end of the first year. However, the Commission does not believe that the 10% reduction in trading volume is a reasonable assumption. While the Swan Study shows that Nasdaq lost 10% of its volume using one volume measure, it lost only 200,000 shares in another. In addition, the Swan Study finds no change in overall volume or in offexchange volume, just a migration from Nasdaq to other exchanges. Therefore, the Commission does not believe that either the 10% volume reduction or, consequently, the estimate of $150 million revenue reduction is reasonable. ii. Broker-Dealer Systems Costs Although the costs of compliance with the Pilot will primarily affect the exchanges, broker-dealers and other market participants are also likely to incur costs as a result of the Pilot. Commenters provided mixed information on the magnitude of these costs. While some commenters stated that the costs to broker-dealers of the Pilot would be substantial,786 other commenters stated that the costs for broker-dealers associated with the Pilot would not be significant or expensive because exchange fee schedules change regularly and broker-dealers are used to adapting their order routing algorithms to new and changed fee schedules.787 This section provides the Commission’s estimates for broker-dealer compliance costs associated with the Pilot.788 786 See, e.g., Larry Harris Letter, at 10–11; STANY Letter, at 2; FIA Letter, at 3; Nasdaq Letter I, at 10; Nasdaq Letter III, at 9. 787 See, e.g., Vanguard Letter, at 3; Healthy Markets Letter I, at 34. 788 One commenter stated that the Commission did not consider implementation and coding costs. See STANY Letter at 2. However, the commenter does not elaborate on why the Proposing Release estimates of $3,741,000 implementation costs for broker-dealers to adjust their order routing systems at the beginning and end of the Pilot and the $20,726,000 costs for broker-dealers to update their order routing systems for fee changes during the VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 In response to the Pilot, market participants might have a one-time cost at the onset and the conclusion of the Pilot to adjust their systems to reflect the shocks and potential additional complexity of transaction-based fees. In addition, there may be additional modifications to routing strategies that are made in subsequent months to adjust to changing liquidity dynamics as behavior changes associated with the pilot settle in. 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, lowest fees, or highest rebates.789 One commenter agreed, stating that such systems changes ‘‘should primarily consist of modifications to the routing tables and other associated operational activities.’’ 790 The Commission understands that some of the associated changes and modifications may already be coded into the smart order router (SOR) algorithms such that changes to associated liquidity shifts may be dynamic and automated, i.e., in need of little additional modification. To estimate these costs, the Commission assumes (1) that all brokerdealer members of exchanges will adjust their systems for the pilot and (2) that all broker-dealer members of exchanges have automated order routing systems.791 While the Pilot does not directly require broker-dealers to adjust their systems, the Commission expects broker-dealers who do not update their systems may incur significant costs relative to those who do in terms of potential impacts on execution quality and in their ability to manage fees and rebates. Broker-dealers might choose to Pilot failed to consider implementation and coding. See Proposing Release, supra note 2, at 13063– 13064. 789 See Bacidore, Jeff, Hernan Otero, and Alak Vasa, 2011, Does smart routing matter ?, Journal of Trading 6, 32- 37. (available at https:// jot.iijournals.com/content/6/1/32), which found that smart-order routers designed to maximize rebates delivered worse execution quality to their clients. 790 See FIF Letter at 8. See also FIA Letter at 3; Nasdaq Letter I at 10. 791 Even in the absence of smart-order routers, broker-dealers could still adjust their execution determinations to take advantage of the changes implemented during the Pilot and these adjustments would incur costs. While the Commission does not estimate these particular costs, the assumption that all broker-dealers have automated order routing systems is reasonable and is necessary to enable the estimation of cost estimates. The Commission believes, however, that the costs to adjusting manual systems could be lower than the costs to adjust automated routing systems. If any broker-dealers still route orders manually, they likely do so because setting up and maintaining manual systems is not economical for them. It is likely that such firms utilize exchange routing services. PO 00000 Frm 00074 Fmt 4701 Sfmt 4700 adjust their systems for the Pilot for many reasons, including to recognize that the Pilot could affect execution quality for investors and/or to better manage fees and rebates.792 Therefore, the cost estimates assume that brokerdealers will adjust to their existing systems to capture changes in fees and rebates associated with each Test Group of securities, rather than bearing start-up costs associated with implementing new order routing systems. In its estimates, the Commission recognizes that the costs associated with adjusting the execution algorithms by broker-dealers for the Pilot are likely to be more costly than the periodic updates that broker-dealers may make to incorporate changes to fee schedules implemented by exchanges or to fine tune their strategies. The additional expected costs may occur because changes for the Pilot are likely to require more complex programming that segments stocks into different fee regimes (assuming exchanges implement fees customized to each Test Group), rather than just altering codes or inputs. As of July 2017, exchanges have 18 fee categories and 21 rebate categories, on average.793 If exchanges maintain the same level of complexity in their fee schedules during the Pilot, up to a two-fold increase in the number of fee and rebate categories could occur, which would increase complexity for broker-dealers who incorporate fees into their order routing decisions.794 Additionally, the Commission agrees with the commenter who stated that, to the extent that broker-dealers’ order routing algorithms are programmed to the exchange, and not the individual security, the Pilot will increase complexity by requiring an adjustment to this methodology.795 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 Pilot would be approximately $9,000 per brokerdealer, or $3,573,000 in aggregate across the 397 broker-dealers that are currently members of equities exchanges.796 The 792 See sections IV.C.1.a.iii and IV.E.5.a for additional discussion. 793 See Table 2 in Section IV.B.2.f supra. 794 In addition, the Commission recognizes the potential costs to exchanges of this complexity above in Section IV.C.2.a. 795 See Larry Harris Letter, at 10–11. 796 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)] ≈ $9,000 per broker-dealer that is a member of at least one exchange. As of December 31, 2016, E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations Commission further estimates that broker-dealers would bear a similar cost to adjust their order routing systems at the conclusion of the Pilot. Additionally, the Commission expects that broker-dealers would update their order routing systems with changes to fees or rebates submitted by exchanges through Form 19b–4 fee filings to the Commission during the Pilot. 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 updating the order routing systems to reflect these routine changes to fees and rebates.797 As in the estimates of the costs of the initial and final adjustments, broker-dealers are likely to face higher costs per update as a result of the Pilot because of the added complexity of having to update multiple modules within their order routing systems. The Commission’s estimates of these updates assume that exchanges update their fees schedules as often during the pilot as at present. Therefore, the costs to broker-dealers associated with the Pilot are the additional costs associated with the complexity of the updates and not the total cost of the updates.798 In other words, brokerdealers would have updated their systems (or routing tables) anyway in the absence of the Pilot to reflect the same number of exchange fee and rebate changes. The Commission estimates described below reflect the additional cost of the Pilot (‘‘additional costs’’), which is how much more an update might cost during the Pilot compared to a scenario without the Pilot. The Commission believes that the perupdate additional costs associated with these changes are likely to be a small fraction of the costs associated with the initial costs of adjusting the routing systems to reflect the required fee and rebate revisions at the outset of the Pilot. The Commission estimates that the additional costs to broker-dealers that are members of exchanges to make periodic adjustments to their order 397 unique broker-dealers were members of exchanges (Form X–17a–5). The aggregate costs of updating order routing systems to reflect the Transaction Fee Pilot requirements would cost $9,000 × 397 ≈ $3,573,000. Note that smaller broker dealers will often use the smart order router of larger broker dealers or those offered by exchanges, and will therefore benefit indirectly from the work done by the providers of their smart order routing services. 797 Several commenters made similar statements. See, e.g., Vanguard Letter, at 3; Healthy Markets Letter I, at 34. 798 The Commission cannot estimate and commenters provided no insight into the degree to which the number of fee and rebate revisions by exchanges will increase or decrease during the Pilot. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 routing systems to reflect changes in fees and rebates would be $265 per adjustment, or approximately $105,000 in aggregate across the 397 brokerdealers that are members of U.S. equities exchanges.799 As shown above, the Commission 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 two-year pilot duration. Therefore, the aggregate costs of updating order routing systems would be $48,000 per brokerdealer, or $19,056,000 in total across all broker-dealers.800 If the Pilot were to automatically sunset at the end of the first year, the aggregate costs of updating order routing systems would be $24,000 per broker-dealer, or $9,528,000 in total across all broker-dealers. In sum the Commission believes that the all in costs to broker-dealers of updating their order routing systems as a result of the Pilot will average approximately $66,000 per brokerdealer to update their systems over the entire Pilot Period. If the Pilot automatically sunsets at the end of the first year, the costs associated with these updates will be approximately $42,000 per broker-dealer.801 The Commission notes that these estimates may be overstated. 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. Additionally, the exchanges could resort to more 799 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) × $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 × 397 ≈ $105,000. 800 If 182 total fee and rebate changes were to occur over the duration of the 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 ≈ $48,000, or $19,056,000 ($48,000 × 397) in aggregate across all broker-dealers over the first year of the Pilot. The Commission estimates that costs would be $9,528,000 ($265 × 13 exchanges × 7 updates × 397 broker-dealers) if the Commission determined that Pilot automatically sunset at the end of the first year. 801 These costs reflect the estimated cost of $9,000 at the outset of the Pilot to update the order routing system to reflect the changes to the fee structure for securities in the test groups, $48,000 to reflect the incremental costs of the estimated 182 revisions to fee schedules during the Pilot ($265 per revisions × 7 revisions per year × 2 years × 13 exchanges), and $9,000 at the conclusion of the Pilot to unwind changes to the order routing systems, for a total of $66,000 per broker-dealer. If the Pilot were to automatically sunset at the end of one year, then these costs would be approximately $42,000 ($265 × 7 revisions × 13 exchanges+2*$9,000) per brokerdealer. PO 00000 Frm 00075 Fmt 4701 Sfmt 4700 5275 simplified fee schedules relative to the current baseline, which would reduce broker-dealers’ costs of updating their systems for the Pilot. iii. Temporary Increase in Brokerage Commissions Beyond the implementation and compliance costs for exchanges and broker-dealers associated with the Pilot, the changes to the exchange transactionbased fee and rebate structure could lead to temporary increases in brokerage commissions charged to their customers. Several studies show, and several commenters concurred, that brokerage commissions today are at historically low levels.802 Brokerage clients may have a preference for low commissions with 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.803 As a result, the Pilot could lead to higher overall commissions as rebates obtained by broker-dealers fall,804 thereby temporarily reducing the overall welfare of retail brokerage clients as a result of increased commissions.805 For instance, the elimination of rebates and Linked Pricing in Test Group 2 could result in a transfer from broker-dealers to exchanges. Assuming, as discussed above, the margin between fees and rebates is approximately $0.0002 per share,806 with transaction fees of $0.0030 per share and rebates of $0.0028 per share, Test Group 2 could result in a transfer of $0.0028 from broker-dealers to the exchanges with 802 See, e.g., Angel, Harris, & Spatt, supra note 530. 803 See Regulation NMS Subcommittee Recommendation for an Access Fee Pilot (June 10, 2016), available at https://www.sec.gov/spotlight/ emsac/emsac-regulation-nmsrecommendation61016.pdf (‘‘June Recommendation’’). See also Shawn O’Donoghue, 2015, ‘‘The Effect of Maker-Taker Fees on Investor Order Choice and Execution Quality in U.S. Stock Markets’’, Working Paper, available at https:// papers.ssrn.com/sol3/papers.cfm?abstract_ id=2607302. 804 Several commenters made similar statements. See, e.g., NYSE Letter I, at 13; ASA Letter, at 2. 805 The Commission acknowledges differing effects on brokerage commissions could occur as a result of the 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. 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. 806 There are approximately 8,000 NMS securities and just under 800 will be included in Test Group 2. E:\FR\FM\20FER2.SGM 20FER2 5276 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations respect to their passively posted nonmarketable orders, particularly because exchanges would be prohibited from offering Linked Pricing mechanisms that could act as substitutes for cash rebates.807 The estimates of the potential increased revenue to exchanges are as follows. Assuming that the share volume in Test Group 2 would be approximately 12.5% of the total share volume across all securities,808 using data from Table 2 in the baseline, Test Group 2 would have share volume of approximately 11.5 billion each month.809 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 2, the Commission anticipates no change in revenue for exchanges, and no transfer from broker-dealers. If, instead, exchanges charged the maximum fees of $0.0030 while they are prohibited from paying rebates or Linked Pricing in Test Group 2, the Commission estimates a monthly aggregate increase in revenues across all exchanges of $32,200,000.810 If the volume on each exchange does not change, then the estimated annual average increase in revenues across all exchanges would be $386.4 million [$32,200,000 × 12 = $386.4M]. This transfer of rebates from the brokerdealers to exchanges could potentially increase exchange revenue by approximately 64.1%.811 Moreover, 807 Although the Commission believes that competition among exchanges would drive transaction fees down for Test Group 2 as a result of the elimination of rebates, exchanges could charge transaction fees as high as the current cap of $0.0030. 808 As designed, the Pilot would allocate an equal number of securities to the two test groups and the control group (e.g., the test groups combined would have approximately 25% of the NMS securities and the control group would have 75%). Each test group will have one-half of the combined test group allocation, thereby, in total leaving each test group with 12.5% of NMS 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 approximately 12.5% of total share volume each month. 809 Table 2 in the baseline shows aggregate exchange share volume for July 2017 was 91.7 billion shares, of which 12.5% would be 11.5 billion shares. Further, the Commission estimates that these volume figures would be similar across all months, assuming no seasonality in share volume. 810 If Test Group 2 has monthly share volume of 11.5 billion shares, and the margin would increase by $0.0028 ($0.0030—$0.0002), the revenue increase per month is estimated to be 11.5 billion × $0.0028 ≈ $32,200,000. 811 As discussed in section IV.B.2.d, the net of rebate revenue for NYSE (NYSE, NYSE Arca, NYSE American, and NYSE National), Nasdaq (Nasdaq, BX, and PSX), and Cboe (Cboe BZX, Cboe BYX, Cboe EDGA, and Cboe EGDX), was $602 million during 2017 ($196M + $253M + $153M). If the estimated margin increased by $386.4 million, then VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 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 2.812 The Commission further acknowledges that if brokerage commissions were to increase as a result of the Pilot, broker-dealers could continue to charge higher commissions even after the conclusion of the Pilot. However, due to competition among broker-dealers, including the proliferation of low-cost online brokerdealers, the Commission believes that broker-dealers would be unlikely to significantly increase brokerage commissions as a result of the Pilot.813 Lastly, the Commission acknowledges that brokerage commissions may decrease during the Pilot if the Pilot results in lower execution costs for some test groups, then those lower costs may be passed on to investors in the form of lower commissions. For example, if a broker-dealer pays the transaction fee more often than they earn the rebate, the reduction of fee caps would reduce the cost of transacting for this broker-dealer, which the brokerdealer may pass onto investors in the form of lower commissions.814 iv. Temporary Reduction in Liquidity The effect of the Pilot on liquidity is uncertain as there are reasons why the Pilot may increase as well as decrease liquidity. Several commenters expressed concern that the Pilot would reduce liquidity. These commenter statements largely focus on the impact of the reduction or elimination of rebates. In considering the comments, and as analyzed in the following sections, the Commission considered the impact of the direct effect of rebates on quoted spreads, the impact of a loss of liquidity provision on quoted spreads and depth, the impact of changes in adverse selection on transaction costs, and the impact of potential conflicts of interest on execution quality. In addition, the Commission analyzed estimates of the costs of a potential reduction in liquidity provided by commenters. The Pilot could result in a positive, negative, or neutral change in liquidity the percentage increase in this margin would be $386.4 million/$602 million ≈ 64.1%. 812 Consistent with this idea one commenter suggested that, any benefits or costs accruing to broker-dealers as a result of changes in fees and rebates are likely to be passed onto their customers. See Decimus Letter, at 2. 813 See supra Section IV.B.2. and IV.D.2. (discussing the competitive environment for brokerdealer services). But cf. Decimus Letter, at 2–4; NYSE Letter I, at 13; ASA Letter, at 2 (noting the possibility that commissions would increase). 814 See Decimus Letter, at 2–4. PO 00000 Frm 00076 Fmt 4701 Sfmt 4700 for the stocks in test groups. Adding to this uncertainty, some commenters felt that to the extent that there are liquidity effects, such effects would be minimal.815 Also, the impacts of the Pilot on liquidity may not be uniform across all securities and several commenters believed that widening of spreads would be limited to a small number of securities. Some commenters stated that the widening of spreads is unlikely to affect the most and least liquid securities, or will not adversely affect liquidity at all.816 Further, as some commenters explained, less liquid stocks tend to have wider spreads, and therefore, the impact of rebates as an incentive to provide liquidity may become less relevant for these securities.817 (1) Direct Impact of Fees and Rebates on Quoted Spreads The Commission believes the impact of the Pilot on liquidity and transaction costs through a direct adjustment of the quoted prices is uncertain. One study argues that transaction-based rebates may artificially narrow the quoted spread on make-take exchanges by the amount of the rebate.818 This effect would particularly impact retail investors whose orders are largely internalized at the best quoted prices. However, whether rebates can effectively narrow quoted spreads in a given stock depends on whether that stock’s natural quoted spread (without artificial narrowing) is constrained by the tick size. For example, if a stock has a natural quoted spread of less than one penny, which is the minimum tick size, then rebates cannot possibly artificially narrow the quoted spread. Many of the most active stocks have average quoted spreads very close to a penny and the Commission believes that the natural spread in some of these stocks could be at or less than a penny. Consequently, the Commission believes that rebates might not artificially narrow spreads in at least some of the most active stocks and, therefore, that the Pilot might not result in wider quoted spreads in all stocks.819 (2) Potential Reduction in Liquidity Provision The Commission recognizes that the Pilot could reduce the incentives to 815 See, e.g., Angel Letter II, at 3. e.g., Citigroup Letter, at 3; Credit Suisse Letter, at 1; Decimus Letter, at 4; MFS Letter, at 1. 817 See, e.g., IEX Letter II, at 5; Credit Suisse Commentary, at 3. 818 See Angel, Harris, & Spatt, supra note 530. 819 See also TD Ameritrade Letter, at 3 (concurring with the view that the Pilot is less likely to affect highly liquid securities). 816 See, E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations provide liquidity, but believes that the impact of this reduced incentive on quoted spreads and transaction costs could be positive or negative and could vary across securities. In particular, the Commission believes that despite a potential reduction in liquidity provision, some investors could actually experience lower or higher transaction costs in some securities for several reasons. Generally, this section provides reasons to expect an increase in transaction costs as well as reasons to expect a decrease in transaction costs. Likely, several of these effects will offset to create a new equilibrium, but the Commission cannot predict whether investors will face higher or lower transaction costs in this new equilibrium. First, some commenters stated that the removal of rebates could cause some liquidity providers to stop providing liquidity, which would result in a temporary increase in transaction costs during the Pilot as the remaining liquidity providers would face less competition for their services and therefore could charge wider spreads to liquidity demanders.820 One Commenter suggested that this effect could be seen by comparing spreads on non-rebate exchanges like Cboe EDGA with the rebate paying exchange Cboe EDGX. The Commenter noted that average spreads on Cboe EDGX tend to be lower than those on Cboe EDGA.821 However, the Commission does not believe that this data point provides robust evidence that spreads will widen across all securities because EDGA and EDGX tend to trade securities with different characteristics, consistent with another commenter who stated that ‘‘EDGA only traffics in the most liquid names’’ consequently comparing average spreads on EDGA and EDGX is not appropriate. Additionally this analysis does not establish a causal link between rebates and quote quality.822 The Commission notes that a reduction in liquidity provision might not result in wider quoted spreads and greater transaction costs, particularly in more active securities. In particular, as suggested by some commenters, if rebates result in excessive intermediation,823 or if ‘‘natural’’ buyers 820 See also Pragma Letter, at 2; Magma Letter, at 2; STA Letter, at 3; STANY Letter, at 2; Morgan Stanley Letter, at 3–4; Energizer Letter, at 1. 821 See NYSE Letter II, at 2, 9. See also, Nasdaq Letter III, at 4–6 (presenting similar data suggesting that quote quality on make-take exchanges is better than on inverted exchanges). 822 See section IV.C.1.a.ii.(3) for a discussion on causality, See also Mulson Letter II, at 1. 823 See NYSE Letter II, at 4 (noting that ‘‘some institutions believe maker-taker pricing VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 and sellers set quoted prices,824 a reduction in rebates need not widen quoted spreads and increase transaction costs and could actually reduce transaction costs to the benefit of investors. Excessive intermediation makes it more difficult for non-market makers to get passive orders to the front of the queue and could induce them to cross the spread to trade aggressively a greater fraction of the time. If a reduction in rebates can result in less excessive intermediation, then a reduction in liquidity provision by market makers might not adversely impact transaction costs but could instead decrease queue lengths faced by non-market maker liquidity providers such as institutional investors. This could allow investors trading test group stocks to potentially experience better execution quality because they could be able to obtain better queue priority on their passive orders. Better queue priority would both diminish adverse selection costs for passive orders and also decrease the fraction of time investors are required to pay the spread and potential take fee to execute a trade.825 The Commission does not have the data necessary to empirically analyze whether rebates indeed result in excessive intermediation, but expects the Pilot to facilitate such analysis. The Commission recognizes the risk, noted by some commenters, that the Pilot could increase the cost of transacting if the reduction of rebates leads to a reduction in quoted depth.826 If the reduction in rebates in test group securities results in liquidity providers such as market makers posting less displayed liquidity, quoted depth could decline even if quoted spreads does not decline. This lower depth could result in increased costs of transacting larger quantities. These effects could be more pronounced in small stocks if, as some commenters suggest, rebates are important to induce market makers to provide liquidity in small stocks either directly or through cross subsidization of liquidity.827 unnecessarily subsidizes quoting in sufficiently liquid securities, resulting in ‘excessive intermediation’ that crowds out long-term investor participation in the market.’’). See also T. Rowe Price Letter, at 2. 824 See, e.g., Mulson Letter. 825 See Pragma Letter, at 2; IEX Letter I, at 6; IEX Letter III, at 4–6. But cf. NYSE Letter II, at 11. 826 See Pragma Letter, at 2; Nasdaq Letter I, at 6. 827 See Nasdaq Letter I, at 8–9; Nasdaq Letter III, at 9. However another commenter suggested that the impact of the Pilot on small stocks would be mitigated by the fact that small stocks tend to have wider spreads, and thus rebates form a smaller fraction of total market making incentives. See Decimus Letter, at 4–5 PO 00000 Frm 00077 Fmt 4701 Sfmt 4700 5277 The Commission also recognizes the potential for a reduction in liquidity and an increase in transaction costs for ETPs and particularly less active ETPs. Multiple commenters expressed concern that the Pilot might particularly reduce liquidity in ETPs.828 These commenters noted that, unlike in stocks, the Pilot might affect liquidity for ETPs in one of two ways: It may affect liquidity in shares of the ETP, or it may affect liquidity in the underlying assets of the ETP. The Pilot may reduce liquidity in the shares of the ETP if the reduction of or elimination of rebates induces market makers to stop or reduce providing liquidity for shares of an ETP. Moreover, another commenter expressed concern that the Pilot is inconsistent with exchanges programs for ETP market makers, whereby incentives are made available to market makers to act as liquidity providers for small, less liquid ETPs and therefore the negative impact of the Pilot could be the most pronounced among illiquid ETPs.829 Additionally, the Pilot may affect the liquidity of ETPs if it impacts the liquidity of the underlying securities. If the Pilot affects liquidity in shares of an ETP or impacts the liquidity of the ETP’s underlying securities, it will also affect the costs to authorized participants of eliminating ETP mispricing by participating in the create-redeem process.830 Additionally, the Commission recognizes that the Pilot might result in other unforeseen changes to market dynamics,831 including improved or diminished execution quality by certain trading centers which could shift the level of market participation. Also, the Pilot may affect the ability of exchanges and ATSs to draw liquidity provision through innovative methods other than rebates. The effects of these changes may have a positive, neutral, or negative effect on liquidity. Consequently, the Commission believes that there is significant uncertainty surrounding the effects of the Pilot on liquidity. (3) Conflicts of Interest As noted above, the Commission is not certain of the extent to which some broker-dealers route investor orders to avoid fees or to capture rebates in such 828 See, e.g., ICI Letter I, at 4; BlackRock Letter, at 1–2; FIA Letter, at 4; SIFMA Letter, at 4; Issuer Network Letter I, at 3; Schwab Letter, at 3; Fidelity Letter, at 9; Invesco Letter, at 2; State Street Letter, at 3; Clearpool Letter, at 8; STA Letter, at 4; STANY Letter, at 4; Healthy Markets Letter II, at 8; Healthy Markets Letter I, at 11; Nasdaq Letter I, at 8; NYSE Letter I, at 7; Cboe Letter I, at 17; Credit Suisse Commentary, at 6; Morgan Stanley Letter, at 3–4. 829 See Virtu Letter, at 7. 830 See infra Section IV.D.1. 831 See IEX Letter II, at 7. E:\FR\FM\20FER2.SGM 20FER2 5278 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations a way that reduces execution quality. To the extent they do, the Pilot could improve execution quality. This would occur if, as many commenters and studies have argued, the offering of rebates produces a conflict of interest that induces orders to be routed to exchanges with sub-optimal execution quality.832 Consequently, the removal or reduction of rebates may cause orders to be routed to exchanges with better execution quality and the execution quality in the stocks in the Test Groups could improve. As noted above, commenters disagreed on whether broker-dealers act on such conflicts of interest and the Commission lacks sufficient information to determine the magnitude of any such conflicts. The Commission notes that the objective of the Pilot is, in part, to study such conflicts of interest. (4) Cost Estimates Multiple commenters provided quantitative cost estimates associated with expected changes in liquidity. The commenters’ estimates all rely on the assumption that a reduction in rebates will increase quoted spreads and transaction costs but took different approaches, resulting in a wide range of estimates from $24 million to $4 billion per year. Overall, while the Commission appreciates the cost estimates, the Commission reiterates that the Pilot could either increase or decrease investor transaction costs for the reasons explained above. However, for the reasons discussed below, the Commission believes that each of the commenters overestimated the potential costs to investors. Below, the Commission first describes each estimate, adjusts the estimate for the change in the structure of the Pilot and then discusses how the assumptions might affect the estimation. The first commenter estimated costs of $24 million per year. Across all three proposed test groups, this commenter calculated an anticipated reduction in the average rebate of $0.002267 per share, and that approximately 50% of all liquidity providers will be affected by the rebate reduction by ‘‘updating their quotes to less aggressive prices,’’ leading to an increased cost to cross the spread of $0.001134 per share.833 Assuming only stocks with an average quoted spread in excess of $0.02 will be adversely affected by the rebate reduction, this commenter estimated that the costs to its customers of a wider 832 See 833 See Section III.A. TD Ameritrade Letter, at 3. VerDate Sep<11>2014 18:36 Feb 19, 2019 quoted spread would be $24 million annually.834 To account for the changes to the Pilot since the proposal, Commission staff estimate that this commenter’s approach would estimate a cost of $12.7 million per year. To arrive at this estimate, the Commission adjusted the average rebate reduction to 0.0024 to account for the change to the test groups and adjusted the average implied volume to account for the inclusion of less than half the number of stocks in test groups. Despite these adjustments, the Commission notes that the estimate is likely imprecise. In particular, this estimate relies on an assumption that the spreads will widen by 50% of the reduction in rebates but does not provide support for this assumption. The commenter does not explain why they expect this relation between rebates and liquidity or provide an explanation for why they feel that 50% is the appropriate adjustment to use. Further, this adjustment does not allow for some liquidity demanders to supply liquidity more often if queue lengths decline with rebates. Such a switch would reduce the impact on transaction costs. The commenter also does not explain whether the share volume used to estimate the costs was all share volume in securities with average quoted spreads of less than two cents or just that portion likely to be in a test group. If the commenter included all volume, the estimates would be closer to $6.34 million. A second commenter estimated that if effective spreads widened by 10% for the 100 top securities, ‘‘the Pilot could conservatively cost investors over $400 million more in annual execution costs.’’ 835 The commenter does not provide an analysis, either quantitative or qualitative, to support their belief that a 10% increase is appropriate to use or explain their methodology. The commenter provided little information about its assumptions or underlying data that would allow the Commission to examine the robustness of the estimate or to adjust the estimate for the changes in the Pilot since the proposal. As such the best way for the Commission to adjust the estimate for the changes in the Pilot is to divide it by two, $200 million, because the changes reduced the number of securities in the Pilot by slightly more than half. However, because of uncertainties about methodology and assumptions, the Commission cannot adjust with any certainty the $400 million estimate and does not believe 834 See id. Letter I, at 3. 835 Cboe Jkt 247001 PO 00000 Frm 00078 Fmt 4701 Sfmt 4700 that a $200 million estimate is reliable. The Commission recognizes that the changes to the Pilot could also change the commenter’s estimate of how much spreads widen. A third commenter provided an analysis that suggested that, due to wider spreads, the increased costs to investors would be at least $1 billion per year and potentially $4 billion.836 Like the first commenter, this $1 billion estimate assumes an adjustment to transaction costs based on the reduction in the rebate, except that this commenter doubled the rebate to adjust transaction costs. To compute their estimate, the commenter estimates the weighted reduction in rebates across all stocks, taking into account the fact that most stocks will see no change in rebates. The commenter then uses the expected weighted average reduction in rebates to compute their estimate for the Pilot’s impact on average spreads across all stocks. The commenter then multiplies the expected impact on spreads by total trading volume to arrive at a total of approximately $1 billion in estimated costs per year.837 Using the commenter’s method, the adopted rule would have an average rebate reduction of approximately $0.0004, which would widen spreads by $0.0009, or approximately half the prior increase, for a new cost estimate of $600 million per year. Other commenters responded to this commenter’s $1 billion estimate in various ways. One commenter criticized the use of quoted spreads to estimate costs.838 Likewise, several commenters 836 See NYSE Letter I, at 13 and NYSE Letter IV, at 4. The commenter estimated the $1 billion increase in expected costs by computing a new consolidated spread, equal to the current consolidated spread + (rebated reduction × 2), where the rebate reduction is the blended average fee change of $0.00082, and multiplied this rebate reduction by 2 as market makers on both sides of the quote will adjust to reflect the rebate reduction. The commenter indicated that this estimation results in a 1.1% increase in average spreads to 28.1 bps. Id. at Addendum 4–5. For principal trades, the anticipated increase in costs as calculated by this commenter is the cost to cross the wider spread netted against lower access fees, while for agency trades, the costs equal the cost to cross the new wider spread. The commenter showed, ‘‘on net, an estimated cost of $1.08bn to the industry, of which $721MM would be incurred by agency flow.’’ Id. at Addendum 5. See also STANY Letter, at 2. 837 The Commenter adjusts their estimate to account for agency verses principle flow using the following formulas. Agency cost = Change in Spread*1/2 * Market Notional Value * Agency Share; Principal Cost = [Change in Spread*1/2 * Market Notional Value * Principal Share]—[Fee Reduction * Market Volume * Principal Share * Maker/Taker Venue Share]. 838 See IEX Letter II, at 6. ‘‘Given that institutional investor orders are typically far larger than [the quoted spread], and retail investor orders are generally executed off-exchange,’’ the quoted spread is ‘‘particularly relevant’’ in ‘‘cases where a E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations suggested that the commenter’s estimates of potential harm are overstated by as much as 90%.839 The Commission views the commenter’s $1 billion estimate as likely overstating the realistic costs associated with the Pilot should it result in increased spreads. One reason the estimate may be overstated is that, as some commenters have noted, and as discussed in section IV.C.2.b.iv.(1), the Pilot might have a diminished impact on penny constrained securities. In a supplemental analysis using TAQ data from the last quarter of 2017 and the first two quarters of 2018, the Commission estimates that between 50– 70% of share trading volume occurs in stocks that are penny constrained.840 Consequently, to the extent that rebates play a diminished or no role in determining the spread of penny constrained stocks the commenter’s estimates will significantly overstate the impact of increased spreads on transaction costs. Also, the commenter’s estimate assumes that spreads will widen by twice the reduction in rebates, an assumption that some commenters question and that the Commission views as a likely upper limit to the impact of the Pilot on quoted spreads.841 This assumption does not take into account that non-market makers may begin to provide liquidity more often during the Pilot in securities with lower or no rebates due to a potential decrease in intermediation by market makers, which may mitigate the impact of less intermediation by market makers as a market participant is attempting to buy or sell, on an exchange, fewer shares than the total amount displayed at the [NBBO][.]’’ Id. NYSE responded to this comment by noting that nearly all trading on exchange is for amounts smaller than the quoted depth, so the quoted spread is relevant. See NYSE Letter II, at 10. 839 See, e.g., IEX Letter II, at 4; Healthy Markets Letter II, at 2 (arguing that the NYSE cost estimate to investors of $1 billion has been ‘‘sufficiently debunked as purely fictional’’); Decimus Letter, at 4 (arguing that the NYSE approach ignores potential indirect benefits to market participants of lower access fees (and possibly lower brokerage commissions), and that the Pilot would provide the information necessary to obtain meaningful analysis of changes to fees and rebates on order routing decisions and execution quality). 840 To determine if a stock is penny constrained, the Commission applied the simple filter: If the stock’s trade weighted quoted spread was less than 1.1 cents, then the stock was considered penny constrained. This threshold yielded approximately 50% of trading volume occurring in stocks that are penny constrained. If the threshold is lifted to 2 cents (implying that at least some of the time the stock was penny constrained), then the fraction of trading volume in penny constrained stocks rises to 70%. Note that the sample period for the supplemental analysis is during the Tick Size Pilot. As such, these figures could underestimate the percentage of volume in penny constrained securities. 841 See Section IV.2.b.iv.(1). VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 result of lower rebates.842 Consequently, the Commission acknowledges that to the extent that the Pilot impacts spreads in a certain small number of test group stocks, this could engender costs to investors. However, as described above, the Commission believes that the estimate of $1 billion per year is likely a significant overstatement of the actual costs that would be incurred in such a scenario.843 The commenter’s $4 billion estimate is based on the comparison between the spreads on a maker-taker exchange compared to the spreads on a takermaker exchange described above in Section IV.C.2.b.iv(2), which the Commission views as even more imprecise than the $1 billion estimate for the reasons laid out above. Beyond the concerns expressed in Section IV.C.2.b.iv(2), the Commission notes that the difference between the spreads of a maker-taker exchange and a takermaker exchange would result from the difference between the fee paid to post an order and the rebate to post. As such, the implied impact of no rebates would be no more than 1⁄2 the spread difference. Thus, thus using the full spread difference overstates costs by a factor of 2. Further, to get the $4 billion estimate, the commenter applied the spread differential to all NMS securities. Because Test Group 2 will be only about 12.5% of securities, applying the spread differential to all NMS securities overstates the cost by a factor of 8. In sum, using the commenter’s approach, but correcting for these issues, would yield a cost 16 times smaller than the commenter’s, or $125 million. v. Impact on Issuers Several commenters expressed concerns that adverse effects to liquidity could induce long-term costs, such as higher costs of capital for issuers subject to certain Test Groups where the 842 One assumption made by NYSE is that ‘‘a reduction in the average passive rebate. . .will result in both the bid and offer being backed off, on average, by the exact same amount as the rebate reduction.’’ However, as another commenter argued this ‘‘assumes that only rebate driven liquidity providers set the quote’’ when ‘‘in reality the quote is almost always set by natural investors, who have a view of fair price, that is informed by both fundamental and quantitative research as well as the likely impact of their own short term trading intentions. See Mulson Letter, at 1. As discussed earlier in this section, the many potential effects of rebates on quoted spreads create significant uncertainty. See also Decimus Letter, at 4; Mulson Letter, at 1; IEX Letter II, at 4. NYSE responded to these comments by noting that even if their volume estimates are overstated by 20%, the cost is still significant and suggesting that investors would not provide liquidity because doing so would increase leakage costs. See NYSE Letter II, at 10–11. 843 See Mulson Letter I, at 1 and IEX Letter II, at 4. PO 00000 Frm 00079 Fmt 4701 Sfmt 4700 5279 incentives to provide liquidity are reduced, likely affecting small and midcapitalization issuers most severely.844 One commenter believed that issuers would have higher costs of capital as a result of wider spreads, making any attempts to raise capital more expensive, particularly for issuers in certain Test Groups of the Pilot.845 Additionally, a number of commenters also expressed concern that wider spreads due to a reduction in rebates could also adversely affect issuers that engage in share repurchase programs.846 The Commission addresses these comments in the capital formation analysis in Section IV.D.3 and concludes that the Pilot is not expected to have a large impact on issuer cost of capital. While the Commission acknowledges the risk that the Pilot may impact liquidity for some securities, as explained above, the Commission believes that the impact of such an effect on the cost of capital for such securities would likely be minimal.847 With the exception of the impact on cost of capital, one commenter stated that the Pilot will require burdensome expenditures by public companies at the start and conclusion of the Pilot.848 The Commission recognizes that some national securities exchanges and broker-dealers are public companies that could incur the costs described in Sections IV.C.2.a and IV.C.2.b.ii at the start and conclusion of the Pilot. However, the commenter did not provide details on what expenditures other public companies will incur as a result of the Pilot. The Commission does not know what such expenditures would be or what they would entail; nevertheless, we do not believe that there will be any such expenditures. vi. Costs to Broker-Dealers of Reverse Engineering Identities in the Order Routing Data Some commenters expressed concern that proposed public dissemination of order routing information would enable competitors to gain proprietary information regarding trading strategies.849 The commenters suggested 844 See NYSE Letter I, at 3, 13–14; ASA Letter, at 3; e.g., Level Brands Letter, at 1; Johnson Letter, at 1; P&G Letter, at 1; Sensient Letter, at 1; Apache Letter, at 2; Ethan Allen Letter, at 1–2. 845 See NYSE Letter I, at 3 and section IV.D.3 for further discussion of NYSE’s cost of capital estimates. 846 See, e.g., Apache Letter, at 2; ACCO Letter, at 1; NorthWestern Letter, at 2; Weingarten Letter, at 1. 847 See section IV.D.3 848 See Nasdaq Letter I at 10. 849 See, e.g., FIA Letter, at 3; Virtu Letter, at 7– 8; SIFMA Letter, at 6; FIF Letter, at 2; Citadel Letter, E:\FR\FM\20FER2.SGM Continued 20FER2 5280 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations that, for example, market participants could learn the identities of individual broker-dealers by sending a specific broker-dealer an order for a relatively thinly-traded security and then study the order routing reports to identify which broker-dealers transacted that security on a given day. The concern is that if market participants can identify the primary venues that certain brokerdealers tend to rout to, then they may be able to use this information along with live market data to identify specific trading algorithms of individual brokerdealers. This could increase transaction costs for broker-dealers if the market participants are able to use this data to identify when a certain algorithm is being used to execute a trade in live time and then to opportunistically trade around the algorithm to profit from any price impact created by the trades. As described above, the Commission has modified its proposal in response to these comments. Consequently, the Commission is not adopting the requirement that exchanges publicly post the order routing datasets and instead the Commission will receive the order routing data. This change significantly reduces the risks identified by the commenters about reverse engineering, and the Commission is sensitive to the need to protect the data from unauthorized disclosure. D. Impact on Efficiency, Competition, and Capital Formation The Commission has considered the effects of the Pilot on efficiency, competition, and capital formation.850 As discussed in further detail below, the Commission believes that many of the direct effects of this rule on efficiency, competition, and capital formation would likely be temporary in nature and affect markets only for the duration of the Pilot. The Commission believes that the information obtained as a result of the 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 Pilot. Further, the Pilot may have a number of temporary effects on price efficiency, the competitive dynamics between at 4; Citi Letter, at 6; TD Ameritrade Letter, at 5; STANY Letter, at 5; IEX Letter I, at 10; Credit Suisse Commentary, at 6; Morgan Stanley Letter, at 4. 850 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. See 15 U.S.C. 78c(f). VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 exchanges, exchanges and off-exchange trading venues, broker-dealers, and issuers, including ETPs. Although the Pilot may temporarily affect liquidity,851 the Commission does not believe that this will result in the Pilot having a significant effect on capital formation. One commenter believed that the Commission did not sufficiently address the impacts of the Pilot on efficiency, competition, and capital formation in the proposing release.852 Several other commenters stated that the Commission inadequately provided justification for the assertions in the proposing release that the effects on efficiency, competition, and capital formation would be temporary in nature and ‘‘would affect markets only for the duration of the [proposed] Pilot.’’ 853 The Commission addresses below commenters’ concerns about issues stemming from efficiency, competition, and capital formation. 1. Efficiency This section discusses the potential impact the Pilot could have on efficiency. The Commission believes that information learned from the Pilot could potentially improve future regulatory efficiency. Additionally, the Commission believes that the Pilot could have a number of temporary impacts on efficiency, including: The efficiency of capital allocation, price efficiency and price discovery, and the efficiency of fees and rebates. As discussed in detail above,854 the Commission believes that there is significant uncertainty regarding the effect, if any, that the Pilot will have on liquidity and trading volume on exchanges. Therefore, the Commission is unable to determine ex ante the overall effects the Pilot will have on the efficiency of capital allocation, price efficiency, or the efficiency of fees and rebates.855 However, the Commission believes that the Pilot will provide 851 See supra Section IV.C.2.b.iv. Nasdaq Letter I, at 3, 8. This commenter expressed concern that the Proposal did not considered the effects on issuers and ETPs. See id., at 8. This commenter also stated that ‘‘the Proposal is a blunt tool lacking nuance that will negatively affect efficiency, competition, and capital formation—none of which have been adequately addressed by the Commission.’’ See id. 853 See NYSE Letter I, at 15–16. See also, e.g., Level Brands Letter, at 1; Johnson Letter, at 1; Knight-Swift Letter, at 1. 854 See supra Sections IV.C.2.b.i and IV.C.2.b.iv. 855 One commenter stated that it did not ‘‘expect that a reduction or outright removal of rebates will have any significant or harmful effects on the quality of prices displayed in the public lit market, interfere with genuine liquidity and price formation, or negatively impact [its] stock’s trading volume, spread or displayed size.’’ See T. Rowe Price Letter, at 5. 852 See PO 00000 Frm 00080 Fmt 4701 Sfmt 4700 useful data that will better inform future policy recommendations of the effects of fees and rebates on price efficiency.856 The Pilot will provide the Commission with an opportunity to empirically examine the effects of an exogenous shock to transaction fees and rebates on order routing behavior, execution quality and market quality. Insofar as the data produced by the Pilot permits the Commission and the public to evaluate and comment upon the potential impacts of alternative policy options, the rule may promote regulatory efficiency.857 In the absence of the Pilot, the Commission would have to rely on currently available data to inform future policy decisions related to transaction-based fees and rebates and data limitations may impair the efficiency of policy decisions based on this information.858 The temporary efficiency impacts the Commission expects during the Pilot depend on how the Pilot fee and rebate restrictions for the two Test Groups balance the interests of different groups of market participants. For example, if during the Pilot, the lower fee cap and no-rebate restriction induced by the 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,859 the Pilot may temporarily improve the efficiency of capital allocation by lowering execution costs.860 Alternatively, the 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.861 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 transaction 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 856 See supra Section IV.C.1.a.ii. supra Section IV.C.1.a.i for a discussion of the potential benefits from studying the Pilot data and supra Section IV.C.1.a.iii for a discussion of the potential limitations of studying the Pilot data. 858 See supra Section IV.B.1.b. 859 See supra Section IV.C.1.b. 860 See supra Section IV.C.2.b.iv. 861 See supra Section IV.C.2.b.iii. 857 See E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations increase the efficiency of capital allocation. For the duration of the Pilot, lower transaction fees could improve the liquidity of stocks and ETPs in some Test Groups by reducing the costs to execute marketable orders.862 As marketable orders become less costly, these orders are likely to be routed to exchanges with lower transaction fees, improving execution quality and possibly creating a liquidity externality,863 whereby lower transaction fee venues will become the preferred trading center for marketable and non-marketable orders.864 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 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.865 Currently, most 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 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 for particular orders. As fees decline or rebates are removed in some 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 Pilot, and temporarily improving pricing efficiency and price discovery.866 Therefore, as an additional benefit of the Pilot, the Pilot will allow an examination of the temporary effect of revisions to transaction fees and rebates on quoted spreads, to better inform 862 See supra Section IV.C.1.b. 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 Section IV.C.2.b.iv. 864 See infra Section IV.D.2.b. 865 See supra Section IV.C.1.b. 866 Some commenters argued that transaction fees and rebates harm price transparency because the prices displayed by exchanges do not include fee or rebate information and therefore do not fully reflect net trade prices. See ICI Letter I, at 2; Goldman Sachs Letter, at 3; Invesco Letter, at 2; State Street Letter, at 2; Wellington Letter, at 1; Oppenheimer Letter, at 2; Capital Group Letter, at 3; Citi Letter, at 2. A number of academic studies also made this argument. See, e.g., Angel, Harris, & Spatt, supra note 530, and Harris, id. future policy recommendations of the effects of exchange transaction-based fees and rebates on price efficiency.867 On the other hand, if the reduction in rebates and Linked Pricing harms liquidity,868 or causes more informed order flow to be routed to off-exchange trading venues,869 then the Pilot may temporarily impair price efficiency and the price discovery process.870 A reduction in rebates could cause informed traders to route more of their non-marketable orders to off-exchange trading venues, which could reduce price discovery, because these orders would no longer be included in displayed quotes or limit order book depth. If liquidity temporarily worsens, then it may lead to a temporary widening of the NBBO, which could lead to a decline in the overall informational efficiency of prices. If liquidity worsens, it could also cause informed traders to route more of their marketable orders off-exchange, which could harm price discovery by reducing the ability of market participants to discern the direction of their order flow. However, if spreads widen or queues shorten, it could attract informed nonmarketable orders onto exchanges, which could improve price discovery, because exchange quotes would be more informative. Because the Commission cannot ex ante predict the effects of the Pilot on liquidity and competition between exchanges and off-exchange trading venues for order flow,871 the Commission is unable to determine the overall effects of the Pilot on price efficiency and the price discovery process. Changes in liquidity could also impact the price efficiency of ETPs. A change in liquidly for either the ETP itself or the underlying securities could impact the create-redeem process for ETPs. This process is an important element in ETP price efficiency and helps to keep the price of the ETP in line with the value of its underlying securities. If there is a mispricing, authorized participants can trade on the mispricing by either purchasing the 863 As VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 867 See supra Section IV.C.1.a.ii. supra Section IV.C.2.b.iv. 869 See infra Section IV.D.2.a. 870 Some commenters argued that rebates improved price discovery by promoting displayed liquidity on exchanges and narrowing the NBBO. See, e.g., State Street Letter, at 2; Virtu Letter, at 3; Magma Letter, at 3; Schwab Letter, at 1; Fidelity Letter, at 3; Cboe Letter I, at 15–16. One commenter argues that the removal of rebates could harm price discovery by causing more market participants to route their orders to off-exchange venues, instead of lit exchanges, where they would be included in the price discovery process. See Nasdaq Letter I, at 2, 4. 871 See supra Section IV.C.2.b.iv and infra Section IV.D.2.a. 868 See PO 00000 Frm 00081 Fmt 4701 Sfmt 4700 5281 underlying shares to create a share of the ETP, or by redeeming a share of the ETP and selling the assets underlying the ETP. These actions affect the existing supply of ETP shares and help to eliminate mispricing. Consequently, if the Pilot impacts liquidity in either the underlying assets, or the ETP itself, it will impact the cost to authorized participants of eliminating mispricing by participating in the create-redeem process. Since the Commission does not ex ante know how the Pilot will impact liquidity,872 it cannot quantify the effects of the Pilot on ETP price efficiency. If the Pilot results in improved liquidity for the stocks in the various Test Groups, or for the ETP itself, then its impact on the createredeem process may be positive and ETP price efficiency may increase as its value may more closely track the value of their underlying assets through a lower cost create-redeem process. The opposite is true if the Pilot negatively affects liquidity in either the ETPs or the underlying securities. Finally, the Commission acknowledges that the fee caps and prohibition on rebates or Linked Pricing imposed on the Test Groups during the 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 less efficient from the exchanges’ perspective. The rule 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.873 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 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 and rebates that may be more efficient. Several commenters asserted that fee and rebate restrictions proposed by the Commission would be government imposed price-controls that would increase inefficiencies and harm consumers.874 One of these commenters elaborated that ‘‘Government-imposed price controls are well understood to have a negative impact on competition and innovation’’ and that ‘‘they are only 872 See supra Section IV.C.2.b.iv. supra Section IV.C.2.b.i. 874 See Nasdaq Letter I, at 2, 5; Cboe Letter I, at 873 See 7. E:\FR\FM\20FER2.SGM 20FER2 5282 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations indicated where they overcome severe market imperfection such as monopoly ownership of a critical resource.’’ 875 As discussed in detail above,876 the Commission believes that the current fee and rebate system may have resulted in a number of market failures, including rebates incentivizing brokers to route orders to trading venues that pay the highest rebates, instead of the venues that offer better execution. However, the Commission currently lacks the data to estimate the extent of any existing market failures.877 While the Commission acknowledges that the Pilot’s restrictions on rebates and fees could potentially harm efficiency, if these market failures currently do exist, then the fee and rebate restrictions in Test Group stocks could temporarily improve efficiency for the duration of the Pilot. Additionally, the information the Commission learns from the Pilot could be used by the Commission in future rulemakings to inform future policy decisions.878 2. Competition This section discusses the potential effects of the Pilot on competition. The Commission believes that the Pilot could have a temporary effect on the competitive dynamics between exchanges, exchanges and off-exchange trading venues, broker-dealers, and issuers, particularly ETPs. Additionally, as discussed in detail below,879 the Pilot could potentially have competitive effects for smaller exchanges that last beyond the Pilot. This could occur if the Pilot attenuates the potentially distortive impact of transaction-based fees and rebates and causes brokerdealers to route orders to trading centers they perceive as more liquid. This could have a lasting effect on the order flow and revenue of smaller exchanges if it produces a liquidity externality that persists beyond the Pilot.880 However, the Commission believes that this is unlikely to occur, because the Pilot would be for a limited duration and the effects are unlikely to be significant enough to cause this result.881 Because the Commission is unable to determine ex ante the Pilot’s effects on liquidity,882 the Commission is unable 875 See Nasdaq Letter I, at 11–12. 876 See supra Section IV.A. 877 See supra Section IV.B.1. and Section IV.C.1.a.iii. 878 See supra Section IV.C.1.a. 879 See infra Section IV.D.2.b (Competition Between Exchanges). 880 See Proposing Release, supra note 2, at 13042, for a discussion of a liquidity externality. 881 See infra Section IV.D.2.b (Competition Between Exchanges). 882 See supra Section IV.C.2.b.iv. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 to quantify many of the effects of the Pilot on competition. In the sections below the Commission offers a qualitative discussion of the effects of the Pilot on competitive. a. Competition Between Exchanges and Off-Exchange Trading Venues This section discusses the potential effects of the Pilot on competition between exchanges and off-exchange trading venues, including ATSs, which, as discussed in the baseline,883 execute approximately 14% of trading volume. Although the Pilot could temporarily affect the competition for order flow between exchanges and off-exchange trading venues, the Commission believes that the overall effects of the Pilot on this competition are unclear, because, as discussed in detail below, there are reasons why the Pilot may temporarily increase as well as decrease the order flow routed to off-exchange trading venues. A number of commenters argued that restricting exchange rebates and fees for stocks in the test Groups without placing similar restrictions on offexchange venues could place exchanges at a competitive disadvantage.884 Although the Commission acknowledges that the Pilot may potentially place exchanges at a competitive disadvantage relative to offexchange trading venues, the Commission believes that the overall effects of the Pilot on this competition would depend on how on-exchange liquidity is affected by the Pilot as well as the renegotiation costs that offexchange trading venues would incur in order to take advantage of the restrictions on exchange fees and rebates. For example, as discussed in detail above,885 ATSs sometimes negotiate bespoke agreements with individual subscribers for a bundle of services. If the costs of renegotiating these agreements are high, then offexchange trading venues may not be able to adjust their pricing models to take advantage of the exchange pricing restrictions, in which case competition between exchanges and off-exchange venues could be unaffected.886 supra Section IV.B.2.a. expressed concern that the Pilot would inhibit exchanges’ ability to compete with off-exchange trading centers, in part due to a reduced ability to innovate on changes to fees and rebates. See, e.g., Cboe Letter I, at 7, 16–17; Nasdaq Letter I, at 6; NYSE Letter I, at 1–2, 4–5; Magma Letter, at 2; FIA Letter, at 3–4; ASA Letter, at 3; P&G Letter, at 1; ACCO Letter, at 1; Johnson Letter, at 1. 885 See supra note 47 and accompanying text. 886 It might be difficult for an ATS to renegotiate these agreements with all of their clients in order to take advantage of the exchange price restrictions Additionally, as discussed below, if offexchange renegotiation costs are high, some of the restrictions on transaction fees could give certain exchanges a competitive advantage relative to offexchange venues in attracting certain types of order flow. However, if offexchange renegotiation costs are small or the Pilot fee and rebate restrictions place certain exchanges at a disadvantage relative to the current pricing policies of some off-exchange trading venues, then the Pilot could affect competition between exchanges and off-exchange trading venues. Although the Commission acknowledges that the distribution of trading volume could change between exchanges and off-exchange trading venues, the Commission believes these changes are difficult to determine in advance and cannot predict ex ante whether these changes would increase or decrease exchange market share.887 As discussed above,888 the Commission lacks data on the current pricing schedules offered by off-exchange venues as well as information on how this affects the routing decisions of broker-dealers. The Commission also lacks information on how difficult it is for off-exchange trading venues to adjust their pricing schedules. Additionally, as discussed above,889 the Pilot’s effects on liquidity could be either positive or negative and vary across securities. Therefore, the Commission is unable to quantify or determine the overall effects that the Pilot will have on competition between exchanges and off-exchange trading venues. However, if competitive rebalancing among trading centers occurs as a result of the Pilot, it could provide information to the Commission about order routing decisions and execution quality to inform future policy actions. Commenter statements regarding the effects of the Pilot on competition between exchanges and off-exchange trading venues indicated that the Pilot could have different effects on the competition for marketable and nonmarketable order flow. In considering the comments, and as analyzed in the following sections, the Commission considered the differential impact 883 See 884 Commenters PO 00000 Frm 00082 Fmt 4701 Sfmt 4700 on a subset of securities (i.e., stocks in the Test Groups). 887 One commenter agreed and stated the Pilot could cause a shift in the balance of activity between exchanges and off-exchange trading centers, but that the direction of such a shift cannot be presupposed. See Decimus Letter, at 5. This commenter also noted that transaction-based fees are one of the drivers behind the current shift by market participants to off-exchange trading centers. Id. at 5–6. 888 See supra Section IV.B.1.b.vii. 889 See supra Section IV.C.2.b.iv. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations changes in exchange fees and rebates could have on the competition between exchanges and off-exchange trading venues for marketable and nonmarketable order flow. As the discussion above indicates, and as commenters point out, it is not clear how the Pilot will affect the competition for both marketable and non-marketable order flow.890 Additionally, since the impacts of the Pilot on liquidity may not be uniform across all securities,891 the effects of the Pilot on competition for marketable and non-marketable order flow may not be uniform across all securities. Therefore, as discussed above, the Commission is unable to quantitatively estimate how the Pilot could affect competition between exchanges and off-exchange trading venues to attract different types of order flow. In the sections below the Commission offers a qualitative discussion regarding how various effects of the Pilot could affect this competition. i. Marketable Order Flow The Pilot could increase or decrease the share of marketable order flow routed to off-exchange trading venues. This is reflected in the divergent views of commenters, who argue over the effects that reduced access fees and rebates could have on the share of marketable order flow routed to offexchange trading venues. In considering these comments, the Commission considered a number of ways the Pilot could potentially impact competition for marketable order flow, including: The impact of changes in liquidity, the direct impact of changes in access fees and rebates, the impact of changes in off-exchange fill rates, and the impact of the Order Protection Rule. Changes in liquidity caused by the Pilot could affect how much marketable order flow is directed to off-exchange trading venues. However, because the overall effects of the Pilot on liquidity could be positive or negative and vary across securities,892 the overall effects of changes in liquidity on the direction of marketable order flow are also unclear. Therefore, the Commission is unable to predict the overall effect that changes in liquidity caused by the Pilot will have on the competition for marketable order flow between exchanges and offexchange trading venues. A number of commenters argued that if the Pilot temporarily decreases liquidity in the test Groups due to the 890 See Decimus Letter, at 5–6. supra Section IV.C.2.b.iv. 892 See supra Section IV.C.2.b.iv. 891 See VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 elimination or reduction of rebates,893 more order flow will likely be directed to off-exchange trading venues.894 As the Commission previously discussed,895 the competition between on and off exchange venues for order flow is characterized as providing a tradeoff between immediacy and execution quality. Off exchange venues tend to get better trade execution on average than lit exchanges, largely because they trade between the prevailing NBBO, but at the cost of not being able to guarantee that a transaction will occur. Thus, the impact of the Pilot on the competition between exchanges and off exchange venues for marketable order flow will depend on how the Pilot impacts execution quality and the cost of immediacy on exchanges compared to the potential for price improvement and the chance of filling an order at an off-exchange venue. If a reduction in rebates causes quoted spreads to widen,896 it could increase the attractiveness of off-exchange price improvement and would likely cause more institutional or proprietary marketable order flow to be directed to off-exchange ATSs. Additionally, if spreads widen, broker-dealers would likely be incentivized to internalize more marketable institutional order flow. If spreads do not widen, a decrease in quoted depth could also result in more marketable orders being routed off-exchange. If quoted depth decreases,897 and if market participants believe that off-exchange venues offer improved execution, it could cause more large marketable orders to get routed to ATSs or be internalized, in order to avoid the increased costs of walking up the book. Alternatively, if liquidity improves, it could reduce the cost of immediacy and the benefits of off-exchange price improvement, which could result in more marketable order flow being routed to exchanges. Changes in exchange access fees and rebates for stocks in the test groups could also directly affect whether some types of marketable order flow are routed to exchanges or off-exchange trading venues. However, as discussed in detail above,898 the Commission currently faces limitations in 893 See id. e.g., Magma Letter, at 2; Home Depot Letter, at 1. 895 See Securities Exchange Act Release No. 76474 (Nov. 18, 2015), 80 FR 80998 (Dec. 28, 2015), 81116–81117. See also Securities Exchange Act Release Nos. 83663 (July 18, 2018), 83 FR 38768 (August 7, 2018), 38891–38892. 896 See supra Section IV.C.2.b.iv.2. 897 See id. 898 See supra Section IV.B.1.a and Section IV.B.1.b. 894 See, PO 00000 Frm 00083 Fmt 4701 Sfmt 4700 5283 determining the effects that exchange transaction fees and rebates have on order routing decisions. The Commission is unable to quantify how changes in exchange transaction fees and rebates for stocks in the test groups will affect the routing decisions for marketable order flow between exchanges and off-exchange trading venues. Therefore, the Commission is unable to determine in advance what effect changes in exchange transaction fees and rebates caused by the Pilot will have on the competition for marketable order flow. One of the goals of the Pilot is to provide the Commission with data so that it can better evaluate these effects. If renegotiation costs are too high for off-exchange trading venues to adjust their pricing schedules, lower transaction fees on maker-taker exchanges could cause some marketable order flow that would be routed to ATSs and other off-exchange trading centers to instead be routed to these exchanges. For example, if the equilibrium transaction fee in Test Group 2 is below $0.0030 in the absence of rebates, exchanges may be able to draw order flow away from off-exchange trading centers. Several commenters agreed that lower access fees could induce some market participants to bring order flow back to exchanges.899 One of these commenters stated that ‘‘the potential that substantially lower take fees in test group securities will counter any potential loss of rebate-driven volume.’’ 900 One commenter disagreed and noted that lowering fees would not attract marketable order flow to exchanges.901 This commenter noted 899 See, e.g., IEX Letter II, at 7, 8–9; TD Ameritrade Letter, at 7; Citi Letter, at 4; Decimus Letter, at 5–6. 900 See IEX Letter II, at 8. 901 See NYSE Letter II, at 12; NYSE Letter I, at 16. This commenter argued that market participants choose to send orders to off-exchange venues for reasons other than avoiding fees, such that simply lowering fees would not attract marketable order flow to exchanges. See NYSE Letter I, at 16. Another commenter noted that the Commission’s assertion that any potential degradation of the effective bid-ask spread due to lower or reduced rebates could be mitigated by lower access fees was ‘‘not supported by empirical data or substantive analysis.’’ See Nasdaq Letter I, at 8–9. In response to these comments, the Commission notes that its belief is support by some theoretical studies that show that it is the net fees, i.e., the rebates plus fees, that affect trading costs. See e.g. Colliard, J.E. & Foucault, T. (2012). ‘‘Trading fees and efficiency in limit order markets.’’ Review of Financial Studies, Vol. 25 (11), 3389–3421 (available at: https:// academic.oup.com/rfs/article/25/11/3389/ 1566107). Some empirical studies produce similar results. See, e.g. Malinova, K. & Park, A. (2015). ‘‘Subsidizing Liquidity: The Impact of Make/Take Fees on Market Quality.’’ Journal of Finance, Vol E:\FR\FM\20FER2.SGM Continued 20FER2 5284 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations that if high access fees drove market participants to route orders to offexchange trading centers, then lower cost venues, such as NYSE American or EDGA would have larger market share.902 Another commenter disagreed and argued that ‘‘the cost of accessing lit markets in the form of access fees on securities exchanges has been one of the key drivers behind the continuing proliferation of non-exchange trading venues.’’ 903 Given the disagreement among commenters, the Commission believes it is possible that lower transaction fees could potentially result in more marketable order flow being routed to exchanges. However, as discussed above, the Commission faces limitations in quantifying the effects that lower exchange transaction fees will have on marketable order flow and is unable to determine how likely this is to occur. One of the goals of the Pilot is to provide the Commission with data so that it can better evaluate these effects. To the extent that conflicts of interest affect order routing,904 lower rebates on taker-maker venues could potentially increase the off-exchange share of trading volume by causing brokerdealers to increase the internalization of smaller marketable orders, even if onexchange liquidity or execution quality does not change. Changes in the fill rates of orders at off-exchange trading venues could also affect how much marketable order flow is directed to off-exchange trading venues. However, there are reasons the 70(5), 509–36 (available at: https:// onlinelibrary.wiley.com/doi/10.1111/jofi.12230). According to this literature, the effects of a reduction in rebates could potentially be offset by lower transaction fees. The Commission also notes that some commenters acknowledged this could be a potential effect of lower access fees. See supra note 23. However, other academic literature shows that in the presence of a fixed tick size, changes in fees and rebates can still affect trading volume, even in the absence of a change in the total fee. See e.g. Foucault, T., Kadan, O., & Kandel, E. (2013). ‘‘Liquidity Cycles and Make/Take Fees in Electronic Markets.’’ Journal of Finance, Vol. 68(1), 299–341 (available at: https://onlinelibrary.wiley.com/doi/ 10.1111/j.1540-6261.2012.01801.x). According to this literature, a reduction in transaction fees may not fully offset the effects of an equal reduction in rebates. Given the mixed results from the academic literature and the disagreement among commenters, the Commission believes it is possible that lower transaction fees could potentially reduce some of the effects of an increase in effective bid-ask spreads caused by a reduction rebates, although the magnitude of this reduction is uncertain. The Commission believes that the Pilot would generate data and analysis that would help the Commission better understand the cumulative effects of changes in transactions fees and rebates on spreads and trading costs. See supra Section IV.C.1.a.i. 902 See NYSE Letter II, at 12. 903 See Decimus Letter, at 5–6. 904 See supra Section IV.A.1 (Market Failure at the Broker-Dealer Level). VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 Pilot could increase or decrease the fill rates of orders at off-exchange trading venues. Therefore, the effect these changes will have on the competition for marketable order flow is uncertain. As discussed below,905 there are reasons the Pilot could cause an increase or decrease in the nonmarketable order flow routed to offexchange trading venues. If there is an increase in the non-marketable order flow routed to off-exchange trading venues, then the fill rates of marketable orders routed to off-exchange trading venues would increase, which could cause more marketable order flow to be directed to off-exchange trading venues. Alternatively, a decrease in the nonmarketable order flow routed to offexchange trading venues would cause a decrease in the fill rate for marketable orders, which would cause less marketable order flow to be directed to off-exchange trading venues. One factor that could reduce the chance of marketable orders being routed away from exchanges is that exchanges have a protected quote. One commenter believed that any offexchange shifts are likely to be limited because these trading centers do not have a protected quote, and any shifts that would occur would still need to be consistent with best execution and not just redistribution to account for market participants’ cost considerations.906 However, given that 34% of all transaction volume occurs off-exchange at trading venues without a protected quote, it is unclear how much effect a protected quote will have on this competition.907 The Commission does not expect the Pilot will have a significant effect on the competition for retail marketable orders. Normally, these orders are internalized by off-exchange wholesale brokerdealers who pay retail broker-dealers for the order flow.908 Since the Pilot does not restrict these rebates, the Commission does not expect the Pilot to affect the routing of marketable retail order flow. ii. Nonmarketable Order Flow The Pilot could increase or decrease the share of non-marketable order flow routed to off-exchange trading venues. This is reflected in the divergent views 905 See infra Section IV.D.2.a.ii (Nonmarketable Order Flow). 906 See Healthy Markets Letter, at 10. Another commenter also emphasized that exchanges have the advantage of a protected quote and that they have an advantage in receiving orders that require immediate execution. See IEX Letter II, at 8. 907 See supra Section IV.B.2.a. 908 See Battalio Equity Market Study, supra note 530. PO 00000 Frm 00084 Fmt 4701 Sfmt 4700 of commenters, who argue over the effects that reduced rebates could have on the share of non-marketable order flow routed to off-exchange trading venues. In considering these comments, and as discussed below, the Commission considered factors that could affect the decision to supply liquidity on exchanges or at offexchange trading venues. Furthermore, in considering comments, the Commission also considered a number of ways the Pilot could potentially impact competition for non-marketable order flow, including: The impact of changes in rebates, the impact of changes in liquidity, and the impact of changes in off-exchange fill rates. The decision to submit a nonmarketable order on-exchange or route it to an off-exchange trading venue is a trade-off between the profits earned from providing liquidity on-exchange compared to the expected execution price and probability of having the order filled off-exchange. Higher exchange rebates, wider spreads, higher onexchange fill rates (shorter on-exchange queue lengths), and lower off-exchange fill rates would all increase the chance of a trader deciding to provide liquidity on-exchange compared to routing an order to an off-exchange venue.909 The impact of the Pilot on the competition between exchanges and off-exchange venues for non-marketable order flow will depend on how the Pilot affects these dimensions. The Commission believes that the overall effect on the competition between exchanges and off-exchange venues for non-marketable order flow from a reduction in rebates for stocks in the test groups is unclear, because a reduction in rebates could result in either an increase or decrease in liquidity.910 In theory, a reduction in exchange rebates without any changes in liquidity or fill rates would likely cause more non-marketable order flow to be routed to off-exchange trading venues. However, the Commission believes that this event is unlikely, because a reduction in exchange rebates and transaction fees could also affect liquidity. Since a reduction in exchange rebates and transaction fees could cause liquidity to increase or decrease,911 it could also cause the share of nonmarketable order flow routed to offexchange trading venues to increase or decrease. Several commenters voiced concerns that reduced rebates could cause liquidity to migrate from exchanges to 909 See supra Section IV.B.2.b. supra Section IV.C.2.b.iv. 911 See id. 910 See E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations non-exchange trading centers, because exchanges will be restricted from providing rebates as incentives for liquidity provision, whereas nonexchange trading centers could freely offer rebates and other incentives to draw orders away from exchanges.912 In contrast, several commenters disagreed and noted that ATSs generally do not pay rebates and tend to charge lower fees than the large exchanges,913 and that such a pricing model would make it challenging for ATSs to start providing rebates sufficiently large enough to draw volume from exchanges. If rebates incentivize liquidity provision by providing extra revenue to liquidity providers, a reduction in rebates for stocks in the Test Groups could incentivize them to divert some of their non-marketable liquidity providing orders from maker-taker exchanges to off-exchange trading venues.914 However, this decision could also be affected by how the rebate reductions impacted other dimensions of liquidity, so the overall effect is difficult to determine. As discussed above, changes in liquidity could also affect the decision regarding where to route nonmarketable limit orders. Since the effects of the Pilot on liquidity could be either positive or negative, The Commission is uncertain how these changes will affect the competition for non-marketable order flow between exchanges and off-exchange trading venues. If on-exchange liquidity worsens and bid-ask spreads widen or 912 See, e.g., Cboe Letter I, at 7–8; Themis Trading Letter I, at 1; MFS Investment Letter, at 2; Wellington Management Letter, at 1; FIA Letter, at 3–4; ASA Letter, at 3; Era Letter, at 2; Knight-Swift Letter, at 2. One of the commenters suggested the Commission should evaluate how disparate treatment of liquidity provision between exchanges and non-exchange trading centers could affect market participants’ incentives to compete for displayed liquidity. See Mastercard Letter, at 2. Another of the commenters also noted that the competitive balance between exchanges and offexchange trading centers is uneven due to differences in regulatory oversight, including filings of fee changes; the ability to assess different fees to different customers; and the ability to offer subpenny price improvements. See Cboe Letter I, at 8. 913 See IEX Letter II, at 8. One commenter disagreed and noted that although ‘‘few ATSs currently use maker-taker fee structures, but they have done so in the past and would be incentivized to do so in the future’’ and that ‘‘restricting fee structures on exchanges only would encourage those off-exchange venues to expand their use of order-routing incentives to gain a competitive advantage.’’ See NYSE Letter I, at 4–5 914 It could also result in market makers reducing their overall submission of non-marketable orders to supply liquidity, if it is the case that rebates encourage market makers to engage in excessive intermediation. This in turn could result in a reduction in trading volume. See supra note 823 and accompanying text. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 quoted depth decreases,915 then institutional traders could direct more of their non-marketable orders to supply liquidity on maker-taker exchanges, either because realized spreads increased or because the queue position and fill rates of their on-exchange nonmarketable orders increased.916 Alternatively, if liquidity improves and either bid-ask spreads tighten or quoted depth increases,917 institutional traders could direct more their non-marketable orders to off-exchanges venues, because the profits earned from providing liquidity decreased. Change in the rate that orders are filled off-exchange could also cause changes in the routing of nonmarketable orders between exchanges and off-exchange trading venues. However, as discussed below, the effect of the Pilot on the fill rate of offexchange non-marketable orders is unclear. Therefore it is difficult to determine the Pilot’s effect on the routing of non-marketable orders. Changes in the rates at which nonmarketable orders are filled offexchange depend on how the routing of marketable order flow to off-exchange trading venues changes. If a reduction in fees causes more marketable orders to be routed to exchanges 918 it could reduce the fill rate of off-exchange orders, which could cause institutions or proprietary traders to substitute some of their off-exchange orders with nonmarketable orders to supply liquidity on maker-taker exchanges. Alternatively, if the Pilot causes more marketable orders to be routed to off-exchange trading venues,919 it could increase offexchange fill rates, which could cause more orders that would have supplied liquidity on exchange to be routed to off-exchange venues. However, as discussed above, the Commission is unclear whether the share of marketable order flow routed to off-exchange trading venues will increase or decrease. The Commission does not expect the Pilot will have a significant effect on the competition between exchanges and offexchange trading venues for retail nonmarketable orders. Often, these orders are routed by retail broker-dealers to maker-taker exchanges or to wholesale broker-dealers who pay retail brokerdealers for the order flow. The Commission believes that, despite the reduction in rebates, these orders will 915 See supra Section IV.C.2.b.iv. could incentivize institutional or proprietary traders to substitute their marketable orders with nonmarketable limit orders on maker-taker exchanges. 917 See supra Section IV.C.2.b.iv. 918 See supra Section IV.D.2.a.i. 919 See id. 916 It PO 00000 Frm 00085 Fmt 4701 Sfmt 4700 5285 still be routed to exchanges or to wholesale broker-dealers who pay them for their order flow.920 b. Competition Between Exchanges This section discusses the potential effects of the Pilot on competition between exchanges that use transactionbased fee and rebate pricing models. Although the Pilot could temporarily affect the competition for order flow between exchanges, the Commission believes that many of the effects of the Pilot on this competition, including the expected redistribution of market share among the existing exchanges, are unclear and difficult to determine in advance. This is reflected in the divergent views of commenters, who disagree about the effects that reduced rebates and transaction fees could have on competition between different types of exchanges. 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 rule on competition depends on the extent to which the fee cap and prohibition on rebates or Linked Pricing restrict exchanges’ transaction-based fee strategies. As discussed in detail above,921 the Commission believes that the Pilot, while changing either transaction fees or rebates on certain subsets of securities, could leave the margins that exchanges obtain from transaction-based pricing models unchanged. On the one hand, this could preserve the current state of competition among exchanges in the market for those securities. For instance, it may be possible for exchanges to modify fee structures in a way that leaves margins unchanged and does not impact competition between exchanges.922 On the other hand, the restrictions on fees and rebates could also alter the competitive dynamics between different exchanges. For example, the restrictions on fees and rebates could make 920 As discussed in detail below, the Commission believes retail non-marketable orders for securities in Test Group 1 will still be routed to maker-taker exchanges. The restrictions on rebates in Test Group 2 may cause some of these orders to be routed to taker-maker venues, if they result in better execution quality. See infra Section IV.D.2.b. 921 See supra Section IV.C.2.b.i. 922 One commenter agreed with this view and suggested that even though the fee cap for the Proposed Test Group 1 was half of the current level, ‘‘there was still significant enough differentiation available in the fee structure that trading may not appear materially different than the control group.’’ See Credit Suisse Commentary, at 3. However, another commenter argued that the fee cap in Proposed Test Group 1 would reduce the exchange’s ability to compete on fees by 50%. See Cboe Letter I, at 16. E:\FR\FM\20FER2.SGM 20FER2 5286 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations exchanges more similar in Test Group stocks.923 This could alter competition between exchanges by causing market participants to focus less on differences in fees and rebates and more on other metrics, such as execution quality when deciding to which exchanges to route order flow. As discussed in detail above,924 the Commission cannot ex ante predict whether the Pilot will increase or decrease trading volume on certain exchanges. Consequently, the Commission acknowledges significant uncertainty with respect to the effect of the Pilot on exchange competition. One commenter suggested that ‘‘inverted venues would likely increase market share as maker rebates disappear and the fee differential between venues declines for market makers, lowering the relative cost for queue priority.’’ 925 The Commission acknowledges that it is possible that a reduction in rebates in Test Group stocks could make makertaker exchanges less competitive for non-marketable orders and cause liquidity provision to migrate to inverted venues. However, if a reduction in rebates reduces excessive intermediation,926 causes market makers to shift their liquidity provision offexchange,927 or worsens liquidity,928 then institutional or proprietary traders’ non-marketable orders could get better queue position and have higher fill rates on maker-taker venues, which could attract non-marketable order flow from taker-maker venues, where maker participants pay fees for better queue positions and fill rates. If the Pilot causes changes in liquidity between exchanges in Test Group stocks,929 it could affect the decision where to route marketable order flow. If an exchange experiences an improvement/decline in liquidity it may also experience an increase/decline in marketable order flow, especially since lower differences in fees/rebates between exchanges could reduce brokerdealer conflicts of interest and make them rely more on execution quality when deciding where to route marketable orders.930 Additionally, it is also possible that lower transaction fees on maker-taker venues could make these venues more competitive and better able to attract marketable order flow in Test Group stocks from inverted venues. 923 See supra Section IV.C.2.b.i. id. 925 See Credit Suisse Commentary, at 4. 926 See supra note 823 and accompanying text. 927 See supra Section IV.D.2.a. 928 See supra Section IV.C.2.b.iv. 929 See id. 930 See supra Section IV.C.1.b. 924 See VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 The Pilot could also alter competition between exchanges by causing exchanges to choose to compete less intensively for order flow in one Test Group, and instead focus on stocks and ETPs in the other Test Group. Some of the shortfall in the competition for order flow for this subset of securities could be filled by off-exchange trading centers.931 Alternatively, exchanges may revise pricing strategies for stocks in other groups, choosing to implicitly subsidize rebates for stocks in Test Group 1 using fees from Control Group stocks.932 This may increase competition for order flow in one Test Group while reducing it in the other. In the presence of tighter restrictions on transaction-based fees during the Pilot Period, exchanges could also compete in other ways to attract trading volume (e.g., discounts on connectivity fees or increased volume discounts), although the Commission believes that for Test Group 1 the ability to offer meaningful volume discounts would be limited in light of the $0.0010 fee cap in that group.933 The Pilot also could affect competition between large and small exchanges. The restrictions on rebates resulting from the Pilot could harm smaller exchanges that may be competing by paying large rebates rather than by producing better prices or execution quality.934 As discussed in the Proposal,935 liquidity tends to consolidate. Therefore, if smaller exchanges are unable to pay larger rebates in test stocks, they may lose order flow to larger, more liquid exchanges. To the extent that increased order flow in a security directed to a particular venue encourages brokerdealers 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.936 Although these effects would likely last only for the duration of the Pilot, depending on the extent of the liquidity externalities, smaller exchanges could experience long-lasting competitive effects, such as a reduction in trading volume that continues after 931 See supra Section IV.D.2.a. e.g., Healthy Markets Letter I, at 27 (noting that exchanges use fees collected to pay rebates). 933 For NMS stocks included in Test Group 2 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. 934 See supra Section IV.B.2.a. 935 See the discussion of a liquidity externality in the Proposing Release, supra note 2, at 13042. 936 See id. 932 See, PO 00000 Frm 00086 Fmt 4701 Sfmt 4700 the expiration of the Pilot.937 The Pilot also could temporarily discourage entry of new exchanges that might otherwise emerge to take advantage of the makertaker and taker-maker pricing models.938 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.939 In theory, this could lead to consolidation or exit by small exchanges as a result of the Pilot.940 However, the Commission believes that either of those events is unlikely because the anticipated revenue shortfall, as discussed above,941 would be for a limited duration and would not be significant enough to cause this result. The Commission recognizes that the potential temporary competitive impacts stemming from the 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 the prohibition on rebates and Linked Pricing applicable to Test Group 2 would apply to a higher proportion of its trading volume. However, the Commission believes that, given its aim of producing representative groups of stocks and ETPs for the purposes of the Pilot, trading centers are not likely to be substantially more exposed to NMS stocks in any one group. 937 One commenter suggested that the effects of the Pilot may be permanent. See NYSE Letter I, at 4, 8. 938 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 & Spatt, supra note 530. However, some commenters suggested that the loss of fee differentiation would lead to an increase in venues as exchanges try to make up for lost revenue through other means. See, e.g., Fidelity Letter, at 8; Cboe Letter I, at 16–17. 939 One commenter said that restricting transaction fees would disproportionally hurt small exchanges because ‘‘large exchanges have diversified revenues away from transaction fees.’’ See Magma Letter, at 2. 940 One commenter believed that the loss in fee differentiation could lead to consolidation and fewer venues overall. See Credit Suisse Commentary, at 5. 941 See supra Section IV.C.2.b.i (Loss of Exchanges’ Fee Revenue). E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations c. Competition Between Broker-Dealers The Pilot also could affect competition between broker-dealers. One commenter believed that, due to differences in broker-dealer business models, any reduction in rebate incentives or other forms of payment for order flow will increase transaction costs, and that large broker-dealers would be better able to adapt to increased trading costs and rebate reductions than small or middle-market broker-dealers.942 The commenter believed that the Pilot would disproportionately advantage large broker-dealers who specialize in low touch execution or own ATSs because more customers and order flow would migrate to the largest brokers, and that the ‘‘Commission should and is required to undertake a rigorous cost-benefit analysis to justify any policy that favors one group of Brokers over another.’’ 943 The Commission believes that the Pilot could differentially affect small and large broker-dealers, but differences in the potential compliance costs they face make it unclear whether the Pilot will disproportionately advantage large broker-dealers over small or middlemarket broker-dealers. Although larger broker-dealers may possess economies of scale which may enable them adapt better to changes in fees and rebates, they are also more likely to be members of exchanges and subject to the compliance costs of adjusting their systems due to changes in exchange fee and rebate schedules discussed above.944 As of December 2017, of the approximately 3,860 broker-dealers registered with the Commission, only 397 are listed as having memberships with at least one exchange and would encompass the set of executing brokerdealers that would be most affected by the Pilot. Therefore, it is likely that many small or middle-market brokerdealers will not have to bear the compliance costs discussed above.945 Additionally, since larger brokerdealers are more likely to be subject to these compliance costs, they may need to increase their commission rates more than smaller broker-dealers to compensate for these increased costs. This could potentially offset any advantage that larger broker-dealers may possess in being able to absorb any revenue loss caused by a reduction in payment for order flow, such as by being able to offer smaller increases in commissions compared to smaller 942 See ASA Letter, at 2. at 2–3. 944 See supra Section V.C.2.b.ii (Broker-Dealer Systems Costs). 945 See id. 943 Id. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 broker-dealers. However, the Commission cannot quantify this difference, because it lacks sufficient data on the differences in commission rates between large and small brokerdealers.946 d. Competition Between Issuers A number of commenters noted that the Commission, in the Proposing Release, did not discuss the competitive effects to issuers (common stocks) from inclusion in various Test Groups of the Pilot.947 While the Pilot could potentially affect product market competition between issuers that compete in the same product market by affecting their ability to raise capital,948 the Commission does not believe that this is likely to occur. Since the Commission does not believe that the Pilot will have a significant effect on the ability of issuers to raise capital,949 the Commission does not believe the Pilot will have a significant effect on product market competition between issuers. Some commenters argued that the Pilot could inadvertently pick ‘‘winners and losers’’ through the selection of securities to Test Groups.950 One commenter believed that issuers in certain Test Groups could become ‘‘less attractive investments than control group issuers’’ 951 while another thought this could ‘‘skew the competitive dynamic between issuers and impact the ability of the affected issuers to raise capital.’’ 952 They argue that among securities with similar characteristics, securities that can offer higher rebates will attract more liquidity and trading volume at the expense of securities with lower rebates. Several commenters argued that issuers included in the test groups with reduced access fees or rebates would experience wider spreads, which would put them at a 946 See supra note 805. e.g., Anixter Letter, at 1; STANY Letter, at 2; NYSE Letter, at 2; Johnson Letter, at 1; Cott Letter, at 1; P&G Letter, at 1; Nasdaq Letter I, at 8– 9. One of these commenters ‘‘urge[d] the Commission to further analyze and study the potential impact of the Transaction Fee Pilot on issuers and their securities (as well as investors in those securities), including the impact on competition between issuers in the pilot test groups and those in the control group.’’ See Anixter Letter, at 1. Another commenter argued that the Commission was ‘‘treating all issuers the same without consideration for the very significant differences in how the securities of different sized and priced companies trade.’’ See Nasdaq Letter I, at 8. 948 See infra Section IV.D.3 (Capital Formation). 949 See id. 950 See Nasdaq Letter I, at 10; Invesco Letter, at 2 (discussing the competitive effects for ETPs). 951 See NorthWestern Letter, at 2. 952 See Ethan Allen Letter, at 1. See also McDermott Letter, at 1; ProAssurance Letter, at 1; Era Letter, at 2; Avangrid Letter, at 1–2. 947 See, PO 00000 Frm 00087 Fmt 4701 Sfmt 4700 5287 competitive disadvantage compared to peer firms in the control group by making it more expensive for them to engage in secondary offerings or conduct share repurchase programs.953 One commenter argued that this would disproportionately affect ‘‘small to medium issuers’’ where ‘‘[l]iquidity rebates can be critical . . . to motivate market makers to support the stock with aggressive and actionable quotations.’’ 954 Although some securities may experience changes in liquidity as a result of the Pilot,955 as discussed in detail below,956 the Commission does not believe that issuers, including small and midcapitalization issuers, will experience significant increases in the cost of capital as a result of the Pilot. However, if the Pilot does differentially affect the cost of firms in the same product market to raise capital, it could affect product market competition by making it more difficult for the firms that experienced an increase in capital costs to compete. While the Commission acknowledges that theoretical and empirical studies suggest that an increase in costs of capital can affect product market competition,957 the Commission does not believe the Pilot will have such an effect on product market competition between issuers. While the Commission acknowledges that some issuers may observe a widening of spreads and possible reductions in liquidity provision,958 as discussed below,959 the Commission does not believe that the Pilot will have a significant effect on capital formation for issuers.960 Therefore, the Commission does not believe the Pilot will have a significant effect on product market competition between issuers. Furthermore, the Pilot will allow the Commission to obtain data to be able to analyze the impact of 953 See NYSE Letter I, at 6–7; Apache Letter, at 2; Mastercard Letter, at 2; Era Letter, at 2. 954 See Nasdaq Letter I, at 8–9. 955 See supra Section IV.C.2.b.iv. 956 See infra Section IV.D.3 (Capital Formation). 957 See, e.g., Maksimovic, V. (1995). ‘‘Financial Structure and Product Market Competition.’’ Ch. 27 in Handbooks in Operations Research and Management Science, Vol. 9, 887–920 (available at: https://www.sciencedirect.com/science/article/abs/ pii/S0927050705800714) and Campello, M. (2006). ‘‘Debt Financing: Does It Boost or Hurt Firm Performance in Product Markets?’’ Journal of Financial Economics, 82(1), 135–172 (available at: https://www.sciencedirect.com/science/article/pii/ S0304405X05001777) (hereafter ‘‘Campello (2006)’’). 958 See supra Section IV.C.2.b.iv. 959 See infra Section IV.D.3 (Capital Formation). 960 One commenter agreed and argued that ‘‘there simply is no evidence that the Pilot will cause any imminent danger to any issuer’s stock price or liquidity.’’ See Better Markets Letter, at 3. E:\FR\FM\20FER2.SGM 20FER2 5288 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations changes to fees and rebates and how those changes affect a myriad of issues, including their impact on competition between issuers. e. Competition Between ETPs The Pilot may also impact the competitive dynamics between ETPs.961 Although some ETPs could potentially be harmed by the Pilot’s effect on this competition, there is uncertainty regarding the Pilot’s effect on the liquidity of ETPs and therefore on competition between ETPs.962 Unlike common stocks, whereby trading and investing in those securities is likely driven by firm-specific characteristics, ETPs with similar investment strategies may be more substitutable. For example, some ETPs may follow the same underlying index, and only differ in expense ratios, trading characteristics, and in some cases, tracking error. Although some of these characteristics may be meaningful distinctions for long-term investors, such as expense ratios, other characteristics, such as trading characteristics, including transaction costs, are likely to be meaningful to market participants that trade rather than invest in some ETPs.963 One concern is that changes in liquidity between similar ETPs in different Pilot groups could have an impact on competition by harming ETPs that experience a decline in liquidity.964 A decline in ETP liquidity could affect competition by causing trading volume (demand) to migrate from an ETP that experienced a decline in liquidity to a nearly identical ETP in another Pilot group that might have experienced an improvement in liquidity.965 For example, ETPs that are subject to higher rebates may benefit and attract more liquidity and trading volume at the 961 A number of commenters stated concerns that the Commission had not fully considered the competitive effects on ETPs resulting from the Pilot. See, e.g., NYSE Letter I, at 7; ICI Letter I, at 4; State Street Letter, at 3; STA Letter, at 4; Schwab Letter, at 3; STANY Letter, at 4; Clearpool Letter, at 7–8; Cboe Letter I, at 17–18; Nuveen Letter, at 1,3; BlackRock Letter, at 1–2; Fidelity Letter, at 9; SIFMA Letter, at 4–5; Credit Suisse Commentary, at 6; Healthy Markets Letter II, at 8; Oppenheimer Letter, at 3; ICI Letter II, at 5; Nasdaq Letter I, at 8. 962 See supra Section IV.C.2.b.iv.2. 963 For example, three ETFs that track the S&P 500 Index have expense ratios of 9 bps (SPY), 5 bps (IVV), and 4 bps (VOO). On a $10,000 holding over a year, this results in fees of $9, $5, and $4, respectively, whereas on a 100-share trade, a widening of spreads by one tick would result in a cost of $1. 964 See supra Section IV.C.2.b.iv. 965 A decline in an ETP’s liquidity could also cause demand to migrate to another type of investment vehicle, such as a mutual fund, that follows the same investment strategy. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 expense of similar ETPs in different Test Groups that are restricted to offering lower rebates.966 A decrease/increase in secondary market demand for an ETP could cause a decrease/increase in the total assets under management of the ETP’s sponsor by causing authorized participants to redeem/create creation units of ETP shares in order to take advantage of arbitrage opportunities in the secondary market.967 However, one commenter (itself an ETP sponsor) noted that the competitive effects for ETPs would likely be temporary and minimal, and would have little effect on investor behavior; therefore, the benefits of including ETPs in the Pilot outweigh the potential costs of competitive impacts for ETPs.968 One commenter stated that these competitive effects are likely to be more challenging for small or less liquid ETPs that rely on ‘‘market maker support and require those same firms to provide seed capital (e.g., capital investments).’’ 969 These commenters raised concerns that reductions or prohibitions on rebates in certain Test Groups could exacerbate the anticompetitive effects for the small, less liquid ETPs in these programs by causing degradation in liquidity provision for these ETPs.970 The Commission acknowledges that the Pilot could potentially alter the competitive dynamics between and demand for similar ETPs that are placed in different Test and Control groups. 966 One commenter noted that ETPs in test groups with significant rebate reductions or restrictions could be disadvantaged competitively to similar ETPs not subject to changes to rebates, and because of the nature of ETPs, may lose market share to their competitors. See Nasdaq Letter I, at 8. Many commenters agreed with this argument. See ICI Letter I, at 4; MFS Letter, at 1; Nuveen Letter, at 2; FIA Letter, at 4; SIFMA Letter, at 4–5; Issuer Network Letter I, at 3; Schwab Letter, at 3; Fidelity Letter, at 9; Invesco Letter, at 2; State Street Letter, at 3; Oppenheimer Letter, at 3; Clearpool Letter, at 7–8; Angel Letter I, at 2; STANY Letter, at 4; Healthy Markets Letter I, at 11; Cboe Letter I, at 17; NYSE Letter I, at 7; Morgan Stanley Letter, at 3–4; BlackRock Letter, at 1–2. One commenter believed that the Pilot could ‘‘unintentionally advantage ETFs in the lower fee group.’’ Credit Suisse Commentary, at 6. 967 See supra Section IV.B.2.d (Market for Assets Under Management). 968 See Vanguard Letter, at 2. Many commenters believed that ETPs should only be included in the Pilot if an alternative design was implemented for ETPs, such a placing similar ETPs in the same group or rotating ETPs between groups. See supra Section II.B.3.b and infra Section IV.E.5.h for a summary of these comments and discussions of the costs and benefits of alternative Pilot designs for ETPs. 969 See Nasdaq Letter I, at 8. 970 See id. One commenter noted that 477 ETPs trade less than 2,000 shares per day, while 234 trade between 2,000 and 5,000 shares per day. In aggregate, these ETPs have approximately $32 billion in AUM, and the Pilot could adversely impact liquidity provision to these names leading to unintended investor harm. See Virtu Letter, at 7. PO 00000 Frm 00088 Fmt 4701 Sfmt 4700 The Pilot could inadvertently create ‘‘winners and losers’’ among ETPs through both competitive shifts and the potential exit of liquidity providers, and for some ETPs if these costs are severe, could lead to exit by certain ETPs from the market. However, as discussed in detail above,971 since the Commission does not know ex ante how the Pilot will impact the liquidity of ETPs, it is unable to quantify the effects that the Pilot will have on competition between ETPs. One of the goals of the Pilot is to provide the Commission with data so that it can better evaluate these effects. In addition to affecting ETP competition through changes in ETP liquidity, the Pilot could also affect ETP competition through its effects on ETPs underlying securities. As discussed in detail above,972 if the Pilot impacts the liquidity of the underlying securities, it could impact the create-redeem process for ETPs. This could affect the price efficiency of the ETP by impacting the cost to authorized participants of eliminating mispricing by participating in the create-redeem process. For example, if the majority of an ETP’s underlying securities are placed in the same Test Group and experience a decline in liquidity, it could cause the deviation between the ETPs price and its NAV to increase, i.e., the price of the ETP could deviate more from the price of its underlying securities. This could cause demand for the ETP to decline and trading volume to migrate to a similar ETP with a lower deviation between its price and NAV, whose underlying securities might not have experienced a decrease in liquidity.973 However, because of the random nature of the assignment of securities to Pilot groups and the fact that similar ETPs may experience similar liquidity changes in their underlying securities, the Commission does not believe that this will have a significant impact on competition between ETPs. 3. Capital Formation The Commission does not expect the Pilot to have a substantial permanent impact on capital formation because the Pilot is limited in duration and because it is not expected to have a large impact on issuer cost of capital. However, many of the implementation costs associated with the Pilot would require exchanges to expend resources that they may have otherwise invested elsewhere or distributed to shareholders in order to 971 See supra Section IV.C.2.b.iv. id. 973 ETPs might not hold all of the securities in the index that they track. ETPs that track similar indexes may hold different underlying securities in their representative portfolios. 972 See E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations maintain the List of Pilot Securities and any changes to those lists, as well as the maintenance of the Exchange Transaction Fee Summary and the order routing data.974 As discussed above,975 the Commission is unable to determine ex ante the overall temporary impact of the Pilot on liquidity and total transaction costs, because the Pilot’s effects on liquidity could be positive or negative and vary across securities. As a result, it is unclear to what degree the Pilot will temporarily promote or harm capital formation. On one hand, the Pilot could temporarily reduce total transaction costs for many market participants by consolidating liquidity and improving execution quality.976 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.977 As a result, the 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 Pilot. On the other hand, the temporary reduction in rebates to certain Test Groups as a result of the implementation of the Pilot could widen quoted spreads, thereby potentially leading to worse execution prices and subsequently reducing liquidity for the duration of the Pilot.978 This would have similar indirect impacts on capital formation but in the opposite direction, by increasing the cost of hedging financial risks. Potentially, if the Pilot leads to a significant deterioration in liquidity for some listed issuers,979 longer term, it could affect capital formation for these securities by increasing the costs for them to raise capital.980 Further, the Pilot could lead to a delay by some 974 The costs associated with implementation and compliance with the Pilot are discussed in more detail above. See supra Section IV.C.2.a. 975 See supra Section IV.C.2.b.iv. 976 See id. 977 One commenter argues that ‘‘the current system increases transaction costs to the public and . . . increases the issuer capital costs.’’ See Larry Harris Letter, at 9. 978 See Chacko, G.C., Jurek, J.W., & Stafford, E. (2008). ‘‘The Price of Immediacy.’’ Journal of Finance, Vol. 63(3), 1253–1290 (available at: https://onlinelibrary.wiley.com/doi/epdf/10.1111/ j.1540-6261.2008.01357.x). 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. See also supra Section IV.C.2.b.iv. 979 See supra Section IV.C.2.b.iv. 980 See supra Section IV.C.2.b.v. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 issuers to raise additional capital during the Pilot’s duration.981 A number of commenters agreed with these assessments and expressed concern that random assignment to certain Test Groups could adversely affect issuers’ ability to raise capital or manage their capital structure, by increasing the cost of secondary offerings or the costs associated with share repurchase programs.982 Several commenters argued that these effects would be worse for small and medium sized companies.983 In theory, if the temporary impacts on liquidity acutely impact some firms, it could lead to the potential exit of these issuers from the capital markets, either through acquisition or delisting. These risks could be greater for smaller issuers, because they may not possess enough capital to ride out negative liquidity shocks. However, the Commission does not believe that this is likely to occur because smaller issuers tend to have high transaction costs relative to fee and rebates.984 Alternatively, a number of commenters disagreed and did not think the Pilot would have a significant impact on issuers’ ability to raise capital.985 The Commission agrees with these commenters. As discussed in detail below, due to the limited magnitude of the effects of the Pilot study, and the uncertain impacts on liquidity, the Commission does not expect the Pilot will have significant 981 Another commenter asserted that the Pilot could harm thinly traded stocks and the IPO market. See Nasdaq Letter III, at 9. With respect to thinly traded securities, the Commission notes that the Pilot will exclude NMS stocks that trade less than 30,000 shares per day. The Commission notes that the Pilot will exclude new publicly traded companies whose IPO occurs after the Pilot Securities are selected, and therefore the Pilot should not harm the market for new IPOs. See Section II.C.6. supra (discussing the exclusion of certain thinly traded securities); see also Section IV.C.2.b.v. supra (discussing the potential impact of the Pilot on issuers). 982 See e.g., Nasdaq Letter I, at 2; ASA Letter, at 3; ACCO Letter, at 1; NorthWestern Letter, at 2.; Unitil Letter, at 1–2; McDermott Letter, at 1; Weingarten Letter, at 1; ProAssurance Letter, at 1; SMP Letter, at 1; Halliburton Letter, at 1; Era Letter, at 2; Newpark Letter, at 1; Knight-Swift Letter, at 1; Avangrid Letter, at 1–2; NYSE Letter I, at 3, 6– 7, 13–14; e.g., Level Brands Letter, at 1; Johnson Letter, at 1; P&G Letter, at 1; Sensient Letter, at 1; Apache Letter, at 2; Ethan Allen Letter, at 1–2. See also the discussion in supra Section IV.C.2.b.v (Impact on Issuers). 983 See Nasdaq Letter I, at 2; ASA Letter, at 4. 984 While the Commission acknowledged this possibility in the Proposing Release, it did not suggest that such effects were likely. Rather, the Commission stated that it did not ‘‘expect the proposed Pilot to have a substantial permanent impact on capital formation . . . .’’ See Proposing Release, supra note 2, at 13068–69. 985 See IEX Letter II, at 3–4; Healthy Markets Letter II, at 2; ICI Letter II at 4–5; T. Rowe Price Letter, at 4–5. PO 00000 Frm 00089 Fmt 4701 Sfmt 4700 5289 effects on the ability of firms to raise capital. The 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 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. Such revisions to portfolio composition as a result of the 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.986 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. One commenter analyzed secondary offerings from its listed issuers during 2017 and found that lower liquidity was associated with a higher cost of capital.987 The Commission points out that the analysis performed by this study merely examines associations between spreads and capital costs and does not establish that wider quoted spreads cause higher costs of capital.988 To supplement this comment, Commission staff analyzed the same secondary offerings and found that after controlling for fundamental issuer characteristics, such as size, book-tomarket, and analyst coverage, the size of the quoted spread was not positively related to issuers’ costs of capital.989 986 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., Nielsen, N.C. (1976). ‘‘The Investment Decision of the Firm under Uncertainty and the Allocative Efficiency of Capital Markets.’’ Journal of Finance, Vol. 31(2), 587–602 (available at: https://onlinelibrary.wiley.com/doi/ abs/10.1111/j.1540-6261.1976.tb01908.x) If the 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. 987 See NYSE Letter I, at 3. 988 One commenter agreed that there is no evidence that ‘‘issuer costs of capital are caused by quoted spreads.’’ See IEX Letter II, at 4. 989 Depending on how exchanges measure discounts (a proxy measure for the cost of capital), whether from the bid price or the midpoint, there could be mechanical variation imposed simply by differences on how data vendors measure E:\FR\FM\20FER2.SGM Continued 20FER2 5290 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations The Commission notes that a temporary effect on transaction costs may not have the same impact on cost of capital as a permanent effect on liquidity and does not believe that any temporary increase in transaction costs resulting from the Pilot could be significant enough to affect issuers’ costs of capital. Indeed, the experience with the recent Tick Size Pilot provides an example of a temporary change in liquidity that did not affect cost of capital. While several studies found that the Tick Size Pilot increased transaction costs,990 the findings of a DERA white paper suggest that the market did not expect the Pilot to affect stock prices of companies in the Test Groups.991 Specifically, the paper finds that the announcement of the assignment of stocks to the Test Groups and the Control Group did not generate significant abnormal returns for stocks in the Test Groups, either in absolute terms or relative to stocks in the Control Group.992 Under the standard assumption that the market’s expectations about the effects of the Pilot were correct, this result indicates that the increase in quoted spreads and transaction costs during with the Pilot had no impact on stock prices. Thus, these findings cast doubt on the idea that temporary changes in transaction costs affected the cost of capital of small capitalization companies. In addition, because the Tick Size Pilot enacted a 500% increase in the tick size, that pilot could arguably have a bigger direct discounts. Staff analyses relied on SDC measures of discounts to approximate issuers’ costs of capital, and observed that using the same spread breakpoints, discounts were approximately 3.6% for issuers with spreads below 20 bps, and 7.6% for issuers with spreads above 20 bps, indicating differences in methodologies of how discounts are computed can affect magnitudes. Regardless of the difference in magnitudes of the discounts, lowspread issuers, on average, had lower discounts than high spread issuers, consistent with NYSE’s spread-discount relationship. See NYSE Letter I, at 3. 990 See e.g., Hu, E., Hughes, P., Ritter, J., Vegella, P., & Zhang, H. (2018). ‘‘The Tick Size Pilot Plan and Market Quality.’’ SEC White Paper (available at: https://www.sec.gov/dera/staff-papers/whitepapers/dera_wp_tick_size-market_quality). 991 See Pachare, S. & Rainer, I. (2018). ‘‘Does the Tick Size Affect Stock Prices? Evidence from the Tick Size Pilot Announcement of the Test Groups and the Control Group,’’ SEC White Paper (available at: https://www.sec.gov/dera/staffpapers/white-papers/dera_wp_does_the_tick_size_ affect_stock_prices). See also fn. 13 in Albuquerque, R.A., Song, S., & Yao, C. (2018). ‘‘The Price Effects of Liquidity Shocks: A Study of SEC’s Tick Size Experiment.’’ Working Paper (available at: https:// papers.ssrn.com/sol3/papers.cfm?abstract_ id=3081125), reporting on their finding that the stock prices did not react to the announcement of which stocks were in the pilot. 992 The results were similar when they limit the analysis to stocks with pre-Pilot quoted spreads smaller than $0.05. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 impact on transaction costs than the Transaction Fee Pilot, which would reduce rebates by 30% of a tick. One commenter disagreed and believed that the findings of the DERA white paper were flawed.993 This commenter argued that the DERA study ‘‘relies on a selective, narrow, and irrelevant data set’’ and that ‘‘focusing on a few days around the time when stocks were assigned to test groups within the Tick Pilot, and not a materially longer period of time during which the Tick Pilot’s quoting and trading restrictions were in effect, is a clear indication that DERA narrowly tailored its study to reach a specific and flawed conclusion.’’ 994 This commenter stated that it ‘‘does not believe that the White Paper supports any conclusion regarding the impact of the Tick Pilot on investors or the potential impact of the Transaction Fee Pilot on issuers.’’ 995 However, another commenter noted that ‘‘DERA’s event study is informative to a central criticism’’ raised by some commenters that ‘‘upon implementation of the [Pilot], spreads will widen in stocks chosen for the ‘low rebate’ or ‘no rebate’ buckets and that wider spreads will harm issuers of the impacted stocks.’’ 996 This commenter found the ‘‘lack of price impact . . . telling,’’ because ‘‘the price of . . . stock is the primary measure’’ of ‘‘potential harm to issuers . . . .’’ 997 This commenter explained that, ‘‘if liquidity diminishes, or expected returns of the stock decline, this would be reflected in the value of the stock—and no such statistically significant decline in value was found.’’ 998 The commenter believed that the short duration of DERA event study was appropriate because ‘‘markets rapidly incorporate new information’’ into stock prices.999 The Commission agrees with this commenter and believes that the DERA white paper used an appropriate methodology to study how the increase in quoted spreads and transaction costs from the Tick Size Pilot affected the stock prices and cost of capital of firms in the Test groups. The Commission believes that the DERA white paper did not rely on a ‘‘selective, narrow, and irrelevant data set’’ and instead picked the appropriate time period, the few days surrounding publication of the list of which stocks would be included in the test and control groups, to examine how the 993 See NYSE Letter V, at 1. id. at 2. 995 See id. at 3. 996 See Verret Letter II, at 1. 997 See id. at 2. 998 See id. 999 See id. at 3. 994 See PO 00000 Frm 00090 Fmt 4701 Sfmt 4700 market reacted to the information about which stocks would have their spreads widen as a result of the Tick Size Pilot. This approach is standard in the academic literature because information is quickly incorporated into stock prices at the time it is made public. The Commission believes that the DERA white paper is relevant to this Pilot because it examines how a firm’s cost of capital is affected by a temporary widening of the firm’s spreads, which is a potential effect of this Pilot.1000 As discussed above and noted by the commenter,1001 if a firm’s cost of capital increased as a result of the wider spreads caused by the Tick Size Pilot, we would expect that stock’s price to decline during the announcement of test and control groups. The Commission recognizes that another paper comes to the opposite conclusion regarding the impact of the Tick Size Pilot on costs of capital, but does not find the paper convincing. This paper compares the stock price reactions of stocks in the test and control groups around the time the Tick Size Pilot was implemented.1002 They find that stocks in the test groups that experienced a decrease in liquidity when the tick size widened also experienced a decrease in prices, relative to stocks in the control group, around the time the Tick Size Pilot was implemented.1003 However, it is unclear exactly what the return differences documented in the study are measuring. If investors expected that test group stocks would experience a temporary reduction in liquidity during the Tick Size Pilot and that this would make it more costly for those stocks to raise capital, then standard economic assumptions would expect to see a negative stock price reaction for test group stocks around the announcement of the Tick Size Pilot test and control group stocks, not during the time period following the Tick Size Pilot implementation. Given the results of the DERA study and the uncertainty surrounding the Albuquerque et al (2018) results, combined with the fact that the average trading cost increase, i.e. decrease in liquidity, during the Tick Size Pilot is greater than the expected potential effects on liquidity during the Transaction Fee Pilot, the Commission 1000 See supra Section IV.C.2.b.iv. Verret Letter II, at 2. 1002 See Albuquerque et al. (2018), supra note 991. 1003 The list of stocks assigned to the Tick Size Pilot test and control groups was announced on September 3, 2016. The rollout of the Tick Size Pilot was implemented on a staggered basis over October 2016. See Hu et al. (2018), supra note 990. 1001 See E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations believes that the costs of capital are unlikely to significantly increase for Test Group stocks due to a temporary decrease in liquidity during the Transaction Fee Pilot. Because the Tick Size Pilot was conducted on firms with small market capitalizations, this should also help alleviate concerns for small to mid-capitalization issuers about temporary decreases in liquidity increasing the costs related to raising capital. One commenter agreed that, although some issuers may have temporary widening of spreads over the Pilot duration, any changes to liquidity caused by the Pilot are unlikely to affect the costs to firms when raising capital.1004 Therefore, the Commission does not believe that issuers, including small and mid-capitalization issuers, will experience significant increases in the cost of capital as a result of the Pilot. E. Alternatives The Commission considered several alternatives to the Pilot, including: (1) Proceed to propose rule amendments without first conducting a Pilot; (2) expand the Pilot to include off-exchange venues, including ATSs; (3) include a trade-at provision; (4) conduct alternative pilots; and (5) adjust the design of the Pilot (e.g., including a number of alternatives proposed by commenters). 1. Propose Rulemaking Without Conducting a Pilot Several commenters suggested that the Commission should proceed with rulemaking rather than first conducting the Pilot. For example, as discussed elsewhere in this release,1005 as an alternative to conducting the Pilot, one commenter suggested that the Commission impose a ‘‘gradual reduction of the current fee cap across all stocks periodically.’’ 1006 Such an approach would address the concerns raised by a number of commenters, discussed above, about the potential impact on largely identical ETPs and listed issuers that are placed in different test groups, without the added cost and complexity of rotating stratified samples through the Pilot.1007 In addition, such an approach could provide data on successive reductions in the current fee cap, which could be useful to the Commission if it considers future policy making to reduce the Rule 610(c) fee cap. IEX Letter II, at 3–4. supra Section II.C.8(g) and (h) and Section IV.E.4. 1006 Morgan Stanley Letter, at 2. 1007 See supra note 104 and accompanying text. However, depending on the number of fee caps to be tested, this alternative would increase instability in the markets in terms of the fee regime that markets are subject to. This would occur because the cap would be reduced successively and linearly and each tranche would need to be in place for a sufficient amount of time in order to obtain statistical power. Further, without a control group, researchers would be unable able to conduct a differences-in-differences analysis as the data would be subject to the impact of events across time, which would frustrate the ability of researchers to compare groups to one another over time. The Commenter was open to having a control group not subject to the decline in fees, which would allow for identifying causality. However, even with the inclusion of a control group, this alternative would still increase the time in which markets are subject to instability in fees and rebates and the time needed to understand the impact of fees and rebates because at each different fee level the Commission would need to test that fee level for a sufficient time to gain statistical power. Further, including a control group in this alternative could potentially result in different treatment for largely identical ETPs, as in the adopted Pilot, but with an increase in the potential time needed for study. Alternatively, this commenter suggested that the Commission implement ‘‘dynamic, stock specific ticks with transaction fees capped at, for example, 10% of the tick size (e.g. $0.0010 per share if a penny tick; $0.0050 per share if a nickel tick.)’’ 1008 Another commenter suggested that, rather than pursuing the Pilot, the Commission should amend Rule 610(c) to reduce the access fee cap to $0.0010 and also conduct ‘‘an abbreviated study of the effects of eliminating rebates’’ similar to the ‘‘no-rebate’’ Test Group.1009 One commenter recommended that the Commission ‘‘ban maker-taker and inverted transaction fee pricing as well as all volume-based discounts that are not clearly and directly related to cost savings’’ 1010 while another suggested that the Commission enhance the duty of best execution in lieu of a pilot.1011 Several commenters opined on the potential benefits and reduced costs of these alternatives as compared to proceeding with the Pilot. For example, according to one commenter, a gradual 1004 See 1005 See VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 1008 Id. at 2–3. Sachs Letter, at 1–4. 1010 Larry Harris Letter, at 9. 1011 See Nasdaq Letter, at 1, 3. 1009 Goldman PO 00000 Frm 00091 Fmt 4701 Sfmt 4700 5291 ‘‘walk down’’ approach would be preferable to the Pilot because it would allow the Commission to ‘‘observe order routing behavior changes, while applying the same economics to all stocks uniformly’’ and would ‘‘eliminate concerns about issuers being subject to disparate treatment.’’ 1012 According to this commenter, it also would ‘‘eliminate[ ] concerns that the Pilot results will not reflect the actual outcome if such changes are applied more broadly to stocks outside of the Pilot.’’ 1013 Similarly, another commenter noted that it would be ‘‘more effective and less damaging to the equities market to strengthen and better articulate the broker-dealers’ Duty of Best Execution’’ than proceeding with the Pilot, which the commenter believed would impost ‘‘tremendous costs’’ to investors and potentially ‘‘upend[ ] the existing economics and framework around equity executions.’’ 1014 Further, one commenter noted that because ‘‘there is broad recognition’’ that the access fee cap should be reduced, there is no need to incur the costs associated with the Pilot and the Commission should simply reduce the fee cap to $0.0010 to ensure that displayed prices reflect the actual economic costs of an execution, while also allowing exchanges to continue to offer rebates to incentivize liquidity provision if they chose to do so, while also maintaining their net capture rates.1015 This commenter believed that lowering the fee cap to $0.0010 would provide ‘‘immediate benefits to the equities markets with respect to price transparency and addressing conflicts of interest’’ 1016 and would be ‘‘better calibrated with today’s market pricing.’’ 1017 Another commenter argued that ‘‘the effects of maker-taker and inverted transaction fee pricing on the markets are well understood’’ and therefore concluded that it was very unlikely that ‘‘we will learn anything of value about the economics of exchange transaction fee pricing’’ from the Pilot.1018 Consequently, this commenter believed that the Commission should mandate that the exchanges return to a traditional transaction fee pricing 1012 Morgan Stanley Letter, at 2. at 2. 1014 Cboe Letter I, at 12, 21–22. See also Nasdaq Letter I, at 2 (referring to the Pilot as a ‘‘risky experiment’’). 1015 Goldman Sachs Letter, at 1, 3. 1016 Id. at 1–3. 1017 Id. at 4. 1018 Larry Harris Letter, at 9–11. See also Goldman Sachs Letter, at 4 (stating there is ‘‘broad support in favor of lowering the Fee Cap today,’’ and the Pilot ‘‘will not yield a different conclusion.’’). 1013 Id. E:\FR\FM\20FER2.SGM 20FER2 5292 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations model, which the commenter believed would not result in much cost to market participants.1019 However, other commenters strongly supported the Pilot as a first step because it ‘‘should provide data to enable the Commission to determine the impact of transaction-based fees and rebates on order routing behavior, on execution quality and on market quality’’ and believed the data collected would ‘‘support appropriate reforms to U.S. equity market structure.’’ 1020 Among those who supported conducting the Pilot before considering rulemaking, one commenter noted the lack of information regarding the rebates paid by each exchange to each broker and stated that such lack of disclosures ‘‘reinforce the difficulty in assessing the impact of the structure of a[cc]ess fees on distorting best execution, conflict[s] of interest and competitiveness of exchange pricing.’’ 1021 Still another commenter opined that the Pilot ‘‘is a necessity’’ to provide a ‘‘quantitative approach to which stocks require liquidity support and how much a rebate should be to incent support.’’ 1022 The diversity of opinion and lack of consensus among the commenters regarding the impact of fees and rebates on market quality and order routing behavior support the view that further study in this area is warranted before permanently adopting any changes through rulemaking. As discussed above, there was sharp disagreement between commenters about the potential impacts of reductions in fees and rebates, yet there is little data available to evaluate these claims on a broad scale. As discussed above, the Commission believes that there is no need to delay proceeding with the Pilot in order to pursue other potential equity market structure initiatives. Equity market structure issues have been considered for a number of years and, as a result of several initiatives in this area, the Commission has developed the Pilot, which is focused on and is intended to gather empirical evidence on the impact of exchange transaction fees and rebates. Similarly, the Commission does not believe that it needs to complete the Pilot before proceeding to consider all other equity market structure initiatives. The Commission expects that it will continue to evaluate the need for other changes to equity market structure during the pending of the Pilot. 1019 Id. 1020 RBC Letter I, at 2. Letter, at 4. 1022 Babelfish Letter, at 3. 1021 Spatt VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 2. Expand Transaction Fee Pilot To Include Non-Exchange Trading Centers The Transaction Fee Pilot would not require ATSs or other non-exchange trading venues to comply with the limits to transaction fees or rebates imposed by the Pilot. Some commenters believed that non-exchange trading centers should be included in the Pilot and that the representativeness of the data obtained from the Pilot would be impaired by the exclusion of ATSs and other off-exchange trading centers.1023 For example, one commenter stated that the Pilot ‘‘would not gather any insight into the trading patterns at those centers’’ because the Commission would be unable to ‘‘follow order flow across all trading venues in the market, leaving it with an incomplete picture of the issue it seeks to study.’’ 1024 Another commenter believed that excluding nonexchange trading centers could skew the results of the Pilot, as broker-dealers could shift order flow away from exchanges in response to the Pilot, thereby limiting the Commission’s understanding of the overall impact of changes to transaction-based fees and rebates.1025 An alternative design that includes non-exchange trading centers like ATSs would be broader than the Pilot—not only because such a design would include more trading venues, but also because such a design would have to account for the fact that non-exchange trading centers like ATSs use other inducements, besides transaction-based fees and rebates, to incent order flow.1026 The inclusion of non-exchange trading centers could, therefore, supply information about a more complete set of order routing decisions, increase the representativeness of the results obtained, and provide a deeper understanding regarding the ways in which exogenous shocks to transaction1023 See Section II.A.4 for a summary of these comments. Some commenters believed that nonexchange trading centers should only be subject to the rebate prohibitions of the no-rebate Test Group. See, e.g., Capital Group Letter, at 3; AJO Letter, at 1; Nasdaq Letter III, at 9. 1024 NYSE Letter I, at 9. See also, e.g., Cboe Letter I, at 12, 19; Nasdaq Letter I, at 2, 5; ViableMkts Letter, at 1–2. 1025 Wellington Letter, at 2. See also, e.g., Oppenheimer Letter, at 3. One commenter also believed that the Pilot could affect the way that securities are traded off-exchange and confound the Commission’s ability to understand the baseline for remuneration occurring off-exchange or the impact that the Pilot has on that baseline. Nasdaq Letter I, at 7. The Commission does not believe that its ability to analyze the impact of changes to transaction-based fees and rebates will be unduly limited, due to information that is now available from Regulation ATS–N and Rule 606. 1026 See, e.g., Morgan Stanley Letter, at 3 n.5; BIDS Letter, at 1–2; AJO Letter, at 2. PO 00000 Frm 00092 Fmt 4701 Sfmt 4700 based fees and rebates (and other inducements) affect order routing decisions. For example, a pilot that included non-exchange trading centers, and regulated the inducements used by such centers, might impact payment for the internalization of retail order flow, which would allow researchers to evaluate how these inducements affect retail order routing. A pilot that addressed payment for order flow on non-exchange trading centers could, in turn, result in more retail order flow being routed to lit exchanges, which also could increase displayed liquidity and potentially improve price efficiency. However, the inclusion of nonexchange trading venues may be difficult to implement. First, nonexchange trading venues charge idiosyncratic and individuallynegotiated fees to market participants, and often bundle fees for ATS usage with other broker-dealer fees, such that it would be exceptionally difficult to create and then impose a uniform fee regime on such venues.1027 For example, it is unclear how an ATS that charges an ‘‘all in’’ flat fee for service and does not charge individually for executions would be able to comply with a transaction-based fee cap. To comply with the Pilot’s transactionbased pricing restrictions, non-exchange venues may be required to entirely restructure their customer relationships to move to a transaction-based pricing model for the duration of the Pilot, which would impose notable costs on those venues. Further, any alternative design would address other inducements provided by non-exchange trading centers aside from transactionbased fees and rebates, in order to produce a fully accurate analysis of the impact of fees and inducements on order routing behavior, market quality, and execution quality. Such a design would be much more complex that the current Proposal. Finally, an alternative design that included non-exchange trading centers also would impose costs on such venues that would be higher relative to the costs imposed on exchanges under the current design, because the Pilot would require nonexchange trading venues to track and report more detailed information than is currently required by the 1027 See, e.g., AJO Letter, at 2–3. It is possible that non-exchange trading venues might respond to the Pilot by choosing to change their existing fee structures to align with the maker-taker (or takermaker) pricing models employed by exchanges, which could lead to additional costs for such venues. See, e.g., Virtu Letter, at 6; SIFMA Letter, at 5; Clearpool Letter, at 4; Healthy Markets Letter I, at 9–10. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations Commission.1028 As discussed above, exchanges are required to file each fee change with the Commission on Form 19b–4 and to disclose the entirety of their schedule of fees on their website, while non-exchanges venues are not subject to those requirements. Thus, including non-exchange trading venues in an alternative version of the Pilot would likely increase the costs of the Pilot because it would require a dramatic shift in the disclosure regime for these trading centers. Although the Pilot excludes nonexchange trading centers, the Commission will still be able to obtain information regarding the proportion of trades executing on such platforms from several sources. First, several transaction datasets, including trade reporting facility (TRF) data and TAQ data, provide information on offexchange trades, including ATS trades. Further, FINRA produces periodic (weekly) data on the total shares of NMS securities executed on individual ATSs.1029 Thus, researchers would obtain information from the Pilot to identify whether exogenous shocks to transaction-based fees on exchanges have an effect on order routing decisions, including whether brokerdealers alter their routing of order to ATSs during the Pilot. 3. Trade-At Test Group The Commission considered an alternative in which the Transaction Fee Pilot would include a ‘‘trade-at’’ provision in conjunction with the changes to the fees and rebates currently in the Pilot. The trade-at alternative would require that orders be routed to a market with the best displayed price or are executed at a materially improved price. Some commenters supported including a trade-at subgroup to provide supplemental information to the Commission about how a combination of trade-at provisions coupled with revisions to transaction-based fees and rebates affect broker-dealer order routing decisions.1030 Some other commenters, however, asserted that 1028 Although Form ATS–N requires ATSs to provide public disclosures about the different types of fees they charge, along with the ranges of those fees and service bundling, these disclosures do not provide as much information as the fee disclosures that will be required by the Pilot. 1029 By 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. 1030 See, e.g., Adorney Letter, at 1; Birch Bay Letter, at 1; NYSE Letter II, at 5. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 including a trade-at requirement could compromise the results of the Pilot as it would introduce an additional variable to one or more treatment groups.1031 To address this concern, the Pilot could include separate test subgroups that also include a trade-at requirement, in addition to requirements regarding transaction fees and/or rebates. Such an approach would require including more stocks in the Pilot. If the amount of securities in each Test Group were too small, the Pilot results would not achieve statistical power. Accordingly, in order to provide information on the impacts of an exogenous shock to transaction fees and rebates while also providing additional information on the effects of a trade-at requirement, the Pilot either would need to increase the number of Pilot securities or add to its duration. The expected impact on liquidity of the inclusion of a trade-at test group is unclear. The recently concluded Tick Size Pilot included a trade-at test group. The Tick Size Pilot included a trade-at group because exchanges were concerned that, in the current market environment, a significantly larger tick size could induce order flow to go off exchange.1032 For the Transaction Fee Pilot, commenters were split on whether marketable order flow will be more or less likely to flow to off-exchange trading centers, with some believing that as access fees for some test groups decline, order flow could be drawn back to exchanges. However, in considering the Tick Size Pilot, it is important to note that it only considered the impacts of trade-at when the tick size was increased and only for smaller, less liquid stocks. The effects might not be the same with 1 cent tick size and more liquid stocks that are included in the Pilot. One commenter noted that in the trade-at test group for the Tick Size Pilot, the number of shares displayed at the NBBO increased and quote volatility was reduced in the trade-at test group 1031 See, e.g., See Citadel Letter, at 6; Fidelity Letter, at 10; Citigroup Letter, at 3; SIFMA Letter, at 4; TD Ameritrade Letter, at 7; Virtu Letter, at 5; ICI Letter I, at 2. 1032 See Tick Size Pilot Approval Order at 27538– 42. As discussed above in Section IV.D.2, a number of commenters have expressed similar concerns with respect to the Transaction Fee Pilot, whereby a reduction in rebates could widen spreads and lead to a migration of order flow to off-exchange trading centers. In the Tick Size Pilot, the trade-at provision applied when the tick size was increased and only smaller, less liquid stocks were included in that pilot. The Transaction Fee Pilot, on the other hand, also will include more liquid stocks and does not test the wider tick increments that were the subject of the Tick Size Pilot, so the effects of trade-at may or may not be the same between the two pilots. PO 00000 Frm 00093 Fmt 4701 Sfmt 4700 5293 relative to the other test groups.1033 Nevertheless, analysis of the Tick Size Pilot data does not reveal significant execution quality or market quality effects of a trade-at rule. Specifically, the data suggests there was no change in effective spreads or price efficiency due to the trade-at requirement.1034 Results from the Tick Size Pilot also suggest that trade-at impacts trade location. Specifically, off-exchange share of trading volume decreased and onexchange market share increased, particularly at inverted exchanges. However, volume for midpoint crossing off-exchange venues increased, but this could be the result of the midpoint exception to the Tick Size Pilot’s tradeat requirements.1035 This shift in trading volume may occur because a trade-at provision increases incentives to display prices because 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. These findings suggest that the inclusion of a trade-at test group may benefit exchanges, which may experience increased trading volumes, but be costly for off-exchange venues, which may lose trading volume. 4. Alternative Pilot One commenter suggested an alternative to the Pilot that would involve directly lowering the Rule 610(c) access fee cap to $0.0010 and establishing a moratorium on fee increases for existing market data, connectivity, and co-location services.1036 The commenter believed its alternative would allow a direct test of the ‘‘anachronistic’’ 610(c) fee cap level and make exchange fees more competitive with non-exchange venues.1037 In addition, similar to the other alternative discussed directly above, it would impose a lower cap on 1033 See Birch Bay Capital Letter, at 1. Other commenters that supported the inclusion of a tradeat test group. See, e.g., C&C Letter, at 1. But see Citadel Letter, at 6 (noting that there was no evidence of improvement in market quality in the trade-at test groups in the Tick Size Pilot). 1034 Id. at 990. See also Farley, Ryan and Eric Kelley and Walter Puckett, Dark Trading Volume and Market Quality: A Natural Experiment (April 3, 2018) available at https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=3088715. 1035 See Comerton-Forde, Carole and Gregoire, Vincent and Zhong, Zhuo, Inverted Fee Structures, Tick Size, and Market Quality (August 10, 2018), Journal of Financial Economics (JFE), Forthcoming, available at SSRN: https://ssrn.com/ abstract=2939012 or https://dx.doi.org/10.2139/ ssrn.2939012. 1036 See NYSE Letter III, at 3; see also Issuer Network Letter II, at 4. 1037 See id. E:\FR\FM\20FER2.SGM 20FER2 5294 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations all NMS stocks simultaneously and thereby address the potential competitive impact on largely identical ETPs and listed issuers. The commenter suggested this alternative would reduce the complexity of implementation and would avoid ‘‘introducing new classes of restrictions’’ including prohibition on payment of transaction-based rebates.1038 Further, in linking transaction fees to market data and connectivity fees, the commenter suggested that its alternative would address commenters’ desire ‘‘to reduce their cost to trade’’ without banning rebates for liquidity provision, which it argued could negatively impact displayed quotes.1039 However, the combined fee cap and moratorium would not feature a control group. While the commenter suggested the Commission could ‘‘use comparisons to the preceding period to evaluate its efficacy,’’ the absence of a control group could frustrate researchers’ ability to detect changes as the results could be influenced by shortterm external events. This alternative also does not directly test the absence of rebates. Further, the direct link between transaction fees and market data and connectivity fees is unclear in the context of the Pilot’s objectives. In particular, the potential distortions that can accompany fee-and-rebate pricing models are unique to exchange transaction fee-and-rebate pricing models and do not directly result from market data and connectivity services. It is therefore unclear how the moratorium on market data fees would impact the objective of the Pilot to study how rebates and fees affect order routing decisions and market quality. Finally, the commenter’s suggested moratorium would only apply to ‘‘existing’’ market data and connectivity and would therefore preserve current fee levels for those services and would seem to not restrict an exchange’s ability to offer new and improved market data, connectivity, and co-location services potentially at higher fee levels. While a moratorium on market data and connectivity fees during a transaction fee experiment could be beneficial to the extent it holds steady a separate variable that can have a marginal impact on order routing, those costs are fixed and therefore the impact, if any, would be slight. Further, to the extent that exchanges were free to introduce new 1038 See id. The commenter also suggested that avoiding this ‘‘new class of restrictions’’ would limit the ‘‘likelihood of court challenge’’ to the Pilot. Id. 1039 See id. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 products at different price points, the moratorium could be easily circumvented. Accordingly, with the exception of the moratorium on market data fees, the suggested alternative is substantively similar to the alternative discussed above to not conduct any pilot and instead proceed to immediately lower the 610(c) fee cap. 5. Adjustments to the Transaction Fee Pilot Structure The alternatives described above provide significant revisions to the approach or the representativeness of the Transaction Fee Pilot. This section complements and expands on the discussion in Section II.C., above, to discuss a number of alternatives and adjustments to the basic structure of the Pilot. These include an alternative time frame for the Pilot duration or the preand 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 Group 1. a. Length of the Core Pilot The core Pilot would last for two years with an automatic sunset at the end of the first year unless the Commission publishes a notice determining that the Pilot shall continue for up to one additional year.1040 Alternatively, the Pilot could feature an earlier or later Pilot sunset or a longer or shorter Pilot duration. As discussed above in Section II.D., a number of commenters discussed the proposed Pilot duration, with some believing the proposed duration would incentivize participation and disincentivize ‘‘waiting out’’ the Pilot, with others believing that a shorter duration would be sufficient to produce results and still others recommending that the Pilot run for a full two year period with no automatic sunset. Further, one commenter questioned the Commission’s statement that the market reacts quickly to pricing changes implemented by exchanges, but that some market participants might not change their behavior unless the Pilot was in place for at least a year.1041 As alternatives to the Pilot’s duration, the Commission considered an earlier Pilot sunset that would shorten the anticipated Pilot duration, reducing the time period during which potential negative (or positive) temporary effects resulting from the Pilot could occur. However, if the anticipated duration of 1040 See supra Section II.D. for a summary and discussion of the commenters discussing the Pilot’s proposed duration. 1041 See NYSE Letter I, at 16. PO 00000 Frm 00094 Fmt 4701 Sfmt 4700 the Pilot were too short, some brokerdealers could 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.1042 In other words, in response to the comment noted above, while many market participants may quickly adopt their order routing in response to fee and rebate changes, others may take longer to respond. A shorter anticipated duration also could reduce the usefulness of the information and the benefits provided by the 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.1043 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 Pilot requirements. However, all else being equal, increasing the duration beyond the automatic sunset at one year, or up to the maximum two years, is unlikely to provide any significant increases in the benefits identified above, unless some event occurs during the first year that impacts the Pilot study in a way that potentially could make the results unrepresentative, in which case an extension of the Pilot for additional time (up to two years) could increase the benefits. As discussed in Section IV.C.1.a.i, the Commission believes that the Pilot duration 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 Pilot or retain pre-Pilot order routing decisions for its duration. Further, a longer Pilot duration would increase the exposure of market participants to the uncertain outcomes of the pilot in terms of liquidity, trading volume, market 1042 See infra Section IV.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 Pilot had a short duration. 1043 To address commenter concerns about the size of the Pilot, the Commission performed a supplemental analysis that refined the power analysis included in the Proposing Release. Based on this refined power analysis, the Commission estimates that it would require a minimum Pilot duration of 12 months to achieve sufficient statistical power to detect whether an effect is actually present; therefore, any Pilot duration shorter than 12 months would have diminished ability to detect the effect of transaction-based fees and rebates on order routing decisions, execution quality, and market quality. See Section IV.C.1.a.ii.(1) and supra note 695 for further information on this supplemental analysis. E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations share, competition etc. that are discussed above. The Commission could alternatively adopt 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. 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 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 Pilot. b. Length of Pre- and Post-Pilot Periods The Pilot requires a six-month prePilot 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 Pilot restrictions as well as across stocks in different test groups. Alternatively, the Commission could adopt shorter prePilot and post-Pilot Periods, which a few commenters recommended.1044 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 reduced ability of the Pilot to produce representative results.1045 In particular, 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 1044 See IEX Letter I, at 4; FIA Letter, at 4. But cf. FIF Letter, at 9; Health Markets Letter I, at 19. 1045 The Commission staff estimates that with the given number of stocks in the Pilot, that the Pilot would need to produce approximately six months of pre and post Pilot data to detect changes unique to ETPs and stocks, 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 for stocks and a 10% change in quoted spreads for ETPs. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 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 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. c. Zero Access Fee Test Group As discussed above, a few commenters recommended that the Pilot include a zero access fee test group to further test the relationship between exchange fee models and order routing, which would effectively serve to temporarily remove a source of revenue for exchanges entirely from a subset of securities.1046 This approach could produce additional information, such as how order routing behavior and execution quality change in the absence of transaction-based fees (and likely rebates), that could be useful to the Commission to facilitate future policy decisions regarding the transactionbased pricing structures of exchanges. The inclusion of a zero access fee test group would eliminate the transactionbased fee model for a subset of securities, which could force exchanges to create entirely new revenue models for securities in this test group with uncertain outcomes for both exchanges and market participants. Doing so presents the risk that if coupled to the current Pilot, the inclusion of a zero access fee test group could contaminate the analysis of both the current test groups and the zero access fee test group. This could occur if exchanges determine that it is cheaper to subsidize trading in the zero access fee group with revenue earned from the control group and the other test groups. In this case the inclusion of the zero access fee test group would alter the behavior of the exchanges with regard to all their other securities, which would weaken the exogeneity of the shock imposed by the Pilot for all test groups. d. Alternative Test Groups As discussed above, the Pilot will have two test groups: (1) One that caps access fees at $0.0010 and (2) one that 1046 See, e.g., Healthy Markets Letter I, at 8; OMERS Letter, at 2. PO 00000 Frm 00095 Fmt 4701 Sfmt 4700 5295 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 instead have proposed only caps on access fees (i.e., fees for removing liquidity), similar to those in the EMSAC recommendation,1047 or could have increased the number of test groups to test more gradations in alternative fee caps. As a few commenters suggested, and as discussed above, the Commission also could have included a test group with a higher fee cap level than Rule 610(c) or no cap on fees at all.1048 Further, as discussed above, a few commenters suggested other alternatives, like basis point pricing or pricing based on the tick size. Many alternatives would have replaced the no-rebate test group with another access fee cap group. These options could provide information to help refine the analysis of the impact of access fees on various market outcomes. However, if the Pilot did not include a no-rebate test group and only studied exogenous shocks to access fees, it would produce more limited information about the role that rebates play in affecting market outcomes. As discussed in more detail above, the Commission believes that it is important to have a test group that specifically focuses on the removal of rebates and the corresponding impact on conflicts of interest, execution quality, and market quality. An alternative to increase the number of test groups to study the impact of the various levels of access fee on various market outcomes could produce additional refinement to the data currently in the Pilot. However, to produce more gradation in the caps to access fees, would increase the complexity of the Pilot, and potentially increase the implementation costs to account for the additional test groups. Increasing the number of test groups would also increase the number of stocks subject to the pilot thereby increasing the fraction of the market exposed to the uncertain outcomes of the Pilot. e. Non-Displayed Liquidity and Depth of Book Only Test Group 2, which eliminates rebates or Linked Pricing, would restrict 1047 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). 1048 See, e.g., Angel Letter II, at 2; Cboe Letter I, at 28 E:\FR\FM\20FER2.SGM 20FER2 5296 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations fees or rebates or Linked Pricing in nondisplayed liquidity and depth-of-book, though a small number of commenters suggested expanding those conditions to Test Group 1.1049 As discussed in Section II.C., under the Pilot, 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 depth of the book as well as for displayed and nondisplayed liquidity. If an exchange were to offer rebates for those types of orders, it would reduce the benefits of the norebate test group as it would inhibit the Commission’s ability to collect data on a treatment group in which rebates do not exist and thus cannot impact or potentially distort the markets and market participants. An alternative could have applied the transaction fee restrictions in Test Group 1 to both non-displayed liquidity and the depth-of-book. However, the Commission believes this is unnecessary. In particular, the Commission does not believe that exchanges would have the incentive to charge higher fees or pay higher rebates for executions against or of nondisplayed and depth of book compared to fees and rebates charged against or of top-of book depth in Test Group 1 securities. Unlike the problem associated with exchanges offering rebates (in the no-rebate test group) for these types of orders that could emerge if rebates or Linked Pricing were not prohibited across the entire depth of the limit order book, the Commission does not believe that under the Pilot incentives would emerge for exchanges to charge higher fees to access nondisplayed interest or depth-of-book quotes. Charging more for nondisplayed 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 and would be uncertain of their fees when they enter their orders. 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 1049 See Clearpool Letter, at 3–4; Healthy Markets Letter I, at 16. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 market, could ultimately cause them to lose order flow. f. Linked Pricing Test Group 2 will prohibit rebates and Linked Pricing. As discussed above, a few commenters suggested that the Commission also prohibit exchanges from offering other inducements, including discounts on non-transaction fees that are linked to trading volumes in the no-rebate Test Group.1050 While such an approach would have the added benefit of testing a greater absence of exchange-offered inducements, it would further increase costs and add to the complexity and scope of the Pilot. As currently designed, the no-rebate Test Group is intended to test the extent to which exchange rebates introduce potential distortions to execution quality and market quality and introduce conflicts of interest in order routing. Adding more variables to the Pilot will increase its complexity, size, and cost, while potentially reducing benefits by inhibiting the Commission’s stated focus on gathering data specifically on the impact of exchange transaction rebates. With more variables, it becomes difficult to isolate the impact of any particular change without dramatically expanding the size, scope, and complexity of the Pilot. Alternatively, the Commission could instead prohibit only rebates, without also prohibiting Linked Pricing, in Test Group 2. While such an approach would reduce costs and simplify the Pilot design, it could reduce the benefits of Test Group 2. Specifically, one of the aims of Test Group 2 is to examine the impact between take fees (rebates) and make rebates (fees) in current exchange fee-and-rebate pricing models. For example, as discussed above, fees may be set above their equilibrium price (within the current regulatory structure) in order to subsidize rebates. An alternative that prohibits rebates but not the ability of an exchange to crosssubsidize make rebates from take fees (or vice versa) would provide opportunities for exchanges to work around the rebate prohibition thus perpetuating the potential subsidization distortion. Consequently, such an alternative would reduce the benefits of Test Group 2 by reducing the effectiveness of the information received about NMS stocks in the no-rebate Test Group. Finally, the Commission could ban Linked Pricing for all market participants in Test Group 2, including market makers. This alternative would allow the Commission to study how 1050 See PO 00000 RBC Letter I, at 3; MFS Letter, at 2–3. Frm 00096 Fmt 4701 Sfmt 4700 markets react in the absence of both rebates and Linked Pricing incentives, whereas the adopted Rule does not allow this analysis. The Commission recognizes that banning Linked Pricing in Test Group 2 may yield different results than under the adopted Rule, which permits an exchange to adopt rules to provide non-rebate Linked Pricing to its registered market makers in consideration for the market maker meeting rules-based market quality metrics. However, the Commission is interested in specifically exploring the effect of eliminating rebates, but continuing to allow Linked Pricing for a narrow, targeted segment of the market, i.e., market makers with specific obligations designed to improve an exchange’s market quality without the various effects previously discussed that may be associated with rebates, in order to understand any effects of rebates on liquidity. In so much as this is an alternative that could be considered at the completion of the Pilot, the Commission seeks to test specifically for this scenario. g. Execution Quality Data The Pilot does not require the exchanges to produce publicly available information on order execution quality statistics. As an alternative, the Commission could require that the exchanges produce daily order execution quality statistics similar to that required in Appendix B.1 of the Tick Size Pilot Plan. Compared to the Pilot, this alternative could provide information on order-based measures of execution quality such as effective spreads, price improvement, and realized spreads for liquidity taking orders, in addition to the trade-based measures available from public data sources. As noted in the baseline, orderbased measures of execution quality from the incorporation of order size and the costs of latency. Exchanges currently have systems in place to produce daily order-based execution quality data, which would limit implementation costs. However, the Commission recognizes that exchanges incur ongoing costs to produce these data. Unlike for the Tick Size Pilot, the Commission does not believe that daily order-based execution quality statistics are as important for the Transaction Fee Pilot as it was for the Tick Size Pilot and that the benefits for the Transaction Fee Pilot could be marginal. In particular, the Commission believes that tradebased execution quality statistics will be sufficient to measure execution quality for liquidity taking orders and notes that the order routing data to be received by the Commission will contain data that E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations can facilitate the measurement of execution quality for liquidity providing orders. h. Excluding or Rotating Securities As discussed above in Section II.B., some commenters were concerned that the Pilot could introduce unintended adverse competitive effects for ETPs or corporate issuers that were placed in certain test groups if those test groups resulted in negative impacts on the trading characteristics of those securities. Accordingly, some commenters, discussed above, recommended either excluding ETPs from the Pilot, clustering ETPs following similar strategies into a single test group, or rotate ETPs through the various test groups and the control group.1051 Other commenters, discussed above, suggested allowing issuers to opt out of the Pilot.1052 The benefits of such an approach would be the avoidance of potential harm or disparate impact on a particular ETP or issuer vis-a`-vis its peers and primary competitors. As discussed more fully above, that potential for harm is uncertain at best and commenters held deeply conflicting views with some asserting that the Pilot could cause widespread harm while others argued that its impact will be mostly positive when considering the potential distortions that will be mitigated or alleviated in the absence of exchange rebates or lower fees. Although there is a potential for temporary competitive effects as a result of the Pilot, outright exclusion of ETPs or clustering like ETPs in the same test group would harm the representativeness of the data produced by the Pilot or the ability of the Pilot to facilitate causal analyses. Exclusion of ETPs, for example, could undermine the ability of the Commission to use the Pilot results to inform future policy making with respect to exchange fees, particularly if ETPs have the potential to respond differently to changes to fees and rebates than do other types of NMS stocks. Similarly, as discussed above, allowing issuers to opt out of the Pilot could undermine the representativeness of the Pilot’s treatment groups and potentially bias the Pilot’s results, depending on the number of issuers that opt out and whether some unobservable characteristic is correlated with both an issuer’s decision to opt out and market outcomes. In turn, the benefits of the Pilot would be reduced if researchers are less able to draw specific conclusions about the impact of the 1051 See 1052 See supra Section II.B. id. VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 Pilot as a result of issuers opting out of the Pilot. Another alternative solution would be to rotate all stocks and or ETPs through each of the test groups for a given amount of time such that all stocks and ETPs spend the same amount of time in each test group. This methodology would reduce potential costs by mitigating potential competitive effects of the Pilot on issuers by ensuring that all stocks and ETPs receive similar exposure to each test group. Rotation would also have the advantage of allowing many more changes from one test group to another, which would create additional independent observations about the effect of the Pilot on various outcomes, potentially increasing statistical power. The realization of the benefit of additional statistical power would depend on how broker-dealers react to the changes. If broker-dealers need to adjust after every change, the statistical power could be lower with rotation than without. To the extent that brokerdealers design their order routing algorithms to the test group, then the time needed for broker-dealers to adapt to a set of Pilot securities that changes every few months would be minimal. The broker-dealer would simply replace one list of securities in a given test group with another. In this case there would likely be a period at the beginning of the Pilot where brokerdealers experiment somewhat to optimize their algorithms in which the data on broker dealer behavior would be noisier, but after that initial adjustment, broker-dealers would not need to repeat their experimentation after every rotation. However, to the extent that broker-dealers’ order routing algorithms are bespoke to a given security, rotation could decrease the statistical power of the tests because each rotation would include a period of time during which broker-dealers adjust where the data is noisier and harder to extract a signal from. This alternative, however, is also likely to be more complex and have higher costs than the Pilot. The exchange compliance costs of rotation would be marginally greater than the compliance costs of the Pilot because it would involve additional compliance checks and complexity, but would likely be largely automated. The added complexity for exchanges could be more significant because complexity increases the risk of errors. To the extent that broker-dealers set up their systems to automate the rotation, they, too would have only marginally higher costs with rotation. However, to the extent that broker-dealers’ order routing algorithms PO 00000 Frm 00097 Fmt 4701 Sfmt 4700 5297 are bespoke to a given security, then rotation would be both more costly for broker-dealers who would have to reoptimize their algorithms every time a stock is included or excluded from a given test group. V. Regulatory Flexibility Analysis The Regulatory Flexibility Act (‘‘RFA’’) 1053 requires Federal agencies, in promulgating rules, to consider the impact of those rules on small entities. The Commission certified, pursuant to section 605(b) of the RFA,1054 that, if adopted, Rule 610T would not have a significant impact on a substantial number of small entities.1055 The Commission solicited comments regarding this certification and received 1 comment.1056 The commenter stated that ‘‘the Commission is obligated under the RFA to adequately address the Proposal’s costs to small-capitalization issuers covered under the statute.’’ 1057 The commenter cited Aeronautical Repair Station Ass’n v. FAA as support for its assertion that the RFA requires the Commission to take into account costs to small-capitalization issuers as they are ‘‘third-party entities incur[ing] downstream costs.’’ 1058 The Commission believes the commenter misconstrues the legal finding in the case to which it cited, as the case confirms the general premise that the RFA analysis shall focus on the impact of a rule on a substantial number of small entities that are ‘‘directly affected and therefore regulated by,’’ in other words subject to, such rule’s requirements.1059 For purposes of the Commission rulemaking in connection with the RFA, Rule 610T, by its terms, applies only to national securities exchanges registered with the Commission under Section 6 of the Exchange Act.1060 1053 5 U.S.C. 601 et seq. U.S.C. 605(b). 1055 The Pilot is discussed in detail in Sections I and II, above. We discuss the potential economic consequences, including the estimated compliance costs and burdens, of the Pilot in Section IV (Economic Analysis) and Section III (Paperwork Reduction Act) above. 1056 See NYSE Letter I, at 13–14. 1057 Id. at 14, n.50. 1058 See id. (citing 494 F.3d 161, 177 (D.C. Cir. 2007)). 1059 See Aeronautical Repair Station Ass’n v. FAA, 494 F.3d 161, 177 (D.C. Cir. 2007) (further stating that the RFA ‘‘requires that the agency conduct the relevant analysis or certify ‘no impact’ for those small businesses that are ‘subject to’ the regulation, that is, those to which the regulation ‘will apply.’ ’’). 1060 See supra Sections III (Paperwork Reduction Act) and IV (Economic Analysis) (discussing, among other things, the current market environment and compliance obligations for national securities exchanges). 1054 5 E:\FR\FM\20FER2.SGM 20FER2 5298 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations 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 17 CFR 242.601 (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.1061 None of the national securities exchanges registered under Section 6 of the Exchange Act that would be subject to the Pilot are ‘‘small entities’’ for purposes of the RFA. In particular, none of the equities exchanges are exempt from Rule 601 of Regulation NMS. Accordingly, the proposed rule will not apply to any ‘‘small entities.’’ Therefore, for the foregoing reasons, the Commission again certifies that Rule 610T will not have a significant economic impact on a substantial number of small entities for purposes of the RFA. VI. Statutory Authority and Text of the Rule Amendments 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 amends 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 amends 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 § 200.30–3 by adding (a)(84) to read as follows: ■ § 200.30–3 Delegation of authority to Director of Division of Trading and Markets. * * 1061 See * * * 17 CFR 240.0–10(e). VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 (a) * * * (84) To issue notices pursuant to 17 CFR 242.610T(b)(1)(i) and (c) (Rule 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 § 242.610T to read as follows: § 242. 610T Equity transaction fee pilot. (a) Pilot pricing restrictions. Notwithstanding § 242.610(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 shall 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 best offer of such market that exceed or accumulate to more than $0.0010 per share; (2) For Test Group 2, 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 (3) For the Control Group, impose, or permit to be imposed, any fee or fees in contravention of the limits specified in § 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. Further, the Commission may designate by notice the assignment of NMS stocks that are interlisted on a Canadian securities exchange to Test Group 2 or the Control Group. (ii) For purposes of this section, ‘‘Pilot Securities’’ means the NMS stocks designated by the Commission on the initial List of Pilot Securities pursuant to paragraph (b)(1)(i) of this section and any successors to such NMS stocks. At the time of selection by the PO 00000 Frm 00098 Fmt 4701 Sfmt 4700 Commission, an NMS stock must have a minimum share price of $2 to be included in the Pilot and must have an unlimited duration or a duration beyond the end of the post-Pilot Period. In addition, an NMS stock must have an average daily volume of 30,000 shares or more to be included in the Pilot. 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 Pilot. (iii) For purposes of this section, ‘‘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 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; and (8) Other; (E) Pilot Group: (1) Control Group; (2) Test Group 1; and (3) Test Group 2; (F) Stratum Code; and (G) 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 end of 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 E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations 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 paragraph (b)(2) of this section. (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 paragraphs (b)(2) and (3) of this section 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: (i) A six-month ‘‘pre-Pilot Period;’’ (ii) 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 one additional year; and (iii) A six-month ‘‘post-Pilot Period.’’ (2) 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 facilitates trading in NMS stocks shall prepare and transmit to the Commission a file, 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 in paragraphs (d)(1) and (2) of this section. For the pre-Pilot Period, order routing VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 datasets shall include each NMS stock. For the Pilot Period and post-Pilot Period, order routing datasets shall include each Pilot Security. Each national securities exchange shall treat the order routing datasets as regulatory information and shall not access or use that information for any commercial or non-regulatory purpose. (1) Dataset of daily volume statistics, with field names as the first record and a consistent naming convention that indicates the exchange and date of the file, that include the following specifications of liquidity-providing orders by security and separating orders by order designation (exchanges may exclude auction orders) and order capacity: (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) The broker-dealer’s CRD number and MPID. (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 PO 00000 Frm 00099 Fmt 4701 Sfmt 4700 5299 (H) ≥ 30 minutes of order receipt. (2) Dataset of daily volume statistics, with field names as the first record and a consistent naming convention that indicates the exchange and date of the file, that include the following specifications of liquidity-taking orders by security and separating orders by order designation (exchanges may exclude auction orders) and order capacity: (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) The broker-dealer’s CRD number and MPID. (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 facilitates trading in 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 equal to or 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 E:\FR\FM\20FER2.SGM 20FER2 5300 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations 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) Exchange Name; (2) Record Type Indicator: (i) Reported Fee is the Monthly Average; (ii) Reported Fee is the Median; and (iii) Reported Fee is the Spot Monthly; (3) Participant Type: (i) Registered Market Maker; and (ii) All Others; (4) Pilot Group: (i) Control Group; (ii) Test Group 1; and (iii) Test Group 2; (5) Applicability to Displayed and Non-Displayed Interest: (i) Displayed only; (ii) Non-displayed only; and (iii) Both displayed and nondisplayed; (6) Applicability to Top and Depth of Book Interest: (i) Top of book only; (ii) Depth of book only; and (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 and rebates; (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; and (B) Top Tier Fee/Rebate reflecting the amount assessed or rebated after any applicable discounts, tiers, caps, or other incentives are applied; and (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; and (B) Top Tier Fee/Rebate reflecting the amount assessed or rebated after any applicable discounts, tiers, caps, or other incentives are applied; VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 (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. By the Commission. Dated: December 19, 2018. Brent J. Fields, Secretary. Note: The following Appendix will not appear in the Code of Federal Regulations. Appendix A Key to Comment Letters Cited in Proposed Transaction Fee Pilot for NMS Stocks (File No. S7–05–18): 1. E-mail from David Adorney, C & C Trading LLC, to Commission, dated March 15, 2018 (‘‘Adorney Email’’). 2. Letter from Peter L. Swan, Professor of Finance, School of Banking and Finance, UNSW Sydney Business School, to Brent J. Fields, Secretary, Commission, dated March 26, 2018 (‘‘Swan Letter’’). 3. Letter from O. Mason Hawkins, CFA, Chairman & CEO, et al., Southeastern Asset Management, Inc., et al., to Brent J. Fields, Secretary, Commission, dated April 6, 2018 (‘‘Joint Asset Managers Letter’’). 4. Letter from Adam D. Clark-Joseph, University of Illinois at UrbanaChampaign, to Brent J. Fields, Secretary, Commission, dated April 9, 2018 (‘‘Clark-Joseph Letter’’). 5. Letter from Brent Woods, Chief Executive Officer, and Joseph Scafidi, Director of Trading, Brandes Investment Partners, to Brent J. Fields, Secretary, Commission, dated April 10, 2018 (‘‘Brandes Letter’’). 6. Letter from Sal Arnuk and Joe Saluzzi, Partners, Co-Founders and Co-Heads of Equity Trading, Themis Trading LLC, to Brent J. Fields, Secretary, Commission, dated April 27, 2018 (‘‘Themis Trading Letter I’’). 7. Presentation from the Institutional Equity Division, Morgan Stanley, to the Division of Trading and Markets, Commission, dated May 1, 2018 (‘‘Morgan Stanley Presentation’’). 8. E-mail from Tim Quast, President, Modern Networks IR LLC, to Brett Redfearn, Director, Division of Trading and Markets, Commission, PO 00000 Frm 00100 Fmt 4701 Sfmt 4700 dated May 2, 2018 (‘‘ModernIR Email’’). 9. Letter from Sean D. Paylor, Trader, AJO, L.P., to Brent J. Fields, Secretary, Commission, dated May 7, 2018 (‘‘AJO Letter’’). 10. Letter from Tim Quast, President & Founder, Modern Networks IR LLC, to Brent J. Fields, Secretary, Commission, dated May 9, 2018 (‘‘ModernIR Letter’’). 11. Letter from Jeffrey P. Mahoney, General Counsel, Council of Institutional Investors, to Brent J. Fields, Secretary, Commission, dated May 10, 2018 (‘‘CII Letter’’). 12. Letter from Kelvin To, Founder& President, Data Boiler Technologies, LLC, to Brent J. Fields, Secretary, Commission, dated May 14, 2018 (‘‘Data Boiler Letter’’). 13. Letter from Chris Barnard to Commission, dated May 14, 2018 (‘‘Barnard Letter’’). 14. Letter from David Mechner, Chief Executive Officer, Pragma Securities, to Brent J. Fields, Secretary, Commission, dated May 14, 2018 (‘‘Pragma Letter’’). 15. Letter from Stuart J. Kaswell, Executive Vice President & Managing Director, General Counsel, Managed Funds Association, to Brent J. Fields, Secretary, Commission, dated May 15, 2018 (‘‘MFA Letter’’). 16. Letter from Timothy J. Mahoney, Chief Executive Officer, BIDS Trading L.P., to Brent J. Fields, Secretary, Commission, dated May 15, 2018 (‘‘BIDS Letter’’). 17. Letter from Brent Robertson, Managing Director, Trading, and Rob Gouley, Principal, Trading, Ontario Municipal Employees Retirement System Administration Corporation, to Brent J. Fields, Secretary, Commission, dated May 15, 2018 (‘‘OMERS Letter’’). 18. Letter from Marc Lipson, Robert F. Vandell Research Professor, Professor of Business Administration, University of Virginia School, Darden School of Business, to Commission, dated May 15, 2018 (‘‘Lipson Letter’’). 19. Letter from Anthony W. Godonis, Principal, Director of Trading, Copeland Capital Management, LLC, to Brent J. Fields, Secretary, Commission, dated May 18, 2018 (‘‘Copeland Letter’’). 20. Letter from George Hessler, CEO, Magma Trading, to Brent J. Fields, Secretary, Commission, dated May 18, 2018 (‘‘Magma Letter’’). 21. Letter from Eric Swanson, CEO, XTX Markets LLC, to Brent J. Fields, E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations Secretary, Commission, dated May 22, 2018 (‘‘XTX Letter’’). 22. Letter from Douglas A. Cifu, Chief Executive Officer, Virtu Financial Inc., to Brent J. Fields, Secretary, Commission, dated May 23, 2018 (‘‘Virtu Letter’’). 23. Letter from Susan M. Olson, General Counsel, Investment Company Institute, to Brent J. Fields, Secretary, Commission, dated May 23, 2018 (‘‘ICI Letter I’’). 24. Letter from Mary E. Keefe, Managing Director, Regulatory Affairs, Nuveen, LLC, to Brent J. Fields, Secretary, Commission, dated May 23, 2018 (‘‘Nuveen Letter’’). 25. Letter from Thomas K. Lee, Executive Director & CIO, et al., New York State Teachers’ Retirement System, to Brent J. Fields, Secretary, Commission, dated May 23, 2018 (‘‘NYSTRS Letter’’). 26. Letter from Hubert De Jesus, Global Head of Market Structure and Electronic Trading, and Joanne Medero, U.S. Head of Global Public Policy, BlackRock, Inc., to Brent J. Fields, Secretary, Commission, dated May 23, 2018 (‘‘BlackRock Letter’’). 27. Letter from Frank L. Jobert, Jr., Executive Director, Louisiana Trustee Education Council, to Brent J. Fields, Secretary, Commission, dated May 23, 2018 (‘‘LATEC Letter’’). 28. Letter from Joanna Mallers, Secretary, FIA Principal Traders Group, to Brent J. Fields, Secretary, Commission, dated May 24, 2018 (‘‘FIA Letter’’). 29. Letter from Theodore R. Lazo, Managing Director & Associate General Counsel, Securities Industry and Financial Markets Association, to Brent J. Fields, Secretary, Commission, dated May 24, 2018 (‘‘SIFMA Letter’’). 30. Letter from Patrick J. Healy, Founder & CEO, Issuer Network, to Brent J. Fields, Secretary, Commission, dated May 24, 2018 (‘‘Issuer Network Letter I’’). 31. Letter from Linda M. Giordano, CoFounder & CEO, and Jeffrey M. Alexander, Co-Founder & President, Babelfish Analytics, Inc., to Brent J. Fields, Secretary, Commission, dated May 24, 2018 (‘‘Babelfish Letter’’). 32. Letter from Dennis M. Kelleher, President & CEO, et al., Better Markets, Inc., to Brent J. Fields, Secretary, Commission, dated May 24, 2018 (‘‘Better Markets Letter’’). 33. Letter from Rich Steiner, Electronic Trading Strategist, RBC Capital VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 Markets, to Brent Fields, Secretary, Commission, dated May 24, 2018 (‘‘RBC Letter I’’). 34. Letter from William H. Hebert, Managing Director, Financial Information Forum, to Brent J. Fields, Secretary, Commission, dated May 24, 2018 (‘‘FIF Letter’’). 35. Letter from Paul M. Russo, Managing Director, Goldman Sachs & Co. LLC, to Brent J. Fields, Secretary, Commission, dated May 24, 2018 (‘‘Goldman Sachs Letter’’). 36. Letter from Tyler Gellasch, Executive Director, Healthy Markets Association, to Brent J. Fields, Secretary, Commission, dated May 24, 2018 (‘‘Healthy Markets Letter I’’). 37. Letter from Jason Clague, Executive Vice President, Operational Services, Charles Schwab & Co., Inc., to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘Schwab Letter’’). 38. Letter from Joseph Brennan, Principal & Global Head of Equity Investment Group, Vanguard, to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘Vanguard Letter’’). 39. Letter from Marc R. Bryant, Deputy General Counsel, Fidelity Investments, to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘Fidelity Letter’’). 40. Letter from Stephen John Berger, Managing Director, Government & Regulatory Policy, Citadel Securities, to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘Citadel Letter’’). 41. Letter from Kevin Cronin, Global Head of Trading, Invesco Ltd., to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘Invesco Letter’’). 42. Letter from Micah Hauptman, Financial Services Counsel, Consumer Federation of America, to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘CFA Letter’’). 43. Letter from Heidi W. Hardin, General Counsel, MFS Investment Management, to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘MFS Letter’’). 44. Letter from Timothy J. Coyne, Global Head of ETF Capital Markets, and Nathaniel N. Evarts, Head of Trading, Americas, State Street Global Advisors, to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘State Street Letter’’). 45. Letter from Dennis Simmons, Executive Director, Committee on Investment of Employee Benefit Access, to Brent J. Fields, Secretary, PO 00000 Frm 00101 Fmt 4701 Sfmt 4700 5301 Commission, dated May 25, 2018 (‘‘CIEBA Letter’’). 46. Letter from Lisa Mahon Lynch, Director, Trading & Counterparty Services, Wellington Management Company LLP, to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘Wellington Letter’’). 47. Letter from Kevin Duggan, Managing Director, Execution & Treasury, Capital Markets, Ontario Teachers’ Pension Plan, et al., to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘Joint Pension Plan Letter’’).1062 48. Letter from Tim Gately, Managing Director, Head of Americas Equities, Citigroup Global Markets Inc., to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘Citi Letter’’). 49. Letter from Michael Jacejko, Birch Bay Capital, LLC, to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘Birch Bay Letter’’). 50. Letter from Cynthia Lo Bessette, General Counsel & Executive Vice President, OFI Global Asset Management, Inc., et al., OppenheimerFunds, Inc., to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘Oppenheimer Letter’’). 51. Letter from Ray Ross, Chief Technology Officer, Clearpool Group, to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘Clearpool Letter’’). 52. Letter from James J. Angel, Associate Professor of Finance, Georgetown University, McDonough School of Business, to Commission, dated May 25, 2018 (‘‘Angel Letter I’’). 53. Letter from Chester Spatt, Former Chief Economist, Commission, to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘Spatt Letter’’). 54. Letter from Joseph Kinahan, Managing Director, Client Advocacy & Market Structure, TD Ameritrade, Inc., to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘TD Ameritrade Letter’’). 55. Letter from Edward S. Knight, Executive Vice President & Global Chief Legal & Policy Officer, Nasdaq, Inc., to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘Nasdaq Letter I’’). 56. Letter from Edward T. Tilly, Chairman & Chief Executive Officer, 1062 The Commission notes that it separately received a copy of a signatory page already attached to this letter from Karl Polen, Chief Investment Officer, Arizona State Retirement System, dated May 21, 2018. For purposes of this summary, the copy has not been counted as a separate letter or comment. E:\FR\FM\20FER2.SGM 20FER2 5302 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations Cboe Global Markets, Inc., to Brent J. Fields, Secretary, Commission, dated May 25, 2018 (‘‘Cboe Letter I’’). 57. Letter from Matt D. Lyons, Global Equity Trading Manager, and Peter D. Stutsman, U.S. Regional Equity Trading Manager, The Capital Group Companies, to Brent J. Fields, Secretary, Commission, dated May 30, 2018 (‘‘Capital Group Letter’’). 58. Letter from Mike Rask, Chairman of the Board, and James Toes, President & CEO, Security Traders Association, to Brent J. Fields, Secretary, Commission, dated May 31, 2018 (‘‘STA Letter’’). 59. Letter from Alan Harris, to Commission, dated May 31, 2018 (‘‘Harris Letter’’). 60. Letter from Elizabeth K. King, General Counsel & Corporate Secretary, NYSE Group, Inc., to Brent J. Fields, Secretary, Commission, dated May 31, 2018 (‘‘NYSE Letter I’’). 61. Letter from Kimberly Unger, CEO & Executive Director, The Security Traders Association of New York, Inc., to Brent J. Fields, Secretary, Commission, dated June 1, 2018 (‘‘STANY Letter’’). 62. Letter from John Ramsay, Chief Market Policy Officer, Investors Exchange LLC, to Brent J. Fields, Secretary, Commission, dated May 30, 2018 (‘‘IEX Letter I’’). 63. Market Commentary by Victor Lin, Credit Suisse, dated June 4, 2018 (‘‘Credit Suisse Commentary’’). 64. Letter from Rajesh Sharma, Corporate Secretary, Apache Corporation, to Brent J. Fields, Secretary, Commission, dated June 7, 2018 (‘‘Apache Letter’’). 65. Letter from ‘‘Danny Mulson’’ to Commission, dated June 7, 2018 (‘‘Mulson Letter I’’). 66. Letter from J.W. Verret, Associate Professor of Law, George Mason University, Antonin Scalia Law School, to Brent J. Fields, Secretary, Commission, dated June 11, 2018 (‘‘Verret Letter I’’). 67. Letter from James D. Rollins III, Chairman & Chief Executive Officer, BancorpSouth Bank, to Brent J. Fields, Secretary, Commission, dated June 11, 2018 (‘‘BancorpSouth Letter’’). 68. Letter from Jonathan A. Clark, Chief Executive Officer, and James C. Dolan, Chief Compliance Officer, Luminex Trading & Analytics LLC, to Brent J. Fields, Secretary, Commission, dated June 12, 2018 (‘‘Luminex Letter’’). VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 69. Letter from Mehmet Kinak, Vice President—Global Head of Systematic Trading & Market Structure, and Jonathan Siegel, Vice President—Senior Legal Counsel (Legislative & Regulatory Affairs), T. Rowe Price, to Brent J. Fields, Secretary, Commission, dated June 12, 2018 (‘‘T. Rowe Price Letter’’). 70. Letter from Jon R. Moeller, Vice Chairman & Chief Financial Officer, The Procter & Gamble Company, to Brent J. Fields, Secretary, Commission, dated June 13, 2018 (‘‘P&G Letter’’). 71. Letter from William P. Neuberger, Managing Director, Global Co-Head of Morgan Stanley Electronic Trading, and Andrew F. Silverman, Managing Director, Global Co-Head of Morgan Stanley Electronic Trading, Morgan Stanley & Co. LLC, to Brent J. Fields, Secretary, Commission, dated June 14, 2018 (‘‘Morgan Stanley Letter’’). 72. Letter from Larry Harris, Fred V. Keenan Chair in Finance, USC Marshall School of Business, to Brent J. Fields, Secretary, Commission, dated June 15, 2018 (‘‘Larry Harris Letter’’). 73. Letter from Keith Neumeyer, President & CEO, First Majestic Silver Corp., to Brent J. Fields, Secretary, Commission, dated June 19, 2018 (‘‘First Majestic Letter’’). 74. Letter from ‘‘Avarice Pleonexia’’ to Commission, dated June 20, 2018 (‘‘Pleonexia Letter’’). 75. Letter from John M. Freeman, Executive Vice President, Chief Legal Officer & Corporate Secretary, McDermott, to Brent J. Fields, Secretary, Commission, dated June 21, 2018 (‘‘McDermott Letter’’). 76. Letter from Janet McGinness, Corporate Secretary, Mastercard, Inc., to Brent J. Fields, Secretary, Commission, dated June 21, 2018 (‘‘Mastercard Letter’’). 77. Letter from Mark Elliott, Chief Financial Officer, Level Brands, Inc., to Brent J. Fields, Secretary, Commission, dated June 21, 2018 (‘‘Level Brands Letter’’). 78. Letter from Geir ;ivind Nyga˚rd, Chief Investment Officer Asset Strategies, and Simon Emrich, Head of Market Structure Strategies, Norges Bank Investment Management, to Brent J. Fields, Secretary, Commission, dated June 21, 2018 (‘‘Norges Letter’’). 79. Letter from Neal V. Fenwick, Executive Vice President & Chief Financial Officer, ACCO Brands, Inc., to Brent J. Fields, Secretary, Commission, dated June 21, 2018 (‘‘ACCO Letter’’). PO 00000 Frm 00102 Fmt 4701 Sfmt 4700 80. Letter from Thomas R. Kubera, Chief Accounting Officer & Interim Chief Financial Officer, SIFCO Industries, Inc., to Brent J. Fields, Secretary, Commission, dated June 21, 2018 (‘‘SIFCO Letter’’). 81. Letter from J.A. to Brent J. Fields, Secretary, Commission, dated June 22, 2018 (‘‘JA Letter I’’). 82. Letter from Timothy P. Olson, Senior Corporate Counsel & Corporate Secretary, NorthWestern Corporation, to Brent J. Fields, Secretary, Commission, dated June 22, 2018 (‘‘NorthWestern Letter’’). 83. Letter from Eric D. Koster, General Counsel & Secretary, Ethan Allen Interiors, Inc., to Brent J. Fields, Secretary, Commission, dated June 22, 2018 (‘‘Ethan Allen Letter’’). 84. Letter from Mark H. Collin, Senior Vice President, Chief Financial Officer & Treasurer, Unitil Corporation, to Brent J. Fields, Secretary, Commission, dated June 22, 2018 (‘‘Unitil Corporation’’). 85. Letter from Michael R. Peterson, Vice President, Corporate Secretary, & Associate General Counsel, to Brent J. Fields, Secretary, Commission, dated June 22, 2018 (‘‘Johnson Letter’’). 86. Letter from ‘‘Anonymous Anonymous’’ to Commission, dated June 22, 2018 (‘‘Anonymous Letter I’’). 87. Letter from Stephen C. Richter, Executive Vice President & CFO, Weingarten Realty, to Brent J. Fields, Secretary, Commission, dated June 22, 2018 (‘‘Weingarten Letter’’). 88. Letter from Richard L. Travis, Jr., Chief Financial Officer, Ennis, Inc., to Brent J. Fields, Secretary, Commission, dated June 22, 2018 (‘‘Ennis Letter’’). 89. Letter from Bryan H. Fairbanks, Chief Financial Officer, Trex Company, to Brent J. Fields, Secretary, Commission, dated June 22, 2018 (‘‘Trex Letter’’). 90. Letter from John J. Manning, Vice President, General Counsel & Secretary, Sensient Technologies Corporation, to Brent J. Fields, Secretary, Commission, dated June 25, 2018 (‘‘Sensient Letter’’). 91. Letter from John Christofilos, Senior Vice-President & Chief Trading Officer, AGF Investments Inc., to Brent J. Fields, Secretary, Commission, dated June 25, 2018 (‘‘AGF Letter’’). 92. Letter from Dean Shigemura, Vice Chairman & Chief Financial Officer, Bank of Hawaii Corporation, to Brent J. Fields, Secretary, E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations Commission, dated June 25, 2018 (‘‘Hawaii Letter’’). 93. Letter from Jerry Fowden, Chief Executive Officer, Cott Corporation, to Brent J. Fields, Secretary, Commission, dated June 26, 2018 (‘‘Cott Letter’’). 94. Letter from Adam F. Wergeles, EVP & General Counsel, Leaf Group Ltd., to Brent J. Fields, Secretary, Commission, dated June 26, 2018 (‘‘Leaf Letter’’). 95. Letter from Haim Bodek, Managing Principal, and Stanislav Dolgopolov, Chief Regulatory Officer, Decimus Capital Markets, LLC, to Brent J. Fields, Secretary, Commission, dated June 26, 2018 (‘‘Decimus Letter’’). 96. Letter from Michael Sherman, Senior Vice President & General Counsel, Genesis Healthcare, Inc., to Brent J. Fields, Secretary, Commission, dated June 26, 2018 (‘‘Genesis Letter’’). 97. Letter from ‘‘Anonymous Anonymous’’ to Commission, dated June 27, 2018 (‘‘Anonymous Letter II’’). 98. Letter from Michael J. Schewel, Vice-President, General Counsel & Secretary, Tredegar Corporation, to Brent J. Fields, Secretary, Commission, dated June 27, 2018 (‘‘Tredegar Letter’’). 99. Letter from Nicholas C. Taylor, Chairman & CEO, Mexco Energy Corporation, to Brent J. Fields, Secretary, Commission, dated June 27, 2018 (‘‘Mexco Letter’’). 100. Letter from John Ramsay, Chief Market Policy Officer, Investors Exchange LLC, to Brent J. Fields, Secretary, Commission, dated June 27, 2018 (‘‘IEX Letter II’’). 101. Presentation from Security Traders Association to Commission, dated June 28, 2018 (‘‘STA Presentation’’). 102. Letter from Timothy W. Gorman, Executive Vice President & Chief Financial Officer, Energizer Holdings, Inc., to Brent J. Fields, Secretary, Commission, dated June 28, 2018 (‘‘Energizer Letter’’). 103. Letter from Christopher A. Iacovella, Chief Executive Officer, American Securities Association, to Brent J. Fields, Secretary, Commission, dated June 28, 2018 (‘‘ASA Letter’’). 104. Letter from W. Stancil Starnes, Chairman, President & Chief Executive Officer, ProAssurance Corporation, to Brent J. Fields, Secretary, Commission, dated June 29, 2018 (‘‘ProAssurance Letter’’). 105. Letter from Isabel Janci, Vice President, Investor Relations, The VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 Home Depot, to Brent J. Field[s], Secretary, Commission, dated June 29, 2018 (‘‘Home Depot Letter’’). 106. Letter from Eric P. Sills, CEO & President, Standard Motor Products, Inc., to Brent J. Fields, Secretary, Commission, dated July 2, 2018 (‘‘SMP Letter’’). 107. Letter from Christopher T. Weber, Executive Vice President & Chief Financial Officer, Halliburton, to Brent J. Fields, Secretary, Commission, dated July 2, 2018 (‘‘Halliburton Letter’’). 108. Letter from Jennifer D. Whalen, Senior Vice President & Chief Financial Officer, Era Group Inc., to Brent J. Fields, Secretary, Commission, dated July 2, 2018 (‘‘Era Letter’’). 109. Letter from David M. Weisberger, Head of Equities, ViableMkts, to Brent J. Fields, Secretary, Commission, dated July 2, 2018 (‘‘ViableMkts Letter’’). 110. Letter from John S. Fischer, General Counsel, Natural Grocers by Vitamin Cottage, Inc., to Brent J. Fields, Secretary, Commission, dated July 3, 2018 (‘‘Natural Grocers Letter’’). 111. Letter from Mark J. Airola, Senior Vice President, General Counsel, Chief Administrative Officer & Corporate Secretary, Newpark Resources, Inc., to Brent J. Fields, Secretary, Commission, dated July 3, 2018 (‘‘Newpark Letter’’). 112. Letter from Jenny H. Parker, Senior Vice President—Finance, Secretary & Treasurer, Haverty Furniture Companies, Inc., to Brent J. Fields, Secretary, Commission, dated July 3, 2018 (‘‘Haverty Letter’’). 113. Letter from Adam W. Miller, Chief Financial Officer & Treasurer, Knight-Swift Transportation Holdings Inc., to Brent J. Fields, Secretary, Commission, dated July 5, 2018 (‘‘Knight-Swift Letter’’). 114. Letter from Tyler Gellasch, Executive Director, Healthy Markets Association, to Brent J. Fields, Secretary, Commission, dated July 6, 2018 (‘‘Healthy Markets Letter II’’). 115. Letter from R. Dale Lynch, Executive Vice President—Chief Financial Officer, Federal Agricultural Mortgage Corporation, to Brent J. Fields, Secretary, Commission, dated July 9, 2018 (‘‘Farmer Mac Letter’’). 116. Letter from Elizabeth K. King, General Counsel & Corporate Secretary, New York Stock Exchange, to Brent J. Fields, Secretary, Commission, dated July 10, 2018 (‘‘NYSE Letter II’’). PO 00000 Frm 00103 Fmt 4701 Sfmt 4700 5303 117. Letter from ‘‘Danny Mulson’’ to Commission, dated July 10, 2018 (‘‘Mulson Letter II’’). 118. Letter from Maria Trainor, Vice President, General Counsel & Secretary, Ampco-Pittsburgh Corporation, to Brent J. Fields, Secretary, Commission, dated July 11, 2018 (‘‘Ampco-Pittsburgh Letter’’). 119. Letter from Ted A. Dosch, Executive Vice President—Finance & Chief Financial Officer, Anixter International Inc., to Brent J. Fields, Secretary, Commission, dated July 13, 2018 (‘‘Anixter Letter’’). 120. Letter from John K. Lines, SVP/ Secretary & General Counsel, National HealthCare Corporation, to Brent J. Fields, Secretary, Commission, dated July 16, 2018 (‘‘NHC Letter’’). 121. E-mail from Patrick Healy, Founder & CEO, Issuer Network, to David Shillman, Commission, dated July 17, 2018 (‘‘Issuer Network Email’’). 122. Letter from R. Scott Mahoney, Senior Vice President—General Counsel & Secretary, AVANGRID, Inc., to Brent J. Fields, Secretary, Commission, dated July 18, 2018 (‘‘Avangrid Letter’’). 123. Letter from J.A. to Brent J. Fields, Secretary, Commission, dated July 19, 2018 (‘‘JA Letter II’’). 124. Letter from Ruairidh Ross, Deputy General Counsel & Assistant Secretary, HP Inc., to Brent J. Fields, Secretary, Commission, dated July 31, 2018 (‘‘HP Letter’’). 125. Letter from Glenn E. Tynan, Vice President & Chief Financial Officer, Curtiss-Wright Corporation, to Brent J. Fields, Secretary, Commission, dated August 3, 2018 (‘‘Curtiss-Wright Letter’’). 126. Letter from James J. Angel, Associate Professor of Finance, Georgetown University, McDonough School of Business, to Commission, dated August 3, 2018 (‘‘Angel Letter II.’’) 127. Letter from John Ramsay, Chief Market Policy Officer, Investors Exchange LLC, to Brent J. Fields, Secretary, Commission, dated August 8, 2018 (‘‘IEX Letter III’’). 128. Letter from Fiona Reynolds, Chief Executive Officer, Principles for Responsible Investment, to Brent J. Fields, Secretary, Commission, dated August 15, 2018 (‘‘PRI Letter’’). 129. Letter from Walter K. Compton, Executive Vice President & General Counsel, Murphy Oil Corporation, to Brent J. Fields, Secretary, E:\FR\FM\20FER2.SGM 20FER2 5304 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations Commission, dated August 15, 2018 (‘‘Murphy Letter’’). 130. Letter from Sal Arnuk & Joe Saluzzi, Partners, Co-Founders & Co-Heads of Equity Trading, Themis Trading LLC, to Brent J. Fields, Secretary, Commission, dated August 16, 2018 (‘‘Themis Trading Letter II’’). 131. Letter from Jeffrey S. Davis, Nasdaq, Inc., to Brent J. Fields, Secretary, Commission, dated August 31, 2018 (‘‘Nasdaq Letter II’’). 132. Recommendation of the Investor Advisory Committee, dated September 13, 2018 (‘‘IAC Recommendation’’). 133. Letter from Sanda E. O’Connor, Chief Regulatory Affairs Officer, JPMorgan Chase & Co., to Brent J. Fields, Secretary, Commission, dated September 14, 2018 (‘‘JPMorgan Letter’’). 134. Letter from Anonymous Anonymous to Commission, dated September 21, 2018 (‘‘Anonymous Letter III’’). 135. Letter from John Ramsay, Chief Market Policy Officer, Investors Exchange LLC, to Brent J. Fields, Secretary, Commission, dated September 24, 2018 (‘‘IEX Letter IV’’). 136. Letter from Chris Concannon, President & Chief Operating Officer, Cboe Global Markets, Inc., to Brent J. Fields, Secretary, Commission, dated September 28, 2018 (‘‘Cboe Letter II’’). 137. Letter from Susan M. Olson, General Counsel, Investment Company Institute, to Brent J. Fields, Secretary, Commission, dated October 1, 2018 (‘‘ICI Letter II’’). 138. Letter from Katya Malinova, Mackenzie Investments Chair in Evidence-Based Investment Management, DeGroote School of Concept Element Exchange exch Record Type. rt Participant Type. ptcpt Pilot Group. grp VerDate Sep<11>2014 18:36 Feb 19, 2019 Type Business, McMaster University, et al., to Brent J. Fields, Secretary, Commission, dated October 1, 2018 (‘‘CSA Letter’’). 139. Letter from ‘‘Richard P. Grasso,’’ ‘‘Grasso Plumbing LLC,’’ to Brent J. Fields, Secretary, Commission, dated October 1, 2018 (‘‘Grasso Letter’’). 140. Letter from Ira S. Lederman, W.R. Berkley Corporation, to Brent J. Fields, Secretary, Commission, dated October 2, 2018 (‘‘Berkley Letter’’). 141. Letter from Stacey Cunningham, President, New York Stock Exchange, to Brent J. Fields, Secretary, Commission, dated October 2, 2018 (‘‘NYSE Letter III’’). 142. Letter from Rich Steiner, Electronic Trading Strategist, RBC Capital Markets, to Brent Fields, Secretary, Commission, dated October 16, 2018 (‘‘RBC Letter II’’). 143. Letter from Elizabeth K. King, General Counsel & Corporate Secretary, NYSE Group, to Brent J. Fields, Secretary, Commission, dated November 9, 2018 (‘‘NYSE Letter IV’’). 144. Letter from Elizabeth K. King, General Counsel & Corporate Secretary, NYSE Group, Inc., to Brent J. Fields, Secretary, Commission, dated November 20, 2018 (‘‘NYSE Letter V’’). 145. Letter from J.A. to Brent J. Fields, Secretary, Commission, dated December 3, 2018 (‘‘JA Letter III’’). 146. Letter from J.W. Verret to Brent J. Fields, Secretary, Commission, dated December 4, 2018 (‘‘Verret Letter II’’). 147. Letter from Patrick J. Healy, Founder & CEO, Issuer Network, to Brent J. Fields, Secretary, Commission, dated December 14, 2018 (‘‘Issuer Network Letter II’’). Spot Non-empty Text S or M Monthly R R R R MM, Other or Blank O O 1, 2, or C R R Jkt 247001 PO 00000 Frm 00104 148. Letter from Jeffrey S. Davis, Vice President & Deputy General Counsel, Nasdaq, Inc., to Brent J. Fields, Secretary, Commission, dated December 17, 2018 (‘‘Nasdaq Letter III’’). Note: The following Exhibit 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 17 CFR 242.610T(e) and the logical representation of those disclosures to a corresponding XML element. The Commission’s XML schema is the formal electronic representation of this data model. • Concept—the information content as described in 17 CFR 242.610T(e) items 1 through 13. • 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’’). When absent Blank Fmt 4701 Definition A required unique code to identify each exchange 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). 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—Test Groups 1, 2; C— Control group. Sfmt 4700 E:\FR\FM\20FER2.SGM 20FER2 Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations Concept Element Type Spot Monthly Displayed disp D, N, or B R R Top/Depth topOrDepth T, D, or B R R Start Date start YYYY-MMDD R O End Date end YYYY-MMDD or Blank O O Month and Year. Pre/Post .. YearMonth YYYY-MM NA R preOrPost 1, 2, or Blank O O Base Taker Fee. baseTakeFee Number R NA Top Tier Taker Fee. topTierTakeFee Number R NA Average Taker Fee. avgTakeFee Number NA R Median Taker Fee. medianTakeFee Number NA R Base Maker Fee. baseMakeFee Number R NA Top Tier Maker Fee. topTierFee Number R NA Average Maker Fee. avgMakeFee Number NA R VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 PO 00000 Frm 00105 When absent Blank Blank Fmt 4701 5305 Definition D—Displayed, N—Not displayed, B—Both. For spot fee type records, if the fees are the same between displayed and nondisplayed 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 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 topof-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-ofbook). Fees have a positive sign; rebates have a negative sign. 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-ofbook), 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-ofbook). Fees have a positive sign; rebates have a negative sign. Sfmt 4700 E:\FR\FM\20FER2.SGM 20FER2 5306 Concept Median Maker Fee. Federal Register / Vol. 84, No. 34 / Wednesday, February 20, 2019 / Rules and Regulations Element medianMakeFee Type Number Spot NA Monthly When absent R Definition 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. [FR Doc. 2018–27982 Filed 2–19–19; 8:45 am] BILLING CODE 8011–01–P VerDate Sep<11>2014 18:36 Feb 19, 2019 Jkt 247001 PO 00000 Frm 00106 Fmt 4701 Sfmt 9990 E:\FR\FM\20FER2.SGM 20FER2

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 84, Number 34 (Wednesday, February 20, 2019)]
[Rules and Regulations]
[Pages 5202-5306]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-27982]

[[Page 5201]]

Vol. 84

Wednesday,

No. 34

February 20, 2019

Part II

Securities and Exchange Commission

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17 CFR Parts 200 and 242

Transaction Fee Pilot for NMS Stocks; Final Rule

Federal Register / Vol. 84 , No. 34 / Wednesday, February 20, 2019 /
Rules and Regulations

[[Page 5202]]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 200 and 242

[Release No. 34-84875; File No. S7-05-18]
RIN 3235-0761

Transaction Fee Pilot for NMS Stocks

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'' or
``SEC'') is adopting a new rule of Regulation National Market System
(``Regulation NMS'') under the Securities and Exchange Act of 1934
(``Exchange Act'') to conduct a Transaction Fee Pilot (``Pilot'') for
National Market System (``NMS'') stocks to study the effects that
exchange transaction fee-and-rebate pricing models may have on order
routing behavior, execution quality, and market quality. We expect the
data generated by the pilot, combined with data from existing sources,
will facilitate an empirical evaluation of whether the existing
exchange transaction-based fee and rebate structure is operating
effectively to further statutory goals.

DATES:
Effective date: April 22, 2019 through December 29, 2023.
Compliance date: As designated by Notice pursuant to 17 CFR
242.610T(c)(2).

FOR FURTHER INFORMATION CONTACT: Richard Holley III, Assistant
Director; Johnna Dumler, Special Counsel; Erika Berg, Special Counsel;
or Benjamin Bernstein, Special Counsel, 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 adopting new 17 CFR
242.610T (Rule 610T) to conduct a Transaction Fee Pilot for NMS stocks.

Table of Contents

I. Executive Summary of Rule 610T
II. Discussion of Rule 610T
A. Focus on Exchange Pricing Models and the Distortions They Can
Cause
1. Exchange Fee Models and Regulatory Framework
2. Impact of Exchange Fee Models
3. Focus on Exchange Fee Models
4. Non-Exchange Trading Centers
5. Options Exchanges
B. Securities
1. The Share Price Threshold of Pilot Securities
2. The Duration of Pilot Securities
3. Selecting Pilot Securities From All NMS Stocks
4. The Ability of Issuers to Opt Out of the Pilot
C. Pilot Design
1. Need for a Pilot
2. Pilot Design
3. No Overlap With Tick Size Pilot
4. Stratified Selection of Pilot Securities
5. Number of NMS Stocks Included in Each Test Group
6. Reduction to the Pilot Size
7. Fee Cap Test Groups
8. Control Group
9. Alternative Designs
10. Metrics To Assess the Pilot
D. Timing and Duration
1. Disclosure Initiatives and the Pilot
2. Automatic Sunset at Year One
3. Pre- and Post-Pilot Periods
4. Early Termination
5. Inclusion of a Phase-In Period
E. Data
1. Pilot Securities Exchange Lists and Pilot Securities Change
Lists
2. Exchange Transaction Fee Summary
3. Order Routing Data
F. Implementation
G. The Commission's Authority To Conduct the Pilot
III. Paperwork Reduction Act
A. Summary of Collection of Information
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 Summaries
3. Order Routing Datasets
E. Collection of Information Is Mandatory
F. Confidentiality of Responses to Collection of Information
G. Retention Period for Recordkeeping Requirements
IV. Economic Analysis
A. Background and Market Failures
1. Market Failure at the Broker-Dealer Level
2. Market Failure at the Exchange Level
B. Baseline
1. Current Information Baseline
2. Current Market Environment
C. Analysis of Benefits and Costs of Transaction Fee Pilot
1. Benefits of Transaction Fee Pilot
2. Costs of the Pilot
D. Impact on Efficiency, Competition, and Capital Formation
1. Efficiency
2. Competition
3. Capital Formation
E. Alternatives
1. Propose Rulemaking Without Conducting a Pilot
2. Expand Transaction Fee Pilot To Include Non-Exchange Trading
Centers
3. Trade-At Test Group
4. Alternative Pilot
5. Adjustments to the Transaction Fee Pilot Structure
V. Regulatory Flexibility Analysis
VI. Statutory Authority and Text of the Rule Amendments

I. Executive Summary of Rule 610T

Congress directed the Commission, through Section 11A of the
Exchange Act, to facilitate the establishment of a national market
system and use its broad authority to carry out the objectives of
Section 11A, including, among others, to assure the economically
efficient execution of securities transactions.\1\ In furtherance of
these goals, and as part of its oversight of registered national
securities exchanges, the Commission periodically undertakes reviews of
various aspects of market structure and current regulations to evaluate
whether, in light of changes in technology and business practices, the
current regulatory framework continues to fairly, effectively, and
efficiently promote fair and orderly markets, serve the public interest
and the protection of investors, and promote capital formation.
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\1\ 15 U.S.C. 78k-1(a)(1)(C)(i). See also supra Section II.G
(discussing the Commission's authority to conduct the Pilot).
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As discussed below, one aspect of the current regulatory framework
focuses on the current pricing and fee structure for transactions in
securities. As the Commission discussed in its Pilot proposal, the
predominant transaction pricing structure that developed among equities
exchanges to attract order flow is the ``maker-taker'' fee model.\2\
Specifically, out of thirteen equities exchanges, seven utilize the
``maker-taker'' fee model, in which they pay a rebate to a provider of
liquidity and charge a fee to a taker of liquidity. Among the remaining
exchanges, four utilize a ``taker-maker'' pricing model (also called an
inverted model) where they charge a fee to a provider of liquidity and
pay a rebate to a taker of liquidity,\3\ and two have a ``flat fee''
model.\4\ In recent years this area has

[[Page 5203]]

attracted considerable attention and generated significant debate,
focusing on the effects, both positive and negative, that exchange
transaction-based pricing models may have on market quality and
execution quality, with some commenters advocating action by the
Commission.
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\2\ See Securities Exchange Act Release No. 82873 (March 14,
2018), 83 FR 13008 (March 26, 2018) (``Proposing Release'' or
``Proposal'').
\3\ See Cboe BYX U.S. Equities Exchange Fee Schedule (as of
December 2018), available at https://markets.cboe.com/us/equities/membership/fee_schedule/byx/; Cboe EDGA U.S. Equities Exchange Fee
Schedule (as of December 2018), available at https://markets.cboe.com/us/equities/membership/fee_schedule/edga/; Nasdaq
BX Fee Schedule (as of December 2018), available at https://www.nasdaqtrader.com/Trader.aspx?id=bx_pricing; NYSE National
Schedule of Fees and Rebates (as of December 2018), available at
https://www.nyse.com/publicdocs/nyse/regulation/nyse/NYSE_National_Schedule_of_Fees.pdf. EDGA adopted a taker-maker fee
schedule in July 2018. See Securities Exchange Act Release No. 83643
(July 16, 2018), 83 FR 34643 (July 20, 2018) (SR-CboeEDGA-2018-012).
\4\ See Investors Exchange Fee Schedule (as of December 2018),
available at https://iextrading.com/trading/fees/; NYSE American
Equities Trading Fees and Price List (as of December 2018),
available at https://www.nyse.com/publicdocs/nyse/markets/nyse-american/NYSE_America_Equities_Price_List.pdf. NYSE American offers
rebates to eDMMs in their assigned NYSE American-listed securities.
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The Commission is uniquely situated and vested with the
responsibility under Section 11A of the Exchange Act to examine the
impact that this aspect of our market structure has on our national
market system. And, in light of the questions raised about the impact
of these fee models and the amount of attention garnered, we believe
this is an area ripe for Commission review. But, the Commission
currently lacks the data necessary to meaningfully analyze the impact
that exchange transaction fee-and-rebate pricing models have on order
routing behavior, market and execution quality, and our market
structure generally. To address this information gap, the Commission
has designed the Pilot to produce data that will facilitate a more
thorough understanding of the potential issues associated with exchange
transaction-based pricing models. In particular, the Commission has
designed the Pilot to gather data on the effect both current regulatory
fee caps and rebates have on market quality and execution quality. The
data gathered will assist the Commission in determining whether any
changes in the current regulatory framework are appropriate and enable
the Commission to make more informed and effective policy decisions.
This, in turn, enables the Commission to carry out the objectives of
the national market system and oversee the national securities
exchanges.
As discussed fully in the proposing release, the Commission
proposed a pilot to test the effect of exchange transaction fees and
rebates.\5\ The following chart summarizes the terms of the Pilot as
adopted, which are discussed in more detail below:
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\5\ See Proposing Release, supra note 2.

Transaction Fee Pilot for NMS Stocks
----------------------------------------------------------------------------------------------------------------

----------------------------------------------------------------------------------------------------------------
Duration...................... 2 years with an automatic sunset at 1 year unless, no later than 30 days prior
to that time, the Commission publishes a notice that the pilot shall continue
for up to 1 additional year; plus a 6-month pre-Pilot Period and 6-month post-
Pilot Period.
----------------------------------------------------------------------------------------------------------------
Applicable trading centers.... Equities exchanges (including maker-taker & taker-maker) but not ATSs or other
non-exchange trading centers.
----------------------------------------------------------------------------------------------------------------
Pilot securities.............. NMS stocks with average daily trading volumes >=30,000 shares with a share price
>=$2 per share that do not close below $1 per share during the Pilot and that
have an unlimited duration or a duration beyond the end of the post-Pilot
Period.
----------------------------------------------------------------------------------------------------------------
Group.................. Number of NMS Fee cap.......... Rebates
stocks. permitted?
----------------------------------------------------------------------------------------------------------------
Pilot design.................. Test Group 1........... 730.............. $0.0010 fee cap Yes.
for removing and
providing
displayed
liquidity (no
cap on rebates).
Test Group 2........... 730 (plus The 17 CFR No. Rebates and
appended 242.610(c) (Rule Linked Pricing
Canadian 610(c)) $0.0030 Prohibited for
interlisted cap continues to removing and
stocks). apply to fees providing
for removing displayed and
displayed undisplayed
liquidity. liquidity
(except for
specified market
maker activity).
Control Group.......... Pilot Securities The Rule 610(c) Yes.
not in Test cap continues to
Groups 1 or 2. apply to fees
for removing
displayed
liquidity (no
cap on rebates).
----------------------------------------------------------------------------------------------------------------
Pilot data.................... 1. Pilot Securities Exchange Lists and Pilot Securities Change Lists.
2. Exchange Transaction Fee Summary.
3. Order Routing Datasets.
----------------------------------------------------------------------------------------------------------------

II. Discussion of Rule 610T

In response to its proposal to conduct a Transaction Fee Pilot in
NMS stocks (the ``Pilot''), the Commission received a number of comment
letters from a diverse group of commenters, including exchanges,
investment managers, broker-dealers, and other market participants, as
well as academics, listed issuers, analytics firms, market observers,
and industry associations.\6\ As discussed below, after review and
consideration of the comments received, the Commission is adopting Rule
610T with certain modifications from that in the proposal.
---------------------------------------------------------------------------

\6\ The Proposal was developed, in part, by reference to a
recommendation for an access fee pilot submitted to the Commission
by the Equity Market Structure Advisory Committee (the ``EMSAC'').
See Proposing Release, supra note 2, at 13009, 13012-14.
---------------------------------------------------------------------------

A. Focus on Exchange Pricing Models and the Effects They Can Cause

1. Exchange Fee Models and Regulatory Framework
Regardless of the fee model, all fees of a registered national
securities exchange ``exchange'') are subject to the standards and
process requirements set forth in the federal securities laws.\7\ In
particular, Section 6 of the Exchange Act requires, among other things,
that the rules of an exchange provide for the ``equitable allocation''
of ``reasonable'' fees and that they not be ``designed to permit unfair
discrimination.'' \8\ Section 11A of the Exchange Act directs the
Commission to use its authority to facilitate the establishment of a
national market system for securities that assures economically
efficient execution of securities transactions, fair competition,
availability of information with respect

[[Page 5204]]

to quotations for and transactions in securities, and the
practicability of brokers executing investors' orders in the best
market.\9\ In addition, Rule 610(c) of Regulation NMS imposes upon
exchanges a fee cap of $0.0030 per share for the execution of an order
against its ``protected quotation.'' \10\
---------------------------------------------------------------------------

\7\ Under the Exchange Act, exchange fee changes 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).
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).
\8\ See 15 U.S.C. 78f(b)(4)-(5).
\9\ See 15 U.S.C. 78k-1(a)(1).
\10\ 17 CFR 242.610(c); Securities Exchange Act Release No.
51808 (June 9, 2005), 70 FR 37496, 37543-46 (June 29, 2005) (``NMS
Adopting Release''). See also 17 CFR 242.600(b)(58) (defining
``protected quotation''); 17 CFR 242.600(b)(57) (defining
``protected bid or protected offer''); 17 CFR 242.600(b)(3)
(defining ``automated quotation'').
---------------------------------------------------------------------------

In 2005, when it adopted the fee limitation in Rule 610(c), the
Commission noted, in part:

The adopted fee limitation set forth in Rule 610(c) of
Regulation NMS is designed to preclude individual trading centers
from raising their fees substantially in an attempt to take improper
advantage of strengthened protection against trade-throughs and the
adoption of a private linkage regime. In particular, the fee
limitation is necessary to address `outlier' trading centers that
otherwise might charge high fees to other market participants
required to access their quotations by the Order Protection Rule. It
also precludes a trading center from charging high fees selectively
to competitors, practices that have occurred in the market for
Nasdaq stocks. 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.\11\
---------------------------------------------------------------------------

\11\ NMS Adopting Release, supra note 10, at 37545.

In light of the considerable debate surrounding exchange fee models
that pay rebates, which is well documented in the comment letters
submitted on the proposed Pilot, and the passage of time since the
Commission first adopted the Rule 610(c) fee cap as part of Regulation
NMS in 2005, the Commission now seeks to gather data to facilitate an
empirical assessment of the effect of exchange transaction fees and
rebates broadly--including the impact and continued appropriateness of
the Rule 610(c) fee cap \12\--by testing the effects of changes to
exchange fees and rebates on the markets and market participant
behavior.
---------------------------------------------------------------------------

\12\ At the time of its adoption in 2005, the fee cap codified
the then-prevailing fee level set through competition among the
various trading centers. See NMS Adopting Release, supra note 10, 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'').
---------------------------------------------------------------------------

2. Impact of Exchange Fee Models
In response to the Proposing Release, the Commission received a
number of comment letters criticizing existing fee-and-rebate pricing
models, but also a number of comment letters expressing support for
those same pricing regimes.\13\
---------------------------------------------------------------------------

\13\ The potential distortions mentioned by the commenters (and
discussed in this section) include, among others: (1) Conflicts of
interest faced by routing broker-dealers; (2) excess intermediation
and potential adverse selection; (3) market fragmentation; (4)
exchange fee avoidance; (5) complexity; (6) transparency; and (7)
elevated fees to subsidize rebates.
---------------------------------------------------------------------------

Many commenters focused on one potential distortion--whether
current pricing models ``present broker-dealers with a potential
conflict of interest,'' because their ``duty to pursue best execution
could be compromised when their trading venue decision is driven by the
economic incentive to minimize access fees paid and maximize rebates
received.'' \14\ As another commenter explained, ``a broker is
incentivized to route an order to the venue that pays it the most (or
costs the least), instead of the venue that has the highest likelihood
of offering the best execution for its customers, such as the one that
offers a higher probability of execution or meaningful price
improvement.'' \15\ As evidence of the potential harm that can result
from the conflicts presented by exchange rebates, one commenter noted
that institutional investors ``that specifically instruct brokers to
remove rebate-driven trading behaviors from their algorithms achieve
significantly lower trading costs that result in higher returns to
their investors.'' \16\ One commenter attributed this harm to the
tendency of rebates to ``affect the length of the order queue of
passive limit orders on the major maker-taker exchanges, while high
take fees on these markets make them less attractive for marketable
orders that cross the spread.'' The commenter argued that the ``net
result of this perverse pricing dynamic is a lower likelihood of
execution and a higher likelihood of adverse selection for orders in
the maker-taker queues,'' because orders at the ``middle or back of the
queue . . . are less likely to trade at their desired price, and when
they do trade, the overall market price as reflected by the [National
Best Bid and Offer (``NBBO'')] is more likely to move against them,
than when trading on venues that do not pay rebates.'' \17\
---------------------------------------------------------------------------

\14\ Capital Group Letter, at 2. See also, e.g., ICI Letter I,
at 2; Vanguard Letter, at 2; Invesco Letter, at 2; CFA Letter, at 2;
Oppenheimer Letter, at 2; Spatt Letter, at 4; AJO Letter, at 1;
Larry Harris Letter, at 3.
\15\ Healthy Markets Letter I, at 5. See also, e.g., Copeland
Letter, at 1; Wellington Letter, at 1; Norges Letter, at 2.
\16\ Babelfish Letter, at 1-3 (also referencing a Clearpool
Group study that found that a ``fee sensitive VWAP algorithm
executed during volatile times incurred seven times as much cost as
a fee agnostic algorithm''). See also T. Rowe Price Letter, at 2
(stating that ``[r]etail orders . . . are generally placed on the
exchange that offers the highest rebate to the broker, but show[s]
lower execution quality in terms of reduced probability of
execution''); Capital Group Letter, at 2 (``Our internal trade
analysis suggests that execution quality may be negatively impacted
when broker-dealers' routing decisions are made to minimize access
fees.'').
\17\ IEX Letter I, at 6, A-1-A-2; IEX Letter II, at 7; IEX
Letter IV (appending research to support these views). See also,
e.g., Babelfish Letter, at 2 (stating that a ``frequently realized
scenario is that flow sent solely to a high rebate destination waits
in queue, often winds up canceled because price moves away, and then
receives an inferior price upon the eventual execution''); Larry
Harris Letter, at 1, 3; Brandes Letter, at 1-2. But see Grasso
Letter, at 3 (``waiting for a rebate[ ] may be fine'' if ``you have
low confidence about future prices for a large order and don't mind
if the order trades slowly while you accumulate shares'').
---------------------------------------------------------------------------

A number of commenters discussed other potential effects of
exchange pricing models. Some commenters believed that transaction fees
and rebates contribute to market fragmentation \18\ because they
encourage investors to ``turn to inverted markets to improve queue
priority'' \19\ or to ``route orders to non-exchange trading centers to
avoid the higher access fees that exchanges charge to subsidize the
rebates they offer.'' \20\ Likewise, one commenter thought that
``transaction fees and rebates contribute to market complexity through
the proliferation of new order types . . . designed to exploit
different transaction pricing models.'' \21\ Other commenters believed
that ``[t]ransaction fees and rebates . . . undermine market
transparency because the prices displayed by exchanges--and provided on
trade reports--do not include fee or rebate information and therefore
do not fully reflect net trade prices.'' \22\ Finally, some commenters

[[Page 5205]]

asserted that current pricing models unfairly subsidize rebates \23\ or
benefit sophisticated market participants like market-makers and
proprietary traders at the expense of other market participants.\24\
---------------------------------------------------------------------------

\18\ See, e.g., ICI Letter I, at 2.
\19\ Credit Suisse Commentary, at 2. See also, e.g., Larry
Harris Letter, at 3 (noting that ``orders standing at inverted
exchanges usually execute before orders standing at the same price
at maker-taker exchanges'').
\20\ Capital Group Letter, at 2. See also, e.g., IEX Letter I,
at 3 (``Excessive take fees . . . have been criticized as leading to
the migration of some order flow to less-regulated non-exchange
venues in search of reduced transaction costs, resulting in
increased market fragmentation and market complexity.'').
\21\ ICI Letter I, at 2. See also, e.g., Vanguard Letter, at 2
(indicating that the ``desire to maximize rebate revenue and avoid
fees created order complexity within the equity markets as traders
sought profitable trading strategies'').
\22\ ICI Letter I, at 2. See also, e.g., Goldman Sachs Letter,
at 3; Invesco Letter, at 2; State Street Letter, at 2; Wellington
Letter, at 1; Oppenheimer Letter, at 2; Capital Group Letter, at 3.
\23\ See, e.g., Clearpool Letter, at 3 (stating that ``exchanges
chase order flow and provide rebates and other pricing incentives to
the largest trading firms at the expense of smaller market
participants who cannot take advantage of such rebates and, in
effect, end up subsidizing the trading of larger firms''); IEX
Letter I, at 3 (stating that transaction fees are ``used in effect
to subsidize the payment of rebates,'' which ``results in a
substantial penalty on investors and other participants who . . .
have a need for immediate liquidity'').
\24\ See, e.g., T. Rowe Price Letter, at 2 (stating that rebates
lead to ``excessive intermediation . . . benefiting short-term
intermediaries at the expense of long-term investors''); ModernIR
Letter, at 3 (stating that rebates ``promote[ ] arbitrage, and
price-setting as its own end,'' leading to a ``paucity of real
orders''); Larry Harris Letter, at 1, 5-6 (stating that current
pricing models facilitate ``the execution of various parasitic
trading strategies by proprietary traders to the detriment of public
investors''); Capital Group Letter, at 3.
---------------------------------------------------------------------------

Other commenters expressed support for current exchange pricing
models. For example, one commenter believed that maker-taker pricing
``provides important benefits to issuers and investors,'' because
exchanges ``use rebates as a tool to promote displayed liquidity and
price discovery, which results in competitive bid-ask spreads, saving
transaction costs that investors may otherwise incur.'' \25\ Another
commenter argued that rebates can promote displayed liquidity by
providing ``a payment in exchange for posters of liquidity giving up
several valuable options,'' including ``the power to decide the time of
the trade'' and the ability to conceal trading intentions until the
point of execution.\26\ Building on this idea, one commenter
characterized ``[a]ccess fee caps and related rebates'' as features
that ``enable exchanges to compete with non-exchange trading venues by
essentially subsidizing the posted prices . . . and narrow[ing] the
NBBO, making it slightly more expensive to either match or improve upon
those prices off-exchange.'' \27\
---------------------------------------------------------------------------

\25\ State Street Letter, at 2. See also, e.g., Virtu Letter, at
3; Fidelity Letter, at 3; Nasdaq Letter I, at 9; Cboe Letter I, at
15-16. See also Nasdaq Letter III, at Exhibit A (providing graphs
using data from September 2018 on average quoted spread across
exchanges in S&P 500 stocks and time at the best quote across those
stocks). But cf. Larry Harris Letter, at 6-9 (acknowledging that
``quoted spreads are narrower under maker-taker pricing,'' but
opining that ``the narrower quoted spreads do not benefit the
public'').
\26\ Magma Letter, at 3. See also, e.g., NYSE Letter IV, at 2
(arguing that ``pricing incentives enhance the quality and
reliability of display markets''); FIA Letter, at 4.
\27\ FIA Letter, at 3-4. See also NYSE Letter I, at 6 (stating
that rebates ``allow liquidity providers to quote narrower spreads
by providing another source of revenue''); Grasso Letter, at 4
(``the main outcome of exchange pricing seems to be that it forces
exchanges to compete for customers,'' because it ``keeps their
margins tight and gives them incentives to improve the quality of
their offerings'').
---------------------------------------------------------------------------

As commenters fundamentally disagreed about the effect of exchange
transaction fee models and whether they have a positive or a negative
impact on the U.S. equities markets, commenters also held conflicting
views regarding whether and how the Commission should conduct the
Pilot.
3. Focus on Exchange Fee Models
Recognizing the unique regulatory framework applicable to exchange
fees, and the disagreement over the impact of exchange fees and rebates
on the markets and market participants, the Commission focused its
proposed Pilot on studying the effect of exchange transaction fees and
rebates on order routing behavior, execution quality, and market
quality. Accordingly, the Commission proposed to include within the
Pilot all equities exchanges regardless of fee model.
A large number of commenters supported applying the Pilot to all
equities exchanges.\28\ For example, one commenter believed that the
Pilot ``should include all equities exchanges . . . because rebates of
any kind provide inducements to trade and distort markets.'' \29\ A
different commenter thought that including taker-maker exchanges was
``both logical and feasible, given that all equities exchanges assess
fees that are subject to the Exchange Act and its rule filing
requirements.'' \30\ Other commenters ``agree[d] with the Commission's
assessment that the Pilot should apply to all equity exchanges . . .
thus treating all similarly situated exchanges equally,'' because this
would be ``critically important in determining what impact the
reduction of access fees or the elimination of rebates will have on
order routing practices.'' \31\ Some other commenters, however, opposed
including taker-maker exchanges in the Pilot, noting that Rule 610(c)
does not apply to taker-maker exchanges.\32\
---------------------------------------------------------------------------

\28\ See, e.g., Joint Asset Managers Letter, at 2; Brandes
Letter, at 2; Themis Trading Letter I, at 3; AJO Letter, at 1-2;
OMERS Letter, at 2; Copeland Letter, at 2; Virtu Letter, at 6;
Nuveen Letter, at 2; BlackRock Letter, at 1; RBC Letter I, at 3;
Vanguard Letter, at 2; CFA Letter, at 4; Wellington Letter, at 2;
Joint Pension Plan Letter, at 2; Oppenheimer Letter, at 2; Clearpool
Letter, at 5 n.8; TD Ameritrade Letter, at 4; Capital Group Letter,
at 3; Healthy Markets Letter I, at 10; Morgan Stanley Letter, at 3
n.5; AGF Letter, at 1.
\29\ AJO Letter, at 1-2.
\30\ See RBC Letter I, at 3-4.
\31\ Capital Group Letter, at 3. See also, e.g., Clearpool
Letter, at 5 n.8; Oppenheimer Letter, at 2; Brandes Letter, at 2;
Copeland Letter, at 2.
\32\ See, e.g., Cboe Letter I, at 28.
---------------------------------------------------------------------------

After considering the comments on this issue, the Commission
continues to believe that focusing the Pilot on equities exchanges
regardless of fee model is appropriate because it treats alike
similarly situated entities that all are subject to the same regulatory
framework and thereby will allow the Commission to evaluate the effect
of exchange fee-and-rebate pricing models and the continued
appropriateness of the Rule 610(c) fee cap. Further, it would be
incongruous to study rebates and fees offered by one type of equities
exchange (maker-taker), but not another type of equities exchange
(taker-maker) where the fees of both types of entities are subject to
the same legal requirements and can introduce the same types of
distortions that the Pilot seeks to study.
4. Non-Exchange Trading Centers
As proposed, the Pilot would exclude non-exchange trading centers
such as alternative trading systems (``ATSs'').\33\ Several commenters
opined on this aspect of the proposal. A number of commenters agreed
with the Commission's proposal to exclude non-exchange trading centers
from the Pilot.\34\ Some of those commenters noted that exchanges are
subject to various fee-related regulatory provisions that are entirely
inapplicable to non-exchange trading centers. For example, one
commenter noted that non-exchange trading centers are not currently
subject to any access fee caps, and including such trading venues in
the Pilot ``would have the unintended and harmful effect of
unnecessarily changing ATS business models . . . .'' \35\
---------------------------------------------------------------------------

\33\ See Proposing Release, supra note 2, at 13014. As discussed
in the Proposing Release, the term ``trading center'' as used there
and throughout this release is a collective term that refers broadly
to the venues that trade NMS stocks. See id. at 13009 n.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.
\34\ See, e.g., Brandes Letter, at 2; AJO Letter, at 2; MFA
Letter, at 2; BIDS Letter, at 1-2; BlackRock Letter, at 1; SIFMA
Letter, at 5; Virtu Letter, at 6; Fidelity Letter, at 10; Citi
Letter, at 2; Clearpool Letter, at 4-5; Luminex Letter, at 1; Morgan
Stanley Letter, at 3 n.5.
\35\ Virtu Letter, at 6. See also, e.g., SIFMA Letter, at 5;
Clearpool Letter, at 5.
---------------------------------------------------------------------------

In addition, several commenters emphasized the fundamental ways in
which the fee structures employed by

[[Page 5206]]

non-exchange trading centers are different from the fee models utilized
by the equities exchanges and, as a result, concluded that excluding
non-exchange trading centers was appropriate.\36\ For example, one such
commenter explained that ``inducements (low fees, no fees, rebates)
offered by ATSs and other off-exchange venues are not universal across
all broker-dealers or market participants. Instead, the fees paid (or
not paid) by market participants to ATSs and other off-exchange venues
are negotiated between each market participant and the trading venue,''
such that ``the number of fee permutations and inconsistencies across
brokers for any single ATS could be substantial.'' \37\ Still other
commenters believed that excluding non-exchange trading centers from
the Pilot was appropriate because ``ATSs are not protected venues, and
thus free market competition among them constrains their pricing
power.'' \38\ One commenter supported excluding ATSs because ``there is
nothing to be gained by including venues that don't have the same
underlying issues that exchanges present with their rebate and `maker-
taker' pricing models.'' \39\
---------------------------------------------------------------------------

\36\ See, e.g., Morgan Stanley Letter, at 3 n.5 (stating that
``many broker-dealer[ ] operators of ATSs generally charge clients
an overall commission rate (rather than an access fee) for a bundle
of services, including access to their ATSs''); BIDS Letter, at 1-2,
AJO Letter, at 2; Healthy Markets Letter I, at 10.
\37\ AJO Letter, at 2.
\38\ Citi Letter, at 2. See also, e.g., Fidelity Letter, at 10
(stating that ``ATS' fee structures are already subject to
competitive market forces and have more complex pricing models than
exchanges[,] making their participation in the Proposed Pilot less
useful''); SIFMA Letter, at 5 (opining that ``competitive forces
already push access fees [at ATSs] to an appropriate level . . .
lower than the access fees charged by exchanges,'' because ATS
access fees ``are included in the total cost consideration of
trading'').
\39\ Luminex Letter, at 1.
---------------------------------------------------------------------------

On the other hand, other commenters expressed concerns with
omitting non-exchange venues from the Pilot.\40\ One concern was that
by excluding non-exchange venues, the Pilot data would be incomplete.
For example, one commenter believed that excluding non-exchange venues
``could create an imperfect picture of the overall impact of the
transaction fees put in place under the Pilot program'' and could
compromise the value and utility of the data collected during the
Pilot. \41\ Another commenter argued that by excluding non-exchange
venues, the Pilot will not return ``meaningful data upon which to make
informed analysis and conclusions'' because it would ``ignore off-
exchange trading representing approximately 39 percent of total U.S.
equities market trading.'' \42\ This commenter further believed that
the Pilot would be unable to properly assess the potential conflicts of
interest because it will not know ``the baseline for remuneration
occurring off-exchange, or know what impact the Proposal has on that
baseline[.]'' \43\ One commenter objected to excluding ATSs ``based on
the fact that the proposed Pilot is a `new regulatory regime' for ATSs
. . . .'' \44\ While one commenter recognized the complexity involved
with subjecting non-exchange trading centers to the access fee cap
under Rule 610(c), it argued that such complexity did not provide a
sufficient basis to treat exchanges and non-exchange trading centers
disparately.\45\ A few commenters recommended excluding ATSs, but
requiring them to submit the required order routing data.\46\
---------------------------------------------------------------------------

\40\ See, e.g., Nasdaq Letter I, at 2, 5-7; Cboe Letter I, at
12-13; MFS Letter, at 2; RBC Letter I, at 4; ASA Letter, at 3;
ViableMkts Letter, at 2; Angel Letter II, at 2.
\41\ See Wellington Letter, at 2 (acknowledging, however, that
it is ``impractical for the Commission to include off-exchange
venues''). See also, e.g., RBC Letter I, at 4; ProAssurance Letter,
at 2.
\42\ Nasdaq Letter I, at 2, 5-7. See also, e.g., NYSE Letter I,
at 2.
\43\ See Nasdaq Letter I, at 7.
\44\ See, e.g., Cboe Letter I, at 13.
\45\ See NYSE Letter I, at 7-8.
\46\ See, e.g., Better Markets Letter, at 8.
---------------------------------------------------------------------------

The Commission believes that excluding non-exchange venues from the
Pilot should not negatively impact the Pilot's data or impact its
results. As noted above, the Pilot is designed, among other things, to
assess the effects of exchange fee models. Because exchange fee models
are materially different both in their structure and regulatory
treatment, the potential effects that may be associated with exchange
fee models are not applicable in the same manner to ATSs. Similarly,
the question of whether rebates narrow the quoted spread is
inapplicable to ATSs, which do not publicly display an automated
quotation. Further, ATS activity is not being overlooked as increases
or decreases in ATS volume during the Pilot will be reflected in other
existing data sources. Accordingly, Commission researchers (hereinafter
``researchers'') will be able to assess market-wide changes in order
flow during the Pilot.
Further, even if non-exchange venues provided order routing data
pursuant to the Pilot, researchers would be unable to meaningfully
correlate changes in an ATS's order flow with the fees of that ATS
because those fees are bespoke, typically bundled, and are not as
transparent as exchange fees.\47\ Exchange fees are not only fully
transparent in published fee schedules, but exchange fee changes must
be filed with the Commission and thus they have a precise effective
date attached to each filing. This level of transparency for exchange
fees and rebates, which is not present for ATSs,\48\ is an important
component facilitating researchers' ability to draw causal connections
with the Pilot's results. While obtaining order routing data from ATSs
might provide interesting insight into their business, it could not be
meaningfully correlated with ATS fees and fee changes and is not
necessary to study the Pilot's results. Rather, existing sources of
data on ATS activity, including data published by the Financial
Industry Regulatory Authority (``FINRA''), will permit researchers to
observe changes in ATS activity during the Pilot.
---------------------------------------------------------------------------

\47\ As noted by several commenters, equities exchanges and non-
exchange trading centers currently employ different fee models.
While equities exchanges charge transaction-based fees, non-exchange
trading centers may not charge separate transaction-based fees, but
instead may use bundled pricing such that a particular order is not
necessarily associated with a particular fee. See, e.g., Morgan
Stanley Letter, at 3 n.5 (stating that ``many broker-dealer[ ]
operators of ATSs generally charge clients an overall commission
rate (rather than an access fee) for a bundle of services, including
access to their ATSs''); BIDS Letter, at 1-2, AJO Letter, at 2. See
also Proposing Release, supra note 2, at 13016. The Commission is
not aware of any ATSs that currently pay transaction-based rebates.
\48\ See supra notes 310-312 and accompanying text (discussing
recent amendments to Regulation ATS and their relevance to the
proposed Pilot).
---------------------------------------------------------------------------

Among commenters critical of excluding non-exchange venues, some
believed it could raise competitive issues to apply the Pilot's pricing
limitations to the equities exchanges, but not impose the same pricing
limitations on non-exchange trading centers that trade the same
equities securities.\49\ One exchange commenter found it
``inexplicabl[e]'' that the Pilot ``focuses only on exchanges and
entirely ignores off-exchange venues, which are the venues that are
most likely to benefit from a pilot that pointedly decreases the
incentive (i.e., rebates) to post protected quotes on-exchange.'' \50\
---------------------------------------------------------------------------

\49\ See, e.g., ASA Letter, at 3; Cboe Letter I, at 12, 26-27;
Nasdaq Letter I, at 5-7; NYSE Letter I, at 3-8.
\50\ See Cboe Letter I, at 12. See also Nasdaq Letter I, at 6;
NYSE Letter I, at 3-5; NYSE Letter II, at 12.
---------------------------------------------------------------------------

Several commenters suggested that the exclusion of non-exchange
trading centers from the Pilot could ``create incentives for market
participants to move more order flow to off-exchange platforms,''
thereby putting the national securities exchanges at a competitive
disadvantage as compared to off-exchange trading centers.\51\ However,
a

[[Page 5207]]

commenter suggested the opposite could happen and that the Pilot might
actually ``encourage more order flow to gravitate to the exchanges''
because the Pilot would reduce the access fee cap on the equities
exchanges thereby making it less expensive to transact on an
exchange.\52\
---------------------------------------------------------------------------

\51\ See, e.g., Wellington Letter, at 2; Oppenheimer Letter, at
3; Angel Letter II, at 2; Nasdaq Letter I, at 6-7; Cboe Letter I, at
12; NYSE Letter I, at 3-5; Curtiss-Wright Letter, at 1; ASA Letter,
at 3.
\52\ See, e.g., Citi Letter, at 2; Decimus Letter, at 5-6.
---------------------------------------------------------------------------

The Commission does not believe that the Pilot necessarily will put
the equities exchanges at a competitive disadvantage or
disproportionally harm them when competing with non-exchange trading
centers for investors' orders. Currently, only exchanges are subject to
the Rule 610(c) fee cap, and Test Group 1 is designed to test a lower
cap. The Commission does not believe that exchanges charging lower fees
will necessarily make them less competitive with other venues for
natural order flow, for example order flow that removes liquidity.
Rather, it is possible that lower fees in Test Group 1 across all
exchanges may actually improve their competitive position in attracting
that order flow,\53\ particularly with respect to fee sensitive routing
algorithms because, all else being equal, fee sensitive algorithms
generally seek to minimize trading costs and would likely rank
exchanges more favorably in their routing tables when exchanges reduce
their fees to remove liquidity.
---------------------------------------------------------------------------

\53\ See, e.g., Citi Letter, at 2; Decimus Letter, at 5-6. See
also, infra Section IV.D ``Impact on Efficiency, Competition and
Capital Formation'' and note 782 infra and accompanying text.
---------------------------------------------------------------------------

In addition to testing a lower fee cap level, the Pilot also will
test a prohibition on rebates and ``Linked Pricing,'' which, as
discussed further below, is defined as a discount or incentive on
transaction fee pricing applicable to removing (or providing) liquidity
that is linked to providing (or removing) liquidity.\54\ The intent of
this is to gather data to assess, among other things, the effect of
exchange rebates. Potential distortions, which may be caused or
exacerbated by exchange rebates, may themselves be placing exchanges at
a competitive disadvantage, in which case the elimination of rebates
could improve the competitive position of exchanges, for example if
taker fees are set at levels independent of the need to subsidize maker
rebates. Once again, data is needed to empirically assess this issue,
and the Commission believes that the Pilot is the best way to obtain
that data.\55\
---------------------------------------------------------------------------

\54\ See Rule 610T(a)(2).
\55\ See infra Section IV.A.2. and C.1.a.i.
---------------------------------------------------------------------------

Further, while exchanges may compete with non-exchange trading
centers for order flow, exchange fees and the fees of non-exchange
trading centers are treated very differently under the federal
securities laws. Indeed, one of the distinguishing features of
registered national securities exchanges is that--unlike non-exchange
trading centers--their fees are subject to the principles-based
standards set forth in the Exchange Act, as well as the rule filing
requirements thereunder. In particular, the federal securities laws
require the entirety of each and every fee, due, and charge assessed by
an exchange to be transparent and publicly posted for all to see, and
must be an equitable allocation of reasonable dues, fees and other
charges and not be unfairly discriminatory.\56\ On the other hand,
similar requirements do not apply to the fees of non-exchange trading
centers that do not provide public transparency into their full
itemized fee schedules and typically are individually negotiated on a
customer-by-customer basis.\57\ By including all equities exchanges
regardless of fee model, and excluding other types of trading centers,
the Pilot is designed to include all trading centers whose fees are
subject to the principles-based standards set forth in the Exchange Act
as well as the rule filing requirements thereunder.\58\ Thus, the Pilot
will produce data to empirically evaluate 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.
---------------------------------------------------------------------------

\56\ See 15 U.S.C. 78f(b)(4)-(5).
\57\ All exchange fee changes are published for public comment
and required to be publicly posted on the internet, whereas fees of
non-exchange trading centers are typically bespoke. Fee changes of
non-exchange trading centers are not subject to the provisions of
the federal securities laws requiring that fees be an ``equitable
allocation'' of ``reasonable'' fees and not ``unfairly
discriminatory.''
\58\ See 15 U.S.C. 78f(b)(4)-(5) (requiring, 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.''). In addition, only exchange fees are subject to
the rule filing requirements under Section 19(b) of the Exchange Act
and 17 CFR 240.19b-4 (Rule 19b-4) thereunder. See also Proposing
Release, supra note 2, at 13016.
---------------------------------------------------------------------------

The Commission believes that subjecting non-exchange trading
centers to the Pilot would go beyond the scope of the current
regulatory framework that applies only to exchanges and would not
further the Commission's evaluation of the impact of the existing
regulatory regime, including, but not limited to, the Regulation NMS
fee cap, which applies exclusively to exchange fees and rebates. In
effect, the Pilot will help the Commission carry out its statutory
responsibility to assess the effect of exchange fees and rebates, which
do not apply to non-exchange trading centers.\59\
---------------------------------------------------------------------------

\59\ While exchange fees are filed with the Commission on Form
19b-4 and the Commission publishes notice of them for public comment
and has an opportunity to summarily suspend them within 60 days, the
Commission's non-action on a fee filing within that period does not
constitute an endorsement or approval of an exchange fee. Issues
with fees and how they impact market participants and market
structure may or may not be obvious at first and adverse effects may
take time to manifest as the market adjusts to a new fee. The
Commission, and the exchanges as self-regulatory organizations, must
enforce their rules and the federal securities laws with the goal of
protecting investors and the public interest.
---------------------------------------------------------------------------

5. Options Exchanges
Finally, the Commission proposed to exclude options exchanges from
the Pilot, because options and equities are materially different types
of securities. In addition, the access fee cap under Rule 610(c) does
not currently apply to the options exchanges.\60\
---------------------------------------------------------------------------

\60\ See Proposing Release, supra note 2, at 13015.
---------------------------------------------------------------------------

Several commenters agreed with the Commission's exclusion of the
options exchanges.\61\ No commenters suggested that the Commission
include options markets in the Pilot. For the reasons noted above and
discussed in the Proposing Release, the Commission is not including
options markets within the scope of the Pilot.\62\
---------------------------------------------------------------------------

\61\ See, e.g., MFA Letter, at 2; SIFMA Letter, at 5; Fidelity
Letter, at 10.
\62\ See Proposing Release, supra note 2, at 13015.
---------------------------------------------------------------------------

B. Securities

As proposed, all NMS stocks \63\ that meet specified initial and
continuing minimum standards would be eligible for inclusion in the
Pilot (collectively, ``Pilot Securities'').\64\ The Commission received
a number of comments regarding the scope of Pilot Securities to be
included in the Pilot.
---------------------------------------------------------------------------

\63\ See 17 CFR 242.600(b)(47) (defining ``NMS stock'').
\64\ See Proposing Release, supra note 2, at 13017. See also
Proposed Rule 610T(b)(1)(ii).
---------------------------------------------------------------------------

1. The Share Price Threshold of Pilot Securities
The Commission proposed that an NMS stock must have a minimum
initial share price of $2 at the time the pre-Pilot Period commences to
be included in the Pilot and that any Pilot Securities that close below
$1 at the end of a trading day during the proposed Pilot would be
removed from the Pilot.\65\
---------------------------------------------------------------------------

\65\ See Proposing Release, supra note 2, at 13017; Proposed
Rule 610T(b)(1)(ii). The Commission notes that the proposed language
in Rule 610T(b)(1)(ii) has been modified slightly. As proposed, Rule
610T(b)(1)(ii) contained the phrase ``minimum initial share price of
at least $2 . . . .'' As adopted, the clause ``minimum initial share
price of $2'' is being substituted for the phrase ``minimum initial
share price of at least $2'' to delete redundant text. In addition,
as proposed, Rule 610T(b)(1)(ii) explained that a Pilot Security
that closes below $1 would 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). . . .'' As adopted, this
language is being modified slightly to make it more concise.
Accordingly, as adopted, this language provides that if the share
price of a Pilot Security closes below $1 at the end of a trading
day ``it will be removed from the Pilot.''

---------------------------------------------------------------------------

[[Page 5208]]

One commenter opposed the $2 initial minimum share price threshold
as overly restrictive.\66\ Other commenters, however, agreed that the
securities in the Pilot should have an initial minimum $2 per share
price threshold at the time of the initial stock selection, because
this threshold ``will capture virtually all NMS stocks while minimizing
the risk that securities will drop out of the Pilot . . . .'' \67\ One
of these commenters believed the proposed thresholds would ``help
ensure consistency among the Test Groups and limit the risk of data
anomalies due to changes in the composition of those groups.'' \68\
Another commenter noted that the choice of ``$2 and $1 thresholds . . .
follows the reasonable parameters established during [the] . . . Tick
Size Pilot'' and asserted that the ``determination to pull out
securities that close at under $1 during the pilot seems appropriate,
especially given the fundamentally different fee structures applicable
to stocks with prices less than $1.00.'' \69\
---------------------------------------------------------------------------

\66\ See Angel Letter I, at 2.
\67\ RBC Letter I, at 5. See also, e.g., Better Markets Letter,
at 6; Healthy Markets Letter I, at 11-12.
\68\ RBC Letter I, at 5.
\69\ Healthy Markets Letter I, at 12.
---------------------------------------------------------------------------

The Commission continues to believe that the proposed share price
thresholds for Pilot Securities are appropriate. The Commission notes
that no commenters opposed the proposed $1 minimum continuing price
threshold, which will exclude such stocks from the Pilot because stocks
with quotations of less than $1 are subject to different regulatory and
fee treatment.\70\ The Commission continues to believe that an initial
$2 share price threshold will best balance the need to include a broad
set of NMS stocks in the Pilot with the desire to ensure that
substantially all of the securities selected at the outset of the Pilot
remain part of their respective Test Groups throughout the duration of
the Pilot, including during the pre- and post-Pilot periods. The
Commission does not believe that the $2 threshold is overly restrictive
because, as discussed in the Proposal, it is uncommon for securities
priced at $2 or more to fall below $1.\71\ Lowering the initial stock
selection threshold below $2 could increase the likelihood that
securities selected for the Pilot get dropped from the Pilot if their
share price closed below $1 during the Pilot. Such a result would
change the composition of the Test Groups during the Pilot, which might
adversely impact the quality of the data produced by the Pilot. For
these reasons and the reasons discussed in the Proposing Release, the
Commission adopts as proposed the share price thresholds set forth in
Rule 610T(b)(1)(ii).
---------------------------------------------------------------------------

\70\ See Proposing Release, supra note 2, at 13017.
\71\ See id. at 13017 n.102 (noting that only 4.3% of publicly
traded common stocks and ETPs with a share price above $2 during
2012-2016 dropped below $1 in that period).
---------------------------------------------------------------------------

2. The Duration of Pilot Securities
The Commission proposed that, in order to be included in the Pilot,
an NMS stock must have an unlimited duration or a duration beyond the
end of the post-Pilot period in order to be included in the Pilot.\72\
No comments were received regarding this condition. For the reasons
outlined in the Proposing Release, the Commission adopts this aspect of
the Pilot as proposed.\73\
---------------------------------------------------------------------------

\72\ See Proposing Release, supra note 2, at 13017; Proposed
Rule 610T(b)(1)(ii).
\73\ See Proposing Release, supra note 2, at 13018 n.103.
---------------------------------------------------------------------------

3. Selecting Pilot Securities From All NMS Stocks
The Commission proposed to select Pilot Securities from among the
entire universe of NMS stocks, subject to the minimum share price
threshold and duration requirements. As proposed, the Pilot would
include a broad and diverse cross-section of securities, including, for
example, stocks of all market capitalizations as well as ETPs.
The Commission received comments on the universe of Pilot
Securities that generally fell into four categories: (1) The inclusion
of stocks with market capitalizations below $3 billion, (2) the
inclusion of ETPs, (3) the inclusion of Canadian interlisted stocks,
and (4) the inclusion of NMS stocks other than stocks of operating
companies and ETPs. Each of these points is discussed below.
a. Market Capitalization and Liquidity
The Commission proposed to select Pilot Securities from among NMS
stocks of all market capitalizations.\74\ A few commenters recommended
that the Pilot exclude securities with smaller market capitalizations
and/or thinly-traded securities. One commenter suggested that the
``majority of securities within the Test Groups should be more liquid''
and that thinly-traded securities, if included, ``should be a minority
of all securities in the Test Groups.'' \75\ Similarly, one exchange
commenter stated that the Pilot ``should exclude less active stocks as
the liquidity in such stocks will likely be severely and negatively
impacted by this Pilot.'' \76\ This commenter asserted that ``[l]ess
active stocks are highly dependent on professional liquidity providers
to post liquidity'' and speculated that ``[d]ecreasing incentives for
liquidity providers to post liquidity in less active stocks will have a
pronounced impact on liquidity . . . manifest[ing] in significantly
wider spreads and significantly less depth in these securities.'' \77\
Noting that ``many industry participants appear to advocate for
increased incentives for liquidity provision in thinly-traded stocks,''
the commenter did not believe that the Pilot's goals were ``worth the
risk to liquidity and capital formation that the Commission itself
identifie[d.]'' \78\
---------------------------------------------------------------------------

\74\ See id. at 13018. The EMSAC's recommendation was to limit a
pilot to stocks above $3 billion in market capitalization in order
to avoid overlap with the Tick Size Pilot. See id. The Commission
notes, however, that the Tick Size Pilot ended on September 28, 2018
and the Pilot Period for the Transaction Fee Pilot will not start
before the post-pilot period for the Tick Size Pilot ends on April
2, 2019. See Section II.C.3. infra.
\75\ RBC Letter I, at 6. See also, e.g., Harris Letter, at 1; T.
Rowe Price Letter, at 4.
\76\ Cboe Letter I, at 28.
\77\ Id. See also, e.g., Morgan Stanley Letter, at 4; Leaf
Letter, at 1.
\78\ Cboe Letter I, at 19. See also, e.g., Proposing Release,
supra note 2, at 13069.
---------------------------------------------------------------------------

Another commenter was similarly concerned that the Pilot would
``have a significant impact on small to medium issuers since exchanges
will not be able to provide incentives to market makers to support
trading in those companies' securities.'' \79\ This commenter stated
that ``[l]iquidity rebates can be critical for such securities to
motivate market makers to support the stock with aggressive and
actionable quotations.'' \80\ Further, the commenter opined that the
Pilot would ``risk damaging companies' ability to efficiently raise
capital,'' which it believed would ``particularly harm small and medium
sized companies, for which the current market structure is already not

[[Page 5209]]

optimized.'' \81\ The commenter further argued that ``incentives
(rebates) are important to creating two-sided markets across all
stocks, especially thinly traded stocks.'' \82\
---------------------------------------------------------------------------

\79\ Nasdaq Letter I, at 8-9.
\80\ Id. at 3, 9 (alleging that the Pilot was ``arbitrary and
capricious and not in accordance with law,'' because it gave ``short
shrift'' to these concerns). See also Virtu Letter, at 7 (expressing
concern that the Pilot would ``harm investors in . . . less liquid
ETPs, which will be faced with less liquidity and wider spreads when
they seek to sell their holdings'').
\81\ Nasdaq Letter I, at 2. See also ASA Letter, at 5.
\82\ Nasdaq Letter III, at 1. The commenter provided a chart
showing how the exchanges compare to each other with respect to
maintaining a two-sided quote at least 50% of the day. In the chart,
some of the exchanges with a higher percent of two-sided markets
more than 50% of the day have taker-maker pricing, in which they
incentivize the removal of liquidity and charge fees to the provider
of liquidity. Id. at Exhibit A. But cf. NYSE Letter II, at 9-10
(arguing that rebates are necessary to promote display of
liquidity).
---------------------------------------------------------------------------

Many other commenters supported including a broad scope of Pilot
Securities. For example, a group of twenty-one asset managers
submitting a joint letter stated that ``[a]s many NMS stocks as
possible should be in scope, including those with market
capitalizations below $3bln,'' in order to create a ``meaningful''
dataset.\83\ Another commenter agreed that the Pilot ``should encompass
the broadest universe of securities, as is feasible, in order to
maximize the sample size and provide the most robust dataset
possible,'' further arguing that ``[o]mitting securities of a specific
market cap seems arbitrary, would provide an incomplete view of the
overall market, and runs the risk of excluding meaningful data and
biasing the study.'' \84\
---------------------------------------------------------------------------

\83\ Joint Asset Managers Letter, at 2. See also, e.g., Spatt
Letter, at 1-2 (stating that the Pilot was a ``very significant
improvement over the EMSAC proposal'' and that one of the ``major
improvements'' was ``the inclusion of lower market value stocks'');
Healthy Markets Letter I, at 11-12; Wellington Letter, at 2; MFA
Letter, at 2; Nuveen Letter, at 2; Lipson Letter, at 1; BlackRock
Letter, at 1; Vanguard Letter, at 2; CFA Letter, at 4; CIEBA Letter,
at 2; Joint Pension Plan Letter, at 2; Oppenheimer Letter, at 2.
\84\ AJO Letter, at 2.
---------------------------------------------------------------------------

Building on these arguments, other commenters believed it was
important to specifically ``test the argument that rebates are required
to promote liquidity provision in illiquid stocks.'' \85\ One commenter
noted that this debate ``has raged for years,'' which is ``the point of
the pilot: To provide market participants and the Commission with the
data needed to make those analyses.'' \86\ Another commenter similarly
asserted that the Pilot should include a broad set of NMS stocks to
``help settle academic debates on the relative impact of rebates on
liquid vs. less-liquid stocks and other supposedly beneficial aspects
of rebates.'' \87\
---------------------------------------------------------------------------

\85\ Babelfish Letter, at 3.
\86\ Healthy Markets Letter I, at 13.
\87\ Better Markets Letter, at 6. See also, e.g., Vanguard
Letter, at 2 (``By including all NMS stocks, the SEC will receive
data to analyze the impacts of transaction fees on market quality
across various types of securities.''); TD Ameritrade Letter, at 6-7
n.11 (``including securities of small, mid and large cap companies .
. . will include some data on the impact that varying transaction
fees will have [on] thinly traded securities'').
---------------------------------------------------------------------------

Notably, some of these commenters directly challenged the argument,
set forth by a number of other commenters, that thinly-traded or
smaller-capitalization NMS stocks would be harmed by the Pilot's
pricing restrictions. One commenter explained that, ``for less liquid
stocks, spreads tend to be wider, and as a result rebates become less
relevant as a matter of simple mathematics.'' \88\ To illustrate the
point, the commenter referred to a ``stock that typically trades at a
five-cent quoted spread,'' noting that a ``typical .0025 per share
rebate would equal one-twentieth of the quoted spread, so in these
instances a market maker's revenue from capturing the spread would far
outweigh the contribution of the rebate'' \89\ (emphasis in original).
Another commenter also questioned the ``significance of liquidity
rebates for making markets in less liquid/smaller-cap stocks,'' because
it believed this ``marginal incentive to provide liquidity . . . is
likely to be weak in the smaller-cap space typically characterized by
wide bid-ask spreads . . . .'' \90\ To support this argument, the
commenter referred to ``an empirical study of changes in maker-taker
arrangements on two European trading venues owned by BATS,'' now owned
by Cboe Global Markets, which suggested that `` `an elimination of the
make fee and a reduced take fee cap would result in worse market
quality for large capitalization stocks but better market quality for
small capitalization stocks' '' (emphasis in original).\91\ For this
reason, the commenter asserted that the ``link articulated by the
opponents of the proposed pilot is at best uncertain and that the pilot
may in fact result in improved liquidity for smaller-cap stocks''
(emphasis in original).\92\ The commenter therefore contended that it
was ``imperative to include a set of smaller-cap stocks in the pilot,
as the opponents' claims on the existence of unambiguous harm to
liquidity appear to be exaggerated and driven by preconceived
notions.'' \93\
---------------------------------------------------------------------------

\88\ IEX Letter II, at 7. See also Credit Suisse Commentary, at
1, 3 (stating that the Pilot ``is likely to affect stocks
differently depending on their liquidity profile,'' but expecting
stocks ``with wider spreads'' in Test Groups 2 and 3 ``to continue
to behave similarly given that their liquidity may be less driven by
rebate-incentivized trading strategies to begin with''). But cf.
NYSE Letter II, at 11 (asserting that it was ``untrue'' that
``spreads for less-liquid securities are not sensitive to rebate
levels'' and referring to chart showing that NYSE American-listed
securities, ``which are generally less-liquid securities'' spent
less average time at the NBBO compared to maker-taker venues).
\89\ IEX Letter II, at 7.
\90\ Decimus Letter, at 4-5 (citing Marios Panayides et al.,
Trading Fees and Intermarket Competition 26 (Charles A. Dice Ctr.
for Research in Fin. Econ., Ohio State Univ., Working Paper No.
2017-3, 2017, available at, https://ssrn.com/abstract=2910438).
\91\ Id. at 5.
\92\ Id.
\93\ Id.
---------------------------------------------------------------------------

The Commission believes that the many commenters have, through
their analysis and ultimate disagreement on this issue, emphasized the
need for the Pilot to test the effect of transaction fees and rebates
on NMS stocks of all market capitalizations. It is unclear whether or
not changes to fees and rebates would harm smaller capitalization or
thinly-traded NMS stocks.\94\ As some commenters have noted, it also is
possible that the Pilot may have little effect on smaller-
capitalization or thinly-traded NMS stocks or that the Pilot may even
improve the liquidity of such stocks.\95\ The Commission also notes
that a pilot focused solely on large capitalization stocks may not
produce sufficient data to investigate how changes to transaction fees
and rebates will affect liquidity or capital formation across the
market. Because including smaller-capitalization NMS stocks in the
Pilot will produce a more meaningful dataset to support a broad
investigation into the effect of transaction fees and rebates on the
full spectrum of NMS stocks and among different segments of the
securities market, the Commission adopts this aspect of the rule as
proposed.
---------------------------------------------------------------------------

\94\ See, e.g., Proposing Release, supra note 2, at 13065-66,
and 13069.
\95\ See, e.g., notes 88-92 supra and accompanying text.
---------------------------------------------------------------------------

As discussed further below, notwithstanding the decision to include
all NMS stocks regardless of market capitalization, the Commission
believes it is appropriate to exclude certain thinly-traded securities
(e.g., securities that trade fewer than 30,000 shares per day), in part
because rebates at that level of trading would be low enough to be
unlikely to impact order routing behavior and researchers would be
unlikely to get sufficient statistical power to analyze them in
isolation at those volume levels.\96\
---------------------------------------------------------------------------

\96\ See supra Section II.C.6 (discussing the exclusion of
securities that trade fewer than 30,000 shares per day on average
from Test Groups 1 and 2). See also supra notes 88-92 and
accompanying text. Accordingly, the Commission notes that many
thinly-traded securities will be excluded from the Pilot, which
should assuage commenters' concerns regarding the impact of the
Pilot on less liquid or thinly-traded securities.

---------------------------------------------------------------------------

[[Page 5210]]

b. The Inclusion of ETPs
The Commission proposed to select Pilot Securities from among all
NMS stocks, including ETPs. A number of commenters supported including
ETPs in the Pilot. Several commenters noted, for example, that
including ETPs ``would produce a more inclusive analysis of rebates and
fees across all segments of NMS stocks.'' \97\ One such commenter
believed that ``the benefits from collecting data that informs long-
term market structure improvements will outweigh any potential
temporary disadvantage.'' \98\
---------------------------------------------------------------------------

\97\ BlackRock Letter, at 1. See also, e.g., Fidelity Letter, at
9.
\98\ Vanguard Letter, at 2.
---------------------------------------------------------------------------

On the other hand, a number of commenters expressed concern with
including ETPs in the Pilot. For example, one commenter stated that
``[m]any ETP issuers are . . . strongly opposed to the inclusion of
ETPs in the Pilot'' and suggested that the Commission had not
``sufficiently explained why it is appropriate to include ETPs in any
Pilot.'' \99\ This commenter noted that ``exchanges have implemented
numerous incentive structures designed to promote liquidity and narrow
spreads in ETPs'' that could be disrupted by the Pilot, ``negatively
impact[ing] liquidity and spreads in ETPs to the detriment of both new
and existing investors.'' \100\ Similarly, another commenter expected
the Pilot to ``result in spreads widening for ETPs holding pilot
stocks, even if ETPs are not included in the pilot, given that fair
value calculations rely on underlying constituent pricing,'' and
therefore cautioned that ``any negative effects of the pilot on
transaction costs could be intensified for ETP investors.'' \101\ A few
commenters ``believe[d] that the goals of the pilot can be achieved
without having to include ETPs in the pilot,'' because ``[t]he effects
of the pilot on stocks will be sufficient to draw conclusions about
potential changes to access fee rules.'' \102\
---------------------------------------------------------------------------

\99\ Cboe Letter I, at 17-18.
\100\ Id.
\101\ State Street Letter, at 3.
\102\ See, e.g., id.
---------------------------------------------------------------------------

The Commission continues to believe that it is important to include
ETPs in the Pilot, because excluding them would hamper the Commission's
ability to gather key data that could be used to inform future
regulatory action in this area. The Commission does not believe it will
be able to draw meaningful conclusions about the impact of changes to
transaction fees and rebates on ETPs by observing the effects of the
Pilot on other securities, in part because ETPs have a unique create-
and-redeem process that does not apply to other NMS stocks.\103\
Nevertheless, ETPs are subject to the same rules and fees that apply to
all NMS stocks. To the extent that the Pilot results may inform future
policymaking, Pilot data that includes all types of NMS stocks that
would be impacted, including ETPs, will be more useful.
---------------------------------------------------------------------------

\103\ See, e.g., Securities Exchange Act Release No. 75165 (June
12, 2015), 80 FR 34729, 34732 (June 17, 2015) (Request for Comment
on Exchange-Traded Products) (discussing the create-and-redeem
process for ETPs); Transcript of the Division of Trading and
Markets' Roundtable on Market Structure for Thinly-Traded Securities
(April 23, 2018), available at https://www.sec.gov/spotlight/equity-market-structure-roundtables/thinly-traded-securities-rountable-042318-transcript.txt (Panel Three discussing ETPs). In particular,
large volumes in ETPs can be transacted directly with the ETP issuer
in creation units, making the trading center volume in ETPs less
relevant to institutional traders that transact in large size
orders.
---------------------------------------------------------------------------

Further, some commenters expressed concern regarding the potential
for competitive effects among certain ETP issuers. As one commenter
noted, ``if two ETPs with similar underliers or that track the same
index are placed in the two different [T]est [G]roups, the Pilot would
inevitably determine winners and losers.'' \104\ Another commenter
explained that ``ETPs with similar investment strategies are more
substitutable than stocks of operating companies,'' such that ``market
quality metrics likely play a greater role in driving flows to ETPs.''
\105\ For that reason, ``[i]f competing ETPs are in different test
groups--and market quality varies among the test groups,'' the
commenter believed that ``investors might migrate toward products in
the test groups with better market quality,'' thereby ``tilt[ing] the
playing field in favor of ETPs that happen to be assigned--at random--
to test groups that perform better at the expense of other products.''
\106\
---------------------------------------------------------------------------

\104\ Morgan Stanley Letter, at 3-4. See also Nasdaq Letter I,
at 8-9 (stating that the Pilot was ``arbitrary and capricious and
not in accordance with law,'' in part because the Commission had
``fail[ed] to consider'' the competitive effects of placing ``ETPs
tracking similar indexes . . . in different test groups''); Cboe
Letter I, at 17.
\105\ ICI Letter I, at 4 n.8.
\106\ Id. at 4. See also, e.g., NYSE Letter I, at 7; Nasdaq
Letter I, at 8.
---------------------------------------------------------------------------

While a few commenters discussed which treatment group would be
most problematic,\107\ many of the commenters took no position on the
direction of the presumed competitive impact and did not speculate
about how (or whether) inclusion in specific Pilot Groups would help or
harm ETPs.\108\
---------------------------------------------------------------------------

\107\ See, e.g., Credit Suisse Commentary, at 6 (stating that
the Pilot could ``unintentionally advantage ETFs in the lower fee
group''). But cf. Nasdaq Letter I, at 8 (stating that ETPs ``in the
lower rebate groups would find themselves at a competitive
disadvantage to their competitors and may lose market share during
the pilot as a result'').
\108\ See, e.g., SIFMA Letter, at 4-5; Invesco Letter, at 2-3;
Morgan Stanley Letter, at 3-4.
---------------------------------------------------------------------------

To address the potential competitive harm, a few of these
commenters recommended that the Commission exclude ETPs from the Pilot
altogether,\109\ while most recommended that the Commission select ETPs
in a manner that may avoid any potential competitive effects among
similar ETPs, by: (1) Rotating all of the Pilot Securities through the
various treatment groups,\110\ (2) rotating only ETPs through the
various treatment groups,\111\ or (3) placing in the same Test Group
ETPs tracking similar indexes or holding similar investments.\112\
---------------------------------------------------------------------------

\109\ See, e.g., Cboe Letter I, at 28; Invesco Letter, at 2-3;
State Street Letter, at 3; STA Letter, at 4.
\110\ See, e.g., ICI Letter I, at 4-5, 5 n.10 (suggesting that
the Commission rotate securities every three to six months);
Oppenheimer Letter, at 3; Angel Letter II, at 3 (suggesting a
quarterly rotation). These commenters did not believe that rotation
would ``adversely affect the validity of pilot data'' or ``impose
more than a de minimis implementation burden or other costs on
market participants.'' ICI Letter I, at 4. See also Angel Letter II,
at 3. These commenters suggested that ``[a]nalysis of individual
security characteristics before and after a rotation to a new group[
] could yield relevant and important results.'' Oppenheimer Letter,
at 3. See also Angel Letter II, at 3.
\111\ See, e.g., SIFMA Letter, at 5; State Street Letter, at 4;
Healthy Markets Letter II, at 8.
\112\ SIFMA Letter, at 4. See also, e.g., Nuveen Letter, at 2;
BlackRock Letter, at 2; FIA Letter, at 4; Fidelity Letter, at 9;
State Street Letter, at 4; STANY Letter, at 4; Healthy Markets
Letter II, at 8. But cf. Angel Letter II, at 3 (stating that
``similar ETFs are probably the best natural controls for each
other, as their underlying portfolios are virtually identical,''
such that ``similar ETFs should definitely be in different treatment
groups to increase the power of the pilot'').
---------------------------------------------------------------------------

Other commenters criticized these proposed alternatives for
selecting ETPs. One commenter, for example, questioned ``whether any of
the proposed remedies would address these concerns effectively or
fairly.'' \113\ Another commenter expressed concern that the
suggestions to place ``similar'' ETPs in the same Test Group might be
too complex to implement, as determining whether ETPs are ``similar''
to one another for purposes of Pilot rotation can be extremely
nuanced.\114\ This commenter explained that an ``effective
classification should take into account an ETP's underlying index,
portfolio constituents and asset class to provide an appropriate
`apples to apples' analysis,'' in addition to ``factors such as assets
under management, spread size and daily trading volume,'' which the
commenter believed ``would

[[Page 5211]]

introduce unnecessary complexity into the Proposal.'' \115\
---------------------------------------------------------------------------

\113\ Schwab Letter, at 3.
\114\ Invesco Letter I, at 2-3. See also, e.g., Healthy Markets
Letter II, at 8 (noting that it may be ``difficult to clearly and
consistently define `similar' ETPs'').
\115\ Invesco Letter, at 2-3.
---------------------------------------------------------------------------

The Commission recognizes the concern that securities placed in one
treatment group could be impacted differently than similar securities
placed in a different treatment group. While that effect could occur
for any security (e.g., stocks of different operating companies in the
same industry), it could potentially be more prominent for ETPs that
may be substantially similar. Nevertheless, the Commission notes that
similar ETPs are not necessarily identical and many other factors
influence investor demand and trading, including expense ratios,
trading commissions, and existing holdings.
The Commission has carefully considered the three alternatives
suggested by the commenters \116\ and declines to adopt them. Rotating
either (1) all Pilot Securities or (2) only ETPs would increase
complexity and could increase the costs of the Pilot as the Commission,
exchanges, and market participants would need to manage a pilot whose
securities change treatment groups every several months. In particular,
a rotation design would be considerably more complex than the proposed
design by, for example, adding more treatment subgroups and requiring
frequent rotation of those subgroups. Given the choice between a simple
Pilot design with a short duration, on one hand, and a considerably
more complex design with a longer duration, on the other hand, the
Commission prefers to adopt this aspect of the rule as proposed.
Compared to the alternative designs suggested by some commenters, the
proposal results in a short narrowly drawn pilot with fewer
complexities and burdens, which is an outcome supported by many
commenters.\117\
---------------------------------------------------------------------------

\116\ The Commission also considered comments providing
suggestions relevant to the implementation of these three
alternatives. As discussed above, the Commission is not adopting the
alternatives.
\117\ See Section II.D.2 (discussing the duration of the Pilot)
and Section II.C.5. through 6. (discussing the number of stocks to
be included in the Pilot) infra.
---------------------------------------------------------------------------

The Commission also considered the suggestion to group ETPs with
similar underlying holdings into the same treatment group. While this
suggestion involves slightly less ongoing complexity than rotating
securities during the Pilot, the Commission declines to adopt this
suggestion because it introduces its own complexity in that
categorizing ETPs according to their underlying holdings (and
potentially other characteristics) involves the exercise of subjective
judgment. In addition, grouping similar ETPs can negatively impact the
representativeness of the different treatment groups, particularly if
all of the similar ETPs are similar in volume, price, and market
capitalization. The Commission believes it may learn more from a study
that compares how different pricing regimes affect similarly-situated
ETPs, whereas keeping similar ETPs in the same treatment groups could
reduce the quality and usefulness of Pilot's results by inhibiting the
ability of researchers to compare treatment groups. While the potential
exists that similar ETPs in different Pilot treatment groups might
trade differently during the Pilot, it is not certain--and commenters
held divergent views concerning--whether and to what extent the Pilot
would be a contributing factor. Whether the absence of rebates or lower
fees help or hurt trading in similar ETPs is far from certain, and
whether investors would base trading decisions on those distinctions is
unclear. Excluding ETPs to avoid speculative harm would, however,
decidedly reduce the utility of the Pilot's results to inform future
policy making. Therefore, the Commission has determined not to adopt a
requirement to rotate securities or to group like ETPs. For these
reasons, the Commission adopts the rule as proposed to include ETPs in
the Pilot.
c. The Inclusion of Canadian Interlisted Stocks
In the Proposal, the Commission requested comment on the selection
criteria and whether the Commission should consider inclusion or
exclusion of certain stocks from the Pilot sample set.\118\ In
response, several commenters discussed the inclusion of Canadian
interlisted stocks in the Pilot and recommended that the Commission
coordinate with Canadian securities regulators to avoid altering the
trading dynamics between Canada and the U.S. in those securities.\119\
For example, one commenter was ``concerned that the inclusion of
Canadian interlisted stocks in either one of the reduced access fee or
no rebate test groups may materially impact order flow by encouraging
transactions to move away from U.S. exchanges and on to Canadian
exchanges.'' \120\ Other commenters suggested that the Commission
coordinate with the Canadian Securities Administrators to avoid
``dramatic differences in the trading economics on inter-listed stocks
between Canadian and U.S. markets.'' \121\
---------------------------------------------------------------------------

\118\ See Proposing Release, supra note 2, at 13019 (Questions
#5 and 8). See also id. at 13013 n.46 (noting the receipt of a
letter from the Canadian Security Traders Association proposing a
cross-border study on the effect of rebates on market quality in
conjunction with the Canadian Securities Administrators).
\119\ See, e.g., Fidelity Letter, at 8; OMERS Letter, at 1; FIA
Letter, at 4; Healthy Markets Letter I, at 35; STA Letter, at 5.
Canadian interlisted stocks are stocks of Canada-based companies
that are primarily listed on a Canadian exchange (generally the
Toronto Stock Exchange), but that choose to also dually-list on a
U.S. exchange. See https://www.tsx.com/trading/toronto-stock-exchange/fee-schedule/ni-23-101 (for a quarterly list of
approximately 187 interlisted securities published by the Toronto
Stock Exchange featuring stocks that are listed on the Toronto Stock
Exchange or the TSX Venture Exchange).
\120\ FIA Letter, at 4. See also Fidelity Letter, at 8.
\121\ See, e.g., STA Letter, at 5.
---------------------------------------------------------------------------

The Commission also received a comment letter from the academics
retained by the Canadian Securities Administrators (``CSA'') to assist
with planning, conducting, and analyzing a Canadian transaction fee
pilot (``Canadian Pilot'').\122\ According to the CSA researchers, the
Canadian Pilot likely will propose that, for approximately 180
interlisted stocks, 90 of them would be included in a no-rebate test
group with the remaining 90 placed in a control group.\123\ In their
letter, the CSA researchers requested that the Commission's Pilot treat
interlisted stocks similarly to their Canadian Pilot proposal--i.e.,
that both pilots place the same 90 interlisted stocks into their
respective no-rebate group and place the other 90 stocks into their
respective control group.\124\ By doing so, the CSA researchers believe
that both pilots will avoid confounding the analysis for each
respective pilot with respect to interlisted stocks because differences
in fees and rebates otherwise could incentivize shifts in cross-border
routing.\125\
---------------------------------------------------------------------------

\122\ See CSA Letter. The preliminary details of the pilot
contemplated by the CSA, as reflected in the CSA Letter, were not
publicly available prior to the Proposing Release.
\123\ Id. at 1.
\124\ Id. at 2.
\125\ Id. at 1-2.
---------------------------------------------------------------------------

The Commission agrees with the CSA researchers and believes that it
is appropriate to coordinate with the CSA on a transaction fee pilot in
order to avoid the potential for distortionary effects between U.S. and
Canadian markets if rebates in the ``no-rebate'' interlisted stocks
continue to be allowed on one country's exchanges but not the other.
Accordingly, in the event that the CSA proceeds with the Canadian
Pilot concurrently with the Commission's Pilot, the Commission will
append to the no-rebate Test Group the same Canadian interlisted stocks
that the CSA selects for its no-rebate treatment group, and the
remaining interlisted stocks will

[[Page 5212]]

be placed into the Control Group.\126\ Placing the same interlisted
stocks into the Pilot's no-rebate test group that the Canadian Pilot
places into its no-rebate test group will avoid the potential to alter
the trading dynamics between Canadian exchanges and U.S. exchanges in
those stocks that otherwise could result if not all exchanges were
subject to the same conditions, which should support the integrity of
the no-rebate test groups in both pilots.\127\ Coordination also will
avoid the potential for the Commission's Pilot to interfere with the
ability of Canadian securities regulators to conduct a pilot of their
own on Canadian-listed stocks which could be adversely impacted in the
absence of coordination.\128\ The Commission appreciates the interest
expressed by the CSA researchers in coordinating on a pilot with
respect to interlisted stocks, and looks forward to cooperating with
the CSA on this important data-gathering initiative in a manner that
benefits both nations' securities markets.
---------------------------------------------------------------------------

\126\ In the event that the Canadian pilot does not go forward
or does not commence simultaneously with the Commission's Pilot,
interlisted stocks will be placed at the Pilot's outset into the
Control Group. Placing interlisted stocks in the Control Group will
preserve the status quo for interlisted stocks and avoid altering
the trading dynamics in them between U.S. and Canadian exchanges,
which will avoid adversely impacting Test Groups 1 and 2 with
respect to those stocks. If the Canadian pilot does go forward, but
the interlisted stocks that will be included in its no-rebate test
group are not known by the Commission at the time the Commission
issues the initial List of Pilot Securities, the Commission may
separately issue a subsequent list identifying the interlisted
stocks that will be appended to Test Group 2 or the Control Group
for the remainder of the Pilot.
\127\ See, e.g., Proposing Release, supra note 2, at 13024
(discussing the design of proposed Test Group 3 and the prohibition
in Linked Pricing to support the integrity of a no-rebate test
group). See also CSA Letter, at 1 (expressing concern that ``the
results of the Canadian Pilot may be statistically and economically
inconclusive'' without coordination with the Pilot).
\128\ See CSA Letter, at 1.
---------------------------------------------------------------------------

d. The Inclusion of Other Types of NMS Stocks
A few commenters addressed the inclusion of other types of NMS
stocks, such as American Depositary Receipts (``ADRs''), rights, and
warrants. One commenter supported the proposed broad scope of Pilot
Securities and believed that ``analysis of . . . ADRs could provide
additional insight into the effect rebates and fees have on liquidity,
spreads and the overall trade experience.'' \129\ Another commenter
objected to the Commission's proposal to include rights and warrants in
the Pilot, but did not explain the basis for its objection.\130\ As
noted above, however, most commenters expressed general support for a
Pilot that includes all NMS stocks.\131\
---------------------------------------------------------------------------

\129\ Oppenheimer Letter, at 3.
\130\ TD Ameritrade Letter, at 4.
\131\ See, e.g., Vanguard Letter, at 2; Joint Pension Plan
Letter, at 2; Oppenheimer Letter, at 2.
---------------------------------------------------------------------------

The Commission continues to believe that it is appropriate to
select Pilot Securities from among the overall universe of NMS stocks.
Accordingly, the Commission will include all types of NMS stocks in the
Pilot, subject to the selection criteria described below. The
Commission believes this is appropriate because exchange fees and
rebates apply to all NMS stocks, as does the fee cap under Rule 610(c).
Aligning the scope of the Pilot with the scope of equities fees and the
equities fee cap will best facilitate analysis of the impact of changes
to transaction fees and rebates on different segments of the securities
market. Excluding from its scope any categories of NMS stocks would
deprive the Commission of data to inform future regulatory action
regarding this segment of the market. For those reasons, the Commission
adopts this aspect of the Pilot as proposed, subject to the selection
methodology described below in Section II.C.
4. The Ability of Issuers To Opt Out of the Pilot
The Commission solicited comment as to whether issuers should be
allowed to request that their securities not be included in one of the
Pilot's Test Groups (i.e., ``opt out'') and the potential impact that
such an approach might have on the extent and quality of the data
collected by the Pilot.\132\
---------------------------------------------------------------------------

\132\ See Proposing Release, supra note 2, at 13019.
---------------------------------------------------------------------------

Several commenters argued that issuers should be permitted to opt
out of participation in the Pilot based on process concerns. For
example, one commenter's ``largest concern [was] that the genesis of
the proposal . . . deliberately excluded issuer representation'' by
``excluding the NYSE and Nasdaq from participation on the [EMSAC].''
\133\ This commenter asserted that the ``exclusion . . . from
participation in the pre-proposal discussions renders the `Opt Out'
option absolutely essential.'' \134\ Another commenter suggested that
the Commission could address such concerns by ``conven[ing] a summit
for issuers and perhaps [creating] a series of webcasts . . . to
explain the purpose of the test,'' as well as by ``form[ing] an Issuer
Advisory Committee that can weigh data and let companies opt into or
out of a test.'' \135\
---------------------------------------------------------------------------

\133\ Issuer Network Letter I, at 2 (emphasis omitted) and
Issuer Network Letter II. See also Cboe Letter I, at 14-15
(criticizing the Pilot as ``based on recommendations made by a
committee that, however well-meaning, was flawed in its
construction'' because it lacked ``exchange or issuer
representation''); Home Depot Letter, at 2 (stating that the EMSAC
``did not include any input from issuers or issuer advocates . . .
like NYSE and Nasdaq'' and that it was ``difficult'' for ``issuers .
. . to understand how this Pilot could be implemented without input
from the issuers . . . it will directly impact''); ModernIR Email,
at 1 (stating that a ``study . . . crafted without input or choice
for issuers . . . would be an inexcusable travesty'').
\134\ Issuer Network Letter I, at 2, 7 (emphasis omitted).
\135\ ModernIR Email, at 1. See also Issuer Network Letter I, at
7 (suggesting that the Commission ``[p]lace the Access Fee Pilot on
hold for 90 days while [it] gathers a Blue Ribbon Panel . . . of a
dozen or so NYSE and Nasdaq listed company financial executives so
that we might conduct a comprehensive review'' of the Pilot
(emphasis omitted)).
---------------------------------------------------------------------------

The Commission's proposal was subject to a full notice-and-comment
rulemaking process during which the Commission received a large number
of comments from the public, including issuers and their listing
exchanges. While the EMSAC recommendation was one of many inputs that
informed the Commission's development of the Pilot, the Commission's
Pilot differs substantially from EMSAC's recommendation as numerous
commenters have recognized.\136\ Accordingly, the Commission believes
that issuers, as well as other market participants, have had ample
opportunity to participate in the consideration of the Commission's
proposal for the Pilot.
---------------------------------------------------------------------------

\136\ The EMSAC held meetings open to the public, which were
publicly webcast, as it was developing its recommendations. To
promote awareness of those meetings, the Commission issued press
releases to announce those meetings, which included the agenda for
those meetings. See, e.g., SEC Press Release 2015-216 (announcing
the agenda for an October 27, 2015 EMSAC meeting, highlighting the
discussion of fees and rebates, and soliciting comments from the
public thereon), available at https://www.sec.gov/news/pressrelease/2015-216.html. The Commission also published meeting minutes and
transcripts of the full EMSAC meetings. Finally, the Commission
provided a mechanism for the public to submit comments to the EMSAC
for its consideration, and a number of people did submit comments.
See https://www.sec.gov/comments/265-29/265-29.shtml (comment file
for File No. 265-29).
---------------------------------------------------------------------------

Other commenters supported opt out based on specific concerns
surrounding the potential impact of the Pilot. A number of these
commenters were listed company issuers that expressed concern about how
the Pilot would affect trading in their securities.\137\ Commenters

[[Page 5213]]

supporting opt out emphasized the importance of giving issuers the
ability to avoid potential costs and uncertainty resulting from the
Pilot.\138\ For example, one commenter believed that the Pilot could
``caus[e] spreads to widen in securities selected for the test
groups,'' such that ``companies conducting a repurchase program or
secondary offering would incur higher costs,'' and the Commission
received a number of comment letters from listed issuers specifically
referencing that point and echoing the same concerns.\139\ This
commenter further argued that ``the Proposal would also harm the
ability of issuers whose securities are subject to access fee caps to
compete'' with issuers not subject to the Pilot's exchange fee
restrictions.\140\
---------------------------------------------------------------------------

\137\ See, e.g., P&G Letter, at 1; McDermott Letter, at 1; Level
Brands Letter, at 1; ACCO Letter, at 1; NorthWestern Letter, at 1-2;
Ethan Allen Letter, at 1; Unitil Letter, at 1; Johnson Letter, at 2;
Sensient Letter, at 2; Hawaii Letter, at 1; Cott Letter, at 1; Leaf
Letter, at 1-2; First Majestic Letter, at 1; SIFCO Letter, at 2;
Weingarten Letter, at 1; Ennis Letter, at 2; Trex Letter, at 1;
Genesis Letter, at 1; Tredegar Letter, at 1; Energizer Letter, at 1;
ProAssurance Letter, at 1; Home Depot Letter, at 1; SMP Letter, at
2; Halliburton Letter, at 1; Era Letter, at 2; Natural Grocers
Letter, at 2; Newpark Letter, at 2; Knight-Swift Letter, at 2;
Farmer Mac Letter, at 1; BancorpSouth Letter, at 1-2; Haverty
Letter, at 1; Ampco-Pittsburgh Letter, at 2; Anixter Letter, at 2;
Avangrid Letter, at 2; NHC Letter, at 1; HP Letter, at 2; Curtiss-
Wright Letter, at 2; Murphy Letter, at 1.
\138\ See, e.g., Cboe Letter I, at 29; ASA Letter, at 4-5.
\139\ See Addendum to Healthy Markets Letter II, at 11
(attaching an email from NYSE to its listed companies). See also
note 137 supra.
\140\ See NYSE Letter I, at 4. In its letter, the commenter
mentioned analysis it performed on NYSE-listed issuer secondary
offerings in 2017 that suggested that issuers ``with average spreads
under 20 basis points paid an average discount to market price of
2.6%'' and that ``companies with spreads above 20 basis points had
to discount their offerings nearly twice as much, to 4.9%.'' NYSE
Letter I, at 14 n.51. It is unclear, however, whether wider spreads
cause larger offering discounts or whether they are simply
correlated with them. For example, smaller companies that are less
well capitalized may have a wider spread compared to a larger,
better capitalized company, which could result in spreads being
correlated with a company's cost of capital (i.e., wider spreads
could be a reflection of a company's relative credit risk and cost
of capital, not a driver of it).
---------------------------------------------------------------------------

Many other commenters opposed opt out.\141\ Some of these
commenters dismissed the concerns described above regarding the
potential costs on issuers whose stock is included in the Pilot.\142\
For example, one commenter disagreed with the notion that ``rebates are
needed to incentivize market makers to quote tight spreads'' in the
stocks of certain issuers who had submitted comment letters.\143\ This
commenter explained that the ``fifth of a cent rebate is not
incentivizing a tight bid-ask spread in these issuers' stocks,''
because that rebate represents an insignificant portion of their
average spread.\144\ Another commenter disagreed with the suggestion
that the Pilot would have a negative impact on issuers, arguing that
such position ``directly contradicts the public support by investors
for the Pilot.'' \145\ This commenter opined that the ``fundamental
forces of supply and demand that affect . . . the relative
attractiveness of individual public company stocks will be in no way
impaired if . . . exchanges are precluded from paying a rebate, or
required to accept a lower access fee.'' \146\
---------------------------------------------------------------------------

\141\ See, e.g., Joint Asset Managers Letter, at 2; Citi Letter,
at 5; AJO Letter, at 2; Lipson Letter, at 1.
\142\ See supra notes 138-140 and accompanying text.
\143\ Themis Trading Letter II, at 3.
\144\ Id. at 2-3.
\145\ IEX Letter II, at 3. See also, e.g., Joint Pension Plan
Letter, at 2 (stating that the ``asset manager/asset owner community
is heavily supportive of such a pilot,'' which should ``provide the
necessary confidence to all public companies to be included''); ICI
Letter II, at 2 (``market structure is not a primary consideration
guiding the investment decisions of long-term investors''); Joint
Asset Managers Letter, at 2; Healthy Markets Letter II, at 2. But
cf. NYSE Letter II, at 4 (stating that ``many buy-side
institutions'' supporting the Pilot ``are willing to experiment with
real-world public companies and end investors to `get the data,'
even if the expected impact of limiting or eliminating rebates will
be a deterioration of the public quote'').
\146\ IEX Letter II, at 3-4.
---------------------------------------------------------------------------

Other commenters asserted that opt out would ``adversely affect the
quality of the data and the credibility of the Pilot,'' which could
weaken the findings that could be drawn from it.\147\ One commenter
explained that opt out ``would undercut the ability of economists to
draw sharp inferences based upon performance differences between the
treated and control stocks'' and that the ``non-random character of
`opt outs' '' could ``disproportionately reflect firms that were
especially responsive to feedback from the listing exchange or could
disproportionately reflect less liquid stocks, which would be
especially important for the access fee pilot.'' \148\
---------------------------------------------------------------------------

\147\ RBC Letter I, at 6. See also, e.g., LATEC Letter, at 2;
Joint Pension Plan Letter, at 2; MFS Letter, at 3; Clearpool Letter,
at 8.
\148\ Spatt Letter, at 3. See also, e.g., Healthy Markets Letter
I, at 12; CII Letter, at 4.
---------------------------------------------------------------------------

One listed issuer, which is a large investment manager,
``welcome[d] the opportunity for [its] stock to be included in the
Pilot, with the ultimate goal of improving the overall market to be one
where prices can be set by long-term investors without distortion from
speculative market participants.'' \149\ This issuer did not ``expect
that a reduction or outright removal of rebates will have any
significant or harmful effects on the quality of prices displayed in
the public lit market, interfere with genuine liquidity and price
formation, or negatively impact [its] stock's trading volume, spread or
displayed size.'' \150\
---------------------------------------------------------------------------

\149\ T. Rowe Price Letter, at 4. The issuer explained that its
stock, ``on average, trades about 1.5 million shares daily, with an
average displayed size of 200 shares and a spread of nearly $0.07,''
with ``40% of [its] average daily volume occur[ring] as displayed on
exchange volume.'' Id. at 4-5.
\150\ Id. at 5.
---------------------------------------------------------------------------

Finally, two commenters further argued that opt out would be
inconsistent with the existing market structure. One of these
commenters observed that ``[i]ssuers currently have no say over
exchanges' policies'' and that ``exchanges that modify their access
fees dozens of times a year do not survey issuers or permit them to
opt-out of these fee changes or creation of order types.'' \151\ The
other commenter opined that opt out ``may set an unfortunate precedent
that would allow an issuer to pick and choose among those aspects of
the National Market System that it likes while rejecting other aspects
that it may find less attractive to it, but [which] are necessary to
the smooth functioning of [the] United States public equity markets.''
\152\
---------------------------------------------------------------------------

\151\ Better Markets Letter, at 7.
\152\ MFS Letter, at 3.
---------------------------------------------------------------------------

After careful consideration, the Commission does not believe that
issuers should be permitted to opt out of participation in the Pilot.
While the Commission understands issuers' concerns, allowing issuers to
opt out could undermine the representativeness of the Pilot's treatment
groups and potentially bias the Pilot's results, depending on the
number and characteristics of issuers that opt out. In turn,
researchers would be less able to rely on the data to perform analyses
and draw specific conclusions about the impact of the Pilot, thereby
limiting the usefulness of the Pilot's data to the Commission and
future regulatory initiatives.\153\ Although some commenters believe
that issuers may incur potential costs or endure competitive harms
depending on which of the Pilot's treatment groups their stock is in,
other commenters have argued that such effects are unlikely to
manifest. The Commission does not believe it is appropriate to
implement an opt out provision that could frustrate the collection of
useful and representative data based solely on concerns expressed by
some commenters regarding uncertain harms. It is precisely because of
this uncertainty that the Commission believes it is necessary to
conduct the Pilot to study these contested issues through an objective
empirical review of exchange transaction fees and rebates. For those
reasons, the Commission

[[Page 5214]]

adopts this aspect of the Pilot as proposed.
---------------------------------------------------------------------------

\153\ See, e.g., Short Sale Position and Transaction Reporting,
Study by the Staff of the Division of Economic and Risk Analysis,
June 5, 2014, at 66-67 (discussing selection bias in the context of
an ``opt in'' voluntary pilot design).
---------------------------------------------------------------------------

C. Pilot Design

1. Need for a Pilot
As a threshold issue, commenters disagreed about whether the
Commission should conduct any kind of pilot study of transaction fees
and rebates. One commenter, for example, characterized the proposed
Pilot as ``a solution in search of problem'' and claimed that the
Commission ``has provided no evidence that existing fee practices are
harming investors or interfering with fair competition.'' \154\ Another
commenter believed that the Pilot was unnecessary, but for the opposite
reason--namely, that there is ample evidence of the negative effects of
exchange rebate pricing models, such that the Commission should instead
take immediate action to ban them.\155\
---------------------------------------------------------------------------

\154\ Cboe Letter I, at 5. See also, e.g., Virtu Letter, at 1-2;
Nasdaq Letter I, at 12-13. But cf. MFA Letter, at 2 (stating that
``regulators should periodically assess market practices and
regulations to ensure that U.S. equity markets continue to remain
efficient, liquid, fair, resilient and transparent for all market
participants'').
\155\ See Larry Harris Letter, at 9-10.
---------------------------------------------------------------------------

Most commenters, however, thought a Commission-led pilot was
necessary and supported the Commission's proposal to conduct one.\156\
These supportive commenters observed that ``market participants have
heavily debated the effects that transaction-based fees, particularly
access fees, and rebates may have on the equity markets'' and
``commend[ed] the SEC for advancing this discussion through a time-
limited, empirical study.'' \157\ Some of those commenters thought a
Commission-led pilot was necessary because competitive pressures among
exchanges may serve as a barrier to market-led reforms in this
area.\158\ The Commission agrees with the commenters that stated that
the Pilot is necessary because, as reflected in the comments discussed
above,\159\ there is strong disagreement about the impact of exchange
fee-and-rebate pricing models but a lack of data to study the issue.
The Commission believes it is important to further investigate these
impacts.\160\
---------------------------------------------------------------------------

\156\ See, e.g., Decimus Letter, at 4 (stating that the Pilot
``would be valuable in generating concrete information and more
preferable to back-of-the-envelope calculations based on
questionable assumptions''); Wellington Letter, at 1 (stating that
the Commission could only ``draw[ ] definitive conclusions on the
impact of existing pricing models . . . through an actual
implementation'' of the Pilot); Verret Letter I, at 4 (stating that
the Commission ``appears to have considered adoption of a mandatory
rule to reshape market structure, and determined instead to take the
more deliberative and less costly approach of an initial pilot
program to generate more data from which it can determine a path
forward on market structure reform''); IAC Recommendation, at 2; MFA
Letter, at 2; ICI Letter I, at 1-2; RBC Letter I, at 2; Joint Asset
Managers Letter, at 2; Clark-Joseph Letter, at 1; Babelfish Letter,
at 3; State Street Letter, at 2; Themis Trading Letter II, at 3; IEX
Letter I, at 2-3.
\157\ Fidelity Letter, at 2. See also, e.g., Brandes Letter, at
1 (expressing support for the Pilot and the ``Commission's effort to
shed light into a subject of heated debate among market
participants''); Barnard Letter, at 1 (stating that the Pilot was
``important, as historically there are many views on this topic, but
a paucity of credible data from which to draw conclusions''); Angel
Letter II, at 1 (stating that ``various commenters have wildly
differing perspectives on what will happen under the pilot,'' which
is ``strong evidence as to why the pilot is necessary'').
\158\ See, e.g., T. Rowe Price Letter, at 3; Clearpool Letter,
at 2. The Commission notes that Nasdaq conducted an independent
access fee experiment in 2015, but the limited nature of that
experiment makes it difficult to draw conclusions from the data
gathered by Nasdaq. See Proposing Release, supra note 2, at 13011-
12. See also, e.g., IEX Letter III, at 6 (``Nasdaq's experiment and
its outcomes aren't a perfect proxy for what is likely to happen in
the Transaction Fee Pilot. That experiment was done unilaterally and
only in highly-liquid securities.''); Larry Harris Letter, at 9
(noting that Nasdaq's ``experimental fee reduction did not occur at
all trading venues that traded the subject securities,''
demonstrating that ``regulatory action is necessary to establish a
common pricing standard because market forces alone will not do
it'').
\159\ See Section II.A.2 for a discussion of these comments.
\160\ See also Section II.A.2 for a discussion of these impacts.
---------------------------------------------------------------------------

2. Pilot Design
For each NMS stock that meets the initial criteria to be a Pilot
Security, discussed above, the Commission proposed to assign it to one
of three Test Groups, with 1,000 NMS stocks each, or the Control
Group.\161\ The composition of each Test Group would remain constant
for the duration of the Pilot, except, 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.\162\
---------------------------------------------------------------------------

\161\ See Proposing Release, supra note 2, at 13019. The
Commission notes that the proposed language in Rule
610T(b)(2)(ii)(E) has been modified slightly. As proposed, Rule
610T(b)(2)(ii)(E) was labeled as ``Test Group.'' As adopted, the
label ``Pilot Group'' is being substituted for the phrase ``Test
Group'' to provide additional clarity.
\162\ See id.
---------------------------------------------------------------------------

The Commission received a number of comments on the proposed Pilot
design, discussed below, focusing mainly on the number of securities
included in each Test Group. After consideration of all the comments
received and for the reasons discussed below, the Commission is
adopting two Test Groups that each contain 730 NMS stocks, functionally
combining proposed Test Groups 1 and 2 into a new Test Group 1 with a
blended fee cap of $0.0010. Accordingly, for the duration of the Pilot,
the following pricing restrictions will apply to Test Groups 1 and 2,
while the Control Group will remain subject to the current access fee
cap in Rule 610(c):

------------------------------------------------------------------------
Proposed Adopted
------------------------------------------------------------------------
Fee Cap Test Group 1............ 1,000 NMS stocks.. 730 NMS stocks.
$0.0015 fee cap $0.0010 fee cap
for removing & for removing &
providing providing
displayed displayed
liquidity. liquidity.
Fee Cap Test Group 2............ 1,000 NMS stocks.. Not adopted.
$0.0005 fee cap
for removing &
providing
displayed
liquidity.
No Rebate Test Group............ 1,000 NMS stocks.. 730 NMS stocks
(plus appended
Canadian
interlisted
stocks).
Rebates and Linked No change.
Pricing
Prohibited for
removing &
providing
displayed &
undisplayed
liquidity (except
for specified
market maker
activity).
Rule 610(c) cap No change.
applies.
Control Group................... Pilot Securities No change.
not in a Test
Group.
------------------------------------------------------------------------

[[Page 5215]]

3. No Overlap With Tick Size Pilot
---------------------------------------------------------------------------

\163\ See Proposing Release, supra note 2, at 13019-13020 n.117,
13020 (describing the proposed composition of the Tick Size Pilot
overlap subgroups). In the Proposal, the Commission specifically
solicited comment on whether the Pilot should overlap with the Tick
Size Pilot. See id. at 13025.
---------------------------------------------------------------------------

While the Commission's proposed Pilot design took into
consideration the possibility that the Pilot could have been adopted
before the end of the Tick Size Pilot Program, the Commission also
noted that the overlap design would not be necessary if that were not
the case.\163\
A few commenters opined on the potential overlap between the
proposed Pilot and the Tick Size Pilot, disagreeing on whether overlap
would be appropriate.\164\ However, because the Tick Size Pilot ended
on September 28, 2018, there no longer is any need for the Transaction
Fee Pilot to control for potential data distortions that could have
otherwise resulted from the simultaneous operation of the two pilot
programs. Accordingly, the Commission is not adopting the proposed Tick
Size Pilot overlap design.
---------------------------------------------------------------------------

\164\ Cf., e.g., Clark-Joseph Letter, at 2 (noting that overlap
``certainly would not be a serious impediment''); SIFMA Letter, at 3
(arguing against an overlap).
---------------------------------------------------------------------------

Relatedly, some commenters discussed whether there should be a
delay between the end of the Tick Size Pilot and the start of the
proposed Transaction Fee Pilot, with commenters disagreeing on that
point. For example, one commenter thought a delay would be appropriate
to allow markets to normalize before conducting a subsequent pilot
\165\ while another commenter thought markets would revert to their
baseline state extremely quickly after the Tick Size Pilot ends.\166\
---------------------------------------------------------------------------

\165\ See Cboe Letter I, at 30.
\166\ See Healthy Markets Letter I, at 14.
---------------------------------------------------------------------------

The Tick Size Pilot concluded, but post-pilot data continues to be
collected until April 2, 2019. However, the Transaction Fee Pilot is
subject to a one-month implementation period followed by a six-month
pre-Pilot Period. Accordingly, the core of the Transaction Fee Pilot
will not commence until after the post-pilot period for the Tick Size
Pilot ends. By then, the Commission believes that the markets will have
had sufficient time to normalize and any overlap between the
Transaction Fee Pilot's pre-Pilot Period and the Tick Size Pilot's
post-pilot period will be minimal. In both cases, the respective pre-
and post-pilot periods are collecting benchmark data on the status quo.
As such, the overlap between them should not compromise either dataset.
Finally, two commenters recommended that the Commission analyze the
Tick Size Pilot data prior to proceeding with the Transaction Fee
Pilot.\167\ While preliminary results from the Tick Size Pilot have
been made public, the two pilots are sufficiently dissimilar that the
Commission sees no reason for delay. The Tick Size Pilot tested a wider
minimum increment (from one cent to five cents) for smaller-
capitalization stocks, whereas the Transaction Fee Pilot will test a
lower rate for the Rule 610(c) fee cap and a prohibition on exchange
rebates (which typically are less than one-third of a penny) for stocks
of all market capitalizations. Accordingly, findings from the Tick Size
Pilot are not relevant to the design of the Transaction Fee Pilot.
---------------------------------------------------------------------------

\167\ See Cboe Letter I, at 29; Nasdaq Letter I, at 4.
---------------------------------------------------------------------------

4. Stratified Selection of Pilot Securities
The Commission proposed to select the stocks to be included in each
of the Test Groups and the Control Group through stratified sampling in
a manner that permits comparisons between each Test Group and the
Control Group.\168\
---------------------------------------------------------------------------

\168\ See Proposing Release, supra note 2, at 13019.
---------------------------------------------------------------------------

One commenter expressed support for the proposed approach to
stratification and noted that it was ``fundamental to the ability to
undertake causal inference in this setting . . . .'' \169\ In contrast,
a number of public company commenters expressed concern that stratified
sampling could result in their stocks being placed in a different Test
Group from other similar stocks in their ``peer group,'' which could
complicate comparisons of their stock's performance against peer-group
metrics.\170\ As discussed above, those commenters supported allowing
companies to ``opt out'' of the Pilot, which could impact the
stratification.\171\ Further, as discussed above, some commenters
recommended that the Commission select ETPs for the Pilot in a manner
that may avoid any potential competitive effects among similar ETPs,
either by: (1) Rotating all of the Pilot Securities through the various
treatment groups, (2) rotating only ETPs through the various treatment
groups, or (3) grouping ETPs with similar underlying holdings into the
same treatment group.\172\
---------------------------------------------------------------------------

\169\ See Spatt Letter, at 3.
\170\ See, e.g., Mastercard Letter, at 2; Avangrid Letter, at 2;
Energizer Letter, at 1.
\171\ See supra Section III.C.4.
\172\ See supra Section III.C.3.b.
---------------------------------------------------------------------------

While the Commission understands the concerns of these commenters,
as discussed above in Section II.B, allowing issuers to opt out of the
Pilot could undermine the representativeness of the Pilot's treatment
groups and bias the Pilot's results. Further, also as discussed above
in Section II.B, rotating ETPs would require the Commission to
implement a more complex and lengthy design in order to maintain
sufficient statistical power, both of which would increase the costs
and complexity of the Pilot--a result viewed unfavorably by most
commenters. Finally, grouping similar ETPs also could negatively impact
the stratification of the different treatment groups, particularly if
all of the similar ETPs are similar in volume, price, and market
capitalization. In turn, this could reduce the quality and usefulness
of Pilot's results by inhibiting the ability of researchers to compare
treatment groups. In order to ensure that the Pilot Securities are
selected in a way that permits researchers to investigate causal
connections, it is imperative to stratify the Test Groups so that
researchers can study the effects of changes in fees and rebates within
each Test Group, between Test Groups, and between a Test Group and the
Control Group. In permitting this type of analysis, the Pilot should be
better able to inform future policy considerations to improve the
operation of the national market system to the benefit of investors and
issuers alike. Accordingly, the Commission is adopting the stratified
sampling construct as proposed.
5. Number of NMS Stocks Included in Each Test Group
The Commission proposed to include 1,000 Pilot Securities in each
Test Group (i.e., 3,000 total across three Test Groups) with the
remainder to be included in the Control Group in order to be
representative of the overall population of NMS stocks and provide
sufficient statistical power to identify differences between the Test
Groups with respect to common stocks and ETPs.\173\
---------------------------------------------------------------------------

\173\ See Proposing Release, supra note 2, at 13019-20.
---------------------------------------------------------------------------

Several commenters supported including 1,000 stocks in each Test
Group, believing that including 1,000 stocks in each Test Group would
facilitate analysis of transaction fees and rebates on a broad cross
section of different types of NMS stocks and generate statistically
significant conclusions.\174\
---------------------------------------------------------------------------

\174\ See Brandes Letter, at 2; Themis Trading Letter I, at 3;
Oppenheimer Letter, at 2; Spatt Letter, at 2; IEX Letter I, at 5;
Verret Letter I, at 4; AGF Letter, at 2; MFA Letter, at 3.
---------------------------------------------------------------------------

Many commenters, however, thought that the Pilot should include
fewer

[[Page 5216]]

securities in each Test Group.\175\ Several of these commenters
believed the Pilot could obtain statistically significant data even
with fewer stocks in each Test Group.\176\ Other commenters urged the
Commission to reduce the number of securities included in the Test
Groups in order to reduce costs associated with the Pilot.\177\ Several
commenters argued that the Pilot was effectively a large scale change
to the current equity market structure and that it would be more
appropriate for a pilot program to apply to a smaller percentage of the
universe of NMS stocks.\178\ Further to this point, several commenters
believed that a large Pilot may be difficult to unwind, with one
commenter stating that an immediate return to current transaction fee
and rebate dynamics for stocks included in the Test Groups ``could
prove to be more disruptive to market participants and overall market
quality than the actual implementation of the Pilot.'' \179\ Some
commenters also believed the Pilot would negatively impact trading in
the stocks placed in certain Test Groups, such as by adversely
impacting spreads, and accordingly recommended including fewer stocks
so as to limit potential negative consequences.\180\ Of the commenters
that advocated for reducing the number of Pilot Securities in each Test
Group, some suggested alternative amounts to be included. Several
commenters recommended including 100 stocks in each Test Group.\181\ A
few others suggested that each Test Group include 500 stocks.\182\ One
commenter recommended ``a more tailored Pilot that includes the 225
most heavily traded names, 225 mid-cap stocks, 225 small caps and 225
ETFs would provide statistically significant data without burdening a
material portion of the market.'' \183\ The Commission has carefully
considered the concerns expressed by commenters regarding the size of
the Pilot's Test Groups.\184\ As previously discussed, the Commission
cannot know in advance the full effects of the Pilot, whether they be
positive or negative. Indeed, commenters expressed a variety of
contradicting viewpoints and estimations about the potential impacts of
the Pilot on the execution quality and market quality of NMS stocks
that would be included in the Test Groups.\185\
---------------------------------------------------------------------------

\175\ See Magma Letter, at 3; FIA Letter, at 4; SIFMA Letter, at
4; Schwab Letter, at 2; Fidelity Letter, at 8-9; Citadel Letter, at
2; State Street Letter, at 3; Citi Letter, at 5; Clearpool Letter,
at 7; TD Ameritrade Letter, at 1; STA Letter, at 3-4; STANY Letter,
at 3; Nasdaq Letter I, at 10; Cboe Letter I, at 27; T. Rowe Price
Letter, at 4; Mastercard Letter, at 2; NorthWestern Letter, at 1;
Energizer Letter, at 1; Era Letter, at 1; Knight-Swift Letter, at 2;
ASA Letter, at 4-5.
\176\ See Magma Letter, at 3; Schwab Letter, at 2; Fidelity
Letter, at 8-9; Clearpool Letter, at 7; STA Letter, at 3-4; Cboe
Letter I, at 27.
\177\ See SIFMA Letter, at 4; Schwab Letter, at 2; Citadel
Letter, at 6; Citi Letter, at 5.
\178\ See Magma Letter, at 3; FIA Letter, at 4; Citi Letter, at
5; Clearpool Letter, at 7; Nasdaq Letter I, at 10.
\179\ See Citadel Letter, at 6. See also SIFMA Letter, at 4;
Citi Letter, at 5.
\180\ See STA Letter, at 3; STANY Letter, at 3; State Street
Letter, at 3; TD Ameritrade Letter, at 1, 3; Mastercard Letter, at
2.
\181\ See FIA Letter, at 4; Schwab Letter, at 2; State Street
Letter, at 3; STANY Letter, at 3; Era Letter, at 1; Cboe Letter I,
at 27.
\182\ See SIFMA Letter, at 4; Citi Letter, at 5; STA Letter, at
3.
\183\ See T. Rowe Price Letter, at 4.
\184\ See supra notes 175-183 and accompanying text.
\185\ See, e.g., supra notes 75-93 and accompanying text.
---------------------------------------------------------------------------

Given this uncertainty, it is crucial that the Pilot be able to
produce results that are capable of facilitating an empirical review of
the effect of the prevailing fee structures on the equities markets. To
achieve this purpose, the Pilot needs to generate a sufficient number
of observations over its one-year duration to obtain sufficient
statistical power to identify differences among the Test Groups with
respect to common stocks and ETPs, thereby permitting researchers to
investigate causal connections using economic analysis capable of
finding statistical significance. Statistical power refers to the
ability for statistical tests to identify differences across samples
when those differences are indeed significant and broadly is derived
from the number of observations during a study. In other words,
statistical power can be present when observing a limited number of
subjects over a long period of time or a large number of subjects over
a shorter period of time. Because the Commission desires a shorter
duration for the Pilot, it therefore needs to have sufficient
observable data points over the shorter pilot duration. Accordingly, if
the Pilot does not contain enough securities, it may be incapable of
producing statistically sound results and will not allow researchers to
analyze differences in securities.
With statistical power and a sufficiently large sample size,
researchers can conduct analysis of what impact (1) reductions in fees
and (2) reductions in or prohibitions on rebates might have, if any, on
stocks depending on their trading volume or market capitalization. A
pilot design that would not provide this meaningful data about the
impact that billions of dollars of exchange fees and rebates may have
on the markets and market structure, would not achieve the Commission's
goal of conducting a pilot capable of facilitating an objective
empirical view to advance that debate.
To achieve these aims, using econometric methods designed to allow
researchers to detect a 10% change with a standard confidence level of
95%, the Commission has determined that 730 securities in each Test
Group are needed to enable the Pilot to produce statistically
meaningful results capable of informing the Commission's future
policymaking efforts. The Commission believes that a 10% change in
behavior represents an economically meaningful change that will
facilitate analysis of the Pilot's results, and therefore is an
appropriate standard for the Pilot.\186\ The determination to include
730 securities in each Test Group accounted for the need to obtain
statistically significant results among stocks of various liquidity
profiles as well as ETPs. While the number of NMS stocks that will be
included in each Test Group will be larger than what was recommended by
some commenters, the Commission believes that a smaller number of
stocks may not have sufficient statistical power given the Pilot's
proposed duration.\187\
---------------------------------------------------------------------------

\186\ A confidence level of 95% is a standard accepted
confidence level in statistical analyses. See, e.g., William H.
Greene, Econometric Analysis 1033 (Appendix C.6) (6th ed. 2007)
(discussing standard confidence levels in academic research).
\187\ See also note 695 infra.
---------------------------------------------------------------------------

Furthermore, in response to comments questioning why the Pilot
included more securities than did the Tick Size Pilot, the Commission
notes that the Tick Size Pilot featured 400 corporate stocks for each
of its Test Groups.\188\ Importantly, the Tick Size Pilot did not
contain ETPs or large-cap stocks. In comparison, the Transaction Fee
Pilot will contain ETPs and large-cap stocks. Accordingly, in light of
the significantly higher number of securities eligible for inclusion,
the Transaction Fee Pilot needs to include considerably more Pilot
Securities than did the Tick Size Pilot, while continuing to achieve
the same statistical power for each of those groups of securities.
---------------------------------------------------------------------------

\188\ See, e.g., Citadel Letter, at 6; TD Ameritrade Letter, at
2; Cboe Letter I, at 27. See also Securities Exchange Act Release
No. 74892 (May 6, 2015), 80 FR 27514, 27517 (May 13, 2015) (File No.
4-657) (order approving the National Market System Plan to Implement
a Tick Size Pilot Program).
---------------------------------------------------------------------------

Moreover, while several commenters either implicitly or explicitly
referenced the EMSAC recommendation to include 100 stocks in each Test
Group, EMSAC's recommendation differs substantially from the
Commission's proposal. Notably, the EMSAC recommendation was limited to
common stocks with a

[[Page 5217]]

market capitalization above $3 billion and did not include ETPs, mid-
and small-cap stocks, or other types of NMS stocks. In order for the
Pilot to permit a broader empirical review of the impact of transaction
fees and rebates on order routing, execution quality, and market
quality, it is critical that the sample size be representative of the
population of NMS stocks for which exchange transaction fees and
rebates are economically meaningful. The Pilot must contain enough
securities to achieve the statistical power necessary to permit closer
analysis of the Pilot's results in order to identify differences in
order routing behavior, market quality, and execution quality among
subgroups of NMS stocks (e.g., ETPs, or tiers of common stock).
6. Reduction to the Pilot Size
To respond to commenters' concerns with the size of the Pilot,
including a recommendation from the SEC's Investor Advisory Committee,
the Commission has determined to eliminate one Test Group and reduce
the number of stocks in each Test Group to 730.
In order to materially reduce the size of the Pilot without
sacrificing statistical power, the Commission has determined to: (1)
Only place Pilot Securities in a Test Group if, at the time of
selection, they trade 30,000 shares or more per day on average and (2)
eliminate a Test Group.
With respect to securities that trade fewer than 30,000 shares per
day, assuming, at an extreme, that such security trades 100% of its
volume on a maker-taker exchange paying a $0.0030 rebate, then it would
generate $100 in rebates per day. In addition, for thinly-traded stocks
with wider spreads, the rebate would be less impactful as it would
represent a smaller percentage of the quoted spread. This amount of
rebates would be economically insignificant and would be unlikely to
impact order routing behaviors of broker-dealers. In addition, this
level of trade volume makes it unlikely to produce sufficient
statistical power to analyze the securities in isolation because the
variability in their quoting and trading characteristics renders it
unlikely the Pilot would generate a sufficient number of observations
given the Pilot's proposed duration. In addition, for commenters that
believe that thinly-traded stocks need rebates to narrow their quoted
spreads, excluding these securities from the Pilot will allow exchanges
to continue to apply their current fee schedules to them, which will
provide another point of reference to analyze when comparing these
securities to those with slightly higher trading volumes.
Finally, the Commission believes that eliminating one Test Group
and functionally combining proposed Test Group 1 and Test Group 2 into
a new Test Group with a $0.0010 cap will result in decreasing the
number of NMS stocks included in a Test Group in the Pilot by one-
third, which is integral in reducing the overall size of the Pilot by
more than one-half. The Commission believes this material reduction
directly responds to commenters' concerns, while still providing the
Pilot with a meaningful group in which to test a reduced fee cap and a
prohibition on rebates and Linked Pricing.
Accordingly, the Commission believes that the Pilot's design of 730
NMS stocks per Test Group strikes an appropriate balance by reducing
the number of stocks in each Test Group and thus mitigating the
concerns of commenters about potential detrimental impacts that could
be caused by the proposed larger size of the Pilot,\189\ without
undermining the ability to obtain useful data to study the impact of
changes to transaction fees and rebates on order routing behavior,
execution quality, and market quality for a broad spectrum of stocks.
It also is large enough to accommodate drop offs among Pilot Securities
(e.g., due to mergers, bankruptcies, or stocks closing below $1).\190\
---------------------------------------------------------------------------

\189\ See supra notes 175-180 and accompanying text.
\190\ See Proposing Release, supra note 2, at n. 102.
---------------------------------------------------------------------------

7. Fee Cap Test Groups
The Commission proposed that 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.\191\ The level proposed for
Test Group 2 was $0.0005 per share.\192\
---------------------------------------------------------------------------

\191\ See Proposed Rule 610T(a)(1). See also Proposing Release,
supra note 2, at 13021-22.
\192\ See Proposed Rule 610T(a)(2). See also Proposing Release,
supra note 2, at 13022.
---------------------------------------------------------------------------

After careful consideration of the comments received, which are
discussed below, the Commission is eliminating Test Group 2 and
adopting a revised Test Group 1 with a $0.0010 cap.
a. Fee Cap Level
Commenters disagreed about the appropriateness or justification for
the proposed fee cap levels.\193\ For example, one commenter stated
that ``exchanges currently compete on fees by offering a range of
access fees and rebates within the confines of the current $0.0030
access fee cap'' but the fee caps in Test Groups 1 and 2 ``will reduce
the exchanges' ability to compete on fees by 50% in Test Group 1'' and
``83% in Test Group 2'' which could be ``to the detriment of investors
and the public interest.'' \194\ In contrast, regarding proposed Test
Group 1, another commenter stated that ``[a]t 15 mils, there is still
room for significant fee differentiation and rebates remain sizeable.''
\195\
---------------------------------------------------------------------------

\193\ See Cboe Letter I, at 16 (stating that the Proposing
Release ``does nothing to justify how the $0.0015 and $0.0005 fee
cap levels are appropriate'' and that lowering the current fee cap
``without meaningful discussion or justification is concerning and
inappropriate''); Morgan Stanley Letter, at 1. But cf. Healthy
Markets Letter I, at 15-16 (stating that the fee caps for Test
Groups 1 and 2 ``appear to be well-justified'').
\194\ See Cboe Letter I, at 16-17.
\195\ See Credit Suisse Commentary, at 3.
---------------------------------------------------------------------------

With respect to Test Group 2, one commenter stated that ``[i]f the
ultimate intent of the proposal is to determine whether or not reducing
access fees will have an effect on how brokers route their customers'
orders, then we fully support the notion of Test Group 2 to see if the
incentive to avoid access fees is eliminated with a 5 cents per 100
share cap.'' \196\ Another commenter further stated that ``to the
extent that rebates have been traditionally funded by exchanges by the
fees collected,'' then Test Group 2 ``may lead to rebate reductions''
and obtaining data on this point is ``part of the reason why a study is
needed.'' \197\
---------------------------------------------------------------------------

\196\ See T. Rowe Price Letter, at 2.
\197\ See Healthy Markets Letter I, at 15-16.
---------------------------------------------------------------------------

Finally, the Investor Advisory Committee recommended that the
Commission structure the Pilot's Test Groups ``as simply as possible,''
and was not persuaded that, in addition to having the no-rebate Test
Group, having two additional Test Groups with separate fee caps ``will
generate enough additional information to justify the additional
effort.'' \198\ Accordingly, the Investor Advisory Committee
recommended that the Commission consider having, in addition to the no-
rebate Test Group, only one Test Group with a fee cap and suggested a
cap of $0.0010.\199\
---------------------------------------------------------------------------

\198\ IAC Recommendation, at 1.
\199\ See id. For other commenters suggesting a $0.0010 fee cap,
see Goldman Sachs Letter and NYSE Letter III.
---------------------------------------------------------------------------

The Commission appreciates the recommendation of the Investor
Advisory Committee and agrees with it. As noted above and further
discussed below, eliminating Test Group 2 will decrease the size of the
Pilot by one-

[[Page 5218]]

third. New Test Group 1 will have a cap of $0.0010, which adopts the
Investor Advisory Committee's recommendation and represents a blended
average of the two fee caps the Commission originally proposed.
The Commission believes that new Test Group 1 retains the equities
exchanges' ability to compete through differing fees and rebates, as a
fee cap of $0.0010 provides exchanges with an opportunity to utilize
various fee and rebate structures to compete for order flow. As some
commenters noted, the current access fee cap was set thirteen years ago
and may represent an outsized portion of transaction costs in light of
the technological efficiencies achieved by the equities markets in the
last decade.\200\
---------------------------------------------------------------------------

\200\ See Citi Letter, at 1-2; Goldman Sachs Letter, at 2.
---------------------------------------------------------------------------

As revised, new Test Group 1 will facilitate an analysis of the
extent to which exchanges reduce rebates from their current levels as a
result of a materially reduced cap on the fees used to subsidize those
rebates, and the impact of a reduced fee and rebate level on order
routing behavior, execution quality, and market quality. In addition,
by materially reducing the fee cap, the Commission believes that new
Test Group 1 will provide useful data on the extent to which current
exchange fee levels (bounded by the current access fee cap) serve as a
disincentive to take liquidity on an exchange. Obtaining useful
information to better understand the potential impact of a
significantly reduced access fee cap will ultimately be beneficial to
investors and the public interest, as it may help illuminate the extent
to which the current fees and rebates effect the market and the extent
to which those effects have a detrimental impact on investor
transaction costs.
b. Applicability to Depth-of-Book and Non-Displayed Liquidity
As proposed, Test Groups 1 and 2 were designed to isolate and test
a reduction in the Rule 610(c) fee cap, with all else remaining
unchanged. In the Proposing Release, the Commission asked whether
commenters thought the fee caps in Test Groups 1 and 2 also should
apply to depth-of-book and undisplayed liquidity.\201\ One commenter
recommended that it should.\202\
---------------------------------------------------------------------------

\201\ See Proposing Release, supra note 2, at 13025.
\202\ See Clearpool Letter, at 3 n.6.
---------------------------------------------------------------------------

In the Proposing Release, the Commission stated that it
preliminarily believed it was unnecessary for the fee cap Test Groups
to apply to depth-of-book and undisplayed liquidity because it would be
highly unlikely for an exchange to begin charging more to access non-
displayed interest or depth-of-book quotes (compared to displayed
interest), as it would lead to uncertainty for market participants that
remove liquidity because they typically would not be able to know in
advance or control with absolute certainty whether they interact with
non-displayed interest or depth-of-book quotes.\203\ The Commission
continues to believe it would be unlikely that either maker-taker or
taker-maker exchanges would begin charging differing fees in such a
manner.\204\ Furthermore, the Commission notes that the Rule 610(c)
access fee cap does not currently apply to non-displayed interest or
depth-of-book quotes. Introducing a new variable into the fee cap Test
Groups would make it more difficult to isolate the effects of a
particular change and uncover causal connections. Accordingly, for the
reasons noted above and discussed in the Proposing Release, the
Commission is not adopting this suggestion.\205\
---------------------------------------------------------------------------

\203\ See Proposing Release, supra note 2, at 13023 n.136-37 and
accompanying text.
\204\ In the Proposing Release, the Commission acknowledged that
there were three exchanges that charged different fees for displayed
and non-displayed liquidity. See id. Currently, there are two, IEX
and NYSE American. The Commission notes that the differences in fees
are minimal and because a small portion of exchanges have chosen to
adopt this fee structure to date, it is unlikely a significant
portion will choose to do so.
\205\ See Proposing Release, supra note 2, at 13022-23.
---------------------------------------------------------------------------

c. Prohibiting Rebates and Linked Pricing in Test Groups 1 and 2
In Test Groups 1 and 2 the Commission did not propose to cap the
level of rebates, prohibit rebates, or prohibit Linked Pricing, the
latter two of which it proposed to do in the no-rebate Test Group as
discussed below.\206\ In response, several commenters advocated for
applying restrictions on rebates to the fee cap Test Groups, primarily
in reaction to the potential for exchanges to subsidize their rebates
at or near current levels from sources other than transaction fee
revenue.\207\ For example, one commenter stated that ``[t]here is
already ample evidence to suggest that some exchanges currently use
revenues from other sources to subsidize their order routing
incentives, including rebates,'' such that the proposed fee caps may
have no impact on the level of rebates paid for Pilot Securities in the
fee cap Test Groups.\208\ This commenter therefore suggested that the
fee cap Test Groups include two subgroups, one as proposed, and a
second that would prohibit rebates and Linked Pricing (and also apply
to depth-of-book and non-displayed liquidity).\209\
---------------------------------------------------------------------------

\206\ See Section II.C.6.d. infra. See also Proposing Release,
supra note 2, at 13021-24.
\207\ See CFA Letter, at 6; Clearpool Letter, at 2-3; Healthy
Markets Letter I at 27-29.
\208\ See Healthy Markets Letter I, at 28.
\209\ See id. at 16.
---------------------------------------------------------------------------

The Commission has carefully considered these comments and has
determined not to adopt these additional restrictions. While adding
more variables or more Test Groups to the Pilot could produce
informative results, it would directly complicate the Pilot's design
thus raising the Pilot's costs and burdens. For example, if the
Commission were to add subgroups to new Test Group 1 to prohibit
rebates, it likely would have to expand the number of stocks included
in the treatment groups or expand the duration of the Pilot in order to
achieve statistical power.\210\ It also would further complicate
exchange fee schedules and could lead to more variability in exchange
fees if exchanges customized their pricing differently for each Test
Group and subgroup. Rather, the Pilot's design represents a
comparatively simple construct that is easier to implement and manage
and yet should still facilitate the Commission's ability to analyze the
impact of fees and rebates on order routing behavior, execution
quality, and market quality. Achieving these goals, while minimizing
complexity and burdens, will also assist the Commission as it considers
potential future policy initiatives informed by the results of the
Pilot.
---------------------------------------------------------------------------

\210\ See supra Section II.C.5 discussing the need to generate a
sufficient number of observations over the Pilot's duration to
permit researchers to investigate causal connections using economic
analysis capable of finding statistical significance.
---------------------------------------------------------------------------

In addition, the fee cap Test Groups were specifically selected to
provide the exchanges with the continued ability to offer rebates,
should they so choose, albeit at lower levels, without impacting an
exchange's ability to maintain its net profit on a per transaction
basis. The Commission declines to prohibit rebates in new Test Group 1
as doing so would go beyond the construct and application of the Rule
610(c) fee cap by introducing additional variables, and thus would
distinctly alter the status quo in that Test Group, thereby
complicating the analysis in that treatment group.
Lastly, the Commission continues to believe that it is unlikely
that exchanges will offer rebates at their current levels for Pilot
Securities in new Test Group 1 because exchanges will need to charge
lower offsetting transaction fees in that group in order to maintain a
profitable

[[Page 5219]]

pricing model. However, the Commission also recognizes, as did
commenters, that it is possible that the exchanges may choose to
subsidize rebates in Test Group 1 from other sources of revenue, which
could result in rebates exceeding the fee cap in that group. Whether
and to what extent that would occur in practice would be an important
result in new Test Group 1, and so the Commission believes the Pilot
should be structured so as not to preclude that possible result. The
Commission will closely monitor the fees charged by the exchanges for
non-transaction services during the Pilot and will consider the Pilot's
impact on such fees.
d. No-Rebate Test Group
The Commission proposed that for Pilot Securities in Test Group 3,
equities exchanges generally would be prohibited from offering rebates,
either for removing or posting liquidity, and from offering Linked
Pricing, which, as discussed further below, is defined as a discount or
incentive on transaction fee pricing applicable to removing (or
providing) liquidity that is linked to providing (or removing)
liquidity.\211\ In addition, Test Group 3 would be unique in that its
restrictions would apply not only to displayed top-of-book \212\
liquidity, but also would apply to depth-of-book \213\ and undisplayed
liquidity.\214\ 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.
---------------------------------------------------------------------------

\211\ See Proposed Rule 610T(a)(3); Proposing Release, supra
note 2, at 13022-24.
\212\ ``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'').
\213\ ``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'').
\214\ ``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'').
---------------------------------------------------------------------------

After careful consideration of the comments received on Test Group
3, discussed below, the Commission is adopting Rule 610T(a)(3) as
proposed, though it is being renamed as ``Test Group 2'' since the
Commission has reduced the number of Test Groups from three to two.
e. Prohibiting Rebates
While there was significant disagreement among commenters on this
aspect of the Pilot, most commenters supported a ``no rebate'' group as
they believed it was critical to fully examine the effect that
transaction fees and rebates have on order routing behavior, execution
quality, and market quality.\215\
---------------------------------------------------------------------------

\215\ See, e.g., Joint Asset Managers Letter, at 1; Clark-Joseph
Letter, at 2; Brandes Letter, at 1; CII Letter, at 3; Themis Trading
Letter I, at 3; AJO Letter, at 3; OMERS Letter, at 2; Copeland
Letter, at 2; ICI Letter I, at 3; Nuveen Letter, at 2; SIFMA Letter,
at 3-4; Better Markets Letter, at 2, 5; RBC Letter I, at 3; Vanguard
Letter, at 2-3; Fidelity Letter, at 9; Invesco Letter, at 2; CFA
Letter, at 4; MFS Letter, at 2; Wellington Letter, at 2; Joint
Pension Plan Letter, at 2; Citi Letter, at 2; Oppenheimer Letter, at
2; Clearpool Letter, at 2; Spatt Letter, at 2; Capital Group Letter,
at 3; Healthy Markets Letter I, at 17; IEX Letter I, at 5; Verret
Letter I, at 4; Norges Letter, at 2; AGF Letter, at 1; Decimus
Letter, at 3; JPMorgan Letter, at 3.
---------------------------------------------------------------------------

In contrast, several commenters opposed prohibiting equities
exchanges from paying rebates. Specifically, three of the four exchange
commenters asserted that it would inhibit the ability of exchanges to
compete with off-exchange trading venues.\216\ In addition, these three
commenters, together with other commenters, expressed concerns that
prohibiting exchanges from paying rebates to liquidity providers would
widen the quoted bid-ask spread on exchanges, which could raise costs
on investors.\217\ Several of these commenters believed that
eliminating rebates for ``less-liquid'' or ``small and medium sized
companies'' would disproportionately impact the quoted spreads for such
stocks as they believed that rebates are a more significant incentive
to provide liquidity for less actively traded securities.\218\ Other
commenters also expressed concerns that spreads would widen for ETPs,
specifically less liquid ETPs, if rebates were prohibited or
significantly reduced.\219\
---------------------------------------------------------------------------

\216\ See Cboe Letter I, at 7, 15-16; NYSE Letter I, at 3-6;
Nasdaq Letter I, at 7-8. See also, e.g., Mastercard Letter, at 1-2;
Capital Group Letter, at 3; Magma Letter, at 2; FIA Letter, at 4.
\217\ See, e.g., Cboe Letter I, at 7; Nasdaq Letter I, at 9;
NYSE Letter I, at 6; Magma Letter, at 2; State Street Letter, at 3;
Morgan Stanley Letter, at 4; Cboe Letter II, at 4-7. See also Nasdaq
Letter III, at Exhibit A (providing graphs using data from September
2018 on average quoted spread across exchanges in S&P 500 stocks and
time at the best quote across those stocks). But cf. Larry Harris
Letter, at 6-9 (acknowledging that ``quoted spreads are narrower
under maker-taker pricing,'' but opining that ``the narrower quoted
spreads do not benefit the public'').
\218\ See, e.g., Nasdaq Letter I, at 9; NYSE Letter II, at 11;
RBC Letter I, at 5; Nasdaq Letter III.
\219\ See, e.g., Virtu Letter, at 7; Schwab Letter, at 3; State
Street Letter, at 2.
---------------------------------------------------------------------------

The Commission is aware of the potential for adversely impacting
smaller capitalization securities, however, the Commission does not
agree with the commenters that believe that the Pilot necessarily will
result in such harm, or if there are adverse effects in the trading of
all or some portion of smaller capitalization securities, that the net
effect across securities will be negative. Rather, the Commission
agrees with the many commenters who believed that it is unclear what
the ultimate net impact of a no-rebate Test Group will be on quoted
spreads and trading costs for NMS stocks of different market
capitalizations and trading characteristics.\220\ The purpose of the
Pilot is to generate results that can offer data-driven insight on
these questions as a basis for possible future policy making in this
area. As discussed elsewhere, the revised Pilot has excluded securities
that trade fewer than 30,000 shares per day, as they are less likely to
provide actionable data.
---------------------------------------------------------------------------

\220\ See, e.g., Decimus Letter, at 5 (observing that ``claims
on the existence of unambiguous harm to liquidity appear to be
exaggerated and driven by preconceived notions''). See also Section
IV infra (discussing the uncertainty of the Pilot's outcomes).
---------------------------------------------------------------------------

This lack of empirical clarity is reflected in the divergent views
of commenters who offered conflicting predictions of the outcome of a
no-rebate Test Group. For example, one commenter questioned whether
rebates were necessary to attract displayed liquidity, opining that
``[p]ublic data shows that inverted and flat-fee exchanges often have
quotes on both sides of the NBBO, which shows that market participants
are willing to pay these exchanges to post quotes at the NBBO based on
their intrinsic desire to trade and not just in response to an exchange
rebate'' \221\ (emphasis in original). In response, one exchange
commenter suggested that Cboe EDGA Exchange, which does not pay
rebates, has wider spreads for displayed liquidity as compared to Cboe
EDGX Exchange, which does pay rebates for posting liquidity.\222\ A
different commenter did not ``anticipate a material widening for the
most liquid names (where rebates aren't necessary to incentivize
liquidity providers) or the most illiquid names (where rebates aren't
sizable enough to incentivize liquidity providers),'' and instead
anticipated ``a likely outcome of increased spreads for the middle tier
of

[[Page 5220]]

securities, where rebates have perhaps kept spreads artificially
narrow.'' \223\
---------------------------------------------------------------------------

\221\ IEX Letter II, at 7.
\222\ See NYSE Letter II, at 2. One commenter questioned NYSE's
analysis in this regard, noting that in general EDGA's volume is
limited to ``the most liquid names.'' This commenter stated that
NYSE ``distorts the real likely impact of the [P]ilot'' by including
spreads on less liquid securities. See Mulson Letter II, at 2.
\223\ Citi Letter, at 3-4. See also Credit Suisse Commentary, at
3.
---------------------------------------------------------------------------

Another commenter believed that quoted prices are ``almost always
set by natural investors'' and therefore, ``[r]emoving rebates will not
disrupt the desire of natural investors to post liquidity and tighten
spreads.'' \224\ In response, one commenter was ``skeptical'' about
this and stated that ``it is not realistic for the buy-side to be
continuously active on both sides of the market across all stocks
impacted by the Transaction Fee Pilot.'' \225\ That said, another
commenter, which also is a listed issuer, stated that it did not
``expect that a reduction or outright removal of rebates will have any
significant or harmful effects on the quality of prices displayed in
the public lit market, interfere with genuine liquidity and price
formation, or negatively impact [its] stock's trading volume, spread or
displayed size.'' \226\
---------------------------------------------------------------------------

\224\ See Mulson Letter I, at 1. See also IEX Letter II, at 6.
\225\ NYSE Letter II, at 11.
\226\ See T. Rowe Price Letter, at 5.
---------------------------------------------------------------------------

The Commission believes that the significant disagreement among
commenters on the potential impacts of prohibiting rebates demonstrates
the need to include a no-rebate bucket in the Pilot. For example, it is
unclear what effect--if any--the payment of a rebate has on a stock
that trades over 10 million shares per day with an average natural
quoted spread width constrained by the minimum trading increment of
$0.01. Likewise, it is unclear what effect--if any--the payment of a
rebate has on a stock that trades less than 100,000 shares per day with
an average quoted spread of $0.10 or more. In either case, the absence
of rebates may have little or no effect on quotes or competition for
natural order flow in such securities. Data is needed to empirically
evaluate commenters' diverging views of the effect of rebates. The
Pilot is designed to produce this and other data.
By prohibiting rebates in one Test Group the Pilot should produce
results that facilitate a direct study of the effect of rebates,
including on fees, order routing, execution quality, and market
quality.\227\ The Commission believes that the no-rebate Test Group
will provide useful information on trading in the absence of rebates
that will facilitate a data-driven approach to better understand the
role and effect of rebates in our current market structure. The results
generated by this Test Group will allow researchers to study the
relationship between rebates and quoted spreads for stocks of varying
liquidity profiles and market capitalizations. It also will allow
market participants to directly test with their own order flow whether,
in the absence of rebates in the most actively traded stocks, they are
better able to compete for queue priority and thereby capture the
quoted spread when posting liquidity.\228\ Therefore, the Commission
continues to believe that the Pilot will be substantially more
informative with a no-rebate bucket and the value of generating that
information to inform the Commission's consideration of the effect of
exchange transaction fee models justifies proceeding with the Pilot to
better inform both sides of the rebate debate with data to test their
hypotheses.
---------------------------------------------------------------------------

\227\ See Proposing Release, supra note 2, at 13022-23.
\228\ See, e.g., T. Rowe Price Letter, at 2; Brandes Letter, at
1-2; Babelfish Letter, at 2.
---------------------------------------------------------------------------

In summary, the Commission has carefully considered commenters'
suggested alternatives and whether to include the no-rebate feature in
the Pilot, and in light of the important regulatory purpose the Pilot
is designed to achieve, the Commission has determined that, for the
reasons discussed throughout, it is important to have a Test Group that
specifically focuses on the removal of rebates and the corresponding
impact on conflicts of interest, execution quality, and market quality.
Finally, one commenter asserted that banning rebates ``presents [a]
misapplication of Rule 610(c)'' because the Commission has never before
banned rebates.\229\ While neither Rule 610(c), nor any other
Commission rule, currently prohibits a national securities exchange
from paying a rebate to provide or remove liquidity, the Commission
does not believe that the no-rebate Test Group misapplies Rule 610(c),
or any other rule. The no-rebate Test Group is not based on or related
to Rule 610(c). Rule 610(c) caps fees for removing a protected
quotation, whereas the no-rebate Test Group does not further limit fees
and instead prohibits rebates, among other things. Indeed, the Rule
610(c) fee cap continues to apply--unchanged and in its entirety--to
the no-rebate Test Group.
---------------------------------------------------------------------------

\229\ See Cboe Letter I, at 12-13. See also Section II.G
(responding to comments regarding the Commission's legal authority
to conduct the Pilot).
---------------------------------------------------------------------------

The data generated by the Pilot will help empirically assess, in
light of changing market conditions, whether the existing transaction-
based fee and rebate structure continues to further the statutory
goals.\230\ Importantly, while exchanges would retain the ability to
charge transaction fees as high as the current $0.0030 cap in the no-
rebate Test Group, they would no longer need to charge transaction fees
at levels priced to offset the rebates they formerly paid. Accordingly,
the no-rebate Test Group is intended to test, within the current
Regulation NMS regulatory structure, natural equilibrium pricing for
transaction fees.
---------------------------------------------------------------------------

\230\ For example, if take fees are set at levels to subsidize
maker rebates, and if those rebates have little or no impact on
quoted spreads of certain NMS stocks, then the take fees on trades
in those stocks may constitute a tax on takers of liquidity without
a corresponding benefit to the market.
---------------------------------------------------------------------------

f. Application to Depth-of-Book and Non-Displayed Liquidity
Several commenters supported applying the prohibition on rebates in
the no-rebate Test Group to depth-of-book and non-displayed liquidity
as they believed it would avoid the risk that the Pilot's results could
be subject to distortions if exchanges continue to offer rebates for
depth-of-book and non-displayed liquidity.\231\ In contrast, two
exchange commenters opposed this aspect of the proposal. One
characterized this aspect of the proposal as an ``unjustified pricing
restriction[ ]'' that was part of a ``new regulatory scheme . . . .''
\232\ The other argued that ``[t]he Proposal lacks internal coherence''
in that it excludes ATSs ``because they do not have protected quotes,
but then includ[es] unlit exchange orders that also are unprotected.''
\233\
---------------------------------------------------------------------------

\231\ See, e.g., Clark-Joseph Letter, at 2; Clearpool Letter, at
3 n.6; Healthy Markets Letter I, at 18; IEX Letter I, at 7.
\232\ NYSE Letter I, at 12.
\233\ Nasdaq Letter I, at 6.
---------------------------------------------------------------------------

For the reasons stated in the Proposing Release, the Commission
continues to believe that allowing exchanges to continue to offer
rebates in the no-rebate Test Group for depth-of-book and non-displayed
orders could substantially distort the Pilot results.\234\ The no-
rebate Test Group is designed to test the absence of exchange
transaction rebates. It would weaken the Pilot's results to prohibit
rebates on displayed orders but allow them on non-displayed orders, as
the Pilot would not be able to collect data on what would happen in the
absence of rebates. Only by prohibiting the payment of all rebates in
one Test Group will the Commission be able to gather data on a pure
``no rebate'' environment, thereby facilitating a direct observation of
the impact of rebates on order routing behavior, execution quality, and
market quality

[[Page 5221]]

when compared to the other Test Group and Control Group.
---------------------------------------------------------------------------

\234\ See Proposing Release, supra note 2, at 13023.
---------------------------------------------------------------------------

As noted above, the Commission received a significant number of
comments in support of directly studying the effects of prohibiting
rebates.\235\ In order to avoid the potential distortion from a too-
narrowly-tailored Test Group that focuses only on one type of rebate
but ignores another, the Commission believes that prohibiting rebates
on all exchange volume--including depth-of-book and non-displayed
liquidity--is necessary to generate the most useful Pilot results on
the effect of exchange transaction rebates broadly.
---------------------------------------------------------------------------

\235\ See supra note 215.
---------------------------------------------------------------------------

In addition, the Commission believes that the no-rebate Test
Group's application to depth-of-book and non-displayed orders is
consistent with the Commission's decision to exclude ATSs, which do not
have protected quotes.\236\ As discussed above, ATSs are excluded from
the Pilot based on a number of reasons, including the materially
different treatment of exchange fees under the current federal
securities laws and their lack of a protected quotation. With respect
to the no-rebate Test Group, it would be incoherent for the Commission
to purport to test a prohibition on exchange transaction-based rebates
but do so only for some rebates (i.e., on displayed interest) while
ignoring the potential for exchanges to pay rebates on non-displayed
liquidity and depth-of-book interest.\237\ The possibility that an
exchange could offer rebates for non-displayed and depth-of-book
quotes, while eliminating them on displayed interest, could present a
loophole with the potential to undermine the design of the no-rebate
Test Group and distort the Pilot results for the no-rebate Test Group,
rendering the results of the Pilot's ``no-rebate'' Test Group incapable
of speaking to the impact of rebates.
---------------------------------------------------------------------------

\236\ Cf. supra note 233.
\237\ Price-time priority (where orders are prioritized for
execution based on ranking by price and, when two orders are at the
same price, by time of entry), generally does provide the ability
for an incoming order to bypass non-displayed liquidity.
---------------------------------------------------------------------------

g. Maintaining Rule 610(c) Access Fee Cap
Two commenters recommended that, unlike Rule 610(c), the no-rebate
Test Group go beyond Rule 610(c) to also prohibit exchanges from
charging fees in excess of $0.0030 to provide displayed liquidity.\238\
As noted in the Proposing Release, the no-rebate Test Group is designed
specifically to test, within the current regulatory structure, natural
equilibrium pricing for transaction fees in an environment where
exchange transaction-based rebates are prohibited.\239\ While this
would theoretically allow an exchange to charge fees in excess of
$0.0030 to provide liquidity, the Commission notes that several
exchanges stated that one of the perceived benefits in providing
rebates to liquidity providers is that it facilitates narrower spreads
and therefore believes it is unlikely exchanges would charge such
higher fees during the Pilot.\240\
---------------------------------------------------------------------------

\238\ See Healthy Markets Letter I, at 18; CFA Letter, at 6-7.
\239\ See Proposing Release, supra note 2, at 13023.
\240\ See supra notes 217-218 and accompanying text.
---------------------------------------------------------------------------

One commenter expressed concerns that the no-rebate Test Group
would ``provide exchanges with the flexibility to propose a variety of
new fee structures for liquidity-taking orders,'' which could create
new conflicts for brokers routing customer orders.\241\ Accordingly,
this commenter believed that the no-rebate Test Group should instead
impose a fee cap of $0.0002, where the expectation would be that
rebates would be lowered to a de minimis amount and the Pilot would be
more symmetrical and thereby more effective in analyzing broker order
routing practices.\242\ The Commission continues to believe that in
light of the current debate surrounding the potential conflict of
interest posed by the payment of rebates and potential effects they may
have on the markets, including the many comments received in response
to the Proposal, the Pilot will be substantially more informative with
a no-rebate bucket than a bucket that dramatically lowers the fee cap
assuming that rebates would follow. While reducing the fee cap to
$0.0002 would reduce the likelihood that an exchange would offer
rebates at current levels (assuming the exchange desired to fund
transaction-based rebates only through transaction-based fees),
exchanges would retain the ability to pay rebates and could subsidize
them from other sources of revenue leading to rebates that greatly
exceed $0.0002. In contrast, only a complete prohibition on rebates
will permit researchers to observe directly the impact of rebates on
order routing behavior, execution quality, and market quality, and
compare this Test Group to the Control Group and the other Test Group
where rebates can continue to be offered. Further, imposing a fee cap
of $0.0002 instead of prohibiting rebates would not allow Test Group 2
to test, within the current Regulation NMS regulatory structure,
natural equilibrium pricing for transaction fees, particularly if the
cap is below where the natural equilibrium price would otherwise be
found.
---------------------------------------------------------------------------

\241\ See Citadel Letter, at 5.
\242\ See id.
---------------------------------------------------------------------------

Two commenters expressed concern that because exchanges can
continue to charge access fees of up to $0.0030 per share in the no-
rebate Test Group, they may fail to engage in competition on fees.\243\
In contrast, another commenter believed that, in the no-rebate Test
Group, ``the fee for removing liquidity could still move closer to zero
in order for exchanges to incentivize takers in the absence of
rebates.'' \244\ The Commission believes that observing price
competition in the absence of any distortive effects caused by rebates
is an important aspect of the Pilot. Accordingly, the no-rebate Test
Group is intended to test, within our current regulatory structure,
whether competitive market forces are sufficient to produce natural
equilibrium pricing for transaction fees in the absence of rebates.
---------------------------------------------------------------------------

\243\ See Fidelity Letter, at 9; Citadel Letter, at 5.
\244\ Credit Suisse Commentary, at 4.
---------------------------------------------------------------------------

h. Prohibiting Linked Pricing
In connection with prohibiting rebates, the no-rebate Test Group
also would prohibit Linked Pricing, such that 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.\245\
---------------------------------------------------------------------------

\245\ See Proposing Release, supra note 2, at 13023. The
Commission notes that most exchanges also utilize tiering in their
pricing models in which they offer lower fees or larger credits in
return for additional volume. See, e.g., Spatt Letter, at 4; RBC
Letter II, at 4.
---------------------------------------------------------------------------

Some commenters that addressed the prohibition on Linked Pricing
were supportive of the proposal and generally believed that the
prohibition would preserve the integrity of the Pilot and facilitate an
environment where exchanges are able to set transaction fees at a
natural equilibrium level.\246\ In contrast, two exchange commenters
opposed the prohibition.\247\ Specifically, one commenter characterized
this aspect of the proposal, in conjunction with the prohibition on
rebates, as an ``unjustified pricing restriction'' that is ``unrelated
to Regulation NMS's Access

[[Page 5222]]

Fee Cap.'' \248\ As discussed above, the no-rebate Test Group,
including the Linked Pricing prohibition, is not based exclusively on
the Rule 610(c) fee cap.
---------------------------------------------------------------------------

\246\ See, e.g., Capital Group Letter, at 3; IEX Letter I, at 7.
\247\ See NYSE Letter I, at 12; Cboe Letter I, at 10.
\248\ NYSE Letter I, at 12.
---------------------------------------------------------------------------

The Commission continues to believe that prohibiting Linked Pricing
supports the objective of the no-rebate Test Group, which is to gather
data on the impact of creating an environment where fee levels are not
potentially distorted by the rebates they subsidize and rebates do not
influence routing, particularly for customer orders.\249\ In the
absence of a Linked Pricing prohibition, exchanges could use make
(take) volume to subsidize take (make) activity, which could perpetuate
the cross-subsidization of fees. For example, if an exchange adopts
Linked Pricing for the no-rebate Test Group securities, it might offer
a discounted transaction fee to remove liquidity only to those market
participants that post a certain volume on the exchange. Perpetuating
this potential distortion could cloud the Pilot results for the no-
rebate Test Group if the Linked Pricing incentive interferes with the
Pilot's ability to isolate and analyze the impacts on fees and routing
that the no-rebate Test Group is designed to study.
---------------------------------------------------------------------------

\249\ See Proposing Release, supra note 2, at 13023-24.
---------------------------------------------------------------------------

Two commenters recommended that the Commission also prohibit an
exchange from offering any inducement, including discounts on non-
transaction fees, such as those for market data, co-location, or
connectivity ports, which are linked to trading volumes in the no-
rebate Test Group.\250\ The Commission is not expanding the application
of the Linked Pricing prohibition in the manner suggested by these
commenters. The Pilot, and the no-rebate Test Group specifically, is
designed to test the extent to which transaction fees and rebates
create conflicts of interest that influence order routing or introduce
distortions that impede execution quality and market quality. The Pilot
is not designed to eliminate or control for all potential inducements
to transact on a particular market and the Commission believes that
expanding the Pilot to a wider array of variables could inhibit the
Pilot's ability to isolate the impacts of exchange transaction-based
rebates and the effects they may have.\251\
---------------------------------------------------------------------------

\250\ See RBC Letter I, at 3; MFS Letter, at 2-3.
\251\ As is the case for any fee or fee change an exchange
adopts, if an exchange were to propose such a fee change it would
need to analyze in its Form 19b-4 filing how its fee change
constitutes an ``equitable allocation'' of ``reasonable'' fees and
how it is not ``unfairly discriminatory.'' See 15 U.S.C.
78s(b)(3)(A)(ii).
---------------------------------------------------------------------------

Further, two commenters requested the Commission to clarify that
the Linked Pricing prohibition applies across Test Groups such that
exchanges may not tie rebates or transaction fee discounts in another
Test Group to volume in the no-rebate Test Group.\252\ As previously
stated in the Proposal, the no-rebate Test Group 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 proposing the Linked Pricing prohibition, the Commission recognized
that a Linked Pricing arrangement could potentially distort transaction
fee pricing if fees continue to be set at a subsidy level above their
natural equilibrium, and it also could perpetuate the potential
conflicts of interest associated with rebates and order routing. Any
Linked Pricing incentives offered by exchanges that are linked, or
otherwise related to, posting or removing liquidity in Pilot Securities
included in the no-rebate Test Group would contradict the Commission's
intent for the no-rebate Test Group and frustrate the ability of the
Pilot to generate useful data in that group. Accordingly, the Linked
Pricing prohibition in Test Group 2 prohibits exchanges from offering
any discounts or incentives on transaction fees that are linked to
activity, whether it be posting or removing activity, in any securities
included in Test Group 2, as well as prohibits exchanges from offering
Linked Pricing arrangements in Test Group 2 securities that are based
on, or include, activity in any Pilot Securities.
---------------------------------------------------------------------------

\252\ See IEX Letter I, at 7-8; Norges Letter, at 2.
---------------------------------------------------------------------------

In addition, one commenter ``suggest[ed] that the linked pricing
prohibition should extend to auction fees or any other transaction fees
charged by the exchange,'' as ``[c]losing auction fees, especially, are
a significant source of listing market revenue, and . . . discounts on
these fees could likewise lead to the distortions described by the
Commission (or even to increases in auction fees to other participants
to fund the targeted discounts).'' \253\ Because Rule 610T(a)(3)
prohibits exchanges from providing a discount or incentive on
transaction fees applicable to removing (providing) liquidity that is
linked to providing (removing) liquidity, and auction fees are
``transaction fees,'' the Linked Pricing prohibition applies to auction
fees. Exchanges will not be permitted to consider make (take) volume
during intraday trading when calculating auction fees, as such an
arrangement would perpetuate potential distortions associated with fee-
and-rebate pricing models including the cross-subsidization of fees.
---------------------------------------------------------------------------

\253\ IEX Letter I, at 7.
---------------------------------------------------------------------------

i. Linked Pricing Market Maker Exception
The Commission proposed an exception to the Linked Pricing
prohibition to permit an exchange to adopt new rules to provide non-
rebate Linked Pricing to its registered market makers during the Pilot
in consideration for the market maker meeting rules-based market
quality metrics.\254\ The Commission explained that to qualify for this
limited exception, an exchange would need to propose market making
standards in a 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.\255\
---------------------------------------------------------------------------

\254\ See Proposing Release, supra note 2, at 13024.
\255\ See id. at 13024 n.140.
---------------------------------------------------------------------------

Several commenters requested further clarification about the market
maker exception to the prohibition on Linked Pricing. Specifically, one
commenter recommended that the Commission provide additional detail
about the types of market quality metrics upon which access to Linked
Pricing is contingent.\256\ Other commenters believed that it is
important that any such standards adopted by exchanges be sufficiently
stringent to prevent market participants from availing themselves of
Linked Pricing in a manner that would jeopardize the ability of the no-
rebate Test Group to provide valuable data on the impact of the absence
of rebates (or a rebate-like incentive) on order routing behavior,
execution quality, and market quality or that would permit market
participants to unfairly exploit this aspect of the Pilot.\257\
---------------------------------------------------------------------------

\256\ See Clark-Joseph Letter, at 2-3.
\257\ See, e.g., Brandes Letter, at 2; Themis Trading Letter I,
at 3; CFA Letter, at 7; Clearpool Letter, at 4; Healthy Markets
Letter I, at 33; Decimus Letter, at 6 n.22.
---------------------------------------------------------------------------

The Commission continues to believe that permitting exchanges to
adopt rules to offer Linked Pricing to their registered market makers
for securities in the no-rebate Test Group preserves the ability of an
exchange to attract market makers through non-rebate incentives and
thereby helps maintain the baseline framework in which exchanges can
provide incentives to their registered market makers.\258\ Commenters
highlighted the importance of ensuring that any new rules that
exchanges propose to provide Linked Pricing to registered market makers
in the no-rebate Test Group be designed so as to not inhibit the
Pilot's ability to

[[Page 5223]]

generate useful data on the impact of rebates on order routing
behavior, execution quality, and market quality. The Commission agrees
that if they are not narrowly tailored, these non-rebate incentive
programs could continue to potentially distort transaction fee pricing,
particularly if the exchange's fees are set at a subsidy level above
the natural equilibrium within the current regulatory structure to
subsidize these market maker incentives.
---------------------------------------------------------------------------

\258\ See Proposing Release, supra note 2, at 13024.
---------------------------------------------------------------------------

Rather, the market maker exception to Linked Pricing is intended to
permit an exchange to impose rules for its registered market makers in
ways that would improve its market in a meaningful way, such that it
could use the enhanced liquidity provided by its registered market
makers to improve its displayed quotation and thereby attract buyers
and sellers to the exchange.\259\ The non-rebate incentives would only
apply to trading activity by a registered market maker in its capacity
as a market maker (i.e., acting as principal), and would not apply to
any customer activity or activity from other trading desks or business
units affiliated with the market maker (and possibly using the same
MPID), be it agency, principal or riskless principal trading, traded by
or through such market maker. Accordingly, only a registered market
maker's principal trading activity in its capacity as a registered
market maker in the no-rebate Test Group would be able to satisfy any
market quality metrics, and the only trades that would be eligible to
receive the non-rebate incentive pricing would be a registered market
maker's principal trades in its capacity as a registered market maker
in the no-rebate Test Group securities.
---------------------------------------------------------------------------

\259\ See id. While it will be up to each individual exchange to
design market quality metrics for offering non-rebate Linked Pricing
to their registered market makers, such metrics could include, for
example: (1) Requirements to trade to stabilize the market; (2)
requirements on consecutive price changes and price continuity; (3)
material time quoting on both sides of the NBBO; (4) materially
enhanced quoted depth on both sides of the NBBO; (5) frequency of
setting an improved BBO on the exchange; (6) frequency of setting an
improved NBBO; and (7) compliance with narrow maximum quote widths.
---------------------------------------------------------------------------

8. Control Group
The Commission proposed that Pilot Securities that are not placed
in one of the Test Groups would be placed in the Control Group.\260\
One commenter addressed the Control Group and supported the
Commission's proposed approach.\261\ The Commission continues to
believe that a control group is vital to test the effects of fee
changes in the Test Groups, as a control group subject to the current
access fee cap would provide an appropriate baseline for analyzing the
effects of the Pilot against the status quo.\262\ For these reasons and
the reasons discussed in the Proposing Release, the Commission is
adopting the Control Group as proposed, which will be subject to the
current Rule 610(c) access fee cap.\263\
---------------------------------------------------------------------------

\260\ See Proposing Release, supra note 2, at 13024.
\261\ See Healthy Markets Letter I, at 19.
\262\ See id.
\263\ See 17 CFR 242.610(c). Consistent with Rule 610(c), the
Control Group will only cap fees for taking (removing) a protected
quotation; it will not apply to fees for posting liquidity or
otherwise cap or prohibit rebates. See also Proposing Release, supra
note 2, at 13024.
---------------------------------------------------------------------------

9. Alternative Designs
a. Include a Trade-At Requirement
In the Proposing Release, the Commission asked whether the Pilot
should include a ``trade-at'' provision that would restrict price
matching of protected quotations.\264\ Several commenters supported
including a trade-at requirement because they believed doing so would
increase the amount of liquidity available on exchanges and thereby
further price discovery.\265\
---------------------------------------------------------------------------

\264\ See Proposing Release, supra note 2, at 13025. A ``trade
at'' provision would require that orders be routed to a market with
the best displayed price or be executed at a materially improved
price.
\265\ See e.g., Adorney Letter, at 1; Birch Bay Letter, at 1. In
addition, in clarifying its position on rebates in equity market
structure, NYSE stated that it could support a prohibition on
rebates if ``done in a measured manner that creates an offsetting
incentive to display liquidity, such as a `Trade At' provision[ ]''
which the Pilot does not provide. NYSE Letter II, at 5.
---------------------------------------------------------------------------

In contrast, other commenters opposed including a trade-at
requirement as they believed doing so would increase the Pilot's
complexity; impact the ability of the data to assess the impact of
transaction fees and rebates on order routing, execution quality, and
market quality; be inconsistent with, or unnecessary for, a study of
the issues pertinent to the Pilot; and be anti-competitive.\266\ In
addition, two commenters noted that a trade-at requirement would not be
necessary because the reduction in the fee cap ultimately could result
in more volume being executed on exchanges.\267\
---------------------------------------------------------------------------

\266\ See, e.g., MFA Letter, at 3; ICI Letter I, at 3; BlackRock
Letter, at 2; FIA Letter, at 5; SIFMA Letter, at 4; Fidelity Letter,
at 10; Citadel Letter, at 6-7; Citi Letter, at 3.
\267\ See SIFMA Letter, at 4; Citi Letter, at 3.
---------------------------------------------------------------------------

The Commission believes that adding a trade-at requirement would
unnecessarily complicate the Pilot in a manner that would increase
costs on market participants and potentially impact the ability of the
Pilot to isolate the effects of changes in exchange transaction fees
and rebates. Accordingly, the Commission is not including a trade-at
requirement in the Pilot. If the Pilot were to also assess the impact
of a trade-at requirement, it would need to increase the number of Test
Groups, thereby increasing the number of securities included in the
Pilot, to be able to isolate the effects of a trade-at requirement
separately from the effects of changes in exchange transaction fees and
rebates. The Commission believes any potential benefits from analyzing
the impact of a trade-at requirement do not justify the additional
costs that expanding the Pilot would impose. Rather than introduce
another variable into the Pilot, the Commission believes that the Pilot
should remain focused on permitting an analysis, in the context of our
current market structure, of the effect of exchange transaction fees
and rebates. Further, the Commission notes that the Tick Size Pilot
featured a trade-at test group, so as that pilot's post-pilot period
concludes, the Commission will have access to current data to analyze
the impact of a trade-at prohibition in the context of that pilot.\268\
---------------------------------------------------------------------------

\268\ See also infra Section IV.E (discussing trade-at).
---------------------------------------------------------------------------

b. No Fee Cap Test Group
Several commenters advocated for including a Test Group that does
not cap transaction fees, believing that it is important to test
whether competition alone can constrain pricing and result in a natural
equilibrium transaction fee.\269\ One commenter noted that currently
fees tend to ``cluster'' at the access fee cap imposed by Rule 610(c)
and as such recommended including an additional Test Group that does
not cap fees.\270\
---------------------------------------------------------------------------

\269\ See, e.g., Clark-Joseph Letter, at 2; Nasdaq Letter I, at
13; Cboe Letter I, at 27-28.
\270\ See Barnard Letter, at 1. Another commenter recommended
including a Test Group that did not cap fees because it believed
that the current structure encourages exchanges to charge fees for
data feeds and technology services, which the commenter suggests are
higher than they otherwise would be if transaction fees were not
capped. See Modern IR Letter, at 3.
---------------------------------------------------------------------------

When it adopted Rule 610(c), the Commission explained that the
access fee cap is necessary to, among other things, inhibit the ability
of exchanges to take advantage of the Order Protection Rule by acting
as a ``toll booth'' between price levels and ensure that quotations are
fair and useful by limiting the ability of high fees to distort the
price of displayed limit orders.\271\
---------------------------------------------------------------------------

\271\ NMS Adopting Release, supra note 10, at 37545.
---------------------------------------------------------------------------

The Commission believes that the no-rebate Test Group will permit
analysis of the impact of competitive forces on fees in the absence of
current practices

[[Page 5224]]

that use fees to subsidize those rebates. Specifically, to the extent
exchanges will no longer need to charge access fees up to $0.0030 to
subsidize rebates in that Test Group, the Commission believes that
competitive forces among the exchanges may result in fees approaching a
new equilibrium level, within the current regulatory structure, for
stocks in the no-rebate Test Group.\272\
---------------------------------------------------------------------------

\272\ See, e.g., Goldman Sachs Letter, at 2 (characterizing
$0.0030 as an ``outdated benchmark'' that ``is too high and far from
representative of true prices in the marketplace'').
---------------------------------------------------------------------------

The Commission notes that the order protection requirements of 17
CFR 242.611 (Rule 611) will continue to apply to all of the Pilot
Securities including those in the no-rebate Test Group. As such, the
basis for imposing a fee cap (summarized above) remains intact during
the Pilot and the Commission believes that applying the current fee cap
to the no-rebate Test Group will guard against the possibility, albeit
highly unlikely, that an outlier exchange could seek to charge
exorbitant fees for the no-rebate Test Group stocks that would be
inconsistent with the rationale behind the Rule 610(c) fee cap.\273\
---------------------------------------------------------------------------

\273\ The Commission notes that the Proposal included a question
regarding whether a fee cap would continue to be necessary to
constrain exchange pricing if equilibrium pricing is achieved and
the Commission expects that some market participants may analyze the
Pilot results for answers to this question. See Proposing Release,
supra note 2, at 13025.
---------------------------------------------------------------------------

c. Basis Point Pricing
Two commenters recommended that, because stock prices have
increased (i.e., a number of high profile stocks currently trade above
$100 per share), using basis point pricing may be a better reference
point than using the current access fee cap because the current access
fee cap can impact stocks differently based on their price.\274\
Specifically, one of these commenters proposed that ``Test Group 1
contain the same constraints as Test Group 3 but with an access fee
limitation expressed in basis points.'' \275\ However, the Commission
believes that doing so would increase the Pilot's complexity and could
interfere with the Pilot's ability to provide useful data to assess the
impact of the current exchange fee models on order routing behavior,
execution quality, and market quality because exchange transaction fees
and rebates are currently not assessed in basis points and thus this
would introduce a new variable into the Test Group as it could raise or
lower the fees depending on a stock's share price, which can vary over
time. The more variables that are introduced, the more difficult it
could be to isolate the effects of a particular change and uncover
causal connections. Accordingly, the Commission is not adopting a
requirement that one of the Test Groups include an access fee cap
expressed in basis points.
---------------------------------------------------------------------------

\274\ See Clearpool Letter, at 3; Cboe Letter II, at 8-9.
Another commenter also stated that it thought it was ``a worthwhile
exercise to explore the possibility of a move to basis points. . . .
'' See Citi Letter, at 6.
\275\ See Clearpool Letter, at 3.
---------------------------------------------------------------------------

d. Higher Fee Caps and Fees Based on Tick Size
Four commenters addressed a question in the Proposing Release about
including a Test Group that would allow for access fees higher than the
current cap under Rule 610(c).\276\ One of these commenters
specifically recommended reducing access fees to $0.0005 per share for
the most liquid securities, while imposing gradually higher access fees
for stocks of lower liquidity, up to a cap of potentially $0.0050 for
the least liquid securities.\277\ Another commenter recommended
including an additional Test Group with an access fee cap of $0.0040,
believing this would provide data to test whether an increase in the
fee cap reduces bid-ask spreads in light of the many comments
contending that spreads will increase in conjunction with lower rebates
connected to a reduced access fee cap.\278\ In addition, one commenter
suggested that if tick sizes were set based on the characteristics of
an individual stock, the transaction fee cap could then be a particular
percentage of the tick size.\279\ Such an approach could result in an
access fee cap above $0.0030 per share for certain securities.
---------------------------------------------------------------------------

\276\ See Nasdaq Letter I, at 13; TD Ameritrade Letter, at 6;
Angel Letter II, at 2; Cboe Letter II, at 8.
\277\ See TD Ameritrade Letter, at 6.
\278\ See Angel Letter II, at 2. See also Cboe Letter II, at 8.
\279\ See Morgan Stanley Letter, at 3.
---------------------------------------------------------------------------

The Commission has carefully considered these suggestions. As
discussed above, other commenters have noted that the current access
fee cap was set thirteen years ago when markets and technology were
markedly different.\280\ Indeed, a few commenters argued it was
outdated and too high.\281\ Accordingly, the Commission does not
believe that raising the access fee cap to levels that are above what
trading centers were charging thirteen years ago necessarily is
consistent with the technological efficiencies that have been realized
in the intervening years. While market-based solutions and even
regulatory responses to enhance the investor experience with trading in
thinly-traded securities are worthy of attention, and were the subject
of a recent Division of Trading and Markets staff roundtable, the
Commission does not believe that the Pilot should introduce the
potential for higher rebates--and the further exacerbated distortions
that would likely accompany them--when it is attempting to study the
effect of the current exchange fee models and fee and rebate
levels.\282\ Accordingly, the Commission is not adopting a higher fee
cap in any of the Pilot's Test Groups.
---------------------------------------------------------------------------

\280\ See supra note 200 and accompanying text.
\281\ See id.
\282\ See Transcript of the Division of Trading and Markets'
Roundtable on Market Structure for Thinly-Traded Securities (April
23, 2018), available at https://www.sec.gov/spotlight/equity-market-structure-roundtables/thinly-traded-securities-rountable-042318-transcript.txt.
---------------------------------------------------------------------------

e. Order Protection Rule
The Commission solicited comment on whether it would be appropriate
to suspend the Rule 611 order protection requirements in one or more
Test Groups.\283\ In response, three commenters opposed eliminating the
order protection requirements within the Pilot because doing so would
increase the cost and complexity of the Pilot, and also could
complicate analysis of the Pilot's results to the extent it clouded the
focus on transaction fees and rebates.\284\
---------------------------------------------------------------------------

\283\ See Proposing Release, supra note 2, at 13025.
\284\ See SIFMA Letter, at 4; JPMorgan Letter, at 3; Schwab
Letter, at 3 (also stating that eliminating Rule 611 for certain
Pilot Securities ``would significantly negatively impact retail
order flow and the quality of trade execution'').
---------------------------------------------------------------------------

In contrast, one commenter recommended eliminating the order
protection requirements for securities in the no-rebate Test
Group.\285\ This commenter stated that prohibiting rebates is
insufficient to ``remove the perceived or real conflicts on broker
routing or materially address'' various negative effects that the
commenter believed Rule 611 has had on the equities markets.\286\
---------------------------------------------------------------------------

\285\ See T. Rowe Price Letter, at 2-4.
\286\ See id. at 4.
---------------------------------------------------------------------------

After considering the comments received, the Commission believes
that the Pilot should not introduce additional variables by, in this
case, removing the Rule 611 protected quotation status for automated
quotations in any particular Test Group. In order to add a new variable
to the Pilot, the Commission would need to include additional Test
Groups and increase the number of securities in order to be able to
isolate separately the effects of each variable that is included

[[Page 5225]]

in the Pilot or else it would create an asymmetric Pilot that would
make it more difficult to evaluate the data and establish causal
inferences regarding the impacts of changes to exchange transaction
fees and rebates. As discussed above, most commenters were critical of
the Pilot's proposed size. The Commission desires to have a narrowly
tailored pilot focused on generating useful data on the impact of
exchange fees and rebates on order routing behavior, execution quality,
and market quality. Adding another variable to the Pilot would increase
the Pilot's complexity as well as costs of the Pilot.
f. Other Ideas for Additional Test Groups and Related Questions
In addition to the above questions, the Commission asked a number
of other questions in the Proposing Release to solicit commenters'
opinions on equities market structure issues and whether the Pilot
should be used as a vehicle to further investigate other related areas.
The Commission received a few comments on these points. For example, in
response to a question about whether commenters believe the minimum
trading increment should be reduced for the most actively traded NMS
stocks if the Pilot's data suggests that rebates do not significantly
improve market quality or execution quality for these securities, one
commenter stated it ``would strongly support inclusion of a half-penny
spread bucket, or consideration of a separate small-tick pilot for
highly liquid stocks.'' \287\
---------------------------------------------------------------------------

\287\ Pragma Letter, at 4. See also Proposing Release, supra
note 2, at 13025.
---------------------------------------------------------------------------

Another commenter recommended that the Pilot test a prohibition on
``tiered pricing,'' whereby exchanges offer lower per share fees or
greater per share rebates to market participants that transact in
greater volumes, believing that absent such a prohibition, exchanges
would continue to offer these incentives, which would serve ``to
potentially work around the prohibition on offering rebates.'' \288\
---------------------------------------------------------------------------

\288\ See Clearpool Letter, at 3-4.
---------------------------------------------------------------------------

Further, one commenter suggested adding a new Test Group ``to test
an anti-fragmentation policy,'' in which ``the order that sets the SIP
NBBO receives the execution in all circumstances (e.g., bypassing
hidden orders). ''\289\
---------------------------------------------------------------------------

\289\ See Birch Bay Letter, at 2.
---------------------------------------------------------------------------

The Commission appreciates all of these recommendations. After
considering these comments, as well as other comments opposed to
including more NMS stocks in the Pilot, the Commission believes that
the Pilot should not introduce additional variables. In order to add a
new variable to the Pilot, the Commission would need to include
additional Test Groups and materially increase the number of securities
(or materially increase the Pilot's duration) to be able to isolate
separately the effects of each variable that is included in the Pilot.
Otherwise, adding variables would create an asymmetric Pilot that would
make it more difficult to evaluate the data and establish causal
inferences regarding the impacts of changes to exchange transaction
fees and rebates. As discussed above, most commenters were critical of
the Pilot's proposed size and the Commission similarly desires to have
a narrowly tailored pilot focused on generating useful data on the
impact of exchange fees and rebates on order routing behavior,
execution quality, and market quality. Adding another variable to the
Pilot would increase the Pilot's size, complexity, and costs.
g. Gradual Reduction of Current Fee Cap Across All Stocks
One commenter suggested that, rather than conducting the Pilot, the
Commission should instead consider imposing a ``gradual reduction of
the current fee cap across all stocks periodically.'' \290\ The
commenter stated that this approach would facilitate data collection
and an opportunity ``to observe order routing behavior changes, while
applying the same economics to all stocks uniformly.'' \291\
Furthermore, the commenter stated that if a control group was necessary
in this scenario ``for comparison purposes'' it would recommend placing
50% of stocks in the control group and the other 50% in the Test Group
subject to the gradual reductions in access fees.\292\
---------------------------------------------------------------------------

\290\ Morgan Stanley Letter, at 2.
\291\ Id.
\292\ Id.
---------------------------------------------------------------------------

The Commission has considered this alternative but believes that
the Pilot is a preferable approach because it will permit researchers
to conduct differences-in-differences analysis over a much shorter time
frame. By establishing stratified treatment groups and simultaneously
testing different changes in the same variable, the Pilot will reduce
the impact of events (economic, natural, political, etc.) across time
and thereby is more conducive to an apples-to-apples comparison of the
various treatment groups to one another. Pursuing a simultaneous and
linear gradual reduction, such as that proposed by the commenter, could
require greatly extending the Pilot's duration depending on the number
of fee cap levels to be tested. More importantly, this proposed
alternative would not provide the Commission with the opportunity to
directly observe the impact of rebates on order routing behavior,
execution quality, and market quality because it would not necessarily
include a prohibition on rebates and therefore having a no-rebate
bucket will be substantially more informative. Lastly, as the
Commission believes that a Control Group is necessary to ensure the
usefulness of the Pilot's data, pursuing the proposed structure would
impact more NMS stocks than the Pilot (as 50% of stocks would be
included in the Test Group and 50% in the control group).
h. $0.0010 Access Fee
One commenter recommended that rather than pursuing the Pilot, the
Commission should instead amend Rule 610(c) to reduce the access fee
cap to $0.0010 and also ``conduct an abbreviated study of the effects
of eliminating rebates similar to the criteria of Pilot Test Group
Three.'' \293\ This commenter stated that ``there is broad
recognition'' that the access fee cap should be reduced and the Pilot
will ``be lengthy, complex and costly'' but ``will not yield a
different conclusion.'' \294\ The commenter stated that reducing the
access fee cap to $0.0010 would be calibrated with present-day trading
and execution costs, would better ensure displayed prices reflect the
actual economic costs of an execution, and would allow exchanges to
continue maintain their current net capture rates, while also choosing
to offer rebates to incentivize liquidity provision if they chose to do
so.\295\
---------------------------------------------------------------------------

\293\ See Goldman Sachs Letter, at 1-4.
\294\ Id. at 1.
\295\ Id.
---------------------------------------------------------------------------

The Commission believes that its revised Pilot design responds to
this commenter's core recommendation, though the Commission is
instituting a $0.0010 fee cap as part of the Pilot and not as an
amendment to Rule 610(c). The Commission continues to believe that a
Pilot is necessary to provide data to objectively evaluate the effect
of exchange fees and rebates. Ultimately, the Pilot will enable a data-
driven analysis of the impact of transaction fees and rebates on order
routing behavior, execution quality, and market quality, which will
serve as a valuable precursor to the Commission's consideration of
future policy making in this area.
10. Metrics To Assess the Pilot
A number of commenters recommended that the Commission

[[Page 5226]]

more clearly articulate what it believes would constitute a
``successful'' Pilot and how it will judge whether the Pilot achieves
that measure of success.\296\ Several of these commenters suggested
specific metrics or criteria they thought the Commission should analyze
when evaluating the impact of the Pilot, many of which were measurement
criteria suggested by EMSAC.\297\ One commenter suggested that the
Commission provide guidance about how its staff will be evaluating the
metrics used to determine whether to recommend market structure changes
to the Commission following the Pilot.\298\ In addition, two commenters
suggested the Commission designate an independent third party to
conduct an analysis of the Pilot data upon the Pilot's completion.\299\
Another commenter stated that the ``industry should be afforded the
opportunity to comment'' on the metrics and criteria used to evaluate
the Pilot.\300\
---------------------------------------------------------------------------

\296\ See, e.g., State Street Letter, at 2; Fidelity Letter, at
3-4; Capital Group Letter, at 4; ICI Letter I, at 5; OMERS Letter,
at 2; MFS Letter, at 2; Virtu Letter, at 8; FIA Letter, at 2; SIFMA
Letter, at 2-3, 5; TD Ameritrade Letter, at 2; STANY Letter, at 3;
Morgan Stanley Letter, at 3; Cboe Letter I, at 29; Nasdaq Letter I,
at 7; NYSE Letter, at 2; Pragma Letter, at 2; ModernNetworks Letter;
Healthy Markets Letter I, at 35.
\297\ See, e.g., State Street Letter, at 2-3; Fidelity Letter,
at 8; Vanguard Letter, at 3; ICI Letter I, at 5; T. Rowe Price
Letter, at 4; MFS Letter, at 2; BlackRock Letter, at 2-3; SIFMA
Letter, at 5-6; Morgan Stanley Letter, at 3; Spatt Letter, at 5;
Cboe Letter I, at 29; IEX Letter I, at 2; Pragma Letter, at 2-3.
\298\ See SIFMA Letter, at 3. Another commenter requested that
the Commission clarify the role it expects the Division of Economic
and Risk Analysis to play in analyzing the Pilot's data and provide
an anticipated timeline for the issuance of a report on the Pilot
data. See IEX Letter I, at 2.
\299\ See Fidelity Letter, at 3, 8; MFS Letter, at 2.
\300\ See Virtu Letter, at 8.
---------------------------------------------------------------------------

In response to these comments, the Commission emphasizes that its
staff will likely not be the sole entity analyzing data related to the
Pilot. As was the case for the recent Tick Size Pilot, the Commission
believes that market participants will publish their own analyses of
the Pilot using data that is uniquely available to them and the metrics
that they believe are most useful or relevant, and encourages market
participants to do so.\301\ To the extent that interested parties
prepare their own analyses, they may submit them to
tradingandmarkets@sec.gov with the words ``Transaction Fee Pilot
Analysis'' in the subject line, and the Commission will post those
reports on its public website.\302\
---------------------------------------------------------------------------

\301\ For example, institutional firms could study their ability
to capture the spread when passively posting, and how that is
impacted within the Pilot's treatment groups.
\302\ The Commission encourages market participants to disclose
what sources of data they used for their analyses and describe the
methodology they used, and to make those reports publicly and freely
available.
---------------------------------------------------------------------------

The Commission encourages market participants to make public any
analysis they perform on their own trading activity, such as non-
proprietary transaction cost analysis (``TCA''), so that it may be
publicly reviewed and used to help inform the public dialogue
concerning the effect of exchange fees and rebates.\303\ To the extent
that independent analyses are made public, they can contribute to the
Commission's consideration of any future regulatory action in this
area.
---------------------------------------------------------------------------

\303\ For example, the Pilot's order routing datasets will
collect aggregated data, not individual order-by-order level data,
and reflects the ``child'' orders that are processed by an exchange.
Thus, the order routing dataset will not capture the entire
lifecycle of a ``parent'' order from its inception through to
execution. Accordingly, the Pilot's order routing datasets will not
by themselves permit analyses on an order-by-order basis, and will
therefore be unable to assess the execution quality of orders at the
``parent'' level. If market participants and other interested
parties conduct parent order-level analyses and make their findings
public, then the Commission would be able to consider them as it
assesses the Pilot's ultimate impact on order routing behavior,
execution quality, and market quality. See, e.g., T. Rowe Price
Letter, at 4 (recommending that the Commission view analyses of the
Pilot conducted by registered investment advisers as a ``key
input'').
---------------------------------------------------------------------------

Given the valuable input of independent analysis, the Commission
believes that the success or failure of the Pilot will be determined by
whether it produces an exogenous shock that generates measurable
responses capable of providing insight into the effects of fees and
rebates on the markets and market participant behavior.\304\ In the
absence of a Commission Pilot that effects change across all equities
exchanges in a coordinated manner, researchers would be unable to
collect meaningful, comparative data to test the effects of such
changes and perform those analyses.\305\
---------------------------------------------------------------------------

\304\ As noted in the Proposal, the Pilot is designed to produce
an exogenous shock that simultaneously creates distinct fee
environments, each of which restricts transaction-based fees or
rebates differently, enabling synchronized comparisons to the
current environment for purposes of inferring the existence of
causal relationships. See Proposing Release, supra note 2, at 13047
and 53. An exogenous shock to a system occurs when an element of the
system is changed from without the system. (i.e., the change or
shock is not under the control or influence of those within the
system) but can induce endogenous (i.e., within the system)
responses. In the Pilot's context, the exogenous shock takes the
form of a reduction of the maximum permissible transaction fees and
a prohibition on rebates and Linked Pricing on all U.S. equities
exchanges. See infra Section IV.
\305\ See infra Section IV.B.1.
---------------------------------------------------------------------------

Success or failure of the Pilot is thus independent of the outcome
of the Pilot. For example, a Pilot that shows, with statistical
significance, that rebates narrow the quoted spread in thinly-traded
stocks would be equally ``successful'' as a Pilot that shows that
rebates do not narrow the spread in such stocks. In this sense, the
``success'' of the Pilot is that it created the conditions that permit
measurement and analysis of that issue in a manner that helps resolve
speculative assumptions among the commenters about the impact of fees
and rebates.
Furthermore, it is worth noting that the data collected pursuant to
Rule 610T is only part of what researchers will need to conduct
analysis of the impact of exchange fees and rebates on the markets. For
example, the Pilot's order routing datasets contain data to help assess
order routing and certain aspects of execution quality, but will not
contain any data on exchange quotations, which is available from
existing sources. Consequently, researchers will need to use existing
data sources to assess the impact of the Pilot on exchange quoting
activity and market quality. As such, to the extent that the Pilot data
produces null results, for example the Pilot's order routing datasets
do not show any change in liquidity during the Pilot, the Commission
believes that independent analysis from market participants, looking at
order-level data, may nevertheless detect an impact. Even if the Pilot
produces a null result for some metrics, and third-party analysis is
not publicly available or does not find an impact, the Commission
nevertheless believes the Pilot would still be useful to inform future
policymaking that is intended to benefit investors.\306\
---------------------------------------------------------------------------

\306\ For example, a result that shows no impact on liquidity
for a Test Group may still be relevant to the Commission's
consideration of the effects of transaction fee-and-rebate pricing
models on order routing behavior, execution quality, and market
quality and whether the existing exchange transaction-based fee and
rebate structure continues to further the statutory goals.
---------------------------------------------------------------------------

In response to commenters' requests for additional insight into the
types of questions that the Commission hopes the Pilot will be able to
answer, the Commission believes that the order routing datasets, as
well as other data that is already readily accessible to researchers,
should facilitate analysis of the impact of the Pilot through a broad
spectrum of metrics. In particular, the Commission will consider, and
encourages others to consider, the following questions in contemplating
the impact of changes to fees and rebates across the exchanges. These
questions include, but are not limited to:

[[Page 5227]]

1. To what extent do access fees and rebates impact routing
decisions for liquidity-taking orders? Are orders to take liquidity
more likely to be routed to an exchange (compared to an off-exchange
venue or ATS) in a lower access fee environment than they are
currently? To what extent are impacts or changes in routing
decisions driven by potential conflicts of interest created by
transaction fees and rebates rather than other factors such as fill
rates and execution quality?
2. To what extent do access fees and rebates impact routing
decisions for liquidity-supplying orders? Are orders to provide
liquidity less likely to be routed to an exchange (compared to an
off-exchange venue or ATS) in a lower rebate environment than they
are currently? To what extent do impacts or changes in order routing
appear to be driven by potential conflicts of interest caused by
rebates rather than other factors such as execution quality (e.g.,
fill-rates, time to fill, capturing the quoted spread, adverse
selection, or reversion)?
3. What impact does a reduction or elimination in rebates have
on the NBBO, including spread width and the depth of interest
displayed at the NBBO? To what extent does a potential decrease in
depth of interest at the NBBO result in lower fill rates or smaller
fill sizes for investor orders? Are natural investors better able to
obtain queue priority in exchange order books, and are they more
frequently able to capture the quoted spread when posting passively
(e.g., buy on the bid and sell on the offer)?
4. Are there common characteristics for securities (e.g.,
average daily trading volume, price, or market capitalization) where
a reduction or elimination of rebates begins to impact quoted
spread? If so, what are those common characteristics and at what
level do reduced rebates begin to have an impact on quoted spread?
To what extent does a change in quoted spread affect transaction
costs for investor orders? If quoted spread widens in a security, to
what extent is the potential spread cost offset by the reduction in
the transaction fees paid, or a change in the ability to capture the
quoted spread?
5. Are there common characteristics for securities where a
reduction or elimination of rebates does not impact quoted spread?
If so, what are those common characteristics (e.g., average daily
trading volume, price, or market capitalization)?
6. Are there common characteristics for securities (e.g.,
average daily trading volume, price, or market capitalization) where
a reduction or elimination of rebates begins to impact effective
spread?
7. How can we best understand the effects of rebates provided on
inverted venues (where rebates are paid to takers of liquidity)?
8. What impact do lower access fees and rebates have on the
amount of displayed and non-displayed liquidity on exchanges?
9. In the absence of rebates, do competition and market forces
operate to produce a market equilibrium (within the current
regulatory structure) that constrains transaction fees to levels at
or below today's current access fee cap? What do such market forces,
and any resultant equilibrium pricing, tell us about the need to
impose a cap on access fees? Does the Pilot provide any data that
suggests, in the absence of rebates, an access fee cap would still
be necessary as long as Rule 611 of Regulation NMS continues to
impose order protection requirements on exchanges with protected
quotes?
10. What is the impact of a lower fee cap on trading volumes on
each exchange? What is the impact of a lower fee cap on other
measures of liquidity on each exchange? How should we understand the
difference between volume and liquidity?
11. What is the impact of lower rebates on the ability of
smaller exchanges to attract liquidity-supplying orders?

By providing a mechanism that is uniquely capable of facilitating
an empirical review of these and similar questions, the Pilot is an
essential tool that can further the understanding of an important
component of equities market structure. While other market structure
issues also might benefit from a pilot, exchange transaction fees
currently are a prime focus for empirical study, as evidenced by, among
other things, the EMSAC's recommendation to the Commission and the
number and nature of comments the Commission received on its proposal.
Ultimately, the Commission desires to use the Pilot's results to help
assess whether (and, if so, in which types of NMS stocks) rebates have
a positive impact on execution and market quality, or whether they have
no or little effect or a negative effect.

D. Timing and Duration

1. Disclosure Initiatives and the Pilot
While a number of commenters urged the Commission to proceed
expeditiously with its proposed pilot,\307\ other commenters believed
the Commission should pursue different market structure initiatives
before conducting the Pilot \308\ or in lieu of the Pilot.\309\ The
Commission has adopted two of the market structure initiatives
identified by commenters--namely, proposals to enhance the operational
transparency of ATSs and to enhance disclosure of order routing
behavior.\310\
---------------------------------------------------------------------------

\307\ See, e.g., IEX Letter I, at 1; Joint Pension Plan Letter,
at 2; Better Markets Letter, at 3; Brandes Letter, at 2; Clearpool
Letter, at 7.
\308\ See, e.g., RBC Letter I, at 4; T. Rowe Price Letter, at 4;
Citi Letter, at 2.
\309\ See, e.g., Nasdaq Letter I, at 1, 3 (``[A] transaction fee
experiment is inappropriate at this time because there are
alternatives and prerequisites the Commission must further
evaluate.''); NYSE Letter I, at 17-19 (stating that the Commission
should consider ``less costly and more effective alternatives'' to
the Pilot); Cboe Letter I, at 12, 22, 27 (recommending that the
Commission undertake a ``holistic examination of the entire equities
market framework'' including consideration of ``possible changes to
the Order Protection Rule [and] the Minimum Tick Increment Rule,''
``[s]trengthening and [a]rticulating the Duty of Best Execution,''
providing ``greater broker-dealer transparency,'' and adopting
amendments to Regulation ATS).
\310\ See, e.g., Nasdaq Letter I, at 1, 3; NYSE Letter, at 17-
18; Cboe Letter I, at 12, 22, 27, Fidelity Letter, at 4. See also
Securities Exchange Act Release Nos. 83663 (July 18, 2018), 83 FR
38768 (August 7, 2018) (``Regulation ATS-N'') and 34528 (November 2,
2018), 83 FR 58338 (November 19, 2018) (``Amendments to Order
Handling Disclosure'').
---------------------------------------------------------------------------

While some commenters believed that the information and data from
those new rules would complement the Pilot and ``improve understanding
of pilot data,'' \311\ others believed the new rules would instead
allow the Commission to determine ``whether a problem exists without
risking the potential negative impact of a pilot'' \312\ or thought
that potential conflicts of interest in order routing behavior would be
better addressed through increased transparency and disclosure than by
the Pilot.\313\ The Commission disagrees. Comments urging the
Commission to pursue disclosure-based initiatives focused only on one
narrow aspect of

[[Page 5228]]

the Pilot--studying the conflicts of interest between brokers and their
customers that are presented when exchanges pay rebates. However, such
an approach does not adequately advance the Pilot's broader purpose--
obtaining a better understanding of all potential impacts from fees and
rebates, and how fees and rebates may affect stocks differently
depending on their liquidity.
---------------------------------------------------------------------------

\311\ ICI Letter I, at 5-6, 6 n.12; ICI Letter II, at 3. See
also, e.g., RBC Letter I, at 4; Citi Letter, at 2; Citadel Letter,
at 3, 7 (stating that ``it is important to first finalize and
implement . . . Rule 606 enhancements before implementing the
Pilot'' to ``safeguard the integrity of the Pilot by ensuring that
any changes to broker-dealer order routing practices that result
from the increased transparency mandated by amended Rule 606 are
isolated from any similar changes that result from the design of the
Pilot''); Spatt Letter, at 4 (stating that the ``the enhanced
disclosures proposed would strengthen the potential causal inference
that the response to [the Pilot] would allow''). Some commenters
questioned whether the Pilot should proceed, because they believed
that the adoption of Regulation ATS-N and the Amendments to Order
Handling Disclosure will ``impact the very potential conflicts of
interest the Commission aims to study . . . .'' Nasdaq Letter II, at
2-4; see also NYSE Letter IV, at 2-3. As noted in this section, the
scope of the Pilot is broader than just conflicts of interest.
Therefore, those initiatives, or the impact they may have on order
routing behavior, would not provide sufficient data to evaluate the
effects of transaction fees and rebates on market quality and
execution quality. See infra Section IV.B.1.
\312\ Nasdaq Letter I, at 1-2, 4; Nasdaq Letter II, at 2-4
(suggesting that the adoption of these regulations ``further
reduce[d] the already weak need for the [Pilot]''). See also, e.g.,
STANY Letter, at 2; ASA Letter, at 5-6; Era Letter, at 1. But cf.
Verret Letter I, at 4 (stating that the ``collection of data from
broker-dealers'' or the use of ``existing data contained in [OATS]''
were not ``feasible alternatives,'' because a ``randomized trial is
far superior for the purpose of generating robust statistical
analysis to inform subsequent rulemaking''); Proposing Release,
supra note 2, at 13046-47 (outlining the limitations of existing
data sources).
\313\ See, e.g., STANY Letter, at 2; FIA Letter, at 3; Grasso
Letter, at 2. But cf. ICI Letter II, at 3 (noting that disclosure-
based rulemakings ``will not directly reduce the potential for
exchange transaction pricing models to create conflicts of interest
for broker dealers, nor will they provide data that would allow an
institutional investor to measure the impact of fee avoidance on
routing decisions''); Luminex Letter, at 1; Spatt Letter, at 4; IEX
Letter II, at 9.
---------------------------------------------------------------------------

Similarly, some commenters recommended that, either before
conducting the Pilot or in lieu of the Pilot, the Commission should
pursue other market initiatives such as enhancing broker-dealers' duty
of best execution \314\ or undertaking a ``broader review of equity
market structure,'' including the consideration of possible changes to
the Order Protection Rule or the Minimum Tick Increment Rule.\315\
Other commenters disagreed and did not believe that the Commission
should delay the Pilot in order to pursue other market structure
initiatives.\316\ For example, a few commenters advocated proceeding
with the Pilot because the Pilot may help to inform future policy
changes in these other areas.\317\ Other commenters characterized the
``holistic reform'' advocated by other commenters as ``an elusive
goal'' \318\ in light of market participants' competing interests--one
that has been used to ``slow down market structure reform for the past
decade.'' \319\
---------------------------------------------------------------------------

\314\ See, e.g., Nasdaq Letter I, at 3-4; Fidelity Letter, at 6;
Cboe Letter I, at 21-22.
\315\ See Cboe Letter I, at 12; FIA Letter, at 3; Nasdaq Letter
I, at 4.
\316\ See, e.g., IEX Letter II, at 9; Better Markets Letter, at
3; Brandes Letter, at 2; AJO Letter, at 2; OMERS Letter, at 3;
Clearpool Letter, at 7. Some of these commenters suggested that the
Pilot should proceed in conjunction with action on other market
structure initiatives. See, e.g., SIFMA Letter, at 1; Pragma Letter,
at 3-4.
\317\ See, e.g., Verrett Letter I, at 5; Better Markets Letter,
at 3.
\318\ Brandes Letter, at 2.
\319\ Themis Trading Letter I, at 6. See also ICI Letter I, at
3.
---------------------------------------------------------------------------

The Commission believes that there is no need to delay proceeding
with the Pilot in order to pursue other potential equity market
structure initiatives. The Pilot seeks to resolve several equity market
structure questions that have been debated for several years.
Similarly, the Commission does not believe that it needs to complete
the Pilot before proceeding to consider other equity market structure
initiatives. Other initiatives may implicate equity market structure
questions that are narrower or broader than, or independent of,
exchange fee models, such as considering innovative approaches to
thinly-traded securities. The Commission expects that it will continue
to evaluate the need for other changes to equity market structure
during the Pilot.
2. Automatic Sunset at Year One
The Commission proposed that the Pilot have a duration of one year
with a maximum period of two years. Specifically, the proposed Pilot
duration featured an automatic sunset at the end of the first year
unless, prior to that time, the Commission publishes a notice that the
Pilot shall continue for up to one additional year.\320\
---------------------------------------------------------------------------

\320\ See Proposing Release, supra note 2, at 13025. The
Commission notes that the proposed language in Rule 610T(c)(a)(ii)
has been modified slightly. As proposed, Rule 610T(c)(1)(ii)
contained the phrase ``shall continue for up to another year.'' As
adopted, the phrase ``shall continue for up to one additional year''
is being substituted for the phrase ``shall continue for up to
another year'' to simplify the rule text without substantively
changing the requirement.
---------------------------------------------------------------------------

After careful consideration of the comments received, the
Commission is adopting Rule 610T(c) as proposed. Many commenters
supported the proposed duration of the Pilot.\321\ For example, one
commenter asserted that ``each pricing experiment needs to be in place
for a sufficient length of time to enable the firms to adjust their
routing logic.'' \322\ Others agreed that the proposed duration would
reduce the ``desire to `wait out' the Pilot'' and would avoid ``the
incentive to alter behavior in order to distort the Pilot's results . .
. .'' \323\ Several commenters supported the automatic sunset provision
after one-year.\324\
---------------------------------------------------------------------------

\321\ See, e.g., SIFMA Letter, at 3; AGF Letter, at 2;
Wellington Letter, at 2. See also RBC Letter I, at 6 (stating ``a
pilot of at least one year and no more than two years will ensure
that ample data is collected over time, that the restrictions of the
various Pilot Test Groups cannot be evaded by delay, and that the
Pilot does not exist for a period of time beyond which its data
would be cumulative or of marginal significance relative to data
produced earlier in the Pilot period'').
\322\ See Citi Letter, at 5 (stating that ``[c]ost-sensitive
firms may be able to more quickly adapt to new pricing, while
liquidity-based routers may need time to collect a new sample set to
adjust their routing logic,'' such that ``data in the weeks closer
to the conclusion of the Pilot may more accurately reflect the state
of the market and what the implications would be if implemented
long-term''). One commenter, however, did not believe that certain
``broker-dealers, proprietary traders, and algorithm vendors'' would
``incorporate the new fees into their routing systems on a timely
basis, if ever,'' because according to this commenter, ``[c]hanges
are costly and may prove to be ultimately unnecessary if pricing
reverts following the termination of the pilot study.'' Larry Harris
Letter, at 11.
\323\ Joint Asset Managers Letter, at 2. See also Joint Pension
Plan Letter, at 2; Brandes Letter, at 2.
\324\ See, e.g., SIFMA Letter, at 3; CFA Letter, at 6; Fidelity
Letter, at 9; IEX Letter I, at 4.
---------------------------------------------------------------------------

A few commenters, however, thought the proposed duration was too
short and that a minimum two-year pilot would be necessary.\325\ Some
other commenters believed that the necessary data could be obtained
within a shorter time frame. Among commenters advocating for a shorter
Pilot Period, the recommended duration varied and ranged from those who
felt there would be an ``immediate and measurable impact upon
implementation'' \326\ to those who felt the appropriate time frame
should be modified to an absolute maximum of one year.\327\ One
commenter questioned whether a ``1-2 year pilot that changes fees on
3,000 names'' was ``really a `pilot' or in fact a de facto imposition
of a significant reduction of transaction fees[.]'' \328\ Several
commenters expressed their view that the proposed length of the Pilot
would ``exacerbate[ ] the negative impact upon the affected issuers.''
\329\
---------------------------------------------------------------------------

\325\ See, e.g., Babelfish Letter, at 3; Healthy Markets Letter
I, at 19.
\326\ See TD Ameritrade, at 5; see also, e.g., NorthWestern
Letter, at 1.
\327\ See, e.g., FIA Letter, at 4; STANY Letter, at 3-4.
\328\ Magma Letter, at 3. See also, e.g., Apache Letter, at 1;
Unitil Letter, at 2.
\329\ See, e.g., Ethan Allen Letter, at 1; ProAssurance Letter,
at 2; Knight-Swift Letter, at 2.
---------------------------------------------------------------------------

One commenter took issue with the proposed length of the Pilot by
challenging what it believed to be conflicting statements of the
Commission in its original Proposal. According to the commenter, the
Commission asserted, on the one hand, that the ``market quickly reacts
to changes in (and elimination of) pricing changes, but on the other
hand, claims that the market does not react unless the changes are in
effect for at least a year.'' \330\ The Commission believes both of
those statements are correct and do not conflict. While many market
participants will react promptly to pricing changes, particularly those
with cost-based routing algorithms, others may need additional time to
fine tune liquidity-based routing algorithms as order flow changes in
response to fee changes.\331\ More importantly, however, the Pilot
needs to be long enough to discourage any market participant inclined
to resist adapting its behavior to the fee changes.\332\
---------------------------------------------------------------------------

\330\ NYSE Letter I, at 16.
\331\ See, e.g., Citi Letter, at 5; Babelfish Letter, at 3.
\332\ See Proposing Release, supra note 2, at 13071.
---------------------------------------------------------------------------

A few commenters opposed the one-year sunset provision, but for a
variety of different reasons. For example, one commenter thought a full
two-year pilot was necessary, another thought the Commission separately
has the authority to revise or terminate the Pilot early and does not
need a sunset

[[Page 5229]]

provision, and a third was critical of the lack of metrics that would
accompany the automatic sunset.\333\
---------------------------------------------------------------------------

\333\ See Babelfish Letter, at 3; Healthy Markets Letter I, at
19; Cboe Letter I, at 19.
---------------------------------------------------------------------------

After careful consideration of the comments received, the
Commission is adopting the Pilot's duration as proposed. The Commission
believes that the Pilot's duration will provide an appropriate balance
between providing certainty about the maximum duration for the Pilot
while also allowing flexibility to conduct a Pilot for more than one
year if necessary to collect representative data. Further, the Pilot's
duration should be long enough to make it economically worthwhile for
market participants to adapt their behavior and not ``wait out'' the
Pilot. In addition, in light of the number of Pilot Securities
selected, which were selected to ensure sufficient statistical power to
allow for meaningful analysis, the Pilot's duration will allow for the
collection of a robust and representative data set over a sufficiently
long period of time,. The Commission considered a shorter time period
for the Pilot, but is concerned that short-term or seasonal events
could unduly impact the Pilot results and therefore data collected over
a shorter duration may not yield a sufficiently representative dataset
that would be capable of permitting analysis into the impact of
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. For example, a shorter pilot period could
be impacted by seasonal idiosyncrasies, macroeconomic factors, or even
weather events.
Further, the Commission recognizes that some market participants,
for example, broker-dealers whose liquidity-focused routing strategies
are based on, and continually updated based on, several weeks' worth of
data, will need time to fine tune their revised routing strategies.
While some market participants may adjust quickly, others, like
proprietary trading market participants, may wait to see how other
market participants react before refining their own routing
strategies.\334\ In other words, it could take a few months before some
market participants finish calibrating their routing strategies to the
fees and rebates that the exchanges adopt consistent with the Pilot's
requirements and adjust them as trading dynamics settle in response to
those changes. The exchanges also could take a number of weeks to
settle on new fee models as they see how other exchanges modify their
fee models to comply with the Pilot's requirements and then respond
accordingly, which could further delay the time it takes for broker-
dealers to adjust their routing and trading algorithms. Accounting for
all of this, the Commission intends that the proposed duration of the
Pilot be long enough to encourage wide participation by all market
participants (and discourage ``waiting out'' the Pilot) and thereby
help ensure that the Pilot produces results that are more reliable,
robust, and useful.
---------------------------------------------------------------------------

\334\ See, e.g., Citi Letter, at 5.
---------------------------------------------------------------------------

The Commission also considered extending the Pilot period to two-
years as suggested by several commenters, and as was recommended by the
EMSAC, but continues to believe that the inclusion of the automatic
sunset provision at the end of the first year is preferable because it
will provide flexibility in the event that the Commission believes
additional time is necessary to ensure the collection of a robust
dataset with adequate statistical power for analysis, but will allow
the Pilot to automatically end after one-year in the event that
sufficient data is collected by that point with sufficient statistical
power to allow for meaningful analysis.
3. Pre- and Post-Pilot Periods
The Commission proposed a six-month pre-Pilot Period as well as a
six-month post-Pilot Period.\335\ During those periods, the Commission
proposed to require the equities exchanges to collect and make
available the order routing datasets and Exchange Transaction Fee
Summaries in order to provide necessary benchmark information against
which researchers could assess the impact of the Pilot.\336\
---------------------------------------------------------------------------

\335\ See Proposing Release, supra note 2, at 13025-26. See also
Proposed Rule 610T(c).
\336\ Proposed Rule 610T(d) and (e). See also Proposing Release,
supra note 2, at 13029, 13032. Primary listing exchanges will also
be required to prepare and publicly post updated Pilot Securities
Exchange Lists and Pilot Securities Change Lists for the duration of
the Pilot Period and through the post-Pilot Period. Id. at 13027-28.
The pre-Pilot data is intended to establish a baseline against which
to assess the effects of the Pilot, while the post-Pilot Period is
intended to help assess any post-Pilot effects following the
conclusion of the Pilot.
---------------------------------------------------------------------------

Two commenters supported the proposed six-month pre-Pilot and post-
Pilot data collection periods.\337\ In contrast, two commenters
suggested adopting three-month long pre-Pilot and post-Pilot
Periods.\338\
---------------------------------------------------------------------------

\337\ See FIF Letter, at 7, 9; Healthy Markets Letter I, at 19.
\338\ See IEX Letter I, at 4; FIA Letter, at 4.
---------------------------------------------------------------------------

The Commission desires to implement the Pilot in a manner that
imposes the least amount of costs on the exchanges without compromising
the ability of the Pilot to obtain useful data. The Commission believes
that six-month pre- and post-Pilot Periods are necessary to establish a
baseline against which to compare the data collected during the Pilot
Period and any post-Pilot effects following the conclusion of the
proposed Pilot. Although the Commission appreciates the desire of
market participants to expedite the Pilot while constraining costs, the
Commission considers six months to be necessary to provide the targeted
statistical power for obtaining baseline data. As discussed above,
statistical power largely is a function of the number of observations
over a specified period of time. In order to shorten the pre- and post-
Pilot Periods (e.g., to three months instead of six months) while
maintaining the same statistical power, the Commission would need to
increase the number of securities in the Pilot by at least 120
securities. As discussed above and consistent with the comments it
received, the Commission desires to limit, not increase, the number of
securities included in the Pilot. Accordingly, the Commission is not
adopting a shorter duration for the pre- and post-Pilot Periods.
4. Early Termination
Proposed Rule 610T did not contain a specific provision regarding
early termination of the Pilot. Several commenters recommended that the
Commission develop specific criteria for evaluating the possibility
that the Pilot may need to be terminated early.\339\ Some recommended
that the Pilot specifically include a ``kill switch'' to effectuate an
early termination.\340\ Several commenters supported the need for the
Commission to address unanticipated negative consequences quickly,\341\
but one commenter cautioned that the Commission would need to act in a
measured manner because the industry would need time to unwind the
Pilot.\342\ One commenter suggested that the Commission might want to
terminate the Pilot early if (1) it produced a ``robust statistical
sample set earlier than a year, such that [the Commission could] end
the Pilot and proceed to adopt permanent rule changes'' and (2) ``if
there is unintended impact from the Pilot that warrants a

[[Page 5230]]

stoppage.'' \343\ Other commenters emphasized the need for the
Commission to closely monitor the impact of the Pilot on retail
investors in particular.\344\ For example, one commenter argued that if
the Pilot data suggests ``clear harm to the retail investor in . . .
relevant execution quality metrics'' like ``quoted spread, depth of
liquidity, intraday stock volatility, and opportunities for price
improvement on impacted securities,'' then the Pilot ``should be
immediately suspended.'' \345\ Another commenter urged the Commission
to closely monitor the Pilot's effect on thinly-traded stocks and
establish ``predetermined means for discontinuing the Pilot in the
event that the reviewed data shows undue harm to market or execution
quality.'' \346\ However, one commenter noted that the Commission is
not obligated to ``cease the [P]ilot if the costs to liquidity prove
significant.'' \347\
---------------------------------------------------------------------------

\339\ See e.g., SIFMA Letter, at 3; Issuer Network Letter I, at
4; State Street Letter, at 4; Cboe Letter I, at 28.
\340\ See Citi Letter, at 4; TD Ameritrade Letter, at 1, 5;
Morgan Stanley Letter, at 4; Cboe Letter I, at 28-29; Vanguard
Letter, at 3; STANY Letter, at 4; Angel Letter II, at 3.
\341\ See Schwab Letter, at 2; Cboe Letter I, at 29.
\342\ See TD Ameritrade Letter, at 5. See also Morgan Stanley
Letter, at 4; SIFMA Letter, at 3.
\343\ See Vanguard Letter, at 3. See also Angel Letter II, at 3
(noting that the Pilot could be suspended quickly if ``there is
abundant evidence one way or the other about the results,'' such as
``a dramatic increase in market quality for one particular treatment
group,'' in which case ``that particular group's treatment could
become the new rule,'' or ``if the pilot produces fast and
unequivocal results showing harm to one particular treatment group,
that treatment should be halted'').
\344\ See Schwab Letter, at 2; Citi Letter, at 4.
\345\ See Schwab Letter, at 2.
\346\ See STANY Letter, at 4.
\347\ Verret Letter I, at 5.
---------------------------------------------------------------------------

The Commission acknowledges the concerns raised by commenters
regarding the potential for unintended and unanticipated consequences
to the equities markets that the Pilot may have. The Commission intends
to carefully monitor for any such effects during the Pilot Period.
However, the Commission does not believe that it is necessary to add a
``kill switch'' to Rule 610T because the Commission already has broad
exemptive authority that obviates the need for a separate kill switch.
For example, if at any time the Commission believes that the protection
of investors may be compromised by the Pilot, the Commission has broad
authority under Section 36 of the Exchange Act to modify or terminate
the Pilot early.\348\
---------------------------------------------------------------------------

\348\ See 15 U.S.C. 78mm (setting forth the Commission's
authority, by rule, regulation or order, to conditionally or
unconditionally exempt persons, transactions or securities (or
classes thereof) from any Exchange Act provision, rule or regulation
if such exemption is necessary or appropriate in the public interest
and is consistent with the protection of investors).
---------------------------------------------------------------------------

5. Inclusion of a Phase-In Period
The Commission did not propose a phase-in period for the Pilot.
Three commenters recommended a phase-in period without elaborating on
its purpose, though they referenced the EMSAC's recommendation for an
initial three-month phase-in period involving 10 stocks.\349\ A
different commenter did not believe that the EMSAC's three-month phase-
in period was necessary.\350\
---------------------------------------------------------------------------

\349\ See State Street Letter, at 4; TD Ameritrade Letter, at 4;
STANY Letter, at 3. See also 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'').
\350\ See AJO Letter, at 2.
---------------------------------------------------------------------------

The Commission has considered these comments and believes a phase-
in approach is not necessary and unnecessarily would add to the length
of the Pilot. Although such an approach would allow the 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 continues to believe that, because exchange fees
can become immediately effective upon their filing with the Commission,
the markets and market participants are accustomed to dealing with
frequent exchange fee changes in which fees can change on all stocks at
once, or only for a subset of stocks or a subset of trading mechanisms.
Accordingly, exchanges and market participants should be capable of
accommodating the terms of the proposed Pilot with the advance notice
contemplated by the Pilot. Further, although exchanges would be
required to collect and report certain data, the proposed Pilot would
not necessitate changes to exchange trading systems, and therefore, the
Commission continues to believe a phased implementation schedule is not
necessary to test the types of changes contemplated by the Pilot.
E. Data
The Commission proposed that certain data be collected and made
publicly available in order to facilitate the Commission's and
researchers' ability to assess the impact of the Pilot, as well as to
promote transparency about the Pilot Securities and to provide basic
information about equities exchange fees and changes to those fees
during the Pilot.\351\ The Commission is adopting the Pilot Securities
Lists, the Exchange Transaction Fee Summary, and the order routing
datasets subject to the modifications described below.
---------------------------------------------------------------------------

\351\ See Proposing Release, supra note 2, at 13026.
---------------------------------------------------------------------------

1. Pilot Securities Exchange Lists and Pilot Securities Change Lists
As proposed, the Commission would publish, approximately one month
before the start of the Pilot Period, the initial List of Pilot
Securities, which identifies the securities in the Pilot and their
designated Test Group (or the Control Group).\352\ Thereafter, each
primary listing exchange \353\ would publish a freely and publicly
available daily Pilot Securities Exchange List of the Pilot Securities
that are primarily listed on its exchange and also publish a Pilot
Securities Change List of the cumulative changes to that list, and keep
both lists available on their websites for five years.\354\
---------------------------------------------------------------------------

\352\ See Proposed Rule 610T(b)(1). See also Proposing Release,
supra note 2, at 13026. When the Commission publishes this list, the
pre-Pilot Period will have been in place for approximately five
months.
\353\ See Proposed Rule 610T(b)(1)(iii) (defining ``primary
listing exchange'' for purposes of Rule 610T).
\354\ See Proposing Release, supra note 2, at 13027-28. The
Commission notes that the proposed language in Rule 610T(b)(3)(i)
has been modified slightly. As proposed, Rule 610T(b)(3)(i)
contained the phrase ``throughout the duration of the Pilot,
including the post-Pilot Period.'' As adopted, the phrase
``throughout the end of the post-Pilot Period'' is being substituted
for the phrase ``throughout the duration of the Pilot, including the
post-Pilot Period'' to simplify the rule text without substantively
changing the applicability of the posting requirement.
---------------------------------------------------------------------------

The Commission received one comment that was supportive of the
proposed requirements for disseminating and updating the Pilot
Securities lists, including the pipe-delimited ASCII file format and
the five year retention period.\355\ This commenter also had ``no
objections to the proposed posting requirements, providing there is
adequate data security and controlled access.'' \356\ The Commission is
not adopting any new requirements for data security with respect to the
Pilot Securities lists because that data is not private or otherwise
sensitive in nature and because the exchanges already are subject to
Regulation SCI governing access to their systems that support
trading.\357\
---------------------------------------------------------------------------

\355\ See FIF Letter, at 5.
\356\ Id.
\357\ See 17 CFR 242.1001(a)(1). SCI systems include all
computer, network, electronic, technical, automated or similar
systems of, or operated by or on behalf of, an SCI entity that
directly support activities such as trading and order routing, among
other things. 17 CFR 242.1000.
---------------------------------------------------------------------------

For the reasons stated in the Proposing Release, the Commission is
adopting as proposed the requirements in Rule 610T(b) for the primary
listing exchanges to publicly post on their websites downloadable files
containing the Pilot Securities Exchange Lists and the Pilot Securities
Change Lists.\358\ The Commission is adding one additional

[[Page 5231]]

field, ``stratum code,'' to both lists.\359\ As discussed in the
Proposal and above, the Commission will stratify Pilot Securities as it
assigns them to the Test Groups and Control Group to ensure that each
group has a similar composition, which facilitates comparison across
groups.\360\ As it does so, the Commission will assign a stratum code
to each Pilot Security that identifies that security's liquidity
strata. The code is a static value and, as such, will remain constant
throughout the Pilot. The Commission will include this stratum code on
the initial List of Pilot Securities that it disseminates. To link each
Pilot Security and its stratum code, the Commission is requiring the
primary listing exchanges to include this data element on each Pilot
Securities Exchange List and Pilot Securities Change List. Including
this field on each list will clearly identify each Pilot Security's
liquidity stratum, thereby allowing researchers to control for the fact
that within some liquidity strata, the ratio of Test Group stocks to
Control Group stocks is lower than it is for others, which should
facilitate analysis of the Pilot's data.
---------------------------------------------------------------------------

\358\ See Proposing Release, supra note 2, 13026-28.
\359\ The Commission is also modifying the name of the field
specified in proposed Rule 610T(b)(2)(ii)(E). The Commission
proposed the field be named ``Test Group.'' As adopted, the field
will be named ``Pilot Group'' to provide additional clarity.
\360\ See Proposing Release, supra note 2, 13019, 13051.
---------------------------------------------------------------------------

2. Exchange Transaction Fee Summary
As proposed, each exchange that trades NMS stocks would be required
to compile, update monthly, and make freely and publicly available a
dataset using an XML schema published on the Commission's website that
contains specified information on its fees and fee changes during the
Pilot.\361\
---------------------------------------------------------------------------

\361\ The Commission notes that the proposed language in Rule
610T(e) has been modified slightly. As proposed, Rule 610T(e)
contained the phrase ``each national securities exchange that trades
NMS stocks. . . .'' As adopted, the clause ``that facilitates
trading in NMS stocks'' is being substituted for the phrase ``that
trades NMS stocks'' to clarify that exchanges facilitate trading by
their members in NMS stocks. In addition, the Commission notes that,
as proposed, Rule 610T(e) contained a parenthetical which explained
that data requirements set forth in subsection (e) were ``applicable
to securities having a price greater than $1.'' As adopted, that
parenthetical has been modified slightly to clarify that the
requirements of subsection (e) apply to ``securities having a price
equal to or greater than $1.''
---------------------------------------------------------------------------

In particular, each exchange would identify, among other things,
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, as well as the Pilot Group (i.e., 1, 2, or Control) that
applies to the fee being reported.\362\ Exchanges also would 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, reported separately for each
participant category (registered market makers or other market
participants), Test Group, displayed/non-displayed, and top/depth of
book.\363\
---------------------------------------------------------------------------

\362\ See Proposed Rule 610T(e). See also Proposing Release,
supra note 2, at 13029-30.
\363\ See Proposing Release, supra note 2, at 13030. See also
Rule 610T(e).
---------------------------------------------------------------------------

In the Proposing Release, the Commission asked several questions
about the Exchange Transaction Fee Summary including questions about
the proposed form, content, and posting requirements. Commenters
supported requiring the equities exchanges to publicly post the
Exchange Transaction Fee Summary as well as the proposed fields
included in the summaries.\364\
---------------------------------------------------------------------------

\364\ See, e.g., SIFMA Letter, at 6; Better Markets Letter, at
7; Spatt Letter, at 4-5; and IEX Letter I, at 9.
---------------------------------------------------------------------------

Among those questions included in the Proposing Release, the
Commission specifically asked commenters to suggest types of
information that should be captured on the Exchange Transaction Fee
Summary that would be useful to make comparisons across exchanges, and
a few commenters offered specific suggestions.\365\ Specifically, two
commenters requested that the Exchange Transaction Fee Summary include
the number of pricing tiers used by the exchanges, the number of firms
that were in each tier, and information on transaction costs in each
tier.\366\ Similarly, another commenter suggested that the Exchange
Transaction Fee Summary provide context on the Base and Top Tier fees
by including the number of member firms, by participant type, that
qualified for the Base and Top Tier fees and rebates reported on the
Exchange Transaction Fee Summary.\367\
---------------------------------------------------------------------------

\365\ See Proposing Release, supra note 2, at 13031.
\366\ See CFA Letter, at 5; Healthy Markets Letter I, at 22.
\367\ See IEX Letter I, at 9.
---------------------------------------------------------------------------

While the Commission appreciates these suggestions, it believes
that adding more granular details about specific pricing tiers, which
can vary greatly by exchange, would overcomplicate the fee summaries
such that it would be difficult to standardize the information, thereby
rendering the data less useful to researchers when comparing exchanges
for purposes of the Pilot.\368\ Further, with respect to the number of
members qualifying for the Base and Top Tier fees and rebates, the
Commission believes that the information that exchanges will report on
average and median realized fees and rebates should be sufficient for
purposes of analyzing the Pilot's results, including any changes in
order routing. We believe that the disclosure of the number of members
qualifying for the Base and Top Tier fees and rebates would also
require other disclosures (including, e.g., such member's trade volume
at each tier) in order to provide context to the information. Providing
all of these additional data points would increase the costs and
complexity of the Pilot. The Commission however, does not believe that
the incremental benefit of this information justifies additional costs
and complexities. Accordingly, the Commission will not be requiring the
exchanges to include additional information on their pricing tiers.
---------------------------------------------------------------------------

\368\ See Proposing Release, supra note 2, at 13030.
---------------------------------------------------------------------------

As part of its request for comment in the Proposal on what
additional information would be helpful to include in the Exchange
Transaction Fee Summary, the Commission specifically asked whether
other measures beyond average and median fees should be selected.\369\
In response, one commenter recommended that in addition to requiring
the average and median per share fees and rebates, the Commission also
require the ``mode'' per share fee and rebate (i.e., the most
frequently paid fee and rebate by each exchange's members), because the
commenter believed it would ``enable a more accurate comparison of the
fees and rebates most often applied by each exchange.'' \370\ The
Commission appreciates this suggestion, but continues to believe that
for purposes of this Pilot, the proposed information on mean and median
realized fees and rebates will be sufficient for purposes of analyzing
the results of the Pilot, including any changes in order routing.
---------------------------------------------------------------------------

\369\ See Proposing Release, supra note 2, at 13031.
\370\ See RBC Letter I, at 5.
---------------------------------------------------------------------------

Lastly, a few commenters requested that the Exchange Transaction
Fee Summary information be hosted at a central location rather than
posted on the exchanges' individual websites.\371\ While the Commission
recognizes that it could be more convenient if the information were
made available in one central location, because the data must be made
available unencumbered and in a standardized XML schema format, the
Commission believes that any person would readily be able to obtain and
combine the summaries posted by each equities exchange with minimal
effort.

[[Page 5232]]

Because of this, the Commission is not adopting a requirement on
exchanges to consolidate this material and make it available in a
central location.
---------------------------------------------------------------------------

\371\ See Better Markets Letter, at 7; CFA Letter, at 5; Healthy
Markets Letter I, at 23.
---------------------------------------------------------------------------

3. Order Routing Data
To facilitate an examination of the impact of the Pilot on order
routing behavior, execution quality, and market quality, the Commission
proposed to require throughout the Pilot (including during the pre-
Pilot Period and the post-Pilot Period) that each equities exchange
prepare and publicly post a monthly downloadable file containing sets
of anonymized order routing data in accordance with the specifications
proposed in Rule 610T(d).\372\ Specifically, Rule 610T(d) would require
exchanges to provide the order routing information in two datasets--one
for liquidity-providing orders and one for liquidity-taking orders,
both aggregated by day, security, and broker-dealer.\373\ The
Commission further proposed that equities exchanges would be required
to anonymize the identity of individual broker-dealers before making
the order routing datasets publicly available, using an anonymization
key provided by the Commission.\374\
---------------------------------------------------------------------------

\372\ See Proposing Release, supra note 2, at 13031.
\373\ Proposed Rule 610T(d)(1)-(2). The Commission notes that
the proposed language in Rule 610T(d) has been modified slightly. As
proposed, Rule 610T(d) contained the phrase ``each national
securities exchange that trades NMS stocks. . . .'' As adopted, the
clause ``that facilitates trading in NMS stocks'' is being
substituted for the phrase ``that trades NMS stocks'' to clarify
that exchanges facilitate trading by their members in NMS stocks.
\374\ See Proposing Release, supra note 2, at 13032.
---------------------------------------------------------------------------

A number of commenters supported the proposed requirements
regarding the order routing datasets, expressing the belief that these
requirements would provide researchers with useful data that would
facilitate an analysis of the impact of transaction fees and rebates on
order routing, execution quality, and market quality.\375\ Several
commenters believed the data would enable the Commission to make data-
driven decisions on potential future equity market structure policy
initiatives.\376\ Others specifically supported the website posting
requirement to make the data freely and publicly available.\377\
---------------------------------------------------------------------------

\375\ See, e.g., Barnard Letter, at 1; CII Letter, at 2-3;
Better Markets Letter, at 7; Invesco Letter, at 1-2; Wellington
Letter, at 1; CFA Letter, at 5; Clearpool Letter, at 6; ICI Letter
I, at 5; RBC Letter I, at 5; Joint Pension Plan Letter, at 2;
Oppenheimer Letter, at 2; IEX Letter I, at 10; Capital Group Letter,
at 4; Healthy Markets Letter I, at 24; Angel Letter, at 1; Verret
Letter I, at 1, 7; Spatt Letter, at 3.
\376\ See, e.g., Clark-Joseph Letter, at 1; Nuveen Letter, at 2;
NYSTRS Letter, at 1; RBC Letter I, at 2; Invesco Letter, at 2; CFA
Letter, at 1; State Street Letter, at 2; AJO Letter, at 1; Vanguard
Letter, at 2.
\377\ See, e.g., AJO Letter, at 3-4; ICI Letter I, at 5; CFA
Letter, at 5.
---------------------------------------------------------------------------

In addition, other comments addressed matters such as: Separating
held and not-held orders in the datasets, separating principal from
agency orders in the datasets, and not collecting ``parent order''
routing information.\378\ Other commenters expressed concern that not
collecting similar data from non-exchange venues would decrease the
utility of the data and provide the Commission with an incomplete
picture of the Pilot's impact.\379\ Other commenters were critical of
the proposed order routing data requirements because they believed,
despite the anonymization and aggregation requirements, that publicly
available data could be reverse engineered to reveal commercially-
sensitive information about individual broker-dealers.\380\ These
concerns are discussed further, below.
---------------------------------------------------------------------------

\378\ See infra notes 382, 386, and 395-397.
\379\ See supra notes 41-46.
\380\ See infra note 404.
---------------------------------------------------------------------------

a. Held and Not-Held Orders
The Commission proposed to require exchanges to separate out held
and not-held orders in the order routing datasets and requested comment
on whether orders should be separated out in that manner and whether
there are certain shared characteristics of such orders that would be
beneficial to assess when analyzing the Pilot data.\381\ In response,
several commenters stated that exchanges currently do not capture
whether orders are held or not held.\382\ Two commenters added that
capturing that information would impose additional costs on market
participants who would need to update their systems to include this
information in the order messages they send to exchanges, as well as
impose additional costs on exchanges to capture and report whether an
order is held or not held.\383\
---------------------------------------------------------------------------

\381\ See Proposing Release, supra note 2, at 13031, 13033.
\382\ See FIA Letter, at 3 fn. 8; FIF Letter, at 6; Citadel
Letter, at 3 fn. 5; IEX Letter I, at 10.
\383\ See FIA Letter, at 3 fn. 8; IEX Letter I, at 10.
---------------------------------------------------------------------------

The Commission has considered these comments and has determined not
to require the exchanges to separate held and not-held orders in the
order routing datasets. In proposing to require capture of held and
not-held orders, the Commission sought to include a data field that is
readily available to and currently captured by exchanges and that would
provide insight into the capacity in which a broker-dealer is handling
orders. In turn, that information could be useful to assess the broker-
dealer's routing of those orders. For example, orders that are ``held
to the market'' may be routed differently than orders that are ``not
held'' and for which the broker-dealer exercises more discretion in
their execution. By separating out these orders, researchers would have
access to an additional metric that potentially could be helpful in
analyzing the Pilot data and parsing the results.
As commenters have indicated, however, broker-dealers do not
transmit this information to exchanges and exchanges thus do not
capture it. The Commission does not wish to impose new data collection
requirements with respect to this Pilot data field, and therefore is
not adopting this element. However, as detailed below, the Commission
is adopting a new requirement for exchanges to instead separate out
orders based on their order capacity (e.g., principal, riskless
principal, and agency), which information currently is transmitted to
exchanges by broker-dealers.\384\
---------------------------------------------------------------------------

\384\ See, e.g., FIX Tag 528 (Order Capacity) under FIX 4.4 and
Fix Tag 47 (Rule80A) under TIF 4.2, available at https://btobits.com/fixopaedia/.
---------------------------------------------------------------------------

b. Principal Order Flow and Order Capacity
In response to the Commission's question in the Proposing Release
about what data are necessary to facilitate an analysis of the
potential conflicts of interest associated with transaction fees and
rebates,\385\ several commenters requested that the order routing
datasets exclude orders marked as principal or riskless principal
because the potential conflicts of interest posed by exchange
transaction fees and rebates pose a potential harm primarily when
broker-dealers are routing orders for customers in an agency capacity
and may be unduly influenced by exchange fees and rebates to the
detriment of obtaining the best execution for the customer's
order.\386\ To the extent a broker-dealer is routing its own
proprietary order and is unduly influenced by exchange fees and
rebates, then, at worst, it would only be harming itself. In other
words, as noted by one commenter, ``a broker may route principal orders
to maximize rebates and minimize access fees which would not be
considered a conflict of interest.''\387\
---------------------------------------------------------------------------

\385\ See Proposing Release, supra note 2, at 13033.
\386\ See FIA Letter, at 3; SIFMA Letter, at 8; Citadel Letter,
at 3; Citi Letter, at 5-6.
\387\ SIFMA Letter, at 8. See also Cboe Letter I, at 3 fn. 8.
---------------------------------------------------------------------------

Without separating out orders by their order capacity, one
commenter argued that the order routing datasets could generate
``misleading results'' because the trades of various market
participants could be aggregated at the same broker

[[Page 5233]]

due to ``direct market access arrangements,'' and these orders would be
indistinguishable from customer orders routed by that broker.\388\ In
this way, agency orders (which are subject to conflicts of interest
concerns that are relevant to the Pilot) could be mixed in with
principal orders (which are not subject to conflicts of interest
concerns that are relevant to the Pilot) and the inability to
distinguish them could cloud the results. Accordingly, one commenter
recommended separating principal and agency orders in the order routing
datasets, while continuing to include both types of order flow.\389\
The commenter believed that specifically identifying the extent to
which orders are principal orders or agency orders ``would further
facilitate the analysis of order flow and a better understanding of the
efficacy of the [P]ilot.'' \390\
---------------------------------------------------------------------------

\388\ See FIA Letter, at 3 fn. 9.
\389\ See Clearpool Letter, at 6.
\390\ Id.
---------------------------------------------------------------------------

After careful consideration of these comments, the Commission has
determined to require exchanges to separate out orders by order
capacity (e.g., principal, riskless principal, and agency). Requiring
exchanges to separately aggregate orders according to their order
capacity will allow researchers to more precisely parse the data as
recommended by several commenters, particularly when analyzing the
potential conflicts of interest in broker-dealer routing presented by
exchange fee-and-rebate pricing models. For example, researchers will
be able to separate out and exclude principal orders when studying
conflicts of interest, as conflicts of interest do not present the
potential for harmful impact with respect to such orders as they do for
agency orders where the broker-dealer is routing for others. In
addition, researchers will be able to include orders of any order
capacity when studying other questions, such as intermediation, queue
length, and time to execution, as such issues are relevant to orders of
any capacity.
Further, the Commission believes that principal orders should be
included in the order routing datasets, as the Pilot is designed to
assess more than just conflicts of interest between brokers and their
customers in order routing. It also is designed to observe the impact
of exogenous shocks to transaction fees and rebates on execution
quality and market quality broadly. Accordingly, the Pilot will provide
the opportunity to obtain useful data on matters such as
intermediation, queue length, and time to execution; the impact of fees
and rebates on liquidity adding and liquidity removing activity; the
relationship between payment of rebates on making activity (or taking
activity on an inverted exchange) and fee levels for taking activity
(or making activity on an inverted exchange); and the impact of fees
and rebates on order routing behavior generally. Consideration of these
issues directly implicates principal order flow and, as such, the
Commission believes it is critical for the aggregated volume statistics
included in the order routing datasets to include principal orders.
c. Order Designation
In response to questions in the Proposing Release on specific
measures and data that would facilitate an analysis of the effects that
changes to transaction fees and rebates have on order routing behavior,
execution quality, and market quality, several commenters recommended
that the Commission analyze the impacts of fees and rebates on various
aspects of the execution quality of investors' limit orders.\391\
Further, on the impact that prohibiting rebates may have on quoted
spreads and displayed liquidity, commenters also disagreed about the
willingness and ability for investors, other than those that are
motivated by rebate capture, to post liquidity in order to capture the
quoted spread.\392\ In addition, in attempting to utilize transaction
data to analyze the impact of reduced or eliminated rebates, one
commenter recommended that the dataset exclude orders that presently
are not eligible for rebates, such as those designated for
participation in opening and closing auctions.\393\
---------------------------------------------------------------------------

\391\ See, e.g., Fidelity Letter, at 8; ICI Letter I, at 5;
SIFMA Letter, at 5-6; IEX Letter I, at 2. See also Proposing
Release, supra note 2, at 13033.
\392\ See supra notes 224-225 and accompanying text.
\393\ See Mulson Letter I.
---------------------------------------------------------------------------

While analyzing the impact of reduced or eliminated rebates is one
potential analysis for which the Pilot's data may be useful, the
Pilot's purpose is broader in scope. As such, the Commission continues
to believe that it is appropriate for the order routing datasets to
capture all liquidity-providing and liquidity-taking orders. However,
in response to the commenters' recommendations discussed above and in
an effort to ensure that the order routing data be as useful as
possible and facilitate an analysis of the impacts of the Pilot, the
Commission has determined to further refine the order routing dataset
by requiring exchanges to report separately the volume statistics by
``order designation,'' which will require exchanges to separate out
post-only orders as well as auction orders.
Separating the volume statistics in this manner will allow
isolation of the cumulative number of post-only orders, which are limit
orders that include instructions to never remove liquidity, and may be
more reflective of a rebate-sensitive market participant. With the data
further refined in this manner, the Commission believes the data will
be more useful in analyzing the impacts of the Pilot both in comparing
the pre-Pilot data to the Pilot data and in comparing the data across
the Test Groups and Control Group during the Pilot. In particular, the
further refinement will facilitate assessment of the impact of the
Pilot on the willingness of investors to passively post orders and
their ability to obtain queue priority (i.e., represent the best price
in the exchange's limit order book) and capture the quoted spread when
doing so (i.e., buy on the bid and sell on the offer).\394\
---------------------------------------------------------------------------

\394\ See supra Section II.C.10.
---------------------------------------------------------------------------

Furthermore, with respect to auction orders, which are orders
specifically designated for execution in either an opening or closing
auction, instead of separating out auction orders, exchanges may
instead elect to simply exclude them from the order routing datasets,
as an alternative means of complying with the order designation
requirement. The Commission has determined to allow the exchanges to
choose between these two approaches so that they may choose the option
that is the least burdensome. If exchanges choose to include auction
order data in the order routing datasets, they will need to comply with
the requirement by separating orders by order designation, so that
these orders may be separately identified and accounted for in any
analyses of the Pilot's data.
The ability to isolate auction orders recognizes the uniqueness of
the auction process and will facilitate separation of that data in
order to study the Pilot's impact on trading during the regular market
session without potentially biasing the results by including auction
activity, for which different trading rules, order types, and fees
apply.

[[Page 5234]]

d. Broker Routing Data
Several commenters addressed the utility of obtaining order routing
data from broker-dealers that route customer orders in assessing the
potential conflicts of interest related to transaction fees and
rebates.\395\ Several of these commenters explained that obtaining data
from broker-dealers (in addition to or in place of obtaining such data
from exchanges) would facilitate an analysis of the impact of
transaction fees and rebates on order routing behavior and potential
conflicts of interest from the perspective of customers, as the brokers
would have information that can be used to assess the execution quality
of a ``parent order'' and would provide information on the broader
universe of potential routing destinations, including non-exchange
trading venues.\396\ One commenter added that investors needed to
conduct their own analyses of their orders to understand the impact of
the Pilot on their brokers.\397\
---------------------------------------------------------------------------

\395\ See, e.g., Healthy Markets Letter I, at 24-25; Pragma
Letter, at 3; NYSE Letter I, at 9-10; NYSE Letter II, at 12-13;
Viable Mkts Letter, at 2; Babelfish Letter, at 3.
\396\ See e.g., Healthy Markets Letter I, at 24-25; Pragma
Letter, at 3; NYSE Letter I, at 9-10; NYSE Letter II, at 12; Viable
Mkts Letter, at 2.
\397\ See Babelfish Letter, at 3.
---------------------------------------------------------------------------

The Commission is not requiring data collection from broker-dealers
or non-exchange trading venues. The order routing datasets will include
aggregated data from exchanges (as opposed to individual order level
data from broker-dealers) representing the sum totals of the ``child''
orders that are processed by an exchange. While the Pilot will not
capture the entire lifecycle of a ``parent'' order from its inception,
the Commission believes that its approach will minimize the
implementation costs on market participants while ensuring that the
Commission and researchers have useful data on child orders to observe
the impacts of introducing exogenous shocks to exchange transaction
fees and rebates. The order routing data provided by the exchanges
represents the information that would be directly correlated to these
exogenous shocks. Data that is available elsewhere \398\ will provide
the ability to understand any observed changes in order flows or market
share to non-exchange venues during the Pilot.
---------------------------------------------------------------------------

\398\ See FINRA OTC Transparency Data, available at https://otctransparency.finra.org/.
---------------------------------------------------------------------------

Further, the Commission agrees with the commenters that noted that
market participants need to conduct their own analyses of their own
order flow. If market participants conduct their own analyses,
including parent order-level analyses, and wish to provide that
information to the Commission and the public, the Commission would be
able to consider the information in assessing the Pilot's ultimate
impact on order routing behavior, execution quality, and market
quality. The Commission encourages market participants to conduct
analyses and make the results of their analyses public. The Commission
also encourages any interested party that prepares an analysis of the
Pilot to submit it to the Commission for posting on the Commission's
website.\399\
---------------------------------------------------------------------------

\399\ See supra note 302 and accompanying text.
---------------------------------------------------------------------------

e. Directed Orders
Two commenters recommended that the order routing datasets identify
whether orders are directed or non-directed.\400\ One of these
commenters believed that directed orders do not feature ``the same
level of discretion and conflicts of interest that are the primary
focus of the'' Pilot.\401\ After careful consideration of these
comments the Commission has determined not to require the order routing
datasets to identify directed orders. The Commission recognizes that
researchers may be interested in isolating orders directed by customers
to specific exchanges because these orders may not be subject to the
same potential conflicts of interest that may be present when a broker
chooses where to route a customer order. However, separating out
directed orders in the datasets (which report aggregated data and not
order-by-order data) would require exchanges and broker-dealers to
incur additional costs in preparing the Pilot's order routing data.
Further, the Pilot is designed to assess more than just conflicts of
interest between brokers and their customers in order routing, and
separate identification of directed and non-directed orders is not
germane to the other questions the Pilot is designed to explore.
Accordingly, the Commission believes that the additional implementation
costs that adding such a requirement would impose are not justified by
any benefits that may accrue from identifying, on an aggregated basis,
directed orders in the order routing data.
---------------------------------------------------------------------------

\400\ See Healthy Markets Letter I, at 23-24; Clearpool Letter,
at 6.
\401\ Healthy Markets Letter I, at 23.
---------------------------------------------------------------------------

f. Utilizing the Consolidated Audit Trail
Two commenters recommended that, instead of requiring separate
order routing datasets, the Commission instead use data that the
equities exchanges will report to the Consolidated Audit Trail
(``CAT'').\402\ In the Proposing Release, the Commission stated that if
the equities exchanges are reporting to the CAT at the time the Pilot
commences, they would be able to compile the order routing datasets by
utilizing the data they collect pursuant to the CAT national market
system plan.\403\ However, there have been delays in the development
and building of the CAT, and the reporting required by the first phase
of the CAT NMS Plan has been delayed. Although the exchanges and FINRA
have recently begun to report certain data to the CAT central
repository, they continue to work to fully implement the first phase of
the CAT NMS Plan, including linkages between reported events and
regulators' query functionality. The Commission believes that it is
important to proceed with the Pilot and not delay the Pilot until the
exchanges have begun full reporting to the CAT and the CAT operates in
a manner that would facilitate the data analysis contemplated by the
Pilot.
---------------------------------------------------------------------------

\402\ See Citadel Letter, at 3; TD Ameritrade Letter, at 6. In
response to the Commission's solicitation of comment in the
Proposing Release on whether the CAT repository, if it were
operational, would provide sufficient data to evaluate the Pilot,
one commenter stated that it believed the data reported from the CAT
would provide the necessary information with respect to order
routing data. See FIF Letter, at 2.
\403\ See Proposing Release, supra note 2, at 13031 n. 172 and
accompanying text.
---------------------------------------------------------------------------

g. Anonymization and Public Availability
Several commenters expressed concerns about having the exchanges
publicly post the order routing datasets, despite the requirement that
the exchanges anonymize the identities of broker-dealers before making
the datasets publicly available. These commenters believed that the
order routing data could potentially be ``reversed engineered'' such
that market participants might be able to ascertain the identities of
individual broker-dealers in some circumstances.\404\ In contrast, one
commenter acknowledged that ensuring confidentiality is ``critical''
and was ``pleased to see that the SEC has recognized this in proposing
anonymizing certain of the proposed data to protect confidential
information.'' \405\
---------------------------------------------------------------------------

\404\ See, e.g., FIA Letter, at 3; Virtu Letter, at 7-8; SIFMA
Letter, at 6; FIF Letter, at 2; Citadel Letter, at 4; Citi Letter,
at 6; TD Ameritrade Letter, at 5; STANY Letter, at 5; IEX Letter I,
at 10; Credit Suisse Commentary, at 6; Morgan Stanley Letter, at 4.
\405\ See Clearpool Letter, at 6-7.
---------------------------------------------------------------------------

Of the commenters concerned about the potential for reverse
engineering, one of these commenters provided an example of how the
information could

[[Page 5235]]

be reverse engineered if ``a market participant could direct a large
order in a particular symbol to a specific broker-dealer, and then
identify the presence of that order'' in the order routing
datasets.\406\ This commenter added that market participants may also
be able to compare the order routing datasets with reports published
pursuant to 17 CFR 242.605 (Rule 605 of Regulation NMS) to determine
the identity of broker-dealers.\407\ Once a broker-dealer's identity is
likely known, this commenter believed that competitors could use the
order routing datasets to discern that broker's ``(a) market share and
activity in a given security, (b) overall routing practices, and (c)
relative aggressiveness or passiveness in specific securities.'' \408\
This commenter also believed that strategies used by institutional
investors that are customers of broker-dealers ``may also be
susceptible to reverse-engineering.'' \409\ Another commenter added
that it believed ``market participants and others will be able to
identify certain broker-dealers routing strategies by comparing the
Pilot data to publicly available 17 CFR 242.606 (Rule 606) disclosures,
or by other means,'' although it did not specify those other
means.\410\
---------------------------------------------------------------------------

\406\ Citadel Letter, at 4.
\407\ See id.
\408\ Id.
\409\ Id.
\410\ See TD Ameritrade Letter, at 5.
---------------------------------------------------------------------------

Several of the commenters that expressed concern about the public
availability of the order routing data, despite the proposed
anonymization requirements, recommended approaches to address their
concerns. Some of these commenters stated that the Commission should
receive order routing data at the broker-dealer level, but that the
public should only have access to data that is further aggregated, such
that the data would include statistics for firms of similar types or
business models, or simply aggregate all orders received by the
exchange.\411\ However, in contrast, two commenters noted that the
order routing data aggregated by broker would be important to analyses
undertaken by researchers and therefore should be made more broadly
available.\412\ Two other commenters suggested that if the order
routing data aggregated by broker would be helpful for researchers, the
Commission should provide that data to researchers only if they sign a
non-disclosure agreement.\413\ In addition, three commenters
recommended that if order routing datasets are to be made publicly
available on exchange websites, they should be subject to a 120 day
delay instead of a 30 day delay.\414\
---------------------------------------------------------------------------

\411\ See, e.g., Citadel Letter, at 4; Credit Suisse Commentary,
at 6; IEX Letter I, at 10; Morgan Stanley Letter, at 4; STANY
Letter, at 5; SIFMA Letter, at 6-7; TD Ameritrade Letter, at 5; FIF
Letter, at 7.
\412\ See Lipson Letter, at 1; Spatt Letter, at 3.
\413\ See Citadel Letter, at 5; Citi Letter, at 6.
\414\ See SIFMA Letter, at 7; STANY Letter, at 5; Fidelity
Letter, at 11.
---------------------------------------------------------------------------

The Commission appreciates commenters' concerns about the need to
safeguard the confidentiality of the order routing datasets. The
Commission agrees that if market participants were able to identify
specific broker-dealers in the datasets, there is the potential that
the data could be reverse engineered to reveal proprietary information
about trading attributable to specific broker-dealers. The Commission
has revised its approach to eliminate the public availability of the
order routing datasets to help address these concerns, while still
furthering the goals of the Pilot. More specifically, to address
commenters' concerns with the public availability of the data and the
exchanges' role in preparing it for dissemination, the Commission is
not adopting the requirement for the exchanges to anonymize \415\ and
publicly post the order routing data.
---------------------------------------------------------------------------

\415\ Several commenters expressed concerns that the equities
exchanges would have access to the Broker Dealer Anonymization Key.
See, e.g., Virtu Letter, at 8; SIFMA Letter, at 7; FIF Letter, at 2;
STANY Letter, at 5; IEX Letter I, at 10; Morgan Stanley Letter, at
4. As adopted, the exchanges would not have access to the Broker
Dealer Anonymization Key, which addresses the commenters' concerns.
---------------------------------------------------------------------------

The Commission, however, believes it is important for the
Commission itself to have access to the order routing dataset, so the
Commission can consider the effects of rebates and transaction-based
fees on order routing behavior, execution quality, and market quality.
Accordingly, given the potential for reverse engineering, the Exchanges
will be required to provide order routing data directly to the
Commission.
While the Commission anticipated benefits from market participants,
researchers, and others in conducting independent analysis of the Pilot
and its impacts, the Commission has carefully balanced the concerns
about possible reverse engineering of the order routing data against
these benefits. The Commission believes that it can assess the effects
of the transaction-fee and rebate models on order routing behavior and
thereby achieve this goal of the Pilot without requiring public
disclosure of order routing data attributable to a specific broker-
dealer.
The Commission is not adopting the requirement for exchanges to
make public in an anonymized form the order routing data, but the
exchanges will instead identify individual broker-dealers by MPID or
CRD number in the order routing data they send to the Commission. The
Commission recognizes that order routing data attributable to a
specific broker-dealer is particularly sensitive and is non-public
information.\416\ The Commission, however, intends to make public
analyses, results, and studies using the order routing data. In
determining whether and how to make public this or any other
information, the Commission will be sensitive to the concerns
articulated by commenters and will consider steps such as aggregating
or anonymizing order routing data.
---------------------------------------------------------------------------

\416\ The Commission will deem broker-dealer identifying order
routing data as being subject to a confidential treatment request
under 17 CFR 200.83 without the need to submit a request. The
Freedom of Information Act provides at least two potentially
pertinent exemptions under which the Commission has authority to
withhold certain information. See 5 U.S.C. 552(b)(4) and (8).
---------------------------------------------------------------------------

Specifically, the Commission is adopting a requirement for each
exchange to prepare and transmit directly to the Commission, in pipe-
delimited ASCII format, no later than the last day of each month, a
file containing sets of order routing data.\417\ While the Commission
is not requiring the exchanges to anonymize the data and thus will no
longer provide exchanges with the Broker-Dealer Anonymization Key, the
Commission is requiring each exchange to provide its order routing data
by broker-dealers' CRD number and MPIDs in order to provide aggregated
broker-dealer level data to the Commission to facilitate its analysis
of the data.\418\
---------------------------------------------------------------------------

\417\ See Proposing Release, supra note 2, at 13033 (asking
whether commenters think exchanges should be required to report the
datasets directly to the Commission). Further, in its Proposal, the
Commission noted that it considers the order routing data to be
``regulatory'' information and proposed to prohibit exchanges from
accessing or using the information for commercial purposes. See id.
at 13032. The Commission is adopting as proposed the prohibition on
exchange personnel accessing the data for commercial purposes, as
exchanges will have access to the information.
\418\ See id. at 13032. See also Rule 610T(d)(1)(iv) and
(d)(2)(iv).
---------------------------------------------------------------------------

The Commission believes that the suggested alternative to further
aggregate the datasets, for example, to combine the data of several
firms together or combine all firms together, would seriously
compromise the ability of researchers to investigate the potential
conflicts of interest in routing because researchers would not be able
to see an individual broker-dealer's orders across all exchanges and
thereby would not be able to assess how any particular broker-dealer
may have been influenced by fees and rebates at

[[Page 5236]]

different exchanges.\419\ Because broker-dealer level data already is
consolidated (i.e., the data would not separate out individual customer
activity), adding another level of consolidation by grouping broker-
dealers together would cloud insight into the potential conflicts of
interest question, rendering the data potentially useless for the
purpose of studying conflicts of interest. Accordingly, the Commission
continues to believe that it needs access to the order routing data in
its proposed form, without further aggregation of the data.\420\
---------------------------------------------------------------------------

\419\ See, e.g., CFA Letter, at 5 (believing that ``breaking the
data out at the broker-dea[le]r level will permit a closer
examination of how different broker-dealers may change their order
routing behavior in response to changes in fees and rebates at each
exchange.''); Lipson Letter, at 1; Spatt Letter, at 3; Better
Markets Letter, at 7; Healthy Markets Letter I, at 24 fn. 87.
\420\ The Commission notes that the proposed language in Rule
610T(d)(1)(vi)(F), (d)(1)(xii)(H), and (d)(2)(vi)(F) has been
modified slightly. As proposed, Rule 610T(d)(1)(vi)(F) and Rule
610T(d)(2)(vi)(F) both noted that the order size code at the largest
share bucket was ``> 10,000.'' As adopted, the largest share bucket
order size code will be reflected as ``>= 10,000 share bucket.'' In
addition, as proposed, Rule 610T(d)(1)(xii)(H) set forth a time
frame of ``> 30 minutes of order receipt.'' As adopted, that time
frame will be clarified to state that the time frame is ``>=30
minutes of order receipt.''
---------------------------------------------------------------------------

F. Implementation

The Commission proposed to publish a notice setting forth the start
and end dates of the pre-Pilot, Pilot, and post-Pilot Periods.\421\ If
applicable, the Commission also would publish a notice if it determines
to suspend the one-year sunset of the Pilot Period.\422\ As discussed
in the Proposing Release, 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. Thus, 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
commence at the conclusion of the Pilot and would end six months from
the post-Pilot Period's start date. The Commission proposed to publish
the initial notice setting forth the start date for each of the Pilot's
three periods, and do so with a one-month minimum advance notice in
order to allow the equities exchanges to finalize their preparations
for the Pilot's pre-Pilot Period, as well as provide at least a seven-
month advance notice to market participants of the start date on which
the Pilot's conditions would go into effect.\423\
---------------------------------------------------------------------------

\421\ See Proposing Release, supra note 2, at 13033.
\422\ See id.
\423\ See id. at 13033-34.
---------------------------------------------------------------------------

One commenter agreed that a one-month period between the
Commission's notice and the start of the pre-Pilot Period would be
``sufficient provid[ed] there are no changes to the Pilot securities
lists and assigned test/control groups.'' \424\ This commenter also
agreed that the proposed seven-month period following the Commission's
notice would be ``sufficient to prepare for the Pilot.'' \425\ However,
this commenter requested that ``any technical specification materials
required to support implementation of the Pilot be reviewed with the
industry and finalized in an expeditious manner, six months prior to
the launch of the pre-Pilot data gathering phase,'' which the commenter
believed would ``allow[ ] necessary time for industry firms to properly
scope necessary development work and assign respective resources.''
\426\ Another commenter, however, did not believe that a one month
period prior to the start of the pre-Pilot period would be sufficient
for the industry to prepare and instead estimated that ``the
implementation of the pre-Pilot processing alone [would] take between
three to four months.'' \427\ As discussed and addressed above, a few
commenters recommended that the Pilot begin with a limited phase-in
period with a small number of securities.\428\
---------------------------------------------------------------------------

\424\ See FIF Letter, at 7-8.
\425\ See id. at 8.
\426\ See FIF Letter, at 8.
\427\ See Cboe Letter I, at 21.
\428\ See supra notes 349-350 and accompanying text.
---------------------------------------------------------------------------

After careful consideration of the comments received, the
Commission continues to believe that the proposed implementation
approach should provide adequate notice and time for those impacted by
the Pilot to prepare for its requirements. The Pilot will begin with a
six-month pre-Pilot period during which exchanges will not need to
revise their fees to comply with the Pilot. At the conclusion of the
pre-Pilot Period, exchanges will be required to revise any of their
fees, which will apply to the Pilot Securities, that currently exceed
the terms of the Pilot's Test Groups. While the Exchange Act allows
exchanges to file their fees for immediate effectiveness, exchanges may
choose to preview their Pilot-related fee changes to their membership
to provide them with additional time to adjust their order routing
systems in response to those changes.\429\ The Commission does not
anticipate that technical specification materials will be required to
support implementation of the Pilot by broker-dealers because the Pilot
solely concerns exchange fees which exchanges commonly adjust with
little or no advance notice though immediately effective fee filings
with the Commission. Therefore, broker-dealers currently are accustomed
to accommodating the types of fee changes that would be required to
comply with the requirements of the Pilot.
---------------------------------------------------------------------------

\429\ Although broker-dealers will need to account for different
fee and rebate levels across two Test Groups and the Control Group
if exchanges maintain different fee and rebate levels across the
treatment groups, they will have seven months before the start of
the Pilot Period to update their execution algorithms, including to
accommodate the prohibition on rebates and Linked Pricing in the no-
rebate Test Group.
---------------------------------------------------------------------------

Further, the Commission believes that publishing the start date for
each of the Pilot's three periods in advance, with at least one month's
advance notice, will provide the exchanges with time to prepare the
three types of data required by the Pilot. First, because the
Commission will determine the initial List of Pilot Securities, the
exchanges will only need to perform the ministerial task of separating
out their listed issuers and creating the Pilot Securities Exchange
Lists and Pilot Securities Change Lists. Second, the Exchange
Transaction Fee Summaries will require each exchange to summarize its
own fees, for which it is solely responsible, in the specified XML
format. For the initial Exchange Transaction Fee Summary, which would
be posted prior to the start of trading on the first day of the pre-
Pilot Period, exchanges would not need to include information that is
calculated on a look-back basis, because the look-back period for that
report would pre-date the pre-Pilot Period. Accordingly, preparation of
the initial Exchange Transaction Fee Summary report should be
streamlined.\430\ Finally, the order routing datasets, because they
also are prepared on a look-back basis, will not need to be prepared
until the end of the second month of the pre-Pilot Period (as it will
contain data for the first month of the pre-Pilot period).\431\
Accordingly, the Commission continues to believe that the proposed time
frames set forth in Rule 610T(c)(4) are sufficient to allow the
equities exchanges and market participants to prepare for the
requirements of the pre-Pilot Period, the Pilot Period, and the post-
Pilot Period.
---------------------------------------------------------------------------

\430\ The fields in the Exchange Transaction Fee Summary that
are calculated based on a look-back period to the prior month are:
Rule 610T(e)(9) (month and year of the average and median figures);
(12) average take/make; and (13) median take/make.
\431\ See Proposed Rule 610T(d).

---------------------------------------------------------------------------

[[Page 5237]]

No comments were received regarding the required notice to suspend
the automatic sunset provision. Accordingly, the Commission adopts this
aspect of the Pilot for the reasons outlined in the Proposing Release.

G. The Commission's Authority To Conduct the Pilot

The Commission is adopting the Pilot in furtherance of its
statutory responsibilities. In 1975, Congress directed the Commission,
through enactment of Section 11A of the Exchange Act, to use its
authority under the Exchange Act to facilitate the establishment of a
national market system to link together the multiple individual markets
that trade securities. Congress intended the Commission to take
advantage of opportunities created by new data processing and
communications technologies to preserve and strengthen the securities
markets. Congress also directed the Commission to exercise this
authority ``to carry out'' certain ``objectives,'' which include
assuring: ``economically efficient execution of securities
transactions''; ``fair competition among brokers and dealers, among
exchange markets, and between exchange markets and markets other than
exchange markets''; the ``availability . . . of information with
respect to quotations for and transactions in securities''; and '' an
opportunity . . . for investors' orders to be executed without the
participation of a dealer.'' \432\ In addition, the Exchange Act
elsewhere requires that the rules of national securities exchanges (i)
``provide for the equitable allocation of reasonable dues, fees, and
other charges among its members and issuers and other persons using its
facilities,'' (ii) not be designed to ``permit unfair discrimination
between customers, issuers, brokers, or dealers,'' and (iii) not
``impose any burden on competition not necessary or appropriate in
furtherance of the purposes of [the Act].'' \433\
---------------------------------------------------------------------------

\432\ 15 U.S.C. 78k-1(a)(1)(C), (a)(2); see also id. sec. 78k-
1(c)(1) (stating that self-regulatory organizations shall not make
use of the mails or any means or instrumentality of interstate
commerce to collect, process, distribute, publish, or prepare for
distribution or publication any information with respect to
quotations to assist, participate in, or coordinate the distribution
or publication of such information, or to effect any transaction in,
or to induce or attempt to induce the purchase or sale of, any such
security in contravention of such rules and regulations as the
Commission shall prescribe to ``assure the . . . fairness and
usefulness of the form and content of such information'').
\433\ 15 U.S.C. 78f(b)(4), (b)(5), (b)(8). The Commission also
has authority to adopt the Pilot pursuant to Exchange Act Sections
17(a) [15 U.S.C. 78q(a)] (requiring each exchange to make and keep''
for prescribed periods such records, furnish such copies thereof,
and make and disseminate such reports as the Commission, by rule,
``prescribes as necessary or appropriate in the public interest, for
the protection of investors, or otherwise in furtherance of the
purposes of [the Act]''), and 23(a) [15 U.S.C. 78w(a)] (granting the
Commission the power to make such rules and regulations as may be
``necessary or appropriate to implement the provisions of this
chapter'' for which the Commission is responsible or for the
execution of the functions vested in the Commission by the Act).
---------------------------------------------------------------------------

Through these provisions Congress conferred on the Commission
``broad authority to oversee the SROs' `. . . operation . . .' of the
national market system.'' \434\ And it is pursuant to this authority
that the Commission originally adopted Rule 610(c). The Pilot reflects
the Commission's efforts to evaluate, in light of changing market
conditions, whether the existing transaction-based fee and rebate
structure continues to further the statutory goals. In that sense, the
Pilot follows as an appropriate progression from Rule 610, and it
represents an important step in the Commission's continuing obligation
to implement Congress's objectives for the national market system.
---------------------------------------------------------------------------

\434\ City of Providence, Rhode Island v. BATS Global Mkts.,
Inc., 878 F.3d 36, 41 (2d Cir. 2017).
---------------------------------------------------------------------------

The Commission disagrees with the suggestion by one commenter that
the Pilot is inconsistent with Exchange Act Section 19(b)(3)(A), which
sets out part of the process by which proposed rule changes by self-
regulatory organizations may become effective.\435\ Contrary to the
commenter's suggestion, nothing in Section 19 interferes with the
Commission's authority described elsewhere in the Exchange Act. Indeed,
Section 19 itself makes clear that the Commission retains ultimate
authority over the rules of registered exchanges, providing that ``[n]o
proposed rule change [by a self-regulatory organization] shall take
effect unless approved by the Commission or otherwise permitted in
accordance with [Section 19(b)]'' \436\ and making clear that the
Commission retains authority to suspend and institute proceedings to
approve or disapprove even those exchange rules that are permitted to
take effect upon filing with the Commission.\437\ Moreover, Section 19
explicitly permits the Commission to summarily implement or suspend any
such proposed rule changes if, in the Commission's view, doing so would
serve the public interest, protect investors, or assist in maintaining
fair and orderly markets.\438\ And it makes clear that the Commission
retains authority to amend exchanges' rules on its own initiative.\439\
---------------------------------------------------------------------------

\435\ See Cboe Letter I, at 10-11. See 15 U.S.C. 78s(b)(3)(A).
\436\ 15 U.S.C. 78s(b)(1).
\437\ Id. Sec. 78s(b)(3).
\438\ Id. Sec. 78s(b)(3)(B), (C).
\439\ Id. Sec. 78s(c).
---------------------------------------------------------------------------

Commenters also disagreed about whether the Pilot complied with the
Commission's statutory obligations under the Administrative Procedure
Act \440\ (``APA'') and whether the Pilot is consistent with the
Exchange Act.\441\ For example, working from the premise that the APA
requires the Commission to `` `examine[ ] the relevant data and
articulate[ ] a satisfactory explanation for its action including a
rational connection between the facts found and the choices made,' ''
\442\ one commenter believed that the Commission ``lacks the
administrative record,'' ``evidence'' and ``analysis'' that would be
``needed to justify such drastic government intrusion into free
markets.'' \443\ Another commenter, however, disputed that notion and
observed that the Commission had developed the Pilot, in part, by
relying on ``empirical literature'' that ``is directly on point and
speaks to the potential distortionary effects that the pilot program is
designed to study'' and that ``certainly provides strong empirical
support for further analysis by way of data generated through a pilot
study.'' \444\ The responding commenter also found it significant that
the Commission was ``presently in the midst of a formal notice and
comment process . . . which was informed by years of discussion at, and
a proposal from, the [EMSAC]'' and that the Commission ``had chosen to
act via a pilot program rather than a proposal for a long-term rule.''
\445\ The commenter therefore believed the

[[Page 5238]]

Commission had fulfilled its statutory obligations in ``determin[ing]
that, given existing evidence suggesting the distortive effect of
practices in the market tied to rebates or access fees, a pilot program
will provide sufficient information to inform potential future
rulemaking.'' \446\
---------------------------------------------------------------------------

\440\ 5 U.S.C. 500, et seq.
\441\ A few commenters suggested that the Pilot ``would not
withstand judicial scrutiny'' because certain aspects of the Pilot
were ``arbitrary and capricious and not in accordance with law.''
See, e.g., Nasdaq Letter I, at 3. Specifically, these commenters
challenged the sufficiency of the Commission's economic analysis,
the exclusion of non-exchange trading centers from the Pilot, the
inclusion of ETPs in the Pilot, the ability of the Pilot to provide
the Commission with usable data, and the Commission's decision to
pursue a Pilot instead of other market structure initiatives. See,
e.g., Nasdaq Letter I, at 1-4, 8-9, 11; Cboe Letter I, at 12; NYSE
Letter, at 2-3, 7. These specific concerns are addressed in Section
IV (discussing the Commission's economic analysis), Section II.A.4
(discussing the exclusion of non-exchange trading centers from the
Pilot), Section II.B.3 (discussing the inclusion of ETPs in the
Pilot), Section II.E (discussing the ability of the Pilot to provide
the Commission with usable data), notes 307-319 supra (discussing
the Commission's decision to pursue a Pilot in conjunction with
other market structure initiatives).
\442\ Nasdaq Letter I, at 11 (quoting Motor Vehicle Mfrs. Ass'n
of U.S., Inc. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43
(1983)).
\443\ Id. at 11-12.
\444\ Verret Letter I, at 5-6.
\445\ Id. at 6.
\446\ Id. at 5.
---------------------------------------------------------------------------

The Commission agrees and notes that it has carefully examined
available data on this issue, engaged in a lengthy and deliberative
process, and taken into account the recommendations of two independent
advisory bodies (EMSAC and the Investor Advisory Committee). The
Commission developed the Pilot through a thorough review of the
empirical literature, which was cited and discussed in the Proposing
Release, as well as submitted as comments in response to this
proposal.\447\ Moreover, as discussed in the Proposal, the EMSAC
conducted a thorough process to consider, and ultimately formally
recommend, that a pilot be conducted.\448\ The EMSAC reflected a broad
and diverse set of perspectives. In addition, EMSAC heard testimony
from experts during its open meetings (which included as panelists
senior executives from exchanges) regarding exchange fee models, the
appropriateness of a transaction fee pilot, and the shape that such a
pilot should take.\449\ In addition to EMSAC, the independent Investor
Advisory Committee also submitted a recommendation in support of the
Pilot.\450\
---------------------------------------------------------------------------

\447\ See, e.g., Swan Letter; IEX Letter I; NYSE Letter I.
\448\ See Proposing Release, supra note 2, at 13009 n.6, 13012-
14.
\449\ See id. at 13009-14.
\450\ See IAC Recommendation.
---------------------------------------------------------------------------

After considering all of the available information, the Commission
has identified a fundamental disagreement among exchanges, market
participants, academics, and industry experts regarding the impact of
such fees and rebates on the markets.\451\ This disagreement is further
exacerbated by the lack of data to evaluate these competing claims. The
Commission believes that the Pilot is necessary to study the impact of
exchange fees and rebates to determine whether a regulatory response is
needed to mitigate the potential distortions that current exchange
pricing models introduce to order routing behavior, market quality, and
execution quality.
---------------------------------------------------------------------------

\451\ See, e.g., Section II.A.2. supra for a discussion of
comments regarding the impact of current pricing models on market
quality, execution quality, and order routing.
---------------------------------------------------------------------------

Some commenters argued that the Pilot's imposition of new fee caps
constituted ``impermissible government rate-making.'' \452\ For
example, one exchange commenter stated that ``[g]overnment-imposed
price controls'' ``reduce choices for market participants,'' ``distort
competition between over-the-counter venues and exchanges,'' and are
``costly to administer and lacking in an incentive to be efficient,''
such that ``they are only indicated where they overcome severe market
imperfection such as monopoly ownership of a critical resource.'' \453\
As discussed above, another commenter asserted that the Exchange Act
``plainly contemplates that exchanges, rather than the SEC, will make
an initial determination as to the price of a particular product or
service,'' and indicating that ``fee setting is the province of each
exchange, subject to the competitive forces that naturally control
fees'' and ``subject to oversight only in particular situations.''
\454\
---------------------------------------------------------------------------

\452\ Nasdaq Letter I, at 2. See also Cboe Letter I, at 1.
\453\ Nasdaq Letter I, at 5, 11-12. See also Cboe Letter I, at
11; Mexco Letter, at 1. One commenter agreed that ``price controls
on access fees indicate something is broken in market structure,''
but observed that ``there has been no serious economic analysis, let
alone a cost-benefit analysis, of what the optimal fee cap (if any)
should be'' and that the Pilot would ``provide solid evidence that
can be used to determine the optimal fee cap.'' Angel Letter I, at
1-2; Angel Letter II, at 2.
\454\ Cboe Letter I, at 10 (citing 15 U.S.C. 78s(b)(3)(A)(ii),
which provides that ``a proposed rule change shall take effect upon
filing with the Commission if designated by the self-regulatory
organization as. . . establishing or changing a due, fee, or other
charge imposed by the self-regulatory organization on any person,
whether or not the person is a member of the self-regulatory
organization''). This commenter also noted that ``every single
exchange transaction fee in place today was filed with, and
processed by, the Commission'' and that any fees that were
inconsistent with the Exchange Act ``could have been suspended or
abrogated by the Commission if that were deemed necessary.'' Id. at
6.
---------------------------------------------------------------------------

Commenters expanded on this argument by stating that the Commission
had not sufficiently ``evaluate[d] whether there is any evidence that
the Commission's objectives in adopting the cap on access fees . . .
are not being met.'' \455\ One commenter, for example, found it
``concerning that the fee caps in the proposed Pilot do absolutely
nothing to further the justification of the original cap and, unlike
the original access fee cap, are set at levels that completely undercut
existing rates.'' \456\ Exchange commenters further contended that the
Pilot imposes ``completely new limitations on exchanges' business''
that were ``unrelated to Regulation NMS's Access Fee Cap,'' because the
Pilot would ``expand[ ] the cap on fees that exchanges may charge for
execution not only against a protected quote, but for execution against
any quote on an exchange, including depth-of-book and non-displayed
orders,'' as well as ``limit . . . the rebates that an exchange pays''
and ``pricing that is linked to providing or removing liquidity on an
exchange.'' \457\
---------------------------------------------------------------------------

\455\ NYSE Letter I, at 11. This commenter identified the
relevant ``objectives'' of Rule 610(c) as preventing the exchanges
from ``undermining Regulation NMS's price protection and linkage
requirements.'' Id. Another commenter similarly characterized the
``justification for the fee cap under Rule 610(c)'' as ``the
existence of sustained market power created by the requirement of
best execution and the prohibition against trading through,'' which
would permit exchanges to ``charge high access fees thereby
undermining Regulation NMS's price protection and linkage
requirements.'' This commenter believed that the Commission had
wrongfully assumed ``that the market power presumably wielded by
equities exchanges is so great that they may charge excessive fees
now and in the future'' unless ``artificial government price
constraints'' are imposed. Nasdaq Letter I, at 12-13, 12 n.38. The
third commenter stated that the ``original fee cap rationale'' was
to ``address predatory outlier pricing.'' Cboe Letter I, at 14.
\456\ Cboe Letter I, at 14.
\457\ NYSE Letter I, at 12. See also Cboe Letter I, at 10
(stating that it was a ``conflict[ ] with the purposes of the
Exchange Act and [a] depart[ure] from Commission precedent'' to
``cap fees for transactions that do not implicate intermarket price
protection'' and ``ban[ ] linked pricing,'' which has been
``utilized by exchanges with SEC consent for years'').
---------------------------------------------------------------------------

The Pilot has two Test Groups, one of which does not cap fees at
all, but rather leaves in place the current Rule 610(c) fee cap and
simply prohibits exchanges from paying rebates or offering Linked
Pricing. The other Test Group does impose a lower fee cap for a small
portion of NMS stocks (730 out of over 8,000 NMS stocks) for a limited
period of time, but is doing so to study the effects of exchange fee-
and-rebate pricing models and to gather data to assess the impact on
the markets and market participants of a revised and lowered cap
compared to the current cap. Further, the Commission selected an amount
for that cap that was recommended by commenters, including the Investor
Advisory Committee.
As explained above, the existing fee cap was designed, in part, to
prevent trading centers from charging unreasonably high fees to market
participants required to honor their quotations by the Order Protection
Rule.\458\ Because ``[a]ccess fees tend to be highest when markets use
them to fund substantial rebates to liquidity providers, rather than
merely to compensate for agency services,'' the Commission was
concerned that ``the published quotations of [outlier]

[[Page 5239]]

markets would not reliably indicate the true price that is actually
available to investors or that would be realized by liquidity
providers.'' \459\ The Commission explained that the fee cap helped
assure the fairness and usefulness of quotation information; limit the
extent to which the true price for those who access quotations can vary
from the displayed price; permit broker-dealers to route orders in a
manner consistent with the operation of a national market system; and
protect limit orders and promote best-priced quotations.\460\
Accordingly, the Commission imposed a $0.0030 fee cap, which it
believed reflected a competitive rate that was consistent with current
business practices at the time (i.e., in 2005).\461\
---------------------------------------------------------------------------

\458\ See Securities Exchange Act Release No. 51808 (June 9,
2005), 70 FR 37496, 37545 (June 29, 2005) (File No. S7-10-04).
\459\ Id.
\460\ Id.
\461\ Id.
---------------------------------------------------------------------------

In establishing the Rule 610(c) fee cap, the Commission did not,
however, cede its responsibility to ensure that markets continue to
function in a fair, transparent, and efficient manner; nor did it state
that the $0.0030 fee cap could not be revisited if market conditions
changed. The Pilot is designed to determine, among other things,
whether such a change has occurred. Despite assertions by one commenter
that ``powerful competitive forces are clearly present that discourage
exchanges from exercising unabated pricing power,'' \462\ a $0.0030 fee
is still consistently charged by many exchanges, raising concerns among
other commenters that the fee cap is stuck at a non-competitive and,
perhaps, an artificially high rate.\463\ Several commenters have also
indicated that current pricing models have resulted in the kind of
distortive pricing that Rule 610(c) was designed to prevent.\464\
Testing lower fee levels, and a no-rebate fee regime,\465\ will help
the Commission to determine whether further regulatory action is needed
to achieve the objectives of Rule 610(c) as well as the Commission's
statutory mandate to oversee the equities markets.
---------------------------------------------------------------------------

\462\ Nasdaq Letter I, at 13.
\463\ See, e.g., BlackRock Letter, at 1 (``[T]he existing access
fee cap is outdated and permits market forces to drive fees and
rebates to excessive levels relative to the current magnitude of
commissions and bid-ask spreads.''); Goldman Sachs Letter, at 2
(identifying a ``well-developed, general consensus amongst market
participants that a $0.0030 per share Fee Cap is an outdated
benchmark for execution costs in today's trading environment . . .
and far from representative of true prices in the marketplace'');
Citi Letter, at 1-2 (stating that ``today's 30-mil cap on access
fees that the exchanges can charge to access liquidity on their
venues represents a more significant percentage of the economics of
each trade'').
\464\ See, e.g., ICI Letter I, at 2 (``Transaction fees and
rebates also undermine market transparency because the prices
displayed by exchanges--and provided on trade reports--do not
include fee or rebate information and therefore do not fully reflect
net trade prices.''); Goldman Sachs Letter, at 3 (stating that
``displayed prices do not reflect the actual economic costs because
exchange fees and rebates are not reflected in those prices'');
Oppenheimer Letter, at 2 (``[T]o the extent that transaction fees
and rebates obfuscate the actual price bid or offered for a
security, the `maker-taker' pricing model has the potential to
undermine price transparency . . . .'').
\465\ In response to commenters who complained that the Pilot's
fee cap Test Group applies to fees to provide liquidity, instead of
being limited to fees to remove liquidity as is the case for Rule
610(c), and therefore it is ``unrelated'' to the existing fee regime
and the Rule 610(c) construct, the Commission notes that when it
adopted the Rule 610(c) fee cap it expressly noted that it would
``monitor the operation of these rules to assess whether in practice
. . . broader coverage of the rule is necessary.'' See NMS Adopting
Release, supra note 10, at 37546.
---------------------------------------------------------------------------

The Commission's position is echoed by other commenters that found
the ``suggest[ion] that the Commission lacks the authority to implement
the Pilot, or that testing a rebate ban or alternative access fee caps
would constitute an impermissible form of price control . . .
meritless'' \466\ or ``entirely inaccurate.'' \467\ One commenter, for
example, noted that the Exchange Act ``provides very broad authority
for the Commission to regulate all aspects of exchange operation,
including fee schedules . . . .'' \468\ This commenter further observed
that ``it makes no sense to attack the Commission's proposal as an
impermissible form of `rate setting' when the markets have been
operating with exchange fee limits for more than 10 years.'' \469\
Moreover, this commenter asserted that ``exchange criticisms''
regarding ``price control[s]'' are ``contradicted by their acceptance
of th[e] existing price regulation'' in Rule 610(c), which ``may better
serve their interests than the alternative caps and rebate prohibition
included in the Pilot.'' \470\
---------------------------------------------------------------------------

\466\ IEX Letter I, at 6.
\467\ Verret Letter I, at 2. See also IAC Recommendation, at 1
(``[T]he purpose of the Pilot is not to consider imposing price
controls, but instead to consider requiring fees (of whatever size)
to be structured so as to minimize complexity and agency costs.'').
\468\ IEX Letter I, at 6-7 (``The fact that the SEC has not
previously chosen to use its authority to prohibit rebates, or test
their elimination through a pilot, does not mean it lacks authority.
. . .''); see also Verret Letter I, at 3.
\469\ IEX Letter II, at 9. See also Verret Letter I, at 2
(stating that ``one might properly describe the Reg NMS regime as
itself a decade-long experiment in price controls'').
\470\ IEX Letter I, at 7; IEX Letter II, at 9 (``NYSE seems to
be saying, `We are fine with the current fee regulation, because we
have been able to operate very profitably under it, but it would be
illegal to even test different fee restrictions unless you impose
them on ATSs.''). See also, e.g., Verret Letter I, at 2 (``Exchanges
appear comfortable when price controls on the liquidity taking side
benefit their business models, but challenge the Commission's
authority to implement what they describe as price controls when
their own business models are negatively impacted.''); Larry Harris
Letter, at 6 (noting that ``exchange holding companies have a strong
interest in maintaining the current system'' and that the ``SEC may
reasonably consider these interests when evaluating comments
submitted by the exchanges); Themis Trading Letter II, at 3 (stating
that the Commission should not be ``distracted. . . by conflicted
stock exchanges desperately fearful that their business models might
come crashing down'').
---------------------------------------------------------------------------

A few other commenters believed that the Commission had not
sufficiently identified or discussed the statutory authority to conduct
the Pilot.\471\ One commenter stated that the Proposing Release did not
contain an ``explanation as to how those specific statutory sections
[cited by the Commission], either individually or collectively, provide
the Commission with the authority to carry out the Proposal's broad
rate-setting requirements'' or a ``discussion of the Commission's
statutory authority at all . . . .'' \472\ This commenter asserted that
the Commission ``cannot simply skip this analysis or assume it has
unrestricted authority to conduct pilots on the basis that the Proposal
is intended to be temporary.'' \473\
---------------------------------------------------------------------------

\471\ See, e.g., Cboe Letter I, at 9.
\472\ NYSE Letter I, at 12.
\473\ Id. See also Cboe Letter I, at 11. For example, the
commenter noted that the Commission had ``provided no analysis or
discussion demonstrating its reasoned decision-making of how the
specific fee structures to be mandated in the Proposal would be
equitably allocated or reasonable'' under Section 6 of the Exchange
Act. NYSE Letter I, at 12. See also 15 U.S.C. 78f(b)(4) (requiring
the rules of an exchange to ``provide for the equitable allocation
of reasonable dues, fees, and other charges among its members and
issuers and other persons using its facilities'').
---------------------------------------------------------------------------

The Commission notes that it followed its standard practice in the
Proposing Release to identify the statutory authority under which it
promulgated its Proposal. The Commission has complied with its
statutory obligations in promulgating the Pilot and has clear statutory
authority to adopt the Pilot, which the Commission believes furthers
the purposes of the Exchange Act.\474\
---------------------------------------------------------------------------

\474\ If any of the provisions of these amendments, or the
application thereof to any person or circumstance, is held to be
invalid, such invalidity shall not affect other provisions or
application of such provisions to other persons or circumstances
that can be given effect without the invalid provision or
application.
---------------------------------------------------------------------------

III. Paperwork Reduction Act

Certain provisions that the Commission is adopting today contain
``collection of information requirements'' within the meaning of the
Paperwork Reduction Act of 1995 (``PRA'').\475\ The Commission
published

[[Page 5240]]

a notice requesting comment on the collection of information
requirements in the Proposing Release \476\ and submitted relevant
information to the Office of Management and Budget (``OMB'') for review
in accordance with the PRA and its implementing regulations.\477\ The
title of the new collection of information for Rule 610T is
``Transaction Fee Pilot Data.'' Compliance with these collections of
information requirements is mandatory. 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. We have applied for an OMB Control Number for this collection
of information.
---------------------------------------------------------------------------

\475\ 44 U.S.C. 3501 et seq.
\476\ See Proposing Release, supra note 2, at 13038-39.
\477\ 44 U.S.C. 3507; 5 CFR 1320.11.
---------------------------------------------------------------------------

The Commission requested comment on the collection of information
requirements in the Proposing Release. The Commission received two
comment letters on the estimates for the collection of information
requirements included in the Proposing Release, which are discussed
below.\478\
---------------------------------------------------------------------------

\478\ See NYSE Letter I, at 15; Cboe Letter I, at 21.
---------------------------------------------------------------------------

A. Summary of Collection of Information

The Pilot requires the equities exchanges to prepare four sets of
data that constitute a collection of information within the meaning of
the PRA. First, pursuant to Rule 610T(b), the primary listing exchanges
will be required to prepare and publicly post two sets of data on the
Pilot Securities listed on their markets--the Pilot Securities Exchange
Lists and the Pilot Securities Change Lists.\479\ In addition, pursuant
to Rule 610T(d), all equities exchanges will be required to provide to
the Commission monthly order routing datasets.\480\ Lastly, pursuant to
Rule 610T(e), all equities exchanges will be required to prepare and
publicly post the Exchange Transaction Fee Summaries, which are monthly
summaries of information concerning fees assessed and rebates paid to
market participants transacting on the exchange.\481\
---------------------------------------------------------------------------

\479\ See supra Section II.E.0.
\480\ See supra Section II.E.3.
\481\ See supra Section II.E.0.
---------------------------------------------------------------------------

B. Proposed Use of Information

The data collected during the Pilot, including the Pilot Securities
Exchange Lists, Pilot Securities Change Lists, Exchange Transaction Fee
Summaries, and order routing datasets, will allow researchers and
market participants to have ready access to information that will
facilitate the study of the impact of an exogenous shock to transaction
fees and rebates on order routing behavior, execution quality, and
market quality. In turn, this information should facilitate a data-
driven evaluation of future policy choices.
In addition, 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,
researchers, 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 Test Groups during the
Pilot.

C. Respondents

The respondents to this collection of information will 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, will
apply to the six primary listing exchanges for NMS stocks. Rule
610T(d), which requires datasets on order routing, will 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, will apply to all thirteen equities exchanges
currently registered with the Commission.

D. Total Initial and Annual Reporting and Recordkeeping Burdens

The burdens associated with the Pilot are described fully below,
but the below table briefly summarizes the relevant burdens set forth
in the Proposing Release and in this release.

----------------------------------------------------------------------------------------------------------------
Annual burdens One-time
Category Release (hours/ burdens (hours/
exchange) exchange)
----------------------------------------------------------------------------------------------------------------
Pilot Securities Exchange Lists............... Proposing Release............... N/A 8
Adopting Release................ N/A 44
Pilot Securities Change Lists................. Proposing Release............... 126 12
Adopting Release................ 126 12
Exchange Transaction Fee Summaries............ Proposing Release............... 64 86
Adopting Release................ 64 86
Order Routing Datasets........................ Proposing Release............... 112 80
Adopting Release................ 124 80
----------------------------------------------------------------------------------------------------------------

1. Pilot Securities Exchange Lists and Pilot Securities Change Lists
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 Rule 610T(b)(2)(i)
on their websites in pipe-delimited ASCII format. The Commission
preliminarily estimated 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 its initial Pilot
Securities Exchange List.\482\ One commenter stated that it
``anticipates it could take as many as 44 hours'' to compile the
initial Pilot Securities Exchange List.\483\ The commenter stated that
its estimates of the costs associated with the Pilot are based on its
``prior experience implementing the Tick Size Pilot, and other similar
initiatives . . . .'' \484\ In light of this comment, the Commission is
increasing its estimate. While, unlike for the Tick Size Pilot, the
Commission will prepare the Initial List of Pilot Securities and assign
them to their

[[Page 5241]]

respective treatment groups, and therefore the exchanges will only need
to separate out their listed securities into a separate list, the
Commission nevertheless will increase its estimate as the commenter
suggested. Accordingly, the Commission estimates that each primary
listing exchange would incur, on average, a one-time burden of
approximately 44 burden hours per primary listing exchange to compile
and publicly post their initial Pilot Securities Exchange List.\485\
Accordingly, the Commission believes that the aggregate one-time burden
associated with the initial Pilot Securities Exchange Lists would be
264 burden hours.\486\
---------------------------------------------------------------------------

\482\ See Proposing Release, supra note 2, at 13036. The
Commission based 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. See id. at 13036 n.186.
\483\ See NYSE Letter I, at 15.
\484\ See id.
\485\ The Commission continues to believe that this will require
the services a full-time Compliance Manager and Programmer Analyst.
The Commission estimates that each Compliance Manager and Programmer
Analyst will each spend approximately 22 hours, for a combined total
of approximately 44 hours, to compile and publicly post to an
exchange's website a downloadable file containing the initial Pilot
Securities Exchange List.
\486\ 44 burden hours per primary listing exchange x 6 primary
listing exchanges = 264 burden hours.
---------------------------------------------------------------------------

After posting its initial Pilot Securities Exchange List, each
equities exchange will be required to keep current that list to reflect
any changes, and to also 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 estimated 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 its market.\487\ The Commission also preliminarily
estimated that, once the primary listing exchanges have established
these systems, on average, each primary listing exchange would incur
0.5 burden hours daily, or 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 its website prior to the start of each
trading day.\488\
---------------------------------------------------------------------------

\487\ 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. See
Proposing Release, supra note 2, at 13036.
\488\ The Commission based 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)). See id.
---------------------------------------------------------------------------

One exchange commenter stated that ``the Commission predicts it
that would take only 12.5 hours to develop and maintain systems to
comply'' with the requirements to update prior to the start of each
trading day the Pilot Securities Exchange Lists and Pilot Securities
Change Lists.\489\ Based on ``its prior experience implementing the
Tick Size Pilot, and other similar initiatives,'' this commenter
further stated that it believed ``it could take as many as 300.5 hours
to develop and maintain those systems.'' \490\ While the commenter did
not elaborate on how it computed its estimate or whether it represents
an aggregate burden estimate or an annualized estimate, the commenter
appears to have misunderstood the burden estimates contained in the
Proposing Release because the Commission's estimate greatly exceeded
12.5 hours. Specifically, the Commission's preliminary estimates
included a one-time burden of 8 hours for primary listing exchanges to
compile and publicly post the initial Pilot Securities Exchange List, a
one-time burden of 12 hours for primary listing exchanges to develop
appropriate systems to track and compile changes to Pilot Securities,
and an ongoing burden of 126 hours annually to compile any such changes
and publicly post the updated Pilot Securities Exchange Lists and Pilot
Securities Change Lists, for an aggregate burden estimate of 335 hours
per exchange for the entire Pilot.\491\ Assuming that the commenter's
estimate of 300.5 hours is meant to be an aggregate burden estimate,
the Commission notes that its revised aggregate burden estimate of 371
hours exceeds the commenter's estimate.
---------------------------------------------------------------------------

\489\ NYSE Letter I, at 15.
\490\ Id. See also Cboe Letter I, at 21 (stating that the
``implementation and ongoing costs of the Pilot will be
significantly larger in terms of burden hours and expenditures than
the Commission estimates,'' but providing no specific analysis or
alternative estimates).
\491\ See Proposing Release, supra note 2, at 13036. The
Commission notes that it has revised its aggregate burden estimate
upwards to 371 hours for each exchange to address commenter concerns
that the estimated burden associated with compiling and publicly
posting the initial Pilot Securities Exchange List was too low.
---------------------------------------------------------------------------

The Commission's estimates are averages that take into account the
diverse set of six primary listing exchanges and the expected burdens
that they would collectively experience as a result of the Pilot.
Moreover, the Commission expects that the primary listing exchanges
will be able to leverage their experience and resources from the recent
Tick Size Pilot to meet the requirements of the Pilot. As noted above,
unlike for the Tick Size Pilot, the Commission will set the initial
List of Pilot Securities and the primary listing exchanges only need to
keep those lists up to date if their listed issuers experience any
relevant change. Accordingly, the burdens on the primary listing
exchanges with respect to the lists of Pilot Securities should be less
than those incurred during the Tick Size Pilot.\492\
---------------------------------------------------------------------------

\492\ See Proposing Release, supra note 2, at 13027 n.153 and
accompanying text; note 740 infra.
---------------------------------------------------------------------------

For those reasons, the Commission continues to believe its estimate
of the aggregate one-time burden for primary listing exchanges to
develop appropriate systems to track and compile changes relevant to
Pilot Securities listed on their markets will be approximately 12
burden hours for each primary listing exchange, or 72 total burden
hours, and the average, aggregate annual burden to update and publicly
post the lists of Pilot Securities will be approximately 126 burdens
hours for each primary listing exchange, or 756 total burden hours for
all 6 exchanges.\493\
---------------------------------------------------------------------------

\493\ 126 burden hours per primary listing exchange x 6 primary
listing exchanges = 756 burden hours.
---------------------------------------------------------------------------

2. Exchange Transaction Fee Summaries
The Commission is requiring 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 believes that all the data necessary to complete the summary
are currently maintained by the equities exchanges. However, the
equities exchanges will be required to compute the monthly realized
average and median per share fees and rebates, each by participant
type, that qualified for the Base and Top Tier fees and rebates, using
fee and volume information that the equities exchanges maintain.
The Commission preliminarily estimated 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.\494\ One commenter objected generally to the
Commission's burden estimates, but

[[Page 5242]]

did not provide its own estimates of specific burden hours or
costs.\495\ The Commission continues to estimate that each equities
exchange will 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.\496\ Accordingly, the 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 Rule 610T(e) will be 1,040 hours.\497\
---------------------------------------------------------------------------

\494\ See Proposing Release, supra note 2, at 13037. The
Commission preliminarily estimated 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
estimated 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 id. at 13037 n.194.
\495\ Cboe Letter I, at 21 (stating that the ``implementation
and ongoing costs of the Pilot will be significantly larger in terms
of burden hours and expenditures than the Commission estimates,''
but providing no specific analysis or alternative estimates). But
cf. Better Markets Letter, at 2 (``All of the data-fields are
thoughtfully proposed, and the cost of producing them is minimal and
certainly acceptable given the enormity of the benefits.'' The
commenter did not provide specific burden hour or cost estimates.).
\496\ (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.
\497\ 80 burden hours per equities exchange x 13 equities
exchanges = 1,040 burden hours.
---------------------------------------------------------------------------

The Commission also preliminarily estimated that, on average, an
equities exchange would incur an ongoing burden of approximately 40
burden hours per year, approximately half the estimated burden to
develop appropriate systems, to monitor and, if necessary, update its
systems used for compiling, formatting and publicly posting the
Exchange Transaction Fee Summaries.\498\ One commenter objected
generally to the Commission's burden estimates, but did not
specifically explain whether or how this burden estimate was
incorrect.\499\ The Commission continues to estimate that the annual
ongoing burdens associated with monitoring and, if necessary, updating
these systems would be approximately half the burdens of initially
developing the systems. Accordingly, the Commission continues to
estimate that an equities exchange will 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.\500\ The average aggregate,
ongoing, annual burden for all equities exchanges to monitor their
systems will be 520 hours.\501\
---------------------------------------------------------------------------

\498\ See Proposing Release, supra note 2, at 13037. (Attorney
at 10 hours) + (Compliance Manager at 10 hours) + (Programmer
Analyst at 10 hours) + (Senior Business Analyst at 10 hours) = 40
burden hours.
\499\ See note 495 supra.
\500\ (Attorney at 10.5 hours) + (Compliance Manager at 10.5
hours) + (Programmer Analyst at 11 hours) + (Senior Business Analyst
at 10.5 hours) = 40 burden hours.
\501\ 40 burden hours per equities exchange x 13 equities
exchanges = 520 burden hours.
---------------------------------------------------------------------------

The equities exchanges will 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 its website such a summary, the Commission preliminarily estimated
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.\502\ In addition, each equities
exchange will be required to make its summary publicly available on its
website using an XML schema to be published on the Commission's
website. As the Commission preliminarily believed that the equities
exchanges had experience applying the XML format to market data,\503\
the Commission estimated that initially each equities exchange would
incur a burden of 2 burden hours specific to the initial Exchange
Transaction Fee Summary to ensure that it has properly implemented the
XML schema.\504\ One commenter objected generally to the Commission's
burden estimates, but did not specifically explain whether or how this
burden estimate was incorrect.\505\ The Commission continues to
estimate that each equities exchange will require approximately 4
burden hours to complete the initial Exchange Transaction Fee
Summary,\506\ for an aggregate, initial burden of 52 hours to complete
its initial Exchange Transaction Fee Summary.\507\ The Commission also
continues to estimate that each equities exchange will incur an initial
burden of approximately 2 burdens hours for an aggregate, initial
burden of 26 hours to post that dataset publicly on its website using
an XML schema to be published on the Commission's website. The total
aggregate, initial burden to complete the initial Exchange Transaction
Fee Summary will therefore be 78 burden hours.\508\
---------------------------------------------------------------------------

\502\ See Proposing Release, supra note 2, at 13037. 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. See id.
at 13037 n.198.
\503\ See id. at 13037 n.199 and accompanying text.
\504\ See id. at 13037. 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. See id.
at fn. 200.
\505\ See note 495 supra.
\506\ (Compliance Manager at 2 hours) + (Senior Business Analyst
at 2 hours) = 4 burden hours per equities exchange.
\507\ 4 burden hours per equities exchange x 13 equities
exchanges = 52 burden hours.
\508\ 2 burden hours per equities exchange x 13 equities
exchanges = 26 burden hours.
---------------------------------------------------------------------------

Each equities exchange will 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 fee and rebate
information. The Commission preliminarily believed that such updates
would require fewer burden hours than the initial Exchange Transaction
Fee Summary, as the equities exchanges would have experience
calculating necessary data and formatting the reports as required by
the Rule.\509\ Accordingly, the Commission preliminarily estimated that
it would require approximately 2 burden hours each month, or 24 burden
hours on an annualized basis, for each equities exchange to update the
Exchange Transaction Fee Summary.\510\ This estimate contemplated the
impact of publicly posting the summary using the XML schema to be
published on the Commission's website. One commenter objected generally
to the Commission's burden estimates, but did not specifically explain
whether or how this burden estimate was incorrect.\511\ The Commission
continues to estimate that it will require approximately 2 burden hours
each month, or 24 burden hours on an annualized basis, for each
equities exchange to update the Exchange Transaction Fee Summary.\512\
As such, the equities exchanges will incur an aggregate, annual burden
of 312 burden hours to update and publicly post on

[[Page 5243]]

their websites the Exchange Transaction Fee Summaries.\513\
---------------------------------------------------------------------------

\509\ See Proposing Release, supra note 2, at 13037.
\510\ See id. 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.
See id. at 13037 n.203.
\511\ See note 495 supra.
\512\ (Compliance Manager at 1 hours) + (Programmer Analyst at 1
hours) = 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.
\513\ 2 burden hours per equities exchange x 13 equities
exchanges x 12 monthly updates = 312 burden hours per year.
---------------------------------------------------------------------------

3. Order Routing Datasets
The Commission preliminarily estimated that, on average, there
would be no paperwork burden to the equities exchanges to capture the
order routing data required pursuant to Rule 610T(d) to be included in
the order routing datasets, as the Commission expected that the
equities exchanges would collect the required data to create the order
routing datasets by leveraging existing systems and technology already
in place for the collection and reporting of data.\514\ The Commission
believes this continues to be true with the changes to the order
routing datasets, which also involve data elements currently captured
by existing systems.
---------------------------------------------------------------------------

\514\ See Proposing Release, supra note 2, at 13038.
---------------------------------------------------------------------------

The Commission preliminarily believed, however, that the equities
exchanges would incur an initial one-time burden of 80 burden hours per
equities exchange to ensure that their systems and technology are able
to accommodate the proposed requirements to aggregate, anonymize, and
publicly post the order routing information.\515\ While the exchanges
will still need to aggregate the data, they no longer will need to
anonymize and publicly post it and instead will transmit the
information to the Commission. The Commission continues to believe that
each equities exchange would incur an initial one-time burden of 80
burden hours to ensure that its systems and technology are able to
accommodate the requirements to aggregate and provide to the Commission
the order routing information. Accordingly, the Commission estimates
that the aggregate one-time initial burden for ensuring an exchange's
systems and technology are able to aggregate and provide to the
Commission the required order routing data in compliance with Rule
610T(d) will be 1,040 burden hours.\516\
---------------------------------------------------------------------------

\515\ See id. The Commission preliminarily estimated 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 estimated 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 id. at 13038
n.207.
\516\ 80 burden hours per equities exchange x 13 equities
exchanges = 1,040 burden hours.
---------------------------------------------------------------------------

The Commission also preliminarily estimated 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 Rule.\517\ The Commission continues to
estimate 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 Rule.
Therefore, the Commission estimates that the aggregate annual burden to
maintain the systems necessary to aggregate and provide to the
Commission the required order routing information is approximately 520
burden hours per year.\518\
---------------------------------------------------------------------------

\517\ See Proposing Release, supra note 2, at 13038. The
Commission derived the total estimated burdens from the following
estimates, which reflected the Commission's preliminary view that
annual ongoing burdens would be approximately half the burdens of
initially ensuring an exchange 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. See id. at 13038 n.209.
\518\ 40 burden hours per equities exchange x 13 equities
exchanges = 520 burden hours.
---------------------------------------------------------------------------

Each equities exchange would incur an ongoing burden associated
with creating and formatting the order routing datasets each month. The
Commission noted that the equities exchanges have experience with
creating similar datasets in accordance with their obligations under
Rule 605 of Regulation NMS.\519\ The Commission preliminarily believed
that each equities exchange would incur burdens similar to those
associated with preparing Rule 605 reports.\520\ Accordingly, the
Commission preliminarily believed 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.\521\ While the order routing datasets will not be publicly
posted but will instead be provided to the Commission, the Commission
is requiring the equities exchanges to separate out post-only orders
and auction-only orders (or exclude auction-only orders if they so
choose). The Commission estimates that separating out these orders will
require approximately 1 additional burden hour per month. As such, the
Commission estimates that each equities exchange will incur a burden of
approximately seven burden hours per month, or 84 burden hours per
year, to prepare and provide to the Commission the order routing
datasets. Therefore, the aggregate, annual burden to prepare and
provide to the Commission order routing datasets in accordance with
Rule 610T(d) will be approximately 1,092 burden hours.\522\
---------------------------------------------------------------------------

\519\ See Proposing Release, supra note 2, at 13038.
\520\ See id. See also FR Doc. 2016-08552, 81 FR 22143 (April
14, 2016) (``Request to OMB for Extension of Rule 605 of Regulation
NMS'').
\521\ Compliance Manager at 3 hours + Programmer Analyst at 4
hours = 7 burden hours per month, per equities exchange. 7 burden
hours per month x 12 months = 84 burden hours per year, per equities
exchange.
\522\ 84 burden hours per year x 13 equities exchanges = 1,092
burden hours.
---------------------------------------------------------------------------

One exchange commenter stated that ``the Commission allocates 160
hours associated with producing order routing data,'' but estimated
that it ``would actually require over 400 hours,'' based on ``its prior
experience implementing the Tick Size Pilot, and other similar
initiatives . . . .'' \523\ While the commenter did not elaborate on
how it computed its estimate or whether it represents an aggregate
burden estimate or an annualized estimate, the commenter appears to
have misunderstood the burden estimates contained in the Proposing
Release because the Commission's estimate exceeds the 160 hours cited
by the commenter. Specifically, the Commission's preliminary estimate
included a one-time burden of 80 hours and an ongoing burden of 112
hours annually,\524\ for an aggregate burden estimate of 416 hours per
exchange for the entire Pilot.\525\ Second, the commenter does not
explain how it calculated its estimate of ``over 400 hours,'' break
down the costs included in this estimate, or specify whether this
number is an aggregate burden estimate or an annualized estimate.
Assuming that the commenter's estimate of over 400 hours is meant to be
an aggregate burden estimate, the Commission notes that its revised
aggregate burden estimate of 452 hours is substantially similar. The
Commission notes that exchanges will no longer be required to publicly
post this data, but will instead transmit the datasets directly to the
Commission. Moreover, the Commission expects that the exchanges will be
able to leverage their experience and

[[Page 5244]]

resources from the Tick Size Pilot to meet the requirements of the
Pilot.\526\
---------------------------------------------------------------------------

\523\ NYSE Letter I, at 15. See also Cboe Letter I, at 21
(stating that the ``implementation and ongoing costs of the Pilot
will be significantly larger in terms of burden hours and
expenditures than the Commission estimates,'' but providing no
specific analysis or alternative estimates).
\524\ The Commission notes that it has revised this estimate
upwards to 124 burden hours annually.
\525\ See Proposing Release, supra note 2, at 13038. The
Commission notes that it has revised this estimate upwards to 452
burden hours per exchange for the entire Pilot.
\526\ See Section C.2.a.iii. infra. See also, e.g., Better
Markets Letter, at 2.
---------------------------------------------------------------------------

For those reasons, the Commission believes its estimate of the one-
time burden for exchanges to develop and implement appropriate systems
to aggregate the order routing data will be, on average, 80 burden
hours for each exchange, and the ongoing annual burden to update these
systems and to gather and to transmit the relevant data to the
Commission will be, on average, 124 burden hours for each exchange.

E. Collection of Information Is Mandatory

All of the collections of information pursuant to Rule 610T would
be mandatory.

F. Confidentiality of Responses to Collection of Information

The Commission believes that the broker-dealer specific order
routing data should be protected from disclosure subject to the
provisions of applicable law.\527\ The Commission will deem broker-
dealer identifying order routing data as being subject to a
confidential treatment request under 17 CFR 200.83 without the need to
submit a request. The Pilot Securities Exchange List, Pilot Securities
Change List, and the Exchange Transaction Fee Summary would not be
confidential. Rather, each would be publicly posted by the exchanges.
---------------------------------------------------------------------------

\527\ See, e.g., 5 U.S.C. 552 et seq.; 15 U.S.C. 78x (governing
the public availability of information obtained by the Commission).
---------------------------------------------------------------------------

G. Retention Period for Recordkeeping Requirements

National securities exchanges would be required to retain records
and information pursuant to 17 CFR 240.17a-1 (Rule 17a-1 under the
Exchange Act).\528\
---------------------------------------------------------------------------

\528\ 17 CFR 240.17a-1.
---------------------------------------------------------------------------

IV. Economic Analysis

As discussed above, the Pilot is designed to produce information on
the impact of transaction fee-and-rebate pricing models on order
routing decisions by broker-dealers, as well as their impact on
execution and market quality.\529\ In recent years, a number of
academics and market participants have expressed concern that the
structure of exchange transaction-based fee pricing may lead, for
example, to potential conflicts of interest between broker-dealers and
their customers when brokers-dealers route customer orders to trading
centers offering rebates so that the broker-dealer can capture the
rebates, even when these venues do not offer high execution
quality.\530\ However, as discussed in more detail below, the
Commission cannot determine from existing empirical evidence the
impact, if any, of exchange transaction fee models on order routing
decisions by broker-dealers or on market and execution quality.\531\
Specifically, determining whether a causal relationship between
exchanges' transaction fee-and-rebate pricing models and broker-
dealers' behavior is complicated because, for example, such pricing
models 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 and any potential negative impacts may manifest.\532\
---------------------------------------------------------------------------

\529\ 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 10, 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, 38 J.
Fin. & Quantitative Analysis 747-77 (2003), https://doi.org/10.2307/4126742https://doi.org/10.2307/4126742; Maureen O'Hara & Mao Ye, Is
Market Fragmentation Harming Market Quality? 100 J. Fin. Econ. 459-
74 (2011), https://doi.org/10.1016/j.jfineco.2011.02.006.
\530\ See, e.g., James Angel, Lawrence Harris & Chester Spatt,
Equity Trading in the 21st Century, 1 Q. J. Fin. (2011), https://doi.org/10.1142/S2010139211000067 (hereinafter ``Angel, Harris, &
Spatt''); Robert H. Battalio, Shane A. Corwin, & Robert H. Jennings,
Can Brokers Have It All? On the Relation Between Make-Take Fees and
Limit Order Execution Quality, 71 J. Fin. 2193-237 (2016), https://onlinelibrary.wiley.com/doi/10.1111/jofi.12422/full (hereinafter
``Battalio Equity Market Study''); Larry Harris, Maker-Taker Pricing
Effects on Market Quotations 24-25 (USC Marshall Sch. Bus., Draft
No. 0.91, 2013), https://bschool.huji.ac.il/.upload/hujibusiness/Maker-taker.pdf (hereinafter ``Harris'').
\531\ For commenters concurring with this assessment, see, e.g.,
Barnard Letter, at 1 (stating the Pilot ``should provide credible
analyses of the effects--both positive and negative--of exchange
fees and rebates on the quality and efficiency of trading.'');
Better Markets Letter at 2 (stating that the Commission ``lacks
sufficient data to outlaw rebates'' and believed that the Pilot
``should fill this data and knowledge gap.'').
\532\ Many commenters expressed support for the Pilot and the
utility of the information that may be gained from it. See AJO
Letter, at 1, CII Letter, at 3, NYSTRS Letter, at 1, ICI Letter I,
at 1-2, MFS Letter, at 1, Nuveen Letter, at 2, Clark-Joseph Letter,
at 1, RBC Letter I, at 2, Invesco Letter, at 2, CFA Letter, at 1,
State Street Letter, at 2, Wellington Letter, at 1, Joint Pension
Plan Letter, at 2, Oppenheimer Letter, at 2, Angel Letter I, at 1,
Vanguard Letter, at 2, Verret Letter I, at 1, T. Rowe Price Letter,
at 1.
---------------------------------------------------------------------------

Because of the existing lack of empirical evidence regarding the
potential conflicts of interest and potential effects of exchange fee
models, additional information would assist the Commission in making
future regulatory decisions. To remedy the insufficiency of existing
empirical evidence, the Commission is adopting the Pilot to generate
data that is otherwise unavailable to study fees and rebates that
exchanges assess to broker-dealers and observe the impacts of those
fees and rebates on the markets and market participants. Specifically,
the Commission expects that the data collected is 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,
and the extent to which exchange pricing models create distortions that
may have adverse impacts. The data obtained from the Pilot will inform
future regulatory initiatives to the ultimate benefit of
investors.\533\ In addition, the Pilot will provide information about
other potential economic effects of reducing access fee caps or
prohibiting rebates and Linked Pricing. For example, the Pilot could
offer information on whether prohibiting rebates and Linked Pricing
alters broker-dealer behavior in a manner that affects market quality,
such as by impacting quoted spreads across NMS stocks.\534\
---------------------------------------------------------------------------

\533\ See, e.g., Babelfish Letter, at 3; Clearpool Letter, at 2;
T. Rowe Price Letter, at 1, 3, and Clark-Joseph Letter, at 1.
\534\ See infra Section V.C.1.a.ii, for further discussion of
the benefits of studying other economic effects of transaction fees
and rebates.
---------------------------------------------------------------------------

The Pilot is uniquely capable of generating empirical evidence that
is currently lacking because it is designed to provide an exogenous
shock to transaction fee-and-rebate pricing models across all exchanges
simultaneously and facilitate the collection of representative data
across a broad range of securities.\535\ An exogenous shock to a system
occurs when an element of the system is changed from without the
system. (i.e., the change or shock is not under the control or
influence of those within the system) but can induce endogenous (i.e.,
within the system) responses. In the Pilot's context, the exogenous
shock

[[Page 5245]]

takes the form of a reduction of the maximum permissible transaction
fees and a prohibition on rebates and Linked Pricing on all U.S.
equities exchanges. This shock will allow researchers to explore how
changes to fees and rebates could lead to changes in broker-dealer
order routing and market and execution quality for a broad sample of
NMS securities.\536\ Specifically, the reduction in fees or the
elimination of rebates and Linked Pricing, as required in specific Test
Groups of the Pilot, may reduce the magnitude or eliminate the
potential conflict of interest between broker-dealers and their clients
and the potential distortions introduced by exchange transaction-based
fees and rebates. These effects would, in turn, be reflected in
measurable changes to the order routing and execution quality of stocks
in the Pilot's Test Groups.
---------------------------------------------------------------------------

\535\ See infra Section V., for discussion of existing studies
related to these topics and their limitations. See also supra
Section II.B (discussing the Nasdaq study, which examined a change
in the access fees and rebates charged by Nasdaq for 14 stocks over
a four-month period).
\536\ See, e.g., CII Letter, at 3, NYSTRS Letter, at 1, RBC
Letter I, at 2, Joint Pension Plan Letter, at 2, Oppenheimer Letter,
at 2
---------------------------------------------------------------------------

The terms of the Pilot are discussed in Section II above. Exchanges
will continue to be permitted to have varying fees within each Test
Group, and will be permitted to change their fees at their discretion,
subject to the proposed rule change filing requirements of Section 19
of the Exchange Act, during the Pilot for securities within each Test
Group, so long as they comply with the conditions applicable to that
Test Group.
In the absence of the Pilot, the Commission 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 analyze the effects of changes to fees and rebates.\537\ By
imposing the same modifications to fees and rebates on all U.S.
equities exchanges, the Pilot will allow researchers to obtain data
that will permit them to examine the impact of changes to fees and
rebates on the order routing decisions of broker-dealers. If all
exchanges were not subject to the pilot terms, the pilot data would be
limited because broker-dealers could redirect their order flow to the
non-participating exchanges. Accordingly, the Commission believes that
the Pilot will enable the collection of valuable data that would
otherwise be unavailable.
---------------------------------------------------------------------------

\537\ See, e.g., Clearpool Letter, at 2. As discussed above,
Nasdaq conducted its own fee experiment, but other exchanges did not
conduct similar experiments simultaneous with Nasdaq.
---------------------------------------------------------------------------

The Commission is mindful of the costs imposed by, and the benefits
obtained from, the rules it promulgates. 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.\538\ 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.\539\ 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.\540\
---------------------------------------------------------------------------

\538\ See 15 U.S.C. 77b(b); 15 U.S.C. 78c(f).
\539\ See 15 U.S.C. 78w(a)(2).
\540\ Id.
---------------------------------------------------------------------------

A few commenters challenged the sufficiency of the economic
analysis contained in the Proposal. For example, one commenter argued
the proposal was ``arbitrary and capricious'' because the Commission
failed to consider the economic consequences of its proposal and only
partially framed the costs and benefits of the Proposal, ignoring
important and significant factors and costs.\541\ Similarly, another
commenter believed that the ``cost-benefit analysis contain[ed]
numerous flaws that are inconsistent with the Commission's obligation
to provide a `reasoned basis' for its regulations,'' namely that the
Commission had ``substantially underestimated the costs of the
Proposal'' and ``fail[ed] to identify any countervailing market benefit
that justifies imposing . . . harms on . . . exchanges and issuers.''
\542\ Another commenter thought the Commission understated the
potential costs of the Pilot while overstating the benefits.\543\ For
example, some commenters noted that they anticipated the Pilot would
result in wider spreads, increased transaction costs, and increased
broker commissions, all of which would result in added costs to
investors.\544\ Several commenters thought the Commission failed to
consider or underestimated the implementation costs of the Pilot,\545\
while other commenters challenged these assertions and instead believed
the Pilot would impose minimal costs on exchanges and broker-dealers,
particularly in light of the existing processes and technology that
currently support immediately effective fee changes from the
exchanges.\546\ Finally, other commenters felt that the economic
analysis failed to adequately account for the projected costs to
particular categories of market participant.\547\
---------------------------------------------------------------------------

\541\ See Nasdaq Letter I, at 3, 11.
\542\ NYSE Letter I, at 3, 12. See also, e.g., Level Brands
Letter, at 1; Johnson Letter, at 1; Sensient Letter; Tredegar
Letter, at 1; Halliburton Letter, at 1.
\543\ See ASA Letter, at 5. See also T.D. Ameritrade Letter, at
3 (estimating costs of widening spreads to its clients at
$24,000,000).
\544\ NYSE Letter I, at 13. See also TD Ameritrade Letter, at 3
(estimating costs of widening spreads to its clients at $24,000,000
annually) and Energizer Letter, at 1.
\545\ See STANY Letter, at 2; Cboe Letter I, at 21; Nasdaq
Letter I, at 10; FIA Letter, at 3; Citi Letter, at 5.
\546\ See, e.g., Vanguard Letter, at 3; Better Markets Letter,
at 2; Healthy Markets Letter I, at 34; Angel Letter II, at 3.
\547\ See, e.g., Cboe Letter, at 7 n.14 and 20 (noting failure
to adequately address lost revenue to exchanges); NYSE Letter I, at
3; NYSE Letter I, at 3 and 13 (addressing impact on small businesses
and issuers); Apache Letter, at 2 (noting potential negative cost
impacts to issuers engaged in secondary offerings or conducting
share repurchasing programs); Nasdaq Letter I, at 8 (noting
potential added cost to market makers when pricing arbitrage
opportunities because of additional complexity in exchange pricing
models under the Pilot).
---------------------------------------------------------------------------

Other commenters supported the Commission's analysis. For example,
one commenter argued that ``differing estimates of costs is not a
sufficient basis alone to challenge Commission action.'' \548\ This
commenter argued that the commenters ``tend to ignore the benefit side
of cost-benefit analysis'' and believed that ``the most significant
benefit of the pilot is its potential to inform subsequent
rulemaking,'' such that the ``mere presence of uncertainty in the
Commission's estimates of potential costs and benefits does not by
itself open the pilot program to challenge.'' \549\ While acknowledging
the potential for ``liquidity effects,'' this commenter further noted
that the Commission ``is merely held to make a reasonable estimate of
those costs before adopting a pilot program,'' not to ``make a perfect
estimate'' or ``cease the pilot if the costs to liquidity prove
significant.'' \550\
---------------------------------------------------------------------------

\548\ Verret Letter I, at 3-4. See also Verret Letter I, at 7
(asserting that ``[a]rguments by the Exchanges concerning the pilot
proposal's failure to quantify costs are irrelevant, in so far as
the proposal properly identifies where they might at present be
unquantifiable and particularly where those unquantifiable costs
relate to the data the pilot is intended to generate.'').
\549\ Verret Letter I, at 3-4. See also IEX Letter III, at 8, 10
(arguing that these commenters ignore ``the full range of benefits
that investors could realize if rebates were banned entirely'').
\550\ Verret Letter I, at 4-5.
---------------------------------------------------------------------------

The economic analysis provided in the Proposing Release thoroughly
described the potential economic effects of the Transaction Fee Pilot,
including the benefits, costs, and alternatives and

[[Page 5246]]

the potential effect on efficiency, competition, and capital formation.
Like the Proposing Release, where possible, the Commission has
quantified below the likely economic effects of the 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
makes it difficult to predict how market participants would act under
the conditions of the 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 the Pilot, such as volume
discounts, the Commission cannot quantify, ahead of the Pilot, the
economic impact of any changes in order routing decisions by broker-
dealers that may result from the 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.

A. Background and Market Failures

The Commission's Proposal provided a review of transaction-based
fee models, including a discussion of the history and mechanics of
transaction-based pricing and an overview of the concerns about
potential conflicts of interest between broker-dealers and their
customers attributed to access fees and rebates assessed by exchanges
as well as the potential distortions that exchange fee models can
introduce into market structure.\551\
---------------------------------------------------------------------------

\551\ See Proposing Release, supra note 2.
---------------------------------------------------------------------------

The Commission considered whether competition within the broker-
dealer industry, as well as competition among the equities exchanges,
is sufficient to alleviate potential conflicts of interest presented by
exchange fees and rebates and also the potential distortions such fee-
and-rebate models may introduce. The Commission believes that
competition between broker-dealers may not be capable of addressing
these potential conflicts and distortions for three reasons: asymmetric
information, switching costs, and a lack of collective action, each of
which is discussed below. Further, competition between broker-dealers
is not readily capable of independently resolving the other potential
concerns presented by exchange fee models, such as excessive
intermediation, fragmentation, complexity, and cross-subsidization
because those issues are within the exclusive control of the exchanges.
The limitations of competition among the equities exchanges is
discussed in detail below.
1. Market Failure at the Broker-Dealer Level
The Commission considered whether competition could alleviate
potential conflicts of interest between investors and broker-dealers,
as investors choose broker-dealers to place orders on their
behalf.\552\ To the extent that investors are able to identify broker-
dealers that do not act on potential conflicts of interest in a manner
inconsistent with the interests of their customers, investors could
discourage broker-dealers from acting on such conflicts of interest and
avoid doing business with those broker-dealers that do not offer such
assurances. However, several commenters opined that competition and
deference to market forces alone would not be sufficient to challenge
the ``deeply rooted conflicts of interest'' that they believe are
present in today's market structure.\553\ For example, one commenter
noted that many institutional clients are tied to large broker/dealers
because of the multitude of services that their brokers provide, so
they cannot simply ``fire their brokers'' if they are unhappy with
their routing decisions.\554\ Further, the Commission does not believe
that competition among broker-dealers alone will be sufficient to
address potential conflicts of interest in order routing decisions
because of three conditions that are present in today's markets:
asymmetric information, switching costs, and a lack of collective
action.
---------------------------------------------------------------------------

\552\ See Section infra IV.B.2.a.
\553\ See, e.g., Better Market Letter at 1 (stating ``[p]ayments
by the exchanges that incentivize and induce routing decisions by
broker-dealers at the expense of best execution and market quality
is one of the most entrenched and insidious market practices today,
and requires forceful and independent intervention by the SEC.'').
See also Themis Trading Letter at 4-5; Larry Harris Letter at 9;
Clearpool at 2.
\554\ See Themis Trading Letter I, at 5.
---------------------------------------------------------------------------

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.\555\ For example,
customers do not generally have access to information about broker-
dealers' individual sources of revenue.\556\ 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 fee-and-rebate pricing models on order routing
decisions. Moreover, while under Rule 606, a customer may request
certain information about how her broker routed certain orders on her
behalf, a customer cannot necessarily use this information to compare
how these orders would have been treated by broker-dealers other than
her own. Further while recent amendments to Rule 606 would provide
customers with limited information about transaction fees paid and
transaction rebates received by the broker, the disclosure would not
provide data to enable the customer to assess the impact of exchange
transaction fees and rebates on market quality and execution quality.
---------------------------------------------------------------------------

\555\ See Larry Harris Letter, at 3 (noting that most brokerage
customers do not know about potential broker agency problems and so
do not know that their brokers may not be representing their orders
as best they might).
\556\ 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.\557\ 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.
---------------------------------------------------------------------------

\557\ 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.\558\ 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. The collective action problem arises because,
although each customer individually bears a cost to switch accounts,
the benefits of a successful threat are available to all customers
whether they would switch or not. If the

[[Page 5247]]

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.
---------------------------------------------------------------------------

\558\ 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.
---------------------------------------------------------------------------

2. Market Failure at the Exchange Level
Several commenters considered whether existing market forces,
including competition among the equities exchanges, are sufficient to
address the potential distortions caused by exchange pricing models.
Some commenters felt that ``some regulatory solution,'' like the Pilot,
``may be necessary to force market participants, particularly
exchanges, to change the manner in which they conduct business''
because competitive pressures on exchanges may serve as a barrier to
market-led reforms in this area.\559\ Further, one commenter noted that
``market forces cause the exchanges to choose maker-taker and inverted
fee models to the detriment of the public interest'' and therefore
regulatory action is necessary to address market distortions caused by
the maker-taker and taker-maker fee models.\560\
---------------------------------------------------------------------------

\559\ Clearpool Letter, at 2. See also T. Rowe Price Letter, at
1 (``enthusiastically agree[ing] with the Commission that a pilot is
necessary to gather data,'' in part because ``exchanges have little
incentive to reduce the fee cap on their own''). See also Larry
Harris Letter, at 9 (noting that ``regulatory action is necessary to
establish a common pricing standard because market forces alone will
not do it''). Larry Harris Letter, at 6 (noting that ``exchange
holding companies have a strong interest in maintaining the current
system'' and that the ``SEC may reasonably consider these interests
when evaluating comments submitted by the exchanges''); Themis
Trading Letter II, at 3 (stating that the Commission should not be
``distracted . . . by conflicted stock exchanges desperately fearful
that their business models might come crashing down'').
\560\ See Larry Harris Letter, at 9. See also Themis Trading
Letter I, at 5 (noting that several exchanges oppose the pilot
because they are motivated by their ``own profit incentives and not
what is best for the market'').
---------------------------------------------------------------------------

Further, the Commission notes that one market conducted a limited
unilateral access fee experiment in 2015 to test the impact of
reductions to its fees and rebates on 14 securities traded on its
market. \561\ Several commenters noted the limited utility of that
study given its narrow scope and applicability to one market.\562\ The
fact that no other exchange joined in the 2015 access fee experiment,
or independently undertook a similar study thereafter, supports the
view that it is unlikely that competition among the exchanges alone
would compel the exchanges to study, let alone address, potential
distortions that may result from their fee and rebate models.
---------------------------------------------------------------------------

\561\ See Proposing Release, supra note 2, at 13011-12. See also
Section IV.B.1.a.ii, infra discussing the Nasdaq Experiment in
greater detail.
\562\ See, e.g., Themis Trading Letter I, at 3 (stating that a
``more comprehensive multilateral market-wide approach would be
needed to yield usable data that could be used to test how lower
access fees, and a lack of rebates, would impact market quality and
marketplace behavior'' (emphasis omitted)); IEX Letter III, at 6
(``Nasdaq's experiment and its outcomes aren't a perfect proxy for
what is likely to happen in the Transaction Fee Pilot. That
experiment was done unilaterally and only in highly-liquid
securities.''); Larry Harris Letter, at 9 (noting that Nasdaq's
``experimental fee reduction did not occur at all trading venues
that traded the subject securities,'' demonstrating that
``regulatory action is necessary to establish a common pricing
standard because market forces alone will not do it'').
---------------------------------------------------------------------------

B. Baseline

We compare the economic effects of the 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 Pilot
is designed to produce information on order routing behavior that would
not otherwise be available. The baseline, therefore, includes the
existing information available to the Commission in the absence of a
pilot, which the Commission could use to inform future regulatory
action.\563\ The baseline also sets out the exchanges' current
practices with respect to fees and rebates and the regulations
governing those fees and rebates.
---------------------------------------------------------------------------

\563\ See supra Section IV.E.1 for the discussion of the
alternative that the Commission proceed with rulemaking initiatives
without first conducting the Pilot. That alternative differs from
the baseline presented here because it directly presumes regulatory
changes whereas the baseline for the Economic Analysis does not
presume regulatory changes resulting from the Pilot.
---------------------------------------------------------------------------

1. Current Information Baseline
While the theoretical studies referenced in the Proposing Release
suggest that transaction-based fee models create potential issues for
investors,\564\ 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 exchange transaction-based fees and
rebates impact market and execution quality and affect the integrity
and structure of the U.S. equity markets.\565\ Consequently, the
relation between transaction-based pricing and conflicts of interest is
not well understood.\566\ Additionally, commenters are divided as to
how to interpret existing knowledge. One Commenter stated that we had
``much to learn'' \567\ while other commenters felt that there was
sufficient existing knowledge to move directly to rule making without a
Pilot.\568\
---------------------------------------------------------------------------

\564\ See, e.g., Proposing Release supra note 6 at Section IV.A.
and C.
\565\ Several commenters supported the Pilot as a necessary step
to produce data to inform the heavily contested debate surrounding
the impact of exchange fees and rebates on order routing, market
quality, and execution quality. See, e.g., Barnard Letter, at 1
(``historically there are many views on this topic, but a paucity of
credible data from which to draw conclusions''); Wellington Letter,
at 1, and Clark-Joseph Letter, at 1.
\566\ See Nuveen Letter, at 2
\567\ See e.g., Spatt Letter, at 3
\568\ See e.g., Larry Harris Letter, at 10
---------------------------------------------------------------------------

Below, we discuss the existing information currently available to
the Commission or the public that concerns the relationship between
transaction-based fee-and-rebate pricing models and order routing
decisions and we describe the limitations of this information for use
in policy discussions regarding transaction-based fees and rebates and
the potential conflicts of interest and potential distortions that may
accompany them. We then discuss the potential to produce additional
information regarding the impact of exchange fees and rebates absent
the Pilot.
While a number of studies attempt to document the relation between
transaction-based fees, order routing decisions, and execution quality,
these 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. This section details these
limitations.
a. Limitations of Existing Studies
Multiple commenters submitted empirical evidence that they argued
was consistent with conflicts of interest. For example, one Commenter
cited evidence that trade execution algorithms that are fee sensitive
tend to have lower execution quality than algorithms that are not fee
sensitive.\569\ Another Commenter cited existing academic, industry,
and government sources suggesting the existence of conflicts of
interest, or of the investing public's perception that there exist
conflicts of interest.\570\ Another commenter suggested evidence
existed that routing decisions were not always in the best interest of
investors by arguing that adverse selection differs by exchange, and
that this difference can be observed using TAQ data.\571\ Another
commenter presented their study arguing that

[[Page 5248]]

longer queues lead to increased transaction costs, and connected longer
queues with the practice of paying rebates.\572\ Another Commenter
referenced a study suggesting that trading costs vary across
exchanges.\573\
---------------------------------------------------------------------------

\569\ See Babelfish Letter, at 2-3
\570\ See CFA Letter, at 2
\571\ See Healthy Markets Letter I, at 2, 6
\572\ See IEX Letter IV, at 9
\573\ See AGF Letter, at 1
---------------------------------------------------------------------------

Although the above listed commenters all felt that the evidence did
suggest that fees and rebates led to conflicts of interest, other
commenters did not come to the same conclusion. One commenter felt that
there was ``no evidence that fee practices are harming investors or
interfering with fair competition'' and consequently felt that a Pilot
was not justified.\574\ The studies and analysis presented by
Commenters and the studies discussed below have significant limitations
with regard to establishing causal links between fees and rebates and
order routing decisions. These limitations fall primarily into two
categories: (1) The results of the studies may not be representative,
and (2) the results of the studies cannot make a causal connection
needed to inform on potential conflicts of interest.
---------------------------------------------------------------------------

\574\ See CBOE Letter I, at 5 See also Nasdaq Letter I, at II-12
---------------------------------------------------------------------------

When a study's results are representative, the results can be
applied across a broadly defined group. Drawing broad inferences from
limited samples could be problematic because the results might be
specific to specific securities, broker-dealers, or trading venues. In
the context of regulatory decision-making, representative results
should inform on the potential effects over the scope of the market
covered by the decision. When results are not representative of the
full scope of a regulatory decision, that regulatory decision may have
an unpredictable effect over the part not represented by the results.
For example, if the results of a study cover only certain types of
issuers, the results may not apply to all types of issuers and
therefore, any regulatory changes based on such studies may have
unanticipated effects on the types of issuers not included in the
study.
In addition to limitations in how representative results may be,
existing studies cannot test for causal relationships between
transaction fees and order routing decisions, even around fee
revisions. 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 frequently modify their fees.\575\ In practice,
researchers attempt to identify and measure causal relations in two
ways: (1) Exogenous shocks and (2) econometric techniques, such as an
instrumental variables approach.\576\
---------------------------------------------------------------------------

\575\ 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 infra Section IV.B.2.b.
\576\ 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.
---------------------------------------------------------------------------

The Commission disagrees with one commenter who felt that
sufficient data existed to move forward with regulation prohibiting
rebates because ``the theory is well-accepted, and no prior evidence
contradicts it.'' \577\ In the absence of causal data, regulators can
use theory--and their best judgment based on their expertise--to guide
their decision making. However, in this case, for the reasons discussed
throughout this release, the Commission believes that empirically
assessing the various theories, causal impacts, and effects of the
transaction fee-and rebate pricing model is appropriate.
---------------------------------------------------------------------------

\577\ See Harris Letter, at 10.
---------------------------------------------------------------------------

i. Battalio Equity Market Study
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.\578\ By
routing orders to exchanges that pay high rebates, broker-dealers may
engage in rebate capture at the expense of client execution.\579\ Using
data obtained from mandatory Rule 606 disclosures over a two-month
window,\580\ 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 charged the highest access fees). 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 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.
---------------------------------------------------------------------------

\578\ 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 5307, at 2193.
\579\ See Battalio Equity Market Study, supra note 5307. See
also supra Section IV.A.2, for an overview of the potential
conflicts of interest that emerge.
\580\ 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) (hereinafter ``Disclosure of Order
Execution and Routing Practices''). See also supra note 310 and
accompanying text and infra Section IV.B.1.b.i, ``Rule 606 Data.''
---------------------------------------------------------------------------

Although the Battalio study provides evidence suggestive of
conflicts of interest, the study has a number of limitations which
render the Commission unable to use this study to robustly determine
that rebates cause costly conflicts of interest for broker-dealers.
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.\581\ 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.\582\ 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.
---------------------------------------------------------------------------

\581\ 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.
See Battalio Equity Market Study, supra note 530.
\582\ Estimates based on data from Form 1 of the X-17A-5
filings. As of December 31, 2017, 3,860 broker-dealers that filed
form X-17A-5. See infra Section IV.B.2.a.
---------------------------------------------------------------------------

The Battalio Equity Market Study also relies on a sample of Rule
606 order routing reports 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

[[Page 5249]]

November 2012). As discussed above, approximately 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.
In sum, the absence of an exogenous shock to access fee caps or
rebates outside the control of exchanges leaves the authors unable to
definitively determine the causes of broker-dealers' order routing
decisions. 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.
ii. The Nasdaq Experiment
Nasdaq independently conducted an experiment, 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.\583\ Nasdaq produced two reports on the
experiment \584\ and an academic study examining the experiment was
submitted as a comment.\585\ Both Nasdaq's first study report and the
Swan study indicate that when Nasdaq lowered fees and rebates they lost
market share in the stocks with lower fees and rebates. According to
analysis in the Swan study, the market share that Nasdaq lost appeared
to migrate to other make-take venues with higher fees and rebates.
Additionally, both Nasdaq's analysis as well as the Swan study find
that the experiment led to a decrease in the fraction of time that
Nasdaq quoted at the NBBO. The Swan study also estimated a variety of
additional tests to measure the impact of the experiment on various
aspects of market quality. The results of these tests are mixed. The
Swan study found that the Nasdaq experiment improved market quality on
Nasdaq in terms of improved fill rates and fill times as well as
narrower cum-fee effective spreads and cum-fee realized spreads.\586\
---------------------------------------------------------------------------

\583\ 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. Nasdaq released two reports see infra note 584 (examining
the changes to a number of metrics related to market quality).
\584\ The first report provided by Nasdaq can be found on their
webpage https://qnasdaqomx.com/AccessFeeExperiment (``Nasdaq's first
report'', or the ``first Nasdaq report''). The second report
provided by Nasdaq can be found at https://people.stern.nyu.edu/jhasbrou/SternMicroMtg/SternMicroMtg2015/Supplemental/ (``Nasdaq's
second report'', or the ``Second Nasdaq report'').
\585\ See Swan Letter which submitted the paper: Yiping Lin,
Peter Swan, & Frederick Harris, Why Maker-Taker Fees Improve
Exchange Quality: Theory and Natural Experiment Evidence, Working
Paper, (2018), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3034901 (hereinafter ``Swan study'');
Nasdaq's Second Report, at 1.
\586\ Cum fee indicates that the computation of spreads included
the fee or rebate charged. It is a measure of the total cost of
transacting.
---------------------------------------------------------------------------

While cum-rebate effective spreads, fill rates and fill times
improve on the Nasdaq during the experiment, the Swan study finds that
the experiment diminished market quality in terms of quoted spreads and
raw realized spreads which both increase during the experiment.\587\
Additionally, the Swan study shows that some measures of market quality
were unchanged by the Nasdaq experiment, namely, the Swan study finds
no change in raw effective spread.\588\ In Nasdaq's second report on
the experiment they examine various market quality measures and find no
impact on effective spread, relative effective spread, quoted spread,
relative quoted spread, displayed dollar depth at the NBBO, time
between quote updates on the consolidated tape, and time between price
changes in the NBBO on the consolidated tape.
---------------------------------------------------------------------------

\587\ The effective spread is the cost to transact and is
defined as two times the absolute difference between the price of a
trade and the prevailing midpoint at the time of trade. The
effective spread can be decomposed into two components, the realized
spread and price impact of the trade. The price impact is generally
viewed as the portion of the effective spread that compensates
market makers for adverse selection losses. The realized spread is
the portion of the spread that market makers `realize' after adverse
selection costs are taken into account. Raw realized spreads are
realized spreads that do not take into account the all-in cost of
trading, i.e., they exclude rebates from the calculations
\588\ Raw effective spreads are effective spreads that do not
take into account the all-in cost of trading, i.e., they exclude
fees from the calculations.
---------------------------------------------------------------------------

In examining the impact of the experiment on price efficiency, the
Swan study finds mixed evidence that prices quoted on Nasdaq become
less efficient during the experiment. First, the Swan study finds that
global price impact declines during the experiment. Price impact is
commonly employed as a measure of the informativeness of trades. The
Swan study explains the decline in price impact with a theoretical
model which suggests that rebates subsidize market makers for the
adverse selection costs that they bear-thereby allowing them the
ability to bear additional adverse selection which induces informed
traders to trade more aggressively in the presence of rebates.
Consequently, their model predicts that informed trades will congregate
on exchanges with high rebates. Additionally, the Swan study finds
using variance ratios that price efficiency declines on Nasdaq during
the experiment. However when using autocorrelation of trades as a
measure of price efficiency, the tests indicate a decrease in
autocorrelation--suggesting more efficient stock prices on Nasdaq.\589\
Additional analysis on price efficiency comes from Nasdaq's second
report which explores the impact of their experiment on market wide
price efficiency and finds no change in price impact, autocorrelation
of trades, or variance ratios.
---------------------------------------------------------------------------

\589\ The interpretation of the price efficiency results is
difficult because it is unclear what price efficiency on one
exchange means in the absence of the other exchanges. Usually price
efficiency is measured across all exchanges trading a given
security.
---------------------------------------------------------------------------

The Swan study also empirically examines how the Nasdaq experiment
impacted the trading behavior of high frequency traders (``HFTs'') and
non-HFTs and finds that as a result of the experiment HFTs added
liquidity less often and took liquidity more often while non-HFTs did
the opposite. Nasdaq also examined trading behavior and found that
there was a shift in the composition of the top five liquidity
providers for the securities that occurred as a result of the
experiment. 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.

[[Page 5250]]

While Nasdaq believes that the results from their study do not
support the need for a pilot,\590\ the Commission disagrees because the
Nasdaq experiment and the subsequent analysis suffers from the
following limitations. First, the Nasdaq experiment may not be
representative of the broader market. Nasdaq selected 14 stocks to be
part of the analysis, which represent 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),\591\ 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.\592\ The small number of stocks makes interpretation of
the results more difficult because a change to such a small number of
stocks may not be significant enough for traders to alter their
behavior.\593\
---------------------------------------------------------------------------

\590\ See Nasdaq Letter I, at 10.
\591\ 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.
\592\ Market capitalizations are computed from CRSP shares
outstanding and stock price, as of December 31, 2014. See also
Themis Trading Letter I, at 2; NorthWestern Letter, at 1 and IEX
Letter III, at 6.
\593\ Nasdaq acknowledges this limitation in their second report
analyzing the experiment. See supra note 584 See also Themis Trading
Letter I, at 2 and IEX Letter III, at 6 for commenters expressing
similar concerns about the representativeness of Nasdaq's sample.
---------------------------------------------------------------------------

Additionally, the Commission is not able to make inference about
the effect of a market wide change to fees and or rebates from the
Nasdaq experiment because, as noted by multiple commenters, the effects
of the experiment apply to a single exchange: Nasdaq.\594\ 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. \595\
---------------------------------------------------------------------------

\594\ See Swan Letter, at 3; Themis Trading Letter I, at 2;
Credit Suisse Commentary, at 2, Larry Harris Letter, at 9, and IEX
Letter III, at 6.
\595\ This point was acknowledged in Nasdaq's second report. See
supra note 584. This point was also brought up by multiple
commenters. See Swan Letter, at 3; Credit Suisse Commentary, at 2;
and Larry Harris Letter, at 9.
---------------------------------------------------------------------------

Lastly, none of the analysis of the Nasdaq study analyzes 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 fees and rebates and potential conflicts of
interest, the limited representativeness of the Nasdaq sample would
limit the generality of the study.
iii. Options Market Studies
Three studies have examined exogenous shifts between maker-taker
and payment for order flow pricing models on U.S. options
exchanges.\596\ 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.\597\ 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.\598\ 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. For example, 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. Each of these models is likely to create
potential conflicts of interest that could affect how broker-dealers
route their customer orders,\599\ 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 or impacts on market and
execution quality that did not previously exist. Therefore, the
Commission 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 and impacts
on market and execution quality driven by the maker-taker and taker-
maker models or to inform the Commission about future regulatory
decisions regarding transaction-based fee models. Additionally, these
studies lack causality. Specifically the decision to invert an exchange
from a taker/maker to a maker/taker exchange, which these studies are
based on, is an endogenous decision, and therefore these studies lack
the ability to make causal inference further hindering the Commission's
ability to draw inference from these studies.
---------------------------------------------------------------------------

\596\ See Amber Anand, Jian Hua, & Tim McCormick, Make-Take
Structure and Market Quality: Evidence from the U.S. Options
Markets, 62 Mgmt. Sci. 3085, 3217-90 (2016), https://pubsonline.informs.org/doi/abs/10.1287/mnsc.2015.2274 (hereinafter
``Anand, Hua, & McCormick''); Robert Battalio, Todd Griffith, &
Robert Van Ness, Make-Take Fees versus Order Flow Inducements:
Evidence from the NASDAQ OMX PHLX Exchange, 12th Ann. Mid-Atlantic
Res. Conf. in Fin. (2017), https://www1.villanova.edu/content/dam/villanova/VSB/assets/marc/marc2017/SSRN-id2870000.pdf (hereinafter
``Battalio, Griffith, and Van Ness''); Robert Battalio, Andriy
Shkilko, & 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, 51 J. Fin. & Quantitative Analysis (Oct. 2016) 1637, 1637-
62 https://www.cambridge.org/core/journals/journal-of-financial-and-quantitative-analysis/article/div-classtitleto-pay-or-be-paid-the-impact-of-taker-fees-and-order-flow-inducements-on-trading-costs-in-us-options-marketsdiv/0782CE3E9679C29BB910A66192D27201 (hereinafter
``Battalio, Shkilko & Van Ness''). Anand, Hua, & 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 as well
as Battalio, Shkilko, & Van Ness examine the shift on NASDAQ OMX
PHLX (``PHLX'') from a maker-taker model to a payment for order flow
model.
\597\ Id.
\598\ Id.
\599\ See Battalio, Shkilko & Van Ness, supra note 596, at 1637-
62.
---------------------------------------------------------------------------

b. Limitations of Existing and Anticipated Data
Some Commenters suggested that existing data sources could be
employed in lieu of a Pilot to study the Commissions objectives.\600\
Another Commenter argued that enhancing existing data would be
sufficient.\601\ To this end, the Commission considered whether a
number of existing data sources could be used independently or in
combination to relate transaction-based fees to order routing and
execution quality. This section discusses these data sources. For
instance, in the Battalio Equity Market Study and the Nasdaq study
discussed above, the authors employed some combination of Rule 606
data, proprietary broker-dealer data, the Trade and Quote (TAQ)
database,\602\ and proprietary exchange data. In addition, while not
employed in previous studies, CAT data, OATS data, Rule 605 data, Form
ATS-N 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, and fees

[[Page 5251]]

and other arrangements. As noted above, several data sources provide
information on order routing and execution quality. While researchers
could use these data sources to produce some representative results
regarding the relation between transaction-based fees, order routing,
and execution quality, the Commission believes that available data has
several limitations, which include: Granularity, completeness,
periodicity, format, and availability.
---------------------------------------------------------------------------

\600\ See STANY Letter, at 2; Nasdaq Letter I, at 11-12; NYSE
Letter I, at 17; and Nasdaq Letter III, at 1-2.
\601\ See Era Letter, at 1. But cf. IEX Letter II, at 9.
\602\ Battalio Equity Market Study, supra note 530, 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.
---------------------------------------------------------------------------

i. Rule 606 Data
Rule 606 requires broker-dealers to make publicly available
quarterly reports that provide an overview of their routing practices
on certain orders in NMS securities. As amended, broker-dealers must
provide information for the ten venues to which the largest number of
total non-directed orders were routed for execution and for any venue
to which five percent or more of non-directed orders were routed for
execution. Rule 606 disclosures also require broker-dealers to disclose
in a standardized format material aspects of their relationships with
trading venues to which they route orders, including a description of,
among other things, the payment for order flow and any profit sharing
relationships, which, like rebates, could influence the broker-dealer's
order routing decision and potentially lead to potential conflicts of
interest for broker-dealers when routing orders.\603\ Researchers and
other analysts interested in order routing data can download these
forms quarterly directly from broker-dealer websites.
---------------------------------------------------------------------------

\603\ See Section III.B.3 of Amendments to Order Handling
Disclosure, supra note 310.
---------------------------------------------------------------------------

Some commenters believed that the amendments to the Rule 606 data
would render the Pilot unnecessary.\604\ Indeed, a few commenters
suggested that Rule 606 data, perhaps combined with other existing
data, would be sufficient to study conflicts of interest among broker-
dealers.\605\ The Commission disagrees that this type of analysis would
serve the purposes of the Pilot.\606\ Such an approach would not
adequately advance the Pilot's broader purpose to study the effects
that exchange transaction fee-and-rebate pricing models may have on
order routing behavior, execution quality, and market quality, in
addition to conflicts of interest between brokers and their customers
that are presented when exchanges pay rebates.\607\ Further, disclosure
alone would not provide an exogenous shock that generates measurable
responses capable of providing insight into the effects of fees and
rebates on the markets and market participant behavior.
---------------------------------------------------------------------------

\604\ See Cboe letter I, at 26; FIA Letter, at 3; STANY Letter,
at 2; Nasdaq Letter I, at 1-2, 4; NYSE Letter I, at 18.
\605\ See STANY Letter, at 2; Nasdaq Letter I, at 11-12; ERA
Letter, at 1.
\606\ See also IEX Letter I, at 9.
\607\ See, e.g., ICI Letter II at 3.
---------------------------------------------------------------------------

In addition, the quarterly frequency of the public 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).\608\ 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. Specifically, the 606 data is aggregated at the
quarterly level. This frequency will not enable researchers to look at
the full picture of how a broker-dealer responds to fees because
exchanges on average revise their fee schedules 6.7 times per year.
With 13 exchanges this amounts to 87 fee changes per year.
Consequently, the fees that exchanges charge in a given quarter
relative to the other exchanges will likely change multiple times
within a quarter. Consequently, Rule 606 data is limited in how it can
be employed to evaluate comprehensively the impact of order flow
responding to fees and rebates.
---------------------------------------------------------------------------

\608\ Not every fee schedule revision pertains to transaction
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. 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.
In sum, the Commission believes that the amended Rule 606 data will
provide useful information to complement the Pilot; however it is
insufficient by itself to determine the impact of exchange transaction
fees and rebates on broker-dealer order routing decisions, or inform
the Commission of the impact of exchange pricing on market and
execution quality.\609\
---------------------------------------------------------------------------

\609\ Multiple commenters expressed views similar to this and
urged the Commission to adopt 606 amendments prior to the adoption
of the Pilot. See, e.g., Citadel Letter, at 3; OMERS Letter, at 3;
ICI Letter I, at 5-6; Fidelity Letter, at 2; IEX Letter II, at 9.
---------------------------------------------------------------------------

ii. CAT Data and OATS Data
Once the CAT Phase 1 becomes operational,\610\ 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 cancellations, and order executions. Likewise, the
Order Audit Trail Systems (OATS) data could inform on order routing
decisions.\611\ The OATS data tracks customer orders from the receipt
of the order through execution or cancellation. Information in the OATS
data reflects the terms of the order, including the security, price,
shares, account type, handling instructions, and side of the market for
which the order was placed; where the order was routed for execution;
modifications to the order; and execution information, including the
capacity in which the firm acted in the trade.
---------------------------------------------------------------------------

\610\ See supra Section II.E.3.vi.
\611\ See Nasdaq Letter I, at 4.
---------------------------------------------------------------------------

Although the CAT and OATS data could feasibly be used to produce
order routing data similar to that required by the Pilot, as indicated
by one commenter, without the corresponding ``randomized trial,'' the
use of OATS data alone would be insufficient to determine causality in
the effect of fees and rebates on order routing decisions because it
would not be possible to determine from the data whether fees respond
to changes in order routing decisions or whether order routing
decisions respond to changes in fees. Consequently, in the absence of
an exogenous shock to fees, CAT and OATS data cannot provide the
Commission with robust evidence about how access fees impact order
routing decisions.\612\
---------------------------------------------------------------------------

\612\ See Verret Letter I, at 4.
---------------------------------------------------------------------------

iii. Proprietary Broker-Dealer Data
Proprietary data from broker-dealers or exchanges could also
provide information about order routing decisions. 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 orders received by an exchange,
including which members routed orders to the exchange, whether the
orders execute, and the price, size, and time of

[[Page 5252]]

execution. Indeed, several commenters stated that if 606 data were not
sufficient to answer the Commission's questions about broker dealer
routing decisions, then the Commission could request routing tables and
information directly from broker-dealers or request other Transaction
Cost Analysis (TCA) data to supplement the 606 data.\613\
---------------------------------------------------------------------------

\613\ See Nasdaq Letter I, at 11-12 and FIA Letter, at 3.
---------------------------------------------------------------------------

While these data would provide potentially more granular data about
order routing, as proprietary datasets, there is no standard format
that exchanges or broker-dealers use to aggregate this data, which
makes cross broker-dealer or cross exchange comparison difficult. Even
if a dataset of proprietary data could be produced from data obtained
directly from exchanges or broker-dealers, the data would still lack an
exogenous shock to fees which is necessary to determine a causal link
between order routing decisions and exchange fees.
iv. Rule 605 Data
A few commenters suggested that Rule 605 data used in conjunction
with other data such as Rule 606 data, could provide information about
broker dealer conflicts of interest.\614\ 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.\615\ 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.
---------------------------------------------------------------------------

\614\ See STANY Letter, at 2 and Nasdaq Letter I, at 11-12.
\615\ See Disclosure of Order Execution and Routing Practices,
supra note 580, at 75417-25.
---------------------------------------------------------------------------

While Rule 605 data is available to researchers and may provide
information about execution quality, it too has 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.\616\ 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.\617\ Finally, Rule
605 data is limited in that it covers only held orders and orders of
less than 10,000 shares.
---------------------------------------------------------------------------

\616\ See Securities Exchange Act Release No. 61358 (January 14,
2010), 75 FR 3594 (January 21, 2010) (hereinafter ``Concept
Release'').
\617\ See, e.g., Jennifer Conrad & Sunil Wahal, The Term
Structure of Liquidity Provision (August 8, 2018) (unpublished
manuscript) https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2837111.
---------------------------------------------------------------------------

v. TAQ Data
Beyond Rule 605 data, researchers could also use the TAQ database
as a means of measuring order execution quality or estimating market
share to use as a measure for order routing decisions. The TAQ database
is publicly available (for a fee) from NYSE and provides access to all
trades and top of the book quotes for NMS securities, from which
researchers and other analysts can estimate trade-based measures of
execution quality such as effective spreads.
While TAQ data are available to academic researchers, TAQ has a
number of limitations in its precision in the measurement of order
routing and execution quality. An exchange's market share can differ
significantly from its share of orders received because exchanges
reroute orders they cannot execute at the best prices and some
exchanges reroute more orders than others. In addition, TAQ doesn't
provide information on the brokers or dealers underlying the trades or
quotes, so TAQ cannot tell us about the decisions of individual
brokers. While TAQ facilitates the estimation of trade and quote-based
measures of execution and market quality, it does not facilitate the
estimation of order-based measures of execution quality, which are more
precise than trade-based measures. In particular, order-based measures
allow for the consideration of order size, which can be different and
often larger than trade size. Order-based measures also consider the
costs of latency whereas trade-based measures do not. Additionally,
since TAQ only provides data on trades it does not provide a means of
estimating execution quality for limit orders.
vi. Information From Exchange 19b-4 Filings
Finally, researchers both in and outside of the Commission, who
wish to link fees and rebates to various outcomes, 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 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.
A key limitation to this data, particularly for researchers outside
the Commission, is that exchanges use bespoke terminology to classify
their fees and rebates. Consequently, identifying comparable fees
across exchanges is difficult. 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.
Lastly, even if a comprehensive dataset of fee changes were
created, it would not be sufficient by itself to study the link between
order routing decisions and fees because the dataset can only tell when
and how an exchange revised fees, and not why the fee changed or if the
fee change affected order routing behavior. In essence the data still
lacks the ability to establish a causal connection between fee changes
and order routing decisions.
vii. Form ATS-N
Following implementation in January 2019, the public will have more
information on ATS conflicts of interest and fees. In particular, in
June 2018, the Commission adopted amendments to 17 CFR 242.300 through
242.303 (Regulation ATS) and 17 CFR 240.3a1-1 (Rule 3a1-1 under the
Exchange Act).\618\ As part of these amendments, NMS Stock ATSs will be
required to

[[Page 5253]]

publicly report on new Form ATS-N information about the manner in which
the ATS operates and activities of the broker-dealer operator and its
affiliates, as well as potential conflicts of interest within the NMS
Stock ATSs. While Form ATS-N will contain high level information on
operations and affiliates of the ATS, it will not contain detailed
information, such as ATS routing tables. Therefore, it would not
contain detailed information on how fees and rebates affect the order
routing decisions of the ATS.
---------------------------------------------------------------------------

\618\ See Securities Exchange Act Release Nos. 83663 (July 18,
2018), 83 FR 38768 (August 7, 2018).
---------------------------------------------------------------------------

Form ATS-N also will require ATSs to provide public disclosures
about the different types of fees they charge, along with the ranges of
those fees and whether they are bundled with any other services.
However this information would not be nearly as granular as the exact
fee disclosures that would be required by the Pilot. Nor do they
provide as much information as the fee disclosures that exchanges are
currently required to disclose. These limitations make it difficult to
use the ATS-N data to make causal inference about the impact of fees
and rebates on order routing decisions.
c. The Potential To Study the Causal Link Between Fees, Rebates, and
Conflicts of Interest Absent a Pilot
Absent a Pilot, the Commission does not believe it would have
comprehensive, empirical evidence to study the effects on the market
that the Pilot is intended to study. In particular, as indicated above,
the Commission does not believe the theoretical evidence on incentives
and potential other effects are indicative of broker-dealers actually
acting on those incentives. Further, even if the data sources above did
not suffer from their limitations, researchers would struggle to
identify the causality necessary to robustly link fee and rebate
effects on order routing to order execution quality.
Indeed, this link requires two steps: First establishing a causal
link between fees and rebates and order routing and then between fee-
based order routing and order execution quality. Even with perfect
data, any study linking fees and rebates to order routing would suffer
from an inability to draw conclusions about causality. While such a
study might find a correlation between fees/rebates and order routing
decisions, the researchers would be unable to conclude which event was
driving which. In particular, since exchanges compete for market share,
it is reasonable to expect that exchanges change their fees and rebates
in response to changes in order routing decisions by broker dealers. If
this is the case it would be the order routing decisions that drive the
exchange fees. The data alone do not allow researchers to distinguish
whether order routing determines fees or whether fees determine order
routing.
Similarly, existing data, even if it didn't have the limitations
above, would not enable researchers to infer the causal impact of fee-
based order routing on order execution quality. If fees and execution
quality are linked, then exchanges may change their fees in response to
changes in execution quality. For example, raising rebates might
attract more liquidity providers and induce additional order flow to
the exchange. An exchange that is experiencing low execution quality
might raise rebates to address this problem. Under these circumstances,
an empirical analysis that lacks an exogenous shock to fees/rebates
might erroneously conclude that increased rebates cause a conflict of
interest because they are correlated with low execution quality and
increased order flow. Such a conclusion might lead the Commission to
draw incorrect conclusions.
2. Current Market Environment
This section provides an overview of the competitive landscape that
could be affected as a result of revisions to the transaction-based fee
structure required by the Pilot. Where information is currently
available to the Commission, a description of the current practices of
exchanges along dimensions that are relevant to the Pilot (e.g.,
summary information on their current fee schedule or the frequency of
fee revisions) are included. The Commission requested that commenters
provide additional information to inform the baseline as part of the
proposal. Where available, the baseline has been supplemented to
reflect additional baseline information that was received from
commenters.
a. Market for Trading Services
The market for trading services, which is served by exchanges,
ATSs, and other liquidity providers (internalizers and others), relies
on competition to supply investors with execution services at efficient
prices. These trading venues, which compete to match traders with
counterparties, provide platforms for price negotiation and the
dissemination of trading information. The market for trading services
in NMS stocks currently consists of 13 national equity market exchanges
and 34 operational ATSs. Other off-exchange venues include broker-
dealer internalizers and wholesalers, which execute a substantial
volume of retail order flow. The remainder of this section discusses
the current competitive landscape for exchanges, ATSs, and others
relevant to our economic analysis of the Pilot.
Since the adoption of Regulation NMS in 2005, the market for
trading services has become more fragmented and competitive. Of the 13
exchanges, seven are maker-taker exchanges and four are taker-maker
pricing exchanges, as shown in Table 1; the NYSE American and IEX
operate as flat-fee exchanges.\619\ 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.\620\ Several studies have suggested that transaction-based fee
pricing partially drove the increase in the number of U.S. equities
exchanges since 2005.\621\
---------------------------------------------------------------------------

\619\ 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 IEX, Investors
Exchange Fee Schedule (August 1, 2018), https://iextrading.com/trading/fees (last visited September 18, 2018). As of March 2018,
EDGA is no longer operating as a taker-maker market, but is also
operating as a flat-fee venue. See Cboe, Cboe US Equities (2018)
https://markets.cboe.com/us/equities/ (last visited September 18,
2018).
\620\ While the number of exchanges was eight, there were other
non-exchange trading venues in 2005 (i.e., ECNs), which were
displayed markets that utilized a standard price-time-priority
market model similar to exchanges. 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. 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 and was re-opened for trading in May 2018. See
Intercontinental Exchange, NYSE Finalizes Acquisition of National
Stock Exchange, Bus. Wire: News (Jan. 31, 2017, 6:28 p.m.) https://www.businesswire.com/news/home/20170131006474/en/. 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.
\621\ See, e.g., Angel, Harris, & Spatt, supra note 530; Harris,
supra note 530.
---------------------------------------------------------------------------

Execution services are a lucrative business, which encourages new
trading centers to enter the market in the hopes of capturing rents
associated with order

[[Page 5254]]

execution.\622\ As discussed in the proposing release, 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.\623\ But 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, and possibly despite the liquidity profile or
execution quality of those venues. Rebates offered by exchanges,
therefore, may ``break'' the liquidity externality.
---------------------------------------------------------------------------

\622\ See, e.g., Angel, Harris, & Spatt, supra note 530; Harris,
supra note 530.
\623\ See Proposing Release, supra note 2, at 13042. See also
ICI Letter II at 4.

Table 1--U.S. National Equities Exchanges
----------------------------------------------------------------------------------------------------------------
Exchange in Market share
Exchange Market fee type \624\ 2005? \625\ (%)
----------------------------------------------------------------------------------------------------------------
Cboe BZX: https://markets.cboe.com........... Maker-Taker................... 6.14
Cboe BYX: https://markets.cboe.com........... Taker-Maker................... 4.86
Cboe EDGA: https://markets.cboe.com.......... Taker-Maker................... 1.26
Cboe EDGX: https://markets.cboe.com.......... Maker-Taker................... 5.58
BX: www.nasdaqtrader.com..................... Taker-Maker................... [check] 3.00
Phlx (PSX): www.nasdaqtrader.com............. Maker-Taker................... [check] 0.70
Nasdaq: www.nasdaqtrader.com................. Maker-Taker................... [check] 15.76
NYSE Arca: https://www.nyse.com/markets...... Maker-Taker................... [check] 8.87
NYSE American \626\: https://www.nyse.com/ Flat Fee...................... [check] 0.32
markets.
NYSE: https://www.nyse.com/markets........... Maker-Taker................... [check] 12.16
NYSE National \627\: https://www.nyse.com/ Taker-Maker................... [check] 0.64
markets.
CHX: www.chx.com............................. Maker-Taker................... [check] 0.57
IEX: www.iextrading.com...................... Flat-fee...................... 6.14
------------------------------------------------------------------
Total.................................... .............................. ............... 66.00
----------------------------------------------------------------------------------------------------------------

Table 1 highlights that the market share of trading volume among
exchanges is not very concentrated. Although NYSE and Nasdaq have the
largest market share of approximately 12% and 16%, respectively, among
the exchanges, as of July 2018, these two exchanges collectively
account for less than 30% of the total market share of trading volume
for NMS stocks, indicating that the market for trading services has
become decentralized, and has become more so over time. For instance,
between 2004 and 2013, the NYSE's market share of NYSE-listed stocks
declined from approximately 80% to 20%, while market share of other
exchanges and off-exchange trading centers has increased.\628\ This
decentralization provides market participants with a choice among
venues when they route orders, and may also encourage exchanges to
compete to attract order flow.
---------------------------------------------------------------------------

\624\ See supra notes 3 and 4.
\625\ Shares are computed based on trading volume in August
2018. Market shares for the exchanges reported do not add up to
100%, because approximately 34% of trading volume is executed off-
exchange on over-the-counter venues. These market share figures
differ slightly from the ones in footnote 9 of Cboe Letter I, which
provided market share for May 2018. While these differences could
result from the focus on more recent data, the Commission is not
sure if the differences could also be driven by differing
methodologies. Nonetheless, the figures in Cboe Letter I are
consistent with the conclusions in this release. Also, the off-
exchange share differs slightly from the 39% share in Nasdaq Letter
I, at 2. Note that the off-exchange share in the Proposing Release
was 40%.
\626\ Since July 2017, NYSE American has not been 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 (July 26, 2018), https://www.nyse.com/publicdocs/nyse/markets/nyse-american/NYSE_America_Equities_Price_List.pdf.
\627\ NYSE acquired NSX in January 2017, and the exchange is now
known as NYSE National. The exchange was re-opened for trading in
May 2018 as taker-maker exchange.
\628\ See Angel, Harris, & Spatt, supra note 5307, Figures 2.17
and 2.18. Although less evident than for NYSE-listed securities, the
effect is similar for the Nasdaq market.
---------------------------------------------------------------------------

A number of commenters suggested that exchanges compete intensely
with each other to attract order flow.\629\ 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 also develop different business models to attract
different types of order flow.\630\ For example, maker-taker venues may
offer large rebates to attract liquidity supplying orders.\631\ They
may then rely on this liquidity to attract marketable orders, to which
they charge a high transaction fee in order to both offset the cost of
the large rebates and to ensure a profitable transaction pricing model.
Alternatively, inverted exchanges offer higher rebates to compete to
attract marketable orders. Exchanges may also compete for order flow on
other dimensions as well, by offering better execution quality, better
technology, and innovations in order types and other trading
mechanisms.\632\
---------------------------------------------------------------------------

\629\ See, e.g., CBOE Letter I, at 2; NASDAQ Letter I, at 11-13.
One commenter suggested that in the Proposal, the Commission made
the assumption that exchange groups had market power without
providing evidence to support the assumption. This commenter also
argued that no exchange group controls even 25 percent of market
share and that competition is robust between and among equities
exchanges. See NASDAQ Letter I, at 12-13.
\630\ One commenter suggested that in the Proposal, the
Commission failed to account for the two-sided nature of exchange
platforms when assessing the competitive impact of the Proposal. See
NASDAQ Letter II, at 4-5. In the Proposal, the Commission separately
discussed the potential impact of the Pilot on the competition for
trading volume, see the Proposal, supra note 2, at 13068. The
Commission also discussed some ways the Pilot could potentially
impact marketable and nonmarketable order flow, see the Proposal,
supra note 2, at 13057. Additionally, in Section IV.D.2.a, the
Commission separately discusses the potential effects of the Pilot
on marketable and non-marketable order flow.
\631\ A number of commenters said exchanges use rebates to
compete to attract limit orders to supply liquidity. See, e.g.
NASDAQ Letter I, at 12; Virtu Letter, at 3; State Street Letter, at
2.
\632\ One commenter also suggested that exchanges also compete
to attract to liquidity using many costly features, including
rebates, incentive programs, superior execution systems, regulatory
quality, and customer service. See NASDAQ Letter I, at 12.
---------------------------------------------------------------------------

In addition to competing with other U.S. equities exchanges,
exchanges also compete for order flow with off-exchange trading
centers, including ATSs, internalizers, and others. One way exchanges
compete with off-exchange trading venues is through the use of rebates.
For example, a number

[[Page 5255]]

of commenters argued that one way exchanges compete with off-exchange
trading venues is by using liquidity rebates to attract liquidity and
narrow the displayed spread, which makes it more expensive for off-
exchange trading venues to either match or improve upon the NBBO.\633\
Exchange transaction fees may also affect competition between exchanges
and off-exchange trading venues. For example, commenters suggested that
broker-dealers may opt to route order flow off-exchange in order to
avoid higher transaction fees charged by exchanges.\634\ Off-exchange
trading venues may also compete with exchanges to attract order flow by
offering more flexibility in how they execute orders. One commenter
noted that ``market participants choose to send orders to off-exchange
venues for reasons other than avoiding fees,'' including ``investors
anonymity, the ability to trade in more granular tick sizes, the
flexibility to segment the treatment of different types of clients, the
ability to choose trading counterparties, and the ability to
accommodate customer errors.'' \635\
---------------------------------------------------------------------------

\633\ See e.g., FIA Letter, at 3-4; NYSE Letter I, at 6; Grasso
Letter, at 4.
\634\ See e.g., IEX Letter I, at 3; Credit Suisse Commentary, at
2.
\635\ See NYSE Letter I, at 6.
---------------------------------------------------------------------------

Off-exchange trading makes up a substantial fraction of total
volume, as approximately 34% of all transaction reports are routed
using the NYSE and Nasdaq Trade Reporting Facilities as of August
2018.\636\ Of that off-exchange NMS share volume, approximately 14% was
attributable to ATSs, of which 34 traded NMS securities as of August
2018.\637\ The remaining 21% of off-exchange share volume is routed to
other off-exchange trading centers, such as internalizers.\638\
---------------------------------------------------------------------------

\636\ Data on off-exchange market share are available from Cboe
https://markets.cboe.com/us/equities/market_share/ (last visited
November 8, 2018).
\637\ 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) (hereinafter ``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: Reg. Filing & Reporting (2018),
https://www.finra.org/Industry/Compliance/MarketTransparency/ATS/.
\638\ Total market share is collected from Cboe https://markets.cboe.com/us/equities/market_share/ (last visited November 8,
2018). ATS weekly market share is collected from FINRA, https://otctransparency.finra.org (last visited November 8, 2018).
---------------------------------------------------------------------------

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 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,\639\ which may provide different incentives to broker-
dealers in order to attract this order flow, including transaction fees
and rebates. We discuss the current levels of transaction-based fees in
Section IV.B.2.e below.
---------------------------------------------------------------------------

\639\ See Angel, Harris, & Spatt, supra note 530.
---------------------------------------------------------------------------

b. Market for Liquidity Provision
Several commenters discussed the importance of liquidity providers
to an exchange's ability to compete in the market for trading
services.\640\ Within the exchange framework, liquidity providers, such
as market makers, other proprietary traders, and investors, compete to
supply liquidity to liquidity demanders. They compete by posting
displayed limit orders on exchanges, or by posting undisplayed limit
orders on exchanges or ATSs. Liquidity providers profit by buying at a
price lower than the price at which they sell and/or by collecting
rebates that are greater than the fees they pay. Hence, an execution is
a necessary means of profiting from liquidity provision, whether the
liquidity provider seeks to profit from price changes or rebates.
---------------------------------------------------------------------------

\640\ See, e.g., Cboe Letter I; NYSE Letter I.
---------------------------------------------------------------------------

Liquidity providers, and traders more generally, seek to manage
their trading profits by managing the tradeoff between the price they
get in an execution, the certainty of execution, and any adverse
selection resulting from the execution.\641\ When a liquidity supplier
more aggressively prices their limit order, they increase the chance
that their order will execute, but they trade this off against their
order executing at a worse price and increased chance of their order
being adversely selected if it does execute.
---------------------------------------------------------------------------

\641\ See NYSE Letter II at 8 for more concrete factors
considered by liquidity providers.
---------------------------------------------------------------------------

To get an execution, the limit orders need to be at the top of a
queue at a given price and venue and placed on a venue able to attract
liquidity demanders. Displaying a limit order attracts liquidity
demanders to the venue displaying the limit order, and thus improves
the probability of execution, but could also increase the risk of being
adversely selected, which reduces profits. For example, an algorithm
that is skilled at identifying short-term price movements may be
programmed to hit displayed limit buy orders at a price following a
signal that the price is about to go down. In such a situation, the
liquidity provider is unlikely to quickly sell at a price higher than
the recent purchase, and therefore, these situations are costly for the
liquidity provider. One way to attempt to reduce adverse selection
costs is to not display the limit order. When the order is not
displayed, the traders with the price signals may not see it and, as a
result, would be less likely to pick it off. On the other hand, an
undisplayed limit order also risks not getting executed when an
execution would be profitable. For example, an undisplayed limit buy
order is less likely to execute than a displayed limit buy order just
prior to an increase in the price because marketable sell orders that
do not anticipate the price increase are likely to route to venues with
competitively priced limit buy orders and would not be able to identify
which venues have undisplayed limit buy orders.
Rebates and fees can also affect where liquidity providers choose
to supply liquidity. Maker-taker exchanges, which pay rebates to
liquidity suppliers, provide them with extra revenue when trades are
executed. This could encourage liquidity suppliers to post at more
aggressive prices for some securities, subject to the fact that
displayed quotes on stock exchanges must be priced in one-cent
increments. However, competition among liquidity suppliers to earn
rebates could lead to longer queues in an order book, which could
decrease the chance that a liquidity supplier's order executes unless
they are at or near the front of the queue. In contrast, inverted
exchanges, which charge liquidity suppliers a fee when they supply
liquidity and offer a rebate to takers of liquidity, usually have
shorter queue lengths and an economic incentive to take liquidity,
which increases the chance that a liquidity supplier's order executes.
c. Market for Broker-Dealer Services
The Commission considered the potential for the Pilot 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.\642\ Large broker-dealers

[[Page 5256]]

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.\643\ As of December 31,
2017, approximately 3,860 broker-dealers filed Form X-17a-5. These
firms vary in size, with median assets of approximately $800,000,
average assets of nearly $1 billion, and total assets across all
broker-dealers of approximately $4 trillion. The twenty largest broker-
dealers held approximately 72% of the assets of broker-dealers overall,
with total assets of $2.89 trillion, indicating the high degree of
concentration in the industry. Of the 3,860 broker-dealers that filed
Form X-17a-5, 397 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 $25.5
million, average assets of $9.2 billion, and total assets across all
broker-dealers that are members of exchanges of $3.65 trillion.
---------------------------------------------------------------------------

\642\ See Securities Exchange Act Release No. 63241 (November 3,
2010), 75 FR 69791, 69822 (November 15, 2010) (hereinafter ``Risk
Management Controls for Brokers or Dealers with Market Access'').
\643\ See id. Larger brokers, or those with more order flow,
also benefit from the economies of scale that accompany the tiering
structure typically provided by exchanges. Accordingly, the brokers
with the most liquidity-providing orders may benefit
disproportionately from rebates because they generally receive
higher rebates within the various tiered pricing models of
exchanges.
---------------------------------------------------------------------------

d. Market for Assets Under Management
Many commenters expressed concern about the impact of the Pilot on
the market for assets under management, particularly on exchange-traded
products (``ETPs''). Asset management firms compete with each other in
a segment of the market for assets under management. They offer
different types of investment vehicles, such as mutual funds, close-end
funds, and ETPs,\644\ which compete with each other to attract investor
funds. Investor funds in an investment vehicle are pooled together and
invested in financial assets, with investors sharing any profits or
losses incurred by the investment vehicle according to each investor's
interest in the vehicle. Asset management firms generally earn revenue
by charging fees based on the value of the assets they manage on behalf
of investors in their investment vehicles.\645\
---------------------------------------------------------------------------

\644\ Not all ETPs are pooled investment vehicles. For example,
exchange traded notes (``ETNs''), which are a subset of ETPs, are
unsecured, unsubordinated debt securities that trade in the
secondary market on exchanges.
\645\ Investment companies can also earn revenue from other
activities such as lending securities.
---------------------------------------------------------------------------

Investment vehicles compete with other investment vehicles that
follow similar investment strategies to attract investor funds. They
often rely on differences in expense ratios, tracking error, and
redemption and trading characteristics when competing to attract
investor funds.\646\
---------------------------------------------------------------------------

\646\ Actively managed investment vehicles also rely on their
historical performance when competing to attract investor funds.
---------------------------------------------------------------------------

One subset of investment vehicles are ETPs. ETPs differ from other
investment vehicles in their trading and redemption characteristics.
ETPs are investment vehicles that issue shares that can be bought or
sold throughout the day on securities exchanges in the secondary market
at a market-determined price.
ETPs provide investors with a diverse set of investment options.
While the first ETPs held portfolios of securities that replicated the
component securities of broad-based domestic stock market indexes, some
ETPs now track more specialized indexes, including international equity
indexes, fixed-income indexes, or indexes focused on particular
industry sectors such as telecommunications or healthcare. Some ETPs
seek to track highly customized or bespoke indexes, while others seek
to provide a level of leveraged or inverse exposure to an index over a
fixed period of time. Investors also have the ability to invest in ETPs
that do not track a particular index and are actively managed.
A number of commenters noted that ETP issuers face strong
competition within similar investment strategies and that small
differences in fees and trading characteristics, such as spreads, daily
volume, and intraday volatility, may be meaningful to market
participants when deciding which ETPs to trade or invest in.\647\
---------------------------------------------------------------------------

\647\ See, e.g. JPMorgan Letter, at 4; STANY Letter, at 4;
Healthy Markets Letter II, at 8; Morgan Stanley Letter, at 3-4.
---------------------------------------------------------------------------

As of September 2018,\648\ there were 2,003 ETPs categorized as
exchange traded funds (``ETFs''), 223 ETPs categorized as non-ETF ETPs,
and 18 ETPs categorized as ETMFs.\649\ As of this date, ETPs had total
net assets of $3.74 trillion. The ten largest ETPs accounted for 28.0%
of total ETP net assets and 27.8% of the average dollar trading volume
on secondary markets.
---------------------------------------------------------------------------

\648\ The results are based on data collected from Bloomberg and
Morningstar as of September 30, 2018 for US-domiciled ETPs.
\649\ ETFs operate under exemptive orders that allow them to
register as investment companies under the Investment Company Act.
See 15 U.S.C. 80a-3(a)(1). Non-ETF ETPs are other ETPs that are not
registered under the Investment Company Act. Some are pooled
investment vehicles with shares that trade on a securities exchange,
but they are not ``investment companies'' under Investment Company
Act because they do not invest primarily in securities. Such ETPs
may invest primarily in assets other than securities, such as
futures, currencies, or physical commodities (e.g., precious
metals). Others are not pooled investment vehicles. For example,
ETNs are senior, unsecured, unsubordinated debt securities that are
linked to the performance of a market index and trade on securities
exchanges. See fn. 10 and accompanying text in the ETF Proposal,
infra note 651, at 37333. ETMFs are exchange traded managed funds.
ETMFs also operate under exemptive orders that allow them to
register as investment companies under the Investment Company Act,
but they have different disclosure requirements than ETFs. See, e.g.
Eaton Vance Management, et al., Investment Company Act Rel. Nos.
31333 (Nov. 6, 2014) (notice) and 31361 (Dec. 2, 2014) (order).
---------------------------------------------------------------------------

As the statistics above indicate, ETFs represent the majority of
ETPs, they possess characteristics of both mutual funds, which issue
redeemable securities, and closed-end funds, which generally issue
shares that trade at market-determined prices on a national securities
exchange and are not redeemable.\650\ Similar to mutual funds, ETFs
continuously offer their shares for sale. Unlike mutual funds, however,
ETFs do not sell or redeem individual shares. Instead, ``authorized
participants'' that have contractual arrangements with the ETF (or its
distributor) purchase and redeem ETF shares directly from the ETF in
blocks called ``creation units.'' \651\
---------------------------------------------------------------------------

\650\ The Investment Company Act defines ``redeemable security''
as any security that allows the holder to receive his or her
proportionate share of the issuer's current net assets upon
presentation to the issuer. See 15 U.S.C. 80a-2(a)(32). While
closed-end fund shares are not redeemable, certain closed-end funds
may elect to repurchase their shares at periodic intervals pursuant
to rule 23c-3 under the Investment Company Act (``interval funds'').
Other closed-end funds may repurchase their shares in tender offers
pursuant to rule 13e-4 under the Exchange Act.
\651\ The Commission's exemptive orders typically contain a
representation by the applicant that an authorized participant will
be either: (a) A broker or other participant in the continuous net
settlement system of the National Securities Clearing Corporation, a
clearing agency registered with the Commission and affiliated with
the Depository Trust Company (``DTC''), or (b) a DTC participant,
which has executed a participant agreement with the ETF's
distributor and transfer agent with respect to the creation and
redemption of creation units. See, e.g., Emerging Global Advisors,
LLC, et al., Investment Company Act Release Nos. 30382 (February 13,
2013), 78 FR 11909 (February 20, 2013) (notice) and 30423 (March 12,
2013) (order) and related application. In June 2018, the Commission
proposed a new rule under the Investment Company Act of 1940 that
would permit ETFs that satisfy certain conditions to operate without
obtaining an exemptive order. In connection with the proposed
exemptive rule, the Commission proposed to rescind certain exemptive
orders that have been granted to ETFs and their sponsors. See
Securities Exchange Act Release No. 10515 (June 28, 2018), 83 FR
37332 (July 31, 2018) (``ETF Proposal'').
---------------------------------------------------------------------------

An authorized participant that purchases a creation unit of ETF
shares directly from the ETF deposits with the ETF a ``basket'' of
securities and other assets identified by the ETF that day, and then
receives the creation unit of

[[Page 5257]]

ETF shares in return for those assets.\652\ The basket is generally
representative of the ETF's portfolio \653\ and, together with a cash
balancing amount, equal in value to the aggregate NAV of the ETF shares
in the creation unit.\654\ After purchasing a creation unit, the
authorized participant may hold the individual ETF shares, or sell some
or all of them in secondary market transactions. The redemption process
is the reverse of the purchase process: The authorized participant
redeems a creation unit of ETF shares for a basket of securities and
other assets.\655\ While the Commission currently lacks data on
authorized participants, a 2015 survey-based study of fifteen fund
sponsors, which together offer two-thirds of all existing ETFs
(covering 90% of all ETF assets), finds that the average ETF has 34
authorized participant agreements.\656\ The study further reports that
creation and redemption transactions occurred only on between 10% to
20% of trading days and that only 10% of the daily activity in all ETF
shares (by volume) are creations or redemptions.\657\
---------------------------------------------------------------------------

\652\ An ETF may impose fees in connection with the purchase or
redemption of creation units that are intended to defray operational
processing and brokerage costs to prevent possible shareholder
dilution (``transaction fees'').
\653\ The basket might not reflect a pro rata slice of an ETF's
portfolio holdings. Subject to the terms of the applicable exemptive
relief, an ETF may substitute other securities or cash in the basket
for some (or all) of the ETF's portfolio holdings. Restrictions
related to flexibility in baskets have varied over time. See the ETF
Proposal, supra note 651, at 37354-58.
\654\ Non-ETF ETPs also offer creation and redemption processes.
Some Non-ETF ETPs that are organized as pooled investment vehicles
may offer creation and redemption processes similar to ETFs. Other
Non-ETF ETPs may offer creations or redemptions on a less frequent
basis. For example, some ETNs may only be redeemed weekly.
\655\ An authorized participant may act as a principal for its
own account when purchasing or redeeming creation units from the
ETF. Authorized participants also may act as agent for others, such
as market makers, proprietary trading firms, hedge funds or other
institutional investors, and receive fees for processing creation
units on their behalf. See Abner, D.J. The ETF Handbook: How to
Value and Trade Exchange Traded Funds, 2nd ed., Wiley Finance (2016)
(``ETF Handbook'').
\656\ See, e.g., Antoniewicz, R. & Heinrichs, J. (2014).
``Understanding Exchange-Traded Funds: How ETFs Work.'' ICI Research
Perspective, Vol. 20(5) (available at: https://www.ici.org/pdf/per20-05.pdf) (``Antoniewicz'').
\657\ NSCC is the sole provider of clearing services for ETF
primary market transactions. Whether a creation or redemption order
is eligible to be processed through NSCC depends on the eligibility
for NSCC processing of the securities in the ETF's basket. See id.
---------------------------------------------------------------------------

Investors can purchase individual ETF shares in the secondary
market at prices that may deviate from the ETF's NAV. As a result, ETF
investors may trade shares at prices that do not necessarily reflect
the intrinsic value of the underlying ETF assets.\658\
---------------------------------------------------------------------------

\658\ It is possible for both the ETF's NAV per share and its
market price to deviate from the intrinsic value of the ETF's
underlying portfolio. In addition, there may be cases in which the
ETF's market price is closer to the intrinsic value of the ETF's
portfolio than its NAV per share. See, e.g., Madhavan, A. & Sobczyk,
A. (2016) ``Price Discovery and Liquidity of Exchange-Traded
Funds.'' Journal of Investment Management, Vol 14(2) (available at:
https://www.joim.com/price-dynamics-and-liquidity-of-exchange-traded-funds-2/).
---------------------------------------------------------------------------

As discussed in the ETF Proposal,\659\ the combination of the
creation and redemption process with secondary market trading in ETF
shares provides arbitrage opportunities that are designed to help keep
the market price of ETF shares at or close to the NAV per share of the
ETF.\660\ For example, if ETF shares are trading on national securities
exchanges at a ``discount'' (a price below the NAV per share of the
ETF), an authorized participant can purchase ETF shares in secondary
market transactions and, after accumulating enough shares to compose a
creation unit, redeem them from the ETF in exchange for the more
valuable securities in the ETF's redemption basket.\661\ The authorized
participant's purchase of an ETF's shares on the secondary market,
combined with the sale of the ETF's basket assets, may create upward
pressure on the price of the ETF shares, downward pressure on the price
of the basket assets, or both, bringing the market price of ETF shares
and the value of the ETF's portfolio holdings closer together.\662\
Alternatively, if ETF shares are trading at a ``premium'' (i.e., a
price above the NAV per share of the ETF), the transactions in the
arbitrage process are reversed and, when arbitrage is working
effectively, keep the market price of the ETF's shares close to its
NAV.\663\
---------------------------------------------------------------------------

\659\ See the ETF Proposal, supra note 651, at 37384.
\660\ ETFs also operate under several conditions designed to
facilitate an efficient arbitrage mechanism. For example, ETFs are
required to provide some degree of transparency regarding their
portfolio holdings by disclosing their holdings prior to the
commencement of trading each business day (i.e., portfolio
transparency).
\661\ This redemption would also cause the ETF's assets under
management to decline.
\662\ As part of this arbitrage process, authorized participants
are likely to hedge their intraday risk. For example, when ETF
shares are trading at a discount to an estimated intraday NAV per
share of the ETF, an authorized participant may short the securities
composing the ETF's redemption basket. After the authorized
participant returns a creation unit of ETF shares to the ETF in
exchange for the ETF's baskets, the authorized participant can then
use the basket assets to cover its short positions.
\663\ Market participants also can engage in arbitrage activity
without using the creation or redemption processes by buying/
shorting shares in the ETF while simultaneously shorting/buying the
ETF's underlying assets.
---------------------------------------------------------------------------

However, authorized participants, other market participants, and
arbitrageurs acting in secondary markets may incur costs and be exposed
to risk when engaging in arbitrage. The costs include bid-ask spreads
and transaction fees associated with the arbitrage trades. In addition,
during the time it takes arbitrageurs to execute these trades, they are
exposed to the risk that the prices of the basket assets and the ETF
shares change. As a consequence, arbitrageurs may decide to wait for
any mispricing between the market price of ETF shares and NAV per share
to widen until the expected profit from arbitrage is large enough to
compensate for any additional costs and risks associated with engaging
in the transaction.\664\
---------------------------------------------------------------------------

\664\ As discussed above, authorized participants can also hedge
the intraday risk associated with the arbitrage process. See supra
note 662.
---------------------------------------------------------------------------

A number of commenters noted that, in order to promote liquidity in
thinly-traded ETPs, exchanges offer market makers who meet certain
quoting requirements enhanced rebates when supplying liquidity in
certain less actively traded ETPs.\665\
---------------------------------------------------------------------------

\665\ See, e.g., Virtu Letter, at 7; Cboe Letter I, at 17-18.
---------------------------------------------------------------------------

e. 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.\666\ When exchanges update their fees,
they are required to file Form 19b-4 with the Commission; fee changes
are permitted to take effect upon filing under Section 19(b)(3)(A) of
the Exchange Act.\667\ 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.
---------------------------------------------------------------------------

\666\ 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.
\667\ As discussed supra Section IV.B.1.b.vi, 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 transaction fees
and rebates, as well as the number of categories for each (in
parentheses below the fee ranges), by exchange, as reported by each
exchange on their recent fee schedules.\668\ On average,

[[Page 5258]]

U.S. exchanges have 18 access fee categories and 21 rebate categories
associated with these fee schedules.\669\ For the maker-taker
exchanges, access fees do not exceed the Rule 610(c) cap 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.\670\
---------------------------------------------------------------------------

\668\ The transaction fee and rebate ranges in Table 2 are
collected from recent fee schedules (as of July 31, 2018) 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.
\669\ This average does not include the IEX exchange as the fee
structure is a flat one. See also, e.g., RBC Letter II (attaching a
report titled ``Complexity of Exchange Pricing and Corresponding
Challenges to Transparency and Routing'' in which they identify
``1,023 separate pricing `paths'--i.e., separate fees or rebates--
across these exchanges.'').
\670\ See, e.g., CFA Letter, at 6.
---------------------------------------------------------------------------

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 (August 1, 2013-July 31, 2018). Exchanges, on average,
have changed their fee schedules 34 times in the last five years,\671\
indicating that the average exchange revises its transaction-based fee
schedules about seven times per year (approximately every 7.4 weeks).
---------------------------------------------------------------------------

\671\ The median number of revisions to fee and rebate schedules
by exchanges is 41 over the five-year period.

Table 2--Summary of Transaction-Based Fee Schedules for U.S. National Equities Exchanges as of July 2018
----------------------------------------------------------------------------------------------------------------
Number of
Exchange Fee model revisions (5 Date of fee Fees (# of Rebates (# of
years) schedule categories) categories)
----------------------------------------------------------------------------------------------------------------
Cboe BZX..................... Maker-Taker.... 54 8/16/2018 $0.0000-$0.0033 ($0.0010)-($0.0
(29)........... 032)
(18)
Cboe BYX..................... Taker-Maker.... 51 8/9/2018 $0.0000-$0.0033 ($0.0005)-($0.0
(40)........... 022)
(12)
Cboe EDGA.................... Taker-Maker.... 41 8/1/2018 $0.0000-$0.0032 ($0.0004)-($0.0
(48)........... 027)
(14)
Cboe EDGX.................... Maker-Taker.... 53 8/16/2018 $0.0000-$0.0032 $0.000-($0.0032
(37)........... )
(20)
BX........................... Taker-Maker.... 29 7/20/2018 $0.0005-$0.0030 $0.0000-($0.002
(13)........... 1)
(12)
Phlx (PSX)................... Maker-Taker.... 24 5/21/2018 $0.0028-$0.0030 $0.00-($0.0030)
(3)............ (8)
Nasdaq....................... Maker-Taker.... 54 7/25/2018 $0.0000-$0.0030 $0.0000-($0.003
(4)............ 25)
(36)
NYSE Arca.................... Maker-Taker.... 51 8/1/2018 $0.0005-$0.0035 ($0.0002)-($0.0
(68)........... 035)
(65)
NYSE American................ Flat........... 9 7/26/2018 $0.0002-$0.0030 $0.0000-($0.004
(12)........... 5)
(4)
NYSE......................... Maker-Taker.... 42 8/10/2018 $0.0003-$0.0030 $0.0000-($0.004
(20)........... 5)
(41)
NYSE National \672\.......... Taker-Maker.... 11 7/26/2018 $0.0003-$0.0025 ($0.0002)-($0.0
(16)........... 020)
(2)
CHX.......................... Maker-Taker.... 8 4/26/2018 $0.0007-$0.0040 ($0.0009)-($0.0
(5)............ 020)
(2)
IEX.......................... Flat........... 10 8/1/2018 $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 2017 capturing the net (of rebates)
transactions-based fee revenues, the Nasdaq exchanges (Nasdaq, BX, and
PSX) earned $253 million.\673\ Based on the same measure the NYSE-
affiliated exchanges (NYSE, NYSE Arca, NYSE American, and NYSE
National) earned $196 million in transaction-based fees net of
rebates,\674\ while the BATS Global Markets (now, Cboe BZX, Cboe BYX,
Cboe EDGA, and Cboe EGDX), for the year ended December 31, 2017, earned
$153 million in transaction-based fees net of rebates.\675\ Neither CHX
(which became a NYSE-affiliated exchange in 2018) 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.
---------------------------------------------------------------------------

\672\ NYSE acquired NSX in January 2017, and the exchange is now
known as NYSE National. As of May 2018, the exchange re-opened for
trading and began submitting new fee schedules periodically.
\673\ See Nasdaq Form 10-K filings (2017), available at https://www.sec.gov/Archives/edgar/data/1120193/000112019318000003/ndaq1231201710-k.htm. Transaction-based revenues for equity
securities accounted for approximately 59% of total operating income
net of rebates and 25% net of rebates and brokerage, clearing, and
exchange fees. The Commission has revised the revenue number for
Nasdaq for 2017 revenue per the correction provided in the Nasdaq
Letter II.
\674\ See Intercontinental Exchange Form 10-K filings (2017),
available at https://www.sec.gov/Archives/edgar/data/1571949/000157194918000003/ice2017123110k.htm. For the Intercontinental
Exchange, net cash equity transaction-based revenues were
approximately 8.2% of operating income for 2016.
\675\ See Cboe Form 10-K filings (2017), available at https://www.sec.gov/Archives/edgar/data/1374310/000155837018000953/cboe-20171231x10k.htm. Cboe's acquisition of BATS Global Markets became
effective on March 1, 2017. For the year ending December 31, 2017,
the net transaction-based revenues were 41% of Cboe operating
profits.
---------------------------------------------------------------------------

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

[[Page 5259]]

most recently reported fee schedule and the share volume of each
exchange for July 25, 2018 through August 24, 2018.\676\ 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.
---------------------------------------------------------------------------

\676\ The share volume is obtained from Cboe, available at
https://markets.cboe.com/us/equities/market_share/ (last visited
September 18, 2018). To compute the maximum profit attainable, staff
took the difference between the highest possible transaction fee and
the lowest possible rebate and multiplied it by the monthly share
volume. For a midpoint profit, the median of the transaction 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 July 25, 2018-August 24, 2018]
[In millions]
----------------------------------------------------------------------------------------------------------------
Share volume Annualized Per share Annualized Per share
Exchanges (millions) midpoint profit maximum profit
\677\ difference (median) difference (maximum)
----------------------------------------------------------------------------------------------------------------
Cboe BZX........................ 9,014 ($486.75) ($0.00450) $248.78 $0.0023
Cboe BYX........................ 7,136 25.69 0.00030 239.76 0.0028
Cboe EDGA....................... 1,853 1.11 0.00005 62.26 0.0028
Cboe EDGX....................... 8,165 (4.90) (0.00005) 205.77 0.0021
BX.............................. 4,389 36.87 0.00070 158.02 0.0030
Phlx (PSX)...................... 1,035 16.15 0.00130 37.27 0.0030
Nasdaq.......................... 23,087 (34.63) (0.00013) 831.14 0.0030
NYSE Arca....................... 13,024 23.44 0.00015 515.75 0.0033
NYSE American................... 473 (3.69) (0.00065) 17.03 0.0030
NYSE............................ 17,823 (128.33) (0.00060) 641.63 0.0030
NYSE National................... 920 3.31 0.00030 25.40 0.0023
CHX............................. 830 8.96 0.00090 30.87 0.0031
IEX............................. 3,757 N/A 0.00000 N/A 0.0000
----------------------------------------------------------------------------------------------------------------

C. Analysis of Benefits and Costs of Transaction Fee Pilot

1. Benefits of Transaction Fee Pilot
The Commission expects that the benefits of the Pilot will fall
into two categories: (1) More informed policy decisions, including more
information about the economic impact of transaction-based fees and
rebates, and (2) other benefits that may accrue to market participants
for the duration of the Pilot. In this section we discuss each of the
categories of benefits as well as potential limitations to the
applicability of information to be drawn from the Pilot.
---------------------------------------------------------------------------

\677\ Monthly share volume obtained from Cboe for July 25, 2017
through August 24, 2017, Cboe, U.S. Equities Market Volume Summary,
available at https://markets.cboe.com/us/equities/market_share/ (last
visited September 18, 2018).
---------------------------------------------------------------------------

a. Benefits of More Informed Policy Decisions
The Commission expects that the primary benefit of the Pilot will
be to inform the Commission and public of the economic impact of
exchange transaction-based fees and rebates.\678\ As a result, the
Commission will have data to better inform its regulatory consideration
of exchange transaction-based fee-and-rebate pricing models and fee
changes, and the potential effects of changes to its regulatory
approach concerning the same. In general, more informed regulatory
decisions are more likely to result in regulatory approaches that
better balance costs and benefits relative to regulatory decisions
based on less precise information. In other words, many of the economic
benefits derive from subsequent decisions that the Commission can
neither predict nor commit to at this time. Indeed, the Commission
cannot predict at this time whether the results of the Pilot will
suggest any particular policy direction and recognizes that the results
could suggest that existing exchange transaction-based fee caps and
related rebates may be more beneficial to investors than the policy
alternatives examined in the Pilot.
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\678\ In contrast, one commenter opined that the primary benefit
of the Pilot would be ``the `better fills' that institutional
investors will get after the pilot is introduced.'' Nasdaq Letter
III, at 9. This commenter asserted that the Commission had not done
a proper cost benefit analysis because its analysis of benefits did
not account for the ``opportunity costs'' inherent in order routing
decisions, or other factors which would impact institutional orders.
See id. Consequently, the commenter asserted that the Commission
overstated the benefit of the Pilot. See id. However, the Commission
does not agree that ``better fills'' will be a certain result of the
Pilot. Furthermore, the Commission disagrees that it has not
adequately analyzed the costs of the Pilot. As noted above, the
Commission has quantified the likely economic effects of the Pilot
where possible; however, the Commission is unable to quantify all of
the economic effects because it lacks the information necessary to
provide reasonable estimates. The Commission agrees with the
commenter that quantifying benefits using existing data is
difficult, thus underscoring the need for a Pilot. A more detailed
analysis of the Pilot's impact on trading costs can be found in
Section IV.C.2.b.
---------------------------------------------------------------------------

i. Expected Analysis From the Pilot
The Proposing Release discussed the theoretical impact of exchange
transaction-based fees and rebates on several potential effects such as
conflicts of interest, fragmentation, complexity, liquidity, and off-
exchange competition and explained that certain components of the
Proposed Pilot would facilitate the study of these effects.\679\ As
noted above, the Commission believes that little empirical evidence
currently exists regarding these effects.
---------------------------------------------------------------------------

\679\ See Proposing Release, supra note 2, at Section V.
---------------------------------------------------------------------------

More specifically, the Pilot will provide information on the direct
effects of exchange transaction fee and rebate levels on execution
quality and market quality and will facilitate studies of the impact of
fees and rebate levels on market participant behavior and competition,
including potential conflicts of interest. Sections IV.C.2 and IV.D.
discuss many potential economic effects for which this economic
analysis

[[Page 5260]]

is unable to draw unambiguous conclusions. For example, many commenters
disagreed on how reducing exchange fees and rebates affects the
competitive landscape between exchanges and off-exchange venues in the
market for trading services,\680\ and the analysis here recognizes that
many competitive forces can drive order flow in either direction. The
Pilot will provide insight into the impact of transaction fees and
rebates on this competitive landscape and can perhaps even shed light
into the mechanism behind any observed changes. Further, one commenter
argued that this economic analysis ``does not accurately account for
the actual level of orders impacted by conflicted broker routing.''
\681\ The Commission believes that it cannot establish the actual level
of orders impacted by potentially conflicted broker routing with
current data and has designed the Pilot in part to gather more data on
the extent to which rebates impact order routing decisions, as
explained in the section that follows. The Commission also notes that
the Pilot seeks to study the effects of exchange pricing models on
market quality and execution quality, which could affect all orders.
The Pilot will facilitate the study of order flow among different
venues, which could provide insights into whether changes in exchange
transaction-based fees and rebates affect, for example, the level of
fragmentation. Existing literature suggests that transaction-based
pricing has contributed to an increase in the number of venues
competing for order flow over time.\682\ By offering rebates or Linked
Pricing, start-up maker-taker and taker-maker exchanges 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.\683\ 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.\684\
---------------------------------------------------------------------------

\680\ See e.g., Cboe Letter I, at 12; NYSE Letter I, at 9;
Nasdaq Letter I, at 2, 5 (suggesting that the Pilot may impact
competitive dynamics between exchanges and ATSs).
\681\ See, e.g., Nasdaq Letter III at 1.
\682\ 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. The majority of the U.S. equities
exchanges belong to three exchange groups. The Commission believes
that any analyses of the effects of transaction-based fees on order
routing decisions can appropriately control for exchange groups.
\683\ See, e.g., ICI Letter II at 2.
\684\ See, e.g., Fidelity Letter, at 9.
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Test Group 2 will provide insight into the natural equilibrium
level of access fees, within the current regulatory structure, in the
absence of rebates and Linked Pricing.\685\ As discussed above,
prohibiting exchanges from offering Linked Pricing in Test Group 2 is
intended to complement and reinforce the prohibition on rebates.\686\
Although Rule 610(c) caps the maximum access fee for exchanges at
$0.0030, in the absence of rebates and Linked Pricing, competition
among exchanges could drive the average access fee to an amount
substantially below $0.0030.\687\ As noted in Section IV.A.2, exchanges
have a reduced competitive incentive to reduce fees because doing so
would require reducing the rebates that attract order flow to the
exchange. Test Group 2 will allow competition among exchanges, in the
absence of pressure to offer high rebates or Linked Pricing, to
determine the level of access fees, which the Commission and others can
observe during the Pilot. Like the other examinations the Pilot can
facilitate, the results of an analysis of the equilibrium access fees
are not currently predictable with much certainty.
---------------------------------------------------------------------------

\685\ Equilibrium refers to conditions of a system in which all
competing influences are balanced. For instance, with respect to the
Test Group 2, this could be the level of transaction fees charged by
exchanges from which no exchange has any incentive to increase or
decrease that fee outside of a constrained competitive margin. This
will be the equilibrium transaction fee. See also, discussion in
Section II.C.7.e. An important potential benefit of the Pilot could
result if the no rebate Test Group were able to demonstrate a set of
conditions wherein regulatory fee caps might not be necessitated in
an environment in which natural competitive forces could effectively
cap access fees. This would occur if in the no-rebate Test Group the
equilibrium fee charged during the Pilot was lower than the fee
cap--implying that the fee cap was not binding in this situation.
\686\ 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.
\687\ See, e.g., Fidelity Letter, at 9; Citadel Letter, at 5. In
addition to removing rebates or Linked Pricing in Test Group 2, the
Commission could also temporarily suspend limitations on access fee
caps imposed by Rule 610(c). Implementing multiple changes within a
single test group, however, could 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 if Rule 610(c) restricted access
fees during the Pilot.
---------------------------------------------------------------------------

The Pilot will facilitate studies of the impact of exchange
transaction-based fees and rebates on liquidity by studying metrics
such as the quoted spreads.\688\ 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 analysis below
is Section IV.C.2.b.iv identifies several reasons that reducing fees
and rebates could increase or decrease quoted spreads. The Pilot could
provide information on whether exchange fees and rebates affect the
liquidity of securities, as measured by the quoted spreads, across
different test groups.\689\
---------------------------------------------------------------------------

\688\ See, e.g., ICI Letter II at 3 (noting that the Pilot could
facilitate the study of how access fees and rebates affect
liquidity, including quoted spreads).
\689\ See. 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, & Spatt, supra note 530.
---------------------------------------------------------------------------

The Commission disagrees with commenters who said that the Pilot
was inappropriate because of a one-size-fits-all approach.\690\ In
selecting the number of securities for each Test Group, the Commission
staff divided NMS securities into three common stock strata and three
ETP strata by liquidity to determine how many stocks each stratum
requires to achieve statistical power.\691\ The staff also separately
examined ETPs to determine how many ETPs would be required to achieve
statistical power. Having statistical power within each Test Group, and
within each Test Group by liquidity strata, helps to ensure that
researchers will be able to use Pilot data to inform the Commission
regarding the issue of whether different securities should have the
same regulatory treatment.
---------------------------------------------------------------------------

\690\ See, e.g., Nasdaq Letter I at 9.
\691\ See supra Section II.C.5 (discussing statistical power)
and infra note 695.
---------------------------------------------------------------------------

ii. How the Pilot Facilitates Study
The Pilot will simultaneously create different fee environments,
each of which restricts transaction-based fees differently to allow for
the comparison of securities that are simultaneously in different
regulatory regimes. The study of these comparisons will inform the
Commission about economic distortions that may arise as a result of
transaction-based fees. Because of the size and length of the Pilot,
the Commission believes that the different fee environments over
representative subsamples of NMS securities, even though implemented
temporarily, will produce effects on market participant behavior that
are identical or similar to

[[Page 5261]]

those that would arise under a similar permanent change.
As explained below, three distinct features of the Pilot's design
will facilitate analyses of the relationship, if any, between fees and
potential economic distortions. Specifically, the Pilot is designed to
provide (1) representative results; (2) more direct access to data that
is currently unavailable or requires lengthy and labor-intensive effort
to compile and process; and (3) sufficient information to determine
causality. The following sections discuss in detail how each of these
aspects of the Pilot could facilitate studies of the issues described
above.
(1) Representative Results
In the context of the Pilot, representative results mean that the
impact of the 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).
Representative results are 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 by some combination of the following: Data from a
single broker-dealer, a small sample of securities, a single exchange,
or a short sample period. By contrast, the Commission believes that the
Pilot, as designed, will produce more representative results.
Specifically, as discussed in detail below, the Pilot will cover a
large stratified sample of NMS stocks (including ETPs), both maker-
taker and taker-maker exchanges, and transaction fee caps as well as a
prohibition on rebates and Linked Pricing, and will 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 Pilot shall
continue for up to one additional year.\692\
---------------------------------------------------------------------------

\692\ As designed, the Pilot will exclude NMS securities that
have prices below $2.00 per share as of the date of pilot selection
and NMS securities with average daily volume of less than 30,000
shares. As detailed above, the data will also be produced for a six-
month pre-Pilot Period and a six-month post-Pilot Period.
---------------------------------------------------------------------------

The Commission believes that the Pilot will produce representative
results, presenting a significant improvement on existing studies,
because the 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, with average daily volume of 30,000
shares or more, and with no restrictions on market capitalization.\693\
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.\694\ Including a broad sample of NMS stocks allows the
results to inform policy choices across subsets 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 within a given stratum, facilitating a comparison
of Test Groups and the Control Group, which further supports the
representativeness of results. If, for instance, the Test Groups and
Control Group had a different composition within strata, researchers
outside the Commission 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 believes
that the sample sizes in the Test Groups are sufficient to provide the
statistical power necessary to identify differences across the samples,
even within strata.
---------------------------------------------------------------------------

\693\ See, e.g., Brandes Letter, at 2 (supporting applying the
Pilot to the ``widest range of stocks possible''); Spatt Letter, at
1-2.
\694\ See, e.g., Battalio Equity Market Study, supra note 5307.
---------------------------------------------------------------------------

The Commission notes that while the adopted Pilot will be able to
provide representativeness within strata, changes since the Proposal
affect the representativeness of the Test Groups as a whole. In
particular, in response to commenters who called for fewer stocks to be
included in the Pilot, Commission staff conducted a supplemental
analysis of Test Group sizes needed to achieve statistical power.\695\
In contrast to its analysis in the Proposal,\696\ the Commission
analyzed the sample sizes in each stratum rather than using the lowest
power stratum to determine the ratio of test group stocks to control
stocks. As a result, the ratio of test group stocks to control group
stocks is lower for some strata. In other words, the Commission was
able to reduce the number of securities in test groups by weighting the
composition of the test groups relative to the control group more
heavily toward securities in certain strata in which more data would be
needed to achieve statistical power. While analyses of the Pilot that
do not consider the strata may fail to provide representative results,
the addition of the stratum identifier to the Exchange Lists will allow
researchers in and outside the Commission to consider the strata in
their analyses.
---------------------------------------------------------------------------

\695\ The supplemental analysis made several improvements over
the analysis used to identify the proposed test group sizes in an
attempt to refine the analysis to respond to commenters' desire for
smaller test groups while preserving statistical power. First, the
supplemental analysis used more refined methodology that more
directly controlled for time series and cross-sectional
dependencies. Second, the supplemental analysis considered three
quoted spread strata instead of two market capitalization stratum.
The market capitalization strata was originally necessary to control
for any overlap with the Tick Size Pilot, but quoted spread strata
more directly align with the potential economic significance of fees
and rebates relative to anticipated transaction costs and the Tick
Size Pilot has ended. Third, the supplemental analysis eliminated
stocks that trade below 30,000 shares per day. See also supra
Section II.C.6. See supra note 175 (citing commenters that favored
smaller test groups).
\696\ See Proposing Release, supra note 2, at 13019.
---------------------------------------------------------------------------

The Commission believes that the inclusion of a broad sample of NMS
stocks, including small and mid-capitalization stocks, ensures
representative results from the Pilot. Although previous studies, as
discussed above, suggest that any possible conflicts of interest are
likely to be the greatest for small-capitalization securities,\697\ the
Commission believes that it is important to the design of the Pilot to
include these small and mid-capitalization stocks (including ETPs). In
particular, including these securities in the Pilot will allow the
results of the Pilot to inform policy choices across any subset of
these securities.
---------------------------------------------------------------------------

\697\ See, e.g., Battalio Equity Market Study, supra note 5307;
Harris, supra note 5307; RBC Letter I, at 5-6.
---------------------------------------------------------------------------

Representativeness of results of the Pilot will also be promoted by
the choice of the Pilot Security selection date. Rule 610T(b) and (c)
contemplate that the Commission will select and announce the Pilot
Securities prior to the Pilot start date. As noted in the Proposal, the
Commission anticipates that it will 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 Pilot start date,
the more comparable the Test Groups will be during the Pilot. Selection
of securities close to the start of the Pilot also will be more likely
to

[[Page 5262]]

include the intended universe of securities, by avoiding securities
that exit between the adoption of the Rule and the start of the Pilot,
while also capturing new securities that enter the market during this
period. Further, to the extent that market participants would change
their behavior in anticipation of the Pilot, setting the selection
period close to the Pilot effective date could reduce the effect of
such behavior on pre-Pilot data.
The results of the Pilot will be further representative because the
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, and rebates on either the
make or take side can both impact market quality and execution quality.
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 Pilot to all exchanges also improves upon the existing
analysis of the limited fee experiment conducted by Nasdaq,\698\ which
only covered a single exchange, as explained in Section IV.B.1.a.ii.
While the results from that study are suggestive that broker-dealers
routed customer orders to other exchanges that did not change their
transaction-based fees and rebates, reasons other than potential
conflicts of interest could have impacted the changes in order routing
decisions. The Commission believes that the Pilot will achieve
representativeness by requiring transaction-fee changes for all U.S.
equities exchanges, which will allow researchers in and outside the
Commission to identify how these revisions affect order routing
decisions across exchanges. As discussed above, excluding non-exchange
trading centers does not forfeit the representativeness of the results
to be obtained from the Pilot, as including them would expand the Pilot
to dissimilarly situated trading centers whose fee models and
regulatory treatment are incomparable to exchanges. Further, the Pilot
will require that changes to fees or rebates are applied at the
security level, which means that for any given security, the limitation
on access fees or rebates is ubiquitous across all exchanges.
---------------------------------------------------------------------------

\698\ See, e.g., Larry Harris Letter, at 9.
---------------------------------------------------------------------------

In addition, the Pilot achieves representativeness by imposing a
fee cap and a prohibition on rebates and Linked Pricing. The existing
literature suggests that the potential distortive effects arising from
access fees could induce behavior that would be different from the
distortions arising from rebates or Linked Pricing. Therefore, the
inclusion of caps on both 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 fees or rebates.
The Commission further believes that the duration of the Pilot will
produce sufficiently representative results. If broker-dealers
incorporate transaction fees and rebates into their order routing
decisions, a two-year duration for the Pilot, with an automatic sunset
at the end of the first year, unless the Commission publishes a notice
determining that the 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 Pilot.\699\ Specifically, as discussed below, the Commission
recognizes that broker-dealers will incur costs to incorporate new fee
schedules that are consistent with the Pilot's requirements into their
order routing decisions.\700\ 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 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 Pilot will
also impose costs on broker-dealers, and these costs increase with the
duration of the Pilot. The Commission believes that the Pilot duration,
even with a one-year sunset, is long enough to produce representative
results because, as discussed below in Section IV.C.2.b.ii, broker-
dealers that incorporate transaction-based fees and rebates into their
routing decisions will find it economically worthwhile to adapt their
behavior in response to the Pilot. Further, the provision to suspend
the automatic sunset facilitates representative results because it
provides the Commission with flexibility as the data from the 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 Pilot to determine
whether to allow the sunset to occur.
---------------------------------------------------------------------------

\699\ See, e.g., Joint Asset Managers Letter, at 2. Other
commenters agreed that the Pilot duration will be sufficient but for
other reasons. See, e.g., Fidelity Letter at 9 and CFA Letter at 6.
\700\ See, e.g., Citi Letter, at 5 and Larry Harris Letter, at
11. Also, see infra Section IV.C.2.b.ii for a discussion of the
costs broker-dealers could incur during the Pilot.
---------------------------------------------------------------------------

Some commenters disagreed that one year will be sufficient to
achieve a representative sample.\701\ One commenter said that ``robust
data . . . should take two years'' and that ``technological changes . .
. to routing and algorithmic logic for some firms are a hurdle that
could require significant time to implement.'' \702\ Another commenter
noted the ``complexities of the pilot and the opportunities for
significant market evolutions.'' \703\ The Commission notes that it
will consider these and other concerns, as noted above, in deciding
whether or not to suspend the automatic sunset.
---------------------------------------------------------------------------

\701\ See, e.g., Babelfish Letter at 3 and Healthy Markets
Letter at 19.
\702\ See Babelfish Letter at 3.
\703\ See Healthy Markets Letter I at 19.
---------------------------------------------------------------------------

The Commission believes that the Pilot will produce representative
results despite the Pilot's treatment of stocks cross-listed on
Canadian exchanges during the Pilot and the exclusion of stocks with
average daily volume of less than 30,000 shares. A supplemental staff
analysis found that the exclusion of the interlisted Canadian stocks
from the selection of securities for test group inclusion would not
materially impact the representativeness of the remaining sample.\704\
Second, the exclusion of securities with average trading volume of less
than 30,000 shares per day should not materially affect the
representativeness of the results because the trading in these stocks
generates less than $100 per day in fees or rebates. Additionally, low
trading volume stocks tend to have wider spreads rendering a rebate of
$.0030 a significantly smaller incentive relative to the size of the
spread than it would be for higher volume tighter spread securities.
Because of these two factors, the Commission believes fees and rebates
are economically much less meaningful inducements to provide liquidity
for these stocks. Because of the diminished economic significance of
rebates in

[[Page 5263]]

these extremely low volume stocks, the Commission believes that there
is a lower risk of applying a suboptimal transaction-based fee
regulatory regime in these stocks. In other words, because rebates are
economically less meaningful for these securities the benefits of the
Pilot in informing policy decisions regarding transaction-based fees in
these securities are likely low. In addition, the supplemental staff
analysis found that excluding these securities increased the potential
statistical power of the Pilot.
---------------------------------------------------------------------------

\704\ Specifically, the supplemental analysis compared the
distributional characteristics of all US listed stocks (including
Canadian interlisted stocks) to the distributional characteristics
of the subset of US listed stocks that excludes Canadian interlisted
stocks to determine whether distributional characteristics of the
subset differs statistically significantly from the distributional
characteristics of all US listed stocks. The analysis finds that the
distribution of the subset that excludes Canadian interlisted
securities is statistically similar to the distribution of all US
listed stocks.
---------------------------------------------------------------------------

Some commenters suggested that the exclusion of ATSs from the data
gathering hinders the representativeness of the data obtained from the
Pilot.\705\ The Commission understands that ATSs often negotiate
bespoke agreements with individual subscribers for a bundle of services
for which rebates may or may not play a significant role. Even if the
Commission obtained detailed information on all of these agreements, it
may not be possible to identify the fees or rebates they pay for order
flow from the fees for the other bundled services the ATS offers the
subscriber in a manner sufficient for inclusion in the Exchange
Transaction Fee Data. Also, as discussed in section IV.D.2.a it is
uncertain whether the Pilot will lead to exchanges to be in an improved
or diminished competitive position with ATSs. Further, without
including ATSs in the Pilot, ample public data exists to assess the
market share of ATSs relative to exchange market share to observe and
measure off-exchange order flow changes.
---------------------------------------------------------------------------

\705\ See, e.g., Nasdaq Letter I, at 2, 5 and RBC Letter I, at
4.
---------------------------------------------------------------------------

(2) Expansion of Readily Available Data
The Commission also expects the Pilot to provide data that would
otherwise require lengthy and labor-intensive collection. Having a
representative source of data is critical for the production of
research and analyses about the impact of transaction-based fees on
potential distortions. If more data becomes available, that data will
assist the Commission in analyzing potential conflicts of interest.
The Commission believes that the data produced by the Pilot will
improve upon existing data,\706\ as is discussed in more detail below.
The ready availability of the Exchange Transaction Fee Summaries will
facilitate the study of distortions and the equilibrium level of fees
and rebates by reducing the cumbersome nature of collecting fee data.
Further, the Pilot will make information on order routing decisions
available to the Commission on a more granular level than current
readily available data and will improve the feasibility of Commission
staff analysis of order routing data during the Pilot.\707\
---------------------------------------------------------------------------

\706\ See Section IV.C.1.a. For commenter statements supporting
the usefulness of the data to be obtained from the Pilot See, e.g.,
Clark-Joseph Letter, at 1, AJO Letter, at 1, CII Letter, at 3,
NYSTRS Letter, at 1, Barnard Letter, at 1; ICI Letter I, at 1-2; MFS
Letter, at 1; Nuveen Letter, at 2; Better Markets Letter, at 2; RBC
Letter I, at 2; Invesco Letter, at 2; CFA Letter, at 1; State Street
Letter, at 2; Wellington Letter, at 1; Joint Pension Plan Letter, at
2; Oppenheimer Letter, at 2; Angel Letter I, at 1. Some commenters
suggest that the data will not be useful because it excludes data
from ATSs and doesn't account for other forms of remuneration that
broker dealers receive which may also impact order routing
decisions. See NYSE Letter 1 at 1,8-10; ProAssurance Letter, at 2;
Cboe Letter I, at 15; Nasdaq Letter I, at 2.
\707\ The aggregation and availability of the data gathered by
the Pilot is one of the primary benefits of the Pilot and provides
much of the value of the data collected. See, e.g., NYSE Letter II,
at 13; Cboe Letter I, at 3.
---------------------------------------------------------------------------

The Pilot will enable Commission staff to gain improved access to
order routing data and will provide access to fee data in a simplified
and standardized form, which will improve the quality of the analyses
produced as a result of the Pilot. Although certain order routing data
and exchange fee schedules are publicly available through a combination
of Rule 606 disclosures and exchange websites, respectively, the Pilot
will resolve a number of limitations associated with using currently
available data to study the effect of transaction-based fees on
potential conflicts of interest and their impact on market quality and
execution quality.
The order routing data that Commission staff will obtain as a
result of the Pilot will provide superior information to that readily
available today. Data will be available for a representative sample of
NMS stocks, across all broker-dealers, and exchanges, at the daily
frequency, which will provide sufficient data for analyses, while
providing more statistical power than the Rule 606(a) public reports
can provide. Relative to the data that some studies have acquired from
broker-dealers and exchanges,\708\ the order routing data will also
allow Commission staff to observe a time series of order routing data
across broker-dealers and exchanges. Further, more granular order
routing data (e.g., daily order routing statistics that separate
principal and agency trading as well as auction, post only, and other
orders) than that available publicly will facilitate more targeted
analysis. Together, these characteristics of the data will facilitate
Commission staff research on issues such as potential conflicts of
interest, which will improve the quality of the information available
to the Commission for policy decisions.
---------------------------------------------------------------------------

\708\ See, e.g., Battalio Equity Market Study, supra note 530.
---------------------------------------------------------------------------

The following discussion illustrates how the data obtained from the
Pilot could be used to study the Commission's objectives.\709\ The key
components in the order routing data that facilitate studies of the
impact of transaction-based fees and rebates on order routing and
execution quality are daily volume information at the exchange, stock,
and broker-dealer level, the separation of liquidity taking and
liquidity making orders, the Order Capacity, the Order Designation, the
time to execution for liquidity-providing orders, and the ability to
estimate fill rates. The routing volume allows Commission researchers
to measure how much volume each broker-dealer sends to each exchange
each day in individual securities, which can be combined with the Pilot
Securities Exchange List and the Exchange Transaction Fee Summary to
observe patterns in routing and correlate those patterns with fees and
Test or Control Group membership. The exchange level is required to
match the order routing data with the fee data; the broker level is
required to allow for different routing strategies across broker-
dealers; and the daily level in the data facilitates statistical power.
The separation of liquidity taking and liquidity making orders allows
researchers to match the order routing volume to the potential fee or
rebates in the Exchange Transaction Fee Summary. Order Capacity allows
Commission researchers to compare order routing and execution quality
statistics for Agency Orders to Principal Orders, which are less
subject to conflicts of interest concerns than Agency Orders and, thus,
provides an added means of obtaining causal identification. Order
Designation allows researchers to exclude auction orders and to
separately analyze Post Only orders because these orders types are
subject to different fee structures (auction orders do not get rebates)
or exist for the purpose of capturing rebates (Post Only). Excluding or
separately analyzing these orders types provides for cleaner tests that
are better able to measure the impacts consistent with the objectives
of the Pilot. Finally, the time to execution and ability to estimate
fill rates (using orders received, executed, canceled or rerouted)

[[Page 5264]]

provides Commission researchers with execution quality information not
readily available for liquidity providing or liquidity taking
orders.\710\
---------------------------------------------------------------------------

\709\ See NYSE Letter II, at 13 suggesting that the proposing
release did not provide an illustration for how the data could be
used to study the Commission's objectives.
\710\ The Commission recognizes that many trade-based execution
quality statistics are readily estimated from publicly available
data. See Section IV.E.5.g infra for a discussion of an alternative
to require order-based execution quality statistics during the
Pilot.
---------------------------------------------------------------------------

An additional requirement of the Pilot is that the exchanges will
be required to provide a standardized dataset of fees, the Exchange
Transaction Fee Summary, to the public. In particular, this information
will allow researchers in and outside the Commission to create proxies
for which exchanges are likely to be more or less expensive and which
offer the highest rebates. For instance, within Test Group 1, the
maximum allowable access fee is $0.0010; however, each exchange may
have different base and top-tier fees. Thus, only knowing that a
security is in Test Group 1 will be incomplete information about the
impact of transaction-based fees and rebates. Moreover, the Exchange
Transaction Fee Summary will provide researchers in and outside the
Commission with historical (realized) average and median per share fees
and rebates to enable an ex post analysis of how actual fees affected
past order routing decisions, which is not available from any data
source today.
Exchanges will construct Exchange Transaction Fee Summaries
according to an XML schema to be published on the Commission's website,
and exchanges will update this information monthly.\711\ These data
will be standardized and consistently formatted, which will ease the
use of these data for researchers in and outside the Commission, as
each exchange will have to report the Base, Top Tier, average and
median fees, as detailed above in Section III.E. Each month, exchanges
will 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 will be publicly posted
on each exchange's website.\712\
---------------------------------------------------------------------------

\711\ The standardized fee data, as would be required by the
proposed Pilot, is discussed supra Section III.E.2.
\712\ 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
will be required to publicly post on its website downloadable files
containing daily aggregated and anonymized order routing statistics,
updated monthly. Each exchange will 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
will: (1) Ease aggregation across exchanges, which affords researchers
in and outside the Commission an opportunity to obtain representative
results; (2) replicate across studies, which will 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. Thus, the Commission believes that a standardized
reporting of summary data on fees by the exchanges will facilitate
analysis of the effect of transaction-based fees.
The rule will require that the Exchange Transaction Fee Summary be
structured using an XML schema to be published on the Commission's
website.\713\ 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 in and outside the
Commission could immediately download the information directly into
databases and use various software packages for viewing, manipulation,
aggregation, comparison, and analysis. This will enhance their ability
to conduct large-scale analysis and immediate comparison of the fee
structures of exchanges. The Commission believes that requiring these
reports to be made available in an XML format will provide flexibility
to researchers in and outside the Commission and will facilitate
statistical and comparative analyses across exchanges, test groups, and
date ranges.
---------------------------------------------------------------------------

\713\ 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 will be published on the Commission's
website and the outdated version of the schema will be removed in
order to maintain data quality and consistency with the XML
standard. The Commission's XML schema will also incorporate certain
validations to help ensure data quality.
---------------------------------------------------------------------------

(3) Causality
In addition to providing representative results, the Commission
expects the Pilot to achieve the benefits identified above because it
will, among other things, provide insight into the degree to which
exchange transaction-based fees and rebates cause economic distortions
that either harm or benefit investors. Such causal information is
especially useful when considering policy choices aimed at reducing any
possible harmful distortions. As detailed in the baseline, exogenous
shocks are a means by which researchers may analyze a causal
relationship between changes to transaction-based fees and rebates and
changes to order routing decisions of broker-dealers.\714\ This Pilot
facilitates the analysis 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.
---------------------------------------------------------------------------

\714\ As discussed in the baseline, analysis of causality can be
accomplished through either exogenous shocks or econometric methods,
such as instrumental variable analysis.
---------------------------------------------------------------------------

The Commission believes that the Pilot is able to facilitate the
examination of causality because the Pilot will produce a single
exogenous shock that differentially impacts either fees or rebates on
both maker-taker and taker-maker exchanges. Exogenous shocks, such as
those in the Pilot provide researchers with data to analyze the
direction of causality.\715\ For example, a researcher seeking to study
the impact of the rebates on transaction costs could estimate a
difference-in-differences test that compares transaction costs during
the Pilot to the transaction costs before the Pilot and then compare
the changes in Test Group securities to the changes in Control Group
securities. It also will allow investors who receive 606(b)(3) data
from their broker-dealers to directly test with their own 606(b)(3)
data whether, in the absence of rebates in the most actively traded
stocks, they are better able to compete for queue priority and thereby
capture the quoted spread when posting liquidity. More generally, the
Pilot will allow researchers, including Commission staff and others, to
run difference-in-difference tests on many measures of execution
quality and market quality based on publicly available data to examine
the causal impact of transaction-based fees and rebates on execution
and market quality.
---------------------------------------------------------------------------

\715\ Other econometric techniques, such as instrumental
variables methodology, are used when an exogenous shock (or other
controlled experiment) cannot be established.
---------------------------------------------------------------------------

As discussed above, the Pilot will produce a single exogenous shock
that

[[Page 5265]]

differentially affects multiple Test Groups at the same time. The
simultaneity of the exogenous shock across Test Groups facilitates
examinations of causality, particularly in the presence of any
confounding effects. For instance, if some market-wide event were to
result in deviations in order routing behavior during the Pilot, the
event would likely affect stocks in each Test Group as well as the
Control Group. The simultaneity allows researchers in and outside the
Commission to control for the impact of the market-wide event, because
the impact would likely affect the Test Groups and the Control Group
similarly. For example, in the difference-in-differences test of
transaction costs mentioned above, any market-wide effect would result
in changes to fill rates in both the Control Group and Test Group 2.
Therefore, the comparison of the changes in Test Group 2 to the changes
in the Control Group subtracts the market-wide effect from the total
effect, thus isolating the effect of the Pilot.
In addition, to facilitate causal analysis of data during the Pilot
Period, the Commission believes that it is important to collect
sufficient data during a pre-Pilot Period.\716\ The pre-Pilot data can
then be compared with the data that will be produced during the Pilot
Period, which will 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 all
researchers to more easily use the information obtained from the Pilot
to inform future regulatory consideration of exchange transaction fees
and rebates and their impact on the markets. The Commission 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.\717\
---------------------------------------------------------------------------

\716\ See Healthy Markets Letter I, at 19.
\717\ See supra. Section II.D.3.
---------------------------------------------------------------------------

The Commission further believes that the combination of the
representative sample, data from the Pilot, and the exogenous shock
will facilitate analysis by Commission staff (or institutions who
receive 606(b)(3) reports from their broker-dealers) of the degree to
which transaction-based fee- and rebate-motivated order routing harms
order execution quality. In particular, with the exogenous shock, the
Order Routing Data, the Exchange Transaction Fee Summaries, and
publicly available data, researchers at the Commission can identify
both the degree to which transaction fees and rebates impact order
routing and, the impact of transaction fee- and rebate-motivated order
routing impacts execution quality.
Several commenters seemed to state that the Pilot would produce
flawed causal results because the Pilot does not include all forms of
remuneration.\718\ While the Commission acknowledges that other forms
of remuneration may impact routing decisions, the results will still be
informative. Even if some order flow migrates between exchanges and
off-exchange venues, Commission staff should still be able to identify
the impact of exchange fees and rebates on exchange routing.
---------------------------------------------------------------------------

\718\ See, e.g., Cboe 15-16; NYSE at 9-10; Nasdaq I at 7; RBC
Letter I, at 4; ProAssurance at 2.
---------------------------------------------------------------------------

The Pilot Securities Exchange List and the Pilot Securities Change
List further enhance the ability for researchers both inside and
outside of the Commission to analyze the effects of transaction-based
fees on order routing decisions. By requiring daily updates to the
Pilot Securities Change List, the Pilot will 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 will 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.
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 Pilot. This
section discusses, in greater detail below, issues associated with
pilots in general and the potential concerns with resultant research
and analyses.
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.\719\ The
Commission believes, however, that the value of the information
obtained from the Pilot is not dependent upon having variation in
market conditions over time, and that the duration of the Pilot will
provide sufficient information to inform policy decisions.
---------------------------------------------------------------------------

\719\ For instance, a pilot could be designed where the
information obtained from the 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 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.\720\ In the context of this pilot, broker-
dealers could choose to retain their current order-routing decisions
for the duration of the Pilot, which could be costly to such broker-
dealers.\721\ 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 Pilot against the
costs of adjusting the algorithms for their smart order routing
systems. Alternatively, broker-dealers could substantially change their
business model in order to

[[Page 5266]]

avoid the Pilot.\722\ In addition, the Commission recognizes that the
anticipated analysis of order routing data from the Pilot could cause
broker-dealers to improve execution quality. This could reflect the
``Hawthorne effect,'' which refers to the idea that people will often
improve their behavior if they believe that they are observed. These
outcomes could lead to results that would not represent the effects of
a permanent rule change. If that were to occur, a few commenters
suggested that this could lead the potential benefits of the Pilot to
not justify the costs or risks that the pilot imposes.\723\
---------------------------------------------------------------------------

\720\ 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, & Xiaoyun Zhang,
Unshackling Short Sellers: The Repeal of the Uptick Rule, Colum. U.
(2008), https://www0.gsb.columbia.edu/mygsb/faculty/research/pubfiles/3231/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 (Aug. 6, 2004) (hereinafter
``Regulation SHO'').
\721\ 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 530, 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 (e.g., based on execution
quality) and are not driven by potential conflicts of interest
(e.g., maximizing rebates), then for at least some broker-dealers,
their order routing decision process may be unchanged. It is also
possible that for broker-dealers with algorithms that dynamically
route based upon real-time market metrics, including liquidity
metrics, expected fill rates, and current queue length, routing
logic may not change, however, routing choices may dynamically
adjust based upon changes in those variables that result from
altered fee schedules that broker-dealers may implement in
conjunction with the Pilot.
\722\ 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.
\723\ See, e.g., FIA Letter, at 3; Citadel Letter, at 4.
---------------------------------------------------------------------------

The Commission believes that the Pilot is designed to obtain
empirical information about how fees and rebates affect order routing
decisions because the size and length of the Pilot render it unlikely
that broker-dealers that currently focus their routing on rebates would
maintain existing order routing decisions or alter their business
models to avoid the Pilot as suggested by some commenters. In
particular, the Commission believes that the Pilot duration is likely
to make it economically worthwhile for broker-dealers to adjust their
order routing behavior. 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, discussed below in Section
IV.C.2.b.ii do not.
In addition, the potential compromise of the data due to the
Hawthorne effect is limited by at least two factors. First, this is not
the Commission's first pilot study. Market participants are relatively
accustomed to the Commission collecting data for analysis. Second, the
analysis of pre-Pilot data will allow for a baseline observation of
unaffected broker-dealer order routing activity. If broker-dealers do
not act on conflicts of interest during the baseline period, the
Hawthorne effect is irrelevant unless it causes that good baseline
behavior.\724\ If, on the other hand, broker-dealers do act on
conflicts of interest during the baseline and the Hawthorne effect
results in good behavior during the Pilot, the Pilot should facilitate
the measurement of the conflicts. As a result, the Commission believes
that the Pilot will produce useful data despite the possible influence
of the Hawthorne effect.
---------------------------------------------------------------------------

\724\ The Commission does not believe that the Hawthorne effect
will cause ``good'' behavior in the baseline because broker-dealers
would need to implement system changes similar to those described in
Section IV.B.2.c prior to the pre-Pilot.
---------------------------------------------------------------------------

The Commission recognizes that not all objectives of the Pilot
would be straightforward to study. For example, the changes in fees or
rebates imposed by the 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 Pilot, without jointly studying why it changes,
would not be sufficient to understand any possible conflicts of
interest. Researchers can carefully study the data 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 Pilot.
Another limitation on the benefits from the Pilot is that the Pilot
will not require that the order routing data be released to the public.
As a result, fewer independent analyses of the Pilot's order routing
datasets are likely to be performed, compared to the analysis that
might have been obtained if the data were publicly released. However,
the Commission believes that sufficient analysis will be produced to
yield credible and reliable results without public dissemination of the
order routing data. In addition, institutions, including broker
dealers, asset managers, and transaction cost analysis (TCA) providers,
may produce their own analyses using proprietary data and information.
To the extent that interested parties prepare their own analyses, they
may submit them to tradingandmarkets@sec.gov with the words
``Transaction Fee Pilot Analysis'' in the subject line, and the
Commission will post those reports on its public website.\725\
---------------------------------------------------------------------------

\725\ As noted above, the Commission encourages market
participants to disclose what sources of data they used for their
analyses and describe the methodology they used, and to make those
reports publicly and freely available.
---------------------------------------------------------------------------

Additionally, only NMS stocks with prices of at least $2 prior to
the start of the Pilot are eligible for inclusion in the Pilot. One
commenter suggested that NMS stocks with prices between $1 and $2 also
be included in the Pilot, as the commenter believed that the impact of
fees and rebates are likely to be greatest for these securities.\726\
The Commission agrees with the commenter who stated that the initial
Test and Control Groups in the Pilot would be more representative if
they contained securities with prices below $2. However, excluding
securities with prices below $2 helps to keep the sample of stocks more
stable across the Pilot. This occurs because if a stock's price falls
below $1 it is subject to different regulations, such as a different
tick size, and thus would be excluded from the Pilot. By excluding
stocks below $2 the Pilot mitigates the risk that the
representativeness of the sample may diminish over time as Pilot stocks
are removed due to their stock prices falling below $1. The Commission
believes that the data obtained from the Pilot will be sufficient to
obtain data on the effects to changes in fees and rebates on small,
low-priced securities (those with prices close to $2, or any Pilot
security that drops below $2 per share, but exceeds $1 per share, after
the start of the Pilot).
---------------------------------------------------------------------------

\726\ See James Angel Letter I, at 2.
---------------------------------------------------------------------------

b. Other Benefits of the Transaction Fee Pilot
Other benefits may emerge that could affect markets and market
participants for the duration of the Pilot, such as potentially reduced
conflicts of interest for some Test Groups, lower all-in costs of
trading, or improved market quality. The Commission believes that many
of the benefits discussed below will be temporary in nature and affect
markets and market participants only for the duration of the Pilot.
Because the Commission lacks information on the extent to which the
impact of exchange fee-and-rebate pricing models affect investors,\727\
the Commission is unable to quantify many of the temporary benefits of
the Pilot discussed below.
---------------------------------------------------------------------------

\727\ See supra Section IV.A.1 (Market Failure at the Broker
Dealer Level) and Section IV.A.2 (Market Failure at the Exchange
Level).
---------------------------------------------------------------------------

Some commenters stated their belief that the Pilot would not help
investors and issuers.\728\ As discussed in Sections IV.C.2.b and
IV.D.1 the Commission acknowledges that the Pilot could harm execution
quality and/or market quality, but the impacts of the Pilot are
uncertain. The Pilot could also improve execution quality and/or market
quality for the reasons explained in those same sections. For example,
as discussed in detail below,\729\ the Commission is uncertain about
whether, or among which securities, the Pilot will result in increases
or decreases in quoted spreads and investor transaction costs. A
decrease in quoted spreads and/or investor transaction costs during the
Pilot in some or all stocks in test groups would benefit investors.
Likewise, the Commission is uncertain about how the Pilot will affect
price efficiency--the

[[Page 5267]]

Pilot could plausibly improve or degrade price efficiency in certain
test group stocks.\730\ Any improvements would benefit issuers and
investors.
---------------------------------------------------------------------------

\728\ See, e.g., Nasdaq I, at 1.
\729\ See infra Section IV.C.2.b.iv
\730\ See infra Section IV.D.1.
---------------------------------------------------------------------------

The Commission believes that another temporary benefit of the rule
will be that the Pilot could prevent some traders from indirectly
quoting in sub-pennies.\731\ 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 exchange fees and
rebates to effectively undercut quotations by sub-pennies is
particularly severe in taker-maker markets.\732\ The 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 this issue.
---------------------------------------------------------------------------

\731\ 17 CFR 242.612 (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 10, at 37550-57.
\732\ See, e.g., Angel, Harris, & Spatt, supra note 530; Harris,
supra note 530. 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, &
Zhuo Zhong, Inverted Fee Venues and Market Quality 1 (August 10,
2018) (unpublished manuscript) (forthcoming J. Fin. Econ.) https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2939012&download=yes.
---------------------------------------------------------------------------

2. Costs of the Pilot
This section describes the compliance costs associated with the
Pilot, followed by the additional costs, some of which are temporary,
that could affect issuers, investors, broker-dealers, exchanges, and
other market participants resulting from the Pilot.
a. Exchange Compliance Costs of the Pilot
The Pilot will impose costs on exchanges to comply with the Pilot's
requirements to collect, calculate, and publicly post data certain
required by the Pilot on their websites, transmit the order routing
datasets to the Commission, as well as to implement fee changes, if
required in order to comply with the Pilot's restrictions. Table 4
provides a summary of the costs discussed in this section.

Table 4--Summary of Compliance Costs for Exchanges
--------------------------------------------------------------------------------------------------------------------------------------------------------
Pilot Exchange Order routing Fee filings Total
--------------------------------------------------------- securities transaction data \735\ \736\ -------------------------------
exchange list fee summary --------------------------------
\733\ \734\
Exchange type -------------------------------- All All Listing Non-listing
Listing All
--------------------------------------------------------------------------------------------------------------------------------------------------------
Per exchange
--------------------------------------------------------------------------------------------------------------------------------------------------------
Implementation.......................................... 15,400 26,100 24,000 96,800 162,000 147,000
Periodic:
--2-yr Pilot........................................ 83,500 55,000 103,800 148,400 391,000 307,000
--1-yr Pilot........................................ 50,100 36,600 69,200 74,200 230,000 180,000
Total (implementation + periodic):
--2-yr Pilot........................................ 98,900 81,000 127,800 245,200 553,000 454,000
--1-yr Pilot........................................ 65,500 62,700 93,200 171,000 392,000 327,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total across exchanges
--------------------------------------------------------------------------------------------------------------------------------------------------------
Implementation.......................................... 92,000 339,000 311,000 1,258,000 2,001,000
Periodic:
--2-yr Pilot........................................ 501,000 714,000 1,350,000 1,929,000 4,494,000
--1-yr Pilot........................................ 301,000 476,000 900,000 964,000 2,641,000
Total (implementation + periodic):
--2-yr Pilot........................................ 593,000 1,054,000 1,661,000 3,187,000 6,495,000
--1-yr Pilot........................................ 393,000 815,000 1,211,000 2,223,000 4,642,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

i. Updating the Pilot Securities Exchange List and Pilot Securities
Change List
---------------------------------------------------------------------------

\733\ See infra Section IV.C.2.a i.
\734\ See infra Section IV.C.2.a ii.
\735\ See infra Section IV.C.2.a iii.
\736\ See infra Section IV.C.2.a iv.
---------------------------------------------------------------------------

During the Pilot, the primary listing exchanges will 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. Further, each primary listing exchange will publicly
post on its website the updated Pilot Securities Change List prior to
the start of each trading day, which will list, separately, changes to
applicable Pilot Securities. Additional details of what will be
included in each list are provided in Section II.E.1.
Upon the initial publication of the List of Pilot Securities by
notice by the Commission, the primary listing exchanges \737\ will need
to determine which of those securities are listed on their market, and
then compile a list of those securities and publicly post on their
websites that list as a downloadable file in pipe-delimited ASCII
format. The Commission initially estimated that the costs associated
with the initial compilation of the Pilot Securities Exchange List
would cost $2,060 per exchange based on an estimated burden of 8 hours.
However, one commenter stated that it ``anticipates it could take as
many as 44 hours'' to compile the initial Pilot Securities Exchange
List.\738\ The commenter stated that its estimates of the costs
associated with the Pilot are based on its ``prior experience
implementing the Tick Size Pilot.'' \739\ In light of this comment, the
Commission is increasing its estimate.\740\ Accordingly, the Commission
estimates that each primary listing exchange would incur, on average, a
one-time

[[Page 5268]]

burden of approximately 44 burden hours per primary listing exchange to
compile and publicly post their initial Pilot Securities Exchange List.
Consequently, the Commission now estimates a cost of approximately
$11,700 per listing exchange to compile the initial list of
securities.\741\ 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.\742\ 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, these
systems would have to be adapted to conform to the requirements of the
Pilot. The Commission estimates that it would cost each primary listing
exchange approximately $3,720 to develop appropriate systems for the
Pilot, or about $22,300 in aggregate across the six U.S. primary
listing exchanges.\743\ Once these systems are established, the
Commission estimates that it would cost each listing exchange
approximately $83,500 for the entire duration of the Pilot, or
approximately $501,000 across the six primarily listing exchanges,\744\
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 Pilot shall automatically sunset at the end of the
first year, the Commission estimates that the costs to each exchange
would be $50,100 for a one-year Pilot duration and the six-month post-
Pilot Period, or approximately $301,000 across the six primarily
listing exchanges.\745\
---------------------------------------------------------------------------

\737\ The primary listing exchanges are NYSE, Nasdaq, NYSE
American, NYSE ARCA, BATS and IEX.
\738\ See NYSE Letter I, at 15.
\739\ See id.
\740\ The Commission notes that the Tick Size Pilot required the
exchanges and FINRA to also select the Pilot securities whereas the
Transaction Fee Pilot does not. Therefore, the Transaction Fee Pilot
could result in lower costs than the Tick Size Pilot. Nonetheless,
the Commission believes it is reasonable to rely on this commenter's
estimate because this commenter has expertise on these costs likely
to result in incorporating relatively precise information into the
cost estimates.
\741\ This estimate is based on the following: [(Compliance
Manager (22 hours) x $298) + (Programmer Analyst (22 hours) x $232)]
= $11,660 [ap]11,700 per exchange, or $11,660 x 6 primary listing
exchanges = $69,960 [ap] 70,000 in aggregate. The burden hours are
obtained from supra Section III.D.1. 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 [SIFMA], Management & Professional Earnings in the
Securities Industry--2013 (October 7, 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 rule below.
\742\ The Commission notes that the primary listing exchanges
maintained public web pages containing similar lists with respect to
the recently concluded Tick Size Pilot. The systems to produce lists
for the Tick Size pilot should be adaptable to meet the requirements
of the Transaction Fee Pilot.
\743\ This estimate is based on the following: [(Attorney (4
hours) x $401) + (Compliance Manager (4 hours) x $298) + (Programmer
Analyst (4 hours) x $232)] = $3,724 per exchange, or $3,724 x 6
exchanges = $22,344 [ap] 22,300 in aggregate. The burden hours are
obtained from supra Section III.D.1.
\744\ If the 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 630 business days (504
business days for the two-year Pilot horizon (252 business days per
year x 2 years), and up to 126 business days for the six-month post-
Pilot Period). The cost estimate for providing these lists for the
entire period is based on the following: [(Compliance Manager (0.25
hour x 630 trading days) x $298) + (Programmer Analyst (0.25 hour x
630 trading days) x $232)] = $83,475 [ap] 83,500, or $83,475 x 6
exchanges = $500,850 [ap] 501,000, in aggregate. The burden hours
are obtained from supra Section III.D.1. One commenter provided an
estimate of 300.5 burden hours for providing these lists, but the
Commission continues to believe its own higher burden estimates are
reasonable. See Section III.D.6, supra.
\745\ If the 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 378 business days (252
business days for the one-year Pilot horizon, and 126 business days
for the six-month post-Pilot Period). The cost estimate for
providing these Lists for the entire period is based on the
following: [(Compliance Manager (0.25 hour x 378 trading days) x
$298) + (Programmer Analyst (0.25 hour x 378 trading days) x $232)]
= $50,085 [ap] $50,100, or $50,085 x 6 exchanges = $300,510 [ap]
$301,000, in aggregate. The burden hours are obtained from supra
Section III.D.1.
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In sum, the Commission estimates a total cost for each listing
exchange of approximately $98,900, or $593,000 in aggregate across
exchanges, to comply with the requirement to update and post on its
website at the beginning of each trading day the list of its listed
securities in each of the Test Groups. This includes an estimated
$15,400 in one-time implementation costs and $83,500 in ongoing costs.
This estimate is based on one provided by a commenter who, based on
their experience with the Tick Size Pilot, estimated that it would take
up to 44 hours to compile. \746\ Accordingly, the Commission continues
to believe its burden estimates are reasonable.
---------------------------------------------------------------------------

\746\ See, e.g., NYSE Letter I, at 15.
---------------------------------------------------------------------------

iii. 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, which are downloadable files containing the initial set of
fees at the outset of the 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 II.E.2. The Exchange Transaction Fee
Summary would need to be updated in response to any changes to its fee
schedule 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 and rebate
changes, according to Rule 610T(e), that they make during the Pilot,
including the effective dates of fee revisions. The rule also requires
that each exchange calculate numerous statistics relating to their fees
as discussed in more detail in Section II.E.2.
A requirement at the outset of the Pilot is that exchanges would
need to report their base and top-tier fees and rebates, which the
Commission estimates would cost each exchange $1,130, or about $14,700,
in aggregate across the 13 U.S. equities exchanges.\747\ 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
Transaction Fee Pilot, the exchanges also would 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 will cost
exchanges $530 each to post this summary dataset to their
websites.\748\
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\747\ The estimate is based on the following: (Compliance
Manager (2 hours) x $298) + (Senior Business Analyst (2 hours) x
$265) = 1,126 [ap] $1,130, or $1,126 x 13 equities exchanges =
$14,638 [ap] 14,600 in aggregate. The burden hours are obtained from
Section III.D.2, supra.
\748\ 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 = $6,890
[ap] 7,000 in aggregate. The burden hours are obtained from supra
Section III.D.2.
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The rule would also require that exchanges compute the monthly
average and median realized per share fees and rebates, as detailed in
Section II.E.2. These data will provide the Commission and the public
with 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 believes that the costs

[[Page 5269]]

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 about $24,000, or approximately $311,000 in aggregate across
the 13 U.S. equities exchanges, associated with the development and
implementation of systems tracking realized monthly average and median
share fees pursuant to the rule.\749\ The Commission further
anticipates that it would cost an additional $12,000 annually, or
$155,000, in aggregate, per year, to ensure that the system technology
is up to date and remains in compliance with the rule.\750\
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\749\ 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] = 23,920 [ap] $24,000
per exchange, or $23,920 x 13 exchanges = $310,960 [ap] 311,000 in
aggregate. The burden hours are obtained from supra Section III.
D.2.
\750\ 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] = $11,960 [ap] $12,000
per exchange, or $11,960 x 13 exchanges = $155,480 [ap] $155,000 in
aggregate. The burden hours are obtained from supra Section III.D.2.
---------------------------------------------------------------------------

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 II.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 Pilot should continue for up to a second
year and not automatically sunset at the end of the first year.\751\
Each exchange would have total costs of updates to the Exchange
Transaction Fee Summary of approximately $19,000 per exchange, or
$248,000 among the 13 exchanges over the pilot duration, including pre-
and post-periods.\752\ If the 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.\753\ 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 $169,000 among
the 13 exchanges over the pilot duration, including pre- and post-
periods.\754\ As detailed above, the Commission 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 Pilot.
---------------------------------------------------------------------------

\751\ 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.
\752\ 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 = $19,080
[ap] $19,000. 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 $19,080 x 13 U.S.
equities exchanges = $248,040 [ap] $247,000. The burden hours are
obtained from supra Section III. D.2.
\753\ 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.
\754\ 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 = $12,720
[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 $12,720 x 13 U.S.
equities exchanges = $165,360 [ap] $165,000. The burden hours are
obtained from supra Section III.D.2.
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As discussed in Section II, the rule will 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 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 \755\ and FpML \756\ to exchange information on highly
structured financial instruments and related market data.\757\
---------------------------------------------------------------------------

\755\ 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
Fix Trading Community, available at https://www.fixtrading.org/.
\756\ 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 Financial products Markup Language [FpML], available
at https://www.fpml.org/.
\757\ 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 for the
NYSE, www.nyse.com, Nasdaq, www.nasdaqomx.com, and Cboe,
www.cboe.com, 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.
---------------------------------------------------------------------------

The Commission anticipates that implementation of the 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 Pilot within
the exchange source systems; mapping the relevant fields in the
exchanges' data source systems to the Commission's XML schema;
implementing, testing and executing the validation rules; and
developing the website posting processes as required by the rule. The
initial costs to exchanges of complying with the Commission's 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.\758\ For all updates to

[[Page 5270]]

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.
---------------------------------------------------------------------------

\758\ 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] = $497 [ap] $500
per exchange, or $500 x 13 exchanges = $6,461 [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.
---------------------------------------------------------------------------

In sum, the Commission estimates the total cost of the pilot
associated with producing the exchange transaction fee summary in XML
format to be approximately $81,000 per exchange if the Pilot runs for 2
years and $62,700 per exchange if the Pilot sunsets at the end of the
first year. These costs comprise of approximately $26,100 in one time
implementation costs and $55,000 in ongoing costs if the Pilot runs for
two years, or $36,600 if the Pilot sunsets at the end of the first
year. These costs aggregate to approximately $1,054,000 in total costs
across all exchanges if the Pilot runs for the entire two years, and
$815,000 if the Pilot sunsets at the conclusion of the first year.
iv. Producing the Order Routing Data
The rule also will require as part of the Pilot that exchanges
prepare, in pipe-delimited ASCII format, and transmit to the
Commission, order routing data, updated monthly, containing aggregated
broker-dealer order routing information. As discussed in Rule 610T(d)
and in Section II.E.3, the datasets would contain separate order
routing data for liquidity-providing and liquidity-taking orders
aggregated by day, by security, by broker-dealer, and by exchange.
The Commission believes that as long as the CAT Phase 1 data are
available at the implementation of the Pilot, the exchanges would be
able to use that data to construct the order routing data required by
the 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. 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 monthly order routing data to
be transmitted to the Commission.
The Commission estimates that each exchange would have a one-time
cost of approximately $23,900, or approximately $311,000 in aggregate
across the 13 exchanges, associated with the development and
implementation of systems needed to aggregate the order routing
information, as well as store the data, in the pipe-delimited ASCII
format specified by the rule and as detailed in Rule 610T(d).\759\ The
Commission anticipates that it will cost each exchange an additional
$12,000 per year, or approximately $156,000 in aggregate per year, to
ensure that the system and storage technology is up to date and remains
in compliance with the rule.\760\
---------------------------------------------------------------------------

\759\ 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] = $23,920 [ap] $23,900
per exchange, or $23,920 x 13 exchanges = $310,960 [ap] $311,000 in
aggregate. The burden hours are obtained from supra Section III.D.3.
\760\ 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] = $11,960 [ap] $12,000
per exchange, or $11,960 x 13 exchanges = $155,480 [ap] $156,000 in
aggregate. The burden hours are obtained from supra Section III.D.3.
---------------------------------------------------------------------------

The rule will require that exchanges produce monthly updates of the
order routing data, and transmit them to the Commission in pipe-
delimited ASCII format by the end of the month, as detailed in Section
II.E.3 and Rule 610T(d). The Commission estimates that the transmittal
and updates of the order routing datasets would cost $1,888 each month.
This will require each exchange to make a total of 36 updates to the
order routing data from the pre-Pilot Period through the post-Pilot
Period (if the core Pilot lasts for a full two years). Each exchange
would have recurring costs of updates to the order routing data of
approximately $68,000 per exchange, or $884,000 among the 13 exchanges
over the entire duration of the Pilot, and the pre-Pilot and post-Pilot
periods.\761\ If the Commission were to allow the 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.\762\ Under the automatic sunset, each exchange would have recurring
costs of updates to the order routing data of approximately $45,300 per
exchange, or $589,000 among the 13 exchanges over a one-year Pilot, and
the pre-Pilot and post-Pilot periods.\763\
---------------------------------------------------------------------------

\761\ This estimate is based on the following: [(Compliance
Manager (4 hours) x $298) + (Programmer Analyst (3 hours) x $232)] =
$1,888 per exchange, or $1,888 x 36 fee changes per exchange =
$67,968 [ap] $68,000. The burden hours are obtained from supra
Section III.D.3. 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 $67,968 x 13
U.S. equities exchanges = $883,584 [ap] $884,000.
\762\ 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.
\763\ This estimate is based on the following: [(Compliance
Manager (4 hours) x $298) + (Programmer Analyst (3 hours) x $232)]
[ap] $1,888 per exchange, or $1,888 x 24 fee changes per exchange =
$45,312 [ap] $45,300. The burden hours are obtained from supra
Section III.D.3. 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 $45,312 x 13
U.S. equities exchanges = $589,056 [ap] $589,000.
---------------------------------------------------------------------------

One commenter stated that the Commission underestimated the number
of burden hours required to produce the order routing data required by
the Pilot.\764\ This commenter indicated that the Commission allocated
160 burden hours to compile and produce the order routing data, while
the commenter estimates that it would take approximately 400 burden
hours.\765\ Over the entire Pilot duration, including the six-month pre
and post-Pilot periods, the Commission estimates that exchanges would
have initial systems burden hours of 80 hours, an additional annual
burden of 40 hours to update and maintain those systems, plus 84 burden
hours per year to produce and publicly post order routing data
monthly.\766\
---------------------------------------------------------------------------

\764\ See NYSE Letter I, at 15.
\765\ However, it is unclear exactly how the commenter
aggregated the data in the Proposing Release to arrive at 160 hours
because they did not provide details of their calculation.
\766\ See Proposing Release, supra note 2, at 13061. Discussion
of comments on these estimates is presented in Section III.D.3
supra.
---------------------------------------------------------------------------

In sum the Commission estimates the costs of producing the order
routing data to include a one-time cost of approximately $23,900 per
exchange to set up the data gathering process, $12,000 per year to
maintain the data gathering systems, and $1,888 per

[[Page 5271]]

month to publish the data. Specifically, the Commission estimates
initial one-time implementation costs of approximately $23,900 and
ongoing costs of approximately $103,800 per exchange if the Pilot lasts
two years or $69,200 if the Pilot lasts one year. These costs total
approximately $127,800 per exchange if the Pilot lasts two years--or
approximately $1,661,000 in aggregate. These costs decline to
approximately $93,200 per exchange--or $1,211,000 in aggregate--if the
Pilot sunsets after one year.
v. Fee-Related Costs to Exchanges
When exchanges alter their fees they are required to submit a Form
19b-4 filing with the Commission. Consequently, the Commission expects
most exchanges to file two 19b-4 Forms that they would not have
otherwise done. Additionally, the Commission expects that the pilot may
increase the complexity of these filings. This section provides
estimates for the costs associated with the submission of 19b-4 Forms
by the exchanges during the Pilot.
At the outset of the Pilot, each equities exchange if their fees do
not at that time comply with the Pilot's pricing restrictions, would
need to file with the Commission a comprehensive Form 19b-4 fee filing
reflecting all of the applicable fees and rebates applicable to each of
the Pilot Groups, as well as the Control Group--to reflect the
temporary changes to transaction-based fees and rebates as a result of
the Pilot. The Commission anticipates that exchanges will incur costs
associated with and devote time to optimally assign fees and rebates
across Test Groups, within the parameters allowed by the 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 $629,100 in aggregate.\767\ The
Commission further anticipates that exchanges would bear similar costs
upon the completion of the Pilot to prepare Form 19b-4 fee filings for
filing with the Commission to reflect changes in fees at the conclusion
of the Pilot, should they wish to change their fees or revert to their
former pricing models after the Pilot concludes.
---------------------------------------------------------------------------

\767\ 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)] = $48,395 [ap] $48,400, or $48,395 x
13 equities exchanges = $629,135 [ap] $629,100 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 Pilot, exchanges may also choose to make periodic
updates to their fee and rebate schedules, and file Form 19b-4 fee
filings to effectuate those changes and thereby 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 Pilot,
exchanges may revise their fee schedules more or less often during the
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
Pilot and has no basis to expect a decrease.
The Commission also recognizes that as an outcome of the Pilot, the
complexity of the Form 19b-4 fee filings could increase if exchanges
seek to impose different fees within Test Groups 1, Test Group 2, and
the Control Group, thereby increasing the overall costs for exchanges
to revise their fee and rebate schedules.\768\ As discussed above, the
Pilot may require exchanges to design new fee structures to comply with
the Pilot's Test Groups, which would then translate into additional
information in each Form 19b-4 fee filing submitted during the Pilot.
These costs are likely to increase because the exchanges could take
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.
Assuming the frequency remains constant, then the Pilot could increase
the incremental costs incurred by exchanges to file the expected Form
19b-4 fee filings during the Pilot.\769\ The additional costs would
only be relevant for Form 19b-4 fee filings that occur during the 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 Pilot, or approximately $1,929,000 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.\770\ If the Pilot were to automatically sunset at the end of
the first year, the Commission estimates that exchanges would bear
costs of approximately $964,000 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.
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\768\ The Commission believes that the inclusion of Linked
Pricing prohibitions for Test Group 2 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 many exchanges currently use Linked
Pricing mechanisms and instead most rely on rebates.
\769\ 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 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 estimates that there will be
91 19b-4 filings (7 filings x 13 exchanges). If the Commission
determines that the 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).
\770\ 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)] =$10,598 [ap] $10,600, or $10,598 x 182 fee changes
in aggregate across 13 exchanges over the two-year pilot duration =
$1,928,836 [ap] $1,929,000 in aggregate, assuming that the
Commission determines that the Pilot shall continue for up to an
additional year. If the Pilot were to automatically sunset after the
first year, the Commission believes that the costs associated with
91 19b-4 filings (13 exchanges x 7 filings) would be approximately
$964,000 ( ~$10,598 x 91 filings). See Request to OMB for Extension
of Rule 19b-4 and Form 19b-4 Filings, supra note 767.
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In sum, the Commission expects the pilot to impose on each exchange
a one-time cost of $48,400 at the beginning and end of the pilot for
the additional 19b-4 filings required by the pilot, as well as an
ongoing cost of approximately $10,600 per additional 19b-4 filing to
account for increased complexity in 19b-4 filings caused by the Pilot.
If we assume that exchanges continue to file 19b-4 filings at an
average rate of 7 per year and if the pilot lasts for 2 years, these
incremental costs sum to approximately $148,400 per exchange--which
declines to $74,200 if the pilot ends after the first year. Combining
the cost of the two additional 19b-4 filings with the cost of potential
increased complexity provides an estimated cost of the pilot associated
with 19b-4 filings of approximately $245,200 per exchange--or
$3,187,000 in aggregate--if the pilot lasts two years, or $171,000 per
exchange--or $2,223,000 in aggregate--if the pilot expires after the
first year.

[[Page 5272]]

vi. Other Costs to Exchanges
The Pilot may result in more complicated fee structures that could
also increase an exchange's processing costs of tracking and
calculating monthly invoices for its members during the 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 and no commenters provided
such information.
b. Other Costs Associated With the Pilot
This section considers additional costs that may occur as a result
of the Pilot. Specifically, this section discusses how the Pilot may
impact exchanges' fee revenue, broker-dealer compliance costs,
brokerage commissions, liquidity, and issuers.
i. Loss of Exchanges' Fee Revenue
The Commission analyzed whether exchanges could experience a change
to their fee revenues associated with transaction-based fees and
rebates for either of two reasons: A decline in the margin between fees
and rebates,\771\ or a decline in overall trading volume on an exchange
as a result of the Pilot.\772\ In the Proposing Release the Commission
stated its belief that only stocks in the test group with a cap of
$0.0005 (former Test Group 2) would experience narrower margins and
estimated that these narrower margins could result in exchanges
incurring revenue losses of up to $7,650,000 per month.\773\ With the
removal of the former Test Group 2 the Commission now believes that the
Pilot may not have a significant effect on Exchange revenue, at least
not because of narrower margins between fees and rebates.
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\771\ On a given trade, an exchange earns the margin between
fees and rebates. For example, if an exchange charges a take fee of
$.0030 per share and offers a make rebate of $.0025 per share then
the margin captured by the exchange is $.0005 per share traded.
\772\ A number of commenters expressed concern that the Pilot
would lead to decreased exchange revenue largely through decreased
trading volume. See, e.g., Cboe Letter I, at 7; NYSE Letter I, at 3
and 15-16.
\773\ See Proposing Release, supra note 2, at 13063.
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For stocks in Test Group 1 (the Test Group with a fee cap of
$0.0010) the Commission does not believe that the Pilot will result in
narrower margins earned by the exchanges because the fee cap in this
group is double the current typical average net capture (i.e., margin)
that exchanges earn which is approximately $0.0005.\774\ Consequently,
the exchanges can maintain current margins by reducing the rebate
offered at the same level as fees charged are reduced.\775\ For stocks
in Test Group 2, the Commission also does not believe that the Pilot is
likely to shrink margins. For these stocks the fee cap remains at
$0.0030, while exchanges are prohibited from paying rebates and
offering Linked Pricing. Consequently, the prohibition of rebates for
securities in this Test Group would conceivably allow the exchanges to
reduce fees to as low as $0.00025--if charged to both parties in a
transaction--without reducing the exchange's average net capture per
trade. While less likely given competitive dynamics, if the exchanges
wanted to increase their net capture, it is possible under the pilot
terms for total net capture in group one to be as high as $0.002 (if
both side were charged the maximum of $0.001), and in group two to be
$0.003, both of which are far in excess of the average net capture that
exchanges receive today. For these reasons, the Commission now expects
the effects of the Pilot on exchange revenue through impacting per-
trade margins to be minimal.
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\774\ See Proposing Release supra 1 at 13067.
\775\ This was the case in Canada when in January 2017 the
Canadian Securities Administrators (CSA) approved the lowering of
the fee cap for non-interlisted Canadian stocks from $0.0030 to
$0.0017. In response to this regulation, the Toronto Stock Exchange
retained its $0.0004 margin per trade for continuous trading--high
priced securities ($1.00 and over) by lowering both fees and rebates
by $0.0008. Fees for taking liquidity on non-interlisted securities
reduced from $0.0023 to $0.0015 whereas rebates provided to
liquidity providers declined from $0.0019 to $0.0011. Fees and
rebates for inter-listed securities remained unchanged. See https://www.tsx.com/resource/en/1501.
---------------------------------------------------------------------------

In addition, the Commission believes that the impact of the Pilot
on exchange revenues through changes in trading volume are difficult to
determine in advance, but recognizes that the magnitude of such changes
could be significant and some potential lost revenue could be in a
transfer to investors or among exchanges. The Commission considered
whether individual exchanges could experience a decline in trading
volume for four reasons, as multiple commenters suggested: If exchanges
lose volume to off-exchange venues, if volume declines because of
increased transaction costs, if the Pilot reduces excessive
intermediation, or if volume shifts among exchanges. The Commission
recognizes that the Pilot presents a risk that the Pilot could result
in less fee revenue for exchanges due to lower trading volumes.
However, the Commission believes that decreased trading volume, while
one possible outcome of the Pilot, is not the only reasonable outcome,
and that the ex ante effect of the Pilot on trading volume is difficult
to determine.
First, several commenters stated that reducing or eliminating the
ability for exchanges to pay rebates may cause exchanges to become less
competitive relative to off-exchange venues like ATSs, which would not
be so constrained. The analysis in Section IV.D.2.a identifies
significant uncertainty in the potential for exchanges to be less
competitive relative to off-exchange venues such as ATSs, and
identifies conditions in which they could actually be more
competitive.\776\ Consequently, the Commission cannot determine in
advance of the Pilot whether exchanges will lose volume to off-exchange
venues.
---------------------------------------------------------------------------

\776\ See Section IV.D.2.a. See also Section IV.C.2.b.iv
---------------------------------------------------------------------------

Second, total trading volume, and consequently exchange revenue,
could decline if the Pilot increases transaction costs. A number of
issuers expressed the concern via comment letters that the Pilot would
lead to lower levels of trading volume because of their experience with
the Tick Size Pilot.\777\ However, not all issuers felt that the Pilot
would result in lower trading volumes. One issuer ``welcome[d] the
opportunity for [its] stock to be included in the Pilot'' and did not
``expect that a reduction or outright removal of rebates will have any
significant or harmful effects on . . . [its] stock's trading volume.''
\778\ On the other hand, if the Pilot decreases the cost of trading on
the exchanges, then the Pilot could increase trading volumes on the
exchanges. This view was expressed by one commenter who stated their
belief ``the Pilot will reduce the costs of trading on exchanges, which
may increase trading volumes on the exchanges.'' \779\ Lower costs of
trading, caused by the reduction in fees, might increase trading volume
on exchanges for at least two reasons. First, lower trading costs may
induce trades that would otherwise not have occurred by allowing
investors the ability to trade on smaller increments of information.
Lower trading costs may also induce the participation of new traders,
such as short-term traders for whom transaction costs are of greatest
concern, to transact in a given stock

[[Page 5273]]

who would not otherwise participate. Consequently, if the Pilot leads
to decreased trading costs, then trading volumes in those stocks may
increase--increasing exchange revenue. In Section IV.C.2.b.iv below,
the Commission discusses its belief that the effect of the Pilot on
liquidity and transaction costs is not clear and could either increase
or decrease. Given this uncertainty in the impact on liquidity, the
Commission cannot determine in advance whether the Pilot will result in
a reduction in liquidity that would reduce trading volume.
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\777\ See, e.g., Leaf Letter, at 1-2; Ennis Letter, at 2.
\778\ T. Rowe Price Letter, at 4-5.
\779\ See, e.g., TD Ameritrade Letter, at 7. Other commenters
also either expressed their belief that the Pilot would not reduce
trading volumes (see, e.g., IEX Letter II, at 8; T. Rowe Price
Letter, at 5) or expressed uncertainty about the outcome of the
Pilot on trading volume (see, e.g. Credit Suisse Commentary, at 5).
---------------------------------------------------------------------------

Third, the Pilot may decrease trading volume, and thus exchange
revenues, if it results in a reduction in intermediation by market
makers for two reasons, but this would be a transfer to investors. The
first reason is that market makers from time to time will use
marketable orders to balance inventory. If these market makers decline
to participate due to reduced rebate incentives, then their marketable
orders will not arrive--diminishing trading volume. The second reason
decreased intermediation may lead to lower volumes is that non-market
makers might begin to execute their trades via non-marketable orders.
Non-market makers may submit marketable orders because of an inability
to achieve high fill rates with non-marketable limit orders due to
significant competition from market makers. The reduction in
intermediation may result in situations where two traders with
offsetting trades, who would have generated two separate trades with
market makers as the counterparty instead execute their trade with each
other resulting in one trade. This could occur, for example, if the
Pilot reduces queue lengths for investors as discussed in Section
IV.C.2.b.iv.(2) below. While this effect would result in a loss in
revenue to exchanges that would collect margin on a smaller number of
trades, it would be a net gain for investors because executions on a
smaller proportion of marketable orders would mean that the investors
pay less in transaction fees and would more often capture, or earn, the
spread where previously they would have paid the spread to transact.
Fourth, even if overall trading volume does not decline or shift to
off-exchange venues during the Pilot, individual exchanges may
experience a decline in trading volume if the Pilot leads to a change
in market share among the lit exchanges. This mechanism is discussed in
Section IV.D.2.a. This section also highlights the difficulties in
determining the expected redistribution of market share among the
existing exchanges due to potentially countervailing economic effects.
To this point, one commenter noted that the loss in revenue estimated
above relied on ``exchanges' existing market share percentages'' which
``assumes that exchanges would remain equally competitive for order
flow.'' \780\ The Commission agrees that the Pilot may impact the level
and distribution of trading volume on lit exchanges but notes that such
a redistribution would be a transfer among exchanges rather than an
economic cost.
---------------------------------------------------------------------------

\780\ NYSE Letter I, at 17.
---------------------------------------------------------------------------

The Commission acknowledges that the reduction or elimination of
rebates may particularly affect smaller exchanges due to the liquidity
externality, especially if their primary competitive differentiation is
based upon a modified fee model. As discussed in the Proposing Release
liquidity tends to consolidate.\781\ Thus, the restrictions on rebates
resulting from the Pilot could harm smaller exchanges that may be
competing 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. It could also have longer-term effects if
smaller exchanges consolidate or exit as a result of the Pilot.
However, the Commission does not believe that consolidation or exit is
likely during the pilot because only about a quarter of NMS stocks will
be included in test groups.
---------------------------------------------------------------------------

\781\ See Proposing Release, supra note 2, at 13042.
---------------------------------------------------------------------------

The Pilot could also impact exchanges' fee revenue after the
conclusion of the Pilot if as a result of the Pilot broker-dealers
permanently alter their order routing decisions after the Pilot is
completed. One commenter argued that this may be the case and suggested
that the Commission's claim that the Pilot's effect on broker-dealers'
routing decisions would be temporary ``[was] contradicted by the
Commission's own finding that broker-dealers would not change their
behavior unless the Transaction Fee Pilot lasts for at least one
year.'' \782\ To this point, given the competitive nature of financial
markets, the Commission does not expect that it would take most broker-
dealers up to one year to alter their behavior. Indeed, this commenter
supports this belief by stating that exchange and non-exchange trading
centers vigorously compete for trading volume, and that market
participants are sensitive to revisions in transaction-based pricing
models.\783\ Given this competition, the Commission believes market
participants will likely adjust their behavior quickly both upon the
implementation and conclusion of the Pilot, and that the Pilot duration
will incentivize broker-dealers not to ``wait out'' the Pilot who could
be otherwise inclined to do so if the duration were not sufficiently
long.\784\
---------------------------------------------------------------------------

\782\ See NYSE Letter I, at 15-16.
\783\ See State Street Letter, at 2.
\784\ See Section IV.C.1.a.iii, supra.
---------------------------------------------------------------------------

If the Pilot results in a decline in fee revenue for exchanges,
then this could lead to other costs borne by investors as a result.
Exchanges could promote additional order types and may even initiate
new types of markets as a result of the Pilot, which would only serve
to further fragment markets and add to their complexity, the costs of
which could be borne by investors.\785\ In particular, the Commission
recognizes the remote possibility that an exchange holding company
could attempt to optimize its overall performance during the Pilot by
further diversifying with other exchange models. The Commission
believes, however, that a new equity exchange registered in direct
response to the Pilot would be unlikely to become operational before
the conclusion of the Pilot. In addition, the Commission believes that
it is unlikely that exchanges will promote additional order types as a
result of the Pilot.
---------------------------------------------------------------------------

\785\ See Section III.A. See also, e.g., Fidelity Letter, at 8.
---------------------------------------------------------------------------

In sum, the Commission believes that the costs to the exchanges due
to narrower margins earned per trade are likely to be minimal--if any--
due to the removal of the proposed Test Group with the fee cap of
$0.0005. However, the Commission does expect that there could be a
change in trading volume or a redistribution of market share among
exchanges as market participants re-optimize their order routing
systems as a result of the Pilot. However, due to the reasons discussed
in this section, the Commission cannot determine in advance of the
Pilot whether these market share/trading volume changes will increase
or decrease exchange revenue. Consequently, the Commission acknowledges
that the Pilot may lead to lower trading volume/market share for
exchanges, which would impose a cost in terms of lost transaction fee
revenue, but is unable to quantify the expected magnitude of this
potential cost and no commenter provided an estimate of the amount of
the lost transaction fee revenue.
While the Commission cannot determine in advance of the Pilot its
impact both in terms of direction and magnitude, the Commission has
attempted to estimate the costs should volume decline. Using data from
Table 3 in section IV.B.2.e the Commission

[[Page 5274]]

estimates an annualized upper bound on the profit earned from
transaction fees for each exchange. Aggregated across all exchanges
this number equals approximately $3 billion per year. However, only
about 1/4th of NMS securities will be in a test group subject to the
Pilot, so the Commission estimates the Pilot could affect the
approximately $750 million per year across all exchanges, depending on
how much volume changes. Consequently, if the Pilot were to cause a 10%
reduction in trading volume on exchanges then this change could reduce
fee revenue on the exchanges by approximately $150 million over two
years or $75 million if the Commission were to allow the Pilot to
automatically sunset at the end of the first year. However, the
Commission does not believe that the 10% reduction in trading volume is
a reasonable assumption. While the Swan Study shows that Nasdaq lost
10% of its volume using one volume measure, it lost only 200,000 shares
in another. In addition, the Swan Study finds no change in overall
volume or in off-exchange volume, just a migration from Nasdaq to other
exchanges. Therefore, the Commission does not believe that either the
10% volume reduction or, consequently, the estimate of $150 million
revenue reduction is reasonable.
ii. Broker-Dealer Systems Costs
Although the costs of compliance with the Pilot will primarily
affect the exchanges, broker-dealers and other market participants are
also likely to incur costs as a result of the Pilot. Commenters
provided mixed information on the magnitude of these costs. While some
commenters stated that the costs to broker-dealers of the Pilot would
be substantial,\786\ other commenters stated that the costs for broker-
dealers associated with the Pilot would not be significant or expensive
because exchange fee schedules change regularly and broker-dealers are
used to adapting their order routing algorithms to new and changed fee
schedules.\787\ This section provides the Commission's estimates for
broker-dealer compliance costs associated with the Pilot.\788\
---------------------------------------------------------------------------

\786\ See, e.g., Larry Harris Letter, at 10-11; STANY Letter, at
2; FIA Letter, at 3; Nasdaq Letter I, at 10; Nasdaq Letter III, at
9.
\787\ See, e.g., Vanguard Letter, at 3; Healthy Markets Letter
I, at 34.
\788\ One commenter stated that the Commission did not consider
implementation and coding costs. See STANY Letter at 2. However, the
commenter does not elaborate on why the Proposing Release estimates
of $3,741,000 implementation costs for broker-dealers to adjust
their order routing systems at the beginning and end of the Pilot
and the $20,726,000 costs for broker-dealers to update their order
routing systems for fee changes during the Pilot failed to consider
implementation and coding. See Proposing Release, supra note 2, at
13063-13064.
---------------------------------------------------------------------------

In response to the Pilot, market participants might have a one-time
cost at the onset and the conclusion of the Pilot to adjust their
systems to reflect the shocks and potential additional complexity of
transaction-based fees. In addition, there may be additional
modifications to routing strategies that are made in subsequent months
to adjust to changing liquidity dynamics as behavior changes associated
with the pilot settle in. 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, lowest fees, or highest
rebates.\789\ One commenter agreed, stating that such systems changes
``should primarily consist of modifications to the routing tables and
other associated operational activities.'' \790\ The Commission
understands that some of the associated changes and modifications may
already be coded into the smart order router (SOR) algorithms such that
changes to associated liquidity shifts may be dynamic and automated,
i.e., in need of little additional modification.
---------------------------------------------------------------------------

\789\ See Bacidore, Jeff, Hernan Otero, and Alak Vasa, 2011,
Does smart routing matter ?, Journal of Trading 6, 32- 37.
(available at https://jot.iijournals.com/content/6/1/32), which found
that smart-order routers designed to maximize rebates delivered
worse execution quality to their clients.
\790\ See FIF Letter at 8. See also FIA Letter at 3; Nasdaq
Letter I at 10.
---------------------------------------------------------------------------

To estimate these costs, the Commission assumes (1) that all
broker-dealer members of exchanges will adjust their systems for the
pilot and (2) that all broker-dealer members of exchanges have
automated order routing systems.\791\ While the Pilot does not directly
require broker-dealers to adjust their systems, the Commission expects
broker-dealers who do not update their systems may incur significant
costs relative to those who do in terms of potential impacts on
execution quality and in their ability to manage fees and rebates.
Broker-dealers might choose to adjust their systems for the Pilot for
many reasons, including to recognize that the Pilot could affect
execution quality for investors and/or to better manage fees and
rebates.\792\ Therefore, the cost estimates assume that broker-dealers
will adjust to their existing systems to capture changes in fees and
rebates associated with each Test Group of securities, rather than
bearing start-up costs associated with implementing new order routing
systems.
---------------------------------------------------------------------------

\791\ Even in the absence of smart-order routers, broker-dealers
could still adjust their execution determinations to take advantage
of the changes implemented during the Pilot and these adjustments
would incur costs. While the Commission does not estimate these
particular costs, the assumption that all broker-dealers have
automated order routing systems is reasonable and is necessary to
enable the estimation of cost estimates. The Commission believes,
however, that the costs to adjusting manual systems could be lower
than the costs to adjust automated routing systems. If any broker-
dealers still route orders manually, they likely do so because
setting up and maintaining manual systems is not economical for
them. It is likely that such firms utilize exchange routing
services.
\792\ See sections IV.C.1.a.iii and IV.E.5.a for additional
discussion.
---------------------------------------------------------------------------

In its estimates, the Commission recognizes that the costs
associated with adjusting the execution algorithms by broker-dealers
for the Pilot are likely to be more costly than the periodic updates
that broker-dealers may make to incorporate changes to fee schedules
implemented by exchanges or to fine tune their strategies. The
additional expected costs may occur because changes for the Pilot are
likely to require more complex programming that segments stocks into
different fee regimes (assuming exchanges implement fees customized to
each Test Group), rather than just altering codes or inputs. As of July
2017, exchanges have 18 fee categories and 21 rebate categories, on
average.\793\ If exchanges maintain the same level of complexity in
their fee schedules during the Pilot, up to a two-fold increase in the
number of fee and rebate categories could occur, which would increase
complexity for broker-dealers who incorporate fees into their order
routing decisions.\794\ Additionally, the Commission agrees with the
commenter who stated that, to the extent that broker-dealers' order
routing algorithms are programmed to the exchange, and not the
individual security, the Pilot will increase complexity by requiring an
adjustment to this methodology.\795\ 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
Pilot would be approximately $9,000 per broker-dealer, or $3,573,000 in
aggregate across the 397 broker-dealers that are currently members of
equities exchanges.\796\ The

[[Page 5275]]

Commission further estimates that broker-dealers would bear a similar
cost to adjust their order routing systems at the conclusion of the
Pilot.
---------------------------------------------------------------------------

\793\ See Table 2 in Section IV.B.2.f supra.
\794\ In addition, the Commission recognizes the potential costs
to exchanges of this complexity above in Section IV.C.2.a.
\795\ See Larry Harris Letter, at 10-11.
\796\ 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] $9,000 per
broker-dealer that is a member of at least one exchange. As of
December 31, 2016, 397 unique broker-dealers were members of
exchanges (Form X-17a-5). The aggregate costs of updating order
routing systems to reflect the Transaction Fee Pilot requirements
would cost $9,000 x 397 [ap] $3,573,000. Note that smaller broker
dealers will often use the smart order router of larger broker
dealers or those offered by exchanges, and will therefore benefit
indirectly from the work done by the providers of their smart order
routing services.
---------------------------------------------------------------------------

Additionally, the Commission expects that broker-dealers would
update their order routing systems with changes to fees or rebates
submitted by exchanges through Form 19b-4 fee filings to the Commission
during the Pilot. 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 updating the
order routing systems to reflect these routine changes to fees and
rebates.\797\ As in the estimates of the costs of the initial and final
adjustments, broker-dealers are likely to face higher costs per update
as a result of the Pilot because of the added complexity of having to
update multiple modules within their order routing systems. The
Commission's estimates of these updates assume that exchanges update
their fees schedules as often during the pilot as at present.
Therefore, the costs to broker-dealers associated with the Pilot are
the additional costs associated with the complexity of the updates and
not the total cost of the updates.\798\ In other words, broker-dealers
would have updated their systems (or routing tables) anyway in the
absence of the Pilot to reflect the same number of exchange fee and
rebate changes. The Commission estimates described below reflect the
additional cost of the Pilot (``additional costs''), which is how much
more an update might cost during the Pilot compared to a scenario
without the Pilot.
---------------------------------------------------------------------------

\797\ Several commenters made similar statements. See, e.g.,
Vanguard Letter, at 3; Healthy Markets Letter I, at 34.
\798\ The Commission cannot estimate and commenters provided no
insight into the degree to which the number of fee and rebate
revisions by exchanges will increase or decrease during the Pilot.
---------------------------------------------------------------------------

The Commission believes that the per-update additional costs
associated with these changes are likely to be a small fraction of the
costs associated with the initial costs of adjusting the routing
systems to reflect the required fee and rebate revisions at the outset
of the 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 approximately $105,000 in
aggregate across the 397 broker-dealers that are members of U.S.
equities exchanges.\799\ As shown above, the Commission 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 two-year pilot duration. Therefore, the
aggregate costs of updating order routing systems would be $48,000 per
broker-dealer, or $19,056,000 in total across all broker-dealers.\800\
If the Pilot were to automatically sunset at the end of the first year,
the aggregate costs of updating order routing systems would be $24,000
per broker-dealer, or $9,528,000 in total across all broker-dealers.
---------------------------------------------------------------------------

\799\ 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 397 [ap] $105,000.
\800\ If 182 total fee and rebate changes were to occur over the
duration of the 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] $48,000, or $19,056,000
($48,000 x 397) in aggregate across all broker-dealers over the
first year of the Pilot. The Commission estimates that costs would
be $9,528,000 ($265 x 13 exchanges x 7 updates x 397 broker-dealers)
if the Commission determined that Pilot automatically sunset at the
end of the first year.
---------------------------------------------------------------------------

In sum the Commission believes that the all in costs to broker-
dealers of updating their order routing systems as a result of the
Pilot will average approximately $66,000 per broker-dealer to update
their systems over the entire Pilot Period. If the Pilot automatically
sunsets at the end of the first year, the costs associated with these
updates will be approximately $42,000 per broker-dealer.\801\ The
Commission notes that these estimates may be overstated. 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. Additionally, the exchanges could resort to more simplified
fee schedules relative to the current baseline, which would reduce
broker-dealers' costs of updating their systems for the Pilot.
---------------------------------------------------------------------------

\801\ These costs reflect the estimated cost of $9,000 at the
outset of the Pilot to update the order routing system to reflect
the changes to the fee structure for securities in the test groups,
$48,000 to reflect the incremental costs of the estimated 182
revisions to fee schedules during the Pilot ($265 per revisions x 7
revisions per year x 2 years x 13 exchanges), and $9,000 at the
conclusion of the Pilot to unwind changes to the order routing
systems, for a total of $66,000 per broker-dealer. If the Pilot were
to automatically sunset at the end of one year, then these costs
would be approximately $42,000 ($265 x 7 revisions x 13
exchanges+2*$9,000) per broker-dealer.
---------------------------------------------------------------------------

iii. Temporary Increase in Brokerage Commissions
Beyond the implementation and compliance costs for exchanges and
broker-dealers associated with the Pilot, the changes to the exchange
transaction-based fee and rebate structure could lead to temporary
increases in brokerage commissions charged to their customers. Several
studies show, and several commenters concurred, that brokerage
commissions today are at historically low levels.\802\ Brokerage
clients may have a preference for low commissions with 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.\803\ As a result, the Pilot
could lead to higher overall commissions as rebates obtained by broker-
dealers fall,\804\ thereby temporarily reducing the overall welfare of
retail brokerage clients as a result of increased commissions.\805\
---------------------------------------------------------------------------

\802\ See, e.g., Angel, Harris, & Spatt, supra note 530.
\803\ 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''). See also Shawn O'Donoghue, 2015, ``The Effect of
Maker-Taker Fees on Investor Order Choice and Execution Quality in
U.S. Stock Markets'', Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2607302.
\804\ Several commenters made similar statements. See, e.g.,
NYSE Letter I, at 13; ASA Letter, at 2.
\805\ The Commission acknowledges differing effects on brokerage
commissions could occur as a result of the 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. 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.
---------------------------------------------------------------------------

For instance, the elimination of rebates and Linked Pricing in Test
Group 2 could result in a transfer from broker-dealers to exchanges.
Assuming, as discussed above, the margin between fees and rebates is
approximately $0.0002 per share,\806\ with transaction fees of $0.0030
per share and rebates of $0.0028 per share, Test Group 2 could result
in a transfer of $0.0028 from broker-dealers to the exchanges with

[[Page 5276]]

respect to their passively posted non-marketable orders, particularly
because exchanges would be prohibited from offering Linked Pricing
mechanisms that could act as substitutes for cash rebates.\807\ The
estimates of the potential increased revenue to exchanges are as
follows.
---------------------------------------------------------------------------

\806\ There are approximately 8,000 NMS securities and just
under 800 will be included in Test Group 2.
\807\ Although the Commission believes that competition among
exchanges would drive transaction fees down for Test Group 2 as a
result of the elimination of rebates, exchanges could charge
transaction fees as high as the current cap of $0.0030.
---------------------------------------------------------------------------

Assuming that the share volume in Test Group 2 would be
approximately 12.5% of the total share volume across all
securities,\808\ using data from Table 2 in the baseline, Test Group 2
would have share volume of approximately 11.5 billion each month.\809\
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 2, the Commission anticipates no change in
revenue for exchanges, and no transfer from broker-dealers. If,
instead, exchanges charged the maximum fees of $0.0030 while they are
prohibited from paying rebates or Linked Pricing in Test Group 2, the
Commission estimates a monthly aggregate increase in revenues across
all exchanges of $32,200,000.\810\ If the volume on each exchange does
not change, then the estimated annual average increase in revenues
across all exchanges would be $386.4 million [$32,200,000 x 12 =
$386.4M]. This transfer of rebates from the broker-dealers to exchanges
could potentially increase exchange revenue by approximately
64.1%.\811\ 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 2.\812\
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\808\ As designed, the Pilot would allocate an equal number of
securities to the two test groups and the control group (e.g., the
test groups combined would have approximately 25% of the NMS
securities and the control group would have 75%). Each test group
will have one-half of the combined test group allocation, thereby,
in total leaving each test group with 12.5% of NMS 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 approximately 12.5% of total share
volume each month.
\809\ Table 2 in the baseline shows aggregate exchange share
volume for July 2017 was 91.7 billion shares, of which 12.5% would
be 11.5 billion shares. Further, the Commission estimates that these
volume figures would be similar across all months, assuming no
seasonality in share volume.
\810\ If Test Group 2 has monthly share volume of 11.5 billion
shares, and the margin would increase by $0.0028 ($0.0030--$0.0002),
the revenue increase per month is estimated to be 11.5 billion x
$0.0028 [ap] $32,200,000.
\811\ As discussed in section IV.B.2.d, the net of rebate
revenue for NYSE (NYSE, NYSE Arca, NYSE American, and NYSE
National), Nasdaq (Nasdaq, BX, and PSX), and Cboe (Cboe BZX, Cboe
BYX, Cboe EDGA, and Cboe EGDX), was $602 million during 2017 ($196M
+ $253M + $153M). If the estimated margin increased by $386.4
million, then the percentage increase in this margin would be $386.4
million/$602 million [ap] 64.1%.
\812\ Consistent with this idea one commenter suggested that,
any benefits or costs accruing to broker-dealers as a result of
changes in fees and rebates are likely to be passed onto their
customers. See Decimus Letter, at 2.
---------------------------------------------------------------------------

The Commission further acknowledges that if brokerage commissions
were to increase as a result of the Pilot, broker-dealers could
continue to charge higher commissions even after the conclusion of the
Pilot. However, due to competition among broker-dealers, including the
proliferation of low-cost online broker-dealers, the Commission
believes that broker-dealers would be unlikely to significantly
increase brokerage commissions as a result of the Pilot.\813\
---------------------------------------------------------------------------

\813\ See supra Section IV.B.2. and IV.D.2. (discussing the
competitive environment for broker-dealer services). But cf. Decimus
Letter, at 2-4; NYSE Letter I, at 13; ASA Letter, at 2 (noting the
possibility that commissions would increase).
---------------------------------------------------------------------------

Lastly, the Commission acknowledges that brokerage commissions may
decrease during the Pilot if the Pilot results in lower execution costs
for some test groups, then those lower costs may be passed on to
investors in the form of lower commissions. For example, if a broker-
dealer pays the transaction fee more often than they earn the rebate,
the reduction of fee caps would reduce the cost of transacting for this
broker-dealer, which the broker-dealer may pass onto investors in the
form of lower commissions.\814\
---------------------------------------------------------------------------

\814\ See Decimus Letter, at 2-4.
---------------------------------------------------------------------------

iv. Temporary Reduction in Liquidity
The effect of the Pilot on liquidity is uncertain as there are
reasons why the Pilot may increase as well as decrease liquidity.
Several commenters expressed concern that the Pilot would reduce
liquidity. These commenter statements largely focus on the impact of
the reduction or elimination of rebates. In considering the comments,
and as analyzed in the following sections, the Commission considered
the impact of the direct effect of rebates on quoted spreads, the
impact of a loss of liquidity provision on quoted spreads and depth,
the impact of changes in adverse selection on transaction costs, and
the impact of potential conflicts of interest on execution quality. In
addition, the Commission analyzed estimates of the costs of a potential
reduction in liquidity provided by commenters.
The Pilot could result in a positive, negative, or neutral change
in liquidity for the stocks in test groups. Adding to this uncertainty,
some commenters felt that to the extent that there are liquidity
effects, such effects would be minimal.\815\ Also, the impacts of the
Pilot on liquidity may not be uniform across all securities and several
commenters believed that widening of spreads would be limited to a
small number of securities. Some commenters stated that the widening of
spreads is unlikely to affect the most and least liquid securities, or
will not adversely affect liquidity at all.\816\ Further, as some
commenters explained, less liquid stocks tend to have wider spreads,
and therefore, the impact of rebates as an incentive to provide
liquidity may become less relevant for these securities.\817\
---------------------------------------------------------------------------

\815\ See, e.g., Angel Letter II, at 3.
\816\ See, e.g., Citigroup Letter, at 3; Credit Suisse Letter,
at 1; Decimus Letter, at 4; MFS Letter, at 1.
\817\ See, e.g., IEX Letter II, at 5; Credit Suisse Commentary,
at 3.
---------------------------------------------------------------------------

(1) Direct Impact of Fees and Rebates on Quoted Spreads
The Commission believes the impact of the Pilot on liquidity and
transaction costs through a direct adjustment of the quoted prices is
uncertain. One study argues that transaction-based rebates may
artificially narrow the quoted spread on make-take exchanges by the
amount of the rebate.\818\ This effect would particularly impact retail
investors whose orders are largely internalized at the best quoted
prices. However, whether rebates can effectively narrow quoted spreads
in a given stock depends on whether that stock's natural quoted spread
(without artificial narrowing) is constrained by the tick size. For
example, if a stock has a natural quoted spread of less than one penny,
which is the minimum tick size, then rebates cannot possibly
artificially narrow the quoted spread. Many of the most active stocks
have average quoted spreads very close to a penny and the Commission
believes that the natural spread in some of these stocks could be at or
less than a penny. Consequently, the Commission believes that rebates
might not artificially narrow spreads in at least some of the most
active stocks and, therefore, that the Pilot might not result in wider
quoted spreads in all stocks.\819\
---------------------------------------------------------------------------

\818\ See Angel, Harris, & Spatt, supra note 530.
\819\ See also TD Ameritrade Letter, at 3 (concurring with the
view that the Pilot is less likely to affect highly liquid
securities).
---------------------------------------------------------------------------

(2) Potential Reduction in Liquidity Provision
The Commission recognizes that the Pilot could reduce the
incentives to

[[Page 5277]]

provide liquidity, but believes that the impact of this reduced
incentive on quoted spreads and transaction costs could be positive or
negative and could vary across securities. In particular, the
Commission believes that despite a potential reduction in liquidity
provision, some investors could actually experience lower or higher
transaction costs in some securities for several reasons. Generally,
this section provides reasons to expect an increase in transaction
costs as well as reasons to expect a decrease in transaction costs.
Likely, several of these effects will offset to create a new
equilibrium, but the Commission cannot predict whether investors will
face higher or lower transaction costs in this new equilibrium.
First, some commenters stated that the removal of rebates could
cause some liquidity providers to stop providing liquidity, which would
result in a temporary increase in transaction costs during the Pilot as
the remaining liquidity providers would face less competition for their
services and therefore could charge wider spreads to liquidity
demanders.\820\ One Commenter suggested that this effect could be seen
by comparing spreads on non-rebate exchanges like Cboe EDGA with the
rebate paying exchange Cboe EDGX. The Commenter noted that average
spreads on Cboe EDGX tend to be lower than those on Cboe EDGA.\821\
However, the Commission does not believe that this data point provides
robust evidence that spreads will widen across all securities because
EDGA and EDGX tend to trade securities with different characteristics,
consistent with another commenter who stated that ``EDGA only traffics
in the most liquid names'' consequently comparing average spreads on
EDGA and EDGX is not appropriate. Additionally this analysis does not
establish a causal link between rebates and quote quality.\822\
---------------------------------------------------------------------------

\820\ See also Pragma Letter, at 2; Magma Letter, at 2; STA
Letter, at 3; STANY Letter, at 2; Morgan Stanley Letter, at 3-4;
Energizer Letter, at 1.
\821\ See NYSE Letter II, at 2, 9. See also, Nasdaq Letter III,
at 4-6 (presenting similar data suggesting that quote quality on
make-take exchanges is better than on inverted exchanges).
\822\ See section IV.C.1.a.ii.(3) for a discussion on causality,
See also Mulson Letter II, at 1.
---------------------------------------------------------------------------

The Commission notes that a reduction in liquidity provision might
not result in wider quoted spreads and greater transaction costs,
particularly in more active securities. In particular, as suggested by
some commenters, if rebates result in excessive intermediation,\823\ or
if ``natural'' buyers and sellers set quoted prices,\824\ a reduction
in rebates need not widen quoted spreads and increase transaction costs
and could actually reduce transaction costs to the benefit of
investors. Excessive intermediation makes it more difficult for non-
market makers to get passive orders to the front of the queue and could
induce them to cross the spread to trade aggressively a greater
fraction of the time. If a reduction in rebates can result in less
excessive intermediation, then a reduction in liquidity provision by
market makers might not adversely impact transaction costs but could
instead decrease queue lengths faced by non-market maker liquidity
providers such as institutional investors. This could allow investors
trading test group stocks to potentially experience better execution
quality because they could be able to obtain better queue priority on
their passive orders. Better queue priority would both diminish adverse
selection costs for passive orders and also decrease the fraction of
time investors are required to pay the spread and potential take fee to
execute a trade.\825\ The Commission does not have the data necessary
to empirically analyze whether rebates indeed result in excessive
intermediation, but expects the Pilot to facilitate such analysis.
---------------------------------------------------------------------------

\823\ See NYSE Letter II, at 4 (noting that ``some institutions
believe maker-taker pricing unnecessarily subsidizes quoting in
sufficiently liquid securities, resulting in `excessive
intermediation' that crowds out long-term investor participation in
the market.''). See also T. Rowe Price Letter, at 2.
\824\ See, e.g., Mulson Letter.
\825\ See Pragma Letter, at 2; IEX Letter I, at 6; IEX Letter
III, at 4-6. But cf. NYSE Letter II, at 11.
---------------------------------------------------------------------------

The Commission recognizes the risk, noted by some commenters, that
the Pilot could increase the cost of transacting if the reduction of
rebates leads to a reduction in quoted depth.\826\ If the reduction in
rebates in test group securities results in liquidity providers such as
market makers posting less displayed liquidity, quoted depth could
decline even if quoted spreads does not decline. This lower depth could
result in increased costs of transacting larger quantities. These
effects could be more pronounced in small stocks if, as some commenters
suggest, rebates are important to induce market makers to provide
liquidity in small stocks either directly or through cross
subsidization of liquidity.\827\
---------------------------------------------------------------------------

\826\ See Pragma Letter, at 2; Nasdaq Letter I, at 6.
\827\ See Nasdaq Letter I, at 8-9; Nasdaq Letter III, at 9.
However another commenter suggested that the impact of the Pilot on
small stocks would be mitigated by the fact that small stocks tend
to have wider spreads, and thus rebates form a smaller fraction of
total market making incentives. See Decimus Letter, at 4-5
---------------------------------------------------------------------------

The Commission also recognizes the potential for a reduction in
liquidity and an increase in transaction costs for ETPs and
particularly less active ETPs. Multiple commenters expressed concern
that the Pilot might particularly reduce liquidity in ETPs.\828\ These
commenters noted that, unlike in stocks, the Pilot might affect
liquidity for ETPs in one of two ways: It may affect liquidity in
shares of the ETP, or it may affect liquidity in the underlying assets
of the ETP. The Pilot may reduce liquidity in the shares of the ETP if
the reduction of or elimination of rebates induces market makers to
stop or reduce providing liquidity for shares of an ETP. Moreover,
another commenter expressed concern that the Pilot is inconsistent with
exchanges programs for ETP market makers, whereby incentives are made
available to market makers to act as liquidity providers for small,
less liquid ETPs and therefore the negative impact of the Pilot could
be the most pronounced among illiquid ETPs.\829\ Additionally, the
Pilot may affect the liquidity of ETPs if it impacts the liquidity of
the underlying securities. If the Pilot affects liquidity in shares of
an ETP or impacts the liquidity of the ETP's underlying securities, it
will also affect the costs to authorized participants of eliminating
ETP mispricing by participating in the create-redeem process.\830\
---------------------------------------------------------------------------

\828\ See, e.g., ICI Letter I, at 4; BlackRock Letter, at 1-2;
FIA Letter, at 4; SIFMA Letter, at 4; Issuer Network Letter I, at 3;
Schwab Letter, at 3; Fidelity Letter, at 9; Invesco Letter, at 2;
State Street Letter, at 3; Clearpool Letter, at 8; STA Letter, at 4;
STANY Letter, at 4; Healthy Markets Letter II, at 8; Healthy Markets
Letter I, at 11; Nasdaq Letter I, at 8; NYSE Letter I, at 7; Cboe
Letter I, at 17; Credit Suisse Commentary, at 6; Morgan Stanley
Letter, at 3-4.
\829\ See Virtu Letter, at 7.
\830\ See infra Section IV.D.1.
---------------------------------------------------------------------------

Additionally, the Commission recognizes that the Pilot might result
in other unforeseen changes to market dynamics,\831\ including improved
or diminished execution quality by certain trading centers which could
shift the level of market participation. Also, the Pilot may affect the
ability of exchanges and ATSs to draw liquidity provision through
innovative methods other than rebates. The effects of these changes may
have a positive, neutral, or negative effect on liquidity.
Consequently, the Commission believes that there is significant
uncertainty surrounding the effects of the Pilot on liquidity.
---------------------------------------------------------------------------

\831\ See IEX Letter II, at 7.
---------------------------------------------------------------------------

(3) Conflicts of Interest
As noted above, the Commission is not certain of the extent to
which some broker-dealers route investor orders to avoid fees or to
capture rebates in such

[[Page 5278]]

a way that reduces execution quality. To the extent they do, the Pilot
could improve execution quality. This would occur if, as many
commenters and studies have argued, the offering of rebates produces a
conflict of interest that induces orders to be routed to exchanges with
sub-optimal execution quality.\832\ Consequently, the removal or
reduction of rebates may cause orders to be routed to exchanges with
better execution quality and the execution quality in the stocks in the
Test Groups could improve. As noted above, commenters disagreed on
whether broker-dealers act on such conflicts of interest and the
Commission lacks sufficient information to determine the magnitude of
any such conflicts. The Commission notes that the objective of the
Pilot is, in part, to study such conflicts of interest.
---------------------------------------------------------------------------

\832\ See Section III.A.
---------------------------------------------------------------------------

(4) Cost Estimates
Multiple commenters provided quantitative cost estimates associated
with expected changes in liquidity. The commenters' estimates all rely
on the assumption that a reduction in rebates will increase quoted
spreads and transaction costs but took different approaches, resulting
in a wide range of estimates from $24 million to $4 billion per year.
Overall, while the Commission appreciates the cost estimates, the
Commission reiterates that the Pilot could either increase or decrease
investor transaction costs for the reasons explained above. However,
for the reasons discussed below, the Commission believes that each of
the commenters overestimated the potential costs to investors. Below,
the Commission first describes each estimate, adjusts the estimate for
the change in the structure of the Pilot and then discusses how the
assumptions might affect the estimation.
The first commenter estimated costs of $24 million per year. Across
all three proposed test groups, this commenter calculated an
anticipated reduction in the average rebate of $0.002267 per share, and
that approximately 50% of all liquidity providers will be affected by
the rebate reduction by ``updating their quotes to less aggressive
prices,'' leading to an increased cost to cross the spread of $0.001134
per share.\833\ Assuming only stocks with an average quoted spread in
excess of $0.02 will be adversely affected by the rebate reduction,
this commenter estimated that the costs to its customers of a wider
quoted spread would be $24 million annually.\834\
---------------------------------------------------------------------------

\833\ See TD Ameritrade Letter, at 3.
\834\ See id.
---------------------------------------------------------------------------

To account for the changes to the Pilot since the proposal,
Commission staff estimate that this commenter's approach would estimate
a cost of $12.7 million per year. To arrive at this estimate, the
Commission adjusted the average rebate reduction to 0.0024 to account
for the change to the test groups and adjusted the average implied
volume to account for the inclusion of less than half the number of
stocks in test groups.
Despite these adjustments, the Commission notes that the estimate
is likely imprecise. In particular, this estimate relies on an
assumption that the spreads will widen by 50% of the reduction in
rebates but does not provide support for this assumption. The commenter
does not explain why they expect this relation between rebates and
liquidity or provide an explanation for why they feel that 50% is the
appropriate adjustment to use. Further, this adjustment does not allow
for some liquidity demanders to supply liquidity more often if queue
lengths decline with rebates. Such a switch would reduce the impact on
transaction costs. The commenter also does not explain whether the
share volume used to estimate the costs was all share volume in
securities with average quoted spreads of less than two cents or just
that portion likely to be in a test group. If the commenter included
all volume, the estimates would be closer to $6.34 million.
A second commenter estimated that if effective spreads widened by
10% for the 100 top securities, ``the Pilot could conservatively cost
investors over $400 million more in annual execution costs.'' \835\ The
commenter does not provide an analysis, either quantitative or
qualitative, to support their belief that a 10% increase is appropriate
to use or explain their methodology. The commenter provided little
information about its assumptions or underlying data that would allow
the Commission to examine the robustness of the estimate or to adjust
the estimate for the changes in the Pilot since the proposal. As such
the best way for the Commission to adjust the estimate for the changes
in the Pilot is to divide it by two, $200 million, because the changes
reduced the number of securities in the Pilot by slightly more than
half. However, because of uncertainties about methodology and
assumptions, the Commission cannot adjust with any certainty the $400
million estimate and does not believe that a $200 million estimate is
reliable. The Commission recognizes that the changes to the Pilot could
also change the commenter's estimate of how much spreads widen.
---------------------------------------------------------------------------

\835\ Cboe Letter I, at 3.
---------------------------------------------------------------------------

A third commenter provided an analysis that suggested that, due to
wider spreads, the increased costs to investors would be at least $1
billion per year and potentially $4 billion.\836\ Like the first
commenter, this $1 billion estimate assumes an adjustment to
transaction costs based on the reduction in the rebate, except that
this commenter doubled the rebate to adjust transaction costs. To
compute their estimate, the commenter estimates the weighted reduction
in rebates across all stocks, taking into account the fact that most
stocks will see no change in rebates. The commenter then uses the
expected weighted average reduction in rebates to compute their
estimate for the Pilot's impact on average spreads across all stocks.
The commenter then multiplies the expected impact on spreads by total
trading volume to arrive at a total of approximately $1 billion in
estimated costs per year.\837\ Using the commenter's method, the
adopted rule would have an average rebate reduction of approximately
$0.0004, which would widen spreads by $0.0009, or approximately half
the prior increase, for a new cost estimate of $600 million per year.
---------------------------------------------------------------------------

\836\ See NYSE Letter I, at 13 and NYSE Letter IV, at 4. The
commenter estimated the $1 billion increase in expected costs by
computing a new consolidated spread, equal to the current
consolidated spread + (rebated reduction x 2), where the rebate
reduction is the blended average fee change of $0.00082, and
multiplied this rebate reduction by 2 as market makers on both sides
of the quote will adjust to reflect the rebate reduction. The
commenter indicated that this estimation results in a 1.1% increase
in average spreads to 28.1 bps. Id. at Addendum 4-5. For principal
trades, the anticipated increase in costs as calculated by this
commenter is the cost to cross the wider spread netted against lower
access fees, while for agency trades, the costs equal the cost to
cross the new wider spread. The commenter showed, ``on net, an
estimated cost of $1.08bn to the industry, of which $721MM would be
incurred by agency flow.'' Id. at Addendum 5. See also STANY Letter,
at 2.
\837\ The Commenter adjusts their estimate to account for agency
verses principle flow using the following formulas. Agency cost =
Change in Spread*1/2 * Market Notional Value * Agency Share;
Principal Cost = [Change in Spread*1/2 * Market Notional Value *
Principal Share]--[Fee Reduction * Market Volume * Principal Share *
Maker/Taker Venue Share].
---------------------------------------------------------------------------

Other commenters responded to this commenter's $1 billion estimate
in various ways. One commenter criticized the use of quoted spreads to
estimate costs.\838\ Likewise, several commenters

[[Page 5279]]

suggested that the commenter's estimates of potential harm are
overstated by as much as 90%.\839\
---------------------------------------------------------------------------

\838\ See IEX Letter II, at 6. ``Given that institutional
investor orders are typically far larger than [the quoted spread],
and retail investor orders are generally executed off-exchange,''
the quoted spread is ``particularly relevant'' in ``cases where a
market participant is attempting to buy or sell, on an exchange,
fewer shares than the total amount displayed at the [NBBO][.]'' Id.
NYSE responded to this comment by noting that nearly all trading on
exchange is for amounts smaller than the quoted depth, so the quoted
spread is relevant. See NYSE Letter II, at 10.
\839\ See, e.g., IEX Letter II, at 4; Healthy Markets Letter II,
at 2 (arguing that the NYSE cost estimate to investors of $1 billion
has been ``sufficiently debunked as purely fictional''); Decimus
Letter, at 4 (arguing that the NYSE approach ignores potential
indirect benefits to market participants of lower access fees (and
possibly lower brokerage commissions), and that the Pilot would
provide the information necessary to obtain meaningful analysis of
changes to fees and rebates on order routing decisions and execution
quality).
---------------------------------------------------------------------------

The Commission views the commenter's $1 billion estimate as likely
overstating the realistic costs associated with the Pilot should it
result in increased spreads. One reason the estimate may be overstated
is that, as some commenters have noted, and as discussed in section
IV.C.2.b.iv.(1), the Pilot might have a diminished impact on penny
constrained securities. In a supplemental analysis using TAQ data from
the last quarter of 2017 and the first two quarters of 2018, the
Commission estimates that between 50-70% of share trading volume occurs
in stocks that are penny constrained.\840\ Consequently, to the extent
that rebates play a diminished or no role in determining the spread of
penny constrained stocks the commenter's estimates will significantly
overstate the impact of increased spreads on transaction costs. Also,
the commenter's estimate assumes that spreads will widen by twice the
reduction in rebates, an assumption that some commenters question and
that the Commission views as a likely upper limit to the impact of the
Pilot on quoted spreads.\841\ This assumption does not take into
account that non-market makers may begin to provide liquidity more
often during the Pilot in securities with lower or no rebates due to a
potential decrease in intermediation by market makers, which may
mitigate the impact of less intermediation by market makers as a result
of lower rebates.\842\ Consequently, the Commission acknowledges that
to the extent that the Pilot impacts spreads in a certain small number
of test group stocks, this could engender costs to investors. However,
as described above, the Commission believes that the estimate of $1
billion per year is likely a significant overstatement of the actual
costs that would be incurred in such a scenario.\843\
---------------------------------------------------------------------------

\840\ To determine if a stock is penny constrained, the
Commission applied the simple filter: If the stock's trade weighted
quoted spread was less than 1.1 cents, then the stock was considered
penny constrained. This threshold yielded approximately 50% of
trading volume occurring in stocks that are penny constrained. If
the threshold is lifted to 2 cents (implying that at least some of
the time the stock was penny constrained), then the fraction of
trading volume in penny constrained stocks rises to 70%. Note that
the sample period for the supplemental analysis is during the Tick
Size Pilot. As such, these figures could underestimate the
percentage of volume in penny constrained securities.
\841\ See Section IV.2.b.iv.(1).
\842\ One assumption made by NYSE is that ``a reduction in the
average passive rebate. . .will result in both the bid and offer
being backed off, on average, by the exact same amount as the rebate
reduction.'' However, as another commenter argued this ``assumes
that only rebate driven liquidity providers set the quote'' when
``in reality the quote is almost always set by natural investors,
who have a view of fair price, that is informed by both fundamental
and quantitative research as well as the likely impact of their own
short term trading intentions. See Mulson Letter, at 1. As discussed
earlier in this section, the many potential effects of rebates on
quoted spreads create significant uncertainty. See also Decimus
Letter, at 4; Mulson Letter, at 1; IEX Letter II, at 4. NYSE
responded to these comments by noting that even if their volume
estimates are overstated by 20%, the cost is still significant and
suggesting that investors would not provide liquidity because doing
so would increase leakage costs. See NYSE Letter II, at 10-11.
\843\ See Mulson Letter I, at 1 and IEX Letter II, at 4.
---------------------------------------------------------------------------

The commenter's $4 billion estimate is based on the comparison
between the spreads on a maker-taker exchange compared to the spreads
on a taker-maker exchange described above in Section IV.C.2.b.iv(2),
which the Commission views as even more imprecise than the $1 billion
estimate for the reasons laid out above. Beyond the concerns expressed
in Section IV.C.2.b.iv(2), the Commission notes that the difference
between the spreads of a maker-taker exchange and a taker-maker
exchange would result from the difference between the fee paid to post
an order and the rebate to post. As such, the implied impact of no
rebates would be no more than \1/2\ the spread difference. Thus, thus
using the full spread difference overstates costs by a factor of 2.
Further, to get the $4 billion estimate, the commenter applied the
spread differential to all NMS securities. Because Test Group 2 will be
only about 12.5% of securities, applying the spread differential to all
NMS securities overstates the cost by a factor of 8. In sum, using the
commenter's approach, but correcting for these issues, would yield a
cost 16 times smaller than the commenter's, or $125 million.
v. Impact on Issuers
Several commenters expressed concerns that adverse effects to
liquidity could induce long-term costs, such as higher costs of capital
for issuers subject to certain Test Groups where the incentives to
provide liquidity are reduced, likely affecting small and mid-
capitalization issuers most severely.\844\ One commenter believed that
issuers would have higher costs of capital as a result of wider
spreads, making any attempts to raise capital more expensive,
particularly for issuers in certain Test Groups of the Pilot.\845\
Additionally, a number of commenters also expressed concern that wider
spreads due to a reduction in rebates could also adversely affect
issuers that engage in share repurchase programs.\846\
---------------------------------------------------------------------------

\844\ See NYSE Letter I, at 3, 13-14; ASA Letter, at 3; e.g.,
Level Brands Letter, at 1; Johnson Letter, at 1; P&G Letter, at 1;
Sensient Letter, at 1; Apache Letter, at 2; Ethan Allen Letter, at
1-2.
\845\ See NYSE Letter I, at 3 and section IV.D.3 for further
discussion of NYSE's cost of capital estimates.
\846\ See, e.g., Apache Letter, at 2; ACCO Letter, at 1;
NorthWestern Letter, at 2; Weingarten Letter, at 1.
---------------------------------------------------------------------------

The Commission addresses these comments in the capital formation
analysis in Section IV.D.3 and concludes that the Pilot is not expected
to have a large impact on issuer cost of capital. While the Commission
acknowledges the risk that the Pilot may impact liquidity for some
securities, as explained above, the Commission believes that the impact
of such an effect on the cost of capital for such securities would
likely be minimal.\847\
---------------------------------------------------------------------------

\847\ See section IV.D.3
---------------------------------------------------------------------------

With the exception of the impact on cost of capital, one commenter
stated that the Pilot will require burdensome expenditures by public
companies at the start and conclusion of the Pilot.\848\ The Commission
recognizes that some national securities exchanges and broker-dealers
are public companies that could incur the costs described in Sections
IV.C.2.a and IV.C.2.b.ii at the start and conclusion of the Pilot.
However, the commenter did not provide details on what expenditures
other public companies will incur as a result of the Pilot. The
Commission does not know what such expenditures would be or what they
would entail; nevertheless, we do not believe that there will be any
such expenditures.
---------------------------------------------------------------------------

\848\ See Nasdaq Letter I at 10.
---------------------------------------------------------------------------

vi. Costs to Broker-Dealers of Reverse Engineering Identities in the
Order Routing Data
Some commenters expressed concern that proposed public
dissemination of order routing information would enable competitors to
gain proprietary information regarding trading strategies.\849\ The
commenters suggested

[[Page 5280]]

that, for example, market participants could learn the identities of
individual broker-dealers by sending a specific broker-dealer an order
for a relatively thinly-traded security and then study the order
routing reports to identify which broker-dealers transacted that
security on a given day. The concern is that if market participants can
identify the primary venues that certain broker-dealers tend to rout
to, then they may be able to use this information along with live
market data to identify specific trading algorithms of individual
broker-dealers. This could increase transaction costs for broker-
dealers if the market participants are able to use this data to
identify when a certain algorithm is being used to execute a trade in
live time and then to opportunistically trade around the algorithm to
profit from any price impact created by the trades.
---------------------------------------------------------------------------

\849\ See, e.g., FIA Letter, at 3; Virtu Letter, at 7-8; SIFMA
Letter, at 6; FIF Letter, at 2; Citadel Letter, at 4; Citi Letter,
at 6; TD Ameritrade Letter, at 5; STANY Letter, at 5; IEX Letter I,
at 10; Credit Suisse Commentary, at 6; Morgan Stanley Letter, at 4.
---------------------------------------------------------------------------

As described above, the Commission has modified its proposal in
response to these comments. Consequently, the Commission is not
adopting the requirement that exchanges publicly post the order routing
datasets and instead the Commission will receive the order routing
data. This change significantly reduces the risks identified by the
commenters about reverse engineering, and the Commission is sensitive
to the need to protect the data from unauthorized disclosure.

D. Impact on Efficiency, Competition, and Capital Formation

The Commission has considered the effects of the Pilot on
efficiency, competition, and capital formation.\850\ As discussed in
further detail below, the Commission believes that many of the direct
effects of this rule on efficiency, competition, and capital formation
would likely be temporary in nature and affect markets only for the
duration of the Pilot. The Commission believes that the information
obtained as a result of the 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 Pilot. Further, the Pilot may have a number of temporary
effects on price efficiency, the competitive dynamics between
exchanges, exchanges and off-exchange trading venues, broker-dealers,
and issuers, including ETPs. Although the Pilot may temporarily affect
liquidity,\851\ the Commission does not believe that this will result
in the Pilot having a significant effect on capital formation. One
commenter believed that the Commission did not sufficiently address the
impacts of the Pilot on efficiency, competition, and capital formation
in the proposing release.\852\ Several other commenters stated that the
Commission inadequately provided justification for the assertions in
the proposing release that the effects on efficiency, competition, and
capital formation would be temporary in nature and ``would affect
markets only for the duration of the [proposed] Pilot.'' \853\ The
Commission addresses below commenters' concerns about issues stemming
from efficiency, competition, and capital formation.
---------------------------------------------------------------------------

\850\ 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. See 15
U.S.C. 78c(f).
\851\ See supra Section IV.C.2.b.iv.
\852\ See Nasdaq Letter I, at 3, 8. This commenter expressed
concern that the Proposal did not considered the effects on issuers
and ETPs. See id., at 8. This commenter also stated that ``the
Proposal is a blunt tool lacking nuance that will negatively affect
efficiency, competition, and capital formation--none of which have
been adequately addressed by the Commission.'' See id.
\853\ See NYSE Letter I, at 15-16. See also, e.g., Level Brands
Letter, at 1; Johnson Letter, at 1; Knight-Swift Letter, at 1.
---------------------------------------------------------------------------

1. Efficiency
This section discusses the potential impact the Pilot could have on
efficiency. The Commission believes that information learned from the
Pilot could potentially improve future regulatory efficiency.
Additionally, the Commission believes that the Pilot could have a
number of temporary impacts on efficiency, including: The efficiency of
capital allocation, price efficiency and price discovery, and the
efficiency of fees and rebates.
As discussed in detail above,\854\ the Commission believes that
there is significant uncertainty regarding the effect, if any, that the
Pilot will have on liquidity and trading volume on exchanges.
Therefore, the Commission is unable to determine ex ante the overall
effects the Pilot will have on the efficiency of capital allocation,
price efficiency, or the efficiency of fees and rebates.\855\ However,
the Commission believes that the Pilot will provide useful data that
will better inform future policy recommendations of the effects of fees
and rebates on price efficiency.\856\
---------------------------------------------------------------------------

\854\ See supra Sections IV.C.2.b.i and IV.C.2.b.iv.
\855\ One commenter stated that it did not ``expect that a
reduction or outright removal of rebates will have any significant
or harmful effects on the quality of prices displayed in the public
lit market, interfere with genuine liquidity and price formation, or
negatively impact [its] stock's trading volume, spread or displayed
size.'' See T. Rowe Price Letter, at 5.
\856\ See supra Section IV.C.1.a.ii.
---------------------------------------------------------------------------

The Pilot will provide the Commission with an opportunity to
empirically examine the effects of an exogenous shock to transaction
fees and rebates on order routing behavior, execution quality and
market quality. Insofar as the data produced by the Pilot permits the
Commission and the public to evaluate and comment upon the potential
impacts of alternative policy options, the rule may promote regulatory
efficiency.\857\ In the absence of the Pilot, the Commission would have
to rely on currently available data to inform future policy decisions
related to transaction-based fees and rebates and data limitations may
impair the efficiency of policy decisions based on this
information.\858\
---------------------------------------------------------------------------

\857\ See supra Section IV.C.1.a.i for a discussion of the
potential benefits from studying the Pilot data and supra Section
IV.C.1.a.iii for a discussion of the potential limitations of
studying the Pilot data.
\858\ See supra Section IV.B.1.b.
---------------------------------------------------------------------------

The temporary efficiency impacts the Commission expects during the
Pilot depend on how the Pilot fee and rebate restrictions for the two
Test Groups balance the interests of different groups of market
participants. For example, if during the Pilot, the lower fee cap and
no-rebate restriction induced by the 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,\859\ the Pilot
may temporarily improve the efficiency of capital allocation by
lowering execution costs.\860\ Alternatively, the 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.\861\ 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
transaction 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

[[Page 5281]]

increase the efficiency of capital allocation.
---------------------------------------------------------------------------

\859\ See supra Section IV.C.1.b.
\860\ See supra Section IV.C.2.b.iv.
\861\ See supra Section IV.C.2.b.iii.
---------------------------------------------------------------------------

For the duration of the Pilot, lower transaction fees could improve
the liquidity of stocks and ETPs in some Test Groups by reducing the
costs to execute marketable orders.\862\ As marketable orders become
less costly, these orders are likely to be routed to exchanges with
lower transaction fees, improving execution quality and possibly
creating a liquidity externality,\863\ whereby lower transaction fee
venues will become the preferred trading center for marketable and non-
marketable orders.\864\ An increase in liquidity could improve
informational efficiency by allowing securities prices to adjust more
quickly to changes in fundamentals.
---------------------------------------------------------------------------

\862\ See supra Section IV.C.1.b.
\863\ 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
Section IV.C.2.b.iv.
\864\ See infra Section IV.D.2.b.
---------------------------------------------------------------------------

As a result of the 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.\865\ Currently, most 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 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 for
particular orders. As fees decline or rebates are removed in some 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 Pilot, and temporarily improving
pricing efficiency and price discovery.\866\ Therefore, as an
additional benefit of the Pilot, the Pilot will allow an examination of
the temporary effect of revisions to transaction fees and rebates on
quoted spreads, to better inform future policy recommendations of the
effects of exchange transaction-based fees and rebates on price
efficiency.\867\
---------------------------------------------------------------------------

\865\ See supra Section IV.C.1.b.
\866\ Some commenters argued that transaction fees and rebates
harm price transparency because the prices displayed by exchanges do
not include fee or rebate information and therefore do not fully
reflect net trade prices. See ICI Letter I, at 2; Goldman Sachs
Letter, at 3; Invesco Letter, at 2; State Street Letter, at 2;
Wellington Letter, at 1; Oppenheimer Letter, at 2; Capital Group
Letter, at 3; Citi Letter, at 2. A number of academic studies also
made this argument. See, e.g., Angel, Harris, & Spatt, supra note
530, and Harris, id.
\867\ See supra Section IV.C.1.a.ii.
---------------------------------------------------------------------------

On the other hand, if the reduction in rebates and Linked Pricing
harms liquidity,\868\ or causes more informed order flow to be routed
to off-exchange trading venues,\869\ then the Pilot may temporarily
impair price efficiency and the price discovery process.\870\ A
reduction in rebates could cause informed traders to route more of
their non-marketable orders to off-exchange trading venues, which could
reduce price discovery, because these orders would no longer be
included in displayed quotes or limit order book depth. If liquidity
temporarily worsens, then it may lead to a temporary widening of the
NBBO, which could lead to a decline in the overall informational
efficiency of prices. If liquidity worsens, it could also cause
informed traders to route more of their marketable orders off-exchange,
which could harm price discovery by reducing the ability of market
participants to discern the direction of their order flow. However, if
spreads widen or queues shorten, it could attract informed non-
marketable orders onto exchanges, which could improve price discovery,
because exchange quotes would be more informative. Because the
Commission cannot ex ante predict the effects of the Pilot on liquidity
and competition between exchanges and off-exchange trading venues for
order flow,\871\ the Commission is unable to determine the overall
effects of the Pilot on price efficiency and the price discovery
process.
---------------------------------------------------------------------------

\868\ See supra Section IV.C.2.b.iv.
\869\ See infra Section IV.D.2.a.
\870\ Some commenters argued that rebates improved price
discovery by promoting displayed liquidity on exchanges and
narrowing the NBBO. See, e.g., State Street Letter, at 2; Virtu
Letter, at 3; Magma Letter, at 3; Schwab Letter, at 1; Fidelity
Letter, at 3; Cboe Letter I, at 15-16. One commenter argues that the
removal of rebates could harm price discovery by causing more market
participants to route their orders to off-exchange venues, instead
of lit exchanges, where they would be included in the price
discovery process. See Nasdaq Letter I, at 2, 4.
\871\ See supra Section IV.C.2.b.iv and infra Section IV.D.2.a.
---------------------------------------------------------------------------

Changes in liquidity could also impact the price efficiency of
ETPs. A change in liquidly for either the ETP itself or the underlying
securities could impact the create-redeem process for ETPs. This
process is an important element in ETP price efficiency and helps to
keep the price of the ETP in line with the value of its underlying
securities. If there is a mispricing, authorized participants can trade
on the mispricing by either purchasing the underlying shares to create
a share of the ETP, or by redeeming a share of the ETP and selling the
assets underlying the ETP. These actions affect the existing supply of
ETP shares and help to eliminate mispricing. Consequently, if the Pilot
impacts liquidity in either the underlying assets, or the ETP itself,
it will impact the cost to authorized participants of eliminating
mispricing by participating in the create-redeem process. Since the
Commission does not ex ante know how the Pilot will impact
liquidity,\872\ it cannot quantify the effects of the Pilot on ETP
price efficiency. If the Pilot results in improved liquidity for the
stocks in the various Test Groups, or for the ETP itself, then its
impact on the create-redeem process may be positive and ETP price
efficiency may increase as its value may more closely track the value
of their underlying assets through a lower cost create-redeem process.
The opposite is true if the Pilot negatively affects liquidity in
either the ETPs or the underlying securities.
---------------------------------------------------------------------------

\872\ See supra Section IV.C.2.b.iv.
---------------------------------------------------------------------------

Finally, the Commission acknowledges that the fee caps and
prohibition on rebates or Linked Pricing imposed on the Test Groups
during the 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 less efficient from the exchanges' perspective. The rule
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.\873\ 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 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 and rebates that may be more efficient.
---------------------------------------------------------------------------

\873\ See supra Section IV.C.2.b.i.
---------------------------------------------------------------------------

Several commenters asserted that fee and rebate restrictions
proposed by the Commission would be government imposed price-controls
that would increase inefficiencies and harm consumers.\874\ One of
these commenters elaborated that ``Government-imposed price controls
are well understood to have a negative impact on competition and
innovation'' and that ``they are only

[[Page 5282]]

indicated where they overcome severe market imperfection such as
monopoly ownership of a critical resource.'' \875\ As discussed in
detail above,\876\ the Commission believes that the current fee and
rebate system may have resulted in a number of market failures,
including rebates incentivizing brokers to route orders to trading
venues that pay the highest rebates, instead of the venues that offer
better execution. However, the Commission currently lacks the data to
estimate the extent of any existing market failures.\877\ While the
Commission acknowledges that the Pilot's restrictions on rebates and
fees could potentially harm efficiency, if these market failures
currently do exist, then the fee and rebate restrictions in Test Group
stocks could temporarily improve efficiency for the duration of the
Pilot. Additionally, the information the Commission learns from the
Pilot could be used by the Commission in future rulemakings to inform
future policy decisions.\878\
---------------------------------------------------------------------------

\874\ See Nasdaq Letter I, at 2, 5; Cboe Letter I, at 7.
\875\ See Nasdaq Letter I, at 11-12.
\876\ See supra Section IV.A.
\877\ See supra Section IV.B.1. and Section IV.C.1.a.iii.
\878\ See supra Section IV.C.1.a.
---------------------------------------------------------------------------

2. Competition
This section discusses the potential effects of the Pilot on
competition. The Commission believes that the Pilot could have a
temporary effect on the competitive dynamics between exchanges,
exchanges and off-exchange trading venues, broker-dealers, and issuers,
particularly ETPs. Additionally, as discussed in detail below,\879\ the
Pilot could potentially have competitive effects for smaller exchanges
that last beyond the Pilot. This could occur if the Pilot attenuates
the potentially distortive impact of transaction-based fees and rebates
and causes broker-dealers to route orders to trading centers they
perceive as more liquid. This could have a lasting effect on the order
flow and revenue of smaller exchanges if it produces a liquidity
externality that persists beyond the Pilot.\880\ However, the
Commission believes that this is unlikely to occur, because the Pilot
would be for a limited duration and the effects are unlikely to be
significant enough to cause this result.\881\
---------------------------------------------------------------------------

\879\ See infra Section IV.D.2.b (Competition Between
Exchanges).
\880\ See Proposing Release, supra note 2, at 13042, for a
discussion of a liquidity externality.
\881\ See infra Section IV.D.2.b (Competition Between
Exchanges).
---------------------------------------------------------------------------

Because the Commission is unable to determine ex ante the Pilot's
effects on liquidity,\882\ the Commission is unable to quantify many of
the effects of the Pilot on competition. In the sections below the
Commission offers a qualitative discussion of the effects of the Pilot
on competitive.
---------------------------------------------------------------------------

\882\ See supra Section IV.C.2.b.iv.
---------------------------------------------------------------------------

a. Competition Between Exchanges and Off-Exchange Trading Venues
This section discusses the potential effects of the Pilot on
competition between exchanges and off-exchange trading venues,
including ATSs, which, as discussed in the baseline,\883\ execute
approximately 14% of trading volume. Although the Pilot could
temporarily affect the competition for order flow between exchanges and
off-exchange trading venues, the Commission believes that the overall
effects of the Pilot on this competition are unclear, because, as
discussed in detail below, there are reasons why the Pilot may
temporarily increase as well as decrease the order flow routed to off-
exchange trading venues.
---------------------------------------------------------------------------

\883\ See supra Section IV.B.2.a.
---------------------------------------------------------------------------

A number of commenters argued that restricting exchange rebates and
fees for stocks in the test Groups without placing similar restrictions
on off-exchange venues could place exchanges at a competitive
disadvantage.\884\ Although the Commission acknowledges that the Pilot
may potentially place exchanges at a competitive disadvantage relative
to off-exchange trading venues, the Commission believes that the
overall effects of the Pilot on this competition would depend on how
on-exchange liquidity is affected by the Pilot as well as the
renegotiation costs that off-exchange trading venues would incur in
order to take advantage of the restrictions on exchange fees and
rebates. For example, as discussed in detail above,\885\ ATSs sometimes
negotiate bespoke agreements with individual subscribers for a bundle
of services. If the costs of renegotiating these agreements are high,
then off-exchange trading venues may not be able to adjust their
pricing models to take advantage of the exchange pricing restrictions,
in which case competition between exchanges and off-exchange venues
could be unaffected.\886\ Additionally, as discussed below, if off-
exchange renegotiation costs are high, some of the restrictions on
transaction fees could give certain exchanges a competitive advantage
relative to off-exchange venues in attracting certain types of order
flow. However, if off-exchange renegotiation costs are small or the
Pilot fee and rebate restrictions place certain exchanges at a
disadvantage relative to the current pricing policies of some off-
exchange trading venues, then the Pilot could affect competition
between exchanges and off-exchange trading venues.
---------------------------------------------------------------------------

\884\ Commenters expressed concern that the Pilot would inhibit
exchanges' ability to compete with off-exchange trading centers, in
part due to a reduced ability to innovate on changes to fees and
rebates. See, e.g., Cboe Letter I, at 7, 16-17; Nasdaq Letter I, at
6; NYSE Letter I, at 1-2, 4-5; Magma Letter, at 2; FIA Letter, at 3-
4; ASA Letter, at 3; P&G Letter, at 1; ACCO Letter, at 1; Johnson
Letter, at 1.
\885\ See supra note 47 and accompanying text.
\886\ It might be difficult for an ATS to renegotiate these
agreements with all of their clients in order to take advantage of
the exchange price restrictions on a subset of securities (i.e.,
stocks in the Test Groups).
---------------------------------------------------------------------------

Although the Commission acknowledges that the distribution of
trading volume could change between exchanges and off-exchange trading
venues, the Commission believes these changes are difficult to
determine in advance and cannot predict ex ante whether these changes
would increase or decrease exchange market share.\887\ As discussed
above,\888\ the Commission lacks data on the current pricing schedules
offered by off-exchange venues as well as information on how this
affects the routing decisions of broker-dealers. The Commission also
lacks information on how difficult it is for off-exchange trading
venues to adjust their pricing schedules. Additionally, as discussed
above,\889\ the Pilot's effects on liquidity could be either positive
or negative and vary across securities. Therefore, the Commission is
unable to quantify or determine the overall effects that the Pilot will
have on competition between exchanges and off-exchange trading venues.
However, if competitive rebalancing among trading centers occurs as a
result of the Pilot, it could provide information to the Commission
about order routing decisions and execution quality to inform future
policy actions.
---------------------------------------------------------------------------

\887\ One commenter agreed and stated the Pilot could cause a
shift in the balance of activity between exchanges and off-exchange
trading centers, but that the direction of such a shift cannot be
presupposed. See Decimus Letter, at 5. This commenter also noted
that transaction-based fees are one of the drivers behind the
current shift by market participants to off-exchange trading
centers. Id. at 5-6.
\888\ See supra Section IV.B.1.b.vii.
\889\ See supra Section IV.C.2.b.iv.
---------------------------------------------------------------------------

Commenter statements regarding the effects of the Pilot on
competition between exchanges and off-exchange trading venues indicated
that the Pilot could have different effects on the competition for
marketable and non-marketable order flow. In considering the comments,
and as analyzed in the following sections, the Commission considered
the differential impact

[[Page 5283]]

changes in exchange fees and rebates could have on the competition
between exchanges and off-exchange trading venues for marketable and
non-marketable order flow. As the discussion above indicates, and as
commenters point out, it is not clear how the Pilot will affect the
competition for both marketable and non-marketable order flow.\890\
Additionally, since the impacts of the Pilot on liquidity may not be
uniform across all securities,\891\ the effects of the Pilot on
competition for marketable and non-marketable order flow may not be
uniform across all securities. Therefore, as discussed above, the
Commission is unable to quantitatively estimate how the Pilot could
affect competition between exchanges and off-exchange trading venues to
attract different types of order flow. In the sections below the
Commission offers a qualitative discussion regarding how various
effects of the Pilot could affect this competition.
---------------------------------------------------------------------------

\890\ See Decimus Letter, at 5-6.
\891\ See supra Section IV.C.2.b.iv.
---------------------------------------------------------------------------

i. Marketable Order Flow
The Pilot could increase or decrease the share of marketable order
flow routed to off-exchange trading venues. This is reflected in the
divergent views of commenters, who argue over the effects that reduced
access fees and rebates could have on the share of marketable order
flow routed to off-exchange trading venues. In considering these
comments, the Commission considered a number of ways the Pilot could
potentially impact competition for marketable order flow, including:
The impact of changes in liquidity, the direct impact of changes in
access fees and rebates, the impact of changes in off-exchange fill
rates, and the impact of the Order Protection Rule.
Changes in liquidity caused by the Pilot could affect how much
marketable order flow is directed to off-exchange trading venues.
However, because the overall effects of the Pilot on liquidity could be
positive or negative and vary across securities,\892\ the overall
effects of changes in liquidity on the direction of marketable order
flow are also unclear. Therefore, the Commission is unable to predict
the overall effect that changes in liquidity caused by the Pilot will
have on the competition for marketable order flow between exchanges and
off-exchange trading venues.
---------------------------------------------------------------------------

\892\ See supra Section IV.C.2.b.iv.
---------------------------------------------------------------------------

A number of commenters argued that if the Pilot temporarily
decreases liquidity in the test Groups due to the elimination or
reduction of rebates,\893\ more order flow will likely be directed to
off-exchange trading venues.\894\ As the Commission previously
discussed,\895\ the competition between on and off exchange venues for
order flow is characterized as providing a tradeoff between immediacy
and execution quality. Off exchange venues tend to get better trade
execution on average than lit exchanges, largely because they trade
between the prevailing NBBO, but at the cost of not being able to
guarantee that a transaction will occur. Thus, the impact of the Pilot
on the competition between exchanges and off exchange venues for
marketable order flow will depend on how the Pilot impacts execution
quality and the cost of immediacy on exchanges compared to the
potential for price improvement and the chance of filling an order at
an off-exchange venue.
---------------------------------------------------------------------------

\893\ See id.
\894\ See, e.g., Magma Letter, at 2; Home Depot Letter, at 1.
\895\ See Securities Exchange Act Release No. 76474 (Nov. 18,
2015), 80 FR 80998 (Dec. 28, 2015), 81116-81117. See also Securities
Exchange Act Release Nos. 83663 (July 18, 2018), 83 FR 38768 (August
7, 2018), 38891-38892.
---------------------------------------------------------------------------

If a reduction in rebates causes quoted spreads to widen,\896\ it
could increase the attractiveness of off-exchange price improvement and
would likely cause more institutional or proprietary marketable order
flow to be directed to off-exchange ATSs. Additionally, if spreads
widen, broker-dealers would likely be incentivized to internalize more
marketable institutional order flow. If spreads do not widen, a
decrease in quoted depth could also result in more marketable orders
being routed off-exchange. If quoted depth decreases,\897\ and if
market participants believe that off-exchange venues offer improved
execution, it could cause more large marketable orders to get routed to
ATSs or be internalized, in order to avoid the increased costs of
walking up the book. Alternatively, if liquidity improves, it could
reduce the cost of immediacy and the benefits of off-exchange price
improvement, which could result in more marketable order flow being
routed to exchanges.
---------------------------------------------------------------------------

\896\ See supra Section IV.C.2.b.iv.2.
\897\ See id.
---------------------------------------------------------------------------

Changes in exchange access fees and rebates for stocks in the test
groups could also directly affect whether some types of marketable
order flow are routed to exchanges or off-exchange trading venues.
However, as discussed in detail above,\898\ the Commission currently
faces limitations in determining the effects that exchange transaction
fees and rebates have on order routing decisions. The Commission is
unable to quantify how changes in exchange transaction fees and rebates
for stocks in the test groups will affect the routing decisions for
marketable order flow between exchanges and off-exchange trading
venues. Therefore, the Commission is unable to determine in advance
what effect changes in exchange transaction fees and rebates caused by
the Pilot will have on the competition for marketable order flow. One
of the goals of the Pilot is to provide the Commission with data so
that it can better evaluate these effects.
---------------------------------------------------------------------------

\898\ See supra Section IV.B.1.a and Section IV.B.1.b.
---------------------------------------------------------------------------

If renegotiation costs are too high for off-exchange trading venues
to adjust their pricing schedules, lower transaction fees on maker-
taker exchanges could cause some marketable order flow that would be
routed to ATSs and other off-exchange trading centers to instead be
routed to these exchanges. For example, if the equilibrium transaction
fee in Test Group 2 is below $0.0030 in the absence of rebates,
exchanges may be able to draw order flow away from off-exchange trading
centers.
Several commenters agreed that lower access fees could induce some
market participants to bring order flow back to exchanges.\899\ One of
these commenters stated that ``the potential that substantially lower
take fees in test group securities will counter any potential loss of
rebate-driven volume.'' \900\ One commenter disagreed and noted that
lowering fees would not attract marketable order flow to
exchanges.\901\ This commenter noted

[[Page 5284]]

that if high access fees drove market participants to route orders to
off-exchange trading centers, then lower cost venues, such as NYSE
American or EDGA would have larger market share.\902\ Another commenter
disagreed and argued that ``the cost of accessing lit markets in the
form of access fees on securities exchanges has been one of the key
drivers behind the continuing proliferation of non-exchange trading
venues.'' \903\ Given the disagreement among commenters, the Commission
believes it is possible that lower transaction fees could potentially
result in more marketable order flow being routed to exchanges.
However, as discussed above, the Commission faces limitations in
quantifying the effects that lower exchange transaction fees will have
on marketable order flow and is unable to determine how likely this is
to occur. One of the goals of the Pilot is to provide the Commission
with data so that it can better evaluate these effects.
---------------------------------------------------------------------------

\899\ See, e.g., IEX Letter II, at 7, 8-9; TD Ameritrade Letter,
at 7; Citi Letter, at 4; Decimus Letter, at 5-6.
\900\ See IEX Letter II, at 8.
\901\ See NYSE Letter II, at 12; NYSE Letter I, at 16. This
commenter argued that market participants choose to send orders to
off-exchange venues for reasons other than avoiding fees, such that
simply lowering fees would not attract marketable order flow to
exchanges. See NYSE Letter I, at 16. Another commenter noted that
the Commission's assertion that any potential degradation of the
effective bid-ask spread due to lower or reduced rebates could be
mitigated by lower access fees was ``not supported by empirical data
or substantive analysis.'' See Nasdaq Letter I, at 8-9. In response
to these comments, the Commission notes that its belief is support
by some theoretical studies that show that it is the net fees, i.e.,
the rebates plus fees, that affect trading costs. See e.g. Colliard,
J.E. & Foucault, T. (2012). ``Trading fees and efficiency in limit
order markets.'' Review of Financial Studies, Vol. 25 (11), 3389-
3421 (available at: https://academic.oup.com/rfs/article/25/11/3389/1566107). Some empirical studies produce similar results. See, e.g.
Malinova, K. & Park, A. (2015). ``Subsidizing Liquidity: The Impact
of Make/Take Fees on Market Quality.'' Journal of Finance, Vol
70(5), 509-36 (available at: https://onlinelibrary.wiley.com/doi/10.1111/jofi.12230). According to this literature, the effects of a
reduction in rebates could potentially be offset by lower
transaction fees. The Commission also notes that some commenters
acknowledged this could be a potential effect of lower access fees.
See supra note 23. However, other academic literature shows that in
the presence of a fixed tick size, changes in fees and rebates can
still affect trading volume, even in the absence of a change in the
total fee. See e.g. Foucault, T., Kadan, O., & Kandel, E. (2013).
``Liquidity Cycles and Make/Take Fees in Electronic Markets.''
Journal of Finance, Vol. 68(1), 299-341 (available at: https://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.2012.01801.x).
According to this literature, a reduction in transaction fees may
not fully offset the effects of an equal reduction in rebates. Given
the mixed results from the academic literature and the disagreement
among commenters, the Commission believes it is possible that lower
transaction fees could potentially reduce some of the effects of an
increase in effective bid-ask spreads caused by a reduction rebates,
although the magnitude of this reduction is uncertain. The
Commission believes that the Pilot would generate data and analysis
that would help the Commission better understand the cumulative
effects of changes in transactions fees and rebates on spreads and
trading costs. See supra Section IV.C.1.a.i.
\902\ See NYSE Letter II, at 12.
\903\ See Decimus Letter, at 5-6.
---------------------------------------------------------------------------

To the extent that conflicts of interest affect order routing,\904\
lower rebates on taker-maker venues could potentially increase the off-
exchange share of trading volume by causing broker-dealers to increase
the internalization of smaller marketable orders, even if on-exchange
liquidity or execution quality does not change.
---------------------------------------------------------------------------

\904\ See supra Section IV.A.1 (Market Failure at the Broker-
Dealer Level).
---------------------------------------------------------------------------

Changes in the fill rates of orders at off-exchange trading venues
could also affect how much marketable order flow is directed to off-
exchange trading venues. However, there are reasons the Pilot could
increase or decrease the fill rates of orders at off-exchange trading
venues. Therefore, the effect these changes will have on the
competition for marketable order flow is uncertain.
As discussed below,\905\ there are reasons the Pilot could cause an
increase or decrease in the non-marketable order flow routed to off-
exchange trading venues. If there is an increase in the non-marketable
order flow routed to off-exchange trading venues, then the fill rates
of marketable orders routed to off-exchange trading venues would
increase, which could cause more marketable order flow to be directed
to off-exchange trading venues. Alternatively, a decrease in the non-
marketable order flow routed to off-exchange trading venues would cause
a decrease in the fill rate for marketable orders, which would cause
less marketable order flow to be directed to off-exchange trading
venues.
---------------------------------------------------------------------------

\905\ See infra Section IV.D.2.a.ii (Nonmarketable Order Flow).
---------------------------------------------------------------------------

One factor that could reduce the chance of marketable orders being
routed away from exchanges is that exchanges have a protected quote.
One commenter believed that any off-exchange shifts are likely to be
limited because these trading centers do not have a protected quote,
and any shifts that would occur would still need to be consistent with
best execution and not just redistribution to account for market
participants' cost considerations.\906\ However, given that 34% of all
transaction volume occurs off-exchange at trading venues without a
protected quote, it is unclear how much effect a protected quote will
have on this competition.\907\
---------------------------------------------------------------------------

\906\ See Healthy Markets Letter, at 10. Another commenter also
emphasized that exchanges have the advantage of a protected quote
and that they have an advantage in receiving orders that require
immediate execution. See IEX Letter II, at 8.
\907\ See supra Section IV.B.2.a.
---------------------------------------------------------------------------

The Commission does not expect the Pilot will have a significant
effect on the competition for retail marketable orders. Normally, these
orders are internalized by off-exchange wholesale broker-dealers who
pay retail broker-dealers for the order flow.\908\ Since the Pilot does
not restrict these rebates, the Commission does not expect the Pilot to
affect the routing of marketable retail order flow.
---------------------------------------------------------------------------

\908\ See Battalio Equity Market Study, supra note 530.
---------------------------------------------------------------------------

ii. Nonmarketable Order Flow
The Pilot could increase or decrease the share of non-marketable
order flow routed to off-exchange trading venues. This is reflected in
the divergent views of commenters, who argue over the effects that
reduced rebates could have on the share of non-marketable order flow
routed to off-exchange trading venues. In considering these comments,
and as discussed below, the Commission considered factors that could
affect the decision to supply liquidity on exchanges or at off-exchange
trading venues. Furthermore, in considering comments, the Commission
also considered a number of ways the Pilot could potentially impact
competition for non-marketable order flow, including: The impact of
changes in rebates, the impact of changes in liquidity, and the impact
of changes in off-exchange fill rates.
The decision to submit a non-marketable order on-exchange or route
it to an off-exchange trading venue is a trade-off between the profits
earned from providing liquidity on-exchange compared to the expected
execution price and probability of having the order filled off-
exchange. Higher exchange rebates, wider spreads, higher on-exchange
fill rates (shorter on-exchange queue lengths), and lower off-exchange
fill rates would all increase the chance of a trader deciding to
provide liquidity on-exchange compared to routing an order to an off-
exchange venue.\909\ The impact of the Pilot on the competition between
exchanges and off-exchange venues for non-marketable order flow will
depend on how the Pilot affects these dimensions.
---------------------------------------------------------------------------

\909\ See supra Section IV.B.2.b.
---------------------------------------------------------------------------

The Commission believes that the overall effect on the competition
between exchanges and off-exchange venues for non-marketable order flow
from a reduction in rebates for stocks in the test groups is unclear,
because a reduction in rebates could result in either an increase or
decrease in liquidity.\910\ In theory, a reduction in exchange rebates
without any changes in liquidity or fill rates would likely cause more
non-marketable order flow to be routed to off-exchange trading venues.
However, the Commission believes that this event is unlikely, because a
reduction in exchange rebates and transaction fees could also affect
liquidity. Since a reduction in exchange rebates and transaction fees
could cause liquidity to increase or decrease,\911\ it could also cause
the share of non-marketable order flow routed to off-exchange trading
venues to increase or decrease.
---------------------------------------------------------------------------

\910\ See supra Section IV.C.2.b.iv.
\911\ See id.
---------------------------------------------------------------------------

Several commenters voiced concerns that reduced rebates could cause
liquidity to migrate from exchanges to

[[Page 5285]]

non-exchange trading centers, because exchanges will be restricted from
providing rebates as incentives for liquidity provision, whereas non-
exchange trading centers could freely offer rebates and other
incentives to draw orders away from exchanges.\912\ In contrast,
several commenters disagreed and noted that ATSs generally do not pay
rebates and tend to charge lower fees than the large exchanges,\913\
and that such a pricing model would make it challenging for ATSs to
start providing rebates sufficiently large enough to draw volume from
exchanges. If rebates incentivize liquidity provision by providing
extra revenue to liquidity providers, a reduction in rebates for stocks
in the Test Groups could incentivize them to divert some of their non-
marketable liquidity providing orders from maker-taker exchanges to
off-exchange trading venues.\914\ However, this decision could also be
affected by how the rebate reductions impacted other dimensions of
liquidity, so the overall effect is difficult to determine.
---------------------------------------------------------------------------

\912\ See, e.g., Cboe Letter I, at 7-8; Themis Trading Letter I,
at 1; MFS Investment Letter, at 2; Wellington Management Letter, at
1; FIA Letter, at 3-4; ASA Letter, at 3; Era Letter, at 2; Knight-
Swift Letter, at 2. One of the commenters suggested the Commission
should evaluate how disparate treatment of liquidity provision
between exchanges and non-exchange trading centers could affect
market participants' incentives to compete for displayed liquidity.
See Mastercard Letter, at 2. Another of the commenters also noted
that the competitive balance between exchanges and off-exchange
trading centers is uneven due to differences in regulatory
oversight, including filings of fee changes; the ability to assess
different fees to different customers; and the ability to offer sub-
penny price improvements. See Cboe Letter I, at 8.
\913\ See IEX Letter II, at 8. One commenter disagreed and noted
that although ``few ATSs currently use maker-taker fee structures,
but they have done so in the past and would be incentivized to do so
in the future'' and that ``restricting fee structures on exchanges
only would encourage those off-exchange venues to expand their use
of order-routing incentives to gain a competitive advantage.'' See
NYSE Letter I, at 4-5
\914\ It could also result in market makers reducing their
overall submission of non-marketable orders to supply liquidity, if
it is the case that rebates encourage market makers to engage in
excessive intermediation. This in turn could result in a reduction
in trading volume. See supra note 823 and accompanying text.
---------------------------------------------------------------------------

As discussed above, changes in liquidity could also affect the
decision regarding where to route non-marketable limit orders. Since
the effects of the Pilot on liquidity could be either positive or
negative, The Commission is uncertain how these changes will affect the
competition for non-marketable order flow between exchanges and off-
exchange trading venues. If on-exchange liquidity worsens and bid-ask
spreads widen or quoted depth decreases,\915\ then institutional
traders could direct more of their non-marketable orders to supply
liquidity on maker-taker exchanges, either because realized spreads
increased or because the queue position and fill rates of their on-
exchange nonmarketable orders increased.\916\ Alternatively, if
liquidity improves and either bid-ask spreads tighten or quoted depth
increases,\917\ institutional traders could direct more their non-
marketable orders to off-exchanges venues, because the profits earned
from providing liquidity decreased.
---------------------------------------------------------------------------

\915\ See supra Section IV.C.2.b.iv.
\916\ It could incentivize institutional or proprietary traders
to substitute their marketable orders with nonmarketable limit
orders on maker-taker exchanges.
\917\ See supra Section IV.C.2.b.iv.
---------------------------------------------------------------------------

Change in the rate that orders are filled off-exchange could also
cause changes in the routing of non-marketable orders between exchanges
and off-exchange trading venues. However, as discussed below, the
effect of the Pilot on the fill rate of off-exchange non-marketable
orders is unclear. Therefore it is difficult to determine the Pilot's
effect on the routing of non-marketable orders. Changes in the rates at
which non-marketable orders are filled off-exchange depend on how the
routing of marketable order flow to off-exchange trading venues
changes. If a reduction in fees causes more marketable orders to be
routed to exchanges \918\ it could reduce the fill rate of off-exchange
orders, which could cause institutions or proprietary traders to
substitute some of their off-exchange orders with non-marketable orders
to supply liquidity on maker-taker exchanges. Alternatively, if the
Pilot causes more marketable orders to be routed to off-exchange
trading venues,\919\ it could increase off-exchange fill rates, which
could cause more orders that would have supplied liquidity on exchange
to be routed to off-exchange venues. However, as discussed above, the
Commission is unclear whether the share of marketable order flow routed
to off-exchange trading venues will increase or decrease.
---------------------------------------------------------------------------

\918\ See supra Section IV.D.2.a.i.
\919\ See id.
---------------------------------------------------------------------------

The Commission does not expect the Pilot will have a significant
effect on the competition between exchanges and off-exchange trading
venues for retail non-marketable orders. Often, these orders are routed
by retail broker-dealers to maker-taker exchanges or to wholesale
broker-dealers who pay retail broker-dealers for the order flow. The
Commission believes that, despite the reduction in rebates, these
orders will still be routed to exchanges or to wholesale broker-dealers
who pay them for their order flow.\920\
---------------------------------------------------------------------------

\920\ As discussed in detail below, the Commission believes
retail non-marketable orders for securities in Test Group 1 will
still be routed to maker-taker exchanges. The restrictions on
rebates in Test Group 2 may cause some of these orders to be routed
to taker-maker venues, if they result in better execution quality.
See infra Section IV.D.2.b.
---------------------------------------------------------------------------

b. Competition Between Exchanges
This section discusses the potential effects of the Pilot on
competition between exchanges that use transaction-based fee and rebate
pricing models. Although the Pilot could temporarily affect the
competition for order flow between exchanges, the Commission believes
that many of the effects of the Pilot on this competition, including
the expected redistribution of market share among the existing
exchanges, are unclear and difficult to determine in advance. This is
reflected in the divergent views of commenters, who disagree about the
effects that reduced rebates and transaction fees could have on
competition between different types of exchanges.
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 rule on competition depends on the extent to which
the fee cap and prohibition on rebates or Linked Pricing restrict
exchanges' transaction-based fee strategies. As discussed in detail
above,\921\ the Commission believes that the Pilot, while changing
either transaction fees or rebates on certain subsets of securities,
could leave the margins that exchanges obtain from transaction-based
pricing models unchanged. On the one hand, this could preserve the
current state of competition among exchanges in the market for those
securities. For instance, it may be possible for exchanges to modify
fee structures in a way that leaves margins unchanged and does not
impact competition between exchanges.\922\
---------------------------------------------------------------------------

\921\ See supra Section IV.C.2.b.i.
\922\ One commenter agreed with this view and suggested that
even though the fee cap for the Proposed Test Group 1 was half of
the current level, ``there was still significant enough
differentiation available in the fee structure that trading may not
appear materially different than the control group.'' See Credit
Suisse Commentary, at 3. However, another commenter argued that the
fee cap in Proposed Test Group 1 would reduce the exchange's ability
to compete on fees by 50%. See Cboe Letter I, at 16.
---------------------------------------------------------------------------

On the other hand, the restrictions on fees and rebates could also
alter the competitive dynamics between different exchanges. For
example, the restrictions on fees and rebates could make

[[Page 5286]]

exchanges more similar in Test Group stocks.\923\ This could alter
competition between exchanges by causing market participants to focus
less on differences in fees and rebates and more on other metrics, such
as execution quality when deciding to which exchanges to route order
flow.
---------------------------------------------------------------------------

\923\ See supra Section IV.C.2.b.i.
---------------------------------------------------------------------------

As discussed in detail above,\924\ the Commission cannot ex ante
predict whether the Pilot will increase or decrease trading volume on
certain exchanges. Consequently, the Commission acknowledges
significant uncertainty with respect to the effect of the Pilot on
exchange competition.
---------------------------------------------------------------------------

\924\ See id.
---------------------------------------------------------------------------

One commenter suggested that ``inverted venues would likely
increase market share as maker rebates disappear and the fee
differential between venues declines for market makers, lowering the
relative cost for queue priority.'' \925\ The Commission acknowledges
that it is possible that a reduction in rebates in Test Group stocks
could make maker-taker exchanges less competitive for non-marketable
orders and cause liquidity provision to migrate to inverted venues.
However, if a reduction in rebates reduces excessive
intermediation,\926\ causes market makers to shift their liquidity
provision off-exchange,\927\ or worsens liquidity,\928\ then
institutional or proprietary traders' non-marketable orders could get
better queue position and have higher fill rates on maker-taker venues,
which could attract non-marketable order flow from taker-maker venues,
where maker participants pay fees for better queue positions and fill
rates.
---------------------------------------------------------------------------

\925\ See Credit Suisse Commentary, at 4.
\926\ See supra note 823 and accompanying text.
\927\ See supra Section IV.D.2.a.
\928\ See supra Section IV.C.2.b.iv.
---------------------------------------------------------------------------

If the Pilot causes changes in liquidity between exchanges in Test
Group stocks,\929\ it could affect the decision where to route
marketable order flow. If an exchange experiences an improvement/
decline in liquidity it may also experience an increase/decline in
marketable order flow, especially since lower differences in fees/
rebates between exchanges could reduce broker-dealer conflicts of
interest and make them rely more on execution quality when deciding
where to route marketable orders.\930\ Additionally, it is also
possible that lower transaction fees on maker-taker venues could make
these venues more competitive and better able to attract marketable
order flow in Test Group stocks from inverted venues.
---------------------------------------------------------------------------

\929\ See id.
\930\ See supra Section IV.C.1.b.
---------------------------------------------------------------------------

The Pilot could also alter competition between exchanges by causing
exchanges to choose to compete less intensively for order flow in one
Test Group, and instead focus on stocks and ETPs in the other Test
Group. Some of the shortfall in the competition for order flow for this
subset of securities could be filled by off-exchange trading
centers.\931\ Alternatively, exchanges may revise pricing strategies
for stocks in other groups, choosing to implicitly subsidize rebates
for stocks in Test Group 1 using fees from Control Group stocks.\932\
This may increase competition for order flow in one Test Group while
reducing it in the other. In the presence of tighter restrictions on
transaction-based fees during the Pilot Period, exchanges could also
compete in other ways to attract trading volume (e.g., discounts on
connectivity fees or increased volume discounts), although the
Commission believes that for Test Group 1 the ability to offer
meaningful volume discounts would be limited in light of the $0.0010
fee cap in that group.\933\
---------------------------------------------------------------------------

\931\ See supra Section IV.D.2.a.
\932\ See, e.g., Healthy Markets Letter I, at 27 (noting that
exchanges use fees collected to pay rebates).
\933\ For NMS stocks included in Test Group 2 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 Pilot also could affect competition between large and small
exchanges. The restrictions on rebates resulting from the Pilot could
harm smaller exchanges that may be competing by paying large rebates
rather than by producing better prices or execution quality.\934\ As
discussed in the Proposal,\935\ liquidity tends to consolidate.
Therefore, if smaller exchanges are unable to pay larger rebates in
test stocks, they may lose order flow to larger, more liquid exchanges.
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.\936\
Although these effects would likely last only for the duration of the
Pilot, depending on the extent of the liquidity externalities, smaller
exchanges could experience long-lasting competitive effects, such as a
reduction in trading volume that continues after the expiration of the
Pilot.\937\ The Pilot also could temporarily discourage entry of new
exchanges that might otherwise emerge to take advantage of the maker-
taker and taker-maker pricing models.\938\
---------------------------------------------------------------------------

\934\ See supra Section IV.B.2.a.
\935\ See the discussion of a liquidity externality in the
Proposing Release, supra note 2, at 13042.
\936\ See id.
\937\ One commenter suggested that the effects of the Pilot may
be permanent. See NYSE Letter I, at 4, 8.
\938\ 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 & Spatt, supra note 530.
However, some commenters suggested that the loss of fee
differentiation would lead to an increase in venues as exchanges try
to make up for lost revenue through other means. See, e.g., Fidelity
Letter, at 8; Cboe Letter I, at 16-17.
---------------------------------------------------------------------------

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.\939\ In theory,
this could lead to consolidation or exit by small exchanges as a result
of the Pilot.\940\ However, the Commission believes that either of
those events is unlikely because the anticipated revenue shortfall, as
discussed above,\941\ would be for a limited duration and would not be
significant enough to cause this result.
---------------------------------------------------------------------------

\939\ One commenter said that restricting transaction fees would
disproportionally hurt small exchanges because ``large exchanges
have diversified revenues away from transaction fees.'' See Magma
Letter, at 2.
\940\ One commenter believed that the loss in fee
differentiation could lead to consolidation and fewer venues
overall. See Credit Suisse Commentary, at 5.
\941\ See supra Section IV.C.2.b.i (Loss of Exchanges' Fee
Revenue).
---------------------------------------------------------------------------

The Commission recognizes that the potential temporary competitive
impacts stemming from the 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 the prohibition on rebates and Linked
Pricing applicable to Test Group 2 would apply to a higher proportion
of its trading volume. However, the Commission believes that, given its
aim of producing representative groups of stocks and ETPs for the
purposes of the Pilot, trading centers are not likely to be
substantially more exposed to NMS stocks in any one group.

[[Page 5287]]

c. Competition Between Broker-Dealers
The Pilot also could affect competition between broker-dealers. One
commenter believed that, due to differences in broker-dealer business
models, any reduction in rebate incentives or other forms of payment
for order flow will increase transaction costs, and that large broker-
dealers would be better able to adapt to increased trading costs and
rebate reductions than small or middle-market broker-dealers.\942\ The
commenter believed that the Pilot would disproportionately advantage
large broker-dealers who specialize in low touch execution or own ATSs
because more customers and order flow would migrate to the largest
brokers, and that the ``Commission should and is required to undertake
a rigorous cost-benefit analysis to justify any policy that favors one
group of Brokers over another.'' \943\
---------------------------------------------------------------------------

\942\ See ASA Letter, at 2.
\943\ Id. at 2-3.
---------------------------------------------------------------------------

The Commission believes that the Pilot could differentially affect
small and large broker-dealers, but differences in the potential
compliance costs they face make it unclear whether the Pilot will
disproportionately advantage large broker-dealers over small or middle-
market broker-dealers. Although larger broker-dealers may possess
economies of scale which may enable them adapt better to changes in
fees and rebates, they are also more likely to be members of exchanges
and subject to the compliance costs of adjusting their systems due to
changes in exchange fee and rebate schedules discussed above.\944\ As
of December 2017, of the approximately 3,860 broker-dealers registered
with the Commission, only 397 are listed as having memberships with at
least one exchange and would encompass the set of executing broker-
dealers that would be most affected by the Pilot. Therefore, it is
likely that many small or middle-market broker-dealers will not have to
bear the compliance costs discussed above.\945\
---------------------------------------------------------------------------

\944\ See supra Section V.C.2.b.ii (Broker-Dealer Systems
Costs).
\945\ See id.
---------------------------------------------------------------------------

Additionally, since larger broker-dealers are more likely to be
subject to these compliance costs, they may need to increase their
commission rates more than smaller broker-dealers to compensate for
these increased costs. This could potentially offset any advantage that
larger broker-dealers may possess in being able to absorb any revenue
loss caused by a reduction in payment for order flow, such as by being
able to offer smaller increases in commissions compared to smaller
broker-dealers. However, the Commission cannot quantify this
difference, because it lacks sufficient data on the differences in
commission rates between large and small broker-dealers.\946\
---------------------------------------------------------------------------

\946\ See supra note 805.
---------------------------------------------------------------------------

d. Competition Between Issuers
A number of commenters noted that the Commission, in the Proposing
Release, did not discuss the competitive effects to issuers (common
stocks) from inclusion in various Test Groups of the Pilot.\947\ While
the Pilot could potentially affect product market competition between
issuers that compete in the same product market by affecting their
ability to raise capital,\948\ the Commission does not believe that
this is likely to occur. Since the Commission does not believe that the
Pilot will have a significant effect on the ability of issuers to raise
capital,\949\ the Commission does not believe the Pilot will have a
significant effect on product market competition between issuers.
---------------------------------------------------------------------------

\947\ See, e.g., Anixter Letter, at 1; STANY Letter, at 2; NYSE
Letter, at 2; Johnson Letter, at 1; Cott Letter, at 1; P&G Letter,
at 1; Nasdaq Letter I, at 8-9. One of these commenters ``urge[d] the
Commission to further analyze and study the potential impact of the
Transaction Fee Pilot on issuers and their securities (as well as
investors in those securities), including the impact on competition
between issuers in the pilot test groups and those in the control
group.'' See Anixter Letter, at 1. Another commenter argued that the
Commission was ``treating all issuers the same without consideration
for the very significant differences in how the securities of
different sized and priced companies trade.'' See Nasdaq Letter I,
at 8.
\948\ See infra Section IV.D.3 (Capital Formation).
\949\ See id.
---------------------------------------------------------------------------

Some commenters argued that the Pilot could inadvertently pick
``winners and losers'' through the selection of securities to Test
Groups.\950\ One commenter believed that issuers in certain Test Groups
could become ``less attractive investments than control group issuers''
\951\ while another thought this could ``skew the competitive dynamic
between issuers and impact the ability of the affected issuers to raise
capital.'' \952\ They argue that among securities with similar
characteristics, securities that can offer higher rebates will attract
more liquidity and trading volume at the expense of securities with
lower rebates. Several commenters argued that issuers included in the
test groups with reduced access fees or rebates would experience wider
spreads, which would put them at a competitive disadvantage compared to
peer firms in the control group by making it more expensive for them to
engage in secondary offerings or conduct share repurchase
programs.\953\ One commenter argued that this would disproportionately
affect ``small to medium issuers'' where ``[l]iquidity rebates can be
critical . . . to motivate market makers to support the stock with
aggressive and actionable quotations.'' \954\ Although some securities
may experience changes in liquidity as a result of the Pilot,\955\ as
discussed in detail below,\956\ the Commission does not believe that
issuers, including small and mid-capitalization issuers, will
experience significant increases in the cost of capital as a result of
the Pilot.
---------------------------------------------------------------------------

\950\ See Nasdaq Letter I, at 10; Invesco Letter, at 2
(discussing the competitive effects for ETPs).
\951\ See NorthWestern Letter, at 2.
\952\ See Ethan Allen Letter, at 1. See also McDermott Letter,
at 1; ProAssurance Letter, at 1; Era Letter, at 2; Avangrid Letter,
at 1-2.
\953\ See NYSE Letter I, at 6-7; Apache Letter, at 2; Mastercard
Letter, at 2; Era Letter, at 2.
\954\ See Nasdaq Letter I, at 8-9.
\955\ See supra Section IV.C.2.b.iv.
\956\ See infra Section IV.D.3 (Capital Formation).
---------------------------------------------------------------------------

However, if the Pilot does differentially affect the cost of firms
in the same product market to raise capital, it could affect product
market competition by making it more difficult for the firms that
experienced an increase in capital costs to compete. While the
Commission acknowledges that theoretical and empirical studies suggest
that an increase in costs of capital can affect product market
competition,\957\ the Commission does not believe the Pilot will have
such an effect on product market competition between issuers. While the
Commission acknowledges that some issuers may observe a widening of
spreads and possible reductions in liquidity provision,\958\ as
discussed below,\959\ the Commission does not believe that the Pilot
will have a significant effect on capital formation for issuers.\960\
Therefore, the Commission does not believe the Pilot will have a
significant effect on product market competition between issuers.
Furthermore, the Pilot will allow the Commission to obtain data to be
able to analyze the impact of

[[Page 5288]]

changes to fees and rebates and how those changes affect a myriad of
issues, including their impact on competition between issuers.
---------------------------------------------------------------------------

\957\ See, e.g., Maksimovic, V. (1995). ``Financial Structure
and Product Market Competition.'' Ch. 27 in Handbooks in Operations
Research and Management Science, Vol. 9, 887-920 (available at:
https://www.sciencedirect.com/science/article/abs/pii/S0927050705800714) and Campello, M. (2006). ``Debt Financing: Does
It Boost or Hurt Firm Performance in Product Markets?'' Journal of
Financial Economics, 82(1), 135-172 (available at: https://www.sciencedirect.com/science/article/pii/S0304405X05001777)
(hereafter ``Campello (2006)'').
\958\ See supra Section IV.C.2.b.iv.
\959\ See infra Section IV.D.3 (Capital Formation).
\960\ One commenter agreed and argued that ``there simply is no
evidence that the Pilot will cause any imminent danger to any
issuer's stock price or liquidity.'' See Better Markets Letter, at
3.
---------------------------------------------------------------------------

e. Competition Between ETPs
The Pilot may also impact the competitive dynamics between
ETPs.\961\ Although some ETPs could potentially be harmed by the
Pilot's effect on this competition, there is uncertainty regarding the
Pilot's effect on the liquidity of ETPs and therefore on competition
between ETPs.\962\
---------------------------------------------------------------------------

\961\ A number of commenters stated concerns that the Commission
had not fully considered the competitive effects on ETPs resulting
from the Pilot. See, e.g., NYSE Letter I, at 7; ICI Letter I, at 4;
State Street Letter, at 3; STA Letter, at 4; Schwab Letter, at 3;
STANY Letter, at 4; Clearpool Letter, at 7-8; Cboe Letter I, at 17-
18; Nuveen Letter, at 1,3; BlackRock Letter, at 1-2; Fidelity
Letter, at 9; SIFMA Letter, at 4-5; Credit Suisse Commentary, at 6;
Healthy Markets Letter II, at 8; Oppenheimer Letter, at 3; ICI
Letter II, at 5; Nasdaq Letter I, at 8.
\962\ See supra Section IV.C.2.b.iv.2.
---------------------------------------------------------------------------

Unlike common stocks, whereby trading and investing in those
securities is likely driven by firm-specific characteristics, ETPs with
similar investment strategies may be more substitutable. For example,
some ETPs may follow the same underlying index, and only differ in
expense ratios, trading characteristics, and in some cases, tracking
error. Although some of these characteristics may be meaningful
distinctions for long-term investors, such as expense ratios, other
characteristics, such as trading characteristics, including transaction
costs, are likely to be meaningful to market participants that trade
rather than invest in some ETPs.\963\ One concern is that changes in
liquidity between similar ETPs in different Pilot groups could have an
impact on competition by harming ETPs that experience a decline in
liquidity.\964\ A decline in ETP liquidity could affect competition by
causing trading volume (demand) to migrate from an ETP that experienced
a decline in liquidity to a nearly identical ETP in another Pilot group
that might have experienced an improvement in liquidity.\965\ For
example, ETPs that are subject to higher rebates may benefit and
attract more liquidity and trading volume at the expense of similar
ETPs in different Test Groups that are restricted to offering lower
rebates.\966\ A decrease/increase in secondary market demand for an ETP
could cause a decrease/increase in the total assets under management of
the ETP's sponsor by causing authorized participants to redeem/create
creation units of ETP shares in order to take advantage of arbitrage
opportunities in the secondary market.\967\ However, one commenter
(itself an ETP sponsor) noted that the competitive effects for ETPs
would likely be temporary and minimal, and would have little effect on
investor behavior; therefore, the benefits of including ETPs in the
Pilot outweigh the potential costs of competitive impacts for
ETPs.\968\
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\963\ For example, three ETFs that track the S&P 500 Index have
expense ratios of 9 bps (SPY), 5 bps (IVV), and 4 bps (VOO). On a
$10,000 holding over a year, this results in fees of $9, $5, and $4,
respectively, whereas on a 100-share trade, a widening of spreads by
one tick would result in a cost of $1.
\964\ See supra Section IV.C.2.b.iv.
\965\ A decline in an ETP's liquidity could also cause demand to
migrate to another type of investment vehicle, such as a mutual
fund, that follows the same investment strategy.
\966\ One commenter noted that ETPs in test groups with
significant rebate reductions or restrictions could be disadvantaged
competitively to similar ETPs not subject to changes to rebates, and
because of the nature of ETPs, may lose market share to their
competitors. See Nasdaq Letter I, at 8. Many commenters agreed with
this argument. See ICI Letter I, at 4; MFS Letter, at 1; Nuveen
Letter, at 2; FIA Letter, at 4; SIFMA Letter, at 4-5; Issuer Network
Letter I, at 3; Schwab Letter, at 3; Fidelity Letter, at 9; Invesco
Letter, at 2; State Street Letter, at 3; Oppenheimer Letter, at 3;
Clearpool Letter, at 7-8; Angel Letter I, at 2; STANY Letter, at 4;
Healthy Markets Letter I, at 11; Cboe Letter I, at 17; NYSE Letter
I, at 7; Morgan Stanley Letter, at 3-4; BlackRock Letter, at 1-2.
One commenter believed that the Pilot could ``unintentionally
advantage ETFs in the lower fee group.'' Credit Suisse Commentary,
at 6.
\967\ See supra Section IV.B.2.d (Market for Assets Under
Management).
\968\ See Vanguard Letter, at 2. Many commenters believed that
ETPs should only be included in the Pilot if an alternative design
was implemented for ETPs, such a placing similar ETPs in the same
group or rotating ETPs between groups. See supra Section II.B.3.b
and infra Section IV.E.5.h for a summary of these comments and
discussions of the costs and benefits of alternative Pilot designs
for ETPs.
---------------------------------------------------------------------------

One commenter stated that these competitive effects are likely to
be more challenging for small or less liquid ETPs that rely on ``market
maker support and require those same firms to provide seed capital
(e.g., capital investments).'' \969\ These commenters raised concerns
that reductions or prohibitions on rebates in certain Test Groups could
exacerbate the anticompetitive effects for the small, less liquid ETPs
in these programs by causing degradation in liquidity provision for
these ETPs.\970\
---------------------------------------------------------------------------

\969\ See Nasdaq Letter I, at 8.
\970\ See id. One commenter noted that 477 ETPs trade less than
2,000 shares per day, while 234 trade between 2,000 and 5,000 shares
per day. In aggregate, these ETPs have approximately $32 billion in
AUM, and the Pilot could adversely impact liquidity provision to
these names leading to unintended investor harm. See Virtu Letter,
at 7.
---------------------------------------------------------------------------

The Commission acknowledges that the Pilot could potentially alter
the competitive dynamics between and demand for similar ETPs that are
placed in different Test and Control groups. The Pilot could
inadvertently create ``winners and losers'' among ETPs through both
competitive shifts and the potential exit of liquidity providers, and
for some ETPs if these costs are severe, could lead to exit by certain
ETPs from the market. However, as discussed in detail above,\971\ since
the Commission does not know ex ante how the Pilot will impact the
liquidity of ETPs, it is unable to quantify the effects that the Pilot
will have on competition between ETPs. One of the goals of the Pilot is
to provide the Commission with data so that it can better evaluate
these effects.
---------------------------------------------------------------------------

\971\ See supra Section IV.C.2.b.iv.
---------------------------------------------------------------------------

In addition to affecting ETP competition through changes in ETP
liquidity, the Pilot could also affect ETP competition through its
effects on ETPs underlying securities. As discussed in detail
above,\972\ if the Pilot impacts the liquidity of the underlying
securities, it could impact the create-redeem process for ETPs. This
could affect the price efficiency of the ETP by impacting the cost to
authorized participants of eliminating mispricing by participating in
the create-redeem process. For example, if the majority of an ETP's
underlying securities are placed in the same Test Group and experience
a decline in liquidity, it could cause the deviation between the ETPs
price and its NAV to increase, i.e., the price of the ETP could deviate
more from the price of its underlying securities. This could cause
demand for the ETP to decline and trading volume to migrate to a
similar ETP with a lower deviation between its price and NAV, whose
underlying securities might not have experienced a decrease in
liquidity.\973\ However, because of the random nature of the assignment
of securities to Pilot groups and the fact that similar ETPs may
experience similar liquidity changes in their underlying securities,
the Commission does not believe that this will have a significant
impact on competition between ETPs.
---------------------------------------------------------------------------

\972\ See id.
\973\ ETPs might not hold all of the securities in the index
that they track. ETPs that track similar indexes may hold different
underlying securities in their representative portfolios.
---------------------------------------------------------------------------

3. Capital Formation
The Commission does not expect the Pilot to have a substantial
permanent impact on capital formation because the Pilot is limited in
duration and because it is not expected to have a large impact on
issuer cost of capital. However, many of the implementation costs
associated with the Pilot would require exchanges to expend resources
that they may have otherwise invested elsewhere or distributed to
shareholders in order to

[[Page 5289]]

maintain the List of Pilot Securities and any changes to those lists,
as well as the maintenance of the Exchange Transaction Fee Summary and
the order routing data.\974\
---------------------------------------------------------------------------

\974\ The costs associated with implementation and compliance
with the Pilot are discussed in more detail above. See supra Section
IV.C.2.a.
---------------------------------------------------------------------------

As discussed above,\975\ the Commission is unable to determine ex
ante the overall temporary impact of the Pilot on liquidity and total
transaction costs, because the Pilot's effects on liquidity could be
positive or negative and vary across securities. As a result, it is
unclear to what degree the Pilot will temporarily promote or harm
capital formation. On one hand, the Pilot could temporarily reduce
total transaction costs for many market participants by consolidating
liquidity and improving execution quality.\976\ 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.\977\ As a result, the 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 Pilot.
---------------------------------------------------------------------------

\975\ See supra Section IV.C.2.b.iv.
\976\ See id.
\977\ One commenter argues that ``the current system increases
transaction costs to the public and . . . increases the issuer
capital costs.'' See Larry Harris Letter, at 9.
---------------------------------------------------------------------------

On the other hand, the temporary reduction in rebates to certain
Test Groups as a result of the implementation of the Pilot could widen
quoted spreads, thereby potentially leading to worse execution prices
and subsequently reducing liquidity for the duration of the Pilot.\978\
This would have similar indirect impacts on capital formation but in
the opposite direction, by increasing the cost of hedging financial
risks.
---------------------------------------------------------------------------

\978\ See Chacko, G.C., Jurek, J.W., & Stafford, E. (2008).
``The Price of Immediacy.'' Journal of Finance, Vol. 63(3), 1253-
1290 (available at: https://onlinelibrary.wiley.com/doi/epdf/10.1111/j.1540-6261.2008.01357.x). 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. See also supra Section IV.C.2.b.iv.
---------------------------------------------------------------------------

Potentially, if the Pilot leads to a significant deterioration in
liquidity for some listed issuers,\979\ longer term, it could affect
capital formation for these securities by increasing the costs for them
to raise capital.\980\ Further, the Pilot could lead to a delay by some
issuers to raise additional capital during the Pilot's duration.\981\ A
number of commenters agreed with these assessments and expressed
concern that random assignment to certain Test Groups could adversely
affect issuers' ability to raise capital or manage their capital
structure, by increasing the cost of secondary offerings or the costs
associated with share repurchase programs.\982\
---------------------------------------------------------------------------

\979\ See supra Section IV.C.2.b.iv.
\980\ See supra Section IV.C.2.b.v.
\981\ Another commenter asserted that the Pilot could harm
thinly traded stocks and the IPO market. See Nasdaq Letter III, at
9. With respect to thinly traded securities, the Commission notes
that the Pilot will exclude NMS stocks that trade less than 30,000
shares per day. The Commission notes that the Pilot will exclude new
publicly traded companies whose IPO occurs after the Pilot
Securities are selected, and therefore the Pilot should not harm the
market for new IPOs. See Section II.C.6. supra (discussing the
exclusion of certain thinly traded securities); see also Section
IV.C.2.b.v. supra (discussing the potential impact of the Pilot on
issuers).
\982\ See e.g., Nasdaq Letter I, at 2; ASA Letter, at 3; ACCO
Letter, at 1; NorthWestern Letter, at 2.; Unitil Letter, at 1-2;
McDermott Letter, at 1; Weingarten Letter, at 1; ProAssurance
Letter, at 1; SMP Letter, at 1; Halliburton Letter, at 1; Era
Letter, at 2; Newpark Letter, at 1; Knight-Swift Letter, at 1;
Avangrid Letter, at 1-2; NYSE Letter I, at 3, 6-7, 13-14; e.g.,
Level Brands Letter, at 1; Johnson Letter, at 1; P&G Letter, at 1;
Sensient Letter, at 1; Apache Letter, at 2; Ethan Allen Letter, at
1-2. See also the discussion in supra Section IV.C.2.b.v (Impact on
Issuers).
---------------------------------------------------------------------------

Several commenters argued that these effects would be worse for
small and medium sized companies.\983\ In theory, if the temporary
impacts on liquidity acutely impact some firms, it could lead to the
potential exit of these issuers from the capital markets, either
through acquisition or delisting. These risks could be greater for
smaller issuers, because they may not possess enough capital to ride
out negative liquidity shocks. However, the Commission does not believe
that this is likely to occur because smaller issuers tend to have high
transaction costs relative to fee and rebates.\984\
---------------------------------------------------------------------------

\983\ See Nasdaq Letter I, at 2; ASA Letter, at 4.
\984\ While the Commission acknowledged this possibility in the
Proposing Release, it did not suggest that such effects were likely.
Rather, the Commission stated that it did not ``expect the proposed
Pilot to have a substantial permanent impact on capital formation .
. . .'' See Proposing Release, supra note 2, at 13068-69.
---------------------------------------------------------------------------

Alternatively, a number of commenters disagreed and did not think
the Pilot would have a significant impact on issuers' ability to raise
capital.\985\ The Commission agrees with these commenters. As discussed
in detail below, due to the limited magnitude of the effects of the
Pilot study, and the uncertain impacts on liquidity, the Commission
does not expect the Pilot will have significant effects on the ability
of firms to raise capital.
---------------------------------------------------------------------------

\985\ See IEX Letter II, at 3-4; Healthy Markets Letter II, at
2; ICI Letter II at 4-5; T. Rowe Price Letter, at 4-5.
---------------------------------------------------------------------------

The 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
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. Such
revisions to portfolio composition as a result of the 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.\986\ 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.
---------------------------------------------------------------------------

\986\ 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., Nielsen, N.C.
(1976). ``The Investment Decision of the Firm under Uncertainty and
the Allocative Efficiency of Capital Markets.'' Journal of Finance,
Vol. 31(2), 587-602 (available at: https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261.1976.tb01908.x) If the 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.
---------------------------------------------------------------------------

One commenter analyzed secondary offerings from its listed issuers
during 2017 and found that lower liquidity was associated with a higher
cost of capital.\987\ The Commission points out that the analysis
performed by this study merely examines associations between spreads
and capital costs and does not establish that wider quoted spreads
cause higher costs of capital.\988\ To supplement this comment,
Commission staff analyzed the same secondary offerings and found that
after controlling for fundamental issuer characteristics, such as size,
book-to-market, and analyst coverage, the size of the quoted spread was
not positively related to issuers' costs of capital.\989\
---------------------------------------------------------------------------

\987\ See NYSE Letter I, at 3.
\988\ One commenter agreed that there is no evidence that
``issuer costs of capital are caused by quoted spreads.'' See IEX
Letter II, at 4.
\989\ Depending on how exchanges measure discounts (a proxy
measure for the cost of capital), whether from the bid price or the
midpoint, there could be mechanical variation imposed simply by
differences on how data vendors measure discounts. Staff analyses
relied on SDC measures of discounts to approximate issuers' costs of
capital, and observed that using the same spread breakpoints,
discounts were approximately 3.6% for issuers with spreads below 20
bps, and 7.6% for issuers with spreads above 20 bps, indicating
differences in methodologies of how discounts are computed can
affect magnitudes. Regardless of the difference in magnitudes of the
discounts, low-spread issuers, on average, had lower discounts than
high spread issuers, consistent with NYSE's spread-discount
relationship. See NYSE Letter I, at 3.

---------------------------------------------------------------------------

[[Page 5290]]

The Commission notes that a temporary effect on transaction costs
may not have the same impact on cost of capital as a permanent effect
on liquidity and does not believe that any temporary increase in
transaction costs resulting from the Pilot could be significant enough
to affect issuers' costs of capital. Indeed, the experience with the
recent Tick Size Pilot provides an example of a temporary change in
liquidity that did not affect cost of capital. While several studies
found that the Tick Size Pilot increased transaction costs,\990\ the
findings of a DERA white paper suggest that the market did not expect
the Pilot to affect stock prices of companies in the Test Groups.\991\
Specifically, the paper finds that the announcement of the assignment
of stocks to the Test Groups and the Control Group did not generate
significant abnormal returns for stocks in the Test Groups, either in
absolute terms or relative to stocks in the Control Group.\992\ Under
the standard assumption that the market's expectations about the
effects of the Pilot were correct, this result indicates that the
increase in quoted spreads and transaction costs during with the Pilot
had no impact on stock prices. Thus, these findings cast doubt on the
idea that temporary changes in transaction costs affected the cost of
capital of small capitalization companies. In addition, because the
Tick Size Pilot enacted a 500% increase in the tick size, that pilot
could arguably have a bigger direct impact on transaction costs than
the Transaction Fee Pilot, which would reduce rebates by 30% of a tick.
---------------------------------------------------------------------------

\990\ See e.g., Hu, E., Hughes, P., Ritter, J., Vegella, P., &
Zhang, H. (2018). ``The Tick Size Pilot Plan and Market Quality.''
SEC White Paper (available at: https://www.sec.gov/dera/staff-papers/white-papers/dera_wp_tick_size-market_quality).
\991\ See Pachare, S. & Rainer, I. (2018). ``Does the Tick Size
Affect Stock Prices? Evidence from the Tick Size Pilot Announcement
of the Test Groups and the Control Group,'' SEC White Paper
(available at: https://www.sec.gov/dera/staff-papers/white-papers/dera_wp_does_the_tick_size_affect_stock_prices). See also fn. 13 in
Albuquerque, R.A., Song, S., & Yao, C. (2018). ``The Price Effects
of Liquidity Shocks: A Study of SEC's Tick Size Experiment.''
Working Paper (available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3081125), reporting on their finding that the
stock prices did not react to the announcement of which stocks were
in the pilot.
\992\ The results were similar when they limit the analysis to
stocks with pre-Pilot quoted spreads smaller than $0.05.
---------------------------------------------------------------------------

One commenter disagreed and believed that the findings of the DERA
white paper were flawed.\993\ This commenter argued that the DERA study
``relies on a selective, narrow, and irrelevant data set'' and that
``focusing on a few days around the time when stocks were assigned to
test groups within the Tick Pilot, and not a materially longer period
of time during which the Tick Pilot's quoting and trading restrictions
were in effect, is a clear indication that DERA narrowly tailored its
study to reach a specific and flawed conclusion.'' \994\ This commenter
stated that it ``does not believe that the White Paper supports any
conclusion regarding the impact of the Tick Pilot on investors or the
potential impact of the Transaction Fee Pilot on issuers.'' \995\
---------------------------------------------------------------------------

\993\ See NYSE Letter V, at 1.
\994\ See id. at 2.
\995\ See id. at 3.
---------------------------------------------------------------------------

However, another commenter noted that ``DERA's event study is
informative to a central criticism'' raised by some commenters that
``upon implementation of the [Pilot], spreads will widen in stocks
chosen for the `low rebate' or `no rebate' buckets and that wider
spreads will harm issuers of the impacted stocks.'' \996\ This
commenter found the ``lack of price impact . . . telling,'' because
``the price of . . . stock is the primary measure'' of ``potential harm
to issuers . . . .'' \997\ This commenter explained that, ``if
liquidity diminishes, or expected returns of the stock decline, this
would be reflected in the value of the stock--and no such statistically
significant decline in value was found.'' \998\ The commenter believed
that the short duration of DERA event study was appropriate because
``markets rapidly incorporate new information'' into stock prices.\999\
The Commission agrees with this commenter and believes that the DERA
white paper used an appropriate methodology to study how the increase
in quoted spreads and transaction costs from the Tick Size Pilot
affected the stock prices and cost of capital of firms in the Test
groups. The Commission believes that the DERA white paper did not rely
on a ``selective, narrow, and irrelevant data set'' and instead picked
the appropriate time period, the few days surrounding publication of
the list of which stocks would be included in the test and control
groups, to examine how the market reacted to the information about
which stocks would have their spreads widen as a result of the Tick
Size Pilot. This approach is standard in the academic literature
because information is quickly incorporated into stock prices at the
time it is made public. The Commission believes that the DERA white
paper is relevant to this Pilot because it examines how a firm's cost
of capital is affected by a temporary widening of the firm's spreads,
which is a potential effect of this Pilot.\1000\ As discussed above and
noted by the commenter,\1001\ if a firm's cost of capital increased as
a result of the wider spreads caused by the Tick Size Pilot, we would
expect that stock's price to decline during the announcement of test
and control groups.
---------------------------------------------------------------------------

\996\ See Verret Letter II, at 1.
\997\ See id. at 2.
\998\ See id.
\999\ See id. at 3.
\1000\ See supra Section IV.C.2.b.iv.
\1001\ See Verret Letter II, at 2.
---------------------------------------------------------------------------

The Commission recognizes that another paper comes to the opposite
conclusion regarding the impact of the Tick Size Pilot on costs of
capital, but does not find the paper convincing. This paper compares
the stock price reactions of stocks in the test and control groups
around the time the Tick Size Pilot was implemented.\1002\ They find
that stocks in the test groups that experienced a decrease in liquidity
when the tick size widened also experienced a decrease in prices,
relative to stocks in the control group, around the time the Tick Size
Pilot was implemented.\1003\ However, it is unclear exactly what the
return differences documented in the study are measuring. If investors
expected that test group stocks would experience a temporary reduction
in liquidity during the Tick Size Pilot and that this would make it
more costly for those stocks to raise capital, then standard economic
assumptions would expect to see a negative stock price reaction for
test group stocks around the announcement of the Tick Size Pilot test
and control group stocks, not during the time period following the Tick
Size Pilot implementation.
---------------------------------------------------------------------------

\1002\ See Albuquerque et al. (2018), supra note 991.
\1003\ The list of stocks assigned to the Tick Size Pilot test
and control groups was announced on September 3, 2016. The rollout
of the Tick Size Pilot was implemented on a staggered basis over
October 2016. See Hu et al. (2018), supra note 990.
---------------------------------------------------------------------------

Given the results of the DERA study and the uncertainty surrounding
the Albuquerque et al (2018) results, combined with the fact that the
average trading cost increase, i.e. decrease in liquidity, during the
Tick Size Pilot is greater than the expected potential effects on
liquidity during the Transaction Fee Pilot, the Commission

[[Page 5291]]

believes that the costs of capital are unlikely to significantly
increase for Test Group stocks due to a temporary decrease in liquidity
during the Transaction Fee Pilot. Because the Tick Size Pilot was
conducted on firms with small market capitalizations, this should also
help alleviate concerns for small to mid-capitalization issuers about
temporary decreases in liquidity increasing the costs related to
raising capital. One commenter agreed that, although some issuers may
have temporary widening of spreads over the Pilot duration, any changes
to liquidity caused by the Pilot are unlikely to affect the costs to
firms when raising capital.\1004\ Therefore, the Commission does not
believe that issuers, including small and mid-capitalization issuers,
will experience significant increases in the cost of capital as a
result of the Pilot.
---------------------------------------------------------------------------

\1004\ See IEX Letter II, at 3-4.
---------------------------------------------------------------------------

E. Alternatives

The Commission considered several alternatives to the Pilot,
including: (1) Proceed to propose rule amendments without first
conducting a Pilot; (2) expand the Pilot to include off-exchange
venues, including ATSs; (3) include a trade-at provision; (4) conduct
alternative pilots; and (5) adjust the design of the Pilot (e.g.,
including a number of alternatives proposed by commenters).
1. Propose Rulemaking Without Conducting a Pilot
Several commenters suggested that the Commission should proceed
with rulemaking rather than first conducting the Pilot. For example, as
discussed elsewhere in this release,\1005\ as an alternative to
conducting the Pilot, one commenter suggested that the Commission
impose a ``gradual reduction of the current fee cap across all stocks
periodically.'' \1006\ Such an approach would address the concerns
raised by a number of commenters, discussed above, about the potential
impact on largely identical ETPs and listed issuers that are placed in
different test groups, without the added cost and complexity of
rotating stratified samples through the Pilot.\1007\ In addition, such
an approach could provide data on successive reductions in the current
fee cap, which could be useful to the Commission if it considers future
policy making to reduce the Rule 610(c) fee cap.
---------------------------------------------------------------------------

\1005\ See supra Section II.C.8(g) and (h) and Section IV.E.4.
\1006\ Morgan Stanley Letter, at 2.
\1007\ See supra note 104 and accompanying text.
---------------------------------------------------------------------------

However, depending on the number of fee caps to be tested, this
alternative would increase instability in the markets in terms of the
fee regime that markets are subject to. This would occur because the
cap would be reduced successively and linearly and each tranche would
need to be in place for a sufficient amount of time in order to obtain
statistical power. Further, without a control group, researchers would
be unable able to conduct a differences-in-differences analysis as the
data would be subject to the impact of events across time, which would
frustrate the ability of researchers to compare groups to one another
over time. The Commenter was open to having a control group not subject
to the decline in fees, which would allow for identifying causality.
However, even with the inclusion of a control group, this alternative
would still increase the time in which markets are subject to
instability in fees and rebates and the time needed to understand the
impact of fees and rebates because at each different fee level the
Commission would need to test that fee level for a sufficient time to
gain statistical power. Further, including a control group in this
alternative could potentially result in different treatment for largely
identical ETPs, as in the adopted Pilot, but with an increase in the
potential time needed for study.
Alternatively, this commenter suggested that the Commission
implement ``dynamic, stock specific ticks with transaction fees capped
at, for example, 10% of the tick size (e.g. $0.0010 per share if a
penny tick; $0.0050 per share if a nickel tick.)'' \1008\ Another
commenter suggested that, rather than pursuing the Pilot, the
Commission should amend Rule 610(c) to reduce the access fee cap to
$0.0010 and also conduct ``an abbreviated study of the effects of
eliminating rebates'' similar to the ``no-rebate'' Test Group.\1009\
One commenter recommended that the Commission ``ban maker-taker and
inverted transaction fee pricing as well as all volume-based discounts
that are not clearly and directly related to cost savings'' \1010\
while another suggested that the Commission enhance the duty of best
execution in lieu of a pilot.\1011\
---------------------------------------------------------------------------

\1008\ Id. at 2-3.
\1009\ Goldman Sachs Letter, at 1-4.
\1010\ Larry Harris Letter, at 9.
\1011\ See Nasdaq Letter, at 1, 3.
---------------------------------------------------------------------------

Several commenters opined on the potential benefits and reduced
costs of these alternatives as compared to proceeding with the Pilot.
For example, according to one commenter, a gradual ``walk down''
approach would be preferable to the Pilot because it would allow the
Commission to ``observe order routing behavior changes, while applying
the same economics to all stocks uniformly'' and would ``eliminate
concerns about issuers being subject to disparate treatment.'' \1012\
According to this commenter, it also would ``eliminate[ ] concerns that
the Pilot results will not reflect the actual outcome if such changes
are applied more broadly to stocks outside of the Pilot.'' \1013\
Similarly, another commenter noted that it would be ``more effective
and less damaging to the equities market to strengthen and better
articulate the broker-dealers' Duty of Best Execution'' than proceeding
with the Pilot, which the commenter believed would impost ``tremendous
costs'' to investors and potentially ``upend[ ] the existing economics
and framework around equity executions.'' \1014\ Further, one commenter
noted that because ``there is broad recognition'' that the access fee
cap should be reduced, there is no need to incur the costs associated
with the Pilot and the Commission should simply reduce the fee cap to
$0.0010 to ensure that displayed prices reflect the actual economic
costs of an execution, while also allowing exchanges to continue to
offer rebates to incentivize liquidity provision if they chose to do
so, while also maintaining their net capture rates.\1015\ This
commenter believed that lowering the fee cap to $0.0010 would provide
``immediate benefits to the equities markets with respect to price
transparency and addressing conflicts of interest'' \1016\ and would be
``better calibrated with today's market pricing.'' \1017\ Another
commenter argued that ``the effects of maker-taker and inverted
transaction fee pricing on the markets are well understood'' and
therefore concluded that it was very unlikely that ``we will learn
anything of value about the economics of exchange transaction fee
pricing'' from the Pilot.\1018\ Consequently, this commenter believed
that the Commission should mandate that the exchanges return to a
traditional transaction fee pricing

[[Page 5292]]

model, which the commenter believed would not result in much cost to
market participants.\1019\
---------------------------------------------------------------------------

\1012\ Morgan Stanley Letter, at 2.
\1013\ Id. at 2.
\1014\ Cboe Letter I, at 12, 21-22. See also Nasdaq Letter I, at
2 (referring to the Pilot as a ``risky experiment'').
\1015\ Goldman Sachs Letter, at 1, 3.
\1016\ Id. at 1-3.
\1017\ Id. at 4.
\1018\ Larry Harris Letter, at 9-11. See also Goldman Sachs
Letter, at 4 (stating there is ``broad support in favor of lowering
the Fee Cap today,'' and the Pilot ``will not yield a different
conclusion.'').
\1019\ Id.
---------------------------------------------------------------------------

However, other commenters strongly supported the Pilot as a first
step because it ``should provide data to enable the Commission to
determine the impact of transaction-based fees and rebates on order
routing behavior, on execution quality and on market quality'' and
believed the data collected would ``support appropriate reforms to U.S.
equity market structure.'' \1020\ Among those who supported conducting
the Pilot before considering rulemaking, one commenter noted the lack
of information regarding the rebates paid by each exchange to each
broker and stated that such lack of disclosures ``reinforce the
difficulty in assessing the impact of the structure of a[cc]ess fees on
distorting best execution, conflict[s] of interest and competitiveness
of exchange pricing.'' \1021\ Still another commenter opined that the
Pilot ``is a necessity'' to provide a ``quantitative approach to which
stocks require liquidity support and how much a rebate should be to
incent support.'' \1022\
---------------------------------------------------------------------------

\1020\ RBC Letter I, at 2.
\1021\ Spatt Letter, at 4.
\1022\ Babelfish Letter, at 3.
---------------------------------------------------------------------------

The diversity of opinion and lack of consensus among the commenters
regarding the impact of fees and rebates on market quality and order
routing behavior support the view that further study in this area is
warranted before permanently adopting any changes through rulemaking.
As discussed above, there was sharp disagreement between commenters
about the potential impacts of reductions in fees and rebates, yet
there is little data available to evaluate these claims on a broad
scale. As discussed above, the Commission believes that there is no
need to delay proceeding with the Pilot in order to pursue other
potential equity market structure initiatives. Equity market structure
issues have been considered for a number of years and, as a result of
several initiatives in this area, the Commission has developed the
Pilot, which is focused on and is intended to gather empirical evidence
on the impact of exchange transaction fees and rebates. Similarly, the
Commission does not believe that it needs to complete the Pilot before
proceeding to consider all other equity market structure initiatives.
The Commission expects that it will continue to evaluate the need for
other changes to equity market structure during the pending of the
Pilot.
2. Expand Transaction Fee Pilot To Include Non-Exchange Trading Centers
The Transaction Fee Pilot would not require ATSs or other non-
exchange trading venues to comply with the limits to transaction fees
or rebates imposed by the Pilot. Some commenters believed that non-
exchange trading centers should be included in the Pilot and that the
representativeness of the data obtained from the Pilot would be
impaired by the exclusion of ATSs and other off-exchange trading
centers.\1023\ For example, one commenter stated that the Pilot ``would
not gather any insight into the trading patterns at those centers''
because the Commission would be unable to ``follow order flow across
all trading venues in the market, leaving it with an incomplete picture
of the issue it seeks to study.'' \1024\ Another commenter believed
that excluding non-exchange trading centers could skew the results of
the Pilot, as broker-dealers could shift order flow away from exchanges
in response to the Pilot, thereby limiting the Commission's
understanding of the overall impact of changes to transaction-based
fees and rebates.\1025\
---------------------------------------------------------------------------

\1023\ See Section II.A.4 for a summary of these comments. Some
commenters believed that non-exchange trading centers should only be
subject to the rebate prohibitions of the no-rebate Test Group. See,
e.g., Capital Group Letter, at 3; AJO Letter, at 1; Nasdaq Letter
III, at 9.
\1024\ NYSE Letter I, at 9. See also, e.g., Cboe Letter I, at
12, 19; Nasdaq Letter I, at 2, 5; ViableMkts Letter, at 1-2.
\1025\ Wellington Letter, at 2. See also, e.g., Oppenheimer
Letter, at 3. One commenter also believed that the Pilot could
affect the way that securities are traded off-exchange and confound
the Commission's ability to understand the baseline for remuneration
occurring off-exchange or the impact that the Pilot has on that
baseline. Nasdaq Letter I, at 7. The Commission does not believe
that its ability to analyze the impact of changes to transaction-
based fees and rebates will be unduly limited, due to information
that is now available from Regulation ATS-N and Rule 606.
---------------------------------------------------------------------------

An alternative design that includes non-exchange trading centers
like ATSs would be broader than the Pilot--not only because such a
design would include more trading venues, but also because such a
design would have to account for the fact that non-exchange trading
centers like ATSs use other inducements, besides transaction-based fees
and rebates, to incent order flow.\1026\ The inclusion of non-exchange
trading centers could, therefore, supply information about a more
complete set of order routing decisions, increase the
representativeness of the results obtained, and provide a deeper
understanding regarding the ways in which exogenous shocks to
transaction-based fees and rebates (and other inducements) affect order
routing decisions. For example, a pilot that included non-exchange
trading centers, and regulated the inducements used by such centers,
might impact payment for the internalization of retail order flow,
which would allow researchers to evaluate how these inducements affect
retail order routing. A pilot that addressed payment for order flow on
non-exchange trading centers could, in turn, result in more retail
order flow being routed to lit exchanges, which also could increase
displayed liquidity and potentially improve price efficiency.
---------------------------------------------------------------------------

\1026\ See, e.g., Morgan Stanley Letter, at 3 n.5; BIDS Letter,
at 1-2; AJO Letter, at 2.
---------------------------------------------------------------------------

However, the inclusion of non-exchange trading venues may be
difficult to implement. First, non-exchange trading venues charge
idiosyncratic and individually-negotiated fees to market participants,
and often bundle fees for ATS usage with other broker-dealer fees, such
that it would be exceptionally difficult to create and then impose a
uniform fee regime on such venues.\1027\ For example, it is unclear how
an ATS that charges an ``all in'' flat fee for service and does not
charge individually for executions would be able to comply with a
transaction-based fee cap. To comply with the Pilot's transaction-based
pricing restrictions, non-exchange venues may be required to entirely
restructure their customer relationships to move to a transaction-based
pricing model for the duration of the Pilot, which would impose notable
costs on those venues. Further, any alternative design would address
other inducements provided by non-exchange trading centers aside from
transaction-based fees and rebates, in order to produce a fully
accurate analysis of the impact of fees and inducements on order
routing behavior, market quality, and execution quality. Such a design
would be much more complex that the current Proposal. Finally, an
alternative design that included non-exchange trading centers also
would impose costs on such venues that would be higher relative to the
costs imposed on exchanges under the current design, because the Pilot
would require non-exchange trading venues to track and report more
detailed information than is currently required by the

[[Page 5293]]

Commission.\1028\ As discussed above, exchanges are required to file
each fee change with the Commission on Form 19b-4 and to disclose the
entirety of their schedule of fees on their website, while non-
exchanges venues are not subject to those requirements. Thus, including
non-exchange trading venues in an alternative version of the Pilot
would likely increase the costs of the Pilot because it would require a
dramatic shift in the disclosure regime for these trading centers.
---------------------------------------------------------------------------

\1027\ See, e.g., AJO Letter, at 2-3. It is possible that non-
exchange trading venues might respond to the Pilot by choosing to
change their existing fee structures to align with the maker-taker
(or taker-maker) pricing models employed by exchanges, which could
lead to additional costs for such venues. See, e.g., Virtu Letter,
at 6; SIFMA Letter, at 5; Clearpool Letter, at 4; Healthy Markets
Letter I, at 9-10.
\1028\ Although Form ATS-N requires ATSs to provide public
disclosures about the different types of fees they charge, along
with the ranges of those fees and service bundling, these
disclosures do not provide as much information as the fee
disclosures that will be required by the Pilot.
---------------------------------------------------------------------------

Although the Pilot excludes non-exchange trading centers, the
Commission will still be able to obtain information regarding the
proportion of trades executing on such platforms 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 on individual ATSs.\1029\
Thus, researchers would obtain information from the Pilot to identify
whether exogenous shocks to 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 Pilot.
---------------------------------------------------------------------------

\1029\ By 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.
---------------------------------------------------------------------------

3. Trade-At Test Group
The Commission considered an alternative in which the Transaction
Fee Pilot would include a ``trade-at'' provision in conjunction with
the changes to the fees and rebates currently in the Pilot. The trade-
at alternative would require that orders be routed to a market with the
best displayed price or are executed at a materially improved price.
Some commenters supported including a trade-at subgroup to provide
supplemental information to the Commission about how a combination of
trade-at provisions coupled with revisions to transaction-based fees
and rebates affect broker-dealer order routing decisions.\1030\ Some
other commenters, however, asserted that including a trade-at
requirement could compromise the results of the Pilot as it would
introduce an additional variable to one or more treatment groups.\1031\
To address this concern, the Pilot could include separate test
subgroups that also include a trade-at requirement, in addition to
requirements regarding transaction fees and/or rebates.
---------------------------------------------------------------------------

\1030\ See, e.g., Adorney Letter, at 1; Birch Bay Letter, at 1;
NYSE Letter II, at 5.
\1031\ See, e.g., See Citadel Letter, at 6; Fidelity Letter, at
10; Citigroup Letter, at 3; SIFMA Letter, at 4; TD Ameritrade
Letter, at 7; Virtu Letter, at 5; ICI Letter I, at 2.
---------------------------------------------------------------------------

Such an approach would require including more stocks in the Pilot.
If the amount of securities in each Test Group were too small, the
Pilot results would not achieve statistical power. Accordingly, in
order to provide information on the impacts of an exogenous shock to
transaction fees and rebates while also providing additional
information on the effects of a trade-at requirement, the Pilot either
would need to increase the number of Pilot securities or add to its
duration.
The expected impact on liquidity of the inclusion of a trade-at
test group is unclear. The recently concluded Tick Size Pilot included
a trade-at test group. The Tick Size Pilot included a trade-at group
because exchanges were concerned that, in the current market
environment, a significantly larger tick size could induce order flow
to go off exchange.\1032\ For the Transaction Fee Pilot, commenters
were split on whether marketable order flow will be more or less likely
to flow to off-exchange trading centers, with some believing that as
access fees for some test groups decline, order flow could be drawn
back to exchanges. However, in considering the Tick Size Pilot, it is
important to note that it only considered the impacts of trade-at when
the tick size was increased and only for smaller, less liquid stocks.
The effects might not be the same with 1 cent tick size and more liquid
stocks that are included in the Pilot. One commenter noted that in the
trade-at test group for the Tick Size Pilot, the number of shares
displayed at the NBBO increased and quote volatility was reduced in the
trade-at test group relative to the other test groups.\1033\
Nevertheless, analysis of the Tick Size Pilot data does not reveal
significant execution quality or market quality effects of a trade-at
rule. Specifically, the data suggests there was no change in effective
spreads or price efficiency due to the trade-at requirement.\1034\
Results from the Tick Size Pilot also suggest that trade-at impacts
trade location. Specifically, off-exchange share of trading volume
decreased and on-exchange market share increased, particularly at
inverted exchanges. However, volume for midpoint crossing off-exchange
venues increased, but this could be the result of the midpoint
exception to the Tick Size Pilot's trade-at requirements.\1035\ This
shift in trading volume may occur because a trade-at provision
increases incentives to display prices because 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. These
findings suggest that the inclusion of a trade-at test group may
benefit exchanges, which may experience increased trading volumes, but
be costly for off-exchange venues, which may lose trading volume.
---------------------------------------------------------------------------

\1032\ See Tick Size Pilot Approval Order at 27538-42. As
discussed above in Section IV.D.2, a number of commenters have
expressed similar concerns with respect to the Transaction Fee
Pilot, whereby a reduction in rebates could widen spreads and lead
to a migration of order flow to off-exchange trading centers. In the
Tick Size Pilot, the trade-at provision applied when the tick size
was increased and only smaller, less liquid stocks were included in
that pilot. The Transaction Fee Pilot, on the other hand, also will
include more liquid stocks and does not test the wider tick
increments that were the subject of the Tick Size Pilot, so the
effects of trade-at may or may not be the same between the two
pilots.
\1033\ See Birch Bay Capital Letter, at 1. Other commenters that
supported the inclusion of a trade-at test group. See, e.g., C&C
Letter, at 1. But see Citadel Letter, at 6 (noting that there was no
evidence of improvement in market quality in the trade-at test
groups in the Tick Size Pilot).
\1034\ Id. at 990. See also Farley, Ryan and Eric Kelley and
Walter Puckett, Dark Trading Volume and Market Quality: A Natural
Experiment (April 3, 2018) available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3088715.
\1035\ See Comerton-Forde, Carole and Gregoire, Vincent and
Zhong, Zhuo, Inverted Fee Structures, Tick Size, and Market Quality
(August 10, 2018), Journal of Financial Economics (JFE),
Forthcoming, available at SSRN: https://ssrn.com/abstract=2939012 or
https://dx.doi.org/10.2139/ssrn.2939012.
---------------------------------------------------------------------------

4. Alternative Pilot
One commenter suggested an alternative to the Pilot that would
involve directly lowering the Rule 610(c) access fee cap to $0.0010 and
establishing a moratorium on fee increases for existing market data,
connectivity, and co-location services.\1036\ The commenter believed
its alternative would allow a direct test of the ``anachronistic''
610(c) fee cap level and make exchange fees more competitive with non-
exchange venues.\1037\ In addition, similar to the other alternative
discussed directly above, it would impose a lower cap on

[[Page 5294]]

all NMS stocks simultaneously and thereby address the potential
competitive impact on largely identical ETPs and listed issuers. The
commenter suggested this alternative would reduce the complexity of
implementation and would avoid ``introducing new classes of
restrictions'' including prohibition on payment of transaction-based
rebates.\1038\ Further, in linking transaction fees to market data and
connectivity fees, the commenter suggested that its alternative would
address commenters' desire ``to reduce their cost to trade'' without
banning rebates for liquidity provision, which it argued could
negatively impact displayed quotes.\1039\
---------------------------------------------------------------------------

\1036\ See NYSE Letter III, at 3; see also Issuer Network Letter
II, at 4.
\1037\ See id.
\1038\ See id. The commenter also suggested that avoiding this
``new class of restrictions'' would limit the ``likelihood of court
challenge'' to the Pilot. Id.
\1039\ See id.
---------------------------------------------------------------------------

However, the combined fee cap and moratorium would not feature a
control group. While the commenter suggested the Commission could ``use
comparisons to the preceding period to evaluate its efficacy,'' the
absence of a control group could frustrate researchers' ability to
detect changes as the results could be influenced by short-term
external events. This alternative also does not directly test the
absence of rebates.
Further, the direct link between transaction fees and market data
and connectivity fees is unclear in the context of the Pilot's
objectives. In particular, the potential distortions that can accompany
fee-and-rebate pricing models are unique to exchange transaction fee-
and-rebate pricing models and do not directly result from market data
and connectivity services. It is therefore unclear how the moratorium
on market data fees would impact the objective of the Pilot to study
how rebates and fees affect order routing decisions and market quality.
Finally, the commenter's suggested moratorium would only apply to
``existing'' market data and connectivity and would therefore preserve
current fee levels for those services and would seem to not restrict an
exchange's ability to offer new and improved market data, connectivity,
and co-location services potentially at higher fee levels. While a
moratorium on market data and connectivity fees during a transaction
fee experiment could be beneficial to the extent it holds steady a
separate variable that can have a marginal impact on order routing,
those costs are fixed and therefore the impact, if any, would be
slight. Further, to the extent that exchanges were free to introduce
new products at different price points, the moratorium could be easily
circumvented. Accordingly, with the exception of the moratorium on
market data fees, the suggested alternative is substantively similar to
the alternative discussed above to not conduct any pilot and instead
proceed to immediately lower the 610(c) fee cap.
5. Adjustments to the Transaction Fee Pilot Structure
The alternatives described above provide significant revisions to
the approach or the representativeness of the Transaction Fee Pilot.
This section complements and expands on the discussion in Section
II.C., above, to discuss a number of alternatives and adjustments to
the basic structure of the Pilot. 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 Group 1.
a. Length of the Core Pilot
The core Pilot would last for two years with an automatic sunset at
the end of the first year unless the Commission publishes a notice
determining that the Pilot shall continue for up to one additional
year.\1040\ Alternatively, the Pilot could feature an earlier or later
Pilot sunset or a longer or shorter Pilot duration. As discussed above
in Section II.D., a number of commenters discussed the proposed Pilot
duration, with some believing the proposed duration would incentivize
participation and disincentivize ``waiting out'' the Pilot, with others
believing that a shorter duration would be sufficient to produce
results and still others recommending that the Pilot run for a full two
year period with no automatic sunset. Further, one commenter questioned
the Commission's statement that the market reacts quickly to pricing
changes implemented by exchanges, but that some market participants
might not change their behavior unless the Pilot was in place for at
least a year.\1041\
---------------------------------------------------------------------------

\1040\ See supra Section II.D. for a summary and discussion of
the commenters discussing the Pilot's proposed duration.
\1041\ See NYSE Letter I, at 16.
---------------------------------------------------------------------------

As alternatives to the Pilot's duration, the Commission considered
an earlier Pilot sunset that would shorten the anticipated Pilot
duration, reducing the time period during which potential negative (or
positive) temporary effects resulting from the Pilot could occur.
However, if the anticipated duration of the Pilot were too short, some
broker-dealers could 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.\1042\ In other
words, in response to the comment noted above, while many market
participants may quickly adopt their order routing in response to fee
and rebate changes, others may take longer to respond. A shorter
anticipated duration also could reduce the usefulness of the
information and the benefits provided by the 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.\1043\
---------------------------------------------------------------------------

\1042\ See infra Section IV.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 Pilot had a short duration.
\1043\ To address commenter concerns about the size of the
Pilot, the Commission performed a supplemental analysis that refined
the power analysis included in the Proposing Release. Based on this
refined power analysis, the Commission estimates that it would
require a minimum Pilot duration of 12 months to achieve sufficient
statistical power to detect whether an effect is actually present;
therefore, any Pilot duration shorter than 12 months would have
diminished ability to detect the effect of transaction-based fees
and rebates on order routing decisions, execution quality, and
market quality. See Section IV.C.1.a.ii.(1) and supra note 695 for
further information on this supplemental analysis.
---------------------------------------------------------------------------

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
Pilot requirements. However, all else being equal, increasing the
duration beyond the automatic sunset at one year, or up to the maximum
two years, is unlikely to provide any significant increases in the
benefits identified above, unless some event occurs during the first
year that impacts the Pilot study in a way that potentially could make
the results unrepresentative, in which case an extension of the Pilot
for additional time (up to two years) could increase the benefits. As
discussed in Section IV.C.1.a.i, the Commission believes that the Pilot
duration 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 Pilot or retain pre-Pilot order routing decisions for its
duration. Further, a longer Pilot duration would increase the exposure
of market participants to the uncertain outcomes of the pilot in terms
of liquidity, trading volume, market

[[Page 5295]]

share, competition etc. that are discussed above.
The Commission could alternatively adopt 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. 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
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 Pilot.
b. Length of Pre- and Post-Pilot Periods
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 Pilot restrictions as well as across stocks in different
test groups. Alternatively, the Commission could adopt shorter pre-
Pilot and post-Pilot Periods, which a few commenters recommended.\1044\
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 reduced ability of the Pilot to produce representative
results.\1045\
---------------------------------------------------------------------------

\1044\ See IEX Letter I, at 4; FIA Letter, at 4. But cf. FIF
Letter, at 9; Health Markets Letter I, at 19.
\1045\ The Commission staff estimates that with the given number
of stocks in the Pilot, that the Pilot would need to produce
approximately six months of pre and post Pilot data to detect
changes unique to ETPs and stocks, 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 for stocks
and a 10% change in quoted spreads for ETPs.
---------------------------------------------------------------------------

In particular, 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 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.
c. Zero Access Fee Test Group
As discussed above, a few commenters recommended that the Pilot
include a zero access fee test group to further test the relationship
between exchange fee models and order routing, which would effectively
serve to temporarily remove a source of revenue for exchanges entirely
from a subset of securities.\1046\ This approach could produce
additional information, such as how order routing behavior and
execution quality change 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.
---------------------------------------------------------------------------

\1046\ See, e.g., Healthy Markets Letter I, at 8; OMERS Letter,
at 2.
---------------------------------------------------------------------------

The inclusion of a zero access fee test group would 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 with uncertain outcomes for both exchanges and market
participants. Doing so presents the risk that if coupled to the current
Pilot, the inclusion of a zero access fee test group could contaminate
the analysis of both the current test groups and the zero access fee
test group. This could occur if exchanges determine that it is cheaper
to subsidize trading in the zero access fee group with revenue earned
from the control group and the other test groups. In this case the
inclusion of the zero access fee test group would alter the behavior of
the exchanges with regard to all their other securities, which would
weaken the exogeneity of the shock imposed by the Pilot for all test
groups.
d. Alternative Test Groups
As discussed above, the Pilot will have two test groups: (1) One
that caps access fees at $0.0010 and (2) 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 instead have proposed only caps
on access fees (i.e., fees for removing liquidity), similar to those in
the EMSAC recommendation,\1047\ or could have increased the number of
test groups to test more gradations in alternative fee caps. As a few
commenters suggested, and as discussed above, the Commission also could
have included a test group with a higher fee cap level than Rule 610(c)
or no cap on fees at all.\1048\ Further, as discussed above, a few
commenters suggested other alternatives, like basis point pricing or
pricing based on the tick size.
---------------------------------------------------------------------------

\1047\ 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).
\1048\ See, e.g., Angel Letter II, at 2; Cboe Letter I, at 28
---------------------------------------------------------------------------

Many alternatives would have replaced the no-rebate test group with
another access fee cap group. These options could provide information
to help refine the analysis of the impact of access fees on various
market outcomes. However, if the Pilot did not include a no-rebate test
group and only studied exogenous shocks to access fees, it would
produce more limited information about the role that rebates play in
affecting market outcomes. As discussed in more detail above, the
Commission believes that it is important to have a test group that
specifically focuses on the removal of rebates and the corresponding
impact on conflicts of interest, execution quality, and market quality.
An alternative to increase the number of test groups to study the
impact of the various levels of access fee on various market outcomes
could produce additional refinement to the data currently in the Pilot.
However, to produce more gradation in the caps to access fees, would
increase the complexity of the Pilot, and potentially increase the
implementation costs to account for the additional test groups.
Increasing the number of test groups would also increase the number of
stocks subject to the pilot thereby increasing the fraction of the
market exposed to the uncertain outcomes of the Pilot.
e. Non-Displayed Liquidity and Depth of Book
Only Test Group 2, which eliminates rebates or Linked Pricing,
would restrict

[[Page 5296]]

fees or rebates or Linked Pricing in non-displayed liquidity and depth-
of-book, though a small number of commenters suggested expanding those
conditions to Test Group 1.\1049\ As discussed in Section II.C., under
the Pilot, 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 depth of the book as well as for displayed
and non-displayed liquidity. If an exchange were to offer rebates for
those types of orders, it would reduce the benefits of the no-rebate
test group as it would inhibit the Commission's ability to collect data
on a treatment group in which rebates do not exist and thus cannot
impact or potentially distort the markets and market participants.
---------------------------------------------------------------------------

\1049\ See Clearpool Letter, at 3-4; Healthy Markets Letter I,
at 16.
---------------------------------------------------------------------------

An alternative could have applied the transaction fee restrictions
in Test Group 1 to both non-displayed liquidity and the depth-of-book.
However, the Commission believes this is unnecessary. In particular,
the Commission does not believe that exchanges would have the incentive
to charge higher fees or pay higher rebates for executions against or
of non-displayed and depth of book compared to fees and rebates charged
against or of top-of book depth in Test Group 1 securities. Unlike the
problem associated with exchanges offering rebates (in the no-rebate
test group) for these types of orders that could emerge if rebates or
Linked Pricing were not prohibited across the entire depth of the limit
order book, the Commission does not believe that under the Pilot
incentives would emerge for exchanges to charge higher fees to access
non-displayed interest or depth-of-book quotes. Charging more for 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 and would be
uncertain of their fees when they enter their orders. 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.
f. Linked Pricing
Test Group 2 will prohibit rebates and Linked Pricing. As discussed
above, a few commenters suggested that the Commission also prohibit
exchanges from offering other inducements, including discounts on non-
transaction fees that are linked to trading volumes in the no-rebate
Test Group.\1050\ While such an approach would have the added benefit
of testing a greater absence of exchange-offered inducements, it would
further increase costs and add to the complexity and scope of the
Pilot. As currently designed, the no-rebate Test Group is intended to
test the extent to which exchange rebates introduce potential
distortions to execution quality and market quality and introduce
conflicts of interest in order routing. Adding more variables to the
Pilot will increase its complexity, size, and cost, while potentially
reducing benefits by inhibiting the Commission's stated focus on
gathering data specifically on the impact of exchange transaction
rebates. With more variables, it becomes difficult to isolate the
impact of any particular change without dramatically expanding the
size, scope, and complexity of the Pilot.
---------------------------------------------------------------------------

\1050\ See RBC Letter I, at 3; MFS Letter, at 2-3.
---------------------------------------------------------------------------

Alternatively, the Commission could instead prohibit only rebates,
without also prohibiting Linked Pricing, in Test Group 2. While such an
approach would reduce costs and simplify the Pilot design, it could
reduce the benefits of Test Group 2. Specifically, one of the aims of
Test Group 2 is to examine the impact between take fees (rebates) and
make rebates (fees) in current exchange fee-and-rebate pricing models.
For example, as discussed above, fees may be set above their
equilibrium price (within the current regulatory structure) in order to
subsidize rebates. An alternative that prohibits rebates but not the
ability of an exchange to cross-subsidize make rebates from take fees
(or vice versa) would provide opportunities for exchanges to work
around the rebate prohibition thus perpetuating the potential
subsidization distortion. Consequently, such an alternative would
reduce the benefits of Test Group 2 by reducing the effectiveness of
the information received about NMS stocks in the no-rebate Test Group.
Finally, the Commission could ban Linked Pricing for all market
participants in Test Group 2, including market makers. This alternative
would allow the Commission to study how markets react in the absence of
both rebates and Linked Pricing incentives, whereas the adopted Rule
does not allow this analysis. The Commission recognizes that banning
Linked Pricing in Test Group 2 may yield different results than under
the adopted Rule, which permits an exchange to adopt rules to provide
non-rebate Linked Pricing to its registered market makers in
consideration for the market maker meeting rules-based market quality
metrics. However, the Commission is interested in specifically
exploring the effect of eliminating rebates, but continuing to allow
Linked Pricing for a narrow, targeted segment of the market, i.e.,
market makers with specific obligations designed to improve an
exchange's market quality without the various effects previously
discussed that may be associated with rebates, in order to understand
any effects of rebates on liquidity. In so much as this is an
alternative that could be considered at the completion of the Pilot,
the Commission seeks to test specifically for this scenario.
g. Execution Quality Data
The Pilot does not require the exchanges to produce publicly
available information on order execution quality statistics. As an
alternative, the Commission could require that the exchanges produce
daily order execution quality statistics similar to that required in
Appendix B.1 of the Tick Size Pilot Plan. Compared to the Pilot, this
alternative could provide information on order-based measures of
execution quality such as effective spreads, price improvement, and
realized spreads for liquidity taking orders, in addition to the trade-
based measures available from public data sources. As noted in the
baseline, order-based measures of execution quality from the
incorporation of order size and the costs of latency. Exchanges
currently have systems in place to produce daily order-based execution
quality data, which would limit implementation costs. However, the
Commission recognizes that exchanges incur ongoing costs to produce
these data.
Unlike for the Tick Size Pilot, the Commission does not believe
that daily order-based execution quality statistics are as important
for the Transaction Fee Pilot as it was for the Tick Size Pilot and
that the benefits for the Transaction Fee Pilot could be marginal. In
particular, the Commission believes that trade-based execution quality
statistics will be sufficient to measure execution quality for
liquidity taking orders and notes that the order routing data to be
received by the Commission will contain data that

[[Page 5297]]

can facilitate the measurement of execution quality for liquidity
providing orders.
h. Excluding or Rotating Securities
As discussed above in Section II.B., some commenters were concerned
that the Pilot could introduce unintended adverse competitive effects
for ETPs or corporate issuers that were placed in certain test groups
if those test groups resulted in negative impacts on the trading
characteristics of those securities. Accordingly, some commenters,
discussed above, recommended either excluding ETPs from the Pilot,
clustering ETPs following similar strategies into a single test group,
or rotate ETPs through the various test groups and the control
group.\1051\ Other commenters, discussed above, suggested allowing
issuers to opt out of the Pilot.\1052\ The benefits of such an approach
would be the avoidance of potential harm or disparate impact on a
particular ETP or issuer vis-[agrave]-vis its peers and primary
competitors. As discussed more fully above, that potential for harm is
uncertain at best and commenters held deeply conflicting views with
some asserting that the Pilot could cause widespread harm while others
argued that its impact will be mostly positive when considering the
potential distortions that will be mitigated or alleviated in the
absence of exchange rebates or lower fees.
---------------------------------------------------------------------------

\1051\ See supra Section II.B.
\1052\ See id.
---------------------------------------------------------------------------

Although there is a potential for temporary competitive effects as
a result of the Pilot, outright exclusion of ETPs or clustering like
ETPs in the same test group would harm the representativeness of the
data produced by the Pilot or the ability of the Pilot to facilitate
causal analyses. Exclusion of ETPs, for example, could undermine the
ability of the Commission to use the Pilot results to inform future
policy making with respect to exchange fees, particularly if ETPs have
the potential to respond differently to changes to fees and rebates
than do other types of NMS stocks.
Similarly, as discussed above, allowing issuers to opt out of the
Pilot could undermine the representativeness of the Pilot's treatment
groups and potentially bias the Pilot's results, depending on the
number of issuers that opt out and whether some unobservable
characteristic is correlated with both an issuer's decision to opt out
and market outcomes. In turn, the benefits of the Pilot would be
reduced if researchers are less able to draw specific conclusions about
the impact of the Pilot as a result of issuers opting out of the Pilot.
Another alternative solution would be to rotate all stocks and or
ETPs through each of the test groups for a given amount of time such
that all stocks and ETPs spend the same amount of time in each test
group. This methodology would reduce potential costs by mitigating
potential competitive effects of the Pilot on issuers by ensuring that
all stocks and ETPs receive similar exposure to each test group.
Rotation would also have the advantage of allowing many more changes
from one test group to another, which would create additional
independent observations about the effect of the Pilot on various
outcomes, potentially increasing statistical power.
The realization of the benefit of additional statistical power
would depend on how broker-dealers react to the changes. If broker-
dealers need to adjust after every change, the statistical power could
be lower with rotation than without. To the extent that broker-dealers
design their order routing algorithms to the test group, then the time
needed for broker-dealers to adapt to a set of Pilot securities that
changes every few months would be minimal. The broker-dealer would
simply replace one list of securities in a given test group with
another. In this case there would likely be a period at the beginning
of the Pilot where broker-dealers experiment somewhat to optimize their
algorithms in which the data on broker dealer behavior would be
noisier, but after that initial adjustment, broker-dealers would not
need to repeat their experimentation after every rotation. However, to
the extent that broker-dealers' order routing algorithms are bespoke to
a given security, rotation could decrease the statistical power of the
tests because each rotation would include a period of time during which
broker-dealers adjust where the data is noisier and harder to extract a
signal from.
This alternative, however, is also likely to be more complex and
have higher costs than the Pilot. The exchange compliance costs of
rotation would be marginally greater than the compliance costs of the
Pilot because it would involve additional compliance checks and
complexity, but would likely be largely automated. The added complexity
for exchanges could be more significant because complexity increases
the risk of errors. To the extent that broker-dealers set up their
systems to automate the rotation, they, too would have only marginally
higher costs with rotation. However, to the extent that broker-dealers'
order routing algorithms are bespoke to a given security, then rotation
would be both more costly for broker-dealers who would have to re-
optimize their algorithms every time a stock is included or excluded
from a given test group.

V. Regulatory Flexibility Analysis

The Regulatory Flexibility Act (``RFA'') \1053\ requires Federal
agencies, in promulgating rules, to consider the impact of those rules
on small entities. The Commission certified, pursuant to section 605(b)
of the RFA,\1054\ that, if adopted, Rule 610T would not have a
significant impact on a substantial number of small entities.\1055\
---------------------------------------------------------------------------

\1053\ 5 U.S.C. 601 et seq.
\1054\ 5 U.S.C. 605(b).
\1055\ The Pilot is discussed in detail in Sections I and II,
above. We discuss the potential economic consequences, including the
estimated compliance costs and burdens, of the Pilot in Section IV
(Economic Analysis) and Section III (Paperwork Reduction Act) above.
---------------------------------------------------------------------------

The Commission solicited comments regarding this certification and
received 1 comment.\1056\ The commenter stated that ``the Commission is
obligated under the RFA to adequately address the Proposal's costs to
small-capitalization issuers covered under the statute.'' \1057\ The
commenter cited Aeronautical Repair Station Ass'n v. FAA as support for
its assertion that the RFA requires the Commission to take into account
costs to small-capitalization issuers as they are ``third-party
entities incur[ing] downstream costs.'' \1058\ The Commission believes
the commenter misconstrues the legal finding in the case to which it
cited, as the case confirms the general premise that the RFA analysis
shall focus on the impact of a rule on a substantial number of small
entities that are ``directly affected and therefore regulated by,'' in
other words subject to, such rule's requirements.\1059\ For purposes of
the Commission rulemaking in connection with the RFA, Rule 610T, by its
terms, applies only to national securities exchanges registered with
the Commission under Section 6 of the Exchange Act.\1060\
---------------------------------------------------------------------------

\1056\ See NYSE Letter I, at 13-14.
\1057\ Id. at 14, n.50.
\1058\ See id. (citing 494 F.3d 161, 177 (D.C. Cir. 2007)).
\1059\ See Aeronautical Repair Station Ass'n v. FAA, 494 F.3d
161, 177 (D.C. Cir. 2007) (further stating that the RFA ``requires
that the agency conduct the relevant analysis or certify `no impact'
for those small businesses that are `subject to' the regulation,
that is, those to which the regulation `will apply.' '').
\1060\ See supra Sections III (Paperwork Reduction Act) and IV
(Economic Analysis) (discussing, among other things, the current
market environment and compliance obligations for national
securities exchanges).

---------------------------------------------------------------------------

[[Page 5298]]

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 17 CFR 242.601 (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.\1061\ None
of the national securities exchanges registered under Section 6 of the
Exchange Act that would be subject to the Pilot are ``small entities''
for purposes of the RFA. In particular, none of the equities exchanges
are exempt from Rule 601 of Regulation NMS. Accordingly, the proposed
rule will not apply to any ``small entities.'' Therefore, for the
foregoing reasons, the Commission again certifies that Rule 610T will
not have a significant economic impact on a substantial number of small
entities for purposes of the RFA.
---------------------------------------------------------------------------

\1061\ See 17 CFR 240.0-10(e).
---------------------------------------------------------------------------

VI. Statutory Authority and Text of the Rule Amendments

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 amends 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 amends
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 Sec. 200.30-3 by adding (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 17 CFR 242.610T(b)(1)(i) and (c)
(Rule 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 Sec. 242.610T to read as follows:

Sec. 242. 610T Equity transaction fee pilot.

(a) Pilot pricing restrictions. Notwithstanding Sec. 242.610(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 shall 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 best offer of such market that exceed or accumulate to more than
$0.0010 per share;
(2) For Test Group 2, 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
(3) For the Control Group, impose, or permit to be imposed, any fee
or fees in contravention of the limits specified in Sec. 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. Further, the Commission may designate by notice the
assignment of NMS stocks that are interlisted on a Canadian securities
exchange to Test Group 2 or the Control Group.
(ii) For purposes of this section, ``Pilot Securities'' means the
NMS stocks designated by the Commission on the initial List of Pilot
Securities pursuant to paragraph (b)(1)(i) of this section and any
successors to such NMS stocks. At the time of selection by the
Commission, an NMS stock must have a minimum share price of $2 to be
included in the Pilot and must have an unlimited duration or a duration
beyond the end of the post-Pilot Period. In addition, an NMS stock must
have an average daily volume of 30,000 shares or more to be included in
the Pilot. 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 Pilot.
(iii) For purposes of this section, ``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 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; and
(8) Other;
(E) Pilot Group:
(1) Control Group;
(2) Test Group 1; and
(3) Test Group 2;
(F) Stratum Code; and
(G) 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 end of 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

[[Page 5299]]

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
paragraph (b)(2) of this section.
(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 paragraphs (b)(2) and (3) of this
section 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:
(i) A six-month ``pre-Pilot Period;''
(ii) 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 one additional year; and
(iii) A six-month ``post-Pilot Period.''
(2) 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 facilitates trading in NMS stocks shall
prepare and transmit to the Commission a file, 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 in paragraphs (d)(1) and (2) of this section. 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. Each national securities exchange
shall treat the order routing datasets as regulatory information and
shall not access or use that information for any commercial or non-
regulatory purpose.
(1) Dataset of daily volume statistics, with field names as the
first record and a consistent naming convention that indicates the
exchange and date of the file, that include the following
specifications of liquidity-providing orders by security and separating
orders by order designation (exchanges may exclude auction orders) and
order capacity:
(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) The broker-dealer's CRD number and MPID.
(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, with field names as the
first record and a consistent naming convention that indicates the
exchange and date of the file, that include the following
specifications of liquidity-taking orders by security and separating
orders by order designation (exchanges may exclude auction orders) and
order capacity:
(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) The broker-dealer's CRD number and MPID.
(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 facilitates trading in 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 equal to or 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

[[Page 5300]]

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) Exchange Name;
(2) Record Type Indicator:
(i) Reported Fee is the Monthly Average;
(ii) Reported Fee is the Median; and
(iii) Reported Fee is the Spot Monthly;
(3) Participant Type:
(i) Registered Market Maker; and
(ii) All Others;
(4) Pilot Group:
(i) Control Group;
(ii) Test Group 1; and
(iii) Test Group 2;
(5) Applicability to Displayed and Non-Displayed Interest:
(i) Displayed only;
(ii) Non-displayed only; and
(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; and
(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 and rebates;
(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; and
(B) Top Tier Fee/Rebate reflecting the amount assessed or rebated
after any applicable discounts, tiers, caps, or other incentives are
applied; and
(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; and
(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.

By the Commission.

Dated: December 19, 2018.
Brent J. Fields,
Secretary.

Note: The following Appendix will not appear in the Code of
Federal Regulations.

Appendix A

Key to Comment Letters Cited in Proposed Transaction Fee Pilot for NMS
Stocks (File No. S7-05-18):

1. E-mail from David Adorney, C & C Trading LLC, to Commission, dated
March 15, 2018 (``Adorney E-mail'').
2. Letter from Peter L. Swan, Professor of Finance, School of Banking
and Finance, UNSW Sydney Business School, to Brent J. Fields,
Secretary, Commission, dated March 26, 2018 (``Swan Letter'').
3. Letter from O. Mason Hawkins, CFA, Chairman & CEO, et al.,
Southeastern Asset Management, Inc., et al., to Brent J. Fields,
Secretary, Commission, dated April 6, 2018 (``Joint Asset Managers
Letter'').
4. Letter from Adam D. Clark-Joseph, University of Illinois at Urbana-
Champaign, to Brent J. Fields, Secretary, Commission, dated April 9,
2018 (``Clark-Joseph Letter'').
5. Letter from Brent Woods, Chief Executive Officer, and Joseph
Scafidi, Director of Trading, Brandes Investment Partners, to Brent J.
Fields, Secretary, Commission, dated April 10, 2018 (``Brandes
Letter'').
6. Letter from Sal Arnuk and Joe Saluzzi, Partners, Co-Founders and Co-
Heads of Equity Trading, Themis Trading LLC, to Brent J. Fields,
Secretary, Commission, dated April 27, 2018 (``Themis Trading Letter
I'').
7. Presentation from the Institutional Equity Division, Morgan Stanley,
to the Division of Trading and Markets, Commission, dated May 1, 2018
(``Morgan Stanley Presentation'').
8. E-mail from Tim Quast, President, Modern Networks IR LLC, to Brett
Redfearn, Director, Division of Trading and Markets, Commission, dated
May 2, 2018 (``ModernIR E-mail'').
9. Letter from Sean D. Paylor, Trader, AJO, L.P., to Brent J. Fields,
Secretary, Commission, dated May 7, 2018 (``AJO Letter'').
10. Letter from Tim Quast, President & Founder, Modern Networks IR LLC,
to Brent J. Fields, Secretary, Commission, dated May 9, 2018
(``ModernIR Letter'').
11. Letter from Jeffrey P. Mahoney, General Counsel, Council of
Institutional Investors, to Brent J. Fields, Secretary, Commission,
dated May 10, 2018 (``CII Letter'').
12. Letter from Kelvin To, Founder& President, Data Boiler
Technologies, LLC, to Brent J. Fields, Secretary, Commission, dated May
14, 2018 (``Data Boiler Letter'').
13. Letter from Chris Barnard to Commission, dated May 14, 2018
(``Barnard Letter'').
14. Letter from David Mechner, Chief Executive Officer, Pragma
Securities, to Brent J. Fields, Secretary, Commission, dated May 14,
2018 (``Pragma Letter'').
15. Letter from Stuart J. Kaswell, Executive Vice President & Managing
Director, General Counsel, Managed Funds Association, to Brent J.
Fields, Secretary, Commission, dated May 15, 2018 (``MFA Letter'').
16. Letter from Timothy J. Mahoney, Chief Executive Officer, BIDS
Trading L.P., to Brent J. Fields, Secretary, Commission, dated May 15,
2018 (``BIDS Letter'').
17. Letter from Brent Robertson, Managing Director, Trading, and Rob
Gouley, Principal, Trading, Ontario Municipal Employees Retirement
System Administration Corporation, to Brent J. Fields, Secretary,
Commission, dated May 15, 2018 (``OMERS Letter'').
18. Letter from Marc Lipson, Robert F. Vandell Research Professor,
Professor of Business Administration, University of Virginia School,
Darden School of Business, to Commission, dated May 15, 2018 (``Lipson
Letter'').
19. Letter from Anthony W. Godonis, Principal, Director of Trading,
Copeland Capital Management, LLC, to Brent J. Fields, Secretary,
Commission, dated May 18, 2018 (``Copeland Letter'').
20. Letter from George Hessler, CEO, Magma Trading, to Brent J. Fields,
Secretary, Commission, dated May 18, 2018 (``Magma Letter'').
21. Letter from Eric Swanson, CEO, XTX Markets LLC, to Brent J. Fields,

[[Page 5301]]

Secretary, Commission, dated May 22, 2018 (``XTX Letter'').
22. Letter from Douglas A. Cifu, Chief Executive Officer, Virtu
Financial Inc., to Brent J. Fields, Secretary, Commission, dated May
23, 2018 (``Virtu Letter'').
23. Letter from Susan M. Olson, General Counsel, Investment Company
Institute, to Brent J. Fields, Secretary, Commission, dated May 23,
2018 (``ICI Letter I'').
24. Letter from Mary E. Keefe, Managing Director, Regulatory Affairs,
Nuveen, LLC, to Brent J. Fields, Secretary, Commission, dated May 23,
2018 (``Nuveen Letter'').
25. Letter from Thomas K. Lee, Executive Director & CIO, et al., New
York State Teachers' Retirement System, to Brent J. Fields, Secretary,
Commission, dated May 23, 2018 (``NYSTRS Letter'').
26. Letter from Hubert De Jesus, Global Head of Market Structure and
Electronic Trading, and Joanne Medero, U.S. Head of Global Public
Policy, BlackRock, Inc., to Brent J. Fields, Secretary, Commission,
dated May 23, 2018 (``BlackRock Letter'').
27. Letter from Frank L. Jobert, Jr., Executive Director, Louisiana
Trustee Education Council, to Brent J. Fields, Secretary, Commission,
dated May 23, 2018 (``LATEC Letter'').
28. Letter from Joanna Mallers, Secretary, FIA Principal Traders Group,
to Brent J. Fields, Secretary, Commission, dated May 24, 2018 (``FIA
Letter'').
29. Letter from Theodore R. Lazo, Managing Director & Associate General
Counsel, Securities Industry and Financial Markets Association, to
Brent J. Fields, Secretary, Commission, dated May 24, 2018 (``SIFMA
Letter'').
30. Letter from Patrick J. Healy, Founder & CEO, Issuer Network, to
Brent J. Fields, Secretary, Commission, dated May 24, 2018 (``Issuer
Network Letter I'').
31. Letter from Linda M. Giordano, Co-Founder & CEO, and Jeffrey M.
Alexander, Co-Founder & President, Babelfish Analytics, Inc., to Brent
J. Fields, Secretary, Commission, dated May 24, 2018 (``Babelfish
Letter'').
32. Letter from Dennis M. Kelleher, President & CEO, et al., Better
Markets, Inc., to Brent J. Fields, Secretary, Commission, dated May 24,
2018 (``Better Markets Letter'').
33. Letter from Rich Steiner, Electronic Trading Strategist, RBC
Capital Markets, to Brent Fields, Secretary, Commission, dated May 24,
2018 (``RBC Letter I'').
34. Letter from William H. Hebert, Managing Director, Financial
Information Forum, to Brent J. Fields, Secretary, Commission, dated May
24, 2018 (``FIF Letter'').
35. Letter from Paul M. Russo, Managing Director, Goldman Sachs & Co.
LLC, to Brent J. Fields, Secretary, Commission, dated May 24, 2018
(``Goldman Sachs Letter'').
36. Letter from Tyler Gellasch, Executive Director, Healthy Markets
Association, to Brent J. Fields, Secretary, Commission, dated May 24,
2018 (``Healthy Markets Letter I'').
37. Letter from Jason Clague, Executive Vice President, Operational
Services, Charles Schwab & Co., Inc., to Brent J. Fields, Secretary,
Commission, dated May 25, 2018 (``Schwab Letter'').
38. Letter from Joseph Brennan, Principal & Global Head of Equity
Investment Group, Vanguard, to Brent J. Fields, Secretary, Commission,
dated May 25, 2018 (``Vanguard Letter'').
39. Letter from Marc R. Bryant, Deputy General Counsel, Fidelity
Investments, to Brent J. Fields, Secretary, Commission, dated May 25,
2018 (``Fidelity Letter'').
40. Letter from Stephen John Berger, Managing Director, Government &
Regulatory Policy, Citadel Securities, to Brent J. Fields, Secretary,
Commission, dated May 25, 2018 (``Citadel Letter'').
41. Letter from Kevin Cronin, Global Head of Trading, Invesco Ltd., to
Brent J. Fields, Secretary, Commission, dated May 25, 2018 (``Invesco
Letter'').
42. Letter from Micah Hauptman, Financial Services Counsel, Consumer
Federation of America, to Brent J. Fields, Secretary, Commission, dated
May 25, 2018 (``CFA Letter'').
43. Letter from Heidi W. Hardin, General Counsel, MFS Investment
Management, to Brent J. Fields, Secretary, Commission, dated May 25,
2018 (``MFS Letter'').
44. Letter from Timothy J. Coyne, Global Head of ETF Capital Markets,
and Nathaniel N. Evarts, Head of Trading, Americas, State Street Global
Advisors, to Brent J. Fields, Secretary, Commission, dated May 25, 2018
(``State Street Letter'').
45. Letter from Dennis Simmons, Executive Director, Committee on
Investment of Employee Benefit Access, to Brent J. Fields, Secretary,
Commission, dated May 25, 2018 (``CIEBA Letter'').
46. Letter from Lisa Mahon Lynch, Director, Trading & Counterparty
Services, Wellington Management Company LLP, to Brent J. Fields,
Secretary, Commission, dated May 25, 2018 (``Wellington Letter'').
47. Letter from Kevin Duggan, Managing Director, Execution & Treasury,
Capital Markets, Ontario Teachers' Pension Plan, et al., to Brent J.
Fields, Secretary, Commission, dated May 25, 2018 (``Joint Pension Plan
Letter'').\1062\
---------------------------------------------------------------------------

\1062\ The Commission notes that it separately received a copy
of a signatory page already attached to this letter from Karl Polen,
Chief Investment Officer, Arizona State Retirement System, dated May
21, 2018. For purposes of this summary, the copy has not been
counted as a separate letter or comment.
---------------------------------------------------------------------------

48. Letter from Tim Gately, Managing Director, Head of Americas
Equities, Citigroup Global Markets Inc., to Brent J. Fields, Secretary,
Commission, dated May 25, 2018 (``Citi Letter'').
49. Letter from Michael Jacejko, Birch Bay Capital, LLC, to Brent J.
Fields, Secretary, Commission, dated May 25, 2018 (``Birch Bay
Letter'').
50. Letter from Cynthia Lo Bessette, General Counsel & Executive Vice
President, OFI Global Asset Management, Inc., et al., OppenheimerFunds,
Inc., to Brent J. Fields, Secretary, Commission, dated May 25, 2018
(``Oppenheimer Letter'').
51. Letter from Ray Ross, Chief Technology Officer, Clearpool Group, to
Brent J. Fields, Secretary, Commission, dated May 25, 2018 (``Clearpool
Letter'').
52. Letter from James J. Angel, Associate Professor of Finance,
Georgetown University, McDonough School of Business, to Commission,
dated May 25, 2018 (``Angel Letter I'').
53. Letter from Chester Spatt, Former Chief Economist, Commission, to
Brent J. Fields, Secretary, Commission, dated May 25, 2018 (``Spatt
Letter'').
54. Letter from Joseph Kinahan, Managing Director, Client Advocacy &
Market Structure, TD Ameritrade, Inc., to Brent J. Fields, Secretary,
Commission, dated May 25, 2018 (``TD Ameritrade Letter'').
55. Letter from Edward S. Knight, Executive Vice President & Global
Chief Legal & Policy Officer, Nasdaq, Inc., to Brent J. Fields,
Secretary, Commission, dated May 25, 2018 (``Nasdaq Letter I'').
56. Letter from Edward T. Tilly, Chairman & Chief Executive Officer,

[[Page 5302]]

Cboe Global Markets, Inc., to Brent J. Fields, Secretary, Commission,
dated May 25, 2018 (``Cboe Letter I'').
57. Letter from Matt D. Lyons, Global Equity Trading Manager, and Peter
D. Stutsman, U.S. Regional Equity Trading Manager, The Capital Group
Companies, to Brent J. Fields, Secretary, Commission, dated May 30,
2018 (``Capital Group Letter'').
58. Letter from Mike Rask, Chairman of the Board, and James Toes,
President & CEO, Security Traders Association, to Brent J. Fields,
Secretary, Commission, dated May 31, 2018 (``STA Letter'').
59. Letter from Alan Harris, to Commission, dated May 31, 2018
(``Harris Letter'').
60. Letter from Elizabeth K. King, General Counsel & Corporate
Secretary, NYSE Group, Inc., to Brent J. Fields, Secretary, Commission,
dated May 31, 2018 (``NYSE Letter I'').
61. Letter from Kimberly Unger, CEO & Executive Director, The Security
Traders Association of New York, Inc., to Brent J. Fields, Secretary,
Commission, dated June 1, 2018 (``STANY Letter'').
62. Letter from John Ramsay, Chief Market Policy Officer, Investors
Exchange LLC, to Brent J. Fields, Secretary, Commission, dated May 30,
2018 (``IEX Letter I'').
63. Market Commentary by Victor Lin, Credit Suisse, dated June 4, 2018
(``Credit Suisse Commentary'').
64. Letter from Rajesh Sharma, Corporate Secretary, Apache Corporation,
to Brent J. Fields, Secretary, Commission, dated June 7, 2018 (``Apache
Letter'').
65. Letter from ``Danny Mulson'' to Commission, dated June 7, 2018
(``Mulson Letter I'').
66. Letter from J.W. Verret, Associate Professor of Law, George Mason
University, Antonin Scalia Law School, to Brent J. Fields, Secretary,
Commission, dated June 11, 2018 (``Verret Letter I'').
67. Letter from James D. Rollins III, Chairman & Chief Executive
Officer, BancorpSouth Bank, to Brent J. Fields, Secretary, Commission,
dated June 11, 2018 (``BancorpSouth Letter'').
68. Letter from Jonathan A. Clark, Chief Executive Officer, and James
C. Dolan, Chief Compliance Officer, Luminex Trading & Analytics LLC, to
Brent J. Fields, Secretary, Commission, dated June 12, 2018 (``Luminex
Letter'').
69. Letter from Mehmet Kinak, Vice President--Global Head of Systematic
Trading & Market Structure, and Jonathan Siegel, Vice President--Senior
Legal Counsel (Legislative & Regulatory Affairs), T. Rowe Price, to
Brent J. Fields, Secretary, Commission, dated June 12, 2018 (``T. Rowe
Price Letter'').
70. Letter from Jon R. Moeller, Vice Chairman & Chief Financial
Officer, The Procter & Gamble Company, to Brent J. Fields, Secretary,
Commission, dated June 13, 2018 (``P&G Letter'').
71. Letter from William P. Neuberger, Managing Director, Global Co-Head
of Morgan Stanley Electronic Trading, and Andrew F. Silverman, Managing
Director, Global Co-Head of Morgan Stanley Electronic Trading, Morgan
Stanley & Co. LLC, to Brent J. Fields, Secretary, Commission, dated
June 14, 2018 (``Morgan Stanley Letter'').
72. Letter from Larry Harris, Fred V. Keenan Chair in Finance, USC
Marshall School of Business, to Brent J. Fields, Secretary, Commission,
dated June 15, 2018 (``Larry Harris Letter'').
73. Letter from Keith Neumeyer, President & CEO, First Majestic Silver
Corp., to Brent J. Fields, Secretary, Commission, dated June 19, 2018
(``First Majestic Letter'').
74. Letter from ``Avarice Pleonexia'' to Commission, dated June 20,
2018 (``Pleonexia Letter'').
75. Letter from John M. Freeman, Executive Vice President, Chief Legal
Officer & Corporate Secretary, McDermott, to Brent J. Fields,
Secretary, Commission, dated June 21, 2018 (``McDermott Letter'').
76. Letter from Janet McGinness, Corporate Secretary, Mastercard, Inc.,
to Brent J. Fields, Secretary, Commission, dated June 21, 2018
(``Mastercard Letter'').
77. Letter from Mark Elliott, Chief Financial Officer, Level Brands,
Inc., to Brent J. Fields, Secretary, Commission, dated June 21, 2018
(``Level Brands Letter'').
78. Letter from Geir [Oslash]ivind Nyg[aring]rd, Chief Investment
Officer Asset Strategies, and Simon Emrich, Head of Market Structure
Strategies, Norges Bank Investment Management, to Brent J. Fields,
Secretary, Commission, dated June 21, 2018 (``Norges Letter'').
79. Letter from Neal V. Fenwick, Executive Vice President & Chief
Financial Officer, ACCO Brands, Inc., to Brent J. Fields, Secretary,
Commission, dated June 21, 2018 (``ACCO Letter'').
80. Letter from Thomas R. Kubera, Chief Accounting Officer & Interim
Chief Financial Officer, SIFCO Industries, Inc., to Brent J. Fields,
Secretary, Commission, dated June 21, 2018 (``SIFCO Letter'').
81. Letter from J.A. to Brent J. Fields, Secretary, Commission, dated
June 22, 2018 (``JA Letter I'').
82. Letter from Timothy P. Olson, Senior Corporate Counsel & Corporate
Secretary, NorthWestern Corporation, to Brent J. Fields, Secretary,
Commission, dated June 22, 2018 (``NorthWestern Letter'').
83. Letter from Eric D. Koster, General Counsel & Secretary, Ethan
Allen Interiors, Inc., to Brent J. Fields, Secretary, Commission, dated
June 22, 2018 (``Ethan Allen Letter'').
84. Letter from Mark H. Collin, Senior Vice President, Chief Financial
Officer & Treasurer, Unitil Corporation, to Brent J. Fields, Secretary,
Commission, dated June 22, 2018 (``Unitil Corporation'').
85. Letter from Michael R. Peterson, Vice President, Corporate
Secretary, & Associate General Counsel, to Brent J. Fields, Secretary,
Commission, dated June 22, 2018 (``Johnson Letter'').
86. Letter from ``Anonymous Anonymous'' to Commission, dated June 22,
2018 (``Anonymous Letter I'').
87. Letter from Stephen C. Richter, Executive Vice President & CFO,
Weingarten Realty, to Brent J. Fields, Secretary, Commission, dated
June 22, 2018 (``Weingarten Letter'').
88. Letter from Richard L. Travis, Jr., Chief Financial Officer, Ennis,
Inc., to Brent J. Fields, Secretary, Commission, dated June 22, 2018
(``Ennis Letter'').
89. Letter from Bryan H. Fairbanks, Chief Financial Officer, Trex
Company, to Brent J. Fields, Secretary, Commission, dated June 22, 2018
(``Trex Letter'').
90. Letter from John J. Manning, Vice President, General Counsel &
Secretary, Sensient Technologies Corporation, to Brent J. Fields,
Secretary, Commission, dated June 25, 2018 (``Sensient Letter'').
91. Letter from John Christofilos, Senior Vice-President & Chief
Trading Officer, AGF Investments Inc., to Brent J. Fields, Secretary,
Commission, dated June 25, 2018 (``AGF Letter'').
92. Letter from Dean Shigemura, Vice Chairman & Chief Financial
Officer, Bank of Hawaii Corporation, to Brent J. Fields, Secretary,

[[Page 5303]]

Commission, dated June 25, 2018 (``Hawaii Letter'').
93. Letter from Jerry Fowden, Chief Executive Officer, Cott
Corporation, to Brent J. Fields, Secretary, Commission, dated June 26,
2018 (``Cott Letter'').
94. Letter from Adam F. Wergeles, EVP & General Counsel, Leaf Group
Ltd., to Brent J. Fields, Secretary, Commission, dated June 26, 2018
(``Leaf Letter'').
95. Letter from Haim Bodek, Managing Principal, and Stanislav
Dolgopolov, Chief Regulatory Officer, Decimus Capital Markets, LLC, to
Brent J. Fields, Secretary, Commission, dated June 26, 2018 (``Decimus
Letter'').
96. Letter from Michael Sherman, Senior Vice President & General
Counsel, Genesis Healthcare, Inc., to Brent J. Fields, Secretary,
Commission, dated June 26, 2018 (``Genesis Letter'').
97. Letter from ``Anonymous Anonymous'' to Commission, dated June 27,
2018 (``Anonymous Letter II'').
98. Letter from Michael J. Schewel, Vice-President, General Counsel &
Secretary, Tredegar Corporation, to Brent J. Fields, Secretary,
Commission, dated June 27, 2018 (``Tredegar Letter'').
99. Letter from Nicholas C. Taylor, Chairman & CEO, Mexco Energy
Corporation, to Brent J. Fields, Secretary, Commission, dated June 27,
2018 (``Mexco Letter'').
100. Letter from John Ramsay, Chief Market Policy Officer, Investors
Exchange LLC, to Brent J. Fields, Secretary, Commission, dated June 27,
2018 (``IEX Letter II'').
101. Presentation from Security Traders Association to Commission,
dated June 28, 2018 (``STA Presentation'').
102. Letter from Timothy W. Gorman, Executive Vice President & Chief
Financial Officer, Energizer Holdings, Inc., to Brent J. Fields,
Secretary, Commission, dated June 28, 2018 (``Energizer Letter'').
103. Letter from Christopher A. Iacovella, Chief Executive Officer,
American Securities Association, to Brent J. Fields, Secretary,
Commission, dated June 28, 2018 (``ASA Letter'').
104. Letter from W. Stancil Starnes, Chairman, President & Chief
Executive Officer, ProAssurance Corporation, to Brent J. Fields,
Secretary, Commission, dated June 29, 2018 (``ProAssurance Letter'').
105. Letter from Isabel Janci, Vice President, Investor Relations, The
Home Depot, to Brent J. Field[s], Secretary, Commission, dated June 29,
2018 (``Home Depot Letter'').
106. Letter from Eric P. Sills, CEO & President, Standard Motor
Products, Inc., to Brent J. Fields, Secretary, Commission, dated July
2, 2018 (``SMP Letter'').
107. Letter from Christopher T. Weber, Executive Vice President & Chief
Financial Officer, Halliburton, to Brent J. Fields, Secretary,
Commission, dated July 2, 2018 (``Halliburton Letter'').
108. Letter from Jennifer D. Whalen, Senior Vice President & Chief
Financial Officer, Era Group Inc., to Brent J. Fields, Secretary,
Commission, dated July 2, 2018 (``Era Letter'').
109. Letter from David M. Weisberger, Head of Equities, ViableMkts, to
Brent J. Fields, Secretary, Commission, dated July 2, 2018
(``ViableMkts Letter'').
110. Letter from John S. Fischer, General Counsel, Natural Grocers by
Vitamin Cottage, Inc., to Brent J. Fields, Secretary, Commission, dated
July 3, 2018 (``Natural Grocers Letter'').
111. Letter from Mark J. Airola, Senior Vice President, General
Counsel, Chief Administrative Officer & Corporate Secretary, Newpark
Resources, Inc., to Brent J. Fields, Secretary, Commission, dated July
3, 2018 (``Newpark Letter'').
112. Letter from Jenny H. Parker, Senior Vice President--Finance,
Secretary & Treasurer, Haverty Furniture Companies, Inc., to Brent J.
Fields, Secretary, Commission, dated July 3, 2018 (``Haverty Letter'').
113. Letter from Adam W. Miller, Chief Financial Officer & Treasurer,
Knight-Swift Transportation Holdings Inc., to Brent J. Fields,
Secretary, Commission, dated July 5, 2018 (``Knight-Swift Letter'').
114. Letter from Tyler Gellasch, Executive Director, Healthy Markets
Association, to Brent J. Fields, Secretary, Commission, dated July 6,
2018 (``Healthy Markets Letter II'').
115. Letter from R. Dale Lynch, Executive Vice President--Chief
Financial Officer, Federal Agricultural Mortgage Corporation, to Brent
J. Fields, Secretary, Commission, dated July 9, 2018 (``Farmer Mac
Letter'').
116. Letter from Elizabeth K. King, General Counsel & Corporate
Secretary, New York Stock Exchange, to Brent J. Fields, Secretary,
Commission, dated July 10, 2018 (``NYSE Letter II'').
117. Letter from ``Danny Mulson'' to Commission, dated July 10, 2018
(``Mulson Letter II'').
118. Letter from Maria Trainor, Vice President, General Counsel &
Secretary, Ampco-Pittsburgh Corporation, to Brent J. Fields, Secretary,
Commission, dated July 11, 2018 (``Ampco-Pittsburgh Letter'').
119. Letter from Ted A. Dosch, Executive Vice President--Finance &
Chief Financial Officer, Anixter International Inc., to Brent J.
Fields, Secretary, Commission, dated July 13, 2018 (``Anixter
Letter'').
120. Letter from John K. Lines, SVP/Secretary & General Counsel,
National HealthCare Corporation, to Brent J. Fields, Secretary,
Commission, dated July 16, 2018 (``NHC Letter'').
121. E-mail from Patrick Healy, Founder & CEO, Issuer Network, to David
Shillman, Commission, dated July 17, 2018 (``Issuer Network E-mail'').
122. Letter from R. Scott Mahoney, Senior Vice President--General
Counsel & Secretary, AVANGRID, Inc., to Brent J. Fields, Secretary,
Commission, dated July 18, 2018 (``Avangrid Letter'').
123. Letter from J.A. to Brent J. Fields, Secretary, Commission, dated
July 19, 2018 (``JA Letter II'').
124. Letter from Ruairidh Ross, Deputy General Counsel & Assistant
Secretary, HP Inc., to Brent J. Fields, Secretary, Commission, dated
July 31, 2018 (``HP Letter'').
125. Letter from Glenn E. Tynan, Vice President & Chief Financial
Officer, Curtiss-Wright Corporation, to Brent J. Fields, Secretary,
Commission, dated August 3, 2018 (``Curtiss-Wright Letter'').
126. Letter from James J. Angel, Associate Professor of Finance,
Georgetown University, McDonough School of Business, to Commission,
dated August 3, 2018 (``Angel Letter II.'')
127. Letter from John Ramsay, Chief Market Policy Officer, Investors
Exchange LLC, to Brent J. Fields, Secretary, Commission, dated August
8, 2018 (``IEX Letter III'').
128. Letter from Fiona Reynolds, Chief Executive Officer, Principles
for Responsible Investment, to Brent J. Fields, Secretary, Commission,
dated August 15, 2018 (``PRI Letter'').
129. Letter from Walter K. Compton, Executive Vice President & General
Counsel, Murphy Oil Corporation, to Brent J. Fields, Secretary,

[[Page 5304]]

Commission, dated August 15, 2018 (``Murphy Letter'').
130. Letter from Sal Arnuk & Joe Saluzzi, Partners, Co-Founders & Co-
Heads of Equity Trading, Themis Trading LLC, to Brent J. Fields,
Secretary, Commission, dated August 16, 2018 (``Themis Trading Letter
II'').
131. Letter from Jeffrey S. Davis, Nasdaq, Inc., to Brent J. Fields,
Secretary, Commission, dated August 31, 2018 (``Nasdaq Letter II'').
132. Recommendation of the Investor Advisory Committee, dated September
13, 2018 (``IAC Recommendation'').
133. Letter from Sanda E. O'Connor, Chief Regulatory Affairs Officer,
JPMorgan Chase & Co., to Brent J. Fields, Secretary, Commission, dated
September 14, 2018 (``JPMorgan Letter'').
134. Letter from Anonymous Anonymous to Commission, dated September 21,
2018 (``Anonymous Letter III'').
135. Letter from John Ramsay, Chief Market Policy Officer, Investors
Exchange LLC, to Brent J. Fields, Secretary, Commission, dated
September 24, 2018 (``IEX Letter IV'').
136. Letter from Chris Concannon, President & Chief Operating Officer,
Cboe Global Markets, Inc., to Brent J. Fields, Secretary, Commission,
dated September 28, 2018 (``Cboe Letter II'').
137. Letter from Susan M. Olson, General Counsel, Investment Company
Institute, to Brent J. Fields, Secretary, Commission, dated October 1,
2018 (``ICI Letter II'').
138. Letter from Katya Malinova, Mackenzie Investments Chair in
Evidence-Based Investment Management, DeGroote School of Business,
McMaster University, et al., to Brent J. Fields, Secretary, Commission,
dated October 1, 2018 (``CSA Letter'').
139. Letter from ``Richard P. Grasso,'' ``Grasso Plumbing LLC,'' to
Brent J. Fields, Secretary, Commission, dated October 1, 2018 (``Grasso
Letter'').
140. Letter from Ira S. Lederman, W.R. Berkley Corporation, to Brent J.
Fields, Secretary, Commission, dated October 2, 2018 (``Berkley
Letter'').
141. Letter from Stacey Cunningham, President, New York Stock Exchange,
to Brent J. Fields, Secretary, Commission, dated October 2, 2018
(``NYSE Letter III'').
142. Letter from Rich Steiner, Electronic Trading Strategist, RBC
Capital Markets, to Brent Fields, Secretary, Commission, dated October
16, 2018 (``RBC Letter II'').
143. Letter from Elizabeth K. King, General Counsel & Corporate
Secretary, NYSE Group, to Brent J. Fields, Secretary, Commission, dated
November 9, 2018 (``NYSE Letter IV'').
144. Letter from Elizabeth K. King, General Counsel & Corporate
Secretary, NYSE Group, Inc., to Brent J. Fields, Secretary, Commission,
dated November 20, 2018 (``NYSE Letter V'').
145. Letter from J.A. to Brent J. Fields, Secretary, Commission, dated
December 3, 2018 (``JA Letter III'').
146. Letter from J.W. Verret to Brent J. Fields, Secretary, Commission,
dated December 4, 2018 (``Verret Letter II'').
147. Letter from Patrick J. Healy, Founder & CEO, Issuer Network, to
Brent J. Fields, Secretary, Commission, dated December 14, 2018
(``Issuer Network Letter II'').
148. Letter from Jeffrey S. Davis, Vice President & Deputy General
Counsel, Nasdaq, Inc., to Brent J. Fields, Secretary, Commission, dated
December 17, 2018 (``Nasdaq Letter III'').

Note: The following Exhibit 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 17 CFR 242.610T(e) and the logical
representation of those disclosures to a corresponding XML element. The
Commission's XML schema is the formal electronic representation of this
data model.
Concept--the information content as described in 17 CFR
242.610T(e) items 1 through 13.
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'').

--------------------------------------------------------------------------------------------------------------------------------------------------------
Concept Element Type Spot Monthly When absent Definition
--------------------------------------------------------------------------------------------------------------------------------------------------------
Exchange........ exch Non-empty Text R R ............... A required unique code to identify
each exchange 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).
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.
Pilot Group..... grp 1, 2, or C R R ............... A required indicator that
identifies the test or control
group during the Pilot and post-
Pilot Period. 1, 2--Test Groups 1,
2; C--Control group.

[[Page 5305]]

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 topTierTakeFee Number R NA ............... The Top Tier Taker Fee is the per
Fee. 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 avgTakeFee Number NA R ............... The monthly average realized Taker
Fee. 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 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 topTierFee Number R NA ............... The Top Tier Maker Fee is the per
Fee. 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 avgMakeFee Number NA R ............... The monthly average realized Maker
Fee. 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 5306]]

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.
--------------------------------------------------------------------------------------------------------------------------------------------------------

[FR Doc. 2018-27982 Filed 2-19-19; 8:45 am]
BILLING CODE 8011-01-P

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