[Federal Register Volume 78, Number 36 (Friday, February 22, 2013)]
[Notices]
[Pages 12397-12402]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-04096]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-68937; File No. SR-NASDAQ-2012-129]
Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order
Granting Approval to Proposed Rule Change, as Modified by Amendment No.
1, To Establish the Retail Price Improvement Program on a Pilot Basis
until 12 Months From the Date of Implementation
February 15, 2013.
I. Introduction
On November 19, 2012, The NASDAQ Stock Market LLC (the ``Exchange''
or ``NASDAQ'') filed with the Securities and Exchange Commission
(``Commission'') pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change to establish a Retail Price Improvement Program
(``Program'') on a pilot basis for a period of 12 months from the date
of implementation, if approved. The proposed rule change was published
for comment in the Federal Register on December 7, 2012.\3\ The
Commission did not receive any comments on the proposed rule change. On
February 13, 2013, the Exchange filed Amendment No. 1 to its
proposal.\4\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 68336 (December 3,
2012), 77 FR 73097 (SR-NASDAQ-2012-129) (``Notice'').
\4\ In Amendment No. 1, the Exchange proposes to clarify that,
to qualify as a ``Retail Order,'' a ``riskless principal'' order
must satisfy the criteria for riskless principal orders set forth in
FINRA Rule 5320.03. Because the changes made in Amendment No. 1 do
not materially alter the substance of the proposed rule change or
raise any novel regulatory issues, Amendment No. 1 is not subject to
notice and comment.
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In connection with the proposal, the Exchange requested exemptive
relief from Rule 612 of Regulation NMS,\5\ which, among other things,
prohibits a national securities exchange from accepting or ranking
orders priced greater than $1.00 per share in an increment smaller than
$0.01.\6\ On January 14, 2013, the Exchange submitted a letter
requesting that the staff of the Division of Trading and Markets not
recommend any enforcement action under Rule 602 of Regulation NMS
(``Quote Rule'') based on the Exchange's and its Members' participation
in the Program.\7\
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\5\ 17 CFR 242.612 (``Sub-Penny Rule'').
\6\ See Letter from Jeffrey Davis, Deputy General Counsel, The
NASDAQ Stock Market LLC, to Elizabeth M. Murphy, Secretary,
Commission, dated November 19, 2012 (``Request for Sub-Penny Rule
Exemption'').
\7\ See Letter from Jeffrey Davis, Deputy General Counsel, The
NASDAQ Stock Market LLC, to John Ramsay, Division of Trading and
Markets, Commission, dated January 14, 2013.
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This order approves the proposed rule change and grants the
exemption from the Sub-Penny Rule sought by the Exchange in relation to
the proposed rule change.
II. Description of the Proposal
The Exchange is proposing a 12-month pilot program to attract
additional retail order flow to the Exchange, while also providing the
potential for price improvement to such retail order flow. The Program
would be limited to trades occurring at prices equal to or greater than
$1.00 per share.\8\ All Regulation NMS securities traded on the
Exchange would be eligible for inclusion in the Program.
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\8\ The Exchange notes that certain orders submitted to the
Program designated as eligible to interact with liquidity outside of
the Program--Type 2 Retail Orders, discussed below--could execute at
prices below $1.00 if they do in fact execute against liquidity
outside of the Program.
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Under the Program, a new class of market participants called Retail
Member Organizations (``RMOs'') \9\ would be eligible to submit certain
retail order flow (``Retail Orders'') to the Exchange. All Exchange
Members would be permitted to provide potential price improvement for
Retail Orders in the form of designated non-displayed interest, called
a Retail Price Improvement Order (``RPI Order'' or ``RPI interest''),
that is priced more aggressively than the Protected National Best Bid
or Offer (``Protected NBBO'') \10\ by at least $0.001 per share. When
RPI interest priced at least $0.001 per share better than the Protected
Bid or Protected Offer for a particular security is available in the
system, the Exchange would disseminate an identifier, known as the
Retail Liquidity Identifier, indicating that such interest exists. A
Retail Order would interact, to the extent possible, with available
contra-side RPI Orders.\11\
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\9\ A RMO would be a Member (or a division thereof) that has
been approved by the Exchange to submit Retail Orders. See Nasdaq
Rule 4780. A ``Member'' is any registered broker or dealer that has
been admitted to membership in the Exchange. See Nasdaq Rule
0120(i).
\10\ The terms Protected Bid and Protected Offer are defined in
Rule 600(b)(57) of Regulation NMS. 17 CFR 242.600(b)(57). The
Exchange represents that, generally, the Protected Bid and Protected
Offer, and the national best bid (``NBB'') and national best offer
(``NBO,'' together with the NBB, the ``NBBO''), will be the same.
However, it further represents that a market center is not required
to route to the NBB or NBO if that market center is subject to an
exception under Regulation NMS Rule 611(b)(1) or if such NBB or NBO
is otherwise not available for an automatic execution. In such case,
the Exchange states that the Protected NBBO would be the best-priced
protected bid or offer to which a market center must route interest
pursuant to Rule 611 of Regulation NMS.
\11\ As explained further below, the Exchange has proposed two
types of Retail Orders, one of which could execute against other
interest if it was not completely filled by contra-side RPI Interest
or other price-improving liquidity. All Retail Orders would first
execute against available contra-side RPI Orders or other price-
improving liquidity. Any remaining portion of the Retail Order would
then either cancel, be executed as an immediate-or-cancel order, or
be routed to another market for execution, depending on the type of
Retail Order.
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The Exchange represents that its proposed rule change is based on
rules recently adopted by other exchanges. The NASDAQ proposal is
virtually identical to BATS Y-Exchange Rule 11.24, which sets forth the
BATS Y-Exchange's Retail Price Improvement Program.\12\ It is also
highly similar to New York Stock Exchange LLC's (``NYSE'') Rule 107C,
which governs NYSE's Retail Liquidity Program,\13\ with three
distinctions. First, the NYSE's Retail Liquidity Program creates a
category of members, Retail Liquidity Providers, who are required to
maintain a retail price-improving order that betters the protected best
bid or offer at least 5% of the trading day in each assigned security
and who receive lower execution fees as a result. Under the NASDAQ
proposal, the Exchange would not create such a category of Members.
Second, NASDAQ's proposal would permit executions in all cases against
resting RPI Orders and, additionally, other non-displayed liquidity
resting on the Exchange's System.\14\ In contrast,
[[Page 12398]]
pursuant to NYSE Rule 107C(k)(1), a Type 1-designated Retail Order,
``will interact only with available contra-side Retail Price
Improvement Orders and will not interact with other available contra-
side interest in Exchange systems.'' \15\ Finally, under the NYSE'S
Retail Liquidity Program, Retail Orders execute at the single price at
which the order will be fully executed. Pursuant to NASDAQ's proposal,
Retail Orders execute at multiple price levels rather than a single
price level.\16\
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\12\ See Securities Exchange Act Release No. 68303 (November 27,
2012), 77 FR 71652 (December 3, 2012) (SR-BYX-2012-019) (``BATS RPI
Approval Order'').
\13\ See Securities Exchange Act Release No. 67347 (July 3,
2012), 77 FR 40673 (July 10, 2012) (SR-NYSE-2011-55; SR-NYSEAmex-
2011-84) (``NYSE RLP Approval Order''). In the RLP Approval Order,
the Commission also approved a Retail Liquidity Program for NYSE
Amex LLC (now known as NYSE MKT LLC) (``NYSE MKT'').
\14\ The Exchange notes that other price improving liquidity may
include, but is not limited to: booked non-displayed orders with a
limit price that is more aggressive than the then-current NBBO;
midpoint-pegged orders (which are by definition non-displayed and
priced more aggressively than the NBBO); non-displayed orders pegged
to the NBBO with an aggressive offset. Orders that do not constitute
other price improving liquidity include, but are not limited to:
orders with a time-in-force instruction of IOC; displayed orders;
limit orders priced less aggressively than the NBBO.
\15\ Additionally, pursuant to NYSE Rules 107C(k)(2) and
107C(k)(3), a Type 2-designated Retail Order and a Type 3-designated
Retail Order can interact with other non-RPI interest in the NYSE
systems; however, such interaction only occurs after a Retail Order
first executes against RPI Orders.
\16\ See Notice, supra note 3, 77 FR at 73100-01 (explaining the
three distinctions in detail).
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Types of Orders and Identifier
A Retail Order would be an agency or riskless principal \17\ order
that originates from a natural person and is submitted to the Exchange
by a RMO, provided that no change is made to the terms of the order
with respect to price (except in the case of a market order being
changed to a marketable limit order) or side of market and the order
does not originate from a trading algorithm or any other computerized
methodology. As discussed in greater detail below, Retail Orders may be
designated as Type 1 or Type 2. Retail Orders, regardless of Type, may
be entered in sizes that are odd lots, rounds lots, or mixed lots.
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\17\ In order to qualify as a ``Retail Order,'' a ``riskless
principal'' order must satisfy the criteria set forth in FINRA Rule
5320.03. RMOs that submit riskless principal orders as Retail Orders
must maintain supervisory systems to reconstruct such orders in a
time-sequenced manner, and the RMOs must submit reports
contemporaneous with the execution of the facilitated orders that
identify such trades as riskless principal.
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An RPI Order would be non-displayed liquidity on the Exchange that
is priced more aggressively than the Protected NBBO by at least $0.001
per share and that is identified as an RPI Order in a manner prescribed
by the Exchange. RPI interest can be priced either as an explicitly
priced limit order or implicitly priced as relative to the NBBO with an
offset of at least $0.001. The price of an RPI Order with an offset
would be determined by a Member's entry of the following into the
Exchange: (1) RPI buy or sell interest; (2) an offset from the
Protected NBBO, if any; and (3) a ceiling or floor price. RPI Orders
submitted with an offset would be similar to other peg orders available
to Members in that the order is tied or ``pegged'' to a certain price,
and would have its price automatically set and adjusted upon changes in
the Protected NBBO, both upon entry and any time thereafter.
RPI Orders in their entirety (the buy or sell interest, the offset,
and the ceiling or floor) will remain non-displayed. The Exchange will
also allow Members to enter RPI Orders which establish the exact limit
price, which is similar to a non-displayed limit order currently
accepted by the Exchange today, except the Exchange will accept sub-
penny limit prices on RPI Orders in increments of $0.001.\18\ The
Exchange will monitor whether RPI buy or sell interest, adjusted by any
offset and subject to the ceiling or floor price, is eligible to
interact with incoming Retail Orders.
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\18\ As noted above, supra note 6 and accompanying text, in
connection with the Program, the Exchange requested exemptive relief
from the Sub-Penny Rule of Regulation NMS, which, among other
things, prohibits a national securities exchange from accepting or
ranking orders priced greater than $1.00 per share in an increment
smaller than $0.01.
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When RPI interest priced at least $0.001 better than the Exchange's
Protected Bid or Protected Offer for a particular security is available
in the System, the Exchange would disseminate an identifier, known as
the Retail Liquidity Identifier, indicating that such interest exists.
The Exchange would implement the Program in a manner that allowed the
dissemination of the identifier through consolidated data streams
(i.e., pursuant to the Consolidated Tape Association Plan/Consolidated
Quotation Plan (``CTA/CQ Plan'') for Tape A and Tape B securities, and
the Nasdaq UTP Plan for Tape C securities as well as through
proprietary Exchange data feeds). The Retail Liquidity Identifier would
reflect the symbol and the side (buy or sell) of the RPI Order, but it
would not include the price or size. In particular, the consolidated
quoting outputs would include a field for codes related to the Retail
Liquidity Identifier. The codes will indicate RPI interest that is
priced better than the Protected Bid or Protected Offer by at least the
minimum level of price improvement as required by the Program.
Retail Member Organizations
In order to become a RMO, a Member must conduct a retail business
or handle retail orders on behalf of another broker-dealer. Any Member
that wishes to obtain RMO status would be required to submit: (1) An
application form; (2) an attestation, in a form prescribed by the
Exchange, that any order submitted by the Member as a Retail Order
would meet the qualifications for such orders under proposed Nasdaq
Rule 4780(b); and (3) supporting documentation sufficient to
demonstrate the retail nature and characteristics of the applicant's
order flow.\19\ If the Exchange disapproves the application, it would
provide a written notice to the Member. The disapproved applicant could
appeal the disapproval as provided below and/or re-apply 90 days after
the disapproval notice is issued by the Exchange. An RMO also could
voluntarily withdraw from such status at any time by giving written
notice to the Exchange.
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\19\ For example, a prospective RMO could be required to provide
sample marketing literature, Web site screenshots, other publicly
disclosed materials describing the retail nature of their order
flow, and such other documentation and information as the Exchange
may require to obtain reasonable assurance that the applicant's
order flow would meet the requirements of the Retail Order
definition.
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The Exchange would require an RMO to have written policies and
procedures reasonably designed to assure that it will only designate
orders as Retail Orders if all the requirements of a Retail Order are
met. Such written policies and procedures would have to require the
Member to exercise due diligence before entering a Retail Order to
assure that entry as a Retail Order is in compliance with the proposed
rule, and monitor whether orders entered as Retail Orders meet the
applicable requirements. If the RMO represents Retail Orders from
another broker-dealer customer, the RMO's supervisory procedures must
be reasonably designed to assure that the orders it receives from such
broker-dealer customer that it designates as Retail Orders meet the
definition of a Retail Order. The RMO must obtain an annual written
representation, in a form acceptable to the Exchange, from each broker-
dealer customer that sends it orders to be designated as Retail Orders
that entry of such orders as Retail Orders will be in compliance with
the requirements of this rule, and monitor whether its broker-dealer
customer's Retail Order flow continues to meet the applicable
requirements.\20\
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\20\ The Exchange represents that it or another self-regulatory
organization on behalf of the Exchange will review a RMO's
compliance with these requirements through an exam-based review of
the RMO's internal controls. See Notice, supra note 3, 77 FR at
73099 n.7.
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Retail Order Designations
Under proposed Nasdaq Rule 4780(f), a RMO submitting a Retail Order
could choose one of two designations dictating how it would interact
with available
[[Page 12399]]
contra-side interest. First, a Retail Order could interact only with
available contra-side RPI interest and other price-improving liquidity.
The Exchange would label this a Type 1 Retail Order and such orders
would not interact with available non-price-improving, contra-side
interest in Exchange systems or route to other markets. Portions of a
Type 1 Retail Order that are not executed would be cancelled
immediately and automatically.
Second, a Retail Order could interact first with available contra-
side RPI Orders and other price-improving liquidity, and any remaining
portion would be eligible to interact with other interest in the System
and, if designated as eligible for routing, would route to other
markets in compliance with Regulation NMS and pursuant to Nasdaq Rule
4758. The shares remaining from a Type 2-designated Retail Order that
do not fully execute against contra-side RPI Orders or other price
improving liquidity, if any, would execute against other liquidity
available on the Exchange or be routed to other market centers for
execution. The remaining unexecuted portion would then be cancelled.
Priority and Allocation
Under proposed Nasdaq Rule 4780(g), the Exchange would follow
price-time priority, ranking RPI interest in the same security
according to price and then time of entry into the System.\21\ Any
remaining unexecuted RPI Orders would remain available to interact with
other incoming Retail Orders if such interest is at an eligible price.
Any remaining unexecuted portion of a Retail Order would cancel or
execute in accordance with proposed Nasdaq Rule 4780(f).\22\
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\21\ See also Nasdaq Rule 4757 (setting forth the Exchange's
price-time priority methodology).
\22\ The Exchange provides three examples of how the priority
and ranking of RPI Orders would operate. See Notice, supra note 3,
77 FR at 73100.
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Failure of RMO To Abide by Retail Order Requirements
Proposed Nasdaq Rule 4780(c) addresses an RMO's failure to abide by
Retail Order requirements. If an RMO were to designate orders submitted
to the Exchange as Retail Orders and the Exchange determined, in its
sole discretion, that those orders failed to meet any of the
requirements of Retail Orders, the Exchange could disqualify a Member
from its status as a RMO. When disqualification determinations are
made, the Exchange would provide a written disqualification notice to
the Member. A disqualified RMO could appeal the disqualification as
provided below and/or re-apply 90 days after the disqualification
notice is issued by the Exchange.
Appeal of Disapproval or Disqualification
Under Proposed Rule 4780(d), the Exchange would establish a Retail
Price Improvement Program Panel (``RPI Panel'') to review disapproval
or disqualification decisions. If a Member disputes the Exchange's
decision to disapprove or disqualify it as a RMO, such Member could
request, within five business days after notice of the decision is
issued by the Exchange, that the RPI Panel review the decision to
determine if it was correct. The RPI Panel would consist of the
Exchange's Chief Regulatory Officer or his or her designee, and two
officers of the Exchange designated by the Exchange's Chief Operating
Officer, and it would review the facts and render a decision within the
timeframe prescribed by the Exchange. The RPI Panel could overturn or
modify an action taken by the Exchange and all determinations by the
RPI Panel would constitute final action by the Exchange on the matter
at issue.
III. Discussion and Commission Findings
After careful review of the proposal, the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
the rules and regulations thereunder that are applicable to a national
securities exchange. In particular, the Commission finds that the
proposed rule change, subject to its term as a pilot, is consistent
with Section 6(b)(5) of the Act,\23\ which requires, among other
things, that the rules of a national securities exchange be designed to
prevent fraudulent and manipulative acts and practices, to promote just
and equitable principles of trade, to foster cooperation and
coordination with persons engaged in regulating, clearing, settling,
processing information with respect to, and facilitating transactions
in securities, to remove impediments to and perfect the mechanism of a
free and open market and a national market system, and, in general, to
protect investors and the public interest; and not be designed to
permit unfair discrimination between customers, issuers, brokers or
dealers.
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\23\ 15 U.S.C. 78f(b)(5).
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The Commission finds that the Program, as it is proposed on a pilot
basis, is consistent with the requirements of the Act because the
Program is reasonably designed to benefit retail investors by providing
price improvement to retail order flow.\24\ The Commission also
believes that the Program could promote competition for retail order
flow among execution venues, and that this could benefit retail
investors by creating additional price improvement opportunities for
their order flow. Currently, most marketable retail order flow is
executed in the over-the-counter (``OTC'') markets, pursuant to
bilateral agreements, without ever reaching a public exchange. The
Commission has noted that ``a very large percentage of marketable
(immediately executable) order flow of individual investors'' is
executed, or ``internalized,'' by broker-dealers in the OTC
markets.\25\ A review of the order flow of eight retail brokers
revealed that nearly 100% of their customer market orders were routed
to OTC market makers.\26\ The same review found that such routing is
often done pursuant to arrangements under which retail brokers route
their order flow to certain OTC market makers in exchange for payment
for such order flow.\27\ To the extent that the Program may provide
price improvement to retail orders that equals what would be provided
under such OTC internalization arrangements, the Program could benefit
retail investors. To better understand the Program's potential impact,
the Exchange represents that it ``will produce data throughout the
pilot, which will include statistics about participation, the frequency
and level of price improvement provided by the Program, and any effects
on the broader market structure, and would be reviewed by the
Commission prior to any extension of the Program beyond the proposed
one-year pilot term, or permanent approval of the Program.'' \28\
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\24\ The Commission recently approved similar Programs for BATS-
Y Exchange, NYSE and NYSE MKT. See BATS RPI Approval Order, supra
note 12, and NYSE RLP Approval Order, supra note 13.
\25\ See Securities Exchange Act Release No. 61358 (Jan. 14,
2010), 75 FR 3594, 3600 (Jan. 21, 2010) (``Concept Release on Equity
Market Structure'').
\26\ See id.
\27\ See id.
\28\ See Notice, supra note 3, 77 FR at 73100.
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The Program proposes to create additional price improvement
opportunities for retail investors by segmenting retail order flow on
the Exchange and requiring liquidity providers that want to interact
with such retail order flow to do so at a price at least $0.001 per
share better than the Protected Best Bid or Offer. The Commission finds
that, while the Program would treat retail order flow differently from
order flow submitted by other market participants, such segmentation
would not be inconsistent
[[Page 12400]]
with Section 6(b)(5) of the Act, which requires that the rules of an
exchange are not designed to permit unfair discrimination. The
Commission previously has recognized that the markets generally
distinguish between individual retail investors, whose orders are
considered desirable by liquidity providers because such retail
investors are presumed on average to be less informed about short-term
price movements, and professional traders, whose orders are presumed on
average to be more informed.\29\ The Commission has further recognized
that, because of this distinction, liquidity providers are generally
more inclined to offer price improvement to less informed retail orders
than to more informed professional orders.\30\ Absent opportunities for
price improvement, retail investors may encounter wider spreads that
are a consequence of liquidity providers interacting with informed
order flow. By creating additional competition for retail order flow,
the Program is reasonably designed to attract retail order flow to the
exchange environment, while helping to ensure that retail investors
benefit from the better price that liquidity providers are willing to
give their orders.
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\29\ See BATS RPI Approval Order, supra note 12 and NYSE RLP
Approval Order, supra note 13. See also Concept Release on Equity
Market Structure, supra note 25; Securities Exchange Act Release No.
64781 (June 30, 2011), 76 FR 39953 (July 7, 2011) (approving a
program proposed by an options exchange that would provide price
improvement opportunities to retail orders based, in part, on
questions about execution quality of retail orders under payment for
order flow arrangements in the options markets).
\30\ See BATS RPI Approval Order, supra note 12, and NYSE RLP
Approval Order, supra note 1313. See also Securities Exchange Act
Release No. 64781 (June 30, 2011), 76 FR 39953 (July 7, 2011)
(noting that ``it is well known in academic literature and industry
practice that prices tend to move against market makers after trades
with informed traders, often resulting in losses for market
makers,'' and that such losses are often borne by uninformed retail
investors through wider spreads (citing H.R. Stoll, ``The supply of
dealer services in securities markets,'' Journal of Finance 33
(1978), at 1133-51; L. Glosten & P. Milgrom, ``Bid ask and
transaction prices in a specialist market with heterogeneously
informed agents,'' Journal of Financial Economics 14 (1985), at 71-
100; and T. Copeland & D. Galai, ``Information effects on the bid-
ask spread,'' Journal of Finance 38 (1983), at 1457-69)).
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The Commission notes that the Program might also create a desirable
opportunity for institutional investors to interact with retail order
flow that they are not able to reach currently. Today, institutional
investors often do not have the chance to interact with marketable
retail orders that are executed pursuant to internalization
arrangements. Thus, by submitting RPI Orders, institutional investors
may be able to reduce their possible adverse selection costs by
interacting with retail order flow.
When the Commission is engaged in rulemaking or the review of a
rule filed by a self-regulatory organization, and is required to
consider or determine whether an action is necessary or appropriate in
the public interest, the Commission shall also consider, in addition to
the protection of investors, whether the action will promote
efficiency, competition, and capital formation.\31\ As discussed above,
the Commission believes this Program will promote competition for
retail order flow by allowing Exchange Members to submit RPI Orders to
interact with Retail Orders. Such competition may promote efficiency by
facilitating the price discovery process. Moreover, the Commission does
not believe that the Program will have a significant effect on market
structure, or will create any new inefficiencies in current market
structure. Finally, to the extent the Program is successful in
attracting retail order flow, it may generate additional investor
interest in trading securities, thereby promoting capital formation.
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\31\ See 15 U.S.C. 78c(f).
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The Commission also believes that the Program is sufficiently
tailored to provide the benefits of potential price improvement only to
bona fide retail order flow originating from natural persons.\32\ The
Commission finds that the Program provides an objective process by
which a Member organization could become a RMO, and for appropriate
oversight by the Exchange to monitor for continued compliance with the
terms of these provisions. The Exchange has limited the definition of
Retail Order to an agency or riskless principal order that originates
from a natural person and not a trading algorithm or any other
computerized methodology. Furthermore, a Retail Order must be submitted
by a RMO that is approved by the Exchange. In addition, RMOs would be
required to maintain written policies and procedures to help ensure
that they designate as Retail Orders only those orders which qualify
under the Program. If a Member's application to become a RMO is denied
by the Exchange, that Member may appeal the determination or re-apply.
The Commission believes that these standards should help ensure that
only retail order flow is submitted into the Program and thereby
promote just and equitable principles of trade and protect investors
and the public interest, while also providing an objective process
through which Members may become RMOs.
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\32\ In addition, the Commission believes that the Program's
provisions concerning the approval and potential disqualification of
RMOs are not inconsistent with the Act. See, e.g., NYSE RLP Approval
Order, supra note 13, 77 FR at 40680 & n.77.
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In addition, the Commission finds that the Program's proposed
dissemination of a Retail Liquidity Identifier would increase the
amount of pricing information available to the marketplace and is
consistent with the Act. The identifier would be disseminated through
the consolidated public market data stream to advertise the presence of
a RPI Order with which Retail Orders could interact. The identifier
would reflect the symbol for a particular security and the side of the
RPI Order interest, but it would not include the price or size of such
interest. The identifier would alert market participants to the
existence of a RPI Order and should provide market participants with
more information about the availability of price improvement
opportunities for retail orders than is currently available.\33\
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\33\ As the Commission noted when approving the comparable BATS
and NYSE programs, the Commission believes that the Program will not
create any best execution challenges for brokers that are not
already present in today's markets. A broker's best execution
obligations are determined by a number of facts and circumstances,
including: (1) The character of the market for the security (e.g.,
price, volatility, relative liquidity, and pressure on available
communications); (2) the size and type of transaction; (3) the
number of markets checked; (4) accessibility of the quotation; and
(5) the terms and conditions of the order which result in the
transaction. See BATS RPI Approval Order, supra note 12, 77 FR at
71657, and NYSE RLP Approval Order, supra note 13, 77 FR at 40680
n.75 (both citing FINRA Rule 5310).
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The Exchange believes that the proposed Program, which will operate
virtually the same as the BATS RPI Program, and similar to, but with
distinctions from, the NYSE RLP Program, should both enhance
competition among market participants and encourage competition among
exchange venues.\34\ Specifically, the Exchange believes that: allowing
all Members to enter RPI Orders, as opposed to adopting a special
category of retail liquidity provider, as NYSE did with its RLP
Program, could result in a higher level of competition and could
maximize price improvement to incoming Retail Orders; the Program will
provide the maximum price improvement available to incoming Retail
Orders because they will always interact with available contra-side RPI
Orders and any other price-improving contra-side interest; and the
Program will provide all of the price improvement available to incoming
Retail Orders by allowing executions at multiple price levels, as
opposed to a
[[Page 12401]]
single clearing price level.\35\ The Commission finds that the Program
is reasonably designed to enhance competition among market participants
and encourage competition among exchange venues. The Commission also
finds that the distinctions between the Exchange's Program and the
approved NYSE and NYSE MKT programs are reasonably designed to enhance
the Program's price-improvement benefits to retail investors and,
therefore, are consistent with the Act.
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\34\ See Notice, supra note 3, 77 FR at 73102.
\35\ See supra notes 14 to 16 and accompanying text.
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The Commission notes that it is approving the Program on a pilot
basis. Approving the Program on a pilot basis will allow the Exchange
and market participants to gain valuable practical experience with the
Program during the pilot period. This experience should allow the
Exchange and the Commission to determine whether modifications to the
Program are necessary or appropriate prior to any Commission decision
to approve the Program on a permanent basis. The Exchange also has
agreed to provide the Commission with a significant amount of data that
should assist the Commission in its evaluation of the Program.
Specifically, the Exchange has represented that it ``will produce data
throughout the pilot, which will include statistics about
participation, the frequency and level of price improvement provided by
the Program, and any effects on the broader market structure.'' \36\
The Commission expects that the Exchange will monitor the scope and
operation of the Program and study the data produced during that time
with respect to such issues, and will propose any modifications to the
Program that may be necessary or appropriate.
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\36\ See supra note 28 and accompanying text.
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The Commission also welcomes comments, and empirical evidence, on
the Program during the pilot period to further assist the Commission in
its evaluation of the Program. The Commission notes that any permanent
approval of the Program would require a proposed rule change by the
Exchange, and such rule change will provide an opportunity for public
comment prior to further Commission action.
IV. Exemption From the Sub-Penny Rule
Pursuant to its authority under Rule 612(c) of Regulation NMS,\37\
the Commission hereby grants the Exchange a limited exemption from the
Sub-Penny Rule to operate the Program. For the reasons discussed below,
the Commission determines that such action is necessary or appropriate
in the public interest, and is consistent with the protection of
investors. The exemption shall operate for a period of 12 months,
coterminous with the effectiveness of the proposed rule change approved
today.
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\37\ 17 CFR 242.612(c).
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When the Commission adopted the Sub-Penny Rule in 2005, it
identified a variety of problems caused by sub-pennies that the Sub-
Penny Rule was designed to address:
If investors' limit orders lose execution priority for a
nominal amount, investors may over time decline to use them, thus
depriving the markets of liquidity.
When market participants can gain execution priority for a
nominal amount, important customer protection rules such as exchange
priority rules and the Manning Rule could be undermined.
Flickering quotations that can result from widespread sub-
penny pricing could make it more difficult for broker-dealers to
satisfy their best execution obligations and other regulatory
responsibilities.
Widespread sub-penny quoting could decrease market depth
and lead to higher transaction costs.
Decreasing depth at the inside could cause institutions to
rely more on execution alternatives away from the exchanges,
potentially increasing fragmentation in the securities markets.\38\
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\38\ See Securities Exchange Act Release No. 51808 (June 9,
2005), 70 FR 37496, 37551-52 (June 29, 2005).
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At the same time, the Commission ``acknowledge[d] the possibility
that the balance of costs and benefits could shift in a limited number
of cases or as the markets continue to evolve.'' \39\ Therefore, the
Commission also adopted Rule 612(c), which provides that the Commission
may grant exemptions from the Sub-Penny Rule, either unconditionally or
on specified terms and conditions, if it determined that such an
exemption is necessary or appropriate in the public interest, and is
consistent with the protection of investors.
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\39\ Id. at 37553.
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The Commission believes that the Exchange's proposal raises such a
case. As described above, under the current market structure, few
marketable retail orders in equity securities are routed to exchanges.
The vast majority of marketable retail orders are internalized by OTC
market makers, who typically pay retail brokers for their order flow.
Retail investors can benefit from such arrangements to the extent that
OTC market makers offer them price improvement over the NBBO. Price
improvement is typically offered in sub-penny amounts.\40\ An
internalizing broker-dealer can offer sub-penny executions, provided
that such executions do not result from impermissible sub-penny orders
or quotations. Accordingly, OTC market makers typically select a sub-
penny price for a trade without quoting at that exact amount or
accepting orders from retail customers seeking that exact price.
Exchanges--and exchange member firms that submit orders and quotations
to exchanges--cannot compete for marketable retail order flow on the
same basis, because it would be impractical for exchange electronic
systems to generate sub-penny executions without exchange liquidity
providers or retail brokerage firms having first submitted sub-penny
orders or quotations, which the Sub-Penny Rule expressly prohibits.
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\40\ When adopting the Sub-Penny Rule, the Commission considered
certain comments that asked the Commission to prohibit broker-
dealers from offering sub-penny price improvement to their
customers, but declined to do so. The Commission stated that
``trading in sub-penny increments does not raise the same concerns
as sub-penny quoting'' and that ``sub-penny executions due to price
improvement are generally beneficial to retail investors.'' Id. at
37556.
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The limited exemption granted today should promote competition
between exchanges and OTC market makers in a manner that is reasonably
designed to minimize the problems that the Commission identified when
adopting the Sub-Penny Rule. Under the Program, sub-penny prices will
not be disseminated through the consolidated quotation data stream,
which should avoid quote flickering and its reduced depth at the inside
quotation. Furthermore, while the Commission remains concerned about
providing enough incentives for market participants to display limit
orders, the Commission does not believe that granting this exemption
(and approving the accompanying proposed rule change) will reduce such
incentives. Market participants that display limit orders currently are
not able to interact with marketable retail order flow because it is
almost entirely routed to internalizing OTC market makers that offer
sub-penny executions. Consequently, enabling the Exchanges to compete
for this retail order flow through the Program should not materially
detract from the current incentives to display limit orders, while
potentially resulting in greater order interaction and price
improvement for
[[Page 12402]]
marketable retail orders. To the extent that the Program may raise
Manning and best execution issues for broker-dealers, these issues are
already presented by the existing practices of OTC market makers.
The exemption being granted today is limited to a one-year pilot.
The Exchange has stated that ``sub-penny trading and pricing could
potentially result in undesirable market behavior,'' and, therefore, it
will ``monitor the Program in an effort to identify and address any
such behavior.'' \41\ Furthermore, the Exchange has represented that it
``will produce data throughout the pilot, which will include statistics
about participation, the frequency and level of price improvement
provided by the Program, and any effects on the broader market
structure.'' \42\ The Commission expects to review the data and
observations of the Exchange before determining whether and, if so, how
to extend the exemption from the Sub-Penny Rule.\43\
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\41\ See Request for Sub-Penny Rule Exemption, supra note 6, at
3, n.6.
\42\ See supra note 28 and accompanying text.
\43\ In particular, the Commission expects the Exchange to
observe how maker/taker transaction charges, whether imposed by the
Exchange or by other markets, might impact the use of the Program.
Market distortions could arise where the size of a transaction
rebate, whether for providing or taking liquidity, is greater than
the size of the minimum increment permitted by the Program ($0.001
per share).
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\44\ that the proposed rule change (SR-NASDAQ-2012-129) be, and
hereby is, approved on a one-year pilot basis.
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\44\ 15 U.S.C. 78s(b)(2).
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It is also hereby ordered that, pursuant to Rule 612(c) of
Regulation NMS, the Exchange is given a limited exemption from Rule 612
of Regulation NMS allowing it to accept and rank orders priced equal to
or greater than $1.00 per share in increments of $0.001, in the manner
described in the proposed rule change above, on a one-year pilot basis
coterminous with the effectiveness of the proposed rule change.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\45\
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\45\ 17 CFR 200.30-3(a)(12); 17 CFR 200.30-3(a)(83).
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Kevin O'Neill,
Deputy Secretary.
[FR Doc. 2013-04096 Filed 2-21-13; 8:45 am]
BILLING CODE 8011-01-P