[Federal Register Volume 78, Number 90 (Thursday, May 9, 2013)]
[Notices]
[Pages 27261-27263]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-11004]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-69513; File Nos. SR-NYSE-2013-08; SR-NYSEMKT-2013-07]
Self-Regulatory Organizations; New York Stock Exchange LLC; NYSE
MKT LLC; Order Granting Approval to Proposed Rule Changes Amending the
Attestation Requirement of Rule 107C (NYSE) and 107C--Equities (NYSE
MKT) To Allow a Retail Member Organization To Attest That
``Substantially All'' Orders Submitted to the Retail Liquidity Program
Will Qualify as ``Retail Orders''
May 3, 2013.
I. Introduction
On January 17, 2013, the New York Stock Exchange LLC (``NYSE'') and
NYSE MKT LLC (``NYSE MKT'' and together with NYSE, the ``Exchanges'')
each 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\ proposed rule changes to
allow Retail Member Organizations (``RMOs'') to attest that
``substantially all,'' rather than all, orders submitted to the
Exchanges' respective Retail Liquidity Programs (``Programs'') qualify
as ``Retail Orders.'' The proposed rule changes were published for
comment in the Federal Register on February 4, 2013.\3\ The Commission
received one comment on the proposals.\4\ On March 20, 2013, the
Commission extended the time for Commission action on the proposed rule
changes until May 5, 2013.\5\ The Exchanges submitted a response to the
comment letter on April 2, 2013.\6\ This order approves the proposed
rule changes.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release Nos. 68747 (Jan. 28,
2013), 78 FR 7824 (SR-NYSE-2013-08); and 68746 (Jan. 28, 2013), 78
FR 7842 (SR-NYSEMKT-2013-07).
\4\ See Letter to the Commission from Theodore R. Lazo, Managing
Director and Associate General Counsel, Securities Industry and
Financial Markets Association (SIFMA), dated March 11, 2013.
\5\ See Securities Exchange Act Release No. 69187, 78 FR 18402
(March 26, 2013).
\6\ See Letter to the Commission from Janet McGinnis, General
Counsel, NYSE Markets, dated April 2, 2013 (``Exchanges' Response
Letter'').
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II. Description of the Proposals
The Exchanges began operating their respective Programs after they
were approved by the Commission on a pilot basis in July, 2012.\7\
Under the current rules, a member organization that wishes to
participate in the Programs as an RMO must submit: (A) An application
form; (B) supporting documentation; and (C) an attestation that ``any
order'' submitted as a Retail Order \8\ will qualify as such under Rule
107C.\9\
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\7\ See Securities Exchange Act Release No. 67347 (July 3,
2012), 77 FR 40673 (July 10, 2012) (``RLP Approval Order'').
\8\ A Retail Order is defined in Rule 107C(a)(3) as ``an agency
order or a riskless principal order that originates from a natural
person and is submitted to the Exchange by a Retail Member
Organization, provided that no change is made to the terms of the
order with respect to price or side of market and the order does not
originate from a trading algorithm or any other computerized
methodology.''
\9\ Given that the rules governing the NYSE and NYSE MKT Retail
Liquidity Programs are virtually identical, and that the rationale
for the adoption of the proposed rule text is the same, references
to the text of NYSE Rule 107C in this order and the rationale for
its adoption, unless otherwise noted, apply equally to NYSE MKT Rule
107C--Equities.
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The proposals seek to lessen the attestation requirements of RMOs
that submit ``Retail Orders'' eligible to receive potential price
improvement through participation in the Programs. Specifically, the
Exchanges propose to amend Rule 107C (NYSE) and 107C--Equities (NYSE
MKT) to provide that an RMO may attest that ``substantially all''--
rather than all--of the orders it submits to the Program are Retail
Orders as defined in Rule 107C.
The Exchanges represented that they believe the categorical nature
of the current ``any order'' attestation requirement is preventing
certain member organizations with retail customer business from
participating in the Programs. According to the Exchanges, some of
these member organizations that wish to participate in the Programs
represent both ``Retail Orders,'' as defined in Rule 107C(a)(3), as
well as other agency flow that may not meet the strict definition of
``Retail Order.'' The Exchanges understand that, due to technical
limitations in order management systems and routing networks, such
member organizations may not be able to fully segregate Retail Orders
from other agency, non-Retail Order flow. As a result, the Exchanges
believe that some member organizations choose not to participate in the
Program because they cannot satisfy the current categorical attestation
requirement, although they could satisfy the proposed ``substantially
all'' requirement.
The Exchanges clarified in their proposals that the ``substantially
all'' standard is meant to allow only de minimis amounts of orders to
participate in the Programs that do not meet the definition of a Retail
Order in Rule 107C and that cannot be segregated from bona fide Retail
Orders due to
[[Page 27262]]
systems limitations. Under the proposals, the Exchanges would require
that RMOs retain in their books and records adequate substantiation
that substantially all orders sent to the Exchange as Retail Orders met
the strict definition and that those orders not meeting the strict
definition are agency orders that cannot be segregated from Retail
Orders due to system limitations, and are de minimis in terms of the
overall number of Retail Orders sent to the Exchange.\10\
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\10\ The Exchanges note that the Financial Industry Regulatory
Authority, Inc. (``FINRA''), on behalf of the Exchanges, will review
a member organization's compliance with these requirements.
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III. Comment Letters and the Exchanges' Responses
The Commission received one comment on the proposals. The comment
letter expressed concern over the proposed ``substantially all''
attestation requirement primarily for four reasons.
First, the comment letter questioned whether the proposals would
undermine the rationale on which the Commission approved the Retail
Liquidity Programs. According to the commenter, when the Commission
granted approval to the Programs, along with exemptive relief in
connection with the operation of the Programs, it did so with the
understanding that the Programs would service ``only'' retail order
flow. To the extent the proposals would potentially allow non-Retail
Orders to receive price improvement in the Programs, the commenter
suggested that the Commission should reexamine its rationale for
granting the exemptive relief relating to the Programs.
In response, the Exchanges noted that the proposed amendments are
designed to permit isolated and de minimis quantities of agency orders
that do not qualify as Retail Orders to participate in the Programs,
because such orders cannot be segregated from Retail Orders due to
systems limitations. The Exchanges also noted that several significant
retail brokers choose not to participate in the Programs currently
because of the categorical ``any order'' standard, and that the
proposed ``substantially all'' standard would allow the significant
amount of retail order flow represented by these brokers the
opportunity to receive the benefits of the Programs. Additionally, the
Exchanges note that the Programs are designed to replicate the existing
practices of broker-dealers that internalize much of the market's
retail order flow off-exchange, and that the Programs, as modified by
the ``substantially all'' proposals, would offer a competitive and more
transparent alternative to internalization.
Second, the commenter expressed its belief that the Exchanges did
not sufficiently explain why retail brokers are not able to separate
all Retail and non-Retail Orders, and thereby satisfy the current
attestation requirement. The commenter expressed its belief that the
Commission should require additional explanation as to how retail
brokers could satisfy the proposed ``substantially all'' standard if
they could not satisfy the current standard, including an analysis of
the costs and benefits to retail brokers of implementing technology
changes to identify orders as Retail or non-Retail. Furthermore, the
commenter suggested that the Exchanges' proposals are at odds with the
situation found in options markets where exchanges and brokers
distinguish between public and professional customers--a distinction
the commenter analogized to the Retail v. non-Retail distinction.
The Exchanges responded that several retail brokers have explained
that their order flow is routed in aggregate for retail execution
purposes and that a de minimis amount of such flow may have been
generated electronically, thus not meeting the strict Retail Order
definition. According to the Exchanges, these retail brokers have
chosen not to direct any of their significant shares of retail order
flow to the Programs because the cost of complying with the current
``any order'' standard, such as implementing any necessary systems
changes, is too high. The Exchanges represented that the retail brokers
have indicated their willingness to comply with the proposed
``substantially all'' standard, as well as their ability to implement
the proposed standard on their systems with confidence. The Exchanges
further responded that the distinction between public and professional
customers in the options market is not like distinction between Retail
and non-Retail Orders; the former distinction turns on volume and is
thus an easier bright-line threshold to implement, while the
distinction between Retail and non-Retail Orders turns on whether the
order originated from a natural person, which imposes a higher
threshold for order flow segmentation purposes.
Third, the commenter contended that the proposed ``substantially
all'' standard is overly vague. According to the commenter, the
Exchanges' proposed guidance on what constitutes ``substantially all''
is so vague that it could allow a material amount of non-retail order
flow to qualify for the Programs. The commenter suggested that, should
the Commission approve the proposals, it should first establish a
bright-line rule to define what constitutes ``substantially all''
retail order flow.\11\
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\11\ The commenter cited one example where a ``de minimis''
transaction is defined in 17 CFR 242.101(b)(7), in connection with a
distribution of securities, as ``less than 2%.''
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The Exchanges responded that the proposals represent only a modest
modification of the attestation requirement. In this respect, the
Exchanges noted that the proposals would permit only isolated and de
minimis quantities of agency orders to participate in the Programs that
do not satisfy the strict definition of a Retail Order but that cannot
be segregated from Retail Orders due to systems limitations.
Furthermore, the Exchanges noted that an RMO's compliance with this
requirement would be monitored and subject to books and record-keeping
requirements.
Fourth, the commenter stated that the proposals may cause an
exponential increase in monitoring and recordkeeping burdens associated
with the Programs. The commenter expressed its belief that it could be
especially difficult for the Exchanges not just to identify non-retail
order flow, but also to monitor whether such flow exceeded a de minimis
amount. The commenter also questioned whether the potential difficulty
of the Exchanges monitoring their respective Programs might increase
the likelihood that members may be subject to unfair discrimination in
the Programs' approval and disqualification process.
In response, the Exchanges note that they will issue Trader Alerts
to provide clear guidance on how the ``substantially all'' standard
will be implemented and monitored. The Exchanges also noted that the
Programs are designed to attract as much retail order flow as possible,
and that, should RMOs begin submitting substantial amounts of non-
retail order flow, Retail Liquidity Providers would become less willing
to participate in the Programs. Finally, the Exchanges disagreed with
the commenter's statement that a standard that provides a de minimis
number of exceptions would be any harder to enforce than an standard
that permitted no exceptions.
IV. Discussion and Commission Findings
After careful review of the proposals, the comment letter received,
and the Exchanges' response, the Commission
[[Page 27263]]
finds that the proposed rule changes are consistent with the
requirements of the Act and the rules and regulations thereunder that
are applicable to a national securities exchange.\12\ In particular,
the Commission finds that the proposed rule changes are consistent with
Section 6(b)(5) of the Act,\13\ 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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\12\ In approving the proposals, the Commission has considered
the proposed rules' impact on efficiency, competition, and capital
formation. See 15 U.S.C. 78c(f).
\13\ 15 U.S.C. 78f(b)(5).
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The Commission finds that the proposed ``substantially all''
standard is a limited and sufficiently-defined modification to the
Programs' current RMO attestation requirements that does not constitute
a significant departure from the Programs as initially approved by the
Commission.\14\ The proposals make clear that to comply with the
standard, RMOs may submit only isolated and de minimis amounts of
agency orders that cannot be segregated from Retail Orders due to
systems limitations.\15\ Furthermore, as the Exchanges note, RMOs will
need to adequately document their compliance with the ``substantially
all'' standard in their books and records. Specifically, an RMO would
need to retain adequate documentation that substantially all orders
sent to the Exchanges as Retail Orders met that definition, and that
those orders not meeting that definition are agency orders that cannot
be segregated from Retail Orders due to system limitations, and are de
minimis in terms of the overall number of Retail Orders sent to the
Exchanges. The Commission also notes that FINRA will monitor an RMO's
compliance with this requirement.
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\14\ The Commission notes that it approved the Programs on a
pilot basis subject to ongoing Commission review.
\15\ While the Commission recognizes the potential benefit of
the commenter's suggestion concerning a bright-line definition of de
minimis, see supra note 11, the Commission believes that, in light
of the facts surrounding the instant proposals, the proposals, and
the guidance that the Exchanges will provide to their members on
this point, are sufficiently clear. The Commission also notes that
the example the commenter cites is found in Regulation M, which
governs different circumstances than those at issue here.
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Additionally, the Commission finds that the Exchanges have provided
adequate justification for the proposals. The Exchanges represented
that, as several significant retail brokers explained to them, the
current ``any order'' standard is effectively prohibitive, given the
brokers' order flow aggregation and management systems. The Exchanges
further represented that these retail brokers indicated their systems
would allow them to comply with the ``substantially all'' standard, as
proposed. By allowing these retail brokers to participate in the
Programs, the proposals could bring the potential benefits of the
Programs, including price improvement and increased transparency,\16\
to the retail order flow that these brokers represent.\17\
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\16\ For a more detailed discussion of the Program's potential
benefits, see RLP Approval Order, supra note 7.
\17\ The commenter also expressed concern that this proposal may
increase the burden upon the Exchanges in monitoring compliance with
the Programs. The Commission finds that any potential concerns
raised by this assertion, which are disputed by the Exchanges, are
outweighed by the potential benefits of the proposals; namely, that
the proposals may allow more retail orders the opportunity to
participate in the Programs and receive the attendant benefits of
the Programs. With respect to the commenter's concern that members
may be subject to unfair discrimination in the approval and
disqualification process for participation in the Programs, the
Commission notes that it previously found that the Programs'
provisions concerning the certification, approval, and potential
disqualification of RMOs and Retail Liquidity Providers are not
inconsistent with the Act. See RLP Approval Order, supra note 7.
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V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\18\ that the proposed rules changes (SR-NYSE-2013-08; SR-NYSEMKT-
2013-07) be, and hereby are, approved.
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\18\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\19\
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\19\ 17 CFR 200.30-3(a)(12); 17 CFR 200.30-3(a)(83).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-11004 Filed 5-8-13; 8:45 am]
BILLING CODE 8011-01-P