[Federal Register Volume 78, Number 233 (Wednesday, December 4, 2013)]
[Notices]
[Pages 72944-72946]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-28968]
[[Page 72944]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-70951; File No. SR-BYX-2013-036]
Self-Regulatory Organizations; BATS Y-Exchange, Inc.; Order
Approving a Proposed Rule Change To Amend BYX Rule 12.6 To Conform to
FINRA Rule 5320 Relating to Trading Ahead of Customer Orders
November 27, 2013.
I. Introduction
On October 3, 2013, BATS Y-Exchange, Inc. (the ``Exchange'' or
``BYX'') filed with the Securities and Exchange Commission
(``Commission'' or ``SEC''), 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 amend BYX Rule 12.6 (``Rule
12.6'') to make it substantially similar to Financial Industry
Regulatory Authority (``FINRA'') Rule 5320. The proposed rule change
was published for comment in the Federal Register on October 22,
2013.\3\ The Commission received no comments on the proposal. This
order approves the proposed rule change.
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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. 70663 (October 11,
2013), 78 FR 62896 (SR-BYX-2013-036) (``Notice'').
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II. Description of the Proposed Rule Change
The Exchange proposes to amend Rule 12.6, which limits trading
ahead of customer orders by Members,\4\ to have the rule substantially
conform to FINRA Rule 5320.\5\ As with FINRA Rule 5320, the proposed
amendments to Rule 12.6 would prohibit Members from trading ahead of
customer orders, subject to specified exceptions. Rule 12.6, as
proposed to be amended, would include exceptions for large orders and
institutional accounts, proprietary transactions effected by a trading
unit of a Member with no knowledge of customer orders held by another
trading unit of the Member, riskless principal transactions,
intermarket sweep orders (``ISOs''), and odd lot and bona fide error
transactions, described below. Rule 12.6 also would provide the same
guidance as FINRA Rule 5320 with respect to minimum price improvement
standards, order handling procedures, and trading outside normal market
hours.
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\4\ Members are registered brokers or dealers that have been
admitted to membership at the Exchange. BYX Rule 1.5(n).
\5\ See Securities Exchange Act Release No. 63895 (February 11,
2011), 76 FR 9386 (February 17, 2011) (SR-FINRA-2009-90).
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Background
Current Rule 12.6, the customer order protection rule, generally
prohibits Members from trading on a proprietary basis ahead of, or
along with, customer orders that are executable at the same price as
the proprietary order. The current rule contains several exceptions
that make it permissible for a Member to enter a proprietary order
while representing a customer order that could be executed at the same
price, including permitting transactions for the purpose of
facilitating the execution, on a riskless principal basis, of one or
more customer orders.
Proposal To Adopt Text of FINRA Rule 5320
To harmonize its rules with FINRA, the Exchange proposes to delete
the current text of Rule 12.6 and its supplementary material and adopt
the text and supplementary material of FINRA Rule 5320, with certain
changes, as Rule 12.6. FINRA Rule 5320 generally provides that a FINRA
member that accepts and holds an order in an equity security for its
own customer, or a customer of another broker-dealer, without
immediately executing the order is prohibited from trading that
security on the same side of the market for its own account at a price
that would satisfy the customer order, unless it immediately thereafter
executes the customer order up to the size and at the same or better
price at which it traded for its own account.
Exceptions
The proposed amendments to Rule 12.6 would include exceptions to
the prohibition against trading ahead of customer orders. A Member that
meets the conditions of an exception would be permitted to trade a
security on the same side of the market for its own account at a price
that would satisfy a customer order in certain circumstances. The
exceptions are set forth below.
Large Orders and Institutional Accounts
One exception would permit a Member to negotiate terms and
conditions with respect to the acceptance of certain large-sized orders
(orders of 10,000 shares or more unless such orders are less than
$100,000 in value) or orders from institutional accounts. The term
``institutional account'' would be defined in accordance with FINRA
Rule 4512(c). Accordingly, an institutional account would be defined as
the account of: (1) A bank savings and loan association, insurance
company or registered investment company; (2) an investment adviser
registered either with the SEC under Section 203 of the Investment
Advisers Act or with a state securities commission (or any agency or
office performing like functions); or (3) any other person (whether a
natural person, corporation, partnership, trust or otherwise) with
total assets of at least $50 million. This exception to Rule 12.6, as
amended, would require the Member to provide clear and comprehensive
written disclosure to each customer at account opening and annually
thereafter that: (a) States that the Member may trade proprietarily at
prices that would satisfy the customer order; and (b) provides the
customer with a meaningful opportunity to opt in to the Rule 12.6
protections with respect to all or any portion of its order. In
addition, if a customer does not opt in to the protections with respect
to all or any portion of its order, the Member may reasonably conclude
that such customer has consented to the Member trading a security on
the same side of the market for its own account at a price that would
satisfy the customer's order.\6\
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\6\ A customer would retain the right to withdraw consent at any
time. Therefore, a Member's reasonable conclusion that a customer
has consented to the Member trading along with such customer's order
would be subject to further instruction and modification from the
customer.
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In lieu of providing written disclosure to customers at account
opening and annually thereafter, Rule 12.6 would permit Members to
provide clear and comprehensive oral disclosure to, and obtain consent
from, a customer on an order-by-order basis. Under Rule 12.6, the
Member would be required to document who provided such consent and that
such consent evidences the customer's understanding of the terms and
conditions of the order. If a customer opted in to the protections of
Rule 12.6, a Member could still obtain consent on an order-by-order
basis to trade ahead of or along with an order from that customer,
provided that the Member documented who provided such consent and that
such consent evidenced the customer's understanding of the terms and
conditions of the order.
No-Knowledge Exception
The Exchange also proposes to include in Interpretation and Policy
.02 a ``no-knowledge'' exception to Rule 12.6. The proposed exception
would allow one trading unit of a Member to trade in a proprietary
capacity and at prices that would satisfy customer orders held by
another, separate trading unit of the Member (``the No-Knowledge
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Exception''). The No-Knowledge Exception would be applicable with
respect to NMS stocks, as defined in Rule 600 of Regulation NMS under
the Act.
To avail itself of the No-Knowledge Exception, a Member would be
required to meet certain conditions. First, it would have to implement
and utilize an effective system of internal controls (such as
appropriate information barriers) that operate to prevent the
proprietary trading unit from obtaining knowledge of the customer
orders held by a separate trading unit. As proposed, Interpretation and
Policy .02 would make clear that appropriate information barriers must,
at a minimum, comply with the Exchange's existing requirements
regarding the prevention of the misuse of material, non-public
information, which are set forth in Exchange Rule 5.5. Second, the
Member would have to provide, at account opening and annually
thereafter, a written description of how it handles customer orders and
the circumstances under which it may trade proprietarily, including in
a market-making capacity, at prices that would satisfy the customer
order. A Member must maintain records indicating which orders rely on
the No-Knowledge Exception and produce these records to the Exchange
upon request. Under the proposed exception, the onus would be on the
Member to produce sufficient documentation justifying reliance on the
No-Knowledge Exception for any given trade. To ensure clarity and
transparency regarding this exception and others, the Exchange will
issue a regulatory notice informing Members of the proposed revisions
to Rule 12.6. The Exchange will include in the regulatory notice the
effective date for the rule as amended, which shall be at least 30 days
after Commission approval of the proposed amendments to Rule 12.6 in
order to allow Members to make any necessary changes to their internal
policies or processes.
Riskless Principal Exception
Another proposed amendment to Rule 12.6 would not apply to a
proprietary trade made by the Member to facilitate the execution, on a
riskless principal basis, of another order from a customer (whether its
own customer or the customer of another broker-dealer). To take
advantage of this exception, the Member would have to: (a) Submit a
report, contemporaneously with the execution of the facilitated order,
identifying the trade as riskless principal to the Exchange; and (b)
have written policies and procedures to ensure that riskless principal
transactions relied upon for this exception comply with applicable
Exchange rules. At a minimum, these policies and procedures would have
to require: (1) Receipt of the customer order before execution of the
offsetting principal transaction; and (2) execution of the offsetting
principal transaction at the same price as the customer order,
exclusive of any markup or markdown, commission equivalent, or other
fee and allocation to a riskless principal or customer account in a
consistent manner and within 60 seconds of execution.
Members would have to have supervisory systems in place that
produce records that enable the Member and the Exchange to reconstruct
accurately, readily, and in a time-sequenced manner all orders on which
a Member relies in claiming this exception.
ISO Exception
A further proposed amendment to Rule 12.6 would exempt a Member
from the obligation to execute a customer order in a manner consistent
with Rule 12.6 with regard to trading for its own account when the
Member routed an ISO in compliance with Rule 600(b)(30)(ii) of
Regulation NMS, if the customer order is received after the Member
routed the ISO. If a Member routes an ISO to facilitate a customer
order, and that customer has consented to not receiving the better
prices obtained by the ISO, the Member would also be exempt with
respect to any trading for its own account that is the result of the
ISO with respect to the consenting customer's order.
Odd Lot and Bona Fide Error Exception
The Exchange also proposes to except a Member's proprietary trade
that: (1) Offsets a customer odd lot order (i.e., an order less than
one round lot, which is typically 100 shares); or (2) corrects a bona
fide error. With respect to bona fide errors, the Member would be
required to demonstrate and document the basis upon which a transaction
meets the bona fide error exception. For purposes of this proposed
exception, the Exchange would adopt the definition of ``bona fide
error'' found in Regulation NMS's exemption for error correction
transactions.\7\ Thus, a bona fide error would be:
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\7\ Securities Exchange Act Release No. 55884 (June 8, 2007), 72
FR 32926, 32927 (June 14, 2007) (Order Exempting Certain Error
Correction Transactions from Rule 611 of Regulation NMS under the
Securities Exchange Act of 1934).
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(i) The inaccurate conveyance or execution of any term of an order
including, but not limited to, price, number of shares or other unit of
trading; identification of the security; identification of the account
for which securities are purchased or sold; lost or otherwise misplaced
order tickets; short sales that were instead sold long or vice versa;
or the execution of an order on the wrong side of a market; (ii) the
unauthorized or unintended purchase sale or allocation of securities or
the failure to follow specific client instructions; (iii) the incorrect
entry of data into relevant systems, including reliance on incorrect
cash positions, withdrawals, or securities positions reflected in an
account; or (iv) a delay, outage, or failure of a communication system
used to transmit market data prices or to facilitate the delivery or
execution of an order.\8\
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\8\ Id.
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Minimum Price Improvement Standards
The proposed rule change also would establish the minimum amount of
price improvement necessary for a Member to execute an order on a
proprietary basis when holding an unexecuted limit order in that same
security without being required to execute the held limit order.
In addition, if the minimum price improvement standards set forth
in proposed Interpretation and Policy .06, paragraphs (a) through (g)
would trigger the protection of a pending customer limit order, any
better-priced customer limit order(s) must also be protected under the
amended Rule, even if those better-priced limit orders would not be
directly triggered under these minimum price improvement standards.
Order Handling Procedures
The proposed rule change would provide that a Member must make
every effort to execute a marketable customer order that it receives
fully and promptly. A Member holding a marketable customer order that
has not been immediately executed would have to make every effort to
cross such order with any other order received by the Member on the
other side of the market, up to the size of such order at a price that
is no less than the best bid and no greater than the best offer at the
time that the subsequent order is received by the Member and that is
consistent with the terms of the orders. If a Member were holding
multiple orders on both sides of the market that have not been
executed, the Member would have to make every effort to cross or
otherwise execute such orders in a manner reasonable and consistent
with the objectives of Rule 12.6, as amended, and with the terms of the
orders. A Member could satisfy the crossing requirement by
contemporaneously buying from the
[[Page 72946]]
seller and selling to the buyer at the same price.
Trading Outside Normal Market Hours
Under the proposed amendments to Rule 12.6, a Member generally
could limit the life of a customer order to the period of normal market
hours of 9:30 a.m. to 4:00 p.m. Eastern Time. However, if the customer
and Member agreed to the processing of the customer's order outside
normal market hours, the protections of Rule 12.6, as amended, would
apply to that customer's order at all times the customer order is
executable by the Member.
III. Discussion and Commission Findings
After careful review of the proposed rule change, the Commission
finds that the Exchange's proposal is consistent with the Act and the
rules and regulations thereunder applicable to a national securities
exchange.\9\ In particular, the Commission finds that the proposed rule
change is consistent with Section 6(b)(5) of the Act,\10\ which
requires that the rules of a national securities exchange be designed,
among other things, to prevent fraudulent and manipulative acts and
practices, to promote just and equitable principles of trade, 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.
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\9\ In approving the BYX proposed rule change, the Commission
has considered its impact on efficiency, competition and capital
formation. 15 U.S.C. 78c(f).
\10\ 15 U.S.C. 78f(b)(5).
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The Commission believes that the proposed rule change, which is
designed to establish a single standard to protect customer orders from
member firms trading ahead of those orders, will help assure the
protection of customer orders without imposing undue regulatory costs
on industry participants. Moreover, the Commission believes that the
proposed rule change will define important parameters by which Members
must abide when trading proprietarily while holding customer orders. In
addition, because the Exchange is proposing to make its customer order
protection rule substantially similar to the customer order protection
rules of FINRA \11\ and other exchanges,\12\ the Commission believes
that the proposed rule change will help reduce the complexity of the
customer order protection rules for those firms subject to these rules.
Taken together, the proposed rule change should provide Members with
clarity and guidance and thereby promote the efficient functioning of
the securities markets.
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\11\ See FINRA Rule 5320, supra note 5.
\12\ Several national securities exchanges submitted proposed
rule changes to adopt customer order protection rules that are
substantially similar to FINRA Rule 5320. See, e.g., Securities
Exchange Act Release No. 64418 (May 6, 2011), 76 FR 27735 (May 12,
2011) (SR-CHX-2011-08); Securities Exchange Act Release No. 65165
(August 18, 2011), 76 FR 53009 (August 24, 2011) (SR-NYSEAmex-2011-
59); Securities Exchange Act Release No. 65166 (August 18, 2011), 76
FR 53012 (August 24, 2011) (SR-NYSEArca-2011-57); Securities
Exchange Act Release No. 69504 (May 2, 2013), 78 FR 26828 (May 8,
2013) (SR-CBOE-2013-027); and Securities Exchange Act Release No.
70011 (July 19, 2013), 78 FR 44994 (July 25, 2013) (SR-CBOE-2013-
074).
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IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\13\ that the proposed rule change (SR-BYX-2013-036) be, and it
hereby is, approved.
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\13\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\14\
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\14\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-28968 Filed 12-3-13; 8:45 am]
BILLING CODE 8011-01-P