[Federal Register Volume 79, Number 66 (Monday, April 7, 2014)]
[Notices]
[Pages 19146-19154]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-07634]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-71837; File No. SR-NYSE-2014-12]
Self-Regulatory Organizations; New York Stock Exchange LLC;
Notice of Filing of Proposed Rule Change Amending Rule 98 To Adopt a
Principles-Based Approach To Prohibit the Misuse of Material Nonpublic
Information and Make Conforming Changes to Other Exchange Rules
April 1, 2014.
Pursuant to Section 19(b)(1) \1\ of the Securities Exchange Act of
1934 (the ``Act'')\2\ and Rule 19b-4 thereunder,\3\ notice is hereby
given that, on March 18, 2014, New York Stock Exchange LLC (``NYSE'' or
the ``Exchange'') filed with the Securities and Exchange Commission
(the ``Commission'') the proposed rule change as described in Items I,
II, and III below, which Items have been prepared by the self-
regulatory organization. The
[[Page 19147]]
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 15 U.S.C. 78a.
\3\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The Exchange proposes to amend Rule 98 to adopt a principles-based
approach to prohibit the misuse of material nonpublic information and
make conforming changes to other Exchange Rules. The text of the
proposed rule change is available on the Exchange's Web site at
www.nyse.com, at the principal office of the Exchange, and at the
Commission's Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the self-regulatory organization
included statements concerning the purpose of, and basis for, the
proposed rule change and discussed any comments it received on the
proposed rule change. The text of those statements may be examined at
the places specified in Item IV below. The Exchange has prepared
summaries, set forth in sections A, B, and C below, of the most
significant parts of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and the
Statutory Basis for, the Proposed Rule Change
1. Purpose
The Exchange proposes to amend Rule 98 to adopt a principles-based
approach to prohibit the misuse of material nonpublic information by a
member organization that operates a DMM unit and make conforming
changes to other Exchange rules. The proposed rule changes would
provide more flexibility for how a member organization may organize its
DMM unit. The Exchange believes that the proposed rule change adopts an
approach more similar to the rules governing equity market makers on
NYSE Arca Equities, Inc. (``NYSE Arca''), the NASDAQ Stock Market LLC
(``Nasdaq''), and the BATS Exchange, Inc. (``BATS''),\4\ while
maintaining certain specified protections that reflect the unique role
of DMMs at the Exchange.\5\ The proposed changes will provide member
organizations operating DMM units with the ability to integrate DMM
unit trading with other trading units, while maintaining narrowly
tailored restrictions to address that DMMs while on the Trading Floor
may have access to certain Floor-based non-public information. The
proposed rule change will also enable DMM units to maintain procedures
and controls to prevent the misuse of material, non-public information
that are effective and appropriate for that member organization.
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\4\ See Securities Exchange Act Release No. 60604 (Sept. 2,
2009), 76 FR 46272 (Sept. 8, 2009) (SR-NYSEArca-2009-78) (Order
approving elimination of NYSE Arca rule that required market makers
to establish and maintain specifically prescribed information
barriers, including discussion of NYSE Arca and Nasdaq rules). See
also Securities Exchange Act Release No. 61574 (Feb. 23, 2010), 75
FR 9455 (Mar. 2, 2010) (SR-BATS-2010-003) (Order approving
amendments to BATS Exchange, Inc. (``BATS'') Rule 5.5 to move to a
principles-based approach to protecting against the misuse of
material, non-public information, and noting that the proposed
change is consistent with the approaches of NYSE Arca and Nasdaq).
\5\ This proposed rule change is not intended to address the
rules governing options market makers.
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As discussed in more detail below, the Exchange proposes to
redefine the structure of a DMM unit by deleting the definitions of
``aggregation unit'' and cross reference to Rule 200 of Regulation SHO
(``Regulation SHO'') \6\ and ``integrated proprietary aggregation
unit'' and redefining the term ``DMM unit.'' The Exchange believes that
these proposed revisions will enable member organizations to integrate
DMM units with other trading operations within the member organization,
including, if applicable, a customer-facing operation, subject to
Exchange and federal rules that prohibit the misuse of material
nonpublic information. In addition, in order to streamline the rule,
the Exchange proposes several non-substantive clarifying and conforming
changes to the provisions of Rule 98 that govern these areas. The
Exchange also proposes to eliminate duplicative provisions in the rule
regarding back-office operations provided by an approved person or
member organization. Finally, the Exchange proposes to delete rules
relating to the DMM that are obsolete.
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\6\ 17 CFR Part 242.200.
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A. Background
Rule 98, which was last amended in 2008,\7\ incorporates various
organizational structures for operating a DMM unit. Rule 98(c) provides
for the operation of a ``DMM unit,'' which can be either a stand-alone
member organization or an ``aggregation unit'' \8\ within a member
organization. As a general matter, unless otherwise specified in Rule
98, a DMM unit must maintain the confidentiality of both DMM
confidential information and non-public orders.\9\ A DMM unit therefore
must not permit either other aggregation units of the member
organization or its approved person(s) to have access to DMM
confidential information or non-public order information.\10\
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\7\ See Securities Exchange Act Release No. 58329 (Aug. 6,
2008), 73 FR 48260 (Aug. 18, 2008) (SR-NYSE-2008-45).
\8\ An ``aggregation unit'' is defined in Rule 98(b)(11) as any
trading or market-making department, division, or desk that meets
the requirements of the definition of ``independent trading unit''
pursuant to Rule 200 of Regulation SHO.
\9\ See Rule 98(c)(2)(A).
\10\ See Rule 98(c)(2)(A)(i) and (ii).
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Rule 98 defines the terms ``non-public order information'' and
``DMM confidential information'' separately. In the case of ``non-
public order information,'' the Exchange seeks to protect price-
sensitive non-DMM trading information that is not publicly available or
that is shared with the DMM with an expectation of privacy. Thus, this
definition captures any information relating to order flow at the
Exchange, including verbal indications of interest made with an
expectation of privacy, electronic order interest, e-quotes, reserve
interest, or information about imbalances at the Exchange, that is not
publicly-available on a real-time basis via an Exchange-provided
datafeed, such as NYSE OpenBook[supreg],\11\ or otherwise publicly
available.
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\11\ NYSE OpenBook[supreg] provides aggregated limit-order
volume that has been entered on the Exchange at price points for all
NYSE-traded securities.
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``DMM confidential information'' refers to principal or proprietary
trading activity of a DMM unit at the Exchange in the securities
allocated to it pursuant to Rule 103B, including the unit's positions
in those securities, decisions relating to trading or quoting in those
securities, and any algorithm or computer system that is responsible
for such trading activity and that interfaces with Exchange systems.
Rule 98(d) permits a member organization to operate the DMM
business within a larger aggregation unit referred to as a ``integrated
proprietary aggregation unit,'' which may only engage in proprietary
trading activity, including electronic market making. Rules 98(d) and
(f)(2) set forth the types of information barriers required within such
a unit to separate the DMM trading at the Exchange from the trading by
the unit's ``upstairs'' desk's trading in assigned securities in away
markets or trading in related products.\12\ In
[[Page 19148]]
particular, the rule requires the DMM unit to protect both non-public
order information and DMM confidential information. When providing risk
management to the DMM unit, the integrated proprietary aggregation unit
may see traded positions of the DMM unit that have been printed to the
Consolidated Tape, but cannot see where the DMM unit is quoting.\13\
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\12\ ``Related products'' are defined as any derivative
instruments that are related to a security allocated to a DMM unit,
including options, warrants, hybrid securities, single-stock
futures, security-based swap agreement, a forward contract, or any
other instrument that is exercisable into or whose price is based
upon or derived from a security listed on the Exchange. See Rule
98(b)(15). The Exchange proposes to make non-substantive edits to
this definition to conform to other changes made to Rule 98, and, as
discussed below, renumber the rule accordingly.
\13\ See Rule 98(f)(1)(v) and (98(f)(2)(A).
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When a DMM unit operates within an integrated proprietary
aggregation unit or engages in off-Floor trading of products related to
securities assigned to the DMM unit, Rule 98 specifically prohibits an
individual DMM who moves off of the Floor of the Exchange from making
DMM confidential information available to off-Floor personnel or
systems of the integrated proprietary aggregation unit.\14\ Senior
managers of the approved person or parent member organization may
provide general oversight to the DMM unit, provided that if the senior
manager receives any DMM confidential information or non-public order
information, he or she must not use such information to directly or
indirectly influence trading based on that confidential
information.\15\
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\14\ See Rule 98(d)(2)(B)(iv) and 98(f)(1)(A)(iii).
\15\ See Rule 98(c)(2)(E).
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Rule 98 further provides that individuals or systems, including
computer algorithms, that are either responsible for trading in related
products within the DMM unit or engaging in risk management on behalf
of the DMM unit, are restricted from having access to DMM confidential
information.\16\ As noted above, the limited exceptions permit the
persons or systems responsible for managing the risk of the DMM unit to
have electronic access to the DMM unit's trades at the Exchange in
securities allocated to the DMM unit, provided that such trades have
been printed to the Consolidated Tape, and to electronically direct the
trading of the DMM unit, subject to the DMM rules.\17\
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\16\ See Rule 98(f)(1)(A)(i), 98(f)(2)(A), and 98(f)(3)(C)(2).
\17\ See Rule 98(f)(1)(A)(v), 98(f)(2)(a)(i), and
98(f)(3)(c)(iii) and (iv).
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In addition to specifying trading restrictions, Rule 98(e) provides
that a DMM unit can share non-trading related services with a parent
member organization or approved persons. However, to share non-trading
related services, a DMM unit must obtain approval from NYSE Regulation
and show that it has policies and procedures to maintain the
confidentiality of DMM confidential information and non-public order
information.
Because not all firms were immediately approved under ``new'' Rule
98, which was last amended in 2008, the Exchange kept the pre-2008
version of Rule 98 in its rulebook as ``Rule 98 Former.'' Because Rule
98 Former was referenced in a number of other Exchange rules, certain
Exchange rules have double references depending on whether the DMM is
approved under Rule 98 Former or the current rule.\18\
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\18\ See Rules 98A Former, 99 Former, 104T(a) (Former), 105(a)
Former, 105(b) Former, 105(d) Former, 105 Guidelines section (m)
Former, and 113 Former.
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All DMM firms are now approved to operate under Rule 98, and are no
longer subject to ``Rule 98 Former.''
B. Proposed Amendments to Rule 98
The Exchange proposes to amend Rule 98 to adopt a more principles-
based approach that would permit a member organization operating a DMM
unit to maintain and enforce its own policies and procedures to, among
other things, prohibit the misuse of material nonpublic information and
eliminate requirements that specify how a member organization must
organize its DMM unit within the firm. While the proposed changes would
provide the ability for member organizations to integrate their DMM
units, the Exchange does not believe that the amendments will reduce in
any way the protections against the misuse of material nonpublic
information. Rather, the Exchange believes that by adding a principles-
based approach that generally prohibits the misuse of material non-
public information, the amended rule will provide for broader
protections than the current rule, which protects only certain defined
non-public information.
To achieve the goal of enabling greater integration of DMM units
within a member organization, the Exchange proposes to revise the
definitions set forth in Rule 98(b) to eliminate the various structures
and instead use a single term to refer to DMM operations. As proposed,
the term ``DMM unit'' would be amended to mean a trading unit within a
member organization that is approved pursuant to Rule 103 to act as a
DMM unit. Accordingly, the Exchange proposes to eliminate the
requirement that a DMM unit be an ``aggregation unit'', which is
currently defined to mean any trading or market-making department,
division or desk that meets the requirements of the definition of
``independent trading unit'' pursuant to Rule 200 of Regulation
SHO.\19\
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\19\ The Exchange proposes to delete rule provisions that
reference the terms ``aggregation unit'' and ``integrated
proprietary aggregation unit.'' See, e.g., Rule 98(c)(2)(B).
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The Exchange proposes to decouple the Rule 98 definition from
Regulation SHO in part because the two rules seek to achieve different
purposes. Rule 200(f) of Regulation SHO sets forth the requirements for
qualifying as an ``independent trading unit'' for the purpose of order
marking requirements under Rule 200. In practice, broker dealers use
information barriers to meet the requirements of an independent trading
unit under Regulation SHO. By contrast, Rule 98 does not concern the
netting of position information. While member organizations operating
DMM units would be required to comply with Regulation SHO, the Exchange
does not believe that it needs to prescribe in its rules how a firm
must structure its DMM operations for purposes of complying with
Regulation SHO.
For similar reasons, the Exchange does not believe it needs to
maintain a definition unique to the Exchange and DMMs of an
``integrated proprietary aggregation unit.'' This definition
contemplates a DMM unit being part of an aggregation unit that engages
in only proprietary trading activity. While a member organization may
choose to structure in this manner, the Exchange does not believe it
needs to be required. Rather, the Exchange believes that Rule 98 should
provide flexibility for a member organization to structure its
business, including any DMM operations, in a manner that a member
organization believes is appropriate for its business purposes, subject
to requirements to protect against the misuse of material, non-public
information, as discussed below.
The Exchange proposes additional changes to Rule 98(b) to delete
definitions that are no longer necessary in the revised rule.
Specifically, the Exchange proposes to delete the definitions for ``DMM
API,'' ``DMM account,'' ``customer-facing department,'' and ``non-
trading related services.'' The terms DMM API and DMM account were
based on Rule 104 before it was amended in 2008. Accordingly, the
Exchange believes that these definitions are now obsolete. In addition,
because the proposed rule changes are intended to provide principles-
based instruction on how to operate a DMM unit, the rule no longer
needs to define terms that support the
[[Page 19149]]
current, more prescriptive rule text. The Exchange proposes to delete
the definitions of ``DMM'' and ``approved person'' as duplicative of
the definitions set forth in Rules 2(i) and 2(c). The Exchange proposes
to make non-substantive edits to the definition of ``related
products.'' The Exchange also proposes to make conforming amendments to
Rule 2(j).
With these proposed definition changes, the Exchange believes that
a member organization operating a DMM unit would be better positioned
to integrate its DMM operations. For example, if a member organization
engages in market-making operations on multiple exchanges, it may be
optimal for a firm to house its DMM operations together with the other
market-making operations, even if such operations are customer-facing.
Another variation could be if a firm chooses to include all of its
equity trading, including customer-facing operations, within a single
independent trading unit. The Exchange believes that providing member
organizations with the ability to integrate DMM operations could
promote liquidity at the Exchange because the DMM operations would be
part of a larger unit with greater sources of liquidity.\20\
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\20\ The Exchange notes that under Regulation SHO, determination
of a seller's net position is based on the seller's position in the
security in all proprietary accounts. See Securities Exchange Act
Release No. 50103 (July 28, 2004), 69 FR 48008, 48010, n.22 (Aug. 6,
2004); see also Securities Exchange Act Release Not 48709 (Oct. 29,
2003), 68 FR 62972, 62991 and 62994 (Nov. 6, 2003); Letter from
Richard R. Lindsey, Director, Division of Market Regulation, to
Roger D. Blanc, Wilkie Farr & Gallagher, SEC No-Action Letter, 1998
SEC No-Act. LEXIS 1038, p. 5 (Nov. 23, 1998); Securities Exchange
Act Release No. 30772 (June 3, 1992), 57 FR 24415, 24419 n.47 (June
9, 1992); Securities Exchange Act Release No. 27938 (Apr. 23, 1990),
55 FR 17949, 17950 (Apr. 30, 1990).
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The Exchange notes that notwithstanding how a member organization
chooses to structure its operations, that firm would need to meet the
requirements of Section 15(g) of the Act,\21\ which requires every
registered broker or dealer to ``establish, maintain, and enforce
written policies and procedures reasonably designed, taking into
consideration the nature of such broker's or dealer's business, to
prevent the misuse . . . of material, nonpublic information by such
broker or dealer or any person associated with such broker or dealer.''
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\21\ 15 U.S.C. 78o(g).
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Accordingly, the Exchange proposes to revise current Rule 98(c)(2)
and replace it with new text based on NYSE Arca Equities Rule 6.3
(Prevention of the Misuse of Material Nonpublic Information) and BATS
Rule 5.5 (Prevention of the Misuse of Material, Non-Public Information)
that specifies that a member organization seeking approval to operate a
DMM unit pursuant to Rule 98 must maintain and enforce written policies
and procedures reasonably designed, taking into consideration the
nature of such member organization's business, (i) to prevent the
misuse of material, non-public information by such member organizations
or persons associated with such member organization and (ii) to ensure
compliance with applicable federal laws and regulations and with
Exchange rules.\22\
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\22\ The Exchange also proposes to revise Rule 98(c)(1) to
replace the term ``NYSE Regulation, Inc.'' with the term
``Exchange.'' Pursuant to Rule 0, the term ``Exchange'' may also
mean FINRA staff working on behalf of the Exchange and NYSE
Regulation, Inc. pursuant to a regulatory services agreement.
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Similar to NYSE Arca Equities Rule 6.3, the Exchange further
proposes to add rule text that provides examples of conduct that would
constitute the misuse of material, non-public information, including,
but not limited to: (A) Trading in any securities issued by a
corporation, or in any related products, while in possession of
material-non-public information concerning the issuer; (B) trading in a
security or related product, while in possession of material non-public
information concerning imminent transactions in the security or related
product; or (C) disclosing to another person or entity any material,
non-public information involving a corporation whose shares are
publicly traded or an imminent transaction in an underlying security or
related product for the purpose of facilitating the possible misuse of
such material, non-public information.\23\
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\23\ Because Rule 98 defines the term ``related product,'' the
Exchange proposes to use the term ``related product'' instead of
``related security,'' which is the term used in NYSE Arca Equities
Rule 6.3.
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The Exchange believes that with the proposed change to Rule
98(c)(2), member organizations will be able to utilize a flexible,
principles-based approach to modify their policies and procedures as
appropriate to reflect changes to their business model, business
activities, or to the securities market itself. Moreover, while
specified information barriers may no longer be required, a member
organization's business model or business activities may dictate that
an information barrier or functional separation be part of the
appropriate set of policies and procedures that would be reasonably
designed to achieve compliance with applicable securities laws and
regulations, and with applicable Exchange rules.
More specifically, the Exchange notes that providing member
organizations with the ability to integrate DMM unit operations with
other equity trading operations, which may include customer-facing
trading desks, would enable member organizations to better manage risk
and adopt uniform trading models across multiple markets. Currently,
because DMM units need to be walled off from other market-making desks,
the DMM units cannot leverage quoting models that may have been
developed for the other market-making desks. And because of the Rule
98-mandated separation, member organizations are restricted in their
ability to manage risk across the DMM unit and other market-making
units. As a result, the costs associated with developing separate
quoting models and risk strategies for a stand-alone DMM unit become
prohibitive as compared to a member organization's investment in
operating an integrated market-making unit that may include both
internalized customer flow and registered market-making on other
exchanges. The Exchange believes that if DMM units could be integrated
with other market-making units, it could not only enable member
organizations to enhance their overall risk management, but could also
potentially lead to flow that would otherwise be internalized being
directed instead to the Exchange.
Consistent with the proposal to adopt a principles-based approach
to protect against the misuse of material non-public information
generally, the Exchange proposes to restructure the defined terms in
current Rule 98 that relate to non-public information. First, the
Exchange proposes to re-define the definition of ``non-public
information'' as ``Floor-based non-public information.'' The Exchange
proposes this redefinition to distinguish this type of non-public
information, which is non-DMM information to which a DMM while on the
Trading Floor may have access due to the unique role of DMMs on the
Trading Floor, from any other non-public information that is covered by
proposed Rule 98(c)(2). As discussed in more detail below, the Exchange
proposes to maintain restrictions in proposed Rule 98(c)(3) tailored to
the Floor-based activities of DMM units and proposes to use the term
``Floor-based non-public order information'' to distinguish which
information those provisions are intended to protect.\24\
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\24\ The Exchange proposes non-substantive changes to this
definition that better reflect how Exchange systems currently
operate. Specifically, the Exchange believes that concept of trading
in ``slow mode'' is duplicative of the remaining rule text, which
covers any order information that is made available to DMMs but that
is not available to other market participants.
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[[Page 19150]]
Second, the Exchange proposes to delete the definition of DMM
confidential information as duplicative of proposed new Rule 98(c)(2),
which protects against the misuse of material non-public information.
As noted above, the term ``DMM confidential information'' includes
position, trading, and quoting information of the DMM unit. This
information is non-public to persons or entities that are not part of
the member organization, but critical information for a member
organization to operate and manage its own risks. The Exchange believes
that the policy concerns relating to specifying separate protections
for this information are no longer applicable. Specifically, unlike
specialists, DMMs are not agents for orders on the Exchange's book and
do not have any negative obligations. Instead, DMMs are required to act
as market makers in assigned securities, subject to affirmative
obligations to maintain a fair and orderly market.\25\ While the DMM
continues to have the ability to, and does, trade manually from the
Floor, the vast majority of the DMM's quotes are entered by means of
algorithms initiated off-Floor. Moreover, DMM interest manually entered
intraday during a slow state or to participate in a verbal transaction
with a Floor broker still yields to public orders.\26\ In addition, to
the extent a DMM on the Floor may have access to Floor-based non-public
order information, proposed Rule 98(c)(3) would continue to specify
protections against the misuse of that information by the member
organization.
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\25\ See Rule 104.
\26\ See Rule 72(c)(xi).
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The Exchange believes that the proposed principles-based approach
to protect against the misuse of material non-public order information
specified in proposed Rule 98(c)(2) would ensure that a member
organization would be required to protect against the misuse of any
material non-public information that currently falls within the
definition of DMM confidential information. As noted above, this
includes refraining from trading while in possession of material non-
public information concerning imminent transactions in the security or
related product. The Exchange believes that moving to a principles-
based approach rather than prescribing how and when to protect the
DMM's own quoting and trading information would provide member
organizations operating DMM units with appropriate tools to better
manage risk across a firm, including integrating DMM unit positions and
quoting information with other quotes and positions by the firm, or as
applicable, by the respective independent trading unit. Specifically,
the Exchange believes that it is appropriate for risk management
purposes for a member organization operating a DMM unit to be able to
consider both DMM unit outstanding quotes as well as traded positions
for purposes of calculating net positions consistent with Rule 200 of
Regulation SHO, calculating intra-day net capital positions, and
managing risk both generally as well as in compliance with Rule 15c3-5
under the Act (the ``Market Access Rule'').\27\ The Exchange notes that
any risk management operations would need to operate consistent with
the requirement to protect against the misuse of material non-public
information.
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\27\ 17 CFR Part 240.15c3-5.
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The Exchange notes that if DMM units are integrated with other
market-making operations, they would be subject to existing rules that
prohibit member organizations from disadvantaging their customers or
other market participants by improperly capitalizing on a member
organization's access to the receipt of material, non-public
information. As such, a member organization that integrates its DMM
unit operations together with customer-facing operations would need to
protect customer information consistent with existing obligations to
protect customer information that already apply to equity market makers
registered on other exchanges. For example, NYSE Rule 5320, which is
substantially similar to FINRA Rule 5320 and NYSE Arca Equities Rule
5320 (generally referred to as the ``Manning Rule.''), generally
prohibits a member organization from trading for its own account ahead
of customer orders. Rule 5320(a) further provides that if a member
organization trades at a price for its own account ahead of the
customer order, it must execute the customer order up to the size and
at the same or better price at which it traded for its own account. The
Manning Rule sets forth certain exceptions to this requirement,
including the Large Orders and Institutional Account Exceptions
(Supplementary Material .01 to Rule 5320) and the No-Knowledge
Exception (Supplementary Material .02 to Rule 5320). A member
organization operating both a DMM unit, which engages in trading for
its own account, and customer-facing operations would need to comply
with the Manning Rule or meet one of the specified exceptions.\28\ In
addition, a member organization operating a DMM unit would also need to
maintain policies and procedures to assure that it does not engage in
any frontrunning of customer order information in violation of
Exchange, FINRA, or federal rules. The Exchange notes that these are
existing obligations that already govern equity market-making
operations on other exchanges and therefore integrating DMM operations
with such desks would not present any novel issues.
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\28\ The Exchange notes that FINRA already monitors member
organizations for compliance with Rule 5320.
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Proposed Rule 98(c)(3)-(7) would set forth the remaining specific
restrictions for member organizations operating a DMM unit. In
recognition of the unique role of DMMs, including limited Floor-based
access to certain non-public order information,\29\ the Exchange
proposes to maintain certain prescriptions on how a DMM unit must
operate. To effect this new structure, the Exchange proposes to delete
subsections (d) and (f) of Rule 98 and move the sections of those rules
that the Exchange proposes to retain to an amended subsection (c)(3)-
(7) of the Rule, which include the relevant restrictions on trading
within the unit. As proposed, the rule will no longer prescribe the
type of trading in which a DMM unit may engage. Rather, the proposed
rule will only specify the types of trading activities that would be
restricted.
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\29\ See Rule 104(j)(ii).
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Proposed Rules 98(c)(3)(A)-(D) would set forth the restrictions
specific to DMM units that address their unique role at the Exchange.
Proposed Rule 98(c)(3)(A) would provide generally that a member
organization shall protect against the misuse of Floor-based non-public
order information. The rule would further specify who may have access
to such Floor-based non-public order information (as permitted pursuant
to Rule 104), which, as proposed, would be the Floor-based employees of
the DMM unit and individuals responsible for the direct supervision of
the DMM unit's Floor-based operations. The Exchange believes that the
proposed rule change specifies in a more straight-forward manner who
may have access to have non-public order information, and replaces the
multiple references in the current Rule 98 to the same concept.\30\
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\30\ See, e.g., Rules 98(c)(2)(A)(i)-(ii), (d)(2)(B)(i)-(iii),
(f)(1)(A)(i), (f)(3)(C)(ii). The current rule is structured as to
who may not have access. The Exchange believes it is clearer to
specify who may have access to such information.
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[[Page 19151]]
Proposed Rule 98(c)(3)(B) would specify the restrictions applicable
to employees of the DMM unit while on the Trading Floor. First, while
on the Trading Floor of the Exchange, employees of the DMM unit, except
as provided for in Rule 36.30, may trade only DMM securities and only
on or through the systems and facilities of the Exchange, as permitted
by Exchange Rules.\31\ Second, while on the Trading Floor, Floor-based
employees may not communicate with individuals or systems responsible
for making trading decisions for related products or for away-market
trading in DMM securities.\32\ Finally, because a DMM unit may be part
of a larger trading unit that includes customer-facing operations, the
Exchange proposes to add a new restriction that while on the Trading
Floor, employees of the DMM unit shall not have access to customer
information or the DMM unit's position in related products.\33\ The
Exchange believes that these proposed restrictions will ensure that
while on the Floor, employees of a DMM unit will not be quoting or
trading based on material non-public information related to customer
information or trading in related products.
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\31\ Compare proposed Rule 98(c)(3)(A) with Rule
98(f)(1)(A)(ii). The Exchange also proposes to replace the term
``Floor'' with the term ``Trading Floor'' to reflect the use of that
term in Rules 6A and 36.
\32\ Compare proposed Rule 98(c)(3)(B) with Rule
98(d)(2)(B)(iii).
\33\ Compare proposed Rule 98(c)(3)(B)(iii) with Rule
98(f)(1)(A)(ii). In addition, the Exchange believes that proposed
Rule 98(c)(3)(B)(iii) replaces the concerns expressed in current
Rule 98(c)(2)(C) that the DMM unit not have access to material non-
public information that is in possession of other aggregation unit.
The Exchange does not believe it needs to maintain Rule 98(c)(2)(C)
because it restates the general concept of how aggregation units
under Regulation SHO are structured, and as noted above, Rule 98 no
longer follows the aggregation unit model.
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As with the current rule, the Exchange proposes to maintain
restrictions on what happens if a non-Floor based individual becomes
aware of Floor-based non-public order information. The Exchange
proposes to consolidate the current rule concerning wall-crossing
provisions into proposed Rule 98(c)(3)(C), which would provide that
when a Floor-based employee of a DMM unit moves to a location off of
the Trading Floor of the Exchange or if any person that provides risk
management oversight or supervision of the Floor-based operations of
the DMM unit is aware of Floor-based non-public order information, he
or she shall not (1) make such information available to customers, (2)
make such information available to individuals or systems responsible
for making trading decisions in DMM securities in away markets or
related products, or (2) use any such information in connection with
making trading decisions in DMM securities in away markets or related
products.
The Exchange believes that consolidating the wall-crossing
provisions into a single provision achieves the same purpose as the
current rule, which states the same concept in multiple places.\34\ The
proposed rule is augmented by adding that Floor-based non-public order
information cannot be made available to customers. The proposed rule
would cover any individual, whether it is an individual that leaves the
Floor or a manager providing oversight of Floor operations, to neither
use nor make available any non-public order information that the
individual becomes aware of. The Exchange believes that replacing the
concept of ``access to'' information with ``aware of'' information
provides a clearer standard for member organizations and is generally
more consistent with federal rules.\35\ Specifically, because the
provision is intended to ensure that information is not used
inappropriately, inappropriate use of such information could only occur
if someone is aware of that information.
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\34\ See Rules 98(c)(2)(E)(i), 98(d)(2)(B)(iv), and
(f)(1)(A)(3).
\35\ See 17 CFR 240.10b5-1(b) (specifying that a purchase or
sale of securities constitutes trading on the basis of material
nonpublic information when the person making the purchase or sale
was aware of the material nonpublic information when the person made
the purchase or sale).
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For example, a DMM unit could be part of a larger trading unit that
engages in customer-facing market making activities on multiple
exchanges. With the proposed changes to Rule 98 generally, a manager
within that unit would be able to monitor risk across the unit,
including positions from trading as a DMM at the Exchange, without
breaching any prohibitions against the misuse of material nonpublic
information. Assume that a Floor-based DMM needs to take on a larger
risk profile in a security because of a proposed Floor broker
transaction and needs to discuss this proposed transaction with the
off-Floor manager. Once this topic is discussed with the off-Floor
manager, that manager is now aware of Floor-based non-public order
information, and therefore must protect against the misuse of this
information. This type of wall-crossing procedure is consistent with
current practices within member organizations.
As with the current rule, but with new rule numbering, the Exchange
proposes to maintain that the DMM unit may make available to a Floor
broker associated with or affiliated with an approved person or member
organization any information that the DMM would be permitted to provide
under Exchange rules to an unaffiliated Floor broker.\36\
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\36\ Compare proposed Rule 98(c)(3)(D) with Rule
98(c)(2)(A)(ii). The Exchange proposes to replace the term ``DMM''
with ``DMM unit'' to be clear that the proposed rule covers any
staff of the DMM unit located on the Trading Floor.
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To ensure that all trading activity by a DMM unit in DMM securities
at the Exchange is available for review, the Exchange proposes to add a
provision that any interest entered by the DMM unit in DMM securities
at the Exchange must be entered through systems that identify such
interest as DMM interest.\37\ As proposed, because the Exchange's
trading systems continue to evolve, the Exchange believes it is
unnecessary to specify which system(s) a DMM unit must use. However,
this rule would require the DMM unit to use a system that would enable
such interest to be identified as DMM trading interest.
---------------------------------------------------------------------------
\37\ See proposed Rule 98(c)(4).
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The Exchange notes that the Rule 104 obligations that relate to
whether a DMM is long or short, i.e., Rules 104(g)(i)(A)(III) and (h),
are applicable to the DMM unit's position in DMM securities together
with any position of a Regulation SHO independent trading unit of which
the DMM unit may be included. For example, if a DMM unit is combined
with market-making desks that are trading on away markets, it would be
the position of that entire unit in DMM securities, and not just the
DMM's Exchange-traded positions, that would be relevant for those
rules. To ensure that the Exchange can monitor for compliance with
these rules, the Exchange proposes to add to Rule 98 that the member
organization must provide the Exchange with real-time unit position
information for any trading in DMM securities by the DMM unit and any
independent trading unit of which it is a part.\38\ For example, if a
DMM unit is part of an independent trading unit that engages in trading
on other markets in DMM securities, the real-time position update would
need to incorporate any away-market transactions in DMM securities by
that independent trading unit.
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\38\ See proposed Rule 98(c)(5). The Exchange proposes to delete
Rule 98(d)(4) and subparagraphs from the rule both because the
Exchange does not believe it needs to separately identify DMM audit
trail requirements and because Rule 132B no longer exists.
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Currently, Rule 98 permits an integrated proprietary aggregation
unit to engage in options market making
[[Page 19152]]
(electronic only), provided that the DMM unit is walled off from the
options market making trading desk. Similar to NYSE Arca Equities, the
Exchange proposes to eliminate prescriptive rules regarding how to
structure DMM operations together with other market-making operations,
and instead believes that the principles-based approach set forth in
proposed Rule 98(c)(2) should protect against the misuse of material
nonpublic information.\39\ The Exchange proposes to amend Rule 98 to
specify restrictions that are unique to the Exchange by virtue of the
close physical proximity of the NYSE MKT LLC options trading floor. As
proposed, the DMM unit may not operate as a specialist or market maker
on the Exchange or the NYSE MKT LLC (``NYSE MKT'') equities or options
trading floors in related products, unless specifically permitted in
Exchange rules.\40\ The Exchange notes that a member organization that
operates a DMM unit may be a specialist or market maker on NYSE MKT
provided that it maintains appropriate information barriers.
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\39\ See footnote 4.
\40\ See proposed Rule 98(c)(6). The Exchange notes that
currently, the only time that a DMM unit may engage in market making
in a related products under Exchange rules is on the NYSE MKT
exchange, pursuant to NYSE MKT Rule 504(b)(5)--Equities. The NYSE
does not have a similar exception.
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The Exchange also proposes to maintain the existing requirement
that the member organization maintain information barriers between the
DMM unit and any investment banking or research departments.\41\ The
amended rule would also continue to provide that no DMM or DMM unit may
be directly supervised or controlled by an individual associated with
an approved person or the member organization who is assigned to any
investment banking or research departments.\42\ The only difference
between the proposed rule text and the current rule is that the
Exchange proposes to delete that a DMM unit may not be supervised or
controlled by an individual assigned to a customer-facing department.
As noted above, the Exchange believes that member organizations should
not be restricted in their ability to combine DMM operations with
customer-facing operations, subject to the restrictions enumerated in
amended Rule 98 and the proposed Exchange and federal requirements that
prohibit the misuse of material nonpublic information, discussed above.
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\41\ Compare proposed Rule 98(c)(7) with 98(c)(2)(A)(i) and
(c)(2)((C). Investment banking activities include activities such as
underwriting, tender offers, mergers, acquisitions,
recapitalizations, etc. See Rule 98(f)(1).
\42\ Compare proposed Rule 98(c)(7) with Rule 98(c)(2)(E)(ii).
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The Exchange also proposes to provide in proposed Rule 98(d) that
the DMM rules will apply only to the DMM unit's quoting or trading in
their DMM securities for their own accounts at the Exchange.\43\ The
Exchange has added that this restriction is only applicable to DMM unit
trading for their own account to be clear that the DMM rule
restrictions are not applicable to any customer orders routed to the
Exchange by that member organization as agent.
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\43\ Compare proposed Rule 98(d) with Rules 98(c)(3) and (d)(3).
As defined in proposed Rule 98(b)(3) (formerly, Rule 98(b)(5)), the
DMM rules mean any rules that govern DMM conduct or trading. These
would include, for example, Rules 36.30, 103, 103A, 103B, and 104.
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The Exchange believes that by restructuring the rule to focus on
protecting against the misuse of material non-public information, Rule
98 no longer needs to specify how a member organization or an approved
person provides back-office support operations, such as clearing, stock
loan, and compliance, for the DMM unit. Rather, the Exchange believes
that how a member organization or approved person provides back-office
operations to the DMM unit should not differ from how such services are
provided to other trading units within that member organization or
approved person. In addition, as proposed, amended Rule 98(c)(2) would
require the member organization to protect against the misuse of
material non-public information, which would govern all aspects of a
member organization's operations. Accordingly, the Exchange proposes to
delete in its entirety Rule 98(e).
The Exchange notes that if a person in the member organization or
an approved person is providing non-trading related services to the DMM
unit, and as a result of such relationship, becomes aware of Floor-
based non-public order information, such person would be subject to the
wall-crossing provisions of proposed Rule 98(c)(3)(C), which is
applicable to any person who is aware of such information. Because
these protections for Floor-based non-public order information are
retained in the proposed revisions to Rule 98, and are applicable to
approved persons pursuant to proposed amended Rule 98(a)(1), the
Exchange believes that Rule 98(e), which concerns the sharing of non-
trading related services, is redundant of existing regulatory
requirements governing the operations of a broker-dealer. The Exchange
proposes conforming amendments to Rule 36.30.
Because of the proposed restructuring of the rule, Rule 98(g) will
be renumbered as Rule 98(e), Rule 98(h) will be renumbered as Rule
98(f), and Rule 98(j) will be renumbered as Rule 98(g). The Exchange is
proposing conforming changes to these sections, including updating
cross-references and changing the reference from the Division of Market
Surveillance and NYSE Regulation to the Exchange.\44\
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\44\ Pursuant to Rule 0, the reference to the Exchange in this
rule may also mean FINRA.
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C. Other Proposed Amendments
As noted above, all DMM firms for which Rule 98 is applicable are
now under the auspices of Rule 98. Accordingly, Rule 98 Former no
longer has any application for any DMM units. The Exchange therefore
proposes to delete Rule 98 Former and any rule that either references
Rule 98 Former, i.e., Rules 98A Former, 99 Former, and 104T(a)(Former)
and supplementary material .13 (Former), or references a rule that is
being proposed for deletion, e.g., Rule 900. The Exchange also proposes
to amend Rule 98(a) and 105 to delete references to Rule 98 Former.
In addition, the Exchange proposes to amend Rule 105 to delete Rule
105(b)-(d) and the Guidelines for DMM's Registered Security Option and
Single Stock Futures Transactions Pursuant to Rule 105 (``Rule 105
Guidelines'') and make conforming amendments to Rule 36.30.\45\ Rule
105 currently sets forth hedging guidelines to permit the DMM to trade
listed options or single-stock futures that overlay DMM securities from
the Trading Floor. Under Rule 98(f)(1), a DMM unit can obtain an
exemption from the Rule 105 Guidelines to trade options or futures,
provided that such trading is conducted by a walled-off, off-Floor
trading desk.
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\45\ The Exchange proposes to amend Rule 105(a) to clarify that
the restriction on pool dealing applies to the DMM unit for
securities registered to that unit.
---------------------------------------------------------------------------
Under proposed revisions to Rule 98, a DMM unit would no longer
need to apply for an exemption from Rule 105 trading restrictions
because, as discussed above, while on the Trading Floor, Floor-based
employees may trade only DMM securities, i.e., no related products, and
only on or through the systems and facilities of the Exchange. Because
there would not be any Floor-based trading in listed options or single-
stock futures, the Rule 105 Guidelines specifying how such Floor-based
trading may occur are now moot. Accordingly, the Exchange proposes to
delete these rules. To conform other Exchange rules
[[Page 19153]]
to this proposal, the Exchange also proposes to delete section (b) from
each of Rules 1300 (streetTRACKS Gold Shares), 1300A (Currency Trust
Shares), and 1300B (Commodity Trust Shares). Each of these subsections
cross-reference Rule 105 Guidelines subsection (m) and would similarly
be mooted by proposed Rule 98(c)(2)(B)(i). The Exchange proposes
further conforming amendments to Rules 900(b) and (d).
In addition, because DMM units no longer have customer
relationships, the Exchange proposes to delete in its entirety the DMM
Booth Wire Policy, which is set forth in Rule 123B, as obsolete.
The Exchange notes that all member organizations currently
operating DMM units already have in place written policies and
procedures to comply with Rule 98, and such policies and procedures
have been approved by NYSE Regulation.\46\ In addition, FINRA has an
exam program that reviews member organizations operating DMM units for
compliance with such procedures. Because the proposed Rule 98
amendments would continue to require Exchange approval of any policies
and procedures to protect against the misuse of material nonpublic
information, if a member organization chooses to modify how it operates
its DMM operations consistent with amended Rule 98, such revised
policies and procedures would be subject to Exchange review before they
could be implemented. In addition, once implemented, FINRA would
continue to monitor a member organization's compliance with those
policies and procedures consistent with the current exam-based
regulatory program associated with Rule 98.
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\46\ FINRA currently approves Rule 98 procedures on behalf of
NYSE Regulation, Inc. pursuant to a regulatory services agreement.
See supra footnote 22.
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In addition, FINRA already has in place surveillances designed to
monitor for manipulative activity and the Exchange believes that
because DMM market-making activity is not materially different from
market-making on other exchanges, these existing programs are
reasonably designed to address any concerns that may be raised by a DMM
unit being integrated with existing market-making operations.
2. Statutory Basis
The basis under the Act for this proposed rule change is the
requirement under Section 6(b)(5) \47\ that an Exchange have rules that
are designed to promote the 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. The Exchange believes that the
proposed rule change would remove impediments to and perfect the
mechanism of a free and open market by adopting a principles-based
approach to permit a member organization operating a DMM unit to
maintain and enforce policies and procedures to, among other things,
prohibit the misuse of material non-public information and eliminating
restrictions on how a member organization structures its DMM unit
operations. The proposed amendments maintain the existing Rule 98
restrictions that are specific to the unique role of the DMM and also
maintain the information barrier requirements between the DMM unit and
any investment banking or research departments. Member organizations
operating DMM units will continue to be subject to federal and Exchange
requirements for protecting material non-public order information \48\
and protecting customer orders that are the consistent with the
existing rules governing broker dealers that operate as equity market
makers on other registered exchanges.\49\
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\47\ 15 U.S.C. 78f(b)(5).
\48\ See 15 U.S.C. 78o(g) and proposed Rule 98(c)(2).
\49\ See Rule 5320.
---------------------------------------------------------------------------
Accordingly, while certain prescriptive elements of Rule 98 are
being deleted, the Exchange notes that the rule will still require that
member organizations maintain and enforce policies and procedures
reasonably designed to ensure compliance with applicable federal
securities laws and regulations and with Exchange rules. The Exchange
notes that such written policies and procedures will continue to be
subject to oversight by the Exchange and therefore the elimination of
prescribed restrictions should not reduce the effectiveness of the
Exchange rules to protect against the misuse of material non-public
information. Rather, member organizations will be able to utilize a
flexible, principles-based approach to modify their policies and
procedures as appropriate to reflect changes to their business model,
business activities, or to the securities market itself. Moreover,
while specified information barriers may no longer be required, a
member organization's business model or business activities may dictate
that an information barrier or functional separation be part of the
appropriate set of policies and procedures that would be reasonably
designed to achieve compliance with applicable securities laws and
regulations, and with applicable Exchange rules. The Exchange therefore
believes that the proposed rule change will maintain the existing
protection of investors and the public interest that is currently set
forth in Rule 98, while at the same time removing impediments to and
perfecting a free and open market by moving to a principles-based
approach to protect against the misuse of material non-public
information.
The Exchange similarly believes that deleting the definition of
``DMM confidential information'' removes impediments to and perfects
the mechanism of a free and open market as it will enable a member
organization to share quoting and position information as may be
necessary to meet order marking requirements under Regulation SHO or to
comply with the Market Access Rule. The Exchange further believes that
the proposed adoption of a principles-based approach to protect against
the misuse of material non-public information, including specifically
requiring refraining from trading based on material non-public
information regarding imminent transactions in a security or related
product, will protect investors and the public interest because it will
assure the protection against the misuse of material non-public
information and delete prescribed rules that may no longer meet this
goal.
The Exchange also believes that amending Rule 98 to apply wall-
crossing procedures to any individual who is aware of non-public order
information both broadens the protection of the rule to any individual,
while at the same time narrowly tailors the rule to when such
protections should apply, i.e., when an individual is aware of non-
public order information and therefore could be in a position to make a
purchase or sale of securities on the basis of such material nonpublic
information. The Exchange believes that such clarifying changes remove
impediments to and perfect the mechanism of a free and open market by
assuring that the protections are applied when necessary.
In addition, the Exchange believes that deleting Rule 98 Former and
all references thereto in Exchange rules removes impediments to and
perfects the mechanism of a free and open market because Rule 98 Former
no longer governs any member organizations or approved persons that
operate a DMM unit, nor would it be applicable to any new DMM units,
and therefore deleting the rule reduces any potential confusion of
which version of
[[Page 19154]]
Rule 98 is applicable. For similar reasons, because DMMs would not be
permitted to trade in related products while on the Trading Floor, the
Exchange believes that the Rule 105 Guidelines are now moot, and
deleting such rule reduces any potential confusion of which rules
govern DMM unit trading in related products. Finally, the Exchange
believes that deleting the Booth Wire Policy reduces confusion as such
policy is now moot given that DMMs do not have public customers.
B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange does not believe that the proposed rule change will
impose any burden on competition that is not necessary or appropriate
in furtherance of the purposes of the Act. The Exchange operates the
only-Floor-based equities market with DMMs. As such, any changes to
Rule 98 would not impact any other markets. However, the Exchange
believes Rule 98 currently imposes a burden on competition for the
Exchange because it requires member organizations that operate a DMM
unit to operate in a manner that the Exchange believes is more
restrictive than necessary for the protection of investors or the
public interest. The Exchange believes that the proposed rule change is
pro-competitive because it adopts a principles-based approach that
prohibit the misuse of material non-public information that is
consistent with the rules of NYSE Arca, BATS, and Nasdaq governing
equity market makers and should provide greater flexibility for how a
member organization could structure its operations.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
No written comments were solicited or received with respect to the
proposed rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve or disapprove the proposed rule change, or
(B) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml ); or
Send an email to [email protected]. Please include
File Number SR-NYSE-2014-12 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.
All submissions should refer to File Number SR-NYSE-2014-12. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for Web site viewing and printing in
the Commission's Public Reference Section, 100 F Street NE.,
Washington, DC 20549-1090. Copies of the filing will also be available
for inspection and copying at the NYSE's principal office and on its
Internet Web site at www.nyse.com. All comments received will be posted
without change; the Commission does not edit personal identifying
information from submissions. You should submit only information that
you wish to make available publicly. All submissions should refer to
File Number SR-NYSE-2014-12 and should be submitted on or before April
28, 2014.
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\50\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\50\
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-07634 Filed 4-4-14; 8:45 am]
BILLING CODE 8011-01-P