Daily Rules, Proposed Rules, and Notices of the Federal Government
In connection with the proposal, the Exchange requested exemptive relief from Rule 612 of Regulation NMS,
This order approves the proposed rule change, as modified by Amendment No. 2, and grants the exemption from the Sub-Penny Rule sought by the Exchange in relation to the proposed rule change.
The Exchange is proposing a one-year pilot program to attract additional retail order flow to the Exchange, while also providing the potential for price improvement to such order flow. The Program would be limited to trades occurring at prices equal to or greater than $1.00 per share.
All securities traded on the Exchange would be eligible for inclusion in the Program. As proposed in Amendment No. 2, for the first 90 days of the pilot program, a group of up to 25 securities would participant in the program. These securities would represent those securities traded most heavily by retail investors. After the initial 90 day period, the Program will be expanded gradually until all securities traded on the Exchange are included. The Exchange will notify Members in an information circular of the securities that are subject to the Program both initially and as additional securities become eligible for inclusion.
Under the Program, a new class of market participants called Retail Member Organizations ("RMOs")
The Exchange represents that its proposed rule change is based on New York Stock Exchange LLC's ("NYSE") Rule 107C, which governs NYSE's previously approved Retail Liquidity Program,
A Retail Order would be an agency order that originates from a natural person and is submitted to the Exchange by a RMO, provided that no change is made to the terms of the order with respect to price or side of market, and the order does not originate from a trading algorithm or any other computerized methodology. Users and RMOs could enter odd lots, round lots, or mixed lots as RPI Orders and as Retail Orders, respectively.
A RPI Order would be non-displayed interest on the Exchange that is better than the Protected NBB or Protected NBO by at least $0.001 and that is identified as a RPI Order in a manner prescribed by the Exchange. An RPI Order may also be entered in a sub-penny increment with an explicit limit price. When such an order is available in the System in a particular security, the Exchange would disseminate an identifier, known as the Retail Liquidity Identifier, indicating that such interest exists. The Exchange would implement the Program in a manner that allowed the dissemination of the identifier through consolidated data streams (
In order to become a RMO, a Member must conduct a retail business or handle retail orders on behalf of another broker-dealer. Any Member that wishes to obtain RMO status would be required to submit: (1) An application form; (2) an attestation, in a form prescribed by the Exchange, that any order submitted by the Member as a Retail Order would meet the qualifications for such orders; and (3) supporting documentation sufficient to demonstrate the retail nature and characteristics of the applicant's order flow.
The Exchange would require a RMO to have written policies and procedures reasonably designed to assure that it will only designate orders as Retail Orders if all the requirements of a Retail Order are met. Such written policies and procedures would have to require the Member to exercise due diligence before entering a Retail Order to assure that entry as a Retail Order is in compliance with the proposed rule, and monitor whether orders entered as Retail Orders meet the applicable requirements. If the RMO represents Retail Orders from another broker-dealer customer, the RMO's supervisory procedures must be reasonably designed to assure that the orders it receives from such broker-dealer customer that it designates as Retail Orders meet the definition of a Retail Order. The RMO must obtain an annual written representation, in a form acceptable to the Exchange, from each broker-dealer customer that sends it orders to be designated as Retail Orders that entry of such orders as Retail Orders will be in compliance with the requirements of this rule, and monitor whether its broker-dealer customer's Retail Order flow continues to meet the applicable requirements.
Under the proposal, a RMO submitting a Retail Order could choose one of two designations dictating how it would interact with available contra-side interest. First, a Retail Order could interact only with available contra-side RPI Orders and other price-improving liquidity. The Exchange would label this a Type 1 Retail Order and such orders would not interact with available non-price-improving, contra-side interest in Exchange systems or route to other markets. Portions of a Type 1 Retail Order that are not executed would be cancelled immediately and automatically.
Second, a Retail Order could interact first with available contra-side RPI Orders and other price-improving liquidity, and any remaining portion would be eligible to interact with other interest in the System
The Exchange would follow price-time priority, ranking RPI Orders in the same security according to price and then time of entry into the System. Any remaining unexecuted RPI Orders would remain available to interact with other incoming Retail Orders if such interest is at an eligible price. Any remaining unexecuted portion of a Retail Order would cancel or execute in accordance with the proposed rule.
The proposed rule addresses an RMO's failure to abide by Retail Order requirements. If a RMO were to designate orders submitted to the Exchange as Retail Orders and the Exchange determined, in its sole discretion, that those orders failed to meet any of the requirements of Retail Orders, the Exchange could disqualify a Member from its status as a RMO. When disqualification determinations are made, the Exchange would provide a written disqualification notice to the Member. A disqualified RMO could appeal the disqualification as provided below and/or re-apply 90 days after the disqualification notice is issued by the Exchange.
Under the proposal, the Exchange would establish a Retail Price Improvement Program Panel ("RPI Panel") to review disapproval or disqualification decisions. If a Member disputes the Exchange's decision to disapprove or disqualify it as a RMO, such Member could request, within five business days after notice of the decision is issued by the Exchange, that the RPI Panel review the decision to determine if it was correct. The RPI Panel would consist of the Exchange's Chief Regulatory Officer or his or her designee, and two officers of the Exchange designated by the Exchange's Chief Operating Officer, and it would review the facts and render a decision within the timeframe prescribed by the Exchange. The RPI Panel could overturn or modify an action taken by the Exchange and all determinations by the RPI Panel would constitute final action by the Exchange on the matter at issue.
As noted above, the Commission received one comment letter that raised concerns about the BYX proposal.
The commenter argued that the BYX's proposal would result in a two-tiered market wherein market participants could only access available interest identified by the Retail Liquidity Identifier if they were seeking to interact with an order placed by a retail customer. The commenter believes that this is inconsistent with the requirements of Section 6(b)(5) of the Exchange Act as it would allow for unfair discrimination against institutional investors. The commenter expressed concern that approval of the NYSE Retail Liquidity Program, coupled with approval of the BYX proposal, would set a precedent for other exchanges to discriminate among members.
In response, the Exchange explained that it believes that the differential treatment proposed in connection with the Program is not designed to permit unfair discrimination, but instead to promote a competitive process through which retail investors would receive better prices than they currently do in light of bilateral internalization arrangements currently utilized to execute such orders. The Exchange argued the Program is consistent with Section 6(b)(5) of the Exchange Act as it is designed to attract retail order flow to the Exchange and help ensure that retail investors benefits from the better prices that liquidity providers are willing to give such orders.
The commenter also express concern that under the BYX proposal, priority
In response, the Exchange noted that Rule 612 was adopted to address the Commission's concern that sub-penny increments could erode the incentives of investors to display limit orders. The Exchange argued that its Program would not reduce such incentives. The Exchange explained that market participants currently are not able to interact with retail order flow because it is routinely routed to internalizing OTC market makers that offer sub-penny executions. The Exchange believes that allowing the Exchange to compete for this retail order flow through the Program should not materially detract from current incentives to display limit orders, and could result in greater order interaction and price improvement for market retail orders on the Exchange. Further, the Exchange explained that its Program would not encourage market participants to step ahead of competing limit orders to gain an insignificant price improvement because pursuant to the Program, neither Retail Orders nor RPI Orders will be displayed by the Exchange.
Finally, the commenter argued that the Exchange's Retail Liquidity Identifier that would be disseminated through the consolidated data stream is an indication of interest that is a quotation, and encouraged the Commission to conduct its own analysis of whether these identifiers are quotations. The commenter also questioned whether broker-dealers would be required to consider these identifiers in making routing decisions consistent with their best execution obligations and expressed concern that a proliferation of the use of identifiers such as that proposed by BYX would increase broker-dealers' compliance burdens because they would be required continuously to evaluate these identifiers on multiple exchanges and it could pose obligations under the order protection rule of Regulation NMS.
In response, the Exchange explained that it believes that neither the Program's RPI Orders nor the retail liquidity identifiers meet the definition of a "bid" or "offer" in Rule 600(b)(8) of Regulation NMS, and therefore are not quotations, because they do not communicate a specific price. Because the Exchange does not believe that RPI are quotations pursuant to Rule 602, it argues that they are not subject the Rule 611of Regulation NMS (Order Protection Rule). Finally, the Exchange stated that it believes that a broker-dealer should consider the Program when conducting its best execution analysis, but does not believe that the Program would create any best execution challenges for broker-dealer's that do not already exist in today's market.
After careful review of the proposal, the comment letter received, and the Exchange's response, the Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder that are applicable to a national securities exchange. In particular, the Commission finds that the proposed rule change, subject to its term as a pilot, is consistent with Section 6(b)(5) of the Act,
The Commission finds that the Program, as it is proposed on a pilot basis, is consistent with the Act because it is reasonably designed to benefit retail investors by providing price improvement to retail order flow.
The Program proposes to create additional price improvement opportunities for retail investors by segmenting retail order flow on the Exchange and requiring liquidity providers that want to interact with such retail order flow to do so at a price at least $0.001 per share better than the Protected Best Bid or Offer. As noted above, the commenter questioned the fairness of treating retail order flow differently from other order flow on an exchange by offering price improvement opportunities only to retail orders. The Commission finds that, while the Program would treat retail order flow differently from order flow submitted by other market participants, such segmentation would not be inconsistent with Section 6(b)(5) of the Act, which requires that the rules of an exchange
The commenter also expressed concern that the Program could create a two-tiered market and questioned the fairness of preventing institutional investors from submitting Retail Orders, and thus receiving price improvement on their orders.
When the Commission is engaged in rulemaking or the review of a rule filed by a self-regulatory organization, and is required to consider or determine whether an action is necessary or appropriate in the public interest, the Commission shall also consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation.
The Commission also believes that the Program is sufficiently tailored to provide the benefits of potential price improvement only to bona fide retail order flow originating from natural persons.
In addition, the Commission finds that the Program's proposed dissemination of a Retail Liquidity Identifier would increase the amount of pricing information available to the marketplace and is consistent with the Act. The identifier would be disseminated through the consolidated public market data stream to advertise the presence of a RPI Order with which Retail Orders could interact. The identifier would reflect the symbol for a particular security and the side of the RPI Order interest, but it would not include the price or size of such interest. The identifier would alert market participants to the existence of a RPI Order and should provide market participants with more information about the availability of price improvement opportunities for retail orders than is currently available.
The commenter questioned whether the Retail Liquidity Identifier is a "quotation".
The commenter also raised concerns about the additional burdens broker-dealers would face in evaluating the information contained in the identifiers to determine their routing obligations. The Commission believes that the Program will not create any best execution challenges that are not already present in today's markets. A broker's best execution obligations are determined by a number of facts and circumstances, including: (1) The character of the market for the security (
The Exchange believes that the proposed distinctions between its Program and the approved programs for NYSE and NYSE MKT will both enhance competition amongst market participants and encourage competition amongst exchange venues.
The Commission notes that it is approving the Program on a pilot basis. Approving the Program on a pilot basis will allow the Exchange and market participants to gain valuable practical experience with the Program during the pilot period. This experience should allow the Exchange and the Commission to determine whether modifications to the Program are necessary or appropriate prior to any Commission decision to approve the Program on a permanent basis. The Exchange also has agreed to provide the Commission with a significant amount of data that should assist the Commission in its evaluation of the Program. Specifically, the Exchange has represented that it "will produce data throughout the pilot, which will include statistics about participation, the frequency and level of price improvement provided by the Program, and any effects on the broader market structure."
The Commission also welcomes comments, and empirical evidence, on the Program during the pilot period to further assist the Commission in its evaluation of the Program. The Commission notes that any permanent approval of the Program would require a proposed rule change by the Exchange, and such rule change will provide an opportunity for public comment prior to further Commission action.
Pursuant to its authority under Rule 612(c) of Regulation NMS,
When the Commission adopted the Sub-Penny Rule in 2005, it identified a variety of problems caused by sub-pennies that the Sub-Penny Rule was designed to address:
* If investors' limit orders lose execution priority for a nominal amount, investors may over time decline to use them, thus depriving the markets of liquidity.
* When market participants can gain execution priority for a nominal amount, important customer protection rules such as exchange priority rules and the Manning Rule could be undermined.
* Flickering quotations that can result from widespread sub-penny pricing could make it more difficult for broker-dealers to satisfy their best execution obligations and other regulatory responsibilities.
* Widespread sub-penny quoting could decrease market depth and lead to higher transaction costs.
* Decreasing depth at the inside could cause institutions to rely more on execution alternatives away from the exchanges, potentially increasing fragmentation in the securities markets.
At the same time, the Commission "acknowledge[d] the possibility that the balance of costs and benefits could shift in a limited number of cases or as the markets continue to evolve."
The Commission believes that the Exchange's proposal raises such a case. As described above, under the current market structure, few marketable retail orders in equity securities are routed to exchanges. The vast majority of marketable retail orders are internalized by OTC market makers, who typically pay retail brokers for their order flow. Retail investors can benefit from such arrangements to the extent that OTC market makers offer them price improvement over the NBBO. Price improvement is typically offered in sub-penny amounts.
The limited exemption granted today should promote competition between exchanges and OTC market makers in a manner that is reasonably designed to minimize the problems that the Commission identified when adopting the Sub-Penny Rule. Under the Program, sub-penny prices will not be disseminated through the consolidated quotation data stream, which should avoid quote flickering and its reduced depth at the inside quotation. Furthermore, while the Commission remains concerned about providing enough incentives for market participants to display limit orders, the Commission does not believe that granting this exemption (and approving the accompanying proposed rule change) will reduce such incentives. Market participants that display limit orders currently are not able to interact with marketable retail order flow because it is almost entirely routed to internalizing OTC market makers that offer sub-penny executions. Consequently, enabling the Exchanges to compete for this retail order flow through the Program should not materially detract from the current incentives to display limit orders, while potentially resulting in greater order interaction and price improvement for marketable retail orders. To the extent that the Program may raise Manning and best execution issues for broker-dealers, these issues are already presented by the existing practices of OTC market makers.
The exemption being granted today is limited to a one-year pilot. The Exchange has stated that "sub-penny trading and pricing could potentially result in undesirable market behavior," and, therefore, it will "monitor the Program in an effort to identify and address any such behavior."