Rule: Securities: National Market System Joint Industry Plans Amendments

Wednesday,
June 29, 2005
Part II
Securities and
Exchange
Commission
17 CFR Parts 200, 201, et al.
Regulation NMS; Final Rule
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37496 Federal Register / Vol. 70, No. 124 / Wednesday, June 29, 2005 / Rules and Regulations
SECURITIES AND EXCHANGE revenues (‘‘Allocation Amendment’’) 3. Locking or Crossing Quotations

COMMISSION and broaden participation in plan B. Description of Adopted Rule
governance (‘‘Governance 1. Access to Quotations
17 CFR Parts 200, 201, 230, 240, 242, 2. Limitation on Access Fees
Amendment’’).
3. Locking or Crossing Quotations
249, and 270 DATES: Effective Date: August 29, 2005. 4. Regulation ATS Fair Access
[Release No. 34–51808; File No. S7–10–04] Compliance Dates: For specific phase-in IV. Sub-Penny Rule
dates for compliance with the final rules A. Background
RIN 3235–AJ18 B. Commission Proposal and Reproposal
and amendments, see section VII of this
on Sub-Penny Quoting
Regulation NMS release.
C. Comments Received
FOR FURTHER INFORMATION CONTACT: 1. Restriction Based on Price of the
AGENCY: Securities and Exchange Order Protection Rule: Heather Seidel, Quotation Not Price of the Stock
Commission. Senior Special Counsel, at (202) 551– 2. Quotations Below $1.00
ACTION: Final rules and amendments to 5608, Marc F. McKayle, Special 3. Revisiting the Penny Increment
joint industry plans. Counsel, at (202) 551–5633, David Hsu, 4. Sub-Penny Trading
Special Counsel, at (202) 551–5664, or 5. Acceptance of Sub-Penny Quotations
SUMMARY: The Securities and Exchange 6. Application to Options Markets
Raymond Lombardo, Attorney, at (202)
Commission (‘‘Commission’’) is 7. One-to-One Negotiating Systems
551–5615; Access Rule: Heather Seidel, 8. Implementation of Rule 612
adopting rules under Regulation NMS Senior Special Counsel, at (202) 551– V. Market Data Rules and Plan Amendments
and two amendments to the joint 5608, or David Liu, Attorney, at (202) A. Response to Comments and Basis for
industry plans for disseminating market 551–5645; Sub-Penny Rule: Michael Adopted Rules
information. In addition to Gaw, Senior Special Counsel, at (202) 1. Alternative Data Dissemination Models
redesignating the national market 551–5602; Market Data Rules, 2. Level of Fees and Plan Governance
system rules previously adopted under Allocation Amendment, and 3. Revenue Allocation Formula
Section 11A of the Securities Exchange Governance Amendment: David Hsu, 4. Distribution and Display of Data
Act of 1934 (‘‘Exchange Act’’), B. Description of Adopted Rules and
Special Counsel, at (202) 551–5664; Amendments
Regulation NMS includes new Regulation NMS: Yvonne Fraticelli, 1. Allocation Amendment
substantive rules that are designed to Special Counsel, at (202) 551–5654; all 2. Governance Amendment
modernize and strengthen the regulatory of whom are in the Division of Market 3. Consolidation, Distribution, and Display
structure of the U.S. equity markets. Regulation, Securities and Exchange of Data
First, the ‘‘Order Protection Rule’’ Commission, 100 F Street, NE., VI. Regulation NMS
requires trading centers to establish, Washington, DC 20549–6628. A. Description of Regulation NMS
maintain, and enforce written policies B. Rule 600—NMS Security Designation
SUPPLEMENTARY INFORMATION:
and procedures reasonably designed to and Definitions
prevent the execution of trades at prices Table of Contents 1. NMS Security Designation—Transaction
Reporting Requirements for Equities and
inferior to protected quotations I. Introduction
A. Summary of Rulemaking Process and Listed Options
displayed by other trading centers, 2. NMS Security and NMS Stock
subject to an applicable exception. To Record
B. NMS Principles and Objectives 3. Changes to Existing Definitions in the
be protected, a quotation must be NMS Rules
1. Competition Among Markets and
immediately and automatically Competition Among Orders 4. Definitions in the Regulation NMS Rules
accessible. Second, the ‘‘Access Rule’’ 2. Serving the Interests of Long-Term Adopted Today
requires fair and non-discriminatory Investors and Listed Companies C. Changes to Other Rules
access to quotations, establishes a limit C. Overview of Adopted Rules VII. Effective Date and Phased-In Compliance
on access fees to harmonize the pricing 1. Order Protection Rule Dates
2. Access Rule VIII. Paperwork Reduction Act
of quotations across different trading
3. Sub-Penny Rule IX. Consideration of Costs and Benefits
centers, and requires each national X. Consideration of Burden on Competition,
securities exchange and national 4. Market Data Rules and Plans
II. Order Protection Rule and Promotion of Efficiency,
securities association to adopt, A. Response to Comments and Basis for Competition and Capital Formation
maintain, and enforce written rules that Adopted Rule XI. Regulatory Flexibility Act
prohibit their members from engaging in 1. Need for Intermarket Order Protection XII. Response to Dissent
a pattern or practice of displaying Rule XIII. Statutory Authority
quotations that lock or cross automated 2. Limiting Protection to Automated and XIV. Text of Adopted Amendments to the
quotations. Third, the ‘‘Sub-Penny Accessible Quotations CTA Plan, the CQ Plan, and the Nasdaq
3. Workable Implementation of Intermarket UTP Plan
Rule’’ prohibits market participants
Trade-Through Protection XV. Text of Adopted Rules
from accepting, ranking, or displaying
4. Elimination of Proposed Opt-Out
orders, quotations, or indications of Exception
I. Introduction
interest in a pricing increment smaller 5. Scope of Protected Quotations The Commission is adopting
than a penny, except for orders, 6. Benefits and Implementation Costs of Regulation NMS, a series of initiatives
quotations, or indications of interest the Order Protection Rule designed to modernize and strengthen
that are priced at less than $1.00 per B. Description of Adopted Rule the national market system (‘‘NMS’’) for
share. Finally, the Commission is 1. Scope of Rule equity securities.1 These initiatives
adopting amendments to the ‘‘Market 2. Requirement of Reasonable Policies and
Procedures
include:
Data Rules’’ that update the
requirements for consolidating, 3. Exceptions
1 The Commission originally proposed Regulation
4. Duty of Best Execution
distributing, and displaying market III. Access Rule
NMS in February 2004. Securities Exchange Act
information, as well as amendments to Release No. 49325 (Feb. 26, 2004), 69 FR 11126
A. Response to Comments and Basis for (Mar. 9, 2004) (‘‘Proposing Release’’). It issued a
the joint industry plans for Adopted Rule supplemental request for comment in May 2004.
disseminating market information that 1. Means of Access to Quotations Securities Exchange Act Release No. 49749 (May
modify the formulas for allocating plan 2. Limitation on Access Fees 20, 2004), 69 FR 30142 (May 26, 2004)
Federal Register / Vol. 70, No. 124 / Wednesday, June 29, 2005 / Rules and Regulations 37497
(1) A new Order Protection Rule,2 the investment needs of the public and consensus, but trying to achieve
which reinforces the fundamental reducing the cost of capital for listed consensus should not impede the
principle of obtaining the best price for companies. Over this period, the achievement of the statutory objectives
investors when such price is Commission has continued to revise and for the NMS and should not damage the
represented by automated quotations refine its NMS rules in light of changing competitiveness of the U.S. equity
that are immediately accessible; market conditions. markets, both at home and
(2) a new Access Rule, which Today, the NMS encompasses the internationally. We believe that further
promotes fair and non-discriminatory stocks of more than 5000 listed delay is not warranted and therefore
access to quotations displayed by NMS companies, which collectively represent have adopted final rules needed to
trading centers through a private linkage more than $14 trillion in U.S. market modernize and strengthen the NMS. The
approach; capitalization. Consistent with following discussion briefly summarizes
(3) a new Sub-Penny Rule, which Congressional intent, these stocks are the deliberate and open rulemaking
establishes a uniform quoting increment traded simultaneously at a variety of process that the Commission has
of no less than one penny for quotations different venues that participate in the undertaken and the extensive record
in NMS stocks equal to or greater than NMS, including national securities that supports the adoption of Regulation
$1.00 per share to promote greater price exchanges, alternative trading systems NMS, including the many empirical
transparency and consistency; (‘‘ATSs’’), and market-making securities studies undertaken by the Commission
(4) amendments to the Market Data dealers. The Commission believes that staff.
Rules and joint industry plans that the NMS approach adopted by Congress
allocate plan revenues to self-regulatory is a primary reason that the U.S. equity A. Summary of Rulemaking Process and
organizations (‘‘SROs’’) for their markets are widely recognized as being Record
contributions to public price discovery the fairest, most efficient, and most The Commission has engaged in a
and promote wider and more efficient competitive in the world. The rules that thorough, deliberate, and open
distribution of market data; and the Commission is now adopting rulemaking process that has provided at
(5) a reorganization of existing represent an important and needed step every point an opportunity for public
Exchange Act rules governing the NMS forward in its continuing participation and debate. We have
to promote greater clarity and implementation of Congress’s objectives actively sought out the views of the
understanding of the rules. for the NMS. By modernizing and public and securities industry
The Commission is adopting strengthening the nation’s regulatory participants. Even prior to formulating
Regulation NMS in furtherance of its structure, the rules are designed to proposals, our review included multiple
statutory responsibilities. In 1975, assure that the equity markets will public hearings and roundtables, an
Congress directed the Commission, continue to serve the interests of advisory committee, three concept
through enactment of Section 11A of the investors, listed companies, and the releases, the issuance of temporary
Exchange Act, to facilitate the public for years to come. exemptions intended in part to generate
establishment of a national market In recent years, the equity markets useful data on policy alternatives, and a
system to link together the multiple have experienced sweeping changes, constant dialogue with industry
individual markets that trade securities. ranging from new technologies to new participants and investors. This process
Congress intended the Commission to types of markets to the initiation of continued after the proposals were
take advantage of opportunities created trading in penny increments. The published for public comment.3 We
by new data processing and pressing need for NMS modernization to held a public hearing on the proposals
communications technologies to reflect these changes is inescapable. in April 2004 (‘‘NMS Hearing’’) that
preserve and strengthen the securities Thus, for the last five years, the included more than 30 panelists
markets. By incorporating such Commission has undertaken a broad representing investors, individual
technologies, the NMS is designed to and systematic review to determine how markets, and market participants from a
achieve the objectives of efficient, best to keep the NMS up-to-date. This variety of different sectors of the
competitive, fair, and orderly markets review has required the Commission to securities industry.4 Because we
that are in the public interest and grapple with many difficult and believed that there were a number of
protect investors. For three decades, the contentious issues that have lingered important developments at the public
Commission has adhered to these unresolved for many years. We have hearing, we published a supplemental
guiding objectives in its regulation of devoted a great deal of effort to studying request for comment and extended the
the NMS, which are essential to meeting these issues, listening to the views of comment period on the proposals in
the public, and have carefully May 2004 to give the public a full
(‘‘Supplemental Release’’). On December 16, 2004, considered the comments contained in opportunity to respond to these
the Commission reproposed Regulation NMS in its
entirety for public comment. Securities Exchange
the record to craft rule proposals that developments.5 We then carefully
Act Release No. 50870 (Dec. 16, 2004), 69 FR 77424 would achieve the statutory objectives considered the more than 700 comment
(Dec. 27, 2004) (‘‘Reproposing Release’’). for the NMS. letters submitted by the public, which
2 Although the Reproposing Release referred to Given the wide range of perspectives encompassed a wide range of views.
Rule 611 as the ‘‘Trade-Through Rule,’’ the on market structure issues, it is perhaps The insights of the commenters, as
reproposed Rule itself was named ‘‘Order
Protection Rule.’’ The term ‘‘Trade-Through Rule’’
inevitable that there would be well as those of the NMS Hearing
was used in the Reproposing Release to avoid differences of opinion on the panelists, contributed to significant
confusion, given that the term had been widely Commission’s policy choices. The time refinements of the original proposals. In
used in public debate. The term ‘‘Order Protection has arrived, however, when decisions addition, the Commission staff prepared
Rule,’’ however, better captures the nature of the
adopted Rule. For example, the term helps
must be made and contentious issues
distinguish the existing trade-through provisions for must be resolved so that the markets can 3 Proposing Release, 69 FR at 11126.
exchange-listed stocks, which do not really protect move forward with certainty concerning 4A list of all panelists and full transcript of the
orders. Limit order users want a fast, efficient their future regulatory environment and NMS Hearing (‘‘Hearing Tr.’’), as well as an
execution of their orders, not a slow, costly archived video and audio webcast, are available on
‘‘satisfaction’’ process that is provided by the
appropriately respond to fundamental the Commission’s Internet Web site (http://
existing trade-through provisions. See infra, note 30 economic and competitive forces. The www.sec.gov).
and accompanying text. Commission always seeks to achieve 5 Supplemental Release, 69 FR at 30142.
several studies of relevant trading data including investors, listed companies, equity markets. Second, protection of
to help evaluate and respond to the individual markets, market participants, the best displayed and accessible prices
views of commenters. Consequently, and academics.8 Many individual and will promote deep and stable markets
rather than immediately adopting rules, institutional investors particularly that minimize investor transaction costs.
the Commission reproposed Regulation supported the Commission’s view that More than 84 million individual
NMS in its entirety in December 2004 to significant problems exist that require Americans participate, directly or
afford the public an additional the Commission to modernize its indirectly, in the U.S. equity markets.10
opportunity to review and comment on regulations. They also suggested the The transaction costs associated with
the details of the rules and on the staff need for strengthened intermarket price the prices at which their orders are
studies. The Commission then received, protection to further their interests, as executed represent a continual drain on
and carefully considered, more than did major groups representing investors, their long-term savings. Although these
1500 additional comments on the such as the Investment Company costs are difficult to calculate precisely,
reproposal.6 Institute (whose mutual fund members they are very real and very substantial,
This extensive rulemaking process manage assets of $7.8 trillion that with estimates ranging from $30 billion
has generated an equally extensive account for more than 95% of all U.S. to more than $100 billion per year.11
record, which is discussed at length mutual fund assets), the Committee on Minimizing these investor costs to the
throughout this release as it relates to Investment of Employee Benefit Assets greatest extent possible is the hallmark
each of the four substantive rulemaking (which represents 110 of the nation’s of efficient markets, which is a primary
initiatives. Indeed, substantial parts of largest corporate retirement funds objective of the NMS. The Order
the release are devoted to responding to managing $1.1 trillion on behalf of 15 Protection Rule is needed to help
the many public comments (particularly million plan participants and achieve this objective, thereby
those opposing the proposals) and to beneficiaries), the National Association improving the long-term financial well-
discussing the estimated costs and of Investors Corporation (whose being of millions of investors and
benefits of the rules. This rulemaking membership consists of investment reducing the cost of capital for listed
raised difficult policy issues on which clubs and individual investors with companies.
commenters submitted differing views. aggregate personal investments of In sum, the rules adopted today are
To move forward, the Commission approximately $116 billion), and the the culmination of a long and
necessarily has had to make policy Consumer Federation of America. comprehensive rulemaking process.
decisions that not everyone will agree Moreover, the commenters’ views on Reaching appropriate policy decisions
with. the need for an intermarket price in an area as complex as market
The fact that each of the adopted rules protection rule were supported by the structure requires an understanding of
provoked conflicting views from various empirical studies of trading data the relevant facts and of the often subtle
commenters should not, however, performed by Commission staff. These ways in which the markets work, as
obscure the very substantial evidence in studies found, among other things, that well as the balancing of policy
the record strongly supporting each of an estimated 1 out of 40 trades for both objectives that sometimes may not point
the four substantive rulemaking NYSE and Nasdaq stocks are executed at in precisely the same direction. Based
initiatives in Regulation NMS. Clearly, prices inferior to the best displayed on the extensive record that we have
the Order Protection Rule was most quotations, or approximately 98,000 developed over the course of the
controversial and attracted the most trades per day in Nasdaq stocks alone.9 rulemaking process, the Commission
public comment and attention, yet the While the Commission believes that the firmly believes that Regulation NMS
breadth of support in the record for the total number of trade-throughs should will protect investors, promote fair
Rule is compelling. Indeed, support for not be the sole consideration in making competition, and enhance market
an intermarket price protection rule its policy choices, the staff studies and efficiency, and therefore fulfills its
begins with the adoption by Congress in analyses demonstrate that trade-through Exchange Act responsibility to facilitate
1975 of the national market system rates are significant and indicate the the development of the NMS.
itself. Both the House and Senate need for strengthened order protection
committees responsible for drafting for all NMS stocks. B. NMS Principles and Objectives
Section 11A specifically considered and Why did a broad spectrum of 1. Competition Among Markets and
endorsed the Commission’s authority to commenters, many of which have Competition Among Orders
adopt a price protection rule as a means extensive experience and expertise
to achieve the statutory objectives for regarding the inner workings of the The NMS is premised on promoting
the NMS.7 equity markets, support the Order fair competition among individual
Consistent with the drafters’ views, a Protection Rule and its emphasis on the markets, while at the same time assuring
broad spectrum of commenters principle of best price? They based their that all of these markets are linked
supported adoption of the Order support on two fundamental rationales, together, through facilities and rules, in
Protection Rule for all NMS stocks, with which the Commission fully a unified system that promotes
agrees. First, strengthened assurance interaction among the orders of buyers
6 The Reproposing Release stated that the
that orders will be filled at the best and sellers in a particular NMS stock.
Commission would continue to consider all prices will give investors, particularly The NMS thereby incorporates two
comments received on the Proposing Release and
retail investors, greater confidence that distinct types of competition—
Supplemental Release, in addition to those on the competition among individual markets
Reproposing Release, in evaluating further they will be treated fairly when they
rulemaking action. 69 FR at 77426. Accordingly, participate in the equity markets. and competition among individual
this release discusses comments received in Maintaining investor confidence is an orders—that together contribute to
response to all three previous releases. Comments
essential element of well-functioning efficient markets. Vigorous competition
on the Proposing Release and Supplemental Release among markets promotes more efficient
are referred to as ‘‘[name of commenter] Letter.’’
Comments on the Reproposing Release are referred 8 See infra, notes 56–59, 939–941, 957–960, and and innovative trading services, while
to as ‘‘[name of commenter] Reproposal Letter.’’ accompanying text.
7 See infra, notes 920–922 and accompanying 9 See infra, notes 66–69, 104, and accompanying 10 See infra, notes 25–26 and accompanying text.
text. text. 11 See infra, note 990.
integrated competition among orders systems that permit investors, excessive short-term volatility that is
promotes more efficient pricing of particularly large institutions, to seek harmful to long-term investors and
individual stocks for all types of orders, counter-parties to their trades listed companies. More broadly, when
large and small. Together, they produce anonymously and with minimal price market prices do not reflect
markets that offer the greatest benefits impact. fundamental values, resources will be
for investors and listed companies. In sum, while NMS regulation may misallocated within the economy and
Accordingly, the Commission’s channel specific types of market economic efficiency—as well as market
primary challenge in facilitating the competition (e.g., by mandating the efficiency—will be impaired.
establishment of an NMS has been to display to investors of consolidated
2. Serving the Interests of Long-Term
maintain an appropriate balance prices and including the prices
Investors and Listed Companies
between these two vital forms of displayed internally by significant
competition. It particularly has sought electronic markets), it has been In its extended review of market
to avoid the extremes of: (1) Isolated remarkably successful in promoting structure issues and in assessing how
markets that trade an NMS stock market competition in its broader forms best to achieve an appropriate balance
without regard to trading in other that are most important to investors and between competition among markets
markets and thereby fragment the listed companies. and competition among orders, the
competition among buyers and sellers in The difficulty, however, is that Commission has been guided by a firm
that stock; and (2) a totally centralized competition among multiple markets belief that one of the most important
system that loses the benefits of trading the same stocks can detract from goals of the equity markets is to
vigorous competition and innovation the most vigorous competition among minimize the transaction costs of long-
among individual markets. Achieving orders in an individual stock, thereby term investors and thereby to reduce the
this objective and striking the proper impeding efficient price discovery for cost of capital for listed companies.
balance clearly can be a difficult task. orders of all sizes. The importance of These functions are inherently related
Since Congress mandated the competition among orders has long been because the cost of capital of listed
establishment of an NMS in 1975, the recognized. Indeed, when Congress companies is influenced by the
Commission frequently has resisted mandated the establishment of an NMS, transaction costs of those who are
suggestions that it adopt an approach it well stated this basic principle: willing to accept the risk of holding
focusing on a single form of competition ‘‘Investors must be assured that they are corporate equity for an extended
that, while perhaps easier to administer, participants in a system which period.15
would forfeit the distinct, but equally maximizes the opportunities for the The Reproposing Release touched on
most willing seller to meet the most this issue in the specific context of
vital, benefits associated with both
willing buyer.’’ 13 To the extent that assessing the effect of the Order
competition among markets and
competition among orders is lessened, Protection Rule on the interests of
competition among orders.
With respect to competition among the quality of price discovery for all professional traders in conducting
markets, for example, the record of the sizes of orders can be compromised. extremely short-term trading strategies
last thirty years should give pause to Impaired price discovery could cause that can depend on millisecond
those who believe that any market market prices to deviate from differences in order response time from
fundamental values, reduce market markets. Noting that any protection
structure regulation is inherently
depth and liquidity,14 and create against trade-throughs could interfere to
inconsistent with vigorous market
some extent with such short-term
competition. Other countries with
13 H.R. Rep. 94–123, 94th Cong., 1st Sess. 50 trading strategies, the release framed the
significant equity trading typically have
(1975). The quotation from the text of the House Commission’s policy choice as follows:
a single, overwhelmingly dominant Report concludes a cogent description of the ‘‘Should the overall efficiency of the
public market.12 The U.S., in contrast, is importance of maintaining the proper balance NMS defer to the needs of professional
fortunate to have equity markets that are between competition among markets and
characterized by extremely vigorous competition among orders that is worth quoting in
full: frequency of quotation updates. See, e.g., Letter
competition among a variety of different from Edward J. Nicoll, Chief Executive Officer,
Critics of this development [multiple trading of
types of markets. These include: (1) stocks] suggest that the markets are becoming
Instinet Group Incorporated, to Jonathan G. Katz,
Traditional exchanges with active Secretary, Commission, dated Jan. 26, 2005
dangerously fragmented. Others contend that the
(‘‘Instinet Reproposal Letter’’) at 9; Letter from Marc
trading floors, which even now are dilution of large market dominance is the result of
E. Lackritz, President, Securities Industry
evolving to expand the range of choices healthy competitive forces which have done much
Association, to Jonathan G. Katz, Secretary,
to add to the liquidity and depth of the securities
that they offer investors for both markets to the benefit of the investing public. The
Commission, dated Feb. 1, 2005 (‘‘SIA Reproposal
automated and manual trading; (2) Letter’’) at 12. The Commission, however, uses the
Committee shares the opinion that our markets will terms specifically to refer to the ability of investors
purely electronic markets, which offer be strengthened by the infusion of marketmaker to trade in large size at low cost and in general to
both standard limit orders and competition in listed securities with the a market’s capacity to absorb order imbalances with
concomitant increase in capital availability and minimized price impact. Depth is measured in
conditional orders that are designed to diminution of risk which results from increased terms of the volume of stock that can be readily
facilitate complex trading strategies; (3) competition among specialists and marketmakers. traded at a particular price point. Liquidity is
market-making securities dealers, which Nonetheless, market fragmentation becomes of measured by the price movement experienced by
offer both automated execution of increasing concern in the absence of mechanisms investors when attempting to trade in large size. See
designed to assure that public investors are able to infra, section II.A.6 (estimate of transaction costs for
smaller orders and the commitment of obtain the best price for securities regardless of the equity mutual funds). Although depth and liquidity
capital to facilitate the execution of type or physical location of the market upon which are correlated with trading volume, they are not
larger, institutional orders; (4) regional his transaction may be executed. Investors must be synonymous. For example, one stock might have
exchanges, many of which have adopted assured that they are participants in a system which less trading volume than another stock, but still
maximizes the opportunities for the most willing have greater depth available at and close to the best
automated systems for executing smaller seller to meet the most willing buyer. quoted prices and lower transaction costs for large
orders; and (5) automated matching Id. institutional investors.
14 The Proposing Release and Reproposing 15 Investors are more willing to own a stock if it
12 These markets include the London Stock Release frequently emphasized the importance of can be readily traded in the secondary market with
Exchange in the United Kingdom, the Tokyo Stock promoting greater depth and liquidity. Some low transaction costs. The greater the willingness of
Exchange in Japan, Euronext in France, and the commenters appeared to equate depth and liquidity investors to own a stock, the higher its price will
Deutsche Bourse in Germany. with other factors, such as trading volume and be, thereby reducing the issuer’s cost of capital.
traders, many of whom rarely intend to term investors can diverge from those of to someone as ‘‘investing’’ in a company
hold a position overnight? Or should the short-term traders. Deep and liquid for a few seconds, minutes, or hours.22
NMS serve the needs of longer-term markets that minimize volatility are of Short-term traders and market
investors, both large and small, that will most benefit to long-term investors. intermediaries unquestionably provide
benefit substantially from intermarket Such markets help reduce transaction needed liquidity to the equity markets
price protection?’’ 16 The Reproposing costs by furthering the ability of and are essential to the welfare of
Release emphasized that the NMS must investors to establish and unwind investors. Consequently, much, if not
meet the needs of longer-term investors, positions in a stock at prices that are as most, of the time the interests of long-
noting that any other outcome would be close to previously prevailing prices as term investors and short-term traders in
contrary to the Exchange Act and its possible. Indeed, the 1975 Senate Report market quality issues such as speed and
objectives of promoting fair and efficient on the NMS emphasized that one of the operational efficiency will coincide.
markets that serve the public interest.17 ‘‘paramount’’ objectives for the NMS is Indeed, implementation of Regulation
In response, some commenters ‘‘the maintenance of stable and orderly NMS likely will lead to a significant
disputed this focus on the interests of expansion of automated trading in
markets with maximum capacity for
long-term investors in formulating exchange-listed stocks that both benefits
absorbing trading imbalances without
Regulation NMS, one even questioning all investors and opens up greater
undue price movements.’’ 20
the Commission’s statutory authority to potential for electronic trading in such
do so.18 Other commenters appeared to Excessively volatile markets, in stocks than currently exists. But when
share this view, as evidenced by their contrast, can generate many the interests of long-term investors and
downplaying, or failing entirely to opportunities for traders to earn short- short-term traders conflict in this
address, indications of a need for term profits from rapid price swings. context, the Commission believes that
improvements in market quality that are Short-term traders, in particular, its clear responsibility is to uphold the
important to long-term investors, such typically possess the systems interests of long-term investors.
as minimizing short-term price capabilities and expertise necessary to Indeed, the core concern for the
volatility.19 enter and exit the market rapidly to welfare of long-term investors who
Most of the time, the interests of exploit such price swings. Moreover, depend on equity investments to meet
short-term traders and long-term short-term traders have great flexibility their financial goals was first expressed
investors will not conflict. Short-term in terms of their choice of stocks, choice in the foundation documents of the
traders clearly provide valuable of initially establishing a long or short Exchange Act itself. In language that
liquidity to the market. But when the position, and time of entering and remains remarkably relevant today, the
interests of long-term investors and exiting the market. Long-term investors 1934 congressional reports noted how
short-term traders diverge, few issues (both institutional and retail), in the national public interest of the equity
are more fundamentally important in contrast, typically have an opinion on markets had grown as more and more
formulating public policy for the U.S. the long-term prospects for a company. Americans had begun to place their
equity markets than the choice between They therefore want to buy or sell a savings in equity investments, both
these interests. While achieving the directly and indirectly through
particular stock at a particular time.
right balance of competition among investment intermediaries.23 Given this
These investors thus are inherently less
markets and competition among orders development, the reports emphasized
able to exploit short-term price swings
will always be a difficult task, there will that ‘‘stock exchanges which handle the
and, indeed, their buying or selling
be no possibility of accomplishing it if distribution and trading of a very
interest often can initiate short-term
in the case of a conflict the Commission substantial part of the entire national
cannot choose whether the U.S. equity price movements.21 Efficient markets
wealth * * * cannot operate under the
markets should meet the needs of long- with maximum liquidity and depth
same traditions and practices as pre-war
term investors or short-term traders. minimize such price movements and
stock exchanges which handled
The objective of minimizing short- thereby afford long-term investors an
substantially only the transactions of
term price volatility offers an important opportunity to achieve their trading professional investors and
example where the interests of long- objectives with the lowest possible speculators.’’ 24
transaction costs.
16 Reproposing Release, 69 FR at 77440. The Commission recognizes that it is 22 The concept of ownership for a significant time
17 Id. period is inherent in the meaning of word ‘‘invest.’’
important to avoid false dichotomies
18 Letter from Phylis M. Esposito, Executive Vice A dictionary definition of ‘‘investor,’’ for example,
President, Chief Strategy Officer, Ameritrade, Inc.,
between the interests of short-term is ‘‘one that seeks to commit funds for long-term
to Jonathan G. Katz, Secretary, Commission, dated traders and long-term investors, and that profit with a minimum of risk.’’ Webster’s Third
Jan. 26, 2005 (‘‘Ameritrade Reproposal Letter’’) at 9 many difficult line-drawing issues New International Dictionary of the English
(among other issues, questioning Commission’s potentially can arise in precisely Language 1190 (Unabridged 1993).
statutory authority); Letter from James A. Duncan, 23 H.R. Rep. No. 1383, 73rd Cong., 2d Sess. 3–4
Chairman, and John C. Giesea, President and CEO,

defining the difference between the two (1934) (‘‘It is estimated that more than 10,000,000
Security Traders Association, to Jonathan G. Katz, terms. For present purposes, however, individual men and women in the United States are
Secretary, Commission, dated Jan. 19, 2005 (‘‘STA these issues can be handled by simply the direct possessors of stocks and bonds; that over
Reproposal Letter’’) at 6; Letter from William A. noting that it makes little sense to refer one-fifth of all the corporate stock outstanding in
Vance, Stephen Kay, and Kimberly Unger, The the country is held by individuals with net incomes
Security Traders Association of New York, Inc., of less than $5,000 a year. Over 15,000,000
dated Jan. 24, 2005 (‘‘STANY Reproposal Letter’’) 20 S. Rep. No. 94–75, 94th Cong., 1st Sess. 7 individuals held insurance policies, the value of
at 8 n. 18. (1975). which is dependent on the security holdings of
19 See, e.g., Instinet Reproposal Letter at 7–8 (‘‘We 21 Long-term investors, of course, also can be insurance companies. Over 13,000,000 men and
further believe there is no basis for the interested in fast executions. One of the primary women have savings accounts in mutual savings
Commission’s assertion that the reproposed trade- effects of the Order Protection Rule adopted today banks and at least 25,000,000 have deposits in
through rule would increase fill rates or reduce will be to promote much greater speed of execution national and State banks and trust companies—
transitory volatility on the Nasdaq market (or, for in the market for exchange-listed stocks. The which are in turn large holders of corporate stocks
that matter, whether these are in fact ‘weaknesses’ difference in speed between automated and manual and bonds.’’).
that need to be addressed.’’). Short-term price markets often is the difference between a 1-second 24 Id. at 4. The Congressional emphasis on the
volatility for Nasdaq stocks is discussed further in response and a 15-second response—a disparity interests of long-term investors versus short-term
section II.A.1.b below. that clearly can be important to many investors. traders also was expressed in the 1934 Report on
In the years since 1934, the priority type of competition—competition only to exchange-listed stocks. The ITS
placed by Congress on the interests of among markets to provide trading provisions are not promulgated by the
long-term investors has grown more and services—at the expense of competition Commission, but rather are rules of the
more significant. Today, more than 84 among orders. The interests of U.S. markets participating in the ITS Plan.
million individuals representing more long-term investors and listed These rules were drafted decades ago
than one-half of American households companies require that the NMS and do not distinguish between manual
own equity securities.25 More than 70 continue to promote both types of and automated quotations. Moreover,
million of these individuals participate competition. they state that markets ‘‘should avoid’’
indirectly in the equity markets through trade-throughs and provide an after-the-
C. Overview of Adopted Rules
ownership of mutual fund shares. Most fact complaint procedure pursuant to
of them hold their investments, at least 1. Order Protection Rule which, if a trade-through occurs, the
in part, in retirement plans. Indeed, The Order Protection Rule (Rule 611 aggrieved market may seek satisfaction
nearly all view their equity investments under Regulation NMS) establishes from the market that traded through.
as savings for the long-term, and their intermarket protection against trade- Finally, the ITS provisions have
median length of ownership of equity throughs for all NMS stocks. A trade- significant gaps in their coverage,
mutual funds, both inside and outside through occurs when one trading center particularly for off-exchange positioners
retirement plans, is 10 years.26 executes an order at a price that is of large, block transactions (10,000
In assessing the current state of the inferior to the price of a protected shares or greater), that have weakened
NMS and formulating its rule proposals, quotation, often representing an investor their protection of limit orders.
the Commission has focused on the limit order, displayed by another In contrast, the adopted Order
interests of these millions of Americans trading center.28 Many commenters on Protection Rule protects only quotations
who depend on the performance of their the proposals, particularly large that are immediately accessible through
equity investments for such vital needs institutional investors, strongly automatic execution. It thereby
as retirement security and their supported the need for enhanced addresses a serious weakness in the ITS
children’s college education. Their protection of limit orders against trade- provisions, which were drafted for a
investment returns are reduced by throughs.29 They emphasized that limit world of floor-based markets and fail to
transaction costs of all types, including orders are the building blocks of public reflect the disparate speed of response
the explicit costs of commissions and price discovery and efficient markets. between manual and automated
mutual fund fees. But the largely hidden They stated that a uniform rule for all quotations. By requiring order routers to
costs associated with the prices at NMS stocks, by enhancing protection of wait for a response from a manual
which trades are executed often can displayed prices, would encourage market, the ITS trade-through
dwarf the explicit costs of trading. For greater use of limit orders and provisions can cause an order to miss
example, the implicit transaction costs contribute to increased market liquidity both the best price of a manual
associated with the price impact of and depth. The Commission agrees that quotation and slightly inferior prices at
trades and liquidity search costs of strengthened protection of displayed automated markets that would have
mutual funds and other institutional limit orders would help reward market been immediately accessible. The Order
investors is estimated at more than $30 participants for displaying their trading Protection Rule eliminates this potential
billion per year.27 Such hidden costs eat interest and thereby promote fairer and inefficiency by protecting only
away at the long-term returns of more vigorous competition among automated quotations. It also promotes
millions of individual mutual fund orders seeking to supply liquidity. equal regulation and fair competition
shareholders and pension plan Moreover, strong intermarket price among markets by eliminating any
participants. One of the primary protection offers greater assurance, on potential advantage that the ITS trade-
objectives of the NMS is to help reduce an order-by-order basis, that investors through provisions may have given
such costs by improving market who submit market orders will receive manual markets over automated
liquidity and depth. The best way to the best readily available prices for their markets.
promote market depth and liquidity is trades. The Commission therefore has In addition, the Order Protection Rule
to encourage vigorous competition adopted the Order Protection Rule to incorporates an approach to trade-
among orders. As a result, the strengthen the protection of displayed throughs that is stricter and more
Commission cannot merely focus on one and automatically accessible quotations comprehensive than the ITS provisions.
in NMS stocks. First, it requires trading centers to
Stock Exchange Practices prepared by investigators The Order Protection Rule takes a establish, maintain, and enforce written
for the Senate Committee on Banking and Currency: substantially different approach than policies and procedures that are
‘‘Transactions in securities on organized the trade-through provisions currently reasonably designed to prevent trade-
exchanges and over-the-counter markets are throughs, or, if relying on one of the
affected with the national public interest. * * * In set forth in the Intermarket Trading
former years transactions in securities were carried System (‘‘ITS’’) Plan,30 which apply rule’s exceptions, that are reasonably
on by a relatively small portion of the American designed to assure compliance with the
people. During the last decade, however, due 28 The nature and scope of quotations that will be exception. To assure effective
largely to the development of the means of protected under the Order Protection Rule are compliance, such policies and
communication * * * the entire Nation has become discussed in detail in sections II.A.2 and II.B.1
acutely sensitive to the activities on the securities procedures will need to incorporate
below.
exchanges. While only a fraction of the multitude 29 See infra, note 56 (overview of commenters
objective standards that are coded into
who now own securities can be regarded as actively supporting trade-through proposal). a trading center’s automated systems.
trading on the exchanges, the operations of these 30 The full title of the ITS Plan is ‘‘Plan for the
few profoundly affect the holdings of all.’’
Purpose of Creating and Operating an Intermarket participants in the ITS Plan. It requires each
S. Rep. No. 73–1455, 73rd Cong., 2d Sess. 5 Communications Linkage Pursuant to Section participant to provide electronic access to its
(1934). 11A(c)(3)(B) of the Securities Exchange Act of displayed best bid or offer to other participants and
25 Investment Company Institute and Securities
1934.’’ The ITS Plan was initially approved by the provides an electronic mechanism for routing
Industry Association, Equity Ownership in America Commission in 1978. Securities Exchange Act orders, called commitments to trade, to access those
17 (2002). Release No. 14661 (Apr. 14, 1978), 43 FR 17419 displayed prices. The participants also agreed to
26 Id. at 85, 89, 92, 96.
(Apr. 24, 1978). All national securities exchanges avoid trade-throughs and locked markets and to
27 See infra, section II.A.6. that trade exchange-listed stocks and the NASD are adopt rules addressing such practices.
Moreover, a trading center is required to Examples of these exceptions include emphasized by many commenters on
regularly surveil to ascertain the intermarket sweep orders, quotations the proposals,34 protecting the best
effectiveness of its policies and displayed by markets that fail to meet displayed prices against trade-throughs
procedures and to take prompt action to the response requirements for would be futile if broker-dealers and
remedy deficiencies. Second, the Order automated quotations, and flickering trading centers were unable to access
Protection Rule eliminates very quotations with multiple prices those prices fairly and efficiently.
significant gaps in the coverage of the displayed in a single second.31 Accordingly, Rule 610 is designed to
ITS provisions that have undermined Some commenters questioned the promote access to quotations in three
the extent to which they protect limit need to extend the Order Protection ways. First, it enables the use of private
orders and promote fair and orderly Rule to Nasdaq stocks.32 These linkages offered by a variety of
trading. In particular, the ITS provisions commenters generally emphasized the connectivity providers,35 rather than
do not cover the transactions of broker- much improved efficiency of trading in mandating a collective linkage facility
dealers acting as off-exchange block Nasdaq stocks in recent years. They such as ITS, to facilitate the necessary
positioners in exchange-listed stocks. particularly were concerned that access to quotations. The lower cost and
They also exclude trade-throughs of extension of intermarket price increased flexibility of connectivity in
100-share quotations, thereby allowing protection to Nasdaq stocks, at least in recent years has made private linkages
some limit orders of small investors to the absence of a general opt-out a feasible alternative to hard linkages,
be bypassed. The Order Protection Rule exception, would interfere with current absent barriers to access. Using private
closes both of these gaps in coverage. trading methods. linkages, market participants may obtain
The definition of ‘‘protected bid’’ or The Commission believes, however, indirect access to quotations displayed
‘‘protected offer’’ in paragraph (b)(57) of that intermarket price protection will by a particular trading center through
adopted Rule 600 controls the scope of benefit investors and strengthen the the members, subscribers, or customers
quotations that are protected by the NMS in both exchange-listed and of that trading center. To promote this
Order Protection Rule. The Commission Nasdaq stocks. It will contribute to the type of indirect access, Rule 610
is adopting the reproposed ‘‘Market maintenance of fair and orderly markets prohibits a trading center from imposing
BBO Alternative’’ that protects only the and, thereby, promote investor unfairly discriminatory terms that
best bids and offers (‘‘BBOs’’) of the confidence in the markets. As discussed would prevent or inhibit the access of
nine self-regulatory organizations below,33 trade-through rates are any person through members,
(‘‘SROs’’) and The Nasdaq Stock Market, significant in both Nasdaq and subscribers, or customers of such
Inc. (‘‘Nasdaq’’) whose members exchange-listed stocks. For example, an trading center.
currently trade NMS stocks. As estimated 1 of every 40 trades in both Second, Rule 610 generally limits the
discussed further in section II.A.5 Nasdaq and NYSE stocks represents a fees that any trading center can charge
below, the Commission has decided not significant trade-through of a displayed (or allow to be charged) for accessing its
to adopt the reproposed ‘‘Voluntary quotation. For many active Nasdaq protected quotations to no more than
Depth Alternative.’’ In particular, it stocks, approximately 1 of every 11 $0.003 per share.36 The purpose of the
believes that the Market BBO shares traded is a significant trade- fee limitation is to ensure the fairness
Alternative: (1) Strikes an appropriate through. The execution of trades at and accuracy of displayed quotations by
balance between competition among prices inferior to those offered by establishing an outer limit on the cost of
markets and competition among orders; displayed and accessible limit orders is accessing such quotations. For example,
and (2) will be less difficult and costly inconsistent with basic notions of if the price of a protected offer to sell
to implement than the Voluntary Depth fairness and orderliness, particularly for an NMS stock is displayed at $10.00, the
Alternative. investors, both large and small, who
The rule text of the original proposal total cost to access the offer and buy the
post limit orders and see those orders stock will be $10.00, plus a fee of no
included a general ‘‘opt-out’’ exception routinely traded through. These trade-
that would have allowed market more than $0.003. The adopted rule
throughs can undermine incentives to thereby assures order routers that
participants to disregard displayed display limit orders. Moreover, many of
quotations. While the opt-out proposal displayed prices are, within a limited
the investors whose market orders are range, true prices.
was intended to provide flexibility to executed at inferior prices may not, in
market participants, such an exception The adopted fee limitation
fact, be aware they received an inferior substantially simplifies the originally-
would have left a gap in protection of
price from their broker and executing proposed limitation on fees, which, in
the best displayed prices and thereby
market. In sum, the Commission general, would have limited the fees of
reduced the proposal’s potential
believes that a rule establishing price individual market participants to $0.001
benefits for investors. The elimination
protection on an order-by-order basis for per share, with an accumulated cap of
of any protection for manual quotations
all NMS stocks is needed to protect the $0.002 per share. Perhaps more than any
is the principal reason that this broad
interests of investors, promote the other single issue, the proposed
exception is no longer necessary in the
display of limit orders, and thereby limitation on access fees splintered the
Order Protection Rule as adopted. In
improve the efficiency of the NMS as a commenters.37 Some supported the
addition, the Rule adds a number of
tailored exceptions that carve out those whole. proposal as a worthwhile compromise
situations in which many investors may 2. Access Rule 34 See infra, section III.A.1.
otherwise have felt they legitimately The Access Rule (Rule 610 under 35 Private linkages are discussed further in section
needed to opt-out of a displayed Regulation NMS) sets forth new III.A.1 below.
quotation. These exceptions are more standards governing access to 36 If the price of a protected quotation is less than
consistent with the principle of quotations in NMS stocks. As $1.00, the fee cannot exceed 0.3% of the quotation
protecting the best price than a general price. The rule as adopted also applies the fee
opt-out exception would have been. The limitation to quotations other than protected
31 Flickering quotations are discussed further in
quotations that are the BBOs of an SRO or Nasdaq.
additional exceptions also will help section II.A.3 below. See infra, section III.A.2.
assure that the Order Protection Rule is 32 See infra, notes 61–62 and accompanying text. 37 The comments on access fees are addressed in
workable for high-volume stocks. 33 See infra, section II.A.1.a.ii. section III.A.2 below.
on an extremely difficult issue. They markets by establishing that the first data would ‘‘form the heart of the
believed that it would level the playing protected quotation at a price, whether national market system.’’ 41
field in terms of who could charge fees, it be a bid or an offer, is entitled to an Accordingly, one of the Commission’s
as well as give greater certainty to execution at that price instead of being most important responsibilities is to
market participants that quoted prices locked or crossed by a quotation on the preserve the integrity and affordability
will, essentially, be true prices. Others other side of the market. of the consolidated data stream.
were strongly opposed to any limitation The adopted amendments promote
on fees, believing that competition alone 3. Sub-Penny Rule this objective in several different
would be sufficient to address high fees The Sub-Penny Rule (adopted Rule respects. First, they update the formulas
that distort quoted prices. Still others 612 under Regulation NMS) prohibits for allocating revenues generated by
were equally adamant that all access market participants from displaying, market data fees to the various SRO
fees of electronic communications ranking, or accepting quotations in NMS participants in the Plans. The current
networks (‘‘ECNs’’) charged to non- stocks that are priced in an increment of Plan formulas are seriously flawed by an
subscribers should be prohibited less than $0.01, unless the price of the excessive focus on the number of trades,
entirely, although they did not see a quotation is less than $1.00. If the price no matter how small the size, reported
problem with fees charged to a market’s of the quotation is less than $1.00, the by an SRO. They thereby create an
members or subscribers. Although minimum increment is $0.0001. A incentive for distortive behavior, such
consensus could not be achieved on any strong consensus of commenters as wash sales and trade shredding,42
particular approach, commenters supported the sub-penny proposal as a and fail to reflect an SRO’s contribution
expressed a strong desire for resolution means to promote greater price to the best displayed quotations in NMS
of a difficult issue that has caused transparency and consistency, as well as stocks. The adopted formula corrects
discord within the securities industry to protect displayed limit orders.39 In these flaws. It also is much less complex
for many years. particular, Rule 612 addresses the than the original proposal, primarily
The Commission believes that a practice of ‘‘stepping ahead’’ of because, consistent with the approach of
single, uniform fee limitation of $0.003 displayed limit orders by trivial the Order Protection Rule and Access
per share is the fairest and most amounts. It therefore should further Rule, the new formula eliminates any
appropriate resolution of the access fee encourage the display of limit orders allocation of revenues for manual
issue. First, it will not seriously and improve the depth and liquidity of quotations. It therefore will promote an
interfere with current business trading in NMS stocks. allocation of revenues to the various
practices, as trading centers have very SROs that more closely reflects the
few fees on their books of more than 4. Market Data Rules and Plans usefulness to investors of each SRO’s
$0.003 per share or earn substantial The adopted amendments to the market information.
revenues from such fees.38 Second, the Market Data Rules (adopted Rules 601 The adopted amendments also are
uniform fee limitation promotes equal and 603 under Regulation NMS) and intended to improve the transparency
regulation of different types of trading joint industry plans (‘‘Plans’’) 40 are and effective operation of the Plans by
centers, where previously some had designed to promote the wide broadening participation in Plan
been permitted to charge fees and some availability of market data and to governance. They require the creation of
had not. Finally and most importantly, allocate revenues to SROs that produce advisory committees composed of non-
the fee limitation of Rule 610 is the most useful data for investors. They SRO representatives. Such committees
necessary to support the integrity of the will strengthen the existing market data will give interested parties an
price protection requirement established system, which provides investors in the opportunity to be heard on Plan
by the adopted Order Protection Rule. In U.S. equity markets with real-time business, prior to any decision by the
the absence of a fee limitation, some access to the best quotations and most Plan operating committees. Finally, the
‘‘outlier’’ trading centers might take recent trades in the thousands of NMS amendments promote the wide
advantage of the requirement to protect stocks throughout the trading day. For availability of market data by
displayed quotations by charging each stock, quotations and trades are authorizing markets to distribute their
exorbitant fees to those required to continuously collected from many own data independently (while still
access the outlier’s quotations. Rule different trading centers and then providing their best quotations and
610’s fee limitation precludes the disseminated to the public in a trades for consolidated dissemination
initiation of this business practice, consolidated stream of data. As a result, through the Plans) and streamlining
which would compromise the fairness investors of all types have access to a outdated requirements for the display of
and efficiency of the NMS. reliable source of information for the market data to investors.
Finally, Rule 610 requires SROs to Many commenters on the market data
best prices in NMS stocks. When
establish, maintain, and enforce written proposals expressed frustration with the
Congress mandated the creation of the
rules that, among other things, prohibit current operation of the Plans.43 These
NMS in 1975, it noted that the systems
their members from engaging in a commenters generally fell into two
for disseminating consolidated market
pattern or practice of displaying groups. One group, primarily made up
quotations that lock or cross the 39 The comments on the sub-penny proposal are
of individual markets that receive
protected quotations of other trading discussed in section IV.C below. market data fees, believed that the
centers. Trading centers will be allowed, 40 The three joint-industry plans are (1) the CTA current model of consolidation should
however, to display automated Plan, which is operated by the Consolidated Tape be discarded in favor of a new model,
quotations that lock or cross the manual Association and disseminates transaction such as a ‘‘multiple consolidator’’ model
information for exchange-listed securities, (2) the
quotations of other trading centers. The CQ Plan, which disseminates consolidated
Access Rule thereby reflects the quotation information for exchange-listed
41 H.R. Rep. No. 94–229, 94th Cong., 1st Sess. 93
disparity in speed of response between securities, and (3) the Nasdaq UTP Plan, which (1975).
42 Trade shredding, or the splitting of large trades
automated and manual quotations, disseminates consolidated transaction and
quotation information for Nasdaq-listed securities. into a series of 100-share trades, is discussed further
while also promoting fair and orderly The CTA Plan and CQ Plan are available at in section V.A.3 below.
www.nysedata.com. The Nasdaq UTP Plan is 43 Comments on the market data proposals are
38 See infra, section III.A.2. available at www.utpdata.com. discussed in section V.A below.
under which each SRO would sell its data fees.46 Yet, as discussed in the steps as are necessary to improve the
own data separately. The other group, Commission’s 1999 concept release on operation of the current model.
primarily made up of securities industry market data,47 nearly the entire burden
II. Order Protection Rule
participants that pay market data fees, of collecting and producing market data
believed that the current level of fees is is borne by the individual markets, not The Commission is adopting Rule 611
too high. This group asserted that, prior by the Plans. If, for example, an SRO’s under Regulation NMS to establish
to modifying the allocation of market systems fail on a high-volume trading protection against trade-throughs for all
data revenues, the Commission should day and it can no longer provide its data NMS stocks. Rule 611(a)(1) requires a
address the level of fees that generated to the Plans, investors will suffer the trading center (which includes national
those revenues.44 consequences of a flawed data stream, securities exchanges, exchange
The Commission has considered these regardless of whether the Plan is able to specialists, ATSs, OTC market makers,
concerns at length in the recent past. As continue operating. and block positioners) 52 to establish,
was noted in the Proposing Release,45 a If the Commission were to limit maintain, and enforce written policies
drawback of the current market data market data fees to cover only Plan and procedures that are reasonably
model, which requires all SROs to costs, SRO funding would have been cut designed to prevent trade-throughs on
participate jointly in disseminating data by $393.7 million in 2004.48 Given the that trading center of protected
through a single consolidator, is that it potential harm if vital SRO functions are quotations and, if relying on an
affords little opportunity for market not adequately funded, the Commission exception, that are reasonably designed
forces to determine the overall level of believes that the level of market data to assure compliance with the terms of
fees or the allocation of those fees to the fees is most appropriately addressed in the exception. Rule 611(a)(2) requires a
individual SROs. Prior to publishing the a context that looks at SRO funding as trading center to regularly surveil to
proposals, therefore, the Commission a whole. It therefore has requested ascertain the effectiveness of its policies
undertook an extended review of the comment on this issue in its recent and procedures and to take prompt
various alternatives for disseminating concept release on SRO structure.49 In action to remedy deficiencies. To
market data to the public in an effort to addition, the recently proposed rules to qualify for protection, a quotation must
identify a better model. These improve SRO transparency would, if be automated. Rule 600(b)(3) defines an
alternatives were discussed at length in adopted, assist the public in assessing automated quotation as one that, among
the Proposing Release, but each has the level and use of market data fees by other things, is displayed and
serious weaknesses. The Commission the various SROs.50 immediately accessible through
particularly is concerned that the In sum, there is inherent tension automatic execution. Thus, Rule 611
integrity and reliability of the between assuring consolidated price does not require market participants to
consolidated data stream must not be transparency for investors, which is a route orders to access manual
compromised by any changes to the fundamental objective of the Exchange quotations, which generally entail a
market data structure. Act,51 and expanding the extent to much slower speed of response than
For example, although allowing each which market forces determine market automated quotations.
SRO to sell its data separately to data fees and SRO revenues. Each Rule 611(b) sets forth a variety of
multiple consolidators may appear at alternative model for data dissemination exceptions to make intermarket price
first glance to subject the level of fees to has its particular strengths and protection as efficient and workable as
competitive forces, this conclusion does weaknesses. The great strength of the possible. These include an intermarket
not withstand closer scrutiny. If the current model, however, is that it sweep exception, which allows market
benefits of a fully consolidated data benefits investors, particularly retail participants to access multiple price
stream are to be preserved, each investors, by helping them to assess levels simultaneously at different
consolidator would need to purchase quoted prices at the time they place an trading centers—a particularly
the data of each SRO to assure that the order and to evaluate the best execution important function now that trading in
consolidator’s data stream in fact of their orders against such prices by penny increments has dispersed
included the best quotations and most obtaining data from a single source that liquidity across multiple price levels.
recent trade report in an NMS stock. is highly reliable and comprehensive. In The intermarket sweep exception
Payment of every SRO’s fees would the absence of full confidence that this enables trading centers that receive
effectively be mandatory, thereby benefit would be retained if a different sweep orders to execute those orders
affording little room for competitive model were adopted, the Commission immediately, without waiting for better-
forces to influence the level of fees. has decided to adopt such immediate priced quotations in other markets to be
The Commission also has considered updated. In addition, Rule 611 provides
the suggestion of many in the second 46 The U.S. equity markets are not alone in their
exceptions for the quotations of trading
group of commenters that market data reliance on market information revenues as a
centers experiencing, among other
fees should be cut back to encompass significant source of funding. All of the other major
world equity markets currently derive large things, a material delay in providing a
only the costs of the Plans to collect and amounts of revenues from selling market response to incoming orders and for
disseminate market data. Under this information. See infra, note 587 and accompanying flickering quotations with prices that
approach, the individual SROs would text.
have been displayed for less than one
47 Securities Exchange Act Release No. 42208
no longer be allowed to fund any second. Both exceptions serve to limit
(Dec. 9, 1999), 64 FR 70613 (Dec. 17, 1999)
portion of their operational and (‘‘Market Information Release’’). the application of Rule 611 to
regulatory functions through market 48 See infra, text accompanying note 564 (table
setting forth revenue allocations for 2004). 52 An ‘‘OTC market maker’’ in a stock is defined
44 Some 49 Securities Exchange Act Release No. 50700
commenters mistakenly believed that the in Rule 600(b)(52) of Regulation NMS as, in general,
level of market data fees had been left unreviewed (Nov. 18, 2004), 69 FR 71256 (Dec. 8, 2004) (‘‘SRO a dealer that holds itself out as willing to buy and
for many years. In fact, the Commission Structure Release’’). sell the stock, otherwise than on a national
comprehensively reviewed market data fees in 50 Securities Exchange Act Release No. 50699
securities exchange, in amounts of less than block
1999, which led to a 75% reduction in fees paid by (Nov. 18, 2004), 69 FR 71126 (Dec. 8, 2004) (‘‘SRO size (less than 10,000 shares). A block positioner in
retail investors for market data. See infra, note 574. Transparency Release’’). a stock, in contrast, limits its activity in the stock
45 Proposing Release, 69 FR at 11177. 51 Section 11A(a)(1)(C)(iii) of the Exchange Act. to transactions of 10,000 shares or greater.
quotations that are truly automated and for the protection of investors, and efficient markets for investors.55 Many
accessible. otherwise in furtherance of the purposes commenters strongly supported the
By strengthening price protection in of the Exchange Act. adoption of a uniform rule for all NMS
the NMS for quotations that can be stocks to promote best execution of
accessed fairly and efficiently, Rule 611 A. Response to Comments and Basis for
market orders, to protect the best
is designed to promote market efficiency Adopted Rule
displayed prices, and to encourage the
and further the interests of both Rule 611 as adopted reflects a number public display of limit orders.56 They
investors who submit displayed limit of changes to the rule as originally stressed that limit orders are the
orders and investors who submit proposed. As discussed below, the cornerstone of efficient, liquid markets
marketable orders.53 Price protection Commission has made these changes in and should be afforded as much
encourages the display of limit orders response to substantial public comment protection as possible.57 They noted, for
by increasing the likelihood that they on the proposed rule and on the issues
will receive an execution in a timely arising out of the NMS Hearing that 55 Nearly all commenters, both those supporting
manner and helping preserve investors’ were addressed in the Supplemental and opposing the need for an intermarket trade-
Release. In addition, the adopted rule through rule, agreed that the current ITS trade-
expectations that their orders will be through provisions are seriously outdated and in
executed when they represent the best includes a new exception for certain need of reform. They particularly focused on the
displayed quotation. Limit orders ‘‘stopped orders’’ in response to the problems created by affording equal protection
typically establish the best prices for an suggestions of commenters on the against trade-throughs to both automated and
reproposal. The public submitted more manual quotations. See supra, section II.A.2.
NMS stock. Greater use of limit orders Adopted Rule 611 responds to these problems by
will increase price discovery and market than 2200 comments addressing the protecting only automated quotations.
depth and liquidity, thereby improving trade-through proposal and 56 Approximately 1689 commenters on the
the quality of execution for the large reproposal.54 Although the comments proposal and reproposal favored a uniform trade-
orders of institutional investors. covered a very wide range of matters, through rule without an opt-out exception. These
they particularly focused on the commenters included: (1) several mutual fund
Moreover, strong intermarket price companies and the Investment Company Institute;
protection offers greater assurance, on following issues: (2) the Consumer Federation of America and the
an order-by-order basis, to investors (1) Whether an intermarket trade- National Association of Individual Investors
who submit market orders that their through rule is needed to promote fair Corporation; (3) the floor-based exchanges and their
and efficient equity markets, members; (4) approximately 107 listed companies;
orders in fact will be executed at the (5) a variety of securities industry participants; and
best readily available prices, which can particularly for Nasdaq stocks which (6) approximately 42 members of Congress. Of the
be difficult for investors, particularly have not been subject to the current ITS commenters supporting the reproposal,
retail investors, to monitor. Investors trade-through provisions; approximately 452 utilized ‘‘Letter Type G’’ (noting
generally can know the best quoted (2) whether only automated and the existence of two alternative proposals and
urging ‘‘support for the Regulation NMS proposal
prices at the time they place an order by immediately accessible quotations without the CLOB’’ alternative), 70 utilized ‘‘Letter
referring to the consolidated quotation should be given trade-through Type H’’ (‘‘we support the ‘top of the book’ proposal
stream for a stock. In the interval protection and, if so, what is the best that has been discussed for the past year as part of
between order submission and order approach for defining such quotations; the Regulation NMS discussion’’), 204 utilized
(3) whether intermarket protection ‘‘Letter Type I’’ (‘‘I believe a better approach would
execution, however, quoted prices can be the SEC’s proposed alternative to the CLOB, to
change. If the order execution price against trade-throughs can be protect the best price in each market center’’), 548
provided by a market differs from the implemented in a workable manner, utilized ‘‘Letter Type J’’ (‘‘Of the two alternatives
best quoted price at order submission, it particularly for high-volume stocks; laid out in the rule as re-proposed on December 15,
(4) whether the exception in the 2004, protecting the best bid and offer in each
can be particularly difficult for retail market center preserves both types of competition
investors to assess whether the original proposal allowing a general opt- in a way that benefits all securities industry
difference was attributable to changing out of protected quotations is necessary participants.’’), 28 utilized ‘‘Letter Type K’’ (‘‘One
quoted prices or to an inferior execution or appropriate, particularly if manual alternative is that of protecting the ‘‘best bid and
quotations are excluded from trade- offer’’ in each market center. This concept enhances
by the market. The Order Protection competition, allows for price negotiation,
Rule will help assure, on an order-by- through protection; encourages innovation, and treats all market
order basis, that markets effect trades at (5) whether the scope of quotations participants fairly and equally.’’), and 109 utilized
the best available prices. Finally, market entitled to trade-through protection ‘‘Letter Type L’’ (noting the existence of two
orders need only be routed to markets should extend beyond the best bids and alternative proposals and urging support for ‘‘the
offers of the various markets; and Regulation NMS proposal without the CLOB’’
displaying quotations that are truly alternative). Each of the letter types is posted on the
accessible. Accordingly, as discussed in (6) whether the benefits of an Commission’s Internet Web site (http://
detail below, the Commission finds that intermarket trade-through rule would www.sec.gov/rules/proposed.shtml). Those
the Order Protection Rule is necessary justify its cost of implementation. commenters that only expressed opposition to the
In the following sections, the Voluntary Depth Alternative were not included in
and appropriate in the public interest, the foregoing summary. In addition, many
Commission responds to comments on commenters supported an opt-out exception to a
53 For ease of reference in this release, the term the trade-through proposal and trade-through rule, but varied in the extent to which
‘‘limit order’’ generally will refer to a non- reproposal and discusses the basis for they made clear whether they supported a trade-
marketable order and the term ‘‘marketable order’’ its adoption of Rule 611. through rule in general. These commenters are not
will refer to both market orders and marketable included in the foregoing summary, but are
limit orders. A non-marketable limit order has a 1. Need for Intermarket Order Protection included in note 232 below addressing supporters
limit price that prevents its immediate execution at Rule of an opt-out exception.
current market prices. Because these orders cannot 57 See, e.g., Letter from John J. Wheeler, Vice
be executed immediately, they generally are Commenters were divided on the President, Director of U.S. Equity Trading,
publicly displayed to attract contra side interest at central issue of whether intermarket American Century Investment Management Inc., to
the price. In contrast, a ‘‘marketable limit order’’ protection of displayed quotations is Jonathan G. Katz, Secretary, Commission, dated
has a limit price that potentially allows its June 30, 2004 (‘‘American Century Letter’’) at 2;
immediate execution at current market prices. As needed to promote the fairest and most Letter from Matt D. Lyons, Capital Research and
discussed further below, marketable limit orders Management Company, to Jonathan G. Katz,
often cannot be filled at current market prices 54 The Commission has considered the views of Secretary, Commission, dated June 28, 2004
because of insufficient liquidity and depth at the all commenters in formulating Rule 611 as adopted, (‘‘Capital Research Letter’’) at 2; Letter from Ari
market price. See infra, text accompanying notes as well as the other rules and amendments adopted Burstein, Associate Counsel, Investment Company
121–123, 134–136. today. Continued
example, that limit orders typically orders and produce the most fair and The Commission has carefully
establish the ‘‘market’’ for a stock.58 In efficient markets. They therefore evaluated the views of these
the absence of limit orders setting the believed that any trade-through rule commenters on both the original
current market price, there would be no would be unnecessary and costly. These proposal and the reproposal. In
benchmark for the submission and commenters also were concerned that addition, Commission staff has prepared
execution of marketable orders. any trade-through rule could interfere several studies of trading in Nasdaq and
Focusing solely on best execution of with the ability of competitive forces to NYSE stocks to help assess and respond
marketable orders (and the interests of produce efficient markets, particularly to commenters’ claims. The studies and
orders that take displayed liquidity), for Nasdaq stocks. the Commission’s conclusions are
therefore, would miss a critical part of Commenters on the original proposal discussed in detail below. In general,
the equation for promoting the most who were opposed to any trade-through however, the Commission has found
efficient markets (i.e., the best execution rule also expressed their view that there that current trade-through rates are not
of orders that supply displayed liquidity is a lack of empirical evidence justifying lower for Nasdaq stocks than NYSE
and thereby provide the most the need for intermarket protection stocks, despite the fact that nearly all
transparent form of price discovery). against trade-throughs. They noted, for quotations for Nasdaq stocks are
Commenters supporting the need for an example, that trading in Nasdaq stocks automated, rather than divided between
intermarket trade-through rule also has never been subject to a trade- manual and automated as they are for
believed that it would increase investor through rule, while trading in exchange- exchange-listed stocks. Moreover, the
confidence by helping to eliminate the listed stocks, particularly NYSE stocks, majority of the trade-throughs that
impression of unfairness when an has been subject to the ITS trade- currently occur in NYSE stocks fall
investor’s order executes at a price that through provisions. Given the difference within gaps in the coverage of the
is worse than the best displayed in regulatory requirements between existing ITS trade-through rules that
quotation, or when a trade occurs at a Nasdaq and NYSE stocks, many will be closed by the Order Protection
price that is inferior to the investor’s commenters relied on two factual Rule. Consequently, the Commission
displayed order.59 contentions to show that a trade-through believes that the Order Protection Rule,
Other commenters, in contrast, rule is not needed: (1) Fewer trade- by establishing effective intermarket
opposed any intermarket trade-through throughs occur in Nasdaq stocks than protection against trade-throughs, will
rule.60 These commenters did not NYSE stocks; 61 and (2) trading in materially reduce the trade-through
believe that such a rule is necessary to Nasdaq stocks currently is more rates in both the market for Nasdaq
promote the protection of limit orders, efficient than trading in NYSE stocks.62 stocks and the market for exchange-
the best execution of market orders, or Based on these factual contentions, listed stocks.
efficient markets in general. They opposing commenters concluded that a In addition, the commenters’ claim
asserted that, given public availability of trade-through rule is not necessary to that the Order Protection Rule is not
each market’s quotations and ready promote efficiency or to protect the best needed because trading in Nasdaq
access by all market participants to such displayed prices. stocks, which currently does not have
quotations, competition among markets, any trade-through rule, is more efficient
a broker’s existing duty of best 61 See, e.g., Letter from Kim Bang, President & than trading in NYSE stocks, which has
execution, and economic self-interest Chief Executive Officer, Bloomberg Tradebook LLC, the ITS trade-through provisions, also is
would be sufficient to protect limit to Jonathan G. Katz, Secretary, Commission, dated not supported by the relevant data.63
June 30, 2004 (‘‘Bloomberg Tradebook Letter’’) at This conclusion is particularly evident
10; Letter from Eric D. Roiter, Senior Vice President
Institute, to Jonathan G. Katz, Secretary, & General Counsel, Fidelity Management and
when market efficiency is examined
Commission, dated Jan. 26, 2005 (‘‘ICI Reproposal Research Company, to Jonathan G. Katz, Secretary, from the perspective of the transaction
Letter’’) at 2; Letter from Henry H. Hopkins, Vice Commission, dated June 22, 2004 (‘‘Fidelity Letter costs of long-term investors, as opposed
President and Chief Legal Counsel, and Andrew M. I’’) at 11; Letter from Suhas Daftuar, Managing
Brooks, Vice President and Head of Equity Trading,
to short-term traders. The data reveals
Director, Hudson River Trading, to Jonathan G.
T. Rowe Price Associates, Inc., to Jonathan G. Katz, Katz, Secretary, Commission, dated August 13, 2004
that the markets for Nasdaq and NYSE
Commission, dated Jan. 27, 2005 (‘‘T. Rowe Price (‘‘Hudson River Trading Letter’’) at 1; Letter from stocks each have their particular
Reproposal Letter’’) at 2; Letter from George U. Edward J. Nicoll, Chief Executive Officer, Instinet strengths and weaknesses. In assessing
Sauter, Managing Director, The Vanguard Group, Group Incorporated, to Jonathan G. Katz, Secretary,
Inc., to Jonathan G. Katz, Secretary, Commission,
the need for the Order Protection Rule,
Commission, dated June 30, 2004 (‘‘Instinet Letter’’)
dated Jan. 27, 2005 (‘‘Vanguard Reproposal Letter’’) at 14; Letter from Edward S. Knight, The Nasdaq
the Commission has focused primarily
at 2. Stock Market, Inc., to Jonathan G. Katz, Secretary, on whether effective intermarket
58 Id.
Commission, dated July 2, 2004 (‘‘Nasdaq Letter II’’) protection against trade-throughs will
59 See, e.g., Letter from Barbara Roper, Director of at 6 and Attachment III. materially contribute to a fairer and
Investor Protection, Consumer Federation of 62 See, e.g., Letter from Ellen L. S. Koplow,
more efficient market for investors in
America, to Jonathan G. Katz, Secretary, Executive Vice President and General Counsel,
Commission, dated June 17, 2004 (‘‘Consumer Ameritrade Holding Corporation, to Jonathan G.
Nasdaq stocks, given their particular
Federation Letter’’) at 2; Letter from Ari Burstein, Katz, Secretary, Commission, dated June 30, 2004 trading characteristics, and in exchange-
Associate Counsel, Investment Company Institute, (‘‘Ameritrade Letter I’’), Appendix at 10; Letter from listed stocks, given their particular
to Jonathan G. Katz, Secretary, Commission, dated William O’Brien, Chief Operating Officer, Brut LLC, trading characteristics. Thus, the critical
June 30, 2004 (‘‘ICI Letter’’) at 7. to Jonathan G. Katz, Secretary, Commission, dated
60 Approximately 448 commenters on the July 29, 2004 (‘‘Brut Letter’’) at 10; Fidelity Letter
issue is whether each of the markets
proposal and reproposal opposed a trade-through I at 11; Instinet Letter at 3, 9 and Exhibit A; Nasdaq would be improved by adoption of the
rule. Approximately 179 of these commenters Letter II at 6 and Attachment II; Letter from Bruce Order Protection Rule, not whether one
utilized ‘‘Letter Type C,’’ which primarily N. Lehmann & Joel Hasbrouck, Organizers, Reg or the other currently is, on some
supported an opt-out exception to the proposed NMS Study Group, to Jonathan G. Katz, Secretary, absolute level, superior to the other. The
rule, but also suggested that having no trade- Commission (no date) (‘‘NMS Study Group Letter’’)
through rule would be simpler. Letter Type C is at 4; Letter from David Colker, Chief Executive Commission believes that effective
posted on the Commission’s Internet Web site Officer & President, National Stock Exchange, to intermarket protection against trade-
(http://www.sec.gov/rules/proposed.shtml). The Jonathan G. Katz, Secretary, Commission, dated throughs will produce substantial
remaining commenters included securities industry June 29, 2004 (‘‘NSX Letter’’) at 3; Letter from Huw benefits for investors in both markets
participants, particularly electronic markets and Jenkins, Managing Director, Head of Equities for the
their participants, a variety of local political and Americas, UBS Securities LLC, to Jonathan G. Katz, and, therefore, has adopted the Order
community groups and individuals, and 34 Secretary, Commission, dated June 30, 2004 (‘‘UBS
members of Congress. Letter’’) at 4. 63 See infra, section II.A.1.b.
Protection Rule for both Nasdaq and throughs was significant—2.3 cents per could intend to sweep the market of all
exchange-listed stocks. share on average for Nasdaq stocks and superior quotations before trading at an
2.2 cents per share for NYSE stocks.69 inferior price, but if they did not
a. Trade-Through Rates in Nasdaq and The staff study also revealed that a effectively sweep both displayed size
NYSE Stocks large volume of block transactions and reserve size, the superior quotations
The first principal factual contention (10,000 shares or greater) trade through would not change and the staff study
of commenters on the original proposal displayed quotations. Block transactions would report a false indication of a
who were opposed to a trade-through represent approximately 50% of total trade-through when the trade in another
rule is premised on the claim that there trade-through volume for both Nasdaq market occurred at an inferior price. In
are fewer trade-throughs in Nasdaq and NYSE stocks.70 Importantly, many practice, however, those who truly
stocks, which are not covered by any block transactions currently are not intend to sweep the best prices are quite
trade-through rule, than in NYSE stocks, subject to the ITS trade-through capable of routing orders to execute
which are covered by the ITS trade- provisions that apply to exchange-listed against both displayed and estimated
through provisions.64 One commenter stocks. Broker-dealers that act solely as reserve size, thereby precluding the
asserted that, outside the exchange- block positioners are not covered by the possibility of a false positive trade-
listed markets, competition alone had ITS trade-through provisions if they through. Indeed, although commenters
been sufficient to create a ‘‘no-trade print their trades in the over-the-counter asserted that the staff study failed to
through zone.’’ 65 To respond to these (‘‘OTC’’) market. In addition to not consider the existence of reserve size for
commenters, the Commissions staff covering the trades of block positioners, Nasdaq stocks, the validity of their own
reviewed public quotation and trade the ITS trade-through provisions argument is premised on the failure of
data to estimate the incidence of trade- include an exception for 100-share sophisticated market participants to
throughs for Nasdaq and NYSE stocks.66 quotations. They therefore often may consider the existence of reserve size
It found that the overall trade-through fail to protect the small orders of retail when routing sweep orders.
rates for Nasdaq stocks and NYSE stocks investors. When block trade-throughs It currently is impossible to determine
were, respectively, 7.9% and 7.2% of and trade-throughs of 100-share from publicly available trade and
the total volume of traded shares.67 quotations are eliminated, the overall quotation data whether the initiator of a
When considered as a percentage of trade-through rate for NYSE stocks is trade-through in one market has
number of trades, the overall trade- reduced from 7.2% to approximately simultaneously attempted to sweep
through rate for both Nasdaq and NYSE 2.3% of total share volume.71 The two better-priced quotations in other
stocks was 2.5%. When considered as gaps in ITS coverage therefore account markets.73 The data can reveal,
the size of traded-through quotations as for most of the trade-through volume in however, the extent to which false-
a percentage of total share volume, the NYSE stocks. The Order Protection positive indications of a trade-through
overall rates for Nasdaq and NYSE Rule, by closing these gaps in protection were even a possibility by examining
stocks were, respectively, 1.9% and against trade-throughs, will establish trading volume at the traded-through
1.2%.68 In addition, the staff study much stronger price protection than the market. If the accumulated volume of
found that the amount of the trade- ITS provisions. trades in that market did not equal or
Commenters opposed to the trade- exceed the displayed size of a traded-
64 See, e.g., Bloomberg Tradebook Letter at 10;
through reproposal offered a number of through quotation, it shows that a sweep
Fidelity Letter I at 11; Hudson River Trading Letter
at 1; Instinet Letter at 14; Nasdaq Letter II at 6 and
criticisms of the staff study. Such order, even one attempting to execute
Attachment III. criticisms generally fall into two only against displayed size, could not
65 Letter from Kevin J. P. O’Hara, Chief categories: (1) Possible reasons why the have been routed to the market that was
Administrative Officer & General Counsel, staff study might have overestimated traded-through. Commission staff
Archipelago Holdings, Inc., to Jonathan G. Katz, trade-through rates, particularly for
Secretary, Commission, dated September 24, 2004
therefore has supplemented its trade-
(‘‘ArcaEx Letter’’) at 3. Nasdaq stocks; and (2) even assuming through study to check this possibility
66 Memorandum to File, from Office of Economic the estimated trade-through rates were and to help the Commission assess and
Analysis, dated December 15, 2004 (analysis of accurate, arguments for why such rates respond to commenters’ criticisms. It
trade-throughs in Nasdaq and NYSE issues) do not support a conclusion that the found that this possibility rarely
(‘‘Trade-Through Study’’). The Trade-Through
Study has been placed in Public File No. S7–10–
Order Protection Rule is needed or will occurs—a finding that fully supports an
04 and is available for inspection on the benefit the markets, particularly for inference that market participants are
Commission’s Internet Web site (http:// Nasdaq stocks. These criticisms are capable of effectively sweeping the best
www.sec.gov). To eliminate false trade-throughs, the evaluated below. prices, both displayed and reserve,
staff calculated trade-through rates using a 3-second
window—a reference price must have been i. Accuracy of Estimated Trade-Through when they intend to do so.74 Thus, it is
displayed one second before a trade and still have Rates
been displayed one second after a trade. In (‘‘Nasdaq Reproposal Letter’’), Exhibit A at 4; Letter
addition, the staff eliminated quotations displayed Several commenters asserted that the from Daniel Coleman, Managing Director and Head
by the American Stock Exchange LLC (‘‘Amex’’) staff study overestimated trade-through of Equities for the Americas, UBS Securities LLC
from the analysis of Nasdaq stocks because they (‘‘UBS Reproposal Letter’’) at 4.
were manual quotations. Finally, the staff used the
rates because it failed to consider the 73 After implementation of Rule 611, such orders
time of execution of a trade, if one was given, rather existence of reserve size and sweep generally will be marked as intermarket sweep
than time of the trade report itself. This orders in the Nasdaq market, which orders pursuant to the exceptions set forth in Rule
methodology was designed to address manual could have caused ‘‘false positive’’ trade 611(b)(5) and (6). As discussed in note 317 below,
trades, such as block trades, that might not be the Commission intends to request that the NMS
reported for several seconds after the trade was
throughs.72 In theory, order routers
trade reporting plans consider collecting and
effected manually. disseminating special modifiers for all trades that
67 Trade-Through Study, Tables 4, 11. The 7.9% 69 Id.,Tables 3, 10. are executed pursuant to an exception from Rule
70 Id.,Tables 4, 11.
and 7.2% figures include the entire size of trades 611. Such modifiers would greatly enhance
that were executed at prices inferior to displayed 71 Id., Table 11. transparency and minimize the potential for false
quotations. 72 Letter from Kim Bang, Bloomberg L.P., to appearances of violations of Rule 611.
68 Id. at 2. The 1.9% and 1.2% figures include Jonathan Katz, Secretary, dated Jan. 25, 2005 74 Memorandum to File, from Office of Economic
only the total displayed size of quotations that were (‘‘Bloomberg Reproposal Letter’’) at 6; Letter from Analysis, dated April 6, 2005, at 1 (supplemental
traded through by trades executed at prices inferior Edward S. Knight, The Nasdaq Stock Market, Inc., trade-through analysis—reserve size analysis,
to the displayed quotations. to Jonathan G. Katz, Secretary, dated Jan. 26, 2005 Continued
very unlikely that the existence of Fall of 2003 to the Fall of 2004. The staff orders to begin interacting with this
reserve size and sweep orders caused a study used data from the Fall of 2003, substantial volume of block trades is
significant number of false positive however, because it was prior to the likely to be one of the most significant
trade-throughs in Nasdaq stocks.75 Commission’s proposal of a trade- incentives for increased display of limit
One commenter asserted that the staff through rule and its public orders after implementation of the Order
study was flawed because its sample announcement that the staff was Protection Rule. Moreover, the Order
trading days involved unusual trading reviewing trade-through rates. While the Protection Rule will promote a more
activity.76 Commission staff chose the conduct of market participants may level playing field for retail investors
sample trading days, however, only after have changed in certain respects when that currently see their smaller
affirming that they were representative they were a focus of regulatory displayed orders bypassed by block
of normal trading. To respond to this attention, the Commission cannot be trades.
commenter’s claim, Commission staff assured that such behavior would Two commenters did not believe the
reaffirmed that all four days were well continue if the Commission did not staff study should have included trades
within the norms for trading volume adopt the proposed regulatory action to larger than quoted size, asserting that
and price volatility.77 In addition, the address trade-throughs. ‘‘[e]ven in a hard CLOB environment,
trade-through rates remained quite Indeed, Nasdaq’s own data illustrates orders larger than the inside quote
stable across the four days (e.g., ranging this possibility.80 Although Nasdaq would still ’trade through’ the inside
only from 2.3% to 2.6% for Nasdaq asserts that the reduction in trade- quote in effect at the time the order was
stocks).78 through rates from 2003 to 2004 is a received.’’ 85 These commenters do not
Two commenters asserted that, even if result of fewer independently operating appear to have understood the
the staff study’s estimate of trade- ECNs, its data undercuts this methodology of the staff study or the
through rates was correct for the trading explanation. For example, Nasdaq’s data operation of a central limit order book
days chosen in the Fall of 2003, such shows that the trade-through rate at (‘‘CLOB’’). As discussed above, large
rates are now outdated for Nasdaq internalizing securities dealers dropped trades would not have been identified as
stocks because of structural changes in from 3.2% in 2003 to 1.4% in 2004.81 trade-throughs in the staff study if
the market.79 In particular, they cited It is unlikely that ECN consolidation orders simultaneously had been routed
the merger of the Island and Instinet could have caused such a major to sweep displayed quotations with
ECNs and Nasdaq’s acquisition of the reduction in trade-through rates at superior prices. To exclude such trades
BRUT ECN. Nasdaq also presented securities dealers when they execute from its analysis, the study used a three-
statistics indicating that the trade- their customer orders internally.82 The second quotation window in which the
through rates for Nasdaq stocks in some great majority of internalized trades are lowest best bid or the highest best offer
trading centers had dropped from the the small trades of retail investors. The during the three-second period must be
fact that, in 2003, nearly 1 of 30 of these traded-through before a trade was
sample day activity analysis, and analysis of quote millions of trades appears to have been identified as a trade-through. The 3-
depth) (‘‘Supplemental Trade-Through Study’’). For executed at a price inferior to an
example, the Supplemental Trade-Through Study second quotation window particularly
found that, when the trade-through statistics are automated and accessible quotation is was designed to allow sufficient time for
adjusted to reflect possible instances in which troubling. Given that one of the primary quotations to update to reflect the
sweep orders could have failed to execute against benefits of the Order Protection Rule is arrival of sweep orders (just as in a
reserve size, the estimated trade-through rates for to backstop a broker’s duty of best
Nasdaq stocks declined slightly from 2.5% of total CLOB environment, the execution of a
trades to 2.3% of total trades, and from 7.9% of execution on an order-by-order basis, large order simultaneously would
total share volume to 7.7% of total share volume. Nasdaq’s data appears to indicate a eliminate all superior-priced
These small reductions do not support the assertion continuing need for regulatory action to quotations). In sum, large orders would
of commenters that market participants reinforce the fundamental principle of
systematically fail to take out reserve size when trade with, rather than trade through,
routing sweep orders. Rather, the reductions are best price for all NMS stocks. the superior-priced displayed
much more consistent with the random distribution Nasdaq also criticized the staff study
quotations, thereby leaving only
of trade volume that would be expected to occur in for failing to address whether large
the traded-through markets from time to time. quotations that did not have superior
block trades ‘‘intentionally avoid
75 ArcaEx noted that it was common practice in prices to the trade price. Such large
interacting with the posted quotes.’’ 83
the market for exchange-listed stocks to send orders therefore would not have been
commitments to trade through the ITS to avoid Far from demonstrating a flaw in the
identified as trade-throughs in the staff
trading through quotations in other markets. Letter staff study, however, the fact that large
from Kevin J. P. O’Hara, Chief Administrative study.
trades intentionally avoid interacting Commenters also criticized the staff
Officer and General Counsel, Archipelago Holdings,
Inc., to Jonathan G. Katz, Secretary, Commission, with displayed quotations was one of study for allegedly failing to consider
dated Jan. 26, 2005 (‘‘ArcaEx Reproposal Letter’’), the primary reasons identified in the
Annex A at 1. Given the slowness with which ITS Reproposing Release supporting the 85 Letter from James J. Angel, Associate Professor
commitments to trade often are processed and need for intermarket order protection.84 of Finance, Georgetown University, to Jonathan G.
manual quotations are updated, ArcaEx suggested
that trade-through rates for exchange-listed stocks The opportunity for displayed limit Katz, Secretary, Commission, dated Jan. 25, 2005
(‘‘Angel Reproposal Letter’’) at 3; Letter from Eric
might be overestimated. The Commission agrees
D. Roiter, Senior Vice President and General
that this criticism may well be valid to some extent. 80 Nasdaq Reproposal Letter, Exhibit 1 at 4.
Counsel, Fidelity Management & Research
Thus, the trade-through rates for NYSE stocks in the 81 Id.
Company, to Jonathan G. Katz, Secretary,
staff study may be overstated for ArcaEx and other 82 Nasdaq also mentions ‘‘less developed’’
Commission, dated Jan. 26, 2005 (‘‘Fidelity
markets trading exchange-listed stocks. The matching systems as contributing to the high rate Reproposal Letter’’) at 7. These commenters also
occurrence of apparent trade-throughs in exchange- of trade-throughs in Fall 2003, but does not identify criticized the staff study for including average-price
listed stocks caused by manual quotations under any major technology advances from Fall 2003 to trades, even when the individual pieces of such
the current ITS provisions is addressed in the Order Fall 2004 that would have enabled the reduction in trades may have been executed at or within the
Protection Rule by protecting only automated trade-through rates at internalizing securities relevant quotations. The staff study, however,
quotations. dealers. Id. at 4.
76 ArcaEx Reproposal Letter, Annex A.
addressed this issue by excluding any trade
83 Nasdaq Reproposal Letter, Exhibit 1 at 4. See
reported as an average-price trade, along with all
77 Supplemental Trade-Through Study at 3.
also UBS Reproposal Letter at 4 (describing other trades that included a non-blank condition
78 Id. numbers in staff study as ‘‘inflated’’ because they code (primarily out-of-sequence trades, late trades,
79 Bloomberg Reproposal Letter at 5; Nasdaq included institutional block trades). and previous reference price trades). Trade-Through
Reproposal Letter, Exhibit 1 at 3–4. 84 69 FR at 77434. Study at 9.
the effect of locked or crossed the data for NYSE stocks, which is to its comment letter a paper prepared
quotations for Nasdaq stocks.86 By using produced by both automated and by two academics, Robert Battalio and
a 3-second quotation window, however, manual markets. Robert Jennings, which included a
the staff study excluded any trade- For example, the staff study used a variety of criticisms of the staff study
throughs that would have been caused three-second quotation window for both and the Reproposing Release in general
by short periods of locking or crossing Nasdaq and NYSE stocks to minimize (‘‘Battalio/Jennings Paper’’).92 Among
quotations. The staff analysis the effect of possible timing lags other things, the Battalio/Jennings Paper
appropriately did not exclude longer between trade data and quotation data. cited an academic paper which, for
periods of locked quotations. Indeed, Given that in Fall 2003 the trading in Nasdaq stocks in 1996 and
locked quotations do not qualify for an overwhelming proportion of trades in 1997, found significant delays between
exception from the Order Protection Nasdaq stocks were executions of the time of trade execution reflected in
Rule—both the best bid and best offer automated orders against automated proprietary trading center data and the
are readily accessible at the same price quotations, with automated reporting of time of trade report in public data
and should not be traded through. trades to the relevant Plan processor, disseminated by Nasdaq as Plan
Quotations rarely are crossed for three three seconds is a conservative time processor.93 The authors of the Battalio/
seconds and therefore are unlikely to frame to assess overall trade-through Jennings Paper, however, did not
have caused a material number of false rates. But even when the quotation account for significant improvements in
trade-throughs.87 window is extended to an overly the quality of trade data for Nasdaq
Finally, commenters asserted a variety conservative eight seconds and thereby stocks since 1997. In particular, the
of arguments relating to timing latencies clearly excludes a large number of true NASD developed and implemented a
in the quotation and trade data that trade-throughs, trade-through rates new order audit trail system
might have caused the staff study to remain significant—1.7% of trades and (‘‘OATS’’).94 As summarized in a 1998
include false trade-throughs, including 6.8% of share volume in Nasdaq NASD Notice to Members, OATS
delayed trade reports, flickering stocks.89 specifically was designed, among other
quotations, stale quotations, manual In addition, the trade execution time things, to address the discrepancies
quotations, and poor clock derived from audit trail data for Nasdaq between proprietary trade data and
synchronization.88 The staff study, stocks, rather than trade report time, trade data reported to Nasdaq’s
however, used a variety of means to was used when it was supplied and Automated Confirmation Transaction
minimize the effect of these factors on whenever the two times differed to Service (‘‘ACT’’):
the data, as well as to check for the minimize timing latencies in the data OATS is designed to provide NASD
extent to which timing latencies might caused by delayed reporting. Separate Regulation, Inc. (NASD Regulation) with the
affect its results. The goal of the staff times derived from audit trail data are ability to reconstruct markets promptly,
study was to obtain a reasonable not reported for NYSE stocks, and conduct efficient surveillance, and enforce
estimate of the true trade-through rates delayed trade reports therefore could NASD and SEC rules. The SEC has directed
for Nasdaq and NYSE stocks. It is have contributed to false reports of that OATS must provide an accurate, time-
important to recognize that, in designing trade-throughs in NYSE stocks. sequenced record of orders and transactions
a methodology to achieve this goal, the Similarly, for Nasdaq stocks, the from the receipt of an order through its
more conservative the methodology quotations of Amex—the only market execution. To accomplish this, NASD
used to eliminate potentially false that displays manual quotations—were Regulation will combine information
indications of trade-throughs, the excluded from the staff study. Because submitted to OATS with transaction data
greater the number of true trade- the NYSE currently displays primarily reported by members through ACT and
throughs that are likely to be eliminated. manual quotations in NYSE stocks, quotation information disseminated by
Thus, a methodology designed simply to while other markets display automated Nasdaq * * *. The ACT trade data and the
assure the elimination of every OATS order information will be used to
quotations, the difficulties of integrating
construct an integrated audit trail. Under the
conceivable false indication of a trade- data from manual and automated amended rules, all trade reports for OATS-
through would not have been useful to markets could have caused false eligible securities entered into Nasdaq’s ACT
the Commission in assessing its policy indications of trade-throughs for NYSE system will be required to have a time of
options because it would have severely stocks.90 The occurrence of false execution expressed in hours, minutes, and
underestimated true trade-through rates. indications of trade-throughs caused by seconds.95
The staff study’s conservative manual quotations in exchange-listed
methodology was designed to produce stocks is addressed in the Order To obtain the most accurate analysis
reasonable estimates of true trade- Protection Rule by protecting only of trade-through rates in Nasdaq stocks,
through rates, but still is more likely to automated quotations that are the staff study used the audit trail
have resulted in an understatement of immediately accessible and record of the time of trade execution,
trade-through rates than an immediately updated. rather than the time of trade report,
overstatement, particularly for Nasdaq Fidelity incorrectly believed that the whenever it was supplied and whenever
stocks. Nasdaq stocks are traded staff study failed to use the time of trade
92 Robert Battalio and Robert Jennings, Analysis
primarily on automated markets, and execution derived from audit trail data
of the Re-Proposing Release of Reg NMS and the
the data for such stocks therefore should when analyzing trade-through rates in OEA’s Trade-Through Study (Mar. 28, 2005)
be less affected by timing latencies than Nasdaq stocks.91 Fidelity also attached (attached to Fidelity Reproposal Letter II). Other
claims made in the Battalio/Jennings Paper are
86 Bloomberg Reproposal Letter at 5; Nasdaq 89 Trade-Through Study, Table 1. addressed below at notes 151–158, 296 and
Reproposal Letter, Exhibit 1 at 5. 90 See
infra, section II.A.2 (discussion of need to accompanying text.
87 See, e.g., Nasdaq Reproposal Letter, Exhibit 1 93 Battalio/Jennings Paper at 12–13. For example,
limit coverage of Order Protection Rule to
at 5 n. 14 (‘‘rare’’ for market to be crossed for the automated quotations). the academic study of 1996–1997 Nasdaq data
entirety of the three-second window). 91 Letter from Eric D. Roiter, Senior Vice found that 65% of trades were reported with delays
88 Angel Reproposal Letter at 3; Bloomberg President and General Counsel, Fidelity of more than 8 seconds.
94 See, e.g., NASD Notice to Members 98–82 (Oct.
Reproposal Letter at 7; Fidelity Reproposal Letter at Management & Research Company, to Jonathan G.
7; Nasdaq Reproposal Letter, Exhibit 1 at 5; UBS Katz, Secretary, Commission, dated Mar. 28, 2005 1998) at 1.
Reproposal Letter at 4. (‘‘Fidelity Reproposal Letter II’’) at 2. 95 Id.
the two times differed.96 The Battalio/ primary exception is for trades reported data are not materially out of
Jennings Paper therefore was mistaken on Nasdaq that trade through Nasdaq synchronization.
when it stated that ‘‘[w]ith the data OEA quotations, but Nasdaq, unlike the other
ii. Significance of Trade-Through Rates
chose to use, we simply cannot major markets, does not consist of a
conclude anything about actual trade- single trading center. Rather, it includes Some commenters questioned
through rates’’ and when it ‘‘urge[d] the the NASDAQ Market Center, several whether the trade-through rates found
OEA to revise their methodology and ECNs, and many market makers that by the staff study were significant
conduct a trade-through analysis using trade, to a great extent, separately. Thus, enough to warrant adoption of the trade-
audit-trail data.’’ 97 The staff study did the trade-through rates for Nasdaq through reproposal.101 They believed,
indeed use audit trail data when reflect true trade-throughs among for example, that the rates were low,
available for Nasdaq stocks and different trading centers, not false trade- particularly when considered as a
therefore provides a reasonable basis for throughs of a single trading center of its percentage of total trades (2.5% for both
estimating true trade-through rates for own quotations. Nasdaq and NYSE stocks) and as the
Nasdaq stocks. Finally, problems with clock percentage of total share volume
As noted above, however, the data for represented by the total displayed size
synchronization at the various trading
exchange-listed stocks may be more of quotations that were traded through
centers are unlikely to have materially
affected by timing latencies because it is (1.9% and 1.2%, respectively, for
detracted from the accuracy of the staff
generated by both automated and Nasdaq and NYSE stocks).102 They
study. The great majority of time stamps
manual markets. The trade-through rates therefore asserted that the rates did not
were assigned to quotations and trades
estimated in the staff study therefore demonstrate a serious problem or a need
as the data was received by a single
may somewhat overstate the true trade- for regulatory action to address trade-
entity—Nasdaq as the Plan processor for
rates for NYSE stocks. Given that the throughs.
Nasdaq stocks and SIAC as the Plan
ITS trade-through provisions currently The Commission does not agree that
processor for NYSE stocks.99 One
apply to exchange-listed stocks, the trade-through rates found in the staff
commenter, however, asserted that the
however, the Commission does not study are insignificant, nor does it
two Plan processors themselves had
believe that the possibility that true believe that the total number of trade-
major clock synchronization problems
trade-through rates potentially are lower throughs is the sole consideration in
between quotation data and trade
than estimated in the staff study detracts evaluating the need for the Order
data.100 If this were in fact the case, the
from the strong policy reasons to Protection Rule. A valid assessment of
staff study likely would have found a
maintain and strengthen trade-through their significance and the need for
high rate of trade-throughs by a single
protection for exchange-listed stocks. intermarket protection against trade-
market of its own quotations, because
Rather, eliminating any trade-through throughs must be made in light of the
the Plan processor’s time stamps for the
protection for exchange-listed stocks Exchange Act objectives for the NMS
market’s quotations would have been
could lead to rates that are as high, or that would be furthered by the Order
out of synchronization with its time
higher, than were conservatively Protection Rule, including: (1) To
stamps for the market’s trades. As noted
estimated for Nasdaq stocks, which have promote best execution of customer
in the preceding paragraph, the staff
not been subject to any trade-through market orders; (2) to promote fair and
study found few trade-throughs by a
restrictions. orderly treatment of customer limit
Moreover, the evidence from the staff single market of its own quotations,
thereby indicating that the Plan orders; and (3) by strengthening
study itself indicates that the concerns protection of limit orders, to promote
about delayed trade reporting discussed processors’ quotation data and trade
greater depth and liquidity for NMS
at length in the Battalio/Jennings Paper stocks and thereby minimize investor
with respect to historical data have in Nasdaq stocks), and Table 12 (0.2% of NYSE
trades are trade-throughs of NYSE quotations in transaction costs. The staff study
largely been resolved. For example, if NYSE stocks). examined trade-through rates from a
delayed trade reporting were truly a 99 As discussed above, the staff study used the variety of different perspectives,
serious problem that caused the staff time of trade execution assigned by individual including percentage of trades,
study to be flawed, one would expect to trading centers in their audit trail data for Nasdaq
stocks when this time was available and differed
percentage of total share volume,
see significant rates of trade-throughs by from the time of trade report. The staff study noted percentage of share volume of trades of
a single trading center’s trades of its that this occurred for approximately 5–10% of less than 10,000 shares, and percentage
own quotations—the two data feeds Nasdaq trades. Trade-Through Study at 8 n. 8. As of total share volume of traded-through
would be out of synchronization with a result, problems with synchronization of clocks at
the various Nasdaq trading centers (which must be
quotations.103 In evaluating the need for
each other because trades were reported synchronized within three seconds of the standard the Order Protection Rule, the different
slower than quotation updates. In fact, set by the National Institute of Standards and measures vary in their relevance
however, the staff study found very low Technology) could have affected the time stamps depending on the particular objective
trade-through rates for single trading for these trades. Nevertheless, the fact that trade-
through rates remain significant for both Nasdaq
under consideration.
centers of their own quotations.98 The stocks and exchange-listed stocks even when the For example, the percentage of total
quotation window is extended to a full eight trades that receive inferior prices is a
96 Trade-Through Study at 8 (‘‘Trade data from
seconds (thereby eliminating many true trade- particularly important measure when
the Nastraq file was used for the analysis of Nasdaq throughs as well as false trade-throughs caused by
stocks. This file contains the executed price, share unsynchronized time stamps) indicates that the
assessing the need to promote best
volume, trade report time, trade execution time, and staff study’s estimates of trade-through rates were
an indicator of non-regular or unusual trade not materially affected by potential clock 101 ArcaEx Reproposal Letter at 6; Fidelity
reporting or settlement conditions. The Nastraq synchronization problems. Moreover, the trades Reproposal Letter at 8; Instinet Reproposal Letter at
trade file was selected over the TAQ trade file, as most likely to be reported with different trade 6 n. 6; Nasdaq Reproposal Letter, Exhibit 1 at 4;
the latter does not have trade execution time, only execution times than trade report times are large, UBS Reproposal Letter at 4.
trade report time.’’). manually-executed block trades reported by dealers. 102 The 1.9% and 1.2% figures include only the
97 Battalio/Jennings Paper at 20. These are the very types of trades that commenters total displayed size of quotations that were traded
98 See, e.g., Trade-Through Study, Table 5 (a admitted often deliberately bypass displayed through by trades executed at prices inferior to the
rounded 0.0% of CSE trades are trade-throughs of quotations. See, e.g., Fidelity Reproposal Letter at displayed quotations.
CSE quotations in Nasdaq stocks; a rounded 0.0% 3; Nasdaq Reproposal Letter, Exhibit 1 at 4. 103 See, e.g., Trade-Through Study at 1–2 and
of PCX trades are trade-throughs of PCX quotations 100 Angel Reproposal Letter at 3. Tables 1, 4, 6, 7–8, 11, 13.
execution of customer market orders. do not interact with displayed orders. It evidence of a market problem, not
The staff study found that 1 of every 40 is this volume of trading interest that market quality.
trades (2.5%) for both Nasdaq and NYSE will begin interacting with displayed Every trade-through transaction in
stocks have an execution price that is orders after implementation of the Order today’s markets potentially sends a
inferior to the best displayed price, or Protection Rule. message to limit order users that their
approximately 98,000 trades per day in The share volume of trade-throughs, displayed quotations can be and are
Nasdaq stocks alone.104 As discussed rather than the number of trade- ignored by other market participants.
above,105 investors (and particularly throughs, is most useful for assessing The cumulative effect of such messages
retail investors) often may have the effect of the Order Protection Rule over time as trade-throughs routinely
difficulty monitoring whether their on depth and liquidity because very occur each trading day should not be
orders receive the best available prices, small trades represent such a large underestimated. When the total share
given the rapid movement of quotations percentage of trades in today’s markets, volume of trade-through transactions
in many NMS stocks. The Commission but a small percentage of share volume. that do not interact with displayed
believes that furthering the interests of For example, the staff study found that, quotations reaches 9% or more for many
these investors in obtaining best for Nasdaq stocks, 100-share trades of the most actively traded Nasdaq
execution on an order-by-order basis is represented 32.7% of the number of stocks,109 this message is unlikely to be
a vitally important objective that trade-throughs, but only 0.8% of the missed by those who watched their
warrants adoption of the Order share volume of trade-throughs.106 quotations being traded through.
Protection Rule. Thus, the number of trade-throughs is Certainly, the routine practice of trading
The percentage of total trades that useful for assessing the number of through displayed size is most unlikely
receive inferior prices also is quite investors, particularly retail investors, to prompt market participants to display
relevant when assessing the need to affected by trade-throughs, while the even greater size.
promote fair and orderly treatment of share volume of trade-throughs is useful Thus, the Commission believes that
limit orders for NMS stocks. Many of for assessing the extent to which depth the percentage of share volume in a
the limit orders that are bypassed are and liquidity are affected by trade- stock that trades through displayed and
small orders that often will have been throughs. For example, 41.1% of the accessible quotations is a useful
submitted by retail investors. One of the share volume of trade-throughs in measure for assessing the potential
strengths of the U.S. equity markets and Nasdaq stocks is attributable to trades of increase in incentives for display of
the NMS is that the trading interests of greater than 1000 shares that bypass limit orders after implementation of the
all types and sizes of investors are quotations of greater than 1000 Order Protection Rule. In particular, the
integrated, to the greatest extent shares.107 Addressing the failure of this dual measurements of percentage of
possible, into a unified market system. substantial volume of trading interest to share volume of traded-through
Such integration ultimately works to interact with significant displayed quotations (an overall 1.9% for Nasdaq
benefit both retail and institutional quotations is a primary objective of the stocks) and the percentage of share
investors. Retail investors will Order Protection Rule. volume of trades that bypass displayed
participate directly in the U.S. equity In contrast, the share volume of quotations (an overall 7.9% for Nasdaq
markets, however, only to the extent quotations that currently are traded stocks) likely represent the lower and
they perceive that their orders will be through grossly underestimates the upper bounds for a potential
treated fairly and efficiently. The potential for increased incentives to improvement in depth and liquidity
perception of unfairness created when a display because it reflects only the after implementation of the Order
retail investor has displayed an order current size of displayed quotations in Protection Rule.
representing the best price for an NMS, the absence of strong price protection. Commenters opposing the trade-
yet sees that price bypassed by 1 in 40 As a result, the share volume of through reproposal questioned whether
trades, is a matter of a great concern to quotations that currently are traded protection against trade-throughs would
the Commission. The Order Protection through is a symptom of the problem lead to any increase in the use of limit
Rule is needed to maintain the that the Order Protection Rule is orders, particularly given the many
confidence of all types of investors that designed to address—a shortage of reasons militating against display (e.g.,
their orders will be treated fairly and quoted depth—rather than an indication displayed limit orders give a free option
efficiently in the NMS. of the benefits that the Order Protection to all other market participants to trade
The third principal objective for the Rule will achieve. For example, when at the limit order price).110 The
Order Protection Rule is to promote many Nasdaq stocks can trade millions Commission is aware of a variety of
greater depth and liquidity for NMS of shares per day, but have average reasons that currently deter market
stocks and thereby minimize investor displayed size of less than 2000 shares participants from displaying their
transaction costs. Depth and liquidity at the NBBO, it will be nearly trading interest in full. Indeed, it is the
will be increased only to the extent that impossible for trade-throughs of existence of these negative factors,
limit order users are given greater displayed size to account for a large combined with a shortage of positive
incentives than currently exist to percentage of total share volume—there incentives for display, that have
display a larger percentage of their simply is not enough displayed contributed to the relatively small
trading interest. The potential upside in depth.108 Small displayed depth is displayed depth at the best prices that
terms of greater incentives for display is characterizes the market for many NMS
106 Trade-Through Study, Table 6.
most appropriately measured in terms of stocks today. A large investor interested
107 Id.
the share volume of trades that currently 108 See Supplemental Study at 4. Commission in buying 50,000 shares of a stock is
staff examined the average displayed depth in unlikely to suddenly decide to display
104 Id., Tables 1, 8. In October 2004, there were
Nasdaq stocks to help evaluate commenters’ claims all of its trading interest simply because
3.9 million average daily trades reported in Nasdaq concerning the current level of depth and liquidity
stocks. Source: http://www.nasdaqtrader.com. The its order is given trade-through
for such stocks. The Supplemental Study measured
average trade-through rate of 2.5% for Nasdaq the total depth displayed at the NBBO in Nasdaq
stocks yields average daily trade-throughs of stocks as follows: an average of 1,833 shares, a 109 SeeTrade-Through Study, Tables 4 and 11.
approximately 98,000. median of 581 shares, 384 shares at the 25th 110 See,e.g., Instinet Reproposal Letter at 6 and
105 Supra, note 53 and accompanying text. percentile, and 987 shares at the 75th percentile. n. 6; UBS Reproposal Letter at 3.
protection. The objective for the Order Specifically, they submitted tables methodology most reflects economic
Protection Rule is more modest. The asserting that effective spreads in reality for investors.117
Rule is designed to increase the Nasdaq stocks in the S&P 500 are With respect to the Matched Pairs
perceived benefits of order display, significantly narrower than effective Study, Nasdaq asserted that it largely
against which the negatives are spreads in NYSE stocks in the S&P examined small stocks. Nasdaq noted,
balanced. As a result, the market 500.113 To help assess and respond to for example, that more than 25% of the
participant that currently displays only the views of commenters on market stocks included in the Matched Pairs
500 shares of its 50,000-share trading efficiency, the Commission staff Study were not eligible for NYSE listing
interest might be willing to display 1000 analyzed Rule 11Ac1–5 reports and and that only 10% of the stocks were
shares. The collective effect of many other trading data to evaluate the included in the Nasdaq-100 Index. The
market participants reaching the same markets for Nasdaq and NYSE stocks.114 purpose of the Matched Pairs Study,
conclusion would be a material increase however, was to compare execution
in the total displayed depth in the In its comment on the reproposal, quality in Nasdaq and NYSE across a
market, thereby improving the Nasdaq argued that the staff studies broad range of stocks, not solely for
transparency of price discovery and contained flaws in their large stocks or those that were eligible
reducing investor transaction costs. methodologies.115 With respect to the for NYSE listing. Although 25% of the
Moreover, because of the enormous S&P Index Study, Nasdaq stated that the stocks may not have been eligible for
volume of trading in NMS stocks, even execution quality statistics were drawn NYSE listing, the staff analysis used
a small percentage improvement in from an atypical month and that the matching criteria more directly designed
depth and liquidity could lead to very methodology for analyzing effective to produce an ‘‘apples-to-apples’’
significant dollar benefits for investors spreads favored higher-priced NYSE comparison—market capitalization,
in the form of reduced transaction costs. stocks over lower-priced Nasdaq stocks. price, average daily dollar volume
As discussed in section II.A.6 below, for The S&P Index Study presented (adjusted downward by 30% for Nasdaq
example, the annual implicit transaction statistics from January 2004, however, stocks to reflect trade reporting practices
costs of large institutional investors are because this was the month selected by in such stocks), and relative price range.
estimated at more than $30 billion in Nasdaq in the comment letter that it The Commission therefore believes that
2003.111 As a result, even a small submitted on the proposal in July 2004. the staff studies provide a valid basis to
percentage reduction in these costs Moreover, the general statistics reported compare trading in Nasdaq stocks and
because of improved depth and by Nasdaq for later months do not NYSE stocks.
liquidity would result in very appear to differ materially from those The staff studies indicate that the
substantial annual savings for millions for January 2004.116 In addition, the S&P execution quality statistics submitted by
of mutual fund and pension fund Index Study analyzed investor commenters on the original proposal are
investors. The Commission therefore transaction costs in terms of a flawed. The claimed large and
believes that the estimated trade- systematic disparities between Nasdaq
percentage of investment rather cents
through rates in the staff study support and NYSE effective spreads disappear
per share because, as discussed below,
the need for enhanced protection of when an analysis of execution quality
the percentage of investment
limit orders as a means to promote more appropriately controls for
greater depth and liquidity in NMS differences in stocks, order types, and
a result generally consistent with the existing
stocks. literature.’’ Id. at 2. Finally, the Mercatus Center order sizes.118 The staff studies reveal
b. Efficiency of Trading in Nasdaq and referenced several statistical studies in its comment that both the market for Nasdaq stocks
letter and concluded that the findings of such and the market for NYSE stocks have
NYSE Stocks studies are mixed. Letter from Susan E. Dudley,
A few commenters on the original Director, Regulatory Studies Program, Mercatus significant strengths. But, as discussed
proposal submitted empirical data to Center, George Mason University, to Jonathan G. below, both markets also have
support their claim that trading in
Katz, Secretary, Commission, dated May 24, 2004 weaknesses that could be reduced by
(‘‘Mercatus Center Letter’’) at 3. strengthened protection against trade-
Nasdaq stocks currently is more 113 Nasdaq and Instinet based their tables on
efficient than trading in NYSE stocks.112 statistics derived from the reports (‘‘Dash 5
throughs.
Reports’’) on order execution quality made public First, the effective spread analyses
111 Implicit transaction costs are associated with by markets pursuant to Exchange Act Rule 11Ac1– submitted by commenters do not, in a
the prices at which trades are executed, in contrast 5 (redesignated as Rule 605 under Regulation NMS). number of respects, reflect appropriately
Their source for these reports is Market Systems,
with explicit transaction costs such as
Inc. (‘‘MSI’’), a private vendor that collects the
the comparative transaction costs in
commissions. Implicit costs include the adverse Nasdaq and NYSE stocks.119 They were
price movements experienced by institutional reports of all markets each month and includes
investors when searching for the liquidity and them in a searchable database. MSI also is the
executing the orders necessary to trade in large size. source of the Dash 5 Reports used in the staff 117 To the extent Nasdaq has more low-priced
See infra, notes 146, 300–305, 990, and analyses. stocks than the NYSE, the Dash 5 statistics favor
114 Memorandum to File, from Office of Economic Nasdaq in the larger order size categories because
accompanying text.
112 Instinet Letter, Exhibit A; Nasdaq Letter II, Analysis, dated December 15, 2004 (comparative of ‘‘bracket creep’’ ‘‘i.e., it typically will be easier
Attachment II. One commenter on the reproposal analysis of execution quality for NYSE and to execute a 2000 share order in a $5 stock ($10,000
referred the Commission to an academic study of NASDAQ stocks based on a matched sample of total volume) than to execute a 2000 share order in
trading in Nasdaq and NYSE stocks, asserting that stocks) (‘‘Matched Pairs Study’’); Memorandum to a $40 stock ($80,000 total volume), assuming the
its conclusion was that ‘‘bid-ask spreads were File, from Division of Market Regulation, dated stocks are otherwise comparable.
shown to be narrower and liquidity shown to be December 15, 2004 (comparative analysis of Rule 118 Matched Pairs Study, Tables 4–10; S&P Index
greater in Nasdaq stocks.’’ STANY Reproposal 11Ac1–5 statistics by S&P Index) (‘‘S&P Index Study, Tables 2–9.
Letter at 8. The referred study was Lehn, Patro, and Study’’). The Matched Pair Study and S&P Index 119 The effective spread is a useful measure of
Shastri, Information Shocks and Stock Market Study are in Public File No. S7–10–04 and are transaction costs for market orders, particularly for
Liquidity: A Comparison of the New York Stock available for inspection on the Commission’s small order sizes, because it reflects the prices
Exchange and Nasdaq (presented at the American Internet Web site (http://www.sec.gov). actually received by investors when compared to
115 Nasdaq Reproposal Letter, Exhibit 1 at 1.
Enterprise Institute on June 10, 2004) (available at the best quotes at the time a market received an
www.aei.com). The commenter misinterpreted, 116 See, e.g., id., Exhibit 1 at 15 (table showing order. Consequently, unlike the quoted spread, the
however, the results of the study. The study found that blended effective spread statistics in terms of effective spread reflects any cost to investors caused
that ‘‘during both the calm and stress periods, cents-per-share for both market orders and by movement in prices during a delay between
quoted and effective bid-ask spreads are marketable limit orders generally declined receipt of an order and execution of an order. In
significantly lower for NYSE versus Nasdaq stocks, throughout 2004 for both Nasdaq and NYSE stocks). other words, the effective spread penalizes slow
presented in terms of ‘‘cents-per-share’’ spreads for marketable limit orders and thereby improve their execution
and therefore failed to control for the therefore represent transaction costs that quality.
varying level of stock prices between are conditional on execution, while For Nasdaq stocks, the Rule 11Ac1–5
Nasdaq stocks and NYSE stocks in the effective spreads for market orders statistics reveal very low fill rates for
S&P 500. Lower priced stocks naturally much more completely reflect the entire larger sizes of marketable limit orders
will tend to have lower spreads in terms implicit transaction cost for a particular (e.g., 2000 shares or more), which
of cents-per-share than higher priced order. Market orders represent only generally fall below 50% for most
stocks, even when such cents-per-share approximately 14% of the blended flow Nasdaq stocks. Contrary to the assertion
spreads constitute a larger percentage of of market and marketable limit orders in of some commenters,125 certainty of
stock price and therefore represent Nasdaq stocks (reflecting the fact that execution for large marketable limit
transaction costs for investors that ECNs now dominate Nasdaq order flow orders clearly is not a strength of the
consume a larger percentage of their and limit orders represent the vast current market for Nasdaq stocks.
investment. By using cents-per-share majority of ECN order flow).122 In Certainty of a fast response is a strength,
statistics, commenters did not adjust for contrast, market orders represent but much of the time the response to
the fact that the average prices of approximately 36% of the blended order large orders will be a ‘‘no fill’’ at any
Nasdaq stocks are significantly lower flow in NYSE stocks.123 Accordingly, given trading center.126
than the average prices of NYSE stocks. the effective spread statistics for Two commenters on the reproposal
For example, the average price of marketable limit orders, and particularly disputed whether low fill rates for
Nasdaq stocks in the S&P 500 in January for orders in Nasdaq stocks, must be marketable limit orders in Nasdaq
2004 was $34.14, while the average considered in conjunction with the fill stocks indicate any weakness that
price of NYSE stocks was $41.32.120 rate for such orders ‘‘while a narrow needed to be addressed.127 Instinet, for
The effective spread analyses spread is good, the benefits are greatly example, believed that ‘‘the Commission
submitted by commenters also were limited if investors are unable to obtain is misplaced in its contention that low
weakened by their failure to address the an execution at that spread. The fill rates in Nasdaq stocks are a
much lower fill rates of orders in analyses presented by the commenters, weakness of that market,’’ and that they
Nasdaq stocks than orders in NYSE however, did not address the respective are a phenomenon ‘‘intrinsic to
stocks. The commenters submitted fill rates for Nasdaq stocks and NYSE electronic markets in which market
‘‘blended’’ statistics that encompassed stocks or reflect the inherent differences participants are free to cancel and
both market orders and marketable limit in measuring the transaction costs of replace orders.’’ 128 Instinet also noted
orders. The effective spread statistics for market orders and marketable limit that many market centers in Nasdaq
these order types are not comparable, orders. stocks have significant reserve size in
however, because market orders do not The analyses prepared by addition to displayed size and that
have a limit price that precludes their Commission staff are designed to market participants commonly routed
execution at prices inferior to the provide appropriate evaluations of oversized marketable limit orders to
prevailing market price at time of order comments on the efficiency of trading in attempt to interact with reserve size.129
receipt. In contrast, the limit price of Nasdaq and NYSE stocks. In particular,
marketable limit orders often precludes they are more finely tuned to evaluate 125 See, e.g., Instinet Reproposal Letter at 7;
an execution, particularly when there is trading for different types of stocks with Nasdaq Letter II at 6. In addition to effective spread
statistics, Instinet submitted statistics indicating
a lack of liquidity and depth at the varying trading volume, different types that combined market and marketable limit orders
prevailing market price. For example, of orders, and different sizes of orders. in Nasdaq stocks were more likely to be executed
the fill rates for marketable limit orders These analyses indicate that the markets at or inside the NBBO than such orders in NYSE
in Nasdaq stocks generally are less than for Nasdaq and NYSE stocks each have stocks. Instinet Letter, Table I–C. These statistics,
75%, and often fall below 50% for larger weaknesses that an intermarket price however, only reflect orders that in fact receive an
execution—not the large volume of orders in
order sizes.121 protection rule could help address. By Nasdaq stocks that fail to receive any execution at
Accordingly, investors must accept ‘‘weakness,’’ the Commission simply all.
trade-offs when deciding whether to means that there appears to be 126 Some commenters asserted that the large
submit market orders or marketable considerable room for improvement. For number of limit orders in Nasdaq stocks indicates
that sufficient incentives exist for the placement of
limit orders (particularly when the limit example, the effective spread statistics limit orders in such stocks. See, e.g., Instinet Letter
price equals the current market price). for large, electronically-received market at 11; Letter from Thomas N. McManus, Managing
Use of a limit price generally assures a orders in NYSE stocks show significant Director & Counsel, Morgan Stanley & Co.
narrower spread by precluding an ‘‘slippage’’—the amount by which Incorporated, to Jonathan G. Katz, Secretary,
orders are executed at prices inferior to Commission, dated August 19, 2004 (‘‘Morgan
execution at an inferior price. By Stanley Letter’’) at 14. Strengthened intermarket
precluding an execution, however, the the national best bid or offer (‘‘NBBO’’) trade-through protection, however, is designed to
limit price may cause the investor to at the time of order receipt.124 Slippage improve the quality of limit orders in a stock,
‘‘miss the market’’ if prices move away often results in effective spreads for particularly their displayed size, and thereby
large orders that are many times wider promote greater depth and liquidity. This goal is
(for example, if prices rise when an not achieved, for example, by a large number of
investor is attempting to buy). Effective than the effective spreads for small limit orders with small sizes and high cancellation
orders in the same NYSE stocks. By rates.
markets for failing to execute trades at their quoted protecting automated quotations, the 127 Instinet Reproposal Letter at 6–7; Nasdaq
prices at the time they received an order. It Order Protection Rule should enhance Reproposal Letter at 5.
therefore provides an appropriate criterion with the depth and liquidity available for 128 Instinet Reproposal Letter at 6–7.
which to compare execution quality between 129 Instinet Reproposal Letter at 7. Instinet also
automated and manual markets for comparable large, electronic orders in NYSE stocks
asserted that low fill rates for large marketable limit
stocks, order types, and order sizes. As discussed orders might be attributable to the frequent locking
below, however, effective spread statistics do not 122 Most market orders in Nasdaq stocks are
of markets in low-priced stocks. In fact, however,
capture transaction costs that are attributable to low executed by market-making dealers pursuant to the Dash 5 fill rates for large orders in low-priced
fill rates—the failure to obtain an execution—for agreement with their correspondent or affiliated stocks generally are higher than those for high-
marketable limit orders. brokers. priced stocks, likely because the dollar value of
120 S&P Index Study, Table 1. 123 Matched Pairs Study at 1.
such orders is low (i.e., 5000 shares of a $5 stock
121 Matched Pairs Study, Table 10; S&P Index 124 Matched Pairs Study, Tables 4, 7; S&P Index ($25,000) generally will be easier to trade than 5000
Study, Tables 7, 9. Study, Tables 2, 4, 6, 8. Continued
Similarly, Nasdaq stated that the staff The Reproposing Release did not as a whole is to facilitate more efficient
studies ‘‘erroneously conclude that suggest, however, that the differential trading in larger sizes, an objective that
differential fill rates for large marketable fill rates for large marketable limit has become much more important to
limit orders in Nasdaq-listed and NYSE- orders in Nasdaq and NYSE stocks were large investors since decimalization.136
listed stocks are evidence of a defect in useful in comparing the liquidity and An improvement in fill rates for larger
Nasdaq’s market structure,’’ and that depth available in each market. Instead, sized orders (or an increase in their
they failed ‘‘to consider a widely used the Reproposing Release focused on the percentage of executed shares) would
order routing technique of intentionally most relevant Dash 5 statistic for each evidence progress toward this objective.
sending oversized orders at displayed market, given its particular trading Fill rates for marketable limit orders,
quotes searching (also known as characteristics. As noted above, the however, offer only indirect evidence of
‘‘pinging’’) for reserves within the many significant amount of ‘‘slippage’’ in the the total transaction costs incurred by
limit order books trading Nasdaq-listed execution of electronically-received investors. They indicate that no
securities.’’ 130 Nasdaq also asserted that large market orders in NYSE stocks execution was obtained for an investor
marketable limit orders are suggest that improved incentives for order at a particular trading center, but
‘‘exceedingly popular in electronic display of automated trading interest do not indicate how the investor
venues where they have effectively will help improve execution quality for subsequently fared in obtaining an
supplanted market orders as the order of NYSE stocks. Notably, Instinet and execution. As discussed above, there are
choice in accessing availability liquidity Nasdaq agreed that slippage rates for significant trade-offs between
at the current price.’’ 131 automated market orders represented a marketable limit orders and market
The Commission continues to believe problem in the market for NYSE orders. The use of a restrictive limit
that fill rates for large marketable limit stocks.133 Because market participants price at the NBBO precludes any
orders are a useful measure of order generally choose not to submit market slippage in execution price, but also
execution quality for Nasdaq stocks. orders to electronic markets in Nasdaq may cause an investor to miss the
They are especially useful because they stocks, however, the fill rates for market if prices subsequently move
measure the availability of both marketable limit orders are a more away from the order (i.e., rise when an
displayed and undisplayed liquidity, relevant Dash 5 statistic to assess depth investor is attempting to buy or fall
whereas simply measuring displayed and liquidity in Nasdaq stocks. when an investor is attempting to sell).
size would understate the total liquidity Accordingly, the Commission’s To evaluate the total transaction costs
readily available for Nasdaq stocks. concern with fill rates for larger orders associated with an order that goes
Indeed, the existence of ‘‘pinging’’ in Nasdaq stocks is not that they are unfilled or receives a partial fill, it is
orders searching for reserve size in lower than those for NYSE stocks, but necessary to know the price at which
Nasdaq stocks at electronic markets is that they are very low in absolute the investor ultimately obtained an
widely known. Such oversized orders terms—often falling well below 50%.134 execution for its full order.
(i.e., orders with sizes greater than Moreover, the larger order sizes To help the Commission evaluate and
displayed size) could as aptly be labeled typically account for a small percentage respond to commenters’ criticisms and,
‘‘liquidity search’’ orders as ‘‘pinging’’ of executed shares compared to the in particular, to supplement its analysis
orders. Given the relatively small executed shares of smaller order of fill rates as a measure of depth and
displayed size in nearly all Nasdaq sizes.135 When considered in liquidity for Nasdaq stocks and to
stocks (i.e., significantly less than 2000 conjunction with one another, the low evaluate the extent to which missed fills
shares),132 orders with sizes of 2000 to fill rates and small percentage of may lead to higher investor transaction
executed shares indicate substantial costs, Commission staff also examined
4999 shares and 5000 to 9999 shares
room for improvement in depth and execution quality statistics for
(the two largest Dash 5 size categories)
liquidity in many Nasdaq stocks. An marketable limit orders in Nasdaq-100
generally will exceed the displayed size.
important objective for Regulation NMS Index stocks that are executed outside
Thus, low fill rates demonstrate that the
the best quotes at the Inet ATS and the
total displayed and reserve liquidity 133 Instinet Reproposal Letter at 6 (‘‘we ourselves NASDAQ Market Center.137 By
available for Nasdaq stocks at any make a point of a high level of slippage as being
particular trading center typically is definition, such orders have been placed
an issue in the NYSE market’’); Nasdaq Letter II,
small compared to the demand for Attachment II (table comparing market order shares
with liberal limit prices that give more
liquidity at the inside prices. Moreover, traded outside the quote for Nasdaq and NYSE flexibility for executions away from the
increased displayed liquidity—a stocks). NBBO than orders with limit prices that
principal goal of the Order Protection
134 See, e.g., Matched Pairs Study, Table 10.
are restrictively set at the NBBO.
135 See, e.g., Matched Pairs Study, Table 3.
Rule—would promote market efficiency Accordingly, the slippage rates for such
Nasdaq also asserted that the difference in share
by reducing the uncertainty and costs volume of Dash 5 marketable limit orders for
orders give another indication of
associated with the need for market Nasdaq stocks versus NYSE stocks indicated the
136 See Reproposing Release, 69 FR at 77425.
superiority of Nasdaq execution quality for
participants to ‘‘ping’’ electronic marketable limit orders. The difference in 137 Memorandum to File, from Division of Market
markets for liquidity that is held in marketable limit order share volume in Nasdaq and Regulation, dated April 6, 2005 (analysis of Rule
reserve. NYSE stocks, however, is attributable to structural 11Ac1–5 statistics for Nasdaq-100 Index) (‘‘Nasdaq-
differences between the two markets. For example, 100 Index Supplemental Study’’). The Nasdaq100
many large orders in NYSE stocks are handled Index Supplemental Study has been placed in
shares of a $50 stock ($250,000)). See infra, text manually by brokers on the NYSE floor and Public File No. S7–10–04 and is available for
accompanying notes 141–142 (average fill rates for therefore are not included in the Dash 5 statistics, inspection on the Commission’s Internet Web site
large orders in low-priced stocks in Nasdaq–100 which only encompass electronic orders. In (http://www.sec.gov). The staff examined Nasdaq-
Index are much higher than fill rates for most other addition, a greater volume of market orders are 100 stocks in response to Nasdaq’s suggestion that
stocks in Index). executed in NYSE stocks than in Nasdaq stocks. they are most appropriate for evaluating execution
130 Nasdaq Reproposal Letter at 5.
Matched Pairs Study, Table 3. As discussed below, quality in the market for Nasdaq stocks. See Nasdaq
131 Id., Exhibit 1 at 8.
the need for a restrictive limit price to prevent Reproposal Letter, Exhibit 1 at 1, 11. The statistics
132 Supplemental Trade-Through Study at 5. In outside-the-quote executions likely is an additional are from December 2004 and are equal-stock
Fall 2003, only 273 Nasdaq stocks had average reason that Nasdaq market participants choose to weighted to give a more representative view of
displayed size at the NBBO of 2000 or greater use marketable limit orders rather than market trading across all stocks, rather than a view
shares, 213 of which were low-priced stocks (prices orders. See infra, notes 138–139 and accompanying concentrated on a few stocks that are much more
of less than $10 per share). text. actively traded than the others.
available liquidity for Nasdaq-100 prices of less than $10 per share. intraday volatility and transitory
stocks. Liquidity for orders with large share volatility are higher for Nasdaq stocks
The statistics for outside-the-quote sizes in these stocks can be expected to than for NYSE stocks.144 Excessive
executions in marketable limit orders be higher than for stocks with higher transitory volatility indicates a shortage
buttress a conclusion that there is prices because the dollar sizes are much of depth and liquidity that otherwise
significant room for improved depth smaller (e.g., a 5000 share order in a $5 would minimize the effect of short-term
and liquidity in Nasdaq stocks. For stock totals $25,000, whereas a 5000 order imbalances. Such volatility may
example, the Inet ATS did not fill share order in a $30 stock totals provide benefits in the form of
83.0% of its large marketable limit $150,000). In terms of economic reality, profitable trading opportunities for
orders.138 Of the orders it executed, therefore, large orders in a low-priced short-term traders or market makers, but
19.5% of shares were executed outside stock generally are easier to execute these benefits come at the expense of
the quote by an average of 2.7 cents. than large orders in a higher-priced other investors, who would be buying at
Thus, while the overall quoted and stock, assuming the stocks are otherwise artificially high or selling at artificially
effective spreads for executed shares for comparable. Finally, the supplemental low prices. Retail investors, in
large orders were, respectively, 1.6 cents staff study separately examined the particular, tend to be relatively
and 2.5 cents, the spread for outside the other 90 stocks in the Nasdaq-100 Index uninformed concerning short-term price
quote executions was 7.0 cents—438% (i.e., stocks with prices of at least $10 movements and are apt to bear the brunt
wider than the narrow quoted spread. per share other than Microsoft, Intel, of the trading costs associated with
The statistics for the NASDAQ Market and Cisco). excessive transitory volatility.145 The
Center are similar. It did not fill 68.4% The supplemental staff study reveals Order Protection Rule, by promoting
of its large marketable limit orders.139 that low fill rates for large marketable greater depth and liquidity, is designed
Of the orders it executed, 14.7% were limit orders are not an inherent feature to help reduce excessive transitory
executed outside the quote by an of the market for Nasdaq stocks. For volatility in Nasdaq stocks.
average of 2.3 cents. The overall quoted example, the NASDAQ Market Center Finally, an important measure of
and effective spreads for large orders fill rates for large orders are 76.7% for depth and liquidity for NMS stocks is
were, respectively, 1.6 cents and 2.5 the three large-cap stocks, 70.1% for the the transaction costs actually incurred
cents, compared to 6.2 cents for outside low-priced stocks, and 27.1% for the by institutional investors when they
the quote executions—388% wider than other 90 stocks in the Nasdaq-100 trade in large size. These costs are not
the narrow quoted spread. The outside- Index.141 Similarly, the Inet ATS fill readily available for public view
the-quote spreads provide the best rates for large orders are 58.5% for the because their measurement requires
available indication of execution quality three large-cap stocks, 55.0% for low- access to a large volume of private order
that otherwise would have been priced stocks, and 12.6% for the other and execution data of institutional
obtained at the time orders were placed 90 stocks in the Nasdaq-100 Index.142 investors. One of the leading authorities
for the 83.0% and 68.4% of shares that The order execution quality measures on institutional transaction costs uses
were not filled due to their restrictive included in Dash 5 reports do not, of an extensive database of such data
limit price. The outside-the-quote course, reflect all types of investor obtained from its clients to calculate
spreads also are relevant in assessing transaction costs. They generally focus their transaction costs. It recently
the reasons why market participants on the execution price of individual published calculations of average
most often use marketable limit orders orders in comparison with the best transaction costs for Nasdaq and NYSE
with limit prices at the NBBO rather quoted prices at the time orders are stocks during the fourth quarter of 2003
than market orders when trading received. As a result, they do not as, respectively, 83 basis points and 55
Nasdaq stocks. capture transaction costs that are basis points.146 Given the significant
In addition, the supplemental staff associated with the short-term
study separately examined fill rates and movement of quoted prices. To further 144 Volatility Study at 1. Nasdaq raised a number
executed share volume for types of assist the Commission in evaluating the of objections to the Volatility Study in its comment
on the reproposal. Nasdaq Reproposal Letter,
Nasdaq-100 stocks where liquidity for views of commenters, Commission staff Exhibit 1 at 16–19. To help the Commission
orders with large share sizes can has analyzed price volatility for trading evaluate these objections, Commission staff
reasonably be expected to be highest.140 in Nasdaq and NYSE stocks.143 This performed supplemental analysis to reflect
These stock groupings were selected analysis particularly focuses on Nasdaq’s concerns and to provide a fuller
description of volatility for Nasdaq and NYSE
primarily to assess whether low fill rates transitory volatility—short-term stocks. The results of the additional analysis
for large marketable limit orders are an fluctuations away from the fundamental confirm the basic conclusions reached in the
inherent part of the structure of the or ‘‘true’’ value of a stock. Transitory original analysis ‘‘the stocks that switched from
market for Nasdaq stocks. Specifically, volatility should be distinguished from Nasdaq listing to NYSE listing during the sample
period experienced a decrease in total volatility and
the supplemental staff study calculated fundamental volatility—price in transitory volatility. Memorandum to File, from
fill rates and executed share volume for fluctuations associated with factors Office of Economic Analysis, dated April 6, 2005
the three Nasdaq stocks with the largest independent of market structure, such (additional analysis of volatility for stocks
capitalization—Microsoft, Intel, and as earnings changes and other economic switching from NASDAQ to NYSE) (‘‘Supplemental
Volatility Study’’). The Supplemental Volatility
Cisco. These three stocks are widely determinants of stock prices. The staff Study has been placed in Public File No. S7–10–
recognized among all Nasdaq stocks as analysis found that on average both 04 and is available for inspection on the
having markets with significant depth Commission’s Internet Web site (http://
and liquidity. In addition, the 141 Nasdaq-100 Index Supplemental Study, www.sec.gov).
Tables, 6–8. 145 See infra, section I.A.2 (discussion of
supplemental staff study examined the 142 Nasdaq-100 Index Supplemental Study, Tables Exchange Act emphasis on minimizing volatility to
seven Nasdaq-100 stocks with share 2–4. protect interests of investors).
143 Memorandum to File, from Office of Economic 146 Wayne H. Wagner, Faster!, 1 FIXGlobal 54, 55
138 Nasdaq-100 Index Supplemental Study, Table
Analysis, dated December 15, 2004 (analysis of (3rd Quarter 2004) (estimate of Plexus Group, Inc.).
1 (orders with sizes of 5000 to 9999 shares). volatility for stocks switching from NASDAQ to Explicit transaction costs such as commissions
139 Nasdaq-100 Index Supplemental Study, Table represent only a small part of total transaction costs
NYSE) (‘‘Volatility Study’’). The Volatility Study
5 (orders with sizes of 5000 to 9999 shares). has been placed in Public File No. S7–10–04 and calculated by Plexus (e.g., 12 basis points for large
140 Nasdaq-100 Index Supplemental Study, Tables is available for inspection on the Commission’s capitalization stocks). The remaining implicit
2–3, 6–7. Internet Web site (http://www.sec.gov). Continued
differences in the overall nature of difficulty monitoring whether their typically representing undisplayed
Nasdaq and NYSE stocks, these figures individual orders miss the best institutional trading interest.
cannot be used to assess the relative displayed prices at the time they are Institutional trading interest, both
efficiency of the two markets. The executed and evaluating the quality of displayed and undisplayed,
figures for both, however, suggest room service provided by their brokers.150 undoubtedly is an important part of the
for improved depth and liquidity, Given the large number of trades that price discovery process. Notably, the
particularly when compared with the fail to obtain the best displayed prices large volume of block trades currently
average quoted spreads in NMS stocks, (e.g., approximately 1 in 40 trades for executed on the NYSE is subject both to
which generally are less, and often both Nasdaq and NYSE stocks), the the NYSE’s order interaction rules and
much less, than 10 basis points for large Commission is concerned that many of the ITS trade-through rules.
capitalization stocks that dominate the investors that ultimately received Accordingly, NYSE block trades cannot
trading volume.147 the inferior price in these trades may be considered as free-riding on
not be aware that their orders did not, displayed limit orders, in contrast to
c. Need for Intermarket Rule to Achieve block trades reported by block
Effective Protection Against Trade- in fact, obtain the best price. The Order
Protection Rule will backstop a broker’s positioners in the OTC market that
Throughs currently do not interact with (and
duty of best execution on an order-by-
As discussed in the preceding section, thereby are free-riding on) displayed
order basis by prohibiting the practice of
the relevant data, as well as the policy liquidity and are not covered by the ITS
executing orders at inferior prices,
choices the Commission has articulated provisions.
absent an applicable exception.
above, supports the need for Moreover, the Order Protection Rule
strengthened protection against trade- Just as importantly, even when market does not require that all institutional
throughs in both Nasdaq and exchange- participants act in their own economic trading interest be displayed. Rather, the
listed stocks. Some commenters argued, self-interest, or brokers act in the best Rule strengthens the incentive for the
however, that competitive forces alone interests of their customers, they may voluntary display of a greater proportion
would achieve the fairest and most deliberately choose, for various reasons, of latent trading interest by assuring
efficient markets.148 In particular, they to bypass (i.e., not protect) limit orders that, when such interest is displayed, it
asserted that reliance on efficient access with the best displayed prices. For is protected against most trade-throughs.
to markets and brokers’ duty of best example, an institution may be willing In these circumstances, institutions will
execution would be sufficient without to accept a dealer’s execution of a choose to display when they determine
the need for an intermarket rule against particular block order at a price outside it is in their own interests, not because
trade-throughs. This argument, the NBBO, thereby transferring the risk it is mandated by Commission rule.
however, fails to take into account two of any further price impact to the dealer. Greater displayed size will improve the
structural problems—principal/agent Market participants that execute orders quality and transparency of price
conflicts of interest and ‘‘free-riding’’ on at inferior prices without protecting discovery for all market participants.
displayed prices. displayed limit orders are effectively Fidelity also asserted that ‘‘an
Agency conflicts may occur when ‘‘free-riding’’ on the price discovery institutional investor, seeking to acquire
brokers have incentives to act otherwise provided by those limit orders. or dispose a large block of stock will be
than in the best interest of their Displayed limit orders benefit all market put to a distinct and unfair advantage if
customers. For example, brokers may participants by establishing the best it is deprived of the ability to negotiate,
have strong financial and other interests prices, but, when bypassed, do not at one time and at a specified price, an
in routing orders to a particular market, themselves receive a benefit, in the form all-in price for its block trade with a
which may or may not be displaying the of an execution, for providing this dealer.’’ 152 Similarly, the Battalio/
best price for a stock. Moreover, the public good. This economic externality, Jennings Paper suggests that, for large
Commission has not interpreted a in turn, creates a disincentive for marketable limit orders of institutions,
broker’s duty of best execution for retail investors to display limit orders and ‘‘it might be better to ignore a penny
orders as requiring that a separate best ultimately could negatively affect price quote for a few hundred shares in order
execution analysis be made on an order- to get a large order done quickly rather
discovery and market depth and
by-order basis.149 Nevertheless, retail than try to chase the small quote and
liquidity.
investors generally expect that their risk losing the ability to fill the size
small orders will be executed at the best Fidelity’s comment letters on the desired.’’ 153 These contentions do not
displayed prices. They may have reproposal questioned whether large recognize that the Order Protection Rule
trades that bypass displayed quotations does not, in fact, preclude institutions
transaction costs are attributable to the impact of should be considered as free-riding on from negotiating ‘‘all-in’’ prices for their
the trade on market price as it interacts with other the price discovery provided by
buyers and sellers, delay or liquidity search costs
trades with dealers or immediately
that occur when portions of the trade are held back
displayed limit orders.151 It emphasized routing orders to access larger-sized
for fear of upsetting the supply/demand balance, that the price-formation process reflects depth-of-book quotations. Rather, the
and opportunity costs that arise when the trade is information stemming from all trading Rule simply requires a dealer, at the
abandoned before all desired shares have been interest and that institutional trading
acquired. Id. same time as executing a large
147 See, e.g., Matched Pairs Study, Tables 3, 8. interest is an important part of the institutional order at an all-in price, to
148 See, e.g., ArcaEx Reproposal Letter at 5; STA process. As evidence, it noted that route an intermarket sweep order to
Reproposal Letter at 3; STANY Reproposal Letter at almost one-third of reported volume on execute against the displayed size of
2. the NYSE in 2004 was of block size,
149 See, e.g., Securities Exchange Act Release No.
protected quotations with superior
37619A (Sept. 6, 1996), 61 FR 48290, 48323 n. 362 prices to the institution’s trade price.
(‘‘Order Handling Rules Release’’) (‘‘Commission 150 See supra, note 53 and accompanying text
Similarly, the Rule allows an institution
has recognized that it may be impractical, both in (discussion of difficulty for investors to monitor to simultaneously route intermarket
terms of time and expense, for a broker that handles whether their order execution prices equal the best
quoted prices at the time of order execution). sweep orders to execute against both
a large volume of orders to determine individually
where to route each order it received.’’). See also 151 Fidelity Reproposal Letter at 5; Fidelity
152 Fidelity Reproposal Letter at 3.
infra, section II.B.4 (discussion of duty of best Reproposal Letter II at 2. See also Battalio/Jennings
execution). Paper at 2. 153 Battalio/Jennings Paper at 29.
small-sized quotations at the best prices the establishment of a marketwide they want to trade on a first-come, first-
and larger-sized depth-of-book trade-through rule. * * * [S]uch a rule served basis. They thereby act as a vital
quotations. The Rule therefore does not represents a significant step in reference point for all other sources of
require institutions to parcel out their providing protection for limit orders. By liquidity. Specifically, reserve size,
block orders in a series of transactions affirming the principle of price priority, undisplayed floor interest, automated
over time. a trade-through rule should encourage matching, and dealer capital
Fidelity and the Battalio/Jennings the display of limit orders, which in commitments all are facilitated by
Paper also incorrectly asserted that the turn would improve the price discovery displayed information concerning the
Commission’s concern about free-riding process and contribute to increased price and size of stock that is available
on displayed quotations related only to market depth and liquidity.’’ 158 for immediate trading in the public
the limit orders of retail investors, citing Another commenter asserted that the markets.
a number of academic studies indicating reproposal overly emphasized the As demonstrated by the current rate of
that institutional trades and quotations importance of displayed limit orders in trade-throughs of the best quotations in
are important contributors to price the price discovery process.159 It stated Nasdaq and NYSE stocks, the problems
discovery.154 In fact, however, the that the interaction of displayed limit of agent/principal conflicts and the free-
Reproposing Release did not distinguish orders with marketable orders is only riding externality often can lead to
between the limit orders of retail one aspect of price discovery, which is executions at prices that are inferior to
investors and those of institutions when ‘‘a dynamic process that operates in the displayed quotations, meaning that limit
discussing the problem of free-riding.155 context of other transactions that have orders are being bypassed. The frequent
Rather, the Order Protection Rule is recently been made, current quotes, and bypassing of limit orders can cause
designed to promote displayed liquidity a richer tapestry of the expressed and fewer limit orders to be placed. The
from all sources, and institutional limit latent interest of a broader array of Commission therefore believes that the
orders clearly are a significant source of market participants.’’ 160 The Order Protection Rule is needed to
such liquidity. Indeed, the Battalio/ Commission generally concurs with this encourage greater use of limit orders.
Jennings Paper itself notes that characterization of the price discovery The more limit orders available at better
‘‘institutions dominate price discovery process, but believes that displayed prices and greater size, the more
via quoting’’ and that ‘‘the limit orders are a critically important liquidity available to fill incoming
preponderance of quote-based discovery element of efficient price discovery that marketable orders. Moreover, greater
for NYSE-listed securities takes place at deserve greater protection against trade- displayed liquidity will at least lower
the NYSE’’ where ‘‘institutions throughs. Publicly displayed and the search costs associated with trying
dominate trading.’’ 156 Many automated limit orders are the most to find liquidity. Increased liquidity, in
institutional investors and the NYSE are transparent and accessible source of turn, could lead market participants to
strong supporters of strengthened limit liquidity in the equity markets. interact more often with displayed
order protection for all NMS stocks.157 Moreover, displayed limit orders orders, which would lead to greater use
For example, the ICI, whose members provide price discovery on a going of limit orders, and thus begin the cycle
manage assets that account for more forward basis—they indicate the prices again. We expect that the end result will
than 95% of assets of all U.S. mutual at which trades can be effected in the be an NMS that more fully meets the
funds, stated that it ‘‘strongly supports future. Trade reports, in contrast, look needs of a broad spectrum of investors.
backward at the prices of trades that
2. Limiting Protection to Automated and
already have occurred, which may or
154 Battalio/Jennings Paper at 4 n. 1, 30–36; Accessible Quotations
Fidelity Reproposal Letter II at 2. may not be still available.
155 See, e.g., Reproposing Release, 69 FR at 77434 There are, of course, other sources of The original trade-through proposal
(‘‘Displayed limit orders benefit all market liquidity, including: (1) Reserve size sought to strengthen protection against
participants by establishing the best prices, but, (limit orders with undisplayed size); (2) trade-throughs, while also addressing
when bypassed, do not themselves receive a benefit, problems posed by the inherent
in the form of an execution, for providing this ‘‘not held’’ institutional orders that are
public good. This economic externality, in turn, worked by floor brokers on an exchange; differences in quotations displayed by
creates a disincentive for investors to display limit (3) automated matching networks that automated markets (which are
orders, particularly limit orders of any substantial allow large buyers and sellers to meet immediately accessible) and quotations
size.’’) (emphasis added). In contrast, the displayed by manual markets (which are
Commission’s concern specifically for the limit directly and anonymously; and (4)
orders of retail investors relates primarily to the securities dealers that are willing to not), by distinguishing between
perception of unfairness created when retail orders commit capital to facilitate customer automated and non-automated markets
are ignored by other market participants. Although orders. Displayed limit orders, however, with respect to trade-through protection.
some of these orders may subsequently be executed The proposal included an exception that
or cancelled, the retail investors that submitted give anyone the ability to trade when
orders with the best prices have not received the would have allowed automated markets
appropriate reward for their use of an aggressive 158 ICI Reproposal Letter at 2. to trade through manual markets, but
limit price—a prompt, efficient execution 159 Letter from Stewart P. Greene, Chief Counsel, only up to certain amounts that varied
consistent with the principle of price priority. Securities Law, to Jonathan G. Katz, Secretary, depending upon the price of the
Moreover, the orders that ultimately never receive Commission, dated Jan. 26, 2005 (‘‘TIAA–CREF
an execution are also likely to be the very orders Reproposal Letter’’), Attachment at 15–16. This
security. Under the proposal, a market
that would have been most profitable for the commenter also asserted that the reproposal failed would have been classified as ‘‘manual’’
investor (e.g., when the order was to buy a stock to appreciate the importance of ‘‘quantity if it did not provide for an immediate
and the stock’s price climbed after the trade- discovery,’’ in addition to price discovery. Id. at 9. automated response to all incoming
through occurred). To meet the Exchange Act’s As evidenced by the repeated concern expressed in
objectives for the NMS, investors of all types should both the proposal and reproposal for improving
orders attempting to access its displayed
have confidence that their orders will be handled market depth and liquidity, the Commission quotations.161
in a fair and orderly fashion. considers the term ‘‘price discovery’’ to encompass At the NMS Hearing, a significant
156 Battalio/Jennings Paper at 35. both the inside prices for a stock and the quantity portion of the discussion of the trade-
157 See, e.g., American Century Letter at 2; Capital of stock that can be traded at and away from the
inside prices. It believes, however, that displayed
through proposal addressed issues
Research Letter at 2; ICI Reproposal Letter at 2;
NYSE Reproposal Letter at 3; T. Rowe Price limit orders are a vital source of price discovery in relating to quotations of automated and
Reproposal Letter at 2; Vanguard Reproposal Letter all of its forms.
at 2. 160 Id. at 16. 161 Proposing Release, 69 FR at 11140.
manual markets. Representatives of two these commenters, the Commission a. Standards for Automated Quotations
floor-based exchanges announced their modified the proposed Rule in the Nearly all commenters addressing the
intent to establish ‘‘hybrid’’ trading Reproposing Release to protect only issue believed that only quotations that
facilities that would offer automatic those quotations that are immediately are truly firm and fully accessible
execution of orders seeking to interact and automatically accessible. As noted should qualify as ‘‘automated.’’ 167 To
with their displayed quotations, while above in Section II.A.1, a substantial achieve this goal, they suggested that, at
at the same time maintaining a number of commenters supported the a minimum, the market displaying an
traditional floor.162 These reproposed Order Protection Rule, with automated quotation should be required
representatives acknowledged the some commenters specifically to provide a functionality for an
difficulties posed in developing an supporting limiting trade-through incoming order to receive an immediate
efficient hybrid market, but emphasized protection to automated and and automated (i.e., without human
that they were committed to developing immediately accessible quotations.166 intervention) execution up to the full
such facilities and that such facilities displayed size of the quotation. In
were likely to become operational prior The Commission agrees with
addition, they believed the market
to any implementation of Regulation commenters that providing protection to
should be required to provide an
NMS. manual quotations, even limited to
immediate and automated response to
Other panelists at the NMS Hearing trade-throughs beyond a certain amount, the sender of the order indicating
strongly believed that manual potentially would lead to undue delays whether the order had been executed (in
quotations should not receive any in the routing of investor orders, thereby full or in part) and an immediate and
protection against trade-throughs and not justifying the benefits of price automated updating of the quotation. A
that the proposed trade-through protection. The Commission therefore is number of commenters advocated
amounts should be eliminated.163 They adopting, as reproposed, an approach requiring a specific time standard for
noted, however, that existing order that excludes manual quotations from distinguishing between manual and
routing technologies are capable of trade-through protection. Under the automated quotations, ranging from one
identifying, on a quote-by-quote basis, Order Protection Rule as adopted, second down to 250 milliseconds.168
indications from a market that a investors will have the choice of Other commenters did not believe the
particular quotation is not immediately whether to access a manual quotation definition of automated quotation
and automatically accessible (i.e., is a and wait for a response or to access an should require a specific time standard,
manual quotation). Using this automated quotation with an inferior generally because setting a specific
functionality, a trade-through rule could price and obtain an immediate response. standard might discourage innovation
classify individual quotations as Moreover, those who route limit orders and become a ‘‘ceiling’’ on market
automated or manual, rather than will be able to control whether their performance.169
classifying an entire market as manual orders are protected by evaluating the
solely because it displayed manual extent to which various trading centers 167 See, e.g., Letter from John J. Wheeler, Vice
quotations on occasion. President, Director of U.S. Equity Trading,

display automated versus manual American Century Investment Management Inc., to
To give the public a full opportunity quotations. Jonathan G. Katz, Secretary, Commission, dated
to comment on these issues, the June 30, 2004 (‘‘American Century Letter’’) at 3;
Commenters expressed differing
Supplemental Release described the Letter from C. Thomas Richardson, Citigroup Global
views, however, on the appropriate Markets, Inc., to Jonathan G. Katz, Secretary,
developments at the NMS Hearing and
standards for automated quotations and Commission, dated July 20, 2004 (‘‘Citigroup
requested comment on whether a trade- Letter’’) at 6–7; Letter from Gary Cohn, Managing
on the standards that should govern
through rule should protect only Director, Goldman, Sachs & Co., to Jonathan G.
automated quotations and whether the ‘‘hybrid’’ markets—those that display Katz, Secretary, Commission, dated July 19, 2004
rule should adopt a ‘‘quote-by-quote’’ both automated and manual quotations. (‘‘Goldman Sachs Letter’’) at 4–5; ICI Letter at 13;
These issues are discussed below. Morgan Stanley Letter at 7; SIA Letter at 6.
approach to identifying protected 168 See, e.g., Ameritrade Letter I at 6; Bloomberg
quotations.164 The Supplemental Tradebook Letter at 13; Letter from Kenneth R.
Release also requested comment on the Jonathan G. Katz, Secretary, Commission, dated Leibler, Chairman, Boston Stock Exchange, Inc., to
June 30, 2004 (‘‘E*Trade Letter’’) at 6; ICI Letter at Jonathan G. Katz, Secretary, Commission, dated
requirements for an automated 12; Nasdaq Letter II at 9, 14; Letter from Marc June 30, 2004 (‘‘BSE Letter’’) at 7; Consumer
quotation, including whether the rule Lackritz, President, Securities Industry Association, Federation Letter at 3; Letter from David A. Herron,
should impose a maximum response to Jonathan G. Katz, Secretary, Commission, dated Chief Executive Officer, Chicago Stock Exchange, to
time, such as one second, on the total June 30, 2004 (‘‘SIA Letter’’) at 15. Jonathan G. Katz, Secretary, Commission, dated
166 See, e.g., Letter from George W. Mann, Jr.,
time for a market to respond to an order June 30, 2004 (‘‘CHX Letter’’) at 7–8; Letter from C.
General Counsel, Boston Stock Exchange, Inc., to Thomas Richardson, Citigroup Global Markets, Inc.,
in an automated manner. Comment also Jonathan G. Katz, Secretary, Commission, dated to Jonathan G. Katz, Secretary, Commission, dated
was requested on mechanisms for January 26, 2005 (‘‘BSE Reproposal Letter’’) at 5; July 20, 2004 (‘‘Citigroup Letter’’) at 7; Letter from
enforcing compliance with the Letter from David Baker, Global Head of Cash Gary Cohn, Managing Director, Goldman, Sachs &
Trading and Global Head of Portfolio Trading, Co., to Jonathan G. Katz, Secretary, Commission,
automated quotation requirements. Deutsche Bank Securities Inc., to Jonathan G. Katz, dated July 20, 2004 (‘‘Goldman Sachs Letter’’) at 4;
Nearly all commenters on the original Secretary, Commission, dated February 3, 2005 ICI Letter at 3, 10; Nasdaq Letter II at 3, 13; Letter
proposal believed that only automated (‘‘Deutsche Bank Reproposal Letter’’) at 2; ICI from John Martello, Managing Director, Tower
quotations should receive protection Reproposal Letter at 3, n. 6; Letter from James T. Research Capital LLC, to Jonathan G. Katz,
Brett, Managing Director, J.P. Morgan Securities Secretary, Commission, dated June 30, 2004
against trade-throughs and that therefore Inc., to Jonathan G. Katz, Secretary, Commission, (‘‘Tower Research Letter’’) at 5.
the proposed limitation on trade- dated January 28, 2005 (‘‘JP Morgan Reproposal 169 See, e.g., American Century Letter at 3; Letter
through amounts for manual markets Letter’’) at 3–4; Letter from Bernard L. Madoff and from Salvatore F. Sodano, Chairman & Chief
should be eliminated.165 In response to Peter B. Madoff, Bernard L. Madoff Investment Executive Officer, American Stock Exchange LLC,
Securities L.L.C., to Jonathan G. Katz, Secretary, to Jonathan G. Katz, Secretary, Commission, dated
162 Hearing
Commission, dated February 3, 2005 (‘‘Madoff June 30, 2004 (‘‘Amex Letter’’), Exhibit A at 6;
Tr. at 90–92, 94–97, 120. Reproposal Letter’’) at 1; Letter from David Letter from Matt D. Lyons, Capital Research and
163 Hearing Tr. at 57–58, 67, 142–143, 157–158. Humphreville, President, The Specialist Management Company, to Jonathan G. Katz,
164 Supplemental Release, 69 FR at 30142–30144.
Association of the New York Stock Exchange, to Secretary, Commission, dated June 28, 2004
165 See, e.g., Ameritrade Letter I at 8; Letter from Jonathan G. Katz, Secretary, Commission, dated (‘‘Capital Research Letter’’) at 2; Fidelity Letter I at
Lou Klobuchar Jr., President and Chief Brokerage January 26, 2005 (‘‘Specialist Assoc. Reproposal 8; Letter from John H. Bluher, Executive Vice
Officer, E*TRADE Financial Corporation, to Letter’’) at 2–3. President & General Counsel, Knight Trading
The Commission included in the may be exercised after the time an order remedy, discussed further in sections
Reproposing Release a definition of is received. Trading centers are required II.A.3 and II.B.3 below, will give trading
automated quotation that incorporated to offer this IOC functionality only to centers needed flexibility to deal with
the three elements suggested by market participants that request another trading center that is
commenters: 170 (1) Acting on an immediate action and response by experiencing systems problems, rather
incoming order; (2) responding to the submitting an IOC order. Market than forcing smoothly-functioning
sender of the order; and (3) updating the participants therefore have the choice of trading centers to slow down for a
quotation. The proposed definition of whether to require an immediate problem trading center.
automated quotation did not set forth a response from the trading center, or to
specific time standard for responding to allow the market to take further action b. Standards for Automated Trading
an incoming order. As noted above, a on the order (such as by routing the Centers
significant number of commenters on order elsewhere, seeking additional The original trade-through proposal
the Reproposing Release supported the liquidity for the order, or displaying the would have classified a market as
reproposed Order Protection Rule,171 order). Finally, trading centers are manual if it did not provide automated
with a few commenters specifically required to immediately and access to all orders seeking access to its
supporting the definition of automated automatically update their automated displayed quotations. Many commenters
quotation.172 As discussed in detail quotations to reflect any change to their responded positively to the concept of
below, the Commission has adopted the material terms (such as a change in allowing hybrid markets to display both
definition of automated quotation as price, displayed size, or ‘‘automated’’ automated and manual quotations that
proposed. status). was raised at the NMS Hearing and
In particular, Rule 600(b)(3) requires The definition of automated quotation discussed in the Supplemental Release.
that the trading center displaying an as adopted does not set forth a specific Most national securities exchanges
automated quotation must provide an time standard for responding to an believed that focusing on whether
‘‘immediate-or-cancel’’ (‘‘IOC’’) incoming order. The Commission agrees individual quotations are automated or
functionality for an incoming order to with commenters that the standard manual would permit hybrid markets to
execute immediately and automatically should be ‘‘immediate’’ ‘‘i.e., a trading function, thereby expanding the range of
against the quotation up to its full size, center’s systems should provide the trading choices for investors.175 For
and for any unexecuted portion of such fastest response possible without any example, Amex stated that hybrid
incoming order to be cancelled programmed delay. Nevertheless, the markets would offer investors the choice
immediately and automatically without Commission also is concerned that to utilize auction markets when
being routed elsewhere. The trading trading centers with well-functioning advantageous for them to do so, while
center also must immediately and systems should not be unnecessarily at the same time offering automatic
automatically respond to the sender of slowed down waiting for responses from execution to those investors desiring
an IOC order. To qualify as ‘‘automatic,’’ a trading center that is experiencing a speed and certainty of a fast
no human discretion in determining any systems problem. Consequently, rather response.176 A majority of other
action taken with respect to an order than specifying a specific time standard commenters also believed that the
that may become obsolete as systems application of any trade-through rule
Group, to William H. Donaldson, Chairman, improve over time, Rule 611(b)(1) should depend on whether a particular
Commission, dated July 2, 2004 (‘‘Knight Letter II’’) addresses the problem of slow trading
at 5; Letter from James T. Brett, J.P. Morgan quotation is automated.177 They
Securities Inc., to Jonathan G. Katz, Secretary, centers by providing an exception for believed that such a rule would achieve
Commission, dated July 8, 2004 (‘‘JP Morgan quotations displayed by trading centers the benefits of encouraging limit orders
Letter’’) at 3; Morgan Stanley Letter at 7; Letter from that are experiencing, among other and improving market depth and
Darla C. Stuckey, Corporate Secretary, New York things, a material delay in responding to
Stock Exchange, Inc., to Jonathan G. Katz, Secretary, liquidity, while avoiding indirectly
Commission, dated July 2, 2004 (‘‘NYSE Letter’’), incoming orders. Given current industry mandating a particular market structure.
Attachment at 3; Letter from David Humphreville, conditions, the Commission believes Although generally supportive of the
President, The Specialist Association, to Jonathan that repeatedly failing to respond within concept of hybrid markets, several
G. Katz, Secretary, Commission, dated June 30, one second after receipt of an order
2004 (‘‘Specialist Assoc. Letter’’) at 8; Letter from commenters on the original proposal
Lisa M. Utasi, President, et al., The Security Traders would constitute a material delay.173 expressed concern about how the
Association of New York, Inc., to Jonathan G. Katz, Accordingly, a trading center would act ‘‘quote-by-quote’’ approach to protected
Secretary, Commission, dated June 30, 2004 reasonably in the current technological quotations would operate in practice.178
(‘‘STANY Letter’’) at 4; Letter from George U. environment if it bypassed the
Sauter, Managing Director, The Vanguard Group,
Inc., to Jonathan G. Katz, Secretary, Commission, quotations of another trading center that objective parameters for its use of the exception in
dated July 14, 2004 (‘‘Vanguard Letter’’) at 4. had repeatedly failed to respond to its required policies and procedures.
170 See, e.g., Letter from Kevin J. P. O’Hara, Chief orders within a one-second time frame 175 See, e.g., Amex Letter at 5; Letter from William
Administrative Officer and General Counsel, (after adjusting for any potential delays J. Brodsky, Chairman & Chief Executive Officer,
Archipelago Holdings, Inc., to Jonathan G. Katz, Chicago Board Options Exchange, Inc., to Jonathan
Secretary, Commission, dated September 24, 2004
in transmission not attributable to the G. Katz, Secretary, Commission, dated July 1, 2004
(‘‘Archipelago Letter’’) at 7; Brut Letter at 7; Letter other trading center).174 This ‘‘self-help’’ (‘‘CBOE Letter’’) at 3; CHX Letter at 7; NYSE Letter
from Lisa M. Utasi, President, et al., The Security at 4.
Traders Association of New York, Inc., to Jonathan 173 Cf. Ameritrade Letter I at 6 (one second 176 Amex Letter, Appendix A at 4–5.
G. Katz, Secretary, Commission, dated June 30, response time is appropriate); Letter from David A. 177 See, e.g., Letter from Joseph M. Velli, Senior
2004 (‘‘STANY Letter’’) at 4; Letter from George U. Herron, Chief Executive Officer, The Chicago Stock Executive Vice President, The Bank of New York,
Sauter, Managing Director, The Vanguard Group, to Exchange, to Jonathan G. Katz, Secretary, to Jonathan G. Katz, Secretary, Commission, dated
Jonathan G. Katz, Secretary, Commission, dated July Commission, dated June 30, 2004 (‘‘CHX Letter’’) at June 30, 2004 (‘‘BNY Letter’’) at 2; Letter from Lou
14, 2004 (‘‘Vanguard Letter’’) at 4. 8 (receive, execute, and report back within one Klobuchar Jr., President and Chief Brokerage
171 See supra section II.A.1. second); Citigroup Letter at 7 (turnaround time of Officer, E*Trade Financial Corporation, to Jonathan
172 Letter from Adam Cooper, Senior Managing no more than one second); Goldman Sachs Letter G. Katz, Secretary, Commission, dated June 30,
Director and General Counsel, Citadel Investment at 4 (orders executed or cancelled within not more 2004 (‘‘E*Trade Letter’’) at 6; ICI Letter at 13;
Group, L.L.C., to Jonathan G. Katz, Secretary, than one second). Morgan Stanley Letter at 6.
Commission, dated July 9, 2004 (‘‘Citadel 174 As discussed further in section II.B.3 below, 178 See, e.g., Citigroup Letter at 6; ICI Letter at 13;
Reproposal Letter’’) at 3; ICI Reproposal Letter at 3, a trading center utilizing the material delay Morgan Stanley Letter at 7; Nasdaq Letter II at 13–
n. 6; SIA Reproposal Letter at 4–5. exception will be required to establish specific 14; Vanguard Letter at 5.
The ICI noted that ‘‘[w]e are concerned automated to manual will be subject to quotations cannot be switched on and
that if it is left completely up to an public notice and comment and off except in specifically defined
individual market’s discretion when a Commission approval pursuant to the circumstances is particularly intended
quote is ‘automated’ or manual, that rule filing process of Section 19(b) of the to assure that hybrid markets do not
market could base its decision on what Exchange Act. If a non-SRO trading give their members, or anyone else,
is in the best interests of that market and center intends to display both overbroad discretion to control the
its members, as opposed to the best automated and non-automated automated or manual status of the
interests of investors and other market quotations, it will be subject to the trading center’s quotations, which
participants.’’ 179 These commenters oversight of the SRO through whose potentially could disadvantage market
suggested that the Commission should facilities its quotations are displayed participants that must protect these
provide clear guidelines as to when and with respect to the reasonableness of its quotations. Changes from automated to
how a market could switch its procedures, as well as Commission manual quotations, and vice versa, must
quotations from automated to manual, oversight. be subject to specific, enforceable
and vice versa, so as to prevent abuse The Commission therefore is adopting limitations as to the timing of switches.
by the market. the definition of automated trading For a trading center to qualify as
After considering the views of center as reproposed. The adopted entitled to display any protected
commenters, the Commission included approach offers flexibility for a hybrid quotations, the public in general must
in the reproposed Rule certain market to display both automated and have fair and efficient access to a
requirements for a trading center to manual quotations, but only when such trading center’s quotations.
qualify as an ‘‘automated trading a market meets basic standards that Some commenters on the Reproposing
center,’’ one of which requires that a promote fair and efficient access by the Release expressed a concern about the
trading center adopt reasonable public to the market’s automated scope of the exception for single-priced
standards limiting when its quotations quotations. This approach is designed to reopenings in Rule 611(b)(3),
change from automated quotations to allow markets to offer a variety of particularly in the context of a trading
manual quotations (and vice versa) to trading choices to investors, but without center switching back and forth from
specifically defined circumstances that requiring other markets and market automated quotation to manual
promote fair and efficient access to its participants to route orders to a hybrid quotation mode.185 They asserted that
automated quotations and that are market with quotations that are not truly the applicability of the exception to the
consistent with the maintenance of fair accessible. recommencement of trading after a non-
and orderly markets. The reproposed To qualify as an automated trading regulatory trading halt in one market
Rule also provided that only a trading center, the trading center must have (such as a trading halt due to an intra-
center that met all of the requirements implemented such systems, procedures, day order imbalance) could lead to
could display protected quotations. and rules as are necessary to render it disruptive trading activity and provide
Although a substantial number of capable of displaying quotations that an unfair competitive advantage for the
commenters supported the reproposed meet the action, response, and updating trading center that halted trading. They
Rule,180 a few commenters continued to requirements set forth in the definition believed this could create a significant
express concern with the ability of a of an automated quotation.182 Further, loophole in the protections provided by
trading center to switch from automated the trading center must identify all the Rule. For instance, one commenter
to manual quotations.181 quotations other than automated expressed concern that a trading center
The Commission recognizes the quotations as manual quotations, and could halt trading and reopen solely to
concerns of commenters regarding the must immediately identify its enable it to trade-through other trading
ability of a trading center to change from quotations as manual quotations centers.186 Another commenter
automated to manual quotation mode, whenever it has reason to believe that it expressed concern regarding the
but believes that the requirements is not capable of displaying automated interplay of the proposed exception and
necessary to qualify as an automated quotations.183 These requirements will the operation of the NYSE’s proposed
trading center will sufficiently mitigate enable other trading centers readily to hybrid trading system, stating that it is
this concern. Any standards established determine whether a particular unclear what would be considered a
by an SRO trading center to govern quotation displayed by a hybrid trading reopening under NYSE’s proposal,
when its quotations change from center is protected by the Order particularly with respect to when a
Protection Rule. Finally, an automated liquidity refreshment point is reached or
179 ICI Letter at 13. trading center must adopt reasonable when the quotation is gapped.187 Two
180 See supra section II.A.1. standards limiting when its quotations commenters suggested that the
181 See Ameritrade Reproposal Letter at 7
change from automated quotations to exception apply only to reopenings after
(questioning whether certain aspects of NYSE’s manual quotations, and vice versa, to
hybrid proposal are ‘‘consistent with the
regulatory trading halts.188
requirement that an automated trading center has specifically defined circumstances that The Commission recognizes the
‘adopted reasonable standards limiting when its promote fair and efficient access to its commenters’ concern, but emphasizes
quotations change from automated quotations to automated quotations and are consistent that the exception will not permit a
manual quotations, and vice versa’ ’’); Letter from with the maintenance of fair and orderly trading center to declare a trading halt
Alistair Brown, Managing Director, Lime Brokerage
LLC, to Jonathan G. Katz, Secretary, Commission, markets.184
dated January 26, 2005 (‘‘Lime Brokerage These requirements are designed to 185 See Letter from C. Thomas Richardson,
Reproposal Letter’’) at 1 (expressing concerns promote efficient interaction between a Citigroup Global Markets, Inc., to Jonathan G. Katz,
regarding the operation of NYSE’s hybrid proposal Secretary, Commission, dated January 26, 2005
hybrid market and other trading centers. (‘‘Citigroup Reproposal Letter’’) at 8; Nasdaq
in conjunction with the Order Protection Rule);
Letter from J. Greg Mills, Managing Director, Head
The requirement that automated Reproposal Letter at 6–7; SIA Reproposal Letter at
of Global Equity Trading, RBC Capital Markets 20–21.
182 Rule 600(b)(4)(i). The Commission is 186 Citigroup Reproposal Letter at 8.
Corporation, to Jonathan G. Katz, Secretary,
Commission, dated January 26, 2005 (‘‘RBC Capital modifying this requirement from the reproposal to 187 Nasdaq Reproposal Letter at 6. See also infra,
Markets Reproposal Letter’’) at 8–9 (requesting that include the term ‘‘procedures,’’ to clarify that non- note 190.
the Commission establish and define standards as SRO trading centers have procedures, not rules. 188 Nasdaq Reproposal Letter at 7; SIA Reproposal
183 Rule 600(b)(4)(ii) and (iii).
to when a hybrid market can switch from Letter at 21 (agreeing that the exception should
automated to manual quotations). 184 Rule 600(b)(4)(iv). apply to regulatory halts).
merely to be able to circumvent the Nasdaq observed that quotations in because of a flood of orders or
operation of the Order Protection Rule many Nasdaq stocks are updated more otherwise, must immediately identify its
upon reopening. The exception applies than two times per second. It said that quotations as manual.
only to single-priced reopenings and these frequent changes could lead to The Commission will monitor and
therefore requires that a trading center many false indications of trade-throughs enforce the adopted requirements for
conduct, pursuant to its rules or written and that eliminating these ‘‘false automated trading centers and
procedures, a formalized and positives’’ would greatly reduce the automated quotations. Nevertheless, it
transparent process for executing orders percentage of transactions subject to a concurs with commenters’ concerns that
during reopening after a trading halt trade-through rule.195 Finally, many well-functioning trading centers should
that involves the queuing and ultimate commenters noted that market not be dependent on the willingness
execution of multiple orders at a single participants need the ability to sweep and capacity of other markets to meet,
equilibrium price.189 In addition, the multiple price levels simultaneously at and the Commission’s ability to enforce,
trading center must have formally different trading centers. They these automation requirements. The
declared a trading halt pursuant to its emphasized that a trade-through rule adopted Order Protection Rule therefore
rules or written procedures. Thus, the should accommodate this trading provides a ‘‘self-help’’ remedy that will
exception would not include a situation strategy by freeing each trading center to allow trading centers to bypass the
where a trading center merely spread its execute orders immediately without quotations of a trading center that fails
quotations or switched back to waiting for other trading centers to to meet the immediate response
automated quotation mode from manual update their better priced quotations.196 requirement. Rule 611(b)(1) sets forth an
quotation mode.190 The Commission agreed with these
exception that applies to quotations
commenters that intermarket protection
3. Workable Implementation of displayed by trading centers that are
against trade-throughs must be workable
Intermarket Trade-Through Protection experiencing a failure, material delay, or
and implemented in a way that
Several commenters expressed malfunction of its systems or
promotes fair and orderly markets, and
concern that the original proposed therefore amended the original proposal equipment. To implement this
trade-through rule could not be in the reproposal to better achieve this exception consistent with the
implemented in a workable manner, objective in a variety of ways. As requirements of Rule 611(a), trading
particularly for high-volume stocks.191 discussed below, commenters were centers will have to adopt policies and
Morgan Stanley, for example, asserted generally supportive of the measures procedures reasonably designed to
that an inefficient trading center might included in the reproposal as providing comply with the self-help remedy. Such
have inferior systems that would delay necessary flexibility, although several policies and procedures will need to set
routed orders and potentially diminish commenters made specific forth specific objective parameters for
their quality of execution.192 Instinet recommendations as to how to improve dealing with problem trading centers
emphasized that protecting a market’s the operation of the exceptions. In and for monitoring compliance with the
quotations ‘‘confers enormous power on response to these comments, the self-help remedy, consistent with Rule
a market * * * Such power can and Commission has made additional 611. Given current industry capabilities,
will be abused either directly (e.g., by modifications to the Order Protection the Commission believes that trading
quoting slower than executing orders) or Rule that, in conjunction with the centers should be entitled to bypass
indirectly (e.g., not investing in more reproposed measures, will further another trading center’s quotations if it
than minimum system capacity or promote its workability. repeatedly fails to respond within one
redundancy).’’ 193 Hudson River Trading First and most importantly, as second to incoming orders attempting to
noted that markets sometimes included in the reproposal and as access its protected quotations.
experience temporary systems problems adopted today, only automated trading Accordingly, trading centers will have
and questioned how a trade-through centers, as defined in Rule 600(b)(4), the necessary flexibility to respond to
rule would address these scenarios.194 that are capable of providing immediate problems at another trading center as
responses to incoming orders are they occur during the trading day.
189 See section III.D.3 of the Proposing Release for
eligible to have their quotations Most commenters that addressed the
a discussion of the practical need for an exception protected. Moreover, an automated
for single-priced openings and reopenings. 69 FR at
self-help exception supported the
11142. trading center is required to identify its exception as providing necessary
190 Under NYSE’s hybrid proposal, the turning off quotations as manual (and therefore not flexibility to trading centers to avoid
of automatic execution, for example, for a gap- protected) whenever it has reason to inaccessible quotations.198 Some
quoting situation, the triggering of a liquidity believe that it is not capable of commenters, however, objected to a
refreshment point, or the reporting of a block
transaction, would not in and of itself halt trading
providing immediate responses to statement in the Reproposing Release
and thus trigger a reopening pursuant to paragraph orders.197 Thus, a trading center that that a trading center must attempt to
(b)(3) of Rule 611. experiences a systems problem, whether contact the non-responsive trading
191 See, e.g., Hudson River Trading Letter at 3;
center to resolve a problem prior to
Instinet Letter at 18–19; Morgan Stanley Letter at routed orders to another market to access the full
11–12; Letter from Edward S. Knight, The Nasdaq disregarding its quotations.199 They
displayed size of its protected quotations under the
Stock Market, Inc., to Jonathan G. Katz, Secretary, Order Protection Rule, the routing trading center believed that such a requirement would
Commission, dated September 29, 2004 (‘‘Nasdaq will be allowed to continue trading without regard not be practicable or workable,
Letter III’’) at 3. to that market’s quotations until it has received a especially during real-time trading.200
192 Morgan Stanley Letter at 12. response from such market. With respect to concern
193 Instinet Letter at 17. that traders will not be able to control the routing
198 See, e.g., BSE Reproposal Letter at 5; Citigroup
194 Hudson River Trading Letter at 3. This of their own orders if markets are required to route
commenter also raised a number of specific out to other markets, a trader’s use of the IOC Reproposal Letter at 7; ICI Reproposal Letter at 6,
questions concerning the operation of an functionality specified in Rule 600(b)(3) will n. 10; Nasdaq Reproposal Letter at 7; SIA
intermarket trade-through rule. To address these preclude the first market from routing to other Reproposal Letter at 19.
detailed order sequencing and response scenarios, markets. 199 Citigroup Reproposal Letter at 7; Nasdaq
195 Nasdaq Letter III at 3–4. Reproposal Letter at 7–8; SIA Reproposal Letter at
trading centers will be able to adopt policies and
procedures that reasonably resolve the practical 196 See, e.g., Brut Letter at 10; Citigroup Letter at 19.
difficulties of handling fast-arriving orders in a fair 10; E*Trade Letter at 8; Goldman Sachs Letter at 7. 200 Citigroup Reproposal Letter at 7; Nasdaq
and orderly fashion. For example, if a trading center 197 Rule 600(b)(4)(iii). Reproposal Letter at 7–8.
One commenter recommended that, quotations. The trading center must flickering quotations, the Commission
instead of requiring notice as a continue to identify its quotations as included in the reproposal a proposed
‘‘condition precedent,’’ the Commission manual until it no longer has reason to exception from Rule 611 that would
require the trading center electing the believe that there will be a problem with allow trading centers a one-second
self-help exception to contact the slow its quotations. A trading center that ‘‘window’’ prior to a transaction for
or non-responding trading center continues to identify its quotations as trading centers to evaluate the
immediately after it elects self-help.201 automated when it has reason to believe quotations at another trading center.
The Commission agrees with the otherwise would make a material Specifically, the Commission proposed
concerns of the commenters that a prior misstatement to other trading centers, that pursuant to Rule 611(b)(8) trading
notice requirement may not be investors, and the public. centers would be entitled to trade at any
practicable or workable in real-time, and One commenter believed that, in the price equal to or better than the least
that a trading center should be allowed absence of an opt-out, the material delay aggressive best bid or best offer, as
simply to notify the non-responding exception was too narrowly drawn, and applicable, displayed by the other
trading center immediately after (or at that market participants should be trading center during that one-second
the same time as) electing self-help allowed to avoid trading with trading window. For example, if the best bid
pursuant to objective standards centers for any objective, reasonable price displayed by another trading
consistent with Rule 611 that are basis as they do today in the context of center has flickered between $10.00 and
contained in its policies and fiduciary and best execution obligations, $10.01 during the one-second window,
procedures. An electing trading center and not just for slow response times.205 the trading center that received the
must also assess, however, whether the The Commission does not believe that order could execute a trade at $10.00
cause of a problem lies with its own the scope of the exception should be
without violating Rule 611.
systems and, if so, take immediate steps expanded to give a trading center the
to resolve the problem appropriately. ability to avoid another trading center Most of the commenters that
Another commenter suggested that for reasons not related to reliable and addressed this exception supported
third-party vendors that provide efficient accessibility because to do so it.208 The SIA noted that the exception
connectivity among trading centers would be inconsistent with the would provide ‘‘much-needed practical
should be allowed to determine when a objectives of the Rule. The exception in relief.’’ 209 Several commenters,
trading center has failed to meet the paragraph (b)(1) of Rule 611, however, however, raised issues regarding the
immediate response requirement.202 covers any failure or malfunction of a time frame for the exception, with some
The Commission agrees that a third- trading center’s systems or equipment, supporting a longer window 210 and
party vendor could perform such a as well as any material delay. The some questioning whether it was
function, but, as with use of the Commission believes that there may be necessary to establish a specific time
intermarket sweep order exception, the certain limited instances where frame in the rule, rather than through
responsibility for compliance with the repeated, critical system problems, even interpretive guidance.211 One
exception remains with the relevant those that do not necessarily cause a commenter opposed the exception
trading center that uses the services of delayed response time during trading because it believed that it would create
the third-party vendor. Thus, a trading (such as systems problems that an arbitrage opportunity that could be
center is responsible for compliance repeatedly result in the breaking of taken advantage of by computerized
with the requirements of the exception, trades), would justify use of the market participants.212 Another
including the obligation to establish, exception by other trading centers until commenter expressed concern that the
maintain, and enforce written policies the problem trading center has provided exception would enable trading centers
and procedures and to surveil for their reasonable assurance to all other trading to execute trades internally and route
effectiveness, regardless of whether it centers that the problems have been
routes orders using its own systems or corrected.206 Katz, Secretary, Commission (no date) (‘‘Lava
a third-party vendor’s systems. In many active NMS stocks, the price Trading Letter’’) at 5; Letter from Marc Lackritz,
Some commenters believed that the of a trading center’s best displayed President, Securities Industry Association, to
quotations can change multiple times in Jonathan G. Katz, Secretary, Commission, dated
trading center experiencing a problem June 30, 2004 (‘‘SIA Letter’’) at 10; Letter from Mary
should have primary responsibility for a single second (‘‘flickering McDermott-Holland, Chairman & John C. Giesea,
notifying other trading centers and quotations’’). These rapid changes can President, Security Traders Association, to Jonathan
market participants when such create the impression that a quotation G. Katz, Secretary, Commission, dated June 30,
was traded-through, when in fact the 2004 (‘‘STA Letter’’) at 5.
problems occur and when they are 208 BSE Reproposal Letter at 5; ICI Reproposal
resolved.203 The definition of automated trade was effected nearly Letter at 6, n. 10; JP Morgan Reproposal Letter at
market center in both the reproposed simultaneously with display of the 4; Letter from Michael J. Lynch, Managing Director,
and adopted rule directly imposes this quotation.207 To address the problem of Merrill Lynch, Pierce, Fenner & Smith Incorporated,
to Jonathan G. Katz, Secretary, Commission, dated
responsibility on the trading center February 4, 2005 (‘‘Merrill Lynch Reproposal
205 Letter from Thomas N. McManus, Managing
experiencing difficulties.204 It requires Letter’’) at 7; SIA Reproposal Letter at 3, 18.
Director and Counsel, Morgan Stanley & Co.
such a trading center immediately to Incorporated, to Jonathan G. Katz, Secretary, 209 SIA Reproposal Letter at 18.
identify its quotations as manual Commission, dated February 7, 2005 (‘‘Morgan 210 Letter from Bruce C. Turner, Managing
whenever it has reason to believe that it Stanley Reproposal Letter’’) at 11–12. Director, CIBC World Markets Corp., to Jonathan G.
206 During the implementation period for the Katz, Secretary, Commission, dated February 4,
is not capable of displaying automated 2005 (‘‘CIBC Reproposal Letter’’) at 3 (supporting a
Order Protection Rule, the Commission staff will be
available to provide guidance to trading centers as 3 second window); SIA Reproposal Letter at 18
201 Nasdaq Reproposal Letter at 7. they develop objective standards to implement this (questioning whether the proposed one second
202 Letterfrom Richard A. Kornhammer, window is too narrow).
exception consistent with Rule 611.
Chairman and Chief Executive Officer, Lava 207 A number of commenters on the original 211 Merrill Lynch Reproposal Letter at 7; SIA
Trading Inc., to Jonathan G. Katz, Secretary, proposal were concerned about flickering Reproposal Letter at 18–19.
Commission, dated January 26, 2005 (‘‘Lava quotations and recommended an exemption to 212 Letter from Meyer S. Frucher, Chairman and
Reproposal Letter’’) at 3. address the problem. CHX Letter at 7, n.19; E*Trade Chief Executive Officer, Philadelphia Stock
203 SIA Reproposal Letter at 19–20; STANY
Letter at 9; JP Morgan Letter at 3; Letter from Exchange, Inc., to Jonathan G. Katz, Secretary,
Reproposal Letter at 12. Richard A. Korhammer, Chairman & Chief Commission, dated January 31, 2005 (‘‘Phlx
204 Rule 600(b)(4)(iii). Executive Officer, Lava Trading Inc., to Jonathan G. Reproposal Letter’’) at 3.
orders using the worst quotation during greater than one second window would all better-priced protected quotations up
the one second window.213 permit the execution of many trade- to their displayed size.220 Consequently,
After reviewing the response from throughs that could have been there is no reason why the trading
commenters, the Commission is reasonably prevented. The Commission center that receives an intermarket
adopting the exception as proposed. also notes that opportunities for sweep order while displaying an
Allowing a one-second ‘‘window’’ prior arbitrage between trading centers inferior-priced quotation should be
to a transaction for trading centers to displaying different prices for the same required to delay an execution of the
evaluate the quotations at another NMS stock would exist irrespective of order.
trading center will ease implementation whether the Commission adopted an Paragraph (b)(6) authorizes a trading
of and compliance with the Order order protection rule, and does not center itself to route intermarket sweep
Protection Rule by giving trading believe that the adoption of the orders and thereby enable immediate
centers added flexibility to deal with the flickering quotation exception to the execution of a transaction at a price
practical difficulties of protecting Rule increases these arbitrage inferior to a protected quotation at
quotations displayed by other trading opportunities. another trading center. For example,
centers, without significantly reducing The Commission also included in the paragraph (b)(6) can be used by a dealer
the benefits of the Rule.214 It appears reproposal paragraphs (b)(5) and (b)(6) that wishes immediately to execute a
that many of the potential of Rule 611 that provided exceptions for block transaction at a price three cents
implementation difficulties with respect intermarket sweep orders that respond away from the NBBO, as long as the
to high-volume stocks are related to the to the need of market participants to dealer simultaneously routed orders to
problem of dealing with sub-second access multiple price levels access all better-priced protected
time increments. The Commission simultaneously at different trading quotations. By facilitating intermarket
generally does not believe that the centers. Commenters that addressed this sweep orders of all kinds, Rule 611 as
benefits would justify the costs imposed exception overwhelmingly supported adopted will allow a much wider range
on trading centers of attempting to it.217 Citadel, for instance, stated that of beneficial trading strategies than as
implement an intermarket price priority the intermarket sweep exception is originally proposed. In addition, the
rule at the level of sub-second time crucial, addresses most of its concerns intermarket sweep exception will help
increments. Accordingly, Rule 611 has about the Commission’s initial trade- prevent an ‘‘indefinite loop’’ scenario in
been formulated to relieve trading through proposal, and would have many which waves of orders otherwise might
centers of this burden.215 The benefits.218 The ICI believed that the be required to chase the same quotations
Commission does not believe, however, exception would allow institutional from trading center to trading center,
that it is necessary to allow more than investors to continue to execute large- one price level at a time.221
a one second window, given the sized orders in an efficient manner.219 Several commenters suggested that
realities of today’s trading environment As discussed below, the Commission is the Commission provide an exception
and the frequency with which many adopting this exception as reproposed. from the Rule for very actively-traded
quotations update.216 The Commission An intermarket sweep order is and highly liquid NMS stocks.222 They
also is concerned that allowing for a defined in Rule 600(b)(30) as a limit argued that the trading of these stocks
order that meets the following already is highly efficient and does not
213 Nasdaq Reproposal Letter at 8. As emphasized requirements: (1) The limit order is raise the concerns that the Commission
in section II.B.4 below, Rule 611 is designed to identified as an intermarket sweep order is trying to address through the
facilitate intermarket trade-through protection only.
It does not lessen the best execution responsibilities
when routed to a trading center; and (2) proposed Order Protection Rule, and
of broker-dealers. In making a best execution simultaneously with the routing of the that imposing the Rule on the trading of
determination, for example, a broker-dealer can not limit order, one or more additional limit these stocks would not improve
rely on the Rule’s exception for flickering orders are routed to execute against all efficiency or protect limit orders in any
quotations to justify ignoring a recently displayed, better-priced protected quotations meaningful way. They also believed that
better-priced quotation when experience shows that
the quotation is likely to be accessible. displayed by other trading centers up to providing such an exception would
214 Even with the one-second exception for their displayed size. These additional make the Rule more workable,
flickering quotations, Rule 611 will address a large orders also must be marked as particularly for NMS stocks with rapid
number of trade-throughs that currently occur in intermarket sweep orders to inform the quotation updates, thus easing
the equity markets. The substantial trade-through
rates discussed in section II.A.1 above were
receiving trading center that they can be compliance and surveillance costs of the
calculated using a 3-second window. Rule 611 will immediately executed without regard to Rule. Some of these commenters
address all of these trade-throughs, assuming no protected quotations in other markets.
other exception is applicable. Paragraph (b)(5) allows a trading center 220 Reserve size, in contrast, is not displayed.
215 Several commenters raised questions Trading centers and broker-dealers therefore will
to execute immediately any order
concerning ‘‘clock drift’’ and time lags between not be required to route orders to access reserve
different data sources. See, e.g., Hudson River
identified as an intermarket sweep size.
Trading Letter at 2; Letter from Edward S. Knight, order, without regard for better-priced 221 The indefinite loop scenario also is addressed
The Nasdaq Stock Market, Inc., to Jonathan G. Katz, protected quotations displayed at one or by: (1) The self-help remedy in Rule 611(b)(1) for
Secretary, Commission, dated September 29, 2004 more other trading centers. The trading centers to deal with slow response times;
(‘‘Nasdaq Letter III’’) at 4. These implementation and (2) the requirement that trading centers
issues are most appropriately addressed in the
exception is fully consistent with the immediately stop displaying automated (and
context of a trading center’s reasonable policies and principle of protecting the best therefore protected) quotations when they can no
procedures. Clearly, one essential procedure will be displayed prices because it is premised longer meet the immediate response requirement
implementation of clock synchronization practices on the condition that the trading center for automated quotations.
that meet or exceed industry standards. In addition, 222 CIBC Reproposal Letter at 1; Citigroup
a trading center’s compliance with the Order
or broker-dealer responsible for routing
Reproposal Letter at 2–3 (advocating granting the
Protection Rule will be assessed based on the times the order will have attempted to access exception on a pilot basis); Letter from Richard M.
that orders and quotations are received, and trades Whiting, Executive Director and General Counsel,
are executed, at that trading center. 217 See, e.g., BSE Reproposal Letter at 5; Citadel
Financial Services Roundtable, to Jonathan G. Katz,
216 Specifically, given the advanced trading and Reproposal Letter at 1, 2; ICI Reproposal Letter at Secretary, Commission, dated February 4, 2005
routing technology available today, a one-second 5; JP Morgan Reproposal Letter at 4; Merrill Lynch (‘‘FSR Reproposal Letter’’) at 4; Merrill Lynch
window should significantly ease the compliance Reproposal Letter at 3; SIA Reproposal Letter at 3. Reproposal Letter at 7; SIA Reproposal Letter at 2,
218 Citadel Reproposal Letter at 1, 2.
burden of trading centers for stocks with many 12–14 (advocating granting the exception on a pilot
quotation updates. 219 ICI Reproposal Letter at 5. basis).
suggested defining liquidity and active with the Rule’s exceptions. American Century, for example,
trading by reference to the frequency of Implementation of intermarket trade- asserted that the Commission should
quotation updates.223 through protection is likely to present focus on the limit order investors who
The Commission recognizes that the greatest challenge for agency have ‘‘opted-in’’ to the NMS, rather than
commenters have raised a serious markets trading active stocks that on those that wish to opt-out.229
concern regarding implementation of handle a large volume of buy and sell Vanguard noted that an opt-out
the Order Protection Rule, particularly orders and must assure that such orders exception might serve a short-term
for many Nasdaq stocks that are very interact in an orderly and efficient desire to obtain an immediate
actively traded and whose trading is manner in compliance with all execution, but ‘‘without recognizing the
spread across many different individual applicable priority rules. The second order effect of potentially
trading centers. An exemption for active requirements to have procedures significantly reducing liquidity in the
stocks, however, would be particularly reasonably designed to prevent trade- long term.’’ 230 Similarly, the ICI stated
inconsistent with the investor throughs will mitigate this challenge. In that ‘‘while our members may be best
protection objectives of the Order this regard, the Commission is served on a particular trade by ’opting-
Protection Rule because these also are encouraged that several trading centers out’ from executing against the best
the stocks that have the highest level of executing the largest number of agency price placed in another market, we
investor participation. For example, the orders currently exhibit the lowest rates believe that in the long term, all
need for a trade-through rule to of trade-throughs.225 investors will benefit by having a
backstop a broker’s duty of best market structure where all limit orders
execution by assuring that retail 4. Elimination of Proposed Opt-Out
Exception are protected and investors are provided
investors receive the best available price with an incentive to place those orders
on an order-by-order basis is perhaps The rule text of the original proposal in the markets.’’ 231 All of the foregoing
most acute with respect to the most included a broad exception for persons views were conditioned on an
active NMS stocks. to opt-out of the best displayed prices if assumption that only accessible,
One of the Commission’s goals they provided informed consent. The automated quotations would be
throughout its review of market Proposing Release indicated that the protected by a trade-through rule.
structure issues has been to formulate exception was particularly intended to Many other commenters, in contrast,
rules for the national market system that allow investors to bypass manual supported the proposed opt-out
adequately reflect current technologies markets, to execute block transactions exception.232 Aside from concerns that
and trading practices and that promote without moving the market price, and to a trade-through rule would be
equal regulation of stocks and markets. help discipline markets that provided unworkable without an opt-out
This goal does not reflect a mere desire slow executions or inadequate access to exception, which were discussed in the
for uniformity, but is identified in the their quotations.226 The Commission preceding section, the primary concerns
Exchange Act as a vital component of a also noted, however, that an opt-out of these commenters were that, without
truly national market system.224 Active exception would be inconsistent with an opt-out exception, a trade-through
stocks obviously are a vital part of the the principle of price protection and, if rule would: (1) Dampen competition
national market system. It should not be used frequently, could undermine among markets, particularly with
that the orders of ordinary investors are investor confidence that their orders respect to factors other than price; and
protected by a Commission rule for will receive the best available price. It (2) restrict the freedom of choice for
some NMS stocks, but that caveat therefore requested comment on an market participants to route marketable
emptor still prevails for others. automated execution alternative to the orders to trading centers that are most
A number of provisions in the Order opt-out exception, under which all
appropriate for their particular trading
Protection Rule are specifically markets would be required to provide
objectives and to achieve best execution.
designed to address the legitimate an automated response to electronic
The Commission formulated the
concern that the Rule must be workable orders. At the subsequent NMS Hearing,
reproposed Order Protection Rule to
for active stocks. These include the some panelists questioned whether,
respond to these concerns, while still
flickering quotation exception, the assuming only truly accessible and
intermarket sweep order exception, and preserving the benefits of intermarket
automated quotations were protected,
the self-help exception. The price protection.
there was a valid reason for opting-out In response to the Reproposing
Commission is committed to working of such a quotation.227 To address this
Release, many commenters supported
closely with trading centers and the issue, the Commission requested
the reproposed Order Protection
securities industry in general to make comment in the Supplemental Release
Rule,233 with some specifically
these exceptions as practical and useful on whether the proposed opt-out
addressing, and supporting, the
as possible, consistent with the price exception would be necessary if manual
elimination of the opt-out exception.234
protection objectives of the Rule and the quotations were excluded from trade-
technology currently available. In through protection. 229 American Century Letter at 4.
addition, the operative provision of the Many commenters on the original 230 Vanguard Letter at 5.
Order Protection Rule requires each proposal opposed a general opt-out 231 ICI Letter at 14 (emphasis in original).
trading center to establish, maintain, exception.228 They believed that it 232 Approximately 371 commenters supported an
and enforce policies and procedures would be inconsistent with the opt-out exception. Approximately 211 of these
that are reasonably designed to prevent principle of price protection and commenters opposed a trade-through rule and
endorsed an opt-out to remediate what they viewed
trade-throughs on that trading center of undermine the very benefits the trade- as its adverse effects. Of these 211 commenters, 179
protected quotations and to comply through rule is designed to provide. commenters utilized Form Letter C. The remaining
commenters supporting an opt-out exception
223 CIBC Reproposal Letter at 1; Citigroup 225 See
Trade-Through Study, Tables 2, 9. included a variety of securities industry
Reproposal Letter at 3; SIA Reproposal Letter at 12. 226 Proposing
Release, 69 FR at 11138. participants and 22 members of Congress.
The Commission notes that the existence of rapid 227 Hearing Tr. at 32, 58, 65, 74, 80, 84–85, 154. 233 See supra, section II.A.1.
quotation updates does not necessarily mean that a 228 See supra note 56 (overview of commenters 234 Letter from Barbara Roper, Director of Investor
security is actively traded or highly liquid. supporting a strong trade-through rule without an Protection, Consumer Federation of America, to
224 Exchange Act Section 11A(c)(1)(F). opt-out exception). Jonathan G. Katz, Secretary, Commission, dated
For example, the ICI noted its strong participants that encounter a minimally center, thereby increasing its
support of the decision to eliminate the competitive or outright non-compliant attractiveness for marketable orders, and
opt-out exception, agreeing that the trading center.239 Instinet believed that, beginning the cycle all over again.
elimination of protection for manual without an opt-out exception, a trade- Importantly, Rule 611 will not require
quotations makes such an exception through rule ‘‘would virtually eliminate that limit orders be routed to any
unnecessary.235 Other commenters intermarket competition by forcing particular market. Consequently,
continued to express the concern that a operational and technological competitive forces will be fully
trade-through rule without an opt-out uniformity on each marketplace, operative to discipline markets that offer
exception would impede intermarket negating price competition, system poor services to limit orders, such as
competition and innovation and restrict performance, or any other limiting the extent to which limit orders
the ability of investors and market differentiating feature that a market may can be cancelled in changing market
intermediaries to choose how best to develop.’’ 240 In its comments on the conditions or providing slow speed of
execute their or their customers’ orders Reproposing Release, Instinet continued cancellation.
to achieve best execution.236 For the to oppose an Order Protection Rule Conversely, trading centers that offer
reasons discussed more fully below, without an opt-out exception, stating poor services, such as a slower speed of
after carefully considering the views of that it does not believe that the response, likely will rank near the
all commenters, the Commission has exclusion of manual quotations from bottom in order-routing preference of
determined to adopt the Order protection and the proposed ‘‘tailored most market participants and
Protection Rule as reproposed, without exceptions’’ are adequate substitutes for intermediaries. Whenever the least-
an opt-out exception. an opt-out exception.241 preferred trading center is merely
The Commission recognizes the vital posting the same price as other trading
a. Preserving Competition Among importance of preserving vigorous centers, orders will be routed to other
Markets competition among markets, but trading centers. As a result, limit orders
Many commenters believed that an continues to believe that commenters displayed on the least preferred trading
opt-out exception was necessary to have overstated the risk that such center will be least likely to be executed
promote competition among trading competition will be eliminated by in general. Moreover, such limit orders
centers, particularly competition based adoption of an order protection rule will be the least likely to be executed
on factors other than price, such as without a general opt-out exception. when prices move in favor of the limit
speed of response. For example, 179 The Commission believes that markets orders, and the most likely to be
commenters on the original proposal likely will have strong incentives to executed only when prices are moving
submitted letters stating that, in the continue to compete and innovate to against the limit order, adding the cost
absence of an opt-out exception, ‘‘Reg. attract both marketable orders and limit of ‘‘adverse selection’’ to the cost of a
NMS will freeze market development orders. Market participants and low likelihood of execution. In sum, the
and, over the long term, could hurt intermediaries responsible for routing lowest ranked trading center in order-
investors.’’ 237 Morgan Stanley asserted marketable orders, consistent with their routing preference, with or without
that allowing market participants to opt- desire to achieve the best price and their intermarket price protection, will suffer
out ‘‘would reward markets that provide duty of best execution, will continue to the consequences of offering a poor
faster and surer executions, and rank trading centers according to the range of services to the routers of
conversely, would penalize those total range of services provided by those marketable orders.243 The Commission
markets that are materially slower or are markets. Such services include cost, therefore does not believe that the
displaying smaller quote sizes by speed of response, sweep functionality, absence of an opt-out exception would
ignoring those quotes.’’ 238 Although and a wide variety of complex order freeze market development or eliminate
agreeing that changes made to the types.242 The most competitive trading competition among markets.
center will be the first choice for routing Commenters have, however,
reproposal in the absence of an opt-out
marketable orders, thereby enhancing identified a troubling potential for
exception generally would strengthen
the likelihood of execution for limit intermarket price protection to lessen
any Order Protection Rule, Morgan
orders routed to that trading center. the competitive discipline that market
Stanley continued to be concerned that,
Because likelihood of execution is of participants now can impose on
without an opt-out exception, the Order
such great importance to limit orders, inefficient trading centers in Nasdaq
Protection Rule may not provide a
routers of limit orders will be attracted stocks. The Order Protection Rule
sufficient amount of flexibility to market
to this preferred trading center. More generally requires that trading centers
January 24, 2005 (‘‘CFA Reproposal Letter’’) at 1; ICI
limit orders will enhance the depth and match the best quoted prices, cancel
Reproposal Letter at 5, n. 8; Letter from Kenneth S. liquidity offered by the preferred trading orders without an execution, or route
Janke, Chairman, National Association of Investors orders to the trading centers quoting the
Corporation, to Jonathan G. Katz, Secretary, 239 Morgan Stanley Reproposal Letter at 6. best prices. This is good for investors
Commission, dated January 14, 2005 (‘‘NAIC 240 InstinetLetter at 19. generally, but may not be if the quoting
Reproposal Letter’’) at 2. 241 Instinet Reproposal Letter at 5. Other
235 ICI Reproposal Letter at 5, n. 8. market is inefficient. For example, a
commenters on the Reproposing Release also
236 See, e.g., Letter from Daniel M. Clifton,
continued to express a concern about the impact the
trading center may have poor systems
Executive Director, American Shareholder reproposed Rule would have on competition and that do not process orders quickly and
Association, to Jonathan G. Katz, Secretary, innovation. See, e.g., JP Morgan Reproposal Letter
Commission, dated January 26, 2005 (‘‘ASA at 7–8; RBC Capital Reproposal Letter at 3–4; Letter 243 As discussed below in section III.A.2, a
Reproposal Letter’’) at 2; Fidelity Reproposal Letter from Jeffrey T. Brown, Senior Vice President, competitive problem could arise if a least preferred
at 3–6; Instinet Reproposal Letter at 5; Morgan Charles Schwab & Co., Inc., to Jonathan G. Katz, market was allowed to charge exorbitant fees to
Stanley Reproposal Letter at 2, 5–6; Nasdaq Secretary, Commission, dated February 1, 2005 access its protected quotations, and then pass most
Reproposal Letter at 3–4; RBC Capital Markets (‘‘Schwab Reproposal Letter’’) at 2. of the fee on as rebates to liquidity providers to
Reproposal Letter at 3–5. Comments discussing 242 One commenter expressed the view that offset adverse selection costs. To address the
concerns that a trade-through rule would be market participants would continue to compete on problem of such an ‘‘outlier’’ market, Rule 610(c)
unworkable without an opt-out exception are a total range of services even with an Order sets forth a uniform fee limitation for accessing
discussed in the preceding section. Protection Rule without an opt-out and with depth- protected quotations, as well as manual quotations
237 Letter Type C.
of-book protection. Vanguard Reproposal Letter at that are the best bid or best offer of an exchange,
238 Morgan Stanley Letter at 11–12. 4. The NASDAQ Market Center, or the ADF.
reliably. Or a low-volume trading center damages investors and the public at the best price point impact the overall
may not be nearly as accessible as a interest. costs associated with trading securities
high-volume trading center. Second, those responsible for the in today’s markets. The Trade Through
Currently, consistent with their best regulatory function at SROs have an rule may harm investors by restricting
execution and other agency affirmative responsibility to examine for their ability to achieve best execution,
responsibilities, participants in the and enforce all Exchange Act and investors deserve the opportunity to
market for Nasdaq stocks can choose not requirements and the SRO rules that make choices.’’ 245 Similarly, Fidelity
to deal with any trading center that they apply to the trading centers that fall asserted that ‘‘as a fiduciary to the
believe provides unsatisfactory services. within their regulatory authority. One of mutual funds under our management,
Under the Order Protection Rule, market the key policy justifications for a self- we should be free to reach our own
participants can limit their involvement regulatory system is that industry informed judgment regarding the market
with any trading center to routing IOC regulators have close proximity to, and center where our funds’ trades are to be
orders to access only the best bid or best significant expertise concerning, their executed, particularly when delay may
offer of the trading center. Nevertheless, particular trading centers. In addition, open the way for exchange floor
even this limited involvement industry regulators typically have members and others to exploit an
potentially could lessen the competitive greater flexibility to address problems informational advantage that arises not
discipline that otherwise would be than governmental authorities. from their greater investment or trading
imposed on an inefficient trading Implementation of the Order Protection acumen but merely from their privileged
center. The Commission therefore Rule will heighten the importance of presence on the physical trading
believes that this potentially serious effective self-regulation. Those floor.’’ 246 Fidelity continues to support
effect must be addressed at multiple responsible for the market operation an opt-out exception, stating in response
levels in addition to the specific functions of an SRO may have business to the Reproposing Release that there is
exceptions included in the Rule that incentives that militate against dealing a substantial risk that an institutional
were discussed above. with potential problems in an effective investor, seeking to trade a large block
First, trading centers themselves have and forthright manner. Regulatory of stock, will be put to a ‘‘distinct and
a legal obligation to meet their personnel are expected to be unfair’’ disadvantage if it cannot
responsibilities under the Exchange Act independent of such business concerns negotiate an all-in price for a block trade
to provide venues for trading that is and have an affirmative responsibility to with a dealer.247
orderly and efficient.244 Through prevent improper factors from The Commission agrees that the
registration and other requirements, the interfering with an SRO’s full interests of investors in choosing the
Exchange Act regulatory regime is compliance with regulatory trading center to which to route
designed to preclude entities that are requirements. marketable orders are vitally important,
not capable of meeting high standards of Finally, the Commission itself plays a but believes that advocates of the opt-
conduct from doing business with the critical role in the Exchange Act out exception have failed to consider
public. This critically important regulatory regime. Effective the interests of all investors—both those
function would be undermined by a implementation of the Order Protection who submit marketable orders and those
trading center that displayed quotations Rule also will depend on the who submit limit orders. A fair and
in the consolidated data stream, but Commission taking any action that is efficient NMS must serve the interests of
could not, because of poor systems or necessary and appropriate to address both types of investors. Moreover, their
otherwise, provide efficient access to trading centers that fail to meet fully interests are inextricably linked
market participants and efficient their regulatory requirements. The together. Displayed limit orders are the
handling of their orders. In addition, a Commission and its staff must continue primary source of public price
trading center would violate its to monitor the markets closely for signs discovery. They typically set quoted
Exchange Act responsibilities if it failed of problems and listen to the concerns spreads, supply liquidity, and in general
to comply fully with the requirements of market participants as they arise, establish the public ‘‘market’’ for a
set forth in Rule 600(b)(3) and (4) for especially with regard to the new stock. The quality of execution for
requirements imposed by the Order marketable orders, which, in turn, trade
automated quotations and automated
Protection Rule. Quick and effective with displayed liquidity, depends to a
trading centers. In particular, an
action will be needed to assure that all great extent on the quality of markets
automated trading center must
responsible parties do not feel that established by limit orders (i.e., the
implement such systems, procedures,
inattention to problems is an acceptable narrowness of quoted spreads and the
and rules as are necessary to render it
course of action. available liquidity at various price
capable of meeting the requirements for
automated quotations and must b. Promoting the Interests of Both levels).
immediately identify its quotations as Marketable Orders and Limit Orders Limit orders, however, make the first
manual whenever it has reason to move—when submitted, they must be
Many commenters that supported an displayed rather than executed, and
believe that it is not capable of opt-out exception believed that an
displaying automated quotations. These therefore offer a ‘‘free option’’ for other
ability to opt-out of the best displayed
requirements place an affirmative and prices was necessary to promote full 245 Letter Type C.
vitally important legal duty on trading freedom of choice in the routing of 246 Fidelity Letter I at 6–7.
centers to identify their quotations as marketable orders, and particularly to 247 Fidelity Reproposal Letter at 3. Other
manual at the first sign of a problem, not allow factors other than quoted prices to commenters continued to express a concern that the
after a problem has fully manifested be considered. For example, 179 reproposed Order Protection Rule would limit the
itself and thereby caused a rippling ability of investors and market intermediaries to
commenters on the original proposal choose how to best execute orders, and, by focusing
effect at other trading centers that submitted a letter stating that exclusively on price, would interfere with the
‘‘[i]nvestors are driven by price, but ability of institutional investors to achieve best
244 See, e.g., Exchange Act Sections 6(b)(1) and execution. See, e.g., JP Morgan Reproposal Letter at
6(b)(5); Exchange Act Section 15; Exchange Act
prices that are inaccessible either 4–5; Morgan Stanley Reproposal Letter at 5; RBC
Sections 15A(b)(2) and 15A(b)(6); Exchange Act because of lagging execution time Capital Reproposal Letter at 4–5; UBS Reproposal
Section 11A(a)(1)(C); Regulation ATS. within a market or insufficient liquidity Letter at 2.
market participants to trade a stock by particular, the Rule incorporates an In the Reproposing Release, the
submitting marketable orders and taking approach that seeks to serve the Commission stated that it preliminarily
the liquidity supplied by limit orders. interests of both marketable orders and did not believe that ‘‘stopped’’ orders
Consequently, the fate of limit orders— limit orders by appropriately balancing should be excepted from Rule 611,251
whether or when they receive an these interests in the contexts where and requested comment on the extent to
execution—is dependent on the choices they may diverge. In this way, the Order which the proposed rule language
made by those who route marketable Protection Rule is designed to promote appropriately designated those
orders. Much of the time, the interests the fairness and efficiency of the NMS transactions that should be excepted
of marketable orders in obtaining the for all investors. because they are consistent with the
best available price are aligned with First and most importantly, Rule 611 price protection objectives of Rule
those of limit orders that are displaying protects only immediately accessible 611.252 Several commenters on the
the best available price. But, as shown quotations that are available through Reproposing Release recommended that
by the significant trade-through rates automatic execution. It does not require the Commission except the execution of
discussed in section II.A.1 above (even investors submitting marketable orders stopped orders from the operation of
for automated quotations in Nasdaq to access ‘‘maybe’’ quotations that, after Rule 611.253 They believed that, because
stocks), the interests of marketable arrival of the order, are subject to dealers executing stopped orders
orders and limit orders are not always human intervention and thereby create provide a source of liquidity that does
aligned. the potential for other market not otherwise exist in the market at the
One important example of where the participants to determine whether to time the order is stopped, the use of
interests of limit orders and marketable honor the quotation. Moreover, as stopped orders represents a common
orders often diverge is large, block discussed in section II.A.2 above, Rule and valuable form of capital
trades. Several commenters noted that 611 includes a variety of provisions commitment by dealers that inures to
they often are willing to bypass the best designed to assure that marketable the benefit of investors. They were
quoted prices if they can obtain an orders must be routed only to well- concerned that, in the absence of an
immediate execution of large orders at functioning trading centers displaying exception for stopped orders, dealers
a fixed price that is several cents away executable quotations. may be unwilling to commit capital in
from the best prices.248 Yet these block Second, Rule 611 has been formulated this manner, or, at a minimum, may
trades often will be priced based on the to promote the interests of investors charge investors a greater risk premium
displayed quotations in a stock. They seeking immediate execution of specific for the capital commitment.
thereby demonstrate the ‘‘free-riding’’ order types that reduce their total The Commission agrees that stopped
economic externality that, as discussed trading costs, particularly for larger orders can provide a valuable tool for
in section II.A.1 above, is one of the orders. Although the Rule does not the execution of institutional orders, but
factors at the heart of the need for provide a general exception for block is concerned that a broad exception for
intermarket price protection. To achieve orders, it addresses the legitimate all stopped orders would undermine the
the full benefits of intermarket price interest of investors in obtaining an price protection objectives of Rule 611.
protection, all investors should be immediate execution in large size (and Several commenters recognized this
governed by a uniform rule that thereby minimizing price impact). The concern and suggested criteria for a
encompasses their individual trades. intermarket sweep order exception will stopped order exception that would
For any particular trade, an investor allow broker-dealers to continue to limit the possibility of abuse.254 For
may believe that the best course of facilitate the execution of block instance, UBS suggested limiting the
action is to bypass displayed quotations orders.249 The entire size of a large order applicability of the exception to
in favor of executing larger size can be executed immediately at any instances where the stop price is ‘‘in the
immediately. The Commission believes, price, so long as the broker-dealer routes
however, that the long-term strength of orders seeking to execute against the full Letter at 7–9. The Commission agrees that
the NMS as a whole is best promoted by displayed size of better-priced protected compliance with Rule 611 should not interfere with
the ability of a dealer to provide its customers the
fostering greater depth and liquidity, quotations. The size of the order benefit of better executions and should not cause
and it follows from this that the therefore need not be parceled out over confusion with respect to the accurate reporting of
Commission should examine the extent time in smaller orders that might tip the transactions. As the commenter noted, the practical
market about pending orders. By both issues for reporting block trades could be resolved
to which it can encourage the limit in a variety of ways. The Commission will work
orders that provide this depth and allowing immediate execution of the with the industry during the implementation period
liquidity to the market at the best prices. large order and protecting better-priced to achieve the most appropriate resolution.
Allowing individual market participants quotations, Rule 611 is designed to 251 For purposes of this discussion and Rule 611,
appropriately balance the interests for a stopped order is an order for which a trading
to pick and choose when to respect center has guaranteed, at the time of order receipt,
displayed quotations could undercut the investors on both sides of the market.250 an execution at a price no worse than a specified
fundamental reason for displaying the price (referred to in this discussion as the ‘‘stop’’
liquidity in the first place. 249 Cf. ICI Reproposal Letter at 5 (stating its belief price).
that the intermarket sweep exception would allow 252 Reproposing Release, 69 FR at 77440 n. 149.
Consequently, the Commission is institutional investors to continue to execute large- 253 See, e.g., Letter from Bruce Lisman, Bear,
adopting the Order Protection Rule as sized orders in an efficient manner). Stearns & Co., to Jonathan G. Katz, Secretary,
reproposed without an opt-out 250 One commenter requested that the Commission, dated January 27, 2005 (‘‘Bear Stearns
exception because such an exception Commission consider the practical aspects of Reproposal Letter’’) at 2–3; Citigroup Reproposal
could severely detract from the benefits executing and reporting large block transactions in Letter at 7–8; Morgan Stanley Reproposal Letter at
compliance with the Rule. For instance, if a dealer 9–10; SIA Reproposal Letter at 16–18; UBS
of intermarket order protection. Instead, agreed to execute a large institutional investor order Reproposal Letter at 6. But see Goldman Sachs
Rule 611 addresses the concerns of at three cents outside the market and sent Letter at 7–8, n. 14; Letter from Mary Yeager,
those who otherwise may have felt they intermarket sweep orders to execute against Assistant Secretary, New York Stock Exchange, Inc.,
needed to opt-out of protected protected quotations at the same time that it to Jonathan G. Katz, Secretary, Commission, dated
executed and reported the trade, practical issues January 12, 2005 (‘‘NYSE Reproposal Letter I’’),
quotations in a more targeted manner. In could arise as to how the dealer could pass through Detailed Comments at 3 n. 13.
to the investor any better-priced executions of the 254 Bear Stearns Reproposal Letter at 3; Morgan
248 See, e.g., Fidelity Letter I at 9; Morgan Stanley sweep orders without canceling and correcting the Stanley Reproposal Letter at 10; SIA Reproposal
Letter at 12. reported block trade. Morgan Stanley Reproposal Letter at 17–18; UBS Reproposal Letter at 6.
money’’ when elected (i.e., below the a related derivative (for instance, a intermarket price protection without an
current best bid for buy stops and above stock-option transaction), risk arbitrage opt-out exception may interfere to some
the current best offer for sell stops). In strategies, and convertible or merger extent with the extremely short-term
these circumstances, the dealer is arbitrage.258 These commenters noted trading strategies of some market
required to commit capital at a that the economics of these transactions participants. Some of these strategies
disadvantageous price that would be are based on the relationship between can be affected by a delay in order-
exacerbated if the dealer also had to the prices of a security and the related routing or execution of as little as 3⁄10ths
satisfy protected quotations at the time derivative (or between two related of one second. Given the current NMS
it executed the stopped order.255 The securities), and the execution of one structure with multiple competing
SIA also suggested that a stopped order trade is contingent upon the execution markets, any protection of displayed
guarantee subject to the exception only of the other trade. Thus, the parties to quotations in one market could affect
be available to a non-broker-dealer or a these transactions are less concerned the implementation of short-term
broker-dealer for the benefit of a non- with the price of the individual trading strategies in another market.
broker-dealer customer and that the transactions than with the spread This conflict between protecting the
customer must agree to the stopped between the individual transaction best displayed prices and facilitating
price on an order-by-order basis.256 prices. They believed that the short-term trading strategies raises a
In response to these comments, the economics of these transactions would fundamental policy question—when
Commission has adopted a separate be distorted, and additional risk would such a conflict exists, should the overall
exception for the execution of stopped be introduced, if the dealer or an efficiency of the NMS defer to the needs
orders in Rule 611(b)(9). The exception investor was forced to comply with the of short-term traders, many of whom
is narrowly drawn to prevent abuse, Order Protection Rule with respect to rarely intend to hold a position
while also facilitating the continued use the execution of one or both sides of the overnight? Or should the NMS serve the
of stopped orders by institutional transaction.259 needs of longer-term investors, both
customers. As suggested by the The Commission has given a great large and small, that will benefit
commenters, the exception will apply to deal of consideration to the comments substantially from intermarket price
the execution of so-called ‘‘underwater’’ favoring a general exception from Rule protection?
stops. Specifically, the exception 611 for broad categories of transactions, The Commission believes that two of
applies to the execution by a trading variously described as ‘‘contingency’’ the most important public policy
center of a stopped order when the price transactions, ‘‘arbitrage’’ transactions, functions of the secondary equity
of the execution of the order was, for a ‘‘spread’’ transactions, and transactions markets are to minimize trading costs
stopped buy order, lower than the priced with reference to derivatives. for long-term investors and to reduce
national best bid in the stock at the time Any exception for such a broad category the cost of capital for listed companies.
of execution or, for a stopped sell order, of transactions, however, potentially These functions are inherently
higher than the national best offer in the could unduly detract from the price connected, because the cost of capital of
stock at the time of execution. To protection objectives of the Rule. For listed companies is influenced by the
qualify for the exception, the stopped example, one of the well-known benefits transaction costs of those who are
order must be for the account of a of arbitrage transactions in general is willing to accept the investment risk of
customer and the customer must have that they promote more efficient pricing holding corporate stock for an extended
agreed to the stop price on an order-by- of securities in the public markets. period. To the extent that the interests
order basis.257 Excluding all such transactions from of short-term traders and market
In addition, as proposed in the interacting with public quotations intermediaries in a broad opt-out
Reproposing Release, paragraph (b)(7) of potentially could lessen the price exception conflict with those of
Rule 611 sets forth an exception that discovery benefits of arbitrage. investors, the Commission believes that
would allow the execution of volume- Accordingly, the Commission has the interests of long-term investors are
weighted average price (‘‘VWAP’’) determined that the most appropriate entitled to take precedence.260 In this
orders, as well as other types of orders process to handle suggestions that way, the NMS will fulfill its Exchange
that are not priced with reference to the specific types of transactions should be Act objectives to promote fair and
quoted price of a stock at the time of excluded from the coverage of Rule 611 efficient equity markets for investors
execution and for which the material is through its exemptive procedure set and to serve the public interest.
forth in paragraph (d) of the Rule. The
terms were not reasonably available at 5. Scope of Protected Quotations
extended implementation period for
the time the commitment to execute the The original trade-through proposal
Regulation NMS will provide a full
order was made. This exception will would have protected all quotations
opportunity for the public to request
serve the interests of marketable orders disseminated by a Plan processor in the
specific exemptions that they believe
and is consistent with the principle of consolidated quote stream. Currently,
are necessary or appropriate in the
protecting the best displayed quotations. the scope of these quotations depends
public interest and consistent with the
Several commenters suggested that on the regulatory status of an SRO.
protection of investors. Of course, the
Rule 611 should include exceptions for Under Exchange Act Rule 11Ac1–1
Commission also will consider
additional types of transactions, such as (‘‘Quote Rule’’) (redesignated as Rule
exemptive requests once Regulation
those involving an equity security and 602), exchange SROs are required to
NMS has been implemented.
255 UBS Reproposal Letter at 6. See also SIA
Even given all the exceptions set forth provide only their best bids and offers
Reproposal Letter at 17 (recommending that the in Rule 611, however, the Commission (‘‘BBOs’’) in a stock. In contrast, a
exception only be available if the customer that recognizes that the existence of national securities association, which
received the stop guarantee is on the advantaged currently encompasses Nasdaq’s trading
side and the dealer that gave the guarantee is on the 258 Bear Stearns Reproposal Letter at 3–4;
facilities and the NASD’s ADF, must
disadvantaged side). Citigroup Reproposal Letter at 7; Morgan Stanley
256 SIA Reproposing Letter at 17.
provide BBOs of its individual
Reproposal Letter at 10; SIA Reproposal Letter at
257 Rule 611(b)(9)(i), (ii), and (iii). ‘‘Customer’’ is 16. members. Consequently, the original
defined in Rule 600(b)(16) as any person that is not 259 See, e.g., Morgan Stanley Reproposal Letter at
a broker or dealer. 10. 260 See supra, section I.B.2.
proposal would have protected only a through the facilities of an effective Exchange Act objectives for the NMS in
single BBO of an exchange and not any national market system plan.267 At the a practical and workable manner. In
additional quotations in its depth of subsequent NMS Hearing, a panelist particular, comment was requested on
book (‘‘DOB’’). For Nasdaq facilities and specifically endorsed the policy and whether extending trade-through
the ADF, however, the proposal would feasibility of extending trade-through protection to DOB quotations would
have protected member BBOs at protection to DOB quotations, as long as significantly increase the benefits of the
multiple price levels. The Proposing such quotations were automated and Order Protection Rule, and on the effect
Release requested comment on whether accessible: ‘‘Automatically executable that adoption of the Voluntary Depth
only a single BBO for Nasdaq and the quotes, whether they are on the top of Alternative would have on competition
ADF should be protected.261 the book or up and down the book, among markets. The Commission also
Commenters expressed concern that should be protected by the trade- requested comment on whether the
the proposed rule text would protect the through rule, and manual quotes should Voluntary Depth Alternative could be
BBOs of individual market makers and not be. This is a simple and technically implemented in a practical and cost-
ATSs in Nasdaq’s facilities and the easy idea to implement* * *.’’268 effective manner.272
ADF, but only a single BBO of exchange Most of the subset of comment letters A large majority of commenters that
SROs.262 The Specialist Association, for on the original proposal that specifically supported the reproposed Order
example, believed that it would be addressed the DOB issue supported the Protection Rule supported the Market
unfair to offer greater protection to the approach of extending trade-through BBO Alternative.273 Many commenters
quotations of members of an association protection to all limit orders displayed
SRO than to those of an exchange in the NMS, not merely the BBOs of the 272 See Section II.A.5 in the Reproposing Release
SRO.263 Morgan Stanley stated that to various markets.269 The Consumer for a detailed discussion of the request for comment
‘‘equalize the protections available to all Federation of America, for example, on the Market BBO Alternative and the Voluntary
market participants, we believe the stated that ‘‘such an approach would Depth Alternative.
273 Approximately 1,556 commenters expressed
Commission should treat SuperMontage result in better price transparency and
support for the Market BBO Alternative, of which
as a single market for purposes of the help to address complaints that decimal approximately 1,411 were form letters. See, e.g.,
trade-through rule, instead of treating pricing has reduced price transparency Letter from Brendan R. Dowd and Zdrojeski, Co-
each individual Nasdaq market maker as because of the relatively thin volume of Presidents, Alliance of Floor Brokers, to Jonathan G.
a separate quoting market trading interest displayed in the best bid Katz, Secretary, Commission, dated January 20,
2005 (‘‘Alliance of Floor Brokers Reproposal
participant.’’ 264 and offer.’’ 270 The ICI noted that Letter’’) at 1; Letter from Neal L. Wolkoff, Acting
The Commission agrees with these protecting all displayed limit orders Chief Executive Officer, American Stock Exchange,
commenters that Rule 611 should not might not be feasible at this time, but LLC, to Jonathan G. Katz, Secretary, Commission,
mandate a regulatory disparity between urged the Commission to examine the dated January 27, 2005 (‘‘Amex Reproposal Letter’’)
the quotations displayed through at 2; Bear Stearns Reproposal Letter at 1 (if properly
issue further.271 modified); Letter from Minder Cheng, Managing
exchange SROs and those displayed The Commission recognized, Director, CIO, US Active Equities, Global Head of
through Nasdaq facilities and the ADF. however, that other commenters may Equity and Currency Trading, Barclays Global
Potentially, Nasdaq and the ADF could have chosen not to address the Investors, N.A., to Jonathan G. Katz, Secretary,
attract a significant number of limit alternative of protecting voluntary DOB Commission, dated January 26, 2005 (‘‘BGI
Reproposal Letter’’) at 2; Letter from Joseph M.
orders if they were able to offer order quotations because it was not included Velli, Senior Executive Vice President, The Bank of
protection that was not available at in the proposed rule text. In the New York, to Jonathan G. Katz, Secretary,
exchange SROs. This result would not Reproposing Release, therefore, the Commission, dated January 26, 2005 (‘‘BNY
be consistent with the Exchange Act Commission proposed rule text for two Reproposal Letter’’) at 2; BSE Reproposal Letter at
2; Letter from David A. Herron, Chief Executive
goals of fair competition among markets alternatives: (1) The Market BBO Officer, The Chicago Stock Exchange, to Jonathan
and the equal regulation of markets.265 Alternative that would protect only the G. Katz, Secretary, Commission, dated January 26,
The Commission therefore modified the BBOs of the exchange SROs, Nasdaq, 2005 (‘‘CHX Reproposal Letter’’) at 2; Letter from
definition of ‘‘protected bid’’ and and the ADF; or (2) the Voluntary Depth Kimberly G. Walker, Chairman, Committee on
Investment of Employee Benefit Assets, to Jonathan
‘‘protected offer’’ in the reproposal to Alternative that, in addition to G. Katz, Secretary, Commission, dated January 25,
encompass the BBOs of an exchange, protecting BBOs, would protect the DOB 2005 (‘‘CIEBA Reproposal Letter’’) at 2; Deutsche
Nasdaq, and the ADF. In this way, quotations that markets voluntarily Bank Reproposal Letter at 2; Form Letters G, H, I,
exchange markets would be treated disseminate in the consolidated J, and K; Letter from D. Keith Ross, Jr., Chief
Executive Officer, Getco, LLC, to Jonathan G. Katz,
comparably with Nasdaq and the ADF. quotations stream. The Commission Secretary, Commission, dated January 26, 2005
The Proposing Release also addressed requested comment on which of the two (‘‘Getco Reproposal Letter’’) at 2; Letter from
the issue of extending trade-through alternatives would most further the Thomas Peterffy, Chairman, and David M. Battan,
protection to DOB quotations, but Vice President, The Interactive Brokers Group, to
Jonathan G. Katz, Secretary, Commission, dated
questioned whether protecting all DOB 267 Id.
January 24, 2005 (‘‘Interactive Brokers Group
quotations would be feasible at this 268 Hearing Tr. at 57 (testimony of Thomas
Reproposal Letter’’) at 1; NAIC Reproposal Letter at
time.266 Comment specifically was Peterffy, Chairman, Interactive Brokers Group). 2; Letter from John M. Schaible, President,
269 American Century Letter at 2; Ameritrade
requested, however, on whether NexTrade Holdings, Inc., to Jonathan G. Katz,
Letter I at 4; BNY Letter at 2; Capital Research Letter Secretary, Commission, dated December 22, 2004
protection should be extended beyond at 2; Consumer Federation Letter at 2; Goldman (‘‘Nextrade Reproposal Letter’’) at 3; NYSE
the BBOs of SROs if individual markets Sachs Letter at 6; ICI Letter at 8. See also ArcaEx Reproposal Letter I at 1–3; Letter from Kenneth J.
voluntarily provided DOB quotations Letter at 7 (supported trade-through protection for Polcari, President, et al., Organization of
exchange-listed stocks only, but for entire depth-of- Independent Floor Brokers, to Jonathan G. Katz,
261 Proposing
book). But see Letter from Samuel F. Lek, Chief Secretary, Commission, dated January 12, 2005
Release, 69 FR at 11136. Executive Officer, Lek Securities Corporation, to
262 See, (‘‘Organization of Independent Floor Brokers
e.g., Goldman Sachs Letter at 6; Morgan Jonathan G. Katz, Secretary, Commission, dated Reproposal Letter’’) at 2; Phlx Reproposal Letter at
Stanley Letter at 8; NYSE Letter, Attachment at 4; May 24, 2004 (‘‘Lek Securities Letter’’) at 7; Letter 1; Letter from Richard A. Rosenblatt, CEO, and
Specialist Assoc. Letter at 3. from David Humphreville, President, the Specialist
263 Specialist Assoc. Letter at 3.
Joseph C. Gawronski, COO, Rosenblatt Securities
Association of the New York Stock Exchange, to Inc., to Jonathan G. Katz, Secretary, Commission,
264 Morgan Stanley Letter at 8. Jonathan G. Katz, Secretary, Commission, dated dated January 26, 2005 (‘‘Rosenblatt Securities
265 Exchange Act Sections 11A(a)(1)(C)(ii) and June 30, 2004 (‘‘Specialist Assoc. Letter’’) at 3. Reproposal Letter’’) at 2; Specialist Association
11A(c)(1)(F). 270 Consumer Federation Letter at 2.
Reproposal Letter at 2; T. Rowe Price Reproposal
266 Proposing Release, 69 FR at 11136. 271 ICI Letter at 8. Letter at 2.
believed that the Market BBO characteristic of a CLOB is strict price/ They believed that NBBO protection
Alternative achieves the appropriate time priority. To achieve time priority, would be a more measured first step
balance between the need to promote all orders must be funneled through a forward that would strengthen existing
competition among orders and to single trading facility so that they can be price protection while helping to
preserve competition among markets,274 ranked by time. Such a facility would mitigate implementation problems and
but that the Voluntary Depth greatly reduce the opportunity for potential unintended consequences
Alternative, by focusing too exclusively markets to compete by offering a variety with either the Market BBO or
on competition among orders, would of different trading services. Price Voluntary Depth Alternative.280
unduly restrict competition among priority alone, however, would not The Commission does not support the
markets.275 Many commenters also cause nearly as significant an impact on NBBO approach. The marginal benefits
believed that implementing the competition among markets because it to be gained from protecting only the
Voluntary Depth Alternative would be allows price-matching by competing NBBO would not justify the costs of
significantly more difficult and costly markets. Thus, while a CLOB requires implementing the approach. In addition,
than implementing the Market BBO centralization of essentially all orders, protecting only the NBBO would be a
Alternative.276 price priority (whether the Market BBO step backwards from the scope of the
The Commission has determined to Alternative or the Voluntary Depth existing ITS trade-through rule, which
adopt the Market BBO Alternative. The Alternative) merely requires the routing covers the best bids and offers of each
Commission believes that providing of a much smaller subset of orders that exchange and the NASD. The
enhanced protection for the best bids otherwise would be executed at inferior Commission also is concerned that an
and offers of each exchange, Nasdaq, prices. order protection rule that protected only
and the ADF will represent a major step A number of commenters believed the NBBO would be excessively
toward achieving the objectives of that enhanced order interaction with vulnerable to gaming behavior, because
intermarket price protection, but with quotations beyond the best bids and a market participant could post a 100-
fewer of the costs and drawbacks offers of the various SROs would likely share order improving the NBBO and
associated with the Voluntary Depth result even if the Commission adopted then execute a much larger order away
Alternative. In particular, the Market the Market BBO Alternative.278 Given from the NBBO while protecting only
BBO Alternative will promote best the existence of highly sophisticated the 100-share quotation. This result
execution for retail investors on an order routing technology and the would not be consistent with the
order-by-order basis, given that most requirement to route orders to access the purposes of the Order Protection Rule.
retail investors justifiably expect that best bids and offers under the Market
BBO Alternative, these commenters 6. Benefits and Implementation Costs of
their orders will be executed at the the Order Protection Rule
NBBO. In addition, implementation of asserted that competition and best
the Market BBO Alternative will not execution responsibilities would lead Commenters were concerned about
require an expansion of the data market participants to voluntarily access the cost of implementing the original
disseminated through the Plans. The depth-of-book quotations in addition to trade-through proposal. Some argued
Plans currently disseminate the BBOs of quotations at the top-of-book. The that, in general, implementing the
each SRO, but do not disseminate the Commission believes that such a proposed rule would be too expensive
depth of book of all SROs. competition-driven outcome would and would outweigh any perceived
The Commission does not agree with benefit investors and the markets in benefits of the rule.281 Commenters also
general. were concerned about the cost of
commenters that the Voluntary Depth
Another group of commenters specific requirements in the proposed
Alternative would be a CLOB, virtual or
advocated protecting only the NBBO.279 rule, particularly the procedural
otherwise.277 The essential
requirements associated with the
CLOB. See, e.g., Alliance of Floor Brokers
274 See, e.g., Amex Reproposal Letter at 3; BGI
Reproposal Letter at 2; BGI Reproposal Letter at 3;
proposed opt-out exception (e.g.,
Reproposal Letter at 2; BNY Reproposal Letter at 2– BNY Reproposal Letter at 2–3; CHX Reproposal obtaining informed consent from
3; Form Letter J; Specialist Association Reproposal Letter at 2–3; Letter from Congressman Peter T. customers and disclosing the NBBO to
Letter at 3. King et al., to Jonathan G. Katz, Secretary,
275 See, e.g., Alliance of Floor Brokers Reproposal customers).282
Commission, dated January 25, 2005
Letter at 2; Amex Reproposal Letter at 3; Bear (‘‘Congressman King et al. Reproposal Letter’’) at 1;
Stearns Reproposal Letter at 2; BNY Reproposal Letter from Congressman Edward R. Royce and supporting or opposing the reproposed Order
Letter at 2–3; BSE Reproposal Letter at 6; CHX Congressman George Radanovich to Jonathan G. Protection Rule but indicating NBBO would
Reproposal Letter at 3; CIEBA Reproposal Letter at Katz, Secretary, Commission, dated January 25, facilitate adoption and ease implementation
2; Deutsche Bank Reproposal Letter at 2; Getco 2005 (‘‘Congressmen Royce & Radanovich concerns); Merrill Lynch Reproposal Letter at 3; SIA
Reproposal Letter at 1–2; Interactive Brokers Reproposal Letter’’); Letter from Congresswoman Reproposal Letter at 5–12; STANY Reproposal
Reproposal Letter at 3; NAIC Reproposal Letter at Lydia M. Velázquez to Jonathan G. Katz, Secretary, Letter at 10.
1–2; NYSE Reproposal Letter I at 2; Organization of Commission, dated January 25, 2005 280 See, e.g., SIA Reproposal Letter at 5–12.
Independent Floor Brokers Reproposal Letter at 2; (‘‘Congresswoman Velázquez Letter’’) at 1; NAIC 281 See, e.g., Bloomberg Tradebook Letter at 14;
Rosenblatt Securities Reproposal Letter at 2; Reproposal Letter at 1; NYC Comptroller Fidelity Letter I at 12; Instinet Letter at 14, 15;
Specialist Association Reproposal Letter at 5. Reproposal Letter; NYSE Reproposal Letter at 2; Nasdaq Letter II at 2; Letter from Junius W. Peake,
276 See, e.g., Amex Reproposal Letter at 3; BNY Organization of Independent Floor Brokers Monfort Distinguished Professor of Finance,
Reproposal Letter, at 3; BSE Reproposal Letter at 7; Reproposal Letter at 1; Form Letters G, H, I, J, K, Kenneth W. Monfort College of Business, University
CHX Reproposal Letter at 2; Letter from W. Leo and L. of Northern Colorado, dated April 23, 2004 (‘‘Peake
McBlain, Chairman, and Thomas J. Jordan, 278 See, e.g., Bear Stearns Reproposal Letter at 2; Letter I’’) at 2; NMS Study Group Letter at 4; Letter
Executive Director, Financial Information Forum, to BNY Reproposal Letter at 2; Interactive Brokers from Richard A. Rosenblatt, Chief Executive Officer,
Jonathan G. Katz, Secretary, Commission, dated Reproposal Letter at 4. & Joseph C. Gawronski, Chief Operating Officer,
January 26, 2005 (‘‘FIF Reproposal Letter’’) at 2–3; 279 CIBC Reproposal Letter at 1 (joining positions Rosenblatt Securities Inc., to William H. Donaldson,
Getco Reproposal Letter at 1; Interactive Brokers taken by SIA in its letter); Citigroup Reproposal Chairman, Commission, dated June 23, 2004
Group Reproposal Letter at 1; Nextrade Reproposal Letter at 6 (arguing that to the extent a trade- (‘‘Rosenblatt Securities Letter II’’) at 4; STANY
Letter at 3; NYSE Reproposal Letter I, Detailed through rule is necessary, it prefers protecting the Letter at 3; UBS Letter at 8.
Comments at 8; Phlx Reproposal Letter at 2; NBBO, with an exception for most liquid securities 282 See, e.g., Ameritrade Letter I at 8; Brut Letter
Specialist Association Reproposal Letter at 4. preferred); FSR Reproposal Letter at 4; JP Morgan at 12; Citigroup Letter at 8–9; E*TRADE Letter at
277 Many of these commenters expressed the view Reproposal Letter at 3 (stating that if Commission 7; Letter from W. Leo McBlain, Chairman, &
that implementation of the Voluntary Depth does not provide large order exception then NBBO Thomas J. Jordan, Executive Director, Financial
Alternative effectively would amount to a virtual preferred); Lava Reproposal Letter at 1,3 (not Information Forum, to Jonathan G. Katz, Secretary,
Some of the commenters based their estimated PRA costs associated with all, of the connectivity among trading
concerns about implementation costs on reproposed Rule 611 were $17.8 million centers necessary to implement
the estimated costs included in the in start-up costs and $3.5 million in intermarket price protection has already
Proposing Release for purposes of the annual costs. In addition, as discussed been put in place. Trading centers for
Paperwork Reduction Act of 1995 further in section IX.A.2 below, the exchange-listed securities already are
(‘‘PRA’’).283 In the Reproposing Release, estimated implementation costs in the connected through the ITS. The
the Commission revised its estimate of Reproposing Release for necessary Commission understands that, at least
the PRA costs associated with the systems modifications were $126 as an interim solution, ITS facilities and
proposed rule to reflect the streamlined million in start-up costs and $18.4 rules can be modified relatively easily
requirements of Rule 611 as reproposed, million in annual costs. Accordingly, and at low cost to provide the current
and to reflect a further refinement of the the total estimated costs in the ITS participants a means of complying
estimated number of trading centers Reproposing Release were $143.8 with the provisions of Rule 611. With
subject to the rule.284 In particular, Rule million in start-up costs and $21.9 respect to Nasdaq stocks, connectivity
611 as reproposed did not contain an million in annual costs. among many trading centers already is
opt-out exception, and thus costs Although a number of commenters established through private linkages.
associated with the proposed exception, generally expressed the view that there Routing out to other trading centers
which represented a large portion of the would be significant costs associated when necessary to obtain the best prices
overall estimated costs described in the with implementing and complying with for Nasdaq stocks is an integral part of
Proposing Release, were no longer the reproposed Rule, they did not the business plan of many trading
applicable.285 In total, eliminating the discuss the specific estimated cost centers, even when not affirmatively
opt-out procedural requirements alone figures included in the Reproposing required by best execution
reduced the estimate of costs in the Release or include their own responsibilities or by Commission rule.
Proposing Release by $294 million in estimates.287 Many commenters Moreover, a variety of private vendors
start-up costs and $207 million in expressed concerns with the costs currently offer connectivity to NMS
annual costs. In the Reproposing associated with implementing the trading centers for both exchange-listed
Release, the Commission also refined its Voluntary Depth Alternative, believing and Nasdaq stocks.
estimate of the number of broker-dealers that the costs of implementing the The Commission believes that the
that would be required to establish, Voluntary Depth Alternative would be benefits of strengthening price
maintain, and enforce written policies substantially greater than the Market protection for exchange-listed stocks
and procedures designed to prevent BBO Alternative.288 As discussed above (e.g., by eliminating the gaps in ITS
trade-throughs pursuant to the in Section II.A.5, the Commission is coverage of block positioners and 100-
reproposed Rule from 6,788 registered adopting the Market BBO Alternative share quotes) and introducing price
broker-dealers to approximately 600 and not the Voluntary Depth protection for Nasdaq stocks will be
broker-dealers.286 Alternative. The Commission does not substantial, although the total amount is
Taken together, these changes believe that the inclusion of a stopped difficult to quantify. One objective,
substantially reduced the estimated order exception will materially impact though quite conservative, estimate of
costs associated with implementation of the estimated costs included in the benefits is the dollar amount of
and ongoing compliance with Reproposing Release.289 The quotations that annually are traded
reproposed Rule 611. As discussed Commission continues to estimate through. The Commission staff’s
further in section VIII.A below, the implementation costs for the Order analysis of trade-through rates indicates
Protection Rule as adopted of that over 12 billion shares of displayed
Commission, dated July 9, 2004 (‘‘Financial approximately $143.8 million and quotations in Nasdaq and NYSE stocks
Information Forum Letter’’) at 2; JP Morgan Letter were traded through in 2003, by an
at 4; SIA Letter at 12–14. annual costs of approximately $21.9
283 44 U.S.C. 3501 et seq. million.290 average amount of 2.3 cents for Nasdaq
284 The PRA analysis is forth in section VIII.A In assessing the implementation costs stocks and 2.2 cents for NYSE stocks.291
below. of the Order Protection Rule, it is These traded-through quotations
285 Specifically, the estimated costs of providing
important to recognize that much, if not represent approximately $209 million in
investors with disclosure necessary to obtain Nasdaq stocks and $112 million in
informed consent to opt-outs and retaining records NYSE stocks, for a total of $321 million
287 See, e.g., CIBC Reproposal Letter at 4; Letter
relating to such disclosures were $100 million in
start-up costs and $59 million annually. Further, from Thomas M. Joyce, CEO & President, Knight in bypassed limit orders and inferior
the estimated costs of the proposed requirement for Trading Group, Inc., to Jonathan G. Katz, Secretary, prices for investors in 2003 that could
broker-dealers to provide every customer that opted Commission, dated January 25, 2005 (‘‘Knight have been addressed by strong trade-
out with the NBBO at the time of execution were Securities Reproposal Letter’’ ‘‘Knight Reproposal
Letter’’) at 5 (expressing the view that the costs of through protection.292 The Commission
$194 million in start-up costs and almost $148
million annually. either the Market BBO or Voluntary Depth believes that this $321 million estimated
286 In the Proposing Release, the Commission Alternative outweigh the nominal benefits of the annual benefit, particularly when
estimated that potentially all of the 6,768 registered Rule); Merrill Lynch Reproposal Letter at 5; Nasdaq combined with the benefits of enhanced
broker-dealers would be subject to this requirement, Reproposal Letter at 2; SIA Reproposal Letter at 11.
288 Amex Reproposal Letter at 3; Letter from Steve investor confidence in the fairness and
but acknowledged that it believed the figure was
likely overly-inclusive because it might include Swanson, CEO & President, Automated Trading orderliness of the equity markets,
registered broker-dealers that do not effect Desk, LLC, to Jonathan G. Katz, Secretary, justifies the one-time costs of
transactions in NMS stocks. As noted in the Commission, dated January 26, 2005 (‘‘ATD implementation and ongoing annual
Reproposing Release, after further consideration, Reproposal Letter’’) at 4; BNY Reproposal Letter at
3; CHX Reproposal Letter at 2; NYSE Reproposal
costs of the Order Protection Rule.
the Commission believes that this number indeed
greatly overestimated the number of registered Letter I, Detailed Comments at 8; RBC Capital Two commenters on the reproposal
broker-dealers that would be subject to the rule, Markets Reproposal Letter at 6; STANY Reproposal asserted that the dollar amount of
given that most of those broker-dealers do not Letter at 9. traded-through quotations overstated
289 The estimated cost figures included the
engage in the business of executing orders the benefits of order protection because
internally. The estimated number therefore was Reproposing Release did not include additional
reduced to approximately 600 broker-dealers in the costs that would be associated with the Voluntary ‘‘trading is for the most part a zero-sum
Reproposing Release. No comments were received Depth Alternative. See section IX.A.2 of the
on this estimate. The estimate is described further Reproposing Release. 291 Trade-Through Study at 3, 5.
in section VIII.A below. 290 See infra sections VIII.A and IX.A.2. 292 Id. at 3.
game.’’ 293 They believed that trades whose quotation was traded through expected to result from increased use of
executed at inferior prices were random and the efficiency of the markets still limit orders, increased depth, and
noise that sometimes benefited and are harmed. Finally, many trade- increased order interaction.
sometimes disadvantaged a particular throughs are dealer internalized trades, Thus, the Commission believes that
investor, stating that ‘‘[i]t is only if one where the party receiving the the $321 million estimate of benefits is
class of investors systematically loses advantageous price is not an investor conservative because it is based solely
out to another class as a result of trade- but a market intermediary, and therefore on the size of displayed quotations in
throughs that there is a problem.’’ 294 such trades cannot be considered a the absence of strong price protection.
The Commission does not agree that transfer of benefits from one group of In essence, it measures the problem—a
trades executed at inferior prices should investors to another equally-situated shortage of quoted depth—that the
be considered merely a transfer of group of investors. This transfer of Order Protection Rule is designed to
benefits from one group of investors to benefits from investors to market address, rather than the benefits that it
another equally-situated group of intermediaries cannot be dismissed as could achieve. Every trade-through
investors. There are at least three parties mere ‘‘random noise.’’ transaction potentially sends a message
affected by every trade-through In addition, economic theory predicts to market participants that their
transaction: (1) The party that received that, in an auction market, buyers who displayed quotations can be and are
an inferior price; (2) the party whose place the highest value on a stock will ignored by other market participants.
superior-priced limit order was traded- bid most aggressively.297 If an incoming When the total share volume of trade-
through; and (3) the contra party to the market order is allocated to an investor through transactions that do not interact
trade-through transaction that received who is not bidding the best price, this with displayed quotations reaches 9%
an advantageous price. The re-allocation is neither zero-sum nor and above for hundreds of the most
redistributions of welfare resulting from random. It systematically reallocates actively traded NMS stocks,298 this
trade-through transactions cannot trades away from those investors for message is unlikely to be missed by
reasonably be expected to occur whom the welfare gains would be those who watched their quotations
randomly across these parties. largest. The argument also can be being traded through. Certainly, the
Customers of brokers that are doing a framed in terms of an investor’s common practice of trading through
poor job of routing orders are more preferences with respect to the tradeoff displayed size is most unlikely to
likely to be harmed than customers of between price and execution speed. prompt market participants to display
brokers that are doing a better job.295 Among those investors who trade using even greater size.
Investors who generally submit limit limit orders, we would expect more A primary objective of the Order
orders at the best prices are more likely aggressive limit orders to be submitted Protection Rule is to increase displayed
to be harmed than customers who by those investors who place more value depth and liquidity in the NMS and
generally submit less aggressively- on speed or certainty of execution and thereby reduce transaction costs for a
priced limit orders. relatively less value on price. wide spectrum of investors, particularly
Thus, trade-through transactions can Conversely, we would expect investors institutional investors that must trade in
result in direct harm to two parties, as who place a lower value on speed and large sizes. Precisely estimating the
well as more general harm to the certainty of execution and a higher extent to which strengthened price
efficiency of the markets by dampening value on price to submit less aggressive protection will improve market depth
the incentive for aggressive quoting. limit orders. When an incoming market and liquidity, and thereby lower the
Moreover, even when the party order is executed against a limit order transaction costs of investors, is very
receiving an inferior price does so with an inferior price, the result is: (1) difficult. The difficulty of estimation
willingly (such as when an institution A faster execution for an investor who should not hide from view, however,
accepts a block trade at a price away does not place as much value on speed the enormous potential benefits for
from the inside quotation),296 the party of execution; and (2) a lost execution or investors of improving the depth and
293 Angel Reproposal Letter at 4; Fidelity
slower execution for the investor who efficiency of the NMS. Because of the
Reproposal Letter at 8. places a higher value on prompt huge dollar amount of trading volume in
294 Angel Reproposal Letter at 4. execution. This is not a zero-sum NMS stocks—more than $17 trillion in
295 As discussed above, it can be difficult for redistribution. 2003 299—even the most incremental
retail investors in particular to monitor whether Moreover, the $321 million estimate improvement in market depth and
their orders in fact received the best available price is a conservative measure of the total liquidity could generate a dollar amount
at the time of order execution. See supra, note 53
and accompanying text. benefits of the Order Protection Rule. It of benefits that annually would dwarf
296 Fidelity and the Battalio/Jennings Paper does not attempt to measure any gains the one-time start-up costs of
asserted that the staff study should not have from trading associated with investors’ implementing trade-through protection.
included block trades in its estimate of the benefits private values, beyond those expressed One approach to evaluating the
of strengthened trade-through protection. Fidelity potential benefits of the Order
Reproposal Letter II at 1; Battalio/Jennings Paper at
in their limit order prices. The Order
2. The Commission does not agree. First, the Protection Rule can be expected to Protection Rule is to examine a category
amount that block trades contributed to the $321 generate other categories of benefits that of investors that stand to benefit a great
million estimate is very small. Block trades are not quantified in the $321 million deal from improved depth and liquidity
represented only 1.9% of total trade-throughs in for NMS stocks—the shareholders in
Nasdaq stocks and 1.1% of total trade-throughs in
estimate, such as the benefits that can be
NYSE stocks. Trade-Through Study, Tables 6, 13. U.S. equity mutual funds. In 2003, the
Most importantly, the staff study used the lesser of the estimation of benefits because their failure to total assets of such funds were $3.68
the size of the traded-through quotation and the size interact with significant displayed quotations is one trillion.300 The average portfolio
of the trade-through transaction when calculating of the most serious problems with respect to the
protection of limit orders that the Order Protection
turnover rate for equity funds was 55%,
the $321 million. Id. at 3. Thus, if a 10,000 share
transaction traded through a 100-share quotation, Rule is designed to address. See supra, section
298 See Trade-Through Study, Tables 4.
only 100 shares counted toward the estimation of II.A.1.c.
299 World Federation of Exchanges, Annual
benefits. The Battalio/Jennings Paper incorrectly 297 See, e.g., B. Hollifield, R. Miller and P. Sandas,
asserted that the staff study did not use this ‘‘Empirical Analysis of Limit Order Markets,’’ 71 Report (2003), at 86.
conservative approach. Battalio/Jennings Paper at 2. Review of Economic Studies 1027–1063 and n. 4 300 Investment Company Institute, Mutual Fund
Finally, block trades are appropriately included in (2004). Fact Book (2004), at 55.
meaning that their total purchases and shareholders, would have amounted to 1. Scope of Rule
sales of securities amounted to approximately $755 million in 2003. The scope of Rule 611 is largely
approximately $4.048 trillion.301 A Of course, the benefits of improved determined by a series of definitions set
leading authority on the trading costs of depth and liquidity for the equity forth in Rule 600(b). In general, the Rule
institutional investors has estimated holdings of other types of investors, addresses trade-throughs of protected
that in the second quarter of 2003 the including pension funds, insurance quotations in NMS stocks by trading
average price impact experienced by companies, and individuals, are not centers. A ‘‘trading center’’ is defined in
investment managers ranged from 17.4 incorporated in the foregoing Rule 600(b)(78) as a national securities
basis points for giant-capitalization calculations. In 2003, these other types exchange or national securities
stocks, 21.4 basis points for large- of investors held 78% of the value of association that operates an SRO trading
capitalization stocks, and up to 35.4 publicly traded U.S. equity outstanding, facility,306 an ATS,307 an exchange
basis points for micro-capitalization with equity mutual funds holding the market maker,308 an OTC market
stocks.302 In addition, it estimated the remaining 22%.304 For example, maker,309 or any other broker or dealer
cost attributable to adverse price pension funds alone held $9 trillion in that executes orders internally by
movements while searching for liquidity assets in 2003, of which an estimated trading as principal or crossing orders as
for institutional orders, which often are $4.9 trillion was held in equity agent. This last phrase is intended
too large simply to be presented to the investments other than mutual funds.305 particularly to cover block positioners.
market. Its estimate of these liquidity Thus, the implicit transaction costs An ‘‘NMS stock’’ is defined in
search costs ranged from 13 basis points incurred by institutional investors each paragraphs (b)(47) and (b)(46) of Rule
for giant capitalization stocks, 23 basis year is likely at least double the $15.1 600 as a security, other than an option,
points for large capitalization stocks, billion estimated for equity mutual for which transaction reports are
and up to 119 basis points for micro- funds, for a total of more than $30 collected, processed and made available
capitalization stocks. billion. Assuming that these other types pursuant to an effective national market
To obtain a conservative estimate of of investors experienced a reduction in system plan. This definition effectively
price impact costs and liquidity search transaction costs that equaled the covers stocks listed on a national
costs incurred across all stocks, the total reduction of trading costs for equity securities exchange and stocks included
market impact and liquidity search costs mutual funds, the assumed 5% in either the National Market or
for giant capitalization stocks (30.4 basis improvement in market depth and SmallCap tiers of Nasdaq. It does not
points) and the total market impact and liquidity could yield total transaction include stocks quoted on the OTC
liquidity search costs for large cost savings for all investors of over $1.5 Bulletin Board or elsewhere in the OTC
capitalization stocks (44.4 basis points) billion annually. Such savings would market.
are averaged together to yield a figure of improve the investment returns of The term ‘‘trade-through’’ is defined
37.4 basis points.303 The much higher equity ownership, thereby promoting in Rule 600(b)(77) as the purchase or
market impact and liquidity search costs the retirement and other long-term sale of an NMS stock during regular
of midcap, smallcap, and microcap financial interests of individual trading hours,310 either as principal or
stocks are not included. Using this investors and reducing the cost of agent, at a price that is lower than a
estimate of 37.4 basis points, the capital for listed companies. protected bid or higher than a protected
shareholders in U.S. equity mutual offer. Rule 600(b)(57), which defines a
B. Description of Adopted Rule
funds incurred implicit transaction ‘‘protected bid’’ or ‘‘protected offer,’’ 311
costs of $15.1 billion in 2003. Based on Rule 611 can be divided into three includes three main elements: (1) An
a hypothetical assumption that, in light elements: (1) The provisions that automated quotation; (2) displayed by
of the current share volume of trade- establish the scope of the Rule’s an automated trading center; and (3)
through transactions that does not coverage, most of which are set forth in that is the best bid or best offer of an
interact with displayed liquidity, the definitions of Rule 600(b); (2) the exchange, The NASDAQ Stock Market,
intermarket trade-through protection operative requirements of paragraph (a) or an association other than The
could improve depth and liquidity for of Rule 611, which, among other things, NASDAQ Stock Market (currently, the
NMS stocks by 5% (or an average mandate the adoption and enforcement best bid or offer of the NASD’s ADF).312
reduction of 1.87 basis points in price of written policies and procedures that As discussed above, an ‘‘automated
impact and liquidity search costs for are reasonably designed to prevent trade quotation’’ is defined in Rule 600(b)(3)
large investors), the savings in throughs on that trading center of as a quotation displayed by a trading
transaction costs for U.S equity funds protected quotations and, if relying on
alone, and the improved returns for an exception, that are reasonably 306 An ‘‘SRO trading facility’’ is defined in Rule
designed to assure compliance with the 600(b)(72) as a facility operated by or on behalf of

their millions of individual an SRO that executes orders in a security or
terms of the exception; and (3) the presents orders to members for execution.
301 Id. at 64. Portfolio turnover is reported as the
exceptions set forth in paragraph (b) of 307 An ‘‘alternative trading system’’ is defined in
lesser of portfolio sales or purchases divided by Rule 611. These elements are discussed Rule 600(b)(2) with a cross reference to Regulation
average net assets. Because price impact occurs for below, followed by a section ATS.
308 An ‘‘exchange market maker’’ is defined in
both purchases and sales, the turnover rate must be emphasizing that a broker’s duty of best
doubled, then multiplied by total fund assets, to Rule 600(b)(24).
estimate the total value of trading that would be
execution is not lessened by the 309 An ‘‘OTC market maker’’ is defined in Rule
affected by an improvement in depth and liquidity. adoption of Rule 611. 600(b)(52).

302 Plexus Group, Inc., Commentary 80, ‘‘Trading 310 The term ‘‘regular trading hours’’ is defined in
Truths: How Mis-Measurement of Trading Costs Is 304 Mutual Fund Factbook, supra note 300, at 59. Rule 600(b)(64) as the time between 9:30 a.m. and
Leading Investors Astray,’’ (April 2004), at 2–3. 305 Id.at 91 (employer-sponsored pension market 4:00 p.m. Eastern time, unless otherwise specified.
303 Cf. supra, note 146 and accompanying text 311 Protected bid and protected offer are
held estimated $9.0 trillion in assets in 2003, $7.7
(Plexus estimate of average transaction costs, trillion of which were not represented by mutual collectively defined as a ‘‘protected quotation’’ in
including commissions, during the fourth quarter of fund assets); Milliman, Inc., Pension Fund Survey Rule 600(b)(58).
2003 for Nasdaq and NYSE stocks as, respectively, (available at www.milliman.com) (consulting firm’s 312 See section II.A.5 above for a discussion of the
83 basis points and 55 basis points; commissions survey of 2003 annual reports for 100 of largest U.S. Commission’s determination to adopt the Market
average 12 basis points for large capitalization corporations found that the median equity BBO Alternative with respect to the scope of
stocks). allocation for pension fund assets was 65%). protected quotations.
center that: (1) Permits an incoming manual indicator. Any quotation that Rule 611 and, if relying on such an
order to be marked as immediate-or- does not meet the requirements for an exception, that are reasonably designed
cancel; (2) immediately and automated quotation is defined in Rule to assure compliance with the terms of
automatically executes an order marked 600(b)(37) as a ‘‘manual quotation.’’ the exception.314 In addition, paragraph
as immediate-or-cancel against the As discussed above, an ‘‘automated (a)(2) of Rule 611 requires a trading
displayed quotation up to its full trading center’’ is defined in Rule center to regularly surveil to ascertain
size; 313 (3) immediately and 600(b)(4) as a trading center that: (1) Has the effectiveness of the policies and
automatically cancels any unexecuted implemented such systems, procedures, procedures required by paragraph (a)(1)
portion of an order marked as and rules as are necessary to render it and to take prompt action to remedy
immediate-or-cancel without routing the capable of displaying quotations that deficiencies in such policies and
order elsewhere; (4) immediately and meet the requirements for an automated procedures.
automatically transmits a response to quotation set forth in paragraph (b)(3) of As discussed in the Proposing
the sender of an order marked as this section; (2) identifies all quotations Release, the Commission believes it
immediate-or-cancel indicating the other than automated quotations as would be inappropriate to implement a
action taken with respect to such order; manual quotations; (3) immediately complete prohibition against any trade-
and (5) immediately and automatically identifies its quotations as manual throughs, particularly given the realities
displays information that updates the quotations whenever it has reason to of intermarket trading and order-routing
displayed quotation to reflect any believe that it is not capable of in many high-volume NMS stocks,315
change to its material terms. displaying automated quotations; and and has not adopted such an approach.
Consequently, a quotation will not (4) has adopted reasonable standards In this trading environment, despite
qualify as ‘‘automated’’ if any human limiting when its quotations change reasonable attempts to prevent them,
intervention after the time an order is from automated quotations to manual false positive or accidental trade-
received is allowed to determine the quotations, and vice versa, to throughs may result from timing
action taken with respect to the specifically defined circumstances that discrepancies resulting from technology
quotation. The term ‘‘immediate’’ promote fair and efficient access to its limitations, latencies in the delivery and
precludes any coding of automated automated quotations and are consistent receipt of quotation updates, and data
systems or other type of intentional with the maintenance of fair and orderly discrepancies. The requirement of
device that would delay the action taken markets. The requirement of reasonable written policies and procedures, as well
with respect to a quotation. Although a standards for switching the automated/ as the responsibility assigned to trading
trading center must provide an IOC/no- manual status of quotations is designed centers to regularly surveil to ascertain
routing functionality for incoming to preclude practices that would cause the effectiveness of their procedures and
orders, it also can offer additional confusion among market participants take prompt remedial steps, is designed
functionalities. Among the changes to concerning the status of a trading to achieve the objective of eliminating
material terms that require an center’s quotations or that would all trade-throughs that reasonably can be
immediate update to a quotation are inappropriately advantage the members prevented, while also recognizing the
price, displayed size, and automated/ or customers of a trading center at the inherent difficulties of eliminating
expense of the public. trade-through transactions that, despite
313 The requirement that an automated quotation The third element of the definition of a trading center’s reasonable efforts,
be accessible up to its full size does not mean that ‘‘protected bid’’ and ‘‘protected offer’’ may occur.
a trading center must automate all of its available
trading interest. For example, trading centers will
identifies which automated quotations In the Reproposing Release, the
be permitted to operate hybrid markets with are protected under the Order Protection Commission requested comment on
different order types and rules for automated Rule. Specifically, Rule 600(b)(57) whether this approach would be
trading and manual trading. Rather, the ‘‘full size’’ provides that an automated quotation sufficient to address enforceability
term in the definition of automated quotation
requires that, once a trading center offers an displayed by an automated trading concerns. Several commenters
automated execution of a particular displayed center that is the BBO of an exchange expressed a concern about the
quotation and thereby obtains protection under SRO, the BBO of Nasdaq, or the BBO of significant burden that would be placed
Rule 611, such quotation must be immediately and the NASD (i.e., the ADF) qualifies as a on market participants to prove
automatically accessible up to its full size, which
will include both the displayed and reserve size of protected quotation. Thus, only a single, compliance and defend each execution
the quotation. Given that to comply with Rule 611, accessible best bid and best offer for that appears to be a trade-through (i.e.,
market participants need to be able to access the each of the exchange SROs, Nasdaq, and they could be presumed to have violated
displayed size of protected quotations at all trading the Rule unless they can prove they did
centers (even when the displayed size of the
the NASD is protected under the Order
quotation may be less than the size of the market Protection Rule. A best bid and best not), particularly in light of the
participant’s total trading interest), the Commission offer must be accessible by routing an significant number of false positives that
believes trading centers must provide fair and order to a single market destination (i.e., are likely to result.316 The Commission
efficient access to the full size available for the
quotation. Cf. infra, sections III.B.1 and III.B.2
currently, either to a single exchange
(access standard and fee limitation of Rule 610 execution system, a single Nasdaq 314 The Commission has modified the language of
apply to both displayed and reserve size of execution system, or a single ADF Rule 611(a)(1) to make clear that a trading center’s
displayed quotations). This requirement, which is policies and procedures must only be reasonably
participant). designed to prevent trade-throughs on its own
applicable to trading centers that display automated
quotations, does not mean that market participants trading center of protected quotations in NMS
2. Requirement of Reasonable Policies stocks that do not fall within an exception set forth
are required to route orders in an attempt to execute
against the reserve size of a protected quotation.
and Procedures in paragraph (b) of Rule 611 and, if relying on such
an exception, that are reasonably designed to assure
Rather, Rule 611 operates as follows. In the first Paragraph (a)(1) of Rule 611 requires compliance with the terms of the exception.
instance, the Rule protects prices—a trading center a trading center to establish, maintain, 315 Proposing Release, 69 FR at 11137 (noting the
cannot execute a transaction at a price inferior to
the price of a protected quotation, absent an and enforce written policies and problem of ‘‘false positive’’ trade-throughs caused
exception. One of the most commonly used procedures that are reasonably designed by rapidly changing quotations, even when a
exceptions to the Rule is likely to be the intermarket to prevent trade-throughs on that trading center took reasonable precautions to
sweep order exception, which applies to sweep prevent trade-throughs).
orders that are routed to execute against the full
trading center of protected quotations in 316 Morgan Stanley Reproposal Letter at 15; Letter
displayed size of better-priced protected quotations. NMS stocks that do not fall within an from David Cummings, Chief Executive Officer,
See infra, note 320 and accompanying text. exception set forth in paragraph (b) of Tradebot Systems, Inc., to Jonathan G. Katz,
recognizes this concern and intends to exception and whether they have failed Paragraph (b)(1) excepts a transaction
work closely with industry participants to implement and maintain policies and if the trading center displaying the
during the implementation period for procedures that would have reasonably protected quotation that was traded
the Order Protection Rule to provide prevented such trade-throughs. through was experiencing a failure,
useful and practical guidance for trading As a further means to bolster material delay, or malfunction of its
centers on the policies and procedures compliance with the Order Protection systems or equipment when the trade-
needed to comply with the Rule. Rule, the Commission has instructed its through occurred. As discussed in
At a minimum, a trading center’s staff to develop for our consideration section II.A.3 above, the exception for a
policies and procedures must enable the and for notice and comment a rule ‘‘material delay’’ gives trading centers a
trading center (and persons responsible proposal that would require trading self-help remedy if another trading
for transacting on its market, such as centers to publicly disclose center repeatedly fails to provide an
specialists) to monitor, on a real-time standardized and comparable statistics immediate response (within one second)
basis, the protected quotations on the incidence of trade-through to incoming orders attempting to access
displayed by other trading centers so as transactions that do not fall within an its quotes. The trading center receiving
to determine the prices at which the exception to the Rule. Such industry- an order can only be held responsible
trading center can and cannot execute wide statistics would promote greater for its own turnaround time (i.e., from
trades. In addition, a trading center’s public accountability by trading centers the time it first received an order to the
policies and procedures must establish for the quality of their policies and time it transmits a response to the
objective standards and parameters procedures. The statistics also would be order). Accordingly, the routing trading
governing its use of the exceptions set helpful for trading centers, as well as center will be required to develop
forth in Rule 611(b). A trading center’s regulatory authorities, in assessing the policies and procedures that allow for
automated order-handling and trading reasonableness and effectiveness of the any potential delays in transmission not
systems must be programmed in policies and procedures adopted by attributable to the receiving trading
accordance with these policies and various trading centers. In particular, a center. The exception in paragraph
procedures. Finally, the trading center trading center that generated a (b)(1) also covers any failure or
must take such steps as are necessary to materially higher rate of trade-throughs malfunction of a trading center’s
enable it to enforce its policies and than other comparable trading centers systems or equipment, as well as any
procedures effectively. For example, would need to closely evaluate the types material delay.
trading centers will need to establish of policies and procedures used by the Trading centers will need to establish
procedures such as regular exception other trading centers as a means to specific objective parameters governing
reports to evaluate their trading and upgrade its own policies and their use of the ‘‘self-help’’ exemption as
order-routing practices. Such reports procedures. On the other hand, the fact part of their reasonable policies and
will need to be examined to affirm that that many trading centers generated procedures. For example, a single
a trading center’s policies and comparable rates of trade-throughs failure to respond within one second
procedures have been followed by its would not shield them from a violation generally will not justify future
personnel and properly coded into its of the Order Protection Rule if a bypassing of another trading center’s
automated systems and, if not, to material number of the trade-through quotations. Many failures to respond
promptly identify the reasons and take transactions could reasonably have been within one second in a short time
remedial action. prevented by the use of particular period, in contrast, clearly will warrant
Of course, surveillance is an policies and procedures. In general, the use of the exception. A trading center
important component of a trading Commission preliminarily believes that making use of the exception must notify
center’s satisfaction of its legal comparable, industry-wide statistics on the non-responding trading center
obligations. In the context of Rule 611, trade-throughs would provide a immediately after (or at the same time
paragraph (a)(2) of the Rule reinforces valuable resource to identify the most as) electing this exception pursuant to
the ongoing maintenance and effective policies and procedures and to reasonable and objective standards
enforcement requirements of paragraph promote their use by all relevant trading contained in its policies and
(a)(1) of the Rule by explicitly assigning centers. procedures.318
Paragraph (b)(8) of Rule 611 sets forth
an affirmative responsibility to trading
3. Exceptions an exception for flickering quotations. It
centers to surveil to ascertain the
Rule 611(b) sets forth a variety of excepts a transaction if the trading
effectiveness of their policies and
exceptions addressing transactions that center displaying the protected
procedures. Trading centers cannot
may fall within the definition of a trade- quotation that was traded through had
merely establish policies and
through, but which are not subject to the displayed, within one second prior to
procedures that may be reasonable
operative requirements of the Rule. The execution of the trade-through, a best
when created and assume that such
exceptions primarily are designed to bid or best offer, as applicable, for the
policies and procedures continue to
satisfy the requirements of Rule 611. achieve workable intermarket price
qualified for an exception and was not a true trade-
Rather, trading centers must regularly protection and to facilitate certain through. The Commission therefore intends to
assess the continuing effectiveness of trading strategies and order types that request that the market data Plans explore the
their procedures and take prompt action are useful to investors, but also are feasibility of identifying trade-through exceptions.
consistent with the principle of price It also intends to initiate a discussion with the
when needed to remedy deficiencies. In Plans on shortening the current 90-second time
particular, trading centers must engage protection.317 frame for reporting trades in light of current
in regular and periodic surveillance to technology and trading practices. Reporting trades
determine whether trade-throughs are 317 Several commenters recommended that the in substantially less than 90 seconds would reduce
consolidated tape should identify trades that were the number of trades that are reported out of
occurring without an applicable executed and reported pursuant to an exception to sequence, thus improving the accuracy and
the Rule. See, e.g., Citigroup Reproposal Letter at reliability of the consolidated trade stream and
Secretary, Commission, dated January 26, 2005 7; SIA Reproposal Letter at 17. The Commission helping to reduce the false appearance of trade-
(‘‘Tradebot Reproposal Letter’’) at 1; UBS agrees that increased transparency would be greatly throughs.
Reproposal Letter at 5 (expressing the view that the beneficial. Such identification would give market 318 For instance, a trading center may wish to use
Rule would be unenforceable). participants and investors timely notice that a trade electronic mail to make this notification.
NMS stock with a price that was equal to do so if it simultaneously routes one sizes,320 it would have been able to
or inferior to the price of the trade- or more intermarket sweep orders to obtain an immediate execution of a
through transaction. This exception execute against the full displayed size of 9400-share trade by sweeping through
thereby provides a ‘‘window’’ to address each such better-priced protected four price levels at Trading Center A,
false indications of trade-throughs that quotations. If there is only one better- while also honoring the protected
in actuality are attributable to rapidly priced protected quotation, then the quotations at two other trading
moving quotations. It also potentially dealer is only required to route an centers.321 The trade therefore would
will reduce the number of instances in intermarket sweep order to execute have both upheld the principle of price
which a trading center must alter its against that protected quotation. protection and served the customer’s
normal trading procedures and route Paragraph (c) of Rule 611 requires that legitimate interest in obtaining an
orders to other trading centers to the trading center, broker, or dealer immediate execution of large size.
comply with Rule 611. The exception is responsible for the routing of an The exception in paragraph (b)(7) of
thereby intended to promote more intermarket sweep order take reasonable Rule 611 will facilitate other types of
workable intermarket price protection. steps to establish that orders are orders that often are useful to
Paragraphs (b)(5) and (b)(6) of Rule properly routed in an attempt to execute investors—benchmark orders. It excepts
611 set forth exceptions for intermarket against all applicable protected the execution of an order at a price that
sweep orders. An intermarket sweep quotations. A trading center, broker, or was not based, directly or indirectly, on
order is defined in Rule 600(b)(30) as a dealer is required to satisfy this the quoted price of an NMS stock at the
limit order 319 that meets the following requirement regardless whether it routes time of execution and for which the
requirements: (1) When routed to a the order through its own systems or material terms were not reasonably
trading center, the limit order is sponsors a customer’s access through a determinable at the time the
identified as an intermarket sweep third-party vendor’s systems. commitment to execute the order was
order; and (2) simultaneously with the To illustrate the operation of the made. A common example of a
routing of the limit order identified as intermarket sweep order exception, benchmark order is a VWAP order.
an intermarket sweep order, one or more assume that a broker-dealer’s customer Assume a broker-dealer’s customer
additional limit orders, as necessary, are wished to sell a large amount of an NMS decides to buy a stock at 9 a.m. before
routed to execute against the full stock. Trading Center A is displaying the markets open for normal trading.
displayed size of all protected the national best bid of 500 shares at The customer submits, and the broker-
quotations with a superior price. These $10.00, along with quotations in its dealer accepts, an order to buy 100,000
additional limit orders must be marked proprietary depth-of-book data feed of shares at the volume-weighted average
as intermarket sweep orders to allow the 1500 shares at $9.99, and 5000 shares at price of the stock from opening until 1
receiving market center to execute the $9.97. The customer decides to sweep p.m. At 1 p.m., the national best offer in
order immediately without regard to all liquidity on Trading Center A down the stock is $20.00, but the relevant
better-priced quotations displayed at to $9.97. Assume also that Trading volume-weighted average price (in a
other trading centers (by definition, Center B is displaying a protected bid of rising market) is $19.90. The broker-
each of the additional limit orders 2000 shares at $9.99, Trading Center C dealer would be able to rely on the
would meet the requirements for an is displaying a protected bid of 400 benchmark order exception to execute
intermarket sweep order). shares at $9.98, and Trading Center D is the order at $19.90 at 1 p.m., without
Paragraph (b)(5) allows a trading regard to better-priced protected
displaying a protected bid of 200 shares
center immediately to execute any order quotations at other trading centers. Of
at $9.97. The broker-dealer could
identified as an intermarket sweep course, any transactions effected by the
execute this trade for its customer,
order. It therefore need not delay its broker-dealer during the course of the
execution for the updating of the better- subject to its best execution
responsibilities, by simultaneously day to obtain sufficient stock to fill the
priced quotations at other trading benchmark order would remain subject
centers to which orders were routed routing the following orders: (1) An
intermarket sweep order to Trading to Rule 611. The benchmark exception
simultaneously with the intermarket also would encompass the execution of
sweep order. Paragraph (b)(6) allows a Center A with a limit price of $9.97 and
a size of 7000 shares; (2) an intermarket an order that is benchmarked to a
trading center itself to route intermarket market’s single-priced opening, as the
sweep orders and thereby clear the way sweep order to Trading Center B with a
for immediate internal executions at the limit price of $9.99 and a size of 2000
320 An intermarket sweep order could go unfilled
trading center. This exception shares; and (3) an intermarket sweep
because the protected quotation at a trading center
particularly will facilitate the immediate order to Trading Center C with a limit was accessed or withdrawn prior to the trading
execution of block orders by dealers on price of $9.98 and a size of 400 shares. center’s receipt of the intermarket sweep order. In
behalf of their institutional clients. All of these orders would meet the addition, the existence of undisplayed orders or
requirements of Rule 600(b)(30) because reserve size at some trading centers could result in
Specifically, if a dealer wishes to an execution at better prices than may have been
execute internally a customer order at a the necessary orders simultaneously indicated by the displayed prices and sizes. The
price that would trade through one or were routed to execute against the router of an intermarket sweep order would only be
more protected quotations on other displayed size of all better-priced responsible, however, for routing orders in
protected quotations. Trading Centers A, accordance with the displayed price and size of
trading centers, the dealer will be able protected quotations. Whether the orders actually
B, and C all could execute their orders execute against the protected quotations, or go
319 Such a limit order would be ‘‘marketable’’ immediately without regard to the unfilled because the quotations have been
because it would be immediately subject to protected quotations displayed at other previously executed or withdrawn, is not within the
execution at current displayed prices. trading centers. No order would need to responsibility or control of the router of the
Consequently, ‘‘limit order’’ is used differently in intermarket sweep order.
this context than elsewhere in this release, where
be routed to Trading Center D because 321 If a trading center has routed intermarket
it is used to refer to non-marketable orders that the price of its bid was not superior to sweep orders to access the full displayed size of
generally will be displayed, in contrast to the most inferior limit price of the order protected quotations under the Order Protection
marketable orders that generally will not be routed to Trading Center A. Assuming Rule, it will be allowed to continue trading without
displayed. See supra, note 53 (description of regard to a particular trading center’s quotations
marketable limit orders and non-marketable limit
the customer obtained a fill for each of until it has received a response from such trading
orders). its orders at the displayed prices and center. See supra, note 194.
Commission would not interpret such quotations were crossed.328 The crossed regarding locked and crossed markets,
an opening price to be the ‘‘quoted quotation exception would not apply but not to remove such quotations from
price’’ of the NMS stock at the time of when a protected quotation crosses a the calculation of the NBBO.334 They
execution. non-protected (e.g., manual) argued that including manual
Paragraph (b)(9) of Rule 611 provides quotation.329 The exception for single- quotations in the benchmark against
an exception for the execution of certain priced reopenings will only apply to which a broker-dealer’s best execution
stopped orders.322 Specifically, the single-priced reopening transactions responsibility is judged provides an
exception applies to the execution by a after a trading halt conducted pursuant unfair standard of comparison,
trading center of a stopped order where to a trading center rule. To qualify, the particularly to the extent manual
the price of the execution of the order reopening process must be transparent quotations are not accessible.335 Several
was, for a stopped buy order, lower than and provide for the queuing and commenters requested that, at a
the national best bid at the time of ultimate execution of multiple orders at minimum, the Commission clarify a
execution or, for a stopped sell order, a single equilibrium price.330 broker-dealer’s duty of best execution
higher than the national best offer at the with respect to manual quotations.336
4. Duty of Best Execution
time of execution.323 To illustrate the Another commenter suggested that
Several commenters on the original manual quotations be removed from the
operation of this requirement, assume proposal who supported excluding NBBO when the manual market is not
that a dealer’s customer wished to buy manual quotations from trade-through the primary market.337
a large amount of an NMS stock. protection also suggested that manual The Commission continues to be
Assume further that the dealer has quotations should be excluded from the concerned that eliminating all manual
agreed to guarantee execution of the NBBO that is calculated and quotations from the NBBO would
order at an average price no worse than disseminated by Plan processors.331 exclude not only inaccessible manual
$10.12 (the stop price), and that the Under this approach, market quotations, but also manual quotations
national best bid and offer for the stock participants could disregard manual that truly establish the best available
at the time was 10.05 to 10.07. If the quotations for purposes of assessing the price for a stock, particularly for those
dealer buys on behalf of the customer best execution of customer orders and stocks with relatively small trading
until half of the order is completed and calculating execution quality statistics volume in which a manual market has
has averaged 10.10 to that point, but the under Rule 11Ac1–5 (redesignated as a dominant share of trading. Such a
national best bid and offer for the stock Rule 605 of Regulation NMS). The result could lead to decreased execution
is then 10.15 to 10.17, the dealer would Reproposing Release did not propose to quality for investors in these stocks by
be obligated to execute the remainder of eliminate manual quotations from the allowing broker-dealers to ignore the
the order by selling to the customer at NBBO and emphasized that adoption of best available quotations when
10.14 to average 10.12 for the entire Rule 611 would not lessen a broker- executing customer orders. The
order. The exception in paragraph (b)(9) dealer’s duty of best execution.332 Commission therefore is not at this time
of Rule 611 permits the dealer to Noting the common business practice of excluding manual quotations from the
execute the remainder at 10.14 without market makers to use the NBBO to price NBBO or from the benchmark used for
being obligated to route to all protected investors orders (particularly retail calculating execution quality statistics
bids at 10.15. In addition, to qualify for orders), the Reproposing Release under Rule 605.
the exception, the stopped order must expressed concern that eliminating The Commission continues to
be for the account of a customer 324 and manual quotations from the NBBO emphasize that adoption of Rule 611 in
the customer must have agreed to the potentially would widen the spreads in no way lessens a broker-dealer’s duty of
‘‘stop’’ price on an order-by-order many stocks, even though the best execution. A broker-dealer has a
basis.325 The Commission notes that any quotations often may in fact represent legal duty to seek to obtain best
individual transactions executed by the the best indication of the current market execution of customer orders.338
dealer in the market for the customer price of the stock. According to the Report of the Special
must be executed in compliance with In response to the Reproposing Study of Securities Markets, ‘‘[t]he
Rule 611. Release, some commenters continued to integrity of the industry can be
Finally, paragraph (b) of Rule 611 assert that manual quotations should be maintained only if the fundamental
includes a variety of other exceptions: excluded from the NBBO.333 They principle that a customer should at all
(1) Transactions other than ‘‘regular believed that that it would be times get the best available price which
way’’ contracts; 326 (2) single-price inconsistent and unreasonable to
334 See, e.g., ATD Reproposal Letter at 6;
opening, reopening, or closing distinguish between automated and
Citigroup Reproposal Letter at 8; Madoff Reproposal
transactions; 327 and (3) transactions manual quotations for purposes of trade- Letter at 4.
executed at a time when protected through protection, market data 335 See, e.g., Citigroup Reproposal Letter at 8;
revenue, access fees, and requirements Knight Reproposal Letter at 6; STANY Reproposal
322 See section II.A.4.b and notes 251 to 257 and Letter at 11.
336 Ameritrade Reproposal Letter at 7–8; Merrill
accompanying text above for a discussion of this 328 Rule 611(b)(4).
exception. 329 Id.
Lynch Reproposal Letter at 8; SIA Reproposal Letter
323 Rule 611(b)(9)(iii).
at 15.
330 See supra, section II.A.2.b for a discussion of
337 ATD Reproposal Letter at 7.
324 Rule 611(b)(9)(i). Customer is defined in Rule this exception. 338 See, e.g., Newton v. Merrill, Lynch, Pierce,
600(b)(16) as any person that is not a broker or 331 See, e.g., Citigroup Letter at 3, 6; Goldman
Fenner & Smith, Inc., 135 F.3d 266, 269–70, 274 (3d
dealer. Sachs Letter at 5–6; Morgan Stanley Letter at 2–3,
325 Rule 611(b)(9)(ii).
Cir.), cert. denied, 525 U.S. 811 (1998); Certain
7; SIA Letter at 13. Market Making Activities on Nasdaq, Securities
326 Rule 611(b)(2). ‘‘Regular way’’ refers to bids, 332 Reproposing Release, 69 FR at 77447.
Exchange Act Release No. 40900 (Jan. 11, 1999)
offers, and transactions that embody the standard 333 See, e.g., Ameritrade Reproposal Letter at 7;
(settled case) (citing Sinclair v. SEC, 444 F.2d 399
terms and conditions of a market. Thus, this ATD Reproposal Letter at 7; Citigroup Reproposal (2d Cir. 1971); Arleen Hughes, 27 SEC 629, 636
exception applies to a transaction that was executed Letter at 8; Knight Reproposal Letter at 6; Madoff (1948), aff’d sub nom. Hughes v. SEC, 174 F.2d 969
other than pursuant to standardized terms and Reproposal Letter at 2–3; Morgan Stanley (D.C. Cir. 1949)). See also Order Execution
conditions, for instance a transaction that has Reproposal Letter at 12; SIA Reproposal Letter at 3, Obligations, Securities Exchange Act Release No.
extended settlement terms. 14–15; STANY Reproposal Letter at 10–11; UBS 37619A (Sept. 6, 1996), 61 FR 48290 (Sept. 12,
327 Rule 611(b)(3). Reproposal Letter at 6. 1996) (‘‘Order Handling Rules Release’’).
can reasonably be obtained for him is must examine their procedures for particular stock if its prior experience
followed.’’ 339 A broker-dealer’s duty of seeking to obtain best execution in light demonstrated that attempting to access
best execution derives from common of market and technology changes and the market would not be in its
law agency principles and fiduciary modify those practices if necessary to customers’ best interest. In making its
obligations, and is incorporated in SRO enable their customers to obtain the best assessment the broker-dealer would be
rules and, through judicial and reasonably available prices.343 In doing entitled to consider both the likelihood
Commission decisions, the antifraud so, broker-dealers must take into of receiving an execution at displayed
provisions of the federal securities account price improvement prices and the potential cost to its
laws.340 opportunities, and whether different customers of failed attempts. The
The duty of best execution requires markets may be more suitable for Commission also emphasizes that any
broker-dealers to execute customers’ different types of orders or particular trading center posting quotations,
trades at the most favorable terms securities.344 whether automated or manual, in the
reasonably available under the The protection against trade-throughs public quotation stream has a
circumstances, i.e., at the best required of trading centers by Rule 611 responsibility to be firm for its
reasonably available price.341 The undergirds the broker-dealer’s duty of quotations pursuant to Rule 602.
Commission has not viewed the duty of best execution, by helping ensure that
best execution as inconsistent with the customer orders are not executed at III. Access Rule
automated routing of orders or requiring prices inferior to the best protected For the NMS to fulfill its statutory
automated routing on an order-by-order quotations. Nonetheless, the Order objectives, fair and efficient access to
basis to the market with the best quoted Protection Rule does not supplant or each of the individual markets that
price at the time. Rather, the duty of diminish the broker-dealer’s participate in the NMS is essential. One
best execution requires broker-dealers to responsibility for achieving best of the statutory NMS objectives, for
periodically assess the quality of execution, including its duty to evaluate example, is to assure the practicability
competing markets to assure that order the execution quality of markets to of brokers executing investors’ orders in
flow is directed to the markets which it routes customer orders, the best market.345 Another is to assure
providing the most beneficial terms for regardless of the exceptions set forth in the efficient execution of securities
their customer orders.342 Broker-dealers the Rule. transactions.346 Clearly, neither of these
At the same time, however, the objectives can be achieved if brokers
339 H.R. Doc. No. 95, 88th Cong., 1st Sess. Pt. II, Commission recognizes the validity of cannot fairly and efficiently route orders
624 (1963). concerns expressed by commenters with to execute against the best quotations for
340 Order Handling Rules Release, 61 FR at 48322.
respect to the need for guidance a stock, wherever such quotations are
See also Newton, 135 F.3d at 270. Failure to satisfy
the duty of best execution can constitute fraud concerning their best execution displayed in the NMS. In 1975,
because a broker-dealer, in agreeing to execute a responsibilities after implementation of Congress determined that the ‘‘linking
customer’s order, makes an implied representation Regulation NMS. As they do today, of all markets’’ for NMS stocks through
that it will execute it in a manner that maximizes broker-dealers will continue to be able communications and data processing
the customer’s economic gain in the transaction.
See Newton, 135 F.3d at 273 (‘‘[T]he basis for the to assess the level of accessibility and facilities would ‘‘foster efficiency;
duty of best execution is the mutual understanding availability of manual quotations in enhance competition; increase the
that the client is engaging in the trade—and making their best execution information available to brokers,
retaining the services of the broker as his agent— determinations. In particular, when the dealers, and investors; facilitate the
solely for the purpose of maximizing his own
economic benefit, and that the broker receives her market for a stock is dominated by offsetting of investors’ orders; and
compensation because she assists the client in trading centers that display automated contribute to the best execution of
reaching that goal.’’); Marc N. Geman, Securities quotations, and a trading center that is investors’ orders.’’ 347 Since 1975, there
Exchange Act Release No. 43963 (Feb. 14, 2001) not a dominant market for the stock have been dramatic improvements in
(citing Newton, but concluding that respondent
fulfilled his duty of best execution). See also displays manual quotations, a broker- communications and processing
Payment for Order Flow, Securities Exchange Act dealer reasonably could determine, as technologies. Rule 610 is intended to
Release No. 34902 (Oct. 27, 1994), 59 FR 55006, part of its regular and rigorous review of capitalize on these improvements and
55009 (Nov. 2, 1994) (‘‘Payment for Order Flow execution quality, to bypass such a thereby enhance the ‘‘linking of all
Final Rules’’). If the broker-dealer intends not to act
in a manner that maximizes the customer’s benefit market with manual quotations in the markets’’ for the future NMS.
when he accepts the order and does not disclose All SROs that trade exchange-listed
this to the customer, the broker-dealer’s implied Market Regulation January 1994) (‘‘Without specific stocks currently are linked through ITS,
representation is false. See Newton, 135 F.3d at instructions from a customer, however, a broker- a collective intermarket linkage facility.
273–274. dealer should periodically assess the quality of
341 Newton, 135 F.3d at 270. Newton also noted competing markets to ensure that its order flow is ITS provides a means of access to
certain factors relevant to best execution—order directed to markets providing the most exchanges and Nasdaq by permitting
size, trading characteristics of the security, speed of advantageous terms for the customer’s order.’’); each market to send a ‘‘commitment to
execution, clearing costs, and the cost and difficulty Payment for Order Flow Final Rules, 59 FR at trade’’ through the system, with
of executing an order in a particular market. Id. at 55009.
270 n. 2 (citing Payment for Order Flow, Exchange 343 Order Handling Rules, 61 FR at 48323.
receiving markets generally having up to
Act Release No. 33026 (Oct. 6, 1993), 58 FR 52934, 344 Order Handling Rules, 61 FR at 48323. For 30 seconds to respond.348 ITS also
52937–38 (Oct. 13, 1993) (Proposed Rules)). See In example, in connection with orders that are to be provides access to quotations of
re E.F. Hutton & Co. (‘‘Manning’’), Securities executed at a market opening price, ‘‘[b]roker- participants without fees and
Exchange Act Release No. 25887 (July 6, 1988). See dealers are subject to a best execution duty in
also Payment for Order Flow Final Rules, 59 FR at
establishes uniform rules to govern
executing customer orders at the opening, and
55008–55009. should take into account the alternative methods in quoting practices.349 Although ITS
342 Order Handling Rules Release, 61 FR at determining how to obtain best execution for their promotes access among participants that
48322–48333 (‘‘In conducting the requisite customer orders.’’ Disclosure of Order Execution is uniform and free, it also is often slow
evaluation of its internal order handling and Routing Practices, Securities Exchange Act
procedures, a broker-dealer must regularly and Release No. 43590 (Nov.17, 2000), 65 FR 75414, 345 Section 11A(a)(1)(C)(iv) of the Exchange Act.
rigorously examine execution quality likely to be 75422 (Dec. 1, 2000) (adopting new Exchange Act 346 Section
obtained from different markets or market makers Rules 11Ac1–5 and 11Ac1–6 and noting that 11A(a)(1)(C)(i) of the Exchange Act.
347 Section 11A(a)(1)(D) of the Exchange Act.
trading a security.’’). See also Newton, 135 F.3d at alternative methods offered by some Nasdaq market
348 ITS Plan, Section 6(b)(i).
271; Market 2000: An Examination of Current centers for pre-open orders included the mid-point
Equity Market Developments V–4 (SEC Division of of the spread or at the bid or offer). 349 ITS Plan, Sections 6(b), 8(d), and 11(b).
and limited. Moreover, it is governed by quotations.352 In addition, the Rules 610(a) and (b) further the goal
a unanimous vote requirement that has Commission is modifying the fair access of fair and efficient access to quotations
at times impeded innovation in the requirements of Regulation ATS to primarily by prohibiting trading centers
system or its set of rules. extend their application to ATSs with from unfairly discriminating against
In contrast, there is no collective 5% of trading volume in a security.353 non-members or non-subscribers that
intermarket linkage system for Nasdaq attempt to access their quotations
A. Response to Comments and Basis for through a member or subscriber of the
stocks. Instead, access is achieved Adopted Rule
primarily through private linkages trading center. Market participants can
among individual trading centers. This 1. Means of Access to Quotations either become members or subscribers
approach has demonstrated its benefits of a trading center to obtain direct
Paragraphs (a) and (b) of Rule 610 access to its quotations, or they can
among electronic markets; it is flexible address means of access to quotations.
and can readily incorporate obtain indirect access by
Among the variety of services offered by ‘‘piggybacking’’ on the direct access of
technological advances as they occur. equity markets, access to displayed
There is no intermarket system, members or subscribers. These forms of
quotations, particularly the best access are widely used today in the
however, that offers free access to quotations of a trading center, is vital for
quotations in Nasdaq stocks. Nor are the market for Nasdaq stocks (as well as to
the smooth functioning of intermarket a lesser extent in the market for
trading centers for Nasdaq stocks subject trading. Brokers responsible for routing
to uniform intermarket standards exchange-listed stocks). Instead of every
their customers’ orders, as well as market participant establishing separate
governing their quoting and trading investors that make their own order-
practices. The fees for access to ECN linkages with every trading center,
routing decisions, clearly must have fair many different private firms have
quotations in Nasdaq stocks, as well as and efficient access to the best
the absence of standards for quotations entered the business of linking with a
displayed quotations of all trading wide range of trading centers and then
that lock and cross markets, have been centers to achieve best execution of
the source of disputes among offering their customers access to those
those orders. In addition, trading centers trading centers through the private
participants in the market for Nasdaq themselves must have the ability to
stocks for many years. Moreover, access firms’ linkages. Competitive forces
execute orders against the displayed determine the types and costs of these
problems have arisen with respect to quotations of other trading centers.
small market centers operating outside private linkages.
Indeed, the very concept of intermarket Most commenters supported this
of an SRO trading facility and markets protection against trade-throughs is private linkage approach for access to
like the Amex that engage in manual premised on the ability of trading quotations.356 They noted the success of
trading of Nasdaq stocks. Access centers to trade with, rather than trade private linkages among electronic
problems also have arisen with respect through, the protected quotations markets for Nasdaq stocks and
to intentional barriers to access, displayed by other trading centers. contrasted the speed and usefulness of
especially involving fees.
Access to quotations, sometimes those linkages with the ITS linkage for
Rule 610 reflects the Commission’s referred to as ‘‘order execution exchange-listed stocks. Morgan Stanley
determination that fair and efficient access,’’ 354 should be distinguished stated that ‘‘[p]rivate linkages are much
access to markets can be achieved from broader access to all of the easier to establish and operate and can
without a collective intermarket linkage different types of services offered by be constructed directly between [order
facility such as ITS, if baseline markets, such as the right to display execution facilities] or through market
intermarket access rules are limit orders or to submit complex order intermediaries. The smooth operation of
established.350 The rule adopts a private types. To obtain the full range of their the market for Nasdaq stocks today
linkage approach for all NMS stocks services, markets generally require that clearly demonstrates the power of
with modifications to address the most an individual or firm become a member private linkages.’’ 357 The NYSE
serious problems that have arisen with or subscriber of the market. This type of concluded that ‘‘[i]n the market for
this approach in the trading of Nasdaq access, or ‘‘membership access,’’ listed stocks, we believe that proposed
stocks. Rule 610 addresses three subject subsumes access to quotations and is Regulation NMS will provide the
areas: (1) Means of access to quotations; governed by particular regulatory framework for alternatives to ITS for
(2) fees for access to protected requirements. Sections 6(b)(2) and intermarket access.’’ 358 The SIA stated
quotations and any other quotations that 15A(b)(3) of the Exchange Act, for that ‘‘[p]rivate linkages, as opposed to
are the best bid or best offer of an example, provide for fair access to ITS-type linkages, will provide the
exchange, The NASDAQ Market Center, membership in SROs. Similarly, Rule flexibility—technologically and
or the NASD’s ADF; and (3) locking and 301(b)(5) of Regulation ATS prohibits otherwise—that is vital to the continued
crossing quotations.351 In response to certain high volume ATSs from denying development of the markets.359
comments on the reproposal, the fair access to their services.355 Rules Bloomberg expressed the belief that
Commission is modifying the fee 610(a) and (b), in contrast, only address private linkages have proven to be
limitation to apply to any quotation at the responsibilities of trading centers to effective in the market for Nasdaq
the best bid or offer as well as protected provide order execution access to their securities and ‘‘can readily, quickly and
quotations.
350 With the implementation of Rule 610, the 356 See, e.g., Citigroup Letter at 12; Consumer
Commission believes that SROs can withdraw from Federation Letter at 4; Goldman Sachs Letter at 4;
352 Seeinfra, section III.A.2.
the ITS Plan, assuming they have otherwise ICI Letter at 16–17; Morgan Stanley Letter at 17;
353 The modification of Regulation ATS is
arranged to meet their access responsibilities. Nasdaq Letter II at 20; NYSE Letter, Attachment at
351 The Commission has modified the language of discussed in section III.B.4 below. 6; Letter from Carrie E. Dwyer, General Counsel &
Rule 610(d) to require that an exchange or 354 See Rule 301(b)(3) of Regulation ATS (order Executive Vice President, Charles Schwab & Co.,
association ‘‘establish, maintain, and enforce’’ rules display and execution access requirements). Inc., to Jonathan G. Katz, Secretary, Commission,
relating to certain locking and crossing activity, and 355 As discussed in section III.B.4 below, the dated June 30, 2004 (‘‘Schwab Letter’’) at 17; SIA
to clarify that such rules must be written, to Commission is amending the fair access Letter at 16; UBS Letter at 8.
357 Morgan Stanley Letter at 17.
conform the language to the operative language of requirements of Regulation ATS to extend their
358 NYSE Letter, Attachment at 7.
Rule 611(a)(1). See infra note 455 and application to ATSs with 5% of trading volume in
accompanying text. a security. 359 SIA Reproposal Letter at 21.
inexpensively be adapted for use in importance of efficient access to each non-members will obtain free access to
exchange-listed securities,’’ and even trading center, particularly with respect quotations. Members who provide
believed that ITS can be abandoned.360 to access to ADF participants, the piggyback access to non-members will
A few commenters opposed the requirements in the Rule are designed to be providing a useful service and
proposed private linkages approach.361 mitigate concerns about the cost of presumably will charge a fee for such
Some questioned whether multiple access to ADF participants, as discussed service. The fee will be subject to
private linkages could match the below. In addition, the Commission competitive forces and likely will reflect
efficiency of a single, uniform believes, given the significant number the costs of SRO membership, plus
intermarket linkage, although they and variety of entities that currently some element of profit to the SRO’s
generally emphasized that the current provide access services and the members. As a result, non-members that
ITS linkage needed to be enhanced. The competitive nature of the market for frequently make use of indirect access
Alliance of Floor Brokers, for example, these services, that competition will be are likely to contribute indirectly to the
suggested that problems with the ITS sufficient to provide routing services for costs of membership in the SRO market.
linkage, such as its slow speed and lack any trading center that chooses to utilize Moreover, the unfair discrimination
of structural flexibility, ‘‘should be an outside vendor rather than incur standard of Rule 610(a) will apply only
addressed before it is determined to costs associated with building its own to access to quotations, not to the full
replace it with some, as yet unspecified, linkages. One ECN, for example, can be
routing methodology or panoply of services that markets
accessed through five extranets and at generally provide only to their
mechanism.’’ 362 While agreeing that least 21 other access providers, as well
private linkages could promote access if members. These other services will be
as through direct connections.366 subject to the more general fair access
they were not the sole means of Several commenters, including some
communications between trading provisions applicable to SROs and large
that otherwise supported the proposal, ECNs, as well as the statutory provisions
facilities and trading centers, and that expressed concern about particular
ITS’ ‘‘archaic technology and restrictive that govern SRO rules.
problems that might arise under a
membership provisions actively limit private linkage approach.367 Some were On the other hand, any attempt by an
access,’’ NexTrade contended that concerned that requiring non- SRO to charge differential fees based on
private linkages, if used to replace discriminatory access to markets might the non-member status of the person
existing and universal industry links, undermine the value of SRO obtaining indirect access to quotations,
could reduce total access.363 STANY membership. CHX stated that ‘‘[b]y such as whether it is a competing
believed that the Commission vastly requiring the Exchange to grant non- market maker, would violate the anti-
underestimated the access issues members access to the full capabilities discrimination standard of Rule 610. As
represented by the proposal, and raised of its order execution systems, the noted above, fair and efficient access to
a number of concerns regarding the Commission’s fair access proposal quotes is essential to the functioning of
costs and feasibility of implementing would inappropriately require the the NMS. To comply with the Order
the private linkage approach, including Exchange’s members to help fund the Protection Rule and their duty of best
issues relating to software, hardware, costs of operating a market that could be execution, trading centers often may be
maintenance, and protocols.364 routinely used by non-members. It required to access the quotations of
The Commission has carefully
would severely undercut the value of other trading centers. If a trading center
considered the views of all the
membership and enable non-members charged discriminatory fees to non-
commenters. The Commission agrees
to free-ride on the fees paid by members, including competitors,
with the commenters that stated that
members.’’ 368 Amex stated that ‘‘to the accessing its quotations, this would
private linkages currently work well in
the market for Nasdaq securities.365 The extent that the proposed rule interfere with the functioning of the
Commission believes that the benefits of undermines our right to differentiate private linkage approach and detract
private linkages, including their between members (who pay fees and from its usefulness to trading centers in
flexibility to meet the needs of different have duties and responsibilities to the meeting their regulatory responsibilities.
market participants and the scope they Exchange) and non-members in our
Other types of differential fees,
allow for competitive forces to charges, it could effectively remove any
however, would not violate the anti-
determine linkages, justifies reliance on incentive for Amex membership.’’ 369
discrimination standard of Rule 610.
this model rather than a single The Commission does not believe that
Fees with volume-based discounts or
intermarket linkage. Recognizing, the private linkage approach adopted
fees that are reasonably based on the
however, that the adoption of the Order today will seriously undermine the
cost of providing a particular service
Protection Rule increases the value of membership in SROs that offer
will be permitted, so long as they do not
valuable services to their members.
vary based on the non-member status of
360 Bloomberg Reproposal Letter at 7–8. First, the fact that markets will not be
361 See, allowed to impose unfairly a person obtaining indirect access to
e.g., Letter from Brendan R. Dowd, Daniel
W. Tandy & Ronald Zdrojeski, Alliance of Floor discriminatory terms on non-members quotations. For example, a member
Brokers, to Jonathan G. Katz, Secretary, who obtain indirect access to quotations providing indirect access could be given
Commission, dated June 24, 2004 (‘‘Alliance of
through members does not mean that a volume discount on the full amount of
Floor Brokers Letter’’) at 2; Ameritrade Letter I, its volume, including the volume
Appendix at 11; BSE Letter at 7; CHX Letter at 13;
E*Trade Letter at 9. 366 See www.nasdaqtrader.com/trader/ebrut/ accounted for by persons obtaining
362 Alliance of Floor Brokers Letter at 2. ourofferings/connectivity.shtm. indirect access to quotations.
363 NexTrade Reproposal Letter at 4. 367 Alliance of Floor Brokers Letter at 10; Amex
Another specific concern expressed
364 STANY Reproposal Letter at 3. Letter, Exhibit A at 25–26; BSE Letter at 12; CHX
365 See, e.g., Bloomberg Reproposal Letter at 7–8; Letter at 14; Citigroup Letter at 12; Letter from Edith by commenters about the private linkage
Brut Letter at 18; Letter from Richard M. Whiting, H. Hallahan, First Vice President, Deputy General approach was the cost and difficulty of
Executive Director and General Counsel, Financial Counsel, Philadelphia Stock Exchange, to Jonathan building efficient linkages to trading
Services Roundtable, to Jonathan G. Katz, Secretary, G. Katz, Secretary, Commission, dated August 10,
2004 (‘‘Phlx Letter’’) at 2; STANY Letter at 9.
centers with a small amount of trading
Commission, dated June 30, 2004 (‘‘FSR Letter’’) at
4; Merrill Lynch Reproposal Letter at 8; Nasdaq 368 CHX Letter at 14. volume that do not make their
Letter II at 20. 369 Amex Letter, Exhibit A at 26. quotations accessible through an SRO
trading facility.370 Such concerns arise it had sought to avoid such ADF trading A large number of commenters on the
at present with respect to the ADF, a centers in the past, but that the reproposal supported the proposed
display-only quotation facility operated extension of trade-through protection to requirements in Rule 610(b)(1).378 The
by the NASD, because quotations Nasdaq stocks would eliminate this SIA, for example, stated that this
displayed by ADF participants can only option. requirement would likely address most
be reached by obtaining direct access to The SIA also believed that ‘‘reliance of its previously stated concerns about
that trading center. As a result, the solely on the SEC’s proposed market ATSs and market makers that choose to
greater the number of ADF participants, access rules would fail to address access make their quotations accessible only
the greater the number of separate issues related to smaller markets * * *. through the ADF.379 One commenter
connectivity points that market If the SEC obligates market participants noted that it thought the approach was
participants will need to access to to trade with [a smaller ADF market fair and appropriate.380
comply with the Order Protection Rule maker or ATS] by promulgating a trade- At the same time, some commenters
and to meet their best execution through rule, we are concerned about (both those supporting and those
responsibilities. The Commission’s the firms’ burden of creating many opposing the reproposed access
original proposal would have required private linkages to many small ATSs standards) continued to voice their
such trading centers to provide access that may charge exorbitant fees for the concerns about the potential need to
only to SROs and other ADF necessary access.’’ 374 SIA members develop, and the costs of developing,
participants. At the NMS Hearing, were divided, however, on the best connections to numerous small trading
several panelists expressed concern that means to resolve the issue. Some centers in the ADF.381 For instance, one
this requirement would be inadequate to favored requiring smaller trading commenter, noting that the ADF is not
assure sufficient access, which centers to make their quotes accessible a single market and that the expense of
prompted the Commission to request through an SRO trading facility. Other access increases proportionally by the
comment on the matter in its SIA members, as well as other number of markets that must be
Supplemental Release.371 It noted that commenters, recommended requiring all accessed, stated that the cost of
panelists at the NMS Hearing had trading centers to make their best accessing more than one or two
suggested that relatively inactive ATSs quotations available through a public additional markets would be prohibitive
and market makers should be required intermarket linkage facility.375 for most of its members.382 Several
to publish their quotations in an SRO One commenter, in contrast, believed commenters believed that non-SRO
trading facility, at least until their share that access to trading centers quoting on trading centers should make their
of trading reached a point where the the ADF should be addressed by quotations available through the
cost of direct connections to those requiring the NASD to add an order automatic execution facilities of an
markets would not be out of proportion execution functionality to ADF. SRO, thereby requiring other market
to their volume of trading. Alternatively, NexTrade stated that the ADF was participants to only have to maintain
the Supplemental Release requested created to make participation in access to six or seven markets, rather
comment on whether an SRO without a Nasdaq’s SuperMontage facility than potentially dozens.383 In contrast,
trading facility, of which the NASD is voluntary. It believed that ‘‘the one commenter that is an ADF
currently the only one, should be Commission should re-evaluate whether participant continued to express its
required to ensure that any ATS or or not ‘private sector’ solutions for SROs concerns with the proposed access
market maker is directly connected to without an execution mechanism are requirements, stating its belief that the
most market participants before sufficient for the investment community proposal to require ADF participants to
publishing its quotations in a display- to satisfy its various obligations under establish the necessary connectivity that
only facility. the Act.’’ 376 would facilitate efficient access to their
Several commenters on the original quotations would create a cost barrier
proposal supported the approach of After considering the various views of that discriminates against smaller firms
requiring low-volume trading centers to commenters on the original proposal, in in the ADF.384
make their quotations available through the Reproposing Release the
an SRO trading center.372 Brut, for Commission proposed to require ADF 378 See, e.g., CIBC Reproposal Letter at 1; JP
example, stated that the presence of participants to bear the costs of Morgan Reproposal Letter at 2; Letter from Paul W.
such low-volume trading centers providing the necessary connectivity Lerro to Jonathan G. Katz, Secretary, Commission,
that would facilitate efficient access to dated January 22, 2005 (‘‘Lerro Reproposal Letter’’)
‘‘requires vast industry investments to at 14; Merrill Lynch Reproposal Letter at 9; Nasdaq
establish private connectivity (or utilize their quotations.377 Specifically, under Reproposal Letter at 18 (although advocating
vendors) to access these markets—no reproposed Rule 610(b)(1) those ATSs requiring trading facilities with less than a five
matter how small or potentially how and market makers that choose to percent share volume to make their quotations
display quotations in the ADF would available through an SRO trading facility, thought
fleeting—to satisfy best execution that the Commission’s proposal was the ‘‘next best
obligations and avoid market bear the responsibility of providing a approach’’); SIA Reproposal Letter at 3, 21; UBS
disruption. The effort and investment to level and cost of access to their Reproposal Letter at 1; Vanguard Reproposal Letter
establish such connectivity is quotations that is substantially at 5.
disproportionate to the liquidity on equivalent to the level and cost of access 379 SIA Reproposal Letter at 3.
380 Citigroup Reproposal Letter at 4.
such market.’’ 373 Brut further noted that to quotations displayed by SRO trading
381 See, e.g., Merrill Lynch Reproposal Letter at 9;
facilities.
SIA Reproposal Letter at 21; STANY Reproposal
370 Amex Letter at 8; Brut Letter at 19; Citigroup Letter at 3–4.
Letter at 13; E*Trade Letter at 9; Nasdaq Letter II 374 SIA Letter at 16. 382 STANY Reproposal Letter at 3.
at 22; SIA Letter at 16; Specialist Assoc. Letter at 375 See, e.g., Ameritrade Letter I, Appendix at 11; 383 See, e.g., Knight Reproposal Letter at 5;
12; STA Letter at 4; STANY Letter at 10; UBS Letter E*Trade Letter at 9; SIA Letter at 17. Nasdaq Reproposal Letter at 17–18 (expressing the
at 9. 376 Letter from John M. Schaible, President, view that trading facilities with less than a five
371 Hearing Tr. at 135, 138–140; Supplemental
NexTrade Holdings, Inc., to Jonathan G. Katz, percent volume shares should be required to make
Release, 69 FR at 30146. Secretary, Commission, dated July 29, 2004 their quotations available through an SRO trading
372 See, e.g., Brut Letter at 13; Citigroup Letter at (‘‘NexTrade Letter’’) at 14. facility); STA Reproposal Letter at 6; Type N
13; SIA Letter at 17 (some firms). 377 See Section III.A.1 of the Reproposing Release Reproposal Letter at 1.
373 Brut Letter at 13. for a discussion of the comments. 384 NexTrade Reproposal Letter at 4–6.
The Commission has decided to adopt wish to trade NMS stocks can choose quotation facility to provide a level and
Rule 610(b)(1) as reproposed, but does from a number of options for quoting cost of access to such quotations that is
not believe that its adopted access and trading. They can become a member substantially equivalent to the level and
approach discriminates against smaller of a national securities exchange and cost of access to quotations displayed by
firms or creates a barrier to access for quote and trade through the exchange’s SRO trading facilities. Rule 610(b)
innovative new market entrants. Rather, trading facilities. They can participate therefore may cause trading centers that
smaller firms and new entrants have a in The NASDAQ Market Center and display quotations in the ADF to incur
range of alternatives from which to quote and trade through that facility. By additional costs to enhance the level of
choose that will allow them to avoid choosing either of these options, an ATS access to their quotations and to lower
incurring any costs to meet the or market maker would not create a new the cost of connectivity for market
connectivity requirements of Rule connectivity point that all other market participants seeking to access their
610(b)(1) if they wish to do so. This participants must reach and would not quotations. The extent to which these
approach is fully consistent with be subject to Rule 610(b)(1). Some firms, trading centers in fact incur additional
Congressional policy set forth in the however, may not want to participate in costs to comply with the adopted access
Regulatory Flexibility Act, which an SRO trading facility. These ATSs and standards will be largely within the
directs the Commission to consider market makers can quote and trade in control of the trading center itself. As
significant alternatives to regulations the OTC market. The existence of the noted above, ATSs and market makers
that accomplish the stated objectives of NASD’s ADF makes this third choice that wish to trade NMS stocks can
the Exchange Act and minimize the possible by providing a facility for choose from a number of options for
economic impact on small entities.385 displaying quotations and reporting quoting and trading, including quoting
Small ATSs are exempt from transactions in the consolidated data and trading in the OTC market. As a
participation in the consolidated stream. result, the additional connectivity
quotation system and, therefore, from The NASD is not, however, statutorily requirements of Rule 610(b) will be
the connectivity requirements of Rule required to provide an order execution triggered only by a trading center that
610. Under Rule 301(b)(3) of Regulation functionality in the ADF. As a national displays its quotations in the
ATS, an ATS is required to display its securities association, the NASD is consolidated data stream and chooses
quotations in the consolidated quotation subject to different regulatory not to provide access to those quotations
stream only in those securities for requirements than a national securities through an SRO trading facility.
which its trading volume reaches 5% of exchange. It is responsible for regulating Currently, nine SROs operate trading
total trading volume. Consequently, the OTC market (i.e., trading by broker- facilities in NMS stocks. Market
smaller ATSs are not required to dealers otherwise than on a national participants throughout the securities
provide their quotations to any SRO securities exchange). Section 15A(b)(11) industry generally have established
(whether an SRO trading facility or the of the Exchange Act requires an connectivity to these nine points of
NASD’s ADF) and thereby trigger the association to have rules governing the access to quotations in NMS stocks. By
access requirements of Rule 610. form and content of quotations relating choosing to display quotations in the
Moreover, potential new entrants with to securities sold otherwise than on a ADF, a trading center effectively could
innovative trading mechanisms can national securities exchange that are require the entire industry to establish
commence business without having to published by a member of the connectivity to an additional point of
incur any costs associated with association. Such rules must be access. Potentially, many trading centers
participation in the consolidated designed to produce fair and could choose to display quotations in
quotation system. informative quotations and to promote the ADF, thereby significantly
Some smaller ATSs, however, may orderly procedures for collecting, increasing the overall costs of
wish to participate voluntarily in the distributing, and publishing quotations. connectivity in the NMS. Such an
consolidated quotation system. Such The Exchange Act does not expressly inefficient outcome would become
participation can benefit smaller firms require an association to establish a much more likely if an ADF trading
and promote competition among facility for executing orders against the center were not required to assume
markets by enabling smaller firms to quotations of its members, although it responsibility for the additional costs
obtain wide distribution of their could choose to do so. associated with its decision to display
quotations among all market The Commission believes that market quotations outside of an established
participants.386 Here, too, such firms makers and ECNs should continue to SRO trading facility.
will have alternatives that would not have the option of operating in the OTC Although the Exchange Act envisions
obligate them to comply with the market, rather than on an exchange or an individual broker-dealer having the
connectivity requirements of Rule The NASDAQ Market Center. As noted option of trading in the OTC market,388
610(b)(1). ATSs and market makers that in the Commission’s order approving it does not mandate that the securities
Nasdaq’s SuperMontage trading facility, industry in general must subsidize the
385 5 U.S.C. 603(c). In the Reproposing Release,
this ability to operate in the ADF is an costs of accessing a broker-dealer’s
the Commission noted that only two of the
approximately 600 broker-dealers (including ATSs)
important competitive alternative to quotations in the OTC market if the
that would be subject to Rule 610 are considered Nasdaq or exchange affiliation.387 NASD chooses not to provide
small (total capital of less than $500,000) for Therefore, the Commission has connectivity. The Commission believes
purposes of the Regulatory Flexibility Act. 69 FR at determined not to require small trading that it is reasonable and appropriate to
77492. The adopted access approach provides
alternatives that will benefit a wider range of
centers to make their quotations require those ATSs and market makers
smaller ATSs than the two that are considered accessible through an SRO trading that choose to display quotations in the
small entities. facility. ADF to bear the responsibility of
386 See infra, note 566 (the Commission’s
Instead, Rule 610(b)(1) requires all providing a level and cost of access to
Advisory Committee on Market Information trading centers that choose to display their quotations that is substantially
recommended retention of the consolidated display
requirement because, among other things, it ‘‘may quotations in an SRO display-only equivalent to the level and cost of access
promote market competition by assuring that
information from newer or smaller exchanges is 387 See Securities Exchange Act Release No. 388 See Sections 11A(c)(3)(A) and (4) of the
widely distributed.’’). 43863 (Jan. 19, 2001), 66 FR 8020 (Jan. 26, 2001). Exchange Act, 15 U.S.C 78k–1(c)(3)(A) and (4).
to quotations displayed by SRO trading direct access options and private participant comes into compliance.395
facilities. Under Rule 610(b)(1), networks. The option of participation in The Commission also believes that, in
therefore, ADF participants will be existing market infrastructure and light of these new access standards, the
required to bear the costs of the systems should reduce a trading center’s addition of a new ADF participant
necessary connectivity to facilitate cost of compliance. would constitute a change in a material
efficient access to their quotations. This Two commenters raised concerns aspect of the operation of the NASD’s
standard will help ensure that about reliance on third party private facilities, and thus require the filing of
additional connectivity burdens are not vendors to provide access, since they a proposed rule change pursuant to
imposed on the securities industry each may not be regulated by the Section 19(b) of the Exchange Act that
time that an additional ADF participant Commission and thus could deny access would be subject to public notice and
necessitates a new connectivity point by to a trading center they viewed as a comment.396 Alternatively, the NASD
choosing to begin displaying quotations competitor, or because utilizing their could choose to provide a
in the consolidated quotation stream. services to link to other trading centers communications facility that would link
To clarify the intent of this is outside the control of a trading all of the ADF participants to each other
requirement, the Commission center.391 The Commission believes that and that would provide a single point of
emphasizes that a ‘‘substantially the requirement in Rule 610(b)(1) that access to market participants attempting
equivalent’’ cost of access will not be ADF participants provide a substantially to access an ADF participant.397
evaluated in terms of absolute dollar equivalent level of access will preclude 2. Limitation on Access Fees
costs of access and therefore does not the ADF participant from providing
necessarily allow an ATS or market A number of ECN trading centers
access only through a narrow range of charge fees to incoming orders that
maker quoting in the ADF to charge the private access providers. The range of
same fees or impose the same costs that execute against their displayed
access providers must be sufficient to quotations.398 These ECNs typically
an SRO trading facility charges or provide access substantially equivalent
imposes. Rather, the standard in Rule pass a substantial portion of the access
to SRO trading facilities. In these fee on to limit order customers as
610(b)(1) compares the costs to an ADF circumstances, and given the significant
participant’s relative degree of trading rebates for supplying the accessed
number and variety of entities that liquidity (i.e., submitting non-
volume.389 Consequently, the cost of currently provide access services and
access to an ADF participant must be marketable limit orders). For Nasdaq
the competitive nature of the market for stocks, ECNs have charged access fees
substantially equivalent to the cost of these services, the Commission believes
access to SRO trading facilities on a per directly to their subscribers, but also
that competition will be sufficient to have charged access fees to non-
transaction basis. For example, a $1000 provide services for any trading center
port fee charged by an ECN participating subscribers when their quotations have
choosing to utilize an outside vendor.392 been displayed and executed through
in the ADF that trades one million
shares a day would not be substantially One commenter emphasized the Nasdaq facilities. Market makers have
equivalent to a $1000 port fee charged importance of the NASD carefully not been permitted to charge any fee for
by an SRO trading facility trading 100 assessing and monitoring the extent to counterparties accessing their
million shares a day. which ADF participants meet the access quotations under the Quote Rule. Other
As discussed above, the Commission standards of Rule 610(b).393 The types of trading centers, including
recognizes that trading centers subject to Commission agrees that effective NASD exchange SROs, may charge fees that are
Rule 610(b)(1) may incur costs oversight of ADF participants’ triggered when incoming orders access
associated with providing access to their compliance with the Rule is critical to their displayed quotations. These fees
quotations in compliance with the Rule, the viability of the access standards have only been charged to their
although the costs will vary depending adopted today, given that these members, because only members have
upon the manner in which each trading participants are not accessible through the right to route orders to an exchange
center determines to provide such an SRO trading facility. As the self- other than through ITS. For exchange-
access. As noted in the Commission’s regulatory authority responsible for the listed stocks, however, the ITS has
order approving the pilot program for OTC market, the NASD must act as the provided free intermarket access to
the ADF, the reduction in ‘‘gatekeeper’’ for the ADF, and, as such, quotations in other markets for its
communications line costs in recent will need to closely assess the extent to participants.
which ADF participants meet the access The trade-through protection and
years and the advent of competing
standards of Rule 610. Prior to linkage requirements adopted today will
access providers offer the potential for
implementation of Rule 610, the NASD significantly alter the conditions that
multiple competitive means of access to
will need to make an affirmative have shaped access fee practices in the
the various trading centers that trade
determination that existing ADF past. For exchange-listed stocks, Rule
NMS stocks.390 To meet their regulatory
participants are in compliance with the 610 adopts a private linkage approach
requirements, ADF participants will
requirements of the Rule.394 If an ADF that relies on access through members
have the option of establishing and,
participant is not complying with these and subscribers rather than through a
when necessary, paying for connections public intermarket linkage system. For
to industry access providers that have access standards, the NASD would have
extensive connections to a wide array of a responsibility to stop publishing the
395 Id.
market participants through a variety of participant’s quotations until the 396 See Rule 19b–4(b)(1) under the Exchange Act,
17 CFR 240.19b–4(b)(1).
389 Cf. NexTrade Reproposal Letter at 6. See 391 NexTrade Reproposal Letter at 6; STANY 397 The Commission does not believe that NASD,
Section III.A.1 of the Reproposing Release and Reproposal Letter at 4. solely by providing such a communications facility,
392 For example, as noted above, one ECN can be
supra notes 370 to 375 discussing the concerns of would fall within the definition of SRO trading
commenters and panelists at the NMS Hearings accessed through five extranets and at least 21 other facility, which applies to an SRO that operates a
regarding access to relatively inactive ATSs and access providers, as well as through direct facility that executes orders in a security or presents
market makers with a small amount of trading connections. orders to members for execution.
volume. 393 SIA Reproposal Letter at 21. 398 A full description of the current framework for
390 Securities Exchange Act Release No. 46249 394 See Section 15A of the Exchange Act, 15 access fees is provided in the Proposing Release. 69
(July 24, 2002), 67 FR 49822 (July 31, 2002). U.S.C. 78o–3. FR at 11156.
access outside of ITS, markets will pay, difficult issue.401 They believed that the one commenter stated that the
directly or indirectly, the fees charged proposal would level the playing field reproposal is a reasonable alternative to
by other markets to their members and in terms of who could charge fees, and either banning access fees outright or
subscribers. For Nasdaq stocks, the provide some measure of certainty to permitting access fees with relatively
Order Protection Rule will, for the first market participants that the quoted high price caps.408
time, establish price protection, so price will be, essentially, the price they Another group of commenters
market participants will no longer have will pay. Other commenters were opposed the Commission’s access fee
the option of bypassing the quotations strongly opposed to any limitation on limitation,409 with some opposing any
of trading centers with access fees that fees, believing that competition alone effort to limit fees through regulatory
they view as too high. would sufficiently address the high fees means 410 and others believing that all
The benefits of strengthened price that distort quoted prices.402 One access fees should be prohibited.411
protection and more efficient linkages asserted that ‘‘[c]ompetitive forces have Many of those against imposing any fee
could be compromised if trading centers satisfactorily dealt with the issue of limitation believed that competition was
are able to charge substantial fees for outlier ECNs * * * [M]arket the best means for determining
accessing their quotations. Moreover, participants have put them at the prices,412 although at least one
the wider the disparity in the level of bottom of their order routing tables, commenter acknowledged a trade-
access fees among different market which means that orders placed on through rule could change this
centers, the less useful and accurate are these ECNs would be the last to be competitive dynamic.413 One
the prices of quotations displayed for executed at any price level, a position commenter questioned the
NMS stocks. For example, if two trading that no market participant wants to be Commission’s statutory authority to
centers displayed quotations to sell an in.’’ 403 In contrast, some commenters impose an access fee cap.414
NMS stock for $10.00 per share, one argued that all access fees charged to Some of the commenters that
offer could be accessible for a total price non-members and non-subscribers supported a total ban on access fees
of $10.00 plus a $0.009 fee, while the should be prohibited, but believed that nonetheless supported the
second trading center might not charge the proposed fee limitations should not Commission’s efforts to limit fees, if the
apply to SRO transaction fees, Commission were to permit access
any access fee. What appeared in the
particularly those that are filed with the fees.415 Some commenters, although
consolidated data stream to be identical
Commission for approval.404 Finally, a opposed to a fee limitation, thought that
quotations would in fact be far from
few commenters questioned the the reproposal improved on the original
identical.
Commission’s authority to set proposal.416 One commenter stated that
To address the potential distortions
caused by substantial, disparate fees, the limitations on access fees.405
inevitable consequence of the trade-through
original access proposal included a After considering the many divergent proposal, needed because markets and market
limitation on fees. Trading centers views of the commenters on the original participants could otherwise take advantage of the
would have been limited to a fee of no proposal, the Commission reproposed a power granted to them. Nasdaq Reproposal Letter
flat $0.003 per share access fee cap.406 at 19.
more than $0.001 per share. Liquidity 408 Deutsche Bank Reproposal Letter at 3.
providers also would have been limited Commenters on the reproposal also held 409 See Ameritrade Reproposal Letter at 10;
to a fee of no more than $0.001 per share varying views with regard to the ArcaEx Reproposal Letter at 9–10; BGI Reproposal
for attributable quotations, but could not proposal to limit access fees to $0.003 Letter at 3; Bloomberg Reproposal Letter at 1, 8; BSE
have charged any fee for non- per share. One group of commenters Reproposal Letter at 2; CHX Reproposal Letter at 4;
supported the reproposal’s simplified Letter from Lawrence E. Harris, Fred V. Keenan
attributable quotations. In addition, the Chair in Finance, Department of Finance and
proposal established an accumulated fee approach to access fees.407 For example, Business Economics, Marshall School of Business,
limitation of no more than $0.002 per University of Southern California, to Jonathan G.
401 See, e.g., BNY Letter at 4; Letter from Kenneth Katz, Secretary, Commission, dated February 5,
share for any transaction. At the NMS 2005 (‘‘Harris Reproposal Letter’’) at 4–5; Instinet
Griffin, President & Chief Executive Officer, Citadel
Hearing, panelists sharply disagreed Investment Group, L.L.C., to Jonathan G. Katz, Reproposal Letter at 10; Merrill Lynch Reproposal
about access fees, with some panelists Secretary, Commission, dated July 9, 2004 (‘‘Citadel Letter at 3, 9; Morgan Stanley Reproposal Letter at
arguing that agency markets must be Letter’’) at 9; Citigroup Letter at 14; E*Trade Letter 12–13; NexTrade Reproposal Letter at 7–8; Phlx
at 10; Nasdaq Letter II at 3; SIA Letter (some Reproposal Letter at 4–5.
allowed to charge access fees for their
members) at 18. 410 See, e.g., ArcaEx Reproposal Letter at 10; BGI
services, and other panelists arguing 402 See, e.g., Brut Letter at 12; Instinet Letter at Reproposal Letter at 3; BSE Reproposal Letter at 2;
that access fees distort quotation prices 24; SIA Letter (some firms) at 18. CHX Reproposal Letter at 4; Phlx Reproposal Letter
and should be banned.399 In the 403 Instinet Letter at 27. at 4–5.
411 See, e.g., Bloomberg Reproposal Letter at 8;
Supplemental Release, therefore, the 404 See, e.g., Amex Letter at 7–8; Goldman Sachs
Letter at 5; Knight Letter II at 2; NYSE Letter at 5; Harris Reproposal Letter at 4–5; Merrill Lynch
Commission requested comment on all Reproposal Letter at 3.
STA Letter at 6.
aspects of the proposed fee limitations, 405 See, e.g., Instinet Letter at 24; Letter from 412 Ameritrade Reproposal Letter at 10; ArcaEx
including whether it should adopt a Roderick Covlin, Executive Vice President, Reproposal Letter at 10; CHX Reproposal Letter at
single accumulated fee limitation that TrackECN, to William H. Donaldson, Chairman, 4; Instinet Reproposal Letter at 10.
would apply to all types of market Commission, dated May 10, 2004 (‘‘TrackECN
centers, and, if so, whether the proposed Letter’’) at 1. 414 Instinet Reproposal Letter at 10.
406 For the relatively small number of NMS stocks 415 See, e.g., Citigroup Reproposal Letter at 4
$0.002 per share was an appropriate priced under $1.00, fees will be limited to 0.3% of (although advocating that the access fee limitation
amount, or whether the amount should the quotation price per share to prevent fees from should be set at $0.001, or the original proposal’s
be higher or lower.400 constituting an excessive percentage of share price. tiered cap of $0.002); Knight Trading Group
Commenters on the original proposal 407 See, e.g., BNY Reproposal Letter at 1,3; Reproposal Letter at 6; STA Reproposal Letter at 4
Deutsche Bank Reproposal Letter at 3; FSR (supporting the $0.003 per share cap in the absence
were splintered on the issue of access Reproposal Letter at 4 (some members supported of complete prohibition on fees); STANY
fees. A number supported the the proposal, which they believed would provide Reproposal Letter at 5 (supporting the $0.003 per
Commission’s proposal as a worthwhile certainty for all market participants, while other share cap in the absence of complete elimination of
compromise resolution on an extremely members believed that access fees should be non-subscriber fees).
banned entirely); JP Morgan Reproposal Letter at 2; 416 Bloomberg Reproposal Letter at 8 (supporting
SIA Reproposal Letter at 3 (members were split). abolishment of all access fees, but praising the
399 See, e.g., Hearing Tr. at 166, 168. Nasdaq, although questioning the inflexibility of the Reproposal’s simplified approach); Instinet
400 Supplemental Release, 69 FR at 30147. fee limitation, stated that the fee limits were an Reproposal Letter at 3, 10–11.
the reproposal improved on the original the Order Protection Rule. It also statutory purposes of the NMS by
fee limitation proposal by eliminating precludes a trading center from charging harmonizing quotation practices and
the attribution requirement, reducing high fees selectively to competitors, precluding the distortive effects of
the potential for unintended practices that have occurred in the exorbitant fees. Moreover, the fee
consequences, and simplifying its market for Nasdaq stocks. In the absence limitation is necessary to further the
administration.417 of a fee limitation, the adoption of the statutory purpose of enabling broker-
Although acknowledging the many Order Protection Rule and private dealers to route orders in a manner
difficult issues associated with access linkages could significantly boost the consistent with the operation of the
fees, the Commission remains viability of the outlier business model. NMS.422 To protect limit orders, orders
concerned that these issues must be Outlier markets might well try to take must be routed to those markets
resolved to promote a fair and efficient advantage of intermarket price displaying the best-priced quotations.
NMS, particularly under the regulatory protection by acting essentially as a toll This purpose would be thwarted if
structure adopted today. As the SIA booth between price levels. The high fee market participants were allowed to
noted in its discussion of access fees, its market likely will be the last market to charge exorbitant fees that distort
members continue to be united in their which orders would be routed, but quoted prices.
desire for a market-wide resolution of prices could not move to the next level The Commission notes the $0.003 fee
the access fee issue, although divided until someone routed an order to take limitation is consistent with current
on the optimum solution.418 out the displayed price at the outlier business practices, as very few trading
After considering the continuing market. Therefore, the outlier market centers currently charge fees that exceed
divergent views of commenters, the might see little downside to charging this amount.423 It appears that only two
Commission believes that a flat exceptionally high fees, such as $0.009, ECNs currently charges fees that exceed
limitation on access fees to $0.003 per even if it is last in priority. While $0.003, charging $0.005 for access
share is the fairest and most appropriate markets would have significant through the ADF. These ECNs currently
solution to what has been a incentives to compete to be near the top do not account for a large percentage of
longstanding and contentious issue.419 in order-routing priority,421 there might trading volume. In addition, while a few
The limitation is intended to achieve be little incentive to avoid being the SROs have large fees on their books for
several objectives. First, Rule 610(c) least-preferred market if fees were not transactions in ETFs that exceed a
promotes the NMS objective of equal limited. certain size (e.g., 2100 shares), it is
regulation of markets and broker-dealers The $0.003 cap will limit the outlier unlikely that these fees generate a large
by applying equally to all types of business model. It will place all markets amount of revenues.
trading centers and all types of market on a level playing field in terms of the Accordingly, the adopted fee
participants.420 As noted above, fees they can charge and the rebates limitation will not impair the agency
although ECNs and other types of they can pass on to liquidity providers. market business model. The
trading centers, including SROs, may Some markets might choose to charge Commission recognizes that agency
currently charge access fees, market lower fees, thereby increasing their trading centers perform valuable agency
makers have not been permitted to ranking in the preferences of order services in bringing buyers and sellers
charge any fee for counterparties routers. Others might charge the full together, and that their business model
accessing their quotations. The $0.003 and rebate a substantial historically has relied, at least in part,
Commission believes, however, that it is proportion to liquidity providers. on charging fees for execution of orders
consistent with the Quote Rule for Competition will determine which against their displayed quotations.
market makers to charge fees for access strategy is most successful. Under current conditions, the
to their quotations, so long as such fees Moreover, the fee limitation is Commission believes that prohibiting
meet the requirements of Rule 610(c). In necessary to achieve the purposes of the access fees entirely would unduly harm
particular, market makers will be Exchange Act. Access fees tend to be this business model.
permitted to charge fees for executions highest when markets use them to fund Several commenters believed that,
of orders against their quotations, substantial rebates to liquidity because best execution responsibilities
irrespective of whether the order providers, rather than merely to may require a broker-dealer to access
executions are effected on an SRO compensate for agency services. If non-protected quotations, the
trading facility or directly by the market outlier markets are allowed to charge Commission should extend the access
maker. high fees and pass most of them through
Second, the adopted fee limitation is fee cap to all quotations, not just
as rebates, the published quotations of protected quotations.424 One commenter
designed to preclude individual trading such markets would not reliably
centers from raising their fees indicate the true price that is actually 422 Section 11A(c)(1)(E) of the Exchange Act
substantially in an attempt to take available to investors or that would be authorizes the Commission to adopt rules assuring
improper advantage of strengthened realized by liquidity providers. Section that broker-dealers transmit orders for NMS stocks
protection against trade-throughs and 11A(c)(1)(B) of the Exchange Act
in a manner consistent with the establishment and
the adoption of a private linkage regime. operation of a national market system.
authorizes the Commission to adopt 423 Cf. Instinet Letter at 38 (‘‘there is no basis for
In particular, the fee limitation is rules assuring the fairness and adopting any limitation other than at the prevailing
necessary to address ‘‘outlier’’ trading usefulness of quotation information. For $0.003 per share level, which was arrived at
centers that otherwise might charge high quotations to be fair and useful, there through open competition among ATSs, ECNs, and
fees to other market participants SRO markets in the Nasdaq market’’) and Instinet
must be some limit on the extent to Reproposal Letter at 11 (‘‘as for an appropriate
required to access their quotations by
which the true price for those who amount for such an accumulated fee limitation, the
access quotations can vary from the Reproposal sets the cap at the prevailing $0.003 per
417 Instinet Reproposal Letter at 3, 10–11. share level for stocks priced above $1.00, which
418 SIA Reproposal Letter at 3.
displayed price. Consequently, the was arrived at through open competition among
419 For the relatively small number of NMS stocks $0.003 fee limitation will further the marketplaces’’).
priced under $1.00, fees will be limited to 0.3% of 424 Ameritrade Reproposal Letter at 10 (only if fee
the quotation price per share to prevent fees from 421 See supra, section II.A.4.a (discussion of limitation is adopted); Citigroup Reproposal Letter
constituting an excessive percentage of share price. competitive implications of trade-through at 4; Madoff Reproposal Letter at 5 (also stating that
420 Section 11A(c)(1)(F) of the Exchange Act. protection). Continued
argued that the potential contribution of charged different fees based on whether obviously will not be a problem for
manual quotations to a market center’s or not a quotation was protected.428 In trading centers that do not charge any
execution quality could require market particular, one commenter raised the fees in excess of the cap. Given the often
participants to access those quotations issue in the context of a sweep order rapid updating of quotations in NMS
to fulfill their duty of best execution, that could hit non-protected quotations, stocks, however, the Commission does
even though they are not protected by and advocated applying the access fee not believe a trading center that charges
Rule 611.425 Thus, the commenter limit to all sweep orders.429 The fees above the cap for quotations that
suggested that the access fee limitation Commission acknowledges these are not subject to the fee cap could
should apply to all quotations, concerns, but notes that market comply with the Rule unless it provides
including manual quotations, so as not participants will be able to control the a functionality that enables market
to disincent market participants from extent to which their orders interact participants to assure that they will
attempting to access those quotations.426 with protected and non-protected never inadvertently be charged a fee in
The Commission agrees that the quotations. First, under the Order excess of the cap. For example, such a
access fee limitation should apply to Protection Rule, the definition of trading center could provide a ‘‘top-of-
manual quotations that are best bids and intermarket sweep order requires market book only’’ or ‘‘limited-fee only’’ order
offers to the same extent it applies to participants to route orders to interact functionality. By using this
protected quotations, to preclude any only with protected quotations. The functionality, market participants
incentive for trading centers to display objective can be achieved by routing an themselves could assure that they were
manual quotations as a means to charge IOC, marketable limit order with a limit never required to pay a fee in excess of
a higher access fee. In addition, the price that equals the price of the the levels set forth in Rule 610(c).
Commission recognizes that at present a protected quotation. The extent to
trading center’s execution quality which they route to non-protected In restricting the fee cap to the top-of-
statistics will be evaluated against the quotations will be subject to the full book, we are attempting to reduce the
NBBO, whether that quotation is a range of competitive forces, including regulatory impact to the minimum
manual or automated quotation. The the fees that trading centers choose to extent necessary to effect the statutory
Commission therefore has modified the charge for access to non-protected purposes. We intend to monitor the
proposed fee limitation in Rule 610(c) to quotations. operation of these rules to assess
apply to any quotation that is the best The Commission recognizes, however, whether in practice, distinguishing
bid or best offer of an exchange, the the concern that a market participant which quotations are subject to the cap
ADF, or The NASDAQ Market Center, in could intend to interact only with a is so difficult, and accessing non-
addition to any protected quotations as protected quotation but in fact execute protected quotations is so essential, that
defined in Rule 600(b)(57).427 against a non-protected quotation. For broader coverage of the rule is
The Commission is not, however, example, at the time a market necessary.
extending the fee cap to all quotations participant routes an order to a trading
displayed by a trading center. Thus, the center, it may be attempting to execute 3. Locking or Crossing Quotations
fee cap will not apply to depth-of-book against only that trading center’s best The original access proposal provided
quotations, or to any other services bid or offer, which will be subject to the that the SROs must establish and
offered by markets. By applying only to fee cap under adopted Rule 610(c) (for enforce rules: (1) Requiring their
the best bid and offer of an exchange, instance, by sending an intermarket members reasonably to avoid posting
the ADF, or The NASDAQ Market sweep order with a limit price equal to quotations that lock or cross the
Center, the limitation is narrowly the price of the protected quotation). By quotations of other markets; (2) enabling
drafted to have minimal impact on the time the order arrives at the trading the reconciliation of locked or crossed
competition and individual business center, the incoming order may, if a markets; and (3) prohibiting their
models while furthering the objectives better priced bid or offer has been members from engaging in a pattern or
of the Exchange Act by preserving the displayed at the trading center for a size
practice of locking or crossing
fairness and usefulness of quotations, as smaller than the size of the incoming
quotations. In light of the discussion at
discussed above. It will provide the order, execute against both the new best
the NMS Hearing concerning automated
necessary support for proper bid or offer and the quotation that
quotations and automated markets,430
functioning of the Order Protection Rule previously was the trading center’s best
the Supplemental Release requested
and private linkages, while leaving bid or offer. To meet the requirements
comment on whether market
trading centers otherwise free to set fees of Rule 610(c), however, a trading center
participants should be allowed to
subject only to other applicable must ensure that it never charges a fee
submit automated quotations that lock
standards (e.g., prohibiting unfair in excess of the cap for executions of an
or cross manual quotations.431 In the
discrimination). order against its quotations that are
Two commenters expressed a concern subject to the fee cap. The operation of Reproposing Release, the Commission
with the ability to determine after-the- this limitation will be based on reproposed restrictions on the practice
fact whether a quotation against which quotations as they are displayed in the of displaying locking or crossing
an incoming order executed was subject consolidated quotation stream. Thus, quotations, but, consistent with its
to an access fee cap, given that under the trading center is responsible for approach in the reproposed Order
the Rule a market participant could be ensuring that any time lag between Protection Rule, modified the proposal
prices in its internal systems and its to allow automated quotations to lock or
extending the fee limitation to all quotations will quotations in the consolidated quotation cross manual quotations. Rule 610(d) as
ensure that all quotations are treated fairly); Merrill system do not cause fees to be charged reproposed thereby addressed the
Lynch Reproposal Letter at 9; SIA Reproposal Letter
that violate the limitation of Rule 610(c). concern that manual quotations may not
at 22; STANY Reproposal Letter at 2, 5. be fully accessible and recognized that
425 Madoff Reproposal Letter at 5. Compliance with this requirement
426 Id.
allowing automated quotations to lock
427 In addition, the Commission notes that the 428 Bloomberg Reproposal Letter at 8, n. 6; SIA
access standards in Rule 610(a) and (b) apply to all Reproposal Letter at 22. 430 See supra, section II.A.2.
quotations, not just automated quotations. 429 Bloomberg Reproposal Letter at 8, n. 6. 431 Supplemental Release, 69 FR at 30147.
or cross manual quotations may provide manual quotations.437 One commenter spreads caused solely by the adopted
useful market information. stated that market participants should rule will be limited to the difference
Most of the commenters who not be forced to seek out slow, uncertain between a sub-penny and penny spread.
addressed the issue supported the executions before being permitted to In addition, a locked market currently
proposed restrictions on locking and offer liquidity at prices they find may not actually represent two market
crossing quotations.432 They generally acceptable.438 participants willing to buy and sell at
A few comments opposed restricting the same price. Often, the locking
agreed that the practice of displaying the practice of locking or crossing
quotations that lock or cross previously market participant is not truly willing to
quotations.439 They generally believed trade at the displayed locking price, but
displayed quotations is inconsistent that the proposal would impair market instead chooses to lock rather than
with fair and orderly markets and transparency and efficiency, such as by execute against the already-displayed
detracts from market efficiency. One prohibiting the display of information as quotation to receive a liquidity
noted, for example, that locked and to the true level of trading interest or rebate.442
crossed markets ‘‘can be a sign of an information that a particular market’s The Commission agrees with
inefficient market structure’’ and ‘‘may quotations may be inaccessible. One commenters supporting the proposal
create confusion for investors, as it is commenter identified a number of that an automated quotation is entitled
unclear under such circumstances what causes, apart from access fees and to protection from locking or crossing
is the true trading interest in a liquidity rebates, which could lead to quotations. When two market
stock.’’ 433 Another commenter stated locked and crossed markets.440 These participants are willing to trade at the
that ‘‘[p]ricing rationality is disrupted included determinations by market same quoted price, giving priority to the
by locked and crossed markets, and participants that quotations displayed first-displayed automated quotation will
efforts should be taken to reduce the by a locked or crossed market are not encourage posting of quotations and
incidence of such disruptions.’’ 434 truly accessible, decisions by market contribute to fair and orderly markets.
Some commenters asserted that locked participants that the potential The basic principle underlying the NMS
markets often occur when a market disadvantages of routing away outweigh is to promote fair competition among
participant deliberately posts a locking the potential advantages (e.g., loss of markets, but within a system that also
quotation to avoid paying a fee to access execution priority on the market place promotes interaction between all of the
the quotation of another market and to currently displaying the order), and buyers and sellers in a particular NMS
receive a liquidity rebate for an decisions by market participants to stock. Allowing market participants
execution against its own displayed exclusively use a particular market to simply to ignore accessible quotations
quotation.435 Nasdaq submitted data run a trading strategy, even at the risk in other markets and routinely display
regarding the frequency of locked and of missing some trading opportunities. locking and crossing quotations is
crossed markets. During a one-week One commenter stated that providing an inconsistent with this principle. The
period in March 2004, it found that exception from the restrictions for Rule will, however, not prohibit
markets for Nasdaq stocks were locked manual quotations would do little to automated quotations from locking or
or crossed an average of 509,018 times mitigate the negative impact of the crossing manual quotations, thereby
each day, with an average of 194,638 of restrictions on market transparency and permitting market participants to reflect
the locks and crosses lasting more than efficiency.441 information regarding the inaccessibility
1 second and an average duration of all The Commission recognizes that Rule
of a particular trading center’s
locks and crosses of 3.1 seconds.436 610(d), by restricting locked markets
quotations.
with respect to automated quotations,
Nasdaq stocks currently are not subject Two commenters requested that the
can prohibit the display of an order that
to provisions discouraging intermarket Commission include an exception to the
would otherwise have been displayed
locking or crossing quotations such as locked and crossed requirements for
and reduced the quoted spread to zero.
those contained in the ITS Plan. system malfunctions and material
However, although locked markets do
Several commenters specifically occur a certain percentage of the time, delays, and one commenter requested
supported the modification to allow they do not occur all the time, even in that the Commission include an
automated quotations to lock or cross extremely active stocks, and thus the exception for flickering quotations,
average effective spread in these stocks similar to the exceptions proposed for
432 Amex Letter, Exhibit A at 27–28; Letter from typically is between one-half cent and the Order Protection Rule.443 The SIA
Steve Swanson, Chief Executive Officer & President, one cent (one cent being the minimum also requested that the Commission
Automated Trading Desk, LLC, to Jonathan G. Katz,
price increment for all but a very few further clarify the operation of the ‘‘ship
Secretary, Commission, dated June 30, 2004 (‘‘ATD and post’’ procedures.444 The
Letter’’) at 3; Brut Letter at 17; BSE Letter at 13; stocks). Thus, the Commission believes
Citigroup Letter at 14; E*Trade Letter at 10; ICI that any widening of average effective Commission believes that it would be
Letter at 18; JP Morgan Letter at 6; Nasdaq Letter reasonable for the SROs to include in
II at 23–24; NYSE Letter, Attachment at 9; SIA 437 Citigroup Reproposal Letter at 4; Nasdaq their rules implemented pursuant to
Letter at 19–20; STA Letter at 6; STANY Letter at Reproposal Letter at 18; SIA Reproposal Letter at Rule 610(d) exceptions equivalent to
8; UBS Letter at 9–10. 23.
433 ICI Letter at 18.
those included in the Order Protection
434 Deutsche Bank Reproposal Letter at 3. 439 CBOE Reproposal Letter at 1–4; Letter from
Rule.445 The Commission intends to
435 Amex Letter, Exhibit A at 27–28; ATD
Linda Lerner, General Counsel, Domestic Securities, 442 See supra, note 435. See also AFB Comment
Reproposal Letter at 5; ICI Letter at 18; Nasdaq Inc., to Jonathan G. Katz, Secretary, Commission,
Letter II at 23. dated September 9, 2004 (‘‘Domestic Securities Letter at 9; Schwab Comment Letter at 17.
443 Nasdaq Reproposal Letter at 18; SIA
436 Nasdaq Letter II at 23. One commenter pointed Letter’’) at 2–3; Hudson River Trading Letter at 5–
to this data as support for not prohibiting locked 6; Instinet Reproposal Letter at 3,11; Letter from Reproposal Letter at 23.
and crossed markets, since 314,380 of the 509,018 Michael J. Simon, Senior Vice President & 444 SIA Reproposal Letter at 23.
locks or crosses lasted less than one second, even Secretary, International Securities Exchange, Inc., to 445 Specifically, such exceptions would be
without a rule. Letter from Edward J. Joyce, Jonathan G. Katz, Secretary, Commission, dated included within SRO rules adopted pursuant to
President and Chief Operating Officer, Chicago June 30, 2004 (‘‘ISE Letter’’) at 7–8; Tower Research Rule 610(d) that require their members to
Board Options Exchange, Incorporated, to Jonathan Letter at 6–8; Tradebot Reproposal Letter at 1. reasonably avoid displaying quotations that lock or
440 Instinet Letter at 39.
G. Katz, Secretary, Commission, dated February 14, cross a protected quotation or displaying manual
2005 (‘‘CBOE Reproposal Letter’’) at 7. 441 Instinet Reproposal Letter at 3. Continued
work closely with the SROs and other reserve size as well as displayed size at a member’s customer would be
industry participants during the each price. inconsistent with Rule 610(a).
implementation period for Regulation Rule 610(a) prohibits an SRO from
Given the critical importance of
NMS to achieve reasonable industry- imposing unfairly discriminatory terms
indirect access to the private linkage
wide standards for SRO rules relating to that prevent or inhibit any person from
obtaining efficient access through a approach incorporated in Rule 610(a),
locked and crossed markets. In addition, the Commission intends to review the
such rules must be filed for Commission member of the SRO to the quotations in
an NMS stock displayed by the SRO current extent to which SRO members
approval, thereby providing an
trading facility. This anti-discrimination have fair and efficient access to
opportunity for public notice and
standard is designed to give non- quotations in NMS stocks that are
comment.
members indirect access to quotations displayed on an SRO trading facility
B. Description of Adopted Rule through members. It is premised on fair (which term does not include the
and efficient access of SRO members NASD’s ADF, as discussed below). In
Paragraphs (a) and (b) of Rule 610 themselves to the quotations of the this regard, we emphasize that the SROs
address access to all quotations SRO’s trading facility. SRO member with trading facilities cannot meet the
displayed by an SRO trading facility or access currently is addressed by a series access requirements of the Exchange Act
by an SRO display-only facility. of provisions of the Exchange Act. simply by assuming direct access is
Paragraph (c) addresses the fees charged Sections (6)(b)(4) and 15A(b)(5) provide available to trading centers that
for access to protected quotations, and that the rules of an exchange or participate in the SRO trading facilities.
paragraph (d) addresses locking and association provide for the equitable Thus, if a trading center displays
crossing quotations. The Commission allocation of reasonable dues, fees, and quotations on an SRO trading facility,
also is extending the scope of the fair other charges among its members and but also provides direct access to such
access requirements of Regulation ATS other persons using its facilities, while
as proposed and reproposed. quotations, that SRO could not rely on
Sections 6(b)(5) and 15A(b)(6) provide the level of direct access to the non-SRO
1. Access to Quotations in part that its rules not be designed to trading center to meet its Exchange Act
permit unfair discrimination between responsibilities. An SRO trading facility
a. Quotations of SRO Trading Facilities customers, brokers, or dealers. In must itself provide fair and efficient
addition, Sections 6(b)(1) and 15A(b)(2)
Paragraph (a) of Rule 610 applies to access to the quotations that are
of the Exchange Act require that an
quotations of an SRO trading facility. In displayed as quotations of such SRO.
exchange or association must have the
Rule 600(b)(72), an SRO trading facility capacity to be able to carry out the Stated another way, an SRO trading
is defined as a facility operated by or on purposes of the Exchange Act. Sections facility cannot be used simply as a
behalf of a national securities exchange 6(b)(5) and 15A(b)(6) also require an conduit for the display of quotations
or a national securities association that exchange or association to have rules that cannot be accessed fairly and
executes orders in securities or presents designed to remove impediments to and efficiently through the SRO trading
orders to members for execution.446 perfect the mechanism of a free and facility itself. Accordingly, each SRO’s
This definition therefore encompasses open market and a national market facilities will be reviewed to determine
the trading facilities of each of the system. Section 11A(a)(1)(C) provides whether they are able to meet the
exchanges, as well as The NASDAQ that two of the objectives of a national enhanced need for access under the
Market Center. The term ‘‘quotation’’ is market system are to assure the adopted regulatory structure.
defined in Rule 600(b)(62) as a bid or an economically efficient execution of
offer, and ‘‘bid’’ or ‘‘offer’’ is defined in b. Quotations of SRO Display-Only
securities transactions and the
Rule 600(b)(8) as the bid price or the practicability of brokers executing Facility
offer price communicated by a member investors’ orders in the best market. To
of a national securities exchange or Paragraph (b) of Rule 610 applies to
achieve these objectives, an SRO’s all quotations displayed by an SRO
national securities association to any members—broker-dealers that have the
broker or dealer or to any customer. display-only facility. The term ‘‘SRO
right to trade directly on an SRO display-only facility’’ is defined in Rule
Rule 610(a) therefore applies to the facility—must themselves have fair and
entire depth of book of displayed orders 600(b)(71) as a facility operated by or on
efficient access to the quotations
of an SRO trading facility, including behalf of a national securities exchange
displayed on such facility.
Rule 610(a) builds on this existing or national securities association that
quotations that lock or cross any quotation in an access structure by prohibiting unfair displays quotations in securities, but
NMS stock. The Commission notes that it has discrimination that prevents or inhibits does not execute orders against such
modified the language of Rule 610(d)(3) from the quotations or present orders to members
reproposal to clarify that, if an SRO’s rules (as
non-members from piggybacking on the
approved by the Commission) provide for access of members. In the absence of for execution.447 For quotations in NMS
reasonable exceptions to the locking and crossing mandatory public linkages directly
requirements of Rule 610(d), the prohibition on its between markets, the ability to obtain 447 The term ‘‘SRO trading facility’’ is defined in
members engaging in a pattern or practice of Rule 600(b)(72) to mean a facility operated by or on
displaying quotations that lock or cross any
indirect access is necessary to assure
behalf of a national securities exchange or a
protected quotation in an NMS stock, or of that non-members can readily access national securities association that executes orders
displaying manual quotations that lock or cross any quotations to meet the requirements of in a security or presents orders to members for
quotation in an NMS stock disseminated pursuant the Order Protection Rule and to fulfill execution. The Commission has included the
to an effective national market system plan, will not phrase ‘‘to members’’ after the phrase ‘‘or present
apply to the display of quotations that lock or cross
their duty of best execution. In general,
orders’’ in the definition of ‘‘SRO display-only
any protected or other quotation as permitted by an any SRO rule or practice that treats facility’’ in Rule 600(b)(71) as adopted to conform
applicable exception. orders less favorably based on the it to the definition of SRO trading facility. The
446 The Commission has modified the definition identity of the ultimate party submitting Commission also has modified the definition of
of SRO trading facility in Rule 600(b)(72) to include the order through an SRO member could SRO display-only facility to include the phrase ‘‘or
the phrase ‘‘or on behalf of’’ after ‘‘operated by’’ to on behalf of’’ after ‘‘operated by’’ to make clear that
make clear that the term includes an SRO trading
violate Rule 610(a). Thus, for example, the term includes an SRO trading facility for which
facility for which an exchange or association has charging differential fees or reducing an an exchange or association has contracted out the
contracted out the operation to a third party. order’s priority based on the identity of operation to a third party.
stocks, this definition currently quotations until the participant comes therefore would encompass executions
encompasses only the NASD’s ADF.448 into compliance.451 The Commission against both the displayed size and any
Paragraph (b)(1) of Rule 610 requires also believes that the addition of a new reserve size at the price of those
any trading center that displays ADF participant would constitute a quotations.
quotations in NMS stocks through an material aspect of the operation of the Rule 610(c) encompasses a wide
SRO display-only facility to provide a NASD’s facilities, and thus require the variety of fees currently charged by
level and cost of access to such filing of a proposed rule change trading centers, including both the fees
quotations that is substantially pursuant to Section 19(b) of the commonly known as access fees charged
equivalent to the level and cost of access Exchange Act that would be subject to by ECNs and the transaction fees
to quotations displayed by SRO trading public notice and comment.452 charged by SROs. So long as the fees are
facilities. The phrase ‘‘level and cost of Paragraph (b)(2) of Rule 610 prohibits based on the execution of an order
access’’ would encompass both (1) the any trading center that displays against a protected quotation or a BBO
policies, procedures, and standards that quotations through an SRO display-only quotation, the restriction of Rule 610(c)
govern access to quotations of the facility from imposing unfairly will apply. Conversely, fees not
trading center, and (2) the connectivity discriminatory terms that prevent or triggered by the execution of orders
through which market participants can inhibit any person from obtaining against protected quotations or BBO
obtain access and the cost of such efficient access to such quotations quotations (e.g., certain periodic fees
connectivity. As discussed in section through a member, subscriber, or such as monthly or annual fees)
III.A.1 above, trading centers that customer of the trading center. This generally will not be included.
choose to display quotations in an SRO prohibition parallels the prohibition in In addition, Rule 610(c) encompasses
display-only facility will be required to Rule 610(a) that applies to the any fee charged directly by a trading
bear the responsibility of establishing quotations of SRO trading facilities.453 center, as well as any fee charged by
the necessary connections to afford fair Thus, a trading center’s differential market participants that display
and efficient access to their quotations. treatment of orders based on the identity quotations through the trading center’s
The nature and cost of these of the party ultimately submitting an facilities. Nothing in Rule 610(c) will
connections for market participants order through a member, subscriber, or preclude an SRO or other trading center
seeking to access the trading center’s customer of such trading center from taking action to limit fees beyond
quotations would need to be generally is inconsistent with this Rule. what is required by the Rule, and
substantially equivalent to the nature trading centers will have flexibility in
2. Limitation on Access Fees establishing their fee schedules to
and cost of connections to SRO trading
facilities.449 In recent years, a variety of Rule 610(c) limits the fees that can be comply with Rule 610(c). In particular,
different types of entities have entered charged for access to protected trading centers could impose a limit on
the business of providing connections quotations and manual quotations at the the fees that market participants are
for brokers and market participants to best bid and offer. It provides that a permitted to charge for quotations that
different trading centers. The trading center shall not impose, nor are accessed through a trading center’s
Commission anticipates that ADF permit to be imposed, any fee or fees for facilities. For example, Nasdaq has
participants will take advantage of the execution of an order against a adopted such a limit for quotations
linking to these service providers to protected quotation of the trading center displayed by The NASDAQ Market
establish the necessary connectivity. or against any other quotation of the Center.454
The NASD, as the self-regulatory trading center that is the best bid or best The Commission believes that it is
authority responsible for enforcing offer of a national securities exchange, consistent with the Quote Rule for
compliance by ADF participants with the best bid or best offer of The Nasdaq market makers to charge fees for access
the requirements of the Exchange Act, Stock Market, Inc., or the best bid or to their quotations, so long as such fees
will need to evaluate the connectivity of best offer of a national securities meet the requirements of Rule 610(c). In
ADF participants to determine whether association other than the best bid or particular, market makers will be
it meets the requirements of Rule best offer of The Nasdaq Stock Market, permitted to charge fees for executions
610(b)(1). Prior to implementation of Inc. in an NMS stock (‘‘BBO of orders against their quotations
Rule 610, the NASD will need to make quotations’’) that exceed or accumulate irrespective of whether the order
an affirmative determination that to more than $0.003 per share or, for its executions are effected on an SRO
existing ADF participants are in protected quotations and BBO trading facility or directly by the market
compliance with the requirements of the quotations with a price of less than maker.
Rule.450 If an ADF participant is not $1.00, that exceed or accumulate to
more than 0.3% of the quotation price 3. Locking or Crossing Quotations
complying with these access standards,
the NASD would have a responsibility per share. Thus, the scope of Rule 610(c) Rule 610(d) restricts locking or
to stop publishing the participant’s is limited to the price of the best bid and crossing quotations, but recognizes that
offer, whether automated or manual, of locked and crossed markets can occur
448 The Commission notes that Rule 610(b)(1) each exchange, The NASDAQ Market accidentally, especially given the
applies to all quotations displayed on an SRO Center, and the ADF. When triggered, differing speeds with which trading
display-only facility, even if the trading center also
displays quotations in an SRO trading facility. To
the fee limitation of Rule 610(c) will centers update their quotations. It
preclude the consolidated data stream from giving apply to any order execution at the requires that each national securities
a misleading indication of available liquidity, displayed price of the protected exchange and national securities
separate quotations displayed on an SRO trading quotation or the BBO quotation. It association establish, maintain, and
facility and an SRO display-only facility must each
be fully accessible. enforce written rules that: 455 (1) Require
449 As stated above in section III.A.1, this 451 Id.
452 See Rule 19b–4(b)(1) under the Exchange Act, 454 NASD Rule 4623(b)(6).
requirement does not apply on an absolute basis,
but instead applies on a per-transaction basis to 17 CFR 240.19b–4(b)(1). 455 The Commission has modified the language of
reflect the costs relative to the ADF participant’s 453 Moreover, as with paragraph (a) of Rule 610, adopted Rule 610(d) to require that an exchange or
trading volume. paragraph (b) applies to both the displayed and association ‘‘establish, maintain, and enforce’’ such
450 See Section 15A of the Exchange Act, 15 reserve size of the displayed quotations of an SRO rules, and to clarify that such rules must be written,
U.S.C. 78o–3. display-only facility. Continued
its members to reasonably avoid 4. Regulation ATS Fair Access coverage consistent with the 5%
displaying quotations that lock or cross The ‘‘fair access’’ standards of Rule threshold triggering the order display
any protected quotation in an NMS 301(b)(5) of Regulation ATS 458 require and execution access requirements of
stock, or of displaying manual a covered ATS, among other things, to: Rule 301(b)(3). As a result, each ATS
quotations that lock or cross any (1) Establish written standards for required to disseminate its quotations in
quotation in an NMS stock disseminated granting access on its system; and (2) the consolidated data stream also will
pursuant to an effective national market not unreasonably prohibit or limit any be prohibited from unreasonably
system plan; (2) are reasonably designed person in respect to services offered by limiting market participants from
to assure the reconciliation of locked or the ATS by applying its access becoming a subscriber or customer.
crossed quotations in an NMS stock; standards in an unfair or discriminatory Aside from lowering the threshold, the
and (3) prohibit its members from manner. As originally proposed and substantive requirements of Rule
engaging in a pattern or practice of reproposed, the Commission is 301(b)(5) are left unchanged.
displaying quotations that lock or cross amending this section of Regulation One commenter, Liquidnet, argued
any protected quotation in an NMS ATS to lower the threshold that triggers that the fair access standards of
stock, or of displaying manual the Regulation ATS fair access Regulation ATS should not apply to
quotations that lock or cross any requirements from 20% of the average systems that display orders only to one
quotation in an NMS stock disseminated daily volume in a security to 5%.459 other system subscriber, such as through
pursuant to an effective national market Under the access approach adopted a negotiation feature.461 Among other
system plan, other than displaying today, the fairness and efficiency of things, Liquidnet maintained that the
quotations that lock or cross any private linkages will assume heightened fair access requirement should not
protected or other quotation as importance. A critical component of apply to it because, in essence, it is an
permitted by an exception contained in private linkages is the ability of institutional block trading desk that
the SRO’s rules established pursuant to interested market participants to does not publish quotations.462 By its
(1). Of course, the SRO’s locking and become members or subscribers of a terms, Rule 301(b)(5) of Regulation ATS
crossing rules should apply only to its trading center, particularly those trading will apply to Liquidnet. However, the
own quoting facility. centers with significant trading volume. Commission believes that some form of
Rule 610(d) distinguishes between As discussed in section III.A.1 above, exemptive relief under Section 36 of the
protected (and therefore automated) 456 market participants then may use their Exchange Act may be appropriate to
quotations and manual quotations. membership or subscribership access as maintain the fair access threshold at
Protected quotations can not be a means for others to obtain indirect 20% for an ATS, such as Liquidnet,
intentionally crossed or locked by any access by piggybacking on the direct that, among other things, limits its
other quotations. Manual quotations, in access of members or subscribers. The business to institutional block trading
contrast, can be locked or crossed by Commission therefore believes that it is and does not disseminate quotations.
automated quotations, but can not appropriate to lower the fair access The Commission intends to consider
themselves intentionally lock or cross threshold of Regulation ATS.460 this matter further during the
any other quotations included in the implementation period for Regulation
Lowering the threshold for paragraph
consolidated data stream, whether NMS.
(b)(5) of Rule 301 also makes its
automated or manual. Recognizing that
quotations may on occasion accidentally IV. Sub-Penny Rule
be similar to the language contained in Section
lock or cross other quotations, Rule 8(d)(i) of the existing ITS Plan that ‘‘[t]he The Commission today is adopting
610(d) requires members to ‘‘reasonably Participants also agree that ‘‘locked markets’’ in Rule 612 under the Exchange Act 463
avoid’’ locking and crossing and System securities should be avoided.’’ The which will govern sub-penny quoting of
Commission emphasizes, however, that the intent
prohibits a ‘‘pattern or practice’’ of and meaning of Rule 610(d) is more strict and NMS stocks. Rule 612 imposes new
locking or crossing quotations where comprehensive than the ITS Plan provision. In requirements on any bid, offer, order, or
this can reasonably be avoided. SRO particular, as noted above, Rule 610(d) requires indication of interest that is displayed,
rules can include so-called ‘‘ship and SROs to restrict their members’ ability to engage in ranked, or accepted by a national
locking and crossing activity. The Commission
post’’ procedures that require a market therefore believes that most existing SRO rules securities exchange, national securities
participant to attempt to execute against established to implement the locked and crossed association, ATS, vendor, or broker-
a relevant displayed quotation while provision of the ITS Plan likely would not be dealer. The Commission is adopting
posting a quotation that could lock or sufficient to comply with Rule 610(d). Rule 612 as it was reproposed in
458 17 CFR 242.301(b)(5).
cross such a quotation. Finally, Rule 459 The Regulation ATS fair access requirements
December 2004 with only a few minor
610(d)(2) requires that each SRO’s rules are triggered on a security-by-security basis for amendments for clarity.
be reasonably designed to enable the equity securities. See Securities Exchange Act
reconciliation of locked or crossed Release No. 40760 (Dec. 8, 1998), 63 FR 70844,
A. Background
quotations in an NMS stock. Such rules 70873 (Dec. 22, 1998). In June 2000, the Commission issued
460 One commenter opposed the proposal to lower
must require the market participant an order directing NASD and the
the threshold for Regulation ATS fair access,
responsible for displaying the locking or primarily because it largely acts as an agency broker
national securities exchanges to act
crossing quotation to take reasonable that routes orders to other venues. Bloomberg jointly in developing a plan to convert
action to resolve the locked or crossed Tradebook Letter at 7. The Commission believes their quotations in equity securities and
market.457 that ATSs, which by definition have chosen to offer options from fractions to decimals.464
market functions beyond mere agency routing,
would appropriately be subject to regulatory 461 See letter to Jonathan G. Katz, Secretary,
to conform the language to the operative language requirements that reflect such functions.
of Rule 611(a)(1). Commenters on the Proposing and Reproposing Commission, from Seth Merrin, Chief Executive
456 Under Rule 600(b)(57), only automated
Releases supported the proposal to lower the fair Officer, Liquidnet Inc., dated January 26, 2005
quotations can qualify as protected quotations. access threshold. See, e.g., Amex Letter at 28–29; (‘‘Liquidnet Reproposal Letter’’) at 3.
457 The Commission notes that the requirement in 462 See id.
Citigroup Reproposal Letter at 3; E*TRADE Letter
463 17 CFR 242.612.
Rule 610(d)(1) that an SRO establish, maintain, and at 10; ICI Letter at 4; Instinet Reproposal Letter at
enforce rules that require its members reasonably to 3,12; Morgan Stanley Letter at 17–18; Merrill Lynch 464 See Securities Exchange Act Release No.
avoid engaging in certain activity relating to locking Reproposal Letter at 9; Nasdaq Reproposal Letter at 42194 (June 8, 2000), 65 FR 38010 (June 19, 2000)
and crossing of displayed quotations may appear to 17; Specialist Assoc. Letter at 11; UBS Letter at 9. (‘‘June 2000 Order’’). On January 28, 2000, the
The June 2000 Order stated that the plan dependent rules; and (4) the operations balance, the benefits of decimalization
could fix the minimum price variation and capacity of automated systems.472 have justified the costs. The
(‘‘MPV’’) during the phase-in period, The Commission received 33 comments Commission cautioned, however, that if
provided the MPV was no greater than on the Concept Release.473 The majority the MPV were to decrease beyond a
$0.05 and no less than $0.01 for any of commenters opposed sub-penny certain level, the potential costs to
equity security.465 The June 2000 Order pricing. Some stated that the negative investors and the markets could at some
also required NASD and the exchanges effects of decimal trading would be point surpass any potential benefits.479
to provide the Commission with studies exacerbated by further reducing the To address this concern, Rule 612 as
analyzing how decimal conversion had MPV, without meaningfully reducing proposed would have prohibited any
affected systems capacity, liquidity, and spreads or securing other benefits for national securities exchange, national
trading behavior, including an analysis the markets or investors.474 These securities association, ATS, vendor, or
of whether there should be a uniform commenters recommended that all broker-dealer from displaying, ranking,
MPV.466 The Commission stated that, if securities have an MPV of at least a or accepting from any person a bid,
NASD or an exchange wished to move penny.475 A smaller number of offer, order, or indication of interest in
to quoting stocks in an increment less commenters believed that the forces of an NMS stock priced in an increment
than $0.01, its study should include a competition, rather than regulation by less than $0.01 per share. This
full analysis of the potential impact on the Commission or Congress, should restriction would not have applied to
the market requesting the change and on determine the MPV.476 These any NMS stock the share price of which
the markets as a whole.467 Furthermore, commenters suggested that a smaller is below $1.00.
the Commission required each SRO to MPV could improve market efficiency The proposed rule was designed to
propose a rule change under Section and provide investors with greater limit the ability of a market participant
19(b) of the Exchange Act 468 to opportunity for price improvement. to gain execution priority over a
establish its individual choice of MPV They argued generally that the problems competing limit order by stepping ahead
for securities traded on its market.469 accompanying decimals could be by an economically insignificant
NASD and the exchanges complied with resolved through technology amount. In issuing the sub-penny
these requirements, and in August 2002 enhancements, rather than through proposal, the Commission cited research
the Commission approved rule changes regulation. performed by OEA showing a high
from all of these SROs to establish an In August 2003, Nasdaq submitted a incidence of sub-penny trades that
MPV of $0.01 for equity securities.470 proposed rule change to the cluster around the $0.001 and $0.009
Between the June 2000 Order and the Commission to adopt an MPV of $0.001 price points. The OEA study concluded
August 2002 Order, the Commission for Nasdaq-listed securities.477 Nasdaq that this phenomenon resulted from
issued a Concept Release seeking public stated that, unless and until a uniform market participants attempting to step
comment on the potential impact of sub- MPV were established, it felt compelled ahead of competing limit orders for the
penny pricing,471 including its effect on: to implement an MPV of $0.001 to smallest economic increment
(1) Price clarity (e.g., the potential to remain competitive with ECNs that possible.480
permit their subscribers to quote in sub- In the Proposing Release, the
cause ephemeral or ‘‘flickering’’
pennies. At the same time, Nasdaq filed Commission pointed to a variety of
quotations); (2) market depth (i.e., the
a petition for Commission action urging additional problems caused by sub-
number of shares available at a given
the Commission ‘‘to adopt a uniform penny quoting, including the following:
price); (3) compliance with the Order • If investors’ limit orders lose
rule requiring market participants to
Handling Rules and other price- execution priority for a nominal
quote and trade Nasdaq securities in a
consistent monetary increment * * * amount, investors may over time
Commission had ordered NASD and the exchanges
to facilitate an orderly transition to decimal pricing with the exception of average price decline to use them, thus depriving the
in the securities markets. See Securities Exchange trades.’’ 478 markets of liquidity.
Act Release No. 42360 (Jan. 28, 2000), 65 FR 5003 • When market participants can gain
(Feb. 2, 2000) (‘‘January 2000 Order’’). In that order, B. Commission Proposal and execution priority for an infinitesimally
the Commission set a timetable for NASD and the Reproposal on Sub-Penny Quoting small amount, important customer
exchanges to begin trading some equity securities,
and options on those securities, in decimals by July In February 2004, the Commission protection rules such as exchange
3, 2000, and to begin trading all equities and proposed new Rule 612 that would priority rules and NASD’s Manning
options by January 3, 2001. See January 2000 Order, govern sub-penny quoting as part of the rule 481 could be rendered meaningless.
65 FR at 5005. In April 2000, the Commission
issued another order staying the original deadlines
overall Regulation NMS proposal. In the
for decimalization. See Securities Exchange Act initial Proposing Release, the 479 See Proposing Release, 69 FR at 11165.
480 See 69 FR at 11169–70.
Release No. 42685 (Apr. 13, 2000), 65 FR 21046 Commission summarized the
481 See NASD IM–2110–2 (generally requiring
(Apr. 19, 2000). conversion of the U.S. securities
465 See June 2000 Order, 65 FR at 38013. The June that a member firm that accepts and holds an
markets from fractional to decimalized unexecuted limit order from its customer in a
2000 Order also required that at least some equity
securities be quoted in minimum increments of trading and stated its view that, on Nasdaq security and that continues to trade the
$0.01. See Id. subject security for its own market-making account
466 See Id. 472 See 66 FR at 38391–95. at prices that would satisfy the customer’s limit
467 See Id. 473 For a list of the commenters, see Proposing order, without executing that limit order, shall be
468 15 U.S.C. 78s(b). Release, 69 FR at 11165. deemed to have acted in a manner inconsistent with
474 See Id. just and equitable principles of trade). The impetus
469 See June 2000 Order, 65 FR at 38013.
475 However, some commenters that opposed sub-
for this rule was a case brought by a customer of
470 See Securities Exchange Act Release No.
an NASD member firm, William Manning, who
46280 (July 29, 2002), 67 FR 50739 (Aug. 5, 2002) penny quoting thought that trading in sub-pennies alleged that the firm had accepted his limit order,
(‘‘August 2002 Order’’) (approving SR–Amex–2002– should be permitted. See Id. failed to execute it, and violated its fiduciary duty
476 See Id. at 11165–66.
02, SR–BSE–2002–02, SR–CBOE–2002–02, SR– to him by trading ahead of the order. In the
CHX–2002–06, SR–CSE–2002–02, SR–ISE–2002–06, 477 See SR–NASD–2003–121. Nasdaq has since
Manning decision, In re E.F. Hutton & Co.,
SR–NASD–2002–08, SR–NYSE–2002–12, SR–PCX– withdrawn this proposal. Exchange Act Release No. 25887 (July 6, 1988), the
2002–04, and SR-Phlx-2002–05). 478 Letter to Jonathan G. Katz, Secretary, Commission affirmed NASD’s finding that a
471 Securities Exchange Act Release No. 44568 Commission, from Edward S. Knight, Executive member firm, upon acceptance of a customer’s limit
(July 18, 2001), 66 FR 38390 (July 24, 2001) Vice President, Nasdaq, dated August 4, 2003 order, undertakes a fiduciary duty to its customer
(‘‘Concept Release’’). (‘‘Nasdaq Petition’’). Continued
Without these protections, professional Release, approximately 33 commenters commenter stated that an industry-wide
traders would have more opportunity to addressed the sub-penny rule. The shift to sub-penny quoting would
take advantage of non-professionals, majority of these commenters supported ‘‘forc[e] the industry into another round
which could result in the latter either a restriction on sub-penny quoting.483 of substantial capital investments to
losing executions or receiving One commenter argued that sub-penny accommodate the quote traffic.’’ 489 A
executions at inferior prices. quoting would too easily permit market third commenter echoed that view,
• Flickering quotations that can result professionals to step ahead of competing stating that the new rule ‘‘will protect
from widespread sub-penny pricing limit orders by an economically industry systems from significant data
could make it more difficult for broker- insignificant amount.484 Another traffic that has little benefit to investors
dealers to satisfy their best execution commenter stated that ‘‘[t]oday, SROs or to the industry.’’ 490
obligations and other regulatory are held to minimum quoting A few commenters on the
responsibilities. The best execution increments, while other market centers Reproposing Release opposed Rule
obligation requires a broker-dealer to are not, and this arbitrage should be 612,491 as did a minority of commenters
seek for its customer’s transaction the eliminated.’’ 485 A third commenter on the initial Proposing Release.492
most favorable terms reasonably offered a similar perspective, stating Some commenters argued that quoting
available under the circumstances.482 that the sub-penny prohibition ‘‘will in sub-pennies should be permitted
This standard is premised on the prevent renegade systems from allowing because it increases liquidity, lowers
practical ability of the broker-dealer to a minority of traders to exploit the trading costs, and promotes efficient
determine whether a displayed price is majority’’ that do not offer sub-penny pricing in the equity markets.493 Two
reasonably obtainable under the quoting.486 commenters believed that government
circumstances. Three commenters argued that, in the intervention was not appropriate, as
• Widespread sub-penny quoting absence of a general prohibition on sub- market forces should address this
could decrease market depth (i.e., the penny quoting, market data systems issue.494 Alternatively, one commenter
number of shares available at the NBBO) would be severely taxed.487 One who objected to reproposed Rule 612
and lead to higher transaction costs, commenter—a trade organization that argued that ‘‘[t]he appropriate MPV in
particularly for institutional investors addresses issues relating to market data the equities market is at least [a] nickel
(such as pension funds and mutual and securities processing automation— or some reasonable, tiered
funds) that are more likely to place large doubted ‘‘whether the impact of sub- alternative.’’ 495
orders. These higher transaction costs penny quoting and trading on rising One commenter on the Reproposing
would likely be passed on to retail infrastructure costs is adequately offset Release—INET, an ECN that currently
investors whose assets are managed by by market quality benefits to investors offers its users the ability to quote
the institutions. and market participants.’’ 488 A second certain NMS stocks in sub-pennies—
• Decreasing depth at the inside also argued generally that ‘‘the various
could cause such institutions to rely 483 See Ameritrade Reproposal Letter at 10; Angel marketplaces * * * are better
more on execution alternatives away Reproposal Letter at 6; Archipelago Reproposal positioned than regulators to evaluate
from the exchanges and Nasdaq that are Letter at 15; ATD Letter at 4; Barclays Global
Investors Reproposal Letter at 4; Bennett Letter at
designed to help larger investors find 1; BSE Reproposal Letter at 2; Citigroup Reproposal
489 Knight Reproposal Letter at 6.
matches for large blocks of securities. Letter at 8–9; DBSI Reproposal Letter at 3; Financial 490 Financial Information Forum Reproposal
Such a trend could increase Information Forum Reproposal Letter at 3; Financial Letter at 3.
491 See letter from Alex Goor, President, INET
fragmentation of the securities markets. Services Roundtable Reproposal Letter at 5; GETCO
Reproposal Letter at 1; Harris Letter at 3–4; JPMSI ATS, Inc. to Jonathan G. Katz, Secretary,
In the Reproposing Release, the sub- Reproposal Letter at 2; Knight Reproposal Letter at Commission, dated January 26, 2005 (‘‘INET
penny rule was fundamentally 6; Lerro Reproposal Letter, Appendix A, at 1; Reproposal Letter’’); Instinet Reproposal Letter at
unchanged although the Commission Merrill Lynch Reproposal Letter at 9–10; Nasdaq 17–18; Malureanu E-mail (no page numbers);
Reproposal Letter at 20; e-mail from Chris Sexton NexTrade Reproposal Letter at 12.
made certain minor modifications in
to William H. Donaldson, Chairman, Commission, 492 See Brut Letter at 24; Domestic Securities
response to the comments received on dated January 31, 2005; SIIA/FISD Reproposal Summary of Intended Testimony (no page
the Proposing Release. These Letter at 4–5; STA Reproposal Letter at 7–8; STANY numbers); GETCO Letter (no page numbers);
modifications in reproposed Rule 612 Reproposal Letter at 2; T. Rowe Price Reproposal memorandum to File No. S7–10–04 from Susan M
Letter at 3; UBS Reproposal Letter at 1. See also Ameel, Counsel to Commissioner Atkins, dated
would have: (1) Based the sub-penny Morgan Stanley Reproposal Letter at 13 (suggesting August 20, 2004 (meeting with Hudson River
restriction on the price of the quotation that ‘‘a reasonable compromise’’ would be to allow Trading) (no page numbers); Instinet Letter at 50;
rather than the price of the NMS stock sub-penny quotations for the sole purpose of King Letter at 1; Mercatus Center Letter at 7;
itself; and (2) limited a quotation priced reflecting an access fee but to prohibit them in all NexTrade Letter at 9–10; Reg NMS Study Group
other circumstances); SIA Reproposal Letter at 23 Letter at 9; Tower Research Letter at 8; Vie
less than $1.00 per share to four decimal (supporting reproposed Rule 612 while noting that Securities Letter at 3. In addition, one commenter
places. a minority of SIA members believe that Commission submitted a study on sub-penny pricing shortly
rulemaking in this area is not necessary). before the Commission approved the Reproposing
C. Comments Received 484 See Knight Reproposal Letter at 6. This
Release for publication. See also e-mail from Dr.
The Commission sought comment on comment echoed similar comments in response to Bidisha Chakrabarty, Assistant Professor, John Cook
the initial Proposing Release. See, e.g., Ameritrade School of Business, Saint Louis University, to
all aspects of reproposed Rule 612. Of Letter at 10; Archipelago Letter at 14; ATD Letter marketreg@sec.gov, dated December 1, 2004,
the total comments that the Commission at 3; Bloomberg Tradebook Letter at 2; Citadel Letter enclosing two articles, ‘‘Can sub-penny pricing
received in response to the Reproposing at 9; Citigroup Letter at 14; ICI Letter at 7–8; Tullo reduce trading costs?’’ (‘‘Chakrabarty and Chung
Letter at 8. Study’’) and ‘‘One tick fits all? A study of the Island
485 Archipelago Reproposal Letter at 15. and Instinet ECN merger’’ (‘‘Chakrabarty and
and cannot trade for its own account at prices more
favorable than the customer’s order. 486 Harris Letter at 4. Tripathi Study’’). While not explicitly opposing the
482 See Securities Exchange Act Release No. 487 See Financial Information Forum Reproposal sub-penny proposal, the studies argued that a
37619A (Sept. 6, 1996), 61 FR 48290, 48322 (Sept. Letter at 3; Knight Reproposal Letter at 6; SIIA/FISD general prohibition on sub-penny quoting would
12, 1996) (adopting the Commission’s Order Reproposal Letter at 5. These comments echoed keep spreads artificially high for many securities.
493 See Hudson River Trading Testimony (no page
Handling Rules). A broker-dealer’s duty of best similar comments on the initial Proposing Release.
execution derives from common law agency See Financial Information Forum Letter at 2–3; numbers); GETCO Letter (no page numbers).
principles and fiduciary obligations and is Financial Services Roundtable Letter at 6; Knight 494 See Instinet Letter at 50; Tower Research
incorporated in SRO rules and, through judicial and Letter at 7; Lehman Brothers Letter at 5; Reuters Summary of Intended Testimony (no page
Commission decisions, the antifraud provisions of Letter at 4. numbers).
the federal securities laws. See id. 488 SIIA/FISD Reproposal Letter at 5. 495 NexTrade Reproposal Letter at 12.
the most appropriate trading Commission’s view that sub-penny various estimates of the costs of
increment.’’ 496 In addition, INET quotations can increase the incidence of prohibiting sub-penny quoting.506
maintained that the existing penny MPV quote flickering, which in turn may Even assuming that quoting in sub-
exacerbates larger market structure have adverse effects such as confusing penny increments would reduce
problems, such as internalization and investors or impeding a broker-dealer’s spreads, the Commission continues to
payment for order flow,497 stating that ability to fulfill its duty of best believe, on balance, that the costs of
‘‘the convention of only quoting in execution.502 sub-penny quoting are not justified by
pennies creates what is in effect an Moreover, the Commission agrees the benefits.507 The Commission instead
underground market where better prices with the many commenters who believe agrees with the commenters who believe
are remitted back to certain firms that Rule 612 will deter the practice of that the substantial costs associated
through payment for order flow stepping ahead of exposed trading with sub-penny quoting—among others,
relationships but not reflected in any interest by an economically disincentives to liquidity providers
quotation.’’ 498 Furthermore, INET insignificant amount. Limit orders whose limit orders are jumped by an
presented specific examples where, it provide liquidity to the market and economically insignificant amount and
claimed, moving from penny to sub- perform an important price-setting the increased incidence of flickering
penny quoting reduced spreads.499 function. The Commission is concerned quotes and the resulting regulatory
After careful consideration of all that, if orders lose execution priority compliance and capacity burdens—
comments received, the Commission is because competing orders step ahead for make the adoption of Rule 612
adopting Rule 612 as reproposed, with an economically insignificant amount, appropriate at this time.
only a few minor amendments for liquidity could diminish. As one Nevertheless, the Commission
clarity. The Commission notes that a commenter, the Investment Company acknowledges the possibility that the
large majority of commenters on both Institute, stated, ‘‘[t]his potential for the balance of costs and benefits could shift
the Reproposing Release 500 and the increased stepping-ahead of limit orders in a limited number of cases or as the
initial Proposing Release 501 supported a would create a significant disincentive markets continue to evolve. Therefore,
sub-penny quoting prohibition. The for market participants to enter any Rule 612—as proposed and as
comments received have reinforced the sizeable volume into the markets and adopted—includes a provision setting
Commission’s preliminary view that would reduce further the value of forth procedures for the Commission, by
there are substantial drawbacks to sub- displaying limit orders.’’ 503 order, to exempt any person, security, or
penny quoting, and the Commission Some commenters argued, however,
believes that a uniform rule banning this that investors would suffer harm from 506 See Chakrabarty and Chung Study at 24
practice (except for quotations priced the artificially wide spreads resulting (stating that, for high volume stocks, ‘‘the spread
from a prohibition on sub-penny reduction in the absence of binding constraints
less than $1.00 per share) is appropriate. * * * translates into savings of millions of
quoting.504 One commenter stated, for
Several commenters agreed with the dollars’’); INET Reproposal Letter at 3 (arguing that
example, that ‘‘the primary result of allowing sub-penny quoting in ‘‘23 of the most
496 See INET Reproposal Letter at 1.
eliminating subpenny trading would be appropriate securities’’ would generate annual
497 INET to preserve a minimum profit for market savings of anywhere between $342 million and $1.9
observed, for example, that NYSE has billion); Instinet Letter at 50 (arguing that, if all
less than a 50% market share in Lucent makers, and would result in markets traded QQQQ solely in sub-pennies, the
Technologies and Nortel Networks, two NMS stocks significantly worse realized prices for savings would be approximately $150 million per
trading below $5 per share, even though NYSE’s the vast majority of market participants year); Tower Research Letter at 9 (arguing that, just
overall market share is approximately 80%. INET in six high-volume securities, the proposed rule
attributed this phenomenon to the internalization of not in the business of making
would have would have costs of over $400 million
orders by other market centers that can readily markets.’’ 505 These commenters offered due to wider spreads).
match the BBO set by NYSE, because vigorous price 507 The Commission notes that the few
competition—in the form of sub-penny 502 See, e.g., Citadel Letter at 9; ICI Letter at 7;
commenters who provided detailed, quantitative
quotations—does not exist. See id. at 6. Knight Letter at 7; Reuters Letter at 4; SIA Letter
498 Id. at 7.
criticisms of the proposed sub-penny rule relied on
at 20–21. a very small number of NMS stocks as examples.
499 For example, INET observed that, with a 503 ICI Letter at 20.
These cost estimates appear to assume that all
penny MPV, JD Uniphase (ticker: JDSU) regularly 504 See Chakrabarty and Chung Study at 24; INET trading in the securities they discuss would occur
traded at a penny spread with large size quoted on Reproposal Letter at 3; Instinet Letter at 51; at narrower quoted spreads if Rule 612 did not
both the bid and the ask. INET claimed that, Mercatus Center Letter at 9; Tower Research Letter exist. The Commission does not believe that the
immediately after reducing the MPV to $0.001 on at 8. commenters provided any evidence to justify that
its system recently, the average spread in JDSU fell 505 Tower Research Letter at 8. Tower Research assumption. Currently, Nasdaq and the national
to a tenth of a penny and trades occurred ‘‘almost also criticized the Nasdaq and OEA studies on securities exchanges generally do not permit
uniformly across each sub-penny increment’’ and which the Commission relied in issuing the sub- quoting in sub-pennies; this practice exists only a
were not clustered around the $0.001 and $0.009 penny proposal. Tower Research argued, for small number of ATSs, and only for a small number
price points. Id. at 5. example, that the studies did not differentiate of securities. Because spreads on Nasdaq and the
500 See supra, note 483.
between sub-penny trades and sub-penny exchanges already cannot be smaller than $0.01,
501 See, e.g., Alliance of Floor Brokers Letter at 12; quotations, and that clustering of sub-penny trades Rule 612 will not require these markets to take any
ACIM Letter at 2; Ameritrade Letter at 10; around the $0.001 and $0.009 price points could action that would cause their spreads to widen.
Archipelago Letter at 14; ATD Letter at 3–4; result from sub-penny price improvement rather Therefore, the Commission believes that the cost to
Bloomberg Tradebook Letter at 2; BNY Letter at 4; than quotation activity. In response to this these markets of not having sub-penny spreads
BSE Letter at 13–14; CBOE Letter at 7; Citadel Letter comment, OEA reviewed the sources of data used should not be considered costs of the rule.
at 9; Citigroup Letter at 14–15; CSE Letter at 23; in the original study and found that sub-penny Furthermore, the INET methodology for computing
Denizkurt Letter (no page numbers); E*Trade Letter trades cluster at these two price points in markets the potential savings to investors from quoting in
at 11; Financial Information Forum Letter at 2–3; where trades necessarily result from quotations, sub-pennies appears to be based on the unjustified
Financial Services Roundtable Letter at 5–6; such as ECNs, not only in markets where that is not assumption that all of selected stocks in their
Goldman Sachs Letter at 10; ICI Letter at 19–20; ISE necessarily the case. See Memorandum from Office sample would trade with the same price-point
Letter at 8; JPMSI Letter at 6–7; Knight Letter at 7– of Economic Analysis, dated December 15, 2004 distribution as the average of JDSU, SIRI, and
8; Lava Letter at 5; Lehman Brothers Letter at 5; (available in Public File No. S7–10–04 and on the QQQQ. With respect to the ATSs that currently do
Liquidnet Letter at 8; LSC Letter at 11; Morgan Commission’s Internet Web site (http:// permit some NMS stocks to be quoted in sub-
Stanley Letter at 3; Nasdaq Letter at 1–2; NYSE www.sec.gov/rules/proposed/s71004.shtml)) (‘‘OEA pennies, the Commission staff has estimated that
Letter at 9–10; NSX Letter at 9; Peake Letter I at 13; December 2004 Sub-Penny Analysis’’). Accordingly, the gross costs of widened spreads in these
Reuters Letter at 4; SBA Letter at 2; Schwab Letter the Commission continues to believe that market securities will be approximately $48 million
at 17; SIA Letter at 20–21; Specialist Association participants frequently used their ability to quote in annually (or approximately $33 million if the
Letter at 13–15; STA Letter at 7; STANY Letter at sub-pennies to step ahead of competing limit orders Commission were to exempt QQQQ from Rule 612).
13–14; UBS Letter at 10; Vanguard Letter at 6. by the smallest possible amount. See OEA December 2004 Sub-Penny Analysis.
quotation (or any class or classes or One commenter, although not clearly $1.00, regardless of the price where the
persons, securities, or quotations) from advocating that the Commission use its stock was in fact trading.519 The second
the sub-penny quoting restriction if it authority to exempt certain securities commenter argued that this approach
determines that such exemption is from Rule 612, stated that ‘‘the ‘‘does not require countless re-
necessary or appropriate in the public Commission may want to employ classifications of stocks as ‘sub-penny
interest, and is consistent with the objective criteria in determining when it eligible’ based on fluctuations in their
protection of investors. The Commission is appropriate to trade in sub- valuation, stock splits, or other price
could grant such exemption either pennies.’’ 516 In this regard, another movements.’’ 520
unconditionally or on specified terms commenter stated: ‘‘If the Commission The Commission agreed with the
and conditions. wanted to permit only certain stocks to second commenter and, therefore,
In the Proposing Release, the be quoted and traded in sub-penny revised paragraph (a) of reproposed Rule
Commission requested comment on increments, the main factor that should 612 to prohibit any bid, offer, order, or
whether certain securities should be be considered is the average spread and indication of interest priced equal to or
exempted from Rule 612.508 In the quoted size. If a security always greater than $1.00 in an increment
particular, the Commission asked trades with a penny spread and there is smaller than $0.01. As the Commission
whether sub-penny quoting of tremendous liquidity available on both stated in the Reproposing Release,521
exchange-traded fund shares (‘‘ETFs’’), sides of the market, this is a strong basing the restrictions on the price of
which are derivatively priced, raised the indication that the minimum increment the quotation or order rather than the
same concerns as with other NMS is too wide.’’ 517 The Commission price of the NMS stock itself would
stocks.509 Some commenters that believes that this would be a reasonable spare market participants the need to
addressed this issue argued that the sub- consideration in analyzing whether it track the eligibility of stocks priced near
penny prohibition should apply to all would be in the public interest and the $1.00 threshold.
NMS stocks, including ETFs.510 These consistent with the protection of Three commenters on the
commenters generally believed that sub- investors to grant an exemption Reproposing Release noted their
penny quoting raises the same type of pursuant to Rule 612(c). Other factors approval of basing the sub-penny
concerns for ETFs as for other types of that the Commission might consider are: quoting restriction on the price of the
securities.511 Other commenters • Whether the NMS stock is an ETF quotation rather than the price of the
provided arguments that exemptions for or other derivative that can readily be NMS stock itself; 522 no commenter
at least certain securities would be converted into its underlying securities objected to this approach. The
appropriate. One commenter that or vice versa, in which case the true Commission continues to believe in the
opposed Rule 612 argued that, if the value of the security as derived from its rationale for this aspect of the proposal
Commission nevertheless did approve underlying components might be at a as described in the Reproposing Release.
the rule, it should provide an exemption sub-penny increment; Therefore, the Commission is adopting
for QQQQ and other ETFs.512 This • Large volume of sub-penny Rule 612(a) substantially in the form
commenter argued that these securities executions in that security due to price reproposed in December 2004. The
‘‘uniquely lend[] themselves to improvement; and Commission is making a non-
subpenny quoting and trading’’ because • Low price of the security. substantive amendment to clarify the
‘‘the[ir] derivative nature * * * enables This list is illustrative, not exclusive. rule. Reproposed Rule 612(a) would
investors to determine their true value The Commission may consider other have stated that no market participant
at any point in time by calculating the factors—noted by a petitioner or in its ‘‘shall display, rank, or accept from any
aggregate price of the securities own analysis—if and when it considers person a bid or offer, an order, or an
constituting a particular ETF.’’ 513 Other whether to issue an exemption. indication of interest in any NMS stock
commenters, while not explicitly The Commission wishes to highlight equal to or greater than $1.00 in an
recommending that the Commission certain aspects of Rule 612, as adopted, increment smaller than $0.01.’’ Rule
grant particular exemptions, argued that that were raised by commenters on both 612(a) as adopted provides that no
sub-penny quoting was reasonable for the Proposing Release and the market participant ‘‘shall display, rank,
certain securities.514 Reproposing Release.
As the Commission stated in the or accept from any person a bid or offer,
Reproposing Release,515 a basis may 1. Restriction Based on Price of the an order, or an indication of interest in
exist to exempt QQQQ and perhaps Quotation Not Price of the Stock any NMS stock priced in an increment
other actively traded ETFs from Rule As initially proposed, the restriction smaller than $0.01 if that bid or offer,
612. The Commission will continue to on sub-penny quoting would have been order, or indication of interest is priced
study this matter during the triggered if the price of the NMS stock equal to or greater than $1.00 per
implementation period for Regulation itself were above $1.00. One commenter share.’’ The purpose of this revision is
NMS. sought clarification of when an NMS to clarify that the qualification ‘‘priced
stock would become sub-penny eligible, equal to or greater than $1.00 per share’’
508 See Proposing Release, 69 FR at 11172. suggesting a threshold of trading below modifies the phrase ‘‘a bid or offer, an
509 See id. $1.00 for 30 consecutive business order, or an indication of interest’’
510 See Ameritrade Reproposal Letter at 10; Amex
days.518 A second commenter suggested rather than ‘‘any NMS stock.’’ The
Letter, Exhibit A, at 29; Citigroup Reproposal Letter adopted text also makes clear that this
at 9; ICI Letter at 20; Knight Letter at 8; Morgan instead that the prohibition should
proviso applies to bids, offers, orders,
Stanley Letter at 21; NYSE Letter at 10; SIA Letter derive from the price of the order, rather
at 21; Specialist Association Letter at 14. and indications of interest priced equal
than the price of the stock; in other
511 See, e.g., Amex Letter, Exhibit A, at 29; ICI to or greater than $1.00 per share. The
words, the rule should permit any sub-
Letter at 20.
512 See Instinet Letter at 51; Instinet Reproposal
penny quotation below $1.00 and 519 See Brut Letter at 25.
Letter at 18. prohibit any sub-penny quotation above 520 Id.
513 Id. 521 See
69 FR at 77457–58.
514 See Brut Letter at 25; Mercatus Center Letter 516 Archipelago Reproposal Letter at 15. 522 See
BSE Reproposal Letter at 2; Nasdaq
at 9–10; Tower Research Letter at 9, 14–15. 517 INET Reproposal Letter at 5.
Reproposal Letter at 20; SIA Reproposal Letter at
515 See 69 FR at 77459. 518 See Citigroup Letter at 15. 23.
modifying phrase ‘‘per share’’ was not Before the Reproposing Release, two The adopted text also makes clear that
present in reproposed Rule 612(a). commenters suggested that the this proviso applies to bids, offers,
As a result of Rule 612(a), a broker- Commission establish an MPV for orders, and indications of interest
dealer may not, for example, accept a quotations below $1.00 per share; both priced less than $1.00 per share. The
sell order in an NMS stock priced at recommended allowing such quotations modifying phrase ‘‘per share’’ was not
$1.0025 per share, even if the NMS to extend to four decimal places.527 The present in reproposed Rule 612(b).
stock currently trades below $1.00. Commission agreed with these During the Regulation NMS
commenters and added a new paragraph implementation period, the Commission
2. Quotations Below $1.00 (b) to reproposed Rule 612 that would intends to consult with the
The Commission initially proposed a have prohibited a bid, offer, order, or administrators of the Plans to help
threshold of $1.00 below which the indication of interest priced less than ensure that sub-penny quotations
prohibition on sub-penny quoting $1.00 per share in an increment smaller permitted by Rule 612 will be widely
would not apply and requested than $0.0001. The Commission believes disseminated to the public. The
comment on whether that threshold was that, without limiting the number of Commission believes this is necessary
appropriate. The majority of decimal places used in quotations for so that the problem of hidden markets—
commenters addressing this issue very low-priced securities, the problems where professionals can see and access
believed that it would be useful for low- caused by sub-penny quoting of higher- more competitive sub-penny quotations
priced securities to trade in increments priced securities, discussed above, that average investors cannot—is fully
finer than a penny, because a penny could arise. Restricting quotations addressed.
would constitute a significant below $1.00 to four decimal places
3. Revisiting the Penny Increment
percentage of the overall price. These should avoid these problems. The same
commenters viewed $1.00 as an two commenters reacted favorably to Some commenters, while generally
appropriate threshold.523 One this aspect of the Reproposing acknowledging problems caused by sub-
commenter stated that there is ‘‘real Release.528 penny quoting, recommended that the
demand for sub-penny trading (and The Commission is adopting, as Commission consider increasing the
therefore subpenny quoting) in reproposed, the provision limiting a MPV above $0.01.530 One commenter
securities trading below $1.00, due to quotation under $1.00 per share to four believed that ‘‘[t]he Commission should
the low trading value of the decimal places. Thus, under new Rule seriously consider experimenting with
security.’’ 524 However, another 612, a quotation of $0.9987 × $1.00 is different tick sizes to help determine the
commenter, Ameritrade, argued that permitted but a quotation of $0.9987 × optimal tick policy.’’ 531 A second
Rule 612 should not contain an $1.0001 is not.529 commenter recommended that the
exception for securities trading under The Commission notes that it has Commission establish an MPV of a
$1.00.525 According to Ameritrade, made non-substantive revisions to Rule $0.01 for high-volume stocks, $0.05
‘‘[t]he appropriate answer to this issue 612(b) in a manner similar to Rule middle-volume stocks, and $0.10 for the
is for the NYSE, AMEX and NASDAQ 612(a). Reproposed Rule 612(b) would low-volume stocks.532 A third
markets to uniformly enforce listing have stated that no market participant commenter argued that the appropriate
standards, which generally require a ‘‘shall display, rank, or accept from any MPV in the equities market is at least
security to trade above $1.00.’’ 526 person a bid or offer, an order, or an $0.05 ‘‘or some reasonable, tiered
The Commission is adopting the $1.00 indication of interest in any NMS stock alternative.’’ 533 The third commenter
threshold as proposed. The Commission less than $1.00 in an increment smaller previously stated that ‘‘sub-penny
agrees with the commenters who believe than $0.0001.’’ Rule 612(b) as adopted quoting does little, if anything, to
that sub-penny quotations for very low- provides that no market participant degrade the market from its current
‘‘shall display, rank, or accept from any state’’ because ‘‘the true damage was
priced securities largely represent
person a bid or offer, an order, or an done to the market in the shift from a
genuine trading interest rather than
indication of interest in any NMS stock fractionalized environment to a penny
unfair stepping ahead. In such cases, a
priced in an increment smaller than spread environment.’’ 534
sub-penny increment represents a
$0.0001 if that bid or offer, order, or Rule 612, as adopted, sets a floor for
significant amount of the price of the
indication of interest is priced less than the MPV but does not, and is not
quotation or order. Accordingly, the
$1.00 per share.’’ The purpose of this designed to, determine the optimal
prohibition on sub-penny quoting in
revision is to clarify that the MPV. Penny pricing in NMS stocks was
paragraph (a) of Rule 612 will apply
qualification ‘‘priced less than $1.00 per established by rules proposed by NASD
only to bids, offers, orders, and
share’’ modifies the phrase ‘‘a bid or and the national securities exchanges
indications of interest that are priced offer, an order, or an indication of
$1.00 or more per share. With respect to and approved by the Commission
interest’’ rather than ‘‘any NMS stock.’’ pursuant to Section 19(b) of the
Ameritrade’s comment, while the
Commission believes that SROs must Exchange Act.535 While some
527 SeeCitigroup Letter at 15; SIA Letter at 21.
vigorously enforce their listing 528 See
commenters argue that penny pricing
Citigroup Reproposal Letter at 8–9; SIA
standards, there are legitimate Reproposal Letter at 23.
impedes transparency and reduces
circumstances where securities may be 529 One commenter, while supporting the general liquidity, the move to decimals (and
trading below $1.00; therefore, the prohibition on sub-penny quoting, noted that specifically the move to a penny
‘‘[t]here are many ‘subpenny’ stocks on the OTCBB
Commission believes it is appropriate that trade at prices close to or less than $.0001. 530 See Amex Letter at 30; Angel Letter at 10; BNY
for Rule 612 to address those Imposing a high minimum tick for stocks in this Letter at 4; Citadel Letter at 10; e-mail from
circumstances. category may adversely trading in those stocks.’’ LaBranche & Co. to rule-comments@sec.gov, dated
Angel Reproposal Letter at 6. The Commission January 26, 2005; McGuire Summary of Intended
523 See Archipelago Letter at 14; BSE Letter at 14;
notes that new Rule 612 applies only to NMS Testimony (no page numbers); Tullo Letter at 9.
stocks, the definition of which generally does not 531 Angel Letter at 10.
Citigroup Letter at 15; LSC Letter at 11; SIA Letter include stocks quoted on the OTCBB. See 17 CFR
at 21; STANY Letter at 14. 242.600(b)(47) (defining ‘‘NMS stock’’). Therefore,
532 See Tullo Letter at 9.
524 Archipelago Letter at 14. 533 NextTrade Reproposal Letter at 12.
Rule 612 does not require that quotations below
525 See Ameritrade Reproposal Letter at 10. 534 NexTrade Letter at 9.
$1.00 per share in securities quoted exclusively on
526 Id. the OTCBB be limited to four decimal places. 535 15 U.S.C. 78s(b). See supra, note .
quotation increment for NMS stocks) midpoint and average-price practice’’ and that prohibiting the
also has significantly reduced spreads algorithms.540 One of these commenters practice ‘‘has the potential to create
and reduced trading costs for investors added that sub-penny trades resulting needless confusion and impose
who enter orders executed at or within from price improvement also should be additional costs.’’ 545 Another
the NBBO. As the Commission stated in permitted.541 commenter on reproposed Rule 612
the Reproposing Release,536 it believes After considering all views expressed argued similarly that keeping the
that the establishment of a $0.01 MPV, on this issue, the Commission is established practice would not present
on balance, has benefited many adopting this aspect of Rule 612 as ‘‘any real potential for confusion among
investors. Accordingly, the Commission proposed and reproposed. Rule 612 will investors.’’ 546
did not propose to raise the MPV in not prohibit a sub-penny execution Notwithstanding these comments, the
connection with Regulation NMS. The resulting from a midpoint or volume- Commission is adopting this aspect of
Commission’s views on this matter have weighted algorithm or from price Rule 612 as proposed and reproposed. A
not changed since issuance of the improvement, so long as the execution market participant, therefore, is
Reproposing Release, and the did not result from an impermissible prohibited from accepting a sub-penny
Commission is not amending Rule 612 sub-penny order or quotation. The order or quotation that is not permitted
to raise the MPV. Commission believes at this time that by the rule, even if it rounds the order
trading in sub-penny increments does or quotation to the nearest permissible
4. Sub-Penny Trading pricing increment. While the
not raise the same concerns as sub-
The Commission stated in the penny quoting. Sub-penny executions Commission does not believe that a
Proposing Release that it did not at that do not cause quote flickering and do not great deal of customer confusion is
time believe that trading in sub-penny decrease depth at the inside quotation. likely to arise in either case, it does
increments raised the same concerns as Nor do they require the same systems believe that confusion is more likely to
sub-penny quoting. Therefore, the capacity as would sub-penny quoting. In result if a broker-dealer, for example,
proposed rule would not have addition, sub-penny executions due to accepted a customer order to buy at
prohibited a market center or broker- price improvement are generally $20.001, then rounded and ultimately
dealer from executing and printing a beneficial to retail investors. executed it at $20.00. A customer
trade in sub-penny increments that was, unfamiliar with Rule 612 could
for example, the result of a midpoint or 5. Acceptance of Sub-Penny Quotations conceivably wonder why his or her
volume-weighted pricing algorithm, as The Commission initially proposed to order did not have priority above orders
long as it did not otherwise violate the prohibit national securities exchanges, to buy at $20.00. A much simpler and
proposed rule. In addition, a broker- national securities associations, ATSs, more transparent approach is for Rule
dealer could, consistent with the vendors, and broker-dealers from 612 to prohibit the acceptance of sub-
proposed rule, provide price displaying, ranking, or accepting sub- penny orders generally (except for
improvement to a customer order that penny orders or quotations in NMS orders priced below $1.00 per share,
resulted in a sub-penny execution as stocks. One commenter argued that Rule which may extend to four decimal
long as the broker-dealer did not accept 612 should allow a market participant to places), and for the broker-dealer to
an order priced above $1.00 per share in accept sub-penny quotations if it adhere to the rule by rejecting the
a sub-penny increment. The consistently re-prices such quotations to customer’s sub-penny order to buy at
Commission sought specific comment an acceptable increment and does not $20.001. The Commission sees no
on this aspect of the proposal. purpose that would be served by
give the sub-penny quotations any
Every commenter that addressed this allowing the broker-dealer to accept this
special priority for ranking or execution
issue in response to the Proposing sub-penny order, since Rule 612 would
Release agreed that Rule 612 should purposes.542 A second commenter
disagreed, arguing that rounding a sub- in any case prohibit the full order from
permit sub-penny trades that result from being displayed or considered for
midpoint and average-price penny quotation to the nearest penny
may be confusing for investors.543 The ranking or execution purposes.547
algorithms.537 While most of these
commenters believed that the rule Commission agreed with the second 545 Id.
should permit broker-dealers to offer commenter and reproposed Rule 612 546 Instinet Reproposal Letter at 18.
sub-penny price improvement to their continued to include a prohibition on 547 The Commission previously has granted
customers’ orders,538 a few commenters accepting and rounding a sub-penny exemptions from Rules 11Ac1–1, 11Ac1–2, and
urged the Commission to bar this order. 11Ac1–4 under the Exchange Act, 17 CFR
In response to the Commission’s 240.11Ac1–1, 240.11Ac1–2, and 240.11Ac1–4, that
practice.539 The Commission did not permit orders and quotations to be accepted and
revise this aspect of the sub-penny rule statements on this matter in the executed in sub-penny increments but displayed in
in the Reproposing Release. Two Reproposing Release, one commenter rounded, penny increments without a rounding
commenters that addressed this issue in stated that the Commission should identifier. See letter from David S. Shillman,
‘‘continu[e] to allow (but, of course, not Associate Director, Division, Commission, to Mai S.
response to the Reproposing Release Shiver, Director of Regulatory Policy, PCX, dated
also believed that the rule should permit require) market centers to adjust the Feb. 10, 2005; letter from David S. Shillman,
sub-penny trades that result from pricing of disallowed sub-penny Associate Director, Division, Commission, to Ellen
quotations, so long as the unadjusted J. Neely, Senior Vice President and General
quotations are not displayed or Counsel, CHX, dated July 15, 2004; letter from
536 See 69 FR at 77458. David S. Shillman, Associate Director, Division,
537 See ACIM Letter at 2; Amex Letter at 12; considered for purposes of ranking.’’ 544 Commission, to James C. Yong, Senior Vice
E*Trade Letter at 11; Liquidnet Letter at 8; SIA This commenter argued that adjusting President, Regulation, and General Counsel, NSX,
Letter at 21; STA Letter at 7; STANY Letter at 14; such quotations ‘‘is a well-established dated June 30, 2004. See also letter to Ronald Aber,
UBS Letter at 10. Vice President and General Counsel, Nasdaq, from
538 See ACIM Letter at 2; Amex Letter, Exhibit A,
540 See BSE Reproposal Letter at 2; Citigroup Richard Lindsey, Director, Division, Commission,
at 31–32; BSE Letter at 14; E*Trade Letter at 11; dated July 30, 1997 (no-action relief provided by
Liquidnet Letter at 8; Morgan Stanley Letter at 21; Reproposal Letter at 9.
541 See Citigroup Reproposal Letter at 9.
Division similar to three Commission exemptions
SIA Letter at 21; STA Letter at 7; STANY Letter at cited above). These exemptions are inconsistent
542 See Brut Letter at 26.
14; UBS Letter at 10. with new Rule 612 but by their terms expire on
539 See CHX Letter at 23; Goldman Sachs Letter 543 See CHX Letter at 23.
June 30, 2005, before the implementation date of
at 10; SIA Letter at 21. 544 Nasdaq Reproposal Letter at 20. Rule 612. Nasdaq’s no-action letter does not by its
6. Application to Options Markets ‘‘Price Improvement Period’’ (‘‘PIP’’).554 Commission agrees with this view.
By initiating a PIP auction, a BOX Currently, sub-penny quoting that
As initially proposed, Rule 612, by its market participant may execute a would be prohibited by Rule 612 exists
terms, would have applied only to NMS portion of its agency order as principal only on a small number of ATSs and in
stocks. The Commission requested in pennies, and BOX market makers can a small number of NMS stocks. Nasdaq
comment on whether the rule also match that price or offer price and all of the national securities
should apply to options.548 Currently, improvement to those orders in penny exchanges already have rules that
SRO rules require options to be quoted increments during the three-second permit quoting only in $0.01
on the U.S. markets in increments of auction. The Commission previously increments. No commenter indicated
$0.05 and $0.10. Therefore, the approved the BOX trading rules, that converting ATS systems to comply
problems that could be created by sub- including the rules governing the PIP, with the rule would impose any
penny quoting currently do not exist in pursuant to Section 19(b) of the significant burdens. In light of this, and
the options markets. Exchange Act.555 The PIP uses pennies the small number of impacted NMS
Two commenters believed that the in an auction, not in public quotations. stocks, the Commission believes that
rule should not apply to quoting in Therefore, the Commission does not only minimal systems changes will be
options.549 One of these commenters, believe that the PIP raises the same necessary for these ATSs to conform to
assuming that the rule as proposed concerns caused by sub-penny Rule 612 and has determined that the
would allow options with a premium of quotations of non-option securities and, implementation date of Rule 612 will be
less than $1.00 to be quoted in sub- therefore, that it is not necessary to August 29, 2005.
pennies and options with a premium prohibit the use of pennies in BOX’s The Commission notes that it
over $1.00 to be quoted in pennies, PIP. previously has granted exemptions from
argued that this approach ‘‘would 7. One-to-One Negotiating Systems existing Rules 11Ac1–1, 11Ac1–2, and
overwhelm the already taxed capacity of 11Ac1–4 under the Exchange Act that,
existing options quote processing One commenter—Liquidnet, an ATS
among other things, allow certain
systems.’’ 550 The Commission did not whose system allows institutional
exchanges to accept sub-penny orders
believe at the time it issued the traders to negotiate large-sized orders—
and quotations and to disseminate them
Reproposing Release that it was argued that Rule 612 should not
in rounded, penny increments without
necessary for the sub-penny rule to prohibit orders priced in half-penny
a rounding identifier.560 By their terms,
extend to options, nor does it believe so increments for one-to-one negotiating
these exemptions—which are not
now. The concerns created by sub- systems.556 Liquidnet currently permits
consistent with new Rule 612—expire
penny quoting—present to some extent a user to submit an order at the mid-
on June 30, 2005.
in the equities markets—currently do point of the spread, which would be at
a half-penny increment if the spread Rule 612 permits, but does not
not exist in the options markets, where require, a trading center to offer its users
the smallest quoting increment is $0.05. were an odd number of cents wide (e.g.,
$10.00 × $10.03). Liquidnet argues that the ability to quote in sub-pennies in a
Therefore, Rule 612 will not apply to limited number of cases. An exchange
options. If a national securities the ‘‘sub-penny pricing abuses that the
SEC is trying to prevent are not or association that wishes to offer this
exchange seeks to quote options in ability to its market participants will
pennies or sub-pennies in the future, it applicable, because any orders are only
seen by the two negotiating parties.’’ 557 likely need to amend its rules before
would first need to propose a rule doing so. The Commission expects the
change to that effect under Section 19(b) Although the Commission does not
believe it is necessary or appropriate to SROs to consider this matter during the
of the Exchange Act.551 The implementation period.561
include in Rule 612 an exception for
Commission would have an opportunity
one-to-one negotiating systems such as V. Market Data Rules and Plan
to consider such a proposal at that time,
Liquidnet’s, it would consider a request Amendments
after publishing notice and obtaining
public comment.552 for exemptive relief that would permit
one-to-one negotiations of sub-penny The Exchange Act rules and joint-SRO
A third commenter,553 while agreeing trades through an ATS. The Plans for disseminating market
strongly with the proposed sub-penny Commission will study this issue information to the public are the heart
rule, argued that the Commission further during the Regulation NMS of the NMS. Pursuant to these rules and
should prohibit the Boston Options implementation period. Plans, investors are able to obtain real-
Exchange (‘‘BOX’’), a facility of the time access to the best current quotes
Boston Stock Exchange, from using 8. Implementation of Rule 612 and most recent trades for all NMS
‘‘sub-increment’’ pricing (i.e., penny While the majority of commenters stocks. As a result, investors of all
prices below the standard $0.05 and supported the sub-penny rule, a few types—large and small—have access to
$0.10 increments used for options) in its specifically requested that the a comprehensive, accurate, and reliable
Commission implement it as quickly as source of information for the prices of
terms include a sunset date. However, Nasdaq may possible.558 One of the commenters any NMS stock at any time during the
not rely on this letter beyond the implementation stated that there are no ‘‘significant trading day.
date of Rule 612.
548 See Proposing Release, 69 FR at 11172.
technological or structural impediments
549 See Amex Letter, Exhibit A, at 32–33; SIA
to immediate implementation.’’ 559 The 560 See supra, note 547.
561 One commenter argued that the Commission
Letter at 21.
550 Amex Letter, Exhibit A, at 32. 554 See BOX Approval Order, 69 FR at 2786–92 should allow ‘‘sufficient time’’ for systems
(explaining PIP auction). development to accommodate sub-penny quoting
551 15 U.S.C. 78s(b).
555 See id. permitted by Rule 612. See Amex Reproposal Letter
552 The Commission has previously stated that,
556 See Liquidnet Reproposal Letter at 4.
at 1, n.1. Because Rule 612 permits but does not
‘‘[g]iven the implications of penny quoting for require market participants to quote very low-
557 Id.
OPRA, penny quoting would require very careful priced NMS stocks in sub-penny increments, the
review by the Commission.’’ Securities Exchange 558 See ACIM Letter at 2; ATD Reproposal Letter
Commission does not believe it is necessary to offer
Act Release No. 49068 (Jan. 13, 2004), 69 FR 2775, at 4; Charles Schwab Letter at 17; Merrill Lynch market participants an extended period in which to
2789 (Jan. 20, 2004) (‘‘BOX Approval Order’’). Reproposal Letter at 10; Nasdaq Letter at 1. build the systems capacity to support this activity
553 See CBOE Letter at 8. 559 ATD Reproposal Letter at 4. before making Rule 612 effective.
The SROs generate consolidated security, the data includes: (1) An of Network expenses (which do not
market data by participating in the NBBO with prices, sizes, and market include the costs incurred by SRO
Plans.562 Pursuant to the Plans, three center identifications; (2) the best bids participants to generate market data and
separate networks disseminate and offers from each SRO that includes supply such data to the Networks),
consolidated market information for prices, sizes, and market center distribute the remaining revenues to
NMS stocks: (1) Network A for identifications; and (3) a consolidated their individual SRO participants. As
securities listed on the NYSE; (2) set of trade reports in the security. The set forth in the following table, the
Network B for securities listed on the Networks establish fees for this data, Networks collected $434.1 million in
Amex and other national securities which must be filed for Commission revenues derived from market data fees
exchanges; and (3) Network C for approval.563-564 The Networks collect in 2004 and distributed $393.7 million
securities traded on Nasdaq. For each the applicable fees and, after deduction to their individual SRO participants:
2004 FINANCIAL INFORMATION FOR NETWORKS A, B, AND C 1

Network A Network B Network C Total
Revenues ................................................................................................. $165,588,000 $103,901,000 $164,656,000 $434,145,000

Expenses ................................................................................................. 10,317,000 3,921,000 26,196,000 40,434,000
Net Income ....................................................................................... 155,271,000 99,980,000 138,460,000 393,711,000
Allocations:.
NYSE ................................................................................................ 140,661,000 1,296,000 0 141,957,000
NASD/Nasdaq .................................................................................. 8,296,000 8,360,000 61,672,000 78,328,000
PCX .................................................................................................. 2,091,000 43,276,000 30,804,000 76,171,000
NSX .................................................................................................. 694,000 14,498,000 36,717,000 51,909,000
Amex ................................................................................................. 0 28,301,000 30,000 28,331,000
BSE ................................................................................................... 1,345,000 850,000 8,757,000 10,952,000
CHX .................................................................................................. 1,995,000 2,946,000 480,000 5,421,000
Phlx ................................................................................................... 189,000 446,000 0 635,000
CBOE ................................................................................................ 0 7,000 0 7,000
1 The Network financial information for 2004 is preliminary and unaudited.
The overriding objective of the Rule prices and evaluate the best execution of the Networks and the consolidated
and Plan amendments adopted today is their orders by obtaining data from a display requirement has not precluded
to preserve the vital benefits that single source that is highly reliable and the NMS from promoting the broad
investors currently enjoy, while comprehensive. But, by requiring objective of assuring competition among
addressing those particular problems vendors and broker-dealers to display markets.
with the current rules and Plans that are data to investors that is consolidated In the Proposing Release, the
most in need of reform. The changes fall from all markets, the current model Commission specifically considered
into three categories: (1) Modifying the effectively also requires the purchase of three alternative models that potentially
current formulas for allocating market data from all markets. As a result, the could introduce greater competition and
data revenues to the SROs to more most significant drawback of the current flexibility into the dissemination of
appropriately reflect their contributions model is that it offers little opportunity market data: (1) A deconsolidation
to public price discovery; (2) for market forces to determine a model, (2) a competing consolidators
establishing non-voting advisory Network’s fees, or the allocation of those model, and (3) a hybrid model. It
committees to broaden participation in fees to a Network’s SRO participants. decided not to propose any of these
Plan governance; and (3) updating and Network fees must be closely alternative models after consideration of
streamlining the various Exchange Act scrutinized for fairness and the benefits and drawbacks of each
rules that govern the distribution and reasonableness, and the revenues model. The Commission did, however,
display of market information. resulting from those fees must be request comment on whether it should
A. Response to Comments and Basis for allocated to the SROs pursuant to a Plan develop an alternative model for
Adopted Rules formula. In addition, individual markets disseminating market data to the public,
have less freedom to innovate in and, in particular, on its evaluation of
1. Alternative Data Dissemination individually providing their quotation the strengths and weaknesses of the
Models and trade data. On the other hand, the current model and of the various
In addition to proposing specific rules consolidated display requirement can alternative models for the dissemination
and amendments, the Proposing Release promote competition by assuring that of market data.
discussed and requested comment on markets, particularly smaller or newer In response to the Commission’s
the Commission’s decision not to ones, can obtain wide distribution of request for comment, a minority of
propose an alternative model of data their displayed quotations.566 As noted commenters expressed their views
dissemination to replace the current in section I.A.1 above, vigorous regarding the appropriate structure for
consolidation model.565 The great competition among multiple markets the dissemination of market information
strength of the current model is that it trading the same securities is one of the to the public. One group believed that
benefits investors, particularly retail distinctive characteristics of the U.S. the current model requiring the display
investors, by enabling them to assess equity markets. Thus, the existence of of consolidated data in a stock through
562 See supra, note 40. 566 See Report of the Advisory Committee on (recommending retention of the consolidated
563-564 See
Exchange Act Rule 11Aa3–2(c)(1). Market Information: A Blueprint for Responsible display requirement because it serves core investor
565 Proposing Release, 69 FR at 11176–11179. Change (September 14, 2001) (available at http:// protection and market integrity functions, as well
www.sec.gov) (‘‘Advisory Committee Report’’) as promoting market competition).
a Plan processor has produced The Commission has considered the disseminated under this model, the fees
significant benefits for investors and the comments advocating a competing for consolidated data would be reduced
markets, although several also strongly consolidators model, but continues to commensurately. The individual SROs
recommended that its operation needed question the extent to which the model would distribute their own trade and
to be improved in significant would in fact subject the level of market quotation information separately and
respects.567 Another group of data fees to competitive forces. If the establish fees for such information. To
commenters, in contrast, asserted that benefits of a fully consolidated data obtain the data eliminated from the
the current system has inhibited stream are to be preserved for investors, consolidated system, investors would
competition among markets and that the every consolidator would need to need to pay the separate SRO fees.
Plans should be eliminated.568 These purchase the data of each SRO to assure In its proposal, Nasdaq suggested that
commenters further suggested that the consolidator’s data stream in consolidated data fees should be
deregulation of market data by allowing fact included the best quotations and reduced,574 but only in the context of
markets to sell their own data, and by most recent trade report in all NMS advocating a hybrid model that would
allowing market forces and competition stocks. Moreover, to comply with the drastically reduce the quantity of
to control the pricing of such data. They adopted Order Protection Rule, each consolidated data that would be
advocated a competing consolidators trading center would need the quotation disseminated to investors (i.e., by
model or a hybrid model. data from every other trading center in eliminating from the consolidated
a security. As a practical matter, systems all trade reports and all
a. Competing Consolidators Model quotations other than the NBBO).
payment of every SRO’s fees would be
Under a competing consolidators mandatory, thereby affording little room Nasdaq stated that the Commission
model, the consolidated display for competitive forces to influence the should allow competitive forces to
requirement would be retained, but the level of fees. Consequently, far from determine the individual SRO fees for
Plans and Networks would no longer be freeing the Commission from deconsolidated data because trade
necessary. Each of the nine SROs that involvement in market data fee reports and non-NBBO quotations are
participate in the NMS, as well as disputes, the multiple consolidator not ‘‘essential to investors.’’ 575
Nasdaq, would be allowed to establish model would require review of at least The Commission believes, however,
its own fees, to enter into and ten separate fees for individual SROs that comprehensive trade and quotation
administer its own market data and Nasdaq. The overall level of fees information, even beyond the NBBO, is
contracts, and to provide its own data would not be reduced unless one or vital to investors. The Commission
distribution facility. Any number of data more of the SROs or Nasdaq was willing remains concerned that an SRO with a
vendors or broker-dealers (i.e., to accept a significantly lower amount significant share of trading in NMS
‘‘competing consolidators’’) could of revenues than they currently are stocks could exercise market power in
purchase data from the individual allocated by the Plans. It seems unlikely setting fees for its data. Few investors
SROs, consolidate the data, and that any SRO or Nasdaq would could afford to do without the best
distribute it to investors and other data voluntarily propose to lower just its quotations and trades of such an SRO
users. Of the commenters that urged the own fees and reduce its own current that is dominant in a significant number
Commission to adopt a competing revenues, and some might well propose of stocks. In the absence of a solid basis
consolidators model,569 the NYSE, for higher fees to increase their revenues, to believe that full trade and quotation
example, believed that allowing the particularly those with dominant market information would continue to be
markets to withdraw from the Plans shares whose information is most vital widely available and affordable to all
would ‘‘reestablish the link between the to investors. No commenter offered types of investors under a hybrid model,
value of a market’s data * * * and the useful, objective standards for the the Commission has determined that the
fair allocation of costs among * * * Commission to use in evaluating the most responsible course of action is to
users,’’ thereby ending inter-market separate fees of SROs and Nasdaq. For
574 At the NMS Hearing, a representative of
subsidies and market-distortive this and for data quality concerns,572 the
Nasdaq stated that the current $20 fee for
initiatives created by the current Commission remains unconvinced that professionals to obtain market data in Nasdaq
system.’’ 570 Similarly, ArcaEx stated discarding the current model in favor of stocks is too high; that the fee, based on a recent
that ‘‘the best way to reform the [P]lans a multiple consolidator model would analysis of Nasdaq’s cost structure, should be
is to abolish them altogether and to benefit investors and the NMS in around $5 to $7; and that the $20 fee is a monopoly
price ‘‘set almost twenty years ago without any
adopt a competing consolidators general. active review of how that relates.’’ Hearing Tr. at
model.’’ 571 b. Hybrid Model 223–224, 253. These remarks subsequently
engendered some confusion among the public,
567 See, e.g., Amex Letter, Exhibit A at 11; Angel In its comment on the original which was reflected in many comments on the
Letter I at 1; CBOE Letter at 2, 9; CHX Letter at 18– proposal, Nasdaq advocated a hybrid market data proposals addressing the level of fees.
20; Financial Information Forum Reproposal Letter To put these comments in perspective and dispel
model of data dissemination as a any potential misconceptions, the following points
at 3; Schwab Letter at 11–13; SIA Letter at 26–28;
STANY Letter at 14.
compromise if the Commission believes should be kept in mind: (1) in 1999, the
568 See, e.g., Alliance of Floor Brokers Letter at 11; that it is necessary to retain the Plans.573 Commission undertook a comprehensive review of
Under a hybrid approach, basic market data fees and revenues, which led to a 75%
Letter from Daniel M. Clifton, Executive Director, reduction in the fees paid by retail investors for
American Shareholders Association, to Jonathan G. elements of the current model market data (Market Information Release, 64 FR at
Katz, Secretary, Commission, dated June 10, 2004 (including the consolidated display 70614); (2) Nasdaq’s suggested $5 to $7 monthly fee
(‘‘ASA Letter’’) at 2; ArcaEx Letter at 4, 12, 14; Brut for professional investors would entitle them to
Letter at 22; Financial Services Roundtable Letter at requirement and the Plans) would be
only the NBBO in Nasdaq stocks, which is a
7; ISE Letter at 8–10; Nasdaq Letter II at 24–26; retained for quotations representing the fraction of the data that currently is disseminated
NYSE Letter, Attachment at 10–11; Reuters Letter NBBO, but all trade reports and all for the $20 monthly fee for professional investors
at 2; Specialist Assoc. Letter at 17. quotations other than the NBBO would for consolidated trades and quotations in Nasdaq
569 See, e.g., ArcaEx Letter at 12, 14; ISE Letter at
be deconsolidated. Because much less stocks; and (3) Nasdaq’s $5 to $7 cost estimate
8–9; NYSE Letter, Attachment at 10–11. encompassed only its own costs and therefore
570 NYSE Letter at 7 and Attachment at 10. The consolidated data would be excluded the costs of other SROs that now represent
NYSE provided several reasons for the elimination a large percentage of trading in Nasdaq-listed
of the Plans. 572 See Proposing Release, 69 FR at 11178. stocks.
571 ArcaEx Letter at 14. 573 Nasdaq Letter II at 26–28. 575 Nasdaq Letter II at 27.
take such immediate steps are necessary described in the 1999 Market defective data stream, regardless of
to improve the operation of the current Information Release, and whether whether the Networks are able to
consolidation model.576 market data fees should be used to fund continue operating.
SRO operational or regulatory costs. The The commenters’ suggested approach
2. Level of Fees and Plan Governance
Commission also has taken steps to to market data fees would eliminate any
a. Level of Fees promote more transparency with respect funding for the SROs that supply data
to market data fees and the use of to the Networks, which would have
In the Proposing Release, the
market data revenues through its reduced SRO funding by $393.7 million
Commission emphasized that one of its
proposal on SRO transparency.582 The in 2004.585 Before imposing such a
primary goals with respect to market
proposal would greatly increase SRO significant and sudden reduction in
data is to assure reasonable fees that
transparency by requiring, among other SRO funding, the Commission must
promote the wide public availability of
things, that SROs file public reports carefully consider the consequences this
consolidated market data. Comment was
with the Commission detailing their reduction might have on the integrity of
requested on the extent to which sources of revenues and their uses of
investors and other data users were the U.S. equity markets. When the
these revenues. Such reports would Commission last reviewed market data
relatively satisfied with the products enhance the public’s ability to evaluate
and fees offered by the Networks.577 At fees and revenues in 1999, it noted the
the role of market data revenues in direct connection between an SRO’s
the NMS Hearing, several panelists funding SROs. For example, proposed
addressed the current level of fees and operational and regulatory functions
amendments to Form 1, Exhibit I would and the value of its market information:
questioned whether such fees remained require exchange SROs to disclose their
reasonably related to the cost of market [T]he value of a market’s information is
revenues earned from market dependent on the quality of the market’s
data.578 The Supplemental Release information fees, itemized by product, operation and regulation. Information is
therefore noted the panelists’ views and and proposed new Rule 17a–26 would worthless if it is cut off during a systems
welcomed comments on the require SROs to file electronic quarterly outage (particularly during a volatile, high-
reasonableness of market data fees and and annual reports on particular aspects volume trading day when reliable access to
whether the Commission should modify of their regulatory activities. market information is most critical), tainted
its approach to reviewing such fees.579 Some commenters suggested that, by fraud or manipulation, or simply fails to
Many commenters recommended that instead of modifying the Plan formulas reflect accurately the buying and selling
the level of market data fees should be for allocating market data revenues, the interest in a security.586
reviewed and that, in particular, greater Commission should impose a cost-based Moreover, the U.S. equity markets are
transparency concerning the costs of limitation on fees.583 Most, however, not alone in their reliance on market
market data and the fee-setting process adopted a very restricted view of market data revenues as a substantial source of
is needed.580 The Commission agrees. data costs—solely the costs of the funding. All of the other major world
To respond to commenters’ concerns, it Networks to collect data from the equity markets currently derive large
has sought comment on market data fees individual SROs and disseminate it to amounts of revenues from selling
in its concept release relating to SRO the public.584 Yet nearly the entire market information, despite having
structure.581 The release discusses and financial burden of collecting and significantly less trading volume and
requests comment on a number of issues producing market data is borne by the less market capitalization than the
raised by commenters in the context of individual markets, not by the NYSE and Nasdaq. To illustrate, the
SRO revenues and the funding of self- Networks. If, for example, an SRO’s following table sets forth the respective
regulation—in particular, whether systems break down on a high-volume market information revenues, dollar
market data fees are reasonable, whether trading day and it can no longer provide value of trading, and market
the Commission should reconsider a its data to the Networks, investors capitalization for the largest world
flexible cost-based approach as would suffer the consequences of a equity markets in 2003: 587
Market capitaliza-
Data revenues Trading volume tion
(millions) (trillions) (trillions)
London ....................................................................................................................... $180 $3.6 $2.5

NYSE ......................................................................................................................... 172 9.7 11.3
Nasdaq ....................................................................................................................... 147 7.1 2.8
Deutsche Bourse ....................................................................................................... 146 1.3 1.1
Euronext ..................................................................................................................... 109 1.9 2.1
Tokyo ......................................................................................................................... 60 2.1 3.0
In sum, the Commission is committed fees for the consolidated market On the other hand, we must maintain
to assuring that investors are not information that they must have to high standards of SRO performance,
required to pay unreasonable or unfair participate in the U.S. equity markets. without which the data they produce
576 The Commission also is concerned about the 21–23; Citigroup Letter at 15; Financial Information 584 See, e.g., ASA Letter at 2; Citigroup Letter at
risk of compromising the quality of market Forum Letter at 3; Financial Services Roundtable 16; Schwab Letter at 6; SIA Letter at 25.
information if the hybrid model were adopted. Letter at 6–7; Goldman Sachs Letter at 2, 10; ICI 585 See supra, table accompanying note 564.
Proposing Release, 69 FR at 11178. Letter at 21–22; Morgan Stanley Letter at 21–22; 586 Market Information Release, 64 FR at 70614–
577 Proposing Release, 69 FR at 11179. Schwab Reproposal Letter at 3–5; SIA Reproposal 70615.
578 Hearing Tr. at 223–224, 228–229, 230–231, Letter at 24; STANY Letter at 14; UBS Letter at 10. 587 Data for this table is derived from the 2003
233. 581 SRO Structure Release, supra note 49.
annual reports of the various markets and from
579 Supplemental Release, 69 FR at 30148. 582 SRO Transparency Release, supra note 50.
statistics compiled by the World Federation of
580 See, e.g., Ameritrade Reproposal Letter 10; 583 See, e.g., Ameritrade Letter I at 10; Goldman Exchanges. The exchange rates are as of August 15,
Bloomberg Tradebook Letter at 8–9; Brut Letter at Sachs Letter at 10; SIA Letter at 22. 2004.
would be worth little. Some interested parties currently have the public on a daily basis. Moreover,
commenters suggested that SRO funding ability to communicate their views on improved governance structures at the
should be provided through more Plan matters or questioning the efficacy SRO level also should contribute to
specifically targeted fees, such as an of the committees.591 improved governance of the Plans
additional regulatory fee to fund market A number of commenters, however, through their selection and guidance of
regulation costs.588 Given the potential believed that the proposal did not go far SRO representatives on the Plan
harm if vital SRO functions are not enough to reform the Plans and that operating committees. The Commission
adequately funded, we believe that the even greater participation by interested therefore believes that the Governance
level of market data fees is most non-SRO parties in the Plans is Amendment represents a useful first
appropriately addressed in a context needed.592 The SIA recommended that step toward improving the
that looks at SRO funding as a whole. the Commission ‘‘amend the governance responsiveness of Plan participants and
The Commission’s review of SRO structures of the Plans to incorporate the the efficiency of Plan operations.
structure, governance, and transparency types of changes that have been Expanding the participation of
provides a useful context in which these implemented recently in corporate interested parties other than SROs in
competing policy concerns can be governance generally.’’ 593 These Plan governance should increase the
evaluated and balanced appropriately. commenters also raised concerns transparency of Plan business, as well as
The Commission does not believe, regarding several other aspects of Plan provide an established mechanism for
however, that reform of the current governance, including current alternative views to be heard by the
revenue allocation formulas should be administrative costs and burden, the Plans and the Commission. Earlier and
delayed until its review of fees is unanimous vote requirement for Plan more broadly based participation could
completed.589 The distortions caused by action, and the current process for
contribute to the ability of the Plans to
these formulas are substantial and reviewing SRO fee filings and Plan
achieve consensus on disputed issues.
ongoing. In particular, it appears that amendments. For instance, the SIA also
With respect to Plan administration,
market participants increasingly are believed that inconsistencies among the
promising private efforts are underway
engaging in the practice of trade Networks regarding administrative
shredding (i.e., splitting large trades into requirements and burdens (i.e., to improve consistency among data
multiple 100-share trades) as a means to agreements and contracts, billing providers and to reduce administrative
increase their share of market data policies, data use policies, and annual burdens.595 The Commission
revenues under the current Plan audit requirements) contribute to high particularly believes that the Plans
formulas. As discussed below, the market data fees and should be reduced, should give full consideration to the
adopted formula would represent a streamlined, and made uniform.594 views of industry participants on steps
substantial improvement because it is In many respects, the Commission that would streamline the
designed to eliminate trade shredding agrees with the concerns expressed by administrative procedures and burdens
and other gaming of the current commenters regarding administration of of the three Plans. Enhanced
formulas and because it would more the Plans. Nevertheless, it is reluctant at participation of advisory committee
directly allocate revenues to those this point to require more intrusive members in Plan affairs should help
markets that contribute data to the changes to Plan governance that might further this process. The Commission
consolidated data stream that is most interfere with effective Plan operations. will continue to monitor and evaluate
useful to investors. The Plans fulfill significant operational Plan developments to determine
functions with respect to the systems whether any further action is warranted.
b. Plan Governance that deliver consolidated data to the 3. Revenue Allocation Formula
The Commission is adopting, as
proposed and reproposed, an 591 CBOE Letter at 2, 17; ISE Letter at 2; Specialist As discussed below, the Commission
amendment to the Plans that requires Assoc. Letter at 16. Two commenters on the
has adopted the Allocation Amendment
the creation of non-voting advisory reproposal suggested that the Commission should
adopt the advisory committee structure currently in with some modifications from the
committees (‘‘Governance place for the Nasdaq UTP Plan. ArcaEx Reproposal proposal and reproposal.596 Given the
Amendment’’). It provides that the Letter at 14; Letter from Bridget M. Farrell, Co- significant changes from the current
members of an advisory committee have Chairman, and Michael P. Rountree, Co-Chairman,
Plan formulas, the Commission will
the right to submit their views to the Operating Committee of the Nasdaq Unlisted
Trading Privileges Plan, to Jonathan G. Katz, monitor the operation of the new
Plan operating committees on Plan Secretary, Commission, dated Feb. 2, 2005 formula to assess whether it achieves its
matters, including any new or modified (‘‘Nasdaq UTP Plan Reproposal Letter’’) at 2. The goals and whether any further
product, fee, contract, or pilot program. Nasdaq UTP Plan advisory committee meets bi-
annually and has the right to present written modifications are warranted. As with
Most commenters supported the any other aspects of the Plans, the
comments or inquiries to the Plan operating
Governance Amendment.590 They committee. The Commission has retained the language added to the Plans by the
generally believed that expanding the reproposed committee structure, primarily because Allocation Amendment can be adjusted
participation of non-SROs parties in it believes that advisory committee members should
in the future pursuant to the normal
Plan governance would be a have more direct involvement in the deliberations
of Plan operating committees. Specifically, the
constructive step. Only a few Governance Amendment gives advisory committee 595 See SIIA/FISD Reproposal Letter at 2–3 (SIIA/
commenters disagreed, stating that members the right to attend meetings of the FISD developing guidelines to encourage
operating committee and to receive information uniformity in exchange and vendor administrative
588 See, e.g., Citigroup Reproposal Letter at 9; disseminated to the operating committee. policies and procedures; guidelines will address
592 See, e.g., Letter from W. Hardy Callcott, to
Goldman Sachs Letter at 11. exchange data delay intervals, subscriber agreement
589 See, e.g., SIA Reproposal Letter at 24 Jonathan G. Katz, Secretary, Commission, dated streamlining, billing and reporting period issues,
(allocation formula should not be revised prior to Dec. 30, 2004 (‘‘Callcott Reproposal Letter’’) at 4; and unit of count definitions).
evaluating the level of market data fees). Financial Services Roundtable Letter at 6–7; 596 As set forth in section VII below, the
590 See, e.g., Amex Letter at 10; Citigroup Letter Goldman Sachs Letter at 12–13; Instinet Reproposal compliance date for the Allocation Amendment is
at 17; Financial Information Forum Letter at 4; Letter at 17; Morgan Stanley Letter at 22; Schwab September 1, 2006. Accordingly, Plan revenues for
SIIA/FISD Reproposal Letter at 2; Financial Reproposal Letter at 5; SIA Reproposal Letter at 27– the first eight months of 2006 will be allocated in
Services Roundtable Letter at 6–7; ICI Letter at 4 28; STANY Letter at 15. accordance with the current Plan formulas. Plan
593 SIA Reproposal Letter at 28.
and 21 n. 35; Instinet Letter at 7, 46; Nasdaq Letter revenues for the remaining part of 2006 will be
II at 33; Reuters Letter at 3; STANY Letter at 15. 594 SIA Letter at 27–28. allocated in accordance with the new formula.
process of Commission-approved proposed allocation formula.599 It noted Other commenters, in contrast,

amendments.597 that the purpose of the automatic cutoff opposed changing the current allocation
The proposal and reproposal included for manual quotations was to minimize formulas.602 Their specific objections to
an amendment to the Plans that would the allocation of revenues for potentially the proposed and reproposed formulas
modify their formulas for allocating stale quotations and requested comment are discussed below, but they also
market data revenues to SRO on whether only automated quotes opposed changing the current formulas
Participants. The current Plan formulas should be entitled to earn an allocation for more general reasons. First, some
are based solely on the trading activity of revenues. The Supplemental Release believed that, rather than changing the
of an SRO. The proposed and also noted that the NBBO Improvement formulas, the Commission simply
reproposed formulas were intended to Share was significantly more complex should prohibit the particular distortive
address three serious weaknesses in the than the other aspects of the proposed practices caused by the old formulas
old formulas: (1) The absence of any formula and that it had been proposed and enforce the existing prohibitions
allocation of revenues for the quotations largely to counter the potential for an against such practices. Commenters also
contributed by an SRO to the excessive allocation of revenues for opposed the proposed and reproposed
consolidated data stream; (2) an manual quotations. As a result, the formulas because they believed they
excessive emphasis on the number of Reproposing Release included a incorporated arbitrary judgments about
trades reported by an SRO that has led reproposed allocation formula that the value of quotations and trades.
to distortive trading practices, such as eliminated the NBBO Improvement Finally, those opposed to changing the
wash sales, trade shredding, and print Share and excluded manual quotations Plan formulas believed that the
facilities; and (3) a disproportional from the Quoting Share.600 It also proposed formula was simply too
allocation of revenues for a relatively allocated revenues equally between the complex to be implemented effectively
small number of stocks with extremely trading activity and quoting activity of and that its costs exceeded any benefits
high trading volume, with a much Plan participants. Based on additional that were likely to be gained.
smaller allocation to the thousands of comments received in response to the The Commission has considered the
other stocks included in a Network, reproposal, the Commission is adopting views of these commenters, but does not
typically issued by smaller companies, the reproposed allocation formula with believe that they warrant leaving the
with less trading volume. certain modifications, as discussed current Plan formulas in place. First, the
To address these problems, the below. Commission intends to continue to
proposed formula included a number of enforce the existing prohibitions against
elements, including a Quoting Share, an The comments on the proposal and distortive trade reporting practices.
NBBO Improvement Share, a Trading reproposal generally addressed four Rather than attempting to devise new
Share, and a Security Income broad categories of issues: (1) Whether prohibitions that address every
Allocation. The Quoting Share and the current Plan formulas need to be conceivable harmful practice, however,
NBBO Improvement Share would have updated; (2) whether quotations should it has determined to address directly the
provided an allocation of revenues for be considered in allocating revenues; (3) formula-driven distortions by adopting
an SRO’s quotations. In particular, the whether the size of trades should be revisions to the current formulas. As
Quoting Share would have allocated considered in allocating revenues; and long as the allocation of market data
revenues for all quotes, both automated (4) whether the allocation of revenues revenues is based primarily on reporting
and manual, according to the dollar size should be allocated more evenly across a large number of very small trades, the
and length of time that such quotes all of a Network’s stocks. These incentive for distortive trade reporting
equaled the price of the NBBO. It comments are discussed below. will continue. Moreover, as discussed
included an automatic cutoff of credit a. Need for New Formula below, the current formulas are flawed
for manual quotations, however, when in several important respects beyond the
they were left alone at the NBBO. This Many commenters agreed with the incentives they create for distortive
cut-off was intended to preclude SROs Commission that, if the Networks were trade reporting practices.
from being allocated revenues merely to continue allocating revenues to the The Commission does not believe that
for slowness in updating their manual SROs, the current allocation formulas the adopted formula incorporates
quotations. The NBBO Improvement needed to be updated.601 Many of these arbitrary judgments about the value of
Share would have allocated revenues to commenters also believed that the trades and quotes. In this regard, it is
SROs for the extent to which they proposed and reproposed formulas important to recognize that any formula
displayed quotations that improved the should be modified in several respects, for allocating market data revenues
price of the NBBO. and their specific suggestions to would reflect some judgment regarding
At the NMS Hearing, representatives improve the proposed formula are the contribution of the various SROs’
of floor-based exchanges stated their discussed below. In general, however, data to the consolidated data stream;
intention to adopt hybrid trading they agreed with the objectives of the otherwise, the revenues could simply be
models that would primarily display proposal and reproposal to eliminate allocated equally among all Plan
automated quotations.598 In response, much of the incentive for distortive participants. The Commission’s goal in
the Commission, in its Supplemental trade reporting practices and to begin adopting a new formula is to improve
Release, stated that the prospect of providing some allocation of revenues on the judgments incorporated in the
hybrid trading models presented an for the quotations that SROs contribute old Plan formulas to more fully achieve
opportunity for simplifying the to the consolidated data stream. NMS objectives.
For example, the current formula for
597 Cf. Letter from Mary Yeager, Assistant 599 Supplemental Release, 69 FR at 30148. Network A and Network B treats a 100-
Secretary, NYSE, to Jonathan G. Katz, Secretary, 600 Reproposing Release, 69 FR at 77464.
Commission, dated Jan. 26, 2005 (‘‘NYSE 601 See, e.g., Bloomberg Tradebook Letter at 7; 602 See, e.g., Brut Letter at 22; Instinet Reproposal
Reproposal Letter II’’) at 5 (suggesting that, given BSE Letter at 15; Deutsche Bank Reproposal Letter Letter at 13; Letter from David Colker, Chief
inability to anticipate all issues that may arise, at 4; Harris Reproposal Letter at 11; ICI Letter at 21; Executive Officer and President, National Stock
markets should be allowed to make adjustments to JP Morgan Reproposal Letter at 2; NYSE Reproposal Exchange, to Jonathan G. Katz, Secretary,
market data plans). Letter II at 3; STA Letter at 7; UBS Letter at 10; Commission, dated Jan. 26, 2005 (‘‘NSX Reproposal
598 Hearing Tr. at 85, 90–92, 94–97, 120–121. Vanguard Letter at 6. Letter’’) at 4; Phlx Letter at 4.
share trade the same as a 20,000 share Share was difficult to understand and the allocation is determined by the
trade in the same stock, even though had the potential to be abused through proportion of an SRO’s Quote Credits in
their importance for price discovery gaming behavior. The Commission relation to other SROs, not the absolute
purposes clearly is not equal. All of the agreed with these commenters and has amount of Quote Credits.
current Plan formulas value only the modified the reproposed formula and Some commenters suggested that
trades reported by an SRO (for Networks adopted formula accordingly. Given that revenue allocations under the formula
A and B, the number of reported trades; only automated quotations will be should be calculated and paid out on a
for Network C, the average of number entitled to earn an allocation under the quarterly basis.608 Currently, the
and share volume of reported trades), adopted formula, the originally Networks make estimated quarterly
thus treating a quotation as having no proposed NBBO Improvement Share, as payments subject to a final annual
value except to the extent it resulted in well as the proposed cutoff of credits for calculation and payment. Commenters
a trade. Quotations are accorded no manual quotations left alone at the believed quarterly calculations and
value even if they were fully accessible NBBO, have been deleted from the payments would simplify
and established the NBBO for a reproposed formula and remain deleted administration of the formula and
substantial period of time, thereby in the adopted formula. The elimination reduce the potential for disparities
providing price discovery for trades of these two elements greatly reduces between quarterly estimated and annual
occurring at other markets that the complexity of the adopted formula final payments. The adopted Allocation
internalize orders with reference to the and promotes more efficient Amendment does not alter the current
NBBO price. Such formulas based solely implementation of the formula. In Plan provisions for annual final
on an SRO’s trading activity may have addition, the 15% of the Security payments. It is important to retain a
been adequate many years ago when a Income Allocation that was allocated to final annual calculation and payment to
single market dominated each group of the NBBO Improvement Share in the minimize the potential for unusual
securities, but are seriously outdated proposed formula now has been shifted trading activity, or intentional gaming
now that trading is split among many to the Quoting Share to assign an even behavior, to inappropriately distort an
different markets whose contributions to allocation of revenues between trading allocation within a quarter. The annual
the public data stream can vary and quoting. calculation will be based on numbers
considerably. Other commenters asserted that it that are four times larger than the
The adopted formula reflects fairly would overly costly and complex to numbers for a quarterly calculation.
straightforward determinations about calculate the other elements of the These larger numbers will help smooth
the kinds of data that, in general, are proposed formula.605 The Commission out the effect of unusual market activity
likely to be useful to investors. For does not agree with this assertion. An in a particular quarter, as well as
example, a $50,000 quote at the NBBO SRO’s Trading Share, for example, will increase the difficulty of any attempt at
in a stock is likely more useful to not be materially more difficult to gaming behavior. Of course, all of the
investors than a $2000 quote in the calculate than the current Network C formula’s calculations can be updated
same stock. Similarly, a $50,000 trade in formula, which is based on an average daily, and quarterly estimated payments
a stock is likely more useful to investors of an SRO’s proportion of trades and based on these calculations can
in assessing the trading trend of that share volume. The Security Income continue to be made to SRO
stock than a $2000 trade; again, not Allocation uses the square root function participants.
necessarily in every case, but in general which is a simple arithmetic Finally, a few commenters were
and on average. By more appropriately calculation. Some commenters believed concerned about the effect of modifying
weighing data that is useful to investors, that the Quoting Share, which the current allocation formulas on the
the adopted formula represents a incorporates the total dollar size of the existing business models and terms of
substantial improvement on the old NBBO in a stock throughout the trading competition for the various markets.609
formulas.603 year, would result in astronomically The Commission recognizes that
Commenters on the original proposal high numbers that would be extremely reforming formulas that have remained
generally believed that the originally difficult to calculate.606 In fact, the unchanged for many years could affect
proposed formula was complex and may largest number of Quote Credits in a the competitive position of various
have been difficult to implement year for even the highest price stock markets. Given the severe deficiencies
efficiently.604 They particularly noted with the greatest displayed depth at the of these formulas, however, it does not
that the proposed NBBO Improvement NBBO is be very unlikely to reach believe that the interests of any
beyond the trillions, a number well particular business model should
603 Some commenters were concerned that the
within the capabilities of even the most preclude updating the formulas to
formula’s use of dollar volume calculations does basic spreadsheet program.607 Moreover,
not sufficiently allocate revenues to markets that reflect current market conditions. The
trade low-priced stocks. See, e.g., BSE Letter at 18; adopted formula is intended to reflect
605 See, e.g., Brut Letter at 22–23; CBOE Letter at
CHX Letter at 16. The Commission believes that more appropriately the contributions of
dollar volume is the most appropriate measure, in 2, 9; NSX Letter at 7.
general, of the importance to investors of trading 606 See, e.g., CBOE Letter at 14 (calculation of the various SROs to the consolidated
and quoting information. Per share stock prices, in Quote Credits will ‘‘yield astronomical numbers’’ data stream and thereby better align the
contrast, are a more arbitrary measure because they that ‘‘can be expressed only in exponential terms’’); interests of individual markets with the
are dependent, to a large extent, on the number of NSX Letter at 7 (calculation of large number of interests of investors. Moreover, by
shares a company chooses to issue, both originally Quote Credits is ‘‘particularly ludicrous’’).
and through stock splits and reverse stock splits. To 607 For example, assume a stock with an average
incorporating a much more broad-based
the extent the commenters were concerned about price of $100 per share has an unusually large measure of an SRO’s contribution to the
the less active stocks of smaller companies, the average quoted size of 200,000 shares at both the consolidated data stream, the adopted
Security Income Allocation of the adopted formula national best bid and the national best offer formula should be less subject to any
incorporates the square root function precisely to throughout every second of the trading year. Over
more appropriately allocate revenues to SROs that an average 252 trading days during a year, the total
particular type of gaming and distortion
provide a venue for price discovery in these stocks. Quote Credits in this stock would be 235.9 trillion
See section V.A.3.d below. ($100*400,000*252*23,400 seconds per trading 608 See, e.g., NYSE Reproposal Letter II at 5;
604 See, e.g., Angel Letter I at 11; Financial day). Quote Credits are only calculated for Nasdaq UTP Plan Reproposal Letter at 3.
Information Forum Letter at 3; NYSE Letter, individual Network stocks and are not be totaled 609 See, e.g., Brut Letter at 22; CHX Letter at 21–
Attachment at 11. across all Network stocks. 22; NSX Letter at 6.
than the narrowly-focused current Plan First, the adopted formula modifies of a Network security to $2 per qualified
formulas.610 the language of the reproposed formula transaction report, but shifted the excess
to clarify that a quotation must be balance of revenues to the Quoting
b. Quotations That Equal the NBBO
displayed by the Network processor for Share for such Network security—
Many commenters supported the a minimum of one full second of time thereby potentially increasing the risk of
proposal to allocate a portion of market before it is entitled to earn any Quote abusive quoting behavior in highly
data revenues based on an SRO’s Credits. This one-second time period is inactive Network securities. Under the
quotations, particularly if only consistent with the one-second time adopted formula, the excess balance
automated and accessible quotations period included in the flickering above the limitation will be allocated
would qualify for an allocation.611 Some quotation exception in the Order across all Network securities in direct
commenters, however, were concerned Protection Rule and is designed to proportion to their share of dollar
about the risk of harmful gaming assure that only quotations that are volume of trading.
behavior by market participants.612 For readily accessible can earn Quote With these clarifications and
example, Instinet stated that the Credits. The time stamps assigned to modifications, the Commission does not
‘‘fundamental problem with the quotations by the Network processors believe that the Quoting Share of the
Commission’s proposed formula stems will control this determination. adopted formula will be unacceptably
from the inherently low cost for market Accordingly, subsecond flickering vulnerable to gaming, particularly
participants to generate quotation quotations are excluded from the because only automated and fully
information and the consequent high formula. accessible quotations will be entitled to
potential for gaming behavior in any Second, the adopted formula modifies earn a share of market data revenues.
formula that attempts to reward such the language of the reproposed formula The potential cost of displaying such
behavior.’’ 613 A specific type of gaming to clarify that, consistent with the quotations, in the form of unprofitable
that concerned commenters was approach of the Order Protection Rule, trades, should not be underestimated.
‘‘flickering quotes’’—quotes that are each SRO participant in a Network is Quotations would earn significant
flashed for a short period of time solely entitled to earn Quote Credits only for revenues only if they represent a
to earn market data revenues, but are the SRO’s best bid and best offer. Thus, significant proportion of the total size of
not truly accessible and therefore do not for example, only a single, accessible quotations displayed at the NBBO for a
add any value to the consolidated quote best bid and best offer for each of the stock throughout the trading year. The
stream. Nasdaq discussed a number of exchange SROs, Nasdaq, and the NASD risk of losses that could result from the
other potential gaming behaviors, will be entitled to earn Quote Credits. A execution of orders against large
including posting quotations in inactive best bid and best offer must be quotations would be likely to dwarf any
markets or for inactive securities so that accessible by routing an order to a single potential allocation of market data
they are less likely to be executed.614 market destination (i.e., currently, to a revenues.616 With the advent of highly
Commenters also were concerned that single exchange execution system, a sophisticated order-routing algorithms,
such practices would increase quotation single Nasdaq execution system, or a accessible automated quotations
traffic and bandwidth costs, but with single ADF participant). By limiting the throughout the NMS can be hit at
little or no benefit for the quality of the number of separate quotations that are lightning speed. Some of these
consolidated data stream. entitled to earn Quote Credits, the algorithms are specifically designed to
adopted formula both reduces the search the market for displayed
The Commission recognizes that ability of market participants to ‘‘shred’’
abusive quoting behavior is a legitimate liquidity and sweep such liquidity
their quotes among many different immediately when it is displayed. The
concern, particularly given that markets and promotes equal regulation
quotations have not been entitled to an market discipline imposed by these
of exchange SROs, Nasdaq, and the order-routing practices should greatly
allocation of market data revenues in NASD.
the past. The adopted formula therefore reduce the potential for ‘‘low cost’’
Third, the adopted formula modifies quotations at the NBBO. A market
incorporates a number of modifications the language of the reproposed formula
to the reproposed formula to minimize participant would have to be prepared
to clarify that a quotation cannot earn to trade at a price, particularly a price
the potential for abusive or costly Quote Credits while it locks or crosses
quoting behavior. as attractive as the NBBO, before
a previously displayed automated displaying accessible and automated
quotation. This limitation is needed to quotations to earn market data revenues.
610 Two commenters on the reproposal suggested
remove any potential financial incentive Moreover, any quotations submitted for
adopting an allocation formula based solely on the
dollar volume of trading. ArcaEx Reproposal Letter
for abusive quoting behavior that would stocks that are inactively traded (and
at 13; Nasdaq Reproposal Letter at 14. Dollar be contrary to the purposes of the therefore less likely to attract trading
volume alone, however, is not a broad-based provisions on locking and crossing
measure and would miss important aspects of an quotations set forth in the Access Rule. 616 For example, Nasdaq asserted that
SRO’s contribution to the public data stream. It Finally, as discussed further below,615 approximately $1 million per month would be
would, for example, allocate a disproportionately
large amount to block trades. Block trades often are the Security Income Allocation in the distributed among SROs based on quoting in the
adopted formula modifies the 2000 least active Nasdaq stocks. Nasdaq Reproposal
internalized by securities dealers at prices based, at
Letter at 13. In this scenario, an average of $500 per
least partly, on current public quotations. A formula reproposed formula by limiting the total month would be allocated to each stock. Given the
based solely on dollar volume would not revenues allocated to any particular approximately 491,400 seconds of trading in an
adequately allocate revenues to the source of
quotations relied on in pricing block trades. Network security to no more than $4 per average month, the average available Quoting Share
611 See, e.g., Bloomberg Tradebook Letter at 7–8; qualified transaction report. This in a stock for each second would be approximately
1/10th of one cent, which would be further divided
Morgan Stanley Letter at 22–23; NYSE Reproposal limitation on each security’s revenue among bids and offers to approximately 1/20th of
Letter II at 3; STA Letter at 7; Vanguard Letter at allocation therefore will apply to both one cent. Moreover, this amount would be shared
6.
612 See, e.g., ArcaEx Reproposal Letter at 13; CHX
the Trading Share and Quoting Share. In among all market participants quoting in the stock.
contrast, the reproposed formula limited Consequently, even the smallest losing trade (i.e., a
Letter at 19; Instinet Reproposal Letter at 14; SIA one-cent loss on an executed 100-share quote)
Reproposal Letter at 30. the allocation only for the Trading Share would wipe out 2000 seconds (more than 33
613 Instinet Letter at 41.
minutes) of the entire Quoting Share allocation for
614 Nasdaq Reproposal Letter at 12–13. 615 Infra, section V.A.3.d. bids or offers in the stock.
interest) will garner a very small above,621 it is unlikely that a marginal contribute to price discovery and should
Quoting Share allocation because the increase in market data revenues would be entitled to earn at least some credit
size of such allocation will be significantly alter the quoting behavior in the calculation of the number of
determined by the proportional dollar of market participants, at least for those qualified trades.624 The Commission
volume of trading in a stock. not already interested in trading a stock agreed and included in the reproposed
Finally, commenters were concerned for separate reasons. The potential cost formula a provision that awards a
that some quotations might be of unprofitable trades would be too fractional proportion of a qualified
submitted to ‘‘hide in the queue’’ when high. Rather, the Commission’s primary report for trades of less than $5000. The
a stock already has significant depth objective is to correct an existing flaw in adopted formula also includes this
displayed at the NBBO.617 The strategy the current formulas by allocating provision. Thus, a $2500 trade will
is risky, however, because of the desire revenues to those SROs that, even now,
constitute 1/2 of a qualified transaction
for greater liquidity evidenced by the benefit investors by contributing useful
report. This approach greatly reduces
number of marketable limit orders quotations to the consolidated data
stream. Currently, such SROs do not the potential for large allocations
entered but not filled, particularly for attributable to shredded trades, while
Nasdaq stocks, that was discussed above receive any allocation for providing a
venue for this beneficial quoting recognizing the contribution of small
in section II.A.1.b. Typically, the
activity. Basing an allocation on the trades to price discovery.
volume of such orders searching for
liquidity at the NBBO far exceeds the extent to which an SRO’s quotes equal Two commenters on the original
available liquidity (both displayed size the NBBO is an appropriate means to proposal asserted that the $5000
and reserve size). Any quotations correct this flaw, even if the allocation threshold was arbitrary.625 As noted in
attempting to hide in the queue at the does not always reflect the precise value the Proposing Release, an analysis of
NBBO when liquidity seeking orders of quotations.622 Network A data indicates that
arrive would necessarily be executed c. Number and Dollar Volume of Trades approximately 90% of dollar volume
immediately.618 and 50% of trades exceed this
The current Plan formulas allocate
A few commenters also opposed the threshold. The Commission believes
revenues based on the number of trades
proposed Quoting Share because they that the $5000 figure represents a
(Networks A and B) or on the average
believed it represented an inappropriate reasonable attempt to address the
of number of trades and share volume
attempt by the Commission to control problem of shredding large trades into
of trades (Network C) reported by SROs.
the quoting behavior of market 100-share trades. By providing only a
By focusing solely on trading activity
participants.619 ArcaEx, for example, proportional allocation for trades with
(and particularly by rewarding the
stated that the ‘‘most important question dollar amounts below this threshold, the
reporting of many trades no matter how
is how paying for top-of-book quotes— ability of market participants to generate
small their size), these formulas have
on a time- and size-weighted basis or on large revenue allocations by shredding
contributed to a variety of distortive
any other basis—encourages beneficial trades would be greatly reduced. For
trade reporting practices, including
behavior,’’ and questioned whether the example, a 2000-share trade in a $25
wash sales, shredded trades, and SRO
Quoting Share would achieve this stock could be shredded into twenty
print facilities. To address these
result. Brut asserted that ‘‘[n]ot only trades in the absence of a dollar
practices and to establish a more broad-
would [the proposed formula] increase
based measure of an SRO’s contribution threshold for qualified trades, but could
the potential unnatural trading and
to the consolidated trade stream, the be shredded into only ten qualified
quoting behavior, it signifies a desire to
proposed formula provided that an trades under the reproposed formula.
use market structure regulation to
SRO’s Trading Share in a particular Moreover, when combined with the
micro-manage market participant
stock would be calculated by taking the allocation of 50% of revenues to the
behavior * * *.’’ 620
average of the SRO’s percentage of total Quoting Share and the allocation of
These commenters appear to have dollar volume in the stock and the
misunderstood the Commission’s another 25% of revenues based on the
SRO’s percentage of qualified trades in dollar volume of trades, the $5000
objective in proposing to update the the stock. A ‘‘qualified trade’’ was
current Plan formulas. As noted threshold for qualified trades will
defined as having a dollar volume of eliminate much of the potential reward
$5000 or more. The Proposing Release for trade shredding under reproposed
617 Nasdaq Reproposal Letter at 13; NYSE
requested comment on whether this formula. In the example of the 2000-
Reproposal Letter at 2.
amount should be higher or lower, or
618 Of course, the Commission and SROs will share trade in a $25 stock, the incentive
continue to monitor quoting activity for any whether trades with a size of less than
for shredding would have been reduced
conduct that violates the federal securities laws, the $5000 should receive credit that was
rules thereunder, or SRO rules and take appropriate proportional to their size.623 by a total of 87.5% (75% + (50% *
action to address such conduct. For example, one Several commenters on the original 25%).626
commenter suggested that a market participant
might enter a buy order at the national best bid at proposal believed that small trades
624 See, e.g., BSE Letter at 16; CHX Letter at 19–
a time when there already is depth at such bid, but
with instructions to ‘‘cancel’’ the order upon 621 Supra,note 616 and accompanying text. 20; E*Trade Letter at 11.
execution of orders earlier in the queue. NYSE 622 ArcaEx noted that top-of-book quotes make 625 E*Trade Letter at 11; Instinet Letter at 42.
Reproposal Letter at 2. Such an order type would only a partial contribution to price discovery and 626 One commenter on the reproposal suggested
effectively be impossible to access because it always that depth-of-book quotes are particularly important that the dollar volume allocation for block trades be
would be cancelled when at risk of execution. As since decimalization. ArcaEx Letter at 13. The capped at $300,000 to preclude a disproportionate
a result, reflecting these orders in a displayed Commission agrees that depth-of-book quotes are allocation. NYSE Reproposal Letter II at 4–5. The
quotation would be a clear violation of the Rule important to investors, and for that reason has
602(b) of Regulation NMS, which requires that adopted formula does not include a cap on block
adopted amendments to the market data rules to
displayed quotations be firm, as well as constitute facilitate the independent dissemination of a trades because it would appear to be easily
a material misstatement to the market and investors market’s depth of book. The rules will not prevent avoidable through trade-shredding. Moreover, the
concerning trading interest in the stock. such a market from charging fees for depth-of-book separate allocations for qualified transaction reports
619 ArcaEx Letter at 13; Brut Letter at 22, Phlx quotations that are fair and reasonable and not and for Quoting Shares serve to limit the extent to
Letter at 4. unreasonably discriminatory. which block trades receive a disproportionate
620 Brut Letter at 22. 623 Proposing Release, 69 FR at 11181. allocation under the adopted formula.
d. Allocation of Revenues Among a $50,000 trade in a stock with an limitation is designed to achieve an
Network Stocks average daily trading volume of $500 appropriately balanced allocation
The proposed formula included a million. Markets that provide price among Network stocks by allowing
Security Income Allocation, pursuant to discovery in less active stocks serve an room for a significant increase in the
which a Network’s total distributable extremely important function for amounts currently allocated for many
revenues would be allocated among investors in those stocks. Price less active stocks, while also preventing
each of the Network’s stocks based on discovery not only benefits those unjustifiably high allocations for the
the square root of dollar volume. The investors who choose to trade on any most extremely inactive stocks that
square root function was intended to particular day, but also benefits those might create an inappropriate incentive
adjust for the highly disproportionate who simply need to monitor the status for abusive quoting behavior.
level of trading in the very top tier of of their investment. Efficient secondary
To illustrate the operation of the $4
Network stocks. A few hundred stocks markets support buy-and-hold investors
limitation, assume that the initial square
(e.g., the top 5%) are much more heavily by offering them a ready opportunity to
trade at any time at a fair price if they root allocation for a security with 10
traded than the other thousands of qualified transaction reports during the
Network stocks. The Proposing Release need to buy or sell a stock. Indeed, this
enhanced assurance is one of the most year was $300, or an average allocation
noted that an allocation that simply was of $30 per qualified transaction report.
directly proportional to trading volume important contributions of secondary
markets to efficient capital-formation Rather than allocate the full $300 to this
would fail to reflect adequately the extremely inactive security, the adopted
importance of price discovery for the and to reducing the cost of capital for
listed companies. The square root formula limits the allocation to $4 per
vast majority of stocks.627 The qualified transaction report, so that a
Reproposing Release retained this function allocates revenues to markets
that perform this function for less-active total of only $40 would be allocated to
provision in the reproposed formula.628 the stock as its Security Income
Of the commenters that addressed this stocks by marginally increasing their
percentage of market data revenues, Allocation. The difference of $260 ($300
issue, several supported the use of a
while still allocating a much greater minus $40) would be reallocated among
square root function to allocate revenues
dollar amount to more actively traded all Network securities in direct
among stocks.629 Nasdaq, for example,
stocks. proportion to their share of dollar
noted that the ‘‘methodology will
With respect to very inactively traded volume of trading.
reduce the disparity between the value
of data of the most active and least stocks, however, the adopted formula 4. Distribution and Display of Data
active securities.’’ 630 Other modifies the reproposed square root
commenters, in contrast, opposed the allocation by limiting the revenues that Most commenters supported the
use of the square root function to can be allocated to a single Network provisions, set forth in both the
allocate revenues among Network security to an amount that is no greater proposal and reproposal, authorizing
stocks.631 ArcaEx believed that the than $4 per qualified transaction report. the independent distribution of market
proposed allocation method ‘‘introduces The amount that exceeds this $4 data outside of what is required by the
limitation will be reallocated among all Plans.636 They generally agreed that the
a steeply progressive tax on liquid
Network securities in direct proportion proposal would allow investors and
stocks to subsidize illiquid stocks’’ and
to their dollar volume of trading (which vendors greater freedom to make their
that the allocation of revenues should
is heavily weighted toward the most own decisions regarding the data they
remain directly proportional to trading
actively traded stocks). The Commission need. They also believed that the
volume.632
With one modification, the is adopting this $4 limitation to respond proposed rule amendment’s ‘‘fair and
Commission has retained the square to commenters’ concerns about the reasonable’’ and ‘‘not unreasonably
root function in the adopted formula to potential for abusive quoting behavior discriminatory’’ standards are
in extremely inactive stocks by anyone appropriate to ensure that the
allocate distributable Network revenues
seeking to game the Quoting Share independently distributed market data
more appropriately among all of the
allocation.633 would be made available to all investors
stocks included in a Network. Although
The $4 limitation is consistent with and data users. A few commenters, in
the extent to which Network stocks are the $2 limitation on Trading Share
tiered according to trading volume contrast, objected to the proposed
allocations in the proposed formula and standards, asserting that the standards
varies among the three Networks, it is reproposed formula.634 Whereas the $2
quite pronounced in each of them. The would not effectively protect investors
reproposed limitation applied only to and ‘‘weaker and newer markets from
use of the square root function reflects the 50% revenue allocation for Trading
the Commission’s judgment that, on Share, the $4 adopted limitation applies
average and not necessarily in every to 100% of the revenue allocation for a securities. For the Networks in 2004, the
particular case, information about a distributable revenue per trade was 15.1 cents for
Network security. The $4 limitation will Network A, 14.5 cents for Network C, and 103.1
$50,000 trade in a stock with an average prevent extremely high allocations per cents for Network B. The foregoing Network
daily trading volume of $500,000 is qualified transaction report for very financial information is preliminary and unaudited.
marginally more useful to investors than inactive Network stocks, particularly
636 See, e.g., Brut Letter at 21, 23; CBOE Letter at
2, 17; Citigroup Letter at 16; Financial Information

627 Proposing
when compared with the current Forum Reproposal Letter at 4; Letter from Coleman
Release, 69 FR at 11180.
628 Reproposing
distributable revenues per trade of the Stipanovich, Executive Director, State Board of
Release, 69 FR at 77466.
629 Amex Letter, Exhibit A at 15; Nasdaq Letter II Networks, which ranged from $0.14 to Administration of Florida, to Jonathan G. Katz,
$1.03 in 2004.635 Consequently, the $4 Secretary, Commission, dated June 29, 2004
at 32; NYSE Reproposal Letter II at 3; Specialist (‘‘Florida State Board Letter’’) at 2; Financial
Assoc. Letter at 16 n. 21. Services Roundtable Letter at 6; Goldman Sachs
630 Nasdaq Letter II at 32. 633 See
supra, section V.A.3.b. Letter at 12; ICI Letter at 4, 21 n. 35; Instinet Letter
631 ArcaEx Reproposal Letter at 11; CBOE Letter 634 See
Proposing Release, 69 FR at 11181; at 45; Nasdaq Letter II at 33; NYSE Letter,
at 11; Instinet Reproposal Letter at 13; Letter from Reproposing Release, 69 FR at 77467. Attachment at 12; Letter from P. Howard Edelstein,
Ronald A. Orguss, President, Xanadu Investment 635 The distributable revenue per trade for a President and CEO, Radianz Americas, Inc., to
Co., to Jonathan G. Katz, Secretary, Commission, Network is calculated by dividing the total Jonathan G. Katz, Secretary, Commission, dated Jan.
dated Jun. 29, 2004 (‘‘Xanadu Letter’’) at 2–3. distributable net income of the Network by the total 27, 2005 (‘‘Radianz Reproposal Letter’’) at 1–2;
632 ArcaEx Letter at 12. number of reported trades for the Network’s Reuters Letter at 3.
predatory actions by stronger markets or transmits the data to a Network what, if any, additional quotations
the potential loss of data integrity.’’ 637 processor. outside the NBBO are displayed to
The Commission is adopting Rule A majority of the commenters investors. Investors who need the BBOs
603(a) as proposed and reproposed.638 supported the Commission’s proposed of each SRO, as well as more
The ‘‘fair and reasonable’’ and ‘‘not reduction of the consolidated display comprehensive depth-of-book
unreasonably discriminatory’’ requirements, stating that it should lead information, will be able to obtain such
requirements in adopted Rule 603(a) are to lower costs for investors.641 A few data from markets or third party
derived from the language of Section commenters, however, opposed vendors.
11A(c) of the Exchange Act. Under eliminating the requirement to display a
full montage of market BBOs.642 Amex, B. Description of Adopted Rules and
Section 11A(c)(1)(C), the more stringent Amendments
‘‘fair and reasonable’’ requirement is for example, believed that elimination
applicable to an ‘‘exclusive processor,’’ of the montage would confuse investors 1. Allocation Amendment
which is defined in Section 3(a)(22)(B) and make it more complicated for For the reasons just discussed, the
of the Exchange Act as an SRO or other vendors and broker-dealers to manage Commission is adopting with
entity that distributes the market market data. Some commenters believed modifications an amendment to each of
information of an SRO on an exclusive that, rather than reducing the the Plans (‘‘Allocation Amendment’’)
basis. Adopted Rule 603(a)(1) extends consolidated display requirement, the that incorporates a broad based measure
this requirement to non-SRO markets Commission should expand the of the contribution of an SRO’s quotes
when they act in functionally the same requirement to include additional and trades to the consolidated data
manner as exclusive processors and are information on depth-of-book stream.645 The adopted formula reflects
the exclusive source of their own data. quotations, stating that the NBBO alone a two-step process. First, a Network’s
Applying this requirement to non-SROs has become less informative since distributable revenues (e.g., $150
is consistent with Section 11A(c)(1)(F) decimalization.643 million) will be allocated among the
of the Exchange Act, which grants the The Commission does not believe that many individual securities (e.g., 3000)
Commission rulemaking authority to streamlining the quotations included in included in the Network’s data stream.
‘‘assure equal regulation of all markets’’ the consolidated display requirement Second, the revenues that are allocated
for NMS Securities. will detract from the quality of to an individual security (e.g., $200,000)
Commenters were concerned about information made available to investors. will be allocated among the SROs based
the statement in the Proposing Release Adopted Rule 603(c), which is adopted on measures of the usefulness to
that the distribution standards would today as proposed and reproposed, will investors of the SROs’ trades and quotes
prohibit a market from distributing its continue to require the disclosure of in the security. The Allocation
data independently on a more timely basic quotation information (i.e., prices, Amendment provides that,
basis than it makes available the ‘‘core sizes and market center identifications notwithstanding any other provision of
data’’ that is required to be disseminated of the NBBO). Particularly for retail a Plan, its SRO participants shall receive
through a Network processor.639 investors, the NBBO continues to retain an annual payment for each calendar
Instinet, for example, requested that the a great deal of value in assessing the year that is equal to the sum of the
Commission clarify that the proposal current market for small trades and the SRO’s Trading Shares and Quoting
would not require a market center to quality of execution of such trades. For Shares in each Network security for the
artificially slow the independent example, statistics on order execution year.646 These two types of Shares are
delivery of its data in order to quality for small market orders (the dollar amounts that are calculated based
synchronize its delivery with the data order type typically used by retail on SRO trading and quoting activity in
disseminated by the Network.640 investors) reveal that their average each Network security.
Adopted Rule 603(a) will not require a execution price is very close to, if not For the reasons discussed in section
market center to synchronize the better than, the NBBO.644 The adopted V.A.3 above, the Commission finds that
delivery of its data to end-users with consolidated display requirement will
delivery of data by a Network processor allow market forces, rather than 645 In 2002, the Commission abrogated several
regulatory requirements, to determine SRO proposals for rebating data revenues to market
to end-users. Rather, independently participants. Securities Exchange Act Release No.
distributed data could not be made 46159 (July 2, 2002), 67 FR 45775 (July 10, 2002).
641 See, e.g., Brut Letter at 21, 23; Financial
available on a more timely basis than The purpose of the abrogation was to allow more
Information Forum Letter at 3–4; Instinet Letter at time for the Commission to consider market data
core data is made available to a Network 7, 45; Nasdaq Letter II at 27, 32; Reuters Letter at issues. Given that the current Plan allocation
processor. Stated another way, adopted 2–3. formulas will be updated to allocate revenues for
Rule 603(a) prohibits an SRO or broker- 642 See, e.g., Amex Letter at 9 & Exhibit A at 12;
more beneficial quoting and trading behavior, the
dealer from transmitting data to a Bloomberg Tradebook Letter at 9; Callcott Letter at Commission will consider whether rebates will be
1, 2, 5. permitted after implementation of the adopted
vendor or user any sooner than it 643 See, e.g., Bloomberg Reproposal Letter at 9; formula, taking into account whether their terms
Schwab Reproposal Letter at 5. meet applicable Exchange Act standards and SROs
637 See, e.g., Amex Letter at 10, Exhibit A at 13. 644 See, e.g., S&P Index Study, Table 2 (slippage are able to meet their regulatory responsibilities.
638 The Commission also is adopting the rates—the extent to which executions occur at Such SRO rebates would, of course, have to be filed
reproposed amendment to current Rule 11Aa3–1 prices inferior to the NBBO at time of order with the Commission for notice, comment, and
(redesignated as Rule 601 under Regulation NMS), receipt—for small market orders range from -2.5 Commission consideration pursuant to Section
which rescinds the prohibition on SROs and their basis points (i.e., price improvement) to 0.5 basis 19(b) of the Exchange Act.
members from disseminating their trade reports points). The Dash 5 statistics used in the S&P Index 646 Two commenters were concerned that the new
independently. Given that members of an SRO will Study were calculated using the NBBO at time of formula might prohibit the Network’s current
continue to be required to transmit their trades to order receipt, whereas trade-through statistics used practice of making estimated quarterly payments of
the SRO (and SROs will continue to transmit trades in the Trade-Through Study were calculated using Network revenues, with a final reconciliation at the
to the Networks pursuant to the Plans), the the market BBOs at the time of order execution. In end of the year. BSE Letter at 18, 19; CHX Letter
Commission believe that SROs and their members addition, the Dash 5 statistics reflect the overall at 22. The language of the reproposed formula and
also should be free to distribute their trades average of order executions inside the NBBO, at the adopted formula, however, merely tracks existing
independently. NBBO, and outside the NBBO. The trade-through Plan language for the calculation of ‘‘Annual
639 Amex Letter, Exhibit A at 12; Instinet Letter
statistics focus solely on trades executed outside the Shares’’ or ‘‘annual payments.’’ Nothing in the
at 47; Reuters Letter at 2. best prices. Consequently, the two sets of statistics adopted formula prohibits Networks from making
640 Instinet Letter at 47. are not directly comparable. estimated quarterly payments.
the Allocation Amendment is necessary Income Allocation for the Eligible does not lock or cross a previously
and appropriate in the public interest, Security by (2) the SRO’s Trade Rating displayed automated quotation.647 To
for the protection of investors and the in the security. A Trade Rating will be qualify for credits, the quoted price
maintenance of fair and orderly markets, a number that represents the SRO’s must be displayed for at least one full
to remove impediments to, and perfect proportion of dollar volume and second, and the relevant size will be the
the mechanisms of, a national market qualified trades in the security, as minimum size that was displayed
system, and otherwise in furtherance of compared to the dollar volume and during the second. Thus, for example, a
the purposes of the Exchange Act. qualified trades of all SROs. The Trade bid with a dollar value of $4000 (e.g., a
Ratings of all SROs will add up to a total bid of $20 with a size of 200 shares) that
a. Security Income Allocation
of one. Thus, for example, multiplying equals the national best bid for three full
The first step of the adopted formula 50% of the Security Income Allocation seconds would be entitled to 12,000
is to allocate a Network’s total for a Network security (e.g., $200,000) Quote Credits. If an SRO quotes
distributable revenues among the many by an SRO’s Trade Rating in that simultaneously at both the national best
different securities that are included in security (e.g., 0.2555) would produce a bid and the national best offer, it would
a Network (the ‘‘Security Income dollar amount (e.g., 50% × $200,000 × earn Quote Credits for each quote. An
Allocation’’). Paragraph (b) of the 0.2555 = $25,550) that is the SRO’s automated quotation is defined by
adopted Allocation Amendment bases Trading Share for the security for the reference to adopted Rule 600(b)(3)
this allocation primarily on the square year. under Regulation NMS. Thus, an SRO’s
root of dollar volume of trading in each Applying 50% of the Security Income manual quotations will not be entitled
security. Use of the square root function Allocation to the Trading Share reflects to earn any Quote Credits.
will more appropriately allocate a judgment that generally trades and
revenues among stocks with widely quotes are of approximately equal 2. Governance Amendment
differing trading volume. A small importance for price discovery For the reasons discussed above in
number of Network stocks are much purposes. An SRO’s Trade Rating will section V.A.2.b, the Governance
more heavily traded than the great be calculated by taking the average of: Amendment is adopted as proposed and
majority of Network stocks. By (1) the SRO’s percentage of total dollar reproposed. Paragraph (a) mandates the
proportionally shifting revenues away volume reported in the Network formation of a Plan advisory committee.
from the very top tier of active stocks security during the year and (2) the Paragraph (b) of the Governance
and increasing the allocation across SRO’s percentage of the total number of Amendment sets forth the composition
other stocks, the Security Income qualified transaction reports in the and selection process for such an
Allocation is intended to reflect more Network security for the year. A advisory committee. Members of the
adequately the importance of price transaction report with a dollar volume advisory committee will be selected by
discovery for all Network stocks. of $5000 or more will constitute one the Plan operating committee, by
For the most inactively traded qualified report. A transaction report majority vote, for two-year terms. At
securities, however, the square root with a dollar volume of less than $5000 least one representative must be
function can disproportionately allocate will constitute a proportional fraction of selected from each of the following five
revenues for a small number of trades a qualified transaction report. As a categories: (1) A broker-dealer with a
during the year. For example, the square result, all sizes of transaction reports substantial retail investor customer
root allocation for a security with 10 will contribute toward an SRO’s Trade base; (2) a broker-dealer with a
qualified transaction reports during the Rating. substantial institutional investor
year might be $300. Rather than allocate customer base; (3) an ATS; (4) a data
the full $300 to such an inactively c. Quoting Share
vendor; and (5) an investor. Each Plan
traded security (for an average Under paragraph (d) of the adopted participant also will have the right to
allocation per qualified transaction Allocation Amendment, an SRO’s select one additional member to the
report of $30), the adopted formula Quoting Share in a particular Network advisory committee that is not
includes a cap of $4 per qualified Security will be a dollar amount that is employed by or affiliated with any Plan
transaction report, so that a total of only determined by multiplying (1) an participant or its affiliates or facilities.
$40 will be allocated to the inactive amount equal to 50% of the Security Paragraphs (c) and (d) of the
security pursuant to the square root Income Allocation for the security by (2) Governance Amendment set forth the
allocation. The difference of $260 ($300 the SRO’s Quote Rating in the security. function of the advisory committee and
minus $40) will be reallocated among A Quote Rating will be a number that the requirements for its participation in
all Network securities in direct represents the SRO’s proportion of best Plan affairs. Pursuant to paragraph (c),
proportion to the dollar volume of bids and best offers that equaled the members of an advisory committee have
transaction reports in Network price of the NBBO during the year the right to submit their views to the
securities. A transaction report with a (‘‘Quote Credits’’), as compared to the operating committee on Plan matters,
dollar volume of $5000 or more Quote Credits of all SRO’s during the including, but not limited to, any new
constitutes one qualified report. A year. The Quote Ratings of all SROs will or modified product, fee, contract, or
transaction report with a dollar volume add up to a total of one. Multiplying pilot program that is offered or used
of less than $5000 constitutes a 50% of the Security Income Allocation
proportional fraction of a qualified for a Network security by an SRO’s 647 Regular trading hours are defined in Rule
transaction report. Quote Rating in that security will 600(b)(64) of Regulation NMS as between 9:30 a.m.
produce a dollar amount that is the and 4:00 p.m. Eastern Time, unless otherwise
b. Trading Share SRO’s Quoting Share for the security for
specified pursuant to the procedures established in
Rule 605(a)(2). One commenter suggested that the
Under paragraph (c) of the adopted the year. reproposal trades also should have limited trades to
Allocation Amendment, an SRO’s An SRO will earn one Quote Credit those reported during regular trading hours. NYSE
Trading Share in a particular Network for each second of time and dollar value Reproposal Letter II at 4. The Commission believes
that after-hours trades generally have price
security will be a dollar amount that is of size that the SRO’s automated best discovery value and is retaining the current Plan
determined by multiplying: (1) an bid or best offer during regular trading practice of including them in the allocation
amount equal to 50% of the Security hours equals the price of the NBBO and formula.
pursuant to the Plan. Paragraph (d) distributed by an exclusive processor, or disseminate consolidated information
provides that members have the right to by a broker or dealer (including ATSs for NMS stocks. Such consolidated
attend all operating committee meetings and market makers) that is the exclusive information must include an NBBO that
and to receive any information source of the information, be made is calculated in accordance with the
distributed to the operating committee available to securities information definition set forth in adopted Rule
relating to Plan matters, except when processors on terms that are fair and 600(b)(42).650 In addition, the NMS
the operating committee, by majority reasonable. Rule 603(a)(2) requires that plans will be required to provide for the
vote, decides to meet in executive any SRO, broker, or dealer that dissemination of all consolidated
session after determining that an item of distributes market information must do information for an individual NMS
Plan business requires confidential so on terms that are not unreasonably stock through a single processor. Thus,
treatment. discriminatory. These requirements different processors would be permitted
For the reasons discussed in section prohibit, for example, a market from to disseminate information for different
V.A.2.b above, the Commission finds making its ‘‘core data’’ (i.e., data that it NMS stocks (e.g., SIAC for Network A
that the Governance Amendment is is required to provide to a Network stocks, and Nasdaq for Network C
necessary and appropriate in the public processor) available to vendors on a stocks), but all quotations and trades in
interest, for the protection of investors more timely basis than it makes a stock must be disseminated through a
and the maintenance of fair and orderly available the core data to a Network single processor. As a result,
markets, to remove impediments to, and processor. With respect to non-core information users, particularly retail
perfect the mechanisms of, a national data, however, Network processors investors, will be able to obtain data
market system, and otherwise in occupy a unique competitive position. from a single source that reflects the
furtherance of the purposes of the As Network processor, it acts on behalf best quotations and most recent trade
Exchange Act. of all markets in disseminating price for a security, no matter where
consolidated information, yet it also such quotations and trade are displayed
3. Consolidation, Distribution, and in the NMS.
may be closely associated with the
Display of Data
competitor of a market. The c. Display of Consolidated Information
a. Independent Distribution of Commission believes that markets
Information should have considerable leeway in For the reasons discussed above in
determining whether, or on what terms, section V.A.4, the Commission is
The Commission is adopting the adopting, as proposed and reproposed,
reproposed amendment to current Rule they provide additional, non-core data
to a Network processor. Rule 603(c) (previously Exchange Act
11Aa3–1 (redesignated as Rule 601), Rule 11Ac1–2), which substantially
which rescinds the prohibition on SROs b. Consolidation of Information revises the consolidated display
and their members from disseminating requirement. It incorporates a new
For the reasons discussed above in
their trade reports independently.648 definition of ‘‘consolidated display’’ (set
section V.A.1, the Commission is
Under adopted Rule 601, members of an forth in adopted Rule 600(b)(13)) that is
retaining the current consolidation
SRO will continue to be required to limited to the prices, sizes, and market
model and adopting the consolidation
transmit their trades to the SRO (and center identifications of the NBBO and
requirements of Rule 603(b) as proposed
SROs would continue to transmit trades ‘‘consolidated last sale information’’
and reproposed. All of the SROs
to the Networks pursuant to the Plans), (which is defined in Rule 600(b)(14)).
currently participate in Plans that
but such members also will be free to The consolidated information on
provide for the dissemination of
distribute their own data independently, quotations and trades must be provided
consolidated information for the NMS
with or without fees. in an equivalent manner to any other
stocks that they trade. The Plans were
For the reasons discussed above in information on quotations and trades
adopted in order to enable the SROs to
section V.A.4, the Commission also is provided by a securities information
comply with Exchange Act rules
adopting, as proposed and reproposed, processor or broker-dealer. Beyond
regarding the reporting of trades and
Rule 603(a), which establishes uniform disclosure of this basic information,
distribution of quotations. With respect
standards for distribution of both market forces, rather than regulatory
to trades, paragraph (b) of Exchange Act
quotations and trades that will create an requirements, will be allowed to
Rule 11Aa3–1 (redesignated as Rule
equivalent regulatory regime for all determine what, if any, additional data
601(a)) requires each SRO to file
types of markets. First, Rule 603(a)(1) from other market centers is displayed.
transaction reporting plans that specify,
requires that any market information 649 In particular, investors and other
among other things, how its transactions
648 See supra, note 638. Adopted Regulation NMS are to be consolidated with the information users ultimately will be
removes the definitions in former paragraph (a) of transactions of other SROs. With respect able to decide whether they need
Rule 11Aa3–1 and places them in adopted Rule to quotations, paragraph (b)(1) of additional information in their displays.
600(b). Current subparagraphs (c)(2) and (c)(3) of Exchange Act Rule 11Ac1–1 In addition, adopted Rule 603(c)
Rule 11Aa3–1 are rescinded. As a result, current narrows the contexts in which a
subparagraph (c)(4) of current Rule 11Aa3–1 is
(redesignated as Rule 602(a)(1)) requires
redesignated as subparagraph (b)(2) of adopted Rule an SRO to establish and maintain consolidated display is required to those
601. procedures for making its best quotes when it is most needed—a context in
649 The information covered by the amendment
available to vendors. which a trading or order-routing
tracks the language of Section 11A(c) of the To confirm by Exchange Act rule that decision could be implemented. For
Exchange Act, which applies to ‘‘information with example, the consolidated display
respect to quotations for or transactions in’’ both existing and any new SROs will be
securities. This statutory language encompasses a required to continue to participate in requirement will continue to cover
broad range of information, including information such joint-SRO plans, adopted Rule broker-dealers who provide on-line data
relating to limit orders held by a market center. See, 603(b) requires SROs to act jointly to their customers in software programs
e.g., S. Report No. 94–75, 94th Cong., 1st Sess. 9 from which trading decisions can be
(1975) (‘‘In the securities markets, as in most other pursuant to one or more NMS plans to
active markets, it is critical for those who trade to implemented. Similarly, the
have access to accurate, up-to-the-second sale reports) and the prices at which other traders
information as to the prices at which transactions have expressed their willingness to buy or sell (i.e., 650 Adopted Rule 600(b)(42) of Regulation NMS
in particular securities are taking place (i.e., last quotations).’’). defines ‘‘national best bid and national best offer.’’
requirement will continue to apply to that use terms that Regulation NMS • Rule 605: Disclosure of Order
vendors who provide displays that amends or eliminates. Execution Information (renumbers
facilitate order routing by broker- The Commission received no Exchange Act Rule 11Ac1–5, the
dealers. It will not apply, however, comments regarding reproposed Rule substance of which remains largely
when market data is provided on a 600, the reproposed redesignation of the intact);
purely informational Web site that does NMS rules as Regulation NMS, or the • Rule 606: Disclosure of Order
not offer any trading or order-routing reproposed changes to other Routing Information (renumbers
capability.651 Commission rules. Accordingly, the Exchange Act Rule 11Ac1–6, the
Commission is adopting Rule 600 and substance of which remains largely
VI. Regulation NMS intact);
redesignating the NMS rules as
To simplify the structure of the rules Regulation NMS, and adopting technical • Rule 607: Customer Account
amendments to certain other Statements (renumbers Exchange Act
adopted under Section 11A of the
Commission rules that cross-reference Rule 11Ac1–3, the substance of which
Exchange Act (‘‘NMS rules’’), the rules
current NMS rules or that use terms that remains largely intact);
adopted today will designate the NMS
Regulation NMS amends or eliminates, • Rule 608: Filing and Amendment of
rules as Regulation NMS, renumber the
substantially as proposed. National Market System Plans
NMS rules, and establish a new
(renumbers Exchange Act Rule 11Aa3–
definitional rule, Rule 600 (‘‘NMS A. Description of Regulation NMS 2, the substance of which remains
Security Designation and Definitions’’).
Regulation NMS renumbers and, in largely intact);
Rule 600(a) replaces Exchange Act Rule • Rule 609: Registration of Securities
11Aa2–1, which designates ‘‘reported some cases, renames the existing NMS
rules, and incorporates Rule 600 and the Information Processors: Form of
securities’’ as NMS securities. In Application and Amendments
addition, Rule 600(b) includes, in other NMS rules adopted today. Where
applicable, existing NMS rules are being (renumbers Exchange Act Rule 11Ab2–
alphabetical order, all of the defined 1, the substance of which remains
terms used in Regulation NMS. amended to remove the definitions that
have been consolidated in Rule 600. The largely intact);
Regulation NMS includes Rules 610, • Rule 610: Access to Quotations
611, and 612, which are adopted in this titles and numbering of the rules in
(adopted in this release);
release, in addition to the existing NMS Regulation NMS, including the NMS • Rule 611: Order Protection Rule
rules. The new rule series is Rule 600 rules adopted today, are as follows: (adopted in this release); and
through Rule 612 (17 CFR 242.600–612). • Rule 600: NMS Security • Rule 612: Minimum Pricing
Designation and Definitions (replaces Increment (adopted in this release).
Rule 600 provides a single set of
Exchange Act Rule 11Aa2–1, which the
definitions that will be used throughout B. Rule 600—NMS Security Designation
Commission is rescinding, and
Regulation NMS. To create a single set and Definitions
incorporates definitions from the
of definitions, Rule 600 updates or
existing NMS rules and the new rules 1. NMS Security Designation—
deletes from the existing NMS rules
adopted today); Transaction Reporting Requirements for
some terms that have become obsolete
and eliminates the use of multiple • Rule 601: Dissemination of Equities and Listed Options
inconsistent definitions for identical Transaction Reports and Last Sale Data
with Respect to Transactions in NMS Section 11A(a)(2) of the Exchange Act
terms. In addition, Rule 600 adopts new directs the Commission to ‘‘designate
terms, ‘‘NMS security’’ and ‘‘NMS Stocks (renumbers and renames
Exchange Act Rule 11Aa3–1, the the securities or classes of securities
stock,’’ to replace some terms that have qualified for trading in the national
been eliminated. These terms are substance of which is being
modified); 652 market system.’’ 654 The 1975
necessary to maintain distinctions Amendments and the legislative history
between NMS rules that apply only to • Rule 602: Dissemination of
to the 1975 Amendments were silent as
equity securities and ETFs (e.g., Quotations in NMS Securities
to the particular standards the
Exchange Act Rules 11Ac1–4 and (renumbers and renames Exchange Act
Commission should employ in
11Ac1–5, redesignated as Rules 604 and Rule 11Ac1–1 (‘‘Quote Rule’’), the
designating NMS securities.655 Instead,
605) and those that apply to equity substance of which remains largely
Congress provided the Commission with
securities, ETFs, and options (e.g., intact);
the flexibility and discretion to base
Exchange Act Rules 11Ac1–1 and • Rule 603: Distribution,
NMS designation standards on the
11Ac1–6, redesignated as Rules 602 and Consolidation, and Display of
Commission’s experience in facilitating
606). Rule 600 retains, unchanged, most Information with Respect to Quotations
the development of an NMS.656
definitions used in the existing NMS for and Transactions in NMS Stocks To satisfy the requirement that it
rules and includes definitions used in (renumbers and renames Exchange Act designate the securities qualified for
the new NMS rules adopted today. The Rule 11Ac1–2 (‘‘Vendor Display Rule’’), trading in the NMS, the Commission
definitional changes do not affect the the substance of which is being adopted Exchange Act Rule 11Aa2–1 in
substantive requirements of the existing modified substantially); 653 1981.657 Exchange Act Rule 11Aa2–1
NMS rules. In addition, the Commission • Rule 604: Display of Customer (redesignated as Rule 600(a)) defined
is adopting technical amendments to a Limit Orders (renumbers Exchange Act the term ‘‘national market system
number of other Commission rules that Rule 11Ac1–4 (‘‘Limit Order Display security’’ to mean ‘‘any reported
cross-reference current NMS rules or Rule’’), the substance of which remains
largely intact); 654 15 U.S.C. 78k–1(a)(2).
651 The 655 See Securities Exchange Act Release No.
amendment would retain the exemptions
currently set forth in Rule 11Ac1–2(f) (redesignated 652 In the market data rules, discussed in section 23817 (Nov. 17, 1986), 51 FR 42856 (Nov. 26, 1986)
as Rule 603(c)(2)) for exchange and market linkage V, the Commission is adopting substantive (proposing amendments to Exchange Act Rules
displays. The current exemption for displays used amendments to Exchange Act Rule 11Aa3–1 11Aa2–1 and 11Aa3–1).
by SROs for monitoring or surveillance purposes (redesignated as Rule 601). 656 See id.
would no longer be necessary because of the 653 See supra section V for a discussion of the 657 See Securities Exchange Act Release No.
limitation of the amendment to trading and order- substantive amendments to the Vendor Display 17549 (Feb. 17, 1981), 46 FR 13992 (Feb. 25, 1981)
routing contexts. Rule. (adopting Exchange Act Rule 11Aa2–1).
security as defined in Rule 11Aa3–1.’’ A As a result, Nasdaq SmallCap securities these inconsistencies. The definitional
‘‘reported security’’ was ‘‘any security or became ‘‘eligible securities’’ because changes adopted today, however, are
class of securities for which transaction they are now reported through an not intended to change materially the
reports are collected, processed and effective transaction reporting plan (i.e., scope of the existing NMS rules.
made available pursuant to an effective the Nasdaq UTP Plan), bringing them
2. NMS Security and NMS Stock
transaction reporting plan.’’ 658 An within the purview of the NMS security
‘‘effective transaction reporting plan’’ designation. Several definitions in the Some NMS rules, including the Quote
was ‘‘any transaction reporting plan existing NMS rules, however, do not Rule (redesignated as Rule 602) and
approved by the Commission pursuant reflect the inclusion of Nasdaq Exchange Act Rule 11Ac1–6
to this section.’’ 659 A ‘‘transaction SmallCap securities in the Nasdaq UTP (redesignated as Rule 606), currently
reporting plan’’ was ‘‘any plan for Plan and therefore must be updated. apply to both: (1) Equities, ETFs and
collecting, processing, making available Regulation NMS does so. related securities for which transaction
or disseminating transaction reports In addition, transactions in exchange- reports are made available pursuant to
with respect to transactions in reported listed options are reported through the an effective transaction reporting plan;
securities filed with the Commission Plan for Reporting of Consolidated and (2) listed options for which market
pursuant to, and meeting the Options Last Sale Reports and information is made available pursuant
requirements of, this section.’’ 660 The Quotation Information (‘‘OPRA to an effective national market system
effective transaction reporting plans are Plan’’).663 Unlike the CTA Plan and the plan. To provide a single term that will
the CTA Plan and the Nasdaq UTP Plan. Nasdaq UTP Plan—transaction reporting be used in any provision of Regulation
In addition to identifying those plans that the Commission approved NMS that applies to both categories of
securities deemed to be NMS securities, pursuant to Exchange Act Rules 11Aa3– securities, Regulation NMS adopts a
when adopted, the Exchange Act Rule 1 and 11Aa3–2 (redesignated as Rules new term, ‘‘NMS security.’’ Specifically,
11Aa2–1 designation also tacitly 601 and 608)—the Commission Regulation NMS defines an ‘‘NMS
identified those securities that did not approved the OPRA Plan pursuant to security’’ as ‘‘any security or class of
meet that designation (i.e., securities Exchange Act Rule 11Aa3–2 securities for which transaction reports
other than those that were so designated (redesignated as Rule 608).664 As such, are collected, processed, and made
as NMS securities). Historically, the OPRA Plan is an ‘‘effective national available pursuant to an effective
securities excluded from this market system plan’’ but not an transaction reporting plan, or an
designation included standardized ‘‘effective transaction reporting plan.’’ effective national market system plan
options and small capitalization equity While at their core the CTA Plan, the for reporting transactions in listed
securities (a subset of which has been Nasdaq UTP Plan, and the OPRA Plan options.’’ 665
identified as Nasdaq SmallCap perform essentially the same function Because many rules in Regulation
securities). Trading in options and (i.e., they govern the consolidated NMS, including the Limit Order Display
Nasdaq SmallCap securities has reporting of securities transactions by Rule (redesignated as Rule 604) and
increased over the past three decades Plan participants), because the OPRA Exchange Act Rule 11Ac1–5
and gradually many of the rules that Plan is not an effective transaction
(redesignated as Rule 605), continue to
govern NMS securities have been reporting plan, listed options covered by
be inapplicable to listed options,
applied to these securities. As a result, the OPRA Plan are technically not
Regulation NMS adopts a new term,
much of the terminology that has been ‘‘securities for which transaction reports
‘‘NMS stock’’ that will be used in those
used to distinguish NMS securities from are collected, processed, and made
provisions. Regulation NMS defines the
options and Nasdaq SmallCap securities available pursuant to an effective
term ‘‘NMS stock’’ as ‘‘any NMS
has become obsolete. transaction reporting plan.’’ Therefore,
security other than an option.’’ 666
For example, the Nasdaq UTP Plan listed options were not considered NMS
provides for the collection from Plan securities as defined by Exchange Act 3. Changes to Existing Definitions in the
participants, and the consolidation and Rule 11Aa2–1. While the impact of this NMS Rules
dissemination to vendors, subscribers distinction may not be readily apparent,
Rule 600(b) provides a single set of
and others, of quotation and transaction the differences in the way the Plans are
definitions that will be used throughout
information in ‘‘eligible securities.’’ designated dictates the securities laws
Regulation NMS. To create a single set
Prior to 2001, the Nasdaq UTP Plan and regulations that apply to securities
of definitions, Regulation NMS
defined an ‘‘eligible security’’ as any reported pursuant to those Plans.
Further, as discussed below, some eliminates multiple, inconsistent
Nasdaq National Market security as to definitions of identical terms. In
which unlisted trading privileges have terms in the existing NMS rules have
become superfluous or outdated, and addition, Regulation NMS amends some
been granted to a national securities definitions in the NMS rules to reflect
exchange pursuant to Section 12(f) of some NMS rules define identical terms
differently. To provide a consolidated changed conditions in the marketplace
the Exchange Act or that is listed on a
national securities exchange.661 In 2001, set of definitions applicable to all of the
665 Rule 600(b)(46). This definition was used to
NMS rules, Regulation NMS eliminates
the Nasdaq UTP Plan was amended to define a ‘‘reported security’’ in the Quote Rule. See
include Nasdaq SmallCap securities.662 former Exchange Act Rule 11Ac1–1(a)(20). For the
45081 (Nov. 19, 2001), 66 FR 59273 (Nov. 27, 2001) reasons described below, the Commission is
(order approving Amendment No. 12 to the Nasdaq eliminating the term ‘‘reported security’’ from the
658 See former Exchange Act Rule 11Aa3–1(a)(4). UTP Plan). See NASD Rule 4200 for the definition Quote Rule and does not include it in Regulation
659 See former Exchange Act Rule 11Aa3–1(a)(3).
of a Nasdaq SmallCap security. NMS.
660 See former Exchange Act Rule 11Aa3–1(a)(2). 663 The exchanges that are participants to the 666 Rule 600(b)(47). The term ‘‘NMS stock’’ is
661 See Securities Exchange Act Release No. OPRA Plan are Amex, BSE, CBOE, ISE, PCX, and defined in part with reference to the term
28146 (June 26, 1990), 55 FR 27917 (July 6, 1990) Phlx. ‘‘transaction reporting plan.’’ The definition of the
(order approving the Nasdaq UTP Plan on a pilot 664 See Securities Exchange Act Release No. term ‘‘transaction reporting plan’’ as proposed used
basis 17638 (Mar. 18, 1981), 22 S.E.C. Docket 484 (Mar. the term ‘‘NMS stocks.’’ Thus, to avoid circularity,
662 In 2001, the Nasdaq UTP Plan was amended 31, 1981). Exchange Act Rule 11Aa3–2 the Commission has clarified the definition of
to, among other things, revise the definition of (redesignated as Rule 608) codifies the procedures ‘‘transaction reporting plan’’ in Rule 600(b)(82) as
‘‘eligible securities’’ to include Nasdaq SmallCap that SROs must follow to seek approval for or adopted by replacing the phrase ‘‘NMS stocks’’ with
securities. See Securities Exchange Act Release No. amendment of a national market system plan. the term ‘‘securities.’’
or to modernize references.667 For a. Covered Security inconsistently in the NMS rules and in
example, as discussed above, several Different definitions of the term light of the changes to related terms,
definitions in the existing NMS rules ‘‘covered security’’ appeared in the Regulation NMS eliminates the term
have been rendered obsolete by the Quote Rule, the Limit Order Display ‘‘reported security’’ from the NMS rules
extension of the Nasdaq UTP Plan to Rule, and Exchange Act Rule 11Ac1–6 and replaces it with the term ‘‘NMS
Nasdaq SmallCap securities.668 Because (redesignated as Rule 606).671 In security’’ or ‘‘NMS stock,’’ depending
the Nasdaq UTP Plan includes Nasdaq addition, as discussed below, the term on the scope of the particular rule.
SmallCap securities, those securities has become obsolete. Therefore, The Limit Order Display Rule used
now are ‘‘securities for which Regulation NMS eliminates the term the term ‘‘reported security’’ solely for
transaction reports are collected, ‘‘covered security’’ from the NMS rules the purpose of defining the term
processed and made available pursuant and replaces it with the term ‘‘NMS ‘‘covered security.’’ 673 Because
to an effective transaction reporting security’’ or ‘‘NMS stock,’’ as applicable, Regulation NMS eliminates the term
plan’’ (i.e., they are ‘‘reported’’ depending upon the scope of the ‘‘covered security,’’ the term ‘‘reported
particular rule. security’’ also is not needed in the Limit
securities).669 For this reason, it is no
Order Display Rule (redesignated as
longer necessary to distinguish, as b. Reported Security Rule 604). Therefore, the term ‘‘NMS
several existing NMS rules do, between
Several NMS rules used the term stock’’ replaces the term ‘‘covered
‘‘reported’’ securities and equity security’’ in the Limit Order Display
securities for which market information ‘‘reported security.’’ Although the Limit
Order Display Rule, the Vendor Display Rule.
is made available through Nasdaq.670 Similarly, the Quote Rule used the
Accordingly, Regulation NMS Rule, and Exchange Act Rule 11Aa3–1
(redesignated as Rule 601) contained term ‘‘reported security’’ primarily to
eliminates or revises the defined terms define the term ‘‘covered security.’’ 674
in the existing NMS rules that make this identical definitions of ‘‘reported
security,’’ the Quote Rule provided a Because Regulation NMS eliminates the
distinction. term ‘‘covered security,’’ the
different definition.672 Because the term
‘‘reported security’’ was defined redesignated Quote Rule (redesignated
667 The term ‘‘electronic communications
as Rule 602) also will not use the term
network’’ was proposed to be defined in the ‘‘reported security.’’ 675
671 Although the Quote Rule and the Limit Order
Proposing Release and Reproposing Release to
mean ‘‘any electronic system that widely Display Rule each defined the term ‘‘covered
security’’ as ‘‘any reported security and any other c. Subject Security
disseminates to third parties orders entered therein
by an exchange market maker or OTC market security for which a transaction report, last sale The Quote Rule and the Vendor
data or quotation information is disseminated
maker, and permits such orders to be executed
through an automated quotation system as
Display Rule both used the term
against in whole or in part; except that the term ‘‘subject security,’’ although they define
electronic communications network shall not described in Section 3(a)(51)(A)(ii) of the Act (15
include: (i) Any system that crosses multiple orders U.S.C. 78c(a)(51)(A)(ii)),’’ the scope of the the term differently. To eliminate this
at one or more specified times at a single price set definitions was not identical because each rule inconsistency, the amended Vendor
defines the term ‘‘reported security’’ differently.
by the system (by algorithm or by any derivative
The Quote Rule defined a ‘‘reported security’’ to Display Rule (redesignated as Rule 603)
pricing mechanism) and does not allow orders to does not use the term ‘‘subject security’’
be crossed or executed against directly by mean ‘‘any security or class of securities for which
participants outside of such times; or (ii) Any
transaction reports are collected, processed and and Regulation NMS retains a slightly
made available pursuant to an effective transaction modified version of the definition of
system operated by, or on behalf of, an OTC market
reporting plan, or an effective national market
maker or exchange market maker that executes
system plan for reporting transactions in listed ‘‘subject security’’ currently found in
customer orders primarily against the account of the Quote Rule.
options.’’ See former Exchange Act Rule 11Ac1–
such market maker as principal, other than riskless
principal.’’ The Commission has modified this
1(a)(20). The Limit Order Display Rule defined a The Vendor Display Rule defined the
‘‘reported security’’ to mean ‘‘any security or class term ‘‘subject security’’ to mean ‘‘(i) any
definition to insert the phrase ‘‘for the purposes of
of securities for which transaction reports are
§ 242.602(b)(5)’’ at the beginning of the definition
collected, processed, and made available pursuant reported security; and (ii) any other
to avoid inadvertently narrowing the scope of the equity security as to which transaction
to an effective transaction reporting plan.’’ See
term ‘‘electronic communications network’’ as used
in the term ‘‘vendor’’ in Rule 600(b)(83) (formerly
former Exchange Act Rule 11Ac1–4(a)(10). reports, last sale data or quotation
Exchange Act Rule 11Ac1–6 (redesignated as information is disseminated through
Exchange Act Rule 11Ac1–2(a)(2)). See also infra,
Rule 606) defined the term ‘‘covered security’’ to
section VI.B.3.g. This modification makes the
mean: ‘‘(i) any national market system security and
NASDAQ.’’ 676 As discussed above, the
definition consistent with the definition of extension of the Nasdaq UTP Plan to
any other security for which a transaction report,
‘‘electronic communications network’’ in former
Rule 11Ac1–1(a)(8).
last sale data or quotation information is include Nasdaq SmallCap securities
668 See supra, section VI.B.1.
disseminated through an automated quotation rendered obsolete the distinction
system as defined in Section 3(a)(51)(A)(ii) of the
669 The Vendor Display Rule and Exchange Act
Act (15 U.S.C. 78c(a)(51)(A)(ii)); and (ii) any option between a ‘‘reported security’’ and a
Rule 11Aa3–1 (redesignated as Rule 601) defined contract traded on a national securities exchange for security for which market information is
the term ‘‘reported security’’ to mean ‘‘any security which last sale reports and quotation information disseminated through Nasdaq.
or class of securities for which transaction reports are made available pursuant to an effective national
are collected, processed and made available market system plan.’’ See former Exchange Act Rule 673 The Limit Order Display Rule defined a
pursuant to an effective transaction reporting plan.’’ 11Ac1–6(a)(1).
See former Exchange Act Rules 11Ac1–2(a)(20) and 672 The Limit Order Display Rule, the Vendor
‘‘covered security’’ to include both reported
11Aa3–1(a)(4). As discussed more fully below, the securities and other securities for which market
Display Rule, and Exchange Act Rule 11Aa3–1
Quote Rule provides a different definition of information is disseminated through Nasdaq. See
defined a ‘‘reported security’’ to mean ‘‘any security
‘‘reported security.’’ former Exchange Act Rule 11Ac1–4(a)(5).
or class of securities for which transaction reports 674 The Quote Rule defined a ‘‘covered security’’
670 See e.g., paragraph (a)(4) of the Vendor
are collected, processed and made available
Display Rule (defining ‘‘subject security’’ to mean pursuant to an effective transaction reporting plan.’’ to include both reported securities and other
‘‘(i) any reported security; and (ii) any other equity See former Exchange Act Rules 11Ac1–4(a)(10), securities for which market information is
security as to which transaction reports, last sale 11Ac1–2(a)(20), and 11Aa3–1(a)(4). The Quote Rule disseminated through Nasdaq. See former Exchange
data or quotation information is disseminated defined the term ‘‘reported security’’ to mean ‘‘any Act Rule 11Aa1–1(a)(6).
675 In paragraph (b)(1)(ii) of the Quote Rule
through NASDAQ’’); and paragraph (a)(6) of the security or class of securities for which transaction
Quote Rule (defining ‘‘covered security’’ to mean reports are collected, processed, and made available (redesignated as Rule 602), which requires a
‘‘any reported security and any other security for pursuant to an effective transaction reporting plan, registered national securities association to
which a transaction report, last sale data or or an effective national market system plan for disseminate quotations at all times when last sale
quotation information is disseminated through an reporting transactions in listed options.’’ See former information is available with respect to ‘‘reported
automated quotation system as described in Section Exchange Act Rule 11Ac1–1(a)(20). As discussed securities,’’ the reference to ‘‘reported security’’ is
3(a)(51)(A)(ii) of the Act (15 U.S.C. above, this release adopts substantial modifications being replaced by a reference to ‘‘NMS security.’’
78c(a)(51)(A)(ii))’’). to the Vendor Display Rule. 676 See former Exchange Act Rule 11Ac1–2(a)(4).
Accordingly, the amended Vendor Regulation NMS clarifies the performed by a stock exchange as that
Display Rule (redesignated as Rule 603) definition of ‘‘subject security’’ by term is generally understood * * *.’’ 682
uses the term ‘‘NMS stock’’ rather than eliminating the phrase ‘‘reported in the Exchange Act Rule 3b–16,683 adopted in
‘‘subject security.’’ consolidated system’’ and replacing it 1998, interprets the statutory definition
The Quote Rule defined the term with the phrase ‘‘reported pursuant to of ‘‘exchange’’ broadly to include any
‘‘subject security’’ to mean: an effective transaction reporting plan organization, association, or group of
(i) With respect to an exchange: (A) Any
or an effective national market system persons that: (1) Brings together the
exchange-traded security other than a plan.’’ Thus, Regulation NMS defines a orders for securities of multiple buyers
security for which the executed volume of ‘‘subject security’’ to include, among and sellers; and (2) uses established,
such exchange, during the most recent other things: (1) With respect to a non-discretionary methods (whether by
calendar quarter, comprised one percent or national securities exchange, any providing a trading facility or by setting
less of the aggregate trading volume for such exchange-traded security other than a rules) under which such orders interact
security as reported in the consolidated security for which the executed volume with each other, and the buyers and
system; and (B) Any other covered security of such exchange, during the most sellers entering such orders agree to the
for which such exchange has in effect an recent calendar quarter, comprised one terms of a trade. Exchange Act Rule 3b–
election, pursuant to paragraph (b)(5)(i) of
this section, to collect, process, and make
percent or less of the aggregate trading 16 was designed to provide ‘‘a more
available to quotation vendors bids, offers, volume for such security as reported comprehensive and meaningful
quotation sizes, and aggregate quotation sizes pursuant to an effective transaction interpretation of what an exchange is in
communicated on such exchange; and reporting plan or effective national light of today’s markets.’’ 684
(ii) With respect to a member of an market system plan; and (2) with respect The Quote Rule’s definition of an
association: (A) Any exchange-traded to a member of a national securities ‘‘exchange market maker’’ defined the
security for which such member acts in the association, any exchange-traded term ‘‘national securities exchange’’ as
capacity of an OTC market maker unless the security for which such member acts in an ‘‘exchange.’’ 685 To avoid confusion
executed volume of such member, during the the capacity of an OTC market maker between a ‘‘national securities
most recent calendar quarter, comprised one
percent or less of the aggregate trading
unless the executed volume of such exchange’’ and the broader
volume for such security as reported in the member, during the most recent interpretation of ‘‘exchange’’ set forth in
consolidated system; and (B) Any other calendar quarter, comprised one percent Exchange Act Rule 3b–16, Regulation
covered security for which such member acts or less of the aggregate trading volume NMS uses the term ‘‘national securities
in the capacity of an OTC market maker and for such security as reported pursuant to exchange’’ rather than ‘‘exchange’’
has in effect an election, pursuant to an effective transaction reporting plan throughout the Regulation. The national
paragraph (b)(5)(ii) of this section, to or effective national market system securities exchange definition is
communicate to its association bids, offers plan.680 intended to capture only those entities
and quotation sizes for the purpose of making This change provides a clearer that operate as national securities
such bids, offers and quotation sizes
definition of ‘‘subject security’’ by exchanges and that are registered as
available to quotation vendors.677
indicating that the trading volume such with the Commission. It is not
Because the Quote Rule (redesignated referred to in the definition is the intended to capture those entities that
as Rule 602) will continue to apply to trading volume in a security that is meet the ‘‘exchange’’ definition under
both listed options and equities covered reported pursuant to an effective Regulation ATS but that operate as
by an effective transaction reporting transaction reporting plan or an something other than a national
plan, Regulation NMS’s definition of effective national market system plan. securities exchange. The use of this term
‘‘subject security’’ revises the Quote Although replacing the phrase ‘‘reported is consistent with the use of the term
Rule’s definition of ‘‘subject security’’ in the consolidated system’’ with the ‘‘exchange’’ in the existing NMS rules.
by replacing references to a ‘‘covered phrase ‘‘reported pursuant to an
security’’ with references to an ‘‘NMS effective transaction reporting plan or f. OTC Market Maker
security.’’ In addition, for the reasons an effective national market system The Quote Rule and Exchange Act
discussed below, Regulation NMS plan’’ produces a clearer definition of Rule 11Ac1–5 (redesignated as Rule
replaces the phrase ‘‘reported in the ‘‘subject security,’’ it does not alter the 605) defined the term ‘‘OTC market
consolidated system’’ with the phrase scope or the substance of the maker’’ differently.686 Unlike the Quote
‘‘reported pursuant to an effective definition.681 Rule, Exchange Act Rule 11Ac1–5
transaction reporting plan or effective defined the term ‘‘OTC market maker’’
national market system plan.’’ e. National Securities Exchange
to include an explicit reference to a
d. Consolidated System Section 3(a)(1) of the Exchange Act securities dealer that holds itself out as
defines the term ‘‘exchange’’ to mean being willing to buy from and sell to
As noted above, the definition of the ‘‘any organization, association, or group customers or others in the United States.
term ‘‘subject security’’ in the Quote of persons * * * which constitutes,
Rule used the phrase ‘‘reported in the maintains, or provides a market place or 682 15 U.S.C. 78c(a)(1).
consolidated system.’’ 678 Paragraph facilities for bringing together 683 17 CFR 240.3b–16.
(a)(5) of the Quote Rule defines the term purchasers and sellers of securities or 684 See Securities Exchange Act Release No.
‘‘consolidated system’’ to mean ‘‘the for otherwise performing with respect to 40760 (Dec. 8, 1998), 63 FR 70844 (Dec. 22, 1998)
consolidated transaction reporting (adopting Regulation ATS).
securities the functions commonly 685 Specifically, the Quote Rule stated that the
system, including a transaction term ‘‘exchange market maker’’ shall mean ‘‘any
reporting system operating pursuant to 680 Rule
600(b)(73). member of a national securities exchange
an effective national market system 681 This
change also impacts certain non-NMS (‘exchange’) who is registered as a specialist or
plan.’’ 679 rules that define the term ‘‘consolidated system.’’ market maker pursuant to the rules of such
See, e.g., Exchange Act Rule 10b–18(a)(7) exchange.’’ See former Exchange Act Rule 11Ac1–
(‘‘consolidated system means the consolidated 1(a)(9). The statutory requirements applicable to a
677 See former Exchange Act Rule 11Ac1–1(a)(25)
transaction reporting system contemplated by Rule national securities exchange are set forth in Section
(emphasis added). 11Aa3–1’’). As discussed below, the Commission 6 of the Exchange Act, 15 U.S.C. 78f.
678 Id.
also is amending certain non-NMS rules that are 686 Compare former Exchange Act Rules 11Ac1–
679 See former Exchange Act Rule 11Ac1–1(a)(5). affected by the definitional changes adopted today. 1(a)(13) and 11 AC1–5(a)(18).
Regulation NMS retains the reference to h. Best Bid, Best Offer, and National national market system plan.692 The
transactions with ‘‘customers or others Best Bid and National Best Offer definition of ‘‘national best bid and
in the United States’’ to indicate clearly national best offer’’ also addresses
The Quote Rule and the Vendor instances where multiple market centers
that a foreign dealer could be an ‘‘OTC
Display Rule defined the terms ‘‘best transmit identical bids and offers to the
market maker’’ if it acts as a securities
bid’’ and ‘‘best offer’’ differently. The plan processor pursuant to an NMS plan
dealer with respect to customers or
Quote Rule stated that ‘‘[t]he terms best by establishing the way in which these
others in the United States.
bid and best offer shall mean the highest bids and offers are to be prioritized.693
Accordingly, Regulation NMS defines priced bid and the lowest priced
‘‘OTC market maker’’ as ‘‘any dealer that offer.’’ 690 The Vendor Display Rule i. Bid, Offer, Customer, Nasdaq Security,
holds itself out as being willing to buy defined the terms ‘‘best bid’’ and ‘‘best Quotations, Quotation Information, and
from and sell to its customers, or others, offer’’ as follows: 691 Responsible Broker or Dealer
in the United States, an NMS stock for (i) With respect to quotations for a Regulation NMS also updates or
its own account on a regular or reported security, the highest bid or clarifies the following terms in the NMS
continuous basis otherwise than on a lowest offer for that security made rules: ‘‘Bid;’’ ‘‘offer;’’ ‘‘customer;’’
national securities exchange.’’ 687 available by any reporting market center ‘‘Nasdaq security;’’ ‘‘quotations’’;
g. Vendor pursuant to § 240.11Ac1–1 (Rule ‘‘quotation information;’’ and
11Ac1–1 under the Act) (excluding any ‘‘responsible broker or dealer.’’
The term ‘‘vendor’’ or ‘‘quotation bid or offer made available by an The Quote Rule defined the terms
vendor’’ was defined differently in three exchange during any period such ‘‘bid’’ and ‘‘offer’’ to mean ‘‘the bid
NMS rules: The Quote Rule, the Vendor exchange is relieved of its obligations price and the offer price communicated
Display Rule, and Exchange Act Rules under paragraphs (b)(1) and (2) of by an exchange member or OTC market
11Aa3–1 (redesignated as Rule 601).688 § 240.11Ac1–1 by virtue of paragraph maker to any broker or dealer, or to any
Although the definitions are similar, the (b)(3)(i) thereof); Provided, however, customer, at which it is willing to buy
definition of ‘‘vendor’’ in the Vendor that in the event two or more reporting or sell one or more round lots of a
Display Rule was the most market centers make available identical covered security, as either principal or
comprehensive because it encompasses bids or offers for a reported security, the agent, but shall not include indications
any SIP that disseminates transaction best bid or best offer (as the case may of interest.’’ 694 Regulation NMS updates
reports, last sale data, or quotation be) shall be computed by ranking all this definition by replacing the term
information, whereas the other such identical bids or offers (as the case ‘‘OTC market maker’’ with the phrase
definitions were less complete in may be) first by size (giving the highest ‘‘member of a national securities
identifying the types of information that ranking to the bid or offer associated association’’ and calls the term ‘‘bid or
vendors typically make available. To with the largest size), then by time offer’’ rather than ‘‘bid and offer’’ to
provide a uniform and comprehensive (giving the highest ranking to the bid or reflect the fact that the terms are not
definition of the term ‘‘vendor,’’ offer received first in time); and always used in the conjunctive.
Regulation NMS includes the definition (ii) With respect to quotations for a Modifying the definition to apply to any
of ‘‘vendor’’ as it was defined in the subject security other than a reported member of a national securities
Vendor Display Rule.689 security, the highest bid or lowest offer association clarifies that bids and offers
(as the case may be) for such security include quotations communicated not
687 The definition of ‘‘OTC market maker’’ uses disseminated by an over-the-counter only by OTC market makers but also by
the term ‘‘NMS stock’’ because there is no OTC market maker in Level 2 or 3 of ATSs, ECNs, and order entry firms that
market in standardized options. NASDAQ. are members of the NASD but that are
688 The Quote Rule defined the term ‘‘quotation not market makers.
vendor’’ to mean ‘‘any securities information In addition, Exchange Act Rule Expanding the definition of ‘‘bid’’ and
processor engaged in the business of disseminating 11Ac1–5(a)(7) defined the term ‘‘offer’’ could have the unintended
to brokers, dealers or investors on a real-time basis, ‘‘consolidated best bid and offer’’ to
bids and offers made available pursuant to this consequence of also expanding the
mean ‘‘the highest firm bid and the scope of the Quote Rule (redesignated as
section, whether distributed through an electronic
communications network or displayed on a lowest firm offer for a security that is Rule 602) where those terms are used to
terminal or other display device.’’ See former calculated and disseminated on a apply to members of a national
Exchange Act Rule 11Ac1–1(a)(19). Former current and continuous basis pursuant
Exchange Act Rule 11Aa3–1(a)(11) defined the term to an effective national market system 692 The definition of ‘‘reporting market center’’ in
‘‘vendor’’ to mean ‘‘any securities information
processor engaged in the business of disseminating plan.’’ paragraph (a)(14) of the Vendor Display Rule, which
transaction reports or last sale data with respect to Regulation NMS retains the was incorporated into that Rule’s definitions of
transactions in reported securities to brokers, ‘‘best bid’’ and ‘‘best offer,’’ is no longer necessary
definitions of ‘‘best bid’’ and ‘‘best and therefore is being deleted.
dealers or investors on a real-time or other current
and continuing basis, whether through an electronic offer’’ used in the Quote Rule. A new 693 See Rule 600(b)(42).
communications network, moving ticker or term called ‘‘national best bid and 694 See former Exchange Act Rule 11Ac1–1(a)(4).
interrogation device.’’ The Vendor Display Rule national best offer’’: (1) Replaces the Paragraph (a)(6) of the Vendor Display Rule used
defined the term ‘‘vendor’’ to mean ‘‘any securities term ‘‘best bid and best offer’’ as that the Quote Rule’s definition of ‘‘bid’’ and ‘‘offer’’ for
information processor engaged in the business of reported securities, but it defined ‘‘bid’’ and ‘‘offer’’
disseminating transaction reports, last sale data or term is used in the Vendor Display Rule; for Nasdaq SmallCap securities as ‘‘the most recent
quotation information with respect to subject and (2) replaces the term ‘‘consolidated bid or offer price of an over-the-counter market
securities to brokers, dealers or investors on a real- best bid and offer’’ as that term is used maker disseminated through Level 2 or 3 of
time or other current and continuing basis, whether in Exchange Act Rule 11Ac1–5 NASDAQ.’’ Because Nasdaq SmallCap securities
through an electronic communications network, now are reported securities, it is unnecessary to
moving ticker or interrogation device.’’ See former (redesignated as Rule 605). This new maintain the distinction between reported
Exchange Act Rule 11Ac1–2(a)(2). term refers to the best quotations that securities and Nasdaq SmallCap securities.
689 See former Exchange Act Rule 11Ac1–2(a)(2). are calculated and disseminated by a Accordingly, to update and provide a single
The Commission modified the adopted definition of plan processor pursuant to an effective definition of the terms ‘‘bid’’ and ‘‘offer,’’
vendor to conform to a technical change being made Regulation NMS eliminates the definitions of ‘‘bid’’
to the definition of ‘‘quotations’’ and ‘‘quotation and ‘‘offer’’ used in the Vendor Display Rule and
690 See former Exchange Act Rule 11Ac1–1(a)(3).
information’’ in Rule 600(b)(62). See infra, note 699 retains modified versions of the terms as they are
and accompanying text. 691 See former Exchange Act Rule 11Ac1–2(a)(15). defined in the Quote Rule.
securities association that are not OTC ‘‘quotation information’’ in Rule trading facility, trade-through, and
market makers (e.g., ECNs and ATSs). 600(b)(62) from the reproposal to delete trading center.
To avoid this unintended expansion of the term ‘‘quotation information’’ and to
the scope of the Quote Rule delete the phrase ‘‘where applicable, C. Changes to Other Rules
(redesignated as Rule 602), Regulation quotations sizes and aggregate quotation In addition to the changes described
NMS proposed a revised version of the sizes.’’ The deleted term and phrase are above, the rules adopted today amend a
Quote Rule’s definition of ‘‘responsible no longer necessary because they were number of rules that cross-reference
broker or dealer.’’ 695 In particular, included in a definition used in the
current NMS rules or that use terms that
Regulation NMS proposed to amend the Vendor Display Rule, which is being
portion of the definition of ‘‘responsible Regulation NMS amends or eliminates.
substantially modified and no longer
broker or dealer’’ found in paragraph These amendments are intended to be
uses the deleted term or phrase.699 As
(a)(21)(ii) of the Quote Rule 696 to limit adopted, Rule 600(b)(62) simply defines non-substantive. Specifically, the rules
its scope to bids and offers the term ‘‘quotation’’ to mean a bid or adopted today make conforming
communicated by an OTC market an offer. changes to the following rules:702
maker. The Commission does not Regulation NMS also amends the § 200.30–3; 703 § 200.800, Subpart N; 704
believe, however, that amending the definition of the term ‘‘customer.’’ The § 201.101; 705 Rule 144 706 under the
definition of ‘‘responsible broker or Quote Rule defined that term to mean Securities Act of 1933; 707 Exchange Act
dealer’’ is necessary because the ‘‘any person that is not a registered Rule 0–10; 708 Exchange Act Rule 3a51–
definition of the term ‘‘subject security’’ broker-dealer.’’ 700 To indicate that the 1; 709 Exchange Act Rule 3b–16; 710
effectively serves to limit the scope of scope of the definition includes broker- Exchange Act Rules 10a–1; 711 Exchange
the Quote Rule, with respect to a dealers that are exempt from registration Act Rule 10b–10; 712 Exchange Act Rule
member of a national securities as well as registered broker-dealers, 10b–18; 713 Exchange Act Rule 15b9–
association, to members acting in the Regulation NMS revises the definition 1; 714 Exchange Act Rule 12a–7; 715
capacity of an OTC market maker.697 by deleting the term ‘‘registered.’’ Thus, Exchange Act Rule 12f–1; 716 Exchange
The Commission therefore is modifying Regulation NMS defines the term Act Rule 12f–2; 717 Exchange Act Rule
the proposed definition of ‘‘responsible ‘‘customer’’ to mean ‘‘any person that is 15c2–11; 718 Exchange Act Rule 19c–
broker or dealer’’ in Rule 600(b)(65)(ii) not a broker-dealer.’’
to replace the term ‘‘an OTC marker
Exchange Act Rule 11Aa3–1 702 In addition, the Commission voted to approve
maker’’ with the term ‘‘a member of an a conforming amendment to Exchange Act Rule
(redesignated as Rule 601) defined the
association’’ and to replace the term 3a55–1 and Commodity Exchange Act (‘‘CEA’’) Rule
term ‘‘NASDAQ security’’ to mean ‘‘any
‘‘the OTC market maker’’ with the term 41.11. These rules were adopted jointly by the
registered equity security for which Commission and the Commodity Futures Trading
‘‘the member.’’ 698
The Commission also is making a quotation information is disseminated Commission (‘‘CFTC’’) pursuant Section
non-substantive modification to the in the National Association of Securities 3(a)(55)(F)(ii) of the Exchange Act and Section
Dealers Automated Quotation system 1a(25)(E)(ii) of the CEA and the amendment also
definition of ‘‘quotations’’ and must be adopted jointly. Section 3(a)(55)(F)(ii) of
(‘‘NASDAQ’’).’’ 701 This acronym is now the Exchange Act and Section 1a(25)(E)(ii) of the
695 See former Exchange Act Rule 11Ac1–1(a)(21). outdated. Therefore, to modernize this CEA provide that the two Commissions shall, by
696 See former Exchange Act Rule 11Ac1– definition and to ensure that any type of rule or regulation, jointly specify the method to be
1(a)(21)(ii). registered security that Nasdaq lists is used to determine market capitalization and dollar
value of average daily trading volume for purposes
697 Rule 600(b)(73)(ii) as adopted defines ‘‘subject
covered by the definition, Regulation of definition of ‘‘narrow-based security index’’ (and
security’’ to mean, with respect to a member of a NMS defines the term ‘‘Nasdaq
national securities association, (A) any exchange- exclusions from that definition). Exchange Act Rule
traded security for which such member acts in the security’’ to mean ‘‘any registered 3a55–1 and CEA Rule 41.11 refer to ‘‘reported
capacity of an OTC market maker unless the security listed on The Nasdaq Stock securities as defined in § 240.11Ac1–1.’’ The rules
executed volume of such member, during the most Market, Inc.’’ adopted today eliminate the term ‘‘reported
recent calendar quarter, comprised one percent or security’’ from the NMS rules and replace it with
less of the aggregate trading volume for such 4. Definitions in the Regulation NMS the term ‘‘NMS security’’ or ‘‘NMS stock,’’
security as reported pursuant to an effective Rules Adopted Today depending on the scope of the particular rule. To
transaction reporting plan or effective national reflect these changes, the joint technical
market system plan; and (B) any other NMS security Rule 600(b) includes a number of new amendment would replace the phrase ‘‘reported
for which such member acts in the capacity of an securities as defined in § 240.11Ac1–1’’ with the
definitions used in Regulation NMS phrase ‘‘NMS securities, as defined in § 242.600 of
OTC market maker and has in effect an election,
pursuant to § 242.602(a)(5)(ii), to communicate to Rules 610 through 612, which are this chapter’’ in Exchange Act Rule 3a55–1 and
its association bids, offers, and quotation sizes for adopted in this release. These new make a corresponding change in CEA Rule 41.11.
the purpose of making such bids, offers, and terms are discussed in detail in Sections 703 17 CFR 200.30–3. In addition to conforming
quotation sizes available to a vendor. II through V above. Specifically, for the changes, the Commission is amending this rule to
698 As adopted, Rule 600(b)(65)(ii) defines the delegate to the Director of the Division of Market
term ‘‘responsible broker or dealer’’ to mean, when
reasons discussed above, Regulation Regulation the authority to grant exemptions to
used with respect to bids and offers communicated NMS adopts the following terms: Rules 610 through 612.
by a member of an association to a broker or dealer automated quotation, automated trading 704 17 CFR 200.800, Subpart N.
or a customer, the member communicating the bid center, consolidated display, 705 17 CFR 201.101.
or offer (regardless of whether such bid or offer is
for its own account or on behalf of another person).
consolidated last sale information, 706 17 CFR 230.144.
This modification conforms the definition of intermarket sweep order, manual 707 15 U.S.C. 77a et seq.
708 17 CFR 240.0–10.
‘‘responsible broker or dealer’’ in Rule 600(b)(65)(ii) quotation, protected bid or protected
709 17 CFR 240.3a51–1.
as adopted to the definition of ‘‘responsible broker offer, SRO display-only facility, SRO
or dealer’’ in former Rule 11Ac1–1(a)(21)(ii) with 710 17 CFR 240.3b–16.
respect to its application to a member of an 711 17 CFR 240.10a–1.

699 Conforming modifications are being made to
association. 712 17 CFR 240.10b–10.
The Commission also is making a change to the definition of ‘‘dynamic market monitoring 713 17 CFR 240.10b–18.
paragraph (b)(3)(i) of Rule 602 from the reproposal device,’’ ‘‘interrogation device,’’ and ‘‘vendor’’ in
714 17 CFR 240.15b9–1.
to insert the word ‘‘size’’ after the phrase ‘‘such Rules 600(b)(20), 600(b)(31), and 600(b)(83) to
715 17 CFR 240.12a–7.
revised quotation.’’ This change will correct the replace the term ‘‘quotation information’’ with the
term ‘‘quotations.’’ 716 17 CFR 240.12f–1.
inadvertent deletion of ‘‘size’’ in a prior amendment
700 See former Exchange Act Rule 11Ac1–1(a)(26). 717 17 CFR 240.12f–2.
to this rule (the Quote Rule) and will not have any
substantive effect. 701 See former Exchange Act Rule 11Aa3–1(a)(6). 718 17 CFR 240.15c2–11.
3; 719 Exchange Act Rule 19c–4; 720 centers must begin trading all NMS exception, that are reasonably designed
Exchange Act Rule 31; 721 Rule 100 of stocks pursuant to the requirements of to assure compliance with the terms of
Regulation M under the Exchange Rules 610 and 611. the exception. The nature and extent of
Act; 722 Rule 300 of Regulation ATS The compliance date for the the policies and procedures that a
under the Exchange Act; 723 Rule 301 of Allocation Amendment to the Plans will trading center will be required to
Regulation ATS under the Exchange be September 1, 2006. establish to comply with this
Act; 724 § 249.1001; 725 and Rule 17a–7 VIII. Paperwork Reduction Act requirement will depend upon the type,
under the Investment Company Act of size, and nature of the trading center.
1940.726 A. Order Protection Rule
2. Proposed Use of Information
VII. Effective Date and Phased-In The Order Protection Rule contains
collection of information requirements The requirement that each trading
Compliance Dates center establish, maintain, and enforce
within the meaning of the Paperwork
Rules 610, 611, 612, the amendment Reduction Act of 1995.727 The written policies and procedures
to Rule 301 of Regulation ATS, the Commission published a notice reasonably designed to prevent the
amendments to the Market Data Rules requesting comment on the collection of execution of trades on that trading
and Plans discussed above in Section V, information requirements in both the center at prices inferior to protected
and the Regulation NMS amendments Proposing Release and Reproposing quotations displayed by other trading
discussed above in Section VI will Release, and submitted these centers or to assure compliance with the
become effective on August 29, 2005. requirements to the Office of terms of an exception will help ensure
The compliance date for Rule 612, the Management and Budget (‘‘OMB’’) for that the trading center and its
amendment to Rule 301 of Regulation review in accordance with 44 U.S.C. customers, subscribers, members, and
ATS, the amendments to the Market 3507(d) and 5 CFR 1320.11. An agency employees, as applicable, generally
Data Rules and Plans discussed above in may not conduct or sponsor, and a avoid engaging in trade-throughs, unless
Section V other than the Allocation person is not required to respond to, an a valid exception is applicable.
Amendment, and the Regulation NMS information collection unless it displays
amendments discussed above in Section 3. Respondents
a currently valid OMB control number.
VI will be the same date as the effective The title of the affected collection is The requirement for each trading
date. Given the significant systems and ‘‘Order Protection Rule’’ under OMB center to establish written policies and
other changes necessary to implement procedures reasonably designed to
control number 3235–0600.
the remaining regulatory changes In the Proposing Release, the prevent the execution of trade-throughs
adopted today, the Commission has Commission proposed to create three will apply to eight registered national
decided to establish delayed compliance new information collections.728 The first securities exchanges that trade NMS
dates for these new regulatory collection of information arose from the stocks and the NASD,730 and
requirements. proposed requirement that trading approximately 600 broker-dealers
Compliance with Rules 610 and Rule registered with the Commission.731 The
centers adopt policies and procedures
611 will be phased-in as follows: Commission did not receive any
• Phase I. The first phase-in of NMS reasonably designed to prevent the
execution of a transaction at prices comment on these estimates.
stocks subject to Rule 610 and 611 will The Commission has considered each
begin on June 29, 2006. Beginning on inferior to prices displayed by other
trading centers. The other two of these respondents for the purposes of
June 29, 2006, and continuing until the calculating the reporting burden under
beginning of Phase II, all trading centers collections of information related to
requirements in a proposed exception to the Order Protection Rule.
must begin trading 100 NMS stocks of
each of Networks A and C, and 50 NMS the Order Protection Rule included in 4. Total Annual Reporting and
stocks of Network B, pursuant to the the Proposing Release—the opt-out Recordkeeping Burden
requirements of Rules 610 and 611. The exception.729 The Order Protection Rule Trading centers will need to develop
particular NMS stocks will be chosen by as reproposed did not, and as adopted written policies and procedures for
the primary listing market, in does not, contain an opt-out exception, preventing and monitoring for trade-
consultation with Commission staff, to and therefore, the collections of throughs that do not fall within an
be reasonably representative of the information associated with the enumerated exception, and, if relying on
range of each Network’s securities. The proposed opt-out exception are no such an exception, that are reasonably
primary purpose of Phase 1 is to allow longer applicable.
all market participants to verify the The discussion below reflects the 730 There are eight national securities exchanges
functionality of their systems and information collection requirements of (Amex, BSE, CBOE, CHX, NSX, NYSE, Phlx and
procedures necessary to effectively the Order Protection Rule as adopted. PCX) and one national securities association
(NASD) that trade NMS stocks and thus will be
comply with the Rules. 1. Summary of Collection of Information subject to the Rule. The ISE does not trade NMS
• Phase II. Phase II will begin on stocks and thus will not be subject to the Rule.
August 31, 2006. As of that date, trading The Order Protection Rule requires a 731 This estimate includes the approximately 585
trading center to establish, maintain, firms that were registered equity market makers or
719 17 CFR 240.19c–3.
and enforce written policies and specialists at year-end 2003 (this number was
720 17 CFR 240.19c–4. procedures reasonably designed to derived from annual FOCUS reports and discussion
721 17 CFR 240.31. prevent the execution of trades on that with SRO staff), as well as ATSs that operate
trading systems that trade NMS stocks. The
722 17 CFR 242.100. trading center at prices inferior to Commission believes it is reasonable to assume that
723 17 CFR 242.300.
protected quotations displayed by other in general, firms that are block positioners—i.e.,
724 17 CFR 242.301. The Commission also is
trading centers, unless a valid exception firms that are in the business of executing orders
adopting a technical change to Rule 301(b)(3)(iii) of internally—are the same firms that are registered
Regulation ATS to correct a cross-reference to Rule
applies, and, if relying on such an
market makers (for instance, they may be registered
301(b)(3)(ii)(A) by deleting the reference to as a market maker in one or more Nasdaq stocks
subparagraph (A). This change has no substantive 727 44 U.S.C. 3501 et seq. (‘‘Paperwork Reduction
and carry on a block positioner business in
effect. Act’’). exchange-listed stocks), especially given the
725 17 CFR 249.1001. 728 See section III.G.1. of the Proposing Release.
amount of capital necessary to carry on such a
726 17 CFR 270.17a–7. 729 See section III.G.1. of the Proposing Release. business.
designed to assure compliance with the personnel time,737 to develop the up-to-date and remain in compliance
terms of the exception, to assure that required policies and procedures. with Rule 611. The Commission staff
they are in compliance with the Rule. Included within this estimate, the estimates that these ongoing costs will
Although the exact nature and extent Commission expects that SRO and non- be 60 hours annually per respondent,
of the required policies and procedures SRO respondents may incur one-time for a total estimated annual cost of
that a trading center will be required to external costs for out-sourced legal $3,456,684.743
establish likely will vary depending services. While the Commission
The Commission did not receive any
upon the nature of the trading center recognizes that the amount of legal
comments on its PRA burden estimates.
(e.g., SRO vs. non-SRO, full service outsourcing utilized to help establish
broker-dealer vs. market maker), the written policies and procedures may 5. General Information About Collection
Commission broadly estimates that it vary widely from entity to entity, it of Information
would take an SRO trading center estimates that on average, each trading
center would outsource 50 hours of This collection of information will be
approximately 270 hours of legal,732 mandatory. The Commission expects
compliance,733 information legal time in order to establish policies
and procedures in accordance with the that the written policies and procedures
technology 734 and business operations that will be generated pursuant to Rule
personnel 735 time,736 and a non-SRO Rule.
The Commission estimates that there 611 will be communicated to the
trading center approximately 210 hours members, subscribers, and employees
will be an initial one-time burden of 220
of legal, compliance, information (as applicable) of all entities covered by
burden hours per SRO trading center or
technology and business operations
1,980 hours,738 and 160 burden hours the Rule. To the extent that this
732 Based on industry sources, the Commission
per non-SRO trading center 739 or 96,000 information is made available to the
estimates that the average hourly rate for
hours, for a total of 97,980 burden hours Commission, it will not be kept
outsourced legal service in the securities industry to establish policies and procedures confidential. Any records generated in
is between $150 per hour and $300 per hour. For reasonably designed to prevent the connection with the Rule’s requirement
purposes of this Release, the Commission will use execution of a trade-through, for an to establish written policies and
the highest rate of $300 per hour to determine
potential outsourced legal costs associated with the
estimated one-time initial cost of procedures will be required to be
proposed rule. For in-house legal services, the $8,646,405.740 The Commission preserved in accordance with, and for
Commission estimates that the average hourly rate estimates a capital cost of approximately the periods specified in, Exchange Act
for an attorney in the securities industry is $9,135,000 for both SRO and non-SRO Rules 17a–1 744 and 17a–4(e)(7).745
approximately $82 per hour. The $82 per hour
figure for an attorney is from the Securities Industry
trading centers resulting from
outsourced legal work 741 for a total one- B. Access Rule
Association, Report on Management & Professional
Earnings in the Securities Industry 2003 (Sept. time initial cost of $17,781,405.742 In the Proposing Release and
2003), adjusted by the SEC staff for an 1800-hour Once a trading center has established
work-year with a 35% upward adjustment for Reproposing Release, the Commission
overhead, reflecting the cost of supervision, space,
written policies and procedures requested comment on its preliminary
and administrative support. reasonably designed to prevent trade- view that proposed Rule 610 and the
733 The Commission estimates that the average throughs in its market, the Commission proposed amendment to Rule 301(b)(5)
hourly rate for an assistant compliance director in estimates that it will take the average under Regulation ATS do not contain a
the securities industry is approximately $103 per SRO and non-SRO trading center
hour. The $103 per hour figure for an assistant collection of information requirement as
compliance director is from the Securities Industry approximately two hours per month of defined by the Paperwork Reduction
Association, Report on Management & Professional internal legal time and three hours of Act.746 No comments were received that
Earnings in the Securities Industry 2003 (Sept. internal compliance time to ensure that
2003), adjusted by the SEC staff for an 1800-hour addressed the issue. The Commission
its written policies and procedures are
work-year with a 35% upward adjustment for continues to believe that Rule 610 and
737 The Commission anticipates that of 210 hours
the amendment to Rule 301(b)(5) do not
and administrative support. contain a collection of information
734 The Commission estimates that the average it estimates will be spent to establish policies and
hourly rate for a senior computer programmer in the procedures, 87 hours will be spent by legal requirement.
securities industry is approximately $67 per hour. personnel, 77 hours will be spent by compliance
The $67 per hour figure for a senior computer personnel, 23 hours will be spent by information C. Sub-Penny Rule
programmer is from the Securities Industry technology personnel and 23 hours will be spent by
Association, Report on Management & Professional business operations personnel of the non-SRO In the Proposing Release and
Earnings in the Securities Industry 2003 (Sept. trading center. Reproposing Release, the Commission
738 The estimated 1,980 burden hours necessary
2003), adjusted by the SEC staff for an 1800-hour stated its preliminary view that
work-year with a 35% upward adjustment for for SRO trading centers to establish policies and
procedures are calculated by multiplying nine times proposed Rule 612 does not contain a
and administrative support. 220 hours (9 × 220 hours = 1,980 hours). collection of information requirement as
735 The Commission estimates that the average 739 The estimated 96,000 burden hours necessary defined by the Paperwork Reduction
hourly rate for an operations manager in the for non-SRO trading centers to establish policies Act.747 No comments were received that
securities industry is approximately $70 per hour. and procedures are calculated by multiplying 600
times 160 hours (600 × 160 hours = 96,000 hours).
addressed this issue. The Commission
The $70 per hour figure for an operations manager
is from the Securities Industry Association, Report 740 This figure was calculated as follows: (70 legal continues to believe that Rule 612 does
on Management & Professional Earnings in the hours × $82) + (105 compliance hours × $103) + (20 not contain a collection of information
Securities Industry 2002 (Sept. 2002), adjusted by information technology hours × $67) + (25 business requirement.
the SEC staff for an 1800-hour work-year with a operation hours × $70) = $19,645 per SRO × 9 SROs
35% upward adjustment for overhead, reflecting the = $176,805 total cost for SROs; (37 legal hours ×
743 This figure was calculated as follows: (2 legal
cost of supervision, space, and administrative $82) + (77 compliance hours × $103) + (23
support. information technology hours × $67) + (23 business hours × 12 months × $82) × (9 + 600) + (3
736 The Commission anticipates that of the 270 operation hours × $70) = $14,116 per broker-dealer compliance hours × 12 months × $103) × (9 + 600))
× 600 broker-dealers = $8,469,600 total cost for = $3,456,684.
hours it estimates will be spent to establish the 744 17 CFR 240.17a–1.
required policies and procedures, 120 hours will be broker-dealers; $176,805 + $8,469,600 = $8,646,405.
741 This figure was calculated as follows: (50 legal 745 17 CFR 240.17a–4(e)(7).
spent by legal personnel, 105 hours will be spent
by compliance personnel, 20 hours will be spent by hours × $300 × 9 SROs) + (50 legal hours × $300 746 Proposing Release, 69 FR at 11160;
information technology personnel and 25 hours will × 600 broker-dealers) = $9,135,000. Reproposing Release, 69 FR at 77476.
be spent by business operations personnel of the 742 This figured was calculated by adding 747 Proposing Release, 69 FR at 11172;
SRO trading center. $8,646,405 and $9,135,000. Reproposing Release, 69 FR at 77476.
D. Market Data Rules and Plan reasonably designed to assure of market orders, to protect the best
Amendments compliance with the terms of the displayed prices, and encourage the
In the Proposing Release and exception. To qualify for protection, a public display of limit orders.752 These
Reproposing Release, the Commission quotation is required to be displayed commenters noted that such a rule
stated its preliminary view that the and immediately accessible through would encourage the use of displayed
proposed amendments to the joint- automatic execution. The Rule also limit orders, thus increasing depth and
industry plans and to Exchange Act requires a trading center to regularly liquidity in the market.753 Some of these
Rules 11Aa3–1 and 11Ac1–2 surveil to ascertain the effectiveness of commenters also stated that the trade-
(redesignated as Rules 601 and 603) do the policies and procedures and to take through proposal would increase
not impose a collection of information prompt remedial action to remedy investor confidence by helping to
requirement as defined by the deficiencies in such policies and eliminate the impression of unfairness
Paperwork Reduction Act.748 No procedures. As discussed above in when an investor’s order executes at a
comments were received that addressed Section II.A.5, the Commission has price that is worse than the best
this issue. The Commission continues to determined to adopt the Market BBO displayed quotation, or when a trade
believe that these amendments do not Alternative with respect to the scope of occurs at a price that is inferior to the
contain a collection of information quotations that will be protected under investor’s displayed order.754 As
requirement. the Rule. The Commission believes that discussed above in Section II.A.1, the
providing enhanced protection for the Commission agrees with these
E. Regulation NMS best bids and offers of each exchange, commenters.
In the Proposing Release and The NASDAQ Stock Market, and the The Commission believes that the
Reproposing Release, the Commission ADF will represent a major step toward Order Protection Rule will enhance the
stated its preliminary view that achieving the objectives of intermarket overall fairness and efficiency of the
proposed Rule 600, the redesignation of price protection, but with fewer of the NMS and produce significant benefits
the NMS rules, and the conforming costs and potential drawbacks for investors. The Order Protection Rule
amendments to various rules do not associated with the Voluntary Depth will benefit investors by promoting the
impose a collection of information Alternative. best execution of customer market
requirement as defined by the Rule 611 includes a variety of orders, promoting the fair treatment of
Paperwork Reduction Act.749 No exceptions to make intermarket price customer limit orders, and
comments were received that addressed protection as efficient and workable as strengthening protection of limit orders
this issue. The Commission continues to possible. These include an intermarket to promote greater depth and liquidity
believe that these amendments do not sweep exception, which allows market for NMS stocks and thereby minimize
contain a collection of information participants simultaneously to access investor transaction costs. By providing
requirement. multiple price levels at different trading greater protection for displayed prices,
centers—a particularly important the Rule should serve to enhance the
IX. Consideration of Costs and Benefits function now that trading in penny depth and liquidity of the NMS, and
In the Proposing Release and increments has dispersed liquidity thus contribute to the maintenance of
Reproposing Release, the Commission across multiple price levels. The fair and orderly markets. By better
identified certain costs and benefits of intermarket sweep exception enables protecting the interests of investors,
the Regulation NMS proposals, and, to trading centers that receive sweep both those that post limit orders and
help evaluate the costs and benefits, orders to execute those orders those that execute against posted limit
requested comment on all aspects of the immediately, without waiting for better- orders, the Rule will promote investor
costs and benefits and encouraged priced quotations in other markets to be confidence in the NMS. The Rule will
commenters to identify or supply any updated. In addition, Rule 611 provides be a significant improvement over the
relevant data concerning the costs or exceptions for the quotations of trading existing ITS trade-through rule, and will
benefits of the proposal.750 To the extent centers experiencing, among other level the competitive playing field
commenters discussed costs and things, a material delay in providing a among markets by eliminating the
benefits, the Commission has response to incoming orders, as well as potential advantage that the ITS rule
considered those comments. for flickering quotations with prices that
afforded to manual markets.
have been displayed for less than one By requiring trading centers to
A. Order Protection Rule second. Both exceptions serve to limit establish written policies and
Rule 611 requires a trading center the application of Rule 611 to procedures reasonably designed to
(which includes national securities quotations that are truly automated and prevent trade-throughs on their markets
exchanges and national securities accessible. In response to commenters, and to comply with exceptions, and by
associations that operate SRO trading the Commission also is including in the requiring them to regularly surveil to
facilities, ATSs, market makers, and Rule an exception for certain ‘‘stopped’’ ascertain the effectiveness of the
block positioners) to establish, maintain, orders.751 policies and procedures and to take
and enforce written policies and prompt remedial action to remedy
1. Benefits
procedures that are reasonably designed deficiencies in such policies and
to prevent trade-throughs on that Although commenters were divided
on the central issue of whether procedures, the Commission believes
trading center of protected quotations, that the Rule also will offer greater
and, if relying on an exception, that are intermarket protection of displayed
quotations is needed to promote the assurance, on an order-by-order basis, to
748 Proposing Release, 69 FR at 11186; fairest and most efficient markets for investors that submit market orders that
Reproposing Release, 69 FR at 77476–77. investors, many commenters strongly their orders in fact will be executed at
749 Proposing Release, 69 FR at 11197;
supported the adoption of a rule against 752 See
Reproposing Release, 69 FR at 77477. supra, section II.A.1.
750 Proposing Release, 69 FR at 11148–11150,
trade-throughs without an opt-out for all 753 See, e.g., BNY Letter at 2; Consumer
11161, 11172–73, 11186–89, 11197–98; NMS stocks to promote best execution Federation Letter at 2; ICI Letter at 7.
Reproposing Release, 69 FR at 77441, 77474, 77475, 754 See, e.g., Consumer Federation Letter at 2; ICI
77477, 77480, 77488, 77489. 751 See supra, section II.A.4. Letter at 7.
the best readily available prices, which promoting the ability of listed because market participants may be less
can be difficult for investors, companies to raise capital. likely to send their order flow to a
particularly retail investors, to monitor. The Order Protection Rule also is market center whose orders are not
As noted above, some commenters designed to promote greater depth and protected by the Order Protection
stated that the trade-through proposal liquidity for NMS stocks and thereby Rule—the Rule generally should
would increase investor confidence by minimize implicit investor transaction improve the accessibility of bids and
helping to eliminate the impression of costs. Depth and liquidity will be offers for all investors and increase the
unfairness when an investor’s order increased only to the extent that limit efficiency of the NMS.
executes at a price that is worse than the order users are given greater incentives The Commission believes that the
best displayed quotation.755 Most retail than currently exist to display a larger benefits of strengthening price
investors justifiably expect that their percentage of their trading interest. protection for exchange-listed stocks
orders will be executed at the NBBO. Investors who post limit orders should (e.g., by eliminating the gaps in ITS
Investors generally can know the best not see trades occurring on another coverage of block positioners and 100-
quoted prices at the time they place an market at a price inferior to their orders, share quotes) and introducing price
order by referring to the consolidated except in circumstances where an protection for Nasdaq stocks will be
quotation stream for a stock. In the exception applies. Price protection substantial, although the total amount is
interval between order submission and encourages the display of limit orders difficult to quantify. One objective,
order execution, however, quoted prices by increasing the likelihood that they though quite conservative, estimate of
can change. If the order execution price will realize an execution in a timely benefits is the dollar amount of
differs from the quoted price at order manner. Limit orders typically establish quotations that annually are traded
submission, it can be particularly the best prices for an NMS stock. through. The Commission staff’s
difficult for retail investors to assess Greater use of limit orders will enhance analysis of trade-through rates indicates
whether the difference was attributable price discovery and increase market that over 12 billion shares of displayed
to changing quoted prices or to an depth and liquidity, thereby improving quotations in Nasdaq and NYSE stocks
inferior execution by the market. By the quality of execution for large orders were traded through in 2003, by an
protecting the BBO of each exchange, of institutional investors. The average amount of 2.3 cents for Nasdaq
the NASDAQ Stock Market, and the Commission believes that the Order stocks and 2.2 cents for NYSE stocks.758
NASD, the Rule will further the Protection Rule is necessary to, and will These traded-through quotations
interests of investors, particularly retail serve to, enhance protection of represent approximately $209 million in
investors, in obtaining—and the ability displayed prices. By requiring trading Nasdaq stocks and $112 million in
of broker-dealers to achieve—best centers to establish written policies and NYSE stocks, for a total of $321 million
execution on an order-by-order basis, procedures reasonably designed to in bypassed limit orders and inferior
because the market to which a broker- prevent trade-throughs and to comply prices for investors in 2003 that could
dealer routes an order will not execute with exceptions, and by requiring them have been addressed by strong trade-
the order at a price that is inferior to a to regularly surveil to ascertain the through protection.759 The Commission
protected bid or offer displayed on the effectiveness of the policies and believes that this $321 million estimated
other market (unless an exception procedures and to take prompt remedial annual benefit, particularly when
applies).756 action to remedy deficiencies in such combined with the benefits of enhanced
The Order Protection Rule also will policies and procedures, the Rule will investor confidence in the fairness and
promote the fair and orderly treatment help ensure that displayed limit orders orderliness of the equity markets,
of limit orders for NMS stocks. Many of are not routinely bypassed by justifies the one-time costs of
the limit orders that are bypassed are transactions occurring in other markets implementation and ongoing annual
small orders that often will have been at inferior prices. costs of the Order Protection Rule.
submitted by retail investors. Retail Almost all commenters agreed that Two commenters on the reproposal
investors will participate directly in the the current ITS trade-through rule must asserted that the dollar amount of
U.S. equity markets only to the extent be fixed to accommodate the realities of traded-through quotations overstated
today’s NMS, in particular the the benefits of order protection because
that they perceive that their orders will
differences in operation among ‘‘trading is for the most part a zero-sum
be treated fairly and efficiently. The
automated and non-automated markets. game.’’ 760 They believed that trades
Commission agrees with commenters
The Commission believes that Rule 611,
that the Order Protection Rule will executed at inferior prices were random
by providing protection only for
increase investor confidence by helping noise that sometimes benefited and
automated quotations displayed by
to eliminate the impression of sometimes disadvantaged a particular
automated trading centers, will
unfairness when a trade occurs at a investor, stating that ‘‘[i]t is only if one
significantly update the ITS trade-
price that is inferior to the investor’s class of investors systematically loses
through rule. Intermarket efficiency and
displayed order.757 By better protecting out to another class as a result of trade-
certainty of execution in the NMS will
the interests of all investors—both those throughs that there is a
be improved as automated markets will
that execute against posted limit orders problem* * *’’ 761
no longer need to wait for responses
and those that post limit orders—the The Commission does not agree that
from non-automated markets and thus
Rule will bolster investor confidence in trades executed at inferior prices should
will be able to execute trades more
the integrity of the NMS, which will be considered merely a transfer of
quickly without regard for potentially
encourage investors to be more willing benefits from one group of investors to
unavailable quotations displayed on
to invest in the market, thus adding another equally-situated group of
non-automated markets. The Rule also
depth and liquidity to the markets and investors. There are at least three parties
will level the playing field by
eliminating the potential competitive 758 Trade-Through
755 See supra, note 59. Study at 3, 5.
756 The
advantage the existing ITS rule provides 759 Id.
at 3.
Commission emphasizes that adoption of
Rule 611 would in no way lessen a broker-dealer’s to manual markets. In addition, by 760 Angel Reproposal Letter at 4; see also Fidelity
duty of best execution. See supra, section II.B.4. providing an incentive for non- Reproposal Letter at 8.
757 See supra, note 59. automated markets to automate— 761 Angel Reproposal Letter at 4.
affected by every trade-through intermediaries cannot be dismissed as When the total share volume of trade-
transaction (1) The party that received mere ‘‘random noise.’’ through transactions that do not interact
an inferior price; (2) the party whose In addition, economic theory predicts with displayed quotations reaches 9%
superior-priced limit order was traded- that, in an auction market, buyers who and above for hundreds of the most
through; and (3) the contra party to the place the highest value on a stock will actively traded NMS stocks,765 this
trade-through transaction that received bid most aggressively.764 If an incoming message is unlikely to be missed by
an advantageous price. The market order is allocated to an investor those who watched their quotations
redistributions of welfare resulting from who is not bidding the best price, this being traded through. Certainly, the
trade-through transactions cannot re-allocation is neither zero-sum nor common practice of trading through
reasonably be expected to occur random. It systematically reallocates displayed size is most unlikely to
randomly across these parties. trades away from those investors for prompt market participants to display
Customers of brokers that are doing a whom the welfare gains would be even greater size.
poor job of routing orders are more largest. The argument also can be A primary objective of the Order
likely to be harmed than customers of framed in terms of an investor’s Protection Rule is to increase displayed
brokers that are doing a better job.762 preferences with respect to the tradeoff depth and liquidity in the NMS and
Investors who generally submit limit between price and execution speed. thereby reduce transaction costs for a
orders at the best prices are more likely Among those investors who trade using wide spectrum of investors, particularly
to be harmed than customers who limit orders, we would expect more institutional investors that must trade in
generally submit less aggressively- aggressive limit orders to be submitted large sizes. Precisely estimating the
priced limit orders. by those investors who place more value extent to which strengthened price
Thus, trade-through transactions can on speed or certainty of execution and protection will improve market depth
result in direct harm to two parties, as relatively less value on price. and liquidity, and thereby lower the
well as more general harm to the Conversely, we would expect investors transaction costs of investors, is very
efficiency of the markets by dampening who place a lower value on speed and difficult. The difficulty of estimation
the incentive for aggressive quoting. certainty of execution and a higher should not hide from view, however,
Moreover, even when the party value on price to submit less aggressive the enormous potential benefits for
receiving an inferior price does so limit orders. When an incoming market investors of improving the depth and
willingly (such as when an institution order is executed against a limit order efficiency of the NMS. Because of the
accepts a block trade at a price away with an inferior price, the result is: (1) huge dollar amount of trading volume in
from the inside quotation),763 the party A faster execution for an investor who NMS stocks—more than $17 trillion in
whose quotation was traded through does not place as much value on speed 2003 766—even the most incremental
and the efficiency of the markets still of execution; and (2) a lost execution or improvement in market depth and
are harmed. Finally, many trade- slower execution for the investor who liquidity could generate a dollar amount
throughs are dealer internalized trades, places a higher value on prompt of benefits that annually would dwarf
where the party receiving the execution. This is not a zero-sum the one-time start-up costs of
advantageous price is not an investor redistribution. implementing trade-through protection.
but a market intermediary, and therefore Moreover, the $321 million estimate One approach to evaluating the
such trades cannot be considered a is a conservative measure of the total potential benefits of the Order
transfer of benefits from one group of benefits of the Order Protection Rule. It Protection Rule is to examine a category
investors to another equally-situated does not attempt to measure any gains of investors that stand to benefit a great
group of investors. This transfer of from trading associated with investors’ deal from improved depth and liquidity
benefits from investors to market private values, beyond those expressed for NMS stocks—the shareholders in
U.S. equity mutual funds. In 2003, the
in their limit order prices. The Order
762 As discussed above, it can be difficult for total assets of such funds were $3.68
retail investors in particular to monitor whether
Protection Rule can be expected to
trillion.767 The average portfolio
their orders in fact received the best available price generate other categories of benefits that
turnover rate for equity funds was 55%,
at the time of order execution. See supra, note 53 are not quantified in the $321 million
and accompanying text. meaning that their total purchases and
estimate, such as the benefits that can be
763 Fidelity and the Battalio/Jennings Paper stated sales of securities amounted to
expected to result from increased use of
that the staff study should not have included block approximately $4.048 trillion.768 A
trades in its estimate of the benefits of strengthened limit orders, increased depth, and
leading authority on the trading costs of
trade-through protection. Fidelity Reproposal Letter increased order interaction.
II at 1; Battalio/Jennings Paper at 2. The institutional investors has estimated
Thus, the Commission believes that
Commission does not agree. First, the amount that that in the second quarter of 2003 the
the $321 million estimate of benefits is
block trades contributed to the $321 million average price impact experienced by
estimate is very small. Block trades represented conservative because it is based solely
investment managers ranged from 17.4
only 1.9% of total trade-throughs in Nasdaq stocks on the size of displayed quotations in
and 1.1% of total trade-throughs in NYSE stocks. basis points for giant-capitalization
the absence of strong price protection.
Trade-Through Study, Tables 6, 13. Most stocks, 21.4 basis points for large-
In essence, it measures the problem—a
importantly, the staff study used the lesser of the capitalization stocks, and up to 35.4
size of the traded-through quotation and the size of shortage of quoted depth—that the basis points for micro-capitalization
the trade-through transaction when calculating the Order Protection Rule is designed to
$321 million. Id. at 3. Thus, if a 10,000 share address, rather than the benefits that it 765 See Trade-Through Study, Tables 4.
transaction traded through a 100-share quotation,
only 100 shares counted toward the estimation of could achieve. Every trade-through 766 World Federation of Exchanges, Annual
benefits. The Battalio/Jennings Paper incorrectly transaction potentially sends a message Report (2003), at 86.
asserted that the staff study did not use this to market participants that their 767 Investment Company Institute, Mutual Fund
conservative approach. Battalio/Jennings Paper at 2. displayed quotations can be and are Fact Book (2004), at 55.
Finally, block trades are appropriately included in 768 Id. at 64. Portfolio turnover is reported as the
the estimation of benefits because their failure to ignored by other market participants. lesser of portfolio sales or purchases divided by
interact with significant displayed quotations is one average net assets. Because price impact occurs for
of the most serious problems with respect to the 764 See, e.g., B. Hollifield, R. Miller and P. Sandas, both purchases and sales, the turnover rate must be
protection of limit orders that the Order Protection ‘‘Empirical Analysis of Limit Order Markets,’’ 71 doubled, then multiplied by total fund assets, to
Rule is designed to address. See supra, section Review of Economic Studies 1027–1063 and n. 4 estimate the total value of trading that would be
II.A.1.c. (2004). affected by an improvement in depth and liquidity.
stocks.769 In addition, it estimated the investments other than mutual funds.772 prevent trade-throughs.776 Taken
cost attributable to adverse price Thus, the implicit transaction costs together, these changes substantially
movements while searching for liquidity incurred by institutional investors each reduced the estimated costs associated
for institutional orders, which often are year is likely at least double the $15.1 with the implementation of and ongoing
too large simply to be presented to the billion estimated for equity mutual compliance with the reproposed Rule.
market. Its estimate of these liquidity funds, for a total of more than $30 Commenters also expressed concern
search costs ranged from 13 basis points billion. Assuming that these other types that applying the trade-through proposal
for giant capitalization stocks, 23 basis of investors experienced a reduction in to the Nasdaq market would harm
points for large capitalization stocks, transaction costs that equaled the market efficiency and execution
and up to 119 basis points for micro- reduction of trading costs for equity quality.777 As discussed above, the
capitalization stocks. mutual funds, the assumed 5% Commission believes that a rule that
improvement in market depth and serves to limit the incidence of trade-
To obtain a conservative estimate of
liquidity could yield total transaction throughs will improve market efficiency
price impact costs and liquidity search cost savings for all investors of over $1.5 and benefit execution quality.778
costs incurred across all stocks, the total billion annually. Such savings would A number of commenters generally
market impact and liquidity search costs improve the investment returns of expressed the view that there would be
for giant capitalization stocks (30.4 basis equity ownership, thereby promoting significant costs associated with
points) and the total market impact and the retirement and other long-term implementing and complying with the
liquidity search costs for large financial interests of individual reproposed Rule,779 with some
capitalization stocks (44.4 basis points) investors and reducing the cost of commenters stating the belief that the
are averaged together to yield a figure of capital for listed companies. costs would outweigh any potential
37.4 basis points.770 The much higher benefits.780 Commenters did not,
market impact and liquidity search costs 2. Costs however, discuss the specific estimated
of midcap, smallcap, and microcap Some commenters expressed concern cost figures included in the Reproposing
stocks are not included. Using this over the anticipated cost of Release or include their own estimates.
estimate of 37.4 basis points, the implementing the original trade-through Many commenters expressed concerns
shareholders in U.S. equity mutual proposal.773 These commenters argued with the costs associated with
funds incurred implicit transaction that Rule 611 would be too expensive implementing the Voluntary Depth
costs of $15.1 billion in 2003. Based on and that the costs associated with Alternative, believing that the costs of
a hypothetical assumption that, in light implementing it would outweigh the implementing the Voluntary Depth
of the current share volume of trade- perceived benefits of the Rule. Some Alternative would be substantially
through transactions that does not commenters were concerned about the greater than the Market BBO
interact with displayed liquidity, cost of specific requirements in the Alternative.781 As discussed above in
intermarket trade-through protection proposed rule, particularly the Section II.A.5, the Commission is
could improve depth and liquidity for procedural requirements associated adopting the Market BBO Alternative
NMS stocks by 5% (or an average with the proposed opt-out exception and not the Voluntary Depth
reduction of 1.87 basis points in price (e.g., obtaining informed consent from Alternative. The Commission does not
impact and liquidity search costs for customers and disclosing the NBBO to
large investors), the savings in customers).774 As discussed above, 776 As noted in the Reproposing Release, the
transaction costs for U.S equity funds however, the Order Protection Rule as Commission revised the estimated number of
broker-dealers that would be subject to the
alone, and the improved returns for reproposed did not (and as adopted reproposed Rule from the original proposal. The
their millions of individual does not) contain an opt-out exception, revised number includes the approximately 585
shareholders, would have amounted to as was originally proposed.775 firms that were registered equity market makers or
Therefore, the concerns expressed by specialists at year-end 2003 (this number was
approximately $755 million in 2003. derived from annual FOCUS reports and discussion
commenters relating to the costs of
Of course, the benefits of improved with SRO staff), as well as ATSs that operate
implementing an opt-out exception are trading systems that trade NMS stocks. The
depth and liquidity for the equity
not applicable, and were not included Commission believes it is reasonable to assume that
holdings of other types of investors, in general, firms that are block positioners—i.e.,
in the Reproposing Release. In the
including pension funds, insurance firms that are in the business of executing orders
Reproposing Release, the Commission internally—are the same firms that are registered
companies, and individuals, are not
also refined its estimate of the number market makers (for instance, they may be registered
incorporated in the foregoing
of broker-dealers that would be required as a market maker in one or more Nasdaq stocks
calculations. In 2003, these other types and carry on a block positioner business in
to establish, maintain, and enforce
of investors held 78% of the value of exchange-listed stocks), especially given the
written policies and procedures to amount of capital necessary to carry on such a
publicly traded U.S. equity outstanding,
business.
with equity mutual funds holding the 772 Id. at 91 (employer-sponsored pension market 777 See, e.g., Archipelago Reproposal Letter at 5–
remaining 22%.771 For example, held estimated $9.0 trillion in assets in 2003, $7.7 6; Citadel Letter at 6; Hudson River Trading Letter
pension funds alone held $9 trillion in trillion of which were not represented by mutual at 1–2; Instinet Reproposal Letter at 9, 14; Nasdaq
assets in 2003, of which an estimated fund assets); Milliman, Inc., Pension Fund Survey Reproposal Letter at 2.
(available at www.milliman.com) (consulting firm’s 778 See supra, section II.A.1.
$4.9 trillion was held in equity survey of 2003 annual reports for 100 of largest U.S. 779 See, e.g., CIBC Reproposal Letter at 4; Knight
corporations found that the median equity Securities Reproposal Letter at 5; Lava Reproposal
769 Plexus Group, Inc., Commentary 80, ‘‘Trading allocation for pension fund assets was 65%). Letter at 1; Merrill Lynch Reproposal Letter at 5;
Truths: How Mis-Measurement of Trading Costs Is 773 See, e.g., Bloomberg Tradebook Letter at 14;
SIA Reproposal Letter at 11.
Leading Investors Astray,’’ (April 2004), at 2–3. Fidelity Letter I at 12; Instinet Letter at 14, 15; 780 See, e.g., Angel Reproposal Letter at 2; Instinet
770 Cf. supra, note 146 and accompanying text Nasdaq Letter II at 2; Peake Letter I at 2; Reg NMS Reproposal Letter at 7; Knight Securities Reproposal
(Plexus estimate of average transaction costs, Study Group Letter at 4; Rosenblatt Securities Letter Letter at 5; MFA Reproposal Letter at 2.
including commissions, during the fourth quarter of II at 4; STANY Letter at 3; UBS Letter at 8. 781 See, e.g., Amex Reproposal Letter at 3; ATD
2003 for Nasdaq and NYSE stocks as, respectively, 774 See, e.g., Ameritrade Letter I at 8; Brut Letter
Reproposal Letter at 4; BNY Reproposal Letter at 3;
83 basis points and 55 basis points; commissions at 10–12; Citigroup Letter at 8–9; E*TRADE Letter CHX Reproposal Letter at 2; NYSE Reproposal
average 12 basis points for large capitalization at 7; Financial Information Forum Letter at 2; JP Letter I, Detailed Comments at 8; RBC Capital
stocks). Morgan Letter at 4; SIA Letter at 12–15. Markets Reproposal Letter at 6; STANY Reproposal
771 Mutual Fund Factbook, supra note 767, at 59. 775 See supra, section II.A.4. Letter at 9.
believe that the inclusion of a stopped quotation basis). Trading centers will estimates that the average cost to the
order exception will materially impact need to make sure they have nine SROs to make necessary system
the estimated costs included in the connectivity to other trading centers in modifications to implement the Rule
Reproposing Release.782 The the NMS that could post protected will be $5 million per SRO, for a total
Commission therefore continues to quotations, whether through proprietary of $45 million. Therefore, estimated
estimate implementation costs for the linkages or through use of third-party overall total one-time implementation
Order Protection Rule of approximately services. As noted below, however, the costs, added to PRA costs, are
$143.8 million and annual costs of Commission believes that most of this approximately $144 million.
approximately $21.9 million, as private linkage functionality already In addition, broker-dealers that do not
discussed below. exists, particularly in the market for fall within the definition of a trading
The Commission recognizes, as noted Nasdaq securities. Surveillance systems center but that employ their own smart-
by commenters, that there will be will need to be modified to assure an order routing technology to route orders
significant one-time costs to implement effective mechanism for monitoring to multiple trading centers could choose
the Order Protection Rule. Trading transactions after-the-fact for ongoing to route orders in compliance with the
centers will necessarily incur costs compliance purposes. Also, trading intermarket sweep exception. These
associated with establishing written systems will need to be programmed to broker-dealers would need to make
policies and procedures reasonably recognize when exceptions to the necessary modifications to their order
designed to prevent trade-throughs—in operative provisions of Rule 611 are routing practices and proprietary order
other words, with determining a course applicable. For example, trading centers routing systems to monitor the protected
of action for how the trading center will will need to be able to identify outgoing quotations of trading centers and to
comply with the requirements of the and recognize incoming orders as properly identify such intermarket
Rule, including compliance with the intermarket sweep orders. Data feeds sweep orders. The Commission does not
exceptions contained in the Rule. and market vendor systems will need to believe that this category of broker-
Although the extent of these costs will be modified to accommodate order dealers is very large. The Commission
vary because the exact nature and extent identifiers for manual quotations and also believes it likely that most if not all
of each trading center’s written policies intermarket sweep orders, which costs of these non-trading center broker-
and procedures will depend on the type, (to the extent incurred) will likely be dealers that employ their own order-
size and nature of each entity’s passed along to the end users of these routing technology already have systems
business, as discussed above in Section systems, the trading centers. These costs in place that monitor best-priced
VIII.A., for purposes of the PRA the are included within the estimates quotations across markets, and thus
Commission broadly estimates that SRO below. does not believe that the changes
trading centers will incur a one-time For non-SRO trading centers that rely necessary to implement the intermarket
initial cost for establishing such policies upon their own internal order routing sweep order will be substantial.
and procedures of approximately and execution management systems, of With respect to maintaining and
$311,805 (calculated by multiplying the which the Commission estimated in the updating its required written policies
average cost of $34,645 per SRO trading Reproposing Release that there are and procedures to ensure they continue
center by the 9 SRO trading centers), approximately 20, the Commission to be in compliance with the Rule, for
and non-SRO trading centers will incur estimates the average cost of necessary purposes of the PRA the Commission
a one-time initial cost for establishing systems changes to implement the Rule estimates that the average annual cost
policies and procedures of will be approximately $3 million per for each trading center will be
approximately $17,469,600 (calculated trading center, for a total one-time start- approximately $5,676 per trading center
by multiplying the average cost of up cost of approximately $60 million.784 per year, for a total annual cost for all
$29,116 per non-SRO trading center by The Commission estimates that the trading centers of $3,456,684.786 With
the 600 non-SRO trading centers), for a remaining non-SRO trading centers that regard to ongoing monitoring for and
total of $17,781,405.783 will be subject to the Rule will utilize
Each trading center also will incur enforcement of trading in compliance
outside vendors to provide these with the Rule, the Commission believes
initial up-front costs associated with services, consistent with their current
taking action necessary to implement that, once the tools necessary to carry
use of such services for order routing out on-going monitoring have been put
the written policies and procedures it and execution management. For these
has developed, which will include in place (which are included in the
non-SRO trading centers, the above cost estimates), a trading center
necessary modifications to order routing Commission estimates the cost of
and execution systems to ‘‘hard-code’’ will be able to incorporate ongoing
necessary systems modifications that monitoring and enforcement within the
compliance with the Rule and the
will be passed along to the trading scope of its existing surveillance and
exceptions. For instance, modifications
centers to be approximately $50,000 per enforcement policies and procedures
to order routing and execution systems
trading center, for a total initial cost of without a substantial additional burden.
will need to be made to route and
$21 million.785 The Commission also The Commission recognizes, however,
execute orders in compliance with the
requirements of the Rule to prevent that this ongoing compliance will not be
784 This number is an average estimated cost;
trade-throughs of protected quotations cost-free, and that trading centers will
thus, it likely overestimates the costs for some
(which include, for instance, the ability trading centers and underestimates it for others. For incur some additional annual costs
to recognize quotations identified in the instance, it likely overestimates the cost for ATS associated with ongoing compliance,
consolidated quotation system as trading centers, particularly smaller ones, as including compliance costs of reviewing
opposed to full-service broker-dealer trading transactions. For instance, the
manual quotations on a quotation-by- centers, in part because of the narrower business
focus of some ATSs. Commission recognizes that access to a
782 The estimated cost figures included the 785 Given that floor-based market-makers and
Reproposing Release did not include additional specialists utilize exchange execution systems, the by the exchange on whose floor they operate to
costs that would have been associated with the Commission believes it is reasonable to assume that make changes to the exchange’s execution systems.
Voluntary Depth Alternative. such market-makers and specialists will not incur Thus, these entities (approximately 160 of the 585)
783 See supra, notes 736 to 742 and accompanying substantial systems-related costs to implement the are not directly included within the cost estimates.
text. Rule independent of the costs that will be incurred 786 See supra, note 743 and accompanying text.
database of BBO information for each incorporate the Order Protection Rule access requirements from 20% to 5% of
trading center whose quotations will be and its exceptions will be minimal. average daily volume in a security.
protected by the Order Protection Rule In determining these estimates the
1. Benefits
will be necessary to monitor Commission also has considered that
transactions for compliance with the many market participants are already The Commission believes that the
Rule on an after-the-fact basis. The making changes to their systems to adopted Access Rule will help achieve
Commission believes that this become more competitive. Many of the the statutory objectives for the NMS by
information currently is available and changes being made will assist the promoting fair and efficient access to
understands that such information market participants in preparing for each individual market. By enabling
currently is maintained by at least one implementation of the Order Protection reliance on private linkages, rather than
industry vendor. The Commission Rule. For example, Nasdaq, which mandating a collective intermarket
believes that the cost to each trading previously did not have an order routing linkage facility, the access provisions of
center to access this database will be system, purchased Brut, LLC last year in Rule 610(a) and (b) allow market centers
incremental in relation to the cost of order to acquire access to such a system. to connect through flexible and cost
other services provided by the vendor. The Commission believes that this effective technologies widely used in
The Commission estimates that each acquisition should reduce the costs that the markets today, particularly in the
trading center will incur an average will be incurred by Nasdaq to market for Nasdaq-listed stocks. This
annual ongoing compliance cost of implement the Order Protection Rule. will allow firms to capitalize on the
$30,144 for a total annual cost of The Commission also notes that the dramatic improvements in
$18,357,696 for all trading centers.787 NYSE is in the process of modifying its communications and processing
Direct+ System to make more quotations technologies in recent years, and
In assessing the costs of systems
available on an automated basis.788 thereby enhance the linking of all
changes that may be required by the
These changes that the NYSE has markets for the future NMS. Private
Order Protection Rule, it is important to
undertaken should reduce the cost of linkages also will provide flexibility to
recognize that much, if not all, of the
additional systems changes needed to meet the needs of different market
connectivity among trading centers
implement the Order Protection Rule. participants and allow competitive
necessary to implement intermarket
Overall, the Commission believes that forces to determine the specific nature
price protection has already been put in
the Order Protection Rule will produce and cost of connectivity. The access
place. For example, trading centers for provisions of Rule 610(a) and (b) thus
exchange-listed securities already are significant benefits that justify the costs
should allow market participants to
connected through the ITS. The of implementation of the Rule.
fairly and efficiently route orders to
Commission understands that, at least B. Access Rule execute against the best displayed
as an interim solution, ITS facilities and quotations for a stock, wherever such
rules can be modified relatively easily Rule 610 of Regulation NMS sets forth
new standards governing means of quotations are displayed in the NMS.
and at low cost to provide the current The Commission believes that fair and
ITS participants a means of complying access to quotations in NMS stocks.
These standards will prohibit trading efficient access to the best displayed
with the provisions of Rule 611. With quotations of all trading centers is
respect to Nasdaq stocks, connectivity centers from imposing unfairly
discriminatory terms that would prevent critical to achieving best execution of
among many trading centers already is those orders.
established through private linkages. or inhibit the efficient access of any
The access provisions of Rule 610(a)
Routing out to other trading centers person through members, subscribers, or
and (b) also will promote fair and
when necessary to obtain the best prices customers of such trading center, and efficient means of access to quotations
for Nasdaq stocks is an integral part of enable access to NMS quotations by prohibiting a trading center from
the business plan of many trading through private linkages, rather than unfairly discriminating against non-
centers, even when not affirmatively mandating a collective intermarket members or non-subscribers that
required by best execution linkage facility. In addition, the Rule is attempt to access its quotations through
responsibilities. Moreover, a variety of designed to ensure the fairness and a member or subscriber of such trading
private vendors currently offer accuracy of displayed quotations by center. Such fair access to the
connectivity to NMS trading centers for establishing an outer limit on the cost of quotations of other trading centers is
both exchange-listed and Nasdaq stocks. accessing protected quotations and any critical for access to all displayed
Many of the broker-dealers that are non- other quotations at the best bid and offer quotations and compliance with the
SRO trading centers that will be subject of no more than $0.003 per share (or adopted Order Protection Rule and
to the Rule already employ smart order 0.3% of the quotation price per share for broker-dealers’ duty of best execution.
routing technology, either their own quotations priced less than $1). Rule The fee limitation of Rule 610(c) will
systems or those of outside vendors, 610 also requires SROs to establish, address the potential distortions caused
which should limit the cost of maintain, and enforce rules that would, by substantial, disparate fees. The wider
implementing systems changes. The among other things, prohibit their the disparity in the level of access fees
Commission also understands that the members from engaging in a pattern or among different market centers, the less
cost to the Plan processors to practice of displaying quotations that useful and accurate are the prices of
lock or cross the automated quotations displayed quotations. As a result of the
787 This estimate was included in the of other trading centers. Finally, the adopted fee limitation, displayed prices
Reproposing Release. The Commission continues to adopted amendment to Rule 301 of will more closely reflect actual costs to
estimate that each trading center will incur an Regulation ATS lowers the threshold trade, thereby enhancing the usefulness
average annual ongoing compliance cost of $30,144 that triggers the Regulation ATS fair
for a total annual cost of $18,357,696 for all trading of market information. The fee
centers. This figure was calculated as follows: (16 limitation also will establish a level
compliance hours × $103) + (8 information 788 See Securities Exchange Act Release Nos.
playing field across all market
technology hours × $67) + (4 legal hours × $82) × 50173 (Aug. 10, 2004), 69 FR 50407 (Aug. 16, 2004),
12 months = $30,144 per trading center × 609 50277 (Aug. 26, 2004), 69 FR 53759 (Sept. 2, 2004)
participants and trading centers. The
trading centers = $18,357,696. See supra, notes 732 and 50667 (Nov. 15, 2004), 69 FR 67980 (Nov. 22, rule promotes the NMS objective of
to 735 for notation as to hourly rates. 2004) (SR–NYSE–2004–05). equal regulation of markets and broker-
dealers by applying equally to all types Moreover, the fee limitation is interest in a stock. Restricting the
of trading centers and all types of necessary to achieve the purposes of the practice of submitting locking or
market participants.789 As noted above Exchange Act. If outlier markets are crossing quotations therefore will
in Section III.A.2, although ECNs and allowed to charge high fees and pass enhance the usefulness of quotation
other types of trading centers, including most of them through as rebates, the information. Consistent with the
SROs, may currently charge access fees, published quotations of such markets approach to trade-through protection,
market makers have not been permitted would not reliably indicate the true however, Rule 610(d) will allow
to charge any fee for counterparties price that is actually available to automated quotations to lock or cross
accessing their quotations. The investors or that would be realized by manual quotations. Rule 610(d) thereby
Commission believes, however, that it is liquidity providers. Section 11A(c)(1)(B) addresses the concern that manual
consistent with the Quote Rule for of the Exchange Act authorizes the quotations may not be fully accessible
market makers to charge fees for access Commission to adopt rules assuring the and recognizes that allowing automated
to their quotations pursuant to Rule fairness and usefulness of quotation quotations to lock or cross manual
610(c), so long as such fees meet the information. For quotations to be fair quotations may provide useful market
requirements of Rule 610(c). and useful, there must be some limit on information regarding the accessibility
the extent to which the true price for of quotations. The Commission believes,
The fee limitation also will address however, that an automated quotation is
those who access quotations can vary
‘‘outlier’’ trading centers that otherwise entitled to protection from locking or
from the displayed price. Consequently,
might charge high fees to other market crossing quotations. When two market
the $0.003 fee limitation will further the
participants required to access their participants are willing to trade at the
statutory purposes of the NMS by
quotations by the Order Protection Rule. same quoted price, giving priority to the
harmonizing quotation practices and
In the absence of a fee limitation, the first-displayed automated quotation will
precluding the distortive effects of
adoption of the Order Protection Rule encourage posting of quotations and
exorbitant fees. Moreover, the fee
and private linkages could significantly contribute to fair and orderly markets.
limitation is necessary to further the
boost the viability of the outlier The basic principle underlying the NMS
statutory purpose of enabling broker-
business model. Outlier markets might is to promote fair competition among
dealers to route orders in a manner
well try to take advantage of intermarket markets, but within a system that also
consistent with the operation of the
price protection by acting essentially as promotes interaction between all of the
NMS.793 To protect limit orders, orders
a toll booth between price levels. Even buyers and sellers in a particular NMS
must be routed to those markets
though high fee markets likely would be stock. Allowing market participants
displaying the best-priced quotations.
the last market to which orders would simply to ignore accessible quotations
This purpose would be thwarted if
be routed, prices could not move to the in other markets and routinely display
market participants were allowed to
next level until someone routed an locking and crossing quotations is
charge exorbitant fees that distort
order to take out the displayed price at inconsistent with this principle. The
quoted prices.
the outlier market. Such a business As discussed above in Section III.A.2, restrictions on locking or crossing
model would detract from the the Commission agrees that the access quotations, in conjunction with the
usefulness of quotation information and fee limitation should apply to manual Order Protection Rule, should
impede market efficiency and quotations that are best bids and offers encourage trading against displayed
competition. The fee cap will limit the to the same extent it applies to protected quotations and enhance the depth and
outlier business model. It will place all quotations, to preclude any incentive for liquidity of the markets.
markets on a level playing field in terms trading centers to display manual Finally, lowering of the fair access
of the fees they can charge and quotations as a means to charge a higher threshold of Rule 301(b)(5) under
ultimately the rebates they can pass on access fee. In addition, the Commission Regulation ATS 795 from 20% to 5% of
to liquidity providers. Some markets recognizes that at present a trading average daily trading volume in a
might choose to charge lower fees, center’s execution quality statistics will security will further strengthen access to
thereby increasing their ranking in the be evaluated against the NBBO, whether the full range of services of ATSs with
preferences of order routers. Others that quotation is a manual or automated significant trading volume in NMS
might charge the full $0.003 and rebate quotation. The Commission therefore stocks. Such access is particularly
a substantial proportion to liquidity has modified the proposed fee important for the success of the private
providers.790 Competition will limitation in Rule 610(c) to apply to any linkage approach adopted for access to
determine which strategy is most quotation that is the best bid or best quotations. The lowering of the fair
successful.791 The Rule also precludes a offer of an exchange, the ADF, or The access threshold also will make its
trading center from charging high fees NASDAQ Market Center, in addition to coverage consistent with the existing
selectively to competitors, practices that any protected quotations as defined in 5% threshold triggering the order
have occurred in the market for Nasdaq Rule 600(b)(57).794 display and execution access
stocks.792 The restrictions on locking or crossing requirements of Rule 301(b)(3) of
quotations in Rule 610(d) will promote Regulation ATS.796 As a result, each
789 Section 11A(c)(1)(F) of the Exchange Act, 15
fair and orderly markets. Locked and ATS that is required to disseminate its
U.S.C. 78k–1(c)(1)(F).
crossed markets can cause confusion quotations in the consolidated data
790 Nothing in Rule 610(c) will preclude an SRO
among investors concerning trading stream also will be prohibited from
or other trading center from taking action to limit
fees beyond what is required by the rule, and
unfairly prohibiting or limiting market
trading centers will have flexibility in establishing 793 Section 11A(c)(1)(E) of the Exchange Act, 15 participants from becoming a subscriber
their fee schedules to comply with Rule 610(c), U.S.C. 78k–1(c)(1)(E), authorizes the Commission to or customer.
consistent with existing requirements of the adopt rules assuring that broker-dealers transmit In adopting Rule 610 and the
Exchange Act and the rules and regulations orders for NMS stocks in a manner consistent with
thereunder.
amendment to Rule 301 of Regulation
the establishment and operation of a national
791 The Commission believes that the fee market system. ATS, the Commission seeks to help
limitation on protected quotations priced less than 794 In addition, the Commission notes that the
$1.00 will provide the same benefits. access standards in Rule 610(a) and (b) apply to all 795 17 CFR 242.301(b)(5).
792 Rule 610(c). quotations, not just automated quotations. 796 17 CFR 242.301(b)(3).
ensure that securities transactions can provide access between markets, some smaller ATSs are not required to
be executed efficiently, at prices commenters (both those supporting and provide their quotations to any SRO
established by vigorous and fair those opposing the reproposed access (whether an SRO trading facility or the
competition among market centers. By standards) voiced their concerns about NASD’s ADF) and thereby trigger the
enabling fair access and transparent the potential need to develop, and the access requirements of Rule 610.
pricing among diverse marketplaces costs of developing, connections to Moreover, potential new entrants with
within a unified national market, the numerous small trading centers in the innovative trading mechanisms can
Commission believes that the access ADF.799 Several commenters felt that commence business without having to
provisions will foster efficiency, non-SRO trading centers should make incur any costs associated with
enhance competition, and contribute to their quotations available through the participation in the consolidated
the best execution of orders for NMS automatic execution facilities of an quotation system.
securities. SRO, thereby requiring other market Some smaller ATSs, however, may
participants to only have to maintain wish to participate voluntarily in the
2. Costs consolidated quotation system. Such
access to six or seven markets, rather
The Commission believes that Rule than potentially dozens.800 In contrast, participation can benefit smaller firms
610 and the amendment to Rule 301 of one commenter that is an ADF and promote competition among
Regulation ATS will not impose participant stated its belief that the markets by enabling smaller firms to
significant costs on most trading centers proposal to require ADF participants to obtain wide distribution of their
and market participants. When establish the necessary connectivity that quotations among all market
assessing the costs of access, it is would facilitate efficient access to their participants.803 Here, too, such firms
important to recognize that much, if not quotations would create a cost barrier will have alternatives that would not
all, of the connectivity among trading that discriminates against smaller firms obligate them to comply with the
centers has already been put in place. in the ADF.801 connectivity requirements of Rule
For example, trading centers for The Commission does not believe that 610(b)(1). ATSs and market makers that
exchange-listed securities already are its adopted access approach in Rule wish to trade NMS stocks can choose
connected through the ITS. The 610(b)(1) discriminates against smaller from a number of options for quoting
Commission understands that the ITS firms or creates a barrier to access for and trading. They can become a member
facilities and rules that currently innovative new market entrants. Rather, of a national securities exchange and
provide intermarket access for smaller firms and new entrants have a quote and trade through the exchange’s
exchange-listed stocks could be range of alternatives from which to trading facilities. They can participate
modified relatively easily and at low choose that will allow them to avoid in The NASDAQ Market Center and
cost to provide the current ITS incurring any costs to meet the quote and trade through that facility. By
participants a means of access, at least connectivity requirements of Rule choosing either of these options, an ATS
as an interim measure until private 610(b)(1) if they wish to do so. This or market maker would not create a new
linkages are fully established for approach is fully consistent with connectivity point that all other market
exchange-listed stocks. In addition, Congressional policy set forth in the participants must reach and would not
private linkages already are widely used Regulatory Flexibility Act, which be subject to Rule 610(b)(1). Some firms,
in the equity markets, particularly for directs the Commission to consider however, may not want to participate in
trading in Nasdaq-listed stocks. significant alternatives to regulations an SRO trading facility. These ATSs and
Moreover, a variety of private vendors that accomplish the stated objectives of market makers can quote and trade in
currently offer connectivity to NMS the Exchange Act and minimize the the OTC market. The existence of the
trading centers for both exchange-listed economic impact on small entities.802 NASD’s ADF makes this third choice
and Nasdaq stocks, and many broker- Small ATSs are exempt from possible by providing a facility for
dealers already employ smart order participation in the consolidated displaying quotations and reporting
routing technology. The Commission quotation system and, therefore, from transactions in the consolidated data
also notes that trading centers already the connectivity requirements of Rule stream.804
are making changes to their systems to 610. Under Rule 301(b)(3) of Regulation As noted above in Section III.A.1,
become more competitive. The changes ATS, an ATS is required to display its however, the NASD is not statutorily
being made will assist those trading quotations in the consolidated quotation required to provide an order execution
centers in preparing for implementation stream only in those securities for functionality in the ADF. The
of the Access Rule.797 The Commission which its trading volume reaches 5% of Commission believes that market
therefore believes that the system total trading volume. Consequently, makers and ECNs should continue to
changes necessary to meet the new have the option of operating in the OTC
access standards will be minor.798 799 See
supra, section III.A.1. market, rather than on an exchange or
While commenters were generally 800 See,
e.g., Knight Trading Group Reproposal The NASDAQ Market Center. As noted
Letter at 5; Nasdaq Reproposal Letter at 17–18 in the Commission’s order approving
supportive of the Commission’s (expressing the view that trading facilities with less
proposal to employ private linkages to than a five percent volume should be required to
Nasdaq’s SuperMontage trading facility,
make their quotations available through an SRO this ability to operate in the ADF is an
797 For example, Nasdaq, which previously did trading facility); STA Reproposal Letter at 6; Type
not have an order routing system, purchased Brut, N Reproposal Letter at 1. 803 See supra, note 566 (the Commission’s
LLC last year in order to acquire access to such a 801 NexTrade Reproposal Letter at 4–6. Advisory Committee on Market Information
system. The Commission believes that this 802 5 U.S.C. 603(c). In the Reproposing Release, recommended retention of the consolidated display
acquisition should reduce the costs that will be the Commission noted that only two of the requirement because, among other things, it ‘‘may
incurred by Nasdaq to implement the Access Rule. approximately 600 broker-dealers (including ATSs) promote market competition by assuring that
798 One commenter, however, felt that the that would be subject to Rule 610 are considered information from newer or smaller exchanges is
bilateral links required for private linkages would small (total capital of less than $500,000) for widely distributed.’’).
be particularly burdensome to smaller market purposes of the Regulatory Flexibility Act. 69 FR at 804 Under Rule 301(b)(3) of Regulation ATS, 17
centers compared to an ITS-type structure. Letter 77493. The adopted access approach provides CFR 242.301(b)(3), an ATS is required to display its
from Donald E. Weeden to Jonathan G. Katz, alternatives that will benefit a wider range of quotations in the consolidated data stream only in
Secretary, Commission, dated June 30, 2004, at 9– smaller ATSs than the two that are considered those securities for which its trading volume
10. small entities. reaches 5% of total trading volume.
important competitive alternative to it does not mandate that the securities vendors. The option of participation in
Nasdaq or exchange affiliation.805 industry in general must subsidize the existing market infrastructure and
Therefore, the Commission has costs of accessing a broker-dealer’s systems should reduce a trading center’s
determined not to require small trading quotations in the OTC market if the cost of compliance.809
centers to make their quotations NASD chooses not to provide Two commenters raised concerns
accessible through an SRO trading connectivity. The Commission believes about reliance on third party private
facility. that it is reasonable and appropriate to vendors to provide access, since they
Instead, Rule 610(b)(1) requires all require those ATSs and market makers may not be regulated by the
trading centers that choose to display that choose to display quotations in the Commission and thus could deny access
quotations in an SRO display-only ADF to bear the responsibility of to a trading center they viewed as a
quotation facility (currently, the ADF) to providing a level and cost of access to competitor, or because utilizing their
provide a level and cost of access to their quotations that is substantially services to link to other trading centers
such quotations that is substantially equivalent to the level and cost of access is outside the control of a trading
equivalent to the level and cost of access to quotations displayed by SRO trading center.810 The Commission believes that
to quotations displayed by SRO trading facilities. Under Rule 610(b)(1), the requirement in Rule 610(b)(1) that
facilities. Rule 610(b)(1) therefore may therefore, ADF participants will be ADF participants provide a substantially
cause trading centers that display required to bear the costs of the equivalent level of access will preclude
quotations in the ADF to incur necessary connectivity to facilitate the ADF participant from providing
additional costs to enhance the level of efficient access to their quotations.807 access only through a narrow range of
access to their quotations and to lower This standard will help ensure that private access providers. The range of
the cost of connectivity for market additional connectivity burdens are not access providers must be sufficient to
participants seeking to access their imposed on the securities industry each provide access substantially equivalent
quotations. The extent to which these time an additional ADF participant to SRO trading facilities. In these
trading centers in fact incur additional necessitates a new connectivity point by circumstances, and given the significant
costs to comply with the adopted access choosing to begin displaying quotations number and variety of entities that
standard will be largely within the in the consolidated quotation stream. currently provide access services and
control of the trading center itself. As The Commission believes that this the competitive nature of the market for
noted above, ATSs and market makers requirement will help reduce overall these services, the Commission believes
that wish to trade NMS stocks can industry costs by more closely aligning that competition will be sufficient to
choose from a number of options for the burden of additional connectivity provide services for any trading center
quoting and trading, including quoting with those entities whose choices have choosing to utilize an outside vendor.811
and trading in the OTC market. As a created the need for additional Several commenters, including some
result, the additional connectivity connectivity. that otherwise supported the proposal,
requirements of Rule 610(b) will be As just discussed, the Commission expressed concern that requiring non-
triggered only by a trading center that recognizes that trading centers subject to discriminatory access to markets might
displays its quotations in the Rule 610(b)(1) may incur costs undermine the value of SRO
consolidated data stream and chooses associated with providing access to their membership.812 The Commission does
not to provide access to those quotations quotations, although the costs will vary not believe that adoption of a private
through an SRO trading facility. depending upon the manner in which linkage approach will seriously
Currently, nine SROs operate trading each trading center provides such undermine the value of membership in
facilities in NMS stocks. Market access. The Commission notes that to SROs that offer valuable services to their
participants throughout the securities meet the standard contained in Rule members. First, the fact that markets
industry generally have established 610(b)(1), a trading center will be will not be allowed to impose unfairly
connectivity to these nine points of allowed to take advantage of the greatly discriminatory terms on non-members
access to quotations in NMS stocks. By expanded connectivity options that who obtain indirect access to quotations
choosing to display quotations in the have been offered by competing access through members does not mean that
ADF, a trading center effectively could service providers in recent years.808 non-members will obtain free access to
require the entire industry to establish These industry access providers have quotations. Members who provide
connectivity to an additional point of extensive connections to a wide array of piggyback access will be providing a
access. Potentially, many trading centers market participants through a variety of useful service and presumably will
could choose to display quotations in direct access options and private charge a fee for such service. The fee
the ADF, thereby significantly networks. A trading center potentially will be subject to competitive forces and
increasing the overall costs of could meet the requirement of Rule likely will reflect the costs of SRO
connectivity in the NMS. Such an 610(b)(1) by establishing connections to membership, plus some element of
inefficient outcome would become and offering access through such profit to the SRO’s members. As a result,
much more likely if an ADF trading 807 Thus, although market participants may still
center were not required to assume be required to access numerous trading centers in
809 As the self-regulatory authority responsible for
responsibility for the additional costs the OTC market, the NASD must act as
the ADF, the Rule should reduce the cost of access
‘‘gatekeeper’’ for the ADF, and, as such, will need
associated with its decision to display to each such trading center by requiring the ADF
to closely assess the extent to which ADF
trading center to provide a cost and level of access
quotations outside of an established substantially equivalent to the level and cost of participants meet the requirements of Rule 610.
SRO trading facility. access to quotations displayed by SRO trading
810 NexTrade Reproposal Letter at 6; STANY
Although the Exchange Act envisions facilities. Reproposal Letter at 4.

811 For example, one large ECN can be accessed
an individual broker-dealer having the 808 As noted in the Commission’s order approving
the pilot program for the ADF, the reduction in through five extranets and at least 21 other access
option of trading in the OTC market,806 providers, as well as through direct connections.
communications line costs in recent years and the
advent of competing access providers offer the See supra, note 366 and accompanying text.
805 See Securities Exchange Act Release No. 812 Alliance of Floor Brokers Letter at 10; Amex
potential for multiple competitive means of access
43863 (Jan. 19, 2001), 66 FR 8020 (Jan. 26, 2001). to the various trading centers that trade NMS Letter, Exhibit A at 25–26; BSE Letter at 12; CHX
806 See Sections 11A(c)(3)(A) and (4) of the stocks. Securities Exchange Act Release No. 46249, Letter at 14; Citigroup Letter at 12; Phlx Letter at
Exchange Act, 15 U.S.C 78k–1(c)(3)(A) and (4). supra note 390. 2; STANY Letter at 9.
non-members that frequently make use objective can be achieved by routing an Although the fee limitation is
of indirect access are likely to contribute IOC, marketable limit order with a limit consistent with current business
indirectly to the costs of membership in price that equals the price of the practices, the fee limitation of Rule
the SRO market. Moreover, the unfair protected quotation. The extent to 610(c) will affect the few markets that
discrimination standard of Rule 610(a) which they route to non-protected currently impose access fees of greater
will apply only to access to quotations, quotations will be subject to the full than $0.003 per share that apply to a
not to the full panoply of services that range of competitive forces, including wide range of NMS stocks.815 These
markets generally provide only to their the fees that trading centers choose to markets will be required to re-evaluate
members. These other services will be charge for access to non-protected their business models in light of the
subject to the more general fair access quotations. adopted fee limitation. In particular,
provisions applicable to SROs and large The Commission recognizes, however, they likely will need to reduce the
ECNs, as well as the statutory provisions the concern that a market participant rebates they currently pay to liquidity
that govern SRO rules. could intend to interact only with a providers. The adopted limitation also
For the reasons discussed below, the protected quotation but in fact execute will affect a few trading centers that
Commission does not believe that the against a non-protected quotation. For charge significant access fees for large
fee limitation of Rule 610(c), including example, at the time a market transactions in specific types of NMS
the fee limitation on non-protected participant routes an order to a trading stocks, such as ETFs. It is unlikely,
quotations at the best bid and offer, will center, it may be attempting to execute however, that such fees currently
impose significant new costs on most against only that trading center’s best generate a large amount of revenues.816
trading centers. First, a few commenters bid or offer, which will be subject to the We do not believe that the locked and
were concerned about the costs to fee cap under adopted Rule 610(c) (for crossed provisions of Rule 610(d) will
market participants of administering a instance, by sending an intermarket impose significant additional costs for
fee program.813 The adopted provision, sweep order with a limit price equal to the SROs. All SROs currently have rules
by imposing a single accumulated fee the price of the protected quotation). By restricting locking and crossing
limitation of $0.003 (when the price of the time the order arrives at the trading quotations in exchange-listed stocks to
the protected quotation is $1 or more), center, the incoming order may, if a
greatly simplifies the fee limitation and comply with the provisions of the ITS
better bid or offer has been displayed at Plan. Such SROs also collect the data
likely will leave existing fee practices the trading center for a size smaller than
largely intact. For trading centers that and related information required to
the size of the incoming order, execute monitor locked and crossed markets,
currently charge and collect fees and against both the new best bid or offer
that will continue to do so, the costs of and the Commission believes that the
and the quotation that previously was additional surveillance and enforcement
imposing and collecting fees are already the trading center’s best bid or offer. To
incurred. The fee limitation does not costs related to the provisions will be
meet the requirements of Rule 610(c), minor. The Commission recognizes,
require trading centers that do not however, a trading center must ensure
currently charge fees to begin charging however, that Rule 610(d), by restricting
that it never charges a fee in excess of
fees. If market makers determine to locked markets with respect to
the cap for executions of an order
begin charging fees, they likely will automated quotations, could prohibit
against its quotations that are subject to
collect fees through an SRO trading the display of an order that would
the fee cap. The operation of this
facility or ECN through which they otherwise have been displayed and
limitation will be based on quotations as
display limit orders or quotations, and reduced the quoted spread to zero.
they are displayed in the consolidated
the administration of such fee program Although locked markets do occur a
quotation stream. Thus, the trading
likely will be handled by the SRO or certain percentage of the time, they do
center is responsible for ensuring that
ECN. Therefore, the adopted fee not occur all the time, even in extremely
any time lag between prices in its
limitation likely will not impose active stocks, and thus the average
internal systems and its quotations in
significant new administrative costs. effective spread in these stocks typically
the consolidated quotation system do
Two commenters expressed a concern is between one-half cent and one cent
not cause fees to be charged that violate
with the ability to determine after-the- (one cent being the minimum pricing
the limitation of Rule 610(c).
fact whether a quotation against which increment for all but a very few stocks).
Compliance with this requirement
an incoming order executed was subject Thus, the Commission believes that any
obviously will not be a problem for
to an access fee cap, given that under widening of average effective spreads
trading centers that do not charge any
the Rule a market participant could be caused solely by the adopted rule will
fees in excess of the cap. Given the often
charged different fees based on whether be limited to the difference between a
rapid updating of quotations in NMS
or not a quotation was protected.814 The sub-penny and penny spread. In
stocks, however, the Commission does
Commission acknowledges these addition, a locked market currently may
not believe a trading center that charges
concerns, but notes that market not actually represent two market
fees above the cap for quotations that
participants will be able to control the participants willing to buy and sell at
are not subject to the fee cap could
extent to which their orders interact the same price. Often the locking market
comply with the Rule unless it provides
with protected and non-protected participant is not truly willing to trade
a functionality that enables market
quotations. First, under the Order at the displayed locking price, but
participants to assure that they will
Protection Rule, the definition of instead chooses to lock rather than
never inadvertently be charged a fee in
intermarket sweep order requires market execute against the already-displayed
excess of the cap. For example, such a
participants to route orders to interact quotation to receive a liquidity
trading center could provide a ‘‘top-of-
only with protected quotations. The rebate.817
book only’’ or ‘‘limited-fee only’’ order
functionality. By using this 815 See
813 Brokerage America Letter at 1; NexTrade supra, note 423 and accompanying text.
functionality, market participants
Reproposal Letter at 8; Oppenheimer Letter at 2; 816 The Commission believes that the same
SIA Reproposal Letter at 22; STANY Letter at 11. themselves could assure that they were analysis would apply to the fee limitation on
814 Bloomberg Reproposal Letter at 8, note 6; SIA never required to pay a fee in excess of protected quotations priced less than $1.00.
Reproposal Letter at 22. the levels set forth in Rule 610(c). 817 See supra, notes 435 and 442.
Finally, reducing the fair access NASD’s Manning rule 820). Rule 612 of Rule 612.823 One commenter
thresholds of Regulation ATS will should increase market depth at the analyzed trading in six high-volume
require ATSs that exceed the 5% NBBO and help reduce quote flickering. securities and concluded that Rule 612
threshold level to comply with Rule In addition, the Commission agrees would have costs of over $400 million
301(b)(5) under Regulation ATS. Rule with the many commenters who in these securities alone due to wider
301(b)(5) requires ATSs, among other believed that prohibiting sub-penny spreads.824 Another commenter stated
things, to establish written standards for quoting would deter the practice of that, if all markets traded QQQQ solely
granting access to trading on its system, stepping ahead of exposed trading in sub-pennies, the savings would be
to not unreasonably prohibit or limit interest by an economically approximately $150 million per year.825
access to its services, to keep records of insignificant amount. Limit orders A third commenter argued that allowing
all grants or denials of access, and to provide liquidity to the market and sub-penny quoting in ‘‘23 of the most
report such information on Form ATS– perform an important price-setting appropriate securities’’ would generate
R. The Commission believes that the function. If a quotation or order can lose annual savings of anywhere between
costs to meet these requirements are execution priority because of $342 million and $1.9 billion.826 No
justified by the need to promote fair and economically insignificant price other commenters provided any
efficient access to trading centers with improvement from a later-arriving quantitative analysis of the costs that a
significant volume. quotation or order, liquidity could sub-penny quoting rule would impose
Overall, the Commission believes that diminish and some market participants by widening spreads to at least a full
the benefits of Rule 610 and the could incur greater execution costs. As penny.827
amendment to Rule 301 of Regulation The commenters who attempted to
one commenter, the Investment
ATS justify the costs of implementation. quantify the costs appear to assume that
Company Institute, stated, ‘‘[t]his
all trading activity in the securities they
C. Sub-Penny Rule potential for the increased stepping-
discuss would occur at narrower sub-
ahead of limit orders would create a
Rule 612 will prohibit market penny spreads if Rule 612 did not exist.
significant disincentive for market
participants from displaying, ranking, or The Commission does not believe that
participants to enter any sizeable
accepting quotations in NMS stocks that these commenters provided any
volume into the markets and would
are priced in an increment less than evidence to justify that assumption.
reduce further the value of displaying
$0.01 per share, except for quotations Currently, Nasdaq and the national
limit orders.’’ 821 Improved liquidity
priced less than $1.00 per share, which securities exchanges generally do not
should decrease the costs of trading, permit quoting in sub-pennies; this
may extend to four decimal places. especially for large orders.822 Market practice exists on only a small number
1. Benefits participants may be more likely to place of ATSs, and only for a small number
The Commission believes that the limit orders if they know that other of securities. Because spreads on
markets’ conversion to decimal pricing market participants cannot quote ahead Nasdaq and the exchanges already
has benefited investors by, among other of them by a sub-penny amount. cannot be smaller than $0.01, Rule 612
things, clarifying and simplifying 2. Costs will not require these markets to take
pricing for investors, making the U.S. any action that would cause spreads to
securities markets more competitive The Commission recognizes that Rule widen. Therefore, the lack of sub-penny
internationally, and reducing trading 612 will impose certain costs on the spreads on these markets should not be
costs by narrowing spreads. The U.S. securities markets. Currently, a few considered costs of Rule 612. With
Commission is concerned, however, that NMS stocks are quoted—and in the respect to the ATSs that currently do
if the MPV decreases beyond a certain absence of the rule, others in the future permit some NMS stocks to be quoted
point, some of the benefits of decimals could be quoted—in sub-penny in sub-pennies, Commission staff
could be lost while some of the negative increments. For these NMS stocks, performed a study to better assess and
effects would be exacerbated. The quoted spreads will be wider than they respond to commenters’ claims.828
Commission believes that Rule 612, otherwise would be, because Rule 612 Based on that study, Commission staff
which will prohibit an MPV of less than will prohibit market participants from estimated that the costs of widened
$0.01 for the vast majority of NMS narrowing the spread by a sub-penny spreads in these securities would be
stocks, will have several benefits. The amount. approximately $48 million annually (or
majority of the commenters supported A few commenters argued that
the proposal and noted various benefits investors would incur costs from 823 See Chakrabarty and Chung Study at 24
artificially widened spreads as a result (stating that, for high volume stocks, ‘‘the spread
of this approach.818 reduction in the absence of binding constraints
The Commission believes that sub- * * * translates into savings of millions of
penny quoting impedes transparency by 820 NASD IM–2110–2. dollars’’); INET Reproposal Letter at 3; Instinet
reducing market depth at the NBBO and 821 ICI
Letter at 20. Letter at 50; Mercatus Center Letter at 9; Tower
822 One commenter argued that a prohibition on Research Letter at 9.
increasing quote flickering. In an 824 Tower Research Letter at 9.
sub-penny quoting should not affect institutional
environment where the NBBO can investors’ trading costs because improvements in 825 Instinet Letter at 50.
change very quickly, broker-dealers trading technology (such as auto-execution and 826 INET Reproposal Letter at 3.
have more difficulty in carrying out VWAP trading algorithms) allow them to fill large 827 However, one commenter stated: ‘‘When
their duties of best execution and orders at minimal cost. See Tower Research Letter analyzed in terms of costs and benefits, we believe
at 9–10. While the Commission agrees that such that the costs of sub-penny quoting (i.e., less
complying with other regulatory improvements have been useful, it believes that this liquidity at quotes, more transactions required to
requirements that require them to commenter did not consider the costs involved in fill large orders, increased quote flickering, and
identify the best bid or offer available at having to develop these technologies in response, increased ability to displace orders through
a particular moment (such as the at least in part, to insufficient liquidity. Moreover, minimal price improvement) far exceed any
the Commission believes that this commenter also incremental benefits that market participants might
Commission’s short sale rule 819 and did not consider the positive externalities that limit enjoy through additional pricing conventions for
orders have on price discovery and price their limit orders.’’ Deutsche Bank Reproposal
818 See
supra, section IV.C.1. Letter at 3. This commenter did not provide
competition; orders that execute without being
819 Rule10a–1 under the Exchange Act, 17 CFR displayed do not contribute to price discovery and empirical evidence to justify that assertion.
240.10a–1. price competition. 828 See OEA December 2004 Sub-Penny Analysis.
approximately $33 million if the resulting from slightly wider spreads establishment of non-voting advisory
Commission were to exempt QQQQ would be $16 million (or only $1.2 committees comprised of interested
from Rule 612).829 million if QQQQ were excluded). parties other than SROs. In addition, the
In this study, Commission staff Similarly, Commission staff estimated Commission is rescinding the current
obtained public data from NYSE’s that the gross costs from wider spreads prohibition in Exchange Act Rule
‘‘Trade and Quote’’ files for all NYSE- would be approximately $12 million 11Aa3–1 (redesignated as Rule 601) on
listed and Amex-listed stocks, and annually for NYSE-listed stocks. SROs and their members from
public data from the Nastraq trade file Another potential cost of Rule 612 is independently distributing their own
for Nasdaq-listed stocks, for the period that market participants that have trade reports, and is adopting an
June 7–10, 2004. Based on trading developed systems allowing their users amendment to Exchange Act Rule
activity of the Nasdaq-listed securities, to quote in sub-pennies will, for most 11Ac1–2 (redesignated as Rule 603) to
Commission staff estimated that 1.5% of NMS stocks, lose the ability to gain any incorporate uniform standards pursuant
all trades executed at a per-share price market advantage from such to which they may independently
over $1.00 were reported in a sub-penny enhancements. In addition, any market
distribute their own trade reports and
increment.830 These trades accounted participant that currently allows its
quotations (outside of providing the
for 4.7% of share volume. However, not users to display, rank, or accept orders
requisite information to Plan
all trades that were reported as having or quotations in sub-pennies will incur
processors). The Commission is further
a sub-penny price resulted from a sub- costs in reprogramming its systems to
prevent the entry of sub-penny orders or amending Exchange Act Rule 11Ac1–2
penny quotation. Commission staff
quotations. The Commission believes, (redesignated as Rule 603) to make
excluded VWAP trades which were
however, that these costs are not explicit that all SROs must act jointly
marked as such in the Nastraq file.831
significant. Currently, only a few through the Plans and through a single
Based on this screened dataset,
ATSs—but not Nasdaq or any of the processor per security to disseminate
Commission staff estimated that 1.4% of
national securities exchanges—permit consolidated market information in
trades were reported in sub-penny
sub-penny quoting, and then only in a NMS stocks to the public. Finally, the
increments, accounting for 2.4% of
small number of securities. These ATSs Commission is adopting amendments to
share volume. Commission staff then
calculated the dollar cost if all such will have to make only minor Exchange Act Rule 11Ac1–2
trades executed at the near-side penny adjustments to their systems to comply (redesignated as Rule 603) to streamline
rather than at a sub-penny amount. This with Rule 612. One commenter, a and simplify the consolidated display
price difference, multiplied by the technology firm that develops software requirements by reducing the data
executed volume, produced a dollar cost and systems for electronic securities required to be displayed under the Rule,
per trade.832 Summed across all sub- trading, stated, ‘‘we do not believe that and by limiting the range of the Rule to
penny trades, the average daily cost in there are significant technological or the display of such data in trading and
this sample was $80,973. At 252 trading structural impediments to immediate order-routing contexts.
days per year, this resulted in an implementation’’ of Rule 612.833 No 1. Revenue Allocation Formula
estimate of $20,400,235 on an annual commenter indicated that the
basis. compliance costs of ATSs that currently a. Benefits
Commission staff performed a similar permit sub-penny quoting would be
significant. The Commission believes, and a
analysis on the trade data for Amex-
Finally, the Commission believes that number of commenters agreed, that the
listed stocks, except that the dataset did
paragraph (b) of Rule 612, which adopted amendment to the Plans
not permit VWAP trades to be excluded.
prohibits quotations below $1.00 per modifying the current formulas for
Commission staff estimated that, on an
share from extending beyond four allocating market data revenues will be
annualized basis, the gross costs
decimal places, will have negligible beneficial to the marketplace because
829 The Commission believes that INET overstated systems costs. The Commission the new formula will allocate revenues
the potential costs of Rule 612. INET’s methodology currently is not aware of any market that to SROs based on the value of their
for computing the potential savings to investors quotes and trades NMS stocks in quotations in addition to their trades.834
from quoting in sub-pennies appears to be based on The current formulas allocate Plan
the incorrect assumption that all of the stocks
increments beyond four decimal places
selected for their sample would trade with the same and believes, therefore, that no market revenues based solely on the number or
price-point distribution as the average of JDSU, will incur systems costs to limit such share volume of an SRO’s reported
SIRI, and QQQQ. quotations to a maximum of four trades, and do not allocate revenues to
830 Trades executed at a per-share price below
decimal places. those market centers that generate
$1.00 were excluded from the sample as Rule 612
will not prohibit sub-penny quotations priced less After carefully considering all the quotations with the best prices and the
than $1.00. comments received, the Commission largest sizes that are an important
831 Executions occurring at a sub-penny price believes that, on balance, the benefits of source of public price discovery. The
resulting from a midpoint, VWAP, or similar Rule 612 will justify the costs. new allocation formula also should help
volume-weighted pricing algorithm are not to reduce the economic and regulatory
prohibited by Rule 612. For purposes of this study, D. Market Data Rules and Plan
Commission staff excluded all other trades that had distortions caused by the current
Amendments
a condition code other than ‘‘regular way’’ (e.g., formulas, including wash sales, trade
trades reported after normal trading hours, bunched The Commission is adopting shredding, and SRO print facilities.
trades, next-day trades, previous reference price amendments to the rules relating to the
trades, and late trades).
Because the adopted formula will
832 For example, the cost to a sub-penny trade at
dissemination of market information to address these distortive practices and
price $25.248 for 300 shares is as follows. The the public. In particular, the would allocate revenues to those market
assumption is that, without sub-penny quotations, Commission is adopting amendments to centers that provide the most useful
this trade would have occurred at $25.25—a the Plans to modify the current formulas market information, the Commission
difference of $0.002 per share. At 300 shares, this for allocating market data revenues to
trade incurs a cost of $0.60 ($0.002 x 300). A sub-
penny trade at $25.242 would incur a cost of $0.002 the SROs, and to require the 834 See, e.g., Bloomberg Tradebook Letter at 7–8;
per share under the assumption that, under Rule BSE Reproposal Letter at 8; ICI Letter at 21; STA
612, it would execute at $25.24. 833 ATD Reproposal Letter at 4. Reproposal Letter I at 8; Vanguard Letter at 6.
believes that the NMS will be benefited such trades under the reproposed become familiar with those formulas for
as a whole. formula. The adopted formula also purposes of allocating revenues and
The adopted new revenue allocation includes this provision. The Trading structuring their businesses. Because the
formula will encompass a two-step Share measure is intended to allocate adopted allocation formula is more
process. The initial step of the adopted revenue to those SROs that actively detailed than the current formulas, the
formula, the ‘‘Security Income trade in the security, thereby providing Network processors will have to learn
Allocation,’’ allocates a Network’s liquidity and price discovery, while the particular features of the new
distributable revenues among the many reducing the potential for the shredding formula and will have to consider SRO
different securities that are included in of trade volume. quotations in addition to reported trades
the Network’s data stream primarily Under the ‘‘Quoting Share’’ criterion, as a measure for allocating Plan
based on the square root of the dollar fifty percent of the revenues allocated to revenues. Accordingly, the Network
volume of trading in each security. Of a particular security under the Security processors, or some other entity retained
those that commented on this aspect of Income Allocation measure will be by the Networks, will be required to
the formula, many generally agreed with allocated to an SRO based on the SRO’s develop a program to calculate the
the benefits of the Commission’s use of proportion of credits earned for each Security Income Allocation, Trading
square roots.835 Some commenters, second of time and dollar value of size Shares, and Quoting Shares of the SRO
however, believed that the use of the that the SRO’s automated best bid or participants. All of the data necessary
square root function overly rewards offer during regular trading hours equals for implementation of the formula will
illiquid stocks at the expense of liquid the price of the NBBO in that security. be disseminated through the
stocks.836 To address this concern, the The Quoting Share criterion of the consolidated data stream on a real-time
adopted formula modifies the square adopted formula is intended to do what basis. If a single entity were retained to
root allocation with respect to very the current formulas do not—allocate handle the task for all three Networks,
inactively traded stocks by limiting the revenue to those markets whose the Commission estimates that it will
revenues that can be allocated to a quotations frequently equal the best cost approximately $1 million annually
single Network security to an amount prices and for the largest sizes. Many to make the requisite calculations under
that is no greater than $4 per qualified commenters agreed with the the proposed new formula and to
transaction report.837 The amount that Commission that, if the Networks were disseminate the results to the SRO
exceeds this limitation will be to continue allocating revenues to the participants on a daily basis. This
reallocated among all Network SROs, the current allocation formulas estimated cost of implementation and
securities in direct proportion to their needed to be updated.839 In particular, compliance represents only 1⁄4 of one
dollar volume of trading. some of these commenters noted the percent of the total revenues collected
Following this initial distribution of benefits of adding a quoting component and distributed through the Plans for
revenues, the next step in the process is to the new formula,840 especially if 2004.
to allocate the revenues distributed to revenues are allocated only for The Commission received a number
an individual security among the automated and accessible quotations. of comments regarding the potential
various SROs that trade the security In sum, the Commission believes that cost and complexity of the originally
based on each SRO’s trading and the greatest benefit of allocating Plan proposed revenue allocation formula.841
quoting activity. Specifically, under the revenues to the SROs based equally on The Commission notes that, consistent
‘‘Trading Share’’ criterion, fifty percent the Trading Share and Quoting Share with the approach of the Order
of the revenues allocated to a particular measures is that such measures will Protection Rule and the Access Rule, it
security will be allocated to SROs based allocate revenues to an SRO for its eliminated in the reproposed formula
on their proportion of the total dollar overall contribution of both quotations the most complex elements of the
volume and number of qualified trades and trades, while reducing the incentive proposed allocation formula that were
(transactions that have a dollar volume for distortive trade reporting practices intended primarily to address the
of $5,000 or greater) in that security. A caused by the current formulas. problem of manual quotations—the
few commenters on the original Investors will benefit from the adopted ‘‘NBBO Improvement Share’’ criterion
proposal stated that small trades new formula because these broad-based and the automatic cut-off for manual
(transactions that have a dollar value of measures will allocate revenues to those quotations left at the NBBO under the
less than $5000) should be entitled to SROs that provide investors with the Quoting Share criterion. The adopted
partial credit under this criterion most useful market information, and amendment also eliminates these two
because these trades also contribute to thus that contribute to public price elements. Because the adopted formula
public price discovery.838 The discovery, by allocating them a larger will allocate revenues for only
Commission acknowledged the benefits portion of Plan revenues. automated quotations, and manual
of small trades and provided for a b. Costs quotations will be excluded from any
proportional allocation of revenues for revenue allocation, the Commission
The Commission recognizes that the believes that an NBBO Improvement
835 Amex Letter, Exhibit A at 15; Nasdaq Letter II
current allocation formulas have been Share criterion and automatic cut-off for
at 32; NYSE Reproposal Letter II at 3; Specialist
used since the creation of the Plans and manual quotations are not necessary in
Assoc. Letter at 16, note 21. Networks in the 1970s, and that the the new formula. As a result, the
836 See, e.g., ArcaEx Reproposal Letter at 11; SROs and the Network processors have adopted formula is substantially less
CBOE Letter at 11; Instinet Reproposal Letter at 13. complex than originally proposed.
837 The limit of $4 per qualified transaction report 839 See, e.g., Bloomberg Tradebook Letter at 7;
is analogous to the reproposal’s limit on Trading
Some commenters argued that it
BSE Letter at 15; Deutsche Bank Reproposal Letter
Shares to $2 per qualified transaction report. at 4; Harris Reproposal Letter at 11; ICI Letter at 21;
would be overly costly and complex to
Whereas the reproposed limit of $2 applied to the JP Morgan Reproposal Letter at 2; NYSE Reproposal calculate the other elements of the
50% Trading Share allocation (described below), Letter II at 3; STA Letter at 7; UBS Letter at 10;
the adopted limit of $4 applies to the 100% Vanguard Letter at 6. 841 See, e.g., Angel Letter I at 11; BSE Letter at 15,
Security Income Allocation. See supra section 840 See, e.g., Bloomberg Tradebook Letter at 7–8; 18; Brut Letter at 22–23; Callcott Letter at 4; CBOE
V.A.3. Morgan Stanley Letter at 22–23; NYSE Reproposal Letter at 2, 9; Instinet Letter at 42; ISE Letter at 9;
838 See, e.g., BSE Letter at 16; CHX Letter at 19– Letter II at 3; STA Letter at 7; Vanguard Letter at Nasdaq Letter II at 31; NSX Letter at 7; NYSE Letter,
20; E*Trade Letter at 11–12. 6. Attachment at 11; Phlx Letter at 3–4.
proposed formula.842 The Commission formula clarifies that a quotation must flow.850 The Commission recognizes
does not agree. An SRO’s Trading Share, be displayed by the Network processor that reforming formulas that have
for example, will not be materially more for a minimum of one full second of remained unchanged for many years
difficult to calculate than the current time before it is entitled to earn any may affect the competitive position of
Network C formula, which is based on quote credits.847 Second, the adopted various markets. Given the severe
an average of an SRO’s proportion of formula clarifies that, consistent with deficiencies of these formulas, however,
trades and share volume. The Security the approach of the Order Protection it does not believe that the interests of
Income Allocation uses the square root Rule, each SRO participant in a Network any particular business model should
function which is a simple arithmetic is entitled to earn quote credits only for preclude updating the formulas to
calculation. In addition, some the SRO’s best bid and best offer.848 By reflect current market conditions. The
commenters believed that the Quoting limiting the number of separate adopted formula is designed to reflect
Share, which incorporates the total quotations that are entitled to earn quote more appropriately the contributions of
dollar size of the NBBO in a stock credits, the adopted formula both the various SROs to the consolidated
throughout the trading year, would reduces the ability of market data stream and thereby better align the
result in astronomically high numbers participants to ‘‘shred’’ their quotes interests of individual markets with the
that would be extremely difficult to among many different markets and interests of investors. Moreover, by
calculate.843 In fact, the largest number promotes equal regulation of exchange representing a much more broad-based
of quote credits in a year for even the SROs, Nasdaq, and the NASD. Third, measure of an SRO’s contribution to the
highest price stock with the greatest the adopted formula modifies the consolidated data stream, the adopted
displayed depth at the NBBO is very language of the reproposed formula to formula will be less subject to any
unlikely to reach beyond the trillions, a clarify that a quotation cannot earn particular type of gaming and distortion
number well within the capabilities of Quote Credits while it locks or crosses than the narrowly-focused current Plan
even the most basic spreadsheet a previously displayed automated formulas.851 The Commission therefore
program.844 Moreover, the allocation is quotation. This limitation is needed to believes that the benefits of the adopted
determined by the proportion of an remove any potential financial incentive new allocation formula justify the costs
SRO’s quote credits in relation to other for abusive quoting behavior that would of implementation.
SROs, not the absolute amount of quote be contrary to the purposes of the
credits. 2. Plan Governance
provisions on locking and crossing
Some commenters were concerned quotations set forth in the Access Rule. a. Benefits
that the inclusion of quotations in the Fourth, the formula limits the revenues
proposed new allocation formula could The Commission believes that the
that can be allocated to a single Network adopted amendment to the Plans
lead new types of ‘‘gaming’’ of the security to an amount that is no greater
formula, such as flashing quotations requiring the creation of Plan advisory
than $4 per qualified transaction report, committees will improve Plan
with no real intention to trade at those in order to achieve an appropriately
prices simply to earn more quote governance. Most commenters generally
balanced allocation among Network supported the adopted amendment to
credits—and thereby more revenues— stocks by allowing room for a significant
under the Quoting Share measure.845 the Plans, generally believing that
increase in the amounts currently expanding the participation of non-
Commenters also were concerned that allocated for many less active stocks,
such practices would increase quotation SROs parties in Plan governance would
while also preventing unjustifiably high be a constructive step.852 Under the
traffic and bandwidth costs, but with
allocations for the most extremely Plans, a representative of each SRO
little or no benefit for the quality of the
inactive stocks that might create an participating in the Plan is a member of
consolidated data stream.846 Because
inappropriate incentive for abusive the operating committee that governs
the Commission recognizes that abusive
quoting behavior. that Plan. The adopted amendment to
quoting behavior is a legitimate concern,
the adopted formula incorporates a In addition, the Commission the Plans will require the establishment
number of modifications to minimize recognizes that some SROs are likely to of non-voting advisory committees
the potential for abusive or costly be allocated a smaller portion of Plan
quoting behavior. First, the adopted revenues under the new allocation 850 See, e.g., BSE Letter at 16; CHX Letter at 19,
formula than they would have received 21–22; E*Trade Letter at 11. The adopted formula
under the prior formulas, while other will provide a partial allocation of revenues for
842 See, e.g., Brut Letter at 22–23; CBOE Letter at
smaller trades that have a dollar value of less than
2, 9; NSX Letter at 7. SROs will receive a larger portion of $5000. This provision should lessen impact of the
843 See, e.g., CBOE Letter at 14 (calculation of revenues. This will result if certain formula on exchanges that handle small retail
Quote Credits will ‘‘yield astronomical numbers’’ SROs are currently reporting a large orders.
that ‘‘can be expressed only in exponential terms’’); 851 Two commenters on the reproposal suggested
NSX Letter at 7 (calculation of large number of
number of trades or share volume of
adopting an allocation formula based solely on the
Quote Credits is ‘‘particularly ludicrous’’). trades, but are not necessarily providing dollar volume of trading. ArcaEx Reproposal Letter
844 For example, assume a stock with an average the best quotations or trades with larger at 13; Nasdaq Reproposal Letter at 14. Dollar
price of $100 per share has an unusually large sizes. A few commenters expressed volume alone, however, is not a broad-based
average quoted size of 200,000 shares at both the concern that certain business models measure and would miss important aspects of an
national best bid and the national best offer SRO’s contribution to the public data stream. It
throughout every second of the trading year. Over would be adversely impacted by the would, for example, allocate a disproportionately
an average 252 trading days during a year, the total proposed new allocation formula,849 large amount to block trades. Block trades often are
Quote Credits in this stock would be 235.9 trillion particularly for those markets that internalized by securities dealers at prices based, at
($100*400,000*252*23,400 seconds per trading primarily handle small retail order least partly, on current public quotations. A formula
day). Quote Credits are only calculated for based solely on dollar volume would not
individual Network stocks and are not totaled adequately allocate revenues to the source of
across all Network stocks. 847 Seesupra, section V.A.3.b. quotations relied on in pricing block trades.
845 See, e.g., ArcaEx Reproposal Letter at 13; CHX 848 Seesupra, section V.A.3.b. 852 See, e.g., Amex Letter at 10; Citigroup Letter
Letter at 19; Instinet Reproposal Letter at 14; SIA 849 See, e.g., Brut Letter at 22; CHX Reproposal at 17; Financial Information Forum Letter at 4;
Reproposal Letter at 30. Letter at 5; CHX Letter at 19, 21–22; NSX Letter at Financial Services Roundtable Letter at 6–7; ICI
846 See, e.g., Financial Information Forum 6–7. See also BSE Reproposal Letter at 2, 3, 8 Letter at 4 and 21 n. 35; Nasdaq Letter II at 33;
Reproposal Letter at 4; Nasdaq Reproposal Letter at (suggesting a pilot approval process to address any Reuters Letter at 3; SIIA/FISD Reproposal Letter at
13; SIA Reproposal Letter at 30. unintended consequences on individual markets). 2.
comprised solely of persons not stating that too many members on an more data products, and/or lower costs,
employed by or affiliated with an SRO advisory committee could complicate thus benefiting market participants.856
participant. This adopted amendment is and disrupt, rather than assist, Plan In addition, one commenter agreed with
intended to broaden participation in the operations due to differing party the Commission that market centers
governance of the Plans. agendas.853 Although such a result may would benefit from additional revenues
The adopted amendment will require occur at times, the Commission believes and stated that the prospect of
the SRO participants to select the that this cost would be justified by the additional revenues would encourage
members of the advisory committee benefits that can be gained by increasing markets to provide better markets.857
comprised, at a minimum, of one or the transparency of Plan operations and Adopted Rule 603(a) establishes
more representatives associated with: giving parties other than SROs an uniform standards for distribution of
(1) A broker-dealer with a substantial opportunity to submit their views. In both quotations and trades. The
retail investor base; (2) a broker-dealer the past, the Plans may not have standards require an exclusive
with a substantial institutional investor adequately considered the viewpoints of processor, or a broker or dealer with
customer base; (3) an ATS; (4) a data non-SRO parties on important issues respect to information for which it is the
vendor; and (5) an investor. In addition, such as fees and administrative burdens. exclusive source, that distributes
each SRO participant will be entitled to Establishing advisory committees will quotation and transaction information
select an additional committee member. address this problem and thereby in an NMS stock to a securities
The Commission believes that the potentially make the Plans more information processor (‘‘SIP’’) to do so
composition of the advisory committee responsive to the needs of market on terms that are fair and reasonable. In
will give interested parties other than participants and investors. addition, those SROs, brokers, or dealers
the SROs a voice in matters that affect that distribute such information to a
them. 3. Amendments to Rules 11Aa3–1 and SIP, broker, dealer, or other persons are
The members of the advisory 11Ac1–2 (Redesignated as Rules 601 required to do so on terms that are not
committee will have the right to submit and 603) unreasonably discriminatory.
their views to the operating committee a. Independent Distribution of Furthermore, these uniform standards
on Plan business (other than matters Information are based, in part, on similar
determined to be confidential by a requirements found in Sections 3 and
i. Benefits
majority of Plan participants), prior to 11A of the Exchange Act 858 for SROs
any decision made by the operating The Commission is adopting as and entities that distribute SRO
committee, and will have the right to proposed the amendment to Rule information on an exclusive basis. The
attend operating committee meetings. 11Aa3–1 (redesignated as Rule 601), Commission believes that extending
Broader participation in the Plans which rescinds the prohibition on SROs these requirements to non-SRO market
through the creation of Plan advisory and their members from disseminating centers, including ATSs and market
committees will be beneficial to the their trade reports independently.854 makers, will help assure equal
administration of the Plans because it Under adopted Rule 601, members of an regulation of all markets that trade NMS
will provide transparency to the Plan SRO will continue to be required to stocks.
governance process and can promote the transmit their trades to the SRO (and
formation of industry consensus on SROs will continue to transmit trades to ii. Costs
disputed issues. the Networks pursuant to the Plans), but The Commission recognizes that the
such members also will be free to rescission of the prohibition on
b. Costs distribute their own data independently, independent distribution of trade
The adopted amendment to the Plans with or without fees. The Commission reports under adopted Rule 601 may
requiring the formation of advisory believes that independently distributed potentially lead to market centers
committees can potentially result in information can be beneficial to incurring costs associated with the
costs to the SRO participants who will investors and other information users independent distribution of their market
be required to engage in a selection because depth-of-book quotations have data if they choose to distribute such
process for purposes of establishing become increasingly important as data without charging a fee. In addition,
such committees. A Plan’s operating decimal trading has spread displayed investors may have to pay for additional
committee as a whole will be required depth across a greater number of price data if market centers choose to charge
to select a minimum of five committee points. Similarly, commenters that a fee for the additional data.
members, while each SRO participant discussed this aspect of the proposal Furthermore, a corollary to one
will also have the right to select an generally agreed that the proposal commenter’s assertion that market
additional committee member. This would benefit investors and vendors by centers could benefit from additional
selection process can potentially result giving them greater freedom to make revenues if market centers choose to
in added costs and administrative their own decisions regarding the data distribute their own quotation
burden and expense to the SRO they need.855 Other commenters information,859 is that the data from one
participants. believed that the proposal would lead to or more other market centers can
The adopted Plan amendment also increased competition, the provision of potentially become more or less
can potentially disrupt the current valuable than another market center’s
governance of the Plans by their 853 See, e.g., Amex Letter, Exhibit A at 21–22; data, and thereby increase or reduce that
participants. Since the creation of the Reuters Letter at 3. market center’s overall income. The
854 Regulation NMS removed the definitions in
Plans, representatives from the SROs Commission does not believe that there
paragraph (a) of Exchange Act Rule 11Aa3–1
have been the sole participants in the (redesignated as Rule 601) and placed them in Rule
will be any costs associated with
Plans and have been responsible for 600. Subparagraphs (c)(2) and (c)(3) of Exchange
856 See, e.g., Brut Letter at 23; Financial Services
their administration. A few commenters Act Rule 11Aa3–1 are being rescinded. As a result,
subparagraph (c)(4) of Exchange Act Rule 11Aa3– Roundtable Letter at 6; Nasdaq Reproposal Letter at
believed that the additional 15–16.
1 is redesignated as subparagraph (b)(2) of Rule 601.
participation of non-SRO parties could 855 See, e.g., CBOE Letter at 17; Financial 857 Specialist Assoc. Letter at 16–17.
potentially increase the difficulty of Information Forum Letter at 3–4; Reuters Letter at 858 15 U.S.C. 78c and 15 U.S.C. 78k–1.
reaching a consensus on Plan business, 3. 859 Specialist Assoc. Letter at 16–17.
establishment of uniform standards for montage of quotations from all market order-routing purposes and in what
the distribution of trades and quotations centers trading a particular security, circumstances they are displaying such
pursuant to adopted Rule 603(a). The which would include the price of information for other purposes. The
Commission did not receive any quotations that may be far away from Commission believes that such a cost
comments on this issue. the current NBBO. Furthermore, will be minimal.
vendors and broker-dealers will have E. Regulation NMS
b. Consolidation of Information
the ability to decide what, if any,
i. Benefits additional data from other market The Commission is redesignating the
centers beyond this basic disclosure to current NMS rules adopted under
All SROs currently participate in
display. Vendors, broker-dealers, and Section 11A of the Exchange Act 861 as
Plans that provide for the dissemination
investors will benefit from this reduced Regulation NMS, making non-
of consolidated information for the NMS
consolidated display requirement substantive conforming changes to
stocks that they trade. Adopted Rule
through a more efficient use of system various rules, and creating a separate
603(b) confirms by Exchange Act rule
capacity and because the costs of definitional rule, Rule 600, which will
that both existing and any new SROs
obtaining necessary data may be contain all of the defined terms used in
will be required to continue to
lowered. The Commission believes that Regulation NMS. Currently, each NMS
participate in joint-industry plans to
giving investors the ability to choose rule includes its own set of definitions,
disseminate consolidated information in and some identical terms, such as
NMS stocks to the public. Adopted Rule (and pay for) only the data they need
and use will be beneficial. ‘‘covered security,’’ ‘‘reported security,’’
603 provides the benefit of clarifying and ‘‘subject security,’’ are defined
that all SROs—whether existing or Rule 603(c) narrows the contexts in
which a consolidated display is inconsistently. Although Rule 600
new—will be required to participate retains, unchanged, most of the
jointly in one or more Plans to required to those when it is most
needed—a context in which a trading or definitions used in the existing NMS
disseminate consolidated information in rules, it deletes or revises obsolete
NMS stocks. Adopted Rule 603 also order-routing decision could be
implemented. For example, the definitions and eliminates the use of
requires that all quotation and trade inconsistent definitions for identical
information for an individual NMS consolidated display requirement will
continue to cover broker-dealers who terms. Rule 600 does not alter the
stock be disseminated through a single requirements or operation of the
processor (currently, SIAC or Nasdaq). provide on-line data to their customers
in software programs from which existing NMS rules.
The Commission believes that requiring
a single processor for a particular trading decisions can be implemented. 1. Benefits
security will help to ensure that Similarly, the requirement will continue
The Commission believes that Rule
investors continue to receive the to apply to vendors who provide
600 and the related amendments to
benefits of obtaining consolidated displays that facilitate order routing by
various Commission rules will benefit
information from a single source. broker-dealers. It will not apply,
all entities that are and will be subject
however, when market data is provided
ii. Costs to the requirements of the rules
on a purely informational website that
contained in Regulation NMS, including
Given that consolidated market does not offer any trading or order-
brokers, dealers, national securities
information currently is disseminated routing capability. Rule 603(c) also
exchanges, the NASD, ECNs, SIPS, and
through a single processor per stock, the simplifies the rule language to require
vendors. By eliminating or revising
Commission does not foresee any new that consolidated data be made available
obsolete and inconsistent definitions
costs associated with adopted Rule in an equivalent manner as other data
and adopting a single set of definitions
603(b). and rescinds unnecessary provisions in
that will be used throughout Regulation
order to update the Rule.860 We expect
c. Display of Consolidated Information NMS, Rule 600 should make Regulation
Rule 603(c) to benefit broker-dealers and NMS clearer and easier to understand,
i. Benefits vendors by making compliance with the thereby facilitating compliance with the
The Commission is adopting as adopted Rule’s more tailored Rules’ requirements and potentially
proposed the amendment to Rule requirements easier and more efficient. easing the compliance burden on
11Ac1–2 (redesignated as Rule 603(c)) ii. Costs entities subject to Regulation NMS.
that substantially revises the Increased compliance with Regulation
consolidated display requirement by A potential cost attributable to Rule
NMS will, in turn, benefit investors and
limiting its scope. It incorporates a new 603(c) is that there currently may be
the public interest. Similarly, the related
definition of ‘‘consolidated display’’ (set individuals who use the displayed
non-substantive amendments to various
forth in adopted Rule 600(b)(13)) that is montage of quotations from all market
Commission rules will ensure that those
limited to the prices, sizes, and market centers trading a particular security. If
rules use the definitions provided in
center identifications of the NBBO and vendors and broker-dealers determined
Rule 600 and refer accurately to the
the ‘‘consolidated last sale information.’’ not to display this additional
redesignated NMS rules.
Beyond disclosure of this basic information, these investors would be
information, market forces, rather than required to obtain the additional data at 2. Costs
regulatory requirements, will be allowed additional cost. Rule 603(c) also may Rule 600 will update and clarify the
to determine what, if any, additional potentially result in an administrative definitions used in existing NMS rules.
data from other market centers is cost or burden for vendors and broker- Neither Rule 600 nor the related
displayed. In particular, investors and dealers that will be required to assess in conforming amendments to various
other information users ultimately will what circumstances they are displaying rules will alter the existing requirements
be able to decide whether they need market data information for trading and of the NMS rules or other Commission
additional information in their displays. 860 The provisions being rescinded include
rules. Accordingly, the Commission
As amended, Rule 603(c) also requirements relating to moving tickers, categories believes that Rule 600 and the related
eliminates the burden on vendors and of market information, and representative bids and
broker-dealers to display a complete offers. 861 15 U.S.C. 78k–1.
amendments will impose few additional Commission also believes that the Order orders routed to that trading center.
costs on entities subject to Regulation Protection Rule, by providing Because likelihood of execution is very
NMS. Although some additional intermarket price protection for important to limit orders, routers of
personnel costs may be incurred in accessible, automated orders (but not limit orders likely will be attracted to
reviewing the changes, the Commission requiring automated markets to wait for this preferred trading center. More limit
believes that these costs will be responses from non-automated markets), orders will enhance the depth and
minimal. will help promote efficiency in the liquidity offered by the preferred trading
markets by more effectively linking center, thereby increasing its
X. Consideration of Burden on
markets together and integrating trading attractiveness for marketable orders, and
Competition, and Promotion of
centers with different market structures beginning the cycle over again. In
Efficiency, Competition, and Capital
into the NMS, and by providing an addition, Rule 611 will not require that
Formation
incentive for non-automated markets to limit orders be routed to any particular
Section 3(f) of the Exchange Act 862 automate. Rule 611 also will promote market. Consequently, the Commission
requires the Commission, when investor confidence in the markets by believes that competitive forces will be
engaging in rulemaking that requires the helping to assure, on an order-by-order fully operative to discipline markets
Commission to consider or determine basis, that customer orders are executed that offer poor services to limit orders,
whether an action is necessary or at the best price available and providing such as limiting the extent to which
appropriate in the public interest, to protection against limit orders being limit orders can be cancelled in
consider whether the action will bypassed by inferior priced executions. changing market conditions or
promote efficiency, competition and In particular, the Commission believes providing slow speed of cancellation.
capital formation. Section 23(a)(2) that the providing enhanced protection Conversely, trading centers that offer
prohibits the Commission from adopting for the best bids and offers of each poor services, such as slow response
any rule that would impose a burden on exchange, The NASDAQ Stock Market, times, will likely rank near the bottom
competition not necessary or and the ADF will represent a major step in order-routing preferences of market
appropriate in furtherance of the toward achieving the objectives of participants and intermediaries.
purposes of the Exchange Act.863 To intermarket price protection. The Order Whenever a least-preferred trading
assist the Commission in evaluating the Protection Rule thus will promote best center is merely posting the same price
costs and benefits of Regulation NMS, execution for retail investors on an as other trading centers, orders will be
the Commission solicited comment in order-by-order basis, given that most routed to the other trading centers.
the Proposing Release and the retail investors justifiably expect that Competitive forces will continue to
Reproposing Release on whether any of their orders will be executed at the dictate that the lowest ranked trading
the proposals discussed therein would NBBO. center in order-routing preference will
have an adverse effect on competition The Commission believes that Rule suffer from offering a poor range of
that was neither necessary nor 611 will promote intermarket services to the routers of marketable
appropriate in furtherance of the competition by leveling the playing orders. The Commission therefore does
purposes of the Exchange Act, and field between automated and non- not believe that Rule 611 will eliminate
whether they would promote efficiency, automated markets and, to the extent competition among markets.
competition and capital formation. The that the existing trade-through rule Commenters have, however,
Commission also requested commenters serves to constrain competition, by identified a troubling potential for
to provide empirical data and other removing this barrier to competition. intermarket price protection to lessen
factual support for their views on these The Commission recognizes the vital the competitive discipline that market
subjects. The Commission has importance of preserving competition participants now can impose on
considered comments received and has among market centers,865 but continues inefficient trading centers.866 The Order
adopted the rules as discussed above, to believe that commenters have Protection Rule generally requires that
taking into account these comments. overstated the risk that such trading centers match the best quoted
A. Order Protection Rule competition will be eliminated by prices, cancel orders without an
adoption of an order protection rule execution, or route orders to the trading
The Commission agrees with centers quoting the best prices. This is
commenters that supported the without an opt-out exception. The
Commission believes that markets likely good for investors generally, but may
Reproposed Rule 864 that the price not be if the quoting market is
will have strong incentives to compete
protection that will be provided by the inefficient. For example, a market center
and innovate to attract both marketable
Order Protection Rule will encourage may have poor systems that do not
orders and limit orders. Market
greater use of limit orders, which will process orders quickly and reliably. Or
participants and intermediaries
help improve the price discovery a low-volume market may not be nearly
responsible for routing marketable
process, and contribute to increased as accessible as a high-volume market.
orders, consistent with their desire to
liquidity and depth in the markets. The Currently, consistent with their best
achieve the best price and their duty of
more limit orders available at better execution and other agency
best execution, will continue to rank
prices and greater size, the more responsibilities, participants in the
trading centers according to the total
liquidity available to fill incoming market for Nasdaq stocks can choose not
range of services provided by such
marketable orders. Greater depth and to deal with any trading center that they
markets. The most competitive trading
liquidity will, at a minimum, lower the believe provides unsatisfactory services.
center will be the first choice for routing
search costs associated with trying to Under the Order Protection Rule, market
marketable orders, thereby enhancing
find liquidity and should lead to participants can limit their involvement
the likelihood of execution for limit
improved execution quality, particularly with any trading center to routing IOC
for larger-sized institutional orders. The 865 Many commenters believed that an opt-out orders to access only the best bid or best
exception would be necessary to promote
862 15 U.S.C. 78c(f). competition among trading centers, particularly 866 See, e.g., Fidelity Reproposal Letter at 2; MFA
863 15 U.S.C. 78w(a)(2). competition based on factors other than price, such Reproposal Letter at 2; Morgan Stanley Reproposal
864 See supra, section II.A.1. as speed of response. See supra, section II.A.4.a. Letter at 2; TIAA–CREF Reproposal Letter at 2.
offer of the trading center. Nevertheless, addition, industry regulators typically through private linkages; (2) establish an
even this limited involvement have greater flexibility to address outer limit on the cost of accessing such
potentially could lessen the competitive problems than governmental authorities. quotations of no more than $0.003 per
discipline that otherwise will be Implementation of the Order Protection share; and (3) require SROs to establish,
imposed on an inefficient trading Rule will heighten the importance of maintain, and enforce rules that, among
center. The Commission therefore effective self-regulation. Those other things, prohibit their members
believes that this potentially serious responsible for the market operation from engaging in a pattern or practice of
effect must be addressed at multiple functions of an SRO may have business displaying quotations that lock or cross
levels in addition to the specific incentives that militate against dealing the automated quotations of other
exceptions included in the Rule that with potential problems in an effective
trading centers. The amendment to Rule
were discussed above. and forthright manner. Regulatory
301(b)(5) under Regulation ATS lowers
First, trading centers themselves have personnel are expected to be
independent of such business concerns the threshold that triggers the
a legal obligation to meet their
responsibilities under the Exchange Act and have an affirmative responsibility to Regulation ATS fair access requirements
to provide venues for trading that is prevent improper factors from from 20% to 5% of average daily
orderly and efficient.867 Through interfering with an SRO’s full volume in a security.
registration and other requirements, the compliance with regulatory The access provisions are intended to
Exchange Act regulatory regime is requirements. bolster investor confidence in the
designed to preclude entities that are Finally, the Commission itself plays a markets by helping to assure investors
not capable of meeting high standards of critical role in the Exchange Act that their orders will be executed at the
conduct from doing business with the regulatory regime. Effective best prices and will not subject to
public. This critically important implementation of the Order Protection hidden fees, regardless of the market on
function will be undermined by a Rule also will depend on the which the execution takes place. By
trading center that displayed quotations Commission taking any action that is
generally imposing a uniform fee
in the consolidated data stream, but necessary and appropriate to address
limitation of $0.003 per share, the Rule
could not, because of poor systems or problem trading centers that fail to meet
fully their regulatory requirements. The will promote equal regulation of
otherwise, provide efficient access to different types of trading centers, where
market participants and efficient Commission and its staff must continue
to monitor the markets closely for signs currently some are permitted to charge
handling of their orders. In addition, a fees and some are not, thereby leveling
trading center will violate its Exchange of problems and listen to the concerns
of market participants as they arise, the playing field among diverse market
Act responsibilities if it failed to comply
especially with regard to the new centers. Moreover, the Commission
fully with the requirements set forth in
requirements imposed by the Order believes that, by prohibiting a trading
Rule 600(b)(3) and (4) for automated
Protection Rule. Quick and effective center from imposing unfairly
quotations and automated trading
action will be needed to assure that all discriminatory terms that would prevent
centers. In particular, an automated
trading center must implement such responsible parties do not feel that or inhibit the efficient access of any
systems, procedures, and rules as are inattention to problems is an acceptable person through members, subscribers, or
necessary to render it capable of course of action. customers of such trading center, the
meeting the requirements for automated The Commission therefore believes Rule will promote competition among
that Rule 611 will not impose any trading centers.
quotations and must immediately
competitive burden that is not necessary
identify its quotations as manual The Commission believes that Rule
and appropriate in furtherance of the
whenever it has reason to believe that it 610 also will increase transparency and
purposes of the Exchange Act. The
is not capable of displaying automated efficiency in the market, thereby
Commission believes that the Order
quotations. These requirements place an enhancing investor confidence, and thus
Protection Rule will help create an NMS
affirmative and vitally important legal capital formation. Specifically, the Rule
that more fully meets the needs of a
duty on trading centers to identify their will permit private linkages between
wide spectrum of investors, particularly
quotations as manual at the first sign of markets, rather than mandating a
long-term investors and publicly traded
a problem, not after a problem has fully collective intermarket linkage facility.
companies, by providing increased
manifested itself and thereby caused a Private linkages will permit market
efficiency and improved depth and
rippling effect at other trading centers centers to connect through cost effective
liquidity to our capital markets. By
that damages investors and the public and technologically advanced
providing increased efficiency and
interest. communications networks. Such
promoting investor confidence in
Second, those responsible for the systems are widely utilized in the
quality executions, investors may be
regulatory function at SROs have an
more willing to invest in our capital market for Nasdaq-listed stocks today
affirmative responsibility to examine for
markets, thus promoting the ability of and likely will provide speed and
and enforce all Exchange Act
listed companies to raise capital at flexibility to trading centers and their
requirements and the SRO rules that
lower cost. market participants. The use of private
apply to the trading centers that fall
within their regulatory authority. One of B. Access Rule linkages can encourage interaction
the key policy justifications for a self- between the markets and reduce
Rule 610 establishes standards fragmentation by removing
regulatory system is that industry governing access to quotations in NMS
regulators will have close proximity to, impediments to the execution of orders
stocks that: (1) Prohibit trading centers between and among marketplaces,
and significant expertise concerning, from unfairly discriminating against
their particular trading centers. In thereby increasing efficiency and
non-members members or non- competition.
867 See, e.g., Exchange Act Sections 6(b)(1) and
subscribers that attempt to access their
quotations through a member or Several commenters expressed
6(b)(5); Exchange Act Section 15; Exchange Act
Sections 15A(b)(2) and 15A(b)(6); Exchange Act subscriber of the trading center, and concerns regarding the impact that the
Section 11A(a)(1)(C); Regulation ATS. enable access to NMS quotations access fee proposal could have on
competition.868 As discussed in detail The $0.003 cap will limit the outlier any competitive burden that is not
in Section III above, the Commission business model. It will place all markets necessary and appropriate in
believes that the flat limitation on on a level playing field in terms of the furtherance of the purposes of the
access fees of $0.003 per share is the fees they can charge and the rebates Exchange Act.
fairest and most appropriate solution to they can pass on to liquidity providers.
C. Sub-Penny Rule
what has been a longstanding and Some markets may choose to charge
contentious issue. A single accumulated lower fees, thereby increasing their The Commission has considered Rule
fee cap will apply equally to all types ranking in the preferences of order 612 in light of Sections 3(f) and 23(a)(2)
of trading centers and all types of routers. Others may charge the full of the Exchange Act and believes that
market participants, thereby promoting $0.003 and rebate a substantial the Rule will not impose a burden on
the NMS objective of equal regulation of proportion to liquidity providers. competition not necessary or
markets and broker-dealers, and Competition will determine which appropriate in furtherance of the
allowing those entities to compete on strategy is most successful. purposes of the Exchange Act. To the
equal footing.869 The Commission notes that the $0.003 contrary, by preserving the benefits of
A fee limitation also is necessary to fee limitation is consistent with current decimalization and guarding against the
preclude individual trading centers business practices, as very few trading less desirable effects of further reducing
from raising their fees substantially in centers currently charge fees that exceed the MPV, Rule 612 should promote fair
an attempt to take improper advantage this amount.871 It appears that only two and vigorous competition. The
of strengthened protection against trade- ECNs currently charges fees that exceed Commission acknowledges that the rule
throughs and the adoption of a private $0.003, charging $0.005 for access will, in some circumstances, prevent
linkage regime. In particular, the fee through the ADF. These ECNs currently market participants from offering
limitation is necessary to address do not account for a large percentage of marginally better prices (through
‘‘outlier’’ trading centers that otherwise trading volume. In addition, while a few quoting or placing orders in sub-
might charge high fees to other market SROs have large fees on their books for pennies). Some commenters argued that
participants required to access their transactions in ETFs that exceed a a prohibition on quoting in sub-pennies,
quotations by the Order Protection Rule. certain size (e.g., 2100 shares), it is at least in some NMS stocks, would
It also precludes a trading center from unlikely that these fees generate a large inhibit price competition and artificially
charging high fees selectively to amount of revenues. Accordingly, the widen spreads.872 Nevertheless, the
competitors, practices that have adopted fee limitation will not impair Commission is concerned that sub-
occurred in the market for Nasdaq the agency market business model. The penny quoting may be used by market
stocks. In the absence of a fee limitation, Commission recognizes that agency participants more as a means of
the adoption of the Order Protection trading centers perform valuable agency stepping ahead of competing limit
Rule and private linkages could services in bringing buyers and sellers orders for an economically insignificant
significantly boost the viability of the together, and that their business model amount than of promoting genuine price
outlier business model. Outlier markets historically has relied, at least in part, competition.
on charging fees for execution of orders The Commission believes that Rule
might well try to take advantage of
against their displayed quotations. 612 will assist broker-dealers in
intermarket price protection by acting
Under current conditions, prohibiting evaluating and complying with their
essentially as a toll booth between price
access fees entirely would unduly harm best execution obligations and other
levels. The high fee market likely would
this business model. rules premised on identifying the price
be the last market to which orders
In addition, the Rule is designed to of a security at a particular moment in
would be routed, but prices could not
reduce the instances of locked and time. The Commission also believes that
move to the next level until someone crossed quotations, which will promote Rule 612 will enhance market depth and
routed an order to take out the capital formation by providing market improve transparency by preventing
displayed price at the outlier market. participants a clear picture of the true trading interest from being spread across
Therefore, the outlier market might see trading interest in a stock. Moreover, the an unnecessarily large number of price
little downside to charging Commission believes that the access points. Therefore, we believe Rule 612
exceptionally high fees, such as $0.009, provisions will encourage interaction will encourage market participants to
even if it is last in priority. While between the markets and reduce use limit orders, an important source of
markets would have significant fragmentation by removing liquidity, and thereby promote market
incentives to compete to be near the top impediments to the execution of orders efficiency, competition, and capital
in order-routing priority,870 there might between and among marketplaces, formation. The Commission also
be little incentive to avoid being the thereby increasing efficiency and believes that the new Rule will bolster
least-preferred market if fees were not competition. Finally, the Commission investor confidence by helping ensure
limited. believes that the access provisions likely that their orders, especially large orders,
will assist broker-dealers in evaluating can be executed without incurring large
868 See, e.g., Amex Letter, Exhibit A at 23–24;
and complying with their best execution transaction costs. This increase in
ArcaEx Reproposal Letter at 10; BGI Reproposal
Letter at 3; Bloomberg Summary of Intended obligations. The Commission therefore investor confidence also will promote
Testimony at 3; BrokerageAmerica Letter at 1; Brut believes that Rule 610 will not impose market efficiency, competition, and
Letter at 14; CHX Letter at 15; Domestic Securities capital formation.
Summary of Intended Testimony; Instinet 871 Cf. Instinet Letter at 35 (‘‘there is no basis for
Reproposal Letter at 10; NexTrade Reproposal Rule 612 will establish common
adopting any limitation other than at the prevailing
Letter at 7–8; Phlx Reproposal Letter at 4 (stating $0.003 per share level, which was arrived at
quoting conventions that will increase
its belief that the proposal is not justified under through open competition among ATSs, ECNs, and transparency in the securities markets.
Section 23(a)(2) of the Exchange Act); TrackECN SRO markets in the Nasdaq market’’) and Instinet Moreover, the Commission believes that
Letter at 3. Reproposal Letter at 11 (‘‘as for an appropriate
869 Section 11A(c)(1)(F) of the Exchange Act, 15
the Rule will encourage interaction
amount for such an accumulated fee limitation, the
U.S.C. 78k-1(c)(1)(F). Reproposal sets the cap at the prevailing $0.003 per between the markets and reduce
870 See supra, section II.A.4.a (discussion of share level for stocks priced above $1.00, which
competitive implications of trade-through was arrived at through open competition among 872 See, e.g., Instinet Letter at 47; Mercatus Center
protection). marketplaces’’). Letter at 9–10; Tower Research Letter at 8–11.
fragmentation by removing not required to receive (and pay for) revenues based on the quality of an
impediments to the execution of orders such data. The Commission also SROs contribution of quotations and
between and among markets. The believes that efficiency is promoted trades to the consolidated data stream.
increased transparency in the markets when broker-dealers may choose to The Commission also believes that the
and reduction of fragmentation between receive (and pay for) additional market adopted Plan amendment requiring the
the markets will bolster investor data based on their own internal Plans to form non-voting advisory
confidence, thereby promoting capital analysis of the need for such data. committees will enhance and promote
formation. Adopted Rule 603(b) also likely will competition by broadening Plan
promote efficiency in the dissemination governance to include non-SRO parties,
D. Market Data Rules and Plan of consolidated market information by
Amendments and thereby provide greater
requiring that all SROs act jointly transparency in the administration of
The Commission believes that the through the Plans to disseminate such such Plans. Furthermore, we expect
adopted Plan amendment updating the information to the public. adopted Rules 601 and 603 to lessen the
current revenue allocation formulas will The Commission believes that the
burden on vendors and broker-dealers
promote efficiency in the marketplace adopted Plan amendments will assist in
from having to comply with certain
by eliminating incentives for market capital formation through a more
consolidated display requirements. A
participants to engage in distortive appropriate allocation of the Networks’
revenues to those SROs that contribute few commenters generally noted that
trading practices such as wash trades, allowing market centers to
trade shredding, and SRO print facilities most to public price discovery. Rule
603(c) also will eliminate the independently disseminate certain
to obtain market data revenues.
requirement to display a complete market data information could increase
Similarly, commenters supported the
montage of quotations from all market competition among markets.878 The
need to update the current allocation
centers and will therefore promote Commission agrees that the competition
formulas.873 In addition, the
capital formation by reducing the costs among market centers will be enhanced
Commission believes, and several
commenters concurred, that the adopted to vendors and broker-dealers that are when such markets also choose to
Plan amendment requiring the creation currently required to display quotations independently distribute their own
of non-voting advisory committees will that may be far away from the NBBO. market data. In addition, the
promote efficiency in the administration One commenter stated that broker- amendment providing that all SROs
of the Plans by allowing interested dealers currently are discouraged from consolidate information in each NMS
parties other than SROs to have a voice making quotation and price information stock and disseminate such information
in Plan matters,874 which can, in turn, on a stock available because, under the through a single processor per security
contribute to the resolution of potential current rule, this information must be will clarify that SROs are on an equal
disputes that SRO participants will accompanied by consolidated competitive footing with each other.
otherwise bring before the Commission. information for which they must pay Thus, the Commission believes that the
Furthermore, we expect Rule 603(a) will market data fees.876 Accordingly, the amendments will enhance rather than
promote efficiency and competition Commission believes that, in certain burden competition by creating a more
among market centers by helping to circumstances, Rule 603(c) will result in equal competitive environment for
assure that independently reported additional market data information market centers and others.
trade and quotation information is being provided, which will assist capital
formation. E. Regulation NMS
distributed on terms that are fair and
reasonable and not unreasonably The Commission further believes that
the adopted amendments to the Plans Rule 600, the redesignation of the
discriminatory. Commenters that existing NMS rules as Regulation NMS,
and to Rules 601 and 603 will not
discussed this Rule generally agreed and the related conforming changes to
impose any competitive burden that is
that adopted Rule 603(a) would allow other Commission rules will help to
not necessary and appropriate in
investors and vendors greater freedom promote efficiency and capital
furtherance of the purposes of the
to make their own decisions regarding formation by making the NMS rules
Exchange Act. One regional exchange
the data they need and that the proposal easier to understand, thereby helping to
urged the Commission to consider the
should lead to lower costs to reduce compliance costs for entities
impact of the formula on competition,
investors.875 The Commission agrees subject to the rules. Enhanced clarity in
because, according to this commenter,
with these commenters and notes that the definitions used in Regulation NMS
most regional market centers rely on
efficiency is promoted when broker- also will benefit investors and the
market data revenues to fund a
dealers who do not need the data public interest by facilitating
significant portion of their budgets and
beyond the prices, sizes, market center compliance with the requirements of
thus a material decrease in such
identifications of the NBBO and Regulation NMS. Because Rule 600 will
revenues could affect their financial
consolidated last sale information are clarify the existing definitions used in
plans, making it infeasible to compete
873 See, e.g., BGI Reproposal Letter at 3; Citigroup
with listing markets, which can survive Regulation NMS without imposing new
Reproposal Letter at 9; Deutsche Bank Reproposal on listing revenues.877 Although any requirements, and because the
Letter at 4; Harris Reproposal Letter at 11; JP change to the current formulas may redesignation of the NMS rules as
Morgan Reproposal Letter at 2; STA Letter at 7; UBS result in a competitive advantage for Regulation NMS and the conforming
Letter at 10; Vanguard Letter at 6. changes to other Commission rules will
874 See, e.g., Financial Services Roundtable Letter
some SROs and in a competitive
at 7; Reuters Letter at 3; SIIA/FISD Reproposal disadvantage for other SROs, the create no new substantive requirements,
Letter at 2. Commission does not believe that this Rule 600 and the related changes will
875 See, e.g., Brut Letter at 23; Financial Services should preclude the adoption of an not impose a burden on competition or
Roundtable Letter at 6; Nasdaq Reproposal Letter at allocation formula that would provide a alter the competitive standing of entities
16. In addition, two commenters believed that the subject to Regulation NMS.
proposal would reduce some regulatory burdens
more useful distribution of market data
imposed on market participants. Financial
876 Reuters Letter at 2–3.
Information Forum Reproposal Letter at 4–5; 878 See, e.g., Amex Letter at 10; Specialist Assoc.
Instinet Reproposal Letter at 16. 877 CHX Reproposal Letter at 5. Letter at 16–17; see also Brut Letter at 23.
XI. Regulatory Flexibility Act the Exchange Act and minimize the transactions in the consolidated data
economic impact on small entities.885 stream.887
A. Order Protection Rule As noted above in Section III.A.1,
Small ATSs are exempt from
The Commission certified, pursuant however, the NASD is not statutorily
to Section 605(b) of the Regulatory participation in the consolidated
required to provide an order execution
Flexibility Act, that the Order Protection quotation system and, therefore, from
functionality in the ADF. The
Rule will not have a significant the connectivity requirements of Rule Commission believes that market
economic impact on a substantial 610. Under Rule 301(b)(3) of Regulation makers and ECNs should continue to
number of small entities.879 This ATS, an ATS is required to display its have the option of operating in the OTC
certification was incorporated into the quotations in the consolidated quotation market, rather than on an exchange or
Reproposing Release.880 The stream only in those securities for The NASDAQ Market Center. As noted
Commission did not receive any which its trading volume reaches 5% of in the Commission’s order approving
comments on this certification. total trading volume. Consequently, Nasdaq’s SuperMontage trading facility,
smaller ATSs are not required to this ability to operate in the ADF is an
B. Access Rule
provide their quotations to any SRO important competitive alternative to
The Commission certified, pursuant (whether an SRO trading facility or the Nasdaq or exchange affiliation.888
to Section 605(b) of the Regulatory NASD’s ADF) and thereby trigger the Therefore, the Commission has
Flexibility Act, that Rule 610 and the access requirements of Rule 610. determined not to require small trading
amendments to Rule 301 of Regulation Moreover, potential new entrants with centers to make their quotations
ATS will not have a significant innovative trading mechanisms can accessible through an SRO trading
economic impact on a substantial commence business without having to facility.
number of small entities.881 This incur any costs associated with Instead, Rule 610(b)(1) requires all
certification was incorporated into the trading centers that choose to display
participation in the consolidated
Reproposing Release.882 The quotations in an SRO display-only
quotation system.
Commission received one comment quotation facility (currently, the ADF) to
discussing the certification. The Some smaller ATSs, however, may provide a level and cost of access to
commenter, an ADF participant, wish to participate voluntarily in the such quotations that is substantially
believed that the Commission in the consolidated quotation system. Such equivalent to the level and cost of access
certification recognized that Rule 610 participation can benefit smaller firms to quotations displayed by SRO trading
could result in a significant economic and promote competition among facilities. Rule 610(b)(1) therefore may
impact on small firms, just not a markets by enabling smaller firms to cause trading centers that display
substantial number of small firms.883 obtain wide distribution of their quotations in the ADF to incur
This commenter continued to express quotations among all market additional costs to enhance the level of
its concerns with the proposed access participants.886 Here, too, such firms access to their quotations and to lower
requirements, stating its belief that the will have alternatives that would not the cost of connectivity for market
proposal to require ADF participants to obligate them to comply with the participants seeking to access their
establish the necessary connectivity that connectivity requirements of Rule quotations. The extent to which these
would facilitate efficient access to their 610(b)(1). ATSs and market makers that trading centers in fact incur additional
quotations would create a cost barrier wish to trade NMS stocks can choose costs to comply with the adopted access
that discriminates against smaller firms from a number of options for quoting standard will be largely within the
in the ADF.884 and trading. They can become a member control of the trading center itself. As
The Commission does not believe that noted above, ATSs and market makers
of a national securities exchange and
its adopted access approach in Rule that wish to trade NMS stocks can
quote and trade through the exchange’s
610(b)(1) discriminates against smaller choose from a number of options for
firms or creates a barrier to access for trading facilities. They can participate
in The NASDAQ Market Center and quoting and trading, including quoting
innovative new market entrants. Rather, and trading in the OTC market. As a
smaller firms and new entrants have a quote and trade through that facility. By
choosing either of these options, an ATS result, the additional connectivity
range of alternatives from which to requirements of Rule 610(b) will be
choose that will allow them to avoid or market maker would not create a new
connectivity point that all other market triggered only by a trading center that
incurring any costs to meet the displays its quotations in the
connectivity requirements of Rule participants must reach and would not
be subject to Rule 610(b)(1). Some firms, consolidated data stream and chooses
610(b)(1) if they wish to do so. This not to provide access to those quotations
approach is fully consistent with however, may not want to participate in
through an SRO trading facility.
Congressional policy set forth in the an SRO trading facility. These ATSs and
Currently, nine SROs operate trading
Regulatory Flexibility Act, which market makers can quote and trade in facilities in NMS stocks. Market
directs the Commission to consider the OTC market. The existence of the participants throughout the securities
significant alternatives to regulations NASD’s ADF makes this third choice industry generally have established
that accomplish the stated objectives of possible by providing a facility for connectivity to these nine points of
displaying quotations and reporting access to quotations in NMS stocks. By
879 5 U.S.C. 605(b).
880 Reproposing
choosing to display quotations in the
Release, 69 FR at 77492. 885 5 U.S.C. 603(c). The adopted access approach
881 5 U.S.C. 605(b). ADF, a trading center effectively could
provides alternatives that will benefit a wider range
882 Reproposing Release, 69 FR at 77493.
of smaller ATSs than the two that are considered require the entire industry to establish
883 In the Reproposing Release, the Commission small entities. See supra note 385.
noted that only two of the approximately 600 886 See supra, note 566 (the Commission’s 887 Under Rule 301(b)(3) of Regulation ATS, 17
broker-dealers (including ATSs) that would be Advisory Committee on Market Information CFR 242.301(b)(3), an ATS is required to display its
subject to the Rule are considered small for recommended retention of the consolidated display quotations in the consolidated data stream only in
purposes of the Regulatory Flexibility Act. See requirement because, among other things, it ‘‘may those securities for which its trading volume
Section XII.B of the Reproposing Release, 69 FR at promote market competition by assuring that reaches 5% of total trading volume.
77493. information from newer or smaller exchanges is 888 See Securities Exchange Act Release No.
884 NexTrade Reproposal Letter at 4–6. widely distributed.’’). 43863 (Jan. 19, 2001), 66 FR 8020 (Jan. 26, 2001).
connectivity to an additional point of allowed to take advantage of the greatly displaying an order, quotation, or
access. Potentially, many trading centers expanded connectivity options that indication of interest in an NMS stock
could choose to display quotations in have been offered by competing access priced in a sub-penny increment (except
the ADF, thereby significantly service providers in recent years.891 for an order, quotation, or indication of
increasing the overall costs of These industry access providers have interest priced less than $1.00 per share,
connectivity in the NMS. Such an extensive connections to a wide array of in which case the price may not extend
inefficient outcome would become market participants through a variety of beyond four decimal places). The rule is
much more likely if an ADF trading direct access options and private designed to improve market depth by
center were not required to assume networks. A trading center potentially preventing quotations from spreading
responsibility for the additional costs could meet the requirement of Rule across an unduly large number of price
associated with its decision to display 610(b)(1) by establishing connections to points, while also encouraging the use
quotations outside of an established and offering access through such of limit orders—an important source of
SRO trading facility. vendors. The option of participation in liquidity—by preventing competing
Although the Exchange Act envisions existing market infrastructure and market participants from stepping ahead
an individual broker-dealer having the systems should reduce a trading center’s of a limit order by an economically
option of trading in the OTC market,889 cost of compliance.892 insignificant amount. We expect the
it does not mandate that the securities Section 3(a) of the Regulatory rule to reduce the instances of quote
industry in general must subsidize the Flexibility Act 893 requires the flickering and to facilitate broker-
costs of accessing a broker-dealer’s Commission to undertake an Initial dealers’ efforts to meet their best
quotations in the OTC market if the Regulatory Flexibility Analysis of execution and other regulatory duties
NASD chooses not to provide proposed rules on small entities unless premised on identifying a security’s
connectivity. The Commission believes the Commission certifies that the prevailing market price.
that it is reasonable and appropriate to proposed rules, if adopted, would not 2. Significant Issues Raised by Public
require those ATSs and market makers have a significant economic impact on Comment
that choose to display quotations in the a substantial number of small entities.
ADF to bear the responsibility of The Commission continues to believe The IRFA appeared in the Proposing
providing a level and cost of access to that the Access Rule will not have a Release and in the Reproposing
their quotations that is substantially significant economic impact on a Release.895 The Commission requested
equivalent to the level and cost of access substantial number of small entities. comment in the IRFA on the impact the
proposals would have on small entities
to quotations displayed by SRO trading
C. Sub-Penny Rule and how to quantify the impact. The
facilities. Under Rule 610(b)(1),
This Final Regulatory Flexibility Act Commission did not receive any
therefore, ADF participants will be
Analysis (‘‘FRFA’’) relating to Rule 612 comment letters addressing the IRFA.
required to bear the costs of the
necessary connectivity to facilitate of Regulation NMS has been prepared in 3. Small Entities Subject to the Rule
efficient access to their quotations.890 accordance with the Regulatory Rule 612 applies to every national
This standard will help ensure that Flexibility Act.894 securities exchange, national securities
additional connectivity burdens are not 1. Need for and Objective of Rule 612 association, ATS, vendor, and broker-
imposed on the securities industry each dealer. Each type of market participant
time an additional ADF participant Although the conversion from
that will be affected by the new Rule
necessitates a new connectivity point by fractional to decimal trading benefited
612 is discussed below.
choosing to begin displaying quotations investors by clarifying and simplifying
in the consolidated quotation stream. prices, making our markets more a. National Securities Exchanges and
The Commission believes that this competitive internationally, and National Securities Associations
requirement will help reduce overall reducing trading costs by narrowing Rule 0–10(e) under the Exchange
industry costs by more closely aligning spreads, these benefits could be diluted Act 896 provides that the term ‘‘small
the burden of additional connectivity if market participants could quote NMS business’’ or ‘‘small organization,’’
with those entities whose choices have stocks in increments less than a penny. when referring to an exchange, means
created the need for additional The Commission is particularly any exchange that: (1) Has been
connectivity. concerned that sub-penny orders may be exempted from the reporting
As just discussed, the Commission used to step ahead of competing limit requirements of Rule 601 under the
recognizes that trading centers subject to orders for an economically insignificant Exchange Act; and (2) is not affiliated
Rule 610(b)(1) may incur costs amount. with any person (other than a natural
associated with providing access to their New Rule 612 prohibits an exchange, person) that is not a small business or
quotations, although the costs will vary association, vendor, ATS, or broker- small organization, as defined by Rule
depending upon the manner in which dealer from accepting, ranking, or 0–10. No national securities exchange
each trading center provides such meets these criteria; therefore, no
891 As noted in the Commission’s order approving
access. The Commission notes that to national securities exchange is a small
the pilot program for the ADF, the reduction in
meet the standard contained in Rule communications line costs in recent years and the
entity. Currently, there is one national
610(b)(1), a trading center will be advent of competing access providers offer the securities association (NASD) that is
potential for multiple competitive means of access subject to Rule 612. NASD is not a small
889 See Sections 11A(c)(3)(A) and (4) of the to the various trading centers that trade NMS entity as defined by 13 CFR 121.201.
Exchange Act, 15 U.S.C 78k–1(c)(3)(A) and (4). stocks. Securities Exchange Act Release No. 46249,
890 Thus, although market participants may still supra note 390. b. Broker-Dealers
892 As the self-regulatory authority responsible for
be required to access numerous trading centers in Commission rules generally define a
the ADF, the Rule should reduce the cost of access the OTC market, the NASD must act as
to each such trading center by requiring the ADF ‘‘gatekeeper’’ for the ADF, and, as such, will need broker-dealer as a small entity for
trading center to provide a cost and level of access to closely assess the extent to which ADF
substantially equivalent to the level and cost of participants meet the requirements of Rule 610. 895 Proposing Release, 69 FR at 11174–75;
893 5 U.S.C. 603(a). Reproposing Release, 69 FR 77493–94.
access to quotations displayed by SRO trading
facilities. 894 5 U.S.C. 604. 896 17 CFR 240.0–10(e).
purposes of the Exchange Act and the 5. Agency Action To Minimize Effect on consolidation—which provide
Regulatory Flexibility Act if the broker- Small Entities important benefits to investors and to
dealer had total capital (net worth plus Rule 612 establishes a uniform pricing others who use market information, but
subordinated liabilities) of less than increment for NMS stocks. All entities amends other parts of the existing rules
$500,000 on the date in the prior fiscal subject to the rule generally are that have resulted in serious economic
year as of which its audited financial prohibited from displaying, ranking, or and regulatory distortions. More
statements were prepared, and the accepting an order, quotation, or specifically, adopted Rules 601 and 603
broker-dealer is not affiliated with any indication of interest priced in a sub- reduce the burden on, and provide
person (other than a natural person) that penny increment. Imposing different simplification and uniformity for, those
is not a small entity.897 The Commission compliance requirements for small market centers, broker-dealers, and data
estimates that, as of the end of 2003, entities would be impractical and vendors that have to comply with
there were approximately 6,565 undermine the goal of uniformity. requirements under the Rules.
Commission-registered broker- Furthermore, the Commission does not Adopted Rules 601 and 603 are
dealers,898 of which approximately 905 believe it necessary or appropriate to designed to fulfill several objectives,
are considered small entities pursuant consider whether small entities should including: (1) Providing market centers,
to Rule 0–10(c) under the Exchange be permitted to use performance rather including ATSs and market makers,
than design standards to comply with with flexibility to independently
Act.899
Rule 612. The rule already establishes distribute their own trade reports, aside
c. Vendors performance standards and does not from their obligation to provide their
dictate any particular design standard trade reports and best quotations to an
A vendor is any securities information that must be employed to achieve the SRO or to the Networks (depending on
processor engaged in the business of rule’s objectives. the type of market center); (2) providing
disseminating transaction reports or last uniform standards for all market
D. Market Data Rules and Plan
sale data with respect to transactions in centers, including non-SRO market
Amendments
reported securities to brokers, dealers, centers and entities that are exclusive
or investors on a real-time or other 1. Regulatory Flexibility Act processors of SRO market data, for the
current and continuing basis, whether Certification for the Plan Amendments independent distribution of market data;
through an ECN, moving ticker, or The Commission certified, pursuant (3) providing that all SROs act jointly
interrogation device.900 Rule 0–10(g) 901 to Section 605(b) of the Regulatory through the Plans and disseminate their
provides that the term ‘‘small business’’ Flexibility Act, that amending the Plans consolidated information through a
or ‘‘small organization,’’ when referring to: (1) Modify the current formulas for single processor, to clarify the practice
to a securities information processor, allocating market data revenues, and; (2) among the SROs and to require
means any securities information require the establishment of non-voting continued participation in the Plans and
processor that: (1) Had gross revenues of advisory committees will not have a dissemination through one processor
less than $10 million during the significant economic impact on a per security; (4) reducing consolidated
preceding fiscal year (or in the time it substantial number of small entities.902 display requirements on broker-dealers
has been in business, if shorter); (2) This certification was incorporated into and vendors and limiting their
the Proposing Release and Reproposing consolidated display obligations to the
provided service to fewer than 100
Release.903 The Commission did not disclosure of the NBBO and
interrogation devices or moving tickers
receive any comments on this consolidated last sale information and
at all times during the preceding fiscal
certification. to the display of market information in
year (or in the time that it has been in a trading or order-routing context; and
business, if shorter); and (3) is not 2. Final Regulatory Flexibility Analysis (5) easing the burden of compliance by
affiliated with any person (other than a for Amendments to Rules 11Aa3–1 and simplifying the current consolidated
natural person) that is not a small 11Ac1–2 (Redesignated as Rules 601
display requirements under the Rule
business or small organization under and 603)
and by rescinding old provisions in the
this section. The Commission estimates This FRFA has been prepared in Rule that are outdated and no longer
that there are approximately 80 vendors, accordance with the Regulatory necessary.
16 of which are considered small Flexibility Act.904 This FRFA relates to
entities. Exchange Act Rules 11Aa3–1 and b. Significant Issues Raised by Public
11Ac1–2 (redesignated as Rules 601 and Comment
4. Reporting, Recordkeeping, and Other 603).
Compliance Requirements The IRFA appeared in the Proposing
a. Need for and Objectives of Rules 601 Release and in the Reproposing
Rule 612 will not impose any new and 603 Release.905 The Commission requested
reporting, recordkeeping, or other comment in the IRFA on the impact the
The Commission believes that an
compliance requirements on any proposals would have on small entities
overall modernization of the rules for
entities subject to the rule, including and how to quantify the impact. The
disseminating market data to the public
small entities. Commission did not receive any
is necessary to address problems posed
comment letters addressing the IRFA.
by the current market data rules. In
897 See 17 CFR 240.0–10(c). adopting Rules 601 and 603 as c. Small Entities Subject to the Rule
898 This number reflects the number of FOCUS reproposed, the Commission retains the
filings. ATSs that are not registered as exchanges
core elements of the existing rules— Adopted Rules 601 and 603 affect
are required to register as broker-dealers. ATSs, market makers, broker-dealers,
Accordingly, an ATS would be considered a small price discovery and mandatory
entity if it fell within the definition of ‘‘small
and SIPs that could potentially be small
entity’’ as it applies to broker-dealers. 902 5
U.S.C. 605(b). entities. Paragraph (c) of Rule 0–10
899 17 CFR 240.0–10(c). 903 Proposing
Release, 69 FR at 11190–91;
900 See 17 CFR 11Aa3–1(a)(11). Reproposing Release, 69 FR at 77495–96. 905 Proposing Release, 69 FR at 11190–91;
901 17 CFR 240.0–10(g). 904 5 U.S.C. 604. Reproposing Release, 69 FR 77495–96.
under the Exchange Act 906 defines the d. Reporting, Recordkeeping and Other The Commission believes that
term ‘‘small business’’ or ‘‘small Compliance Requirements different compliance or reporting
organization,’’ when referring to a Adopted Rules 601 and 603 do not requirements for small entities, and
broker-dealer, to mean a broker or dealer impose any new reporting, further clarification, consolidation, or
that had total capital of less than recordkeeping or other compliance simplification of Rules 601 and 603, is
$500,000 on the date in the prior fiscal not necessary because adopted Rules
requirements on ATSs, market makers,
year as of which its audited financial 601 and 603 do not establish any new
broker-dealers, and SIPs that are small
statements were prepared, or, if not reporting, recordkeeping or other
entities. SROs that would be subject to
required to file such statements, that compliance requirements for small
these proposed amendments are not
entities and, in fact, adopted Rule 603
had total capital of less than $500,000 considered small entities.909
should reduce the compliance burden
on the last business day of the preceding
e. Agency Action To Minimize Effects on small broker-dealers and SIPs by
fiscal year; and is not affiliated with any limiting the data required to be
on Small Entities
person (other than a natural person) that consolidated and displayed under the
is not a small business or small As required by the Regulatory
Flexibility Act, the Commission has Rule. The Commission also notes that
organization. ATSs and market makers the amendments contain performance
would be considered broker-dealers for considered alternatives that would
standards and do not dictate for entities
purposes of this definition. Paragraph accomplish the stated objective, while
of any size any particular design
(g) of Rule 0–10 907 defines the term minimizing any significant adverse
standards (e.g., technology) that must be
‘‘small business’’ or ‘‘small impact on small entities. As discussed
employed to achieve the objectives of
in the Proposing Release and in the
organization,’’ when referring to a SIP, the adopted amendments.
Reproposing Release, the Commission
to mean a SIP that had gross revenues
has considered the following alternative E. Regulation NMS
of less than $10 million during the
models for disseminating market data to The Commission certified, pursuant
preceding fiscal year and provided the public: (1) A competing
service to fewer than 100 interrogation to Section 605(b) of the Regulatory
consolidators model under which each Flexibility Act, that Rule 600 and the
devices or moving tickers at all times SRO would be allowed to sell its market
during the preceding fiscal year; and is redesignation of the NMS rules as
data separately to any number of Regulation NMS will not have a
not affiliated with any person (other consolidators; (2) a rescission of the significant economic impact on a
than a natural person) that is not a small consolidated display requirement and substantial number of small entities.910
business or small organization. allowing all SROs and other market This certification was incorporated into
In the IRFA included in the centers to distribute their market data the Reproposing Release.911 The
Reproposing Release, the Commission individually; and (3) a hybrid model Commission did not receive any
estimated that, as of December 31, 2003, that would retain the consolidated comments on this certification.
there were approximately 905 registered display requirement and existing
Networks solely for the dissemination of XII. Response to Dissent
broker-dealers, including ATSs and
market makers that would be considered the NBBO, but allow the SROs to The Commission has added this
small entities. In addition, distribute their own quotations and section to its release to respond directly
approximately 16 SIPs would be trades independently and without a to the dissent’s claims that the
consolidated display requirement. Commission’s ‘‘statutory interpretations
considered small entities. In the
The primary goal of the adopted and policy changes are arbitrary,
Proposing Release and in the unreasonable and anticompetitive’’ and
amendments to Rules 11Aa3–1 and
Reproposing Release, the Commission that they are ‘‘not supported by
11Ac1–2 (redesignated as Rules 601 and
requested comment on the number of 603) is to retain the benefits of the substantial evidence that,
small entities that would be impacted consolidated display requirement, notwithstanding their anti-competitive
by adopted Rules 601 and 603, which provides a uniform, consolidated effect, they are necessary or appropriate
including any available empirical data. stream of data and is the single most to further the purposes of the Exchange
No commenters responded with cost important tool for unifying all of the Act.’’ 912 Previous sections of this
estimates pertaining to the requested market centers trading NMS Stocks, release discuss in greater detail the basis
data listed above. Adopted Rule 601 while providing market centers that of the Commission’s decision to adopt
enables small market centers, including contribute to consolidated information Regulation NMS. By modernizing and
ATSs and market makers, that with the ability to independently strengthening the regulatory structure of
contribute to consolidated information, distribute their own market data and the U.S. equity markets, Regulation
if they so choose, to also independently reducing the consolidated display NMS will protect investors, promote fair
distribute their own trade reports. requirements on broker-dealers and competition, and enhance market
Adopted Rule 603 reduces the SIPs. As stated in the Proposing Release efficiency. Because the dissent appears
compliance burden on small broker- and in the Reproposing Release and in to have misconstrued a number of the
dealers and SIPs by limiting the data Section V.A.1 above, the Commission Commission’s policy positions and the
required to be displayed under the believes that these potential alternative reasoning underlying them, we are
models pose an unacceptable risk of including this section to clarify the
Rule.908
losing important benefits that investors record.
and other information users receive We understand that reasonable minds
906 17 CFR 240.0–10(c).
under the current system—an affordable can disagree with the policy decisions
907 17 CFR 240.0–10(g).
and highly reliable stream of quotations reflected in Regulation NMS. In light of
908 Adopted Rule 603, providing that all SROs act
jointly through the Plans and disseminate their

and trades that is consolidated from all 910 5U.S.C. 605(b).
consolidated information through a single significant market centers trading an 911 Reproposing Release, 69 FR at 77496.
processor, would only apply to the SROs, which are NMS Stock. 912 Dissent of Commissioners Cynthia A.
not ‘‘small entities’’ for purposes of the Regulatory Glassman and Paul S. Atkins to the Adoption of
Flexibility Act. 909 See supra, section XI.C.3.a. Regulation NMS (‘‘Dissent’’), Introduction.
the substantial record, however, the commenters, particularly those that legislative history, however, makes it
Commission rejects any assertion that disagree with the proposals. However, clear that the Order Protection Rule is
this rulemaking is arbitrary, decisions must be made and contentious squarely consistent with the policy
unreasonable, anticompetitive, or issues must be resolved so that the determinations made by Congress in
otherwise outside the agency’s markets can move forward with 1975—indeed, it may be the dissent’s
authority. In making this claim, the certainty concerning their future disagreement with those Congressional
dissent appears to ignore the clear regulatory environment and policy determinations that explains its
statutory authority for the Commission’s appropriately respond to fundamental opposition to the Order Protection Rule.
action, the many public comments economic and competitive forces. The In particular, the national market system
strongly supporting the adoption of Commission always seeks to achieve a is premised on promoting fair
Regulation NMS, and the extensive and consensus, but when positions have competition among individual markets,
comprehensive rulemaking process become entrenched after many years of while at the same time assuring that
undertaken by the Commission. As study and debate, waiting for consensus these markets are linked together in a
discussed below, the drafters of the can mean indefinite gridlock that unified system that promotes
Exchange Act itself repeatedly affirmed ultimately could damage the competition among the orders of buyers
the basic principles that underlie competitiveness of the U.S. equity and sellers in individual NMS stocks.
Regulation NMS. In particular, they markets, both at home and The most succinct statement of order
specifically contemplated and endorsed internationally. The Commission competition is found in the House
the Commission’s authority to adopt an believes that further delay is not Report on the 1975 Amendments:
intermarket price protection rule.913 In warranted and that the time has come to ‘‘Investors must be assured that they are
addition, the comments supporting make the difficult decisions necessary to participants in a system which
Regulation NMS were submitted by a modernize and strengthen the national maximizes the opportunities for the
broad spectrum of investors, listed market system. most willing seller to meet the most
companies, academics, market centers, A. Statutory Authority for Order willing buyer.’’ 918 This Congressional
and other market participants, many of Protection Rule mandate for the national market system
which have extensive experience and is not achieved when trades occur at
expertise regarding the inner workings The dissent suggests that the prices inferior to the best quotations that
of the equity markets.914 Commission is exceeding its authority are immediately and automatically
Moreover, Regulation NMS is the by attempting to impose an ‘‘optimal accessible.
culmination of a long and open process market structure.’’ 915 This claim The dissent appears to focus on the
that included the original proposals, a misconstrues the nature and impact of NMS objective of fair competition
public hearing, a supplemental request the Order Protection Rule and ignores among markets, without giving
for comment, the reproposals, eight in- the clear mandate provided to the appropriate weight to the important
depth analyses of relevant trading data, Commission by Congress in Section Congressional objective of integrating
and more than 2000 public comments. 11A(a)(2) of the Exchange Act to markets into a system that promotes
The issues raised by Regulation NMS facilitate the establishment of a national order interaction and the best execution
undoubtedly are multifaceted. Reaching market system. Regulation NMS does of investor orders.919 The House Report
decisions in this complex area requires not dictate any particular structure for gives the following overview of the
an understanding of the relevant facts the markets; rather, it establishes basic ‘‘goals and principles to serve as a
and of the often subtle ways in which ‘‘rules-of-the-road’’ for all markets that guide’’ to the Commission that
the markets work, and the balancing of will promote competition on terms that specifically endorses price protection
policy objectives that sometimes may benefit investors. In particular, for investor orders:
not point in precisely the same competition will be guided by three
basic principles—price transparency, Briefly stated, these embrace the principles
direction. Perhaps not surprisingly, of competition in which all buying and
there continue to be differences of open access, and best price. As a result,
selling interests are able to participate and be
opinion, even after this long process, all investors will be able to ascertain the represented. The objective is to enhance
among Commissioners, investors, best prices for NMS stocks, obtain fair competition and to allow economic forces,
market participants, and the public in and non-discriminatory access to the interacting within a fair regulatory field, to
general concerning the most appropriate markets displaying such prices, and arrive at appropriate variations of practices
future regulatory structure for the U.S. have assurance that their orders will be and services. Neither the markets themselves
executed at the best prices that are nor the broker-dealer participant in these
equity markets. markets should be forced into a single mold.
In sum, the Regulation NMS immediately and automatically
accessible. Within this regulatory Market centers should compete and evolve
rulemaking process has required the according to their own natural genius and all
Commission to grapple with many framework of transparency, access, and
actions to compel uniformity must be
difficult and contentious issues that best price, competitive forces will measured and justified as necessary to
have lingered unresolved for many determine the optimal market structure. accomplish the salient purposes of the
years. The Commission has devoted a 1. Intermarket Price Protection Rule Securities Exchange Act, assure the
great deal of effort to studying these maintenance of fair and orderly markets and
The dissent cites a selected few to provide price protection for the orders of
issues, assessing the views of all
passages from the legislative history of investors.920
commenters, and modifying its
the 1975 Amendments 916 to the
proposals to respond appropriately to The establishment of a ‘‘fair regulatory
Exchange Act as support for the claim field’’ that will ‘‘provide price
their comments. Indeed, this release
that an intermarket price protection rule protection for the orders of investors’’ is
discusses at length our response to
is inconsistent with the Exchange
913 See infra, notes 920–922 and accompanying
Act.917 A more complete review of the 918 H.R. Rep. 94–123, 94th Cong., 1st Sess. 50
text. (1975) (‘‘House Report’’).

914 See supra, notes 56–59 and accompanying 915 Dissent, text accompanying note 27. 919 See supra, section I.B (discussion of NMS
916 Pub. L. No. 94–29, 89 Stat. 97 (1975). principles and objectives).
text; infra, notes 939–941, 957–960, and
accompanying text. 917 See, e.g., Dissent, notes 3–5, 51–52. 920 House Report at 51.
precisely what the Order Protection responsibility to assure that the system liquidity. It also may interfere with
Rule is designed to do. develops and operates in accordance with short-term trading strategies that benefit
Similarly, the Senate Report on the Congressionally determined goals and from volatile and illiquid markets. The
1975 Amendments emphasizes both objectives. Section 11A(a) and 11A(c), taken dissent claims that the ‘‘length of time
together, would establish such an
competition among markets and an individual owns a stock is not a
arrangement.923
integration of those markets into a relevant factor in distinguishing among
unified system: Although the dissent may disagree groups of investors’’ and that the
S. 249 would lay the foundation for a new
with the policy of an intermarket price distinction between long-term investors
and more competitive market system, vesting protection rule, there is no basis for the and short-term traders is arbitrary and
in the SEC power to eliminate all claim that Regulation NMS is at odds unreasonable.927 But in those limited
unnecessary or inappropriate burdens on with the Commission’s statutory contexts where the interests of long-
competition while at the same time granting mandate to facilitate the establishment term investors conflict with short-term
to that agency complete and effective powers of a national market system. trading strategies, the conflict cannot be
to pursue the goal to centralized trading of reconciled by stating that the NMS
securities in the interest of both efficiency 2. Long-Term Investors
and investor protection.921
should benefit all investors. In
The dissent questions the particular, failing to adopt a price
By ‘‘centralized trading,’’ the Senate Commission’s authority to give protection rule because short-term
Report did not mean a single market, precedence to the interests of long-term trading strategies can be dependent on
but rather NMS rules and facilities that investors in those limited contexts millisecond response times would be
link the markets into a unified system where their interests conflict with the unreasonable in that it would elevate
to assure best execution of investor interests of short-term traders.924 As is such strategies over the interests of
orders—the approach incorporated in discussed elsewhere in this release,925 millions of long-term investors—a result
Regulation NMS. For example, the the interests of long-term investors and that would be directly contrary to the
Senate Report specifically addresses the short-term traders in fair and efficient purposes of the Exchange Act.928
importance of intermarket price markets coincide most of the time. In As discussed earlier in this release,929
protection: those few contexts where the interests of the legislative history of the Exchange
[A] limited price order is presently long-term investors directly conflict Act from its adoption in 1934
‘‘protected’’ as to price priority on the with short-term trading strategies, we emphasizes the Congressional concern
exchange on which it is held but it is not believe that, in implementing regulatory to protect the interests of the many
protected in any way [with] respect to trading structure reform, the Commission has average investors who are not active
on another exchange or in the third market. both the authority and the responsibility traders or market intermediaries, but
As a consequence, a limit order for a listed to further the interests of long-term who depend on their equity
security held in only one of several markets investors, and that the record provides investments, whether directly in
for that security need not be executed before
a transaction is effected at the same price or
substantial support for the corporate stocks or indirectly through
at a price less favorable to the other party in Commission’s determination to further their investment in mutual funds and
another market. In the Committee’s view this their interests. retirement accounts, to meet their long-
is the basic problem caused by fragmentation As discussed above, intermarket price term financial goals. The dissent
of the securities markets: the lack of a protection will significantly benefit the suggests that these statements of
mechanism by which all buying and selling more than 84 million individual Congressional concern for millions of
interest in a given security can be centralized investors in the U.S. equity markets by average investors were no longer
and thus assure public investors best reducing their transaction costs and relevant when Congress adopted the
execution.922 thereby enhancing their long-term 1975 Amendments, but the legislative
Consequently, the Commission’s investment returns.926 Price protection history of the 1975 Amendments does
challenge in meeting its NMS may, however, interfere to some extent not support this proposition.930
responsibilities is to promote both with the extremely short-term trading The dissent also argues that short-
competition among markets and strategies that can depend on term traders often provide liquidity to
competition among orders, as well as to millisecond response times from the market and thereby benefit long-
assure a regulatory structure that is markets for orders taking displayed term investors. The Commission
workable and minimizes regulatory certainly agrees with this statement as a
costs. Notably, Congress chose not to 923 Senate Report at 8–9. See also H.R. Rep. No. general matter, but believes that, in the
mandate any particular NMS rules in 94–229, 94th Cong., 1st Sess. 92 (1975) specific context of an intermarket price
(‘‘Conference Report’’) (adopting Senate approach to protection rule, directly promoting the
order to give the Commission greater ‘‘provide maximum flexibility to the Commission
flexibility to use its expertise in and the securities industry in giving specific display of limit orders, which directly
achieving NMS objectives: content to the general concept of the national
market system’’). 927 Dissent, section IV.
The Committee considered mandating 924 Dissent, section IV. Many short-term trading 928 See, e.g., Exchange Act Section 11A(a)(1)(C)
certain minimum components of the national strategies are conducted by registered broker- (‘‘It is in the public interest and appropriate for the
market system but rejected this approach. dealers, such as specialists and market makers. protection of investors and the maintenance of fair
The nation’s securities markets are in Despite the dissent’s repeated references in section and orderly markets to assure,’’ among other things,
dynamic change and in some respects are IV to both short-term investors and market ‘‘the economically efficient execution of securities
delicate mechanisms; the sounder approach intermediaries, we do not believe the dissent means transactions’’ and ‘‘the practicability of brokers
appeared to the Committee, therefore, to be to suggest that the Commission lacks authority executing investors’ orders in the best market.’’).
to establish a statutory scheme clearly under the Exchange Act to give precedence to the 929 Supra, section I.B.2.
granting the Commission broad authority to interests of long-term investors over market 930 See, e.g., Conference Report at 91 (‘‘The
intermediaries. securities markets of the United States are an
oversee the implementation, operation, and 925 Supra, section I.B.2.
regulation of the national market system and important national asset. Under the system of
926 See supra, text accompanying notes 25–26 Federal regulation established in the 1930s, these
at the same time to charging it with the clear
(survey finding that more than 84 million markets have flourished. They have provided a
individuals representing more than 50% of means for millions of Americans to share in the
921 S. Rep. No. 94–75, 94th Cong., 1st Sess. 2
American households own equity securities, profits of our free enterprise system and have
(1975) (‘‘Senate Report’’). directly or indirectly, and that nearly all view their facilitated the raising of capital by new and growing
922 Senate Report at 17. equity investments as savings for the long-term). businesses.’’).
provide liquidity to the market, rather Rule.934 This section responds to certain Federation of America believed that
than promoting short-term trading specific claims made in the dissent ‘‘the brokers’’ duty of best execution is
strategies that require millisecond where the dissent appears to have simply too vague to serve as an effective
response times for orders that take misconstrued the Commission’s deterrent to abuse. It is too vague for the
displayed liquidity, is the most decision-making process and broker to know with certainty that it has
appropriate approach to protect conclusions, and highlights the critical satisfied its best execution obligation
investors and enhance market policy issues on which the views and too vague to be enforced
efficiency. Many commenters agreed expressed in the dissent simply conflict consistently and effectively. In fact, one
with this policy decision. For example, with the considered views of the of the real benefits of the proposed
T. Rowe Price stated that ‘‘we do not Commission and many commenters. trade-through rule is that it has the
believe that speed of access The dissent asserts that the potential to simplify compliance with
considerations should drive market Commission’s objectives for the Order best execution rules.’’ 939 The
structure issues if to do so would Protection Rule have been ‘‘a moving Committee on Investment of Employee
jeopardize legitimate market linkage target, morphing from the protection of Benefit Assets also recognized the vital
initiatives. Connected markets provide limit orders, to the need to increase importance of maintaining equity
the opportunity for information market depth and liquidity, to the markets in which all investors can
gathering, block trading, and improved reduction of transaction costs for long- participate with confidence: ‘‘[I]n light
price discovery, as well as the term investors and issuers.’’ 935 In fact, of the scandals in the securities and
legitimacy of the ‘last-sale’ price. While the Commission’s objectives have mutual fund industries, our first priority
speed of access and execution are remained consistent throughout the should be to restore investor confidence
crucial, there is a limit to how fast such NMS rulemaking.936 While certain in our capital markets. To allow trading
linkages need to be in order to protect details in the original proposal have to take place outside of the best price
and enhance our markets.’’ 931 Similarly, been modified to respond appropriately will continue to raise questions of
the Committee on Investment of to public comment, the policies fairness and could diminish investor
Employee Benefit Assets, which underlying the Rule as proposed, confidence.’’ 940 Other commenters
represents 110 of the nation’s largest reproposed, and adopted have remained shared these concerns about the impact
corporate retirement funds managing the same. Indeed, the dissent seems not of trade-throughs on investor confidence
$1.1 trillion on behalf of 15 million plan to appreciate that the ‘‘moving targets’’ in the fairness of the U.S. equity
participants and beneficiaries, stated it identifies—the objectives of protecting markets.941
that ‘‘it is unclear with the advance of limit orders, increasing market depth
automation why we would need or and liquidity, and reducing investor 939 Consumer Federation Letter at 4.
should allow anything other than the transaction costs—are all quite closely 940 CIEBA Letter at 2.
941 See, e.g., BSE Reproposal Letter at 2 (‘‘The
best price requirement for investors. Our inter-related. As the Commission has
Exchange believes that the reproposed Trade-
constituency is concerned with long- explained quite consistently in this Through Rule is critical to the protection of
term growth and market stability and release and in the proposing releases, customer limit orders through ‘protected quotes’ for
the ability to opt-out [of the best price protecting limit orders contributes to all securities.* * * Minimum investor protection
market depth, which in turn reduces principles should not be bifurcated on the basis of
requirement] could place long-term whether a security trades in either a listed or
investors at a disadvantage.’’ 932 Finally, investor transaction costs. In addition, NASDAQ environment.’’); Letter from James W.
the National Association of Investors the Commission has consistently Vitalone, Chair, U.S. Advocacy Committee, and
Corporation emphasized that ‘‘[m]ake emphasized that intermarket price Linda L. Rittenhouse, CFA Institute—Advocacy, to
protection will promote the best Jonathan G. Katz, Secretary, Commission, dated
no mistake, the best price best serves Sep. 22, 2004 (‘‘CFA Institute Letter’’) at 1 (‘‘We
investors. It is part of the value equation execution of investor orders and fair and believe that the current way of doing business has
when buying and selling stock. Please orderly markets.937 become a system permeated with trading practices
keep in mind that individual investors that often obfuscate the manner in which best price
1. Investor Protection is determined or how some limit orders are filled.
are long-term investors and price is of Thus, we strongly support and urge reforms that
As discussed previously in this
utmost importance to them.’’ 933 will bring uniformity and transparency to the
release,938 the Commission believes that current system, ultimately leveling the playing field
Although the dissent may disagree with the Order Protection Rule is needed to as much as possible among market participants. To
the policy views of these commenters strengthen the protection of investors in this end, we support a trade-through rule that
on the best means to protect investors the U.S. equity markets. Many applies to all securities.’’); Letter from Lawrence E.
and to promote market integrity and commenters agreed with the Harris, Marshall School of Business, University of
liquidity, it does not provide a basis for Southern California, to Jonathan G. Katz, Secretary,
Commission on the need for Commission, dated Feb. 5, 2005 (‘‘Harris
concluding that the commenters’ views, strengthened price protection to protect Reproposal Letter’’) at 7 (‘‘The proposed trade-
which the Commission shares, are investors. For example, the Consumer through rule would prevent exchanges from trading
arbitrary or unreasonable. through exposed electronically accessible orders at
another exchange. In principle, such rules should
934 Supra,
section II.A.
B. Basis for Adoption of Order not be necessary because traders generally will
935 Dissent,
section I. The dissent asserts that the
Protection Rule access liquidity wherever it is cheapest. In practice,
Commission has sought to reduce transaction costs dealers, brokers, and exchanges sometimes do trade
A prior section of this release for issuers. Stated more accurately, the Commission through other orders since it is generally in their
discusses at length the Commission’s has sought to reduce transaction costs for investors, self-interest to control an execution rather than
which would thereby help reduce the cost of capital share it. Accordingly, the primary benefit of the
basis for adopting the Order Protection for the listed companies in which they invest. See proposed trade-through regulation will be to
supra, note 15 and accompanying text. promote investor protection.’’); NAIC Letter at 1
931 T. Rowe Price Reproposal Letter at 2. 936 For example, the Proposing Release
(‘‘Having confidence that one is receiving the best
932 Letter from Gary A. Glynn, Chairman, emphasized that one of the three overarching price in stock transactions contributes greatly to the
Committee on Investment of Employee Benefit objectives of the proposals was to ‘‘promote greater confidence that investors have in the fairness and
Assets, to Jonathan G. Katz, Secretary, Commission, order interaction and displayed depth,’’ thereby integrity of the marketplace.’’); Phlx Reproposal
dated June 24, 2004 (‘‘CIEBA Letter’’) at 1. reducing the price impact costs of large, Letter at 1 (‘‘Phlx believes that intermarket
933 Letter from Kenneth S. Janke, Chairman, institutional investors. Proposing Release, 69 FR at protection of firm and accessible quotes is not only
National Association of Investors Corporation, to 11129. necessary, but should foster a more efficient
937 Id. at 11132.
Jonathan G. Katz, Secretary, Commission, dated marketplace, which is consistent with protecting
June 24, 2004 (‘‘NAIC Letter’’) at 1. 938 See supra, section II.A.1. investors and the public interest.’’).
The dissent, however asserts that the The dissent also asserts that the discussed previously in this release,952
Trade-Through Study prepared by Trade-Through Study did not indicate retail customers who submit market and
Commission staff to estimate trade- ‘‘that investors are not obtaining best marketable limit orders seeking the best
through rates does not substantiate execution, that their orders are being available market price generally can
investor protection concerns.942 The unfairly treated, or that investors are ascertain the best quotations at the time
dissent further suggests that the otherwise suffering economic harm.’’ 947 they submit their orders, but quotations
Commission has ‘‘cherry-picked’’ The Study, however, found that 2.5% of can change rapidly, thereby making it
statistics that support its position, while trades in Nasdaq stocks do not receive quite difficult for customers to know
ignoring, or even failing to disclose, the best prices that are immediately and whether their orders were in fact
statistics that do not support its electronically accessible and that the executed at the best quotations at the
position.943 While the Commission average amount by which such trades time of order execution.953 In contrast,
believes that the total number of trade- miss the best prices is 2.3 cents per retail customers who display non-
throughs should not be the sole share.948 In addition, Nasdaq submitted marketable limit orders at the best
consideration in making its policy statistics with its comment letter on the prices can readily see when their orders
choices, an earlier section of this release reproposal indicating that the trade- are traded through—the inferior trade
discusses in detail the data through rate for dealers that internalize prices will be disseminated in the
demonstrating the significance of trade- customer orders in Nasdaq stocks was consolidated trade stream.954 These
through rates found in the Study,944 and 3.2% in 2003. The dissent attempts to customers legitimately may feel that
that discussion makes clear that the minimize the seriousness of these their orders have not been treated in a
Commission has not ignored or failed to statistics on a variety of grounds, but it fair and orderly fashion. By establishing
disclose the findings of the Trade- concedes that the trade-through rate for strong intermarket price protection, the
Through Study. Indeed, at the time the customers in Nasdaq stocks was Order Protection Rule will benefit
Reproposing Release was published, the between 1% and 2% in 2004 and states investors who use both types of orders.
Study was placed in the public file that ‘‘these numbers speak for It will promote the execution of investor
specifically to assure that all themselves’’ that customers are not market orders at the best prices on an
commenters had a full opportunity to being treated unfairly.949 order-by-order basis,955 as well as
evaluate its data and methodologies. Even if the Commission accepted the protect displayed limit orders, no matter
The Study used a variety of dissent’s focus on a limited portion of how small or large their displayed size,
calculation methodologies that the rulemaking record, we strongly from trade throughs. In both contexts,
generated many different statistics on believe that the evidence contained in the Rule will significantly enhance the
trade-through rates, but summarized its this record would raise serious investor protection of investors in all NMS
findings as follows: ‘‘Depending on the protection concerns. Because of the stocks.
methodology applied, the overall trade- enormous volume of trading in the U.S. 2. Improved Depth and Liquidity in
through rate ranged from 2% to 10% of equity markets, even small percentages Nasdaq Stocks
trades and from 2% to 13% of share can translate into significant harm to
volume. Using the more conservative of investors. For example, even a 1.5% The dissent asserts that there is no
these methods, we estimate that 2% to trade-through rate for customers in evidence of a need for greater depth in
3% of all trades and 2% to 8% of all Nasdaq stocks in 2004 would mean that Nasdaq stocks that would warrant
share volume are trade-throughs.’’ 945 14.3 million customer orders received a application of the Order Protection
The Reproposing Release explained why price that was inferior to an Rule.956 In making this assertion, the
the Commission believed that the most immediately and automatically
relevant measure is 2.5% of total trades, accessible quotation.950 Because of the 952 See supra, text accompanying note 53. See
representing more than 7% of total difficulties faced by retail investors in also J.P. Morgan Reproposal Letter at 3 (‘‘[P]rincipal
share volume, that trade through the agent conflicts can lead to less than best execution,
monitoring whether their orders receive particularly for retail investors who may not have
best displayed prices. The Reproposing the best prices, it is likely that a great the sophistication or resources to assess the quality
Release also explained the deficiency of many of these customers were not aware of the trades provided by their agents. By
the dissent’s preferred measure—the that they in fact received an inferior prohibiting the execution of orders at prices inferior
displayed size of quotations that are to those displayed, a trade-through rule can
price for their order.951 We suspect that therefore help provide protection to limit orders
traded through. This measure primarily the millions of customers who received and further encourage their use.’’)
reflects the current shortage of inferior prices, had they known, would 953 Cf. Dissent, note 42 (‘‘the majority fails to
displayed size, which is a symptom of believe that they had been treated acknowledge that retail investors have access to
one of the primary problems that the consolidated information that allows them to
unfairly. monitor their executions’’).
Order Protection Rule is designed to Moreover, the dissent does not appear 954 Cf. Dissent, note 44 (questioning the basis for
address.946 It therefore is not a useful to take into account the practical the Commission’s assertion that retail investors are
means to assess the potential upside of difficulties faced by retail customers in not given a level playing field when their displayed
strengthened price protection. monitoring and obtaining best execution
limit orders are bypassed by large, block trades and
stating that the assertion is ‘‘also inconsistent with
of their orders. Such difficulties vary the majority’s previous assertion that investors have
942 The Trade-Through Study is described in note
depending on the type of order. As difficulty monitoring execution quality’’).
66 above. 955 See supra, notes 341–344 and accompanying
943 Dissent, section II.A.
947 Dissent,
text (duty of best execution not interpreted as
944 Supra, section II.A.1.a.ii. As discussed above, section II.A. requiring order-by-order routing by brokers with
948 Trade-Through Study at 3.
different measures of trade-through rates are large volume of customer orders).
relevant for assessing the extent to which the Order 949 Dissent, text following note 47. 956 Dissent, section II.B. The dissenters imply that
Protection Rule is needed to achieve the objectives 950 More than 955 million trades were reported in
a need for greater depth was the only basis relied
of best execution of market orders, fair and orderly 2004 by the consolidated market data network for on by the Commission for applying the Order
treatment of limit orders, and greater depth and Nasdaq stocks. Protection Rule to Nasdaq stocks. Dissent, text
liquidity for NMS stocks, respectively. 951 The difficulties faced by retail investors in accompanying note 52. As discussed in the
945 Trade-Through Study at 1 (emphasis in
monitoring the execution quality of their market preceding section, the Commission believes that
original). orders are discussed further above in the text enhancing investor protection, particularly for retail
946 Reproposing Release, 69 FR at 77443. accompanying note 53. Continued
dissent does not address the views of In addition to not addressing the Second, the dissent fails to appreciate
many commenters that intermarket views of commenters, the dissent does the significance of staff studies
price protection is needed to improve not refute the significance of data examining fill rates and other order
depth and liquidity in all NMS stocks, analyses prepared by Commission staff execution quality statistics for
including those listed on Nasdaq. For to assess the views of commenters that marketable limit orders in Nasdaq
example, the Investment Company intermarket price protection is needed stocks.964 The dissent incorrectly
Institute, whose members account for to promote depth and liquidity in interprets the Commission’s evaluation
more than 95% of all U.S. mutual fund Nasdaq stocks. First, the dissent does of these studies as critical of the trading
assets, noted that ‘‘[b]y affirming the not mention the staff studies that found strategy of submitting ‘‘pinging’’
principle of price priority, a trade- that short-term price volatility is orders—orders with sizes greater than
through rule should encourage the significantly higher in Nasdaq stocks the displayed size of quotations.965 The
display of limit orders, which in turn than in NYSE stocks.961 Excessive short- Commission’s evaluation of low fill
would improve the price discovery term price volatility indicates a need for rates in Nasdaq stocks is not a criticism
process and contribute to increased greater depth and liquidity to dampen of pinging orders. The use of pinging
market depth and liquidity.’’ 957 It price fluctuations. Although orders is a valid strategy for trading
therefore ‘‘strongly recommend[ed] that acknowledging that the drafters of the stocks on electronic markets and
the Commission adopt a uniform trade- 1975 Amendments identified ‘‘the certainly will continue after
through rule that applies across all maintenance of stable and orderly implementation of the Order Protection
market centers and to all types of markets with maximum capacity for Rule. Indeed, an important goal of the
securities, including Nasdaq-listed absorbing trading imbalances without Rule is to improve the execution quality
securities.’’ 958 Similarly, the Bank of undue price movements’’ as one of the for such orders by increasing their fill
New York stated that ‘‘[w]e agree with ‘‘paramount’’ objectives for the NMS,962 rates and, thereby, the ability of
the Commission that a uniform trade- the dissent does not address the staff investors to trade Nasdaq stocks in
through rule would encourage the use of volatility analyses indicating the need to larger sizes. As discussed earlier in this
displayed limit orders and aggressive address price volatility in Nasdaq release,966 the important consideration
quotation. In the market for Nasdaq stocks.963 is not that fill rates in Nasdaq stocks are
securities, for example, many investors lower than fill rates in NYSE stocks.
are reluctant to show their full trading such as internalization and payment for order flow This difference likely is explained by
interest for fear of having others use that that prevent substantial pockets of orders from broad structural differences unrelated to
interacting with the broader market while leaving market efficiency. Rather, the problem is
information to their detriment. A limit orders that set the best price unfilled * * *.
uniform trade-through rule would [W]e believe a universal trade-through rule will not
that fill rates, as well as the executed
incentivize these investors to display only benefit the investors who have their limit share volume, in Nasdaq stocks for
their interest, knowing their order must orders filled as a result, but also will benefit the orders with sizes ranging from 2,000 to
market as a whole, through increased liquidity, 9,999 shares are very low in absolute
be filled before the next-priced order. improved price discovery, and tighter spreads.’’);
Accordingly, a well-formulated trade- Deutsche Bank Reproposal Letter at 1–2 (‘‘DBSI
terms (falling as low as 12% to 27%),
through rule will promote transparency agrees with the Commission that limit orders are even for many active stocks included in
and liquidity in the national market critically important to our markets, and we believe the Nasdaq-100 Index.967 The
system.’’ 959 Many other commenters that readily accessible limit orders should be Commission believes that this data
protected. In our view, protection means that the supports the views of commenters that
similarly believed that an intermarket first mover who commits to offer liquidity at a
price protection rule is needed to particular price point should be rewarded with the intermarket price protection is needed
promote market depth and liquidity in assurance that others in the marketplace cannot
overlook that price and trade at an inferior price.’’); minimizing price volatility and enhancing depth
all NMS stocks.960 Global Electronic Trading Company Reproposal and liquidity are essential elements for achieving
Letter at 2 (‘‘The BBO Alternative and electronic the broad objective of assuring the ‘‘economically
investors, is a compelling reason to apply the Order efficiencies will have a positive impact on the efficient execution of securities transactions.’’
Protection Rule consistently across all NMS stocks. economy by increasing market efficiency and, Section 11A(a)(1)(C)(i). Both elements help reduce
957 ICI Reproposal Letter at 2. thereby, GDP.’’); Interactive Brokers Group investor transaction costs and thereby promote
958 Id. at 3. Reproposal Letter at 1 (‘‘We strongly support efficient trading. See Conference Report at 91–92
959 BNY Letter at 2. adoption of proposed Regulation NMS, which is a (‘‘The basic goals of the Exchange Act remain
960 See, e.g., American Century Letter at 2 (‘‘[W]e common sense and long-overdue update of the salutatory and unchallenged: To provide fair and
support the establishment of a uniform trade- national market system rules in light of the major honest mechanisms for the pricing of securities, to
through rule for all securities across all market technological changes that have taken place in the assure that dealing in securities is fair and without
centers within the National Market System.’’); equity markets in the last three decades.’’); under preferences or advantages among investors,
Vanguard Reproposal Letter (‘‘We agree with the to ensure that securities can be purchased and sold
Letter from Yakov Amihud, New York University,
Commission that an intermarket trade-through rule at economically efficient transaction costs, and to
and Haim Mendelson, Stanford University, to
should be applied to Nasdaq stocks to strengthen provide, to the maximum degree practicable,
Jonathan G. Katz, Secretary, Commission, dated Jan.
price protection.’’); Weaver Reproposal Letter (‘‘I markets that are open and orderly.’’) (emphasis
25, 2005 (‘‘Amihud/Mendelson Reproposal Letter’’),
also urge the commission to extend the rule to added). The implicit costs associated with the
Attachment at 14 (‘‘The BBO Alternative is most
NASDAQ stocks. Clearly establishing price as the prices at which transactions are executed represent
potent in protecting the interests of small,
primary priority rule in markets will encourage the one of the most significant elements of investor
uninformed investors. This will induce their
submission of limit orders, leading to lower transaction costs. See supra, text accompanying
participation in the stock market and thus will
execution costs for investors, and consequently notes 300–302.
make the market more liquid.’’); Capital Research 964 The relevant studies are the Matched Pairs
Letter at 2 (‘‘We believe providing price protection lowering the cost of capital for traded firms.’’).
will create an incentive for buyers and sellers to
961 The relevant studies are the Volatility Study Study, prepared by the Commission’s Office of
display their intentions. This will generate a more and the Supplemental Volatility Study prepared by Economic Analysis, and the S&P Index Study and
accurate reflection of true supply and demand, the Commission’s Office of Economic Analysis, the Nasdaq-100 Index Supplemental Study,
which will enhance price discovery. We also described in notes 143–144 above. prepared by the Commission’s Division of Market
believe that this will lead to an increased use of 962 Dissent, note 30 (quoting Senate Report on Regulation, described in notes 114 and 137 above.
limit orders outside the best bid and offer which 1975 Amendments). The significance of marketable limit orders in the
will increase depth in the market and dampen 963 Dissent, section II.B. The dissenters also imply market for Nasdaq stocks is addressed at length
volatility. For this reason we favor a trade-through that minimizing price volatility and enhancing elsewhere and will not be repeated here. See supra,
rule.’’); Consumer Federation Letter at 2 (‘‘The lack depth and liquidity are not encompassed within the text accompanying notes 121–123.
965 Dissent, text accompanying notes 57–58.
of a trade-through rule in the Nasdaq market has five broad objectives for the NMS specified in
966 Supra, text accompanying notes 132–136.
unquestionably contributed significantly to Exchange Act Section 11A(a)(1)(C). Dissent, text
fragmentation in that market, by allowing practices accompanying notes 30, 50–52. In fact, both 967 See supra, text accompanying notes 138–139.
to promote greater depth and liquidity from the effectiveness of the Rule in order exception, which will allow them
across the whole range of Nasdaq stocks. strengthening price protection. to execute immediately a large
The dissent also states that the Order transaction at prices outside the best
3. Effectiveness of Order Protection Rule Protection Rule will not increase market prices by routing orders to execute
The dissent suggests that the Order depth and liquidity because the Rule against the displayed size of better-
Protection Rule will not meet its goals does not provide what the dissent views priced quotations.977 Finally, the Order
because some trade-throughs will as complete protection of limit Protection Rule will promote
continue even after implementation of orders.972 In particular, it points to the competition among markets by assuring
the Rule. The dissent notes that the Rule Commission’s decision to protect only new or smaller markets that, if they
contains exceptions for intermarket quotations that are the best bids and display the best prices, they will attract
sweep orders, flickering quotations, offers (‘‘BBOs’’) of markets, and to the order flow, because larger, dominant
trading centers that are experiencing a ability of markets to match the best markets will not be allowed to ignore
material delay, volume weighted prices displayed in other markets. The their quotations. New or smaller
average price (‘‘VWAP’’) orders, and Commission’s reasons for protecting markets also will benefit from the price
stopped orders, and questions whether, market BBOs are discussed in detail transparency and open access elements
given these exceptions, the Rule will earlier in this release.973 The practice of of Regulation NMS, which preclude
lead to a significant reduction in trade- price matching, by definition, does not
dominant markets from unreasonably
through rates.968 cause investors to receive inferior prices
restricting the availability of their
or result in trade-throughs of displayed
The dissent fails to appreciate both market information or unfairly
quotations. Most importantly, the
the methodology of the staff study of discriminating against competing
dissent’s assertion that the other
trade-through rates and the operation of markets by denying access to their
approaches might have given greater
the Order Protection Rule. As explained protection to limit orders does not displayed quotations.
at length earlier in this release,969 the dispose of the relevant question, which The dissent also claims that the Order
staff used a conservative methodology is whether strengthening the current Protection Rule will create barriers to
in the Trade-Through Study that did not level of price protection for market competition and regulatory barriers to
include trade-throughs attributable to BBOs will lead to greater depth and entry, largely because the Rule protects
intermarket sweep orders, flickering liquidity.974 quotations that are displayed by SROs
quotations, and VWAP trades in its registered under the Exchange Act.978
calculation of trade-through rates. Thus, 4. Promoting Competition
Here, however, the dissent appears to
given the consistency between the The dissent claims that the Order take issue with one of the most basic
Study’s methodology and the Rule’s Protection Rule will limit competition, elements of the Exchange Act regulatory
exceptions, the Commission believes stifle innovation, and create regulatory scheme—the equity market registration
that implementation of the Rule will barriers to entry. The dissent argues that requirement. Congress enacted this
lead to the elimination of the great intermarket protection of the best registration requirement in 1934 to
majority of the types of trade-throughs accessible prices will ‘‘reduce markets assure that all significant equity markets
found in the Trade-Through Study.970 to the lowest common denominator.’’ 975 have the capacity and integrity to meet
Moreover, the exceptions in the Order As discussed in an earlier section of this their responsibilities to protect investors
Protection Rule are fully consistent with release, the Commission believes that and promote the public interest. The
the principle of price protection. For markets will continue to have strong Commission strongly believes that this
example, to comply with the incentives to compete and innovate, basic registration requirement is an
exemptions for intermarket sweep particularly to be the first preference of essential element of any effective
orders, VWAP orders, and stopped order routers at any given price and scheme of securities regulation.
orders as a practical matter, market thereby maximize their share of trading Consistent with this requirement, the
participants must trade with, rather than volume.976 Liquidity providers will be
SROs for many years have been
trade through, the displayed size of able to compete on both price and size
responsible for collecting quotations
protected quotations.971 Intermarket through use of the intermarket sweep
and disseminating them to the public in
sweep orders must, by definition, be the consolidated quotation stream.
972 Dissent,section III.C.
routed to execute against the full Broker-dealers and ATSs can participate
973 Supra,section II.A.5.
displayed size of protected quotations, 974 See, e.g., supra, notes 56–59, 957–960, and in the consolidated quotation stream by
while the dealers that execute VWAP accompanying text (commenters supporting providing their quotations to an SRO.
and stopped orders typically will adoption of Order Protection Rule to promote depth They will continue to be able to do so
execute trades in the public markets to and liquidity).
after implementation of the Order
establish the positions necessary to fill 975 Dissent, section V.A.1.
Protection Rule and, to the extent their
976 Supra, section II.A.4.a. See also Bear Stearns
the orders. In addition, the exceptions quotations constitute the best bids or
Reproposal Letter at 2 (Market BBO alternative
for flickering quotations and trading ‘‘accomplishes the right balance for trade-through offers of the SRO, such quotations will
centers experiencing a material delay protection because it encourages competitive be protected. Moreover, small ATSs
are consistent with intermarket price quoting behavior both within and among markets,
with less than 5% of trading volume are
protection because they are designed to without imposing excessive routing obligations and
related costs on receiving trading centers.’’); CHX exempted from participation in the
exclude quotations that are not truly Reproposal Letter at 3 (‘‘[T]he Market BBO consolidated quotation stream, thereby
accessible. The existence of these Alternative provides an ideal balance; it recognizes reducing barriers to entry for new
exceptions, therefore, will not detract the importance of preserving essential price
protections, while permitting market centers to markets.979 But these aspects of the U.S.
968 Dissent,
control costs and to preserve intermarket regulatory scheme all flow from the
section III.A.
969 Supra,
competition.’’); Letter Type J (Letter submitted by basic Exchange Act registration
section II.A.1.a. 548 commenters stating that protecting the best bid
970 See supra, notes 61–63 and accompanying
and offer in each market center preserves both
977 See supra, text accompanying notes 249–250.
text. competition among markets and competition among
971 See supra, notes 220–221, 249–257, and 978 Dissent,sections V.A.3 and V.A.4.
quotations ‘‘in a way that benefits all securities
accompanying text. industry participants.’’). 979 See supra, text accompanying notes 385–386.
requirement for significant equity The dissent minimizes the role of the that amount in one-time start-up costs a
markets, not Regulation NMS. intermarket sweep order exception in significant burden for investors?
the operation of the adopted Order In fact, of course, both of the amounts
5. Scope of Order Protection Rule are substantial, and the dissent has used
Protection Rule. It states that, under the
The dissent argues that the scope of Rule as reproposed, ‘‘trading centers an ‘‘apples-to-oranges’’ comparison. The
the Order Protection Rule has been could route an order to a protected $321 million amount measures the
substantially expanded beyond the quotation’s full displayed size and estimated reduction in investor
reproposal without the benefit of the simultaneously execute an order at an transaction costs. Even the total amount
normal notice and comment process, inferior price,’’ and then implies that of transaction costs will always be a
and further states that the ‘‘practical this practice is no longer allowed under fraction of the total dollar volume of
effect is that market participants must the adopted Rule.984 But simultaneously trading in the U.S. equity markets.
exhaust liquidity in reserve prior to executing orders at multiple price levels Indeed, if transaction costs were ever to
moving to the next price level.’’ 980 Both is precisely what the intermarket sweep represent a large proportion of the total
of these assertions are incorrect. The order exception allows under the dollar volume of trading, investors
scope of the Order Protection Rule has reproposed and adopted Rule. would cease to trade, liquidity would
not been expanded from the reproposal, Regardless of the dissent’s position, dry up, and the cost of capital for listed
nor does the Rule, as reproposed or there is no indication that commenters companies would be prohibitive. All
adopted, require market participants to were confused concerning the transaction costs, however, eat away at
route orders to execute against reserve importance of the exception or the long-term returns of investors. One
size or any other liquidity that is not operation of the Rule.985 of the keys to successful long-term
displayed. As reproposed and adopted, investing is to minimize, wherever
the Rule protects the best displayed 6. Benefits and Costs of Order Protection possible, transaction costs of all kinds.
prices of protected quotations, without Rule Even under the conservative estimate
regard to their sizes,981 but provides an used in the Commission’s cost-benefit
exception for transactions at inferior The dissent states that the analysis, which is based on the dissent’s
prices if intermarket sweep orders Commission’s estimate of $321 million preferred trade-through measure—the
simultaneously are routed to execute in annual benefits to investors from the share volume of quotations that are
against the ‘‘full displayed size’’ of the Order Protection Rule constitutes a traded through 988—investors would
protected quotations.982 Therefore, the ‘‘mere rounding error’’ compared to the benefit over a five-year period by a total
removal of references to size in the $18.7 trillion in total dollar value of of more than $1.3 billion.989 Moreover,
definition of quotation has no effect on trading in 2003.986 However, the dissent this estimate is conservative because it
the operation of the Rule as adopted. also states that $143.8 million in one- does not include any benefits for
Market participants will not be time start-up costs and $22 million in investors that would result from
required to route oversized orders in an annual costs to comply with the Rule, improved market depth and liquidity,990
attempt to execute against reserve size, which ultimately will be paid by nor does it reflect the non-monetary
as the dissenters claim. While a investors, are ‘‘very high.’’ 987 These benefits associated with enhanced
technical correction to a reproposed statements appear to be inconsistent. If investor confidence in the fairness and
Regulation NMS definition has been more than $300 million in net annual orderliness of the equity markets. The
made, it does not raise a notice and benefits is an inconsequential amount to
comment issue. A clause was deleted investors, why is less than one-half of 988 See Dissent, text accompanying note 33;
from the definition of ‘‘quotation’’ in Trade-Through Study at 3 ($321 million ‘‘includes

reproposed Rule 600(b)(63), but this rewritten and redesignated as Rule 603 in only share volume that traded through depth
displayed on market center’s top of book’’).
clause was not relevant to the Order Regulation NMS. See supra, section V.B.3.c. The
989 The estimated net benefits of more than $1.3
Protection Rule or to any other rule in new Rule does not use the terms ‘‘quotation
information,’’ ‘‘quotation sizes,’’ or ‘‘aggregate billion over a five-year period are calculated by
Regulation NMS, as reproposed or quotation sizes,’’ and therefore the deleted language deducting the estimated annual costs of compliance
adopted.983 now is obsolete. The language was inadvertently of $22 million from the estimated annual benefits
left in the definition of ‘‘quotation’’ in the of $321 million, multiplying by five, and then
reproposal and has been deleted as a technical deducting the estimated one-time start-up costs of
980 Dissent, text following note 63.
correction. Its deletion does not change the $143.8 million.
981 For example, ‘‘trade-through’’ is defined in 990 As discussed in section II.A.6 above, even
adopted Rule 600(b)(77), as it was in the reproposal, substantive operation of the reproposed or adopted
Order Protection Rule. small percentage improvements in depth and
solely with respect to price—‘‘the purchase or sale liquidity can generate enormous dollar benefits for
984 Dissent, text following note 63.
of an NMS stock during regular trading hours, investors in the form of reduced transaction costs
985 See, e.g., Letter from Adam Cooper, Senior
either as principal or agent, at a price that is lower because the total amount of transaction costs
than a protected bid or higher than a protected Managing Director and General Counsel, Citadel
incurred each year by investors is so large. Such
offer.’’ This definition is unchanged from the Investment Group, L.L.C., to Jonathan G. Katz, costs were conservatively estimated earlier in this
reproposal. Secretary, Commission, dated Jan. 26, 2005 release at more than $30 billion annually. Supra,
982 Rule 600(b)(30) defines an ‘‘intermarket sweep (‘‘Citadel Reproposal Letter’’) at 2–3 (‘‘The proposed text accompanying notes 300–305. Others have
order’’ as requiring, among other things, that limit intermarket sweep exception addresses most of estimated such costs as being much higher. See,
orders be ‘‘routed to execute against the full Citadel’s concerns about the Commission’s initial e.g., Instinet Group Incorporated, Eliminating
displayed size of any protected bid, in the case of trade-through proposal, and would have many Unnecessary Cost: Reducing Transaction Costs and
a limit order to sell, or the full displayed size of benefits * * *. [T]his exception would increase Recapturing Value for Your Portfolio 2 (2004)
any protected offer, in the case of a limit order to execution speed and reliability because it would (available at www.instinetgroup.com) (‘‘Transaction
buy, for the NMS stock with a price that is superior allow market participants to simultaneously and costs can have a significant effect on returns.
to the limit price of the limit order identified as an immediately sweep through multiple price Implementation shortfall in U.S. equity markets has
intermarket sweep order.’’ This definition is levels.’’); SIA Reproposal Letter at 20 (‘‘We continue been estimated to range from 20 basis points to as
unchanged from the reproposal. to believe that an exception for intermarket sweep much as 2% of the principal value of transactions
983 Reproposed Rule 600(b)(63) provided that orders is imperative for the proper functioning of and orders. Taking the mid-point of this range,
‘‘quotations and quotation information means bids, the trade-through rule and for the facilitation of however, even an average of 1% per year in lost
offers and, where applicable, quotation sizes and various beneficial trading strategies, including performance, before inflation and taxes,
aggregate quotation sizes.’’ As adopted, Rule smart routing and block trading. Therefore, we compounded over the average life of a pension
600(b)(62) simply defines ‘‘quotation’’ as ‘‘a bid or applaud the SEC’s decision to include such an liability, represents substantial foregone value. If we
an offer.’’ The deleted language currently is found exception in its Reproposal.’’). apply it to the $12 trillion U.S. equity market, we
986 Dissent, text accompanying note 41.
only in a definition from Exchange Act Rule get approximately $120 billion lost to transaction
11Ac1–2(a)(5), which Rule has been entirely 987 Dissent, section V.C. costs every year.’’).
Commission believes that all of these exemption to address the pressing need and thereby have little beneficial effect
benefits amply justify the costs of the for regulatory action in these securities, on the incentives to display limit orders.
Order Protection Rule. while it continued to evaluate a more
C. Market Data
comprehensive resolution of NMS
7. Alternatives to Order Protection Rule The dissent addresses issues relating
issues.
The dissent states that the The dissent argues that the exemption to the level of market data fees and the
Commission did not seriously consider led to increased competition, narrowing single consolidator model for
alternatives to the Order Protection of spreads, and a significant reduction disseminating market data. As discussed
Rule.991 It suggests that the Commission in trade-through rates, citing an October above,996 the Commission has
first could have adopted only access 2002 study of trading in the QQQs by determined that the most appropriate
standards, and then adopted a price the Commission’s Office of Economic forum in which to address the level of
protection rule later if deemed Analysis that was referenced in the market data fees is its review of SRO
necessary, or, alternatively, that the Proposing Release.993 This study, structure, and it has retained the single
Commission could have adopted a price however, found that trade-through rates consolidator model primarily because of
protection rule in stages for some were extremely high both before and its significant role in protecting
markets, while waiting to evaluate its after the exemption was granted—48% investors.
effect before applying the rule to other before and 47% after. The exemption D. Conclusion
markets. Both of these alternatives were therefore essentially ratified trading
considered, and the Commission activity that already was occurring.994 The dissent concludes by stating that
believed that they would have led to Consequently, data on trading before Regulation NMS is ‘‘far from final’’ and
continued uncertainty concerning the and after the exemption provides little that it fears that ‘‘inevitable delays in
future regulatory structure of the U.S. basis for drawing conclusions on the obtaining guidance, the attendant
equity markets, and that the second effect of the exemption. regulatory uncertainty, and concomitant
alternative would have perpetuated Most importantly, the Commission costs will harm a competitive
inconsistent regulatory requirements for considered and rejected a rule with a marketplace.’’ 997 In fact, the
different NMS markets and stocks. At three-cent trade-through threshold Commission has taken great care to craft
bottom, these alternatives simply reflect because it so clearly would fail to clear and workable rules for market
the dissenters’ policy view that a price achieve any of the primary objectives of participants to follow. Indeed, as
protection rule is not needed and will the Order Protection Rule, including discussed throughout this release, a
not be effective. Indeed, it is not clear investor protection, fair and orderly variety of changes to the rules as
why the dissent believes that the markets, and increased depth and originally proposed have been made
alternatives should have been seriously liquidity. Such a rule would allow specifically to respond to the comments
considered when they also believe that intermediaries and markets to execute of market participants.998 Given the
intermarket price protection in general investor orders at prices significantly wide range of participants in the
will not be effective. It is even more inferior to the best prices that are securities markets, the particular means
difficult to understand how these immediately and automatically chosen by different entities to comply
alternatives could be suggested by the accessible. In many NMS stocks, quoted with the NMS rules may vary. The staff,
dissenters if they believe that the very spreads are as low as one penny. A under the purview of the Commission,
basis of intermarket price protection is three-cent trade-through on a single will be available to work with the
‘‘arbitrary, unreasonable and trade would represent a 300% increase securities industry and the public to
anticompetitive.’’ The Commission in investor transaction costs in these provide any desired guidance on
disagrees and believes that further delay stocks. In addition, allowing three-cent implementation questions. In this
in reaching final decisions on vital NMS trade-throughs would seriously regard, the NMS rules are no different
issues could have caused significant undercut the objectives of encouraging from other rules that the Commission
harm to the U.S. markets. the display of limit orders. The average adopts, including previously-adopted
The dissent also states that the trade-through amount is 2.3 cents per NMS rules, such as those relating to
Commission failed to consider the share in Nasdaq stocks and 2.2 cents per limit order display and execution
alternative of prohibiting only those share in NYSE stocks.995 Consequently, quality disclosure, which were widely
trade-throughs that are more than three a rule with a three-cent threshold would cited by commenters as effective
cents inferior to the best prices. A three- not affect the majority of trade-throughs regulation. The Commission’s
cent trade-through threshold is experience with these other rules has
analogous to the temporary exemption 993 Dissent, note 6 (citing Proposing Release, 69
demonstrated the wisdom of this
FR at 11134 n. 50). approach.
from the ITS trade-through provisions 994 Unlike the more recent Trade-Through Study,
that was originally granted in 2002 for the October 2002 study did not incorporate a three- XIII. Statutory Authority
trading in three exchange-traded second quotation window to address timing latency
funds.992 These derivative securities, issues. The earlier study also included manual Pursuant to the Exchange Act and
one of which tracks the Nasdaq-100 quotations disseminated by Amex and the NYSE in particularly, Sections 2, 3(b), 5, 6, 11,
the QQQs. The respective findings of the two 11A, 15, 15A, 17(a) and (b), 19, 23(a),
Index (then referred to as the ‘‘QQQ’’), studies therefore are not comparable. The October
are highly liquid and their value is 2002 study did not examine the effect of the and 36 thereof, 15 U.S.C. 78b, 78c(b),
readily derived from the values of their exemption on the spreads paid by investors. The 78e, 78f, 78k–1, 78o, 78o–3, 78q(a) and
dissent also cites a comment letter stating that (b), 78s; 78w(a), and 78mm, and Rules
underlying stocks. The deficiencies of spreads narrowed in the QQQ’s when they became
the ITS trade-through provisions, which a Nasdaq-listed security in December 2004. Dissent,
11Aa3–2(b)(2) and 11Aa3–2(c)(1)
protect both automated and manual note 6. Given that the three-cent trade-through
996 Supra, section V.A.
quotations, were most evident in these threshold already allowed an extremely high
percentage of trade-throughs even prior to the 997 Dissent, Conclusion.
securities. The Commission granted the switch from Amex to Nasdaq listing, there is no 998 See, e.g., supra, text accompanying notes 191–
basis to believe that the effect of the switch on 196 (discussing rule provisions that respond to
991 Dissent,note 6. spreads, if accurately stated, is related to any commenters’ suggestions on ways to make rules
992 SecuritiesExchange Act Release No. 46428 change in trade-through protection. workable and implementable in a fair and orderly
(Aug. 28, 2002), 67 FR 56607 (Sep. 14, 2002). 995 Trade-Through Study, Tables 3, 10. fashion).
thereunder, 17 CFR 240.11Aa3–2(b)(2) greater than $4.00 multiplied by the a quote shall be determined by
and 17 CFR 240.11Aa3–2(c)(1), the total number of qualified transaction multiplying the price of a quote by its
Commission: (1) Redesignates the NMS reports in such Eligible Security during size.
rules under Section 11A of the the calendar year, the excess amount
Governance Amendment
Exchange Act as Regulation NMS rules; shall be subtracted from the initial
(2) adopts Rules 600, 610, 611, and 612 allocation for such Eligible Security and (#) Advisory Committee.
of Regulation NMS; (3) amends current reallocated among all Eligible Securities (a) Formation. Notwithstanding any
Rules 11Aa3–1 and 11Ac1–2 under the in direct proportion to the dollar other provision of this Plan, an
Exchange Act and redesignates them as volume of transaction reports Advisory Committee to the Plan shall be
Rules 601 and 603 of Regulation NMS; disseminated by the Processor in formed and shall function in accordance
(4) amends the CTA Plan, the CQ Plan, Eligible Securities during the calendar with the provisions set forth in this
and the Nasdaq UTP Plan; and (5) year. A transaction report with a dollar section.
amends various other rules to reflect the volume of $5000 or more shall
adoption of Regulation NMS, as set forth constitute one qualified transaction (b) Composition. Members of the
below. report. A transaction report with a Advisory Committee shall be selected
dollar volume of less than $5000 shall for two-year terms as follows:
XIV. Text of Adopted Amendments to (1) Operating Committee Selections.
constitute a fraction of a qualified
the CTA Plan, the CQ Plan, and the By affirmative vote of a majority of the
transaction report that equals the dollar
Nasdaq UTP Plan Participants entitled to vote, the
volume of the transaction report divided
The Commission hereby amends the by $5000. Operating Committee shall select at
CTA Plan, the CQ Plan, and the Nasdaq (c) Trading Share. The Trading Share least one representative from each of the
UTP Plan to incorporate the new net of a Participant in an Eligible Security following categories to be members of
income allocation formula into each shall be determined by multiplying (i) the Advisory Committee: (i) a broker-
Plan, which supersedes the existing an amount equal to fifty percent of the dealer with a substantial retail investor
allocation formulas in those Plans, and Security Income Allocation for the customer base, (ii) a broker-dealer with
to incorporate the new Plan governance Eligible Security by (ii) the Participant’s a substantial institutional investor
language into each Plan. Trade Rating in the Eligible Security. A customer base, (iii) an alternative
Set forth below is the text of (1) the Participant’s Trade Rating in an Eligible trading system, (iv) a data vendor, and
new allocation formula to be Security shall be determined by taking (v) an investor.
incorporated into each of the Plans, and the average of (i) the Participant’s (2) Participant Selections. Each
(2) the new Plan governance language to percentage of the total dollar volume of Participant shall have the right to select
be incorporated into each of the Plans. transaction reports disseminated by the one member of the Advisory Committee.
Allocation Amendment Processor in the Eligible Security during A Participant shall not select any person
the calendar year, and (ii) the employed by or affiliated with any
(#) Allocation of Net Income. Participant’s percentage of the total Participant or its affiliates or facilities.
(a) Annual Payment. Notwithstanding number of qualified transaction reports
any other provision of this Plan, each (c) Function. Members of the
disseminated by the Processor in the Advisory Committee shall have the right
Participant eligible to receive Eligible Security during the calendar
distributable net income under the Plan to submit their views to the Operating
year. Committee on Plan matters, prior to a
shall receive an annual payment for (d) Quoting Share. The Quoting Share
each calendar year that is equal to the decision by the Operating Committee on
of a Participant in an Eligible Security
sum of the Participant’s Trading Shares such matters. Such matters shall
shall be determined by multiplying (i)
and Quoting Shares, as defined below, include, but not be limited to, any new
an amount equal to fifty percent of the
in each Eligible Security for the or modified product, fee, contract, or
Security Income Allocation for the
calendar year. pilot program that is offered or used
Eligible Security by (ii) the Participant’s
(b) Security Income Allocation. The pursuant to the Plan.
Quote Rating in the Eligible Security. A
Security Income Allocation for an Participant’s Quote Rating in an Eligible (d) Meetings and Information.
Eligible Security shall be determined by Security shall be determined by Members of the Advisory Committee
multiplying (i) the distributable net dividing (i) the sum of the Quote Credits shall have the right to attend all
income of the Plan for the calendar year earned by the Participant in such meetings of the Operating Committee
by (ii) the Volume Percentage for such Eligible Security during the calendar and to receive any information
Eligible Security (the ‘‘initial year by (ii) the sum of the Quote Credits concerning Plan matters that is
allocation’’), and then adding or earned by all Participants in such distributed to the Operating Committee;
subtracting any amounts specified in the Eligible Security during the calendar provided, however, that the Operating
reallocation set forth below. The year. A Participant shall earn one Quote Committee may meet in executive
Volume Percentage for an Eligible Credit for each second of time (with a session if, by affirmative vote of a
Security shall be determined by minimum of one full second) multiplied majority of the Participants entitled to
dividing (i) the square root of the dollar by dollar value of size that an automated vote, the Operating Committee
volume of transaction reports best bid (offer) transmitted by the determines that an item of Plan business
disseminated by the Processor in such Participant to the Processor during requires confidential treatment.
Eligible Security during the calendar regular trading hours is equal to the XV. Text of Adopted Rules
year by (ii) the sum of the square roots price of the national best bid (offer) in
of the dollar volume of transaction the Eligible Security and does not lock List of Subjects
reports disseminated by the Processor in or cross a previously displayed 17 CFR Part 200
each Eligible Security during the automated quotation. An automated bid
calendar year. If the initial allocation of (offer) shall have the meaning specified Administrative practice and
distributable net income in accordance in Rule 600 of Regulation NMS of the procedure, Authority delegations
with the Volume Percentage of an Exchange Act for an ‘‘automated (Government agencies), Organization
Eligible Security equals an amount quotation.’’ The dollar value of size of and functions (Government agencies).
17 CFR Part 201 (a) * * * (61) To grant exemptions from Rule

Administrative practice and (27) To approve amendments to the 604 (17 CFR 242.604), pursuant to Rule
procedure, Securities. joint industry plan governing 604(c) (17 CFR 242.604(c)).
consolidated transaction reporting * * * * *
17 CFR Parts 230 and 270 declared effective by the Commission (68) Pursuant to Rule 605(b) (17 CFR
Reporting and recordkeeping pursuant to Rule 601 (17 CFR 242.601) 242.605(b)), to grant or deny
requirements, Securities. or its predecessors, Rule 11Aa3–1 and exemptions, conditionally or
Rule 17a–15, and to grant exemptions unconditionally, from any provision or
17 CFR Parts 240, 242, and 249
from Rule 601 pursuant to Rule 601(f) provisions of Rule 605 (17 CFR
Brokers, Reporting and recordkeeping (17 CFR 242.601(f)) to exchanges trading 242.605).
requirements, Securities. listed securities that are designated as (69) Pursuant to Rule 606(c) (17 CFR
■ For the reasons set out in the preamble, national market system securities until 242.606(c)), to grant or deny
Title 17, Chapter II of the Code of the such times as a Joint Reporting Plan for exemptions, conditionally or
Federal Regulations is amended as such securities is filed and approved by unconditionally, from any provision or
follows: the Commission. provisions of Rule 606 (17 CFR
(28) To grant exemptions from Rule 242.606).
PART 200—ORGANIZATION;
602 (17 CFR 242.602), pursuant to Rule * * * * *
CONDUCT AND ETHICS; AND
602(d) (17 CFR 242.602(d)). (81) To grant or deny exemptions
INFORMATION AND REQUESTS
* * * * * from Rule 610 (17 CFR 242.610),
■ 1. The authority citation for part 200 (36) To grant exemptions from Rule pursuant to Rule 610(e) (17 CFR
continues to read in part as follows: 603 (17 CFR 242.603), pursuant to Rule 242.610(e)).
Authority: 15 U.S.C. 77s, 77o, 77sss, 78d, 603(d) (17 CFR 242.603(d)). (82) To grant or deny exemptions
78d–1, 78d–2, 78w, 78ll(d), 78mm, 79t, 80a– (37) Pursuant to Rule 600 (17 CFR from Rule 611 (17 CFR 242.611),
37, 80b–11, and 7202, unless otherwise pursuant to Rule 611(d) (17 CFR
242.600), to publish notice of the filing
noted. 242.611(d)).
of a designation plan with respect to
* * * * * national market system securities, or (83) To grant or deny exemptions
■ 2. Section 200.30–3 is amended by: any proposed amendment thereto, and from Rule 612 (17 CFR 242.612),
■ a. Removing paragraphs (a)(62) and to approve such plan or amendment. pursuant to Rule 612(c) (17 CFR
(a)(71); 242.612(c)).
■ b. Redesignating paragraphs (a)(63)
* * * * *
(42) Under 17 CFR 242.608(e), to grant * * * * *
through (a)(70) as paragraphs (a)(62)
through (a)(69); or deny exemptions from 17 CFR
Subpart N—Commission Information
■ c. Redesignating paragraphs (a)(72) 242.608.
Collection Requirements Under the
through (a)(82) as paragraphs (a)(70) * * * * * Paperwork Reduction Act: OMB
through (a)(80); (49) Pursuant to section 11A(b) of the Control Numbers
■ d. Revising paragraphs (a)(27), (a)(28), Act (15 U.S.C. 78k–1(b)) and Rule 609
(a)(36), (a)(37), (a)(42), (a)(49), (a)(61), thereunder (17 CFR 242.609), to publish ■ 3. The authority citation for Subpart N
and newly redesignated paragraphs notice of and, by order, grant under continues to read as follows:
(a)(68), and (a)(69); and section 11A(b) of the Act and Rule 609
■ e. Adding new paragraphs (a)(81),
Authority: 44 U.S.C. 3506; 44 U.S.C. 3507.
thereunder: Applications for registration
(a)(82), and (a)(83). ■ 4. Section 200.800 is amended by
as a securities information processor;
■ The revisions and additions read as revising paragraph (b) to read as follows:
and exemptions from that section and
follows:
any rules or regulations promulgated § 200.800 OMB control numbers assigned
§ 200.30–3 Delegation of authority to thereunder, either conditionally or pursuant to the Paperwork Reduction Act.
Director of Division of Market Regulation. unconditionally. * * * * *
* * * * * * * * * * (b) Display.
Current OMB
Information collection requirement 17 CFR part or section where identified and described control No.
Regulation S–X ........................................................................... PART 210 ................................................................................... 3235–0009

Regulation S–B ........................................................................... PART 228 ................................................................................... 3235–0417
Regulation S–K ........................................................................... PART 229 ................................................................................... 3235–0071
Rule 154 ..................................................................................... 230.154 ....................................................................................... 3235–0495
Rule 155 ..................................................................................... 230.155 ....................................................................................... 3235–0549
Rule 236 ..................................................................................... 230.236 ....................................................................................... 3235–0095
Rule 237 ..................................................................................... 230.237 ....................................................................................... 3235–0528
Regulation A ............................................................................... 230.251 thru 230.263 ................................................................. 3235–0286
Regulation C ............................................................................... 230.400 thru 230.494 ................................................................. 3235–0074
Rule 425 ..................................................................................... 230.425 ....................................................................................... 3235–0521
Rule 477 ..................................................................................... 230.477 ....................................................................................... 3235–0550
Rule 489 ..................................................................................... 230.489 ....................................................................................... 3235–0411
Rule 498 ..................................................................................... 230.498 ....................................................................................... 3235–0488
Regulation D ............................................................................... 230.501 thru 230.506 ................................................................. 3235–0076
Regulation E ............................................................................... 230.601 thru 230.610a ............................................................... 3235–0232
Rule 604 ..................................................................................... 230.604 ....................................................................................... 3235–0232
Rule 605 ..................................................................................... 230.605 ....................................................................................... 3235–0232
Rule 609 ..................................................................................... 230.609 ....................................................................................... 3235–0233
Rule 701 ..................................................................................... 230.701 ....................................................................................... 3235–0522
Regulation S ............................................................................... 230.901 thru 230.905 ................................................................. 3235–0357
Current OMB
Regulation S–T ........................................................................... Part 232 ...................................................................................... 3235–0424

Form SB–1 ................................................................................. 239.9 ........................................................................................... 3235–0423
Form SB–2 ................................................................................. 239.10 ......................................................................................... 3235–0418
Form S–1 .................................................................................... 239.11 ......................................................................................... 3235–0065
Form S–2 .................................................................................... 239.12 ......................................................................................... 3235–0072
Form S–3 .................................................................................... 239.13 ......................................................................................... 3235–0073
Form N–2 .................................................................................... 239.14 ......................................................................................... 3235–0026
Form N–1A ................................................................................. 239.15A ...................................................................................... 3235–0307
Form S–6 .................................................................................... 239.16 ......................................................................................... 3235–0184
Form S–8 .................................................................................... 239.16b ....................................................................................... 3235–0066
Form N–3 .................................................................................... 239.17a ....................................................................................... 3235–0316
Form N–4 .................................................................................... 239.17b ....................................................................................... 3235–0318
Form S–11 .................................................................................. 239.18 ......................................................................................... 3235–0067
Form N–14 .................................................................................. 239.23 ......................................................................................... 3235–0336
Form N–5 .................................................................................... 239.24 ......................................................................................... 3235–0169
Form S–4 .................................................................................... 239.25 ......................................................................................... 3235–0324
Form F–1 .................................................................................... 239.31 ......................................................................................... 3235–0258
Form F–2 .................................................................................... 239.32 ......................................................................................... 3235–0257
Form F–3 .................................................................................... 239.33 ......................................................................................... 3235–0256
Form F–4 .................................................................................... 239.34 ......................................................................................... 3235–0325
Form F–6 .................................................................................... 239.36 ......................................................................................... 3235–0292
Form F–7 .................................................................................... 239.37 ......................................................................................... 3235–0383
Form F–8 .................................................................................... 239.38 ......................................................................................... 3235–0378
Form F–9 .................................................................................... 239.39 ......................................................................................... 3235–0377
Form F–10 .................................................................................. 239.40 ......................................................................................... 3235–0380
Form F–80 .................................................................................. 239.41 ......................................................................................... 3235–0404
Form F–X .................................................................................... 239.42 ......................................................................................... 3235–0379
Form F–N ................................................................................... 239.43 ......................................................................................... 3235–0411
Form ET ...................................................................................... 239.62 ......................................................................................... 3235–0329
Form ID ....................................................................................... 239.63 ......................................................................................... 3235–0328
Form SE ..................................................................................... 239.64 ......................................................................................... 3235–0327
Form TH ..................................................................................... 239.65 ......................................................................................... 3235–0425
Form 1–A .................................................................................... 239.90 ......................................................................................... 3235–0286
Form 2–A .................................................................................... 239.91 ......................................................................................... 3235–0286
Form 144 .................................................................................... 239.144 ....................................................................................... 3235–0101
Form 1–E .................................................................................... 239.200 ....................................................................................... 3235–0232
Form CB ..................................................................................... 239.800 ....................................................................................... 3235–0518
Rule 6a–1 ................................................................................... 240.6a–1 ..................................................................................... 3235–0017
Rule 6a–3 ................................................................................... 240.6a–3 ..................................................................................... 3235–0021
Rule 6a–4 ................................................................................... 240.6a–4 ..................................................................................... 3235–0554
Rule 6h–1 ................................................................................... 240.6h–1 ..................................................................................... 3235–0555
Rule 8c–1 ................................................................................... 240.8c–1 ..................................................................................... 3235–0514
Rule 9b–1 ................................................................................... 240.9b–1 ..................................................................................... 3235–0480
Rule 10a–1 ................................................................................. 240.10a–1 ................................................................................... 3235–0475
Rule 10b–10 ............................................................................... 240.10b–10 ................................................................................. 3235–0444
Rule 10b–17 ............................................................................... 240.10b–17 ................................................................................. 3235–0476
Rule 10b–18 ............................................................................... 240.10b–18 ................................................................................. 3235–0474
Rule 10A–1 ................................................................................. 240.10A–1 .................................................................................. 3235–0468
Rule 11a1–1(T) ........................................................................... 240.11a1–1(T) ............................................................................ 3235–0478
Rule 12a–5 ................................................................................. 240.12a–5 ................................................................................... 3235–0079
Regulation 12B ........................................................................... 240.12b–1 thru 240.12b–36 ....................................................... 3235–0062
Rule 12d1–3 ............................................................................... 240.12d1–3 ................................................................................. 3235–0109
Rule 12d2–1 ............................................................................... 240.12d2–1 ................................................................................. 3235–0081
Rule 12d2–2 ............................................................................... 240.12d2–2 ................................................................................. 3235–0080
Rule 12f–1 .................................................................................. 240.12f–1 .................................................................................... 3235–0128
Rule 13a–16 ............................................................................... 240.13a–16 ................................................................................. 3235–0116
Regulation 13D/G ....................................................................... 240.13d–1 thru 240.13d–7 ......................................................... 3235–0145
Schedule 13D ............................................................................. 240.13d–101 ............................................................................... 3235–0145
Schedule 13G ............................................................................. 240.13d–102 ............................................................................... 3235–0145
Rule 13e–1 ................................................................................. 240.13e–1 ................................................................................... 3235–0305
Rule 13e–3 ................................................................................. 240.13e–3 ................................................................................... 3235–0007
Schedule 13E–3 ......................................................................... 240.13e–100 ............................................................................... 3235–0007
Schedule 13e–4F ....................................................................... 240.13e–101 ............................................................................... 3235–0375
Regulation 14A ........................................................................... 240.14a–1 thru 240.14a–12 ....................................................... 3235–0059
Schedule 14A ............................................................................. 240.14a–101 ............................................................................... 3235–0059
Regulation 14C ........................................................................... 240.14c–1 ................................................................................... 3235–0057
Schedule 14C ............................................................................. 240.14c–101 ............................................................................... 3235–0057
Regulation 14D ........................................................................... 240.14d–1 thru 240.14d–9 ......................................................... 3235–0102
Schedule TO ............................................................................... 240.14d–100 ............................................................................... 3235–0515
Schedule 14D–1 ......................................................................... 240.14d–101 ............................................................................... 3235–0102
Schedule 14D–9 ......................................................................... 240.14d–101 ............................................................................... 3235–0102
Schedule 14D–1F ....................................................................... 240.14d–102 ............................................................................... 3235–0376
Schedule 14D–9F ....................................................................... 240.14d–103 ............................................................................... 3235–0382
Current OMB
Regulation 14E ........................................................................... 240.14e–1 thru 240.14e–2 ......................................................... 3235–0102

Rule 14f–1 .................................................................................. 240.14f–1 .................................................................................... 3235–0108
Rule 15a–4 ................................................................................. 240.15a–4 ................................................................................... 3235–0010
Rule 15a–6 ................................................................................. 240.15a–6 ................................................................................... 3235–0371
Rule 15b1–1 ............................................................................... 240.15b1–1 ................................................................................. 3235–0012
Rule 15b6–1(a) ........................................................................... 240.15b6–1(a) ............................................................................ 3235–0018
Rule 15c1–5 ............................................................................... 240.15c1–5 ................................................................................. 3235–0471
Rule 15c1–6 ............................................................................... 240.15c1–6 ................................................................................. 3235–0472
Rule 15c1–7 ............................................................................... 240.15c1–7 ................................................................................. 3235–0134
Rule 15c2–1 ............................................................................... 240.15c2–1 ................................................................................. 3235–0485
Rule 15c2–5 ............................................................................... 240.15c2–5 ................................................................................. 3235–0198
Rule 15c2–7 ............................................................................... 240.15c2–7 ................................................................................. 3235–0479
Rule 15c2–8 ............................................................................... 240.15c2–8 ................................................................................. 3235–0481
Rule 15c2–11 ............................................................................. 240.15c2–11 ............................................................................... 3235–0202
Rule 15c2–12 ............................................................................. 240.15c2–12 ............................................................................... 3235–0372
Rule 15c3–1 ............................................................................... 240.15c3–1 ................................................................................. 3235–0200
Rule 15c3–1(c)(13) ..................................................................... 240.15c3–1(c)(13) ...................................................................... 3235–0499
Appendix F to Rule 15c3–1 ........................................................ 240.15c3–1f ................................................................................ 3235–0496
Rule 15c3–3 ............................................................................... 240.15c3–3 ................................................................................. 3235–0078
Rule 15c3–4 ............................................................................... 240.15c3–4 ................................................................................. 3235–0497
Rule 15d–16 ............................................................................... 240.15d–16 ................................................................................. 3235–0116
Rule 15g–2 ................................................................................. 240.15g–2 ................................................................................... 3235–0434
Rule 15g–3 ................................................................................. 240.15g–3 ................................................................................... 3235–0392
Rule 15g–4 ................................................................................. 240.15g–4 ................................................................................... 3235–0393
Rule 15g–5 ................................................................................. 240.15g–5 ................................................................................... 3235–0394
Rule 15g–6 ................................................................................. 240.15g–6 ................................................................................... 3235–0395
Rule 15g–9 ................................................................................. 240.15g–9 ................................................................................... 3235–0385
Rule 15Aj–1 ................................................................................ 240.15Aj–1 ................................................................................. 3235–0044
Rule 15Ba2–1 ............................................................................. 240.15Ba2–1 .............................................................................. 3235–0083
Rule 15Ba2–5 ............................................................................. 240.15Ba2–5 .............................................................................. 3235–0088
Rule 15Bc3–1 ............................................................................. 240.15Bc3–1 .............................................................................. 3235–0087
Rule 17a–1 ................................................................................. 240.17a–1 ................................................................................... 3235–0208
Rule 17a–2 ................................................................................. 240.17a–2 ................................................................................... 3235–0201
Rule 17a–3 ................................................................................. 240.17a–3 ................................................................................... 3235–0033
Rule 17a–3(a)(16) ...................................................................... 240.17a–3(a)(16) ........................................................................ 3235–0508
Rule 17a–4 ................................................................................. 240.17a–4 ................................................................................... 3235–0279
Rule 17a–4(b)(10) ...................................................................... 240.17a–4(b)(10) ........................................................................ 3235–0506
Rule 17a–5 ................................................................................. 240.17a–5 ................................................................................... 3235–0123
Rule 17a–5(c) ............................................................................. 240.17a–5(c) .............................................................................. 3235–0199
Rule 17a–6 ................................................................................. 240.17a–6 ................................................................................... 3235–0489
Rule 17a–7 ................................................................................. 240.17a–7 ................................................................................... 3235–0131
Rule 17a–8 ................................................................................. 240.17a–8 ................................................................................... 3235–0092
Rule 17a–9T ............................................................................... 240.17a–9T ................................................................................ 3235–0524
Rule 17a–10 ............................................................................... 240.17a–10 ................................................................................. 3235–0122
Rule 17a–11 ............................................................................... 240.17a–11 ................................................................................. 3235–0085
Rule 17a–12 ............................................................................... 240.17a–12 ................................................................................. 3235–0498
Rule 17a–13 ............................................................................... 240.17a–13 ................................................................................. 3235–0035
Rule 17a–19 ............................................................................... 240.17a–19 ................................................................................. 3235–0133
Rule 17a–22 ............................................................................... 240.17a–22 ................................................................................. 3235–0196
Rule 17a–25 ............................................................................... 240.17a–25 ................................................................................. 3235–0540
Rule 17f–1(b) .............................................................................. 240.17f–1(b) ............................................................................... 3235–0032
Rule 17f–1(c) .............................................................................. 240.17f–1(c) ............................................................................... 3235–0037
Rule 17f–1(g) .............................................................................. 240.17f–1(g) ............................................................................... 3235–0290
Rule 17f–2(a) .............................................................................. 240.17f–2(a) ............................................................................... 3235–0034
Rule 17f–2(c) .............................................................................. 240.17f–2(c) ............................................................................... 3235–0029
Rule 17f–2(d) .............................................................................. 240.17f–2(d) ............................................................................... 3235–0028
Rule 17f–2(e) .............................................................................. 240.17f–2(e) ............................................................................... 3235–0031
Rule 17f–5 .................................................................................. 240.17f–5 .................................................................................... 3235–0269
Rule 17h–1T ............................................................................... 240.17h–1T ................................................................................ 3235–0410
Rule 17h–2T ............................................................................... 240.17h–2T ................................................................................ 3235–0410
Rule 17Ab2–1 ............................................................................. 240.17Ab2–1(a) .......................................................................... 3235–0195
Rule 17Ac2–1 ............................................................................. 240.17Ac2–1 .............................................................................. 3235–0084
Rule 17Ad–2(c), (d), and (h) ...................................................... 240.17Ad–2(c), (d) and (h) ......................................................... 3235–0130
Rule 17Ad–3(b) .......................................................................... 240.17Ad–3(b) ............................................................................ 3235–0473
Rule 17Ad–4(b) and (c) .............................................................. 240.17Ad–4(b) and (c) ............................................................... 3235–0341
Rule 17Ad–6 ............................................................................... 240.17Ad–6 ................................................................................ 3235–0291
Rule 17Ad–7 ............................................................................... 240.17Ad–7 ................................................................................ 3235–0291
Rule 17Ad–10 ............................................................................. 240.17Ad–10 .............................................................................. 3235–0273
Rule 17Ad–11 ............................................................................. 240.17Ad–11 .............................................................................. 3235–0274
Rule 17Ad–13 ............................................................................. 240.17Ad–13 .............................................................................. 3235–0275
Rule 17Ad–15 ............................................................................. 240.17Ad–15 .............................................................................. 3235–0409
Rule 17Ad–16 ............................................................................. 240.17Ad–16 .............................................................................. 3235–0413
Rule 17Ad–17 ............................................................................. 240.17Ad–17 .............................................................................. 3235–0469
Current OMB
Rule 19b–1 ................................................................................. 240.19b–1 ................................................................................... 3235–0354

Rule 19b–4 ................................................................................. 240.19b–4 ................................................................................... 3235–0045
Rule 19b–4(e) ............................................................................. 240.19b–4(e) .............................................................................. 3235–0504
Rule 19b–5 ................................................................................. 240.19b–5 ................................................................................... 3235–0507
Rule 19b–7 ................................................................................. 240.19b–7 ................................................................................... 3235–0553
Rule 19d–1 ................................................................................. 240.19d–1(b) thru 240.19d–1(i) ................................................. 3235–0206
Rule 19d–2 ................................................................................. 240.19d–2 ................................................................................... 3235–0205
Rule 19d–3 ................................................................................. 240.19d–3 ................................................................................... 3235–0204
Rule 19h–1 ................................................................................. 240.19h–1(a), (c) thru (e), and (g) ............................................. 3235–0259
Rule 24b–1 ................................................................................. 240.24b–1 ................................................................................... 3235–0194
Rule 101 ..................................................................................... 242.101 ....................................................................................... 3235–0464
Rule 102 ..................................................................................... 242.102 ....................................................................................... 3235–0467
Rule 103 ..................................................................................... 242.103 ....................................................................................... 3235–0466
Rule 104 ..................................................................................... 242.104 ....................................................................................... 3235–0465
Rule 301 ..................................................................................... 242.301 ....................................................................................... 3235–0509
Rule 302 ..................................................................................... 242.302 ....................................................................................... 3235–0510
Rule 303 ..................................................................................... 242.303 ....................................................................................... 3235–0505
Rule 604 ..................................................................................... 242.604 ....................................................................................... 3235–0462
Rule 605 ..................................................................................... 242.605 ....................................................................................... 3235–0542
Rule 606 ..................................................................................... 242.606 ....................................................................................... 3235–0541
Rule 607 ..................................................................................... 242.607 ....................................................................................... 3235–0435
Rule 608 ..................................................................................... 242.608 ....................................................................................... 3235–0500
Rule 609 ..................................................................................... 242.609 ....................................................................................... 3235–0043
Rule 611 ..................................................................................... 242.611 ....................................................................................... 3235–0600
Regulation S–P ........................................................................... Part 248 ...................................................................................... 3235–0537
Form 1 ........................................................................................ 249.1 ........................................................................................... 3235–0017
Form 1–N .................................................................................... 249.10 ......................................................................................... 3235–0554
Form 25 ...................................................................................... 249.25 ......................................................................................... 3235–0080
Form 26 ...................................................................................... 249.26 ......................................................................................... 3235–0079
Form 3 ........................................................................................ 249.103 ....................................................................................... 3235–0104
Form 4 ........................................................................................ 249.104 ....................................................................................... 3235–0287
Form 5 ........................................................................................ 249.105 ....................................................................................... 3235–0362
Form 8–A .................................................................................... 249.208a ..................................................................................... 3235–0056
Form 10 ...................................................................................... 249.210 ....................................................................................... 3235–0064
Form 10–SB ............................................................................... 249.210b ..................................................................................... 3235–0419
Form 18 ...................................................................................... 249.218 ....................................................................................... 3235–0121
Form 20–F .................................................................................. 249.220f ...................................................................................... 3235–0288
Form 40–F .................................................................................. 249.240f ...................................................................................... 3235–0381
Form 6–K .................................................................................... 249.306 ....................................................................................... 3235–0116
Form 8–K .................................................................................... 249.308 ....................................................................................... 3235–0060
Form 10–Q ................................................................................. 249.308a ..................................................................................... 3235–0070
Form 10–QSB ............................................................................. 249.308b ..................................................................................... 3235–0416
Form 10–K .................................................................................. 249.310 ....................................................................................... 3235–0063
Form 10–KSB ............................................................................. 249.310b ..................................................................................... 3235–0420
Form 11–K .................................................................................. 249.311 ....................................................................................... 3235–0082
Form 18–K .................................................................................. 249.318 ....................................................................................... 3235–0120
Form 12B–25 .............................................................................. 249.322 ....................................................................................... 3235–0058
Form 15 ...................................................................................... 249.323 ....................................................................................... 3235–0167
Form 13F .................................................................................... 249.325 ....................................................................................... 3235–0006
Form SE ..................................................................................... 249.444 ....................................................................................... 3235–0327
Form ET ...................................................................................... 249.445 ....................................................................................... 3235–0329
Form ID ....................................................................................... 249.446 ....................................................................................... 3235–0328
Form DF ..................................................................................... 249.448 ....................................................................................... 3235–0482
Form BD ..................................................................................... 249.501 ....................................................................................... 3235–0012
Form BDW .................................................................................. 249.501a ..................................................................................... 3235–0018
Form BD–N ................................................................................. 249.501b ..................................................................................... 3235–0556
Form X–17A–5 ........................................................................... 249.617 ....................................................................................... 3235–0123
Form X–17A–19 ......................................................................... 249.635 ....................................................................................... 3235–0133
Form ATS ................................................................................... 249.637 ....................................................................................... 3235–0509
Form ATS–R ............................................................................... 249.638 ....................................................................................... 3235–0509
Form X–15AJ–1 .......................................................................... 249.802 ....................................................................................... 3235–0044
Form X–15AJ–2 .......................................................................... 249.803 ....................................................................................... 3235–0044
Form 19b–4 ................................................................................ 249.819 ....................................................................................... 3235–0045
Form 19b–4(e) ............................................................................ 249.820 ....................................................................................... 3235–0504
Form Pilot ................................................................................... 249.821 ....................................................................................... 3235–0507
Form SIP .................................................................................... 249.1001 ..................................................................................... 3235–0043
Form MSD .................................................................................. 249.1100 ..................................................................................... 3235–0083
Form MSDW ............................................................................... 249.1110 ..................................................................................... 3235–0087
Form X–17F–1A ......................................................................... 249.1200 ..................................................................................... 3235–0037
Form TA–1 .................................................................................. 249b.100 ..................................................................................... 3235–0084
Form TA–W ................................................................................ 249b.101 ..................................................................................... 3235–0151
Form TA–2 .................................................................................. 249b.102 ..................................................................................... 3235–0337
Form CA–1 ................................................................................. 249b.200 ..................................................................................... 3235–0195
Current OMB
Rule 1(a) ..................................................................................... 250.1(a) ...................................................................................... 3235–0170

Rule 1(b) ..................................................................................... 250.1(b) ...................................................................................... 3235–0170
Rule 1(c) ..................................................................................... 250.1(c) ...................................................................................... 3235–0164
Rule 2 ......................................................................................... 250.2 ........................................................................................... 3235–0161
Rule 3 ......................................................................................... 250.3 ........................................................................................... 3235–0160
Rule 7 ......................................................................................... 250.7 ........................................................................................... 3235–0165
Rule 7(d) ..................................................................................... 250.7(d) ...................................................................................... 3235–0165
Rule 20(b) ................................................................................... 250.20(b) .................................................................................... 3235–0125
Rule 20(c) ................................................................................... 250.20(c) .................................................................................... 3235–0125
Rule 20(d) ................................................................................... 250.20(d) .................................................................................... 3235–0163
Rule 23 ....................................................................................... 250.23 ......................................................................................... 3235–0125
Rule 24 ....................................................................................... 250.24 ......................................................................................... 3235–0126
Rule 26 ....................................................................................... 250.26 ......................................................................................... 3235–0183
Rule 29 ....................................................................................... 250.29 ......................................................................................... 3235–0149
Rule 44 ....................................................................................... 250.44 ......................................................................................... 3235–0147
Rule 45 ....................................................................................... 250.45 ......................................................................................... 3235–0154
Rule 47(b) ................................................................................... 250.47(b) .................................................................................... 3235–0163
Rule 52 ....................................................................................... 250.52 ......................................................................................... 3235–0369
Form 53 ...................................................................................... 250.53 ......................................................................................... 3235–0426
Rule 54 ....................................................................................... 250.54 ......................................................................................... 3235–0427
Rule 57(a) ................................................................................... 250.57(a) .................................................................................... 3235–0428
Rule 57(b) ................................................................................... 250.57(b) .................................................................................... 3235–0429
Rule 58 ....................................................................................... 250.58 ......................................................................................... 3235–0457
Rule 62 ....................................................................................... 250.62 ......................................................................................... 3235–0152
Rule 71(a) ................................................................................... 250.71(a) .................................................................................... 3235–0173
Rule 72 ....................................................................................... 250.72 ......................................................................................... 3235–0149
Rule 83 ....................................................................................... 250.83 ......................................................................................... 3235–0181
Rule 87 ....................................................................................... 250.87 ......................................................................................... 3235–0552
Rule 88 ....................................................................................... 250.88 ......................................................................................... 3235–0182
Rule 93 ....................................................................................... 250.93 ......................................................................................... 3235–0153
Rule 94 ....................................................................................... 250.94 ......................................................................................... 3235–0153
Rule 95 ....................................................................................... 250.95 ......................................................................................... 3235–0162
Rule 100(a) ................................................................................. 250.100(a) .................................................................................. 3235–0125
Uniform System of Accounts for Mutual Service Companies Part 256 ...................................................................................... 3235–0153
and Subsidiary Service Companies, Public Utility Holding
Company Act of 1935.
Preservation and Destruction of Records of Registered Public Part 257 ...................................................................................... 3235–0306
Utility Holding Companies and of Mutual and Subsidiary
Service Companies.
Form U5A ................................................................................... 259.5a ......................................................................................... 3235–0170
Form U5B ................................................................................... 259.5b ......................................................................................... 3235–0170
Form U5S ................................................................................... 259.5s ......................................................................................... 3235–0164
Form U–1 .................................................................................... 259.101 ....................................................................................... 3235–0125
Form U–13–1 .............................................................................. 259.113 ....................................................................................... 3235–0182
Form U–6B–2 ............................................................................. 259.206 ....................................................................................... 3235–0163
Form U–57 .................................................................................. 259.207 ....................................................................................... 3235–0428
Form U–9C–3 ............................................................................. 259.208 ....................................................................................... 3235–0457
Form U–12(I)–A .......................................................................... 259.212a ..................................................................................... 3235–0173
Form U–12(I)–B .......................................................................... 259.212b ..................................................................................... 3235–0173
Form U–13E–1 ........................................................................... 259.213 ....................................................................................... 3235–0162
Form U–R–1 ............................................................................... 259.221 ....................................................................................... 3235–0152
Form U–13–60 ............................................................................ 259.313 ....................................................................................... 3235–0153
Form U–3A–2 ............................................................................. 259.402 ....................................................................................... 3235–0161
Form U–3A3–1 ........................................................................... 259.403 ....................................................................................... 3235–0160
Form U–7D ................................................................................. 259.404 ....................................................................................... 3235–0165
Form U–33–S ............................................................................. 259.405 ....................................................................................... 3235–0429
Form ET ...................................................................................... 259.601 ....................................................................................... 3235–0329
Form ID ....................................................................................... 259.602 ....................................................................................... 3235–0328
Form SE ..................................................................................... 259.603 ....................................................................................... 3235–0327
Rule 7a–15 thru 7a–37 ............................................................... 260.7a–15 thru 260.7a–37 ......................................................... 3235–0132
Form T–1 .................................................................................... 269.1 ........................................................................................... 3235–0110
Form T–2 .................................................................................... 269.2 ........................................................................................... 3235–0111
Form T–3 .................................................................................... 269.3 ........................................................................................... 3235–0105
Form T–4 .................................................................................... 269.4 ........................................................................................... 3235–0107
Form ET ...................................................................................... 269.6 ........................................................................................... 3235–0329
Form ID ....................................................................................... 269.7 ........................................................................................... 3235–0328
Form SE ..................................................................................... 269.8 ........................................................................................... 3235–0327
Form T–6 .................................................................................... 269.9 ........................................................................................... 3235–0391
Rule 0–1 ..................................................................................... 270.0–1 ....................................................................................... 3235–0531
Rule 2a–7 ................................................................................... 270.2a–7 ..................................................................................... 3235–0268
Rule 2a19–1 ............................................................................... 270.2a19–1 ................................................................................. 3235–0332
Rule 3a–4 ................................................................................... 270.3a–4 ..................................................................................... 3235–0459
Rule 6c–7 ................................................................................... 270.6c–7 ..................................................................................... 3235–0276
Current OMB
Rule 6e–2 ................................................................................... 270.6e–2 ..................................................................................... 3235–0177

Rule 7d–1 ................................................................................... 270.7d–1 ..................................................................................... 3235–0311
Rule 7d–2 ................................................................................... 270.7d–2 ..................................................................................... 3235–0527
Section 8(b) of the Investment Company Act of 1940 ............... 270.8b–1 thru 270.8b–32 ........................................................... 3235–0176
Rule 10f–3 .................................................................................. 270.10f–3 .................................................................................... 3235–0226
Rule 11a–2 ................................................................................. 270.11a–2 ................................................................................... 3235–0272
Rule 11a–3 ................................................................................. 270.11a–3 ................................................................................... 3235–0358
Rule 12b–1 ................................................................................. 270.12b–1 ................................................................................... 3235–0212
Rule 17a–7 ................................................................................. 270.17a–7 ................................................................................... 3235–0214
Rule 17a–8 ................................................................................. 270.17a–8 ................................................................................... 3235–0235
Rule 17e–1 ................................................................................. 270.17e–1 ................................................................................... 3235–0217
Rule 17f–1 .................................................................................. 270.17f–1 .................................................................................... 3235–0222
Rule 17f–2 .................................................................................. 270.17f–2 .................................................................................... 3235–0223
Rule 17f–4 .................................................................................. 270.17f–4 .................................................................................... 3235–0225
Rule 17f–6 .................................................................................. 270.17f–6 .................................................................................... 3235–0447
Rule 17f–7 .................................................................................. 270.17f–7 .................................................................................... 3235–0529
Rule 17g–1(g) ............................................................................. 270.17g–1(g) .............................................................................. 3235–0213
Rule 17j–1 .................................................................................. 270.17j–1 .................................................................................... 3235–0224
Rule 18f–1 .................................................................................. 270.18f–1 .................................................................................... 3235–0211
Rule 18f–3 .................................................................................. 270.18f–3 .................................................................................... 3235–0441
Rule 19a–1 ................................................................................. 270.19a–1 ................................................................................... 3235–0216
Rule 20a–1 ................................................................................. 270.20a–1 ................................................................................... 3235–0158
Rule 22d–1 ................................................................................. 270.22d–1 ................................................................................... 3235–0310
Rule 23c–1 ................................................................................. 270.23c–1 ................................................................................... 3235–0260
Rule 23c–3 ................................................................................. 270.23c–3 ................................................................................... 3235–0422
Rule 27e–1 ................................................................................. 270.27e–1 ................................................................................... 3235–0545
Rule 30b2–1 ............................................................................... 270.30b2–1 ................................................................................. 3235–0220
Rule 30d–2 ................................................................................. 270.30d–2 ................................................................................... 3235–0494
Rule 30e–1 ................................................................................. 270.30e–1 ................................................................................... 3235–0025
Rule 31a–1 ................................................................................. 270.31a–1 ................................................................................... 3235–0178
Rule 31a–2 ................................................................................. 270.31a–2 ................................................................................... 3235–0179
Rule 32a–4 ................................................................................. 270.32a–4 ................................................................................... 3235–0530
Rule 34b–1 ................................................................................. 270.34b–1 ................................................................................... 3235–0346
Rule 35d–1 ................................................................................. 270.35d–1 ................................................................................... 3235–0548
Form N–5 .................................................................................... 274.5 ........................................................................................... 3235–0169
Form N–8A ................................................................................. 274.10 ......................................................................................... 3235–0175
Form N–2 .................................................................................... 274.11a–1 ................................................................................... 3235–0026
Form N–3 .................................................................................... 274.11b ....................................................................................... 3235–0316
Form N–4 .................................................................................... 274.11c ....................................................................................... 3235–0318
Form N–8B–2 ............................................................................. 274.12 ......................................................................................... 3235–0186
Form N–6F ................................................................................. 274.15 ......................................................................................... 3235–0238
Form 24F–2 ................................................................................ 274.24 ......................................................................................... 3235–0456
Form N–18F–1 ........................................................................... 274.51 ......................................................................................... 3235–0211
Form N–54A ............................................................................... 274.53 ......................................................................................... 3235–0237
Form N–54C ............................................................................... 274.54 ......................................................................................... 3235–0236
Form N–SAR .............................................................................. 274.101 ....................................................................................... 3235–0330
Form N–27E–1 ........................................................................... 274.127e–1 ................................................................................. 3235–0545
Form N–27F–1 ........................................................................... 274.127f–1 .................................................................................. 3235–0546
Form N–17D–1 ........................................................................... 274.200 ....................................................................................... 3235–0229
Form N–23C–1 ........................................................................... 274.201 ....................................................................................... 3235–0230
Form N–8F ................................................................................. 274.218 ....................................................................................... 3235–0157
Form N–17F–1 ........................................................................... 274.219 ....................................................................................... 3235–0359
Form N–17F–2 ........................................................................... 274.220 ....................................................................................... 3235–0360
Form N–23c–3 ............................................................................ 274.221 ....................................................................................... 3235–0422
Form ET ...................................................................................... 274.401 ....................................................................................... 3235–0329
Form ID ....................................................................................... 274.402 ....................................................................................... 3235–0328
Form SE ..................................................................................... 274.403 ....................................................................................... 3235–0327
Rule 0–2 ..................................................................................... 275.0–2 ....................................................................................... 3235–0240
Rule 203–3 ................................................................................. 275.203–3 ................................................................................... 3235–0538
Rule 204–2 ................................................................................. 275.204–2 ................................................................................... 3235–0278
Rule 204–3 ................................................................................. 275.204–3 ................................................................................... 3235–0047
Rule 206(3)–2 ............................................................................. 275.206(3)–2 .............................................................................. 3235–0243
Rule 206(4)–2 ............................................................................. 275.206(4)–2 .............................................................................. 3235–0241
Rule 206(4)–3 ............................................................................. 275.206(4)–3 .............................................................................. 3235–0242
Rule 206(4)–4 ............................................................................. 275.206(4)–4 .............................................................................. 3235–0345
Form ADV ................................................................................... 279.1 ........................................................................................... 3235–0049
Schedule I to Form ADV ............................................................ 279.1 ........................................................................................... 3235–0490
Form ADV–W ............................................................................. 279.2 ........................................................................................... 3235–0313
Form ADV–H .............................................................................. 379.3 ........................................................................................... 3235–0538
Form 4–R .................................................................................... 279.4 ........................................................................................... 3235–0240
Form 5–R .................................................................................... 279.5 ........................................................................................... 3235–0240
Form 6–R .................................................................................... 279.6 ........................................................................................... 3235–0240
Form 7–R .................................................................................... 279.7 ........................................................................................... 3235–0240
Current OMB
Form ADV–E .............................................................................. 279.8 ........................................................................................... 3235–0361
PART 201—RULES OF PRACTICE during the four-week period specified in § 240.10a–1 Short sales.
paragraph (e)(1)(ii) of this section. (a)(1)(i) No person shall, for his own
Subpart D—Rules of Practice * * * * * account or for the account of any other
■ 5. The authority citation for part 201, person, effect a short sale of any security
PART 240—GENERAL RULES AND registered on, or admitted to unlisted
subpart D, continues to read as follows: REGULATIONS, SECURITIES trading privileges on, a national
Authority: 15 U.S.C. 77f, 77g, 77h, 77h–1, EXCHANGE ACT OF 1934 securities exchange, if trades in such
77j, 77s, 77u, 78c(b), 78d–1, 78d–2, 78l, 78m, securities are reported pursuant to an
78n, 78o(d), 78o–3, 78s, 78u–2, 78u–3, 78v, ■ 9. The authority citation for part 240
78w, 79c, 79s, 79t, 79z–5a, 77sss, 77ttt, 80a–
‘‘effective transaction reporting plan’’ as
continues to read as follows: defined in § 242.600 of this chapter and
8, 80a–9, 80a–37, 80a–38, 80a–39, 80a–40,
80a–41, 80a–44, 80b–3, 80b–9, 80b–11, 80b- Authority: 15 U.S.C. 77c, 77d, 77g, 77j, information as to such trades is made
12, 7202, 7215, and 7217. 77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, available in accordance with such plan
77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 78j, on a real-time basis to vendors of market
■ 6. Section 201.101 is amended by 78j–1, 78k, 78k–1, 78l, 78m, 78n, 78o, 78p,
revising paragraphs (a)(9)(vi) and transaction information:
78q, 78s, 78u–5, 78w, 78x, 78ll, 78mm, 79q,
(a)(9)(vii) to read as follows: 79t, 80a–20, 80a–23, 80a–29, 80a–37, 80b–3, (A) Below the price at which the last
80b–4, 80b–11, and 7201 et seq.; and 18 sale thereof, regular way, was reported
§ 201.101 Definitions. U.S.C. 1350, unless otherwise noted. pursuant to an effective transaction
(a) * * * * * * * * reporting plan; or
(9) * * * (B) At such price unless such price is
(vi) By the filing, pursuant to ■ 10. Section 240.0–10 is amended by
revising paragraph (e)(1) to read as above the next proceeding different
§ 242.601 of this chapter, of an price at which a sale of such security,
application for review of an action or follows:
regular way, was reported pursuant to
failure to act in connection with the § 240.0–10 Small entities under the an effective transaction reporting plan.
implementation or operation of any Securities Exchange Act for purposes of (ii) The provisions of paragraph
effective transaction reporting plan; or the Regulatory Flexibility Act.
(vii) By the filing, pursuant to (a)(1)(i) of this section hereof shall not
* * * * * apply to transactions by any person in
§ 242.608 of this chapter, of an (e) * * *
application for review of an action taken Nasdaq securities as defined in
(1) Has been exempted from the § 242.600 of this chapter, except for
or failure to act in connection with the reporting requirements of § 242.601 of
implementation or operation of any those Nasdaq securities for which
this chapter; and transaction reports are collected,
effective national market system plan; or
* * * * * processed, and made available pursuant
* * * * * to the plan originally submitted to the
■ 11. Section 240.3a51–1 is amended by
PART 230—GENERAL RULES AND revising the introductory text of Commission pursuant to § 240.17a–15
REGULATIONS, SECURITIES ACT OF paragraphs (a) and (e) to read as follows: (subsequently amended and
1933 redesignated as § 240.11Aa3–1 and
§ 240.3a51–1 Definition of ‘‘penny stock.’’ subsequently redesignated as § 242.601
■ 7. The authority citation for part 230 * * * * * of this chapter), which plan was
continues to read in part as follows: (a) That is an NMS stock, as defined declared effective as of May 17, 1974.
in § 242.600 of this chapter: * * * * *
Authority: 15 U.S.C. 77b, 77c, 77d, 77f,
77g, 77h, 77j, 77r, 77s, 77z–3, 77sss, 78c, 78d, * * * * * (e) * * *
78j, 78l, 78m, 78n, 78o, 78t, 78w, 78ll(d), (e) That is registered, or approved for (5) * * *
78mm, 79t, 80a–8, 80a–24, 80a–28, 80a–29, registration upon notice of issuance, on (ii) Effected at a price equal to the
80a–30, and 80a–37, unless otherwise noted. a national securities exchange that most recent offer communicated for the
* * * * * makes transaction reports available security by such registered specialist,
■ 8. Section 230.144 is amended by: pursuant to § 242.601 of this chapter, registered exchange market maker or
■ a. Removing the authority citation provided that: third market maker to an exchange or a
following § 230.144; and * * * * * national securities association
■ b. Revising paragraph (e)(1)(iii). ■ 12. Section 240.3b–16 is amended by (‘‘association’’) pursuant to § 242.602 of
The revision reads as follows: revising paragraph (d) to read as follows: this chapter, if such offer, when
§ 230.144 Persons deemed not to be communicated, was equal to or above
§ 240.3b–16 Definitions of terms used in the last sale, regular way, reported for
engaged in a distribution and therefore not Section 3(a)(1) of the Act.
underwriters. such security pursuant to an effective
* * * * * transaction reporting plan:
* * * * * (d) For the purposes of this section,
(e) * * * Provided, however, That any
(1) * * * the terms bid and offer shall have the exchange, by rule, may prohibit its
(iii) The average weekly volume of same meaning as under § 242.600 of this registered specialist and registered
trading in such securities reported chapter. exchange market makers from availing
pursuant to an effective transaction * * * * * themselves of the exemption afforded by
reporting plan or an effective national ■ 13. Section 240.10a–1 is amended by this paragraph (e)(5) if that exchange
market system plan as those terms are revising paragraphs (a)(1), (e)(5)(ii) and determines that such action is necessary
defined in § 242.600 of this chapter (e)(11) to read as follows: or appropriate in its market in the
public interest or for the protection of price to the customer in the transaction, § 240.12f–2 Extending unlisted trading
investors; and the difference, if any, between the privileges to a security that is the subject
reported trade price and the price to the of an initial public offering.
* * * * *
(11) Any sale of a security covered by customer. (a) General provision. A national
paragraph (a) of this section (except a * * * * * securities exchange may extend unlisted
sale to a stabilizing bid complying with (d) * * * trading privileges to a subject security
§ 242.104 of this chapter) by any broker (7) NMS stock shall have the meaning when at least one transaction in the
or dealer, for his own account or for the provided in § 242.600 of this chapter. subject security has been effected on the
account of any other person, effected at * * * * * national securities exchange upon
a price equal to the most recent offer which the security is listed and the
■ 15. Section 240.10b–18 is amended by
communicated by such broker or dealer transaction has been reported pursuant
revising paragraph (a)(6) to read as to an effective transaction reporting
to an exchange or association pursuant
follows: plan, as defined in § 242.600 of this
to § 242.602 of this chapter in an
amount less than or equal to the § 240.10b–18 Purchases of certain equity chapter.
quotation size associated with such securities by the issuer and others. * * * * *
offer, if such offer, when communicated, * * * * * ■ 20. Section 240.15b9–1 is amended by:
was: (a) * * *
(i) Above the price at which the last ■ a. Removing the authority citation
(6) Consolidated system means a following the section; and
sale, regular way, for such security was consolidated transaction or quotation
reported pursuant to an effective ■ b. Revising paragraph (c).
reporting system that collects and
transaction reporting plan; or publicly disseminates on a current and ■ The revision reads as follows:
(ii) At such last sale price, if such last continuous basis transaction or
sale price is above the next preceding § 240.15b9–1 Exemption for certain
quotation information in common exchange members.
different price at which a sale of such equity securities pursuant to an effective
security, regular way, was reported transaction reporting plan or an * * * * *
pursuant to an effective transaction effective national market system plan (c) For purposes of this section, the
reporting plan. (as those terms are defined in § 242.600 term Intermarket Trading System shall
* * * * * of this chapter). mean the intermarket communications
■ 14. Section 240.10b–10 is amended by: linkage operated jointly by certain self-
* * * * *
■ a. Revising paragraphs (a)(2)(i)(C), regulatory organizations pursuant to a
(a)(2)(ii)(B) and (d)(7); § 240.11Aa2–1 through 240.11Ac1–6 plan filed with, and approved by, the
■ b. Removing paragraph (d)(8); and [Removed] Commission pursuant to § 242.608 of
■ c. Redesignating paragraphs (d)(9) and ■ 16. The undesignated center heading this chapter.
(d)(10) as paragraphs (d)(8) and (d)(9). preceding § 240.11Aa2–1 is removed; ■ 21. Section 240.15c2–11 is amended
The revisions read as follows: and §§ 240.11Aa2–1 through by revising paragraph (f)(5) to read as
§ 240.10b–10 Confirmation of transactions. 240.11Ac1–6 are removed. follows:
■ 17. Section 240.12a–7 is amended by
* * * * * § 240.15c2–11 Initiation or resumption of
(a) * * * revising the introductory text of quotations without specified information.
(2) * * * paragraph (a)(2) to read as follows: * * * * *
(i) * * * § 240.12a–7 Exemption of stock contained (f) * * *
(C) For a transaction in any NMS in standardized market baskets from (5) The publication or submission of
stock as defined in § 242.600 of this section 12(a) of the Act. a quotation respecting a Nasdaq security
chapter or a security authorized for (a) * * * (as defined in § 242.600 of this chapter),
quotation on an automated interdealer (2) The stock is an NMS stock as and such security’s listing is not
quotation system that has the defined in § 242.600 of this chapter and suspended, terminated, or prohibited.
characteristics set forth in section 17B of is either:
the Act (15 U.S.C. 78q–2), a statement * * * * *
whether payment for order flow is * * * * *
■ 22. Section 240.19c–3 is amended by
received by the broker or dealer for ■ 18. Section 240.12f–1 is amended by:
revising paragraph (b)(6) to read as
transactions in such securities and the ■ a. Removing the authority citation
follows:
fact that the source and nature of the following the section;
compensation received in connection ■ b. Removing ‘‘and’’ at the end of § 240.19c–3 Governing off-board trading
paragraph (a)(3); and by members of national securities
with the particular transaction will be
■ c. Revising paragraph (a)(4). exchanges.
furnished upon written request of the
customer; provided, however, that ■ The revision reads as follows: * * * * *
brokers or dealers that do not receive (b) * * *
§ 240.12f–1 Applications for permission to
payment for order flow in connection (6) The term effective transaction
reinstate unlisted trading privileges.
with any transaction have no disclosure reporting plan shall mean any plan
obligations under this paragraph; and (a) * * * approved by the Commission pursuant
(4) Whether transaction information to § 242.601 of this chapter for
* * * * *
(ii) * * * concerning such security is reported collecting, processing, and making
(B) In the case of any other transaction pursuant to an effective transaction available transaction reports with
in an NMS stock as defined by § 242.600 reporting plan contemplated by respect to transactions in an equity
of this chapter, or an equity security that § 242.601 of this chapter; security or class of equity securities.
is traded on a national securities * * * * * ■ 23. Section 240.19c–4 is amended by
exchange and that is subject to last sale ■ 19. Section 240.12f–2 is amended by revising paragraph (e)(6) to read as
reporting, the reported trade price, the revising paragraph (a) to read as follows: follows:
§ 240.19c–4 Governing certain listing or § 242.300 Definitions. cumulative size of such priced orders
authorization determinations by national * * * * * entered therein at such price, or the size
securities exchanges and associations. (g) NMS stock shall have the meaning of the execution sought by such broker-
* * * * * provided in § 242.600; provided, dealer.
(e) * * * however, that a debt or convertible debt * * * * *
(6) The term exchange shall mean a security shall not be deemed an NMS (5) Fair access. (i) An alternative
national securities exchange, registered stock for purposes of this Regulation trading system shall comply with the
as such with the Securities and ATS. requirements in paragraph (b)(5)(ii) of
Exchange Commission pursuant to (h) Effective transaction reporting this section, if during at least 4 of the
section 6 of the Act (15 U.S.C. 78f), plan shall have the meaning provided in preceding 6 calendar months, such
which makes transaction reports § 242.600. alternative trading system had:
available pursuant to § 242.601 of this (A) With respect to any NMS stock, 5
* * * * *
chapter; and percent or more of the average daily
■ 29. Section 242.301 is amended by
* * * * * volume in that security reported by an
revising paragraphs (b)(3), (b)(5), and
■ 24. Section 240.31 is amended by (b)(6) to read as follows: effective transaction reporting plan;
revising paragraph (a)(11)(v) to read as (B) With respect to an equity security
follows: § 242.301 Requirements for alternative that is not an NMS stock and for which
trading systems. transactions are reported to a self-
§ 240.31 Section 31 transaction fees. * * * * * regulatory organization, 5 percent or
(a) * * * (b) * * * more of the average daily trading
(11) * * * (3) Order display and execution volume in that security as calculated by
(v) Any sale of a security that is access. (i) An alternative trading system the self-regulatory organization to which
executed outside the United States and shall comply with the requirements set such transactions are reported;
is not reported, or required to be forth in paragraph (b)(3)(ii) of this (C) With respect to municipal
reported, to a transaction reporting section, with respect to any NMS stock securities, 5 percent or more of the
association as defined in § 242.600 of in which the alternative trading system: average daily volume traded in the
this chapter and any approved plan (A) Displays subscriber orders to any United States;
filed thereunder; person (other than alternative trading (D) With respect to investment grade
* * * * * system employees); and corporate debt, 5 percent or more of the
(B) During at least 4 of the preceding average daily volume traded in the
PART 242—REGULATIONS M, SHO, 6 calendar months, had an average daily United States; or
ATS, AC, AND NMS AND CUSTOMER trading volume of 5 percent or more of (E) With respect to non-investment
MARGIN REQUIREMENTS FOR the aggregate average daily share grade corporate debt, 5 percent or more
SECURITY FUTURES volume for such NMS stock as reported of the average daily volume traded in
by an effective transaction reporting the United States.
■ 25. The authority citation for part 242 (ii) An alternative trading system
plan.
continues to read as follow: shall:
(ii) Such alternative trading system
Authority: 15 U.S.C. 77g, 77q(a), 77s(a), (A) Establish written standards for
shall provide to a national securities
78b, 78c, 78g(c)(2), 78i(a), 78j, 78k–1(c), 78l, granting access to trading on its system;
exchange or national securities (B) Not unreasonably prohibit or limit
78m, 78n, 78o(b), 78o(c), 78o(g), 78q(a), association the prices and sizes of the
78q(b), 78q(h), 78w(a), 78dd–1, 78mm, 80a– any person in respect to access to
23, 80a–29, and 80a–37.
orders at the highest buy price and the services offered by such alternative
lowest sell price for such NMS stock, trading system by applying the
■ 26. The part heading for part 242 is displayed to more than one person in
revised as set forth above. standards established under paragraph
the alternative trading system, for (b)(5)(ii)(A) of this section in an unfair
■ 27. Section 242.100 is amended by
inclusion in the quotation data made or discriminatory manner;
revising the definition for ‘‘electronic available by the national securities
communications network’’ and (C) Make and keep records of:
exchange or national securities (1) All grants of access including, for
‘‘Nasdaq’’ found in paragraph (b) to read association to vendors pursuant to
as follows: all subscribers, the reasons for granting
§ 242.602. such access; and
§ 242.100 Preliminary note; definitions. (iii) With respect to any order (2) All denials or limitations of access
* * * * * displayed pursuant to paragraph and reasons, for each applicant, for
(b)(3)(ii) of this section, an alternative denying or limiting access; and
* * * * * trading system shall provide to any (D) Report the information required
(b) * * * broker-dealer that has access to the on Form ATS–R (§ 249.638 of this
Electronic communications network national securities exchange or national chapter) regarding grants, denials, and
has the meaning provided in § 242.600. securities association to which the limitations of access.
alternative trading system provides the (iii) Notwithstanding paragraph
* * * * *
prices and sizes of displayed orders (b)(5)(i) of this section, an alternative
Nasdaq means the electronic dealer
pursuant to paragraph (b)(3)(ii) of this trading system shall not be required to
quotation system owned and operated
section, the ability to effect a transaction comply with the requirements in
by The Nasdaq Stock Market, Inc.
with such orders that is: paragraph (b)(5)(ii) of this section, if
* * * * * (A) Equivalent to the ability of such such alternative trading system:
■ 28. Section 242.300 is amended by: broker-dealer to effect a transaction with (A) Matches customer orders for a
■ a. Revising paragraphs (g) and (h); other orders displayed on the exchange security with other customer orders;
■ b. Removing paragraphs (i) and (j); and or by the association; and (B) Such customers’ orders are not
■ c. Redesignating paragraphs (k), (l), (B) At the price of the highest priced displayed to any person, other than
and (m) as paragraphs (i), (j), and (k). buy order or lowest priced sell order employees of the alternative trading
■ The revisions read as follows: displayed for the lesser of the system; and
(C) Such orders are executed at a price (G) Promptly notify the Commission (2) Alternative trading system has the
for such security disseminated by an staff of material systems outages and meaning provided in § 242.300(a).
effective transaction reporting plan, or significant systems changes. (3) Automated quotation means a
derived from such prices. (iii) Notwithstanding paragraph quotation displayed by a trading center
(6) Capacity, integrity, and security of (b)(6)(i) of this section, an alternative that:
automated systems. (i) The alternative trading system shall not be required to (i) Permits an incoming order to be
trading system shall comply with the comply with the requirements in marked as immediate-or-cancel;
requirements in paragraph (b)(6)(ii) of paragraph (b)(6)(ii) of this section, if (ii) Immediately and automatically
this section, if during at least 4 of the such alternative trading system: executes an order marked as immediate-
preceding 6 calendar months, such (A) Matches customer orders for a or-cancel against the displayed
alternative trading system had: security with other customer orders; quotation up to its full size;
(A) With respect to any NMS stock, 20 (B) Such customers’ orders are not (iii) Immediately and automatically
percent or more of the average daily displayed to any person, other than cancels any unexecuted portion of an
volume reported by an effective employees of the alternative trading order marked as immediate-or-cancel
transaction reporting plan; system; and without routing the order elsewhere;
(B) With respect to equity securities (C) Such orders are executed at a price (iv) Immediately and automatically
that are not NMS stocks and for which for such security disseminated by an transmits a response to the sender of an
transactions are reported to a self- effective transaction reporting plan, or order marked as immediate-or-cancel
regulatory organization, 20 percent or derived from such prices. indicating the action taken with respect
more of the average daily volume as * * * * * to such order; and
calculated by the self-regulatory ■ 30. Part 242 is amended by adding
(v) Immediately and automatically
organization to which such transactions Regulation NMS, §§ 242.600 through displays information that updates the
are reported; 242.612, to read as follows: displayed quotation to reflect any
(C) With respect to municipal change to its material terms.
securities, 20 percent or more of the Regulation NMS—Regulation of the (4) Automated trading center means a
average daily volume traded in the National Market System trading center that:
United States; Sec. (i) Has implemented such systems,
(D) With respect to investment grade 242.600 NMS security designation and procedures, and rules as are necessary
corporate debt, 20 percent or more of definitions. to render it capable of displaying
the average daily volume traded in the 242.601 Dissemination of transaction quotations that meet the requirements
United States; or reports and last sale data with respect to for an automated quotation set forth in
(E) With respect to non-investment transactions in NMS stocks. paragraph (b)(3) of this section;
242.602 Dissemination of quotations in (ii) Identifies all quotations other than
grade corporate debt, 20 percent or more
NMS securities. automated quotations as manual
of the average daily volume traded in 242.603 Distribution, consolidation, and
the United States. display of information with respect to
quotations;
(ii) With respect to those systems that quotations for and transactions in NMS (iii) Immediately identifies its
support order entry, order routing, order stocks. quotations as manual quotations
execution, transaction reporting, and 242.604 Display of customer limit orders. whenever it has reason to believe that it
trade comparison, the alternative 242.605 Disclosure of order execution is not capable of displaying automated
trading system shall: information. quotations; and
(A) Establish reasonable current and 242.606 Disclosure of order routing (iv) Has adopted reasonable standards
future capacity estimates; information. limiting when its quotations change
(B) Conduct periodic capacity stress 242.607 Customer account statements. from automated quotations to manual
242.608 Filing and amendment of national quotations, and vice versa, to
tests of critical systems to determine market system plans.
such system’s ability to process 242.609 Registration of securities
specifically defined circumstances that
transactions in an accurate, timely, and information processors: form of promote fair and efficient access to its
efficient manner; application and amendments. automated quotations and are consistent
(C) Develop and implement 242.610 Access to quotations. with the maintenance of fair and orderly
reasonable procedures to review and 242.611 Order protection rule. markets.
keep current its system development 242.612 Minimum pricing increment. (5) Average effective spread means the
and testing methodology; share-weighted average of effective
Regulation NMS—Regulation of the
(D) Review the vulnerability of its spreads for order executions calculated,
National Market System
systems and data center computer for buy orders, as double the amount of
operations to internal and external § 242.600 NMS security designation and difference between the execution price
threats, physical hazards, and natural definitions. and the midpoint of the national best
disasters; (a) The term national market system bid and national best offer at the time
(E) Establish adequate contingency security as used in section 11A(a)(2) of of order receipt and, for sell orders, as
and disaster recovery plans; the Act (15 U.S.C. 78k–1(a)(2)) shall double the amount of difference
(F) On an annual basis, perform an mean any NMS security as defined in between the midpoint of the national
independent review, in accordance with paragraph (b) of this section. best bid and national best offer at the
established audit procedures and (b) For purposes of Regulation NMS time of order receipt and the execution
standards, of such alternative trading (§§ 242.600 through 242.612), the price.
system’s controls for ensuring that following definitions shall apply: (6) Average realized spread means the
paragraphs (b)(6)(ii)(A) through (E) of (1) Aggregate quotation size means share-weighted average of realized
this section are met, and conduct a the sum of the quotation sizes of all spreads for order executions calculated,
review by senior management of a responsible brokers or dealers who have for buy orders, as double the amount of
report containing the recommendations communicated on any national difference between the execution price
and conclusions of the independent securities exchange bids or offers for an and the midpoint of the national best
review; and NMS security at the same price. bid and national best offer five minutes
after the time of order execution and, for for execution, including, but not limited the term electronic communications
sell orders, as double the amount of to, orders to be executed at a market network shall not include:
difference between the midpoint of the opening price or a market closing price, (i) Any system that crosses multiple
national best bid and national best offer orders submitted with stop prices, orders at one or more specified times at
five minutes after the time of order orders to be executed only at their full a single price set by the system (by
execution and the execution price; size, orders to be executed on a algorithm or by any derivative pricing
provided, however, that the midpoint of particular type of tick or bid, orders mechanism) and does not allow orders
the final national best bid and national submitted on a ‘‘not held’’ basis, orders to be crossed or executed against
best offer disseminated for regular for other than regular settlement, and directly by participants outside of such
trading hours shall be used to calculate orders to be executed at prices unrelated times; or
a realized spread if it is disseminated to the market price of the security at the (ii) Any system operated by, or on
less than five minutes after the time of time of execution. behalf of, an OTC market maker or
order execution. (16) Customer means any person that exchange market maker that executes
(7) Best bid and best offer mean the is not a broker or dealer. customer orders primarily against the
highest priced bid and the lowest priced (17) Customer limit order means an account of such market maker as
offer. order to buy or sell an NMS stock at a principal, other than riskless principal.
(8) Bid or offer means the bid price or specified price that is not for the (24) Exchange market maker means
the offer price communicated by a account of either a broker or dealer; any member of a national securities
member of a national securities provided, however, that the term exchange that is registered as a
exchange or member of a national customer limit order shall include an specialist or market maker pursuant to
securities association to any broker or order transmitted by a broker or dealer the rules of such exchange.
dealer, or to any customer, at which it on behalf of a customer. (25) Exchange-traded security means
is willing to buy or sell one or more (18) Customer order means an order to any NMS security or class of NMS
round lots of an NMS security, as either buy or sell an NMS security that is not securities listed and registered, or
principal or agent, but shall not include for the account of a broker or dealer, but admitted to unlisted trading privileges,
indications of interest. shall not include any order for a on a national securities exchange;
(9) Block size with respect to an order quantity of a security having a market provided, however, that securities not
means it is: value of at least $50,000 for an NMS listed on any national securities
(i) Of at least 10,000 shares; or security that is an option contract and exchange that are traded pursuant to
(ii) For a quantity of stock having a a market value of at least $200,000 for unlisted trading privileges are excluded.
market value of at least $200,000. any other NMS security. (26) Executed at the quote means, for
(10) Categorized by order size means (19) Directed order means a customer buy orders, execution at a price equal to
dividing orders into separate categories order that the customer specifically the national best offer at the time of
for sizes from 100 to 499 shares, from instructed the broker or dealer to route order receipt and, for sell orders,
500 to 1999 shares, from 2000 to 4999 to a particular venue for execution. execution at a price equal to the
shares, and 5000 or greater shares. (20) Dynamic market monitoring national best bid at the time of order
(11) Categorized by order type means device means any service provided by a receipt.
dividing orders into separate categories vendor on an interrogation device or (27) Executed outside the quote
for market orders, marketable limit other display that: means, for buy orders, execution at a
orders, inside-the-quote limit orders, at- (i) Permits real-time monitoring, on a price higher than the national best offer
the-quote limit orders, and near-the- dynamic basis, of transaction reports, at the time of order receipt and, for sell
quote limit orders. last sale data, or quotations with respect orders, execution at a price lower than
(12) Categorized by security means to a particular security; and the national best bid at the time of order
dividing orders into separate categories (ii) Displays the most recent receipt.
for each NMS stock that is included in transaction report, last sale data, or (28) Executed with price improvement
a report. quotation with respect to that security means, for buy orders, execution at a
(13) Consolidated display means: until such report, data, or quotation has price lower than the national best offer
(i) The prices, sizes, and market been superseded or supplemented by at the time of order receipt and, for sell
identifications of the national best bid the display of a new transaction report, orders, execution at a price higher than
and national best offer for a security; last sale data, or quotation reflecting the the national best bid at the time of order
and next reported transaction or quotation in receipt.
(ii) Consolidated last sale information that security. (29) Inside-the-quote limit order, at-
for a security. (21) Effective national market system the-quote limit order, and near-the-
(14) Consolidated last sale plan means any national market system quote limit order mean non-marketable
information means the price, volume, plan approved by the Commission buy orders with limit prices that are,
and market identification of the most (either temporarily or on a permanent respectively, higher than, equal to, and
recent transaction report for a security basis) pursuant to § 242.608. lower by $0.10 or less than the national
that is disseminated pursuant to an (22) Effective transaction reporting best bid at the time of order receipt, and
effective national market system plan. plan means any transaction reporting non-marketable sell orders with limit
(15) Covered order means any market plan approved by the Commission prices that are, respectively, lower than,
order or any limit order (including pursuant to § 242.601. equal to, and higher by $0.10 or less
immediate-or-cancel orders) received by (23) Electronic communications than the national best offer at the time
a market center during regular trading network means, for the purposes of of order receipt.
hours at a time when a national best bid § 242.602(b)(5), any electronic system (30) Intermarket sweep order means a
and national best offer is being that widely disseminates to third parties limit order for an NMS stock that meets
disseminated, and, if executed, is orders entered therein by an exchange the following requirements:
executed during regular trading hours, market maker or OTC market maker, (i) When routed to a trading center,
but shall exclude any order for which and permits such orders to be executed the limit order is identified as an
the customer requests special handling against in whole or in part; except that intermarket sweep order; and
(ii) Simultaneously with the routing (42) National best bid and national (52) OTC market maker means any
of the limit order identified as an best offer means, with respect to dealer that holds itself out as being
intermarket sweep order, one or more quotations for an NMS security, the best willing to buy from and sell to its
additional limit orders, as necessary, are bid and best offer for such security that customers, or others, in the United
routed to execute against the full are calculated and disseminated on a States, an NMS stock for its own
displayed size of any protected bid, in current and continuing basis by a plan account on a regular or continuous basis
the case of a limit order to sell, or the processor pursuant to an effective otherwise than on a national securities
full displayed size of any protected national market system plan; provided, exchange in amounts of less than block
offer, in the case of a limit order to buy, that in the event two or more market size.
for the NMS stock with a price that is centers transmit to the plan processor (53) Participants, when used in
superior to the limit price of the limit pursuant to such plan identical bids or connection with a national market
order identified as an intermarket sweep offers for an NMS security, the best bid system plan, means any self-regulatory
order. These additional routed orders or best offer (as the case may be) shall organization which has agreed to act in
also must be marked as intermarket be determined by ranking all such accordance with the terms of the plan
sweep orders. identical bids or offers (as the case may but which is not a signatory of such
(31) Interrogation device means any be) first by size (giving the highest plan.
securities information retrieval system ranking to the bid or offer associated (54) Payment for order flow has the
capable of displaying transaction with the largest size), and then by time meaning provided in § 240.10b–10 of
reports, last sale data, or quotations (giving the highest ranking to the bid or this chapter.
upon inquiry, on a current basis on a offer received first in time). (55) Plan processor means any self-
terminal or other device. (43) National market system plan regulatory organization or securities
(32) Joint self-regulatory organization means any joint self-regulatory information processor acting as an
plan means a plan as to which two or organization plan in connection with: exclusive processor in connection with
more self-regulatory organizations, (i) The planning, development, the development, implementation and/
acting jointly, are sponsors. operation or regulation of a national or operation of any facility
(33) Last sale data means any price or market system (or a subsystem thereof) contemplated by an effective national
volume data associated with a or one or more facilities thereof; or market system plan.
transaction. (ii) The development and (56) Profit-sharing relationship means
(34) Listed equity security means any implementation of procedures and/or any ownership or other type of
equity security listed and registered, or facilities designed to achieve affiliation under which the broker or
admitted to unlisted trading privileges, compliance by self-regulatory dealer, directly or indirectly, may share
on a national securities exchange. organizations and their members with in any profits that may be derived from
(35) Listed option means any option any section of this Regulation NMS and the execution of non-directed orders.
part 240, subpart A of this chapter (57) Protected bid or protected offer
traded on a registered national securities
promulgated pursuant to section 11A of means a quotation in an NMS stock that:
exchange or automated facility of a
(i) Is displayed by an automated
national securities association. the Act (15 U.S.C. 78k–1).
trading center;
(36) Make publicly available means (44) National securities association (ii) Is disseminated pursuant to an
posting on an Internet Web site that is means any association of brokers and effective national market system plan;
free and readily accessible to the public, dealers registered pursuant to section and
furnishing a written copy to customers 15A of the Act (15 U.S.C. 78o-3). (iii) Is an automated quotation that is
on request without charge, and notifying (45) National securities exchange the best bid or best offer of a national
customers at least annually in writing means any exchange registered pursuant securities exchange, the best bid or best
that a written copy will be furnished on to section 6 of the Act (15 U.S.C. 78f). offer of The Nasdaq Stock Market, Inc.,
request. (46) NMS security means any security or the best bid or best offer of a national
(37) Manual quotation means any or class of securities for which securities association other than the best
quotation other than an automated transaction reports are collected, bid or best offer of The Nasdaq Stock
quotation. processed, and made available pursuant Market, Inc.
(38) Market center means any to an effective transaction reporting (58) Protected quotation means a
exchange market maker, OTC market plan, or an effective national market protected bid or a protected offer.
maker, alternative trading system, system plan for reporting transactions in (59) Published aggregate quotation
national securities exchange, or national listed options. size means the aggregate quotation size
securities association. (47) NMS stock means any NMS calculated by a national securities
(39) Marketable limit order means any security other than an option. exchange and displayed by a vendor on
buy order with a limit price equal to or (48) Non-directed order means any a terminal or other display device at the
greater than the national best offer at the customer order other than a directed time an order is presented for execution
time of order receipt, or any sell order order. to a responsible broker or dealer.
with a limit price equal to or less than (49) Odd-lot means an order for the (60) Published bid and published offer
the national best bid at the time of order purchase or sale of an NMS stock in an means the bid or offer of a responsible
receipt. amount less than a round lot. broker or dealer for an NMS security
(40) Moving ticker means any (50) Options class means all of the put communicated by it to its national
continuous real-time moving display of option or call option series overlying a securities exchange or association
transaction reports or last sale data security, as defined in section 3(a)(10) of pursuant to § 242.602 and displayed by
(other than a dynamic market the Act (15 U.S.C. 78c(a)(10)). a vendor on a terminal or other display
monitoring device) provided on an (51) Options series means the device at the time an order is presented
interrogation or other display device. contracts in an options class that have for execution to such responsible broker
(41) Nasdaq security means any the same unit of trade, expiration date, or dealer.
registered security listed on The Nasdaq and exercise price, and other terms or (61) Published quotation size means
Stock Market, Inc. conditions. the quotation size of a responsible
broker or dealer communicated by it to communicating the bid or offer (ii) With respect to a member of a
its national securities exchange or (regardless of whether such bid or offer national securities association:
association pursuant to § 242.602 and is for its own account or on behalf of (A) Any exchange-traded security for
displayed by a vendor on a terminal or another person). which such member acts in the capacity
other display device at the time an order (66) Revised bid or offer means a of an OTC market maker unless the
is presented for execution to such market maker’s bid or offer which executed volume of such member,
responsible broker or dealer. supersedes its published bid or during the most recent calendar quarter,
(62) Quotation means a bid or an published offer. comprised one percent or less of the
offer. (67) Revised quotation size means a aggregate trading volume for such
(63) Quotation size, when used with market maker’s quotation size which security as reported pursuant to an
respect to a responsible broker’s or supersedes its published quotation size. effective transaction reporting plan or
dealer’s bid or offer for an NMS (68) Self-regulatory organization effective national market system plan;
security, means: means any national securities exchange and
(i) The number of shares (or units of or national securities association. (B) Any other NMS security for which
trading) of that security which such (69) Specified persons, when used in such member acts in the capacity of an
responsible broker or dealer has connection with any notification OTC market maker and has in effect an
specified, for purposes of dissemination required to be provided pursuant to election, pursuant to § 242.602(a)(5)(ii),
to vendors, that it is willing to buy at to communicate to its association bids,
§ 242.602(a)(3) and any election (or
the bid price or sell at the offer price offers, and quotation sizes for the
withdrawal thereof) permitted under
comprising its bid or offer, as either purpose of making such bids, offers, and
§ 242.602(a)(5), means:
principal or agent; or quotation sizes available to a vendor.
(ii) In the event such responsible (i) Each vendor;
(ii) Each plan processor; and (74) Time of order execution means
broker or dealer has not so specified, a
(iii) The processor for the Options the time (to the second) that an order
normal unit of trading for that NMS
Price Reporting Authority (in the case of was executed at any venue.
security.
(64) Regular trading hours means the a notification for a subject security (75) Time of order receipt means the
time between 9:30 a.m. and 4:00 p.m. which is a class of securities underlying time (to the second) that an order was
Eastern Time, or such other time as is options admitted to trading on any received by a market center for
set forth in the procedures established national securities exchange). execution.
pursuant to § 242.605(a)(2). (70) Sponsor, when used in (76) Time of the transaction has the
(65) Responsible broker or dealer connection with a national market meaning provided in § 240.10b–10 of
means: system plan, means any self-regulatory this chapter.
(i) When used with respect to bids or organization which is a signatory to (77) Trade-through means the
offers communicated on a national such plan and has agreed to act in purchase or sale of an NMS stock during
securities exchange, any member of accordance with the terms of the plan. regular trading hours, either as principal
such national securities exchange who (71) SRO display-only facility means a or agent, at a price that is lower than a
communicates to another member on facility operated by or on behalf of a protected bid or higher than a protected
such national securities exchange, at the national securities exchange or national offer.
location (or locations) or through the securities association that displays (78) Trading center means a national
facility or facilities designated by such quotations in a security, but does not securities exchange or national
national securities exchange for trading execute orders against such quotations securities association that operates an
in an NMS security a bid or offer for or present orders to members for SRO trading facility, an alternative
such NMS security, as either principal execution. trading system, an exchange market
or agent; provided, however, that, in the (72) SRO trading facility means a maker, an OTC market maker, or any
event two or more members of a facility operated by or on behalf of a other broker or dealer that executes
national securities exchange have national securities exchange or a orders internally by trading as principal
communicated on or through such national securities association that or crossing orders as agent.
national securities exchange bids or executes orders in a security or presents (79) Trading rotation means, with
offers for an NMS security at the same orders to members for execution. respect to an options class, the time
price, each such member shall be (73) Subject security means: period on a national securities exchange
considered a responsible broker or (i) With respect to a national during which:
dealer for that bid or offer, subject to the securities exchange: (i) Opening, re-opening, or closing
rules of priority and precedence then in (A) Any exchange-traded security transactions in options series in such
effect on that national securities other than a security for which the options class are not yet completed; and
exchange; and further provided, that for executed volume of such exchange, (ii) Continuous trading has not yet
a bid or offer which is transmitted from during the most recent calendar quarter, commenced or has not yet ended for the
one member of a national securities comprised one percent or less of the day in options series in such options
exchange to another member who aggregate trading volume for such class.
undertakes to represent such bid or offer security as reported pursuant to an (80) Transaction report means a
on such national securities exchange as effective transaction reporting plan or report containing the price and volume
agent, only the last member who effective national market system plan; associated with a transaction involving
undertakes to represent such bid or offer and the purchase or sale of one or more
as agent shall be considered the (B) Any other NMS security for which round lots of a security.
responsible broker or dealer for that bid such exchange has in effect an election, (81) Transaction reporting association
or offer; and pursuant to § 242.602(a)(5)(i), to collect, means any person authorized to
(ii) When used with respect to bids process, and make available to a vendor implement or administer any
and offers communicated by a member bids, offers, quotation sizes, and transaction reporting plan on behalf of
of an association to a broker or dealer aggregate quotation sizes communicated persons acting jointly under
or a customer, the member on such exchange; and § 242.601(a).
(82) Transaction reporting plan means transaction reports or last sale data will transaction reports or last sale data in
any plan for collecting, processing, not be disseminated in a fraudulent or moving tickers permitted by paragraph
making available or disseminating manipulative manner; (d) of this section are collected.
transaction reports with respect to (vii) Specific terms of access to (d) Charges. Nothing in this section
transactions in securities filed with the transaction reports made available or shall preclude any national securities
Commission pursuant to, and meeting disseminated pursuant to the plan; and exchange or national securities
the requirements of, § 242.601. (viii) That transaction reports or last sale association, separately or jointly,
(83) Vendor means any securities data made available to any vendor for pursuant to the terms of an effective
information processor engaged in the display on an interrogation device transaction reporting plan, from
business of disseminating transaction identify the marketplace where each imposing reasonable, uniform charges
reports, last sale data, or quotations with transaction was executed. (irrespective of geographic location) for
respect to NMS securities to brokers, (3) No transaction reporting plan filed distribution of transaction reports or last
dealers, or investors on a real-time or pursuant to this section, or any sale data.
other current and continuing basis, amendment to an effective transaction (e) Appeals. The Commission may, in
whether through an electronic reporting plan, shall become effective its discretion, entertain appeals in
communications network, moving unless approved by the Commission or connection with the implementation or
ticker, or interrogation device. otherwise permitted in accordance with operation of any effective transaction
the procedures set forth in § 242.608. reporting plan in accordance with the
§ 242.601 Dissemination of transaction (b) Prohibitions and reporting provisions of § 242.608(d).
reports and last sale data with respect to requirements. (1) No broker or dealer (f) Exemptions. The Commission may
transactions in NMS stocks. may execute any transaction in, or exempt from the provisions of this
(a) Filing and effectiveness of induce or attempt to induce the section, either unconditionally or on
transaction reporting plans. (1) Every purchase or sale of, any NMS stock: specified terms and conditions, any
national securities exchange shall file a (i) On or through the facilities of a national securities exchange, national
transaction reporting plan regarding national securities exchange unless securities association, broker, dealer, or
transactions in listed equity and Nasdaq there is an effective transaction specified security if the Commission
securities executed through its facilities, reporting plan with respect to determines that such exemption is
and every national securities association transactions in such security executed consistent with the public interest, the
shall file a transaction reporting plan on or through such exchange facilities; protection of investors and the removal
regarding transactions in listed equity or of impediments to, and perfection of the
and Nasdaq securities executed by its (ii) Otherwise than on a national mechanisms of, a national market
members otherwise than on a national securities exchange unless there is an system.
securities exchange. effective transaction reporting plan with
(2) Any transaction reporting plan, or respect to transactions in such security § 242.602 Dissemination of quotations in
any amendment thereto, filed pursuant executed otherwise than on a national NMS securities.
to this section shall be filed with the securities exchange by such broker or (a) Dissemination requirements for
Commission, and considered for dealer. national securities exchanges and
approval, in accordance with the (2) Every broker or dealer who is a national securities associations. (1)
procedures set forth in § 242.608(a) and member of a national securities Every national securities exchange and
(b). Any such plan, or amendment exchange or national securities national securities association shall
thereto, shall specify, at a minimum: association shall promptly transmit to establish and maintain procedures and
(i) The listed equity and Nasdaq the exchange or association of which it mechanisms for collecting bids, offers,
securities or classes of such securities is a member all information required by quotation sizes, and aggregate quotation
for which transaction reports shall be any effective transaction reporting plan sizes from responsible brokers or dealers
required by the plan; filed by such exchange or association who are members of such exchange or
(ii) Reporting requirements with (either individually or jointly with other association, processing such bids, offers,
respect to transactions in listed equity exchanges and/or associations). and sizes, and making such bids, offers,
securities and Nasdaq securities, for any (c) Retransmission of transaction and sizes available to vendors, as
broker or dealer subject to the plan; reports or last sale data. follows:
(iii) The manner of collecting, Notwithstanding any provision of any (i) Each national securities exchange
processing, sequencing, making effective transaction reporting plan, no shall at all times such exchange is open
available and disseminating transaction national securities exchange or national for trading, collect, process, and make
reports and last sale data reported securities association may, either available to vendors the best bid, the
pursuant to such plan; individually or jointly, by rule, stated best offer, and aggregate quotation sizes
(iv) The manner in which such policy or practice, transaction reporting for each subject security listed or
transaction reports reported pursuant to plan or otherwise, prohibit, condition or admitted to unlisted trading privileges
such plan are to be consolidated with otherwise limit, directly or indirectly, which is communicated on any national
transaction reports from national the ability of any vendor to retransmit, securities exchange by any responsible
securities exchanges and national for display in moving tickers, broker or dealer, but shall not include:
securities associations reported transaction reports or last sale data (A) Any bid or offer executed
pursuant to any other effective made available pursuant to any effective immediately after communication and
transaction reporting plan; transaction reporting plan; provided, any bid or offer communicated by a
(v) The applicable standards and however, that a national securities responsible broker or dealer other than
methods which will be utilized to exchange or national securities an exchange market maker which is
ensure promptness of reporting, and association may, by means of an cancelled or withdrawn if not executed
accuracy and completeness of effective transaction reporting plan, immediately after communication; and
transaction reports; condition such retransmission upon (B) Any bid or offer communicated
(vi) Any rules or procedures which appropriate undertakings to ensure that during a period when trading in that
may be adopted to ensure that any charges for the distribution of security has been suspended or halted,
or prior to the commencement of trading exchange, is relieved of any obligation effect if such exchange or member
in that security on any trading day, on imposed by this section for any subject ceases to make available or
that exchange. security by virtue of a notification made communicate bids, offers, and quotation
(ii) Each national securities pursuant to paragraph (a)(3)(i) of this sizes in such security.
association shall, at all times that last section, such exchange shall monitor (b) Obligations of responsible brokers
sale information with respect to NMS the activity or conditions which formed and dealers. (1) Each responsible broker
securities is reported pursuant to an the basis for such notification and shall or dealer shall promptly communicate
effective transaction reporting plan, immediately renotify all specified to its national securities exchange or
collect, process, and make available to persons when that exchange is once national securities association, pursuant
vendors the best bid, best offer, and again capable of collecting, processing, to the procedures established by that
quotation sizes communicated and making available to vendors the exchange or association, its best bids,
otherwise than on an exchange by each data for that security required to be best offers, and quotation sizes for any
member of such association acting in made available pursuant to paragraph subject security.
the capacity of an OTC market maker for (a)(1) of this section in a manner that (2) Subject to the provisions of
each subject security and the identity of accurately reflects the current state of paragraph (b)(3) of this section, each
that member (excluding any bid or offer the market on such exchange. Upon responsible broker or dealer shall be
executed immediately after such renotification, any exchange or obligated to execute any order to buy or
communication), except during any responsible broker or dealer which had sell a subject security, other than an
period when over-the-counter trading in been relieved of any obligation imposed odd-lot order, presented to it by another
that security has been suspended. by this section as a consequence of the broker or dealer, or any other person
(2) Each national securities exchange prior notification shall again be subject belonging to a category of persons with
shall, with respect to each published bid to such obligation. whom such responsible broker or dealer
and published offer representing a bid (4) Nothing in this section shall customarily deals, at a price at least as
or offer of a member for a subject preclude any national securities favorable to such buyer or seller as the
security, establish and maintain exchange or national securities responsible broker’s or dealer’s
procedures for ascertaining and association from making available to published bid or published offer
disclosing to other members of that vendors indications of interest or bids (exclusive of any commission,
exchange, upon presentation of orders and offers for a subject security at any commission equivalent or differential
sought to be executed by them in time such exchange or association is not customarily charged by such
reliance upon paragraph (b)(2) of this required to do so pursuant to paragraph responsible broker or dealer in
section, the identity of the responsible (a)(1) of this section. connection with execution of any such
broker or dealer who made such bid or (5)(i) Any national securities order) in any amount up to its published
offer and the quotation size associated exchange may make an election for quotation size.
with it. purposes of the definition of subject (3)(i) No responsible broker or dealer
(3)(i) If, at any time a national security in § 242.600(b)(73) for any NMS shall be obligated to execute a
securities exchange is open for trading, security, by collecting, processing, and transaction for any subject security as
such exchange determines, pursuant to making available bids, offers, quotation provided in paragraph (b)(2) of this
rules approved by the Commission sizes, and aggregate quotation sizes in section to purchase or sell that subject
pursuant to section 19(b)(2) of the Act that security; except that for any NMS security in an amount greater than such
(15 U.S.C. 78s(b)(2)), that the level of security previously listed or admitted to revised quotation size if:
trading activities or the existence of unlisted trading privileges on only one (A) Prior to the presentation of an
unusual market conditions is such that exchange and not traded by any OTC order for the purchase or sale of a
the exchange is incapable of collecting, market maker, such election shall be subject security, a responsible broker or
processing, and making available to made by notifying all specified persons, dealer has communicated to its
vendors the data for a subject security and shall be effective at the opening of exchange or association, pursuant to
required to be made available pursuant trading on the business day following paragraph (b)(1) of this section, a
to paragraph (a)(1) of this section in a notification. revised quotation size; or
manner that accurately reflects the (ii) Any member of a national (B) At the time an order for the
current state of the market on such securities association acting in the purchase or sale of a subject security is
exchange, such exchange shall capacity of an OTC market maker may presented, a responsible broker or dealer
immediately notify all specified persons make an election for purposes of the is in the process of effecting a
of that determination. Upon such definition of subject security in transaction in such subject security, and
notification, responsible brokers or § 242.600(b)(73) for any NMS security, immediately after the completion of
dealers that are members of that by communicating to its association such transaction, it communicates to its
exchange shall be relieved of their bids, offers, and quotation sizes in that exchange or association a revised
obligation under paragraphs (b)(2) and security; except that for any other NMS quotation size, such responsible broker
(c)(3) of this section and such exchange security listed or admitted to unlisted or dealer shall not be obligated by
shall be relieved of its obligations under trading privileges on only one exchange paragraph (b)(2) of this section to
paragraphs (a)(1) and (2) of this section and not traded by any other OTC market purchase or sell that subject security in
for that security; provided, however, that maker, such election shall be made by an amount greater than such revised
such exchange will continue, to the notifying its association and all quotation size.
maximum extent practicable under the specified persons, and shall be effective (ii) No responsible broker or dealer
circumstances, to collect, process, and at the opening of trading on the business shall be obligated to execute a
make available to vendors data for that day following notification. transaction for any subject security as
security in accordance with paragraph (iii) The election of a national provided in paragraph (b)(2) of this
(a)(1) of this section. securities exchange or member of a section if:
(ii) During any period a national national securities association for any (A) Before the order sought to be
securities exchange, or any responsible NMS security pursuant to this executed is presented, such responsible
broker or dealer that is a member of that paragraph (a)(5) shall cease to be in broker or dealer has communicated to
its exchange or association pursuant to widely disseminates such order shall be (ii) May establish by rule and
paragraph (b)(1) of this section, a deemed to be in compliance with periodically publish a quotation size,
revised bid or offer; or paragraph (b)(5)(i)(A) of this section if which shall not be for less than one
(B) At the time the order sought to be the electronic communications network: contract, for which responsible brokers
executed is presented, such responsible (A)(1) Provides to a national securities or dealers who are members of such
broker or dealer is in the process of exchange or national securities exchange or association are obligated
effecting a transaction in such subject association (or an exclusive processor under paragraph (b)(2) of this section to
security, and, immediately after the acting on behalf of one or more execute an order to buy or sell a listed
completion of such transaction, such exchanges or associations) the prices option for the account of a broker or
responsible broker or dealer and sizes of the orders at the highest dealer that is in an amount different
communicates to its exchange or buy price and the lowest sell price for from the quotation size for which it is
association pursuant to paragraph (b)(1) such security entered in, and widely obligated to execute an order for the
of this section, a revised bid or offer; disseminated by, the electronic account of a customer; and
provided, however, that such communications network by exchange (iii) May establish and maintain
responsible broker or dealer shall market makers and OTC market makers procedures and mechanisms for
nonetheless be obligated to execute any for the NMS security, and such prices collecting from responsible brokers and
such order in such subject security as and sizes are included in the quotation dealers who are members of such
provided in paragraph (b)(2) of this data made available by such exchange, exchange or association, and making
section at its revised bid or offer in any association, or exclusive processor to available to vendors, the quotation sizes
amount up to its published quotation vendors pursuant to this section; and and aggregate quotation sizes in listed
size or revised quotation size. (2) Provides, to any broker or dealer, options for which such responsible
(4) Subject to the provisions of the ability to effect a transaction with a broker or dealer will be obligated under
paragraph (a)(4) of this section: priced order widely disseminated by the paragraph (b)(2) of this section to
(i) No national securities exchange or execute an order from a customer to buy
electronic communications network
OTC market maker may make available, or sell a listed option and establish by
entered therein by an exchange market
disseminate or otherwise communicate rule and periodically publish the size,
maker or OTC market maker that is:
to any vendor, directly or indirectly, for which shall not be less than one
(i) Equivalent to the ability of any
display on a terminal or other display contract, for which such responsible
broker or dealer to effect a transaction
device any bid, offer, quotation size, or brokers or dealers are obligated to
with an exchange market maker or OTC
aggregate quotation size for any NMS execute an order for the account of a
market maker pursuant to the rules of
security which is not a subject security broker or dealer.
the national securities exchange or
with respect to such exchange or OTC (2) If, pursuant to paragraph (c)(1) of
national securities association to which
market maker; and this section, the rules of a national
(ii) No vendor may disseminate or the electronic communications network
supplies such bids and offers; and securities exchange or national
display on a terminal or other display securities association do not require its
device any bid, offer, quotation size, or (ii) At the price of the highest priced
buy order or lowest priced sell order, or members to communicate to it their
aggregate quotation size from any quotation sizes for listed options, a
national securities exchange or OTC better, for the lesser of the cumulative
size of such priced orders entered responsible broker or dealer that is a
market maker for any NMS security member of such exchange or association
which is not a subject security with therein by exchange market makers or
OTC market makers at such price, or the shall:
respect to such exchange or OTC market (i) Be relieved of its obligations under
maker. size of the execution sought by the
paragraph (b)(1) of this section to
(5)(i) Entry of any priced order for an broker or dealer, for such security; or
communicate to such exchange or
NMS security by an exchange market (B) Is an alternative trading system
association its quotation sizes for any
maker or OTC market maker in that that:
listed option; and
security into an electronic (1) Displays orders and provides the (ii) Comply with its obligations under
communications network that widely ability to effect transactions with such paragraph (b)(2) of this section by
disseminates such order shall be orders under § 242.301(b)(3); and executing any order to buy or sell a
deemed to be: (2) Otherwise is in compliance with listed option, in an amount up to the
(A) A bid or offer under this section, Regulation ATS (§ 242.300 through size established by such exchange’s or
to be communicated to the market § 242.303). association’s rules under paragraph
maker’s exchange or association (c) Transactions in listed options. (1) (c)(1) of this section.
pursuant to this paragraph (b) for at A national securities exchange or (3) Thirty second response. Each
least the minimum quotation size that is national securities association: responsible broker or dealer, within
required by the rules of the market (i) Shall not be required, under thirty seconds of receiving an order to
maker’s exchange or association if the paragraph (a) of this section, to collect buy or sell a listed option in an amount
priced order is for the account of a from responsible brokers or dealers who greater than the quotation size
market maker, or the actual size of the are members of such exchange or established by a national securities
order up to the minimum quotation size association, or to make available to exchange’s or national securities
required if the priced order is for the vendors, the quotation sizes and association’s rules pursuant to
account of a customer; and aggregate quotation sizes for listed paragraph (c)(1) of this section, or its
(B) A communication of a bid or offer options, if such exchange or association published quotation size must:
to a vendor for display on a display establishes by rule and periodically (i) Execute the entire order; or
device for purposes of paragraph (b)(4) publishes the quotation size for which (ii)(A) Execute that portion of the
of this section. such responsible brokers or dealers are order equal to at least:
(ii) An exchange market maker or obligated to execute an order to buy or (1) The quotation size established by
OTC market maker that has entered a sell an options series that is a subject a national securities exchange’s or
priced order for an NMS security into an security at its published bid or offer national securities association’s rules,
electronic communications network that under paragraph (b)(2) of this section; pursuant to paragraph (c)(1) of this
section, to the extent that such exchange or dealer shall provide, in a context in (B) Is priced equal to the national best
or association does not collect and make which a trading or order-routing bid or national best offer; and
available to vendors quotation size and decision can be implemented, a display (C) Represents more than a de
aggregate quotation size under of any information with respect to minimis change in relation to the size
paragraph (a) of this section; or quotations for or transactions in an NMS associated with the OTC market maker’s
(2) Its published quotation size; and stock without also providing, in an bid or offer.
(B) Revise its bid or offer. equivalent manner, a consolidated (b) Exceptions. The requirements in
(4) Notwithstanding paragraph (c)(3) display for such stock. paragraph (a) of this section shall not
of this section, no responsible broker or (2) The provisions of paragraph (c)(1) apply to any customer limit order:
dealer shall be obligated to execute a of this section shall not apply to a (1) That is executed upon receipt of
transaction for any listed option as display of information on the trading the order.
provided in paragraph (b)(2) of this floor or through the facilities of a (2) That is placed by a customer who
section if: national securities exchange or to a expressly requests, either at the time
(i) Any of the circumstances in display in connection with the that the order is placed or prior thereto
paragraph (b)(3) of this section exist; or operation of a market linkage system pursuant to an individually negotiated
(ii) The order for the purchase or sale implemented in accordance with an agreement with respect to such
of a listed option is presented during a customer’s orders, that the order not be
effective national market system plan.
trading rotation in that listed option. (d) Exemptions. The Commission, by displayed.
(d) Exemptions. The Commission may
order, may exempt from the provisions (3) That is an odd-lot order.
exempt from the provisions of this
of this section, either unconditionally or (4) That is a block size order, unless
section, either unconditionally or on
on specified terms and conditions, any a customer placing such order requests
specified terms and conditions, any
person, security, or item of information, that the order be displayed.
responsible broker or dealer, electronic
or any class or classes of persons, (5) That is delivered immediately
communications network, national
securities, or items of information, if the upon receipt to a national securities
securities exchange, or national
Commission determines that such exchange or national securities
securities association if the Commission
exemption is necessary or appropriate association-sponsored system, or an
determines that such exemption is
consistent with the public interest, the in the public interest, and is consistent electronic communications network that
protection of investors and the removal with the protection of investors. complies with the requirements of
of impediments to and perfection of the § 242.602(b)(5)(ii) with respect to that
§ 242.604 Display of customer limit orders. order.
mechanism of a national market system. (a) Specialists and OTC market (6) That is delivered immediately
§ 242.603 Distribution, consolidation, and makers. For all NMS stocks: upon receipt to another exchange
display of information with respect to (1) Each member of a national member or OTC market maker that
quotations for and transactions in NMS securities exchange that is registered by complies with the requirements of this
stocks. that exchange as a specialist, or is section with respect to that order.
(a) Distribution of information. (1) authorized by that exchange to perform (7) That is an ‘‘all or none’’ order.
Any exclusive processor, or any broker functions substantially similar to that of (c) Exemptions. The Commission may
or dealer with respect to information for a specialist, shall publish immediately a exempt from the provisions of this
which it is the exclusive source, that bid or offer that reflects: section, either unconditionally or on
distributes information with respect to (i) The price and the full size of each specified terms and conditions, any
quotations for or transactions in an NMS customer limit order held by the responsible broker or dealer, electronic
stock to a securities information specialist that is at a price that would communications network, national
processor shall do so on terms that are improve the bid or offer of such securities exchange, or national
fair and reasonable. specialist in such security; and securities association if the Commission
(2) Any national securities exchange, (ii) The full size of each customer determines that such exemption is
national securities association, broker, limit order held by the specialist that: consistent with the public interest, the
or dealer that distributes information (A) Is priced equal to the bid or offer protection of investors and the removal
with respect to quotations for or of such specialist for such security; of impediments to and perfection of the
transactions in an NMS stock to a (B) Is priced equal to the national best mechanism of a national market system.
securities information processor, broker, bid or national best offer; and
dealer, or other persons shall do so on (C) Represents more than a de § 242.605 Disclosure of order execution
terms that are not unreasonably minimis change in relation to the size information.
discriminatory. associated with the specialist’s bid or
Preliminary Note: Section 242.605 requires
(b) Consolidation of information. offer. market centers to make available
Every national securities exchange on (2) Each registered broker or dealer standardized, monthly reports of statistical
which an NMS stock is traded and that acts as an OTC market maker shall information concerning their order
national securities association shall act publish immediately a bid or offer that executions. This information is presented in
jointly pursuant to one or more effective reflects: accordance with uniform standards that are
national market system plans to (i) The price and the full size of each based on broad assumptions about order
disseminate consolidated information, customer limit order held by the OTC execution and routing practices. The
including a national best bid and market maker that is at a price that information will provide a starting point to
national best offer, on quotations for and would improve the bid or offer of such promote visibility and competition on the
transactions in NMS stocks. Such plan OTC market maker in such security; and part of market centers and broker-dealers,
particularly on the factors of execution price
or plans shall provide for the (ii) The full size of each customer
and speed. The disclosures required by this
dissemination of all consolidated limit order held by the OTC market section do not encompass all of the factors
information for an individual NMS maker that: that may be important to investors in
stock through a single plan processor. (A) Is priced equal to the bid or offer evaluating the order routing services of a
(c) Display of information. (1) No of such OTC market maker for such broker-dealer. In addition, any particular
securities information processor, broker, security; market center’s statistics will encompass
varying types of orders routed by different (D) For shares executed with price inclusion in The Nasdaq Stock Market,
broker-dealers on behalf of customers with a improvement, the share-weighted Inc., and securities that are listed on the
wide range of objectives. Accordingly, the average period from the time of order American Stock Exchange LLC or any
statistical information required by this receipt to the time of order execution; other national securities exchange. Such
section alone does not create a reliable basis
(E) The cumulative number of shares report also shall include a separate
to address whether any particular broker-
dealer failed to obtain the most favorable of covered orders executed at the quote; section for NMS securities that are
terms reasonably available under the (F) For shares executed at the quote, option contracts. Each of the four
circumstances for customer orders. the share-weighted average period from sections in a report shall include the
the time of order receipt to the time of following information:
(a) Monthly electronic reports by
order execution; (i) The percentage of total customer
market centers. (1) Every market center (G) The cumulative number of shares
shall make available for each calendar orders for the section that were non-
of covered orders executed outside the directed orders, and the percentages of
month, in accordance with the quote;
procedures established pursuant to total non-directed orders for the section
(H) For shares executed outside the that were market orders, limit orders,
paragraph (a)(2) of this section, a report quote, the share-weighted average
on the covered orders in NMS stocks and other orders;
amount per share that prices were (ii) The identity of the ten venues to
that it received for execution from any outside the quote; and
person. Such report shall be in which the largest number of total non-
(I) For shares executed outside the directed orders for the section were
electronic form; shall be categorized by quote, the share-weighted average
security, order type, and order size; and routed for execution and of any venue
period from the time of order receipt to to which five percent or more of non-
shall include the following columns of the time of order execution.
information: directed orders were routed for
(2) Every national securities exchange execution, the percentage of total non-
(i) For market orders, marketable limit on which NMS stocks are traded and
orders, inside-the-quote limit orders, at- directed orders for the section routed to
each national securities association the venue, and the percentages of total
the-quote limit orders, and near-the- shall act jointly in establishing
quote limit orders: non-directed market orders, total non-
procedures for market centers to follow directed limit orders, and total non-
(A) The number of covered orders; in making available to the public the
(B) The cumulative number of shares directed other orders for the section that
reports required by paragraph (a)(1) of were routed to the venue; and
of covered orders;
this section in a uniform, readily (iii) A discussion of the material
(C) The cumulative number of shares
accessible, and usable electronic form. aspects of the broker’s or dealer’s
of covered orders cancelled prior to
In the event there is no effective relationship with each venue identified
execution;
(D) The cumulative number of shares national market system plan pursuant to paragraph (a)(1)(ii) of this
of covered orders executed at the establishing such procedures, market section, including a description of any
receiving market center; centers shall prepare their reports in a arrangement for payment for order flow
(E) The cumulative number of shares consistent, usable, and machine- and any profit-sharing relationship.
of covered orders executed at any other readable electronic format, and make
(2) A broker or dealer shall make the
venue; such reports available for downloading
report required by paragraph (a)(1) of
(F) The cumulative number of shares from an Internet Web site that is free
this section publicly available within
of covered orders executed from 0 to 9 and readily accessible to the public.
one month after the end of the quarter
seconds after the time of order receipt; (3) A market center shall make
addressed in the report.
(G) The cumulative number of shares available the report required by
paragraph (a)(1) of this section within (b) Customer requests for information
of covered orders executed from 10 to on order routing. (1) Every broker or
29 seconds after the time of order one month after the end of the month
addressed in the report. dealer shall, on request of a customer,
receipt; disclose to its customer the identity of
(H) The cumulative number of shares (b) Exemptions. The Commission
may, by order upon application, the venue to which the customer’s
of covered orders executed from 30 orders were routed for execution in the
seconds to 59 seconds after the time of conditionally or unconditionally
exempt any person, security, or six months prior to the request, whether
order receipt; the orders were directed orders or non-
(I) The cumulative number of shares transaction, or any class or classes of
persons, securities, or transactions, from directed orders, and the time of the
of covered orders executed from 60
any provision or provisions of this transactions, if any, that resulted from
seconds to 299 seconds after the time of
section, if the Commission determines such orders.
order receipt;
(J) The cumulative number of shares that such exemption is necessary or (2) A broker or dealer shall notify
of covered orders executed from 5 appropriate in the public interest, and is customers in writing at least annually of
minutes to 30 minutes after the time of consistent with the protection of the availability on request of the
order receipt; and investors. information specified in paragraph
(K) The average realized spread for (b)(1) of this section.
executions of covered orders; and § 242.606 Disclosure of order routing (c) Exemptions. The Commission
(ii) For market orders and marketable information. may, by order upon application,
limit orders: (a) Quarterly report on order routing. conditionally or unconditionally
(A) The average effective spread for (1) Every broker or dealer shall make exempt any person, security, or
executions of covered orders; publicly available for each calendar transaction, or any class or classes of
(B) The cumulative number of shares quarter a report on its routing of non- persons, securities, or transactions, from
of covered orders executed with price directed orders in NMS securities any provision or provisions of this
improvement; during that quarter. For NMS stocks, section, if the Commission determines
(C) For shares executed with price such report shall be divided into three that such exemption is necessary or
improvement, the share-weighted separate sections for securities that are appropriate in the public interest, and is
average amount per share that prices listed on the New York Stock Exchange, consistent with the protection of
were improved; Inc., securities that are qualified for investors.
§ 242.607 Customer account statements. text thereof, together with a statement of sponsors and/or participants in
(a) No broker or dealer acting as agent the purpose of such amendment, in connection with access to, or use of, any
for a customer may effect any accordance with the provisions of facility contemplated by the plan or
transaction in, induce or attempt to paragraph (b) of this section. amendment will be determined and
induce the purchase or sale of, or direct (3) Self-regulatory organizations are imposed (including any provision for
orders for purchase or sale of, any NMS authorized to act jointly in: distribution of any net proceeds from
stock or a security authorized for (i) Planning, developing, and such fees or charges to the sponsors
quotation on an automated inter-dealer operating any national market and/or participants) and the amount of
quotation system that has the subsystem or facility contemplated by a such fees or charges;
characteristics set forth in section 17B of national market system plan; (iii) The method by which, and the
the Act (15 U.S.C. 78q–2), unless such (ii) Preparing and filing a national frequency with which, the performance
broker or dealer informs such customer, market system plan or any amendment of any person acting as plan processor
in writing, upon opening a new account thereto; or with respect to the implementation and/
and on an annual basis thereafter, of the (iii) Implementing or administering an or operation of the plan will be
following: effective national market system plan. evaluated; and
(1) The broker’s or dealer’s policies (4) Every national market system plan (iv) The method by which disputes
regarding receipt of payment for order filed pursuant to this section, or any arising in connection with the operation
flow from any broker or dealer, national amendment thereto, shall be of the plan will be resolved.
securities exchange, national securities accompanied by: (6) In connection with the selection of
association, or exchange member to (i) Copies of all governing or any person to act as plan processor with
which it routes customers’ orders for constituent documents relating to any respect to any facility contemplated by
execution, including a statement as to person (other than a self-regulatory a national market system plan
whether any payment for order flow is organization) authorized to implement (including renewal of any contract for
received for routing customer orders or administer such plan on behalf of its any person to so act), the sponsors shall
and a detailed description of the nature sponsors; and file with the Commission a statement
of the compensation received; and (ii) To the extent applicable: identifying the person selected,
(2) The broker’s or dealer’s policies (A) A detailed description of the describing the material terms under
for determining where to route customer manner in which the plan or which such person is to serve as plan
orders that are the subject of payment amendment, and any facility or processor, and indicating the
for order flow absent specific procedure contemplated by the plan or solicitation efforts, if any, for alternative
instructions from customers, including a amendment, will be implemented; plan processors, the alternatives
description of the extent to which (B) A listing of all significant phases considered and the reasons for selection
orders can be executed at prices of development and implementation of such person.
superior to the national best bid and (including any pilot phase) (7) Any national market system plan
national best offer. contemplated by the plan or (or any amendment thereto) which is
(b) Exemptions. The Commission, amendment, together with the projected intended by the sponsors to satisfy a
upon request or upon its own motion, date of completion of each phase; plan filing requirement contained in any
may exempt by rule or by order, any (C) An analysis of the impact on other section of this Regulation NMS
broker or dealer or any class of brokers competition of implementation of the and part 240, subpart A of this chapter
or dealers, security or class of securities plan or amendment or of any facility shall, in addition to compliance with
from the requirements of paragraph (a) contemplated by the plan or this section, also comply with the
of this section with respect to any amendment; requirements of such other section.
transaction or class of transactions, (D) A description of any written (b) Effectiveness of national market
either unconditionally or on specified understandings or agreements between system plans. (1) The Commission shall
terms and conditions, if the Commission or among plan sponsors or participants publish notice of the filing of any
determines that such exemption is relating to interpretations of the plan or national market system plan, or any
consistent with the pubic interest and conditions for becoming a sponsor or proposed amendment to any effective
the protection of investors. participant in the plan; and national market system plan (including
(E) In the case of a proposed any amendment initiated by the
§ 242.608 Filing and amendment of amendment, a statement that such Commission), together with the terms of
national market system plans. amendment has been approved by the substance of the filing or a description
(a) Filing of national market system sponsors in accordance with the terms of the subjects and issues involved, and
plans and amendments thereto. (1) Any of the plan. shall provide interested persons an
two or more self-regulatory (5) Every national market system plan, opportunity to submit written
organizations, acting jointly, may file a or any amendment thereto, filed comments. No national market system
national market system plan or may pursuant to this section shall include a plan, or any amendment thereto, shall
propose an amendment to an effective description of the manner in which any become effective unless approved by the
national market system plan (‘‘proposed facility contemplated by the plan or Commission or otherwise permitted in
amendment’’) by submitting the text of amendment will be operated. Such accordance with paragraph (b)(3) of this
the plan or amendment to the Secretary description shall include, to the extent section.
of the Commission, together with a applicable: (2) Within 120 days of the date of
statement of the purpose of such plan or (i) The terms and conditions under publication of notice of filing of a
amendment and, to the extent which brokers, dealers, and/or self- national market system plan or an
applicable, the documents and regulatory organizations will be granted amendment to an effective national
information required by paragraphs or denied access (including specific market system plan, or within such
(a)(4) and (5) of this section. procedures and standards governing the longer period as the Commission may
(2) The Commission may propose granting or denial of access); designate up to 180 days of such date if
amendments to any effective national (ii) The method by which any fees or it finds such longer period to be
market system plan by publishing the charges collected on behalf of all of the appropriate and publishes its reasons
for so finding or as to which the interest, for the protection of investors limited to, self-regulatory organizations,
sponsors consent, the Commission shall or the maintenance of fair and orderly brokers, dealers, issuers, and vendors),
approve such plan or amendment, with markets, to remove impediments to, and filed not later than 30 days after notice
such changes or subject to such perfect the mechanisms of, a national of such action or failure to act or within
conditions as the Commission may market system or otherwise in such longer period as the Commission
deem necessary or appropriate, if it furtherance of the purposes of the Act. may determine.
finds that such plan or amendment is (5) Any plan (or amendment thereto) (2) Application to the Commission for
necessary or appropriate in the public in connection with: review, or the institution of review by
interest, for the protection of investors (i) The planning, development, the Commission on its own motion,
and the maintenance of fair and orderly operation, or regulation of a national shall not operate as a stay of any such
markets, to remove impediments to, and market system (or a subsystem thereof) action unless the Commission
perfect the mechanisms of, a national or one or more facilities thereof; or determines otherwise, after notice and
market system, or otherwise in (ii) The development and opportunity for hearing on the question
furtherance of the purposes of the Act. implementation of procedures and/or of a stay (which hearing may consist
Approval of a national market system facilities designed to achieve only of affidavits or oral arguments).
plan, or an amendment to an effective compliance by self-regulatory
(3) In any proceedings for review, if
national market system plan (other than organizations and/or their members of
the Commission, after appropriate
an amendment initiated by the any section of this Regulation NMS
notice and opportunity for hearing
Commission), shall be by order. (§§242.600 through 242.612) and part
(which hearing may consist solely of
Promulgation of an amendment to an 240, subpart A of this chapter
consideration of the record of any
effective national market system plan promulgated pursuant to section 11A of
the Act (15 U.S.C. 78k–1), approved by proceedings conducted in connection
initiated by the Commission shall be by with such action or failure to act and an
rule. the Commission pursuant to section
11A of the Act (or pursuant to any rule opportunity for the presentation of
(3) A proposed amendment may be reasons supporting or opposing such
put into effect upon filing with the or regulation thereunder) prior to the
effective date of this section (either action or failure to act) and upon
Commission if designated by the
temporarily or permanently) shall be consideration of such other data, views,
sponsors as:
deemed to have been filed and approved and arguments as it deems relevant,
(i) Establishing or changing a fee or
other charge collected on behalf of all of pursuant to this section and no finds that the action or failure to act is
the sponsors and/or participants in additional filing need be made by the in accordance with the applicable
connection with access to, or use of, any sponsors with respect to such plan or provisions of such plan and that the
facility contemplated by the plan or amendment; provided, however, that all applicable provisions are, and were,
amendment (including changes in any terms and conditions associated with applied in a manner consistent with the
provision with respect to distribution of any such approval (including time public interest, the protection of
any net proceeds from such fees or other limitations) shall continue to be investors, the maintenance of fair and
charges to the sponsors and/or applicable; provided, further, that any orderly markets, and the removal of
participants); amendment to such plan filed with or impediments to, and the perfection of
(ii) Concerned solely with the approved by the Commission on or after the mechanisms of a national market
administration of the plan, or involving the effective date of this section shall be system, the Commission, by order, shall
the governing or constituent documents subject to the provisions of, and dismiss the proceeding. If the
relating to any person (other than a self- considered in accordance with the Commission does not make any such
regulatory organization) authorized to procedures specified in, this section. finding, or if it finds that such action or
implement or administer such plan on (c) Compliance with terms of national failure to act imposes any burden on
behalf of its sponsors; or market system plans. Each self- competition not necessary or
(iii) Involving solely technical or regulatory organization shall comply appropriate in furtherance of the
ministerial matters. At any time within with the terms of any effective national purposes of the Act, the Commission, by
60 days of the filing of any such market system plan of which it is a order, shall set aside such action and/
amendment, the Commission may sponsor or a participant. Each self- or require such action with respect to
summarily abrogate the amendment and regulatory organization also shall, the matter reviewed as the Commission
require that such amendment be refiled absent reasonable justification or deems necessary or appropriate in the
in accordance with paragraph (a)(1) of excuse, enforce compliance with any public interest, for the protection of
this section and reviewed in accordance such plan by its members and persons investors, and the maintenance of fair
with paragraph (b)(2) of this section, if associated with its members. and orderly markets, or to remove
it appears to the Commission that such (d) Appeals. The Commission may, in impediments to, and perfect the
action is necessary or appropriate in the its discretion, entertain appeals in mechanisms of, a national market
public interest, for the protection of connection with the implementation or system.
investors, or the maintenance of fair and operation of any effective national (e) Exemptions. The Commission may
orderly markets, to remove impediments market system plan as follows: exempt from the provisions of this
to, and perfect the mechanisms of, a (1) Any action taken or failure to act section, either unconditionally or on
national market system or otherwise in by any person in connection with an specified terms and conditions, any self-
furtherance of the purposes of the Act. effective national market system plan regulatory organization, member
(4) Notwithstanding the provisions of (other than a prohibition or limitation of thereof, or specified security, if the
paragraph (b)(1) of this section, a access reviewable by the Commission Commission determines that such
proposed amendment may be put into pursuant to section 11A(b)(5) or section exemption is consistent with the public
effect summarily upon publication of 19(d) of the Act (15 U.S.C. 78k–1(b)(5) interest, the protection of investors, the
notice of such amendment, on a or 78s(d))) shall be subject to review by maintenance of fair and orderly markets
temporary basis not to exceed 120 days, the Commission, on its own motion or and the removal of impediments to, and
if the Commission finds that such action upon application by any person perfection of the mechanisms of, a
is necessary or appropriate in the public aggrieved thereby (including, but not national market system.
§ 242.609 Registration of securities offer of a national securities exchange, protected quotations in NMS stocks that
information processors: form of application the best bid or best offer of The Nasdaq do not fall within an exception set forth
and amendments. Stock Market, Inc., or the best bid or in paragraph (b) of this section and, if
(a) An application for the registration best offer of a national securities relying on such an exception, that are
of a securities information processor association other than the best bid or reasonably designed to assure
shall be filed on Form SIP (§ 249.1001 best offer of The Nasdaq Stock Market, compliance with the terms of the
of this chapter) in accordance with the Inc. in an NMS stock that exceed or exception.
instructions contained therein. accumulate to more than the following (2) A trading center shall regularly
(b) If any information reported in limits: surveil to ascertain the effectiveness of
items 1–13 or item 21 of Form SIP or in (1) If the price of a protected the policies and procedures required by
any amendment thereto is or becomes quotation or other quotation is $1.00 or paragraph (a)(1) of this section and shall
inaccurate for any reason, whether more, the fee or fees cannot exceed or take prompt action to remedy
before or after the registration has been accumulate to more than $0.003 per deficiencies in such policies and
granted, the securities information share; or procedures.
processor shall promptly file an (2) If the price of a protected (b) Exceptions. (1) The transaction
amendment on Form SIP correcting quotation or other quotation is less than that constituted the trade-through was
such information. $1.00, the fee or fees cannot exceed or effected when the trading center
(c) The Commission, upon its own accumulate to more than 0.3% of the displaying the protected quotation that
motion or upon application by any quotation price per share. was traded through was experiencing a
securities information processor, may (d) Locking or crossing quotations. failure, material delay, or malfunction of
conditionally or unconditionally Each national securities exchange and its systems or equipment.
exempt any securities information national securities association shall (2) The transaction that constituted
processor from any provision of the establish, maintain, and enforce written the trade-through was not a ‘‘regular
rules or regulations adopted under rules that: way’’ contract.
section 11A(b) of the Act (15 U.S.C. (1) Require its members reasonably to (3) The transaction that constituted
78k–1(b)). avoid: the trade-through was a single-priced
(d) Every amendment filed pursuant (i) Displaying quotations that lock or opening, reopening, or closing
to this section shall constitute a cross any protected quotation in an transaction by the trading center.
‘‘report’’ within the meaning of sections NMS stock; and (4) The transaction that constituted
17(a), 18(a) and 32(a) of the Act (15 (ii) Displaying manual quotations that
the trade-through was executed at a time
U.S.C. 78q(a), 78r(a), and 78ff(a)). lock or cross any quotation in an NMS
when a protected bid was priced higher
stock disseminated pursuant to an
§ 242.610 Access to quotations. than a protected offer in the NMS stock.
effective national market system plan;
(a) Quotations of SRO trading facility. (5) The transaction that constituted
(2) Are reasonably designed to assure
A national securities exchange or the trade-through was the execution of
the reconciliation of locked or crossed
national securities association shall not an order identified as an intermarket
quotations in an NMS stock; and
impose unfairly discriminatory terms (3) Prohibit its members from sweep order.
that prevent or inhibit any person from engaging in a pattern or practice of (6) The transaction that constituted
obtaining efficient access through a displaying quotations that lock or cross the trade-through was effected by a
member of the national securities any protected quotation in an NMS trading center that simultaneously
exchange or national securities stock, or of displaying manual routed an intermarket sweep order to
association to the quotations in an NMS quotations that lock or cross any execute against the full displayed size of
stock displayed through its SRO trading quotation in an NMS stock disseminated any protected quotation in the NMS
facility. pursuant to an effective national market stock that was traded through.
(b) Quotations of SRO display-only system plan, other than displaying (7) The transaction that constituted
facility. (1) Any trading center that quotations that lock or cross any the trade-through was the execution of
displays quotations in an NMS stock protected or other quotation as an order at a price that was not based,
through an SRO display-only facility permitted by an exception contained in directly or indirectly, on the quoted
shall provide a level and cost of access its rules established pursuant to price of the NMS stock at the time of
to such quotations that is substantially paragraph (d)(1) of this section. execution and for which the material
equivalent to the level and cost of access (e) Exemptions. The Commission, by terms were not reasonably determinable
to quotations displayed by SRO trading order, may exempt from the provisions at the time the commitment to execute
facilities in that stock. of this section, either unconditionally or the order was made.
(2) Any trading center that displays on specified terms and conditions, any (8) The trading center displaying the
quotations in an NMS stock through an person, security, quotations, orders, or protected quotation that was traded
SRO display-only facility shall not fees, or any class or classes of persons, through had displayed, within one
impose unfairly discriminatory terms securities, quotations, orders, or fees, if second prior to execution of the
that prevent or inhibit any person from the Commission determines that such transaction that constituted the trade-
obtaining efficient access to such exemption is necessary or appropriate through, a best bid or best offer, as
quotations through a member, in the public interest, and is consistent applicable, for the NMS stock with a
subscriber, or customer of the trading with the protection of investors. price that was equal or inferior to the
center. price of the trade-through transaction.
(c) Fees for access to quotations. A § 242.611 Order protection rule. (9) The transaction that constituted
trading center shall not impose, nor (a) Reasonable policies and the trade-through was the execution by
permit to be imposed, any fee or fees for procedures. (1) A trading center shall a trading center of an order for which,
the execution of an order against a establish, maintain, and enforce written at the time of receipt of the order, the
protected quotation of the trading center policies and procedures that are trading center had guaranteed an
or against any other quotation of the reasonably designed to prevent trade- execution at no worse than a specified
trading center that is the best bid or best throughs on that trading center of price (a ‘‘stopped order’’), where:
(i) The stopped order was for the Authority: 15 U.S.C. 78a et seq. and 7201 system (‘‘consolidated system’’) or the
account of a customer; et seq.; and 18 U.S.C. 1350, unless otherwise average of the highest current
(ii) The customer agreed to the noted. independent bid and lowest current
specified price on an order-by-order * * * * * independent offer for such security
basis; and ■ 32. Section 249.1001 is revised to read (reported pursuant to 17 CFR 242.602)
(iii) The price of the trade-through as follows: if there are no reported transactions in
transaction was, for a stopped buy the consolidated system that day; or
order, lower than the national best bid § 249.1001 Form SIP, for application for
registration as a securities information * * * * *
in the NMS stock at the time of
execution or, for a stopped sell order, processor or to amend such an application Dated: June 9, 2005.
or registration. By the Commission.
higher than the national best offer in the
NMS stock at the time of execution. This form shall be used for Margaret H. McFarland,
(c) Intermarket sweep orders. The application for registration as a Deputy Secretary.
trading center, broker, or dealer securities information processor,
pursuant to section 11A(b) of the Dissent of Commissioners Cynthia A.
responsible for the routing of an
Securities Exchange Act of 1934 (15 Glassman and Paul S. Atkins to the
intermarket sweep order shall take
U.S.C. 78k–1(b)) and § 242.609 of this Adoption of Regulation NMS
reasonable steps to establish that such
order meets the requirements set forth chapter, or to amend such an Introduction
in § 242.600(b)(30). application or registration.
As a result of our strong disagreement
(d) Exemptions. The Commission, by ■ 33. Form SIP (referenced in
with the majority’s adoption of
order, may exempt from the provisions § 249.1001) is amended by revising Regulation NMS,1 we write jointly to
of this section, either unconditionally or Instruction 6 of General Instructions for make clear the reasons for our dissent.
on specified terms and conditions, any Preparing and Filing Form SIP to read as We support Regulation NMS’’
person, security, transaction, quotation, follows: overarching goal of enhancing the
or order, or any class or classes of Note: The text of Form SIP does not and efficiency of our markets. We do not
persons, securities, quotations, or this amendment will not appear in the Code believe, however, that Regulation NMS
orders, if the Commission determines of Federal Regulations. will achieve this goal, and we are
that such exemption is necessary or concerned about its detrimental impact
appropriate in the public interest, and is FORM SIP on competition and innovation. In our
consistent with the protection of view, Regulation NMS is at odds with
* * * * *
investors. Congress’ goal, expressed in the
General Instructions for Preparing and Securities Acts Amendments of 1975
§ 242.612 Minimum pricing increment.
Filing Form SIP (‘‘1975 Act Amendments’’),2 of
(a) No national securities exchange,
national securities association, * * * * * protecting competition within the
alternative trading system, vendor, or 6. Rule 609(b) of Regulation NMS national market system.3 In analyzing
broker or dealer shall display, rank, or requires that if any information
accept from any person a bid or offer, contained in items 1 through 13 or item 1 Securities Exchange Act Release No. 51808
21 of this application, or any (June 9, 2005) (‘‘Adopting Release’’). Regulation

an order, or an indication of interest in NMS is composed of four substantive rules: A
any NMS stock priced in an increment supplement or amendment thereto, is or requirement that markets provide fair and non-
smaller than $0.01 if that bid or offer, becomes inaccurate for any reason, an discriminatory access to quotations, a prohibition
order, or indication of interest is priced amendment must be filed promptly on on the display of quotations in pricing increments
Form SIP correcting such information. of less than a penny, amendments to the formulas
equal to or greater than $1.00 per share. currently used to allocate market data revenues to
(b) No national securities exchange, * * * * * self-regulatory organizations (‘‘SROs’’) under joint
national securities association, industry plans, and a trade-through rule applicable
alternative trading system, vendor, or PART 270—RULES AND to both the listed and the Nasdaq markets. In the
REGULATIONS, INVESTMENT Adopting Release, the trade-through rule is
broker or dealer shall display, rank, or renamed the ‘‘order protection rule.’’ Adopting
accept from any person a bid or offer, COMPANY ACT OF 1940 Release at note 2. This is a misnomer. An order
an order, or an indication of interest in displayed at the best price is not necessarily
any NMS stock priced in an increment ■ 34. The authority citation for part 270 protected because it can be matched or an execution
smaller than $0.0001 if that bid or offer, continues to read in part as follows: can occur at an inferior price by using an exception
to the rule.
order, or indication of interest is priced Authority: 15 U.S.C. 80a–1 et seq., 80a– 2 Pub. L. 94–29, 89 Stat. 97 (1975).
less than $1.00 per share. 34(d), 80a–37, and 80a–39, unless otherwise 3 As the Senate Banking Committee stated in its
(c) The Commission, by order, may noted. report on the bill that ultimately became the 1975
exempt from the provisions of this * * * * * Act Amendments:
section, either unconditionally or on [T]he Commission’s responsibility [is] to balance
■ 35. Section 270.17a–7 is amended by the perceived anti-competitive effects of the
specified terms and conditions, any revising paragraph (b)(1) to read as regulatory policy or decision at issue against the
person, security, quotation, or order, or follows: purposes of the Exchange Act that would be
any class or classes of persons, advanced thereby and the costs of doing so.
securities, quotations, or orders, if the § 270.17a–7 Exemption of certain Competition would not thereby become paramount
purchase or sale transactions between an to the great purposes of the Exchange Act, but the
Commission determines that such need for and effectiveness of regulatory actions in
investment company and certain affiliated
exemption is necessary or appropriate achieving those purposes would have to be weighed
persons thereof.
in the public interest, and is consistent against any detrimental impact on competition.
with the protection of investors. * * * * * Senate Committee on Banking, Housing and
(b) * * * Urban Affairs, S. Rep. No. 94–75, 94th Cong., 1st
PART 249—FORMS, SECURITIES (1) If the security is an ‘‘NMS stock’’ Sess. (1975) (‘‘Senate Report’’), at 13–14. See also
as that term is defined in 17 CFR House Committee on Interstate and Foreign
EXCHANGE ACT OF 1934 Commerce, H.R. Rep. 94–123, 94th Cong., 1st Sess.
242.600, the last sale price with respect (1975), at 47 (‘‘in the economic areas affecting the
■ 31. The authority citation for part 249 to such security reported in the securities industry, competition, rather than
continues to read in part as follows: consolidated transaction reporting regulation, should be the guiding force’’) (quoting
Regulation NMS and voting to dissent concomitant compliance costs that will orders, to the need to increase market
from its adoption, we have been guided ultimately be borne by investors.6 depth and liquidity, to the reduction of
by Congress’ clear preference that For purposes of our dissent, we will transaction costs for long-term investors
competitive forces, rather than focus principally on the trade-through and issuers.
unnecessary regulation, guide the rule. The issues raised in our dissent In February 2004, the Commission
development of the national market reflect the same concerns we made proposed a uniform trade-through rule
system.4 With the adoption of public at the open Commission meeting as part of Regulation NMS, with the
Regulation NMS, the majority’s arbitrary on April 6, 2005, at which we dissented stated goals of encouraging limit orders
notions and unfounded assumptions from the adoption of Regulation NMS. and aggressive quoting.7 The proposed
about how markets and investors should Our specific concerns are set forth rule contained two major exceptions.
interact have taken unwarranted below. The first exception provided an ‘‘opt-
out’’ from the trade-through rule for
precedence over the interplay of I. The Majority Mischaracterizes the
informed customers,8 and the second
competitive forces within the Trade-Through Rule as Needed To
permitted an automated order execution
marketplace.5 We believe that Increase Market Depth
facility to trade through the quotations
Regulation NMS turns back Commission One of the original catalysts for of non-automated markets.9 The opt-out
policy regarding competition and Regulation NMS was the need to proposal was intended to provide
innovation and sets up roadblocks for address market inefficiencies caused by investors with flexibility in choosing
our markets. the antiquated ITS trade-through rule. where to route their orders and in
The majority’s statutory The Commission’s policy objectives for determining whether their orders
interpretations and policy changes are the trade-through rule have expanded, should trade-through better-priced
arbitrary, unreasonable and however, far beyond a cure for quotes.10 The automated market
anticompetitive. They are not supported integrating automated and manual exception was intended to resolve
by substantial evidence that, markets. During the rulemaking, problems of integrating automated and
notwithstanding their anti-competitive rationales offered for the trade-through manual markets under the ITS trade-
effect, they are necessary or appropriate rule have been a moving target, through rule by protecting only the
to further the purposes of the Exchange morphing from the protection of limit quotations of automated markets.11
Act. The impetus for the Commission’s Commenters on the Proposing and
6 Given the uncertainty about the impact of the
efforts to modernize the securities Supplemental Releases were split on the
trade-through rule and the clear determination of
markets was the outdated Intermarket the majority to pursue its chosen policy direction, need for a trade-through rule to promote
Trading System (‘‘ITS’’) trade-through we believe that it would have been prudent for the fair and efficient markets.12 The floor-
rule that impeded the ability of majority to have considered alternatives that would based exchanges and many institutional
have permitted the Commission to gain more investors supported a trade-through rule
electronic trading centers to compete experience with the rule before requiring its
against floor-based exchanges in the implementation on all markets. One alternative and opposed an opt-out.13 Electronic
listed market. It is ironic that the end would have been to implement access standards
first, and adopt a trade-through rule only if deemed 7 See Proposing Release, supra note 6, at Section
result of this lengthy process is the necessary after access and connectivity had been III.B.2 (‘‘Intermarket Price Protection’’).
imposition of even more complex trade- improved. Another alternative would have been to 8 See Proposing Release, supra note 6, at Section
through restrictions, not only on the phase in the implementation of the trade-through III.D.1 (‘‘Opt-Out Orders’’).
rule in successive stages, allowing for sufficient
New York Stock Exchange, Inc. time between stages to permit the Commission to
9 See Proposing Release, supra note 6, at Section
(‘‘NYSE’’), but on Nasdaq, a market in III.D.2 (‘‘Automated Order Execution Facility

evaluate the impact of the rule before full Exception’’).
which competition is already robust. implementation across all markets. Yet another 10 The opt-out exception ‘‘strives to preserve the
alternative would have been to extend the de
We believe the wiser and more usual customers’ expectation of having their orders
minimis pilot approved in August 2002 for certain
executed at the best displayed price, but allows a
practical approach to improving the exchange-traded funds. See Securities Exchange Act
choice for those investors whose trading strategies
efficiency of U.S. markets for all Release No. 46428 (Aug. 28, 2002), 67 FR 56607
(Sept. 4, 2002). The exemption, which the may benefit from an immediate execution priced
investors would have been to improve Commission extended twice, led to increased outside the national best bid and offer (‘NBBO’).’’
access to quotations, enhance competition, narrowing of spreads, and a reduction Proposing Release, supra note 6, at 11138. ‘‘Large
in trade-through rates. See Securities Exchange Act traders may also want the ability to execute a block
connectivity among markets and market immediately at a price outside the quotes, to avoid
Release No. 49325 (Feb. 26, 2004), 69 FR 11126
participants, clarify the broker’s duty of (Mar. 9, 2004) (‘‘Proposing Release’’), at 11134 note parceling the block out over time in a series of
best execution, and reduce barriers to 50 (citing October 2002 Analysis of QQQ Trading transactions that could cause the market to move to
competition. In our view, these steps Before and After De Minimis, Memorandum from an inferior price.’’ Id.
11 See generally Proposing Release, supra note 6,
would improve market efficiency the Commission’s Office of Economic Analysis to
the File (Feb. 24, 2004) (available at: http:// at Sections III.B.2. (‘‘Intermarket Price Protection’’)
without exposing our markets to www.sec.gov/rules/proposed/s71004/ and III.D.2 (‘‘Automated Order Execution Facility
unforeseen consequences, redundant oeamemo022404.pdf)). See also Comment Letter of Exception’’). In May 2004, the Commission solicited
regulatory oversight and the C. Thomas Richardson, Managing Director, comment on whether individual automated
Citigroup Global Markets, Inc. (Jan. 26, 2005) quotations, rather than automated markets, should
(‘‘Citigroup Reproposal Comment Letter’’), at 2–3 receive protection under the trade-through rule.
Securities Industry Study, Report of the Subcomm. (noting, with respect to trading in QQQQs: ‘‘In its Securities Exchange Act Release No. 49749 (May
on Commerce and Finance of the Committee on first six weeks of trading as a Nasdaq-listed product, 20, 2004), 69 FR 30142 (May 26, 2004)
Interstate and Foreign Commerce, H.R. Rep. No. 92– the average consolidated effective spread on trades (‘‘Supplemental Release’’).
1519, 92d Cong., 2d Sess. (1972), at 1). executed dropped by 34%, despite the lack of any 12 See Adopting Release, supra note 1, at Section
4 See, e.g., H.R. Rep. No. 94–229, 94th Cong., 1st II.A.1 (‘‘Need for Intermarket Trade-Through
trade-through protection. In addition, quoted
Sess. (1975) (‘‘Conference Report’’), at 92 (‘‘It is the spreads did not widen, but, in fact, decreased Rule’’).
intent of the [House and Senate] conferees that the approximately 15% as measured by the average 13 See, e.g., Comment Letter of Darla C. Stuckey,
national market system evolve through the interplay consolidated spread. What is so significant about Corporate Secretary of the New York Stock
of competitive forces as unnecessary regulatory this comparison is that before the QQQQs began Exchange, Inc. (July 2, 2004); Comment Letter of
restrictions are removed.’’). trading in Nasdaq’s electronic market, a $0.03 de David Humphreville, President, Specialist
5 See, e.g., Senate Report, supra note , at 12 (‘‘This minimis exception to the Trade-Through Rule Association (June 30, 2004); Comment Letter of
is not to suggest that under S. 249 the SEC would existed already and had narrowed spreads Kenneth J. Polcari, President, Organization of
have either the responsibility or the power to significantly.’’) (citing economic research provided Independent Floor Brokers (May 12, 2004);
operate as an ‘‘economic czar’’ for the development by NASDAQ). However, no such alternatives were Comment Letter of Ari Burstein, Associate Counsel,
of a national market system.’’) (citations omitted). given serious consideration. Continued
markets, online retail broker-dealers, dropped, and concern about market Commission’s rationale for protecting
and Nasdaq market makers were depth became more prominent.18 The limit orders and pointed to flaws in the
generally opposed to a trade-through Commission noted that many OEA Study.23 They also stated that the
rule,14 although there was some support commenters opposing a trade-through Commission had significantly
for a rule, provided that it included an rule, particularly on Nasdaq, had underestimated the costs of
opt-out.15 Numerous commenters pointed to Nasdaq’s efficient implementation.24
particularly opposed extending the functioning without a trade-through Over our dissent, the majority voted
trade-through rule to Nasdaq.16 rule.19 In response to these comments to adopt Regulation NMS on April 6,
In December 2004, the Commission regarding Nasdaq’s market quality, the 2005, approving a trade-through rule
voted to repropose Regulation NMS, Commission’s Office of Economic protecting quotations at the ‘‘top of
over Commissioner Atkins’ dissent.17 In Analysis (‘‘OEA’’) was asked to conduct book.’’ The rule contains several
the Reproposing Release, the a study of trade-through rates on several exceptions, but does not include a
Commission’s prior emphasis on markets.20 The Division of Market general opt-out provision.25 In the
encouraging aggressive quoting was Regulation also prepared an analysis of Adopting Release, the goal of trade-
comparative execution quality statistics through regulation is recast once again.
Investment Company Institute (June 30, 2004); between Nasdaq and NYSE stocks.21
George U. Sauter, Managing Director, The Vanguard The divide among commenters on the S. Knight, Executive Vice President and General
Group, Inc. (July 14, 2004). Counsel, Nasdaq Stock Market, Inc. (Jan. 26, 2005)
14 See, e.g., Comment Letter of John H. Bluher,
need for a trade-through rule continued
(‘‘Nasdaq Reproposal Comment Letter’’); Comment
Executive Vice President and General Counsel, in response to the Reproposing Release. Letter of Adam Cooper, Senior Managing Director
Knight Trading Group (July 2, 2004) (‘‘Knight However, commenters who had and General Counsel, Citadel Investment Group,
Proposal Comment Letter’’); Comment Letter of originally opposed the rule as well as L.L.C. (Jan. 26. 2005); Comment Letter of Phylis M.
Edward S. Knight, Executive Vice President and those whose support for a trade-through Esposito, Executive Vice President and Chief
General Counsel, Nasdaq Stock Market, Inc. (July 2, Strategy Officer, Ameritrade, Inc. (Jan. 26, 2005)
2004) (‘‘Nasdaq Proposal Comment Letter’’);
rule had been conditioned on a general (‘‘Ameritrade Reproposal Comment Letter’’);
Comment Letter of Eric D. Roiter, Senior Vice opt-out provision, which was dropped Comment Letter of Steve Swanson, CEO &
President and General Counsel, Fidelity from the reproposal, were united in President, Automated Trading Desk, LLC (Jan. 26,
Management & Research Co. (June 22, 2004), at 3– their opposition to the reproposed 2005) (‘‘Automated Trading Desk Reproposal
6; Comment Letter of Huw Jenkins, Managing Comment Letter’’); Comment Letter of the
Director, UBS Securities LLC (July 2, 2004) (‘‘UBS
rule.22 They noted fallacies in the Competitive Enterprise Institute (Jan. 26, 2005);
Proposal Comment Letter’’), at 3; Comment Letter Comment Letter of Edward J. Nicoll, Chief
18 Compare Proposing Release, supra note 6, 69
of Kenneth Griffin, President and Chief Executive Executive Officer, Instinet Group Inc. (Jan. 26, 2005)
Officer, Citadel Investment Group, LLC (July 9, FR at 11134 with Reproposing Release, supra note (‘‘Instinet Reproposal Comment Letter’’); Comment
2004) (‘‘Citadel Proposal Comment Letter’’); 6, 69 FR at 77426. Letter of Kevin J.P. O’Hara, Chief Administrative
Comment Letter of Ellen L. S. Koplow, Executive 19 Reproposing Release, supra note 17, 69 FR at Officer & General Counsel, Archipelago Holdings,
Vice President and General Counsel, Ameritrade, 77427–28. Inc. (Jan. 26, 2005) (‘‘Archipelago Reproposal
Inc. (June 30, 2004), at 2–4; Comment Letter of 20 Analysis of Trade-throughs in Nasdaq and Comment Letter’’); Comment Letter of Eric D.
Carrie E. Dwyer, General Counsel and Executive NYSE Issues, Memorandum from the Commission’s Roiter, Senior Vice President and General Counsel,
Vice President, Charles Schwab & Co., Inc. (June 30, Office of Economic Analysis to the File (Dec. 15, Fidelity Management & Research Co. (Jan. 26, 2005)
2004) (‘‘Schwab Proposal Comment Letter’’), at 13– 2004) (‘‘OEA Study’’) (available at: http:// (‘‘Fidelity Reproposal Comment Letter’’); Comment
16; Comment Letter of Kim Bang, President and www.sec.gov/spotlight/regnms/analysis121504.pdf). Letter of Daniel Coleman, Managing Director, Head
Chief Executive Officer, Bloomberg Tradebook LLC As one commenter noted, the Proposing Release’s of Equities for the Americas, UBS Securities LLC
(June 30, 2004), at 2 and 9–14. ‘‘complete lack of economic analysis supporting the (Jan. 25, 2005) (‘‘UBS Reproposal Comment
15 See, e.g., Comment Letter of Thomas N. trade-through provisions’’ was surprising. Comment Letter’’); Comment Letter of Thomas M. Joyce, CEO
McManus, Managing Director and Counsel, Morgan Letter of W. Hardy Callcott (May 6, 2004), at 6. and President, Knight Trading Group, Inc. (Jan. 25,
Stanley & Co., Inc. (Aug. 19, 2004); Comment Letter 21 Comparative Analysis of Rule 11Ac1–5 2005) (‘‘Knight Trading Reproposal Comment
of Edward J. Nicoll, Instinet Group Inc. (June 30, Statistics by S&P Index, Memorandum to File from Letter’’); Comment Letter of Kim Bang, Bloomberg
2004). the Commission’s Division of Market Regulation L.P. (Jan. 25, 2005).
16 See, e.g., Comment Letter of Kevin O’Hara, 23 See, e.g., Fidelity Reproposal Comment Letter,
(Dec. 15, 2004) (‘‘Market Regulation Study’’)
General Counsel, Archipelago Holdings, Inc. (Sept. (available at: http://www.sec.gov/rules/proposed/ supra note 22, at 7–8 (‘‘We caution that the
24, 2004); Nasdaq Proposal Comment Letter, supra s71004/mrmemo121504.pdf). Commission’s analysis, particularly as set forth in
note 14; UBS Proposal Comment Letter, supra note 22 See, e.g., Comment Letter of Thomas N. the OEA’s study * * * is open to serious question
14, at 4; Citadel Proposal Comment Letter, supra McManus, Managing Director and Counsel, Morgan and likely rests on serious methodological flaws.
note 14, at 6; Schwab Proposal Comment Letter, Stanley (Feb. 7, 2005) (‘‘Morgan Stanley Reproposal * * * Our own preliminary review of the OEA’s
supra note 14, at 13 and 16; Knight Proposal Comment Letter’’), at 5; Comment Letter of Bruce study suggests that trade-throughs of displayed
Comment Letter, supra note 14. C. Turner, Managing Director, CIBC World Markets superior orders equal to or greater in size than the
17 Securities Exchange Act Release No. 50870 Corp. (Feb. 4, 2005) (‘‘CIBC Reproposal Comment incoming ‘‘trading-through’’ order may amount to
(Dec. 16, 2004), 69 FR 77424 (Dec. 27, 2004) Letter’’); Comment Letter of Michael J. Lynch, only 0.4% of Nasdaq volume, and perhaps only
(‘‘Reproposing Release’’). The staff had Managing Director, Merrill Lynch, Pierce, Fenner & 0.22% pf NYSE share volume * * *.’’); Nasdaq
recommended a final rule, including a trade- Smith Inc. (Feb. 4, 2005) (‘‘Merrill Lynch Reproposal Comment Letter, supra note 22, Exhibit
through rule covering full depth of book, which was Reproposal Comment Letter’’); Comment Letter of 1, at 5; Instinet Reproposal Comment Letter, supra
scheduled for a Commission vote on December 15, Richard M. Whiting, Executive Director and General note 22, at 6; Comment Letter of Kevin J.P. O’Hara,
2004, without seeking further comment from the Counsel, Financial Services Roundtable (Feb. 4, Chief Administrative Officer & General Counsel,
public. When details of the staff’s final 2005); Comment Letter of David Baker, Global Head Archipelago Reproposal Comment Letter, supra
recommendation for a trade-through rule became of Cash Trading and Global Head of Portfolio note 22, at 6; UBS Reproposal Comment Letter,
public, however, the ensuing outcry led the Trading, Deutsche Bank Securities Inc. (Feb. 3, supra note 22, at 4 (‘‘[T]he OEA Study is based
Commission instead to repropose the rule. Leaving 2005) (‘‘Deutsche Bank Reproposal Comment upon several improper assumptions, and thus
no doubt that there would be a trade-through rule Letter’’); Comment Letter of Jeffrey T. Brown, Senior results in a fundamentally flawed analysis.’’). See
in the final rule, the Commission solicited comment Vice President, Charles Schwab (Feb. 1, 2005) generally Robert Battalio and Robert Jennings,
on whether the trade-through rule should apply to (‘‘Schwab Reproposal Comment Letter’’); Comment Analysis of the Re-proposing Release of Reg NMS
the ‘‘top of book’’ or to a voluntary ‘‘depth of book.’’ Letter of James T. Brett, Managing Director, J.P. and the OEA’s Trade-through Study (Mar. 28, 2005)
At the December 15, 2004 open meeting at which Morgan Securities, Inc. (Jan. 28, 2005) (‘‘J.P. Morgan (‘‘Battalio-Jennings Study’’) (attachment to
Regulation NMS was reproposed, Commissioner Reproposal Comment Letter’’); Comment Letter of Comment Letter of Eric D. Roiter, Senior Vice
Glassman urged commenters not to accept the Stewart P. Greene, Chief Counsel, Securities Law, President and General Counsel, Fidelity
inevitability of a trade-through rule. She asked for Teachers Insurance and Annuity Assoc. of America, Management & Research Co. (Mar. 28, 2005)).
24 See, e.g., Deutsche Bank Reproposal Comment
comment on the need for any trade-through rule, College Retirement Equities Fund (Jan. 27, 2005)
not just whether the rule should offer ‘‘top of book’’ (‘‘TIAA CREF Reproposal Comment Letter’’); Letter, supra note 22, at 4–5.
or ‘‘depth of book’’ protection. SEC Open Meeting Citigroup Reproposal Comment Letter, supra note 6; 25 See Adopting Release, supra note 1, at text
on Regulation NMS (Dec. 15, 2004) (webcast Comment Letter of Minder Cheng, Managing following note 236. See generally Adopting Release,
available at: http://www.sec.gov/news/ Director, Barclays Global Investors (Jan. 26, 2005) supra note 1, at Section II.A.4 (‘‘Elimination of
openmeetings.shtml.). (‘‘Barclays Reproposal Comment Letter’’); Edward Proposed Opt-Out Exception’’).
Now, the goal is increasing market rule into question. We do not believe share volume is actually 2.3%.36 Given
depth and liquidity in order to that current minimal trade-through rates the majority’s concession that the NYSE
minimize the impact of large orders, indicate that investors are not obtaining trade-through rate is 1.2% when
while decreasing transitory volatility best execution, that their orders are measured against displayed size,37 its
and transaction costs for the benefit of being unfairly treated, or that investors emphasis on a possible reduction in
long-term investors and issuers.26 are otherwise suffering economic harm. trade-throughs to 2.3% is disingenuous.
The Reproposing and Adopting The majority’s selective interpretation of
II. The Majority Has Failed To the OEA Study to justify the need for a
Demonstrate the Trade-Through Rule Is Releases interpret the OEA Study as
establishing a seemingly high rate of trade-through rule is unreasonable and
Warranted calls into question the basis of the rule.
trade-throughs. The Reproposing
The Proposing Release set forth three Release claimed that 7.9% and 7.2% of An additional finding of the OEA
broad objectives for a review of market the total share volume on Nasdaq and Study was that the majority of trade-
structure: equalizing regulation of the NYSE, respectively, were traded throughs occurred within a penny or
markets, updating antiquated rules and through.31 The Reproposing Release two of a better bid or offer,38 at an
promoting greater order interaction.27 failed to point out, however, that these estimated total cost in 2003 of $321
Adopted Regulation NMS moves million.39 These statistics overstate the
trade-through rates were calculated, not
beyond these objectives to establish agency/principal conflict because the
on the basis of a quotation’s displayed
goals for a trade-through rule that allow OEA Study was not limited to investors
size, but on the size of the order. Thus,
the majority to construct its own view owed a duty of best execution.40
an order executed at an inferior price
of optimal market structure. The Furthermore, $321 million is a mere
was considered to have been traded-
majority focuses on two types of so- rounding error compared to the dollar
through at its full size even if the order
called market structure ‘‘problems’’ that value of trading on both markets which
was for a larger number of shares than
it claims would be addressed by a trade- totaled approximately $16.8 trillion in
were available in the market.32
through rule: investor protection 2003.41 As a percent of the total dollar
concerns evidenced by trade-through The Adopting Release cites the same value of trading, the $321 million cost
rates on Nasdaq and NYSE 28 and a lack figures, but acknowledges that the trade- savings represents less than 1/100th of
of displayed depth on Nasdaq.29 Neither through rates for total share volume on one percent. These percentages do not
‘‘problem’’ has been substantiated. Nasdaq and the NYSE drop dramatically indicate a significant problem with
However, the majority has contrived from 7.9% and 7.2%, respectively, to trade-throughs or best execution.42
‘‘problems’’ in the Nasdaq market that 1.9% and 1.2%, when executions are
conform with Congressional goals for measured against the displayed number 36 See Adopting Release, supra note 1, at text
the development of a national market of shares available.33 This disclosure accompanying note 71.
37 See OEA Study, supra note 20, at 2.
system in order to advance its own was made only after commenters faulted
38 OEA Study, supra note 20, at Tables 3 and 10.
market structure solutions.30 To achieve the Commission for its selective use of 39 OEA Study, supra note 20, at note 5 and
this result, the majority portrays statistics.34 accompanying text.

successful market-driven innovations as Similarly, the majority relies on the 40 The OEA Study used data from TAQ and
intractable market structure problems NYSE’s 7.2% trade-through rate to Nastraq, neither of which distinguishes among
attempt to show a reduction in trade- different types of investors. See OEA Study, supra
that can only be solved by government note 20, at 1.
intervention. through rates hoped to be achieved from 41 See NYSE Reported Share And Dollar Volume,
the new rule, which does not include 2003, NYSE Fact Book Online (available at:
A.The OEA Study Did Not Substantiate the block size or 100 share exceptions http://www.nysedata.com/factbook/viewer_edition.
Investor Protection Concerns. contained in the ITS trade-through asp?mode=table&key=2923&category=3) (reporting
$9.7 trillion in share trading on the NYSE in 2003);
The majority has failed to establish rule.35 Significantly, the Adopting see also World Federation of Exchanges, Annual
that current trade-through rates indicate Release admits that, after eliminating Report (2004) (available at: http://www.world-
a significant investor protection the effects of both of the ITS exceptions, exchanges.org/WFE/home.asp?menu=315&
problem. The majority has cherry- the NYSE trade-through rate for total document=2174) (reporting $7.1 trillion in share
trading on Nasdaq in 2003).
picked statistics from the results of the 42 The majority asserts that: [g]iven the large
OEA Study that appear to justify the 31 Reproposing Release, supra note 17, 69 FR at
number of trades that fail to obtain the best
adoption of a trade-through rule, while 77433. The OEA Study suggests that the 7.9% and displayed prices (e.g., approximately 1 in 40 trades
7.2% trade-through rates cited above would be for both Nasdaq and NYSE stocks), the Commission
ignoring data that call the need for the ‘‘useful in assessing the potential benefits of is concerned that many of the investors that
increased limit order display and liquidity that the ultimately received the inferior price in these trades
26 See generally Adopting Release, supra note 1,
proposed rule intends to promote,’’ but the majority may not be aware that their orders did not, in fact,
at Section I.B.2 (‘‘Serving the Interests of Long-Term views the statistic as evidence of significant trade- obtain the best price.
Investors and Listed Companies’’) and text throughs. OEA Study, supra note 20, at 1–2. Adopting Release, supra note 1, at text following
accompanying note 15. 32 To illustrate, suppose a broker received a
27 Proposing Release, supra note 6, 69 FR at
note 150. The majority claims that: investors (and
10,000 share customer order to buy and a 3,000 particularly retail investors) often may have
11128–29. share offer is displayed in the market at a price of difficulty monitoring whether their orders receive
28 See Adopting Release, supra note 1, at text $10. Under the OEA Study’s methodology, the best available prices, given the rapid movement
accompanying notes 104 and 105. executing any portion of the remaining 7,000 shares of quotations in many NMS stocks. The
29 See Adopting Release, supra note 1, at text above $10 would be considered a trade-through, Commission believes that furthering the interests of
accompanying note 108. regardless of the fact that only 3,000 shares were these investors in obtaining best execution on an
30 There are two paramount objectives in the offered for sale in the market. OEA acknowledged order-by-order basis is a vitally important objective
development of a national market system. First, the that this was a very conservative approach with the that warrants adoption of the Order Protection Rule.
maintenance of stable and orderly markets with practical effect of overstating the trade-through Adopting Release, supra note 1, at text following
maximum capacity for absorbing trading rates. See OEA Study, supra note 20, at 2. note 105. The majority fails to acknowledge that
33 See Adopting Release, supra note 1, at text
imbalances without undue price movements. And retail investors have access to consolidated
second, the centralization of all buying and selling accompanying note 68. See also OEA Study, supra information that allows them to monitor their
interest so that each investor will have the note 20, at text following note 3. executions. In fact, the majority argues for a single
opportunity for the best possible execution of his 34 See, e.g., supra note 23 (citing comment
consolidator by noting investors need reliable
order, regardless of where in the system it letters). consolidated information to monitor their
originates. 35 See Adopting Release, supra note 1, at text executions. The majority states that ‘‘[t]he great
Senate Report, supra note 3, at 7. accompanying note 71. Continued
Nor do we believe that the trade- both markets did not trade-through The majority has offered no substantive
through rates establish that investors’ better-priced bids or offers. Given that basis for extending the trade-through
orders are being treated unfairly. The the hypothetical cost of trade-throughs rule to the Nasdaq market.51 To justify
Reproposing and Adopting Releases is less than 1/100th of 1%, the evidence imposing the rule on Nasdaq,
cited statistics from the OEA Study does not indicate that investors’ orders particularly in light of the minimal
indicating that in 2003, approximately are treated unfairly. trade-through rates reflected in the OEA
2.5% of all trades on Nasdaq and the In sum, we believe that the numbers Study, the majority attempts to establish
NYSE traded-through the market.43 speak for themselves. The minimal a lack of market depth. Defining
Notwithstanding these minimal trade- trade-through results reflected in the Nasdaq’s ‘‘problem’’ as a lack of depth
through rates, the majority found the OEA Study do not support the is critical for justifying the rule’s
rates ‘‘significant,’’ with customer conclusion that trade-throughs are a extension to Nasdaq because increasing
orders being ‘‘routinely’’ traded- significant problem—certainly not one market depth was one of Congress’ goals
through.44 Commenters identified that justifies regulatory intervention on for the national market system.52 The
possible flaws in the OEA Study, the scale of Regulation NMS. majority relies on a staff study of
suggesting that trade-through rates were comparative execution quality
B. There Is No Evidence of a Lack of
lower than OEA’s estimate.45 They also conducted by the lawyers in the
Depth on Nasdaq.
stated that, while the OEA Study was Division of Market Regulation (not the
based on 2003 data, data from 2004 Over the past eight years, the Nasdaq
economists in OEA),53 anecdotal
reflected a decrease in trade-throughs on market has developed into a completely
evidence, hypothetical cost savings and
Nasdaq to 1.5% due to increased order automated market that meets the
conjecture specifically related to low fill
routing, reduction in internalization objectives of Section 11A of the
rates to attempt to show that, in
rates, and consolidation.46 The Exchange Act.48 It provides
addition to the investor protection
majority’s 2.5% trade-through rate is economically efficient executions for
problem, the Nasdaq market suffers
also overstated because it includes investors, provides fair competition and
from a lack of market depth. This is
trades other than trades for retail equal access for all investors, provides
surprising, given the view of many
customer accounts, including trades for depth of book information with respect
commenters that the large number of
institutions, sophisticated investors and to all quotations and transactions in
limit orders in Nasdaq stocks signifies
intermediaries.47 securities, and allows investors to enter
that sufficient incentives exist for the
Based on the record before us, it orders directly into the market without
appears that the trade-through rate on placement of such orders and that low
participating with a dealer. The Nasdaq
Nasdaq during 2004 was between 1% fill rates do not represent a market
market is connected by private linkages
and 2%. It follows, therefore, that weakness or cause investor harm.54 We
that allow both brokers and investors to
between 98% and 99% of all trades on do not believe that there were
execute transactions at the best price in
complaints about a lack of depth in the
the market they choose.49 This has all
Nasdaq market in the Commission’s
strength of the current model is that it benefits been accomplished in the absence of a
investors, particularly retail investors, by enabling roundtables on market structure or the
trade-through rule.
them to assess prices and evaluate the best
Congress did not mandate that the comment letters. In fact, many broker-
execution of their orders by obtaining data from a dealers representing retail investors and
single source that is highly reliable and Commission go beyond the goals of
comprehensive.’’ See Adopting Release, supra note Section 11A to design its own view of institutions objected to extending the
1, at text following note 565. In addition, the NASD optimal market structure, yet this is trade-through rule to Nasdaq.55
and the SEC monitor brokers for compliance with
their best execution obligations. what the majority seeks to accomplish.50
can be effected at the most favorable price and (2)
43 See Reproposing Release, supra note 17, 69 FR
creating an incentive for multiple market makers to
at 77433; Adopting Release, supra note 1, at text 48 15 U.S.C. 78k–1. Section 11A(a)(1)(C) provides
deal in depth on a continuous basis.’’ Senate
accompanying note 102. that ‘‘[i]t is in the public interest and appropriate Report, supra note 3, at 12 (emphasis added).
44 See Reproposing Release, supra note 17, 69 FR for the protection of investors and the maintenance 51 The Proposing Release, referring to a
at 77428. The majority states that ‘‘the order of fair and orderly markets to assure’’: ‘‘disparity’’ of regulation on the listed and Nasdaq
protection rule will promote a more level playing (i) Economically efficient execution of securities markets, simply asserted the need for a uniform
field for retail investors that currently see their transactions; trade-through rule. No rationale for why uniformity
smaller displayed orders bypassed by block trades.’’ (ii) fair competition among brokers and dealers, was important was offered. See Proposing Release,
Adopting Release, supra note 1, at text following among exchange markets, and between exchange supra note 6, at Section II.A (‘‘Promote Equal
note 84. We question the majority’s basis for markets and markets other than exchange markets; Regulation of Market Centers’’), 69 FR at 11128–29.
asserting that retail investors are not on the same (iii) the availability to brokers, dealers, and We would note that if uniformity of treatment were
playing field as other investors. The statement is investors of information with respect to quotations a valid goal, having no trade-through rule would
also inconsistent with the majority’s previous for and transactions in, securities; accomplish this. In any event, uniformity was not
assertion that investors have difficulty monitoring a Congressional objective for the national market
(iv) the practicability of brokers executing
whether their orders receive best execution. See system:
investors’ orders in the best market; and
supra note 42.
45 See, e.g., Fidelity Reproposal Comment Letter, (v) an opportunity * * * for investors’ orders to This is not to say that it is the goal of the
be executed without the participation of a dealer. legislation to ignore or eliminate distinctions
supra note 22, at 8; Nasdaq Reproposal Comment between exchange markets and over-the-counter
49 In the Adopting Release the majority notes
Letter, supra note 22, at 5; Archipelago Reproposal
approvingly: markets or other inherent differences or variations
Comment Letter, supra note 22, at 6; UBS
[w]ith respect to Nasdaq stocks, connectivity in components of a national market system. Some
Reproposal Comment Letter, supra note 22, at 4.
46 See, e.g., Nasdaq Reproposal Comment Letter, among many trading centers already is established present distinctions may tend to disappear in a
through private linkages. Routing out to other national market system, but it is not the intention
supra note 22. The majority unreasonably credits of the bill to force all markets for all securities into
impending regulation for the decrease in trading centers when necessary to obtain the best
prices for Nasdaq stocks is an integral part of the a single mold.
internalization rates in the Nasdaq market, rather
business plan of many trading centers, even when Senate Report, supra note 3, at 7.
than increased market efficiency. See Adopting 52 See Senate Report, supra note 3, at 7.
Release, supra note 1, at text preceding note 80. not affirmatively required by best execution
47 It is important to note, however, that the OEA responsibilities or by Commission rule. 53 Market Regulation Study, supra note 21.
Study did not distinguish among different investor Adopting Release, supra note 1, at text following 54 See, e.g., Instinet Reproposal Comment Letter,
classes. Thus, the majority would have no basis for note 290. supra note 22.
determining how many orders that traded through 50 ‘‘[T]he fundamental goals of a national market 55 See, e.g., Schwab Reproposal Comment Letter,
the market were owed a duty of best execution nor system must include (1) providing an investor or supra note 22; Ameritrade Reproposal Comment
how many investors were unable to monitor their his broker with the ability to be able to determine, Letter, supra note 22, at 4; Comment Letter of Lou
executions. at any given time, where a particular transaction Klobuchar Jr., President and Chief Brokerage
In the Reproposing Release, Nasdaq’s seeking liquidity in an efficient manner. the plain text of the definition of
small average displayed share size and Unless the majority forces all liquidity quotation clearly included both price
low fill rate for large marketable limit to be displayed in the market, investors and size. Therefore, trading centers
orders was characterized as evidencing will naturally continue to search for could route an order to a protected
a lack of displayed depth, a purported hidden liquidity to meet their demand. quotation’s full displayed size and
defect in its market structure that a The Adopting Release appears to simultaneously execute an order at an
trade-through rule on Nasdaq would suggest that Nasdaq participants should inferior price. This was consistent with
address.56 In the Adopting Release, the change their aggressive order pricing the policy goal of increasing displayed
majority argues that the relatively low behavior and instead expose their orders size. Under the amended formulation,
share volume of traded-through by providing latent displayed however, the critical component of size
quotations evidences a shortage of liquidity.60 In our view, however, the has been eliminated, thus expanding the
quoted depth.57 The Adopting Release rule will not be successful in scope of liquidity falling under the
concedes, however, that Nasdaq’s low significantly modifying market protected quotation umbrella. Thus,
fill rate is attributable to market participant behavior.61 There are under the new definition of quotation,
participants’ liquidity probing activities, legitimate reasons why market trading centers cannot trade-through a
otherwise known as ‘‘pinging.’’ participants may not want to display protected quotation’s price, regardless of
Generally speaking, institutional their orders. For instance, concerns available liquidity, without an
investors seeking liquidity may ‘‘ping’’ about market impact will still act to exception. The practical effect is that
or search for non-displayed limit orders prevent market participants from market participants must exhaust
in the Nasdaq market by sending displaying the full size of their orders, liquidity in reserve prior to moving to
electronic marketable limit orders for a even with a trade-through rule.62 the next price level. Ironically, this
number of shares greater than a market’s In one respect, the majority is correct seems to provide more incentive to
displayed size.58 If there is liquidity in that the trade-through rule, as modified maintain liquidity in reserve, rather
reserve, institutional investors will after its adoption on April 6, 2005, will than to display it publicly, a result that
receive an execution for a number of alter market participant behavior. By would be contrary to the majority’s
shares greater than the displayed size. If amending the rule text to remove the stated goals.
there is no liquidity in reserve, orders reference to ‘‘size’’ from the definition
of quotation, the majority has III. Regulation NMS Will Not Achieve
will receive a partial execution or be left
substantially altered the scope of Its Goals
unfilled, contributing to the purported
low fill rate on Nasdaq. ‘‘Pinging’’ protected liquidity. We do not believe a The majority asserts that a uniform
provides investors with an efficient and change of this magnitude to a major rule trade-through rule will promote market
economical method for searching for should be made without the benefit of efficiency. By encouraging the display
liquidity on an anonymous basis. The the Commission’s usual notice and of limit orders, it argues, the rule will
practice is the electronic version of the comment process. In our view, this increase liquidity and displayed depth
search for liquidity on manual markets change is not merely a technical and lower transaction costs for long-
through the auction market system, amendment, but rather cuts to the heart term investors and issuers. At the same
without the possibility of information of how the rule will operate. time, the majority asserts that the rule
leakage that may create market impact The trade-through rule requires will enhance best execution obligations.
costs for investors. It is a fundamental trading centers to establish and We firmly believe, however, that the
trait of any market that the knowledge maintain written policies and hoped-for benefits of the trade-through
of additional trading interest will likely procedures designed to prevent trade- rule will not materialize.
affect prices. Yet the majority views this throughs of protected quotations unless
A. A Trade-Through Rule Is Not Needed
market-based solution for searching for they fall within an applicable
as a Backstop to Best Execution
liquidity as evidence of a regulatory exception.63 Prior to the amendment,
‘‘problem’’ with Nasdaq’s market The majority believes that the trade-
structure that a trade-through rule must 60 The majority states ‘‘the Rule strengthens the through rule will further the objectives
address.59 incentive for the voluntary display of a greater of the Exchange Act by providing a
proportion of latent trading interest by assuring ‘‘backstop’’ to a broker’s best execution
We believe that Nasdaq’s low fill rate that, when such interest is displayed, it is protected
is evidence that investors are actively against most trade-throughs.’’ Adopting Release,
obligations and that it will ‘‘materially
supra note 1, at preceding note 152. reduce the trade-through rates in both
Officer, E*TRADE Financial (June 30, 2004);
61 As we have previously noted, the 2–8% range the market for Nasdaq stocks and the
Fidelity Reproposal Comment Letter, supra note 22. for lower and upper limits of potential benefits of market for exchange-listed stocks.’’ 64 Its
increased market depth assumes that demand will
56 ‘‘Thus, low fill rates demonstrate that the total
create its own supply. See supra text accompanying
only response to arguments that current
displayed and reserve liquidity available for Nasdaq trade-through rates do not justify the
stocks at any particular trading center typically is notes 32 and 33. There is no basis for OEA’s
small compared to the demand for liquidity at the assumption. need for regulatory action is to assert
inside prices.’’ Adopting Release, supra note 1, at 62 J.P. Morgan Reproposal Comment Letter, supra
that the trade-through rates found in the
text following note 132. note 22, at 4 (‘‘For any particular trade, multiple OEA Study are not insignificant and to
57 ‘‘[T]he share volume of quotations that factors may bear on the quality of execution,
including speed, certainty of execution, liquidity assert that the total number of trade-
currently are traded-through is a symptom of the
problem that the Order Protection Rule is designed and depth, opportunities for price improvement, throughs is not the sole consideration in
to address ‘‘a shortage of quoted depth * * *.’’ anonymity, error rates, and the quality of a trading
Adopting Release, supra note 1, at text center’s program of self-regulation. These factors all that trading center of protected quotations in NMS
accompanying note 108. relate to costs that are not captured by quoted stocks that do not fall within an exception set forth
58 See Adopting Release, supra note 1, at text prices, such as market access and transactional fees, in paragraph (b) of this section and, if relying on
preceding note 132. market impact costs, costs of broken or erroneous such an exception, that are reasonably designed to
59 The majority states that the trade-through rule trades, and indirect costs such as market data assure compliance with the terms of the exception.
will increase displayed liquidity and ‘‘promote costs.’’). 64 See Adopting Release, supra note 1, at text
63 New Rule 611 states:
market efficiency by reducing the uncertainty and preceding note 63. Furthermore, the NASD and the
costs associated with the need for market (a) Reasonable policies and procedures. Commission’s Office of Compliance, Inspections
participants to ‘‘ping’’ electronic markets for (1) A trading center shall establish, maintain, and and Examinations routinely monitor execution
liquidity that is held in reserve.’’ Adopting Release, enforce written policies and procedures that are quality and whether brokers are fulfilling their best
supra note 1, at text following note 132. reasonably designed to prevent trade-throughs on execution obligations.
evaluating the need for the trade- likelihood that the rule will reduce protect limit orders only at the top-of-
through rule.65 trade-throughs to any significant degree. book, the permissibility of
As stated above, we find these internalization, and the numerous
assertions unreasonable given the C. The Trade-Through Rule Will Not
exceptions to the trade-through rule, the
majority’s failure to establish a Augment Market Depth Because It
majority cannot credibly argue that the
significant trade-through problem as Provides Only Incomplete Protection of
Limit Orders protection of limit orders is a high
well as its acknowledgement that trade- priority.72
throughs will continue to occur The majority states that the protection The majority is careful to characterize
following the rule’s adoption. We note of limit orders, the foundation of market the trade-through rule’s objective of
that the Adopting Release does not pricing, is one of its most important increasing market depth as ‘‘modest,’’
contain an estimate of the reduction in goals for market structure.69 This goal translating into a hypothetical $755
trade-throughs. Moreover, consistent may be worthy, but Regulation NMS million in cost savings in 2003 for long-
with the objectives of Section 11A, the will not achieve it because the adopted term investors.73 This amount is based
Nasdaq market provides investors with trade-through rule does not protect all upon a hypothetical 5% improvement
the ability to determine where they can limit orders. Under the voluntary in depth and liquidity or an average
obtain the best price and provides ‘‘depth of book’’ alternative proposed in reduction of 1.87 basis points in price
linkages that allow them to obtain the the Reproposing Release, trade-through impact and liquidity search costs.74 The
best price available. Given the negative protection would have been given to all majority provides no basis, however, for
consequences of the rule, which we quotations that a trading center positing a 5% improvement in depth
discuss below, we believe that any voluntarily transmitted to a securities and liquidity, except to characterize it
potential reduction in the already low information processor (‘‘SIP’’), not just as the ‘‘current share volume of trade-
rate of trade-throughs will be minimal, its best bid or offer. We recognize that through transactions that does not
at best, and will be outweighed by the the full depth of book alternative would interact with displayed liquidity.’’ 75
costs of the rule. Moreover, the create its own set of problems, Although it is apparently intended to
majority’s ‘‘one size fits all’’ approach to particularly with respect to its show an order of magnitude, there is no
best execution will prevent many implications for centralization, basis for the 5% estimate.
investors from obtaining the best technological complications and the Further, the majority fails to provide
execution for themselves and their size of the market data revenue pie. It an estimate of the expected reductions
fiduciaries.66 would also have been the death knell for in trade-throughs or indicate
floor-based exchange trading. However,
B. Some Trade-Throughs Will Continue specifically how the new displayed
the majority’s professed commitment to
depth will be generated. It speculates
The final rule requires trading centers protecting limit orders is difficult to
to establish, maintain and enforce that ‘‘greater displayed liquidity will at
reconcile given its rejection of the full
written policies and procedures to least lower the search costs associated
depth of book alternative.70
prevent trade-throughs, but it does not The final rule claims to protect a with trying to find liquidity,’’ 76 and
prohibit trade-throughs. The rule market’s best bid or offer (‘‘BBO’’), but goes on to make unfounded
contains numerous exceptions for, since market participants can match a assumptions claiming that ‘‘[i]ncreased
among others, intermarket sweeps, self- trading center’s BBO, rather than route liquidity, in turn, could lead market
help, flickering quotes, volume orders to it, the rule does not actually participants to interact more often with
weighted average priced (‘‘VWAP’’) protect limit orders at each market’s displayed orders, which would lead to
trades, and stopped orders,67 which BBO. The Adopting Release greater use of limit orders, and thus
means that trade-throughs will not be acknowledges that the BBO trade- begin the cycle again.’’ 77 The majority
eliminated. In addition, commenters through rule will not draw out every fails to address how internalization,
have suggested that there will be trade- limit order, but asserts that it will free-riding or market impact costs will
throughs, even with a trade-through provide investors with the appropriate factor into the display of additional
rule.68 The minimal rate of trade- incentives to post additional limit 72 The trade-through rule will only apply during
throughs in the current environment orders.71 This assertion is highly normal trading hours. Thus, market participants
and the undoubted existence of trade- questionable. Given its decision to might game the system and avoid the trade-through
throughs even after the rule’s rule by shifting liquidity to after-hours trading
implementation call into question the 69 See Adopting Release, supra note 1, at text sessions.
following note 29. 73 See Adopting Release, supra note 1, at 303. The

70 Commenters saw through this false claim. See, majority explains:
following note 102. e.g., Morgan Stanley Reproposal Comment Letter, The Rule is designed to increase the perceived
66 See, e.g., J.P. Morgan Reproposal Comment
supra note 22, at 4 (‘‘[W]e cannot agree with the benefits of order display, against which the
SEC’s view that the single most important objective negatives are balanced. As a result, the market
Letter, supra note 22, at 6 (‘‘To disenfranchise of the SEC’s trade-through rule alternatives is the participant that currently displays only 500 shares
institutional investors for whom best execution protection of limit orders, as the only effective way of its 50,000-share trading interest might be willing
frequently diverges from best posted quotes by to accomplish that objective would be to impose to display 1000 shares. The collective effect of
limiting their strategies for managing risk would be market-wide price/time priority * * *.’’);
to create a burden that is both unfairly distributed many market participants reaching the same
Comment Letter of George U. Sauter, Managing conclusion would be a material increase in the total
and disproportionate to the limited benefits of Director, The Vanguard Group, Inc. (Jan. 27, 2005)
trade-through protection.’’). displayed depth in the market, thereby improving
(‘‘Vanguard Reproposal Comment Letter’’), at 4 (‘‘If the transparency of price discovery and reducing
67 Rule 611(b).
one believes that the trade-through rule is important investor transaction costs.
68 See, e.g., UBS Reproposal Comment Letter,
for the protection of investors, which we do, there Adopting Release, supra note 1, at text following
supra note 22, at 5; Comment Letter of Reg NMS is no logical reason why price protection should not
note 110.
Study Group (May 23, 2004), at 4 (‘‘Accidental be extended to all displayed liquidity. In fact, 74 See Adopting Release, supra note 1, at text
trade-throughs may be common in a market with protection for just the BBO actually codifies trade-
fleeting quotes and limit orders that persist for only throughs.’’); Ameritrade Reproposal Comment following note 303.
a second or two, making it difficult to effectively Letter, supra note 22, at 5 (‘‘The Market BBO
identify and sanction deliberate trade-throughs.’’); Alternative would protect only the best priced limit following note 303.
orders, while all other limit orders are unprotected 76 See Adopting Release, supra note 1, at text
Comment Letter of David Cummings, Chief
Executive Officer of Tradebot Systems, Inc. (Jan. 26, and can be traded through with impunity.’’). following note 160.
2005) (‘‘Tradebot Reproposal Comment Letter’’), at 71 See Adopting Release, supra note 1, at text 77 See Adopting Release, supra note 1, at text
1. following note 110. following note 160.
limit orders. Instead, it provides only a intermediaries.83 What the majority fails Institutional traders often need to trade off
theoretical response to an extremely to recognize is that, by harming short price for liquidity, speed of execution,
complex question. term investors, the rule may also likelihood of completion, and other
attributes. We believe investors should have
negatively affect long-term investors
IV. The Majority’s Distinction Between the choice over where to execute their orders,
who may face increased spreads and considering these other attributes, and that
Long-Term and Short-Term Investors is
decreased liquidity. Liquidity provided regulatory reform should continue to
Arbitrary and Unreasonable
by short-term investors narrows spreads encourage market centers to compete in all
Essential to the majority’s argument and gives long-term investors better these dimensions of execution quality.85
that a trade-through rule is necessary to executions. Because short-term The majority claims that the
augment market depth is its decision to investors are willing to take risks that limitation on investor choice inherent in
favor the interests of long-term investors strengthen the marketplace and benefit the trade-through rule is in the public
and issuers for purposes of market long-term investors, Congress clearly interest and is needed to protect retail
structure design.78 The majority could not have intended for short-term and long-term investors that may be
interprets Section 11A of the Exchange investors to be harmed through the harmed by trade-throughs. Before
Act as requiring the Commission to Commission’s facilitation of the national restricting investors’ ability to obtain the
facilitate the national market system— market system. In fact, Congress best execution in a manner that satisfies
not for the protection of ‘‘investors,’’ but prioritized the removal of barriers to their investment needs, the majority
for the protection of ‘‘long-term competition to increase the should be required not only to show
investors.’’ 79 We find the majority’s participation of market makers and current harm, but to demonstrate the
parsing of the term ‘‘investor’’ arbitrary increase the competitive trading of benefits provided by the trade-through
and unreasonable. In our view, all securities.84 rule.86
investors are entitled to efficient The majority also fails to take into The majority’s distinction between
executions and access to the best account that long-term and short-term the interests of long- and short-term
markets. This is not the case, however, investors are not mutually exclusive investors simply provides a way for it to
under Regulation NMS.80 groups. Investors can be long-term and attempt to justify its policy choices,
The majority characterizes short-term short-term investors at the same time or without any basis in fact, and it sets a
investors, or traders, as holding they may be a long-term investor one dangerous precedent. Once codified, the
securities for a matter of seconds, moment and, for a variety of reasons, concept may leach into other
minutes or hours.81 It concedes that become a short-term investor the next. rulemakings and alter the basic
short-term investors provide valuable The overlapping nature of these ownership principles governing the
liquidity to long-term investors,82 yet undefined categories highlights the market. Clearly, the interests of long-
acknowledges that the rule may harm arbitrary nature of the majority’s and short-term investors are inextricably
short-term investors and market distinction. The length of time an linked. In the words of the Proposing
individual owns a stock or intends to Release: ‘‘A fair and efficient national
78 See Adopting Release, supra note 1, at Section
own a stock at any particular moment is market system must serve the interests
I.B.2 (‘‘Serving the Interests of Long-Term Investors
and Listed Companies’’). In the 1975 Act
not a relevant factor in distinguishing of both types of investors.’’ 87 In the
Amendments, Congress did not exhibit such among groups of investors. absence of Regulation NMS, fair and
favoritism: The majority claims that the trade-
efficient markets would develop to
The purpose of this title is to insure that our through rule ensures that investors get
Nation’s capital markets continue to be the best in provide economically efficient
the best price. We have indicated above
existence * * * by establishing a framework for a execution of securities transactions for
national market systems in which all qualified why we believe this claim significantly
all investors, not just those favored by
persons throughout our country may be linked overstates the problem the rule is
the Commission.88
together electronically so that they may compete intended to address. By making price
and may bring to the marketplace their capital so the sole criterion for determining how V. The Rule Will Have Negative
as to make for broader, deeper and more liquid
capital markets. and where orders will be executed, the Repercussions
H.R. Rep. No. 94–123, supra note 3, at 90. trade-through rule also restricts investor We believe that, not only will the
79 See Adopting Release, supra note 1, at text choice and ability to obtain best trade-through rule not achieve its
preceding note 15; see generally Adopting Release, execution. As one commenter purported benefits, it will have negative
supra note 1, at Section I.B.2 (‘‘Serving the Interests explained:
of Long-Term Investors and Listed Companies’’). unintended consequences. The
The majority cites the legislative history of the Indeed, based on years of empirical complexity of the rule structure invites
adoption of the Exchange Act in 1934 to support evidence and substantial quantitative exploitation that may create unforeseen
this position, but that history is not relevant. See research into the components of transaction
Adopting Release, supra note 1, at text costs, it is our strong belief that price is just 85 Barclays Reproposal Comment Letter, supra
accompanying notes 20 and 23. The term ‘‘investor’’
as interpreted by the Commission was contained in
one element in overall execution quality. note 22, at 2–3.
Section 11A of the 1975 Act Amendments directing 86 See Senate Report, supra note 3, at 12 (‘‘In
the Commission to facilitate the national market 83 See Adopting Release, supra note 1, at text other words, in the national market system,
system. The legislation did not include a definition following note 22. investors should be able to obtain the best
of the term. 84 One of the fundamental purposes underlying execution of their orders and be assured that
80 The Adopting Release does not credit the national market system contemplated by S. 249 because of open competition among market makers
commenters’ claim that a trade-through rule is not is to enhance the competitive structure of the the total market for each security is as liquid and
needed on the Nasdaq market because that market securities markets in order to foster the risk-taking orderly as the characteristics of that security
is efficient. See Adopting Release, supra note 1, at function of market makers and thereby to provide warrant.’’).
text preceding note 61. The majority unreasonably free market incentives to active participation in the 87 Reproposing Release, supra note 17, 69 FR at
views this claim as suspect ‘‘when market flow of orders. The competitive structure and 77439.
efficiency is examined from the perspective of incentives to participation thus provided should 88 The majority is selective in its reliance on the
transaction costs of long-term investors, as opposed supplement, and ultimately may be able to replace, long- and short-term investor distinction. In
to short-term traders.’’ Adopting Release, supra note most affirmative requirements to deal imposed by rejecting the proposed opt-out, the majority claims
1, at text following note 63. regulation. that advocates of the opt-out ‘‘have failed to
81 See Adopting Release, supra note 1, at note 22
Senate Report, supra note 3, at 14. The trade- consider the interests of all investors—both those
and accompanying text. through rule creates comparable barriers to off- who submit marketable orders and those who
82 See Adopting Release, supra note 1, at text board trading restrictions, which were among the submit limit orders.’’ Adopting Release, supra note
following note 19. barriers Congress sought to remove. 1, at text following note 247.
market distortions. Commenters attendant to the rule’s implementation. and ECNs drove technological
indicated that the BBO trade-through Our concerns about these negative innovation as a means of attracting
rule may introduce market consequences are aggravated by the orders and liquidity to their markets.
inefficiencies, competitive barriers, and rule’s questionable enforceability.95 Under the trade-through rule,
unnecessary costs, while stifling competition among market makers may
A. The Rule Will Limit Competition and
innovation. decrease. Given the rule’s sole focus on
Market participants and academics Stifle Innovation
price, incentives to improve execution
warned the Commission of unintended The majority speaks continually of the quality above and beyond the trade-
consequences,89 including: (i) importance of encouraging two types of through rule’s mandated execution
Decreased price discovery and quantity competition—competition among orders methodology may be reduced. Further,
discovery,90 (ii) increased gaming and competition among markets, and by limiting order routing decisions to
opportunities,91 (iii) the lowest common believes that the trade-through rule the price of protected quotations, the
denominator problem,92 (iv) increased promotes competition on both scores. trade-through rule sacrifices
market fragmentation,93 and (v) We find no mention of different types of competition among SROs and ECNs,
increased volatility.94 The lack of competition in the language of Section which will have a negative impact on
consensus about the likely impact of 11A, the source of the Commission’s innovation. Instead of allowing markets
Regulation NMS among industry authority in this area, and we believe to compete for order flow, the trade-
participants, academics and investors the rule is anti-competitive. through rule forces order flow to the
provides further evidence of the risks 1. Competition Among Markets SRO markets. The majority believes that
In adopting the trade-through rule, the competitive pressures will continue to
89 See, e.g., Comment Letter of Marc E. Lackritz,
President, Securities Industry Assoc. (Feb 1, 2005) majority has opted for government- drive change since orders may still be
(‘‘SIA Reproposal Comment Letter’’), at 10; controlled competition over competitive internalized, and priority for routing
Comment Letter of James A. Duncan, Chairman, and
market forces to determine the decisions can be made when SROs are
John C. Giesea, President and Chief Executive displaying the same price. We believe,
Officer, Security Traders Assoc. (Jan. 19, 2005); J.P. appropriate market structure. Section
Morgan Reproposal Comment Letter, supra note 22, 11A plainly states, however, that a however, that the trade-through rule
at 7; Paul L. Davis and Robert A. Schwartz, Report, national market system should foster will restrict competitive forces and
Comments on SEC Reg NMS (Jan. 26, 2005)
competition among broker-dealers and reduce markets to the lowest common
(attachment to TIAA CREF Reproposal Comment denominator by dampening the
Letter, supra note 22), at 7; Battalio-Jennings Study, among markets. Today, broker-dealers,
supra note 34, at 5 (‘‘[T]he proposed trade-through electronic communications networks incentives for markets to compete on the
rule may have negative unintended (‘‘ECNs’’) and SROs compete in the basis of improved technology and
consequences.’’); Comment Letter of James J. Angel,
Nasdaq market on the basis of services and reduced costs. With the
Assoc. Professor of Finance, McDonough School of government managing all aspects of the
Business, Georgetown University (Jan. 25, 2005) technology, execution quality and cost.
(‘‘Angel Reproposal Comment Letter’’), at 1. Competition among market makers competition, it is difficult to credit the
90 See, e.g., TIAA CREF Reproposal Comment
increased significantly following the majority’s claim that the trade-through
Letter, supra note 22, at 2 (expressing concern that Commission’s adoption of Rule 11Ac1– rule promotes competition. In our view,
‘‘both of the proposed trade-through rules will the trade-through rule limits
compromise’’ price and quantity discovery). 5, which required market centers to
91 See, e.g., J.P. Morgan Reproposal Comment publish execution quality statistics.96 competition among markets.
Letter, supra note 22, at 11. This information permitted brokers to Market share may well shift following
92 See, e.g., Instinet Reproposal Comment Letter,
make more informed order routing implementation of the trade-through
supra note 22, at 17; Merrill Lynch Reproposal decisions, consistent with their best rule, but not because the rule promotes
Comment Letter, supra note 22, at 5. competition. To the extent that we
execution obligations. At the same time,
Letter, supra note 22, at 10 (‘‘[T]he incentive overall execution quality for retail observe shifting market share, it will be
structure created by the Top of Book Alternative customers improved as competition attributable to limit orders being
could also lead to increased market fragmentation among executing broker-dealers on the redistributed among protected SRO
despite the SEC’s intent to the contrary.’’); Citigroup basis of execution quality became a quotations. Market participants may
Reproposal Comment Letter, supra note 6, at 5
(explaining that the top of the book alternative means of attracting retail order flow. game the system by distributing orders
‘‘could cause market participants to choose market Likewise, competition between markets to what might normally be their second-
centers for execution that are more likely to have choice market, so that their orders will
less liquidity and order flow so that the market 95 OEA, in its study on trade-throughs, remarked be protected as top-of-book at the
participant’s order has a greater probability of being on the complexity of identifying actual trade-
at the top of the book (best bid/offer) and therefore
second-choice market. To the extent that
throughs, a necessary predicate to the enforcement
receiving increased protection. * * * Ultimately, of the rule. OEA Study, supra note 20, at 1 (‘‘While
investors spread orders among the
we feel this could result in increased fragmentation trade-through identification seems straightforward, various SROs to obtain as much top-of-
with each broker-dealer’s order flow being in practice it is complicated by quickly changing book protection as possible, any
dispersed throughout the eleven protected market quotes, system time lags, data limitations, and
centers.’’); Tradebot Reproposal Comment Letter,
resulting shift in market share would
imperfect access to markets.’’). See also UBS
supra note 68, at 2 (‘‘It is not widely understood Reproposal Comment Letter, supra note 22, at 5
occur, not as a result of increased
yet, but I think a trade through rule with automated (‘‘[E]nforceability will be unachievable (correctly market competition, but as a result of
quotes would * * * increas[e] market noted by the OEA Study) due to the inability to the Commission’s attempt to engineer
fragmentation. * * *’’). accurately identify when, due to quotation changes,
market structure by imposing a trade-
system imperfections and data discrepancies, a
Letter, supra note 22, at 6 (‘‘A trade-through rule trade-through has even occurred.’’); Morgan Stanley through rule.97
that essentially forces investors to perform sweeps Reproposal Comment Letter, supra note 22, at 14
is likely to increase volatility in the marketplace, (‘‘In order to monitor and enforce a trade-through 97 See, e.g., J.P. Morgan Reproposal Comment
particularly for relatively illiquid securities.’’); rule, it is essential that the Commission promulgate Letter, supra note 22, at 10 (‘‘The result likely
Vanguard Reproposal Comment Letter, supra note standards for an intermarket clock. The existing would be that market participants would engage in
70, at 4 (‘‘The BBO alternative would produce clock synchronization standards, which differ by an economically inefficient competition to develop
greater volatility, as some executions would occur market, combined with penny trading increments, costly computer systems that route and re-route
at inferior prices.’’); Automated Trading Desk would render it virtually impossible to effectively limit orders to various markets based on the
Reproposal Comment Letter, supra note 22, at 3 monitor compliance with the proposed trade- probability of achieving trade-through protection.’’);
(‘‘The proposed rule will create added market through rule.’’). Citigroup Reproposal Comment Letter, supra note 6,
volatility due to behavioral changes by block 96 See Securities Exchange Act Release No. 43590 at 5 (‘‘[T]his type of market regulation may serve
positioners. * * *’’). (Nov. 17, 2000), 65 FR 43590 (Dec. 1, 2000). to support certain market centers that otherwise
2. Competition Among Orders that these ‘‘regulatory restraints’’ will under the trade-through rule and the
The majority believes that by prevent new competitors from entering barriers to entry created by the
protecting limit orders, that is, the market and place unnecessary Commission’s criteria for recognition of
restricting pricing decisions, it will burdens on existing trading centers.101 credit rating agencies as nationally
create the appropriate incentives for Under the rule, only SRO quotations are recognized statistical rating
investors to display more of their protected. Through the SRO registration organizations (‘‘NRSROs’’).103 The delay
interest to buy or sell, which will process, the Commission controls the in obtaining a no-action letter from the
decrease volatility and implicit number of SROs in the national market SEC staff by applicants for NRSRO
transaction costs. However, the trade- system. This barrier to entry will likely status, a process that often takes several
through rule restricts competition increase if the Commission adopts years, has raised barriers to entry for
among orders by requiring a proposed regulations that would place credit rating agencies. We are concerned
government-mandated method of restrictions on SRO ownership and that bureaucratic delay may create
trading. Disfavoring short-term investors substantially increase regulatory similar barriers to entry for market
could upset the market’s liquidity burdens pertaining to SRO governance, participants seeking to register as an
reporting and recordkeeping SRO, new ADF participants and SROs
equilibrium and decrease competition
requirements.102 seeking to make changes to their market
among orders because ‘‘short-term’’
The Commission’s involvement in operations.104
investors provide much needed implementing the access and automated
liquidity to the market through their market provisions of Regulation NMS 4. Stifling Innovation
willingness to buy and sell stock.98 will create additional barriers to entry. Innovation may be another casualty of
Unrestricted market and order the trade-through rule. Decreased
The access provisions require that the
competition in the Nasdaq market has competition and increased regulatory
Commission approve the application of
achieved several objectives under barriers create an environment that
each new participant in the NASD’s
Section 11A, including increased direct stifles innovation, depriving investors of
Automated Display Facility (‘‘ADF’’),
order interaction, reduced execution the benefits of innovation, including
outline the requirements of
costs and improved execution quality ‘‘substantially equivalent’’ access, and efficiencies and cost savings.
for all investors. In the absence of any determine whether trading centers Unfortunately, as we saw in the listed
valid justification for extending the engage in unfairly discriminatory market, where technology was
trade-through rule to Nasdaq, the practices. The Commission will also be antiquated and price discovery
majority is forced to argue that Nasdaq’s involved in determining which markets hampered, it is difficult to determine
vigorous order competition reflects a comply with the definition of an whether a regulatory regime impedes
weakness in market depth and liquidity automated market, involving the innovation until a marketplace is
that requires a trade-through rule. As Commission in highly technical and competitively disadvantaged.
discussed above, the use of electronic subjective judgments, which may By requiring the Commission or its
methods of price and size discovery on neither be fair nor expedient. staff to approve changes to an SRO’s
Nasdaq is evidence of a healthy, We see troubling parallels between market operations, Regulation NMS
competitive market, not evidence of the barriers to entry that we foresee essentially codifies current technologies
structural weakness.99 and methods of trading through the
By adopting a trade-through rule, the err too far in the direction of ensuring intermarket exceptions to the trade-through rule and
majority has shown itself willing to interactions, thereby threatening intermarket controls future innovation.105
sacrifice competition among markets to competition, discouraging innovation, and limiting
investor choice. As a result, we are concerned that Bureaucratic delay creates a competitive
attempt to increase competition among the TOB and DOB Alternatives ultimately may barrier that may impede the future
orders. If increasing order competition cause significant harm to investors and imperil the development of trading and order
were its goal, however, then the preeminence of the U.S. markets. Specifically, we routing systems. In other words, the
believe that the TOB and DOB Alternatives will
majority should have afforded full drive the markets toward one uniform market future development of efficient and
protection of limit orders by imposing model. Indeed, both proposals push the markets effective methods of committing capital
price-time priority. It is questionable toward intermarket competition that is based solely and pricing securities may be inhibited.
how order competition will increase on displayed price * * * [B]oth Alternatives raise What we find disturbing about the
the specter of competition-stifling, micro-
under a rule that applies a price priority management of market structure by the majority’s policy determinations in
structure that is rife with exceptions. government.’’); J.P. Morgan Reproposal Comment Regulation NMS is that they are
The negligible protection afforded to Letter, supra note 22, at 7 (‘‘However, such contrary to prior Commission
limit orders under the trade-through incentives would likely be stronger the greater the
extent of the regulatory license provided by the
statements regarding the importance of
rule simply does not square with the trade-through rule.’’); TIAA CREF Reproposal fostering innovation and competition. In
degree of increased order competition Comment Letter, supra note 22, at 8–9 and 11; Regulation ATS, for example, the
that the majority hopes will materialize. Citigroup Reproposal Comment Letter, supra note 6, Commission designed a regulatory
at 2 and 5; Comment Letter of Daniel M. Clifton,
If anything, the rule’s compromised Executive Director, American Shareholders Assoc. framework for alternative trading
approach favoring long-term investors (Jan. 26, 2005), at 2; Comment Letter of J. Greg systems (‘‘ATSs’’) that ‘‘encourage[d]
may decrease liquidity, and thus Mills, Managing Director, Head of Global Equity market innovation while ensuring basic
decrease order competition. Trading, RBC Capital Markets Corp. (Jan. 26, 2005)
(‘‘RBC Reproposal Comment Letter’’), at 3; Instinet
3. Barriers to Competition Reproposal Comment Letter, supra note 22, at 5;
Archipelago Reproposal Comment Letter, supra (Apr. 19, 2005), 70 FR 21306 (Apr. 25, 2005).
The trade-through rule creates barriers note 22, at 9; UBS Reproposal Comment Letter, 104 Nasdaq’s application for exchange registration
to competition.100 We are concerned supra note 22, at 3. has been pending since March 15, 2001. Securities
101 See Senate Report, supra note 3, at 13 Exchange Act Release No. 44396 (June 7, 2001), 66
(‘‘Unfortunately, because of excessive and FR 31952 (June 13, 2001).
may be incapable of competing because of poor unnecessary regulatory restraints, competition in 105 Schwab Reproposal Comment Letter, supra
technology and inferior execution.’’). the securities industry has not been as vigorous and note 22, at 2 (‘‘A centralized routing algorithm
98 See supra Section IV.
as effective in advancing the public interest as it stifles innovation of new mechanisms for handling
99 See supra Section II.B. could be.’’). order.’’); Archipelago Reproposal Comment letter,
100 See, e.g., SIA Reproposal Comment Letter, 102 Securities Exchange Act Release No. 50699 supra note 22, at 5; Angel Reproposal Comment
supra note 89, at 9 (‘‘[T]he SEC’s two Alternatives (Nov. 18, 2004), 69 FR 71126 (Dec. 8, 2004). Letter, supra note 89, at 2.
investor protections.’’ 106 To help reduce Unfortunately, the majority fails to its staff, many involving interpretation
competitive impediments to innovation use past experience as a guide. In of subjective standards. The end result
by SROs, the Commission approved a adopting the trade-through rule, the is a highly regulated and micromanaged
temporary exemption permitting SROs majority has reversed Commission market that limits competition and
to operate new trading systems without policy, opting for government- innovation. As one commenter
filing for approval under certain controlled competition, a failure under observed:
circumstances.107 ITS, instead of unfettered competition, [T]he rule will require lots of filings from
Likewise, in the order approving the more successful approach over time SROs, and years of intense fighting over
Nasdaq’s SuperMontage, the as evidenced by the Nasdaq market. The details. It is likely that the Commission staff
Commission acknowledged that Nasdaq market has developed into an will end up making numerous important
‘‘competition and innovation are efficient, automated and highly decisions on the important micro-details of
competitive marketplace. Competition market structure with lots of unintended
essential to the health of the securities
among markets trading Nasdaq consequences that will take decades to
markets. Indeed, competition is one of understand and fix.113
the hallmarks of the national market securities has fulfilled the objectives of
system.’’ 108 It stated that the regulatory Section 11A by creating a fully Indeed, the majority concedes that a
structure was designed to ‘‘provide all automated and connected marketplace, trade-through rule may ‘‘lessen the
market centers with structural flexibility decreasing execution costs, and competitive discipline’’ because brokers
in order to enhance competition increasing market data distribution. will not be able to avoid markets that do
between market centers, while Efficiencies born of competition have not provide quality execution
promoting market fairness, efficiency, benefited investors and issuers alike. services.114 The majority would replace
and transparency.’’ 109 In analyzing the The majority’s adoption of the trade- this competitive discipline with
competitive issues involved in through rule assists one market to step increased regulatory oversight. The
approving SuperMontage, the forward, while forcing other markets to Commission now must screen new
Commission stressed that: take two giant steps backward. entrants’ ability to meet access
B. Additional Regulation Is Needed to requirements and standards for
Nasdaq and traditional exchanges must
have the flexibility to rethink their structures Address Problems Created by the Trade- automatic execution through the SRO
to permit appropriate responses to the Through Rule registration process or the 19b-4
rapidly changing marketplace. Congress approval process for new ADF
instructed the Commission to seek to To have its trade-through rule, the participants. The majority notes that the
‘‘enhance competition and to allow economic majority has been compelled to engage self-regulatory function will also be
forces, interacting with a fair regulatory field, in rulemaking that otherwise would important in monitoring compliance
to arrive at appropriate variation in practices have been unnecessary. The with all Exchange Act and SRO rules,
and services.’’ 110 Commission has historically analyzed a including compliance with the trade-
broker’s best execution obligation on the through rule.115 Finally, the Adopting
The Commission found
basis of several factors, including Release notes that ‘‘[e]ffective
SuperMontage consistent with the goals
execution price, speed of execution, the implementation of the Order Protection
of promoting ‘‘price discovery, best
size of the order, the trading Rule also will depend on the
execution, liquidity, and market
characteristics of the security involved, Commission’s taking any action that is
innovation, while continuing to
the availability of accurate information necessary and appropriate to address
preserve competition among market
affecting choices as to the most trading centers that fail to meet fully
centers.’’ 111 Under this policy guidance,
favorable market center for execution their regulatory requirements.’’ 116 This
the markets automated and real
and the availability of technological aids would include taking enforcement
competition emerged, due in large part
to process such information, and the actions against trading centers that fail
to the explosive growth of the ECNs,
cost and difficulty associated with to meet regulatory requirements.
which have been the greatest catalyst for
achieving an execution in a particular Instead of relying on competitive
increased competition and technological
market center.112 One of the forces to discipline market access and
advances in the Nasdaq market. Under
consequences of limiting investor execution services, Regulation NMS
the trade-through rule, ECNs will be
choice to the sole criterion of price is establishes a regulatory back-up plan for
able to compete only if they display
that the Commission must ensure that outlier SROs. We believe the better
quotations through an SRO and offer
markets have comparable access to these approach would have been to clarify
substantially equivalent access.
prices. This has required the best execution guidance, outlining the
Moreover, the fact that dominant
Commission to adopt a cap on access appropriate balancing of factors when
markets can match BBOs undercuts the
fees so that market participants are not routing orders. In any event, the trade-
majority’s argument that competition
held hostage by outlier markets through rule, which does not provide
among markets will increase.
displaying the best price, but charging protection to manual quotes,
excessive access fees. complicates the best execution analysis
(Dec. 8, 1998), 63 FR 70844, at 70847 (Dec. 22,
As noted above, Regulation NMS will because manual quotations may not be
1998). also require Commission involvement in disregarded. Furthermore, guidance on
107 Id. The Commission stated that the pilot was implementation of access standards and best execution will still be needed to
‘‘to provide registered exchanges and national approval for new ADF participants. Key assist brokers in fulfilling their
securities associations with a greater opportunity to standards under trade-through
compete with alternative trading systems registered
as broker-dealers and with foreign markets.’’ Id. at exceptions, including standards for 113 Angel Reproposal Comment Letter, supra note
note 29. automatic execution, will also require 89, at 2.
108 Securities Exchange Act Release No. 43863 determinations by the Commission and 114 See Adopting Release, supra note 1, at text
(Jan. 19, 2001), 66 FR 8020, at 8049 (Jan. 26, 2001). following note 243.
109 Id. at 8052. 112 Newton v. Merrill Lynch, 135 F.3d 266, 270 115 See Adopting Release, supra note 1, at text
110 Id. at note 471 and accompanying text (citing following note 244.
n.2 (3d Cir. 1998)(citing Securities Exchange Act
Senate Report, supra note 3). Release No. 33026 (Oct. 6, 1993), 58 FR 52934 (Oct. 116 Adopting Release, supra note 1, at text
111 Id. at 8055. 13, 1993). following note 244.
obligations for assessing the depth of trade-throughs, there will still be a decision by our colleagues when the
book and manual quotations.117 burden on trading centers to prove the Commission considers the market data
absence of trade-throughs.121 issue in general.
C. Implementation Will Be Costly
We are also concerned about the
The majority’s cost-benefit analysis VI. Market Data Reforms Do Not
majority’s failure to address the level of
Address the Real Problem
underestimates the costs associated with market data fees. The size of market data
implementation and compliance, while While the discussion above focuses revenues and lack of accountability for
overestimating the benefits. Even by the on the trade-through rule, we also the use of these revenues by the SROs
majority’s own estimation, the benefits believe there are serious problems with creates market distortions and
of Regulation NMS will likely be the market data reforms included in inefficient allocation of resources.122 By
modest. But these modest benefits will Regulation NMS. The availability of continuing to fail to address the
come at a very high price. Some of the market data is critical because market reasonableness of the rates charged by
costs of Regulation NMS will be data provides transparency within the the markets, the majority sidesteps
measured in terms of the dollars it will market and allows investors to evaluate serious questions about whether
cost trading centers to modify their the quality of their executions. government-sponsored monopolies
policies and procedures and internal Regulation NMS does not address the should be allowed to charge excessive
systems and monitor compliance with larger issues surrounding market data, rents to cross-subsidize other functional
the trade-through rule on an ongoing and the majority has indicated that costs, and if so, how they should be
basis.118 The cost-benefit analysis these issues will be addressed in a held accountable for the appropriate use
estimates start-up costs at $143.8 different forum. of such funds. What is needed is a
million, with average annual ongoing We have concerns about the market heightened sense of accountability for
costs of approximately $22 million.119 data reforms in Regulation NMS, even the use of market data revenues and an
Market participants will also experience though they are limited, and a particular incentive for the exchanges to increase
significant costs in terms of the time and concern with respect to the codification efficiencies.
effort they will spend negotiating with of the single consolidator model. By Supporters of the current pricing
our staff on the numerous interpretive entrenching the single consolidator schedule indicate that the extra
issues and in explaining to our model, the majority grants a monopoly revenues are needed to fund the
examination staff that apparent trade- for the consolidation of market data, regulatory functions performed by
through violations are not really which erects another barrier to exchanges. Even with the current high
violations.120 Thus, even if there are no encouraging competitive solutions for levels of market data fees, our
market data consolidation. We intend to enforcement docket does not
117 See, e.g., SIA Reproposal Comment Letter, advocate a reconsideration of this demonstrate that higher funding has led
supra note 89, at 15 (‘‘[W]e are concerned that
broker-dealers will be required, as a business and
to effective regulatory oversight by
hundreds of ‘‘exceptions’’ for which the regulatory
legal matter, to take account of the full depth-of- surveillance systems have detected a potential
SROs.123 Critics contend that the
book as well as manual quotes in providing best trade-through violation. In following current exchanges charge an excessive rate for
execution to their customers. Although the SEC examination practice, a firm will be given an
states only that best execution standards will not opportunity to demonstrate to the regulator why it 122 See, e.g., Hearing on Proposed Regulation
change, the SEC will have changed the entire believes that it did not trade through the best posted NMS Before the Securities and Exchange
market structure, which would appear to price (thus the firm will be deemed guilty of these Commission (Apr. 21, 2004) (‘‘Regulation NMS
necessitate a re-evaluation of best execution violations unless it can satisfactorily demonstrate Hearings’’), at 223–24 (testimony of Robert Greifeld,
standards. * * * [W]e are concerned that broker- its innocence). Due to exceptions to the rule, President and Chief Executive Officer, Nasdaq
dealers will be held liable by customers and technological limitations, and latency in delivery Stock Market) (‘‘Currently that cost [of market data]
regulatory examiners, far beyond the requirements and receipt of market updates and quotations, there for professional investors is around $20. * * *
of the trade-through rule, to a best execution will be a substantial number of ‘‘false positives’’ There was no great wisdom in that number, and we
standard based on manual quotes.’’); Comment that would have to be disproved. The likely end look at the number today, that number is too high.
Letter of Bernard L. Madoff and Peter B. Madoff, result of this review will be a justifiable reason for * * * With the current structure, then, data is not
Bernard L. Madoff Investment Securities LLC (Feb. 98% of the exceptions, but firms such as UBS provided at a low enough cost and it [creates]
3, 2005), at 5 (‘‘[W]e urge that the Commission would, most likely, receive a regulatory sanction for unintended results and distortions in our market.
clarify its position by providing specific guidance their inability to demonstrate guilt or innocence for The market centers today are the beneficiaries of
as to the interplay between the trade-through and the remaining 2%. that excessive rent * * *.’’); Regulation NMS
the best execution requirement.’’); RBC Reproposal UBS Reproposal Comment Letter, supra note 22, Hearings, at 229 (testimony of Jeffrey T. Brown,
Comment Letter, supra note 100, at 4; Merrill Lynch at 5. See also CIBC Reproposal Comment Letter, General Counsel, Schwab Soundview Capital
Reproposal Comment Letter, supra note 22, at 6; supra note 22, at 4 (‘‘It will result in wasted Markets) (‘‘[L]ast year, the market data cartels took
UBS Reproposal Comment Letter, supra note 22, at resources sifting through market data to eliminate in $424 million in revenue and had expenses of $38
2. false trade-throughs, and trade-throughs for million. * * * [T]hat’s a profit margin of over a
118 See, e.g., Deutsche Bank Reproposal Comment
economically insignificant sums. We also believe thousand percent. * * * [T]hat excess revenue
Letter, supra note 22, at 5 (‘‘In sum, we are that this task will be inordinately expensive, both manifests itself in the types of practices that you’re
concerned that the adoption of Regulation NMS, in terms of the hard dollars required to build concerned with, * * * tape shredding, market data
unless carefully crafted with sensitivity to practical systems and pay for market data to do surveillance rebates, excessive pay to executives. And there’s
implementation difficulties and expenses, holds the and the lost opportunity cost of resources that could clearly a link * * * between market data revenue
potential to force upon broker-dealers complex be spent investigating execution quality in less and these practices.’’).
challenges and burdensome costs, the scale of liquid stocks.’’). 123 See, e.g., Securities Exchange Act Release No.
which may not be fully appreciated by the 121 One commenter cautioned against 51163 (Feb. 9, 2005) (Report of Investigation
Commission.’’); SIA Reproposal Comment Letter, underestimating costs. See Deutsche Bank pursuant to Section 21(a) of the Securities Exchange
supra note 89, at 11; Citigroup Reproposal Reproposal Comment Letter, supra note 22, at 4 Act of 1934 relating to violations by MarketXT, an
Comment Letter, supra note 6, at 2; Knight Trading (‘‘[W]hat in principle may appear to be a rather NASD member, and registered broker-dealer, which
Reproposal Comment Letter, supra note 22, at 5. straightforward measure, most assuredly involves were not adequately addressed by Nasdaq, as
significant changes to a broker-dealer’s trading, overseen by its parent, NASD); Securities Exchange
following note 782. technology, operations, supervisory and compliance Act Release No. 51524 (Apr. 12, 2005) and SEC
120 As UBS explained, the difficulties associated
platforms. * * * In our experience to date with Press Release 2005–53 (April 12, 2005) (instituting
with inspecting for violations of the rule are likely Regulation SHO, which was a fairly incremental and simultaneously settling an enforcement action
to result in a shifting of the burden to firms to prove initiative that built upon existing SRO rules and against the NYSE, finding that the NYSE, ‘‘over the
that they did not violate the rule: adopted a fraction of the original Commission course of nearly four years, failed to police
[W]e foresee a process, not unlike many current proposal, our costs (represented by hundreds of specialists, who engaged in widespread and
‘‘sweep’’ regulatory actions in which the SEC (or a collective hours * * *) have been real and unlawful proprietary trading on the floor of the
SRO) will provide each firm with a list containing significant.’’ NYSE’’).
consolidating and distributing market marketplace with anachronistic Unfortunately for the marketplace,
data. They note that the relative regulation that reduces investor choice this version of Regulation NMS that the
opaqueness of the market data pricing and raises investor costs. In the name of majority has adopted is far from final.
process inhibits public scrutiny on the investor protection and uniformity, the Imprecise definitions, the acknowledged
current cost of consolidated market majority has opted for greater regulation need for future interpretations that the
information. rather than competition to facilitate majority has seen fit to delegate to an
It is difficult to argue that, in an era what it perceives to be fair treatment of opaque process of staff guidance, and
of heightened disclosure requirements, a customer orders and deep and liquid uncertainty regarding future
virtual public utility should not be markets. However, the majority has examination and enforcement standards
required to openly justify and account failed to establish evidence of investor combine to produce a regulatory
for the use of public funds. Moreover, protection concerns, and the goal of framework that will keep market
having chosen to maintain the current uniformity could have been achieved by participants guessing and seeking
single processor system, the majority, if having no trade-through rule.
it is to accomplish its mission of clarification from our staff. From our
Since the Commission voted on experience with analogous situations,
promoting transparency and protecting Regulation NMS, mergers have been
investors, while allowing competition to we fear that the inevitable delays in
announced between the NYSE and obtaining guidance, the attendant
flourish, must accept the responsibility Archipelago and between Nasdaq and
for scrutinizing rates charged for market regulatory uncertainty, and concomitant
The Instinet Group.125 The timing of
data and monitoring the heavy hand of costs will harm a competitive
these announcements so soon after the
monopoly power.124 marketplace.
adoption of the rule has led some to
Conclusion credit Regulation NMS with enhancing Far from enhancing competition, we
competition and equalizing regulation believe that Regulation NMS will have
We do not believe that Regulation anticompetitive effects. Increasing
among markets. We believe the timing
NMS is the appropriate policy choice. consolidation in the securities industry
can be more accurately explained by the
Instead of facilitating a national market as a result of the proposed mergers and
markets’ simple desire for closure with
system in which technology, the increased barriers to entry created
respect to Regulation NMS. Intensifying
competition and innovation will
competitive pressures, combined with by the trade-through rule magnify our
produce benefits for all investors,
the Commission’s focus on market concerns about the competitive impact
Regulation NMS saddles the
structure, created an environment in of Regulation NMS going forward.
124 The Senate bill required SIPs which act as
which the markets’ strategic business For the reasons stated above, we
exclusive processors to register with the plans likely could not be finalized until respectfully dissent.
Commission and provided the Commission with the the regulatory risk was resolved. In the
authority to require the registration of other end, it was not so much the substance Dated: June 9, 2005.
categories of SIPs. The reference to exclusive
processors did not constitute a mandate for a single
of Regulation NMS that was important, Cynthia A. Glassman,
securities information processor at any stage in the but the fact that the regulation was final.
Commissioner.
processing of quotation or transactional data, but
merely recognized that where SROs utilize an 125 See, e.g., Aaron Lucchetti et al., NYSE to Paul S. Atkins,
exclusive processor, that processor takes on certain Acquire Electronic Trader and Go Public, Wall St. Commissioner.
of the characteristics of a public utility and should J., Apr. 21, 2005, at A1; Aaron Lucchetti, Nasdaq
be regulated accordingly. Chief Plays Hardball in Instinet Deal, Wall St. J.,
[FR Doc. 05–11802 Filed 6–28–05; 8:45 am]
Conference Report, supra note 4, at 93. Apr. 25, 2005, at C1. BILLING CODE 8010–01–P

Rule: Securities: National Market System Joint Industry Plans Amendments

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Wednesday,

June 29, 2005

SECURITIES AND EXCHANGE revenues (‘‘Allocation Amendment’’) 3. Locking or Crossing Quotations

Chairman, and John C. Giesea, President and CEO,

quotations on occasion. President, Director of U.S. Equity Trading,

a broker or dealer. 10. 260 See supra, section I.B.2.

designed to assure compliance with the 600(b)(72) as a facility operated by or on behalf of

affected by an improvement in depth and liquidity. adoption of Rule 611. 600(b)(52).

2004 FINANCIAL INFORMATION FOR NETWORKS A, B, AND C 1

Revenues ................................................................................................. $165,588,000 $103,901,000 $164,656,000 $434,145,000

London ....................................................................................................................... $180 $3.6 $2.5

process of Commission-approved proposed allocation formula.599 It noted Other commenters, in contrast,

Attachment at 11. across all Network stocks. 22; NSX Letter at 6.

2, 17; Citigroup Letter at 16; Financial Information

respect to its application to a member of an 711 17 CFR 240.10a–1.

SRO trading center. $8,646,405 and $9,135,000. Reproposing Release, 69 FR at 77476.

Although the Exchange Act envisions facilities. Reproposal Letter at 4.

reaching a consensus on Plan business, 3. 859 Specialist Assoc. Letter at 16–17.

protection). marketplaces’’). Letter at 9–10; Tower Research Letter at 8–11.

jointly through the Plans and disseminate their

text. (1975) (‘‘House Report’’).

from the definition of ‘‘quotation’’ in Trade-Through Study at 3 ($321 million ‘‘includes

17 CFR Part 201 (a) * * * (61) To grant exemptions from Rule

Regulation S–X ........................................................................... PART 210 ................................................................................... 3235–0009

Regulation S–T ........................................................................... Part 232 ...................................................................................... 3235–0424

Regulation 14E ........................................................................... 240.14e–1 thru 240.14e–2 ......................................................... 3235–0102

Rule 19b–1 ................................................................................. 240.19b–1 ................................................................................... 3235–0354

Rule 1(a) ..................................................................................... 250.1(a) ...................................................................................... 3235–0170

Rule 6e–2 ................................................................................... 270.6e–2 ..................................................................................... 3235–0177

Form ADV–E .............................................................................. 279.8 ........................................................................................... 3235–0361

21 of this application, or any (June 9, 2005) (‘‘Adopting Release’’). Regulation

(‘‘NYSE’’), but on Nasdaq, a market in III.D.2 (‘‘Automated Order Execution Facility

this result, the majority portrays statistics.34 accompanying text.

65 See Adopting Release, supra note 1, at text

1. following note 110. following note 160.

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