

[Federal Register: November 14, 2006 (Volume 71, Number 219)]
[Notices]               
[Page 66352-66354]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr14no06-62]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54714]

 
Order Granting National Securities Exchanges a Limited Exemption 
From Rule 612 of Regulation NMS Under the Securities Exchange Act of 
1934 To Permit Acceptance by Exchanges of Certain Sub-Penny Orders

 November 6, 2006.

I. Introduction

    The Securities and Exchange Commission (``Commission'') is granting 
national securities exchanges a limited exemption from Rule 612 \1\ of 
Regulation NMS under the Securities Exchange Act of 1934 (``Exchange 
Act'') to permit them to accept certain cross orders priced in sub-
penny increments, subject

[[Page 66353]]

to the conditions described below. Rule 612 prohibits a national 
securities exchange (among other entities) from displaying, ranking, or 
accepting a bid or offer, an order, or indication of interest in any 
national market system (``NMS'') stock \2\ that is priced in an 
increment smaller than $0.01 per share, unless the price of the bid or 
offer, order, or indication of interest is priced less than $1.00 per 
share.\3\ If the bid or offer, order, or indication of interest is 
priced less than $1.00 per share, the minimum allowable increment is 
$0.0001 per share.\4\
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    \1\ 17 CFR 240.612.
    \2\ An NMS stock is any non-option security for which 
transaction reports are collected, processed, and made available 
pursuant to an effective transaction reporting plan. See 17 CFR 
242.600(b)(46) and (b)(47).
    \3\ See 17 CFR 242.612(a).
    \4\ See 17 CFR 242.612(b).
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    Recently, the Commission approved a number of SRO rule changes 
that, subject to the Commission's grant of exemptive relief, envision 
the acceptance of certain cross orders arranged by members in sub-penny 
prices.\5\ A cross transaction involves a buy order and sell order for 
the same security at the same price that are pre-matched by an exchange 
member, whether as principal or agent, and submitted to the exchange 
for execution.\6\ In absence of an exemption from the Rule 612, an 
exchange is prohibited from accepting cross orders priced above $1.00 
per share in sub-penny increments,\7\ even if such orders are 
immediately executed and printed by the exchange. However, pursuant to 
Rule 612(c), the Commission, by order, may exempt from the provisions 
of Rule 612, either unconditionally or on specified terms and 
conditions, any person, security, quotation, or order (or any class or 
classes of persons, securities, quotations, or orders) if the 
Commission determines that such exemption is necessary or appropriate 
in the public interest, and is consistent with the protection of 
investors.
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    \5\ See, e.g., Securities Exchange Act Release No. 54550 
(September 29, 2006), 71 FR 59563 (October 10, 2006) (SR-CHX-2006-
05) (approving, among other things, rules permitting cross 
transactions in increments as small as $0.000001); Securities 
Exchange Act Release No. 54538 (September 28, 2006), 71 FR 59184 
(October 6, 2006) (SR-Phlx-2006-43) (approving, among other things, 
benchmark orders that could be priced in increments as small as 
$0.0001).
    \6\ For example, a member could pair together a customer market 
order to buy and a customer market order to sell at the midpoint 
between the exchange's best bid and offer (``BBO''), which would 
result in a sub-penny execution (e.g., $17.895) if the BBO were an 
odd number of cents wide (e.g., $17.89 x $17.90). In addition, a 
member could offer sub-penny price improvement when trading as 
principal with a customer order.
    \7\ An exchange may, consistent with Rule 612(b) of Regulation 
NMS, establish rules that permit it to accept orders that are priced 
less than $1.00 per share in increments as small as $0.0001, whether 
or not as part of a cross transaction.
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II. Discussion

    After careful consideration, the Commission hereby grants the 
national securities exchanges a limited exemption from Rule 612 
permitting them to accept certain sub-penny cross orders. This 
exemption is limited to the acceptance by national securities exchanges 
of cross orders arranged by members that are priced in sub-penny 
increments and immediately executed against each other,\8\ and 
otherwise accepted and handled in accordance with rules approved or 
established pursuant to Section 19(b) of the Exchange Act.\9\
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    \8\ Therefore, if an exchange accepts two sub-penny orders that 
are not immediately executed against each other, the exchange must 
immediately cancel both orders or be in violation of Rule 612. If 
the exchange ranked or displayed either sub-penny order, it also 
would be in violation of Rule 612, as this exemption extends only to 
the acceptance of such orders. For purposes of this exemption, a 
cross order is immediately executed if the exchange automatically 
executes the cross with no delay other than for confirming that the 
conditions for the cross imposed by the exchange's rules are 
satisfied.
    \9\ 15 U.S.C. 78s(b).
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    Among other things, Rule 612 is designed to limit the ability of a 
market participant to gain execution priority over a competing limit 
order by an economically insignificant amount. The Commission noted 
that, ``[i]f investors' limit orders lose execution priority for a 
nominal amount, investors may over time decline to use them, thus 
depriving the markets of liquidity.'' \10\ In addition, Rule 612 is 
intended to reduce the incidence of quote flickering, which makes it 
more difficult for market participants to identify the best price 
available in the national market system at a given moment, and to 
prevent excessive reduction of depth at the best inside quotation.\11\ 
In adopting Rule 612, the Commission explicitly declined to prohibit 
sub-penny executions, provided such executions do not result from an 
impermissible sub-penny orders or quotations.\12\ The Commission 
observed that sub-penny trading ``does not raise the same concerns as 
sub-penny quoting. Sub-penny executions do not cause quote flickering 
and do not decrease depth at the inside quotation. Nor do they require 
the same systems capacity as would sub-penny quoting. In addition, sub-
penny executions due to price improvement are generally beneficial to 
retail investors.'' \13\
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    \10\ See Securities Exchange Act Release No. 51808 (June 9, 
2005), 70 FR 37496, 37551 (June 29, 2005) (``Regulation NMS Adopting 
Release'').
    \11\ See id. at 37752.
    \12\ See id. at 37556. A sub-penny execution could result, for 
example, from a midpoint or volume-weighted trading algorithm or 
from price improvement that a broker-dealer provides to a customer 
order.
    \13\ Id.
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    The Commission believes that this exemption is consistent with the 
protection of investors because allowing the exchanges to accept sub-
penny cross orders for the limited purpose of immediately executing 
them is akin to a sub-penny execution and should not implicate any of 
the problems with sub-penny quoting identified by the Commission in 
adopting Rule 612. Because these sub-penny cross orders are prohibited 
from being displayed, they will not cause quote flickering, decrease 
depth at the inside quotation, or degrade systems capacity. 
Furthermore, because this exemption applies only to pre-arranged cross 
orders, these sub-penny orders will not gain any execution advantage 
over resting limit orders on the book.\14\
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    \14\ Nothing in this exemption relieves a national securities 
exchange of the requirement to establish all rules, including its 
rules related to cross transactions, in a manner consistent with 
Section 19(b) of the Exchange Act, 15 U.S.C. 78s(b), and Rule 19b-4 
thereunder, 17 CFR 240.19b-4, before accepting sub-penny orders in 
reliance on this exemption. In reviewing proposed rules relating to 
cross transactions, the Commission would evaluate, among other 
things, whether cross orders could gain execution priority over 
resting limit orders in a manner inconsistent with the Exchange Act. 
See, e.g., Securities Exchange Act Release No. 54391 (August 31, 
2006), 71 FR 52836 (September 7, 2006) (SR-NSX-2006-08) (approving, 
among other things, NSX Rule 11.12(b), which permits crosses that 
are priced at least $0.01 better than any displayed order on the 
book, and Rule 11.12(c), which permits midpoint crosses); Securities 
Exchange Act Release No. 54422 (September 11, 2006), 71 FR 54537 
(September 15, 2006) (SR-CBOE-2004-21) (approving, among other 
things, CBOE Rule 52.11, which permits crosses to occur at the same 
price as displayed orders on the book if the cross transaction: (1) 
Is for at least 5000 shares; (2) is for a principal amount of at 
least $100,000; and (3) is greater in size than any single public 
customer order displayed on the book at the proposed cross price).
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    Furthermore, the Commission believes that this exemption is 
necessary or appropriate in the public interest to facilitate the 
execution of pre-arranged cross orders on the exchanges. When the 
Commission adopted Rule 612, exchange rules did not contemplate sub-
penny crosses, which therefore could occur only in the over-the-counter 
(``OTC'') market. Since that time, some exchanges have proposed to 
offer such execution services.\15\ In the OTC market, a broker-dealer 
could execute a sub-penny cross without the two orders involved having 
to be accepted by any entity subject to Rule 612. The broker-dealer 
could simply arrange the trade at the sub-penny price, as principal or 
agent, and report the execution to the

[[Page 66354]]

NASD.\16\ To execute the same trade on an exchange, however, the 
exchange's systems might require the broker-dealer to enter matching 
buy and sell orders that are explicitly priced in a sub-penny increment 
that, absent an exemption, would not be permitted by Rule 612. The 
Commission does not believe that Rule 612 should preclude an immediate 
sub-penny execution on an exchange that results from the submission by 
a member of a cross order arranged by that member that otherwise is in 
accordance with exchange rules established consistent with Section 
19(b) of the Exchange Act. The Commission believes, therefore, that 
this exemption is consistent with the public interest because it will 
level the playing field between the exchanges and the OTC market as 
venues for sub-penny crossing transactions.\17\
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    \15\ See supra note 5.
    \16\ While a broker-dealer may execute a cross at a sub-penny 
price without violating Rule 612, the broker-dealer may not accept a 
sub-penny order. For example, the broker-dealer could accept a 
market order to buy, internalize it, and give the customer an 
execution at $10.001 (assuming such execution is consistent with all 
applicable Commission and SRO rules including, for example, rules 
relating to best execution and order protection). Rule 612 prohibits 
the broker-dealer from accepting a limit order to buy that the 
customer has explicitly priced at $10.001.
    \17\ However, as with sub-penny crosses arranged in the OTC 
market, nothing in this exemption permits a broker-dealer itself to 
accept a limit order that a customer has explicitly priced in an 
increment not permitted by Rule 612.
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    For these reasons, the Commission concludes that this limited 
exemption is necessary or appropriate in the public interest, and is 
consistent with the protection of investors.

III. Conclusion

    It is hereby ordered, pursuant to Rule 612(c) of Regulation NMS, 
that a national securities exchange may accept cross orders priced in 
sub-penny increments, provided that:
    (1) The orders are immediately executed against each other; and
    (2) The cross transaction is effected in accordance with exchange 
rules approved or established pursuant to Section 19(b) of the Exchange 
Act.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(83).
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Nancy M. Morris,
Secretary.
 [FR Doc. E6-19120 Filed 11-13-06; 8:45 am]

BILLING CODE 8011-01-P
