
[Federal Register Volume 77, Number 132 (Tuesday, July 10, 2012)]
[Notices]
[Pages 40673-40682]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-16769]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67347; File Nos. SR-NYSE-2011-55; SR-NYSEAmex-2011-84]


Self-Regulatory Organizations; New York Stock Exchange LLC; NYSE 
Amex LLC; Order Granting Approval to Proposed Rule Changes, as Modified 
by Amendments Nos. 1 and 2, Adopting NYSE Rule 107C To Establish a 
Retail Liquidity Program for NYSE-Listed Securities on a Pilot Basis 
Until 12 Months From Implementation Date, and Adopting NYSE Amex Rule 
107C To Establish a Retail Liquidity Program for NYSE Amex Equities 
Traded Securities on a Pilot Basis Until 12 Months From Implementation 
Date, and Granting Exemptions Pursuant to Rule 612(c) of Regulation NMS

July 3, 2012.

I. Introduction

    On October 19, 2011, the New York Stock Exchange LLC (``NYSE'') and 
NYSE Amex LLC (``NYSE Amex'' and together with NYSE, the ``Exchanges'') 
each filed with the Securities and Exchange Commission (``Commission'') 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to 
establish a Retail Liquidity Program (``Program'') on a pilot basis for 
a period of one year from the date of implementation, if approved. The 
proposed rule changes were published for comment in the Federal 
Register on November 9, 2011.\3\ The Commission received 28 comments on 
the NYSE proposal \4\ and 4 comments on the NYSE Amex proposal.\5\ On 
December 19, 2011, the Commission extended the time for Commission 
action on the proposed rule changes until February 7, 2012.\6\ In 
connection

[[Page 40674]]

with the proposals, the Exchanges requested exemptive relief from Rule 
612 of Regulation NMS,\7\ which among other things prohibits a national 
securities exchange from accepting or ranking orders priced greater 
than $1.00 per share in an increment smaller than $0.01.\8\ The 
Exchanges submitted a consolidated response letter on January 3, 
2012.\9\ On January 17, 2012, the Exchanges each filed Amendment No. 1 
to their proposals.\10\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release Nos. 65671 (November 2, 
2011), 76 FR 69774 (SR-NYSE Amex-2011-84); and 65672 (November 2, 
2011), 76 FR 69788 (SR-NYSE-2011-55).
     On May 14, 2012, NYSE Amex filed a proposed rule change, 
immediately effective upon filing, to change its name to NYSE MKT 
LLC. See SR-NYSEAmex-2012-32. To remain consistent with the previous 
documents that were submitted in connection with these proposals, 
the Commission will refer to NYSE MKT LLC as NYSE Amex throughout 
this order.
    \4\ See Letters to the Commission from Sal Arnuk, Joe Saluzzi 
and Paul Zajac, Themis Trading LLC, dated October 17, 2011 (``Themis 
Letter''); Garret Cook, dated November 4, 2011 (``Cook Letter''); 
James Johannes, dated November 27, 2011 (``Johannes Letter''); Ken 
Voorhies, dated November 28, 2011 (``Voorhies Letter''); William 
Wuepper, dated November 28, 2011 (``Wuepper Letter''); A. Joseph, 
dated November 28, 2011 (``Joseph Letter''); Leonard Amoruso, 
General Counsel, Knight Capital, Inc., dated November 28, 2011 
(``Knight Letter I''); Kevin Basic, dated November 28, 2011 (``Basic 
Letter''); J. Fournier, dated November 28, 2011 (``Fournier 
Letter''); Ullrich Fischer, CTO, PairCo, dated November 28, 2011 
(``PairCo Letter''); James Angel, Associate Professor of Finance, 
McDonough School of Business, Georgetown University, dated November 
28, 2011 (``Angel Letter''); Jordan Wollin, dated November 29, 2011 
(``Wollin Letter''); Aaron Schafter, President, Great Mountain 
Capital Management LLC, dated November 29, 2011 (``Great Mountain 
Capital Letter''); Wayne Koch, Trader, Bright Trading, dated 
November 29, 2011 (``Koch Letter''); Kurt Schact, CFA, Managing 
Director, and James Allen, CFA, Head, Capital Markets Policy, CFA 
Institute, dated November 30, 2011 (``CFA Letter I''); David Green, 
Bright Trading, dated November 30, 2011 (``Green Letter''); Robert 
Bright, Chief Executive Officer, and Dennis Dick, CFA, Market 
Structure Consultant, Bright Trading LLC, dated November 30, 2011 
(``Bright Trading Letter''); Bodil Jelsness, dated November 30, 2011 
(``Jelsness Letter''); Christopher Nagy, Managing Director, Order 
Routing and Market Data Strategy, TD Ameritrade, dated November 30, 
2011 (``TD Ameritrade Letter''); Laura Kenney, dated November 30, 
2011 (``Kenney Letter''); Suhas Daftuar, Hudson River Trading LLC, 
dated November 30, 2011 (``Hudson River Trading Letter''); Bosier 
Parsons, Bright Trading LLC, dated November 30, 2011 (``Parsons 
Letter''); Mike Stewart, Head of Global Equities, UBS, dated 
November 30, 2011 (``UBS Letter''); Dr. Larry Paden, Bright Trading, 
dated December 1, 2011 (``Paden Letter''); Thomas Dercks, dated 
December 1, 2011 (``Dercks Letter''); Eric Swanson, Secretary, BATS 
Global Markets, Inc., dated December 6, 2011 (``BATS Letter''); Ann 
Vlcek, Director and Associate General Counsel, Securities Industry 
and Financial Markets Association, dated December 7, 2011 (``SIFMA 
Letter I''); and Al Patten, dated December 29, 2011 (``Patten 
Letter'').
    \5\ See Knight Letter I; CFA Letter I; TD Ameritrade Letter; and 
letter to the Commission from Shannon Jennewein, dated November 30, 
2011 (``Jennewein Letter'').
    \6\ See Securities Exchange Act Release No. 66003, 76 FR 80445 
(December 23, 2011).
    \7\ 17 CFR 242.612 (``Sub-Penny Rule'').
    \8\ See Letter from Janet M. McGinness, Senior Vice President-
Legal and Corporate Secretary, Office of the General Counsel, NYSE 
Euronext, to Elizabeth M. Murphy, Secretary, Commission, dated 
October 19, 2011. The Exchanges amended the exemptive relief request 
on January 13, 2012. See Letter from Janet M. McGinness, Senior Vice 
President-Legal and Corporate Secretary, Office of the General 
Counsel, NYSE Euronext, to Elizabeth M. Murphy, Secretary, 
Commission, dated January 13, 2012 (``Amended Request for Sub-Penny 
Rule Exemption'').
    \9\ See Letter to the Commission from Janet McGinnis, Senior 
Vice President, Legal & Corporate Secretary, Legal & Government 
Affairs, NYSE Euronext, dated January 3, 2012 (``Exchanges' Response 
Letter I'').
    \10\ In Amendment No. 1, the Exchanges propose to modify the 
proposals as follows: (1) To state that Retail Member Organizations 
may receive free executions for their retail orders and the fees and 
credits for liquidity providers and Retail Member Organizations 
would be determined based on experience with the Retail Liquidity 
Program in the first several months; (2) to correct a typographical 
error referring to the amount of minimum price improvement on a 500 
share order; (3) to indicate the Retail Liquidity Identifier would 
be initially available on each Exchange's proprietary data feeds, 
and would be later available on the public market data stream; and 
(4) to limit the Retail Liquidity Program to securities that trade 
at prices equal to or greater than $1.00 per share.
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    On February 7, 2012, the Commission instituted proceedings to 
determine whether to disapprove the proposed rule changes, as modified 
by Amendments No. 1.\11\ On February 16, 2012, the Exchanges each filed 
Amendment No. 2 to their proposals, which the Commission published for 
comment in the Federal Register on March 1, 2012.\12\ In response to 
the Order Instituting Proceedings and the Notice of Amendments No. 2, 
the Commission received four additional comment letters on the 
proposals.\13\ On March 20, 2012, the Exchanges submitted a 
consolidated response letter to the Commission's Order Instituting 
Proceedings.\14\ Additionally, on April 10, 2012, the Exchanges 
submitted a consolidated response to the comments concerning Amendments 
No. 2.\15\ Finally, on April 11, 2012, the Exchanges submitted a letter 
requesting that the staff of the Division of Trading and Markets not 
recommend any enforcement action under Rule 602 of Regulation NMS 
(``Quote Rule'') based on the Exchanges' and liquidity providers' 
participation in the Program (``No-Action Request Letter'').\16\
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    \11\ See Securities Exchange Act Release No. 66346, 77 FR 7628 
(February 13, 2012) (``Order Instituting Proceedings'').
    \12\ See Securities Exchange Act Release No. 66464 (February 24, 
2012), 77 FR 12629. In Amendment No. 2, the Exchanges propose to 
modify the proposals as follows: (1) Limit the definition of 
``Retail Order''; (2) modify the definition of the Retail Liquidity 
Identifier; and (3) clarify the treatment of odd lots, round lots, 
and part of a round lot order.
    \13\ See Letters to the Commission from Leonard Amoruso, General 
Counsel, Knight Capital, Inc., dated March 7, 2012 (``Knight Letter 
II''); Kurt Schact, CFA, Managing Director, Rhodri Preece, CFA, 
Director, Capital Markets Policy, and James Allen, CFA, Head, 
Capital Markets Policy, CFA Institute, dated March 21, 2012 (``CFA 
Letter II''); Ann Vlcek, Director and Associate General Counsel, 
Securities Industry and Financial Markets Association, dated March 
23, 2012 (``SIFMA Letter II''); and Jim Toes, President and CEO, and 
Jennifer Green Setzenfand, Chairman, Security Traders Association, 
dated April 26, 2012 (``STA Letter'').
    \14\ See Letter to the Commission from Janet McGinnis, Senior 
Vice President, Legal & Corporate Secretary, Legal & Government 
Affairs, NYSE Euronext, dated March 20, 2012 (``Exchanges' Response 
Letter II'').
    \15\ See Letter to the Commission from Janet McGinnis, Senior 
Vice President, Legal & Corporate Secretary, Legal & Government 
Affairs, NYSE Euronext, dated April 10, 2012 (``Exchanges' Response 
Letter III'').
    \16\ See Letter from Janet M. McGinness, Senior Vice President-
Legal and Corporate Secretary, Office of the General Counsel, NYSE 
Euronext to Robert Cook, Director, Division of Trading and Markets, 
dated April 11, 2012.
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    This order approves the proposed rule change, as modified by 
Amendments Nos. 1 and 2, and grants exemptions from the Sub-Penny Rule 
sought by the Exchanges in relation to the proposed rule changes.

II. Description of the Proposals

    The Exchanges are proposing to establish a Program on a pilot basis 
to attract retail order flow to the NYSE for NYSE-listed securities, 
and to NYSE Amex for NYSE Amex-listed securities as well as securities 
listed on The NASDAQ Stock Market LLC (``Nasdaq'') and traded pursuant 
to unlisted trading privileges (``UTP''). The proposed Program would 
allow such order flow to receive potential price improvement, and would 
be limited to trades occurring at prices equal to or greater than $1.00 
per share.
    Under the proposed Program, a new class of market participants 
called Retail Liquidity Providers would be able to provide potential 
price improvement, in the form of a non-displayed order that is priced 
better than the Exchange's best protected bid or offer (``PBBO''),\17\ 
called a Retail Price Improvement Order. Other Exchange member 
organizations would be allowed, but not required, to submit Retail 
Price Improvement Orders. When there is a Retail Price Improvement 
Order in a particular security, the Exchange will disseminate an 
indicator, known as the Retail Liquidity Identifier, indicating that 
such interest exists. In response, a new class of market participants 
known as Retail Member Organizations could submit a new type of order, 
called a Retail Order, to the Exchange. A Retail Order would interact, 
to the extent possible, with available contra-side Retail Price 
Improvement Orders.\18\ The Exchanges would approve member 
organizations to be Retail Liquidity Providers and/or Retail Member 
Organizations.
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    \17\ The terms protected bid and protected offer would have the 
same meaning as defined in Rule 600(b)(57) of Regulation NMS. Rule 
600(b)(57) of Regulation NMS defines ``protected bid'' and 
``protected offer'' as ``a quotation in an NMS stock that: (i) [i]s 
displayed by an automated trading center; (ii) [i]s disseminated 
pursuant to an effective national market system plan; and (iii) [i]s 
an automated quotation that is the best bid or best offer of a 
national securities exchange, the best bid or best offer of the 
Nasdaq Stock Market, Inc., or the best bid or best offer of a 
national securities association other than the best bid or best 
offer of the Nasdaq Stock Market, Inc.'' 17 CFR 242.600(b)(57).
    \18\ As explained further below, the Exchanges have proposed 
three kinds of Retail Orders, two of which could execute against 
other interest if they were not completely filled by contra-side 
Retail Price Improvement Order interest. All Retail Orders would 
first execute against available contra-side Retail Price Improvement 
Orders. Any remaining portion of the Retail Order would then either 
cancel, be executed as an immediate-or-cancel order, or be routed to 
another market for execution, depending on the type of Retail Order.
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Types of Orders and Identifier

    A Retail Order would be an agency order that originated from a 
natural person and not a trading algorithm or any other computerized 
methodology. A Retail Order would be an immediate or cancel order. The 
Retail Member Organization submitting the order would not be able to 
alter the terms of such order with respect to price or side of the 
market. A Retail Order could be submitted in a round lot, odd lot, or 
partial round lot amounts.
    A Retail Liquidity Provider would be required to submit Retail 
Price Improvement Orders for securities that are assigned to the Retail 
Liquidity Provider, as further discussed below. A Retail Price 
Improvement Order would be required to be priced better than the PBBO 
by at least $0.001 per share.
    When a Retail Price Improvement Order is available that is priced 
at least $0.001 more than the PBBO for a particular security, the 
Exchange would disseminate an identifier, called a Retail Liquidity 
Identifier. The Exchanges initially proposed to disseminate the 
identifier through their proprietary data feeds; they then amended 
their

[[Page 40675]]

proposals to state that they would implement the Program in a manner 
that allowed the dissemination of the identifier through the 
consolidated public market data stream as soon as practicable, and they 
now represent that they will in fact be able to disseminate the 
identifier through the consolidated public market data stream as soon 
as the Program is implemented, if it is approved.\19\ The identifier 
would reflect the symbol for a particular security and the side (buy or 
sell) of the Retail Price Improvement Order, but it would not include 
the price or size of such interest.
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    \19\ See Exchanges' Response Letter III. For UTP eligible 
securities traded on NYSE Amex, however, the Exchanges represented 
that the identifier will only be available through the Exchanges' 
proprietary data feeds until on or about October 1, 2012, at which 
time NASDAQ will make the identifier for UTP eligible securities 
available through the consolidated public market data stream. See 
email from Brendon Weiss, NYSE Euronext, to Steve Kuan, Division of 
Trading and Markets, Commission, dated June 26, 2012.
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Retail Member Organizations

    In order to become a Retail Member Organization, an Exchange member 
organization must conduct a retail business or handle retail orders on 
behalf of another broker-dealer. The member organization must submit an 
application with supporting documentation and an attestation to the 
Exchange that the order flow would qualify as Retail Orders.
    The Exchange would review the application and notify the member 
organization of the Exchange's decision in writing. If a member 
organization did not receive approval to become a Retail Member 
Organization, then the member organization could appeal as provided 
below or reapply 90 days after the Exchange issued the disapproval.
    The Exchange would require a Retail Member Organization to have 
written policies and procedures in place to assure that only bona fide 
retail orders are designated as such. The written policies and 
procedures would require that the Retail Member Organization exercise 
due diligence to assure that entry of a Retail Order is in compliance 
with the proposed rule, prior to entry of that Retail Order. In 
addition, the Retail Member Organization must monitor whether the 
Retail Order meets the requirements of the proposed rule.
    If the Retail Member Organization represented the Retail Order from 
another broker-dealer, then the Retail Member Organization must have 
adequate supervisory procedures to assure that the Retail Order meets 
the proposed definition. Every year, the Retail Member Organization 
must obtain from each broker-dealer a written representation that the 
Retail Orders the broker-dealer sends comply with the proposed rule and 
must monitor the broker-dealer's order flow to meet the requirements of 
the proposed rule.

Retail Order Interactions

    Under the proposal, a Retail Member Organization submitting a 
Retail Order could choose one of three ways for the Retail Order to 
interact with available contra-side interest. First, a Retail Order 
could interact only with available contra-side Retail Price Improvement 
Orders. The Exchange would label this a Type 1 Retail Order and such 
orders would not interact with other available contra-side interest in 
Exchange systems or route to other markets. Portions of a Type 1 Retail 
Order that are not executed would be cancelled.
    Second, a Retail Order could interact first with available contra-
side Retail Price Improvement Orders and any remaining portion would be 
executed as a non-routable Regulation NMS-compliant Immediate or Cancel 
Order.\20\ The Exchange would label this a Type 2 Retail Order.
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    \20\ Such order would sweep the Exchange's book without being 
routed to other markets, and any remaining portion would be 
cancelled.
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    Finally, a Retail Order could interact first with available contra-
side Retail Price Improvement Orders and any remaining portion would be 
executed as a routable NYSE Immediate or Cancel Order.\21\ The Exchange 
would label this a Type 3 Retail Order.
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    \21\ Such order would sweep the Exchange's book and be routed to 
other markets and any remaining portion would be cancelled.
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Priority and Allocation

    The Exchange would follow price-time priority, ranking Retail Price 
Improvement Orders according to price and then time of entry, without 
regard to the size of the order. Executions would occur at the best 
price that completes the incoming Retail Order, unless there was not 
sufficient Retail Price Improvement interest to fill such order, in 
which case the Retail Order would be executed at the price that results 
in the greatest fill for that order, consistent with its terms. If 
there are remaining Retail Price Improvement Orders, they would be 
available for further incoming Retail Orders. As noted above, Retail 
Orders not executed would be cancelled.

Retail Liquidity Provider Qualifications and Admission

    To qualify, a member organization must be approved as a Designated 
Market Maker \22\ or Supplemental Liquidity Provider \23\ on the 
Exchange and demonstrate an ability to meet the requirements of a 
Retail Liquidity Provider. Moreover, the member organization must have 
mnemonics or the ability to accommodate other Exchange-supplied 
designations that identify to the Exchange Retail Liquidity Provider 
trading activity in assigned securities.\24\
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    \22\ See NYSE Rule 103 and NYSE Amex Rule 103.
    \23\ See NYSE Rule 107B and NYSE Amex Rule 107B.
    \24\ The member organization would not be allowed to use the 
mnemonic or designation for non-Retail Liquidity Provider trading 
activities. Further, the member organization would not receive 
credit for trading activity as a Retail Liquidity Provider if the 
member organization did not use such mnemonic or designation.
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    A member organization must submit an application with supporting 
documentation to the Exchange. Thereafter, the Exchange would notify 
the member organization as to whether it is approved as a Retail 
Liquidity Provider. More than one member organization could act as a 
Retail Liquidity Provider for a security, and a member organization 
could act as a Retail Liquidity Provider for more than one security. A 
member organization could request the Exchange to be assigned certain 
securities. Once approved, the member organization must establish 
connectivity with relevant Exchange systems prior to trading.
    The Exchange would notify a member organization in writing if the 
Exchange does not approve the member organization's application to be a 
Retail Liquidity Provider. Such member organization could request an 
appeal as provided below. The member organization could also reapply 90 
days after the Exchange issues the disapproval notice.
    Once approved as a Retail Liquidity Provider, a member organization 
could withdraw by providing notice to the Exchange. The withdrawal 
would become effective when the Exchange reassigns the securities to 
another Retail Liquidity Provider, but no later than 30 days after the 
Exchange receives the withdrawal notice. In the event that the Exchange 
takes longer than 30 days to reassign the securities, the withdrawing 
Retail Liquidity Provider would have no further obligations under the 
proposed rule.

Retail Liquidity Provider Requirements

    The proposed rule changes would impose several requirements on 
Retail Liquidity Providers. First, a Retail Liquidity Provider could 
enter a Retail

[[Page 40676]]

Price Improvement Order electronically into Exchange systems only in 
its assigned securities. A Retail Liquidity Provider must maintain 
Retail Price Improvement Orders that are better than the PBBO at least 
5% of the trading day for each assigned security.
    To calculate the 5% quoting requirement, the Exchange would 
determine the average percentage of time a Retail Liquidity Provider 
maintains a Retail Price Improvement Order in each assigned security 
during the regular trading day on a daily and monthly basis. The 
Exchange would use the following definitions. The ``Daily Bid 
Percentage'' would be calculated by determining the percentage of time 
a Retail Liquidity Provider maintains a Retail Price Improvement Order 
priced higher than the best protected bid during each trading day for a 
calendar month. The ``Daily Offer Percentage'' would be calculated by 
determining the percentage of time a Retail Liquidity Provider 
maintains a Retail Price Improvement Order priced lower than the best 
protected offer during each trading day for a calendar month. The 
``Monthly Average Bid Percentage'' would be calculated for each 
security by summing the security's ``Daily Bid Percentages'' for each 
trading day in a calendar month, then dividing the resulting sum by the 
total number of trading days in such month. The ``Monthly Average Offer 
Percentage'' would be calculated for each security by summing the 
security's ``Daily Offer Percentages'' for each trading day in a 
calendar month, then dividing the resulting sum by the total number of 
trading days in such month.
    The proposed rule changes specify that only Retail Price 
Improvement Orders entered through the trading day would be used when 
calculating the 5% quoting requirements. Further, a Retail Liquidity 
Provider would have an initial two-month grace period from the 5% 
quoting requirement, so that the Exchange would impose the 5% quoting 
requirements on the first day of the third consecutive calendar month 
after the member organization began operation as a Retail Liquidity 
Provider.

Penalties for Failure to Meet Requirements

    The proposed rule changes provide for penalties when a Retail 
Liquidity Provider or a Retail Member Organization fails to meet the 
requirements of the rule.
    If a Retail Liquidity Provider fails to meet the 5% quoting 
requirements in any assigned security for three consecutive months, the 
Exchange, in its sole discretion, may: (1) Revoke the assignment of any 
or all of the affected securities; (2) revoke the assignment of 
unaffected securities; or (3) disqualify the member organization to 
serve as a Retail Liquidity Provider. If the Exchange moves to 
disqualify a Retail Liquidity Provider's status, then the Exchange 
would notify, in writing, the Retail Liquidity Provider one calendar 
month prior to the determination. Likewise, the Exchange would notify 
the Retail Liquidity Provider in writing if the Exchange ultimately 
determined to disqualify the status of that Retail Liquidity Provider. 
As noted earlier, a Retail Liquidity Provider that is disqualified may 
appeal as provided below or reapply.
    With respect to Retail Member Organizations, the Exchange could 
disqualify a Retail Member Organization if the Retail Orders submitted 
by the Retail Member Organization did not comply with the requirements 
of the proposed rule. The Exchange would have sole discretion to make 
such a determination. The Exchange would provide written notice to the 
Retail Member Organization when disqualification determinations are 
made. Similar to a disqualified Retail Liquidity Provider, a 
disqualified Retail Member Organization could appeal as provided below 
or reapply.

Appeal Process

    Under the proposals, the Exchange would establish a Retail 
Liquidity Program Panel to review disapproval or disqualification 
decisions. An affected member organization would have five business 
days after notice to request review. If a member organization is 
disqualified as a Retail Liquidity Provider and has appealed, the 
Exchange would stay the reassignment of securities pending completion 
of the appeal process.
    The Panel would consist of the Exchange's Chief Regulatory Officer 
or his or her designee, and two officers of the Exchange as designated 
by the co-head of U.S. Listings and Cash Execution. The Panel would 
review the appeal and issue a decision within the time frame prescribed 
by the Exchange. The Panel's decision would constitute final action by 
the Exchange, and the Panel could modify or overturn any Exchange 
action taken under the proposed rule.

III. Comment Letters and the Exchanges' Responses

    As noted above, the Commission received a total of 32 comment 
letters concerning the NYSE proposal and 7 comment letters concerning 
the NYSE Amex proposal, including letters submitted after the 
Commission published the Order Instituting Proceedings and Notice of 
Amendments No. 2. Several commenters expressed support for some or all 
elements of the Exchanges' proposed Program.\25\ For instance, one 
commenter expressed general support for the proposals \26\ and another 
commenter offered support for the Exchanges' efforts to enhance price 
competition for retail customer order flow.\27\ Another commenter was 
supportive of the proposals to the extent they promoted transparency, 
competition, efficiency, and greater investor choice in the capital 
markets.\28\ Two other commenters expressed broad support for the 
proposals' potential to benefit individual retail investors.\29\
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    \25\ See Johannes Letter; Knight Letter I; Angel Letter; TD 
Ameritrade Letter; UBS Letter; Dercks Letter; and BATS Letter.
    \26\ See TD Ameritrade Letter (stating that the proposals are 
``quite appealing'' to the interests of ``fair and transparent 
markets that benefit retail investors'' although there were still 
specific issues to be addressed).
    \27\ See BATS Letter.
    \28\ See UBS Letter.
    \29\ See Johannes Letter and Dercks Letter.
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    However, a number of commenters raised concerns about the proposed 
rule changes. The main areas of concern were: (1) The time and manner 
of the Commission's action on the proposed rule changes, given the 
potential impact on overall market structure; (2) the proposals' impact 
on the Sub-Penny Rule; (3) whether the proposals impede fair access; 
and (4) whether the proposals implicate rules and standards relating to 
best execution and order protection.

1. Time and Manner of Commission Action

    Several commenters requested that the Commission delay taking 
action on the proposals until the Commission has had additional time to 
examine the proposals' potential impact on market structure.\30\ For 
example, several commenters stated that the issues raised by the 
proposals should be considered through Commission rulemaking, rather 
than through a self-regulatory organization's proposed rule change, 
because of the proposals' impact on the Sub-Penny Rule \31\ as well as 
the

[[Page 40677]]

competitive landscape of the markets.\32\ Commenters questioned whether 
the standard action period applicable to self-regulatory organizations' 
proposed rule changes was enough time for the Commission to analyze 
relevant data and sufficiently consider the effects the proposals might 
have on the equities markets.\33\ Another commenter did not expressly 
oppose Commission approval of the proposals on a pilot basis, but 
cautioned that to the extent the Commission approves an effective 
reduction in the minimum price variation, or ``tick size,'' below 
$0.01, the Commission should do so on the basis of industry-wide pilot 
studies that test various tick sizes and publish the studies' data for 
public review and comment.\34\ Lastly, a commenter requested that the 
Commission consider disapproving the proposals while it carefully 
studies the potential market impact of the Program; this commenter felt 
such delay was warranted in this case because it felt the Program is 
not designed to cure a market deficiency, but rather to help the 
Exchanges acquire market share.\35\
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    \30\ In contrast, one commenter requested the Commission to 
expedite approval of the proposals. See Johannes Letter. Other 
commenters did not address issues that specifically related to the 
proposals but rather offered general comments about market 
structure, particularly computer or high frequency trading. See 
Wuepper Letter; Fischer Letter; Cook Letter; Voorhies Letter; Joseph 
Letter; Basic Letter; and Jelsness Letter.
    \31\ See Knight Letter I; SIFMA Letter I; SIFMA Letter II; and 
STA Letter.
    \32\ See Knight Letter I; Hudson River Trading Letter; Knight 
Letter II; and STA Letter.
    \33\ See Knight Letter I and SIFMA Letter I.
    \34\ See Angel Letter. Expressing similar general concerns but 
not offering specific comment on the proposal, one commenter urged 
the Commission to exercise caution when considering expert testimony 
offered by for-profit industry participants as it relates to market 
structure regulation. See Themis Letter.
    \35\ See Knight Letter II.
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    The Exchanges responded that the proposed Program is designed to 
attract retail order flow to the Exchanges by competing with the 
current practices of broker-dealers that internalize much of the 
market's retail order flow. Additionally, the Exchanges responded that 
the fees and credits they would implement as part of the Program would 
be similar to those used by investors in the over-the-counter (``OTC'') 
market with retail order flow providers.\36\
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    \36\ See also UBS Letter (stating that the proposed programs 
would not necessarily lead to more sub-penny activity, but would 
rather shift some of that activity from the over-the-counter markets 
to the Exchanges).
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2. Impact on the Sub-Penny Rule

    A number of commenters raised concerns about the proposed Program's 
use of sub-penny orders, and its implications with respect to the Sub-
Penny Rule.\37\ One commenter noted that, by accepting and ranking non-
displayed orders in sub-penny increments, the proposals could 
discourage liquidity by allowing ``dark'' liquidity to step ahead of 
posted limit orders for only a trivial amount.\38\ The same commenter 
observed that allowing non-displayed liquidity to gain an execution 
advantage over displayed limit orders for trivial per share amounts 
could result in wider bid-ask spreads.\39\
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    \37\ The Sub-Penny Rule is codified at 17 CFR 242.612. See supra 
note 7.
    \38\ See Angel Letter.
    \39\ See id.
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    Other commenters articulated similar concerns about protecting 
public limit orders and public price discovery,\40\ particularly with 
respect to institutional and retail investors,\41\ and one commenter 
stated that the proposals might lead to a potential increase in sub-
penny trading.\42\ In addition, one commenter pointed out the potential 
technical systems and capacity issues that could result from 
effectively reducing the minimum price increment from $0.01 to $0.001, 
thereby substantially increasing the number of price points between 
each dollar level.\43\ Lastly, a commenter stated that any study of the 
data generated while the Program was operating on a limited pilot basis 
would not be sufficiently meaningful in assessing the broader market 
structure impact of these types of proposals.\44\
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    \40\ See Voorhies Letter; Joseph Letter; Fournier Letter; PairCo 
Letter; Wollin Letter; Great Mountain Capital Letter; Koch Letter; 
CFA Letter I; Green Letter; Bright Trading Letter; TD Ameritrade 
Letter; Kenney Letter; Parsons Letter; and BATS Letter.
    \41\ See TD Ameritrade Letter; Knight Letter II; CFA Letter II; 
and SIFMA Letter II.
    \42\ See TD Ameritrade Letter.
    \43\ See Knight Letter I. In a second comment letter, Knight 
asked whether eliminating the proposed Retail Liquidity Identifier 
might remedy the Regulation NMS issues it felt could be implicated 
by the dissemination of a message that would signal the presence of 
sub-penny quotes on the Exchanges' books. See Knight Letter II.
    \44\ See Knight Letter II.
---------------------------------------------------------------------------

    In response, the Exchanges stated that currently, OTC market makers 
internalize retail order flow at negotiated sub-penny prices and not at 
their publicly displayed quotes. The Exchanges agree that the market 
structure impact of sub-penny executions may warrant further Commission 
consideration. However, the Exchanges also believe that the Program 
does not raise any new issues with respect to sub-penny executions; 
rather it simply seeks to compete for retail order flow within the 
current market landscape, while offering potentially greater price 
improvement to retail investors and transparency to the marketplace.
    The Exchanges also rejected commenters' concerns about non-
displayed liquidity stepping ahead of displayed limit orders for 
insignificant amounts. According to the Exchanges, the Commission's 
guidance with respect to the Sub-Penny Rule concerns market 
professionals using displayed sub-penny orders to gain execution 
priority over customer limit orders. The Exchanges distinguished the 
proposed Program by noting that the Retail Liquidity Identifier would 
not be priced and Retail Price Improvement Orders would not be 
displayed. Accordingly, the Exchanges stated that the Program would 
limit its sub-penny activity to sub-penny executions. Similarly, in 
response to comments about the consequences of moving the ``tick size'' 
to $0.001, the Exchanges stated that the ``tick size'' would not in 
fact be altered because the sub-penny components of the Program would 
not be displayed.
    Finally, in response to the concern that the proposals might lead 
to more sub-penny trading, the Exchanges stated that they do not 
anticipate such a result because they believe instead that the 
proposals would likely reallocate existing retail order flow from 
internalizing broker-dealers to the Exchanges. Moreover, the Exchanges 
stated that, if the proposals led to additional sub-penny executions 
for retail order flow, it would benefit retail investors by creating 
additional price competition, and, therefore, greater opportunity for 
price improvement, for such retail order flow.

3. Fair Access

    Commenters also highlighted several elements of the Program that 
potentially implicate the Commission's rules governing fair access. 
First, several commenters raised questions about whether the proposals 
would, in essence, create a private market. Some commenters wrote that 
the proposed segmentation of retail order flow could amount to unfair 
discrimination,\45\ for example, by creating trading interest that 
would not be accessible by institutional investors.\46\ One commenter 
suggested that the proposed Program would be akin to operating a 
limited access dark pool that could have the effect of creating a two-
tiered market.\47\
---------------------------------------------------------------------------

    \45\ See CFA Letter I and Hudson River Trading Letter. At least 
one commenter took the opposite view and supported market 
participant segmentation programs so long as such segmentation is 
done in an objective and transparent manner. See UBS Letter.
    \46\ See SIFMA Letters I and II; see also STA Letter (expressing 
concern over the program's differentiation between retail and 
institutional order flow, particularly since some individual 
investors may utilize managed funds--which may not be classified as 
``Retail Member Organizations''--as an investment vehicle).
    \47\ See Knight Letter I.
---------------------------------------------------------------------------

    Some commenters also took issue with the proposals to the extent 
that the

[[Page 40678]]

Retail Liquidity Identifier would be disseminated only through a 
proprietary data feed rather than the public market data stream.\48\ 
These commenters felt that limiting dissemination of the Retail 
Liquidity Identifier to a proprietary data feed could unfairly harm 
small firms who do not pay for the proprietary feed \49\ or create a 
private, two-tiered market where those who can afford the proprietary 
feed can view and potentially obtain the best prices.\50\ Another 
commenter suggested that the Program could undermine the Commission's 
policies underlying the Quote Rule because the Exchanges would not be 
displaying the ``best'' orders they receive, i.e., the sub-penny Retail 
Price Improvement Orders that the Exchanges would accept and rank under 
the Program.\51\
---------------------------------------------------------------------------

    \48\ See SIFMA Letters I and II and BATS Letter.
    \49\ See SIFMA Letter I.
    \50\ See BATS Letter.
    \51\ See Knight Letter II; see also SIFMA Letter II (stating 
that the Identifier would constitute a ``de facto'' quote, and 
contending that the Commission should address the Identifier, along 
with actionable indications of interest, through Commission 
rulemaking).
---------------------------------------------------------------------------

    The Exchanges responded that the proposals do not create a fair 
access issue because, in their view, the Retail Liquidity Identifier 
does not meet the definition of ``quotation'' under Regulation NMS. In 
essence, the Exchanges believe that the Retail Liquidity Identifier 
cannot be considered a ``bid'' or ``offer'' because the identifier 
would not contain a price. According to the Exchanges, there would be 
no fairness issue in signifying the presence of liquidity by 
distributing the Retail Liquidity Identifier through a proprietary data 
feed, especially because participation in the proposed program would be 
discretionary. However, in response to concerns about the dissemination 
of the Retail Liquidity Identifier, the Exchanges represented in their 
third consolidated response letter that the Retail Liquidity Identifier 
would be available through the consolidated public market data stream 
immediately upon implementation of the Program, if approved.
    Another issue raised by the commenters relates to the clarity and 
transparency of certain defined terms in the proposals. Specifically, 
some commenters expressed concern that, under the proposals, the 
Exchanges would have too much discretion to certify or approve Retail 
Member Organizations and Retail Liquidity Providers, creating the 
potential for discriminatory treatment.\52\ Two commenters also stated 
that the definition of ``Retail Order,'' which relies on the 
representation of the broker sending the order, may not be sufficiently 
clear.\53\ One commenter noted that the definition may impose too great 
of an administrative burden on participants in the Program, as 
participants would be required to surveil their Retail Orders to ensure 
that they comply with the proposed requirements.\54\ In response to the 
Exchanges' Amendments No. 2, which narrowed the definition of ``Retail 
Order,'' one commenter posited that the re-proposed definition was 
vague because the phrase providing that orders ``cannot originate from 
a trading algorithm or any computerized methodology'' is unclear in 
scope.\55\
---------------------------------------------------------------------------

    \52\ See Hudson River Trading Letter; BATS Letter; and SIFMA 
Letter II.
    \53\ See Hudson River Trading Letter and Knight Letter I.
    \54\ See Knight Letter I.
    \55\ See SIFMA Letter II.
---------------------------------------------------------------------------

    The Exchanges responded that they would continually monitor and 
evaluate all aspects of the Retail Member Organization certification 
process during the pilot period. The Exchanges disagreed that the 
definition of ``Retail Order'' and the Retail Member Organization 
certification process are unclear or not subject to enforcement. 
According to the Exchanges, the authentication and certification 
procedures, together with the requirement that Retail Member 
Organizations have written policies and procedures to assure that they 
only submit qualifying retail orders, would result in reliable 
identification and segmentation of retail order flow. The Exchanges 
also did not believe there were ambiguities in defining a Retail Order 
to exclude orders originating from a trading algorithm or computerized 
methodology; however, the Exchanges committed to providing interpretive 
guidance to any firms that have questions about the definition. 
Finally, the Exchanges stated that the Program would be subject to 
regulatory review by FINRA pursuant to a regulatory services agreement 
with the Exchanges.
    Commenters also raised issues related to access fees. One commenter 
suggested that the appropriate amount of access fees would need to be 
revisited if the ``tick size'' is reduced from $0.01 to $0.001 because 
the maximum allowable fee of $0.003 per share would significantly 
increase in relation to the minimum pricing increment.\56\ Another 
commenter noted that the proposals could open the door to revisiting 
whether access fees may be included in quotes, assuming the Program 
leads to sub-penny quotations.\57\ Finally, one commenter questioned 
whether the proposals would result in true price competition because 
non-Retail Liquidity Providers would likely be charged higher access 
fees for executions with Retail Orders than Retail Liquidity Providers, 
and would most likely not be able to quote as aggressively as Retail 
Liquidity Providers as a result.\58\
---------------------------------------------------------------------------

    \56\ See Knight Letter I.
    \57\ See SIFMA Letter I.
    \58\ See BATS Letter.
---------------------------------------------------------------------------

    The Exchanges responded that approval of the proposals does not 
require reexamination of any access fee issue. The Exchanges noted that 
there would be no visible prices disseminated as part of the program 
and expressed the view that the proposals did not contemplate 
``quotes'' subject to the Commission's fair access rules. Given that 
the proposals did not contemplate ``quotes,'' the Exchanges also 
contended that a broker's obligations under Regulation NMS would not 
require it to route a retail order to the Exchanges to interact with a 
Retail Price Improvement Order. Finally, the Exchanges believe that the 
proposals comport with the principles behind the Commission's access 
rules because they intend to welcome broad participation in the 
Program.

4. Best Execution

    Several commenters took the position that the Program would 
complicate broker-dealers' best execution duties. According to one 
commenter, the Exchanges' dissemination of the Retail Liquidity 
Identifier would raise a number of issues, including whether broker-
dealers would be required to route to the Exchanges when they see a 
Retail Liquidity Identifier; whether, if other exchanges were to adopt 
similar proposals and disseminate flags similar to the Retail Liquidity 
Identifier, a broker-dealer would be required to sweep all liquidity 
inside the spread before executing at the NBBO; whether the Exchanges 
would be required to route Retail Orders they receive to other market 
centers if those away markets offered the possibility of further price 
improvement; and whether broker-dealers would be required to subscribe 
to the Exchanges' proprietary feeds to be able to receive the Retail 
Liquidity Identifier.\59\
---------------------------------------------------------------------------

    \59\ See Knight Letter I; see also SIFMA Letter II (raising 
similar questions about broker-dealers' best execution obligations).
---------------------------------------------------------------------------

    Another commenter questioned whether, if other exchanges were to 
adopt competing programs and disseminate flags similar to the Retail

[[Page 40679]]

Liquidity Identifier over their proprietary feeds, a broker-dealer 
would be required to subscribe to each proprietary feed in order to 
fill its best execution obligations.\60\ Relatedly, another commenter 
stated that the proposals would result in confusion among broker-
dealers unsure of how the dissemination of the Retail Liquidity 
Identifier would affect their smart order routing.\61\ Finally, one 
commenter suggested that FINRA's best execution and interpositioning 
rules would need to be updated to reflect the fact that Retail 
Liquidity Identifiers would be widely disseminated yet not accessible 
by non-retail clients.\62\
---------------------------------------------------------------------------

    \60\ See BATS Letter.
    \61\ See SIFMA Letters I and II.
    \62\ See UBS Letter.
---------------------------------------------------------------------------

    The Exchanges responded that they believe the proposals do not 
raise any best execution challenges that are not already confronted by 
broker-dealers in the current market environment. The Exchanges stated 
that best execution is a facts and circumstances determination and 
requires many factors to be considered.\63\
---------------------------------------------------------------------------

    \63\ See Exchanges' Response Letter I (citing Securities 
Exchange Act Release No. 43590 (November 17, 2000), 65 FR 75414 
(December 1, 2000) (Disclosure of Order Execution and Routing 
Practices Adopting Release)).
---------------------------------------------------------------------------

    One commenter also raised related concerns about the proposals' 
potential impact on broker-dealer obligations under FINRA Rule 5320, 
also known as the ``Manning'' rule.\64\ FINRA Rule 5320 generally 
prohibits broker-dealers from trading ahead of their customer orders. 
The commenter noted that firms that both offer Retail Price Improvement 
Orders and accept customer orders will likely find themselves in a 
position where they must fill the customer order at a loss, assuming 
their Retail Price Improvement Orders get executed before the customer 
order.\65\
---------------------------------------------------------------------------

    \64\ See Knight Letter I.
    \65\ See id. In an example offered by the commenter, assume the 
NYSE best bid and offer is 10.01 x 10.02. A non-Retail Liquidity 
Provider, that also handles retail customer orders, posts a Retail 
Price Improvement bid at $10.015 for 500 shares. The Retail Price 
Improvement order executes against an eligible Retail Order, and 
buys 500 shares at $10.015. If that non-Retail Liquidity Provider 
also holds a customer limit order to buy 500 shares at $10.01, the 
commenter states that the non-RLP would be obligated, under the 
current Manning rule, to sell the 500 shares to its client at 
$10.01--losing $0.005 per share in the process.
---------------------------------------------------------------------------

    In response to this comment, the Exchanges stated that the Manning 
obligations of a Retail Liquidity Provider would be no different from 
the obligations on an OTC market maker that internalizes orders. The 
Exchanges stated that OTC market makers commonly rely on the ``no-
knowledge'' exception contained in Supplementary Material .02 of FINRA 
Rule 5320 to separate their proprietary trading from their handling of 
customer orders. The Exchanges expressed their view that this exception 
should be equally applicable to Retail Liquidity Providers 
participating in the Program.

IV. Discussion and Commission Findings

    After careful review of the proposals, the comment letters 
received, and the Exchanges' responses, the Commission finds that the 
proposed rule changes are consistent with the requirements of the Act 
and the rules and regulations thereunder that are applicable to a 
national securities exchange. In particular, the Commission finds that 
the proposed rule changes, subject to their terms as pilots, are 
consistent with Section 6(b)(5) of the Act,\66\ which requires, among 
other things, that the rules of a national securities exchange be 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to foster cooperation 
and coordination with persons engaged in regulating, clearing, 
settling, processing information with respect to, and facilitating 
transactions in securities, to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and, 
in general, to protect investors and the public interest; and not be 
designed to permit unfair discrimination between customers, issuers, 
brokers or dealers.
---------------------------------------------------------------------------

    \66\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    The Commission finds that the Program, as it is proposed on a pilot 
basis, is consistent with the Act because it is reasonably designed to 
benefit retail investors by providing price improvement to retail order 
flow. The Commission also believes that the Program could promote 
competition for retail order flow among execution venues, and that this 
could benefit retail investors by creating additional price improvement 
opportunities for their order flow. Currently, most marketable retail 
order flow is executed in the OTC markets, pursuant to bilateral 
agreements, without ever reaching a public exchange. The Commission 
recently noted that ``a very large percentage of marketable 
(immediately executable) order flow of individual investors'' is 
executed, or ``internalized,'' by broker-dealers in the OTC 
markets.\67\ A recent review of the order flow of eight retail brokers 
revealed that nearly 100% of their customer market orders were routed 
to OTC market makers.\68\ The same review found that such routing is 
often done pursuant to arrangements under which retail brokers route 
their order flow to certain OTC market makers in exchange for payment 
for such order flow.\69\ To the extent that the Program may provide 
price improvement to retail orders that equals what would be provided 
under such OTC internalization arrangements, the Program could benefit 
retail investors. To better understand the Program's potential impact, 
data concerning such potential investor benefit, including the level of 
price improvement provided by the Program, will be submitted by the 
Exchanges and would be reviewed by the Commission prior to any 
extension of the Program beyond the proposed one-year pilot term, or 
permanent approval of the Program.
---------------------------------------------------------------------------

    \67\ See Securities Exchange Act Release No. 61358 (Jan. 14, 
2010), 75 FR 3594, 3600 (Jan. 21, 2010) (``Concept Release on Equity 
Market Structure'').
    \68\ See id.
    \69\ See id.
---------------------------------------------------------------------------

    The Program proposes to create additional price improvement 
opportunities for retail investors by segmenting retail order flow on 
the Exchanges and requiring liquidity providers that want to interact 
with such retail order flow to do so at a price at least $0.001 per 
share better than the Protected Best Bid or Offer. As noted above, some 
commenters questioned the fairness of treating retail order flow 
differently from other order flow on an exchange by offering price 
improvement opportunities only to retail orders. Commenters also raised 
several concerns relating to the way the Program proposes to define and 
identify retail order flow.
    In this case, the Commission finds that while the Program would 
treat retail order flow differently from order flow submitted by other 
market participants, such segmentation would not be inconsistent with 
Section 6(b)(5) of the Act, which requires that the rules of an 
exchange are not designed to permit unfair discrimination.\70\ The 
Commission has previously recognized that the markets generally 
distinguish between individual retail investors, whose orders are 
considered desirable

[[Page 40680]]

by liquidity providers because such retail investors are presumed on 
average to be less informed about short-term price movements, and 
professional traders, whose orders are presumed on average to be more 
informed.\71\ The Commission has further recognized that, because of 
this distinction, liquidity providers are generally more inclined to 
offer price improvement to less informed retail orders than to more 
informed professional orders.\72\ Absent opportunities for price 
improvement, retail investors may encounter wider spreads that are a 
consequence of liquidity providers interacting with informed order 
flow. By creating additional competition for retail order flow, the 
Program is reasonably designed to attract retail order flow to the 
exchange environment, while helping to ensure that retail investors 
benefit from the better price that liquidity providers are willing to 
give their orders. Certain commenters also expressed concern that the 
Program could create a private market or otherwise impede fair 
access.\73\ In this regard, the Commission notes that the Retail 
Liquidity Identifier will be disseminated through the consolidated 
public market data stream, and thus be widely viewable by market 
participants, and that members of the Exchanges that would not 
otherwise participate as Retail Liquidity Providers would be able to 
participate in the Program by submitting Retail Price Improvement 
Orders.
---------------------------------------------------------------------------

    \70\ The comment letters and the Exchanges' responses contained 
extensive discussion of whether the Program's proposed Retail 
Liquidity Identifier constitutes a ``quote'' which would be subject 
to Rule 610 of Regulation NMS. That rule, known as the ``Fair Access 
Rule,'' contains a similar prohibition on unfair discrimination. The 
Commission finds that the Program is not unfairly discriminatory 
under both Section 6(b)(5) of the Act and Rule 610 of Regulation 
NMS. Because the Commission has determined that the Program is not 
unfairly discriminatory pursuant to Rule 610, it need not determine 
whether the Retail Liquidity Identifier is a ``quote'' for purposes 
of Rule 610.
    \71\ See Concept Release on Equity Market Structure, supra note 
67; see also Securities Exchange Act Release No. 64781 (June 30, 
2011), 76 FR 39953 (July 7, 2011) (approving a program proposed by 
an options exchange that would provide price improvement 
opportunities to retail orders based, in part, on questions about 
execution quality of retail orders under payment for order flow 
arrangements in the options markets).
     While certain commenters expressed concern that institutional 
investors, including those that invest money on behalf of individual 
retail clients, would not be eligible to qualify as Retail Member 
Organizations and submit Retail Orders, the Commission notes that 
institutional investors tend to be more informed than retail 
investors. See supra note 46.
    \72\ See Securities Exchange Act Release No. 64781 (June 30, 
2011), 76 FR 39953 (July 7, 2011) (noting that ``it is well known in 
academic literature and industry practice that prices tend to move 
against market makers after trades with informed traders, often 
resulting in losses for market makers,'' and that such losses are 
often borne by uninformed retail investors through wider spreads 
(citing H.R. Stoll, ``The supply of dealer services in securities 
markets,'' Journal of Finance 33 (1978), at 1133-51; L. Glosten & P. 
Milgrom, ``Bid ask and transaction prices in a specialist market 
with heterogeneously informed agents,'' Journal of Financial 
Economics 14 (1985), at 71-100; and T. Copeland & D. Galai, 
``Information effects on the bid-ask spread,'' Journal of Finance 38 
(1983), at 1457-69)).
    \73\ See supra notes 45 through 51 and accompanying text.
---------------------------------------------------------------------------

    As noted above, certain commenters questioned the fairness of 
preventing institutional investors from submitting Retail Orders, and 
thus receiving price improvement on their orders.\74\ In this regard, 
the Commission notes that the Program might create a desirable 
opportunity for institutional investors to interact with retail order 
flow that they are not able to reach currently. Member organizations 
that are not Retail Liquidity Providers can seek to interact with 
Retail Orders by submitting Retail Price Improvement Orders. Today, 
institutional investors often do not have the chance to interact with 
marketable retail orders that are executed pursuant to internalization 
arrangements. Thus, institutional investors, if they participate in the 
Program by submitting Retail Price Improvement Orders, may be able to 
reduce their possible adverse selection costs by interacting with 
retail order flow previously unavailable to them.
---------------------------------------------------------------------------

    \74\ See supra notes 45 through 47 and accompanying text.
---------------------------------------------------------------------------

    The Commission does not share the concern expressed by several 
commenters that the Program will cause a major shift in market 
structure. Instead, the Commission believes the Program should closely 
replicate the trading dynamics that exist in the OTC markets and will 
simply present another competitive venue for retail order flow 
execution. While some commenters stated that the Program would 
potentially increase sub-penny trading, the Commission believes that 
the Program will likely reallocate existing retail order flow from the 
OTC markets to the Exchanges, and is not likely to alter the incentives 
for market participants to post limit orders in a material way, given 
that liquidity providers already interact with most retail order flow 
in non-displayed markets.\75\ In this regard, however, the Commission 
notes that it is approving the Program on a pilot basis, and will 
monitor the Program throughout the pilot period for its potential 
effects on public price discovery, and on the broader market structure.
---------------------------------------------------------------------------

    \75\ For the same reasons, the Commission does not believe that 
the Program will create any best execution challenges that are not 
already present in today's markets. A broker's best execution 
obligations are determined by a number of facts and circumstances, 
including (1) The character of the market for the security (e.g., 
price, volatility, relative liquidity, and pressure on available 
communications); (2) the size and type of transaction; (3) the 
number of markets checked; (4) accessibility of the quotation; and 
(5) the terms and conditions of the order which result in the 
transaction. See FINRA Rule 5310; see also Disclosure of Order 
Execution and Routing Practices Adopting Release, supra note 633. A 
broker would consider the Program when conducting this analysis.
    Furthermore, with respect to the scope of FINRA Rule 5320 (the 
``Manning'' rule), the Commission notes that the Manning obligations 
of a Retail Liquidity Provider likely would not be appreciably 
different from the current obligations of an OTC market maker that 
internalizes orders.
---------------------------------------------------------------------------

    When the Commission is engaged in rulemaking or the review of a 
rule filed by a self-regulatory organization, and is required to 
consider or determine whether an action is necessary or appropriate in 
the public interest, the Commission shall also consider, in addition to 
the protection of investors, whether the action will promote 
efficiency, competition, and capital formation.\76\ As discussed above, 
the Commission believes that this Program will promote competition for 
retail order flow, by allowing Exchange members, either as Retail 
Liquidity Providers, or on an ad hoc basis, to submit Retail Price 
Improvement Orders to interact with Retail Orders. Such competition may 
promote efficiency by facilitating the price discovery process. 
Moreover, the Commission does not believe that the Program will have a 
significant effect on market structure, or will create any new 
inefficiencies in current market structure. Finally, to the extent the 
Program is successful in attracting retail order flow, it may generate 
additional investor interest in trading securities, thereby promoting 
capital formation.
---------------------------------------------------------------------------

    \76\ See 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The Commission also believes that the Program is sufficiently 
tailored to provide the benefits of potential price improvement only to 
bona fide retail order flow originating from natural persons.\77\ The 
Commission finds that the Program provides an objective process by 
which a member organization could become a Retail Member Organization 
or a Retail Liquidity Provider, and for appropriate oversight by the 
Exchanges to monitor for continued compliance with the terms of these 
provisions. The Exchanges have limited the definition of Retail Order 
to an agency order that originates from a natural person and not a 
trading algorithm or any other computerized methodology.

[[Page 40681]]

Furthermore, a Retail Order must be submitted by a Retail Member 
Organization that is approved by the Exchanges. In addition, Retail 
Member Organizations would be required to maintain written policies and 
procedures to help ensure that they designate as Retail Orders only 
those orders which qualify under the Program. If a member's application 
to become a Retail Member Organization or a Retail Liquidity Provider 
is denied by the Exchange, that member may appeal that determination or 
re-apply. Similarly, a Retail Liquidity Provider that is disqualified 
for failing to meet its quoting requirements may appeal or re-apply to 
the Program. The Commission believes that these standards should help 
ensure that only retail order flow is submitted into the Program and 
thereby promote just and equitable principles of trade and protect 
investors and the public interest, while also providing an objective 
process through which members may become Retail Member Organizations or 
Retail Liquidity Providers. The Commission also notes that the 
Exchanges have represented that they would continually monitor all 
aspects of the Retail Member Organization certification process during 
the pilot period, and that the Program would be subject to regulatory 
review by FINRA pursuant to a regulatory services agreements with the 
Exchanges.
---------------------------------------------------------------------------

    \77\ In addition, the Commission believes that the Program's 
provisions concerning the certification, approval, and potential 
disqualification of Retail Member Organizations and Retail Liquidity 
Providers are not inconsistent with the Act. These provisions, which 
contain appeal procedures for adverse decisions against those who 
seek to become Retail Member Organizations or who are disqualified 
from their status as such, are substantially similar to provisions 
in the Exchanges' rules establishing the Supplemental Liquidity 
Provider Program. See NYSE Rule 107B(j)-(k) and NYSE Amex Rule 
107B(i)-(j).
---------------------------------------------------------------------------

    In addition, the Commission finds that the Program's proposed 
dissemination of a Retail Liquidity Identifier would increase the 
amount of pricing information available to the marketplace and is 
consistent with the Act. The identifier would be disseminated through 
the consolidated public market data stream \78\ to advertise the 
presence of a Retail Price Improvement Order with which Retail Orders 
could interact. The identifier would reflect the symbol for a 
particular security and the side of the Retail Price Improvement Order 
interest, but it would not include the price or size of such interest. 
The identifier would alert market participants to the existence of a 
Retail Price Improvement Order and should provide market participants 
with more information about the availability of price improvement 
opportunities for retail orders than is currently available.\79\ Given 
the benefits of adding this information to the marketplace, the 
Commission believes that the Identifier is an appropriate part of the 
Program.\80\
---------------------------------------------------------------------------

    \78\ Certain commenters expressed concerns that the original 
proposals' plan to limit dissemination of the Retail Liquidity 
Identifier to the Exchanges' proprietary data feeds was unfair. See 
supra notes 48 through 50 and accompanying text. In this regard, the 
Commission notes that the Exchanges have committed to making the 
Retail Liquidity Identifier immediately available through the 
consolidated public market data stream for securities listed on NYSE 
and NYSE Amex, and have represented that the Retail Liquidity 
Identifier for UTP eligible securities should be available through 
the consolidated public market data stream in on or about October 1, 
2012. See supra note 19.
    \79\ As noted above, certain commenters questioned whether 
dissemination of the Retail Liquidity Identifier would be compatible 
with the Quote Rule. See supra note 51. In connection with the 
proposals, the Exchanges have requested that the staff of the 
Commission not recommend enforcement action to the Commission, 
either against the Exchanges or Retail Liquidity Providers, under 
the Quote Rule relating to the kind of information disseminated 
through Retail Liquidity Identifier. See Letter from Janet M. 
McGinness, Senior Vice President--Legal and Corporate Secretary, 
Office of the General Counsel, NYSE Euronext to Robert Cook, 
Director, Division of Trading and Markets, dated April 11, 2012. The 
staff has determined to grant the Exchanges' No Action request 
pursuant to a letter which is also being issued today. See Letter 
from David Shillman, Associate Director, Division of Trading and 
Markets, to Janet McGinness, Senior Vice President--Legal and 
Corporate Secretary, Office of the General Counsel, NYSE Euronext, 
dated July 3, 2012.
    \80\ Although one commenter stated that the Retail Liquidity 
Identifier should be eliminated from the Program, as it was 
``tantamount to displaying sub-penny quotations in the lit 
markets,'' see Knight Letter II, for the reasons discussed below, 
the Commission believes that the benefits of the Program justify 
granting exemptive relief from Rule 612(c) of Regulation NMS. See 
also SIFMA Letter II (urging the Commission to address sub-penny 
quoting through the rulemaking process rather than an exemptive 
request specific to a market participant).
---------------------------------------------------------------------------

    Lastly, some commenters questioned whether the exchange rule filing 
process was an appropriate means to introduce the Program, given the 
Program's impact on broader market structure, and the limited timeframe 
in which the Commission would be able to consider the Program and 
comments thereto. Given that the Program involves modifying the 
Exchanges' trading rules to create new order types and categories of 
members, however, the Commission believes that the Program was 
appropriately proposed through the rule filing process pursuant to 
Section 19(b)(1) of the Act. In addition, the Commission does not 
believe that the Program is likely to significantly impact market 
structure because the Program is designed to replicate the trading 
dynamics that exist in the OTC markets and will simply present another 
competitive venue for retail order flow execution.
    Furthermore, the Commission notes that it is approving the Program 
on a pilot basis. Approving the Program on a pilot basis will allow the 
Exchanges and market participants to gain valuable practical experience 
with the Program during the pilot period. This experience should allow 
the Exchanges and the Commission to determine whether modifications to 
the Program are necessary or appropriate prior to any Commission 
decision to approve the Program on a permanent basis. The Exchanges 
also have agreed to provide the Commission with a significant amount of 
data that should assist the Commission in its evaluation of the 
Program. Specifically, the Exchanges have represented that they ``will 
produce data throughout the pilot, which will include statistics about 
participation, the frequency and level of price improvement provided by 
the Program, and any effects on the broader market structure.'' The 
Commission expects that the Exchanges will monitor the scope and 
operation of the Program and study the data produced during that time 
with respect to such issues, and will propose any modifications to the 
Program that may be necessary or appropriate.
    The Commission also welcomes additional comments, and empirical 
evidence, on the Program during the pilot period to further assist the 
Commission in its evaluation of the Program.\81\ The Commission notes 
that any permanent approval of the Program would require a proposed 
rule change by the Exchanges, and such rule change will provide an 
opportunity for public comment prior to further Commission action.\82\
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    \81\ For instance, one commenter noted the need for market 
participants to consider the impact that the Program will have on a 
number of factors, including trading technologies and capacity, 
operational costs, execution quality, liquidity, and gaming. See 
Knight Letter I. The Commission would welcome data from market 
participants on these topics, as well as any others, during the 
pilot period.
    \82\ One comment suggested that the Program should only be 
considered in tandem with industry-wide pilot studies on tick size. 
See Angel Letter. As discussed above, the Commission believes that 
the proposals are properly considered through the rule filing 
process, and expects to monitor and study data produced during the 
Program's pilot term.
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V. Exemption From the Sub-Penny Rule

    Pursuant to its authority under Rule 612(c) of Regulation NMS,\83\ 
the Commission hereby grants each Exchange a limited exemption from the 
Sub-Penny Rule to operate the Program. For the reasons discussed below, 
the Commission determines that such action is necessary or appropriate 
in the public interest, and is consistent with the protection of 
investors. The exemptions shall operate for a period of 12 months, 
coterminous with the effectiveness of the proposed rule changes 
approved today.
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    \83\ 17 CFR 242.612(c).
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    When the Commission adopted the Sub-Penny Rule in 2005, it 
identified a

[[Page 40682]]

variety of problems caused by sub-pennies that the Sub-Penny Rule was 
designed to address:
     If investors' limit orders lose execution priority for a 
nominal amount, investors may over time decline to use them, thus 
depriving the markets of liquidity.
     When market participants can gain execution priority for a 
nominal amount, important customer protection rules such as exchange 
priority rules and the Manning Rule could be undermined.
     Flickering quotations that can result from widespread sub-
penny pricing could make it more difficult for broker-dealers to 
satisfy their best execution obligations and other regulatory 
responsibilities.
     Widespread sub-penny quoting could decrease market depth 
and lead to higher transaction costs.
     Decreasing depth at the inside could cause institutions to 
rely more on execution alternatives away from the exchanges, 
potentially increasing fragmentation in the securities markets.\84\
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    \84\ See Securities Exchange Act Release No. 51808 (June 9, 
2005), 70 FR 37496, 37551-52 (June 29, 2005).
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    At the same time, the Commission ``acknowledge[d] the possibility 
that the balance of costs and benefits could shift in a limited number 
of cases or as the markets continue to evolve.'' \85\ Therefore, the 
Commission also adopted Rule 612(c), which provides that the Commission 
may grant exemptions from the Sub-Penny Rule, either unconditionally or 
on specified terms and conditions, if it determined that such exemption 
is necessary or appropriate in the public interest, and is consistent 
with the protection of investors.
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    \85\ Id. at 37553.
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    The Commission believes that the Exchanges' proposal raises such a 
case. As described above, under the current market structure, few 
marketable retail orders in equity securities are routed to exchanges. 
The vast majority of marketable retail orders are internalized by OTC 
market makers, who typically pay retail brokers for their order flow. 
Retail investors can benefit from such arrangements to the extent that 
OTC market makers offer them price improvement over the NBBO. Price 
improvement is typically offered in sub-penny amounts.\86\ An 
internalizing broker-dealer can offer sub-penny executions, provided 
that such executions do not result from impermissible sub-penny orders 
or quotations. Accordingly, OTC market makers typically select a sub-
penny price for a trade without quoting at that exact amount or 
accepting orders from retail customers seeking that exact price. 
Exchanges--and exchange member firms that submit orders and quotations 
to exchanges--cannot compete for marketable retail order flow on the 
same basis, because it would be impractical for exchange electronic 
systems to generate sub-penny executions without exchange liquidity 
providers or retail brokerage firms having first submitted sub-penny 
orders or quotations, which the Sub-Penny Rule expressly prohibits.
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    \86\ When adopting the Sub-Penny Rule, the Commission considered 
certain comments that asked the Commission to prohibit broker-
dealers from offering sub-penny price improvement to their 
customers, but declined to do so. The Commission stated that 
``trading in sub-penny increments does not raise the same concerns 
as sub-penny quoting'' and that ``sub-penny executions due to price 
improvement are generally beneficial to retail investors.'' Id. at 
37556.
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    The limited exemptions granted today should promote competition 
between exchanges and OTC market makers in a manner that is reasonably 
designed to minimize the problems that the Commission identified when 
adopting the Sub-Penny Rule. Under the Program, sub-penny prices will 
not be disseminated through the consolidated quotation data stream, 
which should avoid quote flickering and its reduced depth at the inside 
quotation. Furthermore, while the Commission remains concerned about 
providing enough incentives for market participants to display limit 
orders, the Commission does not believe that granting this exemption 
(and approving the accompanying proposed rule changes) will reduce such 
incentives. Market participants that display limit orders currently are 
not able to interact with marketable retail order flow because it is 
almost entirely routed to internalizing OTC market makers that offer 
sub-penny executions. Consequently, enabling the Exchanges to compete 
for this retail order flow through the Program should not materially 
detract from the current incentives to display limit orders, while 
potentially resulting in greater order interaction and price 
improvement for marketable retail orders. To the extent that the 
Program may raise Manning and best execution issues for broker-dealers, 
these issues are already presented by the existing practices of OTC 
market makers.
    The exemptions being granted today are limited to a one-year pilot. 
The Exchanges have stated that ``sub-penny trading and pricing could 
potentially result in undesirable market behavior,'' and therefore they 
will ``monitor the Program in an effort to identify and address any 
such behavior.'' \87\ Furthermore, the Exchanges have represented that 
they ``will produce data throughout the pilot, which will include 
statistics about participation, the frequency and level of price 
improvement provided by the Program, and any effects on the broader 
market structure.'' \88\ The Commission expects to review the data and 
observations of the Exchanges before determining whether and, if so, 
how to extend these exemptions from the Sub-Penny Rule.\89\
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    \87\ Amended Request for Sub-Penny Rule Exemption, supra note 8, 
at 4, n. 6.
    \88\ Id.
    \89\ In particular, the Commission expects the Exchanges to 
observe how maker/taker transaction charges, whether imposed by the 
Exchanges or by other markets, might impact the use of the Program. 
Market distortions could arise where the size of a transaction 
rebate, whether for providing or taking liquidity, is greater than 
the size of the minimum increment permitted by the Program ($0.001 
per share).
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VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\90\ that the proposed rules changes (SR-NYSE-2011-55; SR-NYSEAmex-
2011-84), as modified by Amendments Nos. 1 and 2, be and hereby are, 
approved on a one-year pilot basis.
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    \90\ 15 U.S.C. 78s(b)(2).
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    It is also hereby ordered that, pursuant to Rule 612(c) of 
Regulation NMS, each Exchange is given a limited exemption from Rule 
612 of Regulation NMS allowing it to accept and rank orders priced 
equal to or greater than $1.00 per share in increments of $0.001, in 
the manner described in the proposed rule changes above, on a one-year 
pilot basis coterminous with the effectiveness of the proposed rule 
changes.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\91\
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    \91\ 17 CFR 200.30-3(a)(12); 17 CFR 200.30-3(a)(83).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012-16769 Filed 7-9-12; 8:45 am]
BILLING CODE 8011-01-P


