
[Federal Register Volume 77, Number 137 (Tuesday, July 17, 2012)]
[Notices]
[Pages 42052-42073]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-17349]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67411; File Nos. SR-NASDAQ-2012-043; SR-NYSEArca-2012-
37]


Self-Regulatory Organizations; The NASDAQ Stock Market LLC; NYSE 
Arca, Inc.; Order Instituting Proceedings To Determine Whether To 
Approve or Disapprove Proposed Rule Changes Relating to Market Maker 
Incentive Programs for Certain Exchange-Traded Products

July 11, 2012.

I. Introduction

    On March 23, 2012, The NASDAQ Stock Market LLC (``NASDAQ'') filed 
with the Securities and Exchange Commission (``SEC'' or 
``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'' or ``Exchange Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change (``NASDAQ Proposal'') to 
establish the Market Quality Program (``MQP''). On March 29, 2012, 
NASDAQ submitted Amendment No. 1 to the proposed rule change.\3\ The 
proposed rule change, as modified by Amendment No. 1 thereto, was 
published for comment in the Federal Register on April 12, 2012.\4\ The 
Commission initially received fifteen comment letters on the NASDAQ 
Proposal.\5\ On May 18, 2012, pursuant to Section 19(b)(2) of the 
Act,\6\ the Commission designated a longer period within which to 
either approve the NASDAQ Proposal, disapprove the NASDAQ Proposal, or 
institute proceedings to determine whether to disapprove the NASDAQ 
Proposal.\7\ The Commission received three additional comment letters 
on the NASDAQ Proposal.\8\ On July 6, 2012, the Commission received 
NASDAQ's response to the comment letters.\9\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, NASDAQ made a technical amendment to 
Item I of Exhibit 1 to delete an erroneous reference to the NASDAQ 
Options Market and replace it with a reference to NASDAQ.
    \4\ Securities Exchange Act Release No. 66765 (April 6, 2012), 
77 FR 22042 (``NASDAQ Notice'').
    \5\ See Letter from Frank Choi, dated April 13, 2012 (``Choi 
Letter''); Letter from Christopher J. Csicsko, dated April 14, 2012 
(``Csicsko Letter''); Letter from Jeremiah O'Connor III, dated April 
14, 2012 (``O'Connor Letter''); Letter from Dezso J. Szalay, dated 
April 15, 2012 (``Szalay Letter''); Letter from Kathryn Keita, dated 
April 18, 2012; Letter (``Keita Letter''); Letter from Anonymous, 
dated April 18, 2012 (``Anonymous Letter''); Letter from Mark 
Connell, dated April 19, 2012 (``Connell Letter''); Letter from 
Timothy Quast, Managing Director, Modern Networks IR LLC, dated 
April 26, 2012 (``IR Letter''); Letter from Daniel G. Weaver, Ph.D., 
Professor of Finance, Rutgers Business School, dated April 26, 2012 
(``Weaver Letter''); Letter from Amber Anand, Associate Professor of 
Finance, Syracuse University, dated April 29, 2012 (``Anand 
Letter''); Letter from Albert J. Menkveld, Associate Professor of 
Finance, VU University Amsterdam, dated May 2, 2012 (``Menkveld 
Letter''); Letter from James J. Angel, Associate Professor of 
Finance, Georgetown University, dated May 2, 2012 (``Angel 
Letter''); Letter from Ari Burstein, Senior Counsel, Investment 
Company Institute, dated May 3, 2012 (``NASDAQ ICI Letter''); Letter 
from Gus Sauter, Managing Director and Chief Investment Officer, 
Vanguard, dated May 3, 2012 (``NASDAQ Vanguard Letter''); and Letter 
from Leonard J. Amoruso, General Counsel, Knight Capital Group, 
Inc., dated May 4, 2012 (``Knight Letter'').
    \6\ 15 U.S.C. 78s(b)(2).
    \7\ Securities Exchange Act Release No. 67022 (May 18, 2012), 77 
FR 31050 (May 24, 2012). The Commission determined that it was 
appropriate to designate a longer period within which to take action 
on the NASDAQ Proposal so that it has sufficient time to consider 
the NASDAQ Proposal, the comments received, and any response to the 
comments submitted by NASDAQ. Accordingly, the Commission designated 
July 11, 2012 as the date by which it should either approve, 
disapprove, or institute proceedings to determine whether to 
disapprove the NASDAQ Proposal.
    \8\ See Letter from Gary L. Gastineau, Managing Member, ETF 
Consultants LLC, dated June 11, 2012 (``ETF Consultants Letter''); 
Letter from Rey Ramsey, President & CEO, TechNet, dated June 20, 
2012 (``TechNet Letter''); and Letter from Stuart J. Kaswell, 
Executive Vice President & Managing Director, General Counsel, 
Managed Funds Association, dated July 3, 2012 (``MFA Letter'').
    \9\ See Letter from Joan C. Conley, Senior Vice President & 
Corporate Secretary, NASDAQ, dated July 6, 2012 (``NASDAQ Response 
Letter'').
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    On April 27, 2012, NYSE Arca, Inc. (``NYSE Arca'' and together with 
NASDAQ, the ``Exchanges'') filed with the Commission, pursuant to 
Section 19(b)(1) of the Act \10\ and Rule 19b-4 thereunder,\11\ a 
proposed rule change (``NYSE Arca Proposal,'' and together with the 
NASDAQ Proposal, the ``SRO Proposals'') to create and implement, on a 
pilot basis, a Lead Market Maker (``LMM'') Issuer Incentive Program 
(``Fixed Incentive Program,'' and together with the MQP, the 
``Programs'') for issuers of certain exchange-traded products listed on 
NYSE Arca. The NYSE Arca Proposal was published for comment in the 
Federal Register on May 17, 2012.\12\ The Commission received two 
comment letters on the NYSE Arca Proposal.\13\ On June 20, 2012, 
pursuant to Section 19(b)(2) of the Act,\14\ the Commission designated 
a longer period within which to either approve the NYSE Arca Proposal, 
disapprove the NYSE Arca Proposal, or institute proceedings to 
determine whether to disapprove the NYSE Arca

[[Page 42053]]

Proposal.\15\ The Commission received one additional comment letter on 
the NYSE Arca Proposal.\16\
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    \10\ 15 U.S.C. 78s(b)(1).
    \11\ 17 CFR 240.19b-4.
    \12\ Securities Exchange Act Release No. 66966 (May 11, 2012), 
77 FR 29419 (``NYSE Arca Notice'').
    \13\ See Letter from Gus Sauter, Managing Director and Chief 
Investment Officer, Vanguard, dated June 7, 2012 (``NYSE Arca 
Vanguard Letter''); and Letter from Ari Burstein, Senior Counsel, 
Investment Company Institute, dated June 7, 2012 (``NYSE Arca ICI 
Letter'').
    \14\ 15 U.S.C. 78s(b)(2).
    \15\ Securities Exchange Act Release No. 67222 (June 20, 2012), 
77 FR 38116 (June 26, 2012). The Commission determined that it was 
appropriate to designate a longer period within which to take action 
on the NYSE Arca Proposal so that it has sufficient time to consider 
the NYSE Arca Proposal, the comments received, and any response to 
the comments submitted by NYSE Arca. Accordingly, the Commission 
designated August 15, 2012 as the date by which it should either 
approve, disapprove, or institute proceedings to determine whether 
to disapprove the NYSE Arca Proposal.
    \16\ See Letter from John T. Hyland, CFA, Chief Investment 
Officer, United States Commodity Funds LLC, dated June 27, 2012 
(``USCF Letter'').
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    This order institutes proceedings under Section 19(b)(2)(B) of the 
Act to determine whether to approve or disapprove the SRO Proposals. 
Institution of these proceedings, however, does not indicate that the 
Commission has reached any conclusions with respect to the SRO 
Proposals, nor does it mean that the Commission will ultimately 
disapprove the SRO Proposals. Rather, as addressed below, the 
Commission desires to solicit additional input from interested parties 
on the issues presented by the SRO Proposals.

II. Description of the SRO Proposals

    In the SRO Proposals, each of NASDAQ and NYSE Arca separately 
propose to adopt listing fees and related market maker incentive 
programs for certain securities on a pilot basis, as further described 
below.

A. NASDAQ Proposal

    As set forth in more detail in the NASDAQ Notice,\17\ NASDAQ is 
proposing to amend its rules to add new NASDAQ Rule 5950 (Market 
Quality Program) to establish an MQP listing fee and related market 
maker incentive program, and to adopt new IM-2460-1 to exempt the MQP 
from NASDAQ Rule 2460 (Payment for Market Making), on a pilot basis. 
The MQP would be a voluntary program and participation in the program 
would be at the discretion of each MQP Company (as defined below), 
subject to the requirements set forth in the proposed rule.
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    \17\ See supra note 4.
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1. Proposed NASDAQ Rule 5950 (Market Quality Program)
    The proposed MQP would be a program designed to promote market 
quality in certain securities listed on NASDAQ (``MQP Securities'') on 
a voluntary basis.\18\ MQP Securities may include Exchange Traded Funds 
(``ETFs''), Linked Securities (``LS''), and Trust Issued Receipts 
(``TIRs'') listed on NASDAQ pursuant to NASDAQ Rules 5705, 5710, and 
5720, respectively.\19\ An ``MQP Company'' \20\ that lists an eligible 
MQP Security on NASDAQ would pay a listing fee as set forth in proposed 
NASDAQ Rule 5950 (``MQP Fee''), in addition to the standard (non-MQP) 
NASDAQ listing fee applicable to such MQP Security as set forth in the 
NASDAQ Rule 5000 Series (consisting of NASDAQ Rules 5000-5999).\21\ 
NASDAQ represents that an MQP Fee would be used for the purpose of 
incentivizing one or more Market Makers \22\ in the MQP Security (``MQP 
Market Maker'') to enhance the market quality of the MQP Security. 
Subject to the conditions set forth in the proposed rule, this 
incentive payment would be credited (``MQP Credit'') to one or more MQP 
Market Makers that make a quality market in the MQP Security pursuant 
to the MQP.\23\
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    \18\ See proposed NASDAQ Rule 5950 Preamble. NASDAQ notes that 
MQP Securities do not encompass derivatives on such securities. See 
NASDAQ Notice, supra note 4, at 22043.
    \19\ See proposed NASDAQ Rule 5950(e)(1). The term ``Exchange 
Traded Fund'' includes Portfolio Depository Receipts and Index Fund 
Shares, which are defined in NASDAQ Rule 5705; the term ``Linked 
Security'' has the meaning given in NASDAQ Rule 5710; and the term 
``Trust Issued Receipt'' has the meaning given in NASDAQ Rule 5720. 
See proposed NASDAQ Rules 5950(e)(2)-(4). NASDAQ notes that it 
believes that MQP Securities would predominantly, if not entirely, 
consist of ETFs. See NASDAQ Notice, supra note 4, at 22043.
    \20\ The term ``MQP Company'' is defined as a fund sponsor or 
other entity that lists one or more MQP Securities on NASDAQ 
pursuant to the MQP. See proposed NASDAQ Rule 5950(e)(7).
    \21\ See proposed NASDAQ Rule 5950 Preamble. The NASDAQ Rule 
5000 Series contains rules related to the qualification, listing, 
and delisting of Companies on the NASDAQ Stock Market. The NASDAQ 
Rule 5100 Series discusses NASDAQ's general regulatory authority. 
The NASDAQ Rule 5200 Series sets forth the procedures and 
prerequisites for gaining a listing on the NASDAQ Stock Market, as 
well as the disclosure obligations of listed Companies. The NASDAQ 
Rule 5300, 5400, and 5500 Series contain the specific quantitative 
listing requirements for listing on the Global Select, Global 
Market, and Capital Market, respectively. The corporate governance 
requirements applicable to all Companies are contained in the NASDAQ 
Rule 5600 Series. Special listing requirements for securities other 
than common or preferred stock and warrants are contained in the 
NASDAQ Rule 5700 Series. The consequences of a failure to meet 
NASDAQ's listing standards are contained in the NASDAQ Rule 5800 
Series. Listing fees are described in the NASDAQ Rule 5900 Series. 
The term ``Company'' is defined in NASDAQ Rule 5005(a)(6) as the 
issuer of a security listed or applying to list on NASDAQ, and may 
include an issuer that is not incorporated, such as, for example, a 
limited partnership.
    \22\ The term ``Market Maker'' has the meaning given in NASDAQ 
Rule 5005(a)(24). See proposed NASDAQ Rule 5950(e)(5).
    \23\ See proposed NASDAQ Rule 5950 Preamble.
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a. Application and Withdrawal
    An MQP Company that wants to have its MQP Security participate in 
the MQP, and a Market Maker that wants to participate in the MQP, would 
be required to each submit an application in the form prescribed by 
NASDAQ.\24\ NASDAQ could, on a program-wide basis, limit the number of 
MQP Securities that any one MQP Company may list in the MQP.\25\ In 
determining whether to limit the number of MQP Securities in the MQP, 
NASDAQ would consider all relevant information, including whether a 
restriction, if any, is in the best interest of NASDAQ, the MQP Company 
and the goals of the MQP, and investors.\26\ NASDAQ could also, on a 
program-wide basis, limit the number of MQP Market Makers permitted to 
register in an MQP Security.\27\ If such a limit were established, 
NASDAQ would allocate available MQP Market Maker registrations in a 
first-come-first-served fashion based on successful completion of an 
MQP Market Maker application.\28\
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    \24\ See proposed NASDAQ Rule 5950(a)(1).
    \25\ See proposed NASDAQ Rule 5950(a)(1)(A).
    \26\ See proposed NASDAQ Rule 5950(a)(1)(B). Factors that could 
be considered by NASDAQ include, but are not limited to, the current 
and expected liquidity characteristics of MQP Securities; the 
projected initial and continuing market quality needs of MQP 
Securities; and the trading characteristics of MQP Securities (e.g., 
quoting, trading, and volume). See proposed NASDAQ Rule 
5950(a)(1)(B)(i).
    \27\ See proposed NASDAQ Rule 5950(c)(3).
    \28\ See proposed NASDAQ Rule 5950(c)(3)(A).
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    NASDAQ would provide notification on its Web site regarding: (i) 
The acceptance of an MQP Company and an MQP Market Maker into the MQP; 
(ii) the total number of MQP Securities that any one MQP Company may 
have in the MQP; (iii) the names of MQP Securities and the MQP Market 
Maker(s) in each MQP Security; and (iv) any limits on the number of MQP 
Market Makers permitted to register in an MQP Security.\29\
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    \29\ See proposed NASDAQ Rule 5950(a)(1)(C) and proposed NASDAQ 
Rule 5950(c)(3).
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    After an MQP Company is in the MQP for not less than two 
consecutive quarters but less than one year, it could voluntarily 
withdraw from the MQP on a quarterly basis.\30\ The MQP Company would 
be required to notify NASDAQ in writing not less than one month prior 
to withdrawing from the MQP. Notwithstanding, NASDAQ could determine to 
allow an MQP Company to withdraw from the MQP earlier.\31\ In making 
this determination, NASDAQ would take into account the volume and price 
movements in the MQP Security; the liquidity, size quoted, and quality 
of the market in the MQP Security; and any other relevant factors.\32\ 
After an

[[Page 42054]]

MQP Company is in the MQP for one year or more, it could voluntarily 
withdraw from the MQP on a monthly basis, and would be required to 
notify NASDAQ in writing not less than one month prior to withdrawing 
from the MQP.\33\ After an MQP Company is in the MQP for one year, the 
MQP and all obligations and requirements of the MQP would automatically 
continue on an annual basis, unless NASDAQ terminates the MQP by 
providing not less than one month prior notice of intent to terminate; 
the MQP Company withdraws from the MQP pursuant to the proposed rule; 
or the MQP Company is terminated from the MQP pursuant to proposed 
NASDAQ Rule 5950(d).\34\
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    \30\ See proposed NASDAQ Rule 5950(a)(2)(A).
    \31\ Id.
    \32\ Id.
    \33\ See proposed NASDAQ Rule 5950(a)(2)(B).
    \34\ See proposed NASDAQ Rule 5950(a)(3). Proposed NASDAQ Rule 
5950(d) states, in part, that the MQP would terminate in respect of 
an MQP Security under the following circumstances: (A) An MQP 
Security sustains an average NASDAQ daily trading volume of two 
million shares or more for three consecutive months; (B) an MQP 
Company withdraws from the MQP, is no longer eligible to be in the 
MQP pursuant to the proposed rule, or ceases to make MQP fee 
payments to NASDAQ; (C) an MQP Security is delisted or is no longer 
eligible for the MQP; (D) an MQP Security does not have at least one 
MQP Market Maker for more than one quarter; or (E) an MQP Security 
does not, for two consecutive quarters, have at least one MQP Market 
Maker that is eligible for the MQP Credit.
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    After an MQP Market Maker is in the MQP for not less than one 
quarter, the MQP Market Maker could withdraw from the MQP on a 
quarterly basis. The MQP Market Maker would be required to notify 
NASDAQ in writing one month prior to withdrawing from the MQP.\35\
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    \35\ See proposed NASDAQ Rule 5950(a)(2)(C).
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b. MQP Company Eligibility and Fee Liability
    For an MQP Company to be eligible to have its MQP Security 
participate in the MQP, the following conditions would be required to 
be satisfied: (i) NASDAQ must have accepted the MQP Company's 
application in respect of such MQP Security, and must have accepted the 
application of at least one MQP Market Maker in the same MQP Security; 
(ii) the MQP Security must meet all requirements to be listed on NASDAQ 
as an ETF, LS, or TIR; and (iii) the MQP Security must meet all NASDAQ 
requirements for continued listing at all times the MQP Security 
participates in the MQP.\36\
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    \36\ See proposed NASDAQ Rule 5950(b)(1).
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    An MQP Company participating in the MQP would be required to pay to 
NASDAQ an annual basic MQP Fee of $50,000 per MQP Security (``Basic MQP 
Fee''), which fee would be required to be paid in quarterly 
installments as billed by NASDAQ.\37\ The Basic MQP Fee, which would 
fund the MQP Credit to be paid to the eligible MQP Market Maker(s), 
would be allocated 50% toward funding the ``Quote Share Payment'' and 
50% toward funding the ``Trade Share Payment.'' \38\ Quote Share 
Payments would be based in equal proportions on: (i) Average quoted 
size at or better than NBBO; and (ii) average time spent quoting at or 
better than NBBO.\39\ Trade Share Payments would be based upon each MQP 
Market Maker's share of total Qualified Trades in an MQP Security 
executed on the NASDAQ Market Center.\40\
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    \37\ See proposed NASDAQ Rule 5950(b)(2)(A).
    \38\ See proposed NASDAQ Rule 5950(b)(2)(A)(i). Each MQP Credit 
to be paid to the eligible MQP Market Maker(s) would be comprised of 
a ``Quote Share Payment'' that is based on Qualified Quotes, and a 
``Trade Share Payment'' that is based on Qualified Trades. See 
proposed NASDAQ Rule 5950(c)(2)(A). A ``Qualified Quote'' represents 
attributable and displayed liquidity (either quotes or orders) 
entered by an MQP Market Maker in an MQP Security that is posted 
within 2% of the National Best Bid or Offer (``NBBO''). See proposed 
NASDAQ Rule 5950(c)(2)(A)(i). A ``Qualified Trade'' represents a 
liquidity-providing execution of a Qualified Quote on the NASDAQ 
Market Center. See proposed NASDAQ Rule 5950(c)(2)(A)(ii).
    \39\ See proposed NASDAQ Rule 5950(c)(2)(B)(ii).
    \40\ See proposed NASDAQ Rule 5950(c)(2)(B)(i).
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    An MQP Company could also pay an annual supplemental MQP Fee per 
MQP Security (``Supplemental MQP Fee''), which would also fund the MQP 
Credit to be paid to the eligible MQP Market Maker(s) and would be 
required to be paid in quarterly installments as billed by NASDAQ.\41\ 
The Basic MQP Fee and Supplemental MQP Fee when combined could not 
exceed $100,000 per year.\42\ The amount of the Supplemental MQP Fee, 
if any, would be determined by the MQP Company on an annual basis.\43\ 
An MQP Company would be required to indicate the proportions between 0% 
and 100% in which the Supplemental MQP Fee would be allocated to the 
Quote Share Payment and/or the Trade Share Payment.\44\ NASDAQ would 
provide notification on its Web site regarding the amount, if any, of 
any Supplemental MQP Fee and the Quote Share Payment/Trade Share 
Payment allocation determined by an MQP Company.\45\
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    \41\ See proposed NASDAQ Rule 5950(b)(2)(B).
    \42\ Id.
    \43\ See proposed NASDAQ Rule 5950(b)(2)(B)(i).
    \44\ See proposed NASDAQ Rule 5950(b)(2)(B)(ii).
    \45\ See proposed NASDAQ Rule 5950(b)(2)(B)(iii).
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    The Basic MQP Fee and Supplemental MQP Fee, if any, would be in 
addition to the standard (non-MQP) NASDAQ listing fee applicable to the 
MQP Security and would not offset such standard listing fee.\46\ At the 
beginning of a quarter, NASDAQ would bill each MQP Company for the 
quarterly portion of an MQP Company's Basic MQP Fee and Supplemental 
MQP Fee, if any, for each MQP Security, and each quarterly bill would 
be based on the MQP Credit earned by the MQP Market Maker(s) in each 
MQP Security for the immediately preceding quarter.\47\ All revenue 
from the Basic MQP Fee and the Supplemental MQP Fee would be credited 
pro rata to the eligible MQP Market Maker(s) in an MQP Security, and 
any portion of an MQP Fee that is not credited to eligible MQP Market 
Makers would be refunded to the MQP Company.\48\
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    \46\ See proposed NASDAQ Rule 5950(b)(2)(C).
    \47\ See proposed NASDAQ Rule 5950(b)(2)(D).
    \48\ See proposed NASDAQ Rule 5950(b)(2)(E).
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c. MQP Market Maker Eligibility and MQP Credit Distribution
    For a Market Maker to be eligible to participate in the MQP, NASDAQ 
must have accepted such Market Maker's application in respect of an MQP 
Security and must have accepted the application of the MQP Company in 
respect of the same MQP Security.\49\ In addition, to be eligible to 
receive a periodic MQP Credit, MQP Market Makers must, when making 
markets in an MQP Security, meet the applicable Market Maker 
obligations pursuant to NASDAQ Rule 4613,\50\ and must also meet or 
exceed the following requirements on a monthly basis with respect to an 
MQP Security: (i) For at least 25% of the time when quotes can be 
entered in the Regular Market

[[Page 42055]]

Session \51\ as averaged over the course of a month, maintain at least 
500 shares of attributable, displayed quotes or orders at the National 
Best Bid (``NBB'') or better, and at least 500 shares of attributable, 
displayed quotes or orders at the National Best Offer (``NBO'') or 
better; and (ii) for at least 90% of the time when quotes can be 
entered in the Regular Market Session as averaged over the course of a 
month, maintain at least 2,500 shares of attributable, displayed posted 
liquidity on the NASDAQ Market Center \52\ that are priced no wider 
than 2% away from the NBB, and at least 2,500 shares of attributable, 
displayed posted liquidity on the NASDAQ Market Center that are priced 
no wider than 2% away from the NBO.\53\
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    \49\ See proposed NASDAQ Rule 5950(c)(1)(A). NASDAQ could also 
accept the MQP applications of multiple MQP Market Makers in the 
same MQP Security, subject to any limitation on the number of MQP 
Market Makers established pursuant to the proposed rule. Id.
    \50\ NASDAQ Rule 4613 states that market making obligations 
applicable to NASDAQ members that are registered as Market Makers 
include, among other things, quotation requirements and obligations 
as follows: For each security in which a member is registered as a 
Market Maker, the member shall be willing to buy and sell such 
security for its own account on a continuous basis during regular 
market hours and shall enter and maintain a two-sided trading 
interest (``Two-Sided Obligation'') that is identified to NASDAQ as 
the interest meeting the obligation and is displayed in NASDAQ's 
quotation montage at all times. Interest eligible to be considered 
as part of a Market Maker's Two-Sided Obligation shall have a 
displayed quotation size of at least one normal unit of trading (or 
a larger multiple thereof); provided, however, that a Market Maker 
may augment its Two-Sided Obligation size to display limit orders 
priced at the same price as the Two-Sided Obligation. Unless 
otherwise designated, a ``normal unit of trading'' shall be 100 
shares. After an execution against its Two-Sided Obligation, a 
Market Maker must ensure that additional trading interest exists in 
NASDAQ to satisfy its Two-Sided Obligation either by immediately 
entering new interest to comply with this obligation to maintain 
continuous two-sided quotations or by identifying existing interest 
on the NASDAQ book that will satisfy this obligation.
    \51\ The term ``Regular Market Session'' has the meaning given 
in NASDAQ Rule 4120(b)(4)(D). See proposed NASDAQ Rule 5950(e)(8).
    \52\ The term ``NASDAQ Market Center'' has the meaning given in 
NASDAQ Rule 4751(a). See proposed NASDAQ Rule 5950(e)(6).
    \53\ See proposed NASDAQ Rule 5950(c)(1)(B). NASDAQ provides the 
following examples to illustrate these market quality requirements:
    Regarding the first market quality standard (25%), in an MQP 
Security where the NBBO is $25.00 x $25.10, for a minimum of 25% of 
the time when quotes can be entered in the Regular Market Session as 
averaged over the course of a month, an MQP Market Maker must 
maintain bids at or better than $25.00 for at least 500 shares and 
must maintain offers at or better than $25.10 for at least 500 
shares. Thus, if there were 20 trading days in a given month and the 
MQP Market Maker met this requirement 20% of the time when quotes 
can be entered in the Regular Market Session for 10 trading sessions 
and 40% of the time when quotes can be entered in the Regular Market 
Session for 10 trading sessions then the MQP Market Maker would have 
met the requirement 30% of the time in that month.
    Regarding the second market quality standard (90%), in an MQP 
Security where the NBBO is $25.00 x $25.10, for a minimum of 90% of 
the time when quotes can be entered in the Regular Market Session as 
averaged over the course of a month, an MQP Market Maker must post 
bids for an aggregate of 2,500 shares between $24.50 and $25.00, and 
post offers for an aggregate of 2,500 shares between $25.10 and 
$25.60. Thus, if there were 20 trading days in a given month and the 
MQP Market Maker met this requirement 88% of the time when quotes 
can be entered in the Regular Market Session for 10 trading sessions 
and 98% of the time when quotes can be entered in the Regular Market 
Session for 10 trading sessions then the MQP Market Maker would have 
met the requirement 93% of the time in that month.
     See NASDAQ Notice, supra note 4, at 22049.
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    MQP Credits for each MQP Security would be calculated monthly and 
credited quarterly on a pro rata basis to one or more eligible MQP 
Market Makers.\54\ As described above, each MQP Credit would be 
comprised of a ``Quote Share Payment'' that is based on Qualified 
Quotes, and a ``Trade Share Payment'' that is based on Qualified 
Trades.\55\ Quote Share Payments and Trade Share Payments would be 
funded by Basic MQP Fees and Supplemental MQP Fees, if any.\56\
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    \54\ See proposed NASDAQ Rule 5950(c)(2).
    \55\ See supra notes 38-40 and accompanying text.
    \56\ See proposed NASDAQ Rule 5950(c)(2)(B)(iii).
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    An MQP Credit would be credited quarterly to an MQP Market Maker on 
a pro rata basis for each month during such quarter that an MQP Market 
Maker is eligible to receive a credit pursuant to the proposed 
rule.\57\ The calculation to establish the eligibility of an MQP Market 
Maker would be done on a monthly basis.\58\
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    \57\ See proposed NASDAQ Rule 5950(c)(2)(C).
    \58\ Id. For example, if during a quarter an MQP Market Maker 
was eligible to receive a credit for two out of three months, such 
MQP Market Maker would receive a quarterly pro rata MQP Credit for 
those two months. See NASDAQ Notice, supra note 4, at 22049.
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d. Termination of MQP
    The MQP would terminate in respect of an MQP Security under any of 
the following circumstances: (i) Such MQP Security sustains an average 
NASDAQ daily trading volume (``ATV'') of 2,000,000 shares or more for 
three consecutive months; (ii) an MQP Company withdraws such MQP 
Security from the MQP, is no longer eligible to be in the MQP, or 
ceases to make MQP Fee payments to NASDAQ; (iii) such MQP Security is 
delisted or is no longer eligible for the MQP; (iv) such MQP Security 
does not have at least one MQP Market Maker for more than one quarter; 
or (v) such MQP Security does not, for two consecutive quarters, have 
at least one MQP Market Maker that is eligible for MQP Credit.\59\ Any 
MQP Credits remaining upon termination of the MQP in respect of an MQP 
Security would be distributed on a pro rata basis to the MQP Market 
Makers that made a market in such MQP Security and were eligible to 
receive MQP Credits pursuant to the proposed rule, or, if no MQP Market 
Makers qualify, refunded to the MQP Company.\60\ Termination of an MQP 
Company, MQP Security, or MQP Market Maker would not preclude NASDAQ 
from allowing re-entry into the MQP where NASDAQ deems proper.\61\
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    \59\ See proposed NASDAQ Rule 5950(d)(1).
    \60\ See proposed NASDAQ Rule 5950(d)(2).
    \61\ See proposed NASDAQ Rule 5950(d)(3).
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e. Pilot Basis
    As proposed, the MQP would be effective for a one-year pilot period 
that would commence when the MQP is implemented by NASDAQ's acceptance 
of an MQP Company and relevant MQP Market Maker into the MQP and would 
end one year after implementation.\62\
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    \62\ See proposed NASDAQ Rule 5950(f).
---------------------------------------------------------------------------

    During the pilot period, NASDAQ would periodically provide 
information to the Commission about market quality in respect of the 
MQP. Specifically, NASDAQ would submit monthly reports to the 
Commission about market quality in respect of the MQP, which reports 
would endeavor to compare, to the extent practicable, securities before 
and after they are in the MQP, and would include information regarding 
the MQP such as: (i) Rule 605 metrics; \63\ (ii) volume metrics; (iii) 
number of MQP Market Makers; (iv) spread size; and (v) availability of 
shares at the NBBO.\64\ The first report would be submitted within 
sixty days after the MQP becomes operative.\65\
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    \63\ 17 CFR 242.605.
    \64\ See NASDAQ Notice, supra note 4, at 22049.
    \65\ Id.
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2. Proposed IM-2460-1 Market Quality Program
    As part of its proposal to establish the MQP by adding new NASDAQ 
Rule 5950, NASDAQ is proposing to amend NASDAQ Rule 2460 (Payments for 
Market Making), which prohibits direct or indirect payment by an issuer 
to a Market Maker, to adopt a new interpretive provision to the 
rule.\66\ Specifically, NASDAQ is proposing to adopt new IM-2460-1 
(Market Quality Program) to provide that NASDAQ Rule 2460 would not be 
applicable to a member that is accepted into the MQP pursuant to 
proposed NASDAQ Rule 5950 or to a person that is associated with such 
member for their conduct in connection with the MQP.\67\
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    \66\ In relevant part, NASDAQ Rule 2460 provides that ``[n]o 
member or person associated with a member shall accept any payment 
or other consideration, directly or indirectly, from an issuer of a 
security, or any affiliate or promoter thereof, for publishing a 
quotation, acting as market maker in a security, or submitting an 
application in connection therewith.''
    \67\ See proposed IM-2460-1. NASDAQ notes that, based on 
discussions with the Financial Industry Regulatory Authority 
(``FINRA''), it expects FINRA to file a proposed rule change to 
exempt the MQP from FINRA Rule 5250. See NASDAQ Notice, supra note 
4, at 22042. Similar to NASDAQ Rule 2460, FINRA Rule 5250 (formerly 
NASD Rule 2460) prohibits FINRA members from directly or indirectly 
accepting payment from an issuer of a security for acting as a 
market maker. See Securities Exchange Act Release No. 38812 (July 3, 
1997), 62 FR 37105 (July 10, 1997) (SR-NASD-97-29) (``NASD Rule 2460 
Approval Order'').
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3. Surveillance
    NASDAQ represents that its surveillance procedures are adequate to 
properly monitor the trading of the MQP Securities on NASDAQ during all 
trading sessions, and to detect and deter violations of NASDAQ rules 
and applicable federal securities laws. Trading of the MQP Securities 
through NASDAQ would be subject to FINRA's surveillance procedures for 
derivative

[[Page 42056]]

products including ETFs.\68\ NASDAQ may obtain information via the 
Intermarket Surveillance Group (``ISG'') from other exchanges that are 
members or affiliates of ISG and from listed MQP Companies and public 
and non-public data sources such as, for example, Bloomberg.
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    \68\ FINRA surveils trading on NASDAQ pursuant to a regulatory 
services agreement. NASDAQ is responsible for FINRA's performance 
under this regulatory services agreement.
---------------------------------------------------------------------------

B. NYSE Arca Proposal

    As set forth in more detail in the NYSE Arca Notice,\69\ NYSE Arca 
proposes to adopt new NYSE Arca Equities Rule 8.800 to establish and 
implement, on a pilot basis, the Fixed Incentive Program for issuers of 
certain exchange-traded products (``ETPs'') listed on NYSE Arca, to 
incentivize Market Makers to undertake LMM assignments in ETPs. 
Pursuant to the NYSE Arca Proposal, an issuer of an ETP that 
participates in the proposed Fixed Incentive Program would elect to pay 
an ``Optional Incentive Fee'' to NYSE Arca, in an amount ranging from 
$10,000 to $40,000 per year,\70\ and, subject to the requirements set 
forth in the proposed rule, a Market Maker accepting an LMM assignment 
in an ETP in the Fixed Incentive Program would receive a payment from 
NYSE Arca (``LMM Payment'') in an amount equal to the Optional 
Incentive Fee, less a 5% NYSE Arca administration fee. The NYSE Arca 
Proposal would not alter the current requirements and obligations of 
LMMs under NYSE Arca rules or any policies and procedures related to 
LMMs.\71\
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    \69\ See supra note 12.
    \70\ An issuer of an ETP that participates in the proposed Fixed 
Incentive Program would continue to pay the currently applicable 
Listing and Annual Fees. Under the current Fee Schedule for 
listings, an issuer of an ETP is required to pay a Listing Fee that 
ranges from $5,000 to $45,000. ETP issuers also pay a graduated 
Annual Fee based on the number of shares of the ETP that are 
outstanding, which ranges $5,000 to $55,000. See NYSE Arca Notice, 
supra note 12, at 29419.
    \71\ See NYSE Arca Notice, supra note 12, at 29422. An LMM is 
subject to the obligations for Market Makers set forth in NYSE Arca 
Equities Rule 7.23 and the minimum performance standards that are 
referenced in NYSE Arca Equities Rule 7.24. Under NYSE Arca Equities 
Rule 7.24, the minimum performance standards include: (i) Percent of 
time at the NBBO; (ii) percent of executions better than the NBBO; 
(iii) average displayed size; (iv) average quoted spread; and (v) in 
the event the security is a derivative security, the ability to 
transact in underlying markets. An LMM's minimum performance 
standards are higher than those of a Designated Market Maker and are 
described in an official NYSE Arca policy titled NYSE Arca LMM 
Requirements, which may be amended from time to time. The minimum 
performance standards are measured daily and reviewed as a monthly 
average. See id. at 29420, n.5.
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1. Proposed NYSE Arca Equities Rule 8.800 (Terms of Fixed Incentive 
Program)
a. Eligibility for the Fixed Incentive Program
    An ETP would be eligible to participate in the Fixed Incentive 
Program if it is listed on NYSE Arca as of the commencement of the 
pilot period or becomes listed during the pilot period, and the listing 
is under NYSE Arca Equities Rules 5.2(j)(3) (Investment Company Units), 
5.2(j)(5) (Equity Gold Shares), 5.2(j)(6) (Equity Index-Linked 
Securities, Commodity-Linked Securities, Currency-Linked Securities, 
Fixed Income Index-Linked Securities, Futures-Linked Securities and 
Multifactor Index-Linked Securities), 8.100 (Portfolio Depositary 
Receipts), 8.200 (Trust Issued Receipts), 8.201 (Commodity-Based Trust 
Shares), 8.202 (Currency Trust Shares), 8.203 (Commodity Index Trust 
Shares), 8.204 (Commodity Futures Trust Shares), 8.300 (Partnership 
Units), 8.600 (Managed Fund Shares), or 8.700 (Managed Trust 
Securities).\72\
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    \72\ See proposed NYSE Arca Equities Rule 8.800(a).
---------------------------------------------------------------------------

    To be eligible to participate in the Fixed Incentive Program, an 
issuer would be required to be current in all payments due to NYSE Arca 
if it had other securities listed on NYSE Arca.\73\ In addition, the 
issuer would be required to be current in all payments due to NYSE Arca 
and to be compliant with continuing listing standards for the ETP 
proposed for inclusion if the issuer elected to participate in the 
Fixed Incentive Program after listing such ETP on NYSE Arca.\74\
---------------------------------------------------------------------------

    \73\ See proposed NYSE Arca Equities Rule 8.800(b)(2).
    \74\ See id.
---------------------------------------------------------------------------

b. Application and Withdrawal
    An issuer that wishes to have an ETP participate in the Fixed 
Incentive Program would be required to submit a written application in 
a form prescribed by NYSE Arca for each ETP.\75\ An issuer would not be 
permitted to have more than five existing ETPs (ETPs that are listed on 
NYSE Arca prior to the pilot) participate in the Fixed Incentive 
Program.\76\ NYSE Arca would communicate the ETPs proposed for 
inclusion in the Fixed Incentive Program on a written solicitation that 
is sent to all qualified LMM firms along with the Optional Incentive 
Fee the issuer proposes to pay for each ETP.\77\ The permitted range 
for the Optional Incentive Fee would be set forth in the Exchange's Fee 
Schedule, and, as proposed, would be between $10,000 and $40,000 per 
year.\78\ The issuer and the LMM thereafter would agree upon the final 
Optional Incentive Fee for each ETP.\79\ If more than one qualified LMM 
proposed to serve as such, the issuer would choose the LMM.\80\ NYSE 
Arca would provide notification on its Web site regarding the ETPs 
participating in the Fixed Incentive Program and the assigned LMMs.\81\
---------------------------------------------------------------------------

    \75\ See proposed NYSE Arca Equities Rule 8.800(b)(1). An issuer 
could elect to participate at the time of listing or thereafter at 
the beginning of each quarter during the pilot period. See id.
    \76\ See id.
    \77\ See id. The written solicitation would be included in the 
Green Sheet, which is the common term for an email communication 
sent by NYSE Arca staff members to all qualified LMMs prior to an 
LMM selection. The Green Sheet includes, among other things, the 
name, symbol, and description of the ETP(s) as well as the name of 
the issuer and a link to the ETP prospectus. A qualified LMM must 
complete the application for a specific ETP or group of ETPs. See 
NYSE Arca Notice, supra note 12, at 29421, n.11.
    \78\ See id. See also proposed amendment to NYSE Arca's Listing 
Fees Schedule (as defined below).
    \79\ See proposed NYSE Arca Equities Rule 8.800(b)(1).
    \80\ See id.
    \81\ See NYSE Arca Notice, supra note 12, at 29420, n.10.
---------------------------------------------------------------------------

    If an ETP no longer meets continuing listing standards or is being 
liquidated, it would be automatically withdrawn from the Fixed 
Incentive Program as of the ETP suspension date.\82\
---------------------------------------------------------------------------

    \82\ See proposed NYSE Arca Equities Rule 8.800(e)(1).
---------------------------------------------------------------------------

    NYSE Arca, in its discretion, could allow an issuer to withdraw an 
ETP from the Fixed Incentive Program before the end of the pilot if the 
assigned LMM is unable to meet its minimum performance standards for 
two of the three months of a quarter or for five months during the 
pilot and no other qualified Equity Trading Permit Holder is able to 
take over the assignment to become the new LMM for the ETP.\83\
---------------------------------------------------------------------------

    \83\ See proposed NYSE Arca Equities Rule 8.800(e)(2).
---------------------------------------------------------------------------

    An LMM could withdraw from all of its ETP assignments in the Fixed 
Incentive Program.\84\ Furthermore, NYSE Arca, in its discretion, could 
allow an LMM to withdraw from a particular ETP before the end of the 
pilot period if NYSE Arca determines that there are extraneous 
circumstances that prevent the LMM from meeting its minimum performance 
standards for such ETP that do not affect its other ETP assignments in 
the Fixed Incentive Program.\85\
---------------------------------------------------------------------------

    \84\ See proposed NYSE Arca Equities Rule 8.800(e)(3).
    \85\ See id.
---------------------------------------------------------------------------

    If the LMM for a particular ETP does not meet or exceed its minimum 
performance standards for any two of

[[Page 42057]]

the three months of a quarter or five months during the pilot, or 
chooses to withdraw from the Fixed Incentive Program (or from a 
particular ETP in the Fixed Incentive Program), and at least one other 
qualified Market Maker has agreed to become the assigned LMM under the 
Fixed Incentive Program, then the ETP would be reallocated and the 
issuer may select another LMM and renegotiate the Optional Incentive 
Fee in accordance with the solicitation process set forth in the 
proposed rule.\86\
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    \86\ See proposed NYSE Arca Equities Rule 8.800(e)(4). The 
reallocation process would be required to be completed no sooner 
than the end of the current quarter and no later than the end of the 
following quarter. See id.
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c. Payment of Optional Incentive Fee
    As discussed above, as proposed, the permitted range for the 
Optional Incentive Fee would be between 10,000 and 40,000 per year, and 
the issuer and the LMM assigned to an ETP would agree upon the final 
Optional Incentive Fee for each ETP. The Optional Incentive Fee for 
each ETP would be paid by the issuer to NYSE Arca in quarterly 
installments at the beginning of each quarter and prorated if the 
issuer commences participation in the Fixed Incentive Program for an 
ETP after the beginning of a quarter.\87\ The issuer would receive a 
prorated credit from NYSE Arca following the end of the quarter if the 
LMM does not meet its minimum performance standards in any given month 
in such quarter for an ETP.\88\ The credit would be applied against the 
issuer's next quarterly installment of the Optional Incentive Fee for 
the ETP, or otherwise credited or refunded to the issuer if the ETP is 
withdrawn from the Fixed Incentive Program.\89\
---------------------------------------------------------------------------

    \87\ See proposed NYSE Arca Equities Rule 8.800(c)(1).
    \88\ See id.
    \89\ See id.
---------------------------------------------------------------------------

    NYSE Arca would credit an LMM for the LMM Payment in an amount 
equal to the Optional Incentive Fee paid by the issuer, less a NYSE 
Arca administration fee set forth in the Fee Schedule, which, as 
proposed, would initially be 5%.\90\ An LMM that receives an LMM 
Payment would not be eligible for the LMM transaction fees and credits 
set forth in the Trading Fee Schedule for such ETP while participating 
in the Fixed Incentive Program, but would instead be subject to the 
standard transaction fees and credits applicable to Equity Trading 
Permit Holders and Market Makers set forth in the Trading Fee Schedule 
for transactions in such ETP during that quarter.\91\
---------------------------------------------------------------------------

    \90\ See proposed NYSE Arca Equities Rule 8.800(d)(1) and 
proposed amendment to NYSE Arca's Trading Fees Schedule (as defined 
below).
    \91\ See proposed NYSE Arca Equities Rule 8.800(d)(1). NYSE Arca 
generally employs a maker-taker transactional fee structure, whereby 
an Equity Trading Permit Holder that removes liquidity is charged a 
fee (``Take Rate''), and an Equity Trading Permit Holder that 
provides liquidity receives a credit (``Make Rate''). The Take Rate 
for LMMs is currently $0.0025 per share. The Make Rate for LMMs is 
currently between $0.0035 and $0.0045 per share depending on 
consolidated average daily volume. Standard NYSE Arca Tape B Make 
Rates (rebates paid for adding liquidity) range from $0.0022 to 
$0.0033 per share. Standard NYSE Arca Tape B Take Rates (fees 
charged for removing liquidity) range from $0.0026 to $0.0030 per 
share. See NYSE Arca Notice, supra note 12, at 29429, n.8.
---------------------------------------------------------------------------

    NYSE Arca would credit an LMM for the LMM Payment at the end of 
each quarter and, if an LMM does not meet or exceed its minimum 
performance standards for the ETP for a particular month, then the LMM 
Payment would be prorated accordingly.\92\
---------------------------------------------------------------------------

    \92\ See proposed NYSE Arca Equities Rule 8.800(d)(2). LMM 
Payments would be paid directly by NYSE Arca from its general 
revenues. See NYSE Arca Notice, supra note 12, at 29421.
---------------------------------------------------------------------------

    If an issuer does not pay its quarterly installments to NYSE Arca 
on time and the ETP continues to be listed, NYSE Arca would continue to 
credit the LMM in accordance with the proposed rule, except that after 
two quarters, if an issuer is not current in its quarterly installments 
for an ETP, such ETP would be automatically terminated from the Fixed 
Incentive Program.\93\
---------------------------------------------------------------------------

    \93\ See proposed NYSE Arca Equities Rule 8.800(c)(2).
---------------------------------------------------------------------------

2. Proposed Amendments to Listing Fee Schedule and Trading Fee Schedule
    To implement the Fixed Incentive Program, NYSE Arca also proposes 
to amend its Fee Schedules.\94\ NYSE Arca proposes to amend its Listing 
Fee Schedule to provide that the Optional Incentive Fee under proposed 
NYSE Arca Equities Rule 8.800 may range from $10,000 to $40,000 per 
year. In addition, NYSE Arca proposes to amend its Trading Fee Schedule 
to provide that, in accordance with proposed NYSE Arca Equities Rule 
8.800, at the end of each quarter, NYSE Arca would credit the LMM 
assigned to an ETP the Optional Incentive Fee, less a 5% NYSE Arca 
administration fee. NYSE Arca further proposes to amend its Trading Fee 
Schedule to provide that an LMM that receives an LMM Payment under 
proposed NYSE Arca Equities Rule 8.800 would be subject to the standard 
transaction fees and credits applicable to Equity Trading Permit 
Holders and Market Makers set forth in the Trading Fee Schedule for 
transactions in such ETP during that quarter, instead of the LMM 
transaction fees and credits set forth in the Trading Fee Schedule.\95\
---------------------------------------------------------------------------

    \94\ NYSE Arca has one Schedule of Fees and Charges for Exchange 
Services that is for listings (``Listing Fee Schedule'') and another 
that is for trade-related charges (``Trading Fee Schedule''). To 
differentiate them, NYSE Arca proposes to change the name of the 
former to ``SCHEDULE OF FEES AND CHARGES FOR EXCHANGE LISTING 
SERVICES.'' See NYSE Arca Notice, supra note 12 at 29422.
    \95\ See supra note 91 and accompanying text.
---------------------------------------------------------------------------

3. Pilot Program
    The Fixed Incentive Program would be implemented on a pilot basis 
and would be offered to issuers from the date of implementation, which 
would occur no later than 90 days after the effective date of the NYSE 
Arca Proposal, until December 31, 2013.\96\ During the course of the 
pilot period, NYSE Arca would assess the terms of the Fixed Incentive 
Program and would submit a rule filing to the Commission as necessary 
if it determines that any of the terms should be changed. At the end of 
the pilot, NYSE Arca would determine whether to continue or discontinue 
the pilot or make it permanent and submit a rule filing to the 
Commission as necessary.\97\
---------------------------------------------------------------------------

    \96\ See NYSE Arca Notice, supra note 12, at 29422.
    \97\ See NYSE Arca Notice, supra note 12, at 29422.
---------------------------------------------------------------------------

    During the pilot program, the Exchange would provide the Commission 
with certain market quality data on a confidential basis each month, 
including, for all ETPs listed as of the date of implementation of the 
pilot program and listed during the pilot (for comparative purposes), 
volume metrics, NBBO bid/ask spread differentials, LMM participation 
rates, NYSE Arca market share, LMM time spent at the inside, LMM time 
spent within $0.03 of the inside, percent of time NYSE Arca has the 
best price with the best size, LMM quoted spread, LMM quoted depth, and 
Rule 605 statistics (one-month delay).\98\ In addition, NYSE Arca would 
provide such other data as may be periodically requested by the 
Commission.\99\
---------------------------------------------------------------------------

    \98\ See id. See also 17 CFR 242.605.
    \99\ Id. NYSE Arca notes that, based upon discussions with 
FINRA, subsequent to NYSE Arca's filing of the NYSE Arca Proposal, 
FINRA would file an immediately effective rule change indicating 
that participation by LMMs and issuers in the Fixed Incentive 
Program would not be prohibited by FINRA Rule 5250. See NYSE Arca 
Notice, supra note 12, at 29423, n.17.
---------------------------------------------------------------------------

C. Comparison of the SRO Proposals

    As further discussed below, the Commission received comments 
requesting that it consider the SRO Proposals together, to allow 
commenters to compare and contrast the different approaches and assist 
the Commission in considering the overall issues raised

[[Page 42058]]

by the SRO Proposals.\100\ Both of the SRO Proposals would establish 
pilot programs that would allow issuers of certain types of securities 
to pay additional listing fees for additional liquidity services. In 
particular, issuers would make payments to the exchange that the 
exchange would then pay to a market maker(s) in that issuer's security. 
While there are a number of similarities between the SRO Proposals, 
there are also a number of differences between the two. Although not an 
exhaustive comparison, below is a summary of the more significant 
differences between the SRO Proposals:
---------------------------------------------------------------------------

    \100\ See infra notes 203 and 247 and accompanying text.
---------------------------------------------------------------------------

     Under NASDAQ's proposed MQP, MQP Securities may include 
Exchange Traded Funds (``ETFs''), Linked Securities (``LS''), and Trust 
Issued Receipts (``TIRs'') listed on NASDAQ pursuant to NASDAQ Rules 
5705, 5710, and 5720, respectively. Under NYSE Arca's proposal, an ETP 
would be eligible to participate in the Fixed Incentive Program if it 
is listed on NYSE Arca under NYSE Arca Equities Rules 5.2(j)(3) 
(Investment Company Units), 5.2(j)(5) (Equity Gold Shares), 5.2(j)(6) 
(Equity Index-Linked Securities, Commodity-Linked Securities, Currency-
Linked Securities, Fixed Income Index-Linked Securities, Futures-Linked 
Securities and Multifactor Index-Linked Securities), 8.100 (Portfolio 
Depositary Receipts), 8.200 (Trust Issued Receipts), 8.201 (Commodity-
Based Trust Shares), 8.202 (Currency Trust Shares), 8.203 (Commodity 
Index Trust Shares), 8.204 (Commodity Futures Trust Shares), 8.300 
(Partnership Units), 8.600 (Managed Fund Shares), or 8.700 (Managed 
Trust Securities).
     Under NASDAQ's proposed MQP, only ETPs that have an ATV of 
less than 2,000,000 would be eligible for the MQP, and the MQP would 
terminate with respect to an MQP Security if the security obtains 
2,000,000 ATV or greater for three consecutive months. There is no 
similar trading volume threshold for ETPs to be eligible to participate 
in NYSE Arca's proposed Fixed Incentive Program or that would trigger 
termination of such program.
     MQP Market Makers participating in NASDAQ's proposed MQP 
would be subject to higher performance standards than those applicable 
to Market Makers not participating in the MQP. Under NYSE Arca's 
proposed Fixed Incentive Program, participating LMMs would be subject 
to the same performance standards as LMMs not participating in the 
Fixed Incentive Program.
     Under NYSE Arca's proposed Fixed Incentive Program, only 
one market maker, the LMM, would be assigned to each ETP in the Fixed 
Incentive Program, and such LMM would receive the entire LMM Payment, 
provided it met the existing LMM performance standards. Under NASDAQ's 
proposed MPQ, multiple competing MQP Market Makers could be assigned to 
an MQP Security (although NASDAQ would retain discretion to restrict 
the number of MQP Market Makers in an MQP Security), and such MQP 
Market Makers would be compensated on a pro rata basis (provided they 
met the required performance standards) based upon Qualified Quotes and 
Qualified Trades.
     Pursuant to NASDAQ's proposed MQP, an MQP Company 
participating in the MQP would be required to pay a fixed Basic MQP Fee 
of $50,000, and, at its discretion, could choose to pay a Supplemental 
MQP Fee of up to an additional $50,000. The payment by an MQP Company 
of the Supplemental MQP Fee and the amount of such fee would be 
disclosed by NASDAQ on its Web site. Under the NYSE Arca Proposal, an 
issuer participating in the Fixed Incentive Program would be required 
to pay the Optional Incentive Fee in an amount between $10,000 and 
$40,000, which amount would be negotiated between the issuer and the 
LMM assigned to such issuer's ETP, and the final amount of such 
Optional Incentive Fee would not be publicly disclosed.
     Under the proposed Fixed Incentive Program, NYSE Arca, in 
its discretion, could allow an issuer to withdraw an ETP from the Fixed 
Incentive Program before the end of the pilot only if the assigned LMM 
is unable to meet its minimum performance standards for two of the 
three months of a quarter or for five months during the pilot, and no 
other qualified Equity Trading Permit Holder is able to take over the 
assignment and become the new LMM for the ETP. Under NASDAQ's proposed 
MQP, an MQP Company could voluntarily withdraw from the MQP on a 
quarterly basis after it has been in the MQP for two consecutive 
quarters, or on a monthly basis after it has been in the MQP for one 
year.
     Under NYSE Arca's proposed Fixed Incentive Program, an LMM 
could withdraw from all of its ETP assignments. In addition, NYSE Arca, 
in its discretion, could allow an LMM to withdraw from a particular ETP 
before the end of the pilot period if NYSE Arca determines that there 
are extraneous circumstances that prevent the LMM from meeting its 
minimum performance standards for such ETP that do not affect its other 
ETP assignments in the Fixed Incentive Program. Under NASDAQ's proposed 
MQP, an MQP Market Maker that is in the MQP for not less than one 
quarter could withdraw from the MQP on a quarterly basis. In such a 
case, the MQP Market Maker would be required to notify NASDAQ in 
writing not less than one month prior to withdrawing.
     During the pilot period, NASDAQ would provide the 
Commission with certain market quality data for the MQP Securities, as 
further described above, to allow the Commission to assess the impact 
of the MQP. Under the NYSE Arca Proposal, NYSE Arca would provide the 
Commission with certain market quality data for ETPs in the Fixed 
Incentive Program, and also for ETPs not participating in the program, 
to allow the Commission to compare such metrics. NYSE Arca expressly 
indicates that such data would be provided to the Commission on a 
confidential basis.

III. Summary of Comments and Responses to Comments

A. Comments to NASDAQ'S Proposal and NASDAQ Response Letter

    The Commission received 18 comment letters on the NASDAQ 
Proposal.\101\ Ten commenters generally supported the proposal,\102\ 
seven commenters opposed the proposal,\103\ and one commenter neither 
supported nor opposed the proposal, but requested a longer comment 
period to have sufficient time to consider the issues raised by the 
proposal.\104\
---------------------------------------------------------------------------

    \101\ See supra notes 5 and 8.
    \102\ See generally Anonymous Letter, Weaver Letter, Anand 
Letter, Menkveld Letter, Angel Letter, NASDAQ ICI Letter, Knight 
Letter, ETF Consultants Letter, TechNet Letter, and MFA Letter.
    \103\ See generally Choi Letter, Csickso Letter, O'Connor 
Letter, Szalay Letter, Keita Letter, Connell Letter, and IR Letter.
    \104\ See NASDAQ Vanguard Letter at 1-2.
---------------------------------------------------------------------------

    In the NASDAQ Response Letter, NASDAQ reiterated its belief that 
the MQP will be beneficial to issuers, investors, and other market 
participants, and to the economy in general by ``significantly 
enhancing the quality of the market and trading in listed securities.'' 
\105\ In support of its proposal, NASDAQ referenced the commenters that 
submitted letters generally in favor of the proposed MQP.\106\ NASDAQ 
also responded to

[[Page 42059]]

comments opposing the proposed MQP, which responses are summarized 
below.
---------------------------------------------------------------------------

    \105\ See NASDAQ Response Letter at 1. NASDAQ also cited recent 
legislation proposed subsequent to the NASDAQ Notice sponsored by 
Congressman McHenry entitled ``Liquidity Enhancement for Small 
Public Companies Act'' noting current interest in Congress to 
provide for ``much needed support for small businesses.'' See id. at 
2-3.
    \106\ See id. at 4-13. See also supra note 102.
---------------------------------------------------------------------------

1. Generally Support MQP
    The commenters supporting the NASDAQ Proposal generally express the 
view that the MQP would provide greater liquidity and create better 
quality markets for the securities participating in the MQP, including 
lower transaction costs, increased price discovery and lower 
volatility.\107\ One commenter believes that the NASDAQ Proposal will 
benefit all market participants, including issuers, investors 
(institutional and retail), liquidity providers, and the overall U.S. 
economy.\108\ Another commenter believes that the MQP will make a 
substantial contribution to improving the quality of ETF trading 
markets and facilitate trading in improved ETFs as new products are 
introduced.\109\
---------------------------------------------------------------------------

    \107\ See Anonymous Letter at 1, Weaver Letter at 1-2, Anand 
Letter at 1-2, Knight Letter at 1-2, Angel Letter at 3, TechNet 
Letter at 1, and MFA Letter at 2.
    \108\ See Knight Letter at 1.
    \109\ See ETF Consultants Letter at 1.
---------------------------------------------------------------------------

    A number of commenters supportive of the MQP point to academic 
studies finding that paid for market making arrangements applied to 
common stocks generally improve market quality and benefit social 
welfare.\110\ One commenter discusses his own study of paid for market 
making arrangements for common stocks and concludes that market makers 
entering into these types of agreements provide liquidity buffers 
against supply and demand shocks.\111\ Another commenter cites his own 
study for the finding that a paid for market making arrangement 
applicable to common stocks on average improves the liquidity level, 
reduces liquidity risk, and reduces the size of pricing errors in such 
stocks, among other things.\112\ One commenter cites a study for the 
proposition that maintaining a level of liquidity provision that is 
higher than the level that would endogenously arise can increase 
welfare and enhance efficiency for certain securities.\113\
---------------------------------------------------------------------------

    \110\ See Weaver Letter at 2, Anand Letter at 1, Menkveld Letter 
at 2, and MFA Letter at 2 citing to the following studies: Weaver, 
D.G., A. Anand, and C. Tanggaard ``Paying for Market Quality'' 
Journal of Financial and Quantitative Analysis, Vol. 44, 1427-1457, 
2009 (``Weaver Study''); Bessembinder, H., J. Hao, and M. Lemmon 
(2006) ``Why designate market makers? Affirmative obligations and 
market quality'' Working paper, University of Utah (``Bessembinder 
Study''); Menkveld, A.J. and T. Wang (2011), ``How do designated 
market makers create value for small-caps?'' Manuscript, VU 
University, Amsterdam (``Menkveld Study''); Skjeltorp, Johannes A. & 
Bernt Arne Odegaard, ``Why do listed firms pay for market making in 
their own stock?'' (June 2011); and Hengelbrock, Jordis, 
``Designated Sponsors and Bid-Ask Spreads on Xetra,'' University of 
Bonn--The Bonn Graduate School of Economics (October 2008).
    \111\ See Weaver Letter at 2 citing to the Weaver Study.
    \112\ See Menkveld Letter at 1-2 citing the Menkveld Study.
    \113\ See Anand Letter at 1 citing the Bessembinder Study.
---------------------------------------------------------------------------

    A number of commenters supportive of the MQP also state that direct 
payments from issuers to market makers are used in a number of markets 
outside of the U.S., and such programs have been successful.\114\ One 
commenter states that the combined evidence from other markets 
indicates that a paid market making program offers significant promise 
for improving the liquidity of the stocks of smaller firms.\115\
---------------------------------------------------------------------------

    \114\ See Weaver Letter at 3-4, Knight Letter at 1-2, Anand 
Letter at 1-2, Angel Letter at 3, and MFA Letter at 2. These 
commenters cited the Stockholm Stock Exchange, NASDAQ OMX's European 
exchanges, and Euronext's European exchanges, among others, as 
markets where such programs have been successful. Another commenter 
notes that NASDAQ OMX has extensive experience operating exchanges 
in countries that permit issuers to compensate liquidity providers, 
so NASDAQ should have the relevant expertise to administer such a 
program in the U.S. in such a manner as to prevent harm to market 
participants. See Angel Letter at 3.
    \115\ See Anand Letter at 2.
---------------------------------------------------------------------------

    Several commenters supporting the MQP believe that the MQP may 
incentivize not only the MQP Market Makers, but also other market 
participants, to make markets in the MQP Securities, thereby creating 
additional liquidity in the MQP Securities.\116\ One commenter cites an 
article finding that narrower spreads arising from designated market 
makers with an affirmative obligation to set spreads narrower than 
would exist otherwise will induce both uninformed and informed traders 
to trade more, which in turn leads to increased price efficiency and 
faster price discovery.\117\ Another commenter states that a study he 
conducted potentially indicates that other limit order traders compete 
more aggressively in the presence of issuer-paid market makers, thereby 
narrowing spreads beyond the levels mandated by contract.\118\
---------------------------------------------------------------------------

    \116\ See Weaver Letter at 2-3, Knight Letter at 2, Anand Letter 
at 1-2, and ETF Consultants Letter at 2.
    \117\ See Weaver Letter at 2-3 citing to the Bessembinder Study.
    \118\ See Anand Letter at 1.
---------------------------------------------------------------------------

    One commenter believes that the MQP could create value for an 
issuer through liquidity insurance by, ex ante, shareholders agreeing 
to pay for a minimum liquidity guarantee to insure against uncertain 
future liquidity.\119\ This commenter states that if future liquidity 
is less uncertain, more investors should participate in the market, and 
thus, the MQP could be a way to jump-start trading in a particular 
product at launch, and if there is intrinsic interest in the product, 
it should have a better chance of being successful.\120\ Similarly, 
another commenter argues that the MQP is an attractive and low cost way 
to assure reasonably continuous market making, so that investors that 
buy ETF shares will not have to be concerned that it may not be 
possible for them to sell their shares at a price close to the net 
asset value when they decide to sell.\121\
---------------------------------------------------------------------------

    \119\ See Menkveld Letter at 2.
    \120\ Id.
    \121\ See ETF Consultants Letter at 2-3.
---------------------------------------------------------------------------

    One commenter states that the incentives that previously existed on 
NASDAQ for market makers and brokers to nurture smaller companies no 
longer exist, and that the MQP is a tool to create such 
incentives.\122\ Similarly, one commenter states that the cost to trade 
many of the smaller and newer ETFs is unpredictable and that incentives 
to market makers to undertake such costs do not exist under current 
market rules.\123\ This commenter believes that the MQP will provide 
important incentives to attract market makers to participate in the 
introduction and continuous trading of newer, less immediately popular, 
ETFs, and will encourage market makers to be continuous participants in 
the market by looking for links and arbitrage opportunities between and 
among the underlying portfolio and the exchange traded product.\124\
---------------------------------------------------------------------------

    \122\ See Angel Letter at 3.
    \123\ See ETF Consultants Letter at 2.
    \124\ See ETF Consultants Letter at 2.
---------------------------------------------------------------------------

    Three commenters believe that the MQP will benefit the operating 
companies underlying ETFs in the MQP, in addition to the ETFs 
themselves.\125\ One of these commenters states that it is not the 
inclusion in an underlying index that matters to the operating company, 
but rather the trading volume increase resulting from trading products 
based on such index.\126\ Another commenter agrees with NASDAQ's 
assertion that membership of an index enlarges ``visibility'' of a 
company, as substantial trade activity will create investor interest in 
holding the portfolio and therefore holding the company.\127\
---------------------------------------------------------------------------

    \125\ See Weaver Letter at 4, Menkveld Letter at 3-4, and 
TechNet Letter at 1.
    \126\ See Weaver Letter at 5.
    \127\ See Menkveld Letter at 3-4. Another commenter also 
suggests that, looking forward, the MQP could benefit promising tech 
companies that today may lack liquid, quality markets. See TechNet 
Letter at 1.
---------------------------------------------------------------------------

    One commenter supports the overall goal of the MQP--to incentivize 
market

[[Page 42060]]

makers to make high-quality, liquid markets in ETFs--and asserts that, 
to the extent the MQP results in narrower spreads and more liquid 
markets for ETFs without any associated unintended consequences for 
ETFs or the markets as a whole, the MQP could prove beneficial.\128\ 
However, this commenter supports the MQP at this time only through a 
pilot program as contemplated by the NASDAQ Proposal and the 
requirement that NASDAQ provide information to the Commission during 
the pilot about market quality associated with the MQP, to assist in 
the comparison of ETFs before and after they are in the MQP.\129\
---------------------------------------------------------------------------

    \128\ See NASDAQ ICI Letter at 2.
    \129\ See id. at 2-3.
---------------------------------------------------------------------------

2. Generally Oppose MQP
    The commenters opposing the MQP raise various objections to the 
proposal. Several commenters opposing the NASDAQ Proposal believe that 
it would result in manipulation and an unfair market place.\130\ In its 
response letter, NASDAQ argues that the MQP will serve to open the 
market to more participants and ``will be a win for all: For the ETF 
sponsor or company that lists a liquidity-challenged product with the 
MQP and experiences added liquidity; for the market maker that receives 
a modest credit for `stepping up to the plate' and is willing to take 
on added risk by enhancing liquidity pursuant to MQP standards; and for 
the investor that experiences liquidity on both sides of the trading 
continuum (bid and ask) at lower transaction cost.''\131\
---------------------------------------------------------------------------

    \130\ See Choi Letter at 1, O'Connor Letter at 1, Szalay Letter 
at 1, and Connell Letter at 1.
    \131\ See NASDAQ Response Letter at 14.
---------------------------------------------------------------------------

    Several commenters opposing the NASDAQ Proposal argue that it would 
undo the prohibition on issuer payments for market making contained in 
FINRA Rule 5250, which was put in place for important investor 
protection reasons.\132\
---------------------------------------------------------------------------

    \132\ See Csicsko Letter at 1, Keita Letter at 1, and Connell 
Letter at 1. FINRA Rule 5250 was implemented, in part, to address 
concerns about issuers paying market makers to improperly influence 
the price of an issuer's stock. See NASD Rule 2460 Approval Order, 
supra note 67, at 37107 (``Specifically, the Commission finds that 
the rule preserves the integrity of the marketplace by ensuring that 
quotations accurately reflect a broker-dealer's interest in buying 
or selling a security. The decision by a firm to make a market in a 
given security and the question of price generally are dependent on 
a number of factors, including, among others, supply and demand, the 
firm's expectations toward the market, its current inventory 
position, and exposure to risk and competition. This decision should 
not be influenced by payments to the member from issuers or 
promoters. Public investors expect broker-dealers' quotations to be 
based on the factors described above. If payments to broker-dealers 
by promoters and issuers were permitted, investors would not be able 
to ascertain which quotations in the marketplace are based on actual 
interest and which quotations are supported by issuers or promoters. 
This structure would harm investor confidence in the overall 
integrity of the marketplace. The Commission finds that the proposed 
rule supports a longstanding policy and position of the NASD and 
establishes a clear standard of fair practice for member firms.'') 
The Commission's order also discussed conflicts of interest that may 
exist between issuers and market makers. See id. at 37106 (``It has 
been a longstanding policy and position of the NASD that a broker-
dealer is prohibited from receiving compensation or other payments 
from an issuer for quoting, making a market in an issuer's 
securities or for covering the member's out-of-pocket expenses for 
making a market, or for submitting an application to make a market 
in an issuer's securities. As stated in Notice to Members 75-16 
(February 20, 1975), such payments may be viewed as a conflict of 
interest since they may influence the member's decision as to 
whether to quote or make a market in a security and, thereafter, the 
prices that the member would quote.'')
---------------------------------------------------------------------------

    Two commenters who oppose the MQP believe that it would result in 
an increase in statistical arbitrage, which these commenters view as 
speculative short-term trading and as harmful to investors and public 
companies.\133\ NASDAQ responds that the MQP is not designed to 
inherently increase statistical arbitrage and that arbitrage will exist 
regardless of the MQP.\134\ NASDAQ also notes that arbitrage may serve 
to help align the pricing of ETFs and allow investors to experience 
tighter execution related to an ETF's asset value.\135\
---------------------------------------------------------------------------

    \133\ See Keita Letter at 1 and IR Letter at 2-3.
    \134\ See NASDAQ Response Letter at 16-17.
    \135\ See NASDAQ Response Letter at 17.
---------------------------------------------------------------------------

    One commenter opposed to the MQP argues that the NASDAQ Proposal is 
not consistent with the Exchange Act because the proposal: (i) 
Authorizes ETF sponsors to pay market-makers for making markets in a 
distinct and narrow set of securities, and, thus, does not promote 
equitable allocation of reasonable dues, fees and other charges; (ii) 
conjures volume and prices through deliberate, systematic interference 
with market mechanisms and, thus, does not meet the requirement of 
promoting just and equitable principles of trade; and (iii) is designed 
to prompt behavior that would not otherwise occur through payments and, 
thus, is an impediment to free and open markets.\136\ In response, 
NASDAQ states its belief that it has articulated a sufficient statutory 
basis to support the proposal, and argues that the goal of the MQP--to 
incentivize members to make high-quality, liquid markets--supports the 
development of a resilient and efficient national market system.\137\ 
NASDAQ further argues that the MQP represents an equitable allocation 
of fees and dues among Market Makers, because Market Makers that choose 
to undertake increased burdens pursuant to the MQP will be rewarded on 
a pro rata basis with increased credits, while those that do not 
undertake such burdens will receive no benefit; any portion of an MQP 
Fee that is not credited to eligible MQP Market Makers will be refunded 
to the relevant MQP Company; and all of the benefits of the MQP Fees 
will flow to high-performing Market Makers rather than to NASDAQ, 
provided that at least one Market Maker fulfills the obligations under 
the proposed rule.\138\ Finally, NASDAQ argues that the MQP is designed 
to avoid unfair discrimination among Market Makers and issuers because 
it contains objective, measurable standards for both issuers and Market 
Makers that NASDAQ will apply equally to ensure that similarly situated 
parties are treated similarly.\139\
---------------------------------------------------------------------------

    \136\ See IR Letter at 2.
    \137\ See NASDAQ Response Letter at 16.
    \138\ Id.
    \139\ Id.
---------------------------------------------------------------------------

    This commenter further argues that durable markets cannot be 
constructed on prices contrived through payment for order flow 
arrangements such as the MQP, and that incentivized trading resulting 
from such arrangements obfuscates true supply and demand by creating 
volume where no natural buyers or sellers exist.\140\ This commenter 
believes that it should be incumbent upon ETF sponsors to create 
vehicles that attract interest.\141\
---------------------------------------------------------------------------

    \140\ See IR Letter at 2.
    \141\ See id.
---------------------------------------------------------------------------

3. FINRA Rule 5250
    As discussed above, three commenters oppose the NASDAQ Proposal 
because they believe it would violate the prohibition against issuer 
payments to market makers contained in FINRA Rule 5250.\142\ On the 
other hand, four of the commenters that support the MQP argue that the 
MQP adequately addresses the concerns that FINRA Rule 5250 was designed 
to alleviate.\143\
---------------------------------------------------------------------------

    \142\ See supra note 132.
    \143\ See Anonymous Letter at 1, Weaver Letter at 6, NASDAQ ICI 
Letter at 2, and ETF Consultants Letter at 6.
---------------------------------------------------------------------------

    One of these commenters argues that the structure of the MQP and 
the behavior for which an MQP Market Maker is compensated would 
discourage inappropriate behavior by MQP Market Makers.\144\ In 
particular, this commenter notes that the market making incentives 
provided by the MQP should not materially affect the likely price of 
the MQP Securities, as the mid-point of the price range will be

[[Page 42061]]

determined by market forces and not by a market maker's activity, and 
MQP Market Makers have an incentive under the MQP to make spreads 
tight, post reasonable quotes, post them consistently, and post quotes 
that investors will trade against since they are compensated based on 
both the quality of quotes and participation in trading.\145\ This same 
commenter also argues that since the securities eligible for the MQP 
are ETFs, LSs, and TIRs, where net asset value proxies are provided 
frequently for such products during trading hours, any attempt to 
artificially push prices up or down would be countered by the 
availability of this information.\146\
---------------------------------------------------------------------------

    \144\ See ETF Consultants Letter at 6.
    \145\ Id. at 3.
    \146\ Id. at 6.
---------------------------------------------------------------------------

    One commenter argues that placing NASDAQ between the funding 
delivered by the issuer to the market maker will ensure the 
professional integrity of the MQP and the responsibility of the market 
maker, and thus alleviates the concerns FINRA Rule 5250 was designed to 
address.\147\
---------------------------------------------------------------------------

    \147\ See Anonymous Letter at 1.
---------------------------------------------------------------------------

    Another commenter notes that there have been no reports of 
manipulation attempts by issuers or abuses by market makers in paid for 
market making programs abroad, and argues that the implementation of 
paying for market making to improve market quality in other countries 
probably improved investor confidence, as evidenced by the increase in 
volume and order size observed by researchers.\148\ This commenter also 
argues that the payment levels proposed in the MQP are not of 
sufficient size to provide enough incentive for manipulation.\149\
---------------------------------------------------------------------------

    \148\ See Weaver Letter at 4.
    \149\ Id. at 6.
---------------------------------------------------------------------------

    One commenter recognizes that the MQP would represent a departure 
from the current rules precluding these types of issuer payments, which 
were put in place to address concerns surrounding the payment of 
incentives to market makers, and, therefore, supports the establishment 
of the MQP only through a pilot program as contemplated by the 
proposal.\150\ This commenter also notes that NASDAQ has attempted to 
address concerns about investor confidence and market integrity that 
are associated with the MQP through, among other things, disclosure 
requirements and overall transparency built into the MQP.\151\
---------------------------------------------------------------------------

    \150\ See NASDAQ ICI Letter at 2-3.
    \151\ Id. at 3.
---------------------------------------------------------------------------

    The commenter who neither supported nor opposed the proposal also 
reserves judgment as to whether the MQP sufficiently alleviates the 
concerns FINRA Rule 5250 was intended to address.\152\ This commenter 
notes that NASDAQ has proposed a number of safeguards around the MQP in 
an effort to address the concerns underlying the prohibition on issuer 
payments to market makers, including a transparency requirement wherein 
NASDAQ would disclose on its Web site the identity of all ETF and 
market makers participating in the MQP, along with information about 
amounts paid to or received by these participants; objective and 
meaningful market quality standards that market makers must meet to 
receive MQP payments; and opportunity for multiple market makers to 
compete for payments on each participating ETF. This commenter states 
that these safeguards are important but believes that it is unclear 
whether these safeguards would be sufficient to overcome the 
presumption that issuer payments to market makers have the potential to 
distort the market and create conflicts of interests that corrupt the 
integrity of the marketplace.\153\
---------------------------------------------------------------------------

    \152\ See NASDAQ Vanguard Letter at 3-4.
    \153\ See id. at 3. For example, this commenter queries whether 
it is likely that investors would consult NASDAQ's Web site for 
information about which ETFs and market makers are participating in 
the MQP and, if not, whether investors would be able to distinguish 
quotations that reflect true market forces from quotations that have 
been influenced by issuer payments. Id.
---------------------------------------------------------------------------

    In its response letter, NASDAQ states its belief that FINRA Rule 
5250 was originally adopted to prohibit market makers from getting paid 
by issuers for increasing volume without supporting liquidity and 
quality markets, such as ``pump and dump'' schemes.\154\ NASDAQ does 
not believe that the MQP will promote such negative behavior, and 
emphasizes various aspects of the MQP to support this, including the 
fact that payments made pursuant to the MQP are administered by the 
Exchange; an MQP Market Maker can only receive payments under the MQP 
by meeting the MQP performance standards; the MQP is clear, 
unambiguous, and transparent; and that the products that are eligible 
for the MQP, ETFs, have a structure that inherently protects against 
the opportunity for price manipulation by a market maker because their 
value is based on the performance of an underlying index or basket of 
securities.\155\
---------------------------------------------------------------------------

    \154\ See NASDAQ Response Letter at 14-15.
    \155\ See NASDAQ Response Letter at 15.
---------------------------------------------------------------------------

4. Additional Concerns
    One commenter notes a number of additional concerns that the MQP 
may raise, and suggests that the Commission solicit additional public 
comment relating to such concerns before approving NASDAQ's 
Proposal.\156\ The areas of concern this commenter identifies include: 
(i) What effect, if any, the MQP may have on ETFs that are ineligible 
to participate in the MQP, or that are eligible but choose not to 
participate; (ii) whether competitive forces will essentially render 
the MQP compulsory, forcing ETFs into a ``pay-to-play'' environment 
where new ETFs must pay for the MQP to launch and list and existing 
ETFs must pay for the MQP to maintain quality markets; (iii) whether 
NASDAQ's proposed eligibility criteria are consistent with the stated 
goals of the MQP and the public interest; (iv) whether ETFs for which 
there is a limited demand should be allowed to be artificially propped 
up indefinitely by the MQP rather than allowed to fail (or trade at a 
wider spread); \157\ and (v) what implications there are for investors 
who purchase an ETF when it is in the MQP but seek to sell such ETF 
after it is no longer participating in the MQP.\158\
---------------------------------------------------------------------------

    \156\ See NASDAQ Vanguard Letter at 4.
    \157\ On the other hand, another commenter states its belief 
that the implementation of the MQP would not do much to help a small 
fund with an unappealing portfolio or a history of poor performance, 
and that if a fund is not viable, the MQP alone would not save it. 
See ETF Consultants Letter at 5.
    \158\ See id. at 4-6.
---------------------------------------------------------------------------

    In response, NASDAQ states that it does not believe its proposal 
will cause a diminution of market quality for ETFs that do not 
participate in the MQP, and anticipates that the liquidity 
characteristics of ETFs not participating in the MQP will largely 
remain unchanged (e.g., they will continue to be less than 
adequate).\159\ Furthermore, NASDAQ notes that it has ``taken great 
strides to make the MQP wholly voluntary,'' and it does not believe the 
modest market maker credits proposed pursuant to the MQP will result in 
a ``pay to play'' environment.\160\ NASDAQ also disagrees with this 
commenter's concern regarding whether NASDAQ's proposed eligibility 
criteria are consistent with the stated goals of the MQP or the public 
interest. NASDAQ believes that ADV over a three-month period is the 
proper discontinuance metric for the MQP, as the program is designed 
for less liquid products, and NASDAQ notes that during the pilot 
period, the Exchange will evaluate the efficacy of the MQP and may make 
adjustments to the MQP as needed.\161\ NASDAQ does not believe that it 
would be proper to restrict the MQP to newly

[[Page 42062]]

listed ETFs, as it believes numerous products currently exist that may 
benefit from liquidity enhancement.\162\ NASDAQ also does not believe 
the public interest would be better served if there was a time limit on 
an MQP Security's participation in the MQP, arguing that an MQP 
Security should be terminated from the program only once it has 
achieved sustained liquidity.\163\ NASDAQ further argues that continued 
participation in the MQP should be at the discretion of the ETF sponsor 
and should not be limited by the Exchange or the Commission.\164\
---------------------------------------------------------------------------

    \159\ See NASDAQ Response Letter at 18.
    \160\ See id.
    \161\ See NASDAQ Response Letter at 19.
    \162\ See id.
    \163\ See id.
    \164\ See id.
---------------------------------------------------------------------------

    A number of commenters supportive of NASDAQ's Proposal identified 
additional areas of potential concern that the MQP may raise, but went 
on to dispel such concerns as unwarranted.
    For example, one commenter notes the potential risk that insider 
information at an issuer could reach an MQP Market Maker, but concludes 
this risk is low because there is no need for communication between an 
issuer and the market maker after an MQP Security enters the MQP, and 
because the securities for inclusion in the MQP are less likely to be 
affected by such insider information risk since they are baskets of 
securities and security-specific information is less relevant.\165\
---------------------------------------------------------------------------

    \165\ See Menkveld Letter at 3.
---------------------------------------------------------------------------

    Another commenter asserts that an ETF participating in the MQP 
would generally have a substantial market quality advantage over a 
comparable product that is not eligible for or does not participate in 
the MQP; however, this commenter goes on to conclude that this should 
not be a concern as it is inconceivable that a new ETF would launch 
without the MQP from the start.\166\ This commenter also asserts that 
the discontinuance of the MQP for an MQP Security could have unintended 
consequences on fair and orderly markets unless the MQP Market Maker 
continues to trade the shares without compensation from the MQP; 
however, this commenter again concludes that this concern is 
unwarranted as the MQP Fee may be inconsequential at the point of 
discontinuance if the ETF is successful in gathering assets.\167\
---------------------------------------------------------------------------

    \166\ See ETF Consultants Letter at 7.
    \167\ See id. at 7-8.
---------------------------------------------------------------------------

    Addressing whether the voluntary nature of the MQP may have 
negative or unintended effects on the market, one commenter notes that 
allowing issuers to determine whether to enter into paid for market 
making arrangements appropriately allows each issuer to weigh the 
benefits and costs associated with the presence of market makers, and 
paid for market making contracts will only exist where benefits exceed 
the costs.\168\
---------------------------------------------------------------------------

    \168\ See Anand Letter at 1. This commenter cites the Weaver 
Study finding that firms with relatively illiquid stocks enter into 
contracts with market makers, firms with high levels of liquidity do 
not contract with market makers, and firms with very low levels of 
liquidity are also less likely to enter into contracts with market 
makers. Id.
---------------------------------------------------------------------------

5. MQP Standards
a. Generally Support
    Three commenters support the specific provisions and structure of 
the MQP, stating their view that the standards set forth in proposed 
NASDAQ Rule 5950 are sufficiently clear and well-designed.\169\ One 
commenter supports the proposed MQP Market Maker compensation framework 
for creating the right incentives, noting that because MQP Market 
Makers receive payments only when they maintain a quality market 
through quoting and when they provide actual liquidity to buyers and 
sellers through trading, the rule structure assures that there will be 
a two-sided market when an investor seeks to buy shares in an MQP 
Security and a similar two-sided market when an investor returns to the 
market to sell such shares.\170\ Similarly, another commenter applauds 
NASDAQ for basing payments not only on quote activity, but also on 
actual trade activity resulting from those quotes.\171\ One commenter 
supports limiting the scope of the MQP to ETFs, LSs and TIRs as 
proposed.\172\
---------------------------------------------------------------------------

    \169\ See Weaver Letter at 1, Knight Letter at 2, and ETF 
Consultants Letter at 1-2.
    \170\ See ETF Consultants Letter at 3.
    \171\ See NASDAQ Vanguard Letter at 3, n.7.
    \172\ See MFA Letter at 2. This commenter states that it would 
have reservations were the MQP to apply to single-name securities, 
as the commenter believes that payment by corporate issuers for 
market-making could change the market dynamics. See id.
---------------------------------------------------------------------------

b. MQP Supplemental Fee
    One commenter voices support for the MQP Supplemental Fee provision 
of the MQP, noting that permitting MQP issuers to pay the additional 
Supplemental MQP Fee at their discretion and to determine how to 
allocate such fee between quotation and trading performance is 
appropriate, as the standards set forth in the MQP may not necessarily 
be right for every product.\173\
---------------------------------------------------------------------------

    \173\ See ETF Consultants Letter at 7.
---------------------------------------------------------------------------

c. Trading Volume Threshold
    Four commenters discussed the proposed termination of the MQP for 
any MQP Security that sustains ATV of 2,000,000 shares or more for 
three consecutive months.\174\ One commenter believes that 2,000,000 
ATV is an arbitrary threshold that is no better or worse than any other 
large number, and that the number may need to be adjusted after the MQP 
has been implemented.\175\ Similarly, another commenter notes that the 
determination of the correct threshold for discontinuance of the MQP is 
an area that will require additional study, and it is not clear that a 
hard threshold will be the most efficient means of determining whether 
a security remains in the MQP.\176\ Another commenter argues that any 
specific level of trading volume or assets under management or any 
other arbitrary rule as a basis for discontinuing the MQP is 
inappropriate.\177\
---------------------------------------------------------------------------

    \174\ See generally Weaver Letter, Knight Letter, NASDAQ 
Vanguard Letter, and ETF Consultants Letter.
    \175\ See Weaver Letter at 8.
    \176\ See Knight Letter at 2.
    \177\ See ETF Consultants Letter at 7.
---------------------------------------------------------------------------

    Finally, one commenter notes that, although NASDAQ positions the 
MQP as intended to help the most illiquid ETFs, the proposed 2,000,000 
ATV threshold would permit over 90% of the ETFs in existence as of 
March 31, 2012 to enter the MQP.\178\ This commenter suggests that the 
Commission consider whether a lower trading volume threshold would be 
more consistent with the stated goals of the MQP as well as the public 
interest, or alternatively, whether MQP eligibility should be based on 
a metric other than trading volume, such as actual quotation and/or 
transaction data, or should be restricted to newly created ETFs, or 
whether a security's participation in the MQP should be limited to a 
defined period of time, such as one or two years.\179\ As discussed 
above, NASDAQ states in its response letter its belief that the 
proposed 2,000,000 ATV threshold is appropriate at this time, as the 
MQP is designed for less liquid products, and it believes the program 
should be terminated with respect to a particular product once it has 
achieved sustained liquidity.\180\ Nasdaq also states in its response 
letter that it does not believe the MQP should be restricted to newly 
issued ETFs or that a security's participation in the MQP should be 
time-limited, as it believes that not only newly listed products, but 
also many products currently existing may benefit from the program, and 
that continued

[[Page 42063]]

participation in the program should be at the discretion of the MQP 
Company and should not be time-limited.\181\
---------------------------------------------------------------------------

    \178\ See NASDAQ Vanguard Letter at 5.
    \179\ See id.
    \180\ See NASDAQ Response Letter at 19. See also supra note 161 
and accompanying text.
    \181\ See NASDAQ Response Letter at 19. See also supra notes 
162-164 and accompanying text.
---------------------------------------------------------------------------

d. Suggested Additional Disclosure
    One commenter suggests that participation in the MQP should be 
noted on the MQP Security's Web site and in regulatory disclosure 
documents.\182\
---------------------------------------------------------------------------

    \182\ See ETF Consultants Letter at 8.
---------------------------------------------------------------------------

    Another commenter suggests that a ticker symbol identifier would be 
useful for products in the MQP, as products in the MQP will generally 
have lower volatility.\183\ NASDAQ believes that ``changing the ticker 
symbol of a product in the MQP is neither necessary nor desirable,'' 
noting the transparency of the MQP and the Web site disclosure of the 
products accepted into the MQP, as well as the market makers in such 
product.\184\
---------------------------------------------------------------------------

    \183\ See Weaver Letter at 9.
    \184\ See NASDAQ Response Letter at 7-8.
---------------------------------------------------------------------------

6. Fee Payment Clarification
    One commenter believes that it is unclear in the Notice and 
proposed rule text whether the MQP Fees will be paid by ETF sponsors or 
the ETFs themselves.\185\ This commenter argues that if the ETF rather 
than the ETF sponsor is paying the MQP Fee, this would change the 
entire financial dynamic of the MQP because it would require existing 
ETF investors to pay for enhanced liquidity.\186\ In response, NASDAQ 
states that the ETF sponsors will be paying for the MQP.\187\
---------------------------------------------------------------------------

    \185\ See NASDAQ Vanguard Letter at 6.
    \186\ Id.
    \187\ See NASDAQ Response Letter at 11 and 20.
---------------------------------------------------------------------------

    Two other commenters argue that it is irrelevant whether the ETF 
sponsor or the ETF itself pays the MQP Fees, because if the sponsor is 
paying the fee, it will factor the cost into the fee structure of the 
ETF, and if the ETF is paying the fee, the sponsor will likely absorb 
the fee either by capping the expense ratio of the ETF or paying the 
fee itself.\188\
---------------------------------------------------------------------------

    \188\ See Weaver Letter at 7 and ETF Consultants Letter at 3-4.
---------------------------------------------------------------------------

7. Pilot Program
    Eight commenters support implementing the MQP on a pilot basis as 
proposed, and believe that the pilot will provide useful information to 
gauge the effectiveness of the MQP.\189\ Three commenters support the 
proposed one-year time period for the pilot.\190\
---------------------------------------------------------------------------

    \189\ See generally Weaver Letter, Menkveld Letter, Anand 
Letter, NASDAQ ICI Letter, Knight Letter, NASDAQ Vanguard Letter, 
ETF Consultants Letter, and MFA Letter.
    \190\ See Weaver Letter at 8, Menkveld Letter at 4, and ETF 
Consultants Letter at 8.
---------------------------------------------------------------------------

    Two commenters suggest improvements to the implementation of the 
pilot to allow the Commission and NASDAQ to more effectively assess the 
impact of the MQP.\191\ One of these commenters suggests that the pilot 
have a staggered introduction of MQP Securities with a randomized 
sequence, and a long enough pre-and post-event period (e.g., three 
months) for each introduction to identify an effect.\192\ In addition, 
this commenter suggests that NASDAQ provide the Commission with 
detailed reporting of all trades and quotes in all securities for a 
pre-event period and a post-event period (with MQP Market Maker trades 
and quotes flagged).\193\ NASDAQ disagrees with this commenter's 
suggestions for the pilot program, asserting that a staggered 
introduction of MQP Securities and a randomized sequence would add 
``un-needed complexity to the program, and is not necessary in light of 
the optional nature of the MQP'' and that any pre-event period would be 
``antithetical to the goal of the program to enhance liquidity of 
products as soon as possible.'' \194\ Another commenter notes that any 
``before and after'' data needed can be obtained by comparing trading 
and asset growth in existing products which move into the MQP after it 
is launched, and a period after an ETF launch without participation in 
MQP would be an unnecessary and inappropriate handicap for new 
ETFs.\195\ NASDAQ agrees with this commenter.\196\
---------------------------------------------------------------------------

    \191\ See Menkveld Letter at 4-5 and NASDAQ Vanguard Letter at 
4-5.
    \192\ See Menkveld Letter at 4.
    \193\ Id. at 4-5.
    \194\ See NASDAQ Response Letter at 9.
    \195\ See ETF Consultants Letter at 8.
    \196\ See NASDAQ Response Letter at 12.
---------------------------------------------------------------------------

    Another commenter believes NASDAQ should be required to monitor 
market quality metrics during the pilot not only for ETFs participating 
in the MQP, but also for ETFs that do not participate in the MQP, to 
determine whether the non-participating ETFs are negatively 
affected.\197\
---------------------------------------------------------------------------

    \197\ See NASDAQ Vanguard Letter at 4.
---------------------------------------------------------------------------

    One commenter suggests that NASDAQ be required to make available 
the data gathered under the pilot program to ETF sponsors participating 
in the MQP.\198\ NASDAQ states that it intends to give sponsors access 
to trading data associated with liquidity provision in their products 
such as, for example, the performance of market makers for such 
products.\199\
---------------------------------------------------------------------------

    \198\ See NASDAQ ICI Letter at 3.
    \199\ See NASDAQ Response Letter at 11.
---------------------------------------------------------------------------

    Another commenter suggests that NASDAQ disclose publicly on a 
monthly basis each MQP Market Maker's share of Quote Share Payments and 
Trade Share Payments for each MQP Security the market maker 
trades.\200\
---------------------------------------------------------------------------

    \200\ See ETF Consultants Letter at 8.
---------------------------------------------------------------------------

8. Timing
    Two commenters state that the proposal raises significant issues 
and suggest that the Commission provide additional time for the 
submission of comments,\201\ and one of these commenters specifically 
suggests additional areas in which the Commission should seek 
comment.\202\ These two commenters also note that the NYSE Arca 
Proposal raises similar issues to the MQP, and suggest that the 
Commission consider the two proposals together.\203\
---------------------------------------------------------------------------

    \201\ See NASDAQ ICI Letter at 1 and NASDAQ Vanguard Letter at 
1-2.
    \202\ See NASDAQ Vanguard Letter at 4-6; see also supra notes 
156-158 and accompanying text.
    \203\ See NASDAQ ICI Letter at 1, n.3 and NASDAQ Vanguard Letter 
at 5-6. See also infra note 247.
---------------------------------------------------------------------------

B. Comments to NYSE Arca's Proposal

    The Commission received three commenter letters on the NYSE Arca 
Proposal.\204\ One commenter generally supports the goals of the Fixed 
Incentive Program, but questions whether the program will actually 
benefit investors.\205\ Another commenter opposes the Fixed Incentive 
Program.\206\ Both of these commenters believe that NYSE Arca's 
Proposal raises additional issues that were not raised in NASDAQ's 
proposal.\207\ Another commenter supports NYSE Arca's proposal, but 
believes that the party that would be paying the Optional Incentive Fee 
(whether it be the ETP sponsor or shareholder) should be disclosed in 
the ETP's offering documents.\208\
---------------------------------------------------------------------------

    \204\ See supra notes 13 and 16.
    \205\ See NYSE Arca ICI Letter at 2.
    \206\ See NYSE Arca Vanguard Letter at 2.
    \207\ See NYSE Arca ICI Letter at 2 and NYSE Arca Vanguard 
Letter at 2.
    \208\ See USCF Letter at 3.
---------------------------------------------------------------------------

1. Generally Support Fixed Incentive Program
    Two commenters generally support the overall goal of the Fixed 
Incentive Program, and state their views that, to the extent the Fixed 
Incentive Program results in narrower spreads and more liquid markets 
for ETPs, without any associated unintended consequences for ETPs or 
the markets as a whole, the Fixed Incentive Program could prove

[[Page 42064]]

beneficial.\209\ One commenter states that the number and quality of 
firms that are both able and willing to serve as an LMM has declined 
dramatically.\210\ This commenter asserts that the current lack of LMMs 
willing to support new listings raises the concern that ETP issuers 
that also have extensive trading and money management efforts in non-
ETP markets (such as in the open-end mutual fund or institutional fund 
management markets) may use such non-ETP trading revenue to attract 
market makers and LMMs to make markets in their ETP listings, to the 
disadvantage of ETPs without such outside trading revenue.\211\ This 
commenter believes that the Fixed Incentive Program would help to 
alleviate the concerns it has about the decline in the current 
robustness of the LMM universe.\212\ Another commenter states that, 
while it supports the goals of market maker incentive programs such as 
the Fixed Income Program, it is unclear, at this time, whether such 
programs will result in overall benefits to investors.\213\
---------------------------------------------------------------------------

    \209\ See NYSE Arca ICI Letter at 2 and USCF Letter at 1-2.
    \210\ See USCF Letter at 2.
    \211\ See id.
    \212\ See id.
    \213\ See NYSE Arca ICI Letter at 2, n.6.
---------------------------------------------------------------------------

2. Opposes Fixed Incentive Program
    Another commenter opposes NYSE Arca's Proposal and argues that the 
Commission should not approve the Fixed Incentive Program until NYSE 
Arca articulates and provides support for the purported benefits to the 
markets and long-term investors that the program will provide.\214\ 
This commenter argues that issuer payments to market makers are 
prohibited, and exceptions to that prohibition should be made only if 
the rationale is compelling and the exception is narrowly tailored to 
accomplish an important public policy goal, such as providing 
demonstrable benefits to long-term investors.\215\ This commenter 
states that NYSE Arca has focused on the needs of market makers and has 
provided little evidence demonstrating how the Fixed Incentive Program 
will benefit investors.\216\ Furthermore, this commenter argues that, 
even if incentivizng market makers to serve as LMMs (as opposed to 
benefiting investors) were a sufficient objective, NYSE Arca's Proposal 
is not narrowly tailored to achieve that objective, as, according to 
the data provided by NYSE Arca in support of its proposal, more than 
90% of ETPs manage to attract and retain LMMs under the existing 
compensation arrangements.\217\
---------------------------------------------------------------------------

    \214\ See NYSE Arca Vanguard Letter at 2.
    \215\ See id.
    \216\ See id.
    \217\ See id.
---------------------------------------------------------------------------

3. Concerns Raised by NYSE Arca Proposal
    One commenter notes that NYSE's Arca's Proposal, like all market 
maker incentive programs, represents a departure from current rules 
precluding market makers from accepting payment from an issuer for 
acting as a market maker and raises conflict of interest concerns.\218\ 
In addition, this commenter asserts that some of the elements of NYSE 
Arca's Proposal could raise potential conflicts of interest between an 
LMM and an ETP issuer; specifically, certain elements of the NYSE Arca 
Proposal could provide incentives for LMMs to pressure ETP issuers to 
place every NYSE Arca-listed ETP in the Fixed Program or face the 
threat of the withdrawal of the LMM from making a market in that 
issuer's ETPs.\219\
---------------------------------------------------------------------------

    \218\ See NYSE Arca ICI Letter at 2.
    \219\ See id. at 3-4. The commenter notes, however, that 
limiting the number of ETPs from a single issuer in the Fixed 
Incentive Program would prevent incentives for LMMs to pressure ETP 
issuers to place each and every ETP listed on NYSE Arca into the 
Fixed Incentive Program. See id. at 4.
---------------------------------------------------------------------------

    Another commenter states that NYSE Arca's Proposal raises many of 
the same concerns as NASDAQ's Proposal, including: (i) Whether issuer 
payments to market makers could have the potential to distort market 
forces; (ii) failure to place a time limit on an ETP's participation in 
the Fixed Incentive Program could raise concerns; (iii) the Fixed 
Incentive Program could lead to diminished market making activity in 
ETPs that are ineligible to, or choose not to, participate in the 
program; and (iv) the NYSE Arca Proposal could create a pay-to-play 
environment, effectively forcing issuers to pay a fee to maintain 
quality markets for their eligible ETPs.\220\
---------------------------------------------------------------------------

    \220\ See NYSE Arca Vanguard Letter at 2, n.7.
---------------------------------------------------------------------------

    In addition, this commenter asserts that NYSE Arca's Proposal 
raises additional concerns beyond NASDAQ's Proposal because of NYSE 
Arca's rationale for the Fixed Incentive Program and the structure of 
the Fixed Incentive Program.\221\ For example, this commenter states 
that NYSE Arca's justification for the Fixed Incentive Program focuses 
on the needs of LMMs and provides little evidence demonstrating how the 
Fixed Incentive Program would benefit investors.\222\ In addition, to 
prevent ETP issuers from enrolling in the Fixed Incentive Program an 
ETP that already has ample trading volume and good market quality, the 
commenter believes that NYSE Arca should include objective eligibility 
criteria tied to trading volume and/or market quality, as such criteria 
would ensure that issuer payments to LMMs would be permitted only in 
situations where existing compensation arrangements are demonstrably 
insufficient to incentivize market makers to serve as LMMs.\223\ The 
commenter also asserts that, to benefit investors, the Fixed Incentive 
Program should impose materially higher minimum performance standards 
on LMMs.\224\ Finally, the commenter asserts that, in contrast to the 
NASDAQ Proposal, investors purchasing and selling shares of ETPs 
participating in the Fixed Incentive Program will not benefit unless 
(a) the ETP issuer, independent of the Fixed Incentive Program, 
requires the LMM to meet enhanced performance standards, or (b) the LMM 
maintains a higher quality market than would exist in the absence of 
the Fixed Incentive Program; the commenter argues that NYSE Arca has 
not demonstrated that either of the above outcomes will consistently 
occur.\225\
---------------------------------------------------------------------------

    \221\ See id. at 2.
    \222\ See id.
    \223\ See id. at 3.
    \224\ See id.
    \225\ See id.
---------------------------------------------------------------------------

a. Lack of Higher Performance Standards
    Two commenters voice concerns that LMMs in the Fixed Incentive 
Program do not have higher performance standards than LMMs not 
participating in the Fixed Incentive Program, and suggest that NYSE 
Arca impose higher performance standards on LMMs participating in the 
Fixed Incentive Program.\226\ One commenter argues that requiring 
heightened performance standards to receive the Optional Incentive Fee 
would address conflict of interest concerns, may provide a greater 
incentive for LMMs to make better markets in ETPs, and would make the 
overall standards of the Fixed Incentive Program more transparent to 
issuers and investors.\227\
---------------------------------------------------------------------------

    \226\ See NYSE Arca ICI Letter at 3 and NYSE Arca Vanguard 
Letter at 3.
    \227\ See NYSE Arca ICI Letter at 3.
---------------------------------------------------------------------------

b. Lack of Competition Among Market Makers
    Two commenters believe it is significant that, under the NYSE Arca 
Proposal, only one LMM would be assigned to an ETP participating in the 
Fixed Incentive Program, while under the NASDAQ Proposal, multiple 
market makers would compete to receive fees

[[Page 42065]]

from the MQP.\228\ One commenter argues that the Fixed Incentive 
Program is not competitive because all the money contributed by a 
participating ETP issuer goes to its designated LMM so long as that LMM 
meets the existing minimum standards.\229\
---------------------------------------------------------------------------

    \228\ See NYSE Arca ICI Letter at 2, n.5 and NYSE Arca Vanguard 
Letter at 3.
    \229\ See NYSE Arca Vanguard Letter at 3.
---------------------------------------------------------------------------

c. Additional Eligibility Criteria
    Two commenters are concerned that, unlike NASDAQ's Proposal, there 
are no liquidity or trading volume requirements on ETPs that may 
participate in the Fixed Incentive Program.\230\ One commenter notes 
that, as proposed, nothing prevents an ETP issuer from enrolling in the 
Fixed Incentive Program an ETP that already has ample trading volume 
and therefore robust market maker activity and good market 
quality.\231\ To address these concerns, these two commenters recommend 
that NYSE Arca limit the type of ETPs permitted into the Fixed 
Incentive Program based on trading volume.\232\ One commenter argues 
that if an ETP without an LMM has sufficient market maker activity to 
generate a consistent, fair, and orderly market, then there is no 
compelling rationale for the issuer to pay for an LMM, and such 
payments should not be permitted.\233\
---------------------------------------------------------------------------

    \230\ See NYSE Arca ICI Letter at 3 and NYSE Arca Vanguard 
Letter at 3.
    \231\ See NYSE Arca Vanguard Letter at 3. On the other hand, one 
commenter believes that the design of the NYSE Arca Proposal tends 
to provide a disincentive for an LMM to take part in the program 
when dealing with ETPs that are already actively trading and 
eliminates the concern that LMMs will be paid more for doing little 
to nothing extra. See USCF Letter at 3.
    \232\ See NYSE Arca ICI Letter at 3-4 and NYSE Arca Vanguard 
Letter at 3. One of these commenters states that other market 
quality criteria would also be acceptable. See NYSE Arca Vanguard 
Letter at 3, n.9.
    \233\ See NYSE Arca Vanguard Letter at 3, n.9.
---------------------------------------------------------------------------

4. Fixed Incentive Program Standards
    One commenter voices support for certain provisions of NYSE Arca's 
Proposal, such as the ability for issuers to choose the LMMs for their 
ETPs in the Fixed Incentive Program and the ability of issuers to 
negotiate the Optional Incentive Fee with their assigned LMM.\234\ This 
commenter asserts that, given that the NYSE Arca market structure does 
not allow for competing market makers, the choice of a specific LMM for 
an issuer may be more significant than that on other markets where 
multiple market makers exist.\235\
---------------------------------------------------------------------------

    \234\ See NYSE Arca ICI Letter at 2.
    \235\ See id. at 3.
---------------------------------------------------------------------------

    Two commenters support the proposed limit on the number of ETPs 
that an issuer may have in the Fixed Incentive Program.\236\ One of 
these commenters believes that limiting the number of ETPs from a 
single issuer in the Fixed Incentive Program will prevent any incentive 
for LMMs to pressure ETP issuers to place every ETP listed on NYSE Arca 
in the Fixed Incentive Program.\237\
---------------------------------------------------------------------------

    \236\ See NYSE Arca ICI Letter at 2 and USCF Letter at 3.
    \237\ See NYSE Arca ICI Letter at 4.
---------------------------------------------------------------------------

5. Fee Payment Clarification
    Three commenters raised the issue of which party or entity would be 
paying the Optional Incentive Fee.\238\ Two commenters believe that it 
is unclear from NYSE Arca's Proposal whether the entity paying the 
Optional Incentive Fee is the ETP sponsor or the fund itself and 
request that NYSE Arca clarify this element of the proposal.\239\ One 
of these commenters asserts that if the fund itself pays the fee, the 
amount of the fee will be incorporated in the fund's expense ratio and 
will be borne by the fund's shareholders, raising their cost of 
ownership, and it is unlikely that the amount the Fixed Incentive 
Program might save investors in the form of narrower spreads would 
offset the increase in expense ratio.\240\ This commenter further 
argues that the bulk of any savings that would result from the 
narrowing of spreads would accrue to frequent traders, while long-term 
buy-and-hold investors would see little or no savings in spread costs 
to offset the increased expense ratio.\241\ Another commenter does not 
believe that the NYSE Arca Proposal needs to specify who would be 
paying the Optional Incentive Fee, but believes the Program should be 
amended to require clear disclosure in the ETP's offering documents of 
who would be responsible for the fee payment, whether it be the ETP 
sponsor or the ETP shareholders.\242\
---------------------------------------------------------------------------

    \238\ See NYSE Arca ICI Letter at 3, n.8, NYSE Arca Vanguard 
Letter at 3-4, and USCF Letter at 3.
    \239\ See NYSE Arca ICI Letter at 3, n.8 and NYSE Arca Vanguard 
Letter at 3-4.
    \240\ See NYSE Arca Vanguard Letter at 4.
    \241\ See id.
    \242\ See USCF Letter at 3.
---------------------------------------------------------------------------

6. Pilot Program
    Two commenters support the pilot program aspect of the Fixed 
Incentive Program.\243\ One commenter believes it is important that 
NYSE Arca and the Commission have an opportunity to evaluate the impact 
of the program on the quality of markets in ETPs prior to considering 
its permanent approval, both with respect to ETPs participating in the 
program and those ETPs that choose not to participate.\244\ In 
addition, this commenter believes that statistics on the performance of 
LMMs during the pilot should be publicly disclosed, as such information 
could provide meaningful information to investors and would facilitate 
assessing how much liquidity is being provided by LMMs in the Fixed 
Incentive Program.\245\ Another commenter suggests that the Commission 
consider under what circumstances the Fixed Incentive Program should 
move forward from being a pilot program to a permanent one, 
recommending that there be a review process to ensure that the pilot 
program did not produce unintended consequences.\246\
---------------------------------------------------------------------------

    \243\ See NYSE Arca ICI Letter at 4 and USCF Letter at 3.
    \244\ See NYSE Arca ICI Letter at 4.
    \245\ See id.
    \246\ See USCF Letter at 3.
---------------------------------------------------------------------------

7. Consideration of the SRO Proposals Together
    Two commenters recommend that the Commission consider the SRO 
Proposals together as they raise many of the same issues, and generally 
raise the question of whether to permit ETP issuers to pay for market 
making services.\247\
---------------------------------------------------------------------------

    \247\ See NYSE Arca Vanguard Letter at 2 and NYSE Arca ICI 
Letter at 2, n.6.
---------------------------------------------------------------------------

IV. Proceedings To Determine Whether To Approve or Disapprove SR-
NASDAQ-2012-043 and SR-NYSEArca-2012-37 and Grounds for Disapproval 
Under Consideration

    The Commission is instituting proceedings pursuant to Section 
19(b)(2)(B) of the Act to determine whether the SRO Proposals should be 
approved or disapproved. Institution of such proceedings is appropriate 
at this time in view of the significant legal and policy issues raised 
by the SRO Proposals that are discussed below. The institution of 
proceedings does not indicate that the Commission has reached any 
conclusions with respect to any of the issues involved. Rather, as 
described in greater detail below, the Commission seeks and encourages 
interested persons to provide additional comment on the SRO Proposals.
    Pursuant to Section 19(b)(2)(B), the Commission is providing notice 
of the grounds for disapproval under consideration. In particular, 
Section 6(b)(4) of the Act \248\ requires that the rules of a national 
securities exchange provide for the equitable allocation of reasonable 
dues, fees and other charges among its members and issuers and

[[Page 42066]]

other persons using its facilities, and Section 6(b)(5) of the Act 
\249\ 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 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.
---------------------------------------------------------------------------

    \248\ 15 U.S.C. 78f(b)(4).
    \249\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    Two commenters stressed the need to consider the SRO Proposals 
together because they raise similar issues relating to payment for 
market making programs,\250\ and urged the Commission to provide 
additional time for the public to consider the SRO Proposals and to 
submit comments.\251\ In addition, several commenters expressed 
concerns with payment for market making programs generally and with 
certain details of the SRO Proposals.\252\ Moreover, certain commenters 
expressed concerns with the structure of the pilot programs for the SRO 
Proposals, and whether the information to be provided by the Exchanges 
to the Commission would allow the Commission to meaningfully assess the 
impact of the Programs.\253\ One commenter noted its belief that the 
NASDAQ Proposal was not consistent with the Exchange Act.\254\ On the 
other hand, several commenters expressed support for the SRO Proposals 
designed to incentivize market makers to make quality and/or 
consistent, fair, and orderly markets in certain ETPs.\255\
---------------------------------------------------------------------------

    \250\ See supra notes 203 and 247 and accompanying text.
    \251\ See supra notes 201-202 and accompanying text.
    \252\ See supra notes 130-141, 156-168, and 214-233 and 
accompanying text.
    \253\ See supra notes 191-197 and accompanying text.
    \254\ See supra note 136.
    \255\ See supra notes 107-129, 169-172, 209-213, and 235-237 and 
accompanying text.
---------------------------------------------------------------------------

    The SRO Proposals would allow issuers of certain ETPs to pay an 
additional fee to a national securities exchange, which fee (or a large 
portion thereof) would in turn be paid to one or more market makers for 
making markets in such security. As proposed, any payments made by 
issuers pursuant to the SRO Proposals would appear to violate FINRA 
Rule 5250.\256\ In addition, absent exemptive relief, any payments made 
by issuers pursuant to the SRO Proposals would violate Rule 102 under 
Regulation M.\257\ Furthermore, the SRO Proposals raise issues under 
Section 11(d)(1) of the Act \258\ and Rule 12b-1 \259\ under the 
Investment Company Act of 1940 (``1940 Act'').
---------------------------------------------------------------------------

    \256\ See NASDAQ Notice, supra note 4, at 22043 (stating 
NASDAQ's belief that FINRA intends to file an immediately effective 
rule change exempting exchange programs approved by the Commission 
from FINRA Rule 5250) and NYSE Arca Notice, supra note 12, at 29420-
21 (stating NYSE Arca's belief that FINRA would be filing an 
immediately effective rule change indicating that participation by 
LMMs and issuers in the Fixed Incentive Program would not be 
prohibited by FINRA Rule 5250).
     FINRA Rule 5250 states, in relevant part, that ``[n]o member or 
person associated with a member shall accept any payment or other 
consideration, directly or indirectly, from an issuer of a security, 
or any affiliate or promoter thereof, for publishing a quotation, 
acting as a market maker in a security, or submitting an application 
in connection therewith.'' FINRA Rule 5250 was implemented, in part, 
to address concerns about issuers paying market makers to improperly 
influence the price of an issuer's stock. See NASD Rule 2460 
Approval Order, supra note 67, at 37107 (noting that the rule 
preserves the integrity of the marketplace by ensuring that 
quotations accurately reflect a broker-dealer's interest in buying 
or selling a security and that the decision by a firm to make a 
market in a given security and the question of price should not be 
influenced by payments to the member from issuers or promoters; if 
payments to broker-dealers by promoters and issuers were permitted, 
investors would not be able to ascertain which quotations in the 
marketplace are based on actual interest and which quotations are 
supported by issuers or promoters).
    \257\ 17 CFR 242.102.
    \258\ 15 U.S.C. 78k(d)(1).
    \259\ 17 CFT 270.12b-1.
---------------------------------------------------------------------------

    Regulation M. Because pricing integrity is essential during the 
offering process, the Commission proscribes certain activity in 
connection with distributions.\260\ Specifically, Rule 102 of 
Regulation M prohibits, in connection with a distribution of 
securities, issuers, selling security holders, and their affiliated 
purchasers from directly or indirectly bidding for, purchasing, or 
attempting to induce others to bid for or purchase covered securities--
including the security that is the subject of the distribution--during 
the applicable restricted period.\261\ The purpose of this prohibition 
is to ``prevent those persons participating in a distribution of 
securities * * * from artificially conditioning the market for the 
securities in order to facilitate the distribution'' as well as ``to 
protect the integrity of the securities trading market as an 
independent pricing mechanism.'' \262\ As the Commission has stated, 
attempts to induce bids or purchases of covered securities outside of 
the distribution raise substantial concerns about whether they would 
fundamentally interfere with the independence of the market dynamics 
that are essential to the ability of investors to evaluate the terms on 
which securities are offered.\263\
---------------------------------------------------------------------------

    \260\ See Securities Exchange Act Release No. 50831 (Dec. 9, 
2004), 69 FR 75774 (Dec. 17, 2004).
    \261\ 17 CFR 242.102.
    \262\ See Securities Exchange Act Release No. 33924 (Apr. 19, 
1994), 59 FR 21681 (Apr. 26, 1994).
    \263\ See Commission Guidance Regarding Prohibited Conduct in 
Connection with IPO Allocations, Securities Exchange Act Release No. 
51500 (April 7, 2005), 70 FR 19672, 19673 (April 13, 2005).
---------------------------------------------------------------------------

    The Commission believes that issuer payments made under the SRO 
Proposals would constitute an indirect attempt by the issuer \264\ of a 
covered security to induce a purchase or bid in a covered security 
during a restricted period in violation of Rule 102.\265\ Under the 
NASDAQ Proposal, the issuer payments would ``be used for the purpose of 
incentivizing one or more Market Makers in the MQP Security,'' \266\ 
which could induce bids or purchases for the issuer's security during a 
restricted period. Under the NYSE Arca Proposal, the purpose of the 
Program is ``to create a Fixed Incentive Program for issuers of certain 
ETPs listed'' on NYSE Arca,\267\ which likewise could induce bids or 
purchases for the issuer's security during a restricted period.
---------------------------------------------------------------------------

    \264\ Payments to the participating market makers under the NYSE 
Arca Proposal would be made by the issuer (via NYSE Arca), but under 
the NASDAQ Proposal, they would be made by the MQP Company (via 
NASDAQ). ``MQP Company'' is defined as the ``fund sponsor or other 
entity that lists one or more MQP Securities on NASDAQ.'' See 
proposed NASDAQ Rule 5950(e)(7). For exchange traded notes and trust 
issued receipts, the sponsor and issuer are the same entity. For 
exchange traded funds, the payments are for the benefit of the 
issuer (the fund). The Commission would view all of these payments 
as constituting an indirect attempt by the issuer to induce a 
purchase or bid.
    \265\ As the securities participating in the SRO Proposals are 
ETPs that are in continuous distribution, these securities are 
always in a restricted period under Rule 102.
    \266\ Preamble to proposed NASDAQ Rule 5950. See also NASDAQ 
Notice, supra note 4, at 22043.
    \267\ See NYSE Arca Notice, supra note 12, at 29419.
---------------------------------------------------------------------------

    As a result, participation in the Programs by an MQP Company, in 
the case of the NASDAQ Proposal, or issuer that is an ETP, in the case 
of the NYSE Arca Proposal, would violate Rule 102, absent exemptive 
relief.\268\ While the Commission or staff has granted relief from Rule 
102 to a number of ETPs,\269\

[[Page 42067]]

this relief is designed to permit the ordinary operations (i.e., 
redemptions of ETP securities) of the ETP. Participation in the SRO 
Programs is not necessary for the operation of the ETP in the same way 
that redemptions are necessary. Moreover, commenters raised concerns 
that the proposed issuers' payments to market makers have the potential 
to distort market forces, impact pricing integrity, and prevent 
investors from distinguishing quotations that reflect true market 
forces from quotations that have been influenced by issuer payments, 
and that the proposed safeguards of the Programs may not be sufficient 
to overcome such distortions.\270\ Regulation M, among other things, is 
intended to assure that distributions of securities are free of the 
market effects of bids, purchases, and inducements to purchase by those 
who have an interest in the success of a distribution. Thus, the 
Commission would need to consider whether it would be appropriate to 
grant exemptive relief in these circumstances, including whether there 
would be any alternative means to address these concerns, which could 
be established through conditions to any exemptive relief.
---------------------------------------------------------------------------

    \268\ The exception in Rule 102 for the redeemable securities of 
open-end investment companies is not available for ETFs such as 
those participating in the Programs. See 17 CFR 242.102(d)(4). This 
is because while ETFs operate under exemptions from the definitions 
of ``open-end company'' under Section 5(a)(1) of the 1940 Act and 
``redeemable security'' under Section 2(a)(32) of the 1940 Act, 
neither they nor the securities that they issue meet those 
definitions.
    \269\ See, e.g., Letter from James A. Brigagliano, Acting 
Associate Director, Division of Market Regulation, to Stuart M. 
Strauss, Esq., Clifford Chance US LLP (Oct. 24, 2006) (regarding 
class relief for exchange traded index funds).
    \270\ See IR Letter at 2 (``Incentivized trading obfuscates true 
supply and demand by creating volume where no natural buyers or 
sellers exist'') and NASDAQ Vanguard Letter at 3 (noting that ``it 
is not clear whether [the proposed] safeguards will be sufficient to 
overcome the presumption'' that issuer payments to market makers 
have the potential to distort the market and create conflicts of 
interest that corrupt the integrity of the marketplace). See also 
Choi Letter at 1 (stating that the MQP program ``will make the 
markets even more distorted and tilted to those who create an unfair 
marketplace'').
---------------------------------------------------------------------------

    Rule 12b-1. The Commission notes that MQP Securities (in the case 
of the NASDAQ Proposal) and ETPs (in the case of the NYSE Arca 
Proposal) that operate as ETFs registered under the 1940 Act are 
prohibited from paying for distribution of their shares, unless such 
payments are made pursuant to a plan that meets the requirements of 
Rule 12b-1 under the 1940 Act. An ETF's board of directors should 
therefore initially (and periodically thereafter) evaluate the purpose 
and effect of MQP Fees/Optional Incentive Fees (as applicable) proposed 
to be made by an ETF to determine that such payments would be in 
compliance with that provision. In addition, the ETF's board should 
consider initially (and periodically thereafter) whether such fees to 
be paid by an ETF's investment adviser or other affiliate would be an 
indirect use of fund assets for distribution in assessing the 
appropriateness of advisory or other fees paid by the ETF to such 
persons.\271\
---------------------------------------------------------------------------

    \271\ See Payment of Asset-Based Sales Loads by Registered Open-
End Management Investment Companies, Investment Company Act Release 
No. 16431 (June 13, 1988) at n.123 and accompanying text.
---------------------------------------------------------------------------

    In the NASDAQ Response Letter, NASDAQ noted its belief that Rule 
12b-1 is not implicated by payments made pursuant to the MQP because 
the MQP payments are being made by ETF sponsors, rather than the ETFs 
themselves.\272\ The Commission notes that the prohibition in Rule 12b-
1 applies to both direct and indirect payments made by ETFs registered 
under the 1940 Act.
---------------------------------------------------------------------------

    \272\ See NASDAQ Response Letter at 20.
---------------------------------------------------------------------------

    Section 11(d)(1). Section 11(d)(1) of the Exchange Act \273\ 
generally prohibits a broker-dealer from extending or maintaining 
credit, or arranging for the extension or maintenance of credit, on 
shares of new issue securities, if the broker-dealer participated in 
the distribution of the new issue securities within the preceding 30 
days. The Commission's view is that shares of open-end investment 
companies and unit investment trusts registered under the 1940 Act, 
such as ETF shares, are distributed in a continuous manner, and broker-
dealers that sell such securities are therefore participating in the 
``distribution'' of a new issue for purposes of Section 11(d)(1).\274\
---------------------------------------------------------------------------

    \273\ 15 U.S.C. 78k(d)(1).
    \274\ See Exchange Act Release Nos. 6726 (Feb. 8, 1962), 27 FR 
1415 (Feb. 15, 1962) and 21577 (Dec. 18, 1984), 49 FR 50174 (Dec. 
27, 1984).
---------------------------------------------------------------------------

    The Commission, acting under delegated authority, granted an 
exemption from Section 11(d)(1) and Rule 11d1-2 thereunder for broker-
dealers that have entered into an agreement with an ETF's distributor 
to place orders with the distributor to purchase or redeem the ETF's 
shares (``Broker-Dealer APs).\275\ The SIA Exemption allows a Broker-
Dealer AP to extend or maintain credit, or arrange for the extension or 
maintenance of credit, to or for customers on the shares of qualifying 
ETFs subject to the condition that neither the Broker-Dealer AP, nor 
any natural person associated with the Broker-Dealer AP, directly or 
indirectly (including through any affiliate of such Broker-Dealer AP), 
receives from the fund complex any payment, compensation or other 
economic incentive to promote or sell the shares of the ETF to persons 
outside the fund complex, other than non-cash compensation permitted 
under NASD Rule 2830(l)(5)(A), (B), or (C). This condition is intended 
to eliminate special incentives that Broker-Dealer APs and their 
associated persons might otherwise have to ``push'' ETF shares.
---------------------------------------------------------------------------

    \275\ See Letter from Catherine McGuire, Chief Counsel, Division 
of Trading and Markets, Securities and Exchange Commission to 
Securities Industry Association (November 21, 2005) (``SIA 
Exemption'').
---------------------------------------------------------------------------

    The SRO Proposals would permit certain issuers, including ETFs, to 
voluntarily pay increased listing fees to the Exchanges. In turn, the 
Exchanges would use the fees to pay market makers incentives to improve 
the liquidity of participating issuers' securities, and thus enhance 
the market quality for the participating issuers. Incentives would be 
accrued for, among other things, executing purchases and sales on the 
Exchanges. Receipt of the incentive payments by certain broker-dealers 
would implicate the condition of the SIA Exemption from the new issue 
lending restriction in Section 11(d)(1) of the Exchange Act discussed 
above.
    The Commission's view is that the incentives market makers would 
receive under the SRO Proposals are indirect payments from the fund 
complex to the market maker and that those payments are compensation to 
promote or sell the shares of the ETF. If the SRO Proposals were 
approved, a market maker that also is a Broker-Dealer AP for an ETF (or 
an associated person or an affiliate of a Broker-Dealer AP) that 
receives the incentives would not be able to rely on the SIA Exemption 
from Section 11(d)(1). This does not mean that Broker-Dealer APs could 
not participate in the SRO Proposals, if they were approved; it merely 
means they could not rely on the SIA Exemption while doing so. Thus, 
Broker-Dealer APs that participate in the SRO Proposals would need to 
comply with Section 11(d)(1) unless there is another applicable 
exemption.
    In light of the comments received and the importance of the policy 
issues raised by the SRO Proposals, the Commission is seeking further 
comment on various aspects of the Programs to help the Commission 
evaluate whether the SRO Proposals are consistent with the requirements 
of Sections 6(b)(4) and 6(b)(5) of the Act, including whether the 
proposed Programs provide for the equitable allocation of reasonable 
dues, fees and other charges among members and issuers, and whether the 
Programs are designed to prevent fraudulent and manipulative acts and 
practices, would protect investors and the public interest, and not be 
designed to permit unfair discrimination between issuers, brokers or 
dealers.
    Based on comments received on the SRO Proposals, and in light of 
the fact that the proposed Programs raise similar issues, the 
Commission is issuing this

[[Page 42068]]

joint order to institute proceedings on both of the SRO Proposals. The 
Commission believes that instituting proceedings on both filings 
jointly through this order will facilitate the Commission's ability to 
solicit comment on the issues that are common to both SRO Proposals. 
Nevertheless, the Commission will assess each SRO Proposal separately 
for consistency with the requirements of the Exchange Act and the rules 
and regulations thereunder.

V. Procedure: Request for Written Comments

    The Commission requests that interested persons provide written 
submissions of their views, data, and arguments with respect to the 
issues identified above, as well as any others they may have identified 
with the SRO Proposals. In particular, the Commission invites the 
written views of interested persons concerning whether the SRO 
Proposals are consistent with Sections 6(b)(4), 6(b)(5), or any other 
provision of the Act, or the rules and regulations thereunder. Although 
there do not appear to be any issues relevant to approval or 
disapproval which would be facilitated by an oral presentation of 
views, data, and arguments, the Commission will consider, pursuant to 
Rule 19b-4, any request for an opportunity to make an oral 
presentation.\276\
---------------------------------------------------------------------------

    \276\ Section 19(b)(2) of the Act, as amended by the Securities 
Act Amendments of 1975, Pub. L. 94-29 (June 4, 1975), grants the 
Commission flexibility to determine what type of proceeding--either 
oral or notice and opportunity for written comments--is appropriate 
for consideration of a particular proposal by a self-regulatory 
organization. See Securities Act Amendments of 1975, Senate Comm. on 
Banking, Housing & Urban Affairs, S. Rep. No. 75, 94th Cong., 1st 
Sess. 30 (1975).
---------------------------------------------------------------------------

    Interested persons are invited to submit written data, views and 
arguments regarding whether the SRO Proposals should be approved or 
disapproved by August 16, 2012. Any person who wishes to file a 
rebuttal to any other person's submission must file that rebuttal by 
August 31, 2012.
    The Commission is asking that commenters address the merit of the 
statements of each Exchange in support of its respective proposed 
Program and the statements of commenters in response to the SRO 
Proposals, in addition to any other comments they may wish to submit 
about the SRO Proposals. Specifically, the Commission requests comment 
on the following aspects of the SRO Proposals:
    1. FINRA Rule 5250 (formerly NASD Rule 2460) is designed to 
preserve ``the integrity of the marketplace by ensuring that quotations 
accurately reflect a broker-dealer's interest in buying or selling a 
security.'' \277\ Specifically, in the NASD Rule 2460 Approval Order, 
the Commission found that the ``decision by a firm to make a market in 
a given security and the question of price generally are dependent on a 
number of factors, including, among others, supply and demand, the 
firm's expectations toward the market, its current inventory position, 
and exposure to risk and competition. This decision should not be 
influenced by payments to the member from issuers or promoters. Public 
investors expect broker-dealers' quotations to be based on the factors 
described above. If payments to broker-dealers by promoters and issuers 
were permitted, investors would not be able to ascertain which 
quotations in the marketplace are based on actual interest and which 
quotations are supported by issuers or promoters. This structure would 
harm investor confidence in the overall integrity of the marketplace.'' 
\278\ The Commission also added that ``such payments may be viewed as a 
conflict of interest since they may influence the member's decision as 
to whether to quote or make a market in a security and, thereafter, the 
prices that the member would quote.'' \279\
---------------------------------------------------------------------------

    \277\ See NASD Rule 2460 Approval Order, supra note 67, at 
37107.
    \278\ See id.
    \279\ See id. at 37106.
---------------------------------------------------------------------------

    Several commenters have raised concerns that issuer payments such 
as those proposed in the Programs could have the potential to distort 
the market and create conflicts of interest that could corrupt the 
integrity of the marketplace in violation of FINRA Rule 5250 and are 
not consistent with the Exchange Act.\280\ Other commenters, and 
NASDAQ, believe that the NASDAQ Proposal addresses the concerns that 
FINRA Rule 5250 was designed to address.\281\
---------------------------------------------------------------------------

    \280\ See supra note 132 and 136 and accompanying text.
    \281\ See supra notes 143-155 and accompanying text.
---------------------------------------------------------------------------

    Given the rationale behind FINRA Rule 5250, what are commenters' 
views on whether each Program addresses (or does not address) the 
concerns that FINRA Rule 5250 was designed to mitigate, and why or why 
not? If commenters are of the view that a Program does not address the 
concerns that FINRA Rule 5250 was designed to mitigate, what specific 
safeguards, if any, could be imposed to address these concerns? Are 
there aspects of the Programs or features of the ETPs that would be 
included in the Programs that would support their exclusion from the 
general coverage of the Rule? If so, what are they, and why?
    2. The studies cited by NASDAQ in the NASDAQ Notice and by 
commenters supportive of the NASDAQ Proposal examined programs 
applicable to equity securities of operating companies and not to other 
classes of securities, such as ETPs. Are there any studies that have 
observed paid for market making programs specifically relating to ETPs? 
Are there unique features of ETPs that would make market maker programs 
in ETPs similar to the Programs fundamentally different than market 
maker programs in other securities such that results of studies focused 
on other securities cannot be applied to similar programs for ETPs?
    3. The studies cited by NASDAQ in the NASDAQ Notice and by 
commenters supportive of the NASDAQ Proposal looked at the market 
quality characteristics of equity securities of operating companies 
under certain market making programs, but did not provide a comparison 
to the market quality of those same securities before participating in 
such programs. Are there any studies that have compared the market 
qualities of securities before and during their participation in such a 
program? How important is this distinction? Are there any studies that 
have compared the market qualities of securities that did not 
participate in such a program to the market qualities of similar 
securities that participated in the same program? Are there any studies 
that have compared the market qualities of securities during and after 
their participation in such a program?
    4. NASDAQ believes that the MQP will be beneficial to the financial 
markets, to market participants, and to the economy, in general. 
Specifically, NASDAQ believes that the MQP will, among other things, 
lower transaction costs and enhance liquidity in both ETPs and their 
components, making those securities more attractive to a broader range 
of investors, and in so doing, the MQP will help companies access 
capital to invest and grow. Do commenters agree with NASDAQ's argument 
that the MQP will enhance liquidity in both the ETP shares and the 
component companies comprising the underlying index or portfolio? If 
so, why? If not, why not? Do commenters agree with NASDAQ's assertion 
that the MQP will ultimately help ETP component companies to gain 
enhanced access to capital? If so, why? If not, why not? Please answer 
with specificity.
    5. NASDAQ states that one of the goals of the MQP is to enhance 
liquidity

[[Page 42069]]

in both ETFs and their components.\282\ NASDAQ further states that 
there is a ``vital need for the MQP in the U.S. market for products 
facing liquidity challenges.'' \283\ Are there specific examples of 
ETPs that would be, or whose underlying components would be, considered 
less liquid (and perhaps examples of ETPs that have failed in the past) 
that commenters consider would benefit from inclusion in the MQP?
---------------------------------------------------------------------------

    \282\ See NASDAQ Response Letter at 2.
    \283\ See NASDAQ Response Letter at 1.
---------------------------------------------------------------------------

    6. NASDAQ states that the MQP is intended to help ``less actively 
traded'' and ``less well known'' ETFs. As such, NASDAQ proposes to 
terminate the MQP for an MQP Security that sustains an average ATV of 
2,000,000 shares or more for 3 consecutive months. One commenter 
believes that 2,000,000 ATV is an arbitrary threshold that is no better 
or worse than any other large number, and that the number may need to 
be adjusted after the MQP has been implemented.\284\ Similarly, another 
commenter asserts that the determination of the correct threshold for 
discontinuance of the MQP is an area that will require additional 
study, and it is not clear that a hard threshold will be the most 
efficient means of determining whether a security remains in the 
MQP.\285\ Another commenter argues that any specific level of trading 
volume or assets under management or any other arbitrary rule as a 
basis for discontinuing the MQP is inappropriate.\286\ Finally, one 
commenter notes that, although NASDAQ states that the MQP is intended 
to help the most illiquid ETFs, the proposed 2,000,000 ATV threshold 
would permit over 90% of the ETFs in existence as of March 31, 2012 to 
enter the MQP.\287\ This commenter suggests that the Commission 
consider whether a lower trading volume threshold would be more 
consistent with the stated goals of the MQP as well as the public 
interest, or alternatively, whether MQP eligibility should be based on 
a metric other than trading volume, such as actual quotation and/or 
transaction data, or should be restricted to newly created ETFs, or 
whether a security's participation in the MQP should be limited to a 
defined period of time, such as one or two years.\288\
---------------------------------------------------------------------------

    \284\ See Weaver Letter at 8.
    \285\ See Knight Letter at 2.
    \286\ See ETF Consultants Letter at 7.
    \287\ See NASDAQ Vanguard Letter at 5.
    \288\ See id.
---------------------------------------------------------------------------

    With respect to the NASDAQ Proposal, do commenters believe that a 
lower or higher trading volume threshold would be more consistent with 
the stated goals of the MQP as well as the public interest? Please 
explain. Do commenters believe that MQP applicability should be based 
on a metric other than trading volume, such as actual quotation and/or 
transaction data or another metric? Why or why not? If so, what 
metric(s) would commenters suggest and why? In the alternative, should 
ETPs be ineligible for the MQP only when the trading volume (or another 
measure of trading) is consistently over some reasonable level for a 
longer period of time (e.g., 3-6 months) rather than when the ETP 
crosses the 2,000,000 ATV threshold for 3 consecutive months, as 
proposed? Why or why not? Should the MQP be restricted to newly listed 
ETPs? Under a Program that would terminate using a specified threshold 
for a particular ETP, would ETPs just above the threshold (and thus are 
ineligible or no longer able to participate in the Program) suffer as a 
result?
    7. Two commenters state that, unlike NASDAQ's Proposal, there are 
no liquidity or trading volume requirements on ETPs that may 
participate in the Fixed Incentive Program.\289\ One commenter notes 
that, as proposed, nothing prevents an ETP issuer from enrolling in the 
Fixed Incentive Program an ETP that already has ample trading volume 
and therefore robust market maker activity and good market 
quality.\290\ To address these concerns, both commenters recommend that 
NYSE Arca limit the type of ETPs permitted into the Fixed Incentive 
Program based on trading volume.\291\ One commenter argues that if an 
ETP without an LMM has sufficient market maker activity to generate a 
consistent, fair, and orderly market, then there is no compelling 
rationale for the issuer to pay for an LMM, and such payments should 
not be permitted.\292\ Do commenters agree or disagree with these 
comments? Why or why not? Specifically, should NYSE Arca adopt 
liquidity or other market quality requirements for ETPs that may 
participate in the Fixed Incentive Program? Would this help to 
alleviate the concerns voiced by commenters over the NYSE Arca 
Proposal? Why or why not?
---------------------------------------------------------------------------

    \289\ See NYSE Arca ICI Letter at 3 and NYSE Arca Vanguard 
Letter at 3.
    \290\ See NYSE Arca Vanguard Letter at 3.
    \291\ See NYSE Arca ICI Letter at 3 and NYSE Arca Vanguard 
Letter at 3. One of these commenters states that other market 
quality criteria would also be acceptable. See NYSE Arca Vanguard 
Letter at 3, n.9.
    \292\ See NYSE Arca Vanguard Letter at 3, n.9.
---------------------------------------------------------------------------

    8. One commenter expressed the view that the Programs represent a 
subsidization of ETPs that, on their own, are unable to generate much 
trading volume.\293\ Do commenters agree with this view? Why or why 
not? If commenters agree, what are their views on whether such ETPs 
should be included within the Program or be ``allowed to fail'' (or 
simply to trade at a wider spread) rather than artificially propped up 
by the Programs, as one commenter suggests? \294\ Furthermore, should 
such ETPs be allowed to continue in the Programs indefinitely? Why or 
why not? Would the public interest and the protection of investors be 
better served if there was a time limit on participation in the 
Programs? Why or why not?
---------------------------------------------------------------------------

    \293\ See NASDAQ Vanguard Letter at 5.
    \294\ See IR Letter at 2.
---------------------------------------------------------------------------

    9. Under either of the SRO Proposals, issuers would have the 
discretion to exit the respective Program with respect to a particular 
ETP (subject to the requirements outlined in the respective SRO 
Proposals). Please provide comment on how, if at all, the liquidity or 
other market quality characteristics of an ETP participating in a 
Program may or may not be affected once the ETP is no longer in such 
Program. For example, if the issuer of the ETP ceases making payments 
under a Program, could removal of that ETP from a Program lead to 
unexpected illiquidity and/or trading disruptions for the ETP? Why or 
why not? If an ETP is removed from a Program, could such removal impact 
the spreads in the ETP? If so, why? If not, why not? If commenters 
believe that there may be a potential impact on market quality 
characteristics, do commenters believe that investors should be 
provided disclosure of potential impacts? If so, what type of 
disclosure would be effective, and why?
    10. If commenters believe that removal of an ETP from a Program 
would impact market quality characteristics of the ETP, what are the 
implications, if any, for investors? For example, how might removal 
impact an investor's ability to buy or sell shares of the ETP during or 
after removal from the Program? If commenters believe that removal of 
an ETP from a Program could potentially negatively impact liquidity, 
are there other potential solutions to address this concern? For 
example, should the ETP sponsor allow all investors (including retail 
investors) to redeem their shares of the fund if the ETP exits the 
program?
    11. Under either of the SRO Proposals, issuers and market makers 
would have discretion to choose to enter into the respective Program. 
One commenter questions whether

[[Page 42070]]

competitive forces will essentially render the MQP compulsory, forcing 
ETPs into a ``pay-to-play'' environment where new ETPs must pay for it 
to launch and existing ETPs must pay to maintain quality markets.\295\ 
This commenter raises a similar concern for the Fixed Incentive 
Program.\296\ Do commenters agree with this concern? Why or why not? If 
so, should the Commission be concerned with this outcome? Why or why 
not? How might ETPs that do not participate in a Program (even if they 
qualify for participation), for whatever reason, be affected by the 
Programs, if at all? For example, will market makers gravitate to the 
ETPs that participate and avoid those that do not participate, 
potentially rendering non-participating ETPs as funds with diminished 
market making activity? Under this scenario, even if the Programs have 
the desired effect of enhancing market quality for participating ETPs, 
might they have the unintended effect of diminishing market quality 
(widening spreads and limiting book depth) in non-participating ETPs? 
Why or why not? Or, could the Programs result in an unintended 
consequence of creating an over-supply of overall market maker services 
as a result?
---------------------------------------------------------------------------

    \295\ See NASDAQ Vanguard Letter at 4.
    \296\ See NYSE Arca Vanguard Letter at 2, n.7.
---------------------------------------------------------------------------

    12. More generally, is it possible for either Program to result in 
a prisoner's dilemma equilibrium, in which all eligible ETPs 
participate in the program and achieve limited benefits while paying 
higher fees? If so, how could the Programs be designed to prevent such 
an equilibrium? If not, why not? Are there other potential equilibria 
that these Programs should avoid and how could they be designed to 
avoid them? For example, would limiting the number of participating 
ETPs per fund sponsor, as proposed under the NYSE Arca Proposal, 
prevent the possibility of market makers pressuring ETP issuers to 
place every single listed ETP into the Program?
    13. Two commenters voice concerns that LMMs in the Fixed Incentive 
Program would not have higher performance standards than LMMs not 
participating in the Fixed Incentive Program, and suggest that NYSE 
Arca impose higher performance standards on LMMs participating in the 
Fixed Incentive Program.\297\ One commenter argues that requiring 
heightened performance standards to receive the Optional Incentive Fee 
would address conflict of interest concerns, may provide a greater 
incentive for LMMs to make better markets in ETPs, and would make the 
overall standards of the Fixed Incentive Program more transparent to 
issuers and investors.\298\ Do commenters agree or disagree with this 
comment? Why or why not? Specifically, should NYSE Arca adopt higher 
performance standards for LLMs in the Fixed Incentive Program? Would 
this help to alleviate the concerns voiced by commenters over the NYSE 
Arca Proposal? Why or why not?
---------------------------------------------------------------------------

    \297\ See NYSE Arca ICI Letter at 3 and NYSE Arca Vanguard 
Letter at 3.
    \298\ See NYSE Arca ICI Letter at 3.
---------------------------------------------------------------------------

    14. Under the NASDAQ Proposal, multiple market makers may compete 
for incentive payments under the MQP with respect to an MQP Security. 
Under the NYSE Arca Proposal, a single market maker (LMM) would be able 
to receive incentive payments under the Fixed Income Program with 
respect to a security in the program. How, if at all, would having 
multiple Market Makers competing for payments under NASDAQ's MQP impact 
the potential benefits of its program? How, if at all, would having 
only one Market Maker be eligible to receive payments under the NYSE 
Arca's Fixed Incentive Program impact the potential benefits of its 
program?
    15. Under the NASDAQ Proposal, an MQP Company that wants to 
participate in the MQP must submit an application in the form 
prescribed by NASDAQ, which may limit the number of MQP Securities that 
such MQP Company may list in the MQP based on factors relating to 
current and expected liquidity characteristics of the MQP Securities, 
the projected initial and continued market quality needs of the MQP 
Securities, and the trading characteristics of the MQP Securities 
(e.g., quoting, trading, and volume).\299\ In addition, for an MQP 
Company to be eligible to participate in the MQP, NASDAQ must have 
accepted the MQP Company's application in respect of an MQP Security, 
the MQP Security must meet all requirements to be listed on NASDAQ, and 
the MQP Security must meet all NASDAQ requirements for continued 
listing at all times the MQP Security participates in the MQP.\300\ 
Under the NYSE Arca Proposal, an issuer that wants to have an ETP 
participate in the Fixed Incentive Program must submit a written 
application in a form prescribed by NYSE Arca, provided that an issuer 
may not have more than 5 existing ETPs that are listed on NYSE Arca 
prior to the pilot participate in the Fixed Incentive Program.\301\ In 
addition, to be eligible to participate, an issuer must be current in 
all payments due to NYSE Arca if it has other securities listed on NYSE 
Arca and must be current in all payments due to NYSE Arca and compliant 
with continued listing standards for the ETP proposed for inclusion if 
the issuer elects to participate in the Fixed Incentive Program after 
listing such ETP on NYSE Arca.\302\ With respect to each proposal, do 
commenters agree that the applicable criteria defining participation 
eligibility for the ETPs are sufficiently objective and clear? If not, 
do the criteria raise concerns? If so, why, and if not, why not? Should 
the Programs establish additional criteria for participation for ETPs, 
other than those that are proposed? If so, what criteria do commenters 
suggest, and why?
---------------------------------------------------------------------------

    \299\ See proposed NASDAQ Rule 5950(a)(1)(A) and (B).
    \300\ See proposed NASDAQ Rule 5950(b)(1).
    \301\ See proposed NYSE Arca Equities Rule 8.800(b)(1).
    \302\ See proposed NYSE Arca Equities Rule 8.800(b)(2).
---------------------------------------------------------------------------

    16. Under the NASDAQ Proposal, the MQP Company would be paying the 
MQP Fee. The term ``MQP Company'' is defined as ``a fund sponsor or 
other entity that lists one or more MQP Securities on NASDAQ pursuant 
to the MQP.'' \303\ NASDAQ has indicated in the NASDAQ Response Letter 
that the entity paying the MQP Fee would be the ETF sponsor, rather 
than the ETF itself.\304\ Under the NASDAQ Proposal, ETFs, TIRS and LSs 
could all qualify to be MQP Securities. Thus, while NASDAQ indicates 
that only ETF sponsors would be paying the MQP Fee, this only relates 
to ETFs, and does not apply to the TIRs and LSs, which may not have 
``sponsor'' arrangements. Do commenters believe that the entity that 
would pay the MQP Fee under NASDAQ's proposal is sufficiently clear? If 
not, how would commenters suggest clarifying the definition of MQP 
Company as it pertains to each specific type of MQP Security?
---------------------------------------------------------------------------

    \303\ See proposed NASDAQ Rule 5950(e)(7).
    \304\ See NASDAQ Response Letter at 20.
---------------------------------------------------------------------------

    17. Under the NYSE Arca Proposal, the Optional Incentive Fee for 
each ETP in the Fixed Incentive Program would be paid by the 
issuer.\305\ The term ``issuer'' is not defined in the NYSE Arca 
Proposal or elsewhere in the NYSE Arca Equities Rules. Two commenters 
believe that it is unclear from NYSE Arca's Proposal whether the entity 
paying the Optional Incentive Fee would be the ETP sponsor or the fund 
itself. Do commenters believe that the entity that would pay the 
Optional Incentive Fee under NYSE Arca's proposal is sufficiently 
clear? If not,

[[Page 42071]]

how would commenters suggest clarifying the proposal?
---------------------------------------------------------------------------

    \305\ See proposed NYSE Arca Equities Rule 8.800(c)(1).
---------------------------------------------------------------------------

    18. NASDAQ is proposing to disclose on its Web site the acceptance 
of an MQP Company and MQP Market Maker into the MQP; the total number 
of MQP Securities that any one MQP Company may have in the MQP; the 
names of MQP Securities and the MQP Market Maker(s) in each MQP 
Security; the amount, if any, of any Supplemental MQP Fee and the Quote 
Share Payment and Trade Share Payment allocation determined by each MQP 
Company; and any limit on the number of MQP Market Makers that are 
permitted to register in an MQP Security. NYSE Arca proposes to provide 
notification on its Web site of the ETPs participating in the Fixed 
Incentive Program and the LMMs assigned to such ETPs. Is it likely that 
investors and other market participants would consult the Exchanges' 
Web sites for information about which securities and market makers are 
participating in the Programs? Would investors be able to easily 
distinguish quotations for ETPs that are in the Program from those that 
are not? Why or why not?
    One commenter suggests that, in addition to NASDAQ's Web site, 
participation in the MQP also should be noted on the MQP Security's Web 
site and in regulatory disclosure documents.\306\ Do commenters agree 
or disagree with this suggestion? Why or why not? Is there a need for 
additional disclosure to provide information to investors about issuer 
participation in the Programs that would allow investors to make better 
informed investment decisions at the time of purchase of ETPs in the 
Programs, including the potential consequences if an ETP is no longer 
in the Programs?
---------------------------------------------------------------------------

    \306\ See ETF Consultants Letter at 8.
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    One commenter suggests that a ticker symbol identifier would be 
useful for products in the MQP.\307\ NASDAQ asserts in its response to 
comments that such an identifier is unnecessary and that it would be 
undesirable ``to brand MQP products through symbology'' because the MQP 
is designed to be transparent through information to be disclosed on 
the Exchange's Web site.\308\ Would investors be able to easily 
distinguish quotations for ETPs that are in the Program from those that 
are not? If not, should the Commission be concerned about this? If the 
Commission should be concerned, would a ticker symbol identifier for 
securities in the Programs help to address this concern? Why or why 
not? Are there other potential solutions?
---------------------------------------------------------------------------

    \307\ See Weaver Letter at 9.
    \308\ See NASDAQ Response Letter at 7-8.
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    19. Under the NYSE Arca Proposal, an issuer participating in the 
Fixed Incentive Program would be required to pay the Optional Incentive 
Fee in an amount between $10,000 and $40,000, which amount would be 
negotiated between the issuer and the LMM assigned to such issuer's 
ETP, and the final amount of such Optional Incentive Fee would not be 
publicly disclosed. Should NYSE Arca be required to disclose the final 
amount of such Optional Incentive Fee? Would such information be 
helpful to investors in determining whether to invest in an ETP in the 
Fixed Incentive Program? Why or why not?
    20. A commenter suggests that NASDAQ be required to make available 
the data gathered under the pilot to ETP sponsors participating in the 
MQP.\309\ This same commenter also supports the view that, with respect 
to the Fixed Incentive Program,\310\ NYSE Arca should be required to 
publicly (and anonymously) disclose statistics on the performance of 
LMMs in the Program, as such information could be meaningful for 
investors and would help assess how much liquidity is being provided by 
LMMs under the Program.\311\ Another commenter suggests that NASDAQ 
publicly disclose on a monthly basis each MQP Market Maker's share of 
Quote Share Payments and Trade Share Payments for each MQP Security the 
MQP Market Maker quotes/trades.\312\ Should the Exchanges be required 
to disclose the data gathered under the Programs to the issuers 
participating in the Program? Should such information be required to be 
publicly disclosed? Should the Exchanges be required to publicly 
disclose (on an anonymous basis or otherwise) the performance of the 
market makers participating in the respective Programs during the pilot 
period? Should the Exchanges be required to provide to the Commission 
and publically disclose any analysis of the impact of the Programs? 
Would some or all of this information be useful for investors? Would 
the public disclosure provide useful data to academics or other members 
of the public to help assess the impact of the Programs? Would such 
analyses provide useful information to the Exchanges or Commission to 
help assess whether the Programs were operating in a manner consistent 
with the Exchange Act and are consistent with the protection of 
investors? For each question, please explain your answer.
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    \309\ See NASDAQ ICI Letter at 3.
    \310\ Under the Fixed Incentive Program pilot, NYSE Arca states 
that it would provide the Commission with certain market quality 
data on a confidential basis each month. See NYSE Arca Notice, supra 
note 12, at 29422.
    \311\ See NYSE Arca ICI Letter at 4.
    \312\ See ETF Consultants Letter at 8.
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    21. With respect to the NASDAQ Proposal, two commenters suggest 
improvements to the implementation of the pilot to allow the Commission 
and NASDAQ to more effectively assess the impact of the MQP.\313\ One 
of these commenters suggests that the pilot have a staggered 
introduction of MQP Securities with a randomized sequence, and a long 
enough pre- and post-event period (e.g., 3 months) for each 
introduction to identify an effect.\314\ In the NASDAQ Response Letter, 
NASDAQ states that a staggered introduction of MQP Securities and a 
randomized sequence would add ``un-needed complexity to the program, 
and is not necessary in light of the optional nature of the MQP.'' 
\315\ The same commenter also suggests that NASDAQ provide the 
Commission with detailed reporting of all trades and quotes in all 
securities for a pre-event period and a post-event period (with MQP 
Market Maker trades and quotes flagged).\316\ Another commenter, 
however, notes that any ``before and after'' data needed can be 
obtained by comparing trading and asset growth in existing products 
which move into the MQP after it is launched, and a period after an ETF 
launch without participation in MQP would be an unnecessary and 
inappropriate handicap for new ETFs.\317\ NASDAQ states its belief that 
any pre-event period would be ``antithetical to the goal of the program 
to enhance liquidity of products as soon as possible.'' \318\
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    \313\ See Menkveld Letter at 4-5 and NASDAQ Vanguard Letter at 
4-5.
    \314\ See Menkveld Letter at 4-5.
    \315\ See NASDAQ Response Letter at 9.
    \316\ See id.
    \317\ See ETF Consultants Letter at 8.
    \318\ See id.
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    Another commenter believes NASDAQ should be required to monitor 
market quality metrics during the pilot not only for ETFs participating 
in the MQP, but also for ETFs that do not participate in the MQP, to 
determine whether the non-participating ETFs are negatively 
affected.\319\ With respect to the NYSE Arca Proposal, one commenter 
believes it is important that NYSE Arca and the Commission have an 
opportunity to evaluate the impact of the program on the quality of 
markets in ETPs prior to considering its permanent approval, both with 
respect to ETPs

[[Page 42072]]

participating in the program and those ETPs that choose not to 
participate.\320\
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    \319\ See NASDAQ Vanguard Letter at 4.
    \320\ See NYSE Arca ICI Letter at 4.
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    Do commenters agree or disagree with these views? Why or why not? 
Would the structure of each pilot as proposed, as well as the data or 
other information proposed to be provided to the Commission, 
sufficiently help inform the Commission as to whether the MQP or the 
Fixed Incentive Program, as applicable, was working as intended to 
achieve each Exchange's stated objective? Why or why not? For example, 
would the applicable Exchange or the Commission be able to fully 
evaluate a Program without being able to compare the performance of a 
particular ETP before it enters the Program with its performance once 
it has entered the Program? Why or why not? Should securities be 
eligible for the Programs only after trading for some period of time 
(e.g., 3-6 months) without the benefit of participating in the 
applicable Program? In addition, would the structure of each pilot as 
proposed and the data or other information to be provided to the 
Commission allow the Exchanges and the Commission to adequately assess 
commenters' concerns? If not, how should each Exchange amend its 
respective pilot structure and/or data items or other information to 
improve the ability of the Exchange and the Commission to be able to 
adequately assess commenters' concerns? Similarly, would the proposed 
pilot structures and submission of data items or other information be 
helpful to the Commission in determining whether the Programs are 
operating consistent with the requirements of the Exchange Act and the 
rules thereunder? If not, how should each Exchange amend its respective 
pilot structure and/or data items or other information to improve the 
chances that the pilot would operate consistent with the requirements 
of the Exchange Act and rules thereunder?
    22. In addition to the data items and/or other information that the 
Exchanges have proposed to provide to the Commission, should each 
Exchange also provide analyses of its respective pilot that addresses 
the intended impacts of its Program? Have the Exchanges adequately 
responded to commenters' concerns? If not, should the Exchanges be 
required to supplement the public file with additional data and 
analyses on the impact of the Programs? What specific issues should any 
such analyses cover? Should the Exchanges provide empirical support for 
these analyses?
    23. Under the NYSE Arca Proposal, NYSE Arca would retain a 5% 
administrative fee to be deducted from the Optional Incentive Fee paid 
by the ETP issuer.\321\ NYSE Arca states that this fee would be 
reasonable to cover its costs of administering the program.\322\ What 
are commenters views on whether a 5% administrative fee charged by NYSE 
Arca for participation in its Fixed Incentive Program would be 
reasonable? Do commenters believe that NYSE Arca has clearly and 
sufficiently explained why this fee is reasonable? Also, do commenters 
have a view as to whether this fee would or would not impact the 
Exchange's incentives when administering the Program? If so, how so? If 
not, why not?
---------------------------------------------------------------------------

    \321\ See NYSE Arca Notice, supra note 12, at 29421, n.12. 
NASDAQ does not propose any similar fee in its proposal.
    \322\ See NYSE Arca Notice, supra note 12 at 29422.
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    24. Are there any alternative means of addressing the concerns of 
Rule 102 of Regulation M, which could be conditions to exemptive relief 
from that provision? Please specify particular conditions that 
commenters believe would be appropriate to address the Regulation M 
concerns.
    25. Do commenters believe the ``incubation'' period potentially 
provided by these Programs for newly listed ETPs will affect the 
decision making process of ETP sponsors concerning which ETP products 
to bring to market or not to bring to market? Why or why not?
    26. Section 6(b)(8) of the Exchange Act \323\ requires that the 
rules of a national securities exchange not impose any burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Act. Both NASDAQ and NYSE Arca represent they do not believe 
that their respective Programs will not result in any burden on 
competition that is not necessary or appropriate in furtherance of the 
purposes of the Act.\324\ What are commenters views as to whether the 
Exchanges have sufficiently explained why their respective proposals do 
not impose any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act?
---------------------------------------------------------------------------

    \323\ 15 U.S.C. 78f(b)(8).
    \324\ See NASDAQ Notice, supra note 4, at 22050-51; NYSE Arca 
Notice, supra note 12, at 29423.
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    27. NASDAQ states that the MQP would be beneficial to the financial 
markets, to market participants including traders and investors, and to 
the economy in general. First, the Exchange proposes the MQP to 
encourage narrow spreads and liquid markets in situations that 
generally have not been, or may not be, conducive to naturally having 
such markets. In NASDAQ's view, the securities that comprise these 
markets may include less actively traded or less well known ETF 
products that are made up of securities of less well known or start-up 
companies as components.\325\ Second, in rewarding Market Makers that 
are willing to ``go the extra mile'' to develop liquid markets for MQP 
Securities, NASDAQ asserts that the MQP would clearly benefit traders 
and investors by encouraging more quote competition, narrower spreads, 
and greater liquidity. Third, NASDAQ asserts that the MQP will lower 
transaction costs and enhance liquidity in both ETFs and their 
components, making those securities more attractive to a broader range 
of investors. In so doing, NASDAQ states that the MQP will help 
companies access capital to invest and grow. And fourth, NASDAQ asserts 
that the MQP may attract smaller, less developed companies and 
investment opportunities to a regulated and transparent market and 
thereby serve the dual function of providing access to on-Exchange 
listing while expanding investment and trading opportunities to market 
participants and investors.\326\ NYSE Arca states that the Fixed 
Incentive Program is designed to encourage additional market makers to 
pursue LMM assignments and thereby support the provision of consistent 
liquidity in ETPs listed on the Exchange, and further states that the 
assignment of an LMM is a critical component of the promotion of a 
consistent, fair and orderly market in ETPs on the Exchange.\327\
---------------------------------------------------------------------------

    \325\ See NASDAQ Notice, supra note 4, at 22043, n.12 (``These 
small companies and their securities (whether components of listed 
products like ETFs or direct listings) have been widely recognized 
as essential to job growth and creation and, by extension, to the 
health of the economy. Being included in a successful ETF can 
provide the stocks of these companies with enhanced liquidity and 
exposure, enabling them to attract investors and access capital 
markets to fund investment and growth'').
    \326\ See NASDAQ Notice, supra note 4, at 22043.
    \327\ See NYSE Arca Notice, supra note 12, at 29420, 29421-
29422.
---------------------------------------------------------------------------

    Do commenters agree or disagree with NASDAQ's and NYSE Arca's 
assertions as to the Programs' potential impact on efficiency, 
competition, and capital formation? Why or why not? Generally, do 
commenters have any other views as to whether and, if so, how each of 
the Programs would impact efficiency, competition, and capital 
formation? Do the proposed pilot structures, for example, promote 
efficiency, competition, and capital formation? Why or why not?
    Comments may be submitted by any of the following methods:

[[Page 42073]]

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Numbers SR-NASDAQ-2012-043 and/or SR-NYSEArca-2012-37 on the 
subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Numbers SR-NASDAQ-2012-043 and/or 
SR-NYSEArca-2012-37. These file numbers should be included on the 
subject line if email is used. To help the Commission process and 
review your comments more efficiently, please use only one method. The 
Commission will post all comments on the Commission's Internet Web site 
(http://www.sec.gov/rules/sro.shtml). Copies of the submission, all 
subsequent amendments, all written statements with respect to the SRO 
Proposals that are filed with the Commission, and all written 
communications relating to the SRO Proposals between the Commission and 
any person, other than those that may be withheld from the public in 
accordance with the provisions of 5 U.S.C. 552, will be available for 
Web site viewing and printing in the Commission's Public Reference 
Room, 100 F Street NE., Washington, DC 20549, on official business days 
between the hours of 10:00 a.m. and 3:00 p.m. Copies of such filings 
also will be available for inspection and copying at the principal 
office of the Exchanges. All comments received will be posted without 
change; the Commission does not edit personal identifying information 
from submissions. You should submit only information that you wish to 
make available publicly. All submissions should refer to File Numbers 
SR-NASDAQ-2012-043 and/or SR-NYSEArca-2012-37 and should be submitted 
on or before August 16, 2012. Rebuttal comments should be submitted by 
August 31, 2012.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\328\
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    \328\ 17 CFR 200.30-3(a)(57).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-17349 Filed 7-16-12; 8:45 am]
BILLING CODE 8011-01-P


