
[Federal Register Volume 77, Number 232 (Monday, December 3, 2012)]
[Notices]
[Pages 71652-71658]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-29078]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-68303; File No. SR-BYX-2012-019]


Self-Regulatory Organizations; BATS Y-Exchange, Inc.; Order 
Granting Approval to Proposed Rule Change, as Modified by Amendment No. 
2, To Adopt a Retail Price Improvement Program

 November 27, 2012.

I. Introduction

    On August 14, 2012, BATS Y-Exchange, Inc. (the ``Exchange'' or 
``BYX'') filed with the Securities and Exchange Commission 
(``Commission'') pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to establish a Retail Price Improvement Program 
(``Program'') on a pilot basis for a period of one year from the date 
of implementation, if approved. The proposed rule change was published 
for comment in the Federal Register on August 31, 2012.\3\ The 
Commission received one comment on the BYX proposal.\4\ On October 12, 
2012, the Commission extended the time for Commission action on the 
proposed rule change until November 29, 2012.\5\ The Exchange submitted 
a response letter on November 13, 2012.\6\ On October 4, 2012, the 
Exchange filed Amendment No. 1 to its proposal.\7\ On November 13, 
2012, the Exchange filed Amendment No. 2 to its proposal.\8\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 67734 (August 27, 
2012), 77 FR 53242 (SR-BYX-2012-019) (``Notice'').
    \4\ See Letter from Theodore R. Lazo, Managing Director and 
Associate General Counsel, Securities Industry and Financial Markets 
Association, to Elizabeth M. Murphy, Secretary, Commission, dated 
September 26, 2012 (``SIFMA Letter'').
    \5\ See Securities Exchange Act Release No. 68049, 77 FR 64180 
(October 18, 2012).
    \6\ See Letter from Eric Swanson, Senior Vice President and 
General Counsel, BATS Global Markets, to Elizabeth M. Murphy, 
Secretary, Commission, dated November 13, 2012 (``Exchange Response 
to Comments'').
    \7\ The Exchange withdrew Amendment No. 1 on October 4, 2012.
    \8\ In Amendment No. 2, the Exchange proposes to delete a 
statement explaining that a Retail Liquidity Identifier for Tape C 
securities would not be published until after October 1, 2012. The 
Exchange is deleting this statement because the processor is 
currently able to disseminate the identifier. The Exchange also 
proposes to clarify that the securities will be phased into the 
Program, and modify its statutory basis discussion to support this 
change. Finally, the Exchange proposes to modify the Rule Text to 
state that the Exchange will notify its membership regarding the 
securities included in the Program through an information circular 
(``Amendment No. 2''). Because the changes made in Amendment No. 2 
do not materially alter the substance of the proposed rule change or 
raise any novel regulatory issues, Amendment No. 2 is not subject to 
notice and comment.
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    In connection with the proposal, the Exchange requested exemptive 
relief from Rule 612 of Regulation NMS,\9\ which, among other things, 
prohibits a national securities exchange from accepting or ranking 
orders priced greater than $1.00 per share in an increment smaller than 
$0.01.\10\ On November 19, 2012, the Exchange submitted a letter 
requesting that the staff of the Division of Trading and Markets not 
recommend any enforcement action under Rule 602 of Regulation NMS 
(``Quote Rule'') based on the Exchange's and its members' participation 
in the Program (``No-Action Request Letter'').\11\
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    \9\ 17 CFR 242.612 (``Sub-Penny Rule'').
    \10\ See Letter from Eric Swanson, Senior Vice President and 
General Counsel, BATS Global Markets, to Elizabeth M. Murphy, 
Secretary, Commission, dated August 14, 2012 (``Request for Sub-
Penny Rule Exemption'').
    \11\ See Letter from Eric J. Swanson, Senior Vice President and 
General Counsel, BATS Global Markets, to Robert Cook, Division of 
Trading and Markets, Commission, dated November 19, 2012 (``No-
Action Letter'').

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[[Page 71653]]

    This order approves the proposed rule change, as modified by 
Amendment No. 2, and grants the exemption from the Sub-Penny Rule 
sought by the Exchange in relation to the proposed rule change.

II. Description of the Proposal

    The Exchange is proposing a one-year pilot program to attract 
additional retail order flow to the Exchange, while also providing the 
potential for price improvement to such order flow. The Program would 
be limited to trades occurring at prices equal to or greater than $1.00 
per share.
    All securities traded on the Exchange would be eligible for 
inclusion in the Program. As proposed in Amendment No. 2, for the first 
90 days of the pilot program, a group of up to 25 securities would 
participant in the program. These securities would represent those 
securities traded most heavily by retail investors. After the initial 
90 day period, the Program will be expanded gradually until all 
securities traded on the Exchange are included. The Exchange will 
notify Members in an information circular of the securities that are 
subject to the Program both initially and as additional securities 
become eligible for inclusion.\12\
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    \12\ See Amendment No. 2, supra note 8.
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    Under the Program, a new class of market participants called Retail 
Member Organizations (``RMOs'') \13\ would be eligible to submit 
certain retail order flow (``Retail Orders'') to the Exchange. All 
Exchange Users \14\ would be permitted to provide potential price 
improvement for Retail Orders in the form of non-displayed interest 
that is better than the national best bid that is a Protected Quotation 
(``Protected NBB'') or the national best offer that is a Protected 
Quotation (``Protected NBO,'' and together with the Protected NBB, the 
``Protected NBBO'') \15\ called a Retail Price Improvement Order (``RPI 
Order''). When an RPI Order priced at least $0.001 better than the 
Protected Bid or Protected Offer for a particular security is available 
in the System, the Exchange would disseminate an identifier, known as 
the Retail Liquidity Identifier, indicating that such interest exists. 
A Retail Order would interact, to the extent possible, with available 
contra-side RPI Orders.\16\
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    \13\ A RMO would be a Member (or a division thereof) that has 
been approved by the Exchange to submit Retail Orders. A ``Member'' 
is any registered broker or dealer that has been admitted to 
membership in the Exchange. See BYX Rule 1.5(n).
    \14\ A ``User'' is any Member or sponsored participant of the 
Exchange who is authorized to obtain access to the System. See BYX 
Rule 1.5(cc).
    \15\ The term Protected Quotation has the same meaning as 
defined in Rule 600(b)(58) of Regulation NMS. See BYX Rule 1.5(t). 
Rule 600(b)(58) of Regulation NMS defines ``protected quotation'' as 
``a protected bid or a protected offer.'' 17 CFR 242.600(b)(58). The 
Protected NBB is the best-priced protected bid and the Protected NBO 
is the best-priced protected offer. See BYX Rule 1.5(s). The 
Exchange represents that, generally, the Protected NBB and Protected 
NBO, and the national best bid (``NBB'') and national best offer 
(``NBO,'' together with the NBB, the ``NBBO''), will be the same. 
However, it further represents that a market center is not required 
to route to the NBB or NBO if that market center is subject to an 
exception under Regulation NMS Rule 611(b)(1) or if such NBB or NBO 
is otherwise not available for an automatic execution. In such case, 
the Exchange states that the Protected NBB or Protected NBO would be 
the best-priced protected bid or offer to which a market center must 
route interest pursuant to Rule 611 of Regulation NMS.
    \16\ As explained further below, the Exchange has proposed two 
types of Retail Orders, one of which could execute against other 
interest if it was not completely filled by contra-side RPI Interest 
or other price-improving liquidity. All Retail Orders would first 
execute against available contra-side RPI Orders or other price-
improving liquidity. Any remaining portion of the Retail Order would 
then either cancel, be executed as an immediate-or-cancel order, or 
be routed to another market for execution, depending on the type of 
Retail Order.
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    The Exchange represents that its proposed rule change is based on 
New York Stock Exchange LLC's (``NYSE'') Rule 107C, which governs 
NYSE's previously approved Retail Liquidity Program,\17\ with three 
distinctions. First, the NYSE's Retail Liquidity Program creates a 
category of members, Retail Liquidity Providers, who are required to 
maintain an RPI that betters the protected best bid or offer at least 
5% of the trading day in each assigned security. Under the BYX's 
proposal, the Exchange would not create such a category of users. 
Second, NYSE's Retail Liquidity Program does not permit the execution 
of Retail Orders against other resting non-displayed liquidity. BYX's 
proposal would permit such executions. Finally, under the NYSE'S Retail 
Liquidity Program, Retail Orders execute at the single price at which 
the order will be fully executed. Pursuant to the BYX's proposal, 
Retail Orders execute at multiple price levels rather than a single 
price level.\18\
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    \17\ See Securities Exchange Act Release No. 67347 (July 3, 
2012), 77 FR 40673 (July 10, 2012) (SR-NYSE-2011-55; SR-NYSEAmex-
2011-84) (``RLP Approval Order''). In the RLP Approval Order, the 
Commission also approved a Retail Liquidity Program for NYSE Amex 
LLC (now known as NYSE MKT LLC) (``NYSE MKT'').
    \18\ See Notice, supra note 3, 77 FR at 53245-46 (explaining the 
three distinctions in detail).
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Types of Orders and Identifier

    A Retail Order would be an agency order that originates from a 
natural person and is submitted to the Exchange by a RMO, provided that 
no change is made to the terms of the order with respect to price or 
side of market, and the order does not originate from a trading 
algorithm or any other computerized methodology. Users and RMOs could 
enter odd lots, round lots, or mixed lots as RPI Orders and as Retail 
Orders, respectively.
    A RPI Order would be non-displayed interest on the Exchange that is 
better than the Protected NBB or Protected NBO by at least $0.001 and 
that is identified as a RPI Order in a manner prescribed by the 
Exchange. An RPI Order may also be entered in a sub-penny increment 
with an explicit limit price. When such an order is available in the 
System in a particular security, the Exchange would disseminate an 
identifier, known as the Retail Liquidity Identifier, indicating that 
such interest exists. The Exchange would implement the Program in a 
manner that allowed the dissemination of the identifier through 
consolidated data streams (i.e., pursuant to the Consolidated Tape 
Association Plan/Consolidated Quotation Plan (``CTA/CQ Plan'') for Tape 
A and Tape B securities, and the Nasdaq UTP Plan for Tape C securities 
as well as through proprietary Exchange data feeds. The Retail 
Liquidity Identifier would reflect the symbol and the side (buy or 
sell) of the RPI Order, but it would not include the price or size. In 
particular, CQ and UTP quoting outputs would include a field for codes 
related to the Retail Liquidity Identifier. The codes will indicate RPI 
Orders that are priced better than the Protected Bid or Protected Offer 
by at least the minimum level of price improvement as required by the 
Program.

Retail Member Organizations

    In order to become a RMO, a Member must conduct a retail business 
or handle retail orders on behalf of another broker-dealer. Any Member 
that wishes to obtain RMO status would be required to submit: (1) An 
application form; (2) an attestation, in a form prescribed by the 
Exchange, that any order submitted by the Member as a Retail Order 
would meet the qualifications for such orders; and (3) supporting 
documentation sufficient to demonstrate the retail nature and 
characteristics of the applicant's order flow.\19\ If the Exchange 
disapproves the application, it would provide a written notice to the 
Member. The disapproved applicant could appeal the disapproval as 
provided below and/or re-apply 90 days after the disapproval

[[Page 71654]]

notice is issued by the Exchange. An RMO also could voluntarily 
withdraw from such status at any time by giving written notice to the 
Exchange.
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    \19\ For example, a prospective RMO could be required to provide 
sample marketing literature, Web site screenshots, other publicly 
disclosed materials describing the retail nature of their order 
flow, and such other documentation and information as the Exchange 
may require to obtain reasonable assurance that the applicant's 
order flow would meet the requirements of the Retail Order 
definition.
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    The Exchange would require a RMO to have written policies and 
procedures reasonably designed to assure that it will only designate 
orders as Retail Orders if all the requirements of a Retail Order are 
met. Such written policies and procedures would have to require the 
Member to exercise due diligence before entering a Retail Order to 
assure that entry as a Retail Order is in compliance with the proposed 
rule, and monitor whether orders entered as Retail Orders meet the 
applicable requirements. If the RMO represents Retail Orders from 
another broker-dealer customer, the RMO's supervisory procedures must 
be reasonably designed to assure that the orders it receives from such 
broker-dealer customer that it designates as Retail Orders meet the 
definition of a Retail Order. The RMO must obtain an annual written 
representation, in a form acceptable to the Exchange, from each broker-
dealer customer that sends it orders to be designated as Retail Orders 
that entry of such orders as Retail Orders will be in compliance with 
the requirements of this rule, and monitor whether its broker-dealer 
customer's Retail Order flow continues to meet the applicable 
requirements.\20\
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    \20\ The Exchange represents that it or another self-regulatory 
organization on behalf of the Exchange will review a RMO's 
compliance with these requirements through an exam-based review of 
the RMO's internal controls. See Notice, supra note 3, 77 FR at 
53244 n.9.
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Retail Order Designations

    Under the proposal, a RMO submitting a Retail Order could choose 
one of two designations dictating how it would interact with available 
contra-side interest. First, a Retail Order could interact only with 
available contra-side RPI Orders and other price-improving liquidity. 
The Exchange would label this a Type 1 Retail Order and such orders 
would not interact with available non-price-improving, contra-side 
interest in Exchange systems or route to other markets. Portions of a 
Type 1 Retail Order that are not executed would be cancelled 
immediately and automatically.
    Second, a Retail Order could interact first with available contra-
side RPI Orders and other price-improving liquidity, and any remaining 
portion would be eligible to interact with other interest in the System 
\21\ and, if designated as eligible for routing, would route to other 
markets in compliance with Regulation NMS.\22\ The Exchange would label 
this a Type 2 Retail Order, and it could either be submitted as a BATS 
Only Order \23\ or as an order eligible for routing.
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    \21\ The System is ``the electronic communications and trading 
facility designated by the Board through which securities orders of 
Users are consolidated for ranking, execution and, when applicable, 
routing away.'' BYX rule 1.5(aa).
    \22\ See BYX Rule 11.9(b)(1).
    \23\ A BATS Only Order is an order that is not eligible for 
routing to other trading centers. See BYX Rule 11.9(c)(4).
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Priority and Allocation

    The Exchange would follow price-time priority, ranking RPI Orders 
in the same security according to price and then time of entry into the 
System. Any remaining unexecuted RPI Orders would remain available to 
interact with other incoming Retail Orders if such interest is at an 
eligible price. Any remaining unexecuted portion of a Retail Order 
would cancel or execute in accordance with the proposed rule.\24\
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    \24\ The Exchange provides three examples of how the priority 
and ranking of RPI Orders would operate. See Notice, supra note 3, 
77 FR at 53245.
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Failure of RMO To Abide by Retail Order Requirements

    The proposed rule addresses an RMO's failure to abide by Retail 
Order requirements. If a RMO were to designate orders submitted to the 
Exchange as Retail Orders and the Exchange determined, in its sole 
discretion, that those orders failed to meet any of the requirements of 
Retail Orders, the Exchange could disqualify a Member from its status 
as a RMO. When disqualification determinations are made, the Exchange 
would provide a written disqualification notice to the Member. A 
disqualified RMO could appeal the disqualification as provided below 
and/or re-apply 90 days after the disqualification notice is issued by 
the Exchange.

Appeal Process

    Under the proposal, the Exchange would establish a Retail Price 
Improvement Program Panel (``RPI Panel'') to review disapproval or 
disqualification decisions. If a Member disputes the Exchange's 
decision to disapprove or disqualify it as a RMO, such Member could 
request, within five business days after notice of the decision is 
issued by the Exchange, that the RPI Panel review the decision to 
determine if it was correct. The RPI Panel would consist of the 
Exchange's Chief Regulatory Officer or his or her designee, and two 
officers of the Exchange designated by the Exchange's Chief Operating 
Officer, and it would review the facts and render a decision within the 
timeframe prescribed by the Exchange. The RPI Panel could overturn or 
modify an action taken by the Exchange and all determinations by the 
RPI Panel would constitute final action by the Exchange on the matter 
at issue.

III. Comment Letters and the Exchange's Responses

    As noted above, the Commission received one comment letter that 
raised concerns about the BYX proposal.\25\ The main areas of concern 
expressed therein were: (1) Whether the proposal impedes fair access; 
(2) the proposal's impact on the Sub-Penny Rule; and (3) the 
dissemination of quotations.\26\
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    \25\ See note 4, supra.
    \26\ See SIFMA Letter, p. 3-4. In addition to commenting on the 
proposal, the commenter suggested that the Commission, rather than 
the staff by delegated authority, should consider whether to approve 
or disapprove BYX's proposed rule change because of the important 
issues it raises. The commenter further stated that the Commission 
should consider and resolve market structure issues through the 
formal rulemaking process, as opposed to allowing such issues to be 
addressed in rule changes. See SIFMA Letter, p. 1-2.
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    The commenter argued that the BYX's proposal would result in a two-
tiered market wherein market participants could only access available 
interest identified by the Retail Liquidity Identifier if they were 
seeking to interact with an order placed by a retail customer. The 
commenter believes that this is inconsistent with the requirements of 
Section 6(b)(5) of the Exchange Act as it would allow for unfair 
discrimination against institutional investors. The commenter expressed 
concern that approval of the NYSE Retail Liquidity Program, coupled 
with approval of the BYX proposal, would set a precedent for other 
exchanges to discriminate among members.\27\
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    \27\ See SIFMA Letter, p. 3.
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    In response, the Exchange explained that it believes that the 
differential treatment proposed in connection with the Program is not 
designed to permit unfair discrimination, but instead to promote a 
competitive process through which retail investors would receive better 
prices than they currently do in light of bilateral internalization 
arrangements currently utilized to execute such orders. The Exchange 
argued the Program is consistent with Section 6(b)(5) of the Exchange 
Act as it is designed to attract retail order flow to the Exchange and 
help ensure that retail investors benefits from the better prices that 
liquidity providers are willing to give such orders.
    The commenter also express concern that under the BYX proposal, 
priority

[[Page 71655]]

would be given based on sub-penny increments, and tick size would be 
reduced to $.001 even though Rule 612 of Regulation NMS prohibits 
national securities exchanges from accepting or ranking certain order 
based on an increment smaller than the minimum price increment. The 
commenter noted that quoting in sub-penny increments does not 
contribute to the maintenance of orderly markets and that it encourages 
market participants to step ahead of competing limit orders to gain an 
insignificant price improvement. The commenter suggested that if the 
Commission has determined that the protections of Rule 612 are no 
longer necessary, it should address this in a rulemaking, rather than 
granting individual exchange exemptions.\28\
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    \28\ See SIFMA Letter, p. 4.
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    In response, the Exchange noted that Rule 612 was adopted to 
address the Commission's concern that sub-penny increments could erode 
the incentives of investors to display limit orders. The Exchange 
argued that its Program would not reduce such incentives. The Exchange 
explained that market participants currently are not able to interact 
with retail order flow because it is routinely routed to internalizing 
OTC market makers that offer sub-penny executions. The Exchange 
believes that allowing the Exchange to compete for this retail order 
flow through the Program should not materially detract from current 
incentives to display limit orders, and could result in greater order 
interaction and price improvement for market retail orders on the 
Exchange. Further, the Exchange explained that its Program would not 
encourage market participants to step ahead of competing limit orders 
to gain an insignificant price improvement because pursuant to the 
Program, neither Retail Orders nor RPI Orders will be displayed by the 
Exchange.
    Finally, the commenter argued that the Exchange's Retail Liquidity 
Identifier that would be disseminated through the consolidated data 
stream is an indication of interest that is a quotation, and encouraged 
the Commission to conduct its own analysis of whether these identifiers 
are quotations. The commenter also questioned whether broker-dealers 
would be required to consider these identifiers in making routing 
decisions consistent with their best execution obligations and 
expressed concern that a proliferation of the use of identifiers such 
as that proposed by BYX would increase broker-dealers' compliance 
burdens because they would be required continuously to evaluate these 
identifiers on multiple exchanges and it could pose obligations under 
the order protection rule of Regulation NMS.\29\
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    \29\ See SIFMA Letter, p. 4-5.
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    In response, the Exchange explained that it believes that neither 
the Program's RPI Orders nor the retail liquidity identifiers meet the 
definition of a ``bid'' or ``offer'' in Rule 600(b)(8) of Regulation 
NMS, and therefore are not quotations, because they do not communicate 
a specific price. Because the Exchange does not believe that RPI are 
quotations pursuant to Rule 602, it argues that they are not subject 
the Rule 611of Regulation NMS (Order Protection Rule). Finally, the 
Exchange stated that it believes that a broker-dealer should consider 
the Program when conducting its best execution analysis, but does not 
believe that the Program would create any best execution challenges for 
broker-dealer's that do not already exist in today's market.

IV. Discussion and Commission Findings

    After careful review of the proposal, the comment letter received, 
and the Exchange's response, the Commission finds that the proposed 
rule change is consistent with the requirements of the Act and the 
rules and regulations thereunder that are applicable to a national 
securities exchange. In particular, the Commission finds that the 
proposed rule change, subject to its term as a pilot, is consistent 
with Section 6(b)(5) of the Act,\30\ which requires, among other 
things, that the rules of a national securities exchange be designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, to foster cooperation and 
coordination with persons engaged in regulating, clearing, settling, 
processing information with respect to, and facilitating transactions 
in securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest; and not be designed to 
permit unfair discrimination between customers, issuers, brokers or 
dealers.
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    \30\ 15 U.S.C. 78f(b)(5).
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    The Commission finds that the Program, as it is proposed on a pilot 
basis, is consistent with the Act because it is reasonably designed to 
benefit retail investors by providing price improvement to retail order 
flow.\31\ The Commission also believes that the Program could promote 
competition for retail order flow among execution venues, and that this 
could benefit retail investors by creating additional price improvement 
opportunities for their order flow. Currently, most marketable retail 
order flow is executed in the OTC markets, pursuant to bilateral 
agreements, without ever reaching a public exchange. The Commission has 
noted that ``a very large percentage of marketable (immediately 
executable) order flow of individual investors'' is executed, or 
``internalized,'' by broker-dealers in the OTC markets.\32\ A review of 
the order flow of eight retail brokers revealed that nearly 100% of 
their customer market orders were routed to OTC market makers.\33\ The 
same review found that such routing is often done pursuant to 
arrangements under which retail brokers route their order flow to 
certain OTC market makers in exchange for payment for such order 
flow.\34\ To the extent that the Program may provide price improvement 
to retail orders that equals what would be provided under such OTC 
internalization arrangements, the Program could benefit retail 
investors. To better understand the Program's potential impact, the 
Exchange represents that it ``will produce data throughout the pilot, 
which will include statistics about participation, the frequency and 
level of price improvement provided by the Program, and any effects on 
the broader market structure, and would be reviewed by the Commission 
prior to any extension of the Program beyond the proposed one-year 
pilot term, or permanent approval of the Program.'' \35\
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    \31\ The Commission recently approved similar Retail Liquidity 
Programs for NYSE and NYSE MKT. See RLP Approval Order, supra note 
17.
    \32\ See Securities Exchange Act Release No. 61358 (Jan. 14, 
2010), 75 FR 3594, 3600 (Jan. 21, 2010) (``Concept Release on Equity 
Market Structure'').
    \33\ See id.
    \34\ See id.
    \35\ See Notice, supra note 3, 77 FR at 53245.
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    The Program proposes to create additional price improvement 
opportunities for retail investors by segmenting retail order flow on 
the Exchange and requiring liquidity providers that want to interact 
with such retail order flow to do so at a price at least $0.001 per 
share better than the Protected Best Bid or Offer. As noted above, the 
commenter questioned the fairness of treating retail order flow 
differently from other order flow on an exchange by offering price 
improvement opportunities only to retail orders. The Commission finds 
that, while the Program would treat retail order flow differently from 
order flow submitted by other market participants, such segmentation 
would not be inconsistent with Section 6(b)(5) of the Act, which 
requires that the rules of an exchange

[[Page 71656]]

are not designed to permit unfair discrimination.\36\ The Commission 
has previously recognized that the markets generally distinguish 
between individual retail investors, whose orders are considered 
desirable by liquidity providers because such retail investors are 
presumed on average to be less informed about short-term price 
movements, and professional traders, whose orders are presumed on 
average to be more informed.\37\ The Commission has further recognized 
that, because of this distinction, liquidity providers are generally 
more inclined to offer price improvement to less informed retail orders 
than to more informed professional orders.\38\ Absent opportunities for 
price improvement, retail investors may encounter wider spreads that 
are a consequence of liquidity providers interacting with informed 
order flow. By creating additional competition for retail order flow, 
the Program is reasonably designed to attract retail order flow to the 
exchange environment, while helping to ensure that retail investors 
benefit from the better price that liquidity providers are willing to 
give their orders.
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    \36\ The comment letter discussed whether the Program's proposed 
Retail Liquidity Identifier constitutes a ``quote'' which would be 
subject to Rule 610 of Regulation NMS. That rule, known as the 
``Fair Access Rule,'' contains a similar prohibition on unfair 
discrimination. The Commission finds that the Program is not 
unfairly discriminatory under both Section 6(b)(5) of the Act and 
Rule 610 of Regulation NMS. Because the Commission has determined 
that the Program is not unfairly discriminatory pursuant to Rule 
610, it need not determine whether the Retail Liquidity Identifier 
is a ``quote'' for purposes of Rule 610.
    \37\ See also Concept Release on Equity Market Structure, supra 
note 32; Securities Exchange Act Release No. 64781 (June 30, 2011), 
76 FR 39953 (July 7, 2011) (approving a program proposed by an 
options exchange that would provide price improvement opportunities 
to retail orders based, in part, on questions about execution 
quality of retail orders under payment for order flow arrangements 
in the options markets). The commenter expressed concern that 
institutional investors would not be able to submit RMOs. The 
Commission notes that institutional investors tend to be more 
informed than retail investors. See supra note 29 and accompanying 
text.
    \38\ See also Securities Exchange Act Release No. 64781 (June 
30, 2011), 76 FR 39953 (July 7, 2011) (noting that ``it is well 
known in academic literature and industry practice that prices tend 
to move against market makers after trades with informed traders, 
often resulting in losses for market makers,'' and that such losses 
are often borne by uninformed retail investors through wider spreads 
(citing H.R. Stoll, ``The supply of dealer services in securities 
markets,'' Journal of Finance 33 (1978), at 1133-51; L. Glosten & P. 
Milgrom, ``Bid ask and transaction prices in a specialist market 
with heterogeneously informed agents,'' Journal of Financial 
Economics 14 (1985), at 71-100; and T. Copeland & D. Galai, 
``Information effects on the bid-ask spread,'' Journal of Finance 38 
(1983), at 1457-69)).
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    The commenter also expressed concern that the Program could create 
a two-tiered market and questioned the fairness of preventing 
institutional investors from submitting Retail Orders, and thus 
receiving price improvement on their orders.\39\ The Commission notes 
that the Program might create a desirable opportunity for institutional 
investors to interact with retail order flow that they are not able to 
reach currently. Today, institutional investors often do not have the 
chance to interact with marketable retail orders that are executed 
pursuant to internalization arrangements. Thus, by submitting RPI 
Orders, institutional investors may be able to reduce their possible 
adverse selection costs by interacting with retail order flow.
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    \39\ See supra note 29 and accompanying text.
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    When the Commission is engaged in rulemaking or the review of a 
rule filed by a self-regulatory organization, and is required to 
consider or determine whether an action is necessary or appropriate in 
the public interest, the Commission shall also consider, in addition to 
the protection of investors, whether the action will promote 
efficiency, competition, and capital formation.\40\ As discussed above, 
the Commission believes this Program will promote competition for 
retail order flow by allowing Exchange members to submit RPI Orders to 
interact with Retail Orders. Such competition may promote efficiency by 
facilitating the price discovery process. Moreover, the Commission does 
not believe that the Program will have a significant effect on market 
structure, or will create any new inefficiencies in current market 
structure. Finally, to the extent the Program is successful in 
attracting retail order flow, it may generate additional investor 
interest in trading securities, thereby promoting capital formation.
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    \40\ See 15 U.S.C. 78c(f).
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    The Commission also believes that the Program is sufficiently 
tailored to provide the benefits of potential price improvement only to 
bona fide retail order flow originating from natural persons.\41\ The 
Commission finds that the Program provides an objective process by 
which a member organization could become a RMO, and for appropriate 
oversight by the Exchange to monitor for continued compliance with the 
terms of these provisions. The Exchange has limited the definition of 
Retail Order to an agency order that originates from a natural person 
and not a trading algorithm or any other computerized methodology. 
Furthermore, a Retail Order must be submitted by a RMO that is approved 
by the Exchange. In addition, RMOs would be required to maintain 
written policies and procedures to help ensure that they designate as 
Retail Orders only those orders which qualify under the Program. If a 
member's application to become a RMO is denied by the Exchange, that 
member may appeal the determination or re-apply. The Commission 
believes that these standards should help ensure that only retail order 
flow is submitted into the Program and thereby promote just and 
equitable principles of trade and protect investors and the public 
interest, while also providing an objective process through which 
members may become RMOs.
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    \41\ In addition, the Commission believes that the Program's 
provisions concerning the approval and potential disqualification of 
RMOs are not inconsistent with the Act. See RLP Approval Order, 
supra note 17, 77 FR at 40680 & n.77.
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    In addition, the Commission finds that the Program's proposed 
dissemination of a Retail Liquidity Identifier would increase the 
amount of pricing information available to the marketplace and is 
consistent with the Act. The identifier would be disseminated through 
the consolidated public market data stream to advertise the presence of 
a RPI Order with which Retail Orders could interact. The identifier 
would reflect the symbol for a particular security and the side of the 
RPI Order interest, but it would not include the price or size of such 
interest. The identifier would alert market participants to the 
existence of a RPI Order and should provide market participants with 
more information about the availability of price improvement 
opportunities for retail orders than is currently available.
    The commenter questioned whether the Retail Liquidity Identifier is 
a ``quotation''. \42\ As we note above, because the Commission has 
determined that the Program is not unfairly discriminatory pursuant to 
Rule 610, it need not determine whether the Retail Liquidity Identifier 
\43\ is a ``quote'' for purposes of Rule 610. Furthermore, the 
Commission notes that the staff granted the no-action requests of the 
New York Stock Exchange LLC and NYSE MKT concerning Rule 602 of 
Regulation NMS with respect to the Retail Liquidity Identifier.\44\
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    \42\ ``Quotation'' means a bid or an offer. 17 CFR 242.601(62).
    \43\ The Commission notes that the Retail Liquidity Identifier 
proposed by the Exchange is identical to that used by NYSE and NYSE 
MKT.
    \44\ In that letter, the staff recognized the representations 
made by NYSE and NYSE MKT that the Retail Liquidity Identifier does 
not meet the definition of ``bid'' or ``offer'' in Rule 600(b)(8) of 
Regulation NMS because it does not communicate a specific price. See 
Letter from David Shillman, Associate Director, Division of Trading 
and Markets, to Janet McGinness, Senior Vice President-Legal and 
Corporate Secretary, Office of the General Counsel, NYSE Euronext, 
dated July 3, 2012.
    A ``bid'' or ``offer'' means the bid price or the offer price 
communicated by a member of a national securities exchange or member 
of a national securities association to any broker or dealer, or to 
any customer, at which it is willing to buy or sell one or more 
round lots of an NMS security, as either principal or agent, but 
shall not include indications of interest. 17 CFR 242.601(8).
    The Exchange similarly requested that the staff of the 
Commission not recommend enforcement action to the Commission 
against the Exchange under the Quote Rule relating to the kind of 
information disseminated through Retail Liquidity Identifier. See 
No-Action Letter, supra note 13. The staff has determined to grant 
the Exchange's No-Action request pursuant to a letter which is also 
being issued today. See Letter from David Shillman, Associate 
Director, Division of Trading and Markets, to Eric Swanson, Senior 
Vice President and General Counsel, BATS, dated November 27, 2012.

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[[Page 71657]]

    The commenter also raised concerns about the additional burdens 
broker-dealers would face in evaluating the information contained in 
the identifiers to determine their routing obligations. The Commission 
believes that the Program will not create any best execution challenges 
that are not already present in today's markets. A broker's best 
execution obligations are determined by a number of facts and 
circumstances, including: (1) The character of the market for the 
security (e.g., price, volatility, relative liquidity, and pressure on 
available communications): (2) the size and type of transaction; (3) 
the number of markets checked; (4) accessibility of the quotation; and 
(5) the terms and conditions of the order which result in the 
transaction.\45\ A broker would consider the Program when conducting 
this analysis. Given the benefits of adding this information to the 
marketplace, the Commission believes that the Retail Liquidity 
Identifier is an appropriate part of the Program.
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    \45\ See FINRA Rule 5310.
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    The Exchange believes that the proposed distinctions between its 
Program and the approved programs for NYSE and NYSE MKT will both 
enhance competition amongst market participants and encourage 
competition amongst exchange venues.\46\ Specifically, the Exchange 
believes that: allowing all Exchange Users to enter RPI Orders, as 
opposed to adopting a special category of retail liquidity provider, 
will result in a higher level of competition and maximize price 
improvement to incoming Retail Orders; the Program will provide the 
maximum price improvement available to incoming Retail Orders because 
they will always interact with available contra-side RPI Orders and any 
other price-improving contra-side interest; and the Program will 
provide all of the price improvement available to incoming Retail 
Orders by allowing executions at multiple price levels, as opposed to a 
single clearing price level.\47\ The Commission finds that the Program 
is reasonably designed to enhance competition amongst market 
participants and encourage competition amongst exchange venues. The 
Commission also finds that the distinctions between the Exchange's 
Program and the approved NYSE and NYSE MKT programs are reasonably 
designed to enhance the Program's price-improvement benefits to retail 
investors and, therefore, are consistent with the Act.
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    \46\ See Notice, supra note 3, 77 FR at 52346.
    \47\ See Notice, supra note 3, 77 at 53245-46.
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    The Commission notes that it is approving the Program on a pilot 
basis. Approving the Program on a pilot basis will allow the Exchange 
and market participants to gain valuable practical experience with the 
Program during the pilot period. This experience should allow the 
Exchange and the Commission to determine whether modifications to the 
Program are necessary or appropriate prior to any Commission decision 
to approve the Program on a permanent basis. The Exchange also has 
agreed to provide the Commission with a significant amount of data that 
should assist the Commission in its evaluation of the Program. 
Specifically, the Exchange has represented that it ``will produce data 
throughout the pilot, which will include statistics about 
participation, the frequency and level of price improvement provided by 
the Program, and any effects on the broader market structure.'' \48\ 
The Commission expects that the Exchange will monitor the scope and 
operation of the Program and study the data produced during that time 
with respect to such issues, and will propose any modifications to the 
Program that may be necessary or appropriate.
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    \48\ See supra note 37 and accompanying text.
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    The Commission also welcomes comments, and empirical evidence, on 
the Program during the pilot period to further assist the Commission in 
its evaluation of the Program. The Commission notes that any permanent 
approval of the Program would require a proposed rule change by the 
Exchange, and such rule change will provide an opportunity for public 
comment prior to further Commission action.

V. Exemption From the Sub-Penny Rule

    Pursuant to its authority under Rule 612(c) of Regulation NMS,\49\ 
the Commission hereby grants the Exchange a limited exemption from the 
Sub-Penny Rule to operate the Program.\50\ For the reasons discussed 
below, the Commission determines that such action is necessary or 
appropriate in the public interest, and is consistent with the 
protection of investors. The exemption shall operate for a period of 12 
months, coterminous with the effectiveness of the proposed rule change 
approved today.
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    \49\ 17 CFR 242.612(c).
    \50\ The commenter opined that if the Commission believes that 
the protections afforded by sub-penny rule are no longer necessary, 
the Commission should address that change in policy through a formal 
rulemaking rather than individual exemptions. See supra note 30. For 
the reasons expressed in this section, the Commission believes that 
granting an exemption from Rule 612 for purposes of the BYX RLP as 
proposed is appropriate.
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    When the Commission adopted the Sub-Penny Rule in 2005, it 
identified a variety of problems caused by sub-pennies that the Sub-
Penny Rule was designed to address:
     If investors' limit orders lose execution priority for a 
nominal amount, investors may over time decline to use them, thus 
depriving the markets of liquidity.
     When market participants can gain execution priority for a 
nominal amount, important customer protection rules such as exchange 
priority rules and the Manning Rule could be undermined.
     Flickering quotations that can result from widespread sub-
penny pricing could make it more difficult for broker-dealers to 
satisfy their best execution obligations and other regulatory 
responsibilities.
     Widespread sub-penny quoting could decrease market depth 
and lead to higher transaction costs.
     Decreasing depth at the inside could cause institutions to 
rely more on execution alternatives away from the exchanges, 
potentially increasing fragmentation in the securities markets.\51\
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    \51\ See Securities Exchange Act Release No. 51808 (June 9, 
2005), 70 FR 37496, 37551-52 (June 29, 2005).
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    At the same time, the Commission ``acknowledge[d] the possibility 
that the balance of costs and benefits could shift in a limited number 
of cases or as the markets continue to evolve.'' \52\ Therefore, the 
Commission also adopted Rule 612(c), which provides that the Commission 
may grant exemptions from the Sub-Penny Rule, either unconditionally or 
on specified terms and conditions, if it determined that such an 
exemption is necessary or appropriate in the public interest, and is

[[Page 71658]]

consistent with the protection of investors.
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    \52\ Id. at 37553.
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    The Commission believes that the Exchange's proposal raises such a 
case. As described above, under the current market structure, few 
marketable retail orders in equity securities are routed to exchanges. 
The vast majority of marketable retail orders are internalized by OTC 
market makers, who typically pay retail brokers for their order flow. 
Retail investors can benefit from such arrangements to the extent that 
OTC market makers offer them price improvement over the NBBO. Price 
improvement is typically offered in sub-penny amounts.\53\ An 
internalizing broker-dealer can offer sub-penny executions, provided 
that such executions do not result from impermissible sub-penny orders 
or quotations. Accordingly, OTC market makers typically select a sub-
penny price for a trade without quoting at that exact amount or 
accepting orders from retail customers seeking that exact price. 
Exchanges--and exchange member firms that submit orders and quotations 
to exchanges--cannot compete for marketable retail order flow on the 
same basis, because it would be impractical for exchange electronic 
systems to generate sub-penny executions without exchange liquidity 
providers or retail brokerage firms having first submitted sub-penny 
orders or quotations, which the Sub-Penny Rule expressly prohibits.
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    \53\ When adopting the Sub-Penny Rule, the Commission considered 
certain comments that asked the Commission to prohibit broker-
dealers from offering sub-penny price improvement to their 
customers, but declined to do so. The Commission stated that 
``trading in sub-penny increments does not raise the same concerns 
as sub-penny quoting'' and that ``sub-penny executions due to price 
improvement are generally beneficial to retail investors.'' Id. at 
37556.
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    The limited exemption granted today should promote competition 
between exchanges and OTC market makers in a manner that is reasonably 
designed to minimize the problems that the Commission identified when 
adopting the Sub-Penny Rule. Under the Program, sub-penny prices will 
not be disseminated through the consolidated quotation data stream, 
which should avoid quote flickering and its reduced depth at the inside 
quotation. Furthermore, while the Commission remains concerned about 
providing enough incentives for market participants to display limit 
orders, the Commission does not believe that granting this exemption 
(and approving the accompanying proposed rule change) will reduce such 
incentives. Market participants that display limit orders currently are 
not able to interact with marketable retail order flow because it is 
almost entirely routed to internalizing OTC market makers that offer 
sub-penny executions. Consequently, enabling the Exchanges to compete 
for this retail order flow through the Program should not materially 
detract from the current incentives to display limit orders, while 
potentially resulting in greater order interaction and price 
improvement for marketable retail orders. To the extent that the 
Program may raise Manning and best execution issues for broker-dealers, 
these issues are already presented by the existing practices of OTC 
market makers.
    The exemption being granted today is limited to a one-year pilot. 
The Exchange has stated that ``sub-penny trading and pricing could 
potentially result in undesirable market behavior,'' and, therefore, it 
will ``monitor the Program in an effort to identify and address any 
such behavior.'' \54\ Furthermore, the Exchange has represented that it 
``will produce data throughout the pilot, which will include statistics 
about participation, the frequency and level of price improvement 
provided by the Program, and any effects on the broader market 
structure.'' \55\ The Commission expects to review the data and 
observations of the Exchange before determining whether and, if so, how 
to extend the exemption from the Sub-Penny Rule.\56\
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    \54\ See Request for Sub-Penny Rule Exemption, supra note 10, at 
3, n.7.
    \55\ See supra note 37 and accompanying text.
    \56\ In particular, the Commission expects the Exchange to 
observe how maker/taker transaction charges, whether imposed by the 
Exchange or by other markets, might impact the use of the Program. 
Market distortions could arise where the size of a transaction 
rebate, whether for providing or taking liquidity, is greater than 
the size of the minimum increment permitted by the Program ($0.001 
per share).
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VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\57\ that the proposed rule change (SR-BYX-2012-019), as modified 
by Amendment No. 2, be and hereby is, approved on a one-year pilot 
basis.
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    \57\ 15 U.S.C. 78s(b)(2).
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    It is also hereby ordered that, pursuant to Rule 612(c) of 
Regulation NMS, the Exchange is given a limited exemption from Rule 612 
of Regulation NMS allowing it to accept and rank orders priced equal to 
or greater than $1.00 per share in increments of $0.001, in the manner 
described in the proposed rule change above, on a one-year pilot basis 
coterminous with the effectiveness of the proposed rule change.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\58\
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    \58\ 17 CFR 200.30-3(a)(12); 17 CFR 200.30-3(a)(83).
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Kevin O'Neill,
Deputy Secretary.
[FR Doc. 2012-29078 Filed 11-30-12; 8:45 am]
BILLING CODE 8011-01-P


