
[Federal Register Volume 78, Number 114 (Thursday, June 13, 2013)]
[Notices]
[Pages 35656-35658]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-14001]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69719; File No. SR-NASDAQ-2013-031]


Self-Regulatory Organizations; The NASDAQ Stock Market LLC; Order 
Granting Approval to Proposed Rule Change To Amend the Attestation 
Requirement of Rule 4780 To Allow a Retail Member Organization To 
Attest That ``Substantially All'' Orders Submitted to the Retail Price 
Improvement Program Will Qualify as ``Retail Orders''

June 7, 2013.

I. Introduction

    On February 19, 2013, The NASDAQ Stock Market LLC (``NASDAQ'' or 
``Exchange'') 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 allow Retail Member Organizations (``RMOs'') to 
attest that ``substantially all,'' rather than all, orders submitted to 
the Exchange's Retail Price Improvement Program (``Program'') qualify 
as ``Retail Orders.'' The proposed rule change was published for 
comment in the Federal Register on March 11, 2013.\3\ The Commission 
received one comment on the proposal.\4\ NASDAQ submitted a response to 
the comment letter on April 24, 2013.\5\ On April 25, 2013, the 
Commission extended the time for Commission action on the proposed rule 
change until June 9, 2013.\6\ This order approves the proposed rule 
change.
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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. 69039 (March 5, 
2013), 78 FR 15392.
    \4\ See Letter to the Commission from Theodore R. Lazo, Managing 
Director and Associate General Counsel, Securities Industry and 
Financial Markets Association (SIFMA), dated March 11, 2013.
    \5\ See Letter to the Commission from Jonathan F. Cayne, 
Associate General Counsel, NASDAQ OMX, dated April 24, 2013 
(``Exchange's Response Letter'').
    \6\ See Securities Exchange Act Release No. 69450, 78 FR 25501 
(May 1, 2013).
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II. Description of the Proposal

    The Exchange began operating the Program after it was approved by 
the Commission on a pilot basis in February, 2013.\7\ Under the current 
rules, a member organization that wishes to participate in the Program 
as an RMO must submit: (A) An application form; (B) supporting

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documentation; and (C) an attestation that ``any order'' submitted as a 
Retail Order\8\ will qualify as such under NASDAQ Rule 4780.
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    \7\ See Securities Exchange Act Release No. 68937 (February 15, 
2013), 78 FR 12397 (February 22, 2012) (``RPI Approval Order'').
    \8\ A Retail Order is defined in NASDAQ Rule 4780(a)(2) as ``an 
agency or riskless principal order that originates from a natural 
person and is submitted to NASDAQ by a Retail Member Organization, 
provided that no change is made to the terms of the order with 
respect to price (except in the case that a market order is changed 
to a marketable limit order) or side of market and the order does 
not originate from a trading algorithm or any other computerized 
methodology.''
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    The proposal seeks to lessen the attestation requirements of RMOs 
that submit ``Retail Orders'' eligible to receive potential price 
improvement through participation in the Program. Specifically, the 
Exchange proposes to amend NASDAQ Rule 4780 to provide that an RMO may 
attest that ``substantially all''--rather than all--of the orders it 
submits to the Program are Retail Orders as defined in Rule 4780(a)(2). 
NASDAQ states that the current ``any order'' attestation requirement is 
effectively preventing certain significant retail brokers from 
participating in the Program due to operational constraints.
    The Exchange makes clear in its proposal that the ``substantially 
all'' standard is meant to allow only de minimis amounts of orders to 
participate in the Program that do not meet the definition of a Retail 
Order in NASDAQ Rule 4780(a)(2) and that cannot be segregated from bona 
fide Retail Orders due to systems limitations. Under the proposal, the 
Exchange would require that RMOs retain in their books and records 
adequate substantiation that substantially all orders sent to the 
Exchange as Retail Orders met the strict definition and that those 
orders not meeting the strict definition are agency orders that cannot 
be segregated from Retail Orders due to system limitations, and are de 
minimis in terms of the overall number of Retail Orders sent to the 
Exchange.\9\
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    \9\ NASDAQ notes that the Financial Industry Regulatory 
Authority, Inc. (``FINRA''), on behalf of the Exchange, will review 
a member organization's compliance with these requirements.
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III. Comment Letter and the Exchange's Response

    The Commission received one comment on the proposal. The comment 
letter expressed concern over the proposed ``substantially all'' 
attestation requirement primarily for four reasons.
    First, the comment letter questioned whether the proposal would 
undermine the rationale on which the Commission approved the Retail 
Price Improvement Program. According to the commenter, when the 
Commission granted approval to the Program, along with exemptive relief 
in connection with the operation of the Program, it did so with the 
understanding that the Program would service ``only'' retail order 
flow. To the extent the proposal would potentially allow non-Retail 
Orders to receive price improvement in the Program, the commenter 
suggested that the Commission should reexamine its rationale for 
granting the exemptive relief relating to the Program.
    In response, NASDAQ noted that the proposed amendment is designed 
to permit isolated and de minimis quantities of agency or riskless 
principal orders that do not qualify as Retail Orders to participate in 
the Program, because such orders cannot be segregated from Retail 
Orders due to systems limitations. The Exchange also noted that several 
significant retail brokers choose not to participate in the Program 
currently because of the categorical ``any order'' standard, and that 
the proposed ``substantially all'' standard would allow the significant 
amount of retail order flow represented by these brokers the 
opportunity to receive the benefits of the Program. Additionally, the 
Exchange noted that the Program is designed to replicate the existing 
practices of broker-dealers that internalize much of the market's 
retail order flow off-exchange, and that the Program, as modified by 
the ``substantially all'' proposal, would offer a competitive and more 
transparent alternative to internalization.
    Second, the commenter expressed its belief that the Exchange did 
not sufficiently explain why retail brokers are not able to separate 
all Retail and non-Retail Orders and thereby satisfy the current 
attestation requirement. The commenter expressed its belief that the 
Commission should require additional explanation as to how retail 
brokers could satisfy the proposed ``substantially all'' standard if 
they could not satisfy the current standard, including an analysis of 
the costs and benefits to retail brokers of implementing technology 
changes to identify orders as Retail or non-Retail. Furthermore, the 
commenter suggested that the Exchange's proposal is at odds with the 
situation found in options markets where exchanges and brokers 
distinguish between public and professional customers--a distinction 
the commenter analogized to the Retail versus non-Retail distinction.
    The Exchange responded that several retail brokers have explained 
that their order flow is routed in aggregate for retail execution 
purposes and that a de minimis amount of such flow may have been 
generated electronically, thus not meeting the strict Retail Order 
definition. According to NASDAQ, these retail brokers have chosen not 
to direct any of their significant shares of retail order flow to the 
Program because the cost of complying with the current ``any order'' 
standard, such as implementing any necessary systems changes, is too 
high. The Exchange represented that the retail brokers have indicated 
their willingness to comply with the proposed ``substantially all'' 
standard, as well as their ability to implement the proposed standard 
on their systems with confidence. The Exchange further responded that 
the distinction between public and professional customers in the 
options market is not like distinction between Retail and non-Retail 
Orders; the former distinction turns on volume and is thus an easier 
bright-line threshold to implement, while the distinction between 
Retail and non-Retail Orders turns on whether the order originated from 
a natural person, which imposes a higher threshold for order flow 
segmentation purposes.
    Third, the commenter contended that the proposed ``substantially 
all'' standard is overly vague. According to the commenter, the 
Exchange's proposed guidance on what constitutes ``substantially all'' 
is so vague that it could allow a material amount of non-retail order 
flow to qualify for the Program. The commenter suggested that, should 
the Commission approve the proposal, it should first establish a 
bright-line rule to define what constitutes ``substantially all'' 
retail order flow.\10\
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    \10\ The commenter cited one example where a ``de minimis'' 
transaction is defined in 17 CFR 242.101(b)(7), in connection with a 
distribution of securities, as ``less than 2%.''
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    NASDAQ responded that the proposal represents only a modest 
modification of the attestation requirement. In this respect, the 
Exchange noted that the proposal would permit only isolated and de 
minimis quantities of agency orders to participate in the Program that 
do not satisfy the strict definition of a Retail Order but that cannot 
be segregated from Retail Orders due to systems limitations. 
Furthermore, the Exchange noted that an RMO's compliance with this 
requirement would be monitored and subject to books and record-keeping 
requirements.
    Fourth, the commenter stated that the proposal may cause an 
exponential increase in monitoring and recordkeeping burdens associated 
with the Program. The commenter expressed its belief that it could be 
especially difficult for the Exchange not just to

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identify non-retail order flow, but also to monitor whether such flow 
exceeded a de minimis amount. The commenter also questioned whether the 
potential difficulty of the Exchange monitoring the Program might 
increase the likelihood that members may be subject to unfair 
discrimination in the Program's approval and disqualification process.
    In response, the Exchange noted that it will issue Equity Trader 
Alerts to provide clear guidance on how the ``substantially all'' 
standard will be implemented and monitored. The Exchange also noted 
that the Program is designed to attract as much retail order flow as 
possible, and that, should RMOs begin submitting substantial amounts of 
non-retail order flow, liquidity providers would become less willing to 
participate in the Program. Finally, the Exchange disagreed with the 
commenter's statement that a standard that provides a de minimis number 
of exceptions would be any harder to enforce that a standard that 
permitted no exceptions.

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.\11\ In particular, the Commission finds that the 
proposed rule change is consistent with Section 6(b)(5) of the Act,\12\ 
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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    \11\ In approving the proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f).
    \12\ 15 U.S.C. 78f(b)(5).
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    The Commission finds that the proposed ``substantially all'' 
standard is a limited and sufficiently-defined modification to the 
Program's current RMO attestation requirements that does not constitute 
a significant departure from the Program as initially approved by the 
Commission.\13\ The proposal makes clear that to comply with the 
standard, RMOs may submit only isolated and de minimis amounts of 
agency orders that cannot be segregated from Retail Orders due to 
systems limitations.\14\ Furthermore, as the Exchange notes, RMOs will 
need to adequately document their compliance with the ``substantially 
all'' standard in their books and records. Specifically, an RMO would 
need to retain adequate documentation that substantially all orders 
sent to the Exchange as Retail Orders met that definition, and that 
those orders not meeting that definition are agency orders that cannot 
be segregated from Retail Orders due to system limitations, and are de 
minimis in terms of the overall number of Retail Orders sent to the 
Exchange. The Commission also notes that FINRA will monitor an RMO's 
compliance with this requirement.
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    \13\ The Commission notes that it approved the Program on a 
pilot basis subject to ongoing Commission review. The Commission 
notes further that it recently approved nearly identical proposals 
submitted by NYSE, NYSE MKT, and BATS-Y concerning those exchanges' 
respective retail programs. See Securities Exchange Act Release Nos. 
69513 (May 3, 2013), 78 FR 27261 (May 9, 2013) (NYSE and NYSE MKT), 
and 69643 (May 28, 2013), 78 FR 33136 (June 3, 2013) (BATS-Y).
    \14\ While the Commission recognizes the potential benefit of 
the commenter's suggestion concerning a bright-line definition of de 
minimis, see supra note 10, the Commission believes that, in light 
of the facts surrounding the instant proposal, the proposal, and the 
guidance that the Exchange will provide to its members on this 
point, is sufficiently clear. The Commission also notes that the 
example the commenter cites is found in Regulation M, which governs 
different circumstances than those at issue here.
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    Additionally, the Commission finds that the Exchange has provided 
adequate justification for the proposal. The Exchange represented that, 
as explained to it by several significant retail brokers, the current 
``any order'' standard is effectively prohibitive, given the brokers' 
order flow aggregation and management systems. The Exchange further 
represented that these retail brokers indicated their systems would 
allow them to comply with the ``substantially all'' standard, as 
proposed. By allowing these retail brokers to participate in the 
Program, the proposal could bring the potential benefits of the 
Program, including price improvement and increased transparency,\15\ to 
the retail order flow that these brokers represent.\16\
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    \15\ For a more detailed discussion of the Program's potential 
benefits, see RPI Approval Order, supra note 7.
    \16\ The commenter also expressed concern that this proposal may 
increase the Exchange's burden monitoring compliance with the 
Program. The Commission finds that any potential concerns raised by 
this assertion, which is disputed by the Exchange, are outweighed by 
the potential benefits of the proposal; namely, that the proposal 
may allow more retail orders the opportunity to participate in the 
Program and to receive the attendant benefits of the Program. With 
respect to the commenter's concern that members may be subject to 
unfair discrimination in the approval and disqualification process 
for participation in the Program, the Commission notes that it 
previously found that the Program's provisions concerning the 
certification, approval, and potential disqualification of RMOs are 
not inconsistent with the Act. See RPI Approval Order, supra note 7.
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\17\ that the proposed rule change (SR-NASDAQ-2013-031) be, and 
hereby is, approved.
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    \17\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-14001 Filed 6-12-13; 8:45 am]
BILLING CODE 8011-01-P


