
[Federal Register Volume 78, Number 204 (Tuesday, October 22, 2013)]
[Notices]
[Pages 62828-62831]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-24655]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-70662; File No. SR- BATS-2013-056]


Self-Regulatory Organizations; BATS Exchange, Inc.; Notice of 
Filing of a Proposed Rule Change To Amend Rule 12.6 To Conform to FINRA 
Rule 5320 Relating to Trading Ahead of Customer Orders

October 11, 2013.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on October 3, 2013, BATS Exchange, Inc. (the ``Exchange'' or 
``BATS'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I and 
II below, which Items have been prepared by the Exchange. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange filed a proposal to amend Rule 12.6 to make it 
substantially the same as Financial Industry Regulatory Authority 
(``FINRA'') Rule 5320.
    The text of the proposed rule change is available at the Exchange's 
Web site at http://www.batstrading.com, at the principal office of the 
Exchange, and at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange has prepared summaries, set forth in 
Sections A, B, and C below, of the most significant parts of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Exchange proposes to amend Rule 12.6, which limits trading 
ahead of customer orders by Members,\3\ to make the rule substantially 
the same as FINRA Rule 5320.\4\ As with FINRA Rule 5320, amended Rule 
12.6 would prohibit Members from trading ahead of customer orders, 
subject to specified exceptions. The amended rule would include 
exceptions for large orders and institutional accounts, proprietary 
transactions effected by a trading unit of a Member with no knowledge 
of customer orders held by another trading unit of the Member, riskless 
principal transactions, intermarket sweep orders (``ISOs''), and odd 
lot and bona fide error transactions, discussed in detail below. 
Amended Rule 12.6 would also provide the same guidance as FINRA Rule 
5320 on minimum price improvement standards, order handling procedures, 
and trading outside normal market hours.
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    \3\ Members are registered brokers or dealers that have been 
admitted to membership at the Exchange. BATS Rule 1.5(n).
    \4\ See Securities Exchange Act Release No. 63895 (February 11, 
2011), 76 FR 9386 (February 17, 2011) (SR-FINRA-2009-90).
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Background
    Current Rule 12.6, the customer order protection rule, generally 
prohibits Members from trading on a proprietary basis ahead of, or 
along with, customer orders that are executable at the same price as 
the proprietary order. The rule contains several exceptions that make 
it permissible for a Member to enter a proprietary order while 
representing a customer order that could be executed at the same price, 
including permitting transactions for the purposes of facilitating the 
execution, on a riskless principal basis, of one or more customer 
orders.
Proposal To Adopt Text of FINRA Rule 5320
    To harmonize its rules with FINRA, the Exchange proposes to delete 
the current text of Rule 12.6 and its supplementary material and adopt 
the text and supplementary material of FINRA Rule 5320, with certain 
technical changes, as Rule 12.6. FINRA Rule 5320 generally provides 
that a FINRA member that accepts and holds an order in an equity 
security from its own

[[Page 62829]]

customer, or a customer of another broker-dealer, without immediately 
executing the order is prohibited from trading that security on the 
same side of the market for its own account at a price that would 
satisfy the customer order, unless it immediately thereafter executes 
the customer order up to the size and at the same or better price at 
which it traded for its own account.
Exceptions
    Amended Rule 12.6 would include exceptions to the prohibition 
against trading ahead of customer orders. That is, a Member that meets 
the conditions of an exception would be permitted to trade a security 
on the same side of the market for its own account at a price that 
would satisfy a customer order in certain circumstances. The exceptions 
are set out below.
Large Orders and Institutional Accounts
    One exception would permit a Member to negotiate terms and 
conditions with respect to the acceptance of certain large-sized orders 
(orders of 10,000 shares or more unless such orders are less than 
$100,000 in value) or orders from institutional accounts. The term 
``institutional account'' will be defined in accordance with FINRA Rule 
4512(c). That is, an institutional account will be defined as the 
account of: (1) A bank savings and loan association, insurance company 
or registered investment company; (2) an investment adviser registered 
either with the SEC under Section 203 of the Investment Advisers Act or 
with a state securities commission (or any agency or office performing 
like functions); or (3) any other person (whether a natural person, 
corporation, partnership, trust or otherwise) with total assets of at 
least $50 million. This exception would require the Member to provide 
clear and comprehensive written disclosure to each customer at account 
opening and annually thereafter that: (a) states that the Member may 
trade proprietarily at prices that would satisfy the customer order, 
and (b) provides the customer with a meaningful opportunity to opt in 
to the Rule 12.6 protections with respect to all or any portion of its 
order. If a customer does not opt in to the protections with respect to 
all or any portion of its order, the Member may reasonably conclude 
that such customer has consented to the Member trading a security on 
the same side of the market for its own account at a price that would 
satisfy the customer's order.\5\
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    \5\ A customer would retain the right to withdraw consent at any 
time. Therefore, a Member's reasonable conclusion that a customer 
has consented to the Member trading along with such customer's order 
is subject to further instruction and modification from the 
customer.
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    In lieu of providing written disclosure to customers at account 
opening and annually thereafter, the proposed rule would permit Members 
to provide clear and comprehensive oral disclosure to, and obtain 
consent from, a customer on an order-by-order basis. The Member would 
be required to document who provided such consent and that such consent 
evidences the customer's understanding of the terms and conditions of 
the order. If a customer opted in to the Rule 12.6 protections, a 
Member could still obtain consent on an order-by-order basis to trade 
ahead of or along with an order from that customer, provided that the 
Member documented who provided such consent and that such consent 
evidenced the customer's understanding of the terms and conditions of 
the order.
No-Knowledge Exception
    The Exchange is also proposing to include in Interpretation and 
Policy .02 a ``no-knowledge'' exception to its customer order 
protection rule. The proposed exception would allow one trading unit of 
a Member to trade in a proprietary capacity and at prices that would 
satisfy customer orders held by another, separate trading unit of the 
Member. The No-Knowledge Exception would be applicable with respect to 
NMS stocks, as defined in Rule 600 of Regulation NMS under the Act.
    To avail itself of the No-Knowledge Exception, a Member would be 
required to meet certain conditions. First, it would have to implement 
and utilize an effective system of internal controls (such as 
appropriate information barriers) that operate to prevent the 
proprietary trading unit from obtaining knowledge of the customer 
orders held by a separate trading unit. As proposed, Interpretation and 
Policy .02 will make clear that appropriate information barriers must, 
at a minimum, comply with the Exchange's existing requirements 
regarding the prevention of the misuse of material, non-public 
information, which are set forth in Exchange Rule 5.5. Second, the 
Member would have to provide, at account opening and annually 
thereafter, a written description of how it handles customer orders and 
the circumstances under which it may trade proprietarily, including in 
a market-making capacity, at prices that would satisfy the customer 
order. A Member must maintain records indicating which orders rely on 
the no-knowledge exception and produce these records to the Exchange 
upon request. The onus will be on the Member to produce sufficient 
documentation justifying reliance on the No-Knowledge exception for any 
given trade. To ensure clarity and transparency regarding this 
exception and others, the Exchange will be issuing a regulatory notice 
informing Members of these proposed rule changes. The Exchange will 
include in the regulatory notice the effective date for the rule as 
amended, which shall be at least 30 days after the approval of the 
amendments to Rule 12.6 in order to allow Members to make any necessary 
changes to their internal policies or processes.
Riskless Principal Exception
    Amended Rule 12.6 would not apply to a proprietary trade made by 
the Member to facilitate the execution, on a riskless principal basis, 
of another order from a customer (whether its own customer or the 
customer of another broker-dealer). To take advantage of this 
exception, the Member would have to: (a) Submit a report, 
contemporaneously with the execution of the facilitated order, 
identifying the trade as riskless principal to the Exchange, and (b) 
have written policies and procedures to ensure that riskless principal 
transactions relied upon for this exception comply with applicable 
Exchange rules. At a minimum, these policies and procedures would have 
to require: (1) Receipt of the customer order before execution of the 
offsetting principal transaction, and (2) execution of the offsetting 
principal transaction at the same price as the customer order, 
exclusive of any markup or markdown, commission equivalent, or other 
fee and allocation to a riskless principal or customer account in a 
consistent manner and within 60 seconds of execution.
    Members would have to have supervisory systems in place that 
produce records that enable the Member and the Exchange to reconstruct 
accurately, readily, and in a time-sequenced manner all orders on which 
a Member relies in claiming this exception.
ISO Exception
    The proposed rule change would also exempt a Member from the 
obligation to execute a customer order in a manner consistent with Rule 
12.6 with regard to trading for its own account when the Member routed 
an ISO in compliance with Rule 600(b)(30)(ii) of Regulation NMS if the 
customer order is received after the Member routed the ISO. If a Member 
routes an ISO to facilitate a customer order, and that customer has 
consented to not receiving the better

[[Page 62830]]

prices obtained by the ISO, the Member would also be exempt with 
respect to any trading for its own account that is the result of the 
ISO with respect to the consenting customer's order.
Odd Lot and Bona Fide Error Exception
    The Exchange proposes to except a Member's proprietary trade that: 
(1) Offsets a customer odd lot order (i.e., an order less than one 
round lot, which is typically 100 shares), or (2) corrects a bona fide 
error. With respect to bona fide errors, the Member would be required 
to demonstrate and document the basis upon which a transaction meets 
the bona fide error exception. For purposes of this proposed Rule, the 
Exchange will adopt the definition of ``bona fide error'' found in 
Regulation NMS's exemption for error correction transactions.\6\ Thus, 
a bona fide error is:
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    \6\ Securities Exchange Act Release No. 55884 (June 8, 2007), 72 
FR 32926, 32927 (June 14, 2007) (Order Exempting Certain Error 
Correction Transactions from Rule 611 of Regulation NMS under the 
Securities Exchange Act of 1934).
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    (i) The inaccurate conveyance or execution of any term of an order 
including, but not limited to, price, number of shares or other unit of 
trading; identification of the security; identification of the account 
for which securities are purchased or sold; lost or otherwise misplaced 
order tickets; short sales that were instead sold long or vice versa; 
or the execution of an order on the wrong side of a market; (ii) the 
unauthorized or unintended purchase sale or allocation of securities or 
the failure to follow specific client instructions; (iii) the incorrect 
entry of data into relevant systems, including reliance on incorrect 
cash positions, withdrawals, or securities positions reflected in an 
account; or (iv) a delay, outage, or failure of a communication system 
used to transmit market data prices or to facilitate the delivery or 
execution of an order. \7\
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    \7\ Id.
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Minimum Price Improvement Standards
    The proposed rule change establishes the minimum amount of price 
improvement necessary for a Member to execute an order on a proprietary 
basis when holding an unexecuted limit order in that same security 
without being required to execute the held limit order.
    In addition, if the minimum price improvement standards set forth 
in proposed Interpretation and Policy .06, paragraphs (a) through (g) 
would trigger the protection of a pending customer limit order, any 
better-priced customer limit order(s) must also be protected under this 
Rule, even if those better-priced limit orders would not be directly 
triggered under these minimum price improvement standards.
Order Handling Procedures
    The proposed rule change provides that a Member must make every 
effort to execute a marketable customer order that it receives fully 
and promptly. A Member holding a marketable customer order that has not 
been immediately executed would have to make every effort to cross such 
order with any other order received by the Member on the other side of 
the market, up to the size of such order at a price that is no less 
than the best bid and no greater than the best offer at the time that 
the subsequent order is received by the Member and that is consistent 
with the terms of the orders. If a Member were holding multiple orders 
on both sides of the market that have not been executed, the Member 
would have to make every effort to cross or otherwise execute such 
orders in a manner reasonable and consistent with the objectives of the 
proposed Rule and with the terms of the orders. A Member could satisfy 
the crossing requirement by contemporaneously buying from the seller 
and selling to the buyer at the same price.
Trading Outside Normal Market Hours
    Under the proposed amendments to Rule 12.6, a Member generally 
could limit the life of a customer order to the period of normal market 
hours of 9:30 a.m. to 4:00 p.m. Eastern Time. However, if the customer 
and Member agreed to the processing of the customer's order outside 
normal market hours, the protections of amended Rule 12.6 would apply 
to that customer's order at all times the customer order is executable 
by the Member.
2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \8\ in general, and furthers the objectives of Section 
6(b)(5) of the Act \9\ in particular, in that it is designed to promote 
just and equitable principles of trade, to foster cooperation and 
coordination with persons engaged in 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. The Exchange believes that 
amending the rule to conform to FINRA Rule 5320 will contribute to 
investor protection by defining important parameters by which Members 
must abide when trading proprietarily while holding customer limit and 
market orders, and foster cooperation by harmonizing requirements 
across self-regulatory organizations. The Exchange also believes that 
including this rule will reinforce the importance of and ensure that 
Members are aware of these requirements.
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    \8\ 15 U.S.C. 78f(b).
    \9\ 15 U.S.C. 78f(b)(5).
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 B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act. To the contrary, the Exchange 
believes that the proposal enhances cooperation among markets and other 
trading venues to promote fair and orderly markets and to protect the 
interests of the public and of investors. Specifically, by aligning the 
Exchange's customer protection rules with those of FINRA and other 
exchanges,\10\ the proposed rule change will reduce the complexity of 
the customer order protection rules for those Members that are also 
subject to the customer order protection rules of FINRA and other 
exchanges. As a result, the proposed rule will help assure the 
protection of customer orders without imposing undue regulatory costs 
on industry participants.
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    \10\ See, e.g., Securities Exchange Act Release No. 64418 (May 
6, 2011), 76 FR 27735 (May 12, 2011) (SR-CHX-2011-08) (notice of 
filing and immediate effectiveness of proposed rule change of 
Chicago Stock Exchange, Inc. to adopt customer order protection 
language consistent with FINRA Rule 5320); Securities Exchange Act 
Release No. 65165 (August 18, 2011), 76 FR 53009 (August 24, 2011) 
(SR-NYSEAmex-2011-059) (notice of filing and immediate effectiveness 
of proposed rule change of NYSE Amex LLC (now known as NYSE MKT LLC) 
to adopt customer order protection language that is substantially 
the same as FINRA Rule 5320); and Securities Exchange Act Release 
No. 65166 (August 18, 2011), 76 FR 53012 (August 24, 2011) (SR-
NYSEArca-2011-057) (notice of filing and immediate effectiveness of 
proposed rule change of NYSE Arca, Inc. to adopt customer order 
protection language that is substantially the same as FINRA Rule 
5320).
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C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    The Exchange has neither solicited nor received written comments on 
the proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to

[[Page 62831]]

90 days of such date if it finds such longer period to be appropriate 
and publishes its reasons for so finding or (ii) as to which the self-
regulatory organization consents, the Commission will:
    (A) By order approve or disapprove the proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

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 Number SR-BATS-2013-056 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 Number SR-BATS-2013-056. This file 
number 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 proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change 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 filing also will be available 
for inspection and copying at the principal offices of the Exchange. 
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 Number SR-BATS-2013-056, 
and should be submitted on or before November 12, 2013.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-24655 Filed 10-21-13; 8:45 am]
BILLING CODE 8011-01-P


