
[Federal Register Volume 78, Number 250 (Monday, December 30, 2013)]
[Notices]
[Pages 79524-79530]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-31131]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-71176; File No. SR-NYSEArca-2013-107]


Self-Regulatory Organizations; NYSE Arca, Inc.; Order Granting 
Approval to Proposed Rule Change To Establish a Retail Liquidity 
Program on a Pilot Basis for a Period of One Year From the Date of 
Implementation and Granting Request for a Limited Exemption From Rule 
612 of Regulation NMS

December 23, 2013.

I. Introduction

    On October 22, 2013, NYSE Arca, Inc. (``NYSE Arca'' 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 establish a Retail Liquidity Program 
(``Program'') on a pilot basis for a period of one year from the date 
of implementation. The proposed rule change was published for comment 
in the Federal Register on November 13, 2013.\3\ The Commission did not 
receive any comments on the proposed rule

[[Page 79525]]

change. In connection with the proposal, the Exchange requested 
exemptive relief from Rule 612 of Regulation NMS,\4\ 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.\5\
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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. 70824 (Nov. 6, 
2013), 78 FR 68116 (``Notice'').
    \4\ 17 CFR 242.612 (``Sub-Penny Rule'').
    \5\ See Letter from Janet McGinness, EVP & Corporate Secretary, 
NYSE Euronext, to Elizabeth M. Murphy, Secretary, Commission (Oct. 
11, 2013) (``Request for Sub-Penny Rule Exemption'').
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    This order approves the proposed rule change and grants the 
exemption from the Sub-Penny Rule sought by the Exchange in relation to 
the proposed rule change.

II. Description of the Proposals

Overview

    The Exchange is proposing a 12-month pilot program to attract 
additional retail order flow to the Exchange, while also providing the 
potential for price improvement to this order flow. The Program would 
be limited to trades occurring at prices equal to or greater than $1.00 
per share.\6\ The Program would include NYSE Arca-listed securities and 
UTP Securities, but it would exclude NYSE-listed securities.
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    \6\ The Exchange notes that certain orders submitted to the 
Program designated as eligible to interact with liquidity outside of 
the Program--Type 2 Retail Orders, which are discussed below--could 
execute at prices below $1.00 if they do in fact execute against 
liquidity outside of the Program.
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    Under the proposed Program, a new class of market participants 
called Retail Liquidity Providers (``RLPs'') would be able to provide 
potential price improvement to designated retail orders by submitting a 
Retail Price Improvement Order (``RPI Order''), which would be a non-
displayed order that is priced better than the Exchange's best 
protected bid or offer (``PBBO'').\7\ RLPs could receive special 
execution fees for executing against retail orders in exchange for 
satisfying certain specified quoting obligations.\8\ Other Exchange 
member organizations \9\ would be allowed, but not required, to submit 
RPI Orders. When there is an RPI Order in a particular security, the 
Exchange would disseminate an indicator, called the Retail Liquidity 
Identifier, to indicate that such interest exists. In response to the 
indicator, a new class of market participants known as Retail Member 
Organizations (``RMOs'') could submit a new type of order, called a 
Retail Order, to the Exchange. A Retail Order would interact, to the 
extent possible, with available contra-side RPI Orders and then may 
interact with other liquidity on the Exchange or elsewhere, depending 
on the Retail Order's instructions. The Exchange would approve ETP 
Holders to be RLPs or RMOs.
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    \7\ The terms protected bid and protected offer would have the 
same meaning as defined in Rule 600(b)(57) of Regulation NMS. Rule 
600(b)(57) of Regulation NMS defines ``protected bid'' and 
``protected offer'' as ``a quotation in an NMS stock that: (i) [i]s 
displayed by an automated trading center; (ii) [i]s disseminated 
pursuant to an effective national market system plan; and (iii) [i]s 
an automated quotation that is the best bid or best offer of a 
national securities exchange, the best bid or best offer of the 
Nasdaq Stock Market, Inc., or the best bid or best offer of a 
national securities association other than the best bid or best 
offer of the Nasdaq Stock Market, Inc.'' 17 CFR 242.600(b)(57).
    \8\ The Exchange stated in its filing that it would submit a 
separate proposal to amend its Price List to reflect the fees and 
credits connected to the program.
    \9\ NYSE Arca refers to its members as Equity Trading Permit 
(``ETP'') Holders.
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Types of Orders and the Retail Liquidity Identifier

    An RPI Order would be non-displayed interest in NYSE Arca-listed 
securities and UTP Securities, excluding NYSE-listed (Tape A) 
securities, that is priced more aggressively than the PBBO by at least 
$0.001 per share and that is identified as an RPI Order in a manner 
prescribed by the Exchange. RPI Orders would be entered at a single 
limit price, rather than being pegged to the PBBO, although an RPI 
Order could also be designated as a Mid-Point Passive Liquidity 
(``MPL'') Order, in which case the order would re-price as the PBBO 
changes.\10\ RPI Orders would remain non-displayed and could only 
execute against Retail Orders.
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    \10\ RPI Orders not designated as MPL Orders would alternatively 
need to be designated as a PL Order. As noted above, supra note 12, 
MPL and PL Orders are defined in Exchange Rule 7.31(h).
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    When an RPI Order priced at least $0.001 better than the Exchange's 
PBBO 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. The identifier would 
be disseminated through the Consolidated Quotation System (``CQS''), 
the UTP Quote Data Feed, and the Exchange's proprietary data feed. The 
identifier would reflect the symbol for a particular security and the 
side (buy or sell) of the RPI Order, but it would not include the price 
or size of such interest.
    A Retail Order would be an agency or riskless principal \11\ order 
that originates from a natural person and is submitted to the Exchange 
by an RMO, provided that no change is made to the terms of the order 
with respect to price (except in the case of a market order being 
changed to a marketable limit order) or side of market and provided 
that the order does not originate from a trading algorithm or any other 
computerized methodology. Retail Orders could be entered in sizes that 
are odd lots, rounds lots, or mixed lots.
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    \11\ In order to qualify as a ``Retail Order,'' a ``riskless 
principal'' order must satisfy the criteria set forth in FINRA Rule 
5320.03. RMOs that submit riskless principal orders as Retail Orders 
must maintain supervisory systems to reconstruct such orders in a 
time-sequenced manner, and the RMOs must submit reports, 
contemporaneously with the execution of the facilitated orders, that 
identify such trades as riskless principal.
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    Under the proposal, an RMO that submits a Retail Order could choose 
one of two designations to dictate how that order would interact with 
available contra-side interest.
    First, a Retail Order could interact only with available contra-
side RPI Orders, as well as other non-displayed liquidity \12\ and 
displayable odd-lot interest priced better than the PBBO on the 
opposite side of the Retail Order, excluding contra-side Retail Orders. 
The Exchange would label this a Type 1 Retail Order, and such an order 
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.
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    \12\ Such other non-displayed liquidity would include, for 
example, Passive Liquidity (``PL'') Orders and Mid-Point Passive 
Liquidity (``MPL'') Orders. These orders are defined in Exchange 
Rule 7.31(h). However, any Retail Order could be designated with a 
``No Midpoint Execution'' modifier, pursuant to existing Exchange 
Rule 7.31(h)(5); an order so designated would not execute against 
resting MPL Orders but would execute against eligible RPIs that are 
also designated as MPL Orders.
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    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 
and, if designated as eligible for routing, would route to other 
markets in compliance with Regulation NMS. The Exchange would label 
this a Type 2 Retail Order. Type 2 orders could be marked as Immediate 
or Cancel, Day, or Market. A Type 2 IOC order would interact first with 
available contra-side RPI Orders and other price improving liquidity, 
excluding contra-side Retail Orders, and then any remaining portion of 
the Retail Order would be executed as a limit order marked as an IOC, 
pursuant to Exchange Rule 7.31(e)(2). For Type 2 Day orders, any shares 
that remain after executing against contra-side RPI Orders or other 
price-improving liquidity would

[[Page 79526]]

execute against other liquidity available on the Exchange or be routed 
to other market centers for execution; any remaining portion of the 
order would thereafter post to the NYSE Arca Book.\13\ Type 2 Market 
orders would execute first against RPI Orders or other price-improving 
liquidity, and they would then be executed as a typical Exchange Market 
Order.\14\
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    \13\ Exchange Rule 1.1(a) defines the ``NYSE Arca Book'' as 
``the NYSE Arca Marketplace's electronic file of orders, which 
contains all the User's orders in each of the Directed Order, 
Display Order, Working Order and Tracking Order Processes.''
    \14\ The Exchange noted that Type 2 Market orders would be 
subject to the Exchange's trading collars. See NYSE Arca Equities 
Rule 7.31(a).
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Priority and Allocation

    Under proposed NYSE Arca Equities Rule 7.44(l), the Exchange would 
rank and allocate RPI Orders in a particular security together with all 
other non-displayed interest according to their price first and then, 
at any given price point, by their time of entry into the system.\15\ 
Any displayable odd-lot interest priced between the PBBO would be 
ranked ahead of any RPIs and other non-displayed interest at a given 
price point.
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    \15\ The Exchange sets forth its price-time priority scheme in 
its Rule 7.36.
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    Following execution against a Retail Order, any remaining 
unexecuted portion of an RPI Order would remain available to interact 
with other incoming Retail Orders if the remainder of the RPI Order 
were at an eligible price, i.e., better than the PBBO by at least 
$0.001. Any remaining unexecuted portion of a Retail Order would 
cancel, execute, or post to the NYSE Arca Book in accordance with its 
order type designation, as explained above and set forth in proposed 
Exchange Rule 7.44(k).

Retail Member Organizations

    In order to become an RMO, an ETP Holder must conduct a retail 
business or handle retail orders on behalf of another broker-dealer. 
Any ETP Holder 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 substantially all orders submitted by 
the ETP Holder as Retail Orders would meet the qualifications for such 
orders under proposed Exchange Rule 7.44; and (3) supporting 
documentation sufficient to demonstrate the retail nature and 
characteristics of the applicant's order flow.\16\ If the Exchange 
disapproves the application, it would provide written notice to the ETP 
Holder. The disapproved applicant could appeal the disapproval as 
provided below or re-apply 90 days after the disapproval notice is 
issued by the Exchange. An RMO also could voluntarily withdraw from RMO 
status at any time by giving written notice to the Exchange.
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    \16\ 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 its 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 an 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 ETP 
Holder 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 to require the ETP Holder to monitor whether orders entered as 
Retail Orders meet the applicable requirements. If an RMO represents 
Retail Orders from another broker-dealer customer, the RMO's 
supervisory procedures must be reasonably designed to assure that the 
Retail Orders it receives from the broker-dealer customer 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. 
The representation must state that entry of Retail Orders will be in 
compliance with the requirements of this rule. The RMO must also 
monitor whether its broker-dealer customer's Retail Order flow 
continues to meet the applicable requirements.\17\
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    \17\ The Exchange represents that it or another self-regulatory 
organization on behalf of the Exchange will review an RMO's 
compliance with these requirements through an exam-based review of 
the RMO's internal controls. See Notice, supra note 3, 78 FR at 
68117 n.10.
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Retail Liquidity Provider Qualifications and Admission

    To qualify as an RLP under proposed Exchange Rule 7.44(c), an ETP 
Holder must be approved as a Market Maker or Lead Market Maker \18\ on 
the Exchange and demonstrate an ability to meet the requirements of a 
being an RLP (discussed below). Moreover, the ETP Holder must have the 
ability to accommodate Exchange-supplied designations that identify to 
the Exchange RLP trading activity in assigned RLP securities and must 
have adequate trading infrastructure and technology to support 
electronic trading.
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    \18\ The requirements for Market Makers are generally set forth 
in NYSE Arca Equities Rule 7. The terms ``Market Maker'' and ``Lead 
Market Maker'' are defined in NYSE Arca Equities Rule 1.1 (v) and 
(ccc), respectively.
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    An ETP Holder must submit an application with supporting 
documentation to the Exchange. Thereafter, the Exchange would notify 
the ETP Holder as to whether it was approved as an RLP. More than one 
member organization could act as an RLP for a security, and an ETP 
Holder could act as an RLP for more than one security. An ETP Holder 
could ask to be assigned certain securities. Once approved, an RLP must 
establish connectivity with relevant Exchange systems prior to trading.
    The Exchange would notify an ETP Holder in writing if the Exchange 
does not approve that firm's application to become an RLP. The ETP 
Holder could then request an appeal as provided below. The ETP Holder 
could also reapply 90 days after the Exchange issues the disapproval 
notice.
    Once approved, an RLP could withdraw by providing notice to the 
Exchange. The withdrawal would become effective when the Exchange 
reassigns the securities to another RLP, but no later than 30 days 
after the Exchange receives the withdrawal notice. In the event that 
the Exchange takes longer than 30 days to reassign the securities, the 
withdrawing RLP would have no further obligations.

Retail Liquidity Provider Requirements

    The proposed rule changes would impose several requirements on 
RLPs. First, under proposed Rule 7.44(f), an RLP could enter, in its 
role as an RLP, an RPI Order electronically into Exchange systems only 
in its assigned securities.\19\ In order to be eligible for special 
execution fees,\20\ an RLP must maintain RPI Orders that are better 
than the PBBO at least 5% of the trading day for each assigned 
security. An RLP would not receive special execution fees during a 
month in which it had not satisfied its 5% quoting requirement.
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    \19\ An RLP could enter RPI Orders into Exchange systems and 
facilities for securities to which it was not assigned; however, it 
would be not be doing so in its role as RLP and thus would not be 
eligible for execution fees that are lower than non-RLP rates for 
securities to which it was not assigned.
    \20\ As noted above, supra note 8, the Exchange plans to submit 
a separate filing to establish the levels of fees and credits 
associated with the program.
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    To calculate the 5% quoting requirement, the Exchange would 
determine the average percentage of time an RLP maintains an RPI Order 
in each assigned security during the regular trading day on a daily and

[[Page 79527]]

monthly basis. The Exchange would use the following definitions. The 
``Daily Bid Percentage'' would be calculated by determining the 
percentage of time an RLP maintains an RPI Order priced higher than the 
best protected bid during each trading day for a calendar month. The 
``Daily Offer Percentage'' would be calculated by determining the 
percentage of time an RLP maintains an RPI Order priced lower than the 
best protected offer during each trading day for a calendar month. The 
``Monthly Average Bid Percentage'' would be calculated for each 
security by summing the security's ``Daily Bid Percentages'' for each 
trading day in a calendar month, then dividing the resulting sum by the 
total number of trading days in that month. The ``Monthly Average Offer 
Percentage'' would be calculated for each security by summing the 
security's ``Daily Offer Percentages'' for each trading day in a 
calendar month, then dividing the resulting sum by the total number of 
trading days in that month.
    The proposal specifies that only RPI Orders entered through the 
trading day would be used when determining compliance with the 5% 
quoting requirements. Further, an RLP would have an initial two-month 
grace period, so that the Exchange would impose the 5% quoting 
requirements on the first day of the third consecutive calendar month 
after the member organization began operation as an RLP.

Penalties for Failure To Meet Requirements

    The proposal provides for penalties when an RLP or RMPO fails to 
meet the requirements of the rule.
    If an RLP fails to meet the 5% quoting requirements in any assigned 
security for three consecutive months, the Exchange, in its sole 
discretion, may: (1) Revoke the assignment of any or all of the 
affected securities; (2) revoke the assignment of unaffected 
securities; or (3) disqualify the ETP Holder from its status as an 
RLP.\21\ If the Exchange moves to disqualify an ETP Holder as an RLP, 
then the Exchange would notify the ETP Holder in writing one calendar 
month prior to the determination. Likewise, the Exchange would notify 
the ETP Holder in writing if the Exchange ultimately determined to 
disqualify the ETP Holder as an RLP. An RLP that is disqualified may 
appeal as provided below or reapply.
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    \21\ Additionally, as noted above, an RLP that failed to meet 
its quoting obligations in a given month would not be eligible to 
receive special execution fees for its RPI Orders for that month.
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    With respect to RMOs, the Exchange could disqualify an ETP Holder 
from its RMO status if the Retail Orders submitted by the RMO did not 
comply with the requirements of the proposed rule. The Exchange would 
have sole discretion to make such a determination. The Exchange would 
provide written notice to the RMO when a disqualification determination 
was made. Similar to a disqualified RLP, a disqualified RMO could 
appeal as provided below or reapply for RMO status.

Appeal Process

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

Comparison With Existing Retail Programs on Other Markets

    As the Exchange noted in its filing, the proposal is based on the 
New York Stock Exchange's Retail Liquidity Program.\22\ It is also 
shares features with similar retail programs adopted by BATS Y-Exchange 
(``BYX'') \23\ and The NASDAQ Stock Market (``NASDAQ'').\24\
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    \22\ See Securities Exchange Act Release No. 67347 (July 3, 
2012), 77 FR 40673 (July 10, 2012) (SR-NYSE-2011-55; SR-NYSEAmex-
2011-84) (``NYSE RLP Approval Order''). In the same order, the 
Commission also approved a nearly identical Retail Liquidity Program 
for NYSE MKT LLC (which was known as NYSE Amex LLC at the time it 
filed its proposal). The initial one-year term of the NYSE RLP pilot 
came to an end on July 31, 2013, and it was extended for a second 
pilot year, until July 31, 2014. See Securities Exchange Act Release 
No. 70096 (August 2, 2013), 78 FR 48535 (August 8, 2013).
    \23\ See Securities Exchange Act Release No. 68303 (Nov. 27, 
2012), 77 FR 71652 (Dec. 3, 2012) (``BYX RPI Approval Order'').
    \24\ See Securities Exchange Act Release No. 69837 (Feb. 15, 
2013), 78 FR 12397 (Feb. 22, 2013) (``NASDAQ RPI Approval Order'').
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    The Exchange's proposal differs from the NYSE RLP in three key 
ways. First, the Exchange's proposal would allow all incoming Retail 
Orders to execute against resting RPI Orders and other resting price 
improving liquidity, just as the BYX and NASDAQ retail programs do.\25\ 
With the NYSE RLP, in contrast, a Type 1 Retail Order, will interact 
only with available contra-side RPI Orders and will not interact with 
other available contra-side interest in the NYSE's systems.\26\ Second, 
the Exchange could provide price improvement to an incoming Retail 
Order at multiple price levels. This is similar to how the BYX and 
NASDAQ programs operate, and it differs from the NYSE RLP, which 
executes an incoming Retail Order at a single clearing price level.\27\ 
Finally, because of technological limitations, the Exchange would not 
offer the ability for RLPs to enter RPI Orders that track the PBBO, as 
they often do in the NYSE RLP.\28\
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    \25\ See BYX Rules 11.24(f)(1) and (2) and NASDAQ Rules 
4780(f)(1) and (2) (providing that Retail Orders may execute against 
both RPIs and other price improving interest).
    \26\ See NYSE Rule 107C(k)(1). Additionally, pursuant to NYSE 
Rules 107C(k)(2) and 107C(k)(3), a Type 2 Retail Order and a Type 3 
Retail Order can interact with other non-RPI interest in the NYSE 
systems; however, such interaction only occurs after a Retail Order 
first executes against RPI Orders.
    \27\ See Notice, supra note 3, 78 FR at 68121 (explaining this 
distinction from the NYSE RLP and referencing the similarity with 
BYX); see also Nasdaq RPI Approval Order, supra note 24, 78 FR at 
12398 (explaining that NASDAQ's program would execute potentially at 
multiple price levels, unlike the NYSE RLP).
    \28\ See Notice, supra note 3, 78 FR at 68121 (discussing the 
three key distinctions in greater detail). See also supra note 12 
and accompanying text (noting that RPI Orders also designated as MPL 
Orders would re-price as the PBBO changes).
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III. Discussion and Commission Findings

    After careful review of the proposal, the Commission finds that the 
proposed rule changes are consistent with the requirements of the Act 
and the rules and regulations thereunder that are applicable to a 
national securities exchange. In particular, the Commission finds that 
the proposed rule change, subject to its term as a pilot, is consistent 
with Section 6(b)(5) of the Act,\29\ 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

[[Page 79528]]

investors and the public interest; and not be designed to permit unfair 
discrimination between customers, issuers, brokers or dealers.
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    \29\ 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 requirements of the Act because the 
Program is reasonably designed to benefit retail investors by providing 
price improvement to retail order flow.\30\ 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.
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    \30\ As discussed above, supra notes 22 to 28 and accompanying 
text, the Commission recently approved similar programs for NYSE, 
NYSE MKT, BATS-Y Exchange, and The NASDAQ Stock Market.
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    Currently, most marketable retail order flow is executed in the OTC 
markets, pursuant to bilateral agreements, without ever reaching a 
public exchange. The Commission recently noted that ``a very large 
percentage of marketable (immediately executable) order flow of 
individual investors'' is executed, or ``internalized,'' by broker-
dealers in the OTC markets.\31\ A recent review of the order flow of 
eight retail brokers revealed that nearly 100% of their customer market 
orders were routed to OTC market makers.\32\ 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.\33\
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    \31\ See Securities Exchange Act Release No. 61358 (Jan. 14, 
2010), 75 FR 3594, 3600 (Jan. 21, 2010) (``Concept Release on Equity 
Market Structure'').
    \32\ See id.
    \33\ See id.
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    To the extent that the Program may provide price improvement to 
retail orders that equals what would be provided under OTC 
internalization arrangements, the Program could benefit retail 
investors. To better understand the Program's potential impact, data 
concerning investor benefits, including the level of price improvement 
provided by the Program, will be submitted by the Exchange \34\ and 
would be reviewed by the Commission prior to any extension of the 
Program beyond the proposed one-year pilot term, or any permanent 
approval of the Program.
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    \34\ The Exchange committed in the proposal to ``produce data 
throughout the pilot, which would include statistics about 
participation, the frequency and level of price improvement provided 
by the Program, and any effects on the broader market structure.'' 
See Notice, supra note 3, 78 FR at 68120.
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    The Program proposes to create additional price improvement 
opportunities for retail investors by segmenting 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 PBBO. The Commission finds that, while the Program 
would treat retail order flow differently from order flow submitted by 
other market participants, such segmentation would not be inconsistent 
with Section 6(b)(5) of the Act, which requires that the rules of an 
exchange are not designed to permit unfair discrimination. The 
Commission previously has recognized that the markets generally 
distinguish between individual retail investors, whose orders are 
considered desirable by liquidity providers because such 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.\35\ 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.\36\
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    \35\ See, e.g., Nasdaq RPI Approval Order, supra note 24; BATS 
RPI Approval Order, supra note 23; and NYSE RLP Approval Order, 
supra note 22.
    \36\ See, e.g., id.
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    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.
    The Commission notes that the Program might also create a desirable 
opportunity for institutional investors to interact with retail order 
flow that they are not able to reach currently. ETP Holders that are 
not RLPs can seek to interact with Retail Orders by submitting RPI 
Orders. 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.
    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.\37\ As discussed above, 
the Commission believes this Program will promote competition for 
retail order flow by allowing ETP Holders, either as RLPs, or on an ad 
hoc basis, 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, or 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, which may promote capital 
formation.
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    \37\ 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.\38\ The 
Commission finds that the Program provides an objective process by 
which an ETP Holder could become an RMO and that it provides 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 or riskless principal order 
that originates from a natural person and not from a trading algorithm 
or any other computerized methodology. Furthermore, a Retail Order must 
be submitted by an 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 that 
qualify under the Program. If an ETP Holder's application to become an 
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 order flow submitted into the Program is retail order flow, 
thereby promoting just and equitable principles of trade and protecting 
investors and the public interest, while also providing an

[[Page 79529]]

objective process through which ETP Holders may become RMOs.
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    \38\ 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, e.g., NYSE RLP Approval 
Order, supra note 22, 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 
an 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 an RPI Order priced better than the PBBO and should 
provide market participants with more information about the 
availability of price improvement opportunities for retail orders than 
is currently available.\39\
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    \39\ As the Commission noted when approving the comparable 
retail programs of other exchanges, the Commission believes that the 
Program will not create any best execution challenges for brokers 
that are not already present in today's markets. A broker's best 
execution obligations are determined by a number of facts and 
circumstances, including: (1) the character of the market for the 
security (e.g., price, volatility, relative liquidity, and pressure 
on available communications); (2) the size and type of transaction; 
(3) the number of markets checked; (4) accessibility of the 
quotation; and (5) the terms and conditions of the order which 
result in the transaction. See, e.g., NYSE RLP Approval Order, supra 
note 22, 77 FR at 40680 n.75 (citing FINRA Rule 5310).
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    The Exchange stated that the proposed Program, which will operate 
similar to the retail programs in place at the NYSE, NYSE MKT, BYX, and 
NASDAQ, should encourage additional liquidity and competition among 
exchange venues, while providing the potential for price improvement to 
retail investors.\40\ The Exchange also noted that the Program would 
differ from the existing NYSE RLP in that it would provide the maximum 
price improvement available to incoming Retail Orders by allowing them 
to interact with available contra-side RPI Orders and other price-
improving, contra-side interest. Moreover, the Exchange's Program would 
allow Retail Orders to execute at multiple price levels, as opposed to 
a single clearing price level. The Commission finds that the Program is 
reasonably designed to enhance competition among market participants 
and encourage competition among exchange venues. The Commission finds 
further that the distinctions between the Exchange's Program and the 
other approved retail 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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    \40\ See notice, supra note 3, 78 FR at 68122.
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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.'' \41\ 
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 that the Exchange will propose any 
modifications to the Program that may be necessary or appropriate.
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    \41\ See supra note 34.
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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 that the filing of a proposed rule change would 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,\42\ 
the Commission hereby grants the Exchange a limited exemption from the 
Sub-Penny Rule to operate the Program. For the reasons discussed below, 
the Commission determines that such action is necessary or appropriate 
in the public interest and that it is consistent with the protection of 
investors. The exemption shall operate for a period of 12 months, 
beginning with the effectiveness of the proposed rule change approved 
today.
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    \42\ 17 CFR 242.612(c).
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    When the Commission adopted the Sub-Penny Rule in 2005, it 
identified a variety of problems caused by sub-penny prices 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.\43\
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    \43\ 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.'' \44\ 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 
consistent with the protection of investors.
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    \44\ Id. at 37553.
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    The Commission believes that the Exchange's proposal is 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.\45\ An 
internalizing

[[Page 79530]]

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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    \45\ 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 associated 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 Exchange 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.'' \46\ 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.'' \47\ 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.\48\
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    \46\ See Request for Sub-Penny Rule Exemption, supra note 5, at 
3, n.5.
    \47\ See supra note 34 and accompanying text.
    \48\ 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,\49\ that the proposed rule change (SR-NYSEArca-2013-107) be, and 
hereby is, approved on a one-year pilot basis.
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    \49\ 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 to allow it to accept and rank orders priced equal to 
or greater than $1.00 per share in increments of $0.001, in the manner 
described in the proposed rule changes above, on a one-year pilot basis 
beginning with the effectiveness of the proposed rule change.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\50\
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    \50\ 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. 2013-31131 Filed 12-27-13; 8:45 am]
BILLING CODE 8011-01-P


