[Federal Register Volume 83, Number 151 (Monday, August 6, 2018)]
[Notices]
[Pages 38434-38441]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-16724]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83753; File No. SR-FINRA-2018-015]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Granting Approval of a Proposed Rule Change To 
Amend FINRA Rule 6433 To Adopt the OTC Quotation Tier Pilot as 
Permanent

July 31, 2018.

I. Introduction

    On April 20, 2018, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') 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 amend FINRA Rule 6433 to adopt as permanent the 
minimum quotation sizes that are applicable to quotations in over-the-
counter (``OTC'') equity securities and that were implemented on a 
pilot basis. The proposed rule change was published for comment in the 
Federal Register on May 7, 2018.\3\ The Commission received one comment 
letter on the proposed rule change.\4\ On June 13, 2018, pursuant to 
Section 19(b)(2) of the Act,\5\ the Commission designated a longer 
period within which to approve the proposed rule change, disapprove the 
proposed rule change, or institute proceedings to determine whether to 
disapprove the proposed rule change.\6\ In a letter dated July 5, 2018, 
FINRA responded to the comment letter.\7\
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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. 83129 (April 30, 
2018), 83 FR 20131 (``Notice'').
    \4\ See Letter from Eugene P. Torpey, Chief Compliance Officer, 
Vandham Securities Corp., dated May 10, 2018. Comments on the 
proposed rule change are available at https://www.sec.gov/comments/sr-finra-2018-015/finra2018015.htm.
    \5\ 15 U.S.C. 78s(b)(2).
    \6\ See Securities Exchange Act Release No. 83422, 83 FR 28483 
(June 19, 2018).
    \7\ See Letter from Racquel L. Russell, Associate General 
Counsel, FINRA, to Brent J. Fields, Secretary, Commission (``FINRA 
Letter''). The FINRA Letter is available at https://www.sec.gov/comments/sr-finra-2018-015/finra2018015-4002848-167246.pdf.

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[[Page 38435]]

    This order approves the proposal.

II. FINRA's Description of the Proposed Rule Change

    FINRA proposes to amend FINRA Rule 6433 (Minimum Quotation Size 
Requirements for OTC Equity Securities) to adopt as permanent the 
minimum quotation sizes applicable to quotations in OTC equity 
securities \8\ that were proposed pursuant to File No. SR-FINRA-2011-
058 \9\ and implemented on a pilot basis on November 12, 2012 (``Tier 
Size Pilot'' or ``Pilot''). The Pilot initially was approved for a one-
year term,\10\ has been extended a number of times,\11\ and currently 
is scheduled to expire on December 7, 2018.\12\
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    \8\ An OTC equity security is an equity security that is not an 
``NMS Stock'' as defined in Rule 600(b)(47) of Regulation NMS; 
provided, however, that the term ``OTC equity security'' shall not 
include any Restricted Equity Security. See FINRA Rule 6420(f).
    \9\ See Securities Exchange Act Release No. 65568 (October 14, 
2011), 76 FR 65307 (October 20, 2011) (Notice of Filing of File No. 
SR-FINRA-2011-058) (``Original Proposal''). Comments on the Original 
Proposal are available at https://www.sec.gov/comments/sr-finra-2011-058/finra2011058.shtml.
    \10\ See Securities Exchange Act Release No. 67208 (June 15, 
2012), 77 FR 37458 (June 21, 2012) (Notice of Filing of Amendment 
No. 2 and Order Granting Accelerated Approval of a Proposed Rule 
Change, as Modified by Amendment Nos. 1 and 2, To Amend FINRA Rule 
6433 (Minimum Quotation Size Requirements for OTC Equity 
Securities)) (``Order Approving Tier Size Pilot'').
    \11\ See Securities Exchange Act Release No. 70839 (November 8, 
2013), 78 FR 68893 (November 15, 2013) (Notice of Filing and 
Immediate Effectiveness of a Proposed Rule Change to Extend the Tier 
Size Pilot to November 14, 2014; File No. SR-FINRA-2013-049); 
Securities Exchange Act Release No. 73299 (October 3, 2014), 79 FR 
61120 (October 9, 2014) (Notice of Filing and Immediate 
Effectiveness of a Proposed Rule Change to Extend the Tier Size 
Pilot to February 13, 2015; File No. SR-FINRA-2014-041); Securities 
Exchange Act Release No. 74251 (February 11, 2015), 80 FR 8741 
(February 18, 2015) (Notice of Filing and Immediate Effectiveness of 
a Proposed Rule Change to Extend the Tier Size Pilot to May 15, 
2015; File No. SR-FINRA-2015-002); Securities Exchange Act Release 
No. 74927 (May 12, 2015), 80 FR 28327 (May 18, 2015) (Notice of 
Filing and Immediate Effectiveness of a Proposed Rule Change to 
Extend the Tier Size Pilot to August 14, 2015; File No. SR-FINRA-
2015-010); Securities Exchange Act Release No. 75639 (August 7, 
2015), 80 FR 48615 (August 13, 2015) (Notice of Filing and Immediate 
Effectiveness of a Proposed Rule Change to Extend the Tier Size 
Pilot to December 11, 2015; File No. SR-FINRA-2015-028); Securities 
Exchange Act Release No. 76519 (November 24, 2015), 80 FR 75155 
(December 1, 2015) (Notice of Filing and Immediate Effectiveness of 
a Proposed Rule Change to Extend the Tier Size Pilot to June 10, 
2016; File No. SR-FINRA-2015-051); Securities Exchange Act Release 
No. 77923 (May 26, 2016), 81 FR 35432 (June 2, 2016) (Notice of 
Filing and Immediate Effectiveness of a Proposed Rule Change to 
Extend the Tier Size Pilot to December 9, 2016; File No. SR-FINRA-
2016-016); Securities Exchange Act Release No. 79401 (November 25, 
2016), 81 FR 86762 (December 1, 2016) (Notice of Filing and 
Immediate Effectiveness of a Proposed Rule Change to Extend the Tier 
Size Pilot to June 9, 2017; File No. SR-FINRA-2016-044); Securities 
Exchange Act Release No. 80727 (May 18, 2017), 82 FR 23953 (May 24, 
2017) (Notice of Filing and Immediate Effectiveness of a Proposed 
Rule Change to Extend the Tier Size Pilot to December 8, 2017; File 
No. SR-FINRA-2017-014); and Securities Exchange Act Release No. 
82153 (November 22, 2017), 82 FR 56300 (November 28, 2017) (Notice 
of Filing and Immediate Effectiveness of a Proposed Rule Change to 
Extend the Tier Size Pilot to June 7, 2018; File No. SR-FINRA-2017-
035)
    \12\ See Securities Exchange Act Release No. 83392 (June 7, 
2018), 83 FR 27638 (June 13, 2018) (Notice of Filing and Immediate 
Effectiveness of a Proposed Rule Change to Extend the Tier Size 
Pilot to December 7, 2018; File No. SR-FINRA-2018-022).
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    According to FINRA, the Pilot tiers are designed to: (1) Simplify 
the structure of the minimum quotation sizes for OTC equity securities; 
(2) facilitate the display of customer limit orders under FINRA Rule 
6460 (Display of Customer Limit Orders) (``limit order display rule''); 
and (3) expand the scope of FINRA Rule 6433 to provide for uniform 
treatment of the types and sources of quotations that would be subject 
to FINRA Rule 6433.\13\ FINRA believes that the Pilot has resulted in 
its intended objectives, and particularly notes that the Pilot has 
yielded a significant positive result with regard to increased display 
of customer limit orders. FINRA states that, at the same time, market 
quality measures have been neutral (i.e., unchanged) or slightly 
positive (i.e., slightly improved) overall during the Pilot, as 
compared to the pre-Pilot period, as discussed more fully below. 
Accordingly, FINRA believes that it is appropriate and consistent with 
the Act to adopt the Pilot tier sizes on a permanent basis.
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    \13\ See Order Approving Tier Size Pilot, supra note 10, 77 FR 
at 37458.
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Objectives of the Pilot

    FINRA Rule 6433 sets forth the minimum quotation sizes applicable 
to the display of quotations in OTC equity securities on any inter-
dealer quotation system that permits quotation updates on a real-time 
basis. FINRA Rule 6433 provides different minimum quotation sizes that 
apply depending upon the price level of the bid or offer in the 
security.
    Prior to the Pilot, which has been in effect since November 12, 
2012,\14\ FINRA Rule 6433 provided for nine tier sizes that applied 
only to market makers' proprietary quotes. The pre-Pilot tiers ranged 
in price points from $0.00 through $2,500.01, and are shown below in 
Table 1.
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    \14\ See FINRA Regulatory Notice 12-51 (November 2012), 
available at: http://www.finra.org/industry/notices/12-51; see also 
FINRA Regulatory Notice 12-37 (August 2012), available at: http://www.finra.org/industry/notices/12-37.

                                 Table 1
------------------------------------------------------------------------
                                                           Minimum quote
                  Price (bid or offer)                     size (number
                                                            of shares)
------------------------------------------------------------------------
$0 to $0.50.............................................           5,000
$0.51 to $1.00..........................................           2,500
$1.01 to $10.00.........................................             500
$10.01 to $100.00.......................................             200
$100.01 to $200.00......................................             100
$200.01 to $500.00......................................              25
$500.01 to $1,000.00....................................              10
$1,000.01 to $2,500.00..................................               5
$2,500.01+..............................................               1
------------------------------------------------------------------------

    Under the Pilot, the number of tiers was reduced from nine to six 
tiers, and the tiers apply to all quotations displayed by market 
makers, whether representing proprietary or customer interest, as well 
as quotations displayed by non-market makers (i.e., alternative trading 
systems or any other member firm).\15\
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    \15\ FINRA initially proposed six tiers, some of which differed 
from those tiers that ultimately were adopted. However, in response 
to comments received, FINRA amended its original filing to increase 
the minimum quotation size for most price points between $0.02 and 
$1.00. FINRA stated that the amended tiers were intended to 
facilitate the display of additional liquidity by market makers. See 
Securities Exchange Act Release No. 66819 (April 17, 2012), 77 FR 
23770 (April 20, 2012) (Amendment No. 1 to File No. SR-FINRA-2011-
058); see also Original Proposal, supra note 9.
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    In addition, for price points between $1.00 and $174.99, the Pilot 
established a minimum quotation size of 100 shares, which is comparable 
to the minimums generally applicable to quotations in securities on 
equity exchanges. The Pilot also revised the smallest price point from 
$0.00 to $0.0001 to conform to the minimum quotation increments under 
FINRA Rule 6434 (Minimum Pricing Increment for OTC Equity 
Securities).\16\ The Pilot tiers that ultimately were adopted are shown 
below in Table 2.
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    \16\ FINRA Rule 6434, among other things, prohibits members from 
displaying a bid or offer in an OTC equity security in an increment 
smaller than $0.01 if the bid or offer is priced $1.00 or greater 
per share, or in an increment smaller than $0.0001 if the bid or 
offer is priced below $1.00.

                                 Table 2
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                                                           Minimum quote
                  Price (bid or offer)                     size (number
                                                            of shares)
------------------------------------------------------------------------
$0.0001 to $0.0999......................................          10,000
$0.10 to $0.1999........................................           5,000
$0.20 to $0.5099........................................           2,500

[[Page 38436]]

 
$0.51 to $0.9999........................................           1,000
$1.00 to $174.99........................................             100
$175.00+................................................               1
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    FINRA states that the Pilot was designed to facilitate the display 
of customer limit orders under FINRA's limit order display rule, which 
generally requires that OTC market makers fully display better-priced 
customer limit orders (or same-priced customer limit orders that are at 
the best bid or offer and that increase the OTC market maker's size by 
more than a de minimis amount).\17\ Pursuant to FINRA's limit order 
display rule, OTC market makers are not required to display a customer 
limit order on an inter-dealer quotation system unless doing so would 
comply with the minimum quotation size applicable to the price of the 
quotation under FINRA Rule 6433. Therefore, although a customer limit 
order otherwise would have been required to be displayed under the 
limit order display rule--for example, because it improved price or the 
size (more than a de minimis amount)--if the size of the order were 
less than the minimum quotation size prescribed by FINRA Rule 6433, the 
member would not be required to display the order. Thus, FINRA believed 
that the revisions implemented by the Pilot would improve the overall 
display of customer limit orders.
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    \17\ See FINRA Rule 6460 (Display of Customer Limit Orders).
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    For example, because the Pilot would reduce the minimum quotation 
size from 2,500 to 100 shares for securities priced at or above $1.00, 
FINRA believed that competitively priced customer limit orders, which 
tend to be smaller-sized orders, would more likely be displayed and 
potentially yield a variety of benefits, including improved price 
transparency, enhanced execution of customer limit orders, and narrower 
spreads. In addition, in a memorandum on the potential effects of the 
Pilot, Commission staff of the Division of Risk, Strategy and Financial 
Innovation (n/k/a the Division of Economic Research and Analysis 
(``DERA'')) noted that enhanced visibility of customer limit orders 
could reduce customers' execution costs.\18\
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    \18\ See Memorandum to File No. SR-FINRA-2011-058 re: FINRA 
Proposal to Reduce Minimum Quotation Size in OTC Market Tiers from 
Division of Risk, Strategy, and Financial Innovation, dated June 1, 
2012, available at: http://www.sec.gov/comments/sr-finra-2011-058/finra2011058-13.pdf (``Memorandum from Division of Risk, Strategy, 
and Financial Innovation'').
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    An additional objective of the Pilot was to expand the scope of 
FINRA Rule 6433 to apply to all member quotations on an inter-dealer 
quotation system. Prior to the Pilot, FINRA Rule 6433 applied only to 
market makers' proprietary quotes in OTC equity securities on an inter-
dealer quotation system. Under the Pilot, the minimum tier sizes apply 
to any member quotations entered on an inter-dealer quotation system 
(including quotes representing customer interest and quotations entered 
by non-market makers).

Concerns Raised Regarding FINRA's Original Proposal

    The Commission received several comments in response to FINRA's 
Original Proposal.\19\ Commenters generally were supportive of the goal 
of increased customer limit order display.\20\ However, commenters also 
raised concerns regarding the impact of the proposed revisions to the 
tiers in FINRA Rule 6433. Specifically, some commenters questioned 
whether the proposed Pilot might harm market quality by permitting 
market makers to post quotes representing minimum dollar value 
commitments that would not be financially meaningful, or otherwise 
would erode market maker liquidity in OTC equity securities.\21\ In 
addition, some commenters believed that there was not sufficient data 
analysis to support the proposed changes to the then existing tier 
sizes.\22\
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    \19\ See supra note 9.
    \20\ See Order Approving Tier Size Pilot, supra note 10.
    \21\ See id.
    \22\ See id. at 37461-62.
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    In response to commenters' concerns, FINRA filed Amendment No. 1 to 
the Original Proposal to increase the minimum quotation sizes for most 
price points between $0.02 and $1.00, and proposed that the revised 
tiers operate as a one-year pilot program instead of on a permanent 
basis. FINRA also submitted Amendment No. 2 to the Original Proposal, 
which, among other things, specified the items of data that FINRA would 
collect and provide to the Commission during the duration of the Pilot. 
These data items were:
    1. The price of the first trade of each trading day executed at or 
after 9:30:00 a.m., based on execution time.
    2. The price of the last trade of each trading day executed at or 
before 4:00:00 p.m., based on execution time.
    3. Daily share volume.
    4. Daily dollar volume.
    5. Number of limit orders from customers and in total.
    6. Percentage of the day that the size of the Best Bid or Offer 
(``BBO'') equals the minimum quote size.
    7. Number of market makers actively quoting.
    8. Number of executions from a limit order and number of limit 
orders at the BBO or better by tier size from a customer and in total.
    9. Liquidity/BBO metrics
    a. Time-weighted quoted spread.
    b. Effective spread.
    c. Time-weighted quoted depth (number of shares) at the inside.
    d. Time-weighted quoted depth (dollar value of shares) at the 
inside.
    FINRA also committed to submitting an assessment, at least 60 days 
before the end of the Pilot, that would address the impact of the 
proposed Pilot, the concerns raised by commenters during the rule 
filing process, and whether the proposed Pilot resulted in its desired 
effects.\23\
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    \23\ See Order Approving Tier Size Pilot, supra note 10.
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Pilot Assessment

    FINRA submitted an assessment on the operation of the Tier Size 
Pilot on September 13, 2013, which utilized pilot data covering the 
period from November 12, 2012 through June 30, 2013.\24\ The 2013 
Assessment, discussed in greater detail below, included a 
recommendation, based on the analysis conducted, that the Pilot tiers 
be adopted as permanent. Nonetheless, FINRA submitted proposed rule 
changes to extend the Pilot's duration to allow the effects of the 
Pilot to be more thoroughly reviewed.\25\ During this extension period, 
DERA conducted a study, dated July 28, 2017, that assessed the impact 
of the Pilot on the liquidity of OTC equity securities.\26\ Although 
the two studies covered different time periods and employed different 
methods, FINRA notes that the DERA Memo to File reported findings 
consistent with those of the 2013 Assessment. In light of the 2013

[[Page 38437]]

Assessment, FINRA's further observations, and the DERA Memo to File, 
FINRA continues to believe that it is appropriate for the Commission to 
approve permanently the tier sizes that have been in operation since 
November 12, 2012.
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    \24\ FINRA engaged a third-party, Cornerstone Research, to 
conduct an analysis of the impact of the Pilot on OTC market 
quality. The ``OTC Tier Size Analysis'' prepared by Cornerstone 
Research and the accompanying FINRA Executive Summary were submitted 
as Exhibit 3a of the instant proposed rule change and are available 
at https://www.sec.gov/rules/sro/finra/2018/34-83129-ex3a.pdf 
(``2013 Assessment'').
    \25\ See supra notes 11 and 12.
    \26\ See DERA Staff Memorandum regarding FINRA's Pilot Program 
Amending Minimum Quotation Size Requirements for OTC Equity 
Securities (SR-FINRA-2011-058), dated July 28, 2017, available at: 
https://www.sec.gov/files/otc_tiersizepilot_memo.pdf (``DERA Memo to 
File'').
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    According to FINRA, the 2013 Assessment demonstrates that the Pilot 
has accomplished its objectives, including increased customer limit 
order display, and that key market quality indicators have been 
unchanged or have slightly improved overall. FINRA continued to collect 
and provide Pilot data to the Commission after the issuance of the 2013 
Assessment. In addition, FINRA continued to monitor the impact of the 
operation of the Pilot on market quality metrics for the over-the-
counter marketplace, which FINRA generally believes indicate positive 
trends overall, thus providing continued support for permanent adoption 
of the Pilot tiers.\27\ Moreover, FINRA states that the DERA Memo to 
File provides further evidence, in a regression framework, to support 
the conclusion that the Pilot had a neutral to positive impact on 
market quality.
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    \27\ FINRA engaged in outreach with member firms that are active 
in the market for OTC equity securities regarding the operation of 
the Tier Size Pilot, and the majority of those firms did not oppose 
the permanent adoption of the Pilot.
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    FINRA further believes that the 2013 Assessment demonstrates that 
the Pilot has resulted in a meaningful increase in the display of 
customer limit orders. Moreover, FINRA believes that the data collected 
during the Pilot also supports that market quality has not been harmed, 
as suggested by the analysis of market quality measures such as spreads 
and market depth.
(A) Enhanced Customer Limit Order Display
    According to FINRA, when the Commission approved the Pilot, it 
recognized the potential benefits of enhancing customer limit order 
display. Notably, the Commission stated that ``[i]n the Commission's 
view, FINRA's proposed revisions are designed to protect investors by 
revising the . . . tier thresholds [in FINRA Rule 6433] such that a 
larger percentage of customer limit orders are reflected in quotations 
for OTC equity securities, thereby potentially improving the prices at 
which customer limit orders will be executed, consistent with the 
protection of investors and the public interest.'' \28\ FINRA believes 
that the Pilot has achieved the objective of increased customer limit 
order display.
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    \28\ See Order Approving Tier Size Pilot, supra note 10, 77 FR 
at 37466. See also Memorandum from Division of Risk, Strategy, and 
Financial Innovation, supra note 18.
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    As noted in the 2013 Assessment, FINRA analyzed the number of 
customer limit orders that would be eligible under both the Pilot and 
the pre-Pilot tier sizes and observed that between November 1, 2012 and 
June 30, 2013, for all tier sizes combined, there was a 13% increase in 
the number of customer limit orders that met the minimum quotation 
sizes to be eligible for display under the Pilot tiers.\29\ For that 
same period, FINRA also observed a significant increase in the number 
of customer limit orders in securities priced between $0.20 and $100.00 
that became eligible for display. According to FINRA, this trend 
continued through July 31, 2014. Specifically, for the period between 
July 1, 2013 and July 31, 2014, FINRA indicates that it observed, for 
all tier sizes combined, an 18.45% increase in the number of customer 
limit orders that met the minimum quotation sizes and, therefore, were 
eligible for display, with the most significant increase observed for 
securities priced between $0.20 and $100.00.\30\
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    \29\ See Notice, supra note 3.
    \30\ See Notice, supra note 3.
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    Tables 3 \31\ and 4 \32\ below show the percentage of customer 
limit orders that were equal to or greater than the minimum quotation 
size under both the Pilot and pre-Pilot tier sizes for the specified 
price ranges for the periods of November 1, 2012 through June 30, 2013, 
and from July 1, 2013 through July 31, 2014, respectively.
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    \31\ Table 3 originally was included in FINRA's Executive 
Summary, dated September 13, 2013, which is part of the 2013 
Assessment. See supra note 24. See also Notice, supra note 3.
    \32\ Table 4 was included in the Notice, supra note 3.

                                                     Table 3
                                    [November 1, 2012 through June 30, 2013]
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                                                                  Customer limit                  Customer limit
                   Price range                      Pilot tier    orders >= tier  Pre-pilot tier  orders >= tier
                                                       size          size (%)          size          size (%)
----------------------------------------------------------------------------------------------------------------
0.0001-0.0999...................................          10,000           78.29           5,000           86.30
0.10-0.1999.....................................           5,000           56.89           5,000           56.89
0.20-0.5099.....................................           2,500           57.35           5,000           43.30
0.51-0.9999.....................................           1,000           72.81           2,500           46.05
1.00-10.00......................................             100           97.86             500           74.73
10.01-100.00....................................             100           98.24             200           87.93
100.01-174.99...................................             100           90.49             100           90.49
175.00-200.00...................................               1             100             100           96.71
200.01-500.00...................................               1             100              25           90.74
500.01-1,000.00.................................               1             100              10           64.62
1,000.00-2,500.00...............................               1             100               5           61.38
2,500.00+.......................................               1             100               1          100.00
----------------------------------------------------------------------------------------------------------------


                                                     Table 4
                                      [July 1, 2013 through July 31, 2014]
----------------------------------------------------------------------------------------------------------------
                                                                  Customer limit                  Customer limit
                   Price range                      Pilot tier    orders >= tier  Pre-pilot tier  orders >= tier
                                                       size          size (%)          size          size (%)
----------------------------------------------------------------------------------------------------------------
0.0001-0.0999...................................          10,000           78.29           5,000           88.70

[[Page 38438]]

 
0.10-0.1999.....................................           5,000           56.89           5,000           57.78
0.20-0.5099.....................................           2,500           57.35           5,000           42.31
0.51-0.9999.....................................           1,000           72.81           2,500           42.10
1.00-10.00......................................             100           97.86             500           68.36
10.01-100.00....................................             100           98.24             200           78.03
100.01-174.99...................................             100           90.49             100           90.60
175.00-200.00...................................               1             100             100           91.94
200.01-500.00...................................               1             100              25           89.41
500.01-1,000.00.................................               1             100              10           66.65
1,000.00-2,500.00...............................               1             100               5           65.58
2,500.00+.......................................               1             100               1          100.00
----------------------------------------------------------------------------------------------------------------

    FINRA states that, as was noted in the 2013 Assessment, of the 
301,628,686 customer limit orders in OTC equity securities reported to 
FINRA's Order Audit Trail System (``OATS'') between November 1, 2012 
and June 30, 2013, over 86.6% were priced between $0.20 and $100.00. 
FINRA further notes that 58.7 million customer limit orders, or almost 
20% of all customer limit orders, were priced between $1.00 and $10.00. 
According to FINRA, this price range experienced an increase of almost 
24% in the number of customer limit orders that met the minimum 
quotation size to be eligible for display under the Pilot. Further, 
181.6 million customer limit orders, or over 60% of all customer limit 
orders, were priced between $10.01 and $100.00. FINRA observes that 
this price range experienced an increase of over 10% in the number of 
customer limit orders that met the Pilot tier sizes and were eligible 
for display under the Pilot tier sizes. FINRA points out that the 2013 
Assessment found that an additional 32 million customer limit orders 
priced between $1.00 and $100.00 became eligible for display during the 
Pilot that otherwise would not have been eligible for display.
    According to FINRA, the trends during the period since the 2013 
Assessment are similar. FINRA states that of the 573,973,197 customer 
limit orders in OTC equity securities reported to OATS between July 1, 
2013 and July 31, 2014, 81.4% were priced between $0.20 and $100.00. 
FINRA notes that 114.5 million customer limit orders, or almost 20% of 
all customer limit orders, were priced between $1.00 and $10.00. From 
July 1, 2013 through July 31, 2014, this price range experienced an 
increase of over 29% in the number of customer limit orders that met 
the minimum quotation size to be eligible for display under the Pilot 
than would have been eligible in the absence of the Pilot. Further, 
312.1 million customer limit orders, or over 54% of all customer limit 
orders, were priced between $10.01 and $100.00. FINRA remarks that this 
price range experienced an increase of over 19% in the number of 
customer limit orders that met the Pilot tier sizes and were eligible 
for display under the Pilot tier sizes. Consequently, an additional 
94.9 million customer limit orders priced between $1.00 and $100.00 
became eligible for display during the Pilot between June 30, 2013 and 
July 31, 2014 than otherwise would have been eligible for display.
    FINRA states that there was an aggregate overall increase in 
displayed customer limit orders in OTC equity securities over the 
period from November 12, 2012 through July 31, 2014 of 16.24%, 
representing approximately 142 million additional orders than otherwise 
would have been eligible for display As a result, FINRA believes that 
the impact of the Pilot on limit order display has been positive, with 
stronger than average results concentrated in the price points ranging 
from $10.01 and $100.00 (the range in which the majority of all 
customer limit orders fell (approximately 57%)).
(B) Impact on Market Quality
    FINRA explains that when the Commission approved the Pilot, it 
acknowledged that the Pilot may raise issues of ``potentially competing 
forces''--enhanced customer limit order display on the one hand and 
potential harm to OTC equity market quality (liquidity, efficiency, and 
volatility) on the other.\33\ FINRA notes that the Commission, however, 
expressed the view that ``as well as increasing the number of customer 
limit orders eligible for display and the potential for better 
executions, arguments can be made that FINRA's proposal will benefit 
the OTC market by facilitating market making activity, narrowing 
spreads and increasing liquidity.'' \34\
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    \33\ See Order Approving Tier Size Pilot, supra note 10, 77 FR 
at 37467.
    \34\ Id.
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    FINRA believes that analysis of the Pilot and pre-Pilot data 
generally shows that the market quality measures that the Commission 
had identified--i.e., market maker activity, spreads and liquidity--
were unchanged to slightly improved, and that therefore there has been 
an overall neutral to positive impact on OTC market quality for the 
majority of Pilot tiers as compared to the pre-Pilot data.\35\
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    \35\ FINRA notes that, from an analytical perspective, changes 
in market quality measures may not be attributable solely as a 
result of the Pilot, since they also may be impacted by other 
contemporaneous market factors.
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    As noted in the 2013 Assessment, where the minimum quotation size 
decreased under the Pilot, effective spreads generally remained the 
same or narrowed, quoted spreads narrowed, and price impact generally 
decreased. The 2013 Assessment also stated that some of the market 
quality metrics provided inconclusive results, specifically for Tier 1 
securities, where the minimum quote size requirement had increased 
under the Pilot. FINRA remarks that the 2013 Assessment documented that 
effective spreads had widened, but with no significant reduction in 
quoted depth.\36\
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    \36\ FINRA points out that for Tier 1 securities, the DERA Memo 
to File finds that both quoted and effective spreads increased 
between the pre-Pilot period (November 14, 2011 through October 31, 
2012) and the Pilot period (November 12, 2012 through November 28, 
2014) covered by the analysis. However, the DERA Memo to File does 
not find sufficient evidence that these increases in spreads were 
caused by the Pilot, because spreads had started to widen at least 
six months prior to the implementation of the Pilot.
---------------------------------------------------------------------------

    In the post-2013 Assessment period of July 1, 2013 through July 31, 
2014,

[[Page 38439]]

FINRA observes that the number of stocks quoted in the OTC market has 
remained relatively constant \37\ and market makers continued to 
provide liquidity.\38\ The number of BBO quotes also significantly 
increased throughout 2014, which was the second year of the Pilot, as 
the number of quotes generally hovered around 2 million per day during 
the Pre-Pilot period, but steadily increased, reaching a high of 
approximately 6 million per day in early 2014 and leveling off to an 
average of 5 million per day during the month of July 2014. The average 
number of trades per day was higher during the first two years of the 
Pilot compared to the pre-Pilot level, and more than tripled by March 
2014.\39\ FINRA states, however, that trading activity appears to have 
leveled-off in mid-2014, albeit still at levels above the pre-Pilot 
trading.\40\ Liquidity continued to be provided at levels greater than 
the minimum required depth, evidenced by executions at sizes greater 
than the required minimums, which enabled the execution of large trades 
in the OTC market. For example, for Tier 1 securities where the minimum 
quotation size increased, the number of trades executed above the 
minimum size increased by approximately 75%. Although there was 
virtually no change in the frequency of trades above the minimum size 
for Tiers 2 and 3, FINRA notes that all the other tiers experienced a 
positive change. Trading in sizes greater than the minimum quotation 
size occurred infrequently in these tiers both prior to and during the 
Pilot.
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    \37\ The number of stocks quoted on the OTC market remained 
stable at around 10,000 throughout the pre-Pilot period and during 
the period covered in the 2013 Assessment, as well as during FINRA's 
subsequent observations (November 1, 2012 through July 31, 2014).
    \38\ There was an average of nine market-makers for each symbol 
with no significant change in the number of market makers between 
the pre-Pilot period and during the period covered in the 2013 
Assessment and during FINRA's subsequent observations (November 1, 
2012 through July 31, 2014).
    \39\ The daily number of trades executed during the year prior 
to the Pilot is estimated at approximately 75,000, and reached 
around 250,000 trades by the end of the first quarter in 2014.
    \40\ The daily average number of trades was approximately 
100,000 by July 2014.
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    FINRA further notes that the analysis of data from the second year 
of the Pilot also confirms its position that the impact of the change 
in the minimum quotation size on the market quality metrics generally 
is positive. FINRA staff analyzed the change in five measures to 
evaluate the impact of the Pilot on market quality--time-weighted 
quoted spreads, volume-weighted spreads, time-weighted quoted depth at 
the BBO, time-weighted quoted depth around the BBO, and price impact. 
Based on FINRA's analysis, time-weighted quoted spreads continued to 
narrow during the first two years of the Pilot and these positive 
changes in time-weighted quoted spreads between the pre-Pilot and the 
first two years of the Pilot were statistically significant for all 
tiers.\41\ Similarly, volume-weighted spreads were unchanged (or 
slightly narrowed) for all tiers between the pre-Pilot period and the 
first two years of the Pilot when accounting for the longer Pilot 
period.
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    \41\ For stocks in price tiers where the minimum quotation size 
requirement had decreased, the DERA Memo to File also finds that 
both quoted and effective spreads had decreased between the pre-
Pilot period (from November 14, 2011 to October 31, 2012) and the 
Pilot period (November 12, 2012 to November 28, 2014) covered by the 
analysis. Furthermore, the DERA Memo to File's analysis suggests 
that these decreases in spreads may reflect causal effects of the 
Pilot. In contrast, for stocks in price tiers where the minimum 
quotation size requirement increased or remained the same, the DERA 
Memo to File does not find sufficient evidence that the Pilot had a 
causal impact on spreads.
---------------------------------------------------------------------------

    FINRA observes that the displayed depth decreased slightly for most 
tiers, but a consideration of depth beyond the BBO demonstrated that 
any declines were mostly statistically insignificant across tiers in 
the first two years of the Pilot. FINRA believes that consideration of 
depth beyond the BBO is a useful additional measure for assessing 
market depth.
    In addition, based on a data review using the same methodology as 
was employed for the 2013 Assessment, subsequent to the completion of 
the 2013 Assessment, FINRA observed that the price impact of 
hypothetical market orders continued to remain lower during the second 
year of the Pilot period than during the pre-Pilot period.\42\ For 
example, the following two tables prepared by FINRA present the price 
impact for hypothetical market buy and sell orders with sizes five 
times larger than the minimum size requirement for each tier. The price 
impact associated with the hypothetical orders is estimated to have 
declined for all tiers, which is an indication of improved market 
quality. The decline is significant for all levels except for Tiers 5b 
and 5c (for buy trades) and Tier 1 (for sell trades).
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    \42\ As FINRA discussed in the 2013 Assessment, the price impact 
of hypothetical market orders is the effective half spread for a 
hypothetical market ``sweep'' order of a particular size. In other 
words, it is an estimate of what the volume-weighted average 
effective half spread would have been had a market order been broken 
up and routed to the market makers based on price priority.
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    According to FINRA, the t-statistic in the charts below is designed 
to measure whether the price impact associated with a trade of a given 
(relative) size is different between the pre-Pilot and Pilot sample 
periods. The difference is tested for significance by calculating the 
two-sample un-pooled Student's t-statistic,
[GRAPHIC] [TIFF OMITTED] TN06AU18.004

    The null hypothesis (i.e., that price impact is unchanged between 
the two sample periods) is rejected at the 90% and 95% confidence 
levels, if the t-statistics are greater than 1.65 and 1.96, 
respectively.

                                                     Table 5
                             [Price impact for hypothetical large market buy orders]
----------------------------------------------------------------------------------------------------------------
                     Minimum
     Tier        quotation size      Number of    Pre-pilot  (10/   Pilot  (11/     Difference      t-statistic
                     change           stocks       2011-10/2012)   2012-7/2014)
----------------------------------------------------------------------------------------------------------------
1.............  Increased.......           3,586          0.0055          0.0050         -0.0005          (2.60)
2.............  Maintained......           1,254          0.0235          0.0197         -0.0038          (5.03)
3.............  Decreased.......           1,752          0.0506          0.0420         -0.0086          (6.41)
4.............  Decreased.......           1,537          0.0969          0.0810         -0.0159          (5.00)

[[Page 38440]]

 
5a............  Decreased.......           3,038          0.3295          0.2530         -0.0765          (7.79)
5b............  Decreased.......           2,026          1.1630          1.0661         -0.0969          (1.55)
5c............  Maintained......             177          4.8322          4.7906         -0.0416          (0.06)
----------------------------------------------------------------------------------------------------------------


                                                     Table 6
                             Price impact for hypothetical large market sell orders
----------------------------------------------------------------------------------------------------------------
                     Minimum
     Tier        quotation size      Number of    Pre-pilot  (10/   Pilot  (11/     Difference      t-statistic
                     change           stocks       2011-10/2012)   2012-7/2014)
----------------------------------------------------------------------------------------------------------------
1.............  Increased.......           3,931          0.0062          0.0059         -0.0003          (1.60)
2.............  Maintained......           1,483          0.0233          0.0169         -0.0064          (3.41)
3.............  Decreased.......           1,787          0.0540          0.0311         -0.0229          (4.87)
4.............  Decreased.......           1,676          0.1214          0.0656         -0.0558          (4.95)
5a............  Decreased.......           3,059          0.4170          0.1500         -0.2670          (6.01)
5b............  Decreased.......           2,145          2.3563          0.4214         -1.9349          (6.79)
5c............  Maintained......             288         14.8135          4.2683        -10.5452          (3.13)
----------------------------------------------------------------------------------------------------------------

    As noted above, FINRA states that the 2013 Assessment was not 
conclusive as to the impact of the Pilot on market quality for Tier 1 
securities, the only tier where the minimum quotation size had 
increased. For example, the 2013 Assessment indicated that the time-
weighted quoted spread was unchanged for Tier 1 securities in the Pilot 
period. However, FINRA explains that from June 30, 2013 to July 2014, 
there was a statistically significant narrowing of time-weighted quoted 
spreads in this tier. Evidence from the second year of the Pilot 
suggests that volume-weighted effective spreads and depth beyond the 
BBO were unchanged from pre-Pilot levels, but there was a statistically 
significant increase in depth at the BBO. FINRA therefore concludes 
that the updated analysis provides reliable evidence that market 
quality for Tier 1 securities also has improved during the Pilot.\43\ 
The data for other tiers, however, continue to provide reliable 
evidence that market quality has been unchanged or slightly improved 
under the Pilot. Thus, because the Pilot had a demonstrable positive 
impact on customer limit order display, and appears to have had an 
overall neutral to positive impact on market quality, FINRA believes 
that it is appropriate and in the best interest of investors to adopt 
the Pilot tiers as permanent.
---------------------------------------------------------------------------

    \43\ As noted in note 36, supra, FINRA points out that the DERA 
Memo to File finds that quoted and effective spreads for Tier 1 
securities increased between the pre-Pilot period of November 14, 
2011 to October 31, 2012 and the Pilot period of November 12, 2012 
to November 28, 2014 covered by the analysis, but it does not find 
sufficient evidence that these increases in spreads were caused by 
the Pilot.
---------------------------------------------------------------------------

    FINRA notes that, if the Commission approves the proposed rule 
change, the implementation date of the proposed rule change shall be 
the date of approval by the Commission.

III. Comment Summary and FINRA's Response

    As noted above, the Commission received one comment letter on the 
proposed rule change and a response letter from FINRA.\44\ The 
commenter generally supports making the proposed tier sizes 
permanent.\45\ However, the commenter believes that there should be no 
tier sizes for unsolicited customer orders.\46\ The commenter is 
concerned that when a broker-dealer is quoting on an unsolicited basis 
in certain securities, the tier sizes work to restrict customers from 
being able to trade their positions because the unsolicited customer 
order does not meet the revised tier size requirements.\47\
---------------------------------------------------------------------------

    \44\ See supra note 4.
    \45\ Id.
    \46\ Id.
    \47\ Id.
---------------------------------------------------------------------------

    In its response letter, FINRA states that one of its goals in 
revising FINRA Rule 6433 was to achieve a reasonable balance between 
customer limit order display and facilitating a meaningful minimum 
dollar-value commitment to the market for all displayed quotations.\48\ 
FINRA believes that the Pilot tiers achieve an appropriate balance of 
these objectives.\49\ FINRA further explains that the Pilot tiers have 
resulted in a positive impact on the level of customer limit orders 
eligible for display under FINRA Rule 6460 and does not believe that an 
exception for any subset of customer orders should be adopted at this 
time.\50\
---------------------------------------------------------------------------

    \48\ See FINRA Letter, supra note 7.
    \49\ Id. at 2.
    \50\ Id.
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IV. Discussion of Commission Findings

    After careful review of the proposed rule change, the comment 
letter, and FINRA's response to the comment letter, the Commission 
finds that the proposal is consistent with the requirements of the Act 
and the rules and regulations thereunder that are applicable to a 
national securities association.\51\ Specifically, the Commission finds 
that the rule change is consistent with Section 15A(b)(6) of the 
Exchange Act,\52\ which requires, among other things, that FINRA rules 
be designed to prevent fraudulent and manipulative acts and practices, 
to promote just and equitable principles of trade, and, in general, to 
protect investors and the public interest. The Commission also finds 
that the proposed rule change is consistent with the provisions of 
Section 15A(b)(11) of the Act,\53\ which requires that FINRA rules 
include provisions governing the form and content of quotations 
relating to securities sold otherwise than on a national securities 
exchange which may be distributed or published by any

[[Page 38441]]

member or person associated with a member, and the persons to whom such 
quotations may be supplied.
---------------------------------------------------------------------------

    \51\ In approving this rule change, the Commission has 
considered the rule's impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f).
    \52\ 15 U.S.C. 78o-3(b)(6).
    \53\ 15 U.S.C. 78o-3(b)(11).
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    As stated in the Notice, FINRA believes that making the Pilot tiers 
permanent would promote just and equitable principles of trade and 
protect investors and the public interest. FINRA believes that the 2013 
Assessment and subsequent observations demonstrate that the Pilot has 
resulted in an increased display of customer limit orders. FINRA notes 
that the 2013 Assessment found a 13% increase in the number of customer 
limit orders that met the minimum quotation sizes eligible for display 
across all Pilot tiers, and FINRA's updated data through July 2014 
shows an even greater increase of 18.45% than otherwise would have been 
eligible for display. The increase in customer limit orders eligible 
for display was significant in tiers that make up substantial 
percentages of the overall volume transacted in OTC equity securities.
    In the Notice, FINRA further states its belief that any concerns 
about market quality raised by public commenters prior to the 
Commission's approval of the Pilot have not materialized. In fact, 
FINRA states that it believes that the Pilot has had a positive impact 
on OTC market quality for the majority of OTC equity securities and the 
tiers set forth in the Pilot. FINRA believes that the Pilot data shows 
overall a slight reduction in spreads for most OTC equity securities 
with no negative (and perhaps a positive) impact on liquidity.
    When the Commission approved the Pilot, it emphasized the potential 
benefit of increasing customer limit order display. For instance, the 
Commission noted that increased limit order display potentially could 
improve the prices at which customer limit orders would be executed, 
consistent with the protection of investors and the public 
interest.\54\ The Commission also stated its belief that greater 
customer limit order display could increase quote competition, narrow 
spreads, and increase the likelihood of price improvement for OTC 
equity securities.\55\ The Commission has maintained a longstanding 
view that there are benefits to promoting customer limit order 
display.\56\
---------------------------------------------------------------------------

    \54\ See Order Approving Tier Size Pilot, supra note 10, 77 FR 
at 37466.
    \55\ See id. at 37469.
    \56\ See id. at 37469 n.168 (citing, among other things, the 
Commission's 1996 Order Handling Rules Release).
---------------------------------------------------------------------------

    As noted above, the sole commenter on the proposed rule change is 
concerned that when a firm is quoting on an unsolicited basis in 
certain securities, the Pilot tier sizes work to restrict customers 
from being able to trade their positions if the unsolicited customer 
order does not meet FINRA's minimum tier size requirements.\57\ The 
Commission notes that FINRA's 2013 Assessment and its subsequent 
assessment for the period covering July 1, 2013 through July 31, 2014 
indicate that there was a meaningful increase in the number of customer 
limit orders eligible for display. The Commission agrees with FINRA 
that the minimum tier size requirements of FINRA Rule 6433, which have 
been in place on a Pilot basis, achieve a reasonable balance between 
fostering customer limit order display and facilitating a meaningful 
minimum dollar-value commitment to the market for all displayed 
quotations.
---------------------------------------------------------------------------

    \57\ See supra note 4.
---------------------------------------------------------------------------

    The Commission believes that the Pilot has accomplished its 
intended objectives and has realized its anticipated benefits, 
including greater customer limit order display. At the same time, 
market quality indicators during the Pilot suggest that the revised 
tiers and evidence of greater customer limit order display did not 
result in a harmful reduction in liquidity for OTC equity securities. 
The Commission believes that these results are consistent with FINRA's 
assessment that the Pilot has had a neutral to positive impact on 
liquidity for the majority of OTC equity securities and price 
tiers.\58\ At the same time, the Commission notes that there is 
inconclusive evidence regarding the effects of the Pilot on liquidity 
for the price tier for which the minimum quotation size requirement was 
increased.\59\ In light of the foregoing, the Commission believes that 
it is consistent with the Act to adopt the Pilot tiers, which have been 
in effect for nearly six years, on a permanent basis.
---------------------------------------------------------------------------

    \58\ See id. at 2.
    \59\ Id. The minimum quotation size requirement increased for 
those securities prices between $0.0001 and $0.0999. These 
securities are included in the lowest tier which requires a minimum 
quotation size of 10,000 shares.
---------------------------------------------------------------------------

IV. Conclusion

    It is therefore ordered pursuant to Section 19(b)(2) \60\ of the 
Exchange Act that the proposal (SR-FINRA-2018-015) be and hereby is 
approved.
---------------------------------------------------------------------------

    \60\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\61\
---------------------------------------------------------------------------

    \61\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Robert W. Errett,
Deputy Secretary.
[FR Doc. 2018-16724 Filed 8-3-18; 8:45 am]
 BILLING CODE 8011-01-P


